BASIC CONCEPTS OF ECONOMICS

The word ‘Economics’ originates from the Greek work ‘Oikonomikos’ which can be divided
into two parts:
(a) ‘Oikos’, which means ‘Home’, and
(b) ‘Nomos’, which means ‘Management’.
Thus, Economics means ‘Home Management’. The head of a family faces the problem
of managing the unlimited wants of the family members within the limited income of the
family. In fact, the same is true for a society also. If we consider the whole society as a
‘family’, then the society also faces the problem of tackling unlimited wants of the members
of the society with the limited resources available in that society. Thus, Economics means the
study of the way in which mankind organises itself to tackle the basic problems of scarcity.
All societies have more wants than resources. Hence, a system must be devised to allocate
these resources between competing ends.
Goods: Goods are the articles and services which satisfy a human want like books, pens,
cell phones etc. Hence, all tangible things that satisfy human wants are called goods
Good can be divided into two types
 Free Goods
 Economic Goods
Free Goods
 Free goods are Nature’s gift
 Their supply is abundant
 They do not have price
 There is no cost of production
 They have value in use and do not have value in exchange
 Their notional values are not included in national income
 Example: Air, Water and Sunshine
Economic goods
 Economic goods are man made
 Supply is always less than their demand
 These goods have prices
 These goods have cost of production
 These goods have value in use and also value in exchange
 Their values are included in national income
  Example: Pens, Books, Laptops etc.
They are further classified into Consumer goods, Capital goods and Intermediary goods
Consumer goods
A consumer good is an economic good or commodity purchased by households for final
consumption (they directly satisfy human wants)
Consumer goods are divided into two types
 Perishable goods
 Durable goods
They are also divided into
 Necessary goods
 Comfortable goods and
 Luxury goods
Perishable & durable goods
Perishable Goods:
 They lose their value in single use
 For example milk, fruits, etc
Durable Goods:
 They yield service or utility over a time rather than being completely used up at
the moment of consumption.
 For example televisions, computers etc.
Necessary goods:
 These are much essential to continue our life and without using these goods
survival is questionable
 Generally its utility will be more than its price
 Example: Rice
Comfortable goods
 Comfortable goods are not necessary for our day to day living
 But these goods will enhance our efficiency
 For example: Fan, chair and table etc.
Luxury goods
 Luxury goods are neither required as essential goods, nor useful as comfortable
goods.
 Generally it utility will be less than its price
  For example: BMW car etc.
Producer / capital goods
 Goods which are used in the production of other goods are called producer goods
 They satisfy human wants indirectly
 For example: Machines, buildings etc.
 A good can be classified into consumer good or capital good depending on the
nature of its use. For example, when paddy is used for food it becomes a
consumer good and when used as seed in cultivation, it become a capital good
Capital goods
Producer or capital goods are divided into two types
 Single use capital goods: Used only once in the production process. For example
raw materials, coal, electricity etc.
 Durable use capital goods: Used for long time in the process of production . For
example Machines ,tools etc.
Intermediary goods
 Goods which are under the process of production and semi finished goods are
known as intermediary goods.
 For example, bricks and steel used as intermediary goods in construction work.
Wealth
Wealth means stock of assets held by an individual or institution that has the potential for
yielding income in some form. Wealth may be held in various forms. These include
money, shares of companies, land etc.
The important characteristics of wealth are:
(i) Utility
(ii) Scarcity
(iii) Value in exchange and
(iv) transferability
wealth
Wealth in physical for is tangible wealth. Diamonds, factories and houses are example of
physical assets.
Human capital is intangible wealth
Wealth is classified into personal wealth, social wealth, national wealth and international
wealth
Income
Income is a flow from wealth where as wealth is a stock. In every economy income flows
from households to firms and vice versa.
Thus the factor market and product market are closely related to each other
Utility
The concept of utility has great importance in economics. The want satisfying capacity of
a commodity at a point of time is known as utility.
It is a subjective concept, only consumer can judge the utility of a commodity
Types of Utility
 Form Utility
 Place Utility
 Time Utility
 Service Utility
1. Form Utility: If a commodity satisfies a consumer by its shape, colour, size etc. it
is known as ‘form utility’. For example conversion of wooden log into a chair or a
table
2. Place Utility: When goods acquire utility with the change of their place, is known
as ‘place utility’. For example vegetables at the production place have no utility
but when they are brought to the market they gain utility
3. Time Utility: Goods acquire additional utility because of time. For example ice
creams and coolers have more utility in summer
4. Service Utility: Services also have the ability to satisfy human wants. For example
the teaching of a good teacher directly helps a student to build his career.
Value
I. Value in Use: it refers to the capacity of the goods to satisfy human wants. Free goods
have value in use and they do not have any value in exchange. For example water has
greater value in use but no value in exchange
II. Value in Exchange: it refers to the quantity of other goods (or more usually money) a
good can be exchanged for. All economic goods have value in use and value in exchange.
For example a pen can be exchanged to a book.
Wants
Human wants are the basis for all economic activities. They depend on economic and
social status of individuals. The nature of human wants can be understood by considering
the following characteristics:
 1. Unlimited wants: Human wants are unlimited. If you satisfy on want, another one
crops up
2. A particular want is satiable: As wants are unlimited, a person can satisfy a
particular want at a point of time. For example if a person is thirsty he can satisfy
it by drinking a glass of water
3. Competition: Wants are unlimited whereas resources to satisfy them are limited.
Therefore, a scale of preference is essential to satisfy wants
4. Complementary: Satisfaction of a single want requires the use of more number of
commodities. For example writing need is satisfied only when we have a pen, ink
and paper together
5. Substitution: A person can satisfy his wants with various commodities. If a person
is hungry he can eat rice or fruits
6. Recurring: When you satisfy a particular want at a point of time it may reappear at
another time
7. Habits: Wants change into habits. For example smoking cigarettes for casual
results into a habit if it is not controlled
8. Wants vary with Time, Place and Person: Wants are dynamic in nature. Hence,
they are changing for time to time, place to place and person to person
(Necessities, Comforts and Luxuries)
Welfare
 Welfare is an important concept in economics.
 It refers to the satisfaction that an individual or society derives from wealth and
can be attributed to the standard of living of individuals or societies.
 It is a subjective concepts and cannot be measure obejctively
 Welfare depends on the distribution of income among different sections of people
in the society
 As economy grows, the living conditions of its people improve, which can be
taken as an indicator of improvement in welfare
NATURE AND SCOPE OF ECONOMICS
Economics is the Social Science that describes the factors that determine the
1. Production
2. Distribution
3. Consumption of Goods and Services
Origin
The term economics comes from two Greek terms –
“Oikos” = “house”
“Nomos” = “custom” or “law”
“Rules of the household for good management”
A Separate Discipline
Political Economy was the earlier name for the subject, but economists in the late 19th
century suggested “economics” as a shorter term for “economic science” to establish
itself as a separate discipline outside of political science and other social sciences
Traditionally classification of Economics
Traditionally, the subject matter of economics has been divided into five groups i.e.
 Consumption
 Production
 Distribution
 Exchange
 Public Finance
Modern classification of Economics
Modern economic theory divided economics into two branches
 Micro Economics
 Macro Economics
Micro-economics
 Micro economics is the study of individual units of the economy (household,
firms, buyers & sellers)
 It is known as “Price theory”
 It explains price determination in both commodity and factor markets
 It is based on price mechanism which depends on demand and supply
 Scope of micro economics
 Product Pricing (Theory of Demand and Theory of Production and Costs)
  Factor Pricing (Theory of Distribution) (Rent, Wage, Interest, Profit)
Macro-economics
 Macro economics is the study of economy as a whole
 It is known as “Income and Employment theory”
 It deals with national income, total employment, aggregate savings and
investment, general price level and economic growth
 Based on aggregate demand and aggregate supply
Deductive and inductive methods
Mainly two methods are used by economists for conducting economic investigation.
Deductive Method: This method is also known as ‘a priori’ method because it is based
on abstract reasoning and not on actual facts.
 Selecting the problem
 Formulating assumptions
 Formulating the hypothesis and
 Verifying the hypothesis
Advantages and limitations
ADVANTAGES:
 It is less expensive and less time consuming
 It helps in laying down basic principles of human behavior and
 It analyses complex economic phenomena and brings exactness to economic
generalizations
LIMITATION:
 It is based on unrealistic assumptions with little empirical content
Inductive Method
This method is also known as concrete, ethical or realistic method. This method proceeds
from particular to the general
 Selection of the problem
 Collection of data
 Observations and
 Generalization

Advantages and limitations

Advantages:
  It is nearer to reality and therefore expected to depict reality, and
 This method involves less chances of mistakes
Limitation:
 This method is expensive and time consuming
 It can be used who possess skill and competence in handling complex data
Economic Static and dynamic analyses
Economic Statics: It refers to that type of analysis where we establish the functional
relationship between two variables whose values are related to the same point of time or
the same period of time.
Economic Dynamics: A system is dynamic if its behavior over time is determined by
functional equations in which variables at different points of time are involved in an
essential way.
Positive & Normative Economics
Positive Economics: A positive science may be defined as a body of systematized
knowledge concerning ‘what it is’. The classical schools of economists were of the
opinion that economics is purely a positive science which had no right to comment upon
the rightness or wrongness of economic policy. Further economist cannot give any final
judgment on any matter.
A Positive or Pure Science analyses cause and effect relationship between variables but it
does not pass value judgment. It states what is and not what ought to be.
Positive Science studies the phenomena as they actually are or as they happen. it does
not involve in any value Judgment on whether what happens is good or bad, desirable or
undesirable.
Normative Economics:
A normative science may be defined as a body of systematized knowledge relating to the
object of ‘what ought to be’, and concerned with the ideal as distinguished from the
actual. The historical school of Germany has introduced this in economics.
Normative Economics or Normative Science involves value Judgment on whether what
happens is socially desirable or undesirable, and if undesirable, how it can be made
desirable. It is concerned with what ought to be. It is not concerned with facts rather it is
concerned with how things should be. Ex: What should be the National Income etc.
Economics prescribes methods to correct undesirable economic happenings; it is also
called a Prescriptive Science.
Economics as Science
Economics as an Art
DEFINITION OF ECONOMICS
Various definition of economics emerged during the course of history. It is not possible to
study all these definitions individually. For simplicity purpose, all these definitions can be
studied under the following categories:
 Wealth definition of Adam Smith
 Welfare definition of Marshall
 Scarcity definition of Lionel Robbins
 Growth definition of Prof. Samuelson

WEALTH DEFINITION
The classical economists beginning with Adam Smith defined economics as the science
of wealth. He defined it in his famous book ‘wealth of nation’, as “an enquiry into the
nature and causes of wealth of nation”.
Besides Adam smith, other classical economists have also regarded economics as the
study of wealth. In the words of “J.B.Say”, “the aim of political economy is to show the
way in which wealth is produced, distributed and consumed”.
Important features of wealth definition
1. The main objective of human activity is the acquisition of wealth.
2. Wealth refers to goods produced.
3. Man is treated as selfish whose objective is to accumulate more and more wealth
Criticism
They view that ‘economics is a science of wealth’ was subjected to severe criticisms for
its narrow view.
1. Many economists criticized this definition. Carlyle, Ruskin and others criticized that
economics must discuss ordinary man’s activities and not those of the economic man.
They termed it as a “dismal science”.
2. Marshall criticized that wealth is only a mean to an end, but not an end itself.
3. Adam Smith’s definition covers only materialistic human activities and not the non-
materialist activities like the services of teachers and doctors. Due to this the scope of
economics is limited.
4. This definition concentrated mainly on the production side and neglected the
distribution side.

WELFARE DEFINITION
Alfred Marshall raised economics to a dignified status by advancing a new definition in
1890. He shifted emphasis from production of wealth to distribution of wealth (welfare).
In the words of Marshall, “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 the 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”
Features of welfare definition
Marshall used the term “economics” for “political economy” to make it similar to
physics. He assumed that economics must be a science even though it deals with the ever
changing forces of human nature
Economics studies only economic aspects of human life and it has no concern with the
political, social and religious aspects of life. It examines that part of individual and social
action which is closely connected with acquisition and use of material wealth which
promote human welfare
Marshall’s definition considered those human activities which increased welfare
This definition has given importance to man and his welfare and recognized wealth as a
mean for the promotion of human welfare.
Criticism
Robbins in his “Essay on the Nature and Significance of Economic Science” finds fault
with the welfare definition of economics.
1. Economics is a human science rather than a social science. The fundamental laws of
economics apply to all human being and, therefore, economics should be treated as a
human science and not as a social science.
2. Lionel Robbins criticized it as classificatory. It distinguishes between materialistic and
non materialistic goods and non materialistic goods and not given any importance to non-
materialistic goods which are also very important. Therefore it is incomplete.
3. Another serious objection is about the quantitative measurement of welfare. Welfare is
a subjective concept and changes according to time, place and persons
4. Marshall includes only those activities which promote human welfare. But the
production of alcohol and drugs do not promote human welfare. Yet economics deals
with the production and consumption of those goods
5. Robbins has taken serious objection for not considering ‘scarcity of resources’.
According to Robbins’ economic problem arises due to limited resources which are to be
used to satisfy unlimited wants.

SCARCITY DEFINITION
Lionel Robbins’ book “An Essay on the Nature and Significance of Economic Science”
in 1932 has brought out the logical inconsistencies and inadequacies of the earlier
definitions and formulated his own definition of economics. He has given a more
scientific definition of economics. In the words of Robbins, “Economics is the science
which studies human behavior as a relationship between ends and scarce means which
have alternative uses”
Features
1. Human Wants are Unlimited: The fulfillment of one want gives rise to a number of
new wants.
2. Means are Scares: The means of a person by which his wants may be satisfied are
limited. It leads to economic problems as all wants cannot be satisfied by these limited
means.
3. Alternative Uses of Scarce Means: Resources are not only scarce but also have
multiple uses. For example electricity can be used in home and also in industry
4. Man has therefore to choose between wants. Problem of choice arises
Superiority of Robbins’ Definition
1. It is non-classificatory, as it includes all human activities whether they promote human
welfare or not.
2. This is a universally accepted definition. It is applicable to all types of societies,
because the scarcity of resources is felt by individuals as well as societies
3. Robbins’ definition of economics is neutral between ends. Being a positive science it
does not pass any value judgments regarding ends.
Criticism
1. Even though Robbins criticized Marshall’s welfare definition, he has introduced the
welfare concept indirectly in his definition. Therefore the criticism of welfare definition is
equally applicable to it.
 2. Another criticism of Robbins’ definition is that this definition does not distinguish
between ‘ends’ and ‘means’
3. Robbins made economics a positive science. As per Macfie, “economics is
fundamentally normative science, not merely positive science like chemistry”.
GROWTH DEFINITION
Growth definition of economic is given by Prof. Paul A Samuelson, an American
Economist and Economics Nobel Prize winner in 1970. Samuelson’s definition includes
the time element and is dynamic in nature. Hence it is called a growth oriented definition
of economics. In the words of Samuelson,
“economics is the study how people and society choose, with or without the use of
money, to employ scarce and productive resources which could have alternative uses, to
produce various commodities over time and distribute them for consumption, now or in
the future among various people and groups in the society. It analyses the benefits of
improving patterns of resource allocation”
Features
1. His definition like Robbins’ agreed that resources are not only limited but also have
several uses.
2. Prof Samuelson’s definition is dynamic in nature as it considers both the present and
future consumption, production and distribution
3. Growth definition deals with the problems of choice in a dynamic society. Hence his
definition broadened the scope of economics.

Evolution in the Definitions of Economics

Wealth Definition (1776) Adam Smith
Welfare Definition (1890) Alfred Marshall
Scarcity Definition (1932) Lionel Robbins
Growth Definition (1948) P.A. Samuelson
Modern Definition (2011) A.C. Dhas
Adam smith (1723 - 1790), Father of Economics
 Book “An Inquiry into Nature and Causes of the Wealth of Nations” (1776)
 Defined economics as the practical science of production and distribution of wealth.
He emphasized the production and growth of wealth as the subject matter of economics.
 Emphasis on Wealth, ‘Invisible Hand’,
 Laisezz Faire
 Features of Wealth Definition
Characteristics:
 It takes into account only material goods
 Exaggerated the emphasis on wealth
 It inquires the caused behind creation of wealth
Criticisms:
 It considered economics as a dismal or selfish science.
 It defined wealth in a very narrow and restricted sense.
 It considered only material and tangible goods.
 It gave emphasis only to wealth and reduced man to secondary place.

Alfred Marshall (1842 - 1924)

Wrote a book “Principles of Economics” (1890)
 Welfare definition
Defined “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 the material requisites of well being”.
It is on one side a study of wealth; and on the other side, a study of human welfare based on
wealth.
Features of Welfare Definition
Characteristics:
 It is primarily the study of mankind.
 It is on one side a study of wealth; and on other side the study of man.
 It takes into account ordinary business of life – It is not concerned with social,
religious and political aspects of man’s life.
 It emphasizes on material welfare i.e., human welfare which is related to wealth.
 It limits the scope to activities amenable to measurement in terms of money
Criticisms:
 It considers economics as a social science rather than a human science.
 It restricts the scope of economics to the study of persons living in organized
communities only.
 Welfare in itself has a wide meaning which is not made clear in definition.

Lionel Robbins (Scarcity definition) (1898-1984)

 book “An Essay on the Nature and Significance of Economic Science” in 1932.
 According to him, “economics is a science which studies human behaviour as a
relationship between ends and scarce means which have alternative uses”
 Ends – human wants
 Means – resources with which wants are fulfilled
 Scarcity, Unlimited Wants, Analytical
He emphasized on ‘choice under scarcity’. In his own words, “Economics ,,, is concerned
with that aspect of behavior which arises from the scarcity of means to achieve given ends.”
Features of Scarcity Definition
Characteristics:
 Economics is a positive science.
 New concepts: Unlimited ends, scarce means, and alternate uses of means.
 It emphases on Choice – A study of human behavior
 It tried to bring the economic problem which forms the foundation of economics as a
social science.
 It takes into account all human activities.
Criticisms:
 It does not focus on many important economic issues of cyclical instability,
unemployment, income determination and economic growth and development.
 It did not take into account the possibility of increase in resources over time.
 It has treated economics as a science of scarcity only.

Prof. Paul Samuelson (Growth definition) (1915-2009)

“Economics: An Introductory Analysis”(1948)
 Defined economics as the study of how people and society end up choosing with or
without the use of money, to employ scarce productive resources that could have alternative
uses; it produces various commodities over time & distributes them for consumption, now or
in the future, among various persons & groups in society.
It analyses costs & benefits of improving patterns of resource allocation’
Economic Resources, Full utilization of resources
Features of Scarcity Definition
Characteristics:
 It is not merely concerned with the allocation of resources but also with the expansion
of resources.
  It analysed how the expansion and growth of resources to be used to cope with
increasing human wants.
 It is a more dynamic approach.
 It considers the problem of resource allocation as a universal problem.
 It focused on both production and consumption activities.
 It is comprehensive in nature as it is both growth-oriented as well as future-oriented.
 It incorporated the features of all the earlier definitions
Criticisms:
 It assumes that economics is relevant for scarcity
 Situations and it ignored surplus resource conditions.

Modern Definition of Economics (2011)

• According to Prof.A.C.Dhas,
“Economics is the study of choice making by individuals, institutions, societies, nations and
globe under conditions of scarcity and surplus towards maximizing benefits and satisfying
their unlimited needs at present and future”.
• In short, the subject Economics is defined as the “Study of choices by all in maximizing
production and consumption benefits with the given resources of scarce and surplus, for
present and future needs.”
Features of Modern Definition
Characteristics:
 It takes into account all the earlier definitions – wealth, welfare, scarcity and growth.
 It covers both micro and macro aspects of economics.
 It considers both production and consumption activities.
 It emphasises Choice Making dimension as crucial in economics.
 It aims at obtaining maximum benefits with given resources
 It is suitable in conditions of both scarcity and surplus.
 It takes in to account the present and future –Time dimension – Growth dimension.
 It is relevant in the context of globalisation and sustainable development.

In Sum
 A review of all these definitions and their evolution indicate that the core of the
subject economics is ‘choice making’.
  It is a subject concerned about achieving growth by optimizing the given resources,
based on choices.
 The evolution of the definition of economics has taken 235 years, with the origin of
Adam Smith in 1776.

--Adam Smith (1776) emphasized on wealth (Production Activity),

– Alfred Marshall (1890) focused on (Production and Consumption Activities),
– Lionel Robbins(1932) highlighted the problem of scarcity (Choices under scarcity),
– Paul A Samuelson(1948) focused on production and consumption activities and achieving
growth under scarcity (choices under scarcity and growth),
– A.C.Dhas(2011) gave emphasis on choice making in maximizing production and
consumption benefits under scarce and surplus, and achieving growth (choices under scarcity
and surplus, and growth).
The core of economics is ‘Choices’
• The fundamental economic activities are production and consumption
• The aim of economics is optimizing given resources (both scarce and surplus) and
achieving growth
Production Possibility Curve (PPC)
PPC is used to explain the basic economic concepts of scarcity, choice and opportunity cost.
The PPC shows various possible combinations of goods and services produced within a
specified time with all its resources (land, labour and capital) fully and efficiently employed.
Assumptions:
A1. The economy is operating at full employment and full production capacity (Full
efficiency)
A2. The amount of resource available is fixed.
A3. The state of technology does not change throughout the production.
Points A to F are the best possible combinations of resources to enable full utilization and
ensure that the country is at full employment.
Any point inside the PPC say (Y), these combinations of production are attainable. But it
shows waste of resources and inefficiency since the production has not reached its maximum
level. This also leads to unemployment.
Any point outside the PPC say (Z), are unattainable, due to limited /lack of technology, this
cannot be achieved, when wants exceed output, there is scarcity.
Any point along the PPC say (A, B, C, D, E, and F)), choices from these various possible
combinations, will maximize the satisfaction. Choose any point along the PPC which is both
attainable and efficient.
Movement from one point to another (From C to D) depicts opportunity Cost.
Factors that influence the shift of the PPC
Factors of production such as Land, Labour, Capital and Entrepreneurship are the available
resources in any economy.
1. Economic Growth
2. Technological advances
3. Population
Shape of the PPC
The slope of the PPC depends on the opportunity cost. The opportunity cost of ‘P’product
is calculated based on how much the product has to give up in order producing more of
units of product ‘Q’ and vicevesra.
The PPC for an increasing opportunity cost slopes from left to right and is Concave
from the origin
The PPC for a decreasing opportunity cost is Convex.
If opportunity cost is constant, then the PPC is Linear
DEMAND ANALYSIS
Generally the two words demand and desire are used in the similar sense. But, there is a
clear difference between demand and desire.
Features of Demand:
 Desire for the commodity;
 Ability to purchase the commodity;
 Willingness to pay the price of commodity;
 Demand is always at a price and
 Demand is always per unit of time
Demand function
Demand function is a mathematical expression showing the relationship between the
quantity demanded of a commodity and the factors that determine it. It can be expressed
in the form of a function as given below:
Dx = f(Px, P1,……., Pn, Y, T)
Where Dx = demand for good X,
Px = price of good X,
P1 …..Pn = prices of substitutes and complementaries
Y = income of the consumer
T = tastes of the consumer
Determinants of demand
 Price of the Commodity
 Prices of Substitutes and Complementary
 Income of the Consumer
 Tastes and Preferences
 Population size and age
 Technological Changes
 Changes in Weather
 State of Business
Types of demand
Three major kinds of demand may be distinguished based on its determinants. They are:
 Price Demand;
 Income Demand and
 Cross Demand
Price demand / law of demand
Price demand states that there is an inverse or negative relationship between the price and
quantity demanded of a commodity at a point of time. It is assumed here that other things
such as consumer’s income, prices of substitutes, prices of complementary goods, tastes
and preferences of the consumer, etc. remain constant.
Prof. Marshall defines the law of demand as “ the amount demanded increases with a fall
in price and diminishes with a rise in price when other things remain the same”
Demand schedule
Individual Demand Schedule Demand curve
Market demand schedule and demand curve
We can obtain the market demand schedule by adding up the individual demand
schedules of all the consumers in the market.
We can draw the market demand curve with the help of the market demand schedule.
Even the market demand curve has negative slope like individual demand curve
Assumptions of the law of demand
 No change in the income of the consumer
 No change in the tastes and preferences of the consumer
 No change in the price of substitutes and complementary goods
 No new substitutes are discovered
 No expectation of future price changes
Exceptions to the law of demand
The law of demand is a general statement stating that price and quantity demanded of a
commodity are inversely related. But in certain situations, more will be demanded at a
higher price and less will be demanded at a lower price. In such cases, the demand curve
slopes upward from left to right which is called an exceptional demand curve
Giffen’s Paradox: Sir Robert Giffen (1637-1910) observed that
poor people will demand more of inferior goods, if their prices rise. He observed that
when the price of bread increased, workers in England purchased more of the bread by
reducing the consumption of meat whose price was constant. Giffen noticed that people
spent a higher portion of their income on bread (most essential), substituting bread for
meat. Good of this type are known as Giffen Goods.
Veblen Effect (Prestigious Goods): Veblen (1857-1929) is most famous for his
book “The Theory of the Leisure Class”. Veblen pointed that there are some goods like
diamonds, precious stones, costly furniture etc. which are demanded by very rich people
for their social prestige. If the prices of these goods fall, poor people also can buy and
hence rich people stop buying these goods as these goods do not have any special status.
Speculation Effect: If the prices of the commodities are expected
to increase still further in future, the consumers will buy more of it now. Thus an increase
in price may not be accompanied by a decrease in its demand which is contrary to the law
of demand. Such a situation takes place in the market for stocks and shares.
Illusion: Some times, consumers develop a false idea that
high priced goods will have a better quality instead of low priced goods. If the price of
such a goods decrease, they feel that their quality also deteriorates and at the same time
middle class people may prefer these goods. To maintain their status they do no buy these
goods, which is contrary to the law of demand.
Reasons for the negative slope of demand curve
 Old and New Buyers
 Income Effect
 Substitution Effect
 Law of Diminishing Marginal Utility
 Multiple Uses of Commodity
 Changes in demand
(i) Extension and Contraction
Being other things remaining constant increase or decrease in demand due to a change in
price are called extension and contraction of demand
When more units are demanded at lower price, then it is called demand extension.
On the other hand, when less units are demanded at higher price, then it is called
demand contraction
(ii) Increase and decrease in demand
Being Price of the commodity remaining constant, the demand curve shifts right
or left due to a change in other determinants of demand.
Increase or decrease in demand takes place due to a change in other determinants
of demand like income, prices of substitutes and complementary goods, tastes of
the consumers etc. except price.
Income demand
Income demand explains the relationship between consumer’s income and various
quantities of goods and services demanded at various levels of income assuming other
factors remaining constant.
The functional relationship between income and demand is show as
Dx = f(Y)
Where Dx = demand for good X;
Y = Income of a consumer
Income demand schedule
Whenever income increases, the quantity demanded for both superior and inferior goods.
Whenever income increases, the quantity demanded of superior goods increases and
quantity demanded of inferior goods decreases
 Superior / normal goods
 Inferior goods
Cross demand
Cross demand refers to the relationship between any two goods which are either
demanded when the price of its substitute or complementary goods change.
Functional relationship between the price of a commodity, say Y, and the quantity
demanded for another commodity, say X, is called cross demand
Dx = f(Py);
where Dx = Demand for X commodity;
Py = Price of Y commodity.
Substitute goods
Substitutes are those goods which satisfy the same want. For example tea and coffee,
Pepsi and Thumps up etc. are substitutes
There is a positive relationship between the price of coffee and the quantity demanded of
tea. If the price of coffee decreases the quantity demanded of tea decreases, even though
its price is constant. However, relative price of tea when compared to the price of coffee
becomes higher. Therefore, consumers shift their demand from tea to coffee, vice versa.
Complementary goods
Complementary goods are those which satisfy the same want jointly. For instant car and
fuel, bread and butter etc. are complementary
There is an inverse relationship between the price of fuel and the demand for cars. If the
price of fuel decreases, the demand for cars may increase (being prices of the cars
remaining constant)
 MARKET STRUCTURE AND DEMAND CURVE
In perfectly competitive markets the demand curve, the average revenue curve, and the
marginal revenue curve all coincide and are horizontal at the market-given price. [5] The
demand curve is perfectly elastic and coincides with the average and marginal revenue
curves. Economic actors are price-takers. Perfectly competitive firms have zero market
power; that is, they have no ability to affect the terms and conditions of exchange. A
perfectly competitive firm's decisions are limited to whether to produce and if so, how
much. In less than perfectly competitive markets the demand curve is negatively sloped
and there is a separate marginal revenue curve. A firm in a less than perfectly competitive
market is a price-setter. The firm can decide how much to produce or what price to
charge. In deciding one variable the firm is necessarily determining the other variable

ELASTICITY OF DEMAND
It refers to measure of responsiveness (elasticity) of demand to the change in any of the
determinants of demand. Elasticity of demand is a ratio of proportionate change in
quantity demanded to the proportionate change in any of the determinants.
Definition: It is defined as percentage of proportional change in dependent variable result
to change in an independent variable.
Demand usually varies with prices, but the extent of variation is not uniform in all the
cases. In some cases, variation is extremely wide and some cases it is just nominal. And
sometimes it may not be responsive.
Now to measure this responsiveness or extent of variation economists use the word
"elasticity". In measuring elasticity of demand two variables are there: 1) Demand 2)
Determinant
The term elasticity of demand is commonly referred as price elasticity of demand. This is
a loose interpretation of term. Logically elasticity of demand should measure
responsiveness of demand for a commodity to changes in the variables confined to its
demand function.
Hence there are many kinds of elasticity of demand as it's determinants. Economist
usually consider three important kinds of elasticity of demand: 1) Price 2) Income 3)
Cross price elasticity
Price Elasticity of Demand
 Responsiveness in quantity demanded of a commodity to a change in its price..
 It means change in quantity demanded as a result of change in price in commodity.
 It is the ratio of proportional change in quantity demanded to a given proportional
change in its price.
 Hence it is defined as ratio of proportionate change in quantity demanded, to
proportionate change in price of commodity
Example:
Price of Quantity
Apples Demanded
(Rs.) (Kg’s)
20  (P1) 100  (Q1)
21  (P2) 96  (Q2)
Because of inverse price & demand relationship, the coefficient of price elasticity of
demand is usually -ve.
However economists report it as a positive number, for the sake of convenient
comparison & analysis. Hence -ve symbol is ignored.
In the above example elasticity of demand is less than one. Hence by using above formula
numerical coefficient of price elasticity can be measured from any searched given data.
Depending upon proportional change involved in data on demand & price, one may
obtain various numerical value of coefficient of price elasticity ranging from 0 to ∞.
Types of Price Elasticity
There are 5 types of price elasticity of demand:
1) Elastic Demand (e=1)
2) Inelastic Demand (e=1)
3) Unitary Elastic Demand (e=1)
4) Perfectly Elastic Demand (e=1)
5) Imperfectly Elastic Demand (e=1)
LAW OF SUPPLY
Law of Supply Meaning
The law of supply describes the practical interaction between the price of a commodity
and the quantity offered by producers for sale. The law of supply is a hypothesis, which
claims that at higher prices the willingness of sellers to make a product available for sale
is more while other things being equal. When the price of a product is high, more
producers are interested in producing the products. On the contrary, if the price of a
product is low, producers are less interested in producing the product and hence the offer
for sale is low. The concept of law of supply can be explained with the help of a supply
schedule and a supply curve.

Supply Schedule
Supply schedule represents the relationship between prices and the quantities that the
firms are willing to produce and supply. In other words, at what price, how much quantity
a firm wants to produce and supply.
Suppose the following is an individual’s supply schedule of oranges.
Table 1
Price Per unit Quantity Supplied
4 3
6 6
8 9
10 12
12 13

The supply curve is a graphical representation of the law of supply. The supply curve has
a positive slope, and it moves upwards to the right. This curve shows that at the price of
Rs.6, six units will be supplied and at the higher price Rs. 12, a larger quantity of 13 units
will be supplied.
Market Supply Curve
The summation of supply curves of all the firms in the industry gives us the market
supply curve.
Table 2: Supply Schedule for Two Suppliers and the Market Supply Schedule
Quantity Quantity
Price (in Rs.) offered by offered by Market Supply
Supplier A Supplier B
4 5 6 5 + 6 = 11
6 7 7 7 + 7 = 14
8 9 8 9 + 8 = 17
10 11 9 11 + 9 = 20
12 13 10 13 + 10 = 23

In the figure 2 given above, there are three supply curves. It is assumed that there are two
sellers in the industry A and B. S A is the supply curve for A and SB is the supply curve for
B. by the lateral summation of these curves we get the market supply curve.

ASSUMPTIONS OF THE LAW OF SUPPLY

1. No change in cost of production
2. No change in technology
3. No change in climate
4. No change in price of substitutes
5. No change in natural resources
EXCEPTIONS TO THE LAW OF SUPPLY
The law of supply states that other things being equal, the supply of a commodity extends
with a rise in price and contracts with a fall in price. There are however a few exceptions
to the law of supply.
1. Exceptions of a fall in price
If the firms anticipate that the price of the product will fall further in future, in order to
clear their stocks they may dispose it off at a price that is even lower than the current
market price.
2. Sellers who are in need of cash
If the seller is in need of hard cash, he may sell his product at a price which may even be
below the market price.
3. When leaving the industry
If the firms want to shut down or close down their business, they may sell their products
at a price below their average cost of production.
4. Agricultural output
In agricultural production, natural and seasonal factors play a dominant role. Due to the
influence of these constraints supply may not be responsive to price changes.
5. Backward sloping supply curve of labor
The rise in the price of a good or service sometimes leads to a fall in its supply. The best
example is the supply of labor. A higher wage rate enables the worker to maintain his
existing material standard of living with less work, and he may prefer extra leisure to
more wages. The supply curve in such a situation will be ‘backward sloping’ SS 1 as
illustrated in figure 3.

At WN wage rate, the supply of labor is ON. But beyond NW wage rate the worker will
reduce rather than increase his working hours. At MW 1 wage rate the supply of labor is
reduced to OM.

Extension and Contraction of Supply

‘Extension’ and ‘contraction’ of supply refer to movements on the same supply curve. If
with a rise in price, the supply rises, it is called an extension of supply; if, with a fall in
price, the supply declines it is called a contraction of supply. The ‘extension’ and
‘contraction’ of supply are illustrated in figure 4. In figure 4, the movement from point E
to E1 on the same supply curve shows an extension of supply and E1 to E shows a
contraction of supply.

Increase and Decrease in Supply

‘Increase’ and ‘decrease’ in supply causes shifts in the supply curve. A shift in the supply
curve due to a change in some factor other than the price of the commodity is referred to
as a change in supply.
Supply is said to increase when more is offered in the market without a change in price.
Supply is said to decrease when less is offered in the market without a change in the price
of the commodity. In figure 5, at price EM, the supply is OM. SS is the supply curve
before the change. S1S1 shows an increase in supply because at the same price ME =
M1E1 more is offered for sale, i.e., OM1 instead of OM. S2S2 shows the decrease in supply
because at the same price ME = M2E2less is offered for sale, i.e., OM2 instead of OM.