LECTURE NOTES

Course No. AEC 101

Introductory Economics

Compiled by

Md. Abdus Salam

Associate Professor
And
Professor M. Kamruzzaman
Department of Agricultural Economics
Faculty of Agricultural Economics and Rural Development
Bangabandhu Sheikh Mujibur Rahman Agricultural University
Gazipur, Bangladesh

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Lecture no.1

Economics – Meaning, Definitions, Nature, scope and Subject matter of Economics,

Micro economics vs Macro Economics, Positive vs normative economics, deductive
and inductive methods of economics, basic problems of economic organization.

1.0 AIMS AND OBJECTIVES

After having studied this unit, you should be able
· To understand the fundamentals of Business Economics
· To know whether Economics is a Science or an Art
· To Study the Basic Economic terminologies

1.1 INTRODUCTION
Economics was formerly called political economy. The term Political economy means the
management of the wealth of the state. “Adam Smith, the father of modem Economics,
in his book entitled 'An Enquiry into the Nature and Causes of the Wealth of Nations’
(Published in 1776) defined Economics as a study of wealth. Smith considered the
acquisition of wealth as the main objective of human activity. According to him the subject
matter of Economics is the study of how wealth is produced and consumed. Smith's
definition is known as wealth definition. This definition was too materialistic. It gave more
importance to wealth than to man for whose use wealth is produced. The emphasis on
wealth was severely criticized by many other Tk. Cailyle, Ruskin and other philosophers
called it the Gospel of Mammon. They even called it a dismal science as it was supposed to
teach selfishness.

Later economists held that apart from man the said study of wealth has no meaning
Economics is concerned not only with the production and use of wealth but also with man. It
deals with wealth as serving the purpose of man. Wealth is only a means to the end of
human welfare. We cannot consider the desire to acquire wealth as the inspiring factor
behind every human endeavor. Nor can it be expected to be the sole cause of human
happiness. The emphasis has now shifted from wealth to man. Man occupies the primary
place and wealth only a secondary place.

1.2 DEFINITIONS OF ECONOMICS

Several definitions of Economics have been given. For the sake of convenience let us
classify the various definitions into four groups:
1. Science of wealth

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2. Science of material well-being
3. Science of choice making and
4. Science of dynamic growth and development

We shall examine each one of these briefly.

1. Science of wealth. Some earlier economists defined Economics as follows:
“An inquiry into the nature and causes of the wealth of the nations’’ by Adam Smith
“Science which deals with wealth" by J.B. Say

In the above definition wealth becomes the main focus of the study of Economics.
The definition of Economics, as science of wealth, had some merits. The important ones are:
1. It highlighted an important problem faced by each and every nation of the world,
namely creation of wealth.
2. Since the problems of poverty, unemployment etc. can be solved to a greater extent
when wealth is produced and is distributed equitably; it goes to the credit of Adam
Smith and his followers to have addressed to the problems of economic growth and
increase in the production of wealth. The study of Economics as a 'Science of
Wealth' has been criticized on several grounds.
The main criticisms leveled against this definition are;
i. Adam Smith and other classical economists concentrated only on material wealth.
They totally ignored creation of immaterial wealth like services of Agricultural
Economists, Agriculturists, Teachers, Doctors etc.
ii. The advocates of Economics as 'science of wealth' concentrated too much on the
production of wealth and ignored social welfare. This makes their definition
incomplete and inadequate.
2. Science of material well-being. Under this group of definitions the emphasis is on
welfare as compared with wealth in the earlier group. Two important definitions are as
follows: "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 the man", Alfred
Marshall
"The range of our inquiry becomes restricted to that part of social welfare that can be
brought directly or indirectly into relation with the measuring rod of money" A.C. Pigou.

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 In the first definition Economics has been indicated to be a study of mankind in the
ordinary business of life. By ordinary business we mean those activities which occupy
considerable part of human effort. The fulfillment of economic needs is a very important
business which every man ordinarily does. Professor Marshall has clearly pointed that
Economics is the study of wealth but more important is the study of man. Thus, man gets
precedence over wealth. There is also emphasis on material requisites of well-being.
Obviously, the material things like food, clothing and shelter, are very important economic
objectives.
The second definition by Pigou emphasizes social welfare but only that part of it
which can be related with the measuring rod of money. Money is general measure of
purchasing power by the use of which the science of Economics can be rendered more
precise.
Marshall's and Pigou's definitions of Economics are wider and more comprehensive
as they take into account the aspect of social welfare. But their definitions have their share of
criticism. Their definitions are criticised on the following grounds.
i. Economics is concerned with not only material things but also with immaterial things
like services of Agricultural Economists, Agriculturists, Teachers, Doctors etc.
ii. Marshall and Pigou chose to ignore them.
iii. Robbins criticised the welfare definition on the ground that it is very difficult to state
which things would lead to welfare and which will not. He is of the view that we would
study in Economics all those goods and services which carry a price whether they
promote welfare or not.
3. Science of choice making. Robbins gave a more scientific definition of Economics. His
definition is as follows:
"Economics is the science which studies human behavior as a relationship between ends
and scarce means which have alternative uses".
The definition deals with the following four aspects:
(i) Economics is a science: Economics studies economic human behaviour scientifically. It
studies how humans try to optimise (maximize or minimize) certain objective under given
constraints. For example, it studies how consumers, with given income and prices of the
commodities, try to maximize their satisfaction.
(ii) Unlimited ends: Ends refer to wants. Human wants are unlimited. When one want is
satisfied, other wants crop up. If man's wants were limited, then there would be no economic
problem.
(iii) Scarce means: Means refer to resources. Since resources (natural productive
resources, man-made capital goods, consumer goods, money and time etc.) are limited
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economic problem arises. If the resources were unlimited, people would be able to satisfy all
their wants and there would be no problem.
(iv) Alternative uses: Not only resources are scarce, they have alternative uses. For
example, water can be used for drinking purposes, for irrigation purposes, as a means of
transportation and for so many purposes. Similarly, financial resources can be used for
many purposes. The man or society has, therefore, to choose the uses for which resources
would be used. If there was only a single use of the resource then the economic problem
would not arise. It follows from the definition of Robbins that Economics is a science of
choice. An important thing about Robbin's definition is that it does not distinguish between
material and non-material, between welfare and non-welfare. Anything which satisfies the
wants of the people would be studied in Economics. Even if a good is harmful to a person it
would be studied in Economics if it satisfies his wants. No doubt, Robbins has made
Economics a scientific study and his definition has become popular among some
economists. But his definition has also been criticised on several grounds. Important ones
are:
(i) Robbins has made Economics quite impersonal and colourless. By making it a complete
positive science and excluding normative aspects he has narrowed down its scope.
(ii) Robbins' definition is totally silent about certain macro-economic aspects such as
determination of national income and employment.
(iii) His definition does not cover the theory of economic growth and development. While
Robbins takes resources as given and talks about their allocation, it is totally silent about the
measures to be taken to raise these resources i.e. national income and wealth.
4. Science of dynamic growth and development. Although the fundamental economic
problem of scarcity in relation to needs is undisputed it would not be proper to think that
economic resources - physical, human, financial are fixed and cannot be increased by
human ingenuity, exploration, exploitation and development. A modern and somewhat
modified definition is as follows:
"Economics is the study of how men and society choose, with or without the 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 amongst various people and groups of society". Paul A. Samuelson
The above definition is very comprehensive because it does not restrict to material well-
being or money measure as a limiting factor. But it considers economic growth over time.

NATURE OF ECONOMICS

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Under this, we generally discuss whether Economics is science or art or both and if it is a
science whether it is a positive science or a normative science or both.
Economics - As a science and as an art:
Often a question arises - whether Economics is a science or an art or both.
(a) Economics is a science: A subject is considered science if It is a systematized body of
knowledge which studies the relationship between cause and effect.
It is capable of measurement.
It has its own methodological apparatus.
It should have the ability to forecast.
If we analyse Economics, we find that it has all the features of science. Like science it
studies cause and effect relationship between economic phenomena. To understand, let us
take the law of demand. It explains the cause and effect relationship between price and
demand for a commodity. It says, given other things constant, as price rises, the demand for
a commodity falls and vice versa. Here the cause is price and the effect is fall in quantity
demanded. Similarly like science it is capable of being measured, the measurement is in
terms of money. It has its own methodology of study (induction and deduction) and it
forecasts the future market condition with the help of various statistical and non-statistical
tools. But it is to be noted that Economics is not a perfect science. This is because
Economists do not have uniform opinion about a particular event. The subject matter of
Economics is the economic behaviour of man which is highly unpredictable.
Money which is used to measure outcomes in Economics is itself a dependent
variable. It is not possible to make correct predictions about the behaviour of economic
variables.
(b) Economics is an art: Art is nothing but practice of knowledge. Whereas science teaches
us to know art teaches us to do. Unlike science which is theoretical, art is practical. If we
analyse Economics, we find that it has the features of an art also. Its various branches,
consumption, production, public finance, etc. provide practical solutions to various economic
problems. It helps in solving various economic problems which we face in our day-to-day life.
Thus, Economics is both a science and an art. It is science in its methodology and art in its
application. Study of unemployment problem is science but framing suitable policies for
reducing the extent of unemployment is an art.

Economics as Positive Science and Economics as Normative Science

(i) Positive Science: As stated above, Economics is a science. But the question arises
whether it is a positive science or a normative science. A positive or pure science analyses
cause and effect relationship between variables but it does not pass value judgment. In other
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words, it states what is and not what ought to be. Professor Robbins emphasized the
positive aspects of science but Marshall and Pigou have considered the ethical aspects of
science which obviously are normative.
According to Robbins, Economics is concerned only with the study of the economic
decisions of individuals and the society as positive facts but not with the ethics of these
decisions. Economics should be neutral between ends. It is not for economists to pass value
judgments and make pronouncements on the goodness or otherwise of human decisions.
An individual with a limited amount of money may use it for buying liquor and not milk, but
that is entirely his business. A community may use its limited resources for making guns
rather than crops, but it is no concern of the economists to condemn or appreciate this
policy. Economics only studies facts and makes generalizations from them. It is a pure and
positive science, which excludes from its scope the normative aspect of human behaviour.

Complete neutrality between ends is, however, neither feasible nor desirable. It is because
in many matters the economist has to suggest measures for achieving certain socially
desirable ends. For example, when he suggests the adoption of certain policies for
increasing employment and raising the rates of wages, he is making value judgments; or that
the exploitation of labour and the state of unemployment are bad and steps should be taken
to remove them. Similarly, when he states that the limited resources of the economy should
not be used in the way they are being used and should be used in a different way; that the
choice between ends is wrong and should be altered, etc. he is making value judgments.
(ii) Normative Science: As normative science, Economics involves value judgments. It is
prescriptive in nature and described 'what should be the things'. For example, the questions
like what should be the level of national income, what should be the wage rate, how the fruits
of national product be distributed among people - all fall within the scope of normative
science. Thus, normative economics is concerned with welfare propositions. Some
economists are of the view that value judgments by different individuals will be different and
thus for deriving laws or theories, it should not be used.

Subject matter of economics

Economics has subject mater of its own. Economics tells how a man utilizes his limited
resources for the satisfaction of unlimited wants. Man has limited amount of time and money.
He should spend time and money in such away that he derives maximum satisfaction. A
man wants food, clothing and shelter. To get these things he must have money. For getting
money he must make an effort. Effort leads to satisfaction. Thus, wants- efforts- satisfaction

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sums up the subject mater of economics initially in a primitive society where the connection
between wants efforts and satisfaction is direct .

Divisions of Economics
The subject matter of economics can be explained under two approaches viz., Traditional
approach and Modern approach.
Traditional Approach
It considered economics as a science of wealth and divided it into four divisions
viz., consumption, production, exchange and distribution

1. Consumption: It means the use of wealth to satisfy human wants. It also means the
destruction of utility or use of commodities and services to satisfy human wants.
2. Production: It is defined as the creation of utility. It involves the processes and methods
employed in transformation of tangible inputs (raw materials, semi3 finished goods, or
subassemblies) and intangible inputs (ideas, information, know how) into goods or services.
3. Exchange: It implies the transfer of goods from one person to the other. It may occur
among individuals or countries. The exchange of goods leads to an increase in the welfare
of the individuals through creation of higher utilities for goods and services.
4. Distribution: Distribution refers to sharing of wealth that is produced among the different
factors of production .It refers to personal distribution and functional distribution of income.
Personal distribution relates to the forces governing the distribution of income and wealth
among the various individuals of a country. Functional distribution or factor share distribution
explains the share of total income received by each factor of production viz., land, labour,
capital and organisation.

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Modern Approach – Microeconomics and macroeconomics - Methods of economic
investigation – Deduction &, Induction

Modern Approach:
This approach divides subject matter of economics into two divisions i.e., micro economics
and macro economics. The terms „micro-„ and „macro-„ economics were first coined and
used by Ragnar Frisch in 1933.

1. Micro-Economics or Price Theory:

The term „micro-economics ‟is derived from the Greek word „micro‟, which means small or a

millionth part. It is also known as „price theory‟. It is an analysis of the behaviour of small

decision-making unit, such as a firm, or an industry, or a consumer, etc. It studies only the
employment in a firm or in an industry. It also studies the flow of economic resources or
factors of production from the resource owners to business firms and the flow of goods and
services from the business firms to households. It studies the composition of such flows and
how the prices of goods and services in the flow are determined.

A noteworthy feature of micro-approach is that, while conducting economic analysis on a

micro basis, generally an assumption of „full employment‟ in the economy as a whole is

made. On that assumption, the economic problem is mainly that of resource allocation or of
theory of price.
Importance of Micro-Economics: Micro-economics occupies a very important place in the
study of economic theory.
 Functioning of free enterprise economy: It explains the functioning of a free enterprise
economy. It tells us how millions of consumers and producers in an economy take
decisions about the allocation of productive resources among millions of goods and
services.
 Distribution of goods and services: It also explains how through market mechanism
goods and services produced in the economy are distributed.
 Determination of prices: It also explains the determination of the relative prices of
various products and productive services.
 Efficiency in consumption and production: It explains the conditions of efficiency both in
consumption and production. Formulation of economic policies: It helps in the
formulation of economic policies calculated to promote efficiency in production and the
welfare of the masses.

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Limitations of Micro-Economics: Micro-economic analysis suffers from certain limitations:
 It does not give an idea of the functioning of the economy as a whole. It fails to analyse
the aggregate employment level of the economy, aggregate demand, inflation, gross
domestic product, etc.

 It assumes the existence of „full employment‟ in the whole economy, which is practically

impossible.

2. Macro-Economics or Theory of Income and Employment:

The term „macro-economics‟ is derived from the Greek word „macro‟, which means “large”.

Macro-economics is an analysis of aggregates and averages pertaing to the entire economy,

such as national income, gross domestic product, total employment, total output, total
consumption, aggregate demand, aggregate supply, etc. Macro-economics looks to the
nation's total economic activity to determine economic policy and promote economic
progress.

Importance of Macro-Economics:
 It is helpful in understanding the functioning of a complicated economic system. It also
studies the functioning of global economy. With growth of globalisation and WTO
regime, the study of macro-economics has become more important.
 It is very important in the formulation of useful economic policies for the nation to
remove the problems of unemployment, inflation, rising prices and poverty.
 Through macro-economics, the national income can be estimated and regulated. The

per capita income and the people‟s living standard are also estimated through

macroeconomic study.

Limitations of Macro-Economics:
 Individual is ignored altogether. For example, in macro-economics national saving is
increased through increasing tax on consumption, which directly affects the consumer
welfare.
 The macro-economic analysis overlooks individual differences. For instance, the
general price level may be stable, but the prices of food grains may have gone up which
ruin the poor. A steep rise in manufactured articles may conceal a calamitous fall in
agricultural prices, while the average prices were steady. The agriculturists may be
ruined.
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Positive Economics and Normative Economics:

1. Positive economics is concerned with „what is‟ whereas Normative economics is

concerned with „what ought to be‟.

2. Positive economics describe economic behaviours without any value judgment while
normative economics evaluate them with moral judgment.
3. Positive economics is objective while normative economics is subjective.
4. The statement, “Price rise as demand increase” is related to positive economics, whereas
the statement, “Rising prices is a social evil” is related to normative economics.

Agricultural Economics – Definitions, Meaning, Importance of Agricultural

Economics – Branches of agricultural economics

AGRICULTURAL ECONOMICS
Introduction
A study of economic principles, with emphasis on their application to the solution of farm,
agribusiness, and agricultural industry problems in relationship to other sectors is known as
Agricultural Economics. In other words, it applies principles of economics to issues of
agricultural production, natural resources, and rural development. It mainly focuses on
principles of microeconomics.
Agricultural economics began in the 19th century as a way to apply economic principles and
research methods to crop production and livestock management. The roots of the discipline,
however, can be found in the writings of the classical economists like Adam Smith.
The word, agriculture comes from the Latin word ager, referring to the soil and cultura, to its
cultivation. Agriculture, in its widest sense can be defined as the cultivation and /or
production of crop plants or livestock products. It is synonymous with farming: the field or
field –dependent production of food, fodder and industrial organic materials. Having known
the meaning of agriculture, let us know what economics is. Economics is the science that
studies as to how people choose to use scarce productive resources to produce various
goods and to distribute these goods to various members of society for their consumption.
Now having defined agriculture and economics, we look into the field of agricultural
economics.

Definition
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Agricultural economics is an applied field of economics in which the principles of choice are
applied in the use of scarce resources such as land, labour, capital and management in
farming and allied activities. It deals with the principles that help the farmer in the efficient
use of land, labour and capital. Its role is evident in offering practicable solutions in using
scarce resources of the farmers for maximization of income.
Prof. Gray has defined agricultural economics as “The science in which the principles and
methods of economics are applied to the special conditions of agricultural industry”
According to Prof.Hibbard, “Agricultural economics is the study of relationships arising from
the wealth-getting and wealth-using activity of man in agriculture”
Snodgras and Wallace defined agricultural economics as “an applied phase of social
science of economics in which attention is given to all aspects of problems related to
agriculture.”

Importance of agricultural economics

Akin to economics, the field of agricultural economics finds to seek relevance between cause
and effect using the most advanced methods viz, production functions and programming
models. It uses theoretical concepts of economics to provide answers to the problems of
agriculture and agribusiness. Initially earnest efforts were made by the economists to use the
economic theory to agricultural problems. Now the subject matters of agricultural economics
is enriched in many directions and fields taking the relevant tools of sciences particularly
mathematics and statistics. Agricultural depression which occurred in last quarter of 19th
century and middle of 20th century brought about increased attention and concern to find out
plausible cause and solutions for world agricultural depression. Here in this context the
contribution made by agronomists, economists, horticulturists, etc., is noteworthy. Agriculture
is the integral part of the world food system, having the foundation links between crops and
animal production system. Agricultural economists here have to play a major role in
understanding the intricacies involved in the foundation systems. Knowledge regarding
problems in production, finance, marketing and government policies and their impact on
production and distribution is very essential to find out suitable solutions for the farm
problems. Students of agricultural economics are taught the subject disciplines viz.,
microeconomics, macroeconomics, agricultural production economics, farm management,
agricultural marketing etc., to fulfill the requirements.

Basic problems of an economy/ the questions facing all economies

Following three questions have to face all economies:

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 1. What to produce? or which goods and services will be produced and in what
quantities? or problem of choice
2. How to produce? or how should the various goods and services be produced? or
problem of technology
3. For whom to produce? or how should the goods and services be distributed? or
problem of distribution
1. What to produce?
The first and major function of an economic system is to determine in some way the
actual quantities and varieties of goods and services that will best meet the wants of its
citizens.
2. How to produce?
Most goods and services can be produced by a variety of methods. Rice can be grown by
making use of more labor and less capital that means labor intensive technology, or by using
large amounts of capital and very little labor that means capital intensive technology. The
method of production of an economic system depends on its available resources. If labor is
available then it will adopt labor intensive technology or if capital is available then it will adopt
capital intensive technology.
3. For whom to produce?
The total output has to be shared out among the members of the society. The economic
system has to determine the relative sizes of the shares going to each household:
- Should everyone be given an equal share?
- Should the division depend upon the individual’s contribution to production?
- Should the output be shared out in accordance with people’s ability to pay for the
price?
Economic systems operating in the world
Three kinds of economic systems are operating in the world to solve the basic problems-
1. Market economy, or Capitalistic economy, or Free enterprise economy
2. Planned economy, or Command economy, or Collectivist economy, or
Socialistic economy
3. Mixed economy
1. Market economy
A market economy is one in which the government does not interfere on economic
activities of the people.
Characteristics
a. Private ownership of resources
b. Free enterprise economy
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 c. Consumers sovereignty
d. Maximum profit earning motive
e. Competition
f. Automatic price mechanism
g. A very limited role of the government
2. Planned economy
A planned economy is one in which the government makes the decisions on what to
produce, how to produce it and who gets it. In planned economy all lands, housing,
factories, offices, power stations, transport systems and so on are usually owned by the
state. The logic of public ownership in these societies is based upon the desire for a
fairer distribution of income and wealth. Private ownership of property leads to great
inequalities of wealth.
Characteristics
a. State ownership of resources
b. Absence of individual profit
c. Social welfare
d. Central planning
e. Social safety
f. Distribution of output according to his work
3. Mixed economy
A mixed economy is one where the both the public sector and private sector make the
decision on what to produce, how to produce it and who gets it.
Characteristics
a. Both private and state ownership of resources
b. Social welfare
c. Consumer sovereignty
d. Moderate role of the government
e. Competition
Country types based on economic development
There are two types of country in the world based on economic development-
1. Developed country
2. Under developed country or developing country
1. Developed country
Developed countries are those where the per capita income and standard of living
are high by the means of modernized and improved production technology and the
proper use of natural and human resources.
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Characteristics
a. High level of per capita income
b. High level of standard of living
c. Industrial economy
d. Modern and improved technology
e. High rate of education
f. Proper use of natural resources
g. Efficient human resources
h. Modernized agricultural system
i. Political stability
j. Improved socio-economic infrastructure
2. Underdeveloped/ developing country
An underdeveloped country is one in which per capita real income is lower than
developed economy like U.S.A, Canada, Australia, European countries.
Underdeveloped country is one which is poor but which has future possibility and
prospect of removing poverty and raising the levels of living of its people by utilizing the
idle and unutilized resources for production.
Characteristics
a. Lower level of per capita income
b. Lower level of standard of living
c. Poverty
d. Excessive dependence on agriculture
e. Industrial backwardness
f. Poor socio-economic infrastructure
g. Political unrest
h. Corruption
i. Income inequality
j. Lower investment
k. Technological backwardness
l. Inefficient labor force

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Lecture 4 : BASIC TERMS AND CONCEPTS IN ECONOMICS

Goods: All material and non-material commodities that have the capacity to satisfy wants.
It is defined as anything that satisfies human wants or needs.
Characteristic features of goods:
1. They are tangible in nature
2. They are the material outcome of production
Example: Foodgrains, Machinery, Seeds, Fertilizers etc.,

Classification of Goods
The goods are classified based on supply, durability, consumption and transferability.
1) Based on Supply: The goods are categorized as economic goods and free goods
based on the supply criteria. Free goods are those goods that exist in lenty that can be used
as much as we like. They are gifts of nature and used without payment Example: Air,
sunshine etc. The economic goods, on the other hand, are scarce and can be had only on
payment. They are limited and generally man- made and hence those can be available only
on payment. In Economics, we are concerned with economic goods only. Economic goods
mean wealth. Thus there would have been no science of economics if all goods had been
free goods. The distinction between free goods and economic goods, of course is not
permanent, for instance air is a free good but when we receive it under fan it is an economic
good.

2) Based on Consumption: The Goods are categorized as Consumer goods and Producer
Goods. Consumer goods are those which yield, satisfaction directly. They are used by
consumer directly to satisfy the wants Example: food, clothing, etc. These goods are known
as the Goods of First order. Producer goods are these goods which help us to produce other
goods. They give satisfaction indirectly by producing other goods which will yield final
satisfaction. Example: machinery, tools etc. They are also termed goods of the second
order.

3) Based on Durability: This classification emphasized on the nature of the goods and their
usage. Mono Period Goods are those goods which can be used only once in the production
and consumption process. Example: Seeds, Fertilizers, food etc., Poly Period Goods are
those which can be used repeatedly during the production and consumption process over
several periods. Example: refrigerator machinery, implements etc.

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4) Based on Transferability:
 External Material Transferable good. Example: Land, Buildings etc.,
 External material non-Transferable good. Example: Degree Certificate, PAN Card
etc.,
 External non material transferable good. Example: Goodwill of a business
 External non material Non-transferable good. Example: Friendship,light
 Internal non material Non-Transferable good. Example: Intelligence Quotient ,ability,
cruelty etc.,

Services: Services would be the performance of any duties or work for another or
professional activity.
Characteristic Features of Services:
1. They are intangible
2. Non- Materialistic
3. Inseparable
4. Variable
5. Perishable
Example: Services rendered by agricultural labourers, doctors, teachers etc.,

Value and wealth

Value
The word “Value” in economics conveys value-in-exchange. It does not include free goods
which have only value-in-use. In other words, value of a commodity refers to those goods
that can be obtained in exchange for itself or purchasing power of a commodity in terms of
other commodities and services. Value can be referred to as the capacity of a good to
command other things in exchange.

Characteristics of Value.
1. It must possess utility
2. It must be scarce and
3. It must be transferable and marketable.
Price
In Pre historic times, people did not know money and they had a barter system in which
goods are exchanged with goods. Therefore, in those days value and price were used

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synonymously. But now days, goods are exchanged for money. Therefore, Value expressed
in monetary terms is Price

Wealth
In ordinary language, “Wealth” conveys an idea of prosperity and abundance. A man of
wealth understood as a rich person. But in Economics Wealth is synonymous with economic
goods. In short, Wealth means anything which has value.
Definition: It consists of all potentially exchangeable means of satisfying human wants
(J.M.Keynes)
Characteristics of wealth:
1. It should possess utility
2. It must be scarce
3. It must be transferable
4. It must be external to person
Relation between Money and Wealth: Money is a form of wealth .All money is wealth but
all wealth is not money

Types of Wealth:
1. Individual Wealth: It consists of all tangible and intangible possessions of the individuals
besides loans due to them. Example: Land, bonds, deposits are tangible possessions
while, intangible possessions are copyrights, patents etc.
2. Social Wealth: It is the wealth, which is collectively used by all the people in a nation.
Example: Railways, Public Parks, Government colleges etc.
3. Representative Wealth: It is that form of wealth in the form of title deeds
4. National Wealth: It is an aggregate of all individuals wealth and social wealth of the
country inclusive of loans due to people and to the nation debts have to be deducted.
Example: Rivers, mountains.
5. Cosmopolitan Wealth: It is wealth of the whole word. It is a sum total wealth of all
nationals.
6. Negative Wealth: It refers to the exclusive debts owed by the individuals and the nation.

Wealth and Welfare compared

Wealth Welfare
It is the means to an end It is the end itself
It is objective It is subjective
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It includes harmful goods It does not include harmful goods
It does not include free goods Free and economic goods lead to welfare

Wants: Desire to have any materials and non-materials commodities.

Classification of wants:
1.Necessary-Necessaries for existence. eg. minimum food, minimum clothing etc.
Necessaries for efficiency. eg. nutritious food and education.
Necessaries for convention. eg. Tea, cigarette
2. Comforts. eg. worm clothing, electric fan in the factory.
3. Luxury. eg. valuable car, air condition for a student.

UTILITY
The basis of consumer behaviour is that people tend to choose those goods and services
they value high. Based on this premise economists developed the notion of utility to describe
the consumption patterns adopted by the consume Tk.
Definition: Utility means the power to satisfy a human want. Any commodity or service which
can satisfy a human want is said to have utility

Characteristics of Utility:
1. Utility is subjective: Utility varies from person to person, for Eg:- A high yielding variety
seed gives more utility to the farmer. The same seed provided to a cloth merchant gives
zero utility.
2. Utility varies with purpose: For Eg:- Coconut oil is used as coking oil or hair oil or as
lubricant.

3. Utility varies with time: The Intensity of a person‟s desire for a commodity is different at

various time periods, for Eg:- Labour requirement for paddy is peak during
transplantation harvesting and threshing period than other operations taken up in paddy
cultivation.
4. Utility varies with ownership: Ownership of a good creates greater utility from a good
than when it is hired Eg:- owning a tractors gives more utility than hiring it.
5. Utility need not be synonymous with pleasure: For Eg:- A sick man has to consume
medicines for getting cured. He does not get pleasure during the process.
6. Utility does not mean satisfaction: utility is distinct from satisfaction. It implies potentiality
of satisfaction in a given commodity. But the satisfaction is the end result of

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 consumption. Satisfaction is what we get and the utility is the quality in agood which
gives satisfaction.

KINDS OR TYPES OF UTILITY

The kinds or types of utilities are 1)Form utility 2) Place utility 3) Time utility and 4)
Possession utility.
1. Form Utility: The Change in the form offers greater utility to the good than in its original
form. For example: Processing of paddy into rice. Rice, fetches superior price than
paddy because of processing.
2. Place Utility: The utility obtained by spatial movement of the goods is termed as place
utility. Transportation aids in place utility i.e., through the transfer of goods from surplus
production area to deficit or slack areas. Example: Shimla apples are transported to all
parts of the country thereby increasing the utility of apples.
3. Time utility: Storing the commodity at the times of surplus production and make them
available during scarcity creates time utility. Storage aids in creation of time utility by the
supply of seasonal products during off season as per the consumers requirements.
4. Possession Utility: The Utility obtained due to possession or transfer of ownership of the
commodity is called possession utility. Buying and selling creates possession utility. For
Eg:- Agriculture land sold to real estate for plots would increase the utility for the same
piece of land.

Cardinal and Ordinal Utility

Cardinal utility: This is based on the premise that utiIity could be measured and can be
aggregated across individuals. It quantitatively measures the preference of an individual
towards a certain commodity. Numbers assigned to different goods or services can be
compared. A utility of 100 units towards a cup of coffee is twice as desirable as a cup of tea
with a utility level of 50 units. The only limitation is its subjectivity.
Ordinal utility: this is the ordinal measurement of utility. According to this utility can not\ be
quantified. For Example: If the utility is 100 units towards a cup of coffee and 50 units for a
cup of tea, the conclusion drawn is that Coffee is preferred over tea. The ordering is
important rather than the magnitude of the numerical values like 100 and 50 in the given
instance. This approach faces the limitation of utilities not being compared.

Want vs. Need

A need is something you have to have, something you can't do without. A good example is
food. If you don't eat, you won't survive for long. Many people have gone days without
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eating, but they eventually ate a lot of food. You might not need a whole lot of food, but you
do need to eat.
A want is something you would like to have. It is not absolutely necessary, but it would be a
good thing to have. A good example is music. Now, some people might argue that music is a
need because they think they can't do without it. But you don't need music to survive. You do
need to eat.

Capital
Capital refers to sums of money or assets put to productive use. Capital, in the form of
money seeking to expand itself through investment, forms the basis of capitalism.[1]

In economics, capital goods, or real capital are those already-produced durable goods that
are used in production of goods or services. The capital goods are not significantly
consumed, though they may depreciate in the production process. Capital is distinct from
land in that capital must itself be produced by human labor before it can be a factor of
production. At any moment in time, total physical capital may be referred to as the capital
stock (which is not to be confused with the capital stock of a business entity.) In a
fundamental sense, capital consists of any produced thing that can enhance a person's
power to perform economically useful work—a stone or an arrow is capital for a caveman
who can use it as a hunting instrument, and roads are capital for inhabitants of a city. Capital
is an input in the production function. Homes and personal autos are not capital but are
instead durable goods because they are not used in a production effort.

Capital budgeting (or investment appraisal) is the planning process used to determine
whether an organization's long term investments such as new machinery, replacement
machinery, new plants, new products, and research development projects are worth
pursuing. It is budget for major capital, or investment, expenditures.
The process in which a business determines whether projects such as building a new plant
or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's
lifetime cash inflows and outflows are assessed in order to determine whether the returns
generated meet a sufficient target benchmark.

Investment
1. In finance, the purchase of a financial product or other item of value with an expectation of
favorable future returns. In general terms, investment means the use money in the hope of
making more money.

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2. In business, the purchase by a producer of a physical good, such as durable equipment or
inventory, in the hope of improving future business.

Production: Creation of utility with exchange value.

Factors of production: Land, labour, capital and organization.

Distribution: Accounts for sharing of wealth among the agents or the owners of the agents
which have been active in its production.
Rent for land
Wage for labour
Interest for capital and
Profit for organization

Hypothesis: Hypothesis are those which are considered as true and needed to be
considered whether it is true or false.
Theory: When a hypothesis becomes true for a long time then it is called theory. eg.
Malthusian theory of population.
Law: When a hypothesis becomes true forever then it is called law. eg. law of demand.
Firm: Accumulation of all the pruducing units, producing the same commodity under single
ownership is called firm. eg. Kabir poultry firm.
Industry: Accumulation of all the pruducing units, producing the same commodity under
different ownership is called industry. eg. Bangladesh poultry industry.
Equilibrium: Equilibrium is the state of balance from which no deviation is desired.

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DEMAND ANALYSIS

Lecture 7: Aims and Objectives, Introduction, Meaning of Demand, Determinants of

Demand

AIMS AND OBJECTIVES

After having studied this unit, you should be able
 To understand the concept of demand
 To identify the determinants of the demand for a commodity
INTRODUCTION
This lesson examines demand and its determinants. Demand is the force that drives all
business without a demand for its goods or services; a firm is doomed to failure.

MEANING OF DEMAND
In economic science, the term "demand" refers to the desire, backed by the necessary ability
to pay. The demand for a good at a given price is the quantity of it that can be bought per
unit of time at the price. There are three important things about the demand: 1. It is the
quantity desired at a given price. 2. It is the demand at a price during a given time. 3. It is the
quantity demanded per unit of time.
Consumers cannot satisfy or afford all of their wants due to limited resources. So he has to
decide about his wants which can be satisfied by his means. Demand reflects the decision
about which want to satisfy. That is, the affordable wants are considered as demand. So,
consumer has demand for commodity X means-

i) The consumer has want or desire for commodity x

ii) The consumer has sufficient purchasing power to buy the commodity
iii) The consumer is willing to pay money for that commodity

So, desire or wants is changed into demand when the consumer is willing and able to pay for
what he desires.

Components of demand
Demand has three components:
i) Desire to have the commodity
ii) Ability to pay money for that commodity
iii) Willingness to pay money for that commodity
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Definition of demand
Demand means the various quantities of a given commodity or service which consumers
would buy in one market in a given period of time at various prices.

DETERMINANTS OF DEMAND
The factors that determine the size and amount of demand are manifold. The term "function"
is employed to show such "determined" and "determinant" relationship. For instance, we say
that the quantity of a good demanded is a function of its price
i.e., Q = f(p)
Where Q represents quantity demanded
f means function, and
p represents price of the good.

There are many important determinants of the demand for a commodity:

1. Price of the goods: The first and foremost determinant of the demand for good is price.
Usually, higher the price of goods, lesser will be the quantity demanded of them.
2. Income of the buyer: The size of income of the buyers also influences the demand for a
commodity. Mostly it is true that "larger the income, more will be the quantity demanded".
3. Prices of Related Goods: The prices of related goods also affect the demand for a good.
In some cases, the demand for a good will go up as the price of related good rises. The
goods so inter-related arc known as substitutes, e.g. radio and gramophone. In some other
cases, demand for a good will comes down as the price of related good rises. The goods so
inter-related are complements, e.g. car and petrol, pen and ink, cart and horse, etc.
4. Tastes of the buyer: This is a subjective factor. A commodity may not be purchased by
the consumer even though it is very cheap and useful, if the commodity is not up to his taste
or liking. Contrarily, a good may be purchased by the buyer, even though it is very costly, if it
is very much liked by him.
5. Seasons prevailing at the time of purchase; In winter, the demand for woolen clothes
will rise; in summer, the demand for cool drinks rises substantially; in the rainy season, the
demand for umbrellas goes up.
6. Fashion: When a new film becomes a success, the type of garments worn by the hero or
the heroine or both becomes an article of fashion and the demand goes up for such
garments.

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7. Advertisement and Sales promotion: Advertisement in newspapers and magazines, on
outdoor hoardings on buses and trains and in radio and television broadcasts, etc. have a
substantial effect on the demand for the good and thereby improves sales.
The need to have clarity in demand analysis makes us adopt a 'ceteris paribus' assumption,
i.e. all other things remain the same except one. This enables us to consider the relation
between demand and each of the variable factors considered in isolation.

Factors affecting demand

1. Price of own commodity
2. Price of other commodity
3. Expectations or anticipations
4. Changes in size of population
5. Composition of population
6. Changes in income
7. Changes in the distribution of income
8. Weather and climate
9. Changes in savings
10. Asset preferences
11. Trade cycle

LET US SUM UP
We have studied that the term demand refers to the quantities of goods that consumers are
willing and able to purchase at various prices during a given period of time. Also we
identified the various vital determinants of the demand for a commodity.

LESSON-END ACTIVITIES
1. Identify and discuss the various determinants of the demand for acommodity.

REFERENCES
1. Petersen, H. Craig and W. Cris Lewis, Managerial Economics,m Pearson Education Asia.
2. Sankaran, Business Economics.
3. Mote, V.L. Samuel Paul and G.S. Gupta “Managerial Economics.

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Page 27 of 82
Lesson: 7 LAW OF DEMAND

Lecture 8: Aims and Objectives, Introduction, Law of Demand, Demand Schedule, Demand
Curve, Market Demand, Shifts in Demand Curve, Why the demand curve slopes
downward?, Exceptions to the law of demand, Types of Demand, Extension and Contraction
of demand, Shift in demand, other types of demand, Indifference Curve analysis and
Consumer’s equilibrium, Let Us Sum Up, Lesson-End Activities, References

AIMS AND OBJECTIVES

After having studied this lesson, you should be able
 To understand the relation of price to sales
 To know about the reasons for the Law of Demand
 To sort out certain cases where the Law of demand does not hold good
 To know the various types of demand
 To explain consumer’s demand through indifference curve analysis

INTRODUCTION
For a long period of time economists are much interested to study the relationship of price
and sales. An in depth knowledge of such relationship is necessary for the management

Law of Demand
Among the many causal factors affecting demand, price is the most significant and the price-
quantity relationship called as the Law of Demand is stated as follows: "The greater the
amount to be sold, the smaller must be the price at which it is offered in order that it may find
purchasers, or in other words, the amount demanded increases with a fall in price and
diminishes with a rise in price" (Alfred Marshall). In simple words other things being equal,
quantity demanded will be more at a lower price than at higher price. The law assumes that
income, taste, fashion, prices of related goods, etc. remain the same in a given period. The
law indicates the inverse relation between the price of a commodity and its quantity
demanded in the market. However, it should be remembered that the law is only an
indicative and not a quantitative statement. This means that it is not necessary that such
variation in demand be proportionate to the change in price.

Demand Schedule
It is a list of alternative hypothetical prices and the quantities demanded of a good
corresponding to these prices. It refers to the series of quantities an individual is ready to

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buy at different prices. An imaginary demand schedule of an individual for guava is given
below:

Table 1. Demand of a Consumer for guava

Price of guava per unit (in taka) Quantity demanded of guava (pcs)
5 1
4 2
3 3
2 4

Assuming the individual to be rational in his purchasing behaviour, the above schedule
illustrates the law of demand. At Tk.5/- per guava, the consumer demands 1 piece of guava;
at Tk.4/- per unit 2 pieces, at Tk.3/- per unit 3 pieces and at Tk.2/~ per unit 4 pieces. Thus
the inverse relationship between price and demand is shown in the demand schedule.

Demand Curve
When the data presented in the demand schedule can be plotted on a graph with quantities
demanded on the horizontal or X- axis and hypothetical prices on the vertical or Y- axis, and
a smooth curve is hypothetical prices on the vertical or Y- axis, and a smooth curve is drawn
Joining all the points so plotted, it gives a demand curve. Thus, the demand schedule is
translated into a diagram known as the demand curve.

Fig -1
The demand curve slopes downwards from left to right, showing the inverse relationship between
price and quantity as in Figure 1.

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Market Demand
The market demand reflects the total quantity purchased by all consumers at alternative
hypothetical prices. It is the sum- total of all individual demands. It is derived by adding the
quantities demanded by each consumer for the product in the market at a particular price.
The table presenting the series of quantities demanded of all consumers for a product in the
market at alternative hypothetical prices is known as the Market Demand Schedule. If the
data are represented on a two dimensional graph, the resulting curve will be the Market
Demand Curve. From the point of view of the seller of the product, the market demand curve
shows the various quantities that he can sell at different prices. Since the demand curve of
an individual is downward sloping, the lateral addition of such curves to get market demand
curve will also result in downward sloping curve.

Shifts in Demand Curve

The price-quantity relationship represented by the law of demand is important but it is more
important for the manager of the firm to know about the shifts in the demand function (or
curve). For many products, change in price has little effect in the quantity demanded in
relevant price ranges. Many other determinants like incomes, tastes, fashion, and business
activity have larger effect on demand for such product. Thus, changes or shifts in demand
curve rather than movement along the demand curve is of greater significance to the
decision-maker in the firm.
Let us clearly know the difference between movement along one and the same demand
curve and shift in demand curve due to changes

Fig: 2a

in demand. When price of a good alone varies, ceteris paribus, the quantity demanded of the
good changes. These changes due to price variations alone are called as extension or
contraction of demand represented by movement along the same demand curve. Such
movement along the same demand curve is shown in Figure 2(a). Price declines from OP1
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to OP2 and demand goes up from OM1 to OM2. Here the demand for the good is said to
have extended or expanded. This is represented by movement from point A to point B along
the demand curve. On the contrary, if price rises from OP2 to OP1 demand falls from OM2
to OM1. Here the demand for the good is said to have contracted. This is represented by
movement from point B to point A along the demand curve D1D1.

Shift in Quantity Demanded

Shifts in demand curve take place on account of determinants other than price such as
changes in income, fashion, tastes, etc. The ceteris paribus assumption is relaxed; other
factors than price influence demand and the impact of these factors on demand is described
as changes in demand or shifts in demand, showing increase or decrease in demand. This
kind of change is shown in Figure 2(b). The quantity demanded at OP1 is OM1. If, as a
result of increase in income, more of the product is demanded, say OM2 at the same price
OP1. Note that OM2 is due to the new demand curve D2D2. This is a case of shift in
demand. Due to fall in income, less of the good may be demanded at the same price and
this will be a case of decrease in demand. Thus increase or decrease in demand with shifts
in demand curves upward or downward are different from extension or contraction of
demand.
Price per Unit

Quantity of Demand

Causes of changes in demand may be due to:

1. Changes in the consumer's income.
2. Changes in the tastes of the consumer.
3. Changes in the prices of related goods (substitutes and complements).
4. Changes in exogenous factors like fashion, social structure, etc.

Why the Demand Curve Slopes Downward or Reasons for the Law of Demand
Truly, the demand curve slopes left downward to right, throughout its length although the
slope may be much steeper in some parts. It means, demand increases with the fall in price
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and contracts with an increase in price. There are several reasons responsible for the
inverse price demand relationship which has been explained as under:
1. Law of Diminishing Marginal Utility. The law of demand is based on the law of
diminishing marginal utility which states that as the consumer purchases more and more
units of a commodity, the utility derived from each successive unit goes on decreasing. It
means as the price of the commodity falls, consumer purchases more of the commodity so
that his marginal utility from the commodity falls to be equal to the reduced price and vice-
versa.
2. Substitution Effect. Substitution effect also leads the demand curve to slope from left
downward to right. As the price of a commodity falls, prices of its substitute goods remain the
same, the consumer will buy more of that commodity. For instance, tea and coffee are the
substitute goods. If the price of tea goes down, the consumers may substitute tea for coffee,
although price of coffee remains the same. Therefore, with a fall in price, the demand will
increase due to favourable substitution effect. On the other hand with the rise in price, the
demand falls due to unfavourable substitution effect. This is nothing but the application of
Law of Demand.
3. Income Effect. Another reason for the downward slope of demand curve is the income
effect. As the price of the commodity falls, the real income of the consumer goes up. Real
income is that income which is measured in terms of goods and services. For example, a
consumer has Tk.400, he wants to buy mango whose price is Tk.80 per kg. It means the
consumer can buy 5 kg of mango with his fixed income. Now, suppose the price of the
mango falls to Tk.50 per kg which leads to an increase in his real income by Tk.150. In this
case, either the consumer will buy 8 kg of mango or he will buy some other commodity with
his increased income.
4. New Consume. When the price of commodity falls, many other consumers who were not
consuming that commodity previously will start consuming the commodity. As a result, total
market demand goes up. For example, if the price of mobile set falls, the poor man can buy
the mobile set. Consequently, the total demand for mobiles goes up.
5. Several Uses. Some commodities can be put to several uses which lead to downward
slope of the demand curve. When the price of such commodities goes up they will be used
for important purposes, so their demand will be limited. On the other hand, when the price
falls, the commodity in question will extend its demand. For instance, when the price of coal
increases, it will be used for important purposes but as the price falls its demand will
increase and it will be used for many other uses.
6. Psychological Effects. When the price of a commodity falls, people favor to buy more
which is natural and psychological. Therefore, the demand increases with the fall in prices.
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For example, when the price of China 3 Litchi falls, it is purchased for all the members of the
family.

EXCEPTIONS TO THE LAW OF DEMAND

The Law of Demand will not hold good in certain peculiar cases in which more will be
demanded at a higher price and less at a lower price. In these cases the demand curves will
be exceptionally different, differing from the usual downward sloping shape of the demand
curve. The exceptions are as follows:
(i) Conspicuous goods: Some consumers measure the utility of a commodity by its price
i.e., if the commodity is expensive they think that it has got more utility. As such, they buy
less of this commodity at low price and more of it at high price. Diamonds are often given as
example of this case. Higher the price of diamonds, higher is the prestige value attached to
them and hence higher is the demand for them.
ii) Giffen goods: Sir Robert Giffen, an economist, was surprised to find out that as the price
of bread increased, the British workers purchased more bread and not less of it. This was
something against the law of demand. Why did this happen? The reason given for this is that
when the price of bread went up, it caused such a large decline in the purchasing power of
the poor people that they were forced to cut down the consumption of meat and other more
expensive foods. Since bread even when its price was higher than before was still the
cheapest food article, people consumed more of it and not less when its price went up.
Such goods which exhibit direct price-demand relationship are called 'Giffen goods'.
Generally those goods which are considered inferior by the consumers and which occupy a
substantial place in consumer's budget are called 'Giffen goods'. Examples of such goods
are coarse grains like Parija and low quality of rice etc.
(iii) Future expectations about prices: It has been observed that when the prices are
rising, households expecting that the prices in the future will be still higher tend to buy larger
quantities of the commodities. For example, when there is wide-spread drought, people
expect that prices of food grains would rise in future. They demand greater quantities of food
grains as their price rise. But it is to be noted that here it is not the law of demand which is
invalidated but there is a change in one of the factors which was held constant while deriving
the law of demand, namely change in the price expectations of the people.
(iv) The law has been derived assuming consumers to be rational and knowledgeable about
market-conditions. However, at times consumers tend to be irrational and make impulsive
purchases without any cool calculations about price and usefulness of the product and in
such contexts the law of demand fails.

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(v) Similarly, in practice, a household may demand larger quantity of a commodity even at a
higher price because it may be ignorant of the ruling price of the commodity. Under such
circumstances, the law will not remain valid. The law of demand will also fail if there is any
significant change in other factors on which demand of a commodity depends. If there is a
change in income of the household, or in prices of the related commodities or in tastes and
fashion etc. the inverse demand and price relation may not hold good.

TYPES OF DEMAND
There are three types of demand. They are
 Price Demand
 Income Demand and
 Cross Demand which are explained below:

1. Price Demand
It refers to the various quantities of the good which consumers will purchase at a given time
and at certain hypothetical prices assuming that other conditions remain the same. We are
generally concerned with price demand only. In the explanation of the law of demand given
above, we dealt in detail with price demand only.

Fig - 3

Income demand: Income demand refers to the various quantities of a commodity that a
consumer would buy at a given time at various levels of income. Generally, when the income
increases, demand increases and vice versa.

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 Fig – 4

Cross Demand: When the demand of one commodity is related with the price of other
commodity is called cross demand. The commodity may be substitute or complementary.

Fig – 5a Fig – 5b
Substitute goods are those goods which can be used in case of each other. For example,
tea and coffee, Coca-cola and Pepsi. In such case demand and price are positively related.
This means if the price of one increased then the demand for other also increases and vise
versa. Complementary goods are those goods which are jointly used to satisfy a want. In
other words, complementary goods are those which are incomplete without each other.
These are things that go together, often used simultaneously. For example, pen and ink.
Tennis rackets and tennis balls, cameras and film, etc. In such goods the price and demand
are negatively related. This means when the price of one commodity increases the demand
for the other falls.

Extension and Contraction of Demand

The change in demand due to change in price only (when other factors remain constant) is
called extension and contraction of demand. Increase in demand due to fall in price is called
extension of demand. Decrease in demand due to rise in price is called contraction of
demand. Extension and Contraction of demand results in movement on the same demand
curve. It is shown in the following diagram.

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 Fig-6
When price is OP, the quantity demanded is OQ. Suppose the price falls from OP Fig – 6 to
0P2 demand will be increased to OQ2 . This is a downward movement along the demand
curve DD from a to c. This indicates extension of demand. When the price rises to OP1 , the
demand will be decreased to OQ1 this is an upward movement along the demand curve from
a to b. This indicates contraction of demand.

Shift in Demand
We have seen that the demand depends not only on price but also on other factors like
income, population, taste and preference of consumers etc. The change in demand due to
change in any of the factors other than the price is'called shift in demand. Change in any one
of the factors shifts the entire demand curve. A change in demand will shift the demand
curve either upwards or downwards. An upward shift in demand curve is called increase in
demand. Downward shift in demand curve is called decrease in demand. Shift in demand is
shown in the following diagram.

Quantity Demand
Fig - 7
In the given figure DD is the original demand curve. When the demand increases, (e.g., due
to increase in income) the curve will shift upwards to D2D2 without any increase in price. It is
constant at OP. Similarly when the demand decreases, (e.g., due to decrease in income) the
curve will shift downwards to D1D1. The price remains constant. Thus extension of demand
is different from increase in demand. Likewise, contraction of demand doesn't mean
decrease in demand.
It should be noted that exclusion and contraction of demand is called "change in quantity
demanded" and shift in demand is called "change in demand".

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Other Types of Demand
Joint demand: When several commodities are demanded for a joint purpose or to satisfy a
particular want. It is a case of a joint demand. Milk , sugar and tea dust are jointly demanded
to make tea. Similarly, we may demand paper, pen and ink for writing. Demand for such
commodities in bunch is known as joint demand. Demand for land, labour, capital and
organisation for producing commodity is also a case of joint demand.
Composite demand: The demand for a commodity which can be put to several uses is a
composite demand. In this case a single product is wanted for a number of uses. For
example, electricity is used for lighting, heating, for running the engine, for the fans etc.
Similarly coal is used in industries, for cooking etc.
Direct and Derived demand: The demand for a commodity which is for direct consumption,
i.e.. Demand for ultimate object, is called direct demand, e.g food, cloth, etc. Direct demand
is called autonomous demand. Here the demand is not linked with the purchase of some
main products. When the commodity is demanded as a result of the demand for another
commodity or service, it is known as the derived demand or induced demand. For example,
demand for cement is derived from the demand for building construction; demand for tires is
derived from the demand for cars or scooters, etc.

Importance of the Law of Demand

The law of demand plays a crucial role in decision-making and forward planning of a
business unit. The production planning in a firm mainly rests on accurate demand analysis.
The law of demand has theoretical as well as practical advantages. These are as follows:
1. Price determination: With the help of law of demand a farm fixes the price of his
product. He is able to decide the most profitable quantity of output for him.
2. Useful to government: The finance minister takes the help of this law to know the
effects of his tax reforms and policies. Only those commodities which have relatively
inelastic demand should be taxed.
3. Useful to farmers: From the law of demand, the farmer knows how far a good or
bad crop will affect the economic condition of the farmer. If there is a good crop and
demand for it remains the same, price will definitely go down. The farmer will not
have much benefit from a good crop, but the rest of the society will be benefited.
4. In the field of planning: The demand schedule has great importance in planning for
individual commodities and industries. In such cases it is necessary to know whether
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a given change in the price of the commodity will have the desired effect on the
demand for commodity within the country or abroad. This is known from a study of
the nature of demand schedule for the commodity.

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Supply
Supply means the quantity of a good or service offered by a seller at different prices in a
given market at a point of time.

Stock
Supply and stock are not same. Stock is the total volume of a commodity, which can be
brought into the market for sale at a short notice and supply means the quantity, which is
actually brought in the market.

Supply schedule
Supply schedule shows the various quantities of goods supplied at various prices in a table.
It is of two types-

i) Individual supply schedule: When a supply schedule is prepared for an individual

seller is called individual supply schedule.
ii) Market supply schedule: When a supply schedule is prepared considering all the
sellers of a market is called market supply schedule.

Supply curve
Graphical representation of a supply schedule is called supply curve.

Law of supply
Other things remaining the same, if price decreases supply will decrease and if price
increases supply will increase. This is the law of supply.

Contraction and extension in supply

When supply is decreased due to fall in price is called contraction in supply. When supply is
increased due to rise in price is called extension in supply. In such cases consumer moves
along the same supply curve.
Movement along the supply curve happens due to change in the price of the good
and resulting change in the quantity supplied at that price. For instance, an increase in the
price of the good from P1 to P2 in the figure below results in an increase of quantity supplied
of the good from Q1 to Q2. This movement from point A to point B on the supply curve S due
to change in price of the good all other factors of supply remaining unchanged is called
movement along the supply curve.

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Decrease and increase in supply
When supply is decreased due to change in any other factors except price is called
decrease in supply. When supply is increased due to change in any other factors except
price is called increase in supply. In such cases the supply curve is shifted upward or
downward.

Factors affecting changes in supply:

The factors causing Shifts in supply curve are
1. Changes in Factor Prices: If the prices of the various factors of production fall down, it
will result in lowering the cost of production and so an increase in the supply on varying
prices.
2. Changes in Technique: If an improvement in technique takes place in a particular
industry, it will help in reducing its cost of production. This will result in greater
production and so an increase in the supply of the commodity. The supply curve will
shifts to the right of the original supply curve.
3. Improvement in the Means of Transport: The supply of the commodity may also
increase due to improvement in the means of communication and transport. If the
means of transport are cheap and fast, then supply of the commodity can be increased
at a short notice at lower price.
4. Climatic Changes in case of Agricultural Products: The supply of agricultural products is
directly affected by the weather conditions and the use of the better methods of
production. If rain is timely, plentiful, well-distributed and improved methods of
cultivation are employed then other things remaining the same, there will be bumper
crop. It would then be possible to increase the supply of the agricultural products.
5. Political Changes: The increase or decrease in supply may also take place due to
political disturbances in a country. If country wages wars against another country or
some kind of political disturbances take place just as we had at the time of partition,
then the channels of production are disorganized. It results in the decrease of certain
goods the supply curve shifts to the left of originals curve.
6. Taxation Policy: If a government levies heavy taxes on the import of particular
commodities, then the supply of these commodities is reduced at each price. The
supply curve shifts to the left, conversely, if the taxes on output in the country are low
and government encourages the import of foreign commodities, then the supply can be
increased easily. The supply curve shifts to the right of original supply curve.

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7. Goals of firms. If the firms expect higher profits in the future, they will take the risk and
produce goods on large scale resulting in larger supply of the commodities. The supply
curve shifts to the right.

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 ELASTICITY OF DEMAND
CONTENTS: Aims and Objectives, Introduction, Elasticity of Demand, Definition of Price
Elasticity of Demand, Factors determining Price Elasticity of Demand, Measurement of Price
Elasticity of Demand, Income Elasticity of Demand, Cross Elasticity of Demand, Importance
of Elasticity of Demand, Let us sum up, References

AIMS AND OBJECTIVES

After having studied this lesson you should be able
 To Understand the concept of Elasticity
 To Know the different kinds of Elasticity of demand
 To acquire knowledge on the importance of elasticity of demand

INTRODUCTION
In this lesson a detailed discussion regarding el sticities as a measure of the responsiveness
of one item to changes in another item is made. Elasticity is a common concept that
economists, Business people and others rely upon for the measurement between two
variables say for example the ratio of percentage change in quantity demanded to
percentage change in some other factor like Price or Income.

Elasticity of Demand
The concept of price-elasticity of demand was first of all introduced in economics by Dr.
Marshall. In simple words, price elasticity of demand is the ratio of percentage change in
quantity demanded to the percentage change in price. In other words, price elasticity of
demand is a measure of the relative change in quantity purchased of a good in response to
a relative change in its price. It is, thus a rate at which the demand changes to the given
change in prices. So, it means the rate or the degree of response in demand to the change
in price. Thus, the co-efficient of price-elasticity of demand can be expressed as under:

Ed = Proportionate change in quantity demanded / Proportionate change in price

Price Elasticity of Demand

The concept of price elasticity of demand has been defined by different economists as
under:
According to Alfred Marshall "Elasticity of demand may be defined as the percentage
change in quantity demanded to the percentage change in price"
According to A.K. Cairncross "The elasticity of demand for a commodity is the rate at which
quantity bought changes as the price changes"
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According to J.M. Keynes: "The elasticity of demand is a measure of the relative change in
quantity to a relative change in price"
According to Kenneth Boulding: "Elasticity of demand measures the responsiveness of
demand to changes in price"
The concept of price elasticity of demand is commonly used in economic literature.
Price elasticity of demand is the degree of responsiveness of quantity demanded of a good
to a change in its price. Precisely, it is defined as the ratio of proportionate change in the
quantity demanded of a good caused by a given proportionate change in price. The formula
for measuring price elasticity of demand is:

Price Elasticity = Percentage change in quantity demanded / Percentage change in price

= Δq / q ÷ ΔP / P
Example, Let us suppose that price of a good falls from Tk.10 per unit to Tk.9 per unit in a
day. The decline in price causes the quantity of the good demanded to increase from 125
units to 150 units per day. The price elasticity using the simplified formula will be:

Ep = Δq / ΔP x P / q
Δq = 150 - 125 = 25 ΔP = 10 - 9 = 1
Original quantity = 125 Original price = 10
Ep = 25 / 1 x 10 / 125 = 2. The elasticity coefficient is greater than one.
Therefore the demand for the good is elastic.

DEGREES OF PRICE ELASTICITY

Different commodities have different price elasticities. Some commodities have more elastic
demand while others have relative elastic demand. Basically, the price elasticity of demand
ranges from zero to infinity. It can be equal to zero, less than one, greater than one and
equal to unity.

According to Dr. Marshall: "The elasticity or reponsiveness of demand in a market is great

or small according as the amount demanded increases much or little for a given fall in price
and diminishes much or little for a given rise in price."
However, some particular values of elasticity of demand have been explained as under;
Perfectly Elastic Demand.

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Perfectly elastic demand is said to happen when a
little change in price leads to an infinite change in
quantity demanded. A small rise in price on the part of
the seller reduces the demand to zero. In such a case
the shape of the demand curve will be horizontal
straight line as shown in figure 8

The figure 8 shows that at the ruling price OP, the

demand is infinite. A slight rise in price will contract
the demand to zero. A slight fall in price will attract more consumers but the elasticity of
demand will remain infinite. But in real world, the cases of perfectly elastic demand are
exceedingly rare and are not of any practical interest

Perfectly inelastic Demand

Perfectly inelastic demand is opposite to perfectly elastic
demand. Under the perfectly inelastic demand, irrespective of
any rise or fall in price of a commodity, the quantity demanded
remains the same. The elasticity of demand in this case will be
equal to zero. In this figure, DD shows the perfectly inelastic
demand. At price OP, the quantity demanded is OQ. Now, the
price falls to OP, from OP1, demand remains the same.
Similarly, if the price rises to OP2 the demand still remains the
same. But just as we do not see the example of perfectly elastic demand in the real world, in
the same fashion it is difficult to come across the cases of perfectly inelastic demand
because even the demand for rare essentials of life does show some degree of
responsiveness to change in price.

Unitary Elastic Demand

The demand is said to be unitary elastic when a given
proportionate change in the price level brings about an equal
proportionate change in quantity demanded, The numerical
value of unitary elastic demand is exactly one i.e., ed = 1.
Marshall calls it unit elastic. In figure, DD demand curve
represents unitary elastic demand. This demand curve is
called rectangular hyperbola. When price is OP, the quantity
demanded is OQ1. Now price falls to OP1, the quantity

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 demanded increases to OQ1. The shaded area in the fig. equal in terms of price and quantity
demanded denotes that in all cases price elasticity of demand is equal to one.

Relatively Elastic Demand

Relatively elastic demand refers to a situation in which a small change in price leads to a big
change in quantity demanded. In such a case elasticity of demand is said to be more than
one. This has been shown in figure, DD is the demand curve which indicates that when price
is OP the quantity demanded is OQ1, Now the price falls from OP to OP1 , the quantity
demanded increases from OQ1 to OQ2 i.e. quantity demanded changes more than the
change in price.

Relatively Inelastic Demand

Under the relatively inelastic demand a given percentage change in price produces a
relatively less percentage change in quantity demanded. In such a case elasticity of demand
is said to be less than one as shown in
figure 12.
All the five degrees of elasticity of demand
have been shown in figure11. On OX axis,
quantity demanded and on OY axis price is
given. It shows:
1. AB — Perfectly Inelastic Demand
2. CD — Perfectly Elastic Demand
3. EQ — Less Than Unitary Elastic Demand
4. EF — Greater Than Unitary Elastic Demand
5. MN — Unitary Elastic Demand.

FACTORS DETERMINING PRICE ELASTICITY OF DEMAND

The factors that determine elasticity of demand are numberless. But the most important
among them are the nature, uses and prices of related goods and the level of income. They
are stated below:
1. Nature of the commodity: Generally, all commodities can be dividend into three
categories, i.e:
i. Necessaries of Life: For necessaries of life the demand is inelastic because people buy
the required amount of goods whatever their price. For example, necessaries such as
rice, salt, cloth are purchased whether they are dear or cheap.

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ii. Luxury Commodities: The demand for luxury is usually elastic as people buy more of
them at a lower price and less at a higher price. For example, the demand of luxuries like
ornaments, cars, LED TV increases at a lower price and diminishes at a higher price.
Here, we must keep in mind that luxury is a relative term, which varies from person to
person, place to place and from time to time. For example, what is a luxury to a poor
man is a necessity to the rich. The luxury of the past may become a necessity of today.
Similarly a commodity which is a necessity to one class may be a luxury to another.
Hence, the elasticity of demand in such cases should have to be carefully expressed.
2. Substitutes: Demand is elastic for those goods which have substitutes and inelastic for
those goods which have no substitutes. The availability of substitutes, thus, determines the
elasticity of demand. For instance, tea and coffee are substitutes. The change in the price of
tea affects the demand for coffee. Hence, the demand for coffee and tea is elastic.
3. Number of Uses: Elasticity of demand for any commodity depends on its number of uses.
Demand is elastic; if a commodity has more uses and inelastic if it has only one use. As coal
has multiple uses, if its price falls it will be demanded more for cooking, heating, industrial
purposes etc. But if its price rises, minimum will be demanded for every purpose.
4. Raw Materials and Finished Goods: The demand for raw materials is inelastic but the
demand for finished goods is elastic. For instance, raw cotton has inelastic demand but cloth
has elastic demand. In the same way, petrol has inelastic demand but car itself has only
elastic demand.
5. Price Level: The demand is elastic for moderate prices but inelastic for lower and higher
prices. The rich and the poor do not bother about the prices of the goods that they buy. For
example, rich buy cars and diamonds etc. at any price. But the poor buy coarse rice, cloth
etc. whatever their prices are.
6. Income Level: The demand is inelastic for higher and lower income groups and elastic for
middle income groups. The rich people with their higher income do not bother about the
price. They may continue to buy the same amount whatever the price. The poor people with
lower incomes buy always only the minimum requirements and, therefore, they are induced
neither middle income group is sensitive to the change in price. Thus, they buy more at a
lower price and less at higher price.
7. Habits. If consumers are habituated of some commodities, the demand for such
commodities will be usually inelastic. It is because that the consumer will use them even
their prices go up. For example, a smoker does not smoke less when the price of cigarette
goes up.
8. Nature of Expenditure. The elasticity of demand for a commodity also depends as to
how much part of the income is spent on that particular commodity. The demand for such
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commodities where a small part of income is spent is generally highly inelastic i.e.
newspaper, boot-polish etc. On the other hand, the demand of such commodities where a
significant part of income is spent, elasticity of demand is very elastic.
9. Distribution of Income: If the income is uniformly distributed in the society, a small
change in price will affect the demand of the whole society and the demand will be elastic. In
case of unequal distribution of income and wealth, a change in price will hardly influence the
poor section of the society and the demand will be relatively inelastic.
10. Influence of Diminishing Marginal Utility. We know that utility falls when we consume
more and more units but not in a uniform way. In case utility falls rapidly, it means that the
consumer has no other near substitutes. As a result, demand is inelastic. Conversely, if the
utility falls slowly, demand for such commodity would be elastic and raises much for a fall in
price.

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

There are five methods to measure the price elasticity of demand.
1. Total Expenditure Method.
2. Proportionate Method.
3. Point Elasticity of Demand
4. Arc Elasticity of Demand.
5. Revenue Method.

Total Expenditure Method

Dr. Marshall has evolved the total expenditure method to measure the price elasticity of
demand. According to this method, elasticity of demand can be measured by considering the
change in price and the subsequent change in the total quantity of goods purchased and the
total amount of money spend on it.
Total Outlay = Price x Quantity Demanded.
There are three possibilities:
(i) If with a fall in price (demand increases) the total expenditure increases or with a rise in
price (demand falls) the total expenditure falls, in that case the elasticity of demand is
greater than one i.e. (Ed >1.)
(ii) If with a rise or fall in the price (demand falls or rises respectively), the total expenditure
remains the same, the demand will be unitary elastic i.e. (Ed = 1).
(iii) with a fall in price (Demand rises), the total expenditure also falls, and with a rise in price
(Demand falls) the total expenditure also rises, the demand is said to be less elastic or
elasticity of demand is less than one i.e. (Ed <1).
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Table Representation: The method of total expenditure has been explained with the help of
Table 3.

Price (P) Quantity Demanded (Q) Total Outlay Elasticity of demand (Ed)

10 1 10
9 2 18
Ed < 1
8 3 24
7 4 28
6 5 30
Ed = 1
5 6 30
4 7 28
3 8 24 Ed > 1
2 9 18
1 10 10
In the above Table 3, we find three possibilities:

1. More Elastic Demand. When price is Tk. 10 the quantity demanded is 1 unit and total
expenditure is 10. Now price falls from Tk. 10 to Tk. 6, the quantity demanded increases
from 1 to 5 units and correspondingly the total expenditure increases from Tk. 10 to Tk.
30. Thus it is clear that with the fall in price, the total expenditure increases and vice-
versa. So elasticity of demand is greater than one or Ed > 1.
2. Unitary Elastic Demand. If price is Tk. 6, demand is 5 units so the total outlay is Tk. 30.
Now price falls to Tk. 5, the demand increases to 6 units but the total expenditure
remains the same i.e., Tk. 30. Thus it is clear that with the rise or fall in price, the total
expenditure remains the same. The elasticity of demand in this case is equal to one or
Ed = 1.

3. Less Elastic Demand. If price is Tk. 5, demand is 6 and

total outlay is Tk. 30. Now price falls from Tk. 5 to Re. 1.
The demand increases from 6 units to 10 units and hence
the total expenditure falls from Tk. 30 to Tk. 10. Thus it is
clear that with the fall in price, the total expenditure also
falls and vice-versa. In this case, the elasticity of demand
is less than one or Ed<l.
Diagrammatic Representation:
Measurement of price elasticity through total expenditure method can be shown with the
help of fig. 19 In the figure 19 total expenditure has been shown on X-axis and price on Y-
axis. Line TT' is the total expenditure line. When price of the commodity falls from OP to OP 1
total expenditure increases from OM1 to OM2. The elasticity of demand is greater than one
as is shown in TB portion of the figure. Now, suppose that the price of the commodity
decreases from OP1 to OP3 the total expenditure falls from OM2 to OM. This is shown in T'C
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part of the figure which represents the less than unity elasticity of demand. In the same way,
BC part of the figure represents the unit elasticity of demand. Thus it is clear that the
changes in total expenditure due to changes in price also
affect the elasticity of demand.

Proportionate Method
This method is also associated with the name of Dr.
Marshall. According to this method, "price elasticity of
demand is the ratio of percentage change in the amount
demanded to the percentage change in price of the
commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and
Arithmetic Method.
Ed = Proportionate change in Quantity Demanded / Proportionate change in price

Arc Elasticity of Demand

According to Prof. Baumol: "Arc elasticity is a measure of the average responsiveness to
price change exhibited by a demand curve over some finite stretch of the curve".
According to Watson: "Arc elasticity is the elasticity at the mid-point of an are of a demand
curve."
According to Leftwitch: "When elasticity is computed between two separate points on a
demand curve, the concept is called Are elasticity."

This method of measuring elasticity of demand is also known as

P1  P2
"Average Elasticity" In this method, we use rather than P
2
Q1  Q2
Thus, we apply rather than q The formula for Arc elasticity of demand is as follows:
2
Change in demand
Original demand  new demand
Arc Elasticity of Demand (EA) =
Change in price
Original price  new Price
Are elasticity of demand in notational farm can be express
Where,
Q1 = Original quantity demanded
Q2 = New quantity demanded
P1= Original price

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 P2 = New price
This can be shown with the help of a Figure 20
In figure 20 quantity is measured on X-axis while price on Y- axis. DD is the demand curve.
Now if we want to measure the arc elasticity between A and B on the demand curve DD, we
will have to take the average of prices OPl and OP2 as well as of quantities; Q1 and Q2.
[P  (P  P)] Q
EA = 
[Q  (Q  Q)] P

Revenue Method
Joan Robinson has given this method. She says that elasticity of demand can be measured
with the help of average revenue and marginal revenue. Therefore, a sale proceeds that a
firm obtains by selling its products is called its revenue. However, when total revenue is
divided by the number of units sold, we get average revenue. On the contrary, when addition
is made to the total revenue by the sale of one more unit of the commodity is called marginal
revenue. Therefore, the formula to measure elasticity of demand can be written as,
A
Ed =
AM
Where,
Ed represents elasticity of demand, A = average
revenue and M = marginal revenue.

This method can be explained with the help of diagram 21.

In this diagram 21 revenue has been shown on OY-axis while
quantity of goods on OX- axis. AB is the average revenue or
demand curve and AN is the marginal revenue curve. At point
P on demand curve, elasticity of demand is calculated with the formula,
Lower Portion PB
Ep = or
Upper Portion PA
We can see in the figure that ∆ AEP and ∆ PMB are similar, thus ratio of their sides is also
equal.
PB PM
Ep =  and; ∆ AET and ∆ TPL are congruent triangles, therefore PL = AE. Putting
PA AE
PL in place of AE in the above equation, we shall get
PM
Ep = (Because PL = PM—LM)
PL

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 PM
Ep = (Where PM = AR and LM = MR)
PM - LM
PM AR A
.Therefore, Ep =  or
PM - LM AR - MR A-M
In this way, if value of Ep is one it means that price elasticity of demand is unitary. Similarly,
if it is more than one, price elasticity of demand is greater than one and if it is less than one,
price elasticity of demand is less than unity.

INCOME ELASTICITY OF DEMAND

According to Stonier and Hague: "Income elasticity of demand shows the way in which a
consumer's purchase of any good changes as a result of change in his income." It shows the
responsiveness of a consumer's purchase of a particular commodity to a change in his
income. Income elasticity of demand means the ratio of percentage change in the quantity
demanded to the percentage change in income. In brief income elasticity.
proportionate change in quantity purchased
Ie =
proportionate change in Income
Percentage change in demand
Ie =
Percentage change in income

Income is an important variable affecting the demand for a good. When there is a
change in the level of income of a consumer, there is a change in the quantity demanded of
a good, other factors remaining the same. The degree of change or responsiveness of
quantity demanded of a good to a change in the income of a consumer is called income
elasticity of demand. Income elasticity of demand can be defined as the ratio of percentage
change in the quantity of a good purchased, per unit of time to a percentage change in the
income of a consumer.
Ey = Percentage change in demand / Percentage change in income
Ey = Δq / Δy x y / q
Let us assume that the income of a person is Tk.4000 per month and he purchases six CDs
per month. Let us assume that the monthly income of the consumer increases to Tk.6000
and the quantity demanded of CD's per month rises to eight .The elasticity of demand for
CDs will be calculated as under:
Δq = 8 - 6 = 2 Δy = 6000 - 4000 = 2000
Original quantity demanded = 6 Original income 4000
Ey = Δq / Δy x y / q = 2 / 200 x 4000 / 6 = 0.66
The income elasticity is 0.66 which is less than one.
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Degrees of Income Elasticity of Demand
Positive income elasticity of Demand: Positive income
elasticity of demand is said to occur when with the increase in the
income of the consumer, his demand for goods and services also
increases and vice-versa. Income elasticity of demand is positive
in case of normal goods.
In fig. 22, quantity of commodity T has been measured on X-axis and income of the
consumer on Y-axis. DD is the positive income elasticity of demand curve. It slopes upward
from left to right indicating that increase in income is accompanied by increase in demand of
goods and services and vice-versa.
1.Income Elasticity is Unity. The change in demand is
proportionate to the change in income. For example Income
25% change in demand
Elasticity = 1 when
25% change in income
2. Income Elasticity Greater than One. When the change in
demand is more than
proportionate change in income, income elasticity of demand is
greater than one or unity.
For example,
15% change in demand
Income Elasticity >1 when  1.5
10% change in income
3. Income Elasticity Less than One. If change in demand is less than proportionate
change in income, income elasticity of demand is less than one or unity.
For example.

20% change in demand

Income Elasticity <1 when = 0.5
40% change in income
(ii) Negative Income Elasticity of Demand: Negative income elasticity of demand is said to
occur when increase in the income of the consumers is accompanied by fall in demand of
goods and services and vice-versa. It is the case of giffen goods.
In fig. 23 when income of the consumer is 01, demand for goods and services is OX. Now as
the income I1 increases to I1 quantity demanded falls o to OX1. Again as the income
increases to I2, quantity income elasticity of demand curve. demanded falls to OX2. DD is
the negative.
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(iii) Zero Income Elasticity of Demand: Zero income elasticity of demand is said to exist
when increase or decrease in income has no impact on the demand of goods and services.
In fig. 24 initially when income is OI, quantity demanded is OD. Now, income increases to
OI2 demand Remains constant i.e. OD. Even when income reduces to 01 , quantity
demanded remains OD.
Generally, as income increases demand for goods increases. But in some cases, demand
may not change to change in income or demand may diminish for an increase in income.
The former case represents zero income elasticity. Income elasticity is zero if a change in
income fails to produce any change in demand. Income elasticity is negative, if an increase
in income leads to a reduction of demand. This happens only in the
case of inferior goods. But in all other cases it is positive.
In short income elasticity is greater than one for luxuries but less
than one for necessaries.

CROSS ELASTICITY OF DEMAND

It is the ratio of proportionate change in the quantity demanded of Y
to a given proportionate change in the price of the related
commodity X. It is a measure of relative change in the quantity demanded of a commodity
due to a change in the price of its substitute complement.
It can be expressed as
proportion ate change in the quantity demanded of Y
Ce =
proportionate change in the price of X
Cross elasticity may be infinite or zero. It is infinite if the slightest change in the price of X
causes a substantial change in the quantity demanded of Y. It is always the case with goods
which have perfect substitutes for one another. Cross elasticity is zero, if a change in the
price of one commodity will not affect the quantity demanded of the other. In the case of
goods which are not related to each other, cross elasticity of demand is zero.

The concept of cross elasticity of demand is used for measuring the responsiveness of
quantity demanded of a good to changes in the price of related goods. Cross elasticity of
demand is defined as the percentage change in the demand of one good as a result of the
percentage change in the price of another good.. The formula for measuring cross elasticity
of demand is:
Exy = % change quantity demanded of good X / % change in price of good Y

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The numerical value of cross elasticity depends on whether the two
goods in question are substitutes, complements or unrelated.
For example: Coke and Pepsi
Types of Cross Elasticity of Demand
1.Positive: When goods are substitute of each other than cross
elasticity of demanded is positive. In other words, when an increase in
the price of Y leads to an increase in the demand of X. For instance with the increase in
price of a tea, demand of coffee will increase. In fig 25 Quantity has been measured on OX
axis and price on OY axis. At price OP of Y commodity, demand of X – commodity is OM.
Now as price Of Y commodity increase to OP1 demand of X-commodity increases to OM1.
Thus, cross, elasticity of demand is positive.
2. Negative: In case of complementary goods, cross elasticity of demand is negative. A
proportionate increase in price of one commodity leads to a proportionate fall in the demand,
of .another commodity because both are demanded jointly.

In fig. 26 quantity has been measured on OX-axis while price has been measured on OY-
axis.
Fig – 25 Fig. 26
When the price of commodity increases from OP to OP1 quantity demanded falls from OM to
OM1 Thus, cross elasticity of demand is negative.
3. Zero: Cross elasticity of demand is zero when two goods are related to each other. For
instance, increase in price of car
does not affect the demand of cloth.
Thus, cross elasticity of demand is
zero. It has been shown in fig. 27
Therefore, it can be concluded that
cross elasticity depends upon
Substitutability is perfect, cross
elasticity is infinite; if on the other
hand, substitutability does not exist,
cross elasticity is zero. In the case of complementary goods like jointly demanded goods
cross elasticity is negative.
Fig. 27
A rise in the price of one commodity X will mean not only decrease in the quantity of X but
also decrease in the quantity demanded of Y because both are demanded together.

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IMPORTANCE OF ELASTICITY OF DEMAND
The concept of elasticity of demand is of great importance in practical life. Its main points are
given as under:
1. Useful for Business: It enables the business in general and the monopolists in
particular to fix the price. Studying the nature of demand the monopolist fixes higher
prices for those goods which have inelastic demand and lower prices for goods which
have elastic demand. In this way, this helps him to maximize his profit.
2. Fixation of Prices: It is very useful to fix the price of jointly supplied goods. In the
case of joint products like paddy and straw, the cost of production of each is not
known. The price of each is then fixed by its elastic and inelastic demand.
3. Helpful to Finance Minister: It helps the Finance Minister to levy tax on goods. After
levying taxes more and more on goods which have inelastic demand, the
Government collects more revenue from the people without causing them
inconvenience. Moreover, it is also useful for the planning.
4. Fixation of Wages: It guides the producers to fix wages for laboureTk. They fix high
or low wages according to the elastic or inelastic demand for the labour.
5. In the Sphere of International Trade: It is of greater significance in the sphere of
international trade. It helps to calculate the terms of trade and the consequent gain
from foreign trade. If the demand for home product is inelastic, the terms of trade will
be profitable to the home country.
6. Paradox of Poverty. It explains the paradox of poverty in the midst of plenty. A
bumper crop instead of bringing prosperity may result in disaster, if the demand for it
is inelastic. This is specially so, if the products are perishable and not storable.
7. Significant for Government Economic Policies. The knowledge of elasticity of
demand is very important for the government in such matters as controlling This
watermark does not appear in the registered version of business cycles, removing
inflationary and deflationary gaps in the economy. Similarly, for price stabilization and
the purchase and sale of stocks, information about elasticity of demand is most
useful.
8. Determination of Price of Public Utilities. This concept is significant in the
determination of the prices of public utility services. Economic welfare of the society
largely depends upon the cheap availability

LET US SUM UP
In this lesson we studied the concept of elasticity which is the slope relationship of two
variables expressed in percentage terms. We discussed about price elasticity, income
Page 55 of 82
elasticity and cross elasticity of demand. While concluding this lesson we also looked into
the general importance of elasticity of demand

REFERENCES
1. Petersen, H. Craig and W. Cris Lewis, Managerial Economics.
2. Mote, V.L., Samuel Paul and G.S. Gupta, Managerial Economics, Concepts and
Cases, Tata McGraw Hill.

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 MARKET AND THEIR CHARACTERISTICS
Meaning of Market:
Generally market is a place where commodities are bought and sold.
In economics, the term “market” does not refer to a particular place. Market means
an arrangement whereby buyers and sellers interact to determine the prices and quantities
of a commodity. Some markets take place in physical location; other markets are conducted
over the telephone or are organized by computer.

Component of the market:

For a market to exist, certain conditions must be satisfied. These conditions should be both
necessary and sufficient. They may also be termed as the components of a market.
a) The existence of a good or commodity for transactions;
b) The existence of buyers and sellers;
c) Business relationship or intercourse between buyers and sellers that means
interaction between buyers and sellers that only one price should prevail for the
same commodity at the same time.
d) Isolation of area such as place, region, country or the whole world.

Market structure/ Market forms

The term structure refers to something that has organization and dimension- shape, size and
design; and which is evolved for the purpose of performing a function.
Market structure refers to those organizational characteristics of a market which
influence the nature of competition and pricing, and affect the conduct of business firms.

Classification of Market:
Market may be classified:
 On the basis of area as local or village market, regional market, national market and
world market;
 On the basis of time as short period market, periodic market and long period market;
 On the basis of volume of transactions as wholesale market and retail market.
 On the basis of nature of transactions as spot or cash market and forward market;
 On the basis of nature of commodities as commodity market and capital market;
 On the basis of degree of competition obtaining their in as perfect competition and
imperfect competition market

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Pure competition:
Modern economists draw a distinction between Perfect competition and pure
competition. Pure competition is said to exist when the following condition are fulfilled-
a) Large number of buyers and sellers
b) Homogeneous product
c) Free entry or exit in the market
If the above three conditions are found in a market then it is said to be under pure
competition.

Perfect competition:
There is said to be perfect competition when every buyer and seller is so small relative to the
entire market that he cannot influence the market price by increasing or decreasing his
purchases or his output.

Characteristics of perfect competition market:

a) Large number of buyers and sellers in the markets.
b) Homogeneous product
c) Free entry or exit in the market
d) Perfect knowledge in the market
e) Absence of transport costs
f) Perfect mobility of the factors of production
g) No government regulation

Imperfect competition:
Imperfect competition takes three forms such as:
i) Monopoly
ii) Monopolistic competition
iii) Oligopoly
iv) Duopoly
v) Monopsony
vi) Bi-lateral monopoly

Monopoly Market:
Monopoly is a market condition, wherein the entire supply of a commodity is
concentrated in the hand of a single firm that means single seller controlling the entire
market.

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The characteristics/ features of monopoly market:
a) The monopolist is the only producer in the market
b) There is no closely competitive substitute for the product produced by the
monopolist. So buyers have no alternative choice.
c) Monopoly is a complete negation of competition
d) A pure monopoly has no immediate rivals due to certain barriers entry in the field
e) Large number of buyers in the market
f) The price is solely determined at the market, since the monopolist control over the
supply.

Monopolistic competition
It is the market situations where a large number of firms are prevailing their products
are differentiated from each other. Entry of new firm is relatively open and easy.

Following are the important features of monopolistic competition:

i) Firm in the industry produce heterogeneous product;
ii) There are large number of sellers;
iii) Product differentiation is its basic phenomenon. Each seller occur a degree of
monopoly power through product differentiation
iv) Advertising and sales promotion efforts are taken in monopolistic competition.

Oligopoly:
When in a market there are only a few sellers of a product, it is called oligopoly. In
oligopolistic market, the firms may be producing either homogeneous or product
differentiation (heterogeneous) in given line of production.

Following are the distinguish features of an oligopolistic market:

a) There is few number of sellers supplying homogeneous or product differentiation
(heterogeneous) product.
b) The firms have a high degree of interdependence in their business policy about fixing
of price and determination of output.
c) There is always fear of retaliation by rival to each other.
d) Advertising and selling cost have strategies importance to oligopolistic firms.
e) Lack of uniformity in the sizes of different oligopolistic is also remarkable
characteristics.
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Duopoly
It is a market situation in which there are only two selleTk. It is very close to oligopoly. Each
firm keeps a close watch on the actions of the other firms. Hence, the stiff competition exists
between the two firms.

Monopsony
Monopsony means the presence of a single buyer for the products produced by the firms.
For example- farmers who are registered as sugarcane growers under factory’s jurisdiction
are supposed to sell their product to sugar factory only

Bi-lateral monopoly
It is a market condition where there are only one buyer and seller for a product.

Comparison among different market forms

Market forms
SL
Features Perfect Monopoly Monopolistic Oligopoly
No
competition competition
1 No. of farm Sufficient large One Many but not A few
large
2 Nature of Homogeneous unique Product Homogeneous of
product differentiation Heterogeneous
3 Condition of Free entry Entries Free entry Restrict entry
entry blocked
4 Firm’s degree Not control over Control over Some control Some control
of control over price price over price over price
price
5 Degree of Zero Absolute Limited Considerable
monopoly
power

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 Cost and Revenue Concept

What is the firm’s goal?

The firm’s goal is to maximize profit. A firm that does not seek to maximize profit is
either eliminated or bought by firms that do not seek that goal.

Meaning of short run and long run

Short run is the period of time within which the firm can vary its output by varying only
the amount of variable factors such as labour and raw materials. Fixed factors such as
capital equipment cannot vary.
On the other hand, long run is a period of time during which the quantities of all
factors, variable as well as fixed factors can be adjusted.

Explicit & Implicit Costs:

 Explicit costs are those money payments which are actually made by a firm for
purchasing the inputs or hiring the services of factors of production. This expenditure is
recorded in the firm’s account book. These include:
 Wages paid to the labourers;
 Rent paid for the land;
 Payment made for the raw materials;

 Implicit costs are the costs of self-owned and self-employed resources. For these resources
entrepreneur has not made any payment. These are not the actual payments but the
imputed value based on opportunity cost. These include the following:
 Rent of the building owned by the entrepreneur
 Interest on capital invested by the entrepreneur in his own business.

Normal Profit:
Normal Profit is the minimum profit needed to be paid to the entrepreneur to retain him in the
industry. If the entrepreneur does not earn normal profit, he may leave the industry. Like
rent, wages and interest, normal profit is a factor cost. Thus normal profit is part of the total
cost.

The Total Cost is the sum of explicit costs, implicit costs and normal profit.

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Private, External & Social Costs:
Private cost refers to the cost of production borne by the firm. A cost that is not borne by the
firm, but is incurred by others in society is called an external cost e.g. cost of treating water
polluted by an industrial firm. The true cost to the society must include all costs regardless of
who bears them. Thus, the social cost is the sum of private and external cost.

Social cost = Private Cost + External Cost

If external cost is less than external benefit, social cost would be less than private cost as
the External cost is negative. Whereas social cost would be more than the private cost if
external cost is more than the external benefit.
Fixed cost:
These are costs which do not vary as output varies. Fixed costs are not influenced by
changes in output. Whether a firm is working at full capacity or half capacity these costs will
be unaffected. Indeed, fixed costs are the costs which have to be paid even when output is
zero. Sometimes these costs are called overheads or indirect costs.

Variable cost:
These are the costs which are related directly to 150
TC, VC,FC

output and so change when output changes. The most

100 TC
obvious items of variable costs are the wages of labour, TVC
50
the costs of raw materials and fuel and power. Variable FC

costs are sometimes referred to as direct or prime costs. 0

Variable costs are not incurred when output is zero. In 1 2 3 4 5 6 7
the long run all costs are variable. output
Variable cost varies directly with the variation in
output. An increase in total output results in an increase in total variable costs and decrease
in total output results in a proportionate decline in the total variable costs. The variable cost
per unit will be constant. Variable costs include the costs of all inputs that vary with output
like raw materials, running costs of fixed assets such as fuel, ordinary repairs, routine
maintenance expenditure, direct labour charges etc.

Total costs:
Short run total costs represent the sum of fixed and variable costs. When output is
zero, total costs will be equal to fixed costs since variable costs will be zero. When
production commences, total costs will begin to rise as variable costs start to increase.

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Symbolically, TC = TFC+ TVC
Average cost:
-
Average cost is total costs divided by output. It can
50
be also called average total cost. When output is small,
40
average cost will be high because fixed costs will be spread 30

AC
over a small number of units of output. As output increases, 20

average costs will be tend to fall as each unit is carrying a 10

0
smaller element of fixed cost.
1 2 3 4 5 6 7 8
So it may be expected that for the individual firm Output

with a fixed capacity, average cost will at first decline but as output increases there will come
a point where it will rise. This is why the average cost curve will be U-shaped. When the firm
is producing at its minimum average cost it is said to be have reached its optimum output.

Average fixed cost

Average fixed cost equals total fixed costs divided by the level of output. As total fixed cost is
constant, average fixed cost must fall with output. The fixed cost is spread over a greater
and greater output (Fig).
AFC = TFC/Q

Average variable cost:

Average variable cost is total variable cost divided by output. The average variable cost
curve is U-shaped.
AVC = TVC/Q

Marginal cost:
Marginal cost is addition to the total cost caused by producing one more unit of
output. More precisely, marginal cost is the change in total costs when output is changed by
one unit.

Opportunity cost/Alternative/Transfer cost:

Opportunity cost of a decision may be defined as the cost of next best alternative
sacrificed in order to take this decision. According to the school of economists “the real cost
of production of a given commodity is the next best alternative sacrificed in order to obtain
that commodity.” It is also called displacement cost.
The opportunity cost of any good is the next best alternative good that is foregone. For
example; a farmer who is producing wheat can also produce potatoes with the same factoTk.
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Therefore, "the opportunity cost of a quintal of wheat is the amount of the output of potatoes
given up" 'Opportunity cost is simply the cost of best foregone alternative.
Economic cost and Accounting cost:
By economic costs is meant those payments which must be received by resource owner in
order to ensure that they will continue to supply them in the process of production. Economic
cost includes normal profit.
Accounting costs are recorded with the intention of preparing the balance sheet and
profit and loss statements which are intended for the legal, financial and tax purposes of the
company. The accounting concept is a historical concept. It records what has happened.
The past cost data revealed by the books of accounts does not help very much in decision-
making. Decision-making needs future costs. Economic concept considers future costs and
future revenues which help future planning and choice. When the accountant describes what
has happened, the economist aims at projecting what will happen. Accounting data ignores
implicit. or imputed cost. The economist considers decision-making costs. For this, different
cost classifications relevant to different kinds of problems are considered. The cost
distinctions such as opportunity and outlay cost, short run and long-run cost and
replacement and historical cost are made from the economic viewpoint.

Business and Full costs

A firm's business cost is the total money expenses recorded in the books of accounts. This
includes the depreciation provided on plant and equipment. It is similar to the actual or real
cost. Full cost of a firm includes not only the business costs but also opportunity costs of the
firm and normal profits. The firm's opportunity cost includes interest on self-owned capital,
the salary forgone by the entrepreneur if he were, working in his firm. Normal profit is the
minimum returns which induces the entrepreneur to produce the same product.

Replacement and Historical costs

These are the two methods of valuing assets for balance sheet purpose and to find out the
cost figures from which profit can be arrived at; Historical cost is the original cost of an asset.
Historical cost valuation shows the cost of an asset as the original price paid for the asset
acquired in the past. Historical valuation is the basis for financial accounts.
Replacement cost is the price that would have to be paid currently to replace the same
asset. For example, the price of a machine at the time of purchase was Tk. 17,000 and the
present price of the machine is Tk. 20,000. The original price Tk. 17,000 is the historical cost
while Tk. 20,000 is the replacement cost. During periods of substantial change in the price
level, historical valuation gives a poor projection of the future cost intended for managerial
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decision. Replacement cost is a relevant cost concept when financial statements have to be
adjusted for inflation.
Controllable and Non-controllable costs
Controllable costs are the ones which can be regulated by the executive who is in charge of
it. The concept of controllability of cost varies with levels of management. If a cost is
uncontrollable at one level of management it may be controllable at some other level.
Similarly the controllability of certain costs may be shared by two or more executives. For
example, material cost, the price of which comes under the responsibility of the purchase
executive whereas its usage comes under the responsibility of the production executive.
Direct expenses like material, labour etc. are controllable costs.
Some costs are not directly identifiable with a process or product. They are apportioned to
various processes or products in some proportion. This cost varies with the variation in the
basis of allocation and is independent of the actions of the executive of that department.
These apportioned costs are called uncontrollable costs.

Incremental and Sunk cost:

Incremental cost is the additional cost due to a change in the level or nature of business
activity. The change may be caused by adding a new product, adding new machinery,
replacing machinery by a better one etc. Incremental or differential cost is not marginal cost.
Marginal cost is the cost of an added (marginal) unit of output.

Sunk cost is an expenditure that has been made and cannot be recovered. A sunk cost is
usually visible but after it has been incurred it should always be ignored when making further
economic decisions.

Revenue:
Revenue means the sales receipts of the output produced by the firm. Revenue depends on
the price.

Total Revenue (TR):

Total Revenue refers to the total amount of sale proceeds earned by selling the whole
amount of commodity produced in the farm. It includes both main products and byproducts of
the farm by selling which some amount of money has been earned. Total revenue can be
found out by multiplying the total volume of outputs sold by the number of units at normal
price.

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It is the total sales receipts of the output produced over a given period of time.
TR= P. Q
Where, TR= Total revenue, P= Price per unit, Q= Quantity of a product
Average Revenue (AR):
It is the average receipt per unit of output Average revenue can be found out by
dividing the total sale proceeds by the amount of output sold in the market.

AR is the sales receipts per unit of output produced. Thus AR = TR/Q

Marginal Revenue (MR):

Marginal Revenue is the addition to the total revenue earned by selling additional unit of
outputs. It is the extra revenue resulting from selling an extra unit of product. It can be
calculated by deducting the total receipts obtained by selling the total volume of products minus
the marginal or additional receipt earned by selling additional or extra produce over and above
the total output.

MR is the addition made to the total revenue by selling one or more unit of the
product per unit of time. Thus, MR = TRn – TRn-1

Relationship among the price, AR, MR and TR

The relationship among the price, AR, MR and TR are discussed below:
 In perfect competition it will be seen that:
a) Price is constant,
b) AR is also constant since AR=P
c) MR also remains constant and MR=AR=P,
d) TR increases at a constant rate as the units of output sold increase.

 In imperfect competition it will be see that:

a) AR and MR both are downward sloping curve,
b) MR curve is below AR curve
c) AR = P

REFERENCES
1. Mehta, P.L. “Managerial Economics ‘Analysis, Problems & Cases’, Sultan Chand & Sons.
2. Sundharam, K.P.M. and Sundharam E.N. “Business Economics.

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 CONCEPT OF NATIONAL INCOME

Meaning of national Income

National income may be defined as the total market value or money value of all
goods and services produced by all the people of the country in a year. According to Lipsey,
“National income refers to the total market value of all goods and services produced in the
economy during some specified period of time and the total of all incomes earned over the
same period of time”

The definitions of National income can be grouped into two classes as the traditional
definition advanced by Marshall, Pigou and Fisher and the modern definitions.
Marshallion Definition:- According to Marshall, the labour and capital of a country acting on
its natural resources produce annually a certain net aggregate of commodities, material and
immaterial, including services of all kinds. This is the true net annual income or revenue of
the country or national dividend.
Pigovian Definition:- According to Pigou "National income is that part of objective income
of the community, including of course income derived from abroad which can be measured
in money”
Fisher's Definition:- Fisher adopted consumption as the criterion of national certain
whereas Marshall and Pigou regarded it to be production.
According to Fisher ‘The national income consists solely of services as received by ultimate
consumers whether from their material or from their human environment'. From the modern
point of view national income is defined as the net output of commodities and services
flowing during the year from country's productive system in the hands of ultimate consumer.

Significance or importance of national income Estimates

The following are the main uses of national income analysis:
1. The national income estimate reveals the overall production performance of the
economy. It records the level of production in each year. This enables to compare the
real growth of the economy over the years.
2. The percapita income measures the average standard of living of the people. It is used
to compare standards of living in different countries.
3. National income data are used to measure economic welfare of the community. Other
things being equal, economic welfare is greater if rational income is higher and vice
versa.
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4. The study of national income statistics is useful in diagnosing the economic ills of a
country and suggesting remedies.
5. The national income figures are useful in assessing the pace of economic development
of a country.
6. The national income figures are used to assess the savings and investment potential of
the community. The rate of saving and investment depend on national income.
7. The comparison of rational income over the years enables to know the nature of the
economy. This is important when the government of a country launches planning for
economic development. In factor planning is possible without national income
estimates.
8. National income estimates show the contribution made by different sectors of f he
economy such as agriculture, industry, trade and commerce, service etc. On the basis
of national income figures.
9. National income estimates will tell us how far different categories of income such as
rent, wages, interest, and profits are contributing to national income.
10. The formulation of panning for different sectors of the economy is based on the national
income figures. National income estimates are very useful in formulating plans for the
development of agriculture, industry, infrastructure etc.
11. We can evaluate the achievements of the development targets laid down in the plus
from the changes in national income and various components.
12. National income data are useful for forecasting future economic events.
13. National income statistics can be used to determine how an international financial
burden should be apportioned between different countries.
14. In war time the study of the components of national income is of great importance
because they show the maximum production possibilities of the country.

Gross National Products (G.N.P)

Gross National Product is defined as the total market value of all final goods and
services produced in a year. It measures the market value of the annual output or it is a
monetary measures.
For calculating GNP accurately, all goods and services produced in any given year
must be counted once, but not more than once. Most of the goods go through a series of
production stages before reaching a market. As a result, part or components of many goods
are bought and sold many times. Hence to avoid counting several times the part of goods
that are sold and resold, GNP only includes the market value of final goods and ignores
transactions involving intermediate goods.
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 GNP = C + I + G + (X-M) + (R-P)
Where, C = Consumption goods
I = Gross investment, G = government service, X = Export
M = Import, R = Income received from abroad,
P = Income paid abroad
Final goods: Final goods are those goods which are being purchased for final use and not
for resale or further processing.

Intermediate goods: Intermediate goods are those goods which are purchased for further
processing or for resale.
The sale of final goods is included in gross national product, while the sale of
intermediate goods is excluded from GNP because the value of final goods includes the
value of all intermediate goods used in their production. For instance, the value of cloths
includes the value of cotton used in the making of cloths.

Net National Product (NNP):

In the case of GNP, we use up some capital equipment and machinery etc. Every
year it bears depreciation from this equipment. So the net national product is obtained by
deducting the value of depreciation of capital assets from the GNP.
Thus, NNP = GNP – Depreciation costs.

Gross Domestic Product (GDP):

The market value of final goods and services produced in the normal residents as
well as non residents in the domestic territory of a country in a year. When we take the sum
of total values of output of goods and services in the country without adding net income
received from abroad, the figure so obtained is called GDP. The difference between GDP
and GNP arises due to the existence of income from abroad. GDP does not include income
from abroad whereas, GNP includes it.

GDP = C + I + G + (X-M)
Where, C = Consumption goods
I = Gross investment, G = government service, X = Export
M = Import
Personal income:
Personal income refers to the sum of all incomes actually received by all individuals
or households during a given year. There is a difference between national income and
personal income. National income is that which is received and used in the production
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process. But personal income is actually earned income including transfer payments of old
age pension, unemployment allowances, relief etc. Similarly undistributed business profit
and depreciation costs cannot be consumed by the individuals and that is way these are not
regarded personal income.
So, Personal income = (National income + Transfer payment) – (undistributed
business profit + Depreciation costs)
Disposable Income:
A good part of personal income is paid to government in the form of personal taxes
like income tax, personal property taxes etc., what remains of personal income is called
disposable income.
Thus, Disposable Income = personal income - personal taxes
or Disposable Income = consumption + savings

Per Capita Income (PCI):

Per capita income can be derived by dividing national income with total population of
the country.
Thus, PCI = National income/ Total population

Measurement of National Income:

There are three possible methods of measuring national income. They are-

a) Product or output method:

b) Income method:
c) Expenditure Method:

1. Product or inventory method: Under this method national income is computed by

adding the net value of all commodities and services produced during a given period. Thus
national income is equal to the total of final products. We first estimate the gross value of
domestic output in the various sectors of production (Agriculture, manufacturing industry,
and services including government). The value of gross output is obtained by multiplying the
output of each sector by their respective market prices and adding them together. Then we
deduct value of depreciation from gross value of domestic output. The figure so obtained has
to be adjusted with net income from abroad. This is the national income at factor cost. This
method is also known as output method or value added method. This method is very

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complicated because of non-availability of adequate and requisite data. It is also difficult to
calculate depreciation.
2. Income Method: Under this method the national income of a country is obtained by
adding the incomes accrue to factors of production within the national territory. Basic factors
of production used producing the national products are land, labour, capital and
organisation. The national income is equal to total rent plus total wages and salaries of all
employees including income of self employed persons plus total interest on capital including
dividends of the shareholders plus total profit of all firms including undistributed corporate
profits and earnings of public enterprises. In short, the national income represents the total
of rent, wages, interest and profit.
It is difficult to make distinction between the earnings from ordinary labour and organisational
efforts. It is also difficult to make distinction between earnings from land and capital.
Therefore factors of production are grouped as labour and capital for purposes of estimating
national income. Under this method, the income earned by all individuals of the country
during a year is taken. Individuals earn income in the form of Rent, profit, wages, and
salaries and interest. This method is called income method.

3. Expenditure method: This method is based on the assumption that income is equal to
expenditure plus savings. Under this method the personal consumption expenditure,
government purchase of goods and services, gross private domestic investment and net
foreign investment are added together to get the national income of a country. This method
is also known as consumption- saving method.
The expenditure method is not generally used because the necessary data regarding
consumption expenditure are not easily available. This method includes the total expenditure
of a country during a given year. The income is spent on consumer goods or on producer
goods. The consumption expenditure and investment expenditure of all the individuals in a
government during a year is added. Thus
National Income = Consumption Expenditure + Investment Expenditure + government
expenditure + exports - imports.
Y = C + I + G + X-M

Difficulties of measuring National Income:

There are conceptual problems that arise when we start measuring the national income of a
country. These are following problems:
1. The National Income must be calculated in monetary terms. There are certain
nonmonetary transactions which are not included in the value of product. For
example the unpaid personal services of a housewife cannot be included in the
national product.
2. The Government services such as justice .administration and defence should he
treated as equivalent to any other capital formation.
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 3. The treatment of profits of foreign firms as income of the parent country is another
difficulty in measurement, because the foreign firms production is taking place in
Bangladesh while the profits of the firm is not considered in the income calculation of
the country.
4. In underdeveloped countries like Bangladesh, the major part of the output does not
come to the market due to non monitised transaction. This results in the
underestimation of the National Income.
5. Due to illiteracy regular accounts are not kept by the produceTk. This also makes the
national income calculation more difficult.
6. The agriculture and industrial sectors are unorganized and scattered in Bangladesh.
7. Finally the lack of statistical data and unreliability of statistics is the major difficulties
in measuring the National Income.
8. A Greatest difficulty in calculating the national income is of double counting which
arises from the failure, to distinguish properly, between a final and intermediate
product.
9. Income earned through illegal activities such as gambling or illicit extraction of wine
etc is not included in national income. Such goods and services do have value and
meet the needs of consumeTk. But by leaving them out, national income works out to
less than actual.
10. There arises difficulty of including transfer payments in the national income.
Individuals get pension, unemployment allowance and interest on public loan's but
whether these should be included on the national income in a difficult problem.
11. Another difficulty in calculating national income is that of price changes which fail to
keep stable the measuring rod of money for national income. When the price level in
the country rises the national income also shows an increase even though production
might have fallen.
Thus the above difficulties involved in National Income analysis are both statistical and
conceptual. Therefore the National Income cannot be calculated accurately.

REFERENCES
1. Misra, S.K. and Puri V.K. “Indian Economy, Himalaya Publishing House.
2. Dhingra, I.C., The Indian Economy, Sultan Chand & Sons.
3. Rangarajan, C. and Dholakia, B.H., Principles of Macro Economics, Tata McGraw
Hill Publishing Co. Ltd.
4. Maurice Thomas: Managerial Economics.

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 5. Charles J. Stokes: Economics for Managers Intl. Student Edition, McGraw Hill,
Kogakusha Ltd.
6. J. harrvey and M. Johnson, “Introduction to Macro Economics” MacMillan.

Money

Barter system:
When exchange is done without the intervention money, we call it barter. Barter,
however, is possible only under extremely simple conditions of exchange.
The direct exchange for goods and services without intervention of money is called
the barter system

Difficulties of barters:
1. Lack of coincidence of wants
2. Lack of common measure of value
3. Indivisibility of certain articles
4. want of store of value
5. Difficulty in transferring value
6. Lack of portability

Meaning of money:
Money has been defined in various ways:
Walker – “Money is what money does”

In Coulborn books – “Money may be defined as the means of valuation and payment as
both the unit of account and the generally acceptable medium of exchange”

Lastly we can say money is anything that serves as a commonly accepted medium of
exchange or means of payment and they are accepted as payment for buying goods and
services.
The different stages in the development of money are as follows:
a) Commodity money b) Metallic money c) Paper money d) Bank money

Kinds of money:
The main kinds of money are (1) Metallic money and (2) Paper money. These are further
divided into standard money and token money

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Standard money: For such type of money, the real value is equal to face value (the value
written on the coin). The coins are made of gold or silver. As such, no country has such a
money in circulation.
Token money: This money is made up of cheaper metal. Its face value is greater than its
intrinsic value. The rupee is a standard unit of money in India, but its face value is greater
than its real value.

Characteristics of money/ quality of good money:

Following are the characteristics of money:
1. Cognisability: Money should be easily recognized by one and all.
2. Utility: Money will have different forms of utilities.
3. Portability: Money should facilitate easy carrying from one place to another without
expense or inconvenience to the individual user.

4. Durability: Coins are more durable than paper currencies. For this reasons, the
standard paper are used for printing currency note.

5. Indestructibility: In the normal usage the coins should not get disfigured easily and
the paper currency should not get torn easily in the circulation.

6. Stability: The value of money should not be changing. It should more stable.

7. Homogeneity: All coins of the same metal should be as identified as possible with
regard to quality and weights and all notes should be printed with same quality of
paper.

8. Universal acceptability: The value of the currency issued by monetary authority in the
country should be recognized uniformly in all the states of the nation.

Functions of money:
Money performs five important functions:-
1. It serves as a medium of exchanges
“Money is a matter of function four
2. A measure of value
3. It is used as a store of value A medium, a measure, a standard and a
store”
4. A standard of deferred payments
5. Means of transferring value

Demand for money:

There are three main motives on account of which money is wanted by the people:

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 i) Transaction motive
ii) Precautionary motive
iii) Speculative motive
Supply of money:
Sum total of all forms of money which are held by a community at a given moment is the
supply of money.

Constituents of money supply:

1. Legal tender:
a) Paper money
b) Coin money
i) Standard money
ii) Token money
2. Commodity money e.g. cattle, olive oil, cigarettes etc.
3. Bank money e.g. check, bank draft (DD) etc.
4 Near money: debenture, govt. bond, postal order, prize bond etc.

Gresham’s Law:
Gresham’s law can be briefly defined as “bad money drives good money out of
circulation”

How does it operate?

Gresham’s law operates in three ways:
a. Good money is hoarded
b. Good money is melted; and
c. Good money is exported or foreign payment

Limitations of the law: The law will not operate

a) if there is shortage of currency, and
b) if there is strong public opinion against bad money or if the bad money is too bad that
non can agree to take it then the bad money will have to go.

Value of money:
The value of money is its purchasing power, i.e. the quantity of goods and services that a
unit of money can purchase.

There are three principal approaches to monetary analysis:

1. The quantity-velocity approach or cash transaction approach or Fisher’s equation;
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 2. The cash balances approach or Cambridge equation;
3. Income expenditure approach

The quantity-velocity/ cash transaction approach or Fisher’s equation

Statement of the theory: “Other things remaining the same, the value of money falls
proportionately with a given increase in the quantity of money.” Or in other words, other
things remaining the same, the changes in the general price level are directly proportional to
the change in money supply. Double the quantity of money and the price level will be
doubled.

Other things remaining the same:

1. Constant velocity of circulation of money;
2. The use of credit instrument as money
3. No barter transaction
4. Volume of transactions must remain constant

Equation of exchanges:
Professor Irving Fisher has expressed the relationship between the quantity of money and its
value in the form of a formula, which he calls the equation of exchange. This is
MV  MV
P
T
Where, P = Price level
T = Transaction to be performed by money
M = Metallic money
M' = Credit money
V = Velocity of metallic money
V' = Velocity of credit money
This formula equates the supply of money to the demand for it. Demand for money = p =
price level multiplied by the transactions. Supply of money (MV + M' V' ) = cash and credit
instruments with their velocities of circulation.

PT = MV + M' V' and P = = MV + M' V' /T

Professor Fisher assumes that in the short period, T, V, V' remain constant and the
proportion of M' to M also remains constant. So P varies directly with M.

Mathematical example:

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Suppose, M = 150, V = 2 and M' = 50, V' = 2 and T =10
MV  MV 150 * 2  50 * 2
So P  =  40
T 10
If T, V, V' remain constant and M' to M proportion also remains constant but double then,
MV  MV 300 * 2  100 * 2
P =  80
T 10
It indicates that if the money supply is doubled the price level has been doubled but the
value of money (1/P) will be half.

When, M = 150 then P = 40 and the value of money is 1/P = 1/40= 0.025
When, M = 300 then P = 80 and the value of money is 1/P = 1/80= 0.0125

Criticism of Fisherian equation:

1. Money used only as medium of exchange, it is not always true
2. V, V’, T are constant. It is not true. If P increases the business will expand and vice-
versa.
3. T is constant but if P increases the transaction will be increased.
4. Value of money depends on quantity of money supply, it is not always true.
5. According to Mrs. Robinson, it is not a theory of money because this theory has no
indication of interest rate.
6. This theory shows the average price but not actual price.

References
“Modern Economic Theory” by K.K Dewett
“Agricultural Economics” by S. Subba reddy, P. Raghu Ram, T.V N. Sastry and I. B. devi

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 Bank

Bank: A bank is a financial institution which deals in money and credit. Broadly speaking,
banks draw surplus money from the people who are not using it at the time, and lend to
those who are in the position to use of productive purpose.

Role of banks in developing countries

In a developing country like Bangladesh, banking facilities are highly inadequate. The vast
number of people living in villages and small towns do not have banking facilities and
consequently all their savings are wasted. The opening of banks in these areas or extension
of bank facilities will help mobilize savings. They would promote investment in rural areas
and thus increase output and employment. Commercial banks have started undertaking
new functions to help the private sector industries. Thus, banks have come to occupy an
important place in the industrial and commercial life of a nation. A developed banking
organisation is a necessary condition for the industrial development of a country.

Types of bank:
1. Commercial Bank
2. Central Bank
3. Specialized Bank
i) Industrial bank
ii) Agricultural bank (BKB)
iii) Mortgage Bank
iv) Co-operative bank
v) Islami Bank
4. International Bank (ADB, IBRD, IMF etc)

Commercial bank:
Commercial banks deal with the financing of business activities and thus earn profits. In
other word, the bank which provides short term credit to the business, trade and industrial
institutions of the country is called commercial bank (Sonali bank, Janata bank, Rupali bank
etc.).
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Functions of Commercial Bank:
Major functions of commercial bank are discussed below:
A. General functions
B. Public utility functions
C. Agency functions

A. General functions:
i) Deposit collection (current, fixed and saving): The commercial banks collect
scattered savings of the people in the form of deposits.
ii) Advancing loan: The second function of commercial bank is to give loans to the
traders and merchants against security or without any security
iii) Creation of money: Commercial banks create purchasing power in the form of bank
deposits withdrawable by cheques. Bank cheques also serve as money and circulate
like money.
iv) Foreign trade: Trades both internal and external are financed by the banks.
Acceptance and collection of bills of exchange, discounting bills helps smooth
transaction of foreign exchange.

B. Public utility functions:

Modern commercial banks usually perform certain general utility services for society such
as:
a) Bank drafts and travel’s cheques are issued in order to provide facilities for transfer
of funds from one part of the country to another.
b) Letters of credit may be given by the banks to their customers to enable them to go
abroad.
c) Reservation of valuables: Certain banks arrange for safe deposit vaults, so that
customers may entrust their securities and valuables to them for safe custody.
d) Bank may deal in foreign exchange or finance foreign trade by accepting or collecting
foreign bills of exchange.
e) Some banks may publish valuable journals or bulletins containing research on
financial, economic and commercial matters.

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C. Agency functions:
Bankers perform certain functions on behalf of the customers. Such as:
a) To collect or make payments for bills, cheques, promissory note, interest dividends,
rents, subscriptions, insurance premium etc.
b) To forward funds on behalf of the clients by drafts or mail or telegraphic transfer
c) To act as executor, trustee and attorney for the customer’s will.
d) Often bankers obtain passports; travel’s tickets etc. for their customers and receive
letters on their behalf.

Central Bank:
A central bank is a bank which constitutes the apex of the monetary and banking
structure. It is the lender of last resort and has monopoly on note issue (De Kock).
A central bank is a bank of bankers. Its duty is to control the monetary base and
through the control of this high-powered money to control the community’s supply of money
(Samuelson, P.A).
Thus we may define the central bank as in institution whose main function is to help,
control and stabilize the monetary and banking systems of the country in the national
economic interest.

Functions of central bank:

The aim and responsibilities of a central bank it a quit different institution from the ordinary
banks. It has to perform functions which are a great importance. A modern central bank has
to perform the following functions:
1. It acts as the note issuing agency.
2. It acts as the bakers to the state
3. It acts as the baker’s bank
4. Acts as guardian of the money market through controlling credit.
5. Acts as the lender of the last resort
6. It maintain the value of the democratic currency
7. It maintain stable exchange rate
8. It fights in economic crises
9. Acts as a clearing house

BALANCE SHEET
Balance sheet is the most significant financial statement. It indicates the financial condition or
the state of affairs of a business at a particular moment of time. More specifically, balance
sheet contains information about resources and obligations of a business entity and about its
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owners' interests in the business at a particular point of time. Thus, the balance sheet of a firm
prepared on 31 December 2011 reveals the firm's financial position on this specific date. In the
language of accounting, balance sheet communicates information about assets, liabilities and
owner's equity for a business firm as on a specific date. It provides a picture of the financial
position of the firm at the close of the firm's accounting period.
The following summarizes the classification criteria in the new balance sheet:
Account Examples of Accounts
Category Classifications Definition Included

Assets Current AssetsAssets that will be Cash, Accounts Receivable,

converted to cash, or Merchandise Inventory,
"used up," within one Prepaid Insurance, Prepaid
year from the date of Rent, Supplies
the balance sheet.
Property and Assets that (1) are Land, Equipment, Building,
Equipment tangible, (2) have long Machinery, Furniture and
useful lives, usually Fixtures. Also includes the
exceeding 3 years, Accumulated Depreciation
and (3) are used in accounts as contra-assets
business operations. (except Land, which is not
depreciated).
Liabilities Current Liabilities that are Accounts Payable, Wages
liabilities expected to be paid, Payable, Unearned Revenue,
or otherwise and Notes
terminated, within one Payable—current portion.
year
from the date of the
balance sheet.
Long-term Liabilities that are Notes Payable, due after one
liabilities expected year.
to be paid, or
otherwise
terminated, after one
year from the date of
the balance sheet.
Owner’s No sub- The owner's capital Owner, Capital. The amount
Equity classifications. balance at the end of comes from the statement of
the year, after closing owner’s equity.
entries.

Table 1. Balance sheet of a hypothetical farm.

Assets Amount (In Tk.) Liabilities Amount (In Tk.)
Current assets Current Liabilities
Cash on hand Crop Ions
Savings in bank
Intermediate assets Intermediate Liabilities

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Long term assets Longterm Liabilities

Total of assets Total of liabilities

Net worth or equity

Current Assets: They are very liquid or short-term assets. They can be converted into
cash within a short time, usually one year. For example, cash on hand, agricultural produce
ready for disposal, i.e. stocks of paddy.
Intermediate or Working Assets: Intermediate assets are less liquid asserts. Examples:
Machinery, equipment, livestock, tractors.
Long-term Assets or Fixed Assets: An asset that is permanent or will be used continuously
for several years is called a long-term asset. It takes longer time to convert into cash due to
verification of records, legal transactions, etc. Example: land, buildings, etc.
Current Liabilities: Debts that must be paid in the short term or in very near future. Examples:
Crop loans.
Intermediate Liabilities: These loans are due for the repayment within a period of two to five or
more years. Examples: Livestock loans, machinery loans, etc.
Long-term Liabilities: The duration of loan repayment is five or more years. Tractor
loan, land development loan, etc.

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