ECONOMICS-1

Course outline
introduction to
economics

 micro economics

 Economics macro economics


 public finance

 international trade
 Essential readings-
  Economics, Paul A. Samuelson & William D. Nordhaus, Tata McGraw Hill
 Principles of Economics, Gregory N. Mankiw, South-Western College Pub
 Public Finance in Theory and Practice, R. A. Musgrave and P. B. Musgrave, McGraw-Hill
College
 International Economics, Bo Sodersten and Geoffrey Read, London: Macmillan
 Economic Times
 Economic & political weekly (magazine)
 Additional Readings-
 Positive Economics, Richard G. Lipsey & K. Alec Chrystal, Oxford University Press
 A Text Book of Economic Theory, 5th.edition, W. Stonier and D.C. Hague, Longman Higher
Education
 Modern Micro Economics, A. Koutsoyiannis, Princeton University Press
 Macro Economics, E. Shapiro, Harcourt Brace Jovanovich
 Macroeconomics, Rangarajan, C, Tata-McGraw Hill
Unit UNIT 1 No. of Hours
Topic: Introduction to Economics

1.1 Introduction, Nature and Scope of Economics: Basic Concepts of Economics, Micro and 4
Macro Economics, Static and Dynamic and Comparative Analysis, Positive and Normative
Economics, Opportunity Cost

1.2 Demand-Supply analysis and its applications 2

1.3 Economics and Law 1
  UNIT 2  
Topic: Micro Economics
2.1 Theory of Demand: Cardinal and Ordinal Utility; Law of Diminishing Marginal Utility, Law 5
of Equi-marginal principle, Indifference Curve analysis and its applications, Elasticity-
demand and supply. Consumer’s Surplus,

2.2 Theory of Production: Production Function and Factors of Production, Law of Variable 3
Proportions, Returns to Scale

2.3 Theory of cost: Cost curves and function, Revenue, and Profit Functions, and Profit 3
Maximization.
2.4 Markets and Price Determination in different markets: 10
Perfect and Imperfect Competition, Monopoly and its regulation, Monopolistic
competition, and Oligopoly
  UNIT 3  
Topic: Macro Economics
3.1 National Income— Concepts and Measurement, Uses 1
3.2 Theories of Consumption, Theories of Investment, Theories of Employment 5

3.3 Meaning and Value of Money- Fisher’s Quantity theory of Money 2

3.4 Monetary Policy, Role of Reserve Bank of India (RBI) 2

  UNIT 4  
Topic: Public Finance
4.1 Taxation: Cannons and its Objectives, Direct and Indirect Taxes 3
4.2 Taxation in Developed Countries and Developing Countries 3
4.3 Public Expenditure: Nature and Importance 2
4.4 Public Debt: Nature, Objective and Management 2
4.5 Fiscal policy 1
  UNIT 5  
Topic: International Economics
5.1 Classical and Modern Theories of International Trade 3
5.2 Balance of Payments: Meaning and Its Importance, Equilibrium and Disequilibrium in The 2
BOP
5.3 Exchange Rate Regimes- Fixed Vs Flexible 1
5.4 International Financial Institutions-IMF,IBRD, and WTO 3
5.5 Foreign Direct Investment (FDI), Foreign Debt Burden, Foreign Trade Policy 2
Top 10 Reasons for studying Economics
1. Economic Forecaster

2. You can always give advice

3. Diminishing Returns

4. Rational Behaviour

5. Economics is a very humorous subject

6. Economics gets you a high paid job

7. Economies of Scale

8. However - On the Other Hand contradicting yourself

9. You will Know Why you are Unemployed

10. You can apply it to understand issues related to economics as well as other
issues related to other fields of knowledge
 WHY STUDY ECONOMICS?
 Economics is the study of how societies, governments, businesses,
households, and individuals allocate their scarce resources.
 Economics has two important features–
 1. Develops conceptual models of behavior to predict responses to changes
in policy and market conditions.
 2. Uses rigorous statistical analysis to investigate the changes.
 Economists are well known for advising the government on economic
issues, formulating policies at the Federal Reserve Bank, and analyzing
economic conditions for investment banks, brokerage houses, real estate
companies, and other private sector businesses.
 They also contribute to the development of many other public policies
including health care, welfare, and school reform and efforts to reduce
inequality, pollution and crime.
 Contd…
 The study of economics can also provide valuable knowledge for making decisions in
everyday life.
 It offers a tool with which to approach questions about the desirability of a particular
financial investment opportunity, whether or not to attend college or graduate school, the
benefits and costs of alternative careers, and the likely impacts of public policies including
universal health care and a higher minimum wage.
 The complementary study of econometrics, the primary quantitative method used in the
discipline, enables students to become critical consumers of statistically based arguments
about numerous public and private issues rather than passive recipients unable to sift
through the statistics.
 Such knowledge enables us to ask whether the evidence on the desirability of a particular
policy, medical procedure, claims about the likely future path of the economy, or many
other issues is really compelling or whether it simply sounds good but falls apart upon
closer inspection.
 Economics in study of Law
 Interest has grown recently in the combined study often known as “law and economics”,
for which the economic analysis of law is really a better description.
 Anyone with an interest in the institutional framework, i.e., the “rules of the game”,
governing economic activity, will find the economics of law useful in understanding how
laws affect human incentives.
 The economics of law may be defined as the application of economic principles to legal
instruments, questions, and procedures.
 It has many practical applications, such as helping with the drafting of laws, or in
assessing the amount of damages required to return a person to the level of welfare
enjoyed before an accident occurred.
 Legal instruments are devices like damages for breach of contract that feature regularly
in the legal system and have implications for economic incentives.
 Legal questions, such as whether it would be appropriate to award damages for the
interruption to production following an oil spill from a tanker, are also amenable to
economic analysis.
 Legal procedures may also interact with economic incentives: for example when lawyers
work for contingent fees on a “no-win, no-fee” basis.
 Questions to be answered set-1
 What is Economics?
 What is the definition of Economics?
 What is the meaning of Economics?
 Why to study Economics? Or what is the importance of Economics?
 What is/are the methodology to study Economics?
 What are the branches of Economics?
 What is the nature of Economics?
 What is the scope of economics?
 What is/are the economic problem/s?
 What is the relationship/role of other field of knowledge/Subjects in
Economics?
 What is the relationship/role of Economics in other field of
knowledge/Subjects in general and Law in particular?
Questions to be answered, set-2
 What is rationality?
 How rationality effects the system/economic system?
 What is rational choice?
 What is the difference between economics and economy?
 what are the basic problems of economics?
 What is resource?
 What is scarcity? What is trade-off?
 What is want/s and need/s?
 What is/are economic forces?
 What is economic analysis?
 What is opportunity cost? Its applications?
 Questions set-3
 What/ Who is/are economic agent/s?
 Why the economic agents?
 What is the need/role/importance of economic agent?
 Do the economic agents make decisions?
 How they make decision?
 Do the decision making depends on rationality? How?
 Dothe decisions are based on any- of the following?
basis/criteria/principles/parameters/standards etc.? What
are these?
 What is cost-benefit analysis? Its applications?
 Do the decisions are also based on law?
 How law effects the decision making and vice-versa?
 Questions, set-4
 What is demand?
 What is the definition of demand?
 What is the meaning of demand?
 What are the factors effecting the demand “or” demand depends on which
factors “or” determinants of demand?
 What is demand function (general and specific), equation?
 What is demand schedule?
 What is demand curve?
 What is the law of demand?
 What is the need/role/importance of demand?
 What is role of law/s(statutory) in relation to demand?
 Do the demand of any good or service has/ve effect on the law/s(statutory)?
 Can the demand be created or generated?
 Can the demand be suppressed?
 Questions, set-5
 What is supply?
 What is the definition of supply?
 What is the meaning of supply?
 What are the factors effecting the supply “or” supply depends on which factors
“or” determinants of supply?
 What is supply function (general and specific), equation?
 What is supply schedule?
 What is supply curve?
 What is the law of supply?
 What is the need/role/importance of supply?
 What is role of law/s(statutory) in relation to supply?
 Do the supply of any good or service has/ve effect on the law/s(statutory)?
 Can the supply be created or generated?
 Can the supply be suppressed?
 Questions, set-6
 What is demand-supply analysis?
 Why to study demand-supply analysis?
 Who do the demand-supply analysis?
 Where to apply demand-supply analysis?
 When to do demand-supply analysis?
 How to do demand-supply analysis?
 Can the demand-supply analysis help us to understand the
law(statutory)?
 What is the role of demand-supply analysis in real life?
 What is the methodology of demand-supply analysis?
 What are the applications of demand-supply analysis in economics
and in law(statutory)?
 Questions, set-7
 What is elasticity?
 What is the definition of elasticity?
 What is the meaning of elasticity?
 What are the types of elasticity?
 What are the advantages and disadvantages of elasticity?
 What are the applications of elasticity in economics?
 Can the elasticity be applied in the study of law(statutory)?
 What is the role of elasticity in making policy by the government
or a private entity?
 How elasticity helps in understanding different activities in
economics and in the law(statutory)?
 Economics DEMAND AND SUPPLY

 Goods and Services, Consumer/ Consumer behavior, Producer/Producer

 behavior, Market and types of Market, Welfare, National Income,

 Consumption, Savings, Investment, Multiplier, Accelerator,
 Trade/Business cycles, Money, Taxation, Expenditure/Subsidies, Debt,
 Public Good and Private Good, Budget, Finances, Export, Import, Trade
 Surplus/Deficit, Balance of Payments, Foreign Exchange, National and
International Economic Institutions/Organizations like WTO, IBRD, IMF

 Policies related to all matters/ECONOMIC POLICIES

 Economics Subject
 Social Science
 study of social behavior in general
 study of economic behavior in particular
 way of thinking
 ways and means ,end
 tool/s, methods
 Basis of social welfare
 Concepts
 Micro and Macro Economics/analysis
 Static and Dynamic and Comparative Analysis
 Positive and Normative Economics/analysis
 Opportunity Cost
 Equilibrium, example- market, consumer, producer
 Optimization, example- consumption, production
 Production possibility curve
 Efficiency
 Equity
Definition of Economics A) Wealth Definition
 B) Welfare
Definition
 C) Scarcity
Definition
 D) Growth
Definition
A) Wealth Definition
 1.) Adam Smith- Father of Economics. “An enquiry into the nature
and causes of wealth of Nations”- Book, 1776
 “a science which enquires into the nature and causes of wealth of nations”
 2.) J. B. Say- “Economics is the science which treats of wealth.”
 3.) J.S. Mill- “ Economics investigates the nature of wealth and the laws of
its production and distribution.”
 4.) Walker- “Economics is the body of knowledge that relates to wealth.”
 5.) Senior- “The subject of political economy is not happiness but wealth.”
 B) Welfare Definition
 1) Dr. Alfred Marshall, “Principles of Economics”, 1890
 “Political economy or economics is a study of mankind in the ordinary business of life; it
examines that part of individual and social action which is most closely connected with the
attainment and with the use of material requisites of well being. Thus, it is, on the one
side, a study of wealth and on the other, and more important side, a part of the study of
man.”
 2.) Prof. Pigou- the range of our enquiry becomes restricted to that part of social welfare
that can be brought directly or indirectly into relation with measuring rod of money.”
 3.) Prof. Cannon- “The aim of political economy is the exploration of the general causes on
which the material welfare of human beings depends.”
 4.) William Beveridge- “Economics is the study of general methods by which men
cooperate to meet their material needs.”
 5.) Penson- “Economics is the science of material welfare.”
 C) Scarcity Definition
 1.)
Prof. Lionel Robbins, “An essay on the Nature and
significance of Economic Science”, 1931
 “Economics is the science which studies human
behavior as a relationship between ends and scarce
means which have alternative uses.”
 2.)Stonier and Hague- “Economics is fundamentally a
study of scarcity and the problems which scarcity gives
rise to.”
 3.)
Scitovsky- “Economics is a science concerned with
the administration of scarce resources.”
 D) Growth Definition
 1.)
Prof. P.A. Samuelson- “Economics is the study of how
people and society choose, with or without use of
money, to employ scarce productive resources, which
could have alternative uses, to produce various
commodities over time and distribute them for
consumption now and in the future among various
people and groups of society.”
 2.)
J.M. Keynes, “Economics is the study of the
administration of scarce resources and of the
determinants of income and employment.”
 The importance of economics?
 Economics is concerned with the optimal distribution of resources in society. The subject
involves-
 1.) Understanding what happens in markets and the macro-economy.
 2.) Examining statistics about the state of economy and explaining their significance
 3.) Understanding different policy options and evaluating their likely outcomes.
 Examples of the importance of economics
 1.) Dealing with a shortage of raw materials
 2.) To what extent should the government intervene in the economy 
 3.) The principle of opportunity cost 
 4.) Social efficiency
 5.) Knowledge and understanding 
 6.) Forecasts
 7.) Evaluation
 8.) Behavioural economics 
 9.) Applying economics in everyday life
 the methodology

INDUCTIVE AND DEDUCTIVE METHOD

MICRO ANALYSIS AND MACRO ANALYSIS
POSITIVE ANALYSIS AND NORMATIVE ANALYSIS
Static, dynamic and comparative analysis
 Branches of economics-
 ECONOMICS 1.) MICRO ECONOMICS
2.) MACRO ECONOMICS
3.) PUBLIC FINANCE
4.) INTERNATIONAL ECONOMICS
5.) AGRICULTURAL ECONOMICS
6.) INDUSTRIAL ECONOMICS
7.) MANAGERIAL ECONOMICS
8.) LABOUR ECONOMICS
9.) FINANCIAL ECONOMICS
10.) Environmental Economics
11.) ECONOMETRICS
ETC.
 MICRO ECONOMICS CONSUMER BEHAVIOR

 PRODUCER BEHAVIOR

 MARKET AND ITS TYPES

 PRICE AND OUTPUT

DETERMINATION


 WELFARE
 DEMAND SIDE
 CONSUMER BEHAVIOR A) UTILITY ANALYSIS BY ALFRED
MARSHALL
 B) INDIFFERENCE CURVE ANALYSIS BY
HICKS
 C) REVEALED PREFERENCE ANALYSIS
BY P. A.

SAMUELSON
 D) OTHER ANALYSIS/ MODERN
APPROACHES
 GREEN’S THEORY, LANCASTER
ETC.
 SUPPLY SIDE
 PRODUCER’S BEHAVIOR 1.) COST OF PRODUCTION
 A.) LAND AND RENT,
 B.)LABOUR AND
WAGES,
 C.) CAPITAL AND
INTEREST,
 D.) ORGANIZATION/

ENTREPRENEURSHIP AND
 PROFIT AND

 E.) OTHER COST

 Basic Economic problem/s
1. What to produce?
2. How to produce?
3. For whom to produce?
 Economic Problems
 1. The economizing problem involves the allocation of resources
among competing wants.
 There is an economizing problem because there are:
 A. unlimited wants B. limited resources
 2. Resources and factor payments:
 A. land - includes space (i.e., location), natural resources, and
what is commonly thought of as land land is paid rent
 B. capital - are the physical assets used in production - i.e., plant
and equipment capital is paid interest
 C. labor - is the skills, abilities, knowledge (called human capital)
and the effort exerted by people in production labor is paid
wages
 D. entrepreneur or entrepreneurial talent - (risk taker) the
economic agent who creates the enterprise entrepreneurial
 Micro vs Macro Economics
 Key Difference-
Microeconomics focuses on individual markets,
while macroeconomics focuses on whole economy
 Microeconomics
 Microeconomics deals with-
 the economic interactions of a specific person
 a single entity or a company
 it is the study of markets
 Macroeconomics
 Macroeconomics is the study of-
 the performance
 Structure of an economy as a whole
 behavior and decision-making
 Contd…
 Microeconomics and macroeconomics both focus on the allocation of scarce
resources. Both disciplines study how the demand for certain resources
interacts with the ability to supply that good to determine how to best
distribute and allocate that resource among many consumers.
 Microeconomics studies the behavior of individual households and firms in
making decisions on the allocation of limited resources. Another way to
phrase this is to say that microeconomics is the study of markets.
 Macroeconomics is generally focused on countrywide or global economics.
It studies involves the sum total of economic activity, dealing with the
issues such as growth, inflation, and unemployment.
 There are some economic events that are of great interest to both micro-
economists and macro-economists, but they will differ in how and why they
analyze the events.
 Contd…
 Stemming from Adam Smith’s seminal book, The Wealth of Nations, microeconomic and macroeconomics both
focus on the allocation of scarce resources. Both disciplines study how the demand for certain resources
interacts with the ability to supply that good to determine how to best distribute and allocate that resource
among many consumers. Both disciplines are about maximization: microeconomics is about maximizing profit
for firms, and surplus for consumers and producers, while macroeconomics is about maximizing national
income and growth.
 The main difference between microeconomics and macroeconomics is scale. Microeconomics studies the
behavior of individual households and firms in making decisions on the allocation of limited resources. Another
way to phrase this is to say that microeconomics is the study of markets.
 In contrast macroeconomics involves the sum total of economic activity, dealing with the issues such as
growth, inflation, and unemployment. Macroeconomics is the study of economies on the national, regional or
global scale.
 This key difference alters how the two approach economic situations. Microeconomics does consider how
macroeconomic forces impact the world, but it focuses on how those forces impact individual firms and
industries. While macroeconomists study the economy as a whole, micro-economists are concerned with
specific firms or industries.
 Many economic events that are of great interest to both micro-economist and macroeconomists, though they
differ in how they analyze those events. A shift in tax policy would interest economists in both disciplines. A
micro-economist might focus on how the tax might shift supply in a specific market or influence a firm’s
decision making, while the macroeconomist will consider whether the tax will translate into an improved
standard of living for all of the economy’s participants.
 microeconomics
 The two key elements of this economic science are-
 the interaction between supply and demand, and
 scarcity of goods.
 One of the major goals of microeconomics is-
 to analyze the market and determine the price for goods and services that best allocates limited
resources among the different alternative uses.
 This study is especially important for producers as they decide what to manufacture and the
appropriate selling price. Microeconomics assumes businesses are rational and produce goods
that maximizes their profit.
 If each firm takes the most profitable path, the principles of microeconomics state that the
market’s limited resources will be allocated efficiently.
 The science of microeconomics covers a variety of specialized areas of study including:
 Industrial Organization: the entry and exit of firms, innovation, and the role of
trademarks.
 Labor Economics: wages, employment, and labor market dynamics.
 Financial Economics: topics such as optimal portfolios, the rate of return to capital, and
corporate financial behavior.
 Public Economics: the design of government tax and expenditure policies.
 Political Economics: the role of political institutions in policy.
 Health Economics: the organization of health care system.
 Urban Economics: challenges faced by cities, such as sprawl, traffic congestion, and
poverty.
 Law and Economics: applies economic principles to the selection and enforcement of
legal regimes.
 Economic History: the history and evolution of the economy.
Macroeconomics
 Macroeconomics is the study of the performance, structure, behavior and
decision-making of an economy as a whole.
 Macroeconomics is the study of the performance, structure, behavior and
decision-making of an economy as a whole.
 Macroeconomists focus on the national, regional, and global scales.
 For most macroeconomists, the purpose of this discipline is to maximize
national income and provide national economic growth.
 Economists hope that this growth translates to increased utility and an
improved standard of living for the economy’s participants.
 While there are variations between the objectives of different national and
international entities, most follow the ones detailed below:
 macroeconomics
 Sustainability occurs when an economy achieves a rate of growth which allows an increase in living standards without undue
structural and environmental difficulties.
 Full employment occurs when those who are able and willing to have a job can get one. Most economists believe that there will
always be a certain amount of frictional, seasonal and structural unemployment (referred to as the natural rate of
unemployment). As a result, full employment does not mean zero unemployment.
 Price stability occurs when prices remain largely stable and there is not rapid inflation or deflation. Price stability is not
necessarily zero inflation; steady levels of low-to-moderate inflation is often regarded as ideal.
 External balance occurs when exports roughly equal imports over the long run.
 Equitable distribution of income and wealth among the economy’s participants. This does not, however, mean that income and
wealth are the same for everyone.
 Increasing Productivity over time throughout the national economy.

 To achieve these goals, macroeconomists develop models that explain the relationship
between factors such as national income, output, consumption, unemployment, inflation,
savings, investment and international trade. These models rely on aggregated economic
indicators such as GDP, unemployment, and price indices.
 On the national level, macroeconomists hope that their models help address two key areas of research:
 the causes and consequences of short-run fluctuations in national income, otherwise known as the business cycle, and
 what determines long-run economic growth.
Interdependence between Micro Economics and Macro Economics
 Micro Economic analysis and Macro Economic analysis are complementary
to each other;
 They do not complement but supplement each other.
 The basic goal of both the theories is same: the maximization of the
material welfare of the nation.
 From the micro economic point of view, the nation’s material welfare will be
maximized by achieving optimal allocation of resources.
 From the macro economic point of view, the nation’s material welfare will
be maximized by achieving full utilisation of productive resources of the
economy.
 The study of both is equally vital so as to have full knowledge of the
subject-matter of economics.
 The contemporary economists are concerned with both micro economics
and macro economics.
 Opportunity Cost
 The concept of opportunity cost occupies a very important place in modern economic analysis.
 Factors of production are scarce in relation to wants.
 When a factor is used in the production of a particular commodity, the society has to forgo other goods
which this factor could have produced.
 This gave birth to the notion of opportunity cost in economics.
 Suppose a particular kind of steel is used in manufacturing war-goods, it clearly implies that the society
has to give up the amount of utensils that could have been produced with the help of this steel.
 Hence we can say that the opportunity cost of producing war-goods is the amount of utensils forgone.
 Opportunity cost is the cost of the next-best alternative that has been forgone.
 From the meaning of opportunity cost two important points emerge:
 (i) The opportunity cost of anything is only the next-best alternative foregone and not any other
alternative.
 (ii) The opportunity cost of a good should be viewed as the next-best alternative good that could be
produced with the same value of the factors which are more or less the same.
 The Formula for Opportunity Cost is:
 Opportunity Cost = Total Revenue – Economic Profit
The concept of opportunity cost can better be explained with the help of an illustration.
 Suppose a piece of land can be used for growing wheat or steel. If the land is used for
growing steel, it is not available for growing wheat.
 Therefore the opportunity cost for steel is the wheat crop foregone.
 This is illustrated with the help of the following diagram:
 Suppose the farmer, using a piece of land can produce either 50 quintals (ON) of
rice or 40 quintals (OM) of wheat.
 If the farmer produces 50 quintals of rice (ON), he cannot produce wheat.
 Therefore the opportunity cost of 50 quintals (ON) of rice is 40 quintals (OM) of wheat.
 The farmer can also produce any combination of the two crops on the production
possibility curve MN.
 Let us assume that the farmer is operating at point A on the production possibility curve
where he produces OD amount of rice and OC amount of wheat.
 Now he decides to operate at point B on the production possibility curve.
 Here he has to reduce the production of wheat from OC to OE in order to increase the
production of rice from OD to OF.
 It means the opportunity cost of DF amount of rice is the CE amount of wheat.
 Thus, opportunity cost for a commodity is the amount of other next-best goods which have
to be given up in order to produce additional amount of that commodity.
 Applications of Opportunity

Cost
The concept of opportunity cost has been widely used by modern economists in various fields. The main
applications of the concept of opportunity cost are as follows –
 (i) Determination of factor prices - The factors of production need to be paid a price that is at least equal to
what they command for alternative uses. If the factor price is less than factor’s opportunity cost, the factor will
quit and get employed in the better-paying alternative.
 (ii) Determination of economic rent - The concept of opportunity cost is widely used by modern economists
in the determination of economic rent. According to them economic rent is equal to the factor’s actual earning
minus its opportunity cost (or transfer earnings).
 (iii) Decisions regarding consumption pattern - The concept of opportunity cost suggests that with given
money income, if a consumer chooses to have more of one thing, he has to have more of one thing, he has to
have less of the other. He cannot increase the consumption of all the goods simultaneously. Hence with the help
of opportunity cost he decides the consumption pattern, that is, which goods should be consumed and in what
quantities.
 (iv) Decisions regarding production plan - With given resources and given technology if a producer decides
to produce greater amount of one commodity, he has to sacrifice some amount of another commodity. Thus on
the basis of opportunity costs a firm makes decisions regarding its production plan.
 (v) Decisions regarding national priorities - With given resources at its command a country has to plan the
production of various commodities. The decision will depend on national priorities based on opportunity costs. If
a country decides that more resources must be devoted to arms production then less will be available to
produce civilian goods. In this situation a choice will have to be made between arms production and civilian
goods. The concept of opportunity cost helps in making such choices.
 Opportunity Cost Formula –Example #1
A Furniture manufacturer who manufactures and sells
furniture was given two orders and in which he can only
take one order only.
 Now it’s up to the Furniture manufacturer to decide
between the two orders as he has time and labor
limitations. The manufacturer has to pay wages @ INR
100/hour to the labor.
 1storder: One table Selling Price INR 7500, the time required-
16Hours, Raw material costs- INR 1800
 2ndOrder: Two Chairs Selling Price INR 4000 each, Time required –
11 hours each, Raw material costs – INR 800 each.
 Findout the better option and the opportunity costs he
misses?
 Solution:
 As the manufacturer has two different orders with diversified characteristics, so we have to
calculate the profit from both of the orders individually
 Profit from the First Order
 Opportunity Cost = Total Revenue – Economic Profit
 First Order = INR 7500 – [(16 * 100) + 1800]
 First Order = INR (7500 – 3400)
 First Order = INR 4100
 Profit from the Second Order
 Second Order = INR (4000 * 2) – [(11 * 2 * 100)+ (800 * 2)]
 Second Order = INR 8000 – 3800
 Second Order = INR 4200
 Conclusion – The manufacturer will take order no. 2 as it will give him much
more earnings (INR 4200 vs INR 4100). Thus the Opportunity cost is INR 4100 which
the manufacturer misses during his course of business. As the manufacturer has time
limitations and he can take only one order at a time, so he would opt for the second order.
 Opportunity Cost Formula – Example #2
 Tata Motors have three bulk orders and it can take the most
profitable one first as to strengthen its Cash Flow so has to
enhance its working capital to process the rest of the two orders.
Find out the most profitable and the least profitable in a
descending manner in order to protect its Cash balance. (Assume
that all the Sales are made on a Cash basis).
 Order 1: 100 Cars of Selling Price of INR 4.5 lakh each, RM costs – INR 80
lakhs, Total Labor expenses – INR 22 lakhs
 Order 2: 50 Cars of Selling Price of INR 8 lakh each, RM costs – INR 95
lakhs, Total Labor expenses – INR 45 lakhs
 Order 3: 20 Trucks of Selling Price of INR 22 lakh each, RM costs – INR 1.12
Cr, Total Labor expenses – INR 38 lakhs
 Solution:
 From the above problem, we should calculate the profitability in each case.
As we all know the Sales are done in a Cash basis, so more earnings would
help the business to generate higher cash flow and there would not be
pressure on the Working capital as the company will borrow less short term
borrowings.
 Profitability from First Order
 First Order = INR [(4, 50,000 * 100) – (80,00,000 + 22,00,000)]
 First Order = INR 4,50,00,000 – 1,02,00,000
 First Order = INR 3,48,00,000
 Profitability from Second Order
 Second Order = INR [(8,00,000 * 50) – (95,00,000 + 45,00,000)]
 Second Order = INR (4,00,00,000 – 1,40,00,000)
 Second Order= INR 2,60,00,000
 Profitability from Third Order
 ThirdOrder = INR [(22,00,000 * 20) – (1,12,00,000 +
38,00,000)]
 Third Order = INR 4,40,00,000 – 1,50,00,000
 Third Order = INR 2, 90,00,000
 Thus Tata Motors will undertake the First order First , then it will
take the Third order and lastly it will take the second order in
order of profitability so as to strengthen its working capital.
 Thus the opportunity costs after the First order is done would
be = INR (2.9 +2.6) Cr or INR 5.5 Cr (as the company has not
executed the other orders and it might choose not to execute)
and after the second order the opportunity costs would be INR
2.6 cr.
 Opportunity Cost Formula – Example #3
 Larsen and Toubro Ltd has two order for execution, But it can undertake only
one. Based on the following data choose which one to operate and the
opportunity costs.
 Order one will derive a Revenue of INR 10,00,000 and Costs 4,00,000.
 Order two will derive a Revenue worth INR 12,00,000 and will cost INR 8,00,000.
 Solution:
 Profitability from First Order
 First Order = INR 10,00,000 – 4,00,000
 First Order = INR 6,00,000
 Profitability from Second Order
 Second Order = INR 12,00,000 – 8,00,000
 Second Order = INR 4,00,000
 Thus L&T will take order one and the Opportunity costs of not taking second order would
be INR 400000.