Definition of Economics

Modern Definition
The credit for revolutionizing the study of economics surely goes to Lord J.M Keynes.
He defined economics as the “study of the administration of scares resources and the
determinants of income and employment”.

Meaning and Definition of Managerial Economics

Managerial economics is concerned with the application of business
principles and methodologies to the decision making process within the firm or
organization under theconditions of uncertainty

Objectives and Uses (Importance) of managerial Economics

Objectives: The basic objective of managerial economics is to analyze the economic

problems faced by the business. The other objectives are:

1. To integrate economic theory with business practice.

2. To apply economic concepts and principles to solve business problems
4. To make all-round development of a firm.
5. To minimize risk and uncertainty
7. To help in profit maximization

Importance: In order to solve the problems of decision making, data are to be collected
and analyzed in the light of business objectives. Managerial economics provides help in
this area. The importance of managerial economics maybe relies in the following points:

1. It provides tool and techniques for managerial decision making.

2. It gives answers to the basic problems of business management.
3. It supplies data for analysis and forecasting
6. It helps in formulating business policies.
7. It assists the management to know internal and external factors influence the business

Chief Characteristics of Managerial or Business economics

1. Managerial economics is Micro economic in character. Because it studies the

problems of a business firm, not the entire economy
2. Managerial economics largely uses the body of economic concepts and principles
which is known
3. as “Theory of the Firm” or “Economics of the firm”.
4. Managerial economics is pragmatic. It is purely practical oriented.
5. It is management oriented

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 THEORY OF CONSUMER BEHAVIOUR

Consumer behavior theory rests upon three basic assumptions regarding the utility tied to
consumption.
First, ―More is better‖:- Consumers will always prefer more to less of any good or service.
It is often being referred to as the ―non satiation principle‖

Second, ―Preferences are complete‖:- When preferences are complete, consumers are able
to compare and rank the benefits tied to consumption of various goods and services.

Third, ―Preferences are transitive‖ :- When preferences are transitive, consumers are able
to rank/order the desirability of various goods and services.

Utility Function :-
A utility function is a descriptive statement that relates satisfaction or well being to the
consumption of goods and services

Marginal Utility :- (MU)

Marginal utility measures the added satisfaction derived from a one unit increase in
consumption of a particular good or service

Law of Diminishing Marginal Utility :-

In general, the law of diminishing marginal utility states that ―as an individual increases
consumption of a given product within a set period of time, the marginal utility gained from
consumption eventually declines.
a consumer tries to equalize marginal utility of a commodity with its price so that his
satisfaction is maximized

Equilibrium of the consumer :-

Let‘s begin with the simple model of a single commodity X. the consumer can either buy X or
retain his money income Y. Under these conditions, the consumer is in equilibrium when the
marginal utility of X is equated to its market price (pX).

Symbolically we have,

MUX = pX

■Marginal Utility(MU)-The additiona lsatisfaction gained by the consumption or use

of one more unit of output
■𝑀𝑈𝑛 = 𝑇𝑈𝑛−𝑇𝑈𝑛−1
■𝑀𝑈 =ΔTu/ΔQ

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■TotalUtility(TU)-The total amount of satisfaction obtained from consumption of a good
o rservice

Total Utility

Marginal Utility

INDIFFERENCE CURVE
 Indifference curve has abandoned the concept of cardinal utility and replaced it by
ordinal utility theory
 Indifference curve analysis on demand is based upon the weak ordering
form of preference hypothesis
 An indifference curve is the locus of points particular combinations or
bundles of goods which yields the same utility or level of satisfaction to the
consumer
 All combinations of the goods lying on a consumer’s indifference curve
are equally desirable to or equally preferred by him.

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 Indifference schedule shows the various combinations of the two
commodities such that the consumer is indifferent to those combinations

 Take the case of two goods, Good X and Good Y and demonstrate an indifference
schedule

 The amount of goods X and Y in each combination are so arranged that the consumer
is indifferent among the combinations

INDIFFERENCE SCHEDULE:
COMBINATION GOOD X GOOD Y
A 1 18
B 2 13
C 3 9
D 4 6
E 5 4
F 6 3

INDIFFERENCE CURVE:

Marginal Rate of Substitution (MRS)

MRS of X for Y MRS(xy) represents the amount of Y which the consumer has
to give up for the gain of one additional unit of x so that his level of
satisfaction remains the same

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[Slope of Indifference Curve: -Δy = MRS (xy)
.Δx.

combination Good x Good y MRSxy

A 1 12 ---
B 2 8 4:1
C 3 5 3:1
D 4 3 2:1
E 5 2 1:1

 If the MRSxy is diminishing, the indifference curve must be convex to the

Origin

 If the MRSxy is constant, the indifference curve will be a straight line sloping
downwards to the right

 If the MRSxy is increasing, the indifference curve will be concave to the

Origin

 In the case of perfect complementary the MRSxy is zero and the

indifference curve will be L shaped

Properties of Indifference Curve

 Indifference curves slopes downward to the right

 Indifference curves are convex to the origin


 Indifference curves can neither intersect nor touch each other

 Higher indifference curves give higher level of satisfaction (Indifference map)

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WHAT IS DEMAND?
•Desireforacommodity
•Abilitytopurchase
•Willingnesstospendmoney

demand for a commodity is its quantity which

consumer is able and willing to buy at various prices during a given period of time

TYPES OF DEMAND
•PriceDemand
•IncomeDemand
•CrossDemand

PRICE DEMAND
•Various quantities of a commodity or a service that a consumer would purchase at a
given time in a market at a hypothetical price.

•Assumption is income,his tastes and prices of related goods remain constant.

INCOME DEMAND

Various quantities of goods and services which would be purchased by the consumers at
various levels of income.

•Assumption is prices of the commodity ,prices of interrelated goods,tastes and desires of

the consumer do not change.

CROSS DEMAND
•Various quantities of a good and services that will be purchased by the consumer with
reference to change in price of related good.

•These goods are either substitutes or complementary goods.

Demand Analysis
Demand analysis means an attempt to determine the factors affecting the demand of a
commodity or service and to measure such factors and their influences. The demand
analysis includes the study of law of demand, demand schedule, demand curve and
demand forecasting. Main objectives of demand analysis are;

1) To determine the factors affecting the demand.

2) To measure the elasticity of demand.

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3) To forecast the demand.
4) To increase the demand.
5) To allocate the recourses efficiently

Law of Demand
The law of Demand is known as the “first law in market”. Law of demand shows the
relation between price and quantity demanded of a commodity in the market. In the
words of Marshall “the amount demanded increases with a fall in price and diminishes
with a rise in price”.

the law of demand is an inverse or negative relationship because the variables (price and
demand) move in opposite direction

Demand Schedule and Demand Curve

Demand schedule is a statistical/tabular statement showing the different quantities of a
commodity which will be bought at its different prices during a specified time period.

Demand Curve: By plotting the demand schedule on graph, we can obtain the demand
curve. According to Prof. Samuelson, “Picturization of demand schedule is called the
demand curve”.

Individual demand Schedule

An individual demand schedule is a list of quantities of a commodity purchased by an
individual consumer at different prices

Price of Apple Quantitydemanded

(In Rs.)
10 1
8 2
6 3
4 4
2 5

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The demand curve DD shows the inverse relation between price and demand of apple.
Due to this inverse relationship, demand curve is slopes downward from left to right. This
kind of slope is also called “negative slope”.

Market demand schedule

Market demand refers to the total demand for a commodity by all the consumers. It is the
aggregate quantity demanded for a commodity by all the consumers in a market.

Assumptions of Law of Demand

Law of demand is based on certain basic assumptions. They are as follows

1) There is no change in consumers’ taste and preference

2) Income should remain constant.
3) Prices of other goods should not change.
4) There should be no substitute for the commodity.
5) The commodity should not confer any distinction.
6) The demand for the commodity should be continuous.
7) People should not expect any change in the price of the commodity.

Why does demand curve slopes downward?

Demand curve slopes downward from left to right (Negative Slope). There are many
causes for downward sloping of demand curve:-

1) Law of Diminishing Marginal utility

As the consumer buys more and more of the commodity, the marginal utility of the
additional units falls. Therefore the consumer is willing to pay only lower prices for
additional units. If the price is higher, he will restrict its consumption

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2) Principle of Equi- Marginal Utility
Consumer will arrange his purchases in such a way that the marginal utility is equal in all
his purchases. If it is not equal, they will alter their purchases till the marginal utility is
equal.

3) Income effect
When the price of the commodity falls, the real income of the consumer will increase. He
will spend this increased income either to buy additional quantity of the same commodity
or other commodity

4) Substitution effect.
When the price of tea falls, it becomes cheaper. Therefore the consumer will substitute
this commodity for coffee. This leads to an increase in demand for tea.

5) Different uses of a commodity.

Some commodities have several uses. If the price of the commodity is high, its use will
be restricted only for important purpose. For e.g. when the price of tomato is high, it will
be used only for cooking purpose. When it is cheaper, it will be used for preparing jam,
pickle etc.,

6) Psychology of people.
Psychologically people buy more of a commodity when its price falls. In other word it
can be termed as price effect.Tendency of human beings to satisfy unsatisfied wants.

Exceptions to the Law of Demand. (Exceptional Demand Curve).

The basic feature of demand curve is negative sloping. But there are some exceptions to
this. i.e., in certain circumstances demand curve may slope upward from left to right
(positive slopes). These phenomena may due to;

1) Giffen paradox
The Giffen goods are inferior goods is an exception to the law of demand. When the price
of inferior good falls, the poor will buy less and vice versa. When the price of maize falls,
the poor will not buy it more but they are willing to spend more on superior goods than
on maize. Thus fall in price will result into reduction in quantity. This paradox is first
explained by Sir Robert Giffen.

2) Veblen or Demonstration effect.

According to Veblen, rich people buy certain goods because of its social distinction or
prestige.Diamonds and other luxurious article are purchased by rich people due to its high
prestige value. Hence higher the price of these articles, higher will be the demand.

3) Ignorance.
Sometimes consumers think that the product is superior or quality is high if the price of
that product is high. As such they buy more at high price.

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4) Speculative Effect.
When the price of commodity is increasing, then the consumer buy more of it because of
the fear that it will increase still further.

5) Fear of Shortage.
During the time of emergency or war, people may expect shortage of commodity and buy
more at higher price to keep stock for future.

6) Necessaries
In the case of necessaries like rice, vegetables etc., People buy more even at a higher
price.

7) Brand Loyalty
When consumer is brand loyal to particular product or psychological attachment to
particular product, they will continue to buy such products even at a higher price.

8) Festival, Marriage etc.

In certain occasions like festivals, marriage etc. people will buy more even at high price..

Exceptional Demand Curve (perverse demand curve)

When price raises from OP to OP1 quantity

demanded also increases from OQ to OQ1. In other words,from the above, we can see
that there is positive relation between price and demand. Hence, demand curve(DD)
slopes upward.

CHANGES IN DEMAND
Demand of a commodity may change. It may increase or decrease due to changes in
certain factors. These factors are called determinants of demand. These factors include;

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1) Price of a commodity
2) Nature of commodity
3) Income and wealth of consumer
4) Taste and preferences of consumer
5) Price of related goods (substitutes and compliment goods)
6) Consumers’ expectations.
7) Advertisement etc.

Determinants of Demand/Demand Function.

There is a functional relationship between demand and its various determinants. i.e., a
change in any determinant will affect the demand. When this relationship expressed
mathematically, it is called Demand Function. Demand function of a commodity can be
written as follows:

D = f (P, Y, T, Ps, U)
Where, D= Quantity demanded P= Price of the commodity
Y= Income of the consumer T= Taste and preference of consumers.
Ps = Price of substitutes U= Consumers expectations & others
f = Function of (indicates how variables are related)

Extension and Contraction of Demand

A change in demand solely due to change in price is called extension and contraction.

When the quantity demanded of a commodity rises due to a fall in price, it is called
extension of demand

when the quantity demanded falls due to a rise in price, it is called contraction of
demand.

When the price of commodity is OP, quantity demanded is OQ. If the price falls to P2,
quantity demanded increases to OQ2. When price rises to P1, demand decreases from OQ
to OQ1. In demand curve, the area a to c is extension of demand and the area a to b is
contraction of demand. As result of change in price of a commodity, the consumer moves
along the same demand curve.

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Shift in Demand (Increase or Decrease in demand)
When the demand changes due to changes in other factors, like taste and preferences,
income, price of related goods etc., it is called shift in demand.
Due to changes in other factors, if the consumers buy more goods, it is called increase in
demand or upward shift.
if the consumers buy fewer goods due to change in other factors, it is called downward
shift or decrease in demand

DD is the original demand curve. Demand curve shift upward due to change in income,
taste & preferences etc., of consumer, where price remaining the same. In the above
diagram demand curve D1-D1 is showing upward shift or increase in demand and D2-D2
shows downward shift or decrease in demand.

Different types of demand.

Joint demand:
When two or more commodities are jointly demanded at the same time to satisfy a
particular want, it is called joint or complimentary demand. (Demand for milk, sugar, tea
for making tea).

Composite demand:
The demand for a commodity which can be put for several uses (Demand for electricity)

Direct and Derived demand:

Demand for a commodity which is for a direct consumption is called direct demand
(food, cloth). When the commodity is demanded as the result of the demand of another
commodity, it is called derived demand (Demand for tyres depends on demand of
vehicles).

Industry demand and company demand:

Demand for the product of particular company is company demand and total demand for
the products of particular industry which includes number of companies is called industry
demand.

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 gross demand for a good is the amount of the good that the consumer actually ends up
consuming

net demand for a good is the difference between what the consumer ends up with (the
gross demand) and the initial endowment of goods.

ELASTICITY OF DEMAND

Meaning of Elasticity: The concept of elasticity of demand was introduced by Marshall.

This concept explains the relationship between a change in price and consequent change
in quantity demanded. Nutshell, it shows the rate at which changes in demand take place.

Elasticity of demand can be defined as “the degree of responsiveness in quantity

demanded to a change in price”. Thus it represents the rate of change in quantity
demanded due to a change in price. There are mainly three types of elasticity of demand:

1. Price Elasticity of Demand.

2. Income Elasticity of Demand. and
3. Cross Elasticity of Demand.

Price Elasticity of Demand It is the ratio of percentage change in quantity demanded to

a percentage change in price

Price Elasticity = Proportionate change in quantity demanded

Proportionate change in price

Ep = Change in Quantity demanded / Quantity demanded

Change in Price/price
Ep = (Q2-Q1)/Q1
(P2-P1) /P1 ,

Where: Q1 = Quantity demanded before price change

Q2 = Quantity demanded after price change
P1 = Price charged before price change
P2 = Price charge after price change.

There are five types of price elasticity of demand

1) Perfectly elastic demand (infinitely elastic)

When a small change in price leads to infinite change in quantity demanded, it is called
perfectly elastic demand. In this case the demand curve is a horizontal straight line as
given below. (Here ep= ∞)

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2) Perfectly inelastic demand
In this case, even a large change in price fails to bring about a change in quantity
demanded. i.e., the change in price will not affect the quantity demanded and quantity
remains the same whatever the change in price. Here demand curve will be vertical line
as follows and ep= 0

3) Relatively elastic demand

Here a small change in price leads to very big change in quantity demanded. In this case
demand curve will be fatter one and ep=>1

4) Relatively inelastic demand

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Here quantity demanded changes less than proportionate to changes in price. A large
change in price leads to small change in demand. In this case demand curve will be
steeper and ep=<1

5) Unit elasticity of demand (Unitary elastic)

Here the change in demand is exactly equal to the change in price. When both are equal,
ep= 1, the elasticity is said to be unitary.

S. type Numerical expresion description Shape of curve

n
1 Perfectly elastic α infinity Horizontal
2 Perfectly inelastic 0 Zero Vertical
3 Unitary elastic 1 one Rectangular
hyperbola
4 Relatively elastic >1 More than one Flat
5 Relatively inelastic <1 Less than one Steep

 Income Elasticity of Demand

Income elasticity of demand shows the change in quantity demanded as a result of a
change in consumers’ income. Income elasticity of demand may be stated in the form of
formula:

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Ey = Proportionate Change in Quantity Demanded
Proportionate Change in Income

Income elasticity of demand mainly of three types:

1) Zero income Elasticity.
2) Negative income Elasticity
3) Positive income Elasticity
1. Zero income elasticity – In this case, quantity demanded remain the same, even
though money income increases.ie, changes in the income doesn’t influence the
quantity demanded (Eg., salt, sugar etc.,). Here Ey (income elasticity) = 0

2. Negative income elasticity -In this case, when income increases, quantity
demanded falls. Eg., inferior goods. Here Ey = < 0.

3. Positive income Elasticity - In this case, an increase in income may led to an

increase in the quantity demanded. i.e., when income rises, demand also rises. (Ey
=>0) This can be further classified in to three types:
a) Unit income elasticity; Demand changes in same proportion to change in income. i.e.,
Ey= 1

b) Income elasticity greater than unity: An increase in income brings about a more than
proportionate increase in quantity demanded. i.e., Ey =>1

c) Income elasticity less than unity: when income increases quantity demanded is also
increases but less than proportionately. i.e., Ey = <1

Cross Elasticity of DemandCross elasticity of demand is the proportionate change in the

quantity demanded of a commodity in response to change in the price of another related
commodity.

Related commodity may either substitutes or complements.

 substitute commodities are tea and coffee
 Compliment commodities are car and petrol.

Cross Elasticity = Proportionate Change in Quantity Demanded of a Commodity

Proportionate Change in the Price of Related Commodity

If the cross elasticity is positive, the commodities are said to be substitutes and if cross
elasticity is negative, the commodities are compliments. The substitute goods (tea and
Coffee) have positive cross elasticity because the increase in the price of tea may increase
the demand of the coffee and the consumer may shift from the consumption of tea to
coffee.

Complementary goods (car and petrol) have negative cross elasticity because increase in
the price of car will reduce the quantity demanded of petrol.

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The concept of cross elasticity assists the manager in the process of decision making. For
fixing the price of product which having close substitutes or compliments, cross elasticity
is very useful.

Determinants of elasticity.
Elasticity of demand varies from product to product, time to time and market to market.
This is due to influence of various factors. They are;

 Nature of commodity - Demand for necessary goods (salt, rice, etc.,) is inelastic.
Demand for comfort and luxury good are elastic.
 Availability/range of substitutes – A commodity against which lot of substitutes
are available, the demand for that is elastic. But the goods which have no substitutes,
demand is inelastic
 Extent /variety of uses - a commodity having a variety of uses has a comparatively
elastic demand. Eg. Demand for steel, electricity etc.,
 Postponement/urgency of demand - if the consumption of a commodity can be post
pond, then it will have elastic demand. Urgent commodity has inelastic demand
 Income level - income level also influences the elasticity. E.g. Rich man will not
curtail the consumption quantity of fruit, milk etc., even if their price rises, but a poor
man will not follow it.
 Range of Prices - if the products at very high price or at very low price having
inelastic demand since a slight change in price will not affect the quantity demand.
 Purchase frequency of a product/time – if the frequency of purchase of a product
is very high, the demand is likely to be more price elastic.

Measurement of Elasticity
There are various methods for the measurement of elasticity of demand. Following are
the important methods:
1. Proportional or Percentage Method: Under this method the elasticity of demand is
measured by the ratio between the proportionate or percentage change in quantity
demanded and proportionate change in price. It is also known as formula method. It can
be computed as follows:
ED = Proportionate change in quantity demanded
Proportionate change in price.
OR
= Change in Demand Original/Quantity demanded
Change in Price/Original price

2. Expenditure or Outlay Method: This method was developed by Marshall. Under this
method, the elasticity is measured by estimating the changes in total expenditure as a
result of changes in price and quantity demanded. This has three components

If the price changes, but total expenditure remains constant, unit elasticity exists.

If the price changes, but total expenditure moves in the opposite directions, demand is
elastic (>1).

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If the price changes and total revenues moves in the same direction, demand is inelastic
(<1). This can be expressed by the following diagram.

3. Geometric or Point method: This also developed by Marshall. This is used as a

measure of the change in quantity demanded in response to a very small change in the
price. In this method we can measure the elasticity at any point on a straight line demand
curve by using the following formula;

ED = Lower section of the Demand curve

Upper section of Demand curve.

In the above diagram, AB is a straight line demand

curve with P as its middle point. Further it is assumed that AB is 6 cm. Then,
At point P, ED = PB/PA=3/3=1
At point P1, ED = P1B/P1A= 4.5/1.5= 3=>1,
At point A, ED = AB/A= 6/0= α (infinity),
At point P2, ED = P2B/P2A = 1.5/4.5 = 1/3 = <1,
At point B, ED = B/BA = 0/6 = 0

4. Arc Method: the point method is applicable only when there are minute (very small)
changes in price and demand. Arc elasticity measures elasticity between two points. It is a

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measure of the average elasticity According to Watson,” Arc elasticity is the elasticity at
the midpoint of an arc of a demand curve”. formula to measure elasticity is:
ED = ΔQ/ ΔP × (P1+P2)/ (Q1+Q2) or Change in D × Average P
Average D Change in P
Where, ΔQ= change in quantity Q1= original quantity
P1 = original price Q2= new quantity
P2 = New price ΔP= change in price

SUPPLY
The term supply refers to the quantity of a good or service that producers are willing and
able to sell during a certain period under a given set of conditions.

Market Supply Function

The market supply function for a product is a statement of the relation between the
quantity supplied and all factors affecting that quantity. In functional form, a supply
function can be expressed as
Quantity of Product X Supplied = Q = f (Price of X, Prices of Related Goods,
Current State of Technology, Input Prices, Weather, and so on)

Determinants of Supply

1. Price of the commodity: At a higher price, producer offers more quantity of the
commodity for sale and at a lower price, less quantity of the commodity. There is a direct
relationship between price and quantity supplied of the commodity as given by the Law
of Supply.

2. Price of related good: Supply of a commodity depends upon the prices of its related
goods, especially substitute goods. If the price of a remains constant and the price of its
substitute good Z increases, the producers will find it more profitable to produce good Z.

3. State of Technology: If there is up gradation in the technique of production or new

discovery, it will lead to fall in the cost of production. Thus, supply of the commodity
will increase.

4. Cost of Production: a change in the cost of production i.e., prices of factors of

production affects the supply of a commodity. If wages of labour or price of raw

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materials increase, then marginal cost (MC) of production will rise. As a result, supply of
the good will fall because producers would prefer to produce some other commodities
that can be produced at a lower cost.

5. Government Policy: Government levy taxes or grant subsidies to producers. If heavy

excise taxes are imposed on a commodity, it will discourage producers as it will increase
the cost of production and as a result, its supply will decrease and the supply curve will
shift to the left. Similarly, if subsidies are granted by the government to the producers
then supply will increase and the supply curve will shift to the right.

Law of Supply
It is observed in markets that when more price of commodities are offered to sellers.
They increase the quantity supplied of these commodities and when the level of prices
decreases, the sellers decrease the quantity supplied. This behaviour of seller is called law
of supply.
according to the law of supply, the quantity supplied of a commodity is positively related
to price. Because of this direct or positive relationship between price and quantity
supplied of a commodity the supply curve slopes upward to the right.
Assumptions of the Law of Supply (ceteris paribus)
The law supply is based on the assumption that factors, other than price of the
commodity, that affect the supply remain the same. The functional relationship between
the quantity supplied and the price of a commodity can be expressed as:

Qs = f (P)

Where Qs = quantity supplied and P = price of commodity

Supply Schedule
It is a statement in the form of a table that shows the different quantities of a commodity
that a firm or a producer offers for sale in the market at different prices.

It denotes the relationship between the supply and the price, while all non-price variables
remain constant.

There are two types of Supply Schedules:

1. Individual Supply Schedule
2. Market Supply Schedule

Individual Supply Schedule

It is a supply schedule that depicts the supply by an individual firm or producer of a
commodity in relation to its price. Let us understand it with the help of an example.

Price per unit of commodity X (Px) Quantity supplied of commodity X (Dx)

100 1000
200 2000
300 3000

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 400 4000
500 5000
The above schedule depicts the individual supply schedule. We can see that when the
price of the commodity is ₹100, its supply is 1000 units. Similarly, when its price is 500,
its supply increases to 5000 units.

Market Supply Schedule

It is a summation of the individual supply schedules and depicts the supply of different
customers for a commodity in relation to its price. example

Price per unit of Quantity supplied Quantity supplied Market

commodity X by firm A (QA) by firm B (QB) Supply QA + QB
100 1000 3000 4000
200 2000 4000 6000
300 3000 5000 8000
400 4000 6000 10000
500 5000 7000 12000
The above schedule shows the market supply of commodity X. When the price of the
commodity is Rs. 100, firm A supplies 1000 units while the firm B supplies 3000 units.

Thus, the market supply is 4000 units. Similarly, when its price is Rs. 500, firm A
supplies 5000 units while firm B supplies 7000 units. Thus, it’s market demand increases
to 12000 units.

Supply CurveThe supply curve expresses the relation between the price charged and the
quantity supplied, holding constant the effects of all other variables.

Change Supply and Shift in Supply Curve

A movement in a supply curve is a change in supply as a result of a change in price. A
shift in a supply curve is a change in supply for a reason other than a change in price.
This is illustrated in the figure given below. If there is a rise in price of commodity P to
P1it will lead to increase in quantity supplied by the producer from Q to Q1, and if there
is a fall in price of the commodity from P to P2, then it will lead to reduction in the
quantity supplied by the producer from Q to Q2. On the other hand if there is any change

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in the determinant of supply it will lead to shift in the supply curve either left or right
depending upon the nature of change in the determinant of supply.

Figure showing Shift in Supply & Movement along a Supply Curve

Reason for Change in Supply or movement along supply curve: Change in the price
of the product.
Reason for upward movement (Expansion of supply): A rise in price of the product
Reason for downward movement (Contraction of supply): A fall in price of the
product.

Elasticity of Supply
When a small fall in price leads to a large contraction in supply, the supply is
comparatively elastic. But when a big fall in price leads to a very small contraction in
supply, the supply is said to be comparatively inelastic. On the other hand, a small rise in
price leading to a big extension in supply shows more elastic supply, and a big rise in
price leading to a small extension in supply indicates inelastic supply. Let us discuss
elastic and inelastic supply graphically–

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From the above two figures we got two supply curves ‘SS’ and S1S1. Quantity supplied
is measured along the horizontal axis and price is measured along the vertical axis. In
figure 1, at price OP1, the quantity supplied is OQ1, and in figure 2 the quantity supplied
is ON1. Price is same in both the cases. With rise in price of the commodity, quantity
supplied increases. In figure 1, due to change in price from OP1 to OP2, quantity
supplied increases to OQ2. In figure 2, the change in quantity supplied is from ON1 to
ON2. In figure 1, the change in quantity supplied Q1Q2 is much larger as compared to
increase in quantity supplied N1N2. In figure 2. Therefore, supply in figure 1 is elastic
whereas supply in figure 2 is inelastic.

Definition of Elasticity of Supply: The elasticity of supply is the degree of

responsiveness of supply to changes in the price of a good. More precisely, the elasticity
of supply can be defined as a proportionate change in quantity supplied of a good in
response to a given proportionate change in price of the good. It can be expressed as
follows–
Proportionate change in quantity supplied
Es = Proportionate change in price
Symbolically we can write it as follows–
Δq
Es = q
Δp
p
Using above formula we can measure elasticity of supply. In the given formula–
Es = elasticity of supply
Δq = change in quantity supplied
Δp = change in price
p = price of commodity
q = quantity supplied of the commodity

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Problem: If the price of a refrigerator rises from Rs. 2000 to Rs.2100 per unit and in
response to this rise in price the quantity supplied increases from 2500 to 3000 units,
what will be the elasticity of supply?

Solution: We know that,

Δq
Es = q
Δp
P

Here, Dq (Change in quantity supplied) = (3000-2500) units

= 500 units
Dp (Change in price) = (2100-2000)
= Rs. 100

P (initial price) = Rs. 2000

or (initial quantity supplied) = 2500 units
Hence, elasticity of supply will be 4.

MARKET EQUILIBRIUM

•Role of market price as a determinant of both of quantity demanded and quantity

supplied
•Operation of market- the interaction between suppliers and demanders
•Three conditions may prevail in every market:
–The quantity demanded exceeds the quantity supplied at the current price
(ExcessDemand)
–The quantity supplied exceeds the quantity demanded at the current price ( Excess
Supply )
–The quantity supplied equals to quantity demanded at the current price(Equilibrium)
EXCESS DEMAND

•Excess demand- Quantity demanded is greater than quantity supplied at the current price
•Tendency will be a rise in price

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EXCESS SUPPLY

•Excess Supply When the quantity supplied exceeds the quantity demanded at the
current price
•Results fall in price
•Fall in price lead to decrease in quantity supply

CHANGES IN EQUILIBRIUM
•Shift of supply and demand curve results change in equilibrium price and quantity

SHIFTS OF SUPPLY CURVE

INCREASE IN THE COST OF PRODUCTION OF X

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 DECREASE IN THE COST OF PRODUCTION OF X

DEMAND SHIFTS
INCREASE IN INCOME: X IS A NORMAL GOOD

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INCREASE IN INCOME: X IS AN INFERIOR GOOD

DECREASE IN INCOME: X IS AN INFERIOR GOOD

DECREASE IN INCOME: X IS A NORMAL GOOD

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INCREASE IN THE PRICE OF A SUBSTITUTE FOR X

INCREASE IN THE PRICE OF A COMPLEMENT FOR X

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DECREASE IN THE PRICE OF SUBSTITUTE FOR X

DECREASE IN THE PRICE OF A COMPLEMENT FOR X

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