CONTENT

The Scope and Method of Economics, the Economic Problem:

Scarity & Choice, The Price Mechanism, Demand & Supply
UNIT Method of Equilibrium: The Concept of Elasticity and it’s
Applications. The Production Process: the Output decisions -
I Revenues Costs and Profit Maximization, Laws of returns &
Returns to Scale: Economics and Diseconomies of scale

Market Structure: Market Equilibrium of a firm and Price, Output

Determination under Structure Perfect Competition Monopoly,
UNIT Monopolistic Competition & Oligopoly

II

Macro Economic Concerns :Inflalation, Unemployment, Trade-

Cycles, Circular Flow upto Four Concerns Sector Economy,
UNIT Government in the Macro Economy: Fiscal Policy, Monetary
Policy, Measuring national Income and Output
III

The World Economy- WTO, Globalisation, MNC’s, Outsourcing,

Foreign Capital in Economy India, Trips, Groups of Twenty (G-20),
UNIT Issues of dumping, ExportImport Policy 2004-2009

IV
 UNIT -I
THE SCOPE AND METHOD OF ECONOMICS
MEANING OF ECONOMICS:

Economics is a social science that studies human behavior which aims at allocation
of scarce resources in such a way that consumer can maximize their satisfaction,
producers can maximize their profits and society can maximize its social welfare. It
is about making choice in the presence of scarcity.
It is concerned with the production, distribution, and consumption of goods and
services. It studies how individuals, businesses, governments, and nations make
choices about how to allocate resources.
DEFINITIONS OF ECONOMICS:
Various definition of economics can be grouped under four broad heads:
❖ Wealth definition
❖ Welfare definition
❖ Scarcity definition
❖ Growth and development definition
1. Wealth definition: Adam smith who is also known as the father of economics
defined economics as a science of studying the process of production and
consumption of wealth. His famous book “An inquiry into the Nature and
Causes of the Wealth of Nations” lays full emphasis on wealth.
According to Smith: “The great object of the Political Economy of every country
is to increase the riches and power of that country.”
2. Welfare definition: Alfred Marshall in his book “Principles of Economics”
placed emphasis on human activities or human welfare rather than on wealth .He
argued that economics, on one side, is a study of wealth and, on the other and more
important side, a part of the study of man.
According to Alfred Marshall “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.”
He gave, ‘Man’ the first place and Wealth’ as secondary and clarified that wealth is
for man and man is not for wealth. Wealth is not the ‘End’, it is only a ‘Means’ to
attain welfare.
3. Scarcity definition: The most accepted definition of economics was given by
Lord Robbins in his book “An Essay on the Nature and Significance of
Economic Science”. According to Robbins, neither wealth nor human welfare
should be considered as the subject-matter of economics. His definition runs in
terms of scarcity: According to L. Robbins “Economics is the science which
studies human behaviour as a relationship between ends and scarce means which
have alternative uses.”
He considered economics as the science of scarcity. Since the means to satisfy the
unlimited human wants are scarce and the allocation of scarce resources to different
uses is the central idea of Robbins definition.
4.Growth and development definition: Modern economists felt that the better
allocation and efficient use of scarce means for economic growth should also be the
subject matter of economics.
According to Samuelson, “Economics is the study of how people 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 among various persons and
groups of society.”
This definition introduced the dimension of growth under scarce situation.
Conclusion: From the above definitions we can conclude that economics is a
social science which is concerned with those activities of society which promote
welfare and economic growth ,through production and consumption of goods and
services with better and efficient use of limited means having alternative uses.
 Nature of Economics
Nature of economics refers to whether economics is a science or art or both, and if
it is a science, whether it is positive science or normative science or both.

Economics as a Science
To consider anything as a science, first, we should know what science is all
about? Science is a systematic study of knowledge and fact which develops the
correlationship between cause and effect. In science, facts and figures are collected
and are analysed systematically to arrive at any certain conclusion. For these
attributes, economics can be considered as a science. ‘economics has also several
characteristics similar to other science subjects.

• It involves a systematic collection of facts and figures.

• Like in science, it is based on the formulation of theories and laws.

• It deals with the cause and effect relationship. For example, supply is a
positive function of price, i.e., change in price is cause but change in supply
is effect.

• All the laws in economics are also universally accepted, like, law of demand,
law of supply, law of diminishing marginal utility etc.
• Theories and laws of economics are based on experiments.

However, some critics of the field argue that economics falls short of the
definition of a science for a number of reasons:
1)Economists do not have uniform opinion about a particular event.

2)The subject matter of economics is the economic behaviour of man, which is

highly unpredictable

3)It is not possible to make correct predictions about the behaviour of economic
variables.

Hence, economics is regarded as the social science.

Economics as a Positive or Normative Science

➢ Economics as a Positive science:
a) It studies “what is”.
b) It is based on facts and is purely objective and fact based.
c) It can be tested and proven
d)It describes economic topic and issues without judging them.
Example of a positive economic statement: "Government-provided
healthcare increases public expenditures." This statement is fact-based and
has no value judgment attached to it.

➢ Economics as a Negative science:

a) It studies “What ought to be”.
b) It is based on values and therefore subjective.
c) Originating from personal perspectives, feelings, or opinions of the
people.
d) Normative economics cannot be verified or tested.

An example of a normative economic statement is: "The government

should provide basic healthcare to all citizens." As you can deduce from
this statement, it is value-based, rooted in personal perspective, and
satisfies the requirement of what "should" be.

Economics as an Art
According to Т.К. Mehta, ‘Knowledge is science, action is art.’ Art is the practical
application of knowledge for achieving particular goals. Science gives us principles
of any discipline however; art turns all these principles into reality. Therefore,
considering the activities in economics, it can claimed as an art also, because the
knowledge of economic laws helps us in solving practical economic problems in
everyday life.
Conclusion: Therefore, from all the above discussions we can conclude that
economics is neither a science nor an art only. However, it is a golden
combination of both. Hence, economics is considered as both a
science as well as an art.

Scope of Economics
Scope means an area of study or coverage of the particular subject. Scope of
economics means area covered by subject economics i.e. the whole topics which
should be studied in economics. It is divided into two parts :
❖ Microeconomics and
❖ Macroeconomics.

Microeconomics:
The word micro is derived from the Greek word ‘Mikros’ which means small.
Thus, micro economics analyses individualistic behaviour. It studies an individual
consumer, producer, price of a particular commodity, household, etc.
According to Prof. K. E. Boulding, "Micro Economics is the study of particular
firm, particular household, individual prices, wages, incomes, individual industries
and particular commodities."
Scope of micro economics
1.Commodity Pricing:
Prices of individual commodities are determined by market forces of demand and
supply. So micro economics makes demand analysis (individual consumer
behaviour) and supply analysis (individual producer behaviour).

2. Factor Pricing:
Land, labour, capital and entrepreneur, all factors contribute in production process.
So they get rewards in the form of rent, wages, interest and profit respectively.
Micro economics deals with determination of such rewards i.e. factor prices. So
micro economics is also called as 'Price Theory' or 'Value Theory'.

3. Welfare Theory:
Micro economics deals with optimum allocation of available resources and
maximization of social welfare. It provides answers for 'What to produce?', 'When to
produce?', 'How to produce?' and 'For whom it is to be produced?'. In short, Micro
economics guides for utilizing scarce resources of economy to maximize public
welfare.

Macroeconomics:
The term macro has been derived from Greek word ‘makros’ which means
large. It is the study of aggregates or groups or the entire economy such as
gross domestic product, total employment, aggregate demand, aggregate
supply, total savings, general price level, etc.
Scope of Macroeconomics
There are six significant theories under macroeconomics:
Economic Growth and Development: The status of a country’s economy can be
evaluated in terms of the per capita real income, as studied under macroeconomics.
Theory of National Income: It covers the various topics related to the evaluation of
national income, including the income, expenditure and budgeting.
Theory of Money: Macroeconomics analyses the functions of the reserve bank in
the economy, the inflow and outflow of money, along with its impact on the
employment level.
Theory of International Trade: It is a field of study that enlightens upon the export
and import of goods or services. In brief, it determines the impact of cross-border
trade and duty charged, on the economy.
Theory of Employment: This stream of macroeconomics helps to figures out the
level of unemployment and prevailing employment conditions in the country. Also,
to know how it affects the supply, demand, savings, consumption, expenditure
behaviour.
Theory of General Price Level: The most important of all is the analysis of product
pricing and how these price levels fluctuate because of inflation or deflation.
Macroeconomics Policies
The government and the reserve bank functions together while determining the
macroeconomic policies, for the nation’s welfare and development.The two
segments of this section are as follows:
Fiscal Policy: Fiscal policy is the guiding force that helps the government decide
how much money it should spend to support the economic activity, and how much
revenue it must earn from the system, to keep the wheels of the economy running
smoothly.
Monetary Policy: Monetary policy is framed by the reserve bank in collaboration
with the government. These policies are the measures taken to maintain economic
stability and growth in the country by regulating the various interest rates
 ECONOMIC PROBLEM
Meaning of Economic problem:
An economic problem also known as basic or central problem is the problem of
how to make the best use of limited, or scarce resources. The economic
problem exists because the needs and wants of people are unlimited while the
resources available to satisfy these needs and wants are limited. Therefore,
problem of optimum adjustment of limited resources with unlimited wants
arises in the economy, e.g. limited factors give rise to the problems that how
much amount of resources should be utilised for satisfying different wants. For
this we face the problem of ‘Choice’.
Thus, economic problem is the problem of choice or economising
problem.
Definitions of economic problem :

According to Eric Roll, “Economic problem is essentially a problem arising

from the necessity of choice; choice of the manner in which limited resources
with alternative uses are disposed off. It is a problem of husbandry of
resources”.

According to Milton Friedman, “ An economic problem exists wherever

scarce means are used to satisfy alternative ends .If means are not scarce
,there is no problem at all.”
Causes of an Economic Problem

• Scarcity of Resources- Resources like labour, land, and capital, etc. are
insufficient as compared to the demand. Therefore, the economy cannot provide
everything that people want.
• Unlimited Human Wants- Human beings demands and wants are unlimited and
never ends, which means they will never be satisfied. If a person one wants is
satisfied, they will start tempting some new desires. People wants are unlimited
and keep multiplying, therefore, cannot be satisfied because of limited resources.
• Resources have alternative Uses- Resources being scarce they are put into
different uses. So, to make a choice among resources are essential. For instance,
petrol is not only used in a vehicle but it is also used for generator, running
machine, etc. So, now the economy should make a choice within the alternative
uses.

Basic Problems of an economy

The five basic problems of an economy are:

1. What to Produce and in What Quantities?

2. How to Produce?

3. For whom to Produce?

4. How to make efficient utilisation of the resources?

5. How to accelerate the rate of economic growth?

Problem # 1. What to Produce and in What Quantities?

The first central problem of an economy is to decide what goods and services are to be
produced and in what quantities. Since resources are scarce, the society has to decide
about the type of goods to be produced. For example, should we produce more capital
goods (e.g. machine, tools, equipments etc...) or we should opt for consumer goods (e.g.
sugar, wheat, cloths etc...).

Once the nature of goods to be produced is decided, then their quantities are to be
decided. How many tonnes of wheat, how many machines are to be produced. Since the
resources of the economy are scarce, the problem of the nature of goods and their
quantities has to be decided on the basis of priorities or preferences of the society .
 Problem # 2. How to Produce these Goods?

The next basic problem of an economy is to decide about the techniques or

methods to be used in order to produce the required goods. This problem is
primarily dependent upon the availability of resources within the economy.

If labour is in abundance, it may use labour-intensive techniques; while in the

case of labour shortage, capital-intensive techniques may be used. Thus the
choice depends on the availability of different factors of production and their
prices.

Problem # 3. For whom is the Goods Produced?

The third basic problem to be decided is the allocation of goods among the
members of the society. Since the resources are scarce, the resulting total output
of the economy is limited; the economy has to decide about the distribution of
this limited output among the members of the economy. For e.x. a rich person
may have a large share of the luxuries goods, and a poor person may have more
quantities of the basic consumer goods he needs.

Problem # 4. How to make efficient utilisation of the resources?

This is one of the important basic problems of an economy because having made
the three earlier decisions, the society has to see whether the resources it owns
are being utilised fully or not. In case the resources of the economy are lying idle,
it has to find out ways and means to utilise them fully.

Problem # 5. How to accelerate the rate of economic growth?

The last and the most important problem is to find out whether the economy is
growing through time or is it stagnant. If the economy is stagnant it has to be
moved on .Economic growth takes place through a higher rate of capital
formation which consists of replacing existing capital goods with new and more
productive ones and by adopting more efficient production techniques or through
innovations.
 PRODUCTION POSSIBILITY CURVE

A production–possibility curve (PPC) or production possibility

frontier (PPF) is a curve which shows graphical representation of various
combinations of the amounts of two goods which can be produced with the given
resources and technology where the given resources are fully and efficiently
utilized.

Assumptions for PPF:

Production possibility frontier is based on the following assumptions:

1. The amount of resources in an economy is fixed, but these resources can be

transferred from one use to another;

2. with the help of given resources, only two goods can be produced;

3. The resources are fully and efficiently utilised;

4. Resources are not equally efficient in production of all products. So, when resources
are transferred from production of one good to another, the productivity decreases;

5. The level of technology is assumed to be constant.

Properties of a PPC
➢ Concave to Origin: PPC curve is concave to the origin.
➢ Downward Sloping: PPC curve is downward sloping as more production of
one good is associated with the decline in production of the other good.
 ➢ Optimum utilization of resources: The points that lie on the Production
Possibility Frontier are associated with full employment of resources and
efficient utilization of the available technology.

Economic Growth Explained with Production Possibility curve

The PPC curve shifts outward as a result of economic growth.

Working of price mechanism

Meaning of price Mechanism:
Price mechanism refers to the determination of prices of all goods and
services by the interaction of the forces of demand and supply without any
external interference. In a capitalist economy, the prices of all goods
and services are determined by the price mechanism. In such a
scenario price mechanism plays an important role . Consumers and producers
react differently to price changes. Higher prices tend to reduce demand while
encouraging supply, and lower prices increase demand while discouraging
supply.

Economic theory suggests that, in a free market there will be a single price which
brings demand and supply into balance, called equilibrium price.
Working of Price Mechanism
There are three important economic ideas that describe the way in which
price mechanism works:

➢ Principal of demand
➢ Principal of supply
➢ Equilibrium Price

DEMAND
Meaning of Demand:
Demand for a commodity refers to the desire to buy a commodity backed with sufficient
purchasing power and the willingness to spend. Thus, there are three elements for the
demand of a commodity:
➢ Desire for a commodity
➢ Money to fulfill the desire
➢ Willingness to spend money

Factor affecting Demand /Determinants of Demand

(1) Price of the commodity: Inverse relationship exists between price of the commodity
and demand of that commodity. It means with the rise in price of the commodity the
demand of that commodity falls and vice-versa.
(2) Price of related goods: It may be of two types:
➢ Substitute goods
➢ Complementary goods
(i) Substitute Goods: Substitute goods are those goods which can be used in place of
another goods and give the same satisfaction to a consumer. There would always
exist a direct relationship between the price of substitute goods and demand for
given commodity.
It means with an increase in price of substitute goods, the demand for given
commodity also rises and vice-versa. For example, Pepsi and Coke.

(ii) Complementary Goods: Complementary goods are those which are useless in the
absence of another goods and which are demanded jointly. There would always exist an
inverse relationship between price of complementary goods and demand for given
commodity.
It means, with a rise in price of complementary goods, the demand for given commodity
falls and vice-versa. For example pen and refill.

(iii) Income of the Consumers:

Rising incomes lead to a rise in the number of goods demanded by consumers. Similarly,
a drop in income is accompanied by reduced consumption levels.

(iv) Taste and Preferences of the Consumer: Tastes, preferences and habits of a
consumer also influence its demand for a commodity. For example, if Black and White TV
set goes out of fashion, its demand will fall. Similarly, a student may demand more of
books and pens than utensils of his preferences and taste.

(v) Consumer Expectations with regard to future price: Expectations of an increase in

prices of goods in the nearby future will lead to an increase the quantity demanded.
Similarly, expectations of lowering in prices of goods will decrease the quantity
demanded.

(vi) Population Size and composition : Demand increases with the increase in population and
decreases with the decrease in population. This is because with the increase (or decrease) in
population size, the number of buyers of the product tends to increase (or decrease).
Composition of population also affects demand. If composition of population changes, namely,
female population increases, demand for goods meant for women will go up.

Demand function
Demand function shows the relationship between quantity demanded for a particular
commodity and the factors that are influencing it.
Individual demand function refers to the functional relationship between individual
demand and the factors affecting the individual demand.

Market demand function refers to the functional relationship between market demand
and the factors affecting the market demand.

Demand Schedule
Demand Schedule is a table showing different quantities being demanded of a given
commodity at various levels of price. It shows the inverse relationship between price of the
commodity and its quantity demanded. It is of two types:

1. Individual Demand Schedule

2. Market Demand Schedule

10. Individual demand schedule refers to a table that shows various quantities of a commodity
that a consumer is willing to purchase at different prices during a given period of time.
11. Market demand schedule is a tabular statement showing various quantities of a commodity
that all the consumers are willing to buy at various levels of price. It is the sum of all individual
demand schedules at each and every price.
Market demand schedule can be expressed as,

Demand curve

Demand curve is a graphical representation of demand schedule. It is the locus of all the
points showing various quantities of a commodity that a consumer is willing to buy at
various levels of price, during a given period of time, assuming no change in other
factors. Demand curve is of two types:

(a) Individual Demand Curve

(b) Market Demand Curve

Individual Demand Curve: Individual demand curve refers to a graphical representation
of individual demand schedule.

Market Demand Curve: Market demand curve refers to a graphical representation of

market demand schedule. It is obtained by horizontal summation of individual demand
curves. Market demand curve is flatter than the individual demand curves.

Law of Demand

The law of demand states that “other things being equal the demand of a good increases
with a fall in price and decreases with a rise in price”. Thus, there is an inverse
relationship between price of a commodity and its quantity demanded.

Definitions:
Some major definitions of the Law of Demand are as follows:

"Law of Demand states that people will buy more at lower prices and buy less at higher
prices, if other things remaining the same."- Prof. Samuelson.
The Law of Demand states that amount demanded increases with a fall in price and
diminishes when price increases." - Prof. Marshall

"According to the law of demand, the quantity demanded varies inversely with price." –
Ferguson.

The law of demand can be explained with the help of the following demand schedule:
 Price of Commodity (X) Quantity Demanded of X
(Rs) (Units)
5 100
10 75
15 50
20 25

The schedule shows that as the price of commodity X increases from Rs 10 to Rs 15, the
quantity demanded for X falls from 75 units to 50 units. Thus, there is a negative relationship
between demand and price.

Assumptions of the Law of Demand:

i. Size of the population remains the same.
ii. Income of the consumer remains unchanged.
iii. Prices of related goods remain unchanged.
iv. Consumer’s tastes and preferences remain unchanged.
v. Government’s policies remain unchanged.
vi. There is no change in the expectations about the future.

Reasons for law of Demand

Or
Why demand curve slopes downwards

1. Law of Diminishing Marginal Utility:

Law of diminishing marginal utility states that as we consume more and more
units of a commodity, the utility derived from each successive unit goes on
decreasing. So, demand for a commodity depends on its utility.
If the consumer gets more satisfaction, he will pay more. As a result, consumer
will not be prepared to pay the same price for additional units of the commodity.
The consumer will buy more units of the commodity only when the price falls.
Law of diminishing marginal utility is considered as the basic reason for operation
of ‘Law of Demand’.

2. Substitution Effect:
Substitution effect refers to substituting one commodity in place of other when it
becomes relatively cheaper. When price of the given commodity falls, it becomes
relatively cheaper as compared to its substitute (assuming no change in price of
substitute). As a result, demand for the given commodity rises.

3. Income Effect:
Income effect refers to effect on demand when real income of the consumer
changes due to change in price of the given commodity. When price of the given
commodity falls, it increases the purchasing power (real income) of the consumer.
As a result, he can purchase more of the given commodity with the same money
income.

4. Large number of consumers:

When price of a commodity falls, many new consumers, who were not in a
position to buy it earlier due to its high price, starts purchasing it. In addition to
new customers, old consumers of the commodity start demanding more due to its
reduced price. Thus, there are large number of consumers of the product leading
to increase in demand.

5. Varied uses of the product:

When the price of a commodity rises then the consumer restricts its usage for the
most important purpose. On the other hand if the commodity becomes cheap then
it can be utilised for all kind of purposes, weather important or not.
Exceptions to Law of Demand:

1.Giffen Goods:
The term Giffen good was named after Scottish economist
Sir Robert Giffen. These are special kind of inferior goods
whose demand rises with an increase in price and demand
falls with decrease in price. For example, in our country, it
is often seen that when price of coarse cereals like jowar
and bajra falls, the consumers have a tendency to spend
less on them and shift over to superior cereals like wheat
and rice. This phenomenon, popularly known as’ Giffen’s
Paradox’.
2. Veblen Goods:
Veblen Goods is a concept that is named after the economist Thorstein Veblen, who introduced the theory
of “conspicuous consumption“. According to Veblen, there are certain goods that become more valuable
as their price increases. If a product is expensive, then its value and utility are perceived to be more, and
hence the demand for that product increases.
And this happens mostly with precious metals and stones such as gold and diamonds and luxury cars such
as Rolls-Royce. As the price of these goods increases, their demand also increases because these
products then become a status symbol.

3. Necessary Goods and Services:

Another exception to the law of demand is necessary or basic goods. People will continue to buy
necessities such as medicines or basic staples such as sugar or salt even if the price increases. The prices
of these products do not affect their associated demand.

4.Expectation of Price Change in Future:

When the consumer expects that the price of a commodity is likely to further increase in the future, then
he will buy more of it despite its increased price in order to escape himself from the pinch of much higher
price in the future.
On the other hand, if the consumer expects the price of the commodity to further fall in the future, then
he will likely postpone his purchase despite less price of the commodity in order to avail the benefits of
much lower prices in the future.

5.Ignorance: Often people are misconceived as high-priced commodities are better than the low-
priced commodities and rest their purchase decision on such a notion. They buy those commodities whose
price are relatively higher than the substitutes.

6.Emergencies: During emergencies such as war, natural calamity- flood, drought, earthquake, etc.,
the law of demand becomes ineffective. In such situations, people often fear the shortage of the essentials
and hence demand more goods and services even at higher prices.

7.Change in fashion and Tastes & Preferences: The change in fashion trend and tastes
and preferences of the consumers negates the effect of law of demand. The consumer tends to buy those
commodities which are very much ‘in’ in the market even at higher prices.

ELASTICITY OF DEMAND

ELASTICITY OF DEMAND: “The elasticity of demand measures the responsiveness of the

quantity demanded of a good, to change in its price, price of other goods and change in
consumer’s income”. Accordingly, elasticity of demand is of three types :
1)Price elasticity of Demand
 2)Income Elasticity of Demand
3)Cross Elasticity of Demand

Price Elasticity of Demand: Price elasticity of demand (PED) measures the responsiveness of
demand after a change in price.

Degrees of Price Elasticity of Demand

1. Perfectly Elastic Demand:

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 1.

2. 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 (ed = 0).

3.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.
Marshall calls it unit elastic

4.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 (ed > 1)

5.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 (ed < 1).

Measurement Of Price Elasticity of Demand

Q. The price of a commodity falls from Rs 50 to Rs 30, resulting in an increase in the purchase of the
commodity from 200 units to 220 units.Calculate the price elasticity of demand.(Ans.ep =0.25)
P= ₹50 Q=200units
P1 ₹30 Q1=220 units

Price elasticity of demand= ∆Q x P

∆P Q

=20 X50 = .25

20 200
Hence , price elasticity of demand is = .25{Ans}

Factors upon which price elasticity of demand depends:

1. Nature of commodity:
Elasticity of demand of a commodity is influenced by its nature. A commodity for a person may be a
necessity, or a luxury.
i.) When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand is generally
inelastic as it is required for human survival and its demand does not fluctuate much with change in
price.
ii) When a commodity is a luxury like AC, sports car etc., its demand is generally elastic.

2. Availability of substitutes:
Demand for a commodity with large number of substitutes will be more elastic. The reason is that even
a small rise in its prices will induce the buyers to go for its substitutes. For example, a rise in the price of
Pepsi encourages buyers to buy Coke and vice-versa.

On the other hand, commodities with few or no substitutes like wheat and salt have less price elasticity
of demand.

3. Number of Uses:
If the commodity under consideration has several uses, then its demand will be elastic. When price of
such a commodity increases, then it is generally put to only more urgent uses and, as a result, its
demand falls. When the prices fall, then it is used for satisfying even less urgent needs and demand
rises.
On the other hand, a commodity with no or few alternative uses has less elastic demand.

4. Postponement of Consumption:
Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic demand as
their consumption can be postponed in case of an increase in their prices. However, commodities with
urgent demand like life saving medicines, have inelastic demand because of their immediate
requirement.

5. Share in Total Expenditure:

Proportion of consumer’s income that is spent on a particular commodity also influences the elasticity of
demand for it. Greater the proportion of income spent on the commodity, more is the elasticity of
demand for it and vice-versa.
Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers spend a
small proportion of their income on such goods. When prices of such goods change, consumers continue
to purchase almost the same quantity of these goods. However, if the proportion of income spent on a
commodity is large, then demand for such a commodity will be elastic.

Application of elasticity of demand:

Determination of price under Monopoly: The concept is useful in monopoly price- decisions. The
monopolist, being the sole supplier of a particular commodity, can raise price but cannot affect demand
pattern of consumers. So, in fixing the price the monopolist will have, of necessity, to take note of the
elasticity of demand for his product. He will fix the price at a low level when the demand is elastic and at
a high level when it is inelastic.
Price Discrimination: In perfect competition, the same price is charged from all the buyers. But, the
downward slope of the demand curve of the monopolist gives scope for price discrimination. Price
discrimination refers to the practice of charging different prices for the same product from different
buyers at the same time. It can be profitably practiced only when price elasticity of demand differs from
market to market or from one segment of the market to another.

Wage Bargaining by Trade Unions:

The bargaining power of the trade unions in raising the wages of a group of labour in a particular
industry also depends, among other things, on the elasticity of demand for their services to the
employer. A trade union usually succeeds in raising wages when the demand for the services of labour
to the employer is inelastic: because, in such a case the employer cannot easily dispense with their
services. On the other hand, it may not succeed when demand for labour is elastic.

International Trade :
The concept of elasticity of demand is also important in the field of International trade . A country will
gain by increasing the price of her exports if their demand in the importing country is inelastic. If their
demand in the importing country is elastic, then the exporting country reduce the price and increase her
total exports and thereby stand to gain.

Importance in taxation :
If any good is considered as harmful one and has highly inelastic demand then the government can
deliberately impose a huge tax on it with the objective of reducing its consumption.

INCOME ELASTICITY OF DEMAND

Income elasticity of demand 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:

Degrees of Income Elasticity of Demand:

(i) 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.
 (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.

(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.

CROSS ELASTICITY OF DEMAND

Cross Price Elasticity of Demand (XED) measures the responsiveness of demand for one good to the
change in the price of another good. It is the ratio of the percentage change in quantity demanded of
Good X to the percentage change in the price of Good Y.

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:

Degrees of Cross Elasticity of Demand:

1. Positive Cross Elasticity of Demand:

When goods are substitute of each other then cross elasticity of demand 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 tea,
demand of coffee will increase.

2. Negative Cross Elasticity of Demand:

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.
3. Zero Cross Elasticity of Demand:
Cross elasticity of demand is zero when two goods are not related to each
other. For instance, increase in price of car does not effect the demand of
cloth. Thus, cross elasticity of demand is zero.

PRODUCTION
Production in Economics can be defined as the process of converting the inputs into outputs. Inputs
include land, labour and capital, whereas output includes finished goods and services.

Factors of production

Production function: The production function is a statement of the relationship between a

firm’s scarce resources (i.e., its inputs) and the output that results from the use of these resources.
Inputs include the factors of production, such as land, labour, capital, whereas physical output includes
quantities of finished products produced. The long-run production function (Q) is usually expressed as
follows:
Q= f (LB, L, K, M, T, t)
Where, LB= land and building
L = labour
K = capital
M = raw material
T = technology
t = time

Assumptions of Production Function

Assumptions of production function are as follow:

• Production function is related to a specific time period.

 • The state of technology is fixed during this period of time.

• The factors of production are divisible into the most viable units.

• There are only two factors of production, labour and capital.

• Inelastic supply of factors in the short-run period.

Return to a Factor
1) Law of Increasing Returns
2) Law of Constant Returns
3) Law of Diminishing Returns

Law of Increasing Returns/Law of Diminishing Cost:

The law of increasing returns is also called the law of diminishing costs. The law of increasing return
states that:

"When more and more units of a variable factor is employed, while other factor remain fixed, there is an
increase of production at a higher rate. The tendency of the marginal return to rise per unit of variable
factors employed in fixed amounts of other factors by a firm is called the law of increasing return".
The law can be expressed in terms of costs also. Increasing returns mean lower costs per unit, just as
diminishing returns mean higher cost. Thus, the Law of Increasing Returns signifies that cost per unit of
the marginal or additional output falls with the expansion of an industry. As more and more units of
commodity are produced the cost per unit goes on falling steadily.
Units Units Total Marginal Total Average
of of production Cost cost=T.C/T.P
production
Land labour

2 1 4 - 40 10

2 2 10 6 80 8

2 3 18 8 120 6.6

2 4 28 10 160 5.71
 Law Of Diminishing Returns/law of increasing cost:
law of diminishing returns or principle of diminishing marginal productivity states that if one input in the
production of a commodity is increased while all other inputs are held fixed, a point will eventually be
reached at which additions of the input yield progressively smaller, or diminishing, increases in output.

It is also called “the law of increasing costs” because adding one more production unit diminishes the
marginal returns, and the average cost of production inevitably increases.

Units Units Total Marginal Total Average

of of production Cost cost=T.C/T.P
production
Land labour

2 1 5 - 40 8

2 2 8 3 80 10

2 3 10 2 120 12

2 4 11 1 160 14.5

Law Of Constant Returns/law of constant cost:

According to the law of Constant Returns, as more and more units of a variable factor are
combined with the fixed factor marginal product tends to remain constant. Consequently ,
total output increases at a constant rate.
Units Units Total Marginal Total Average
of of production Cost cost=T.C/T.P
production
Land labour

2 1 5 - 25 5

2 2 10 5 50 5

2 3 15 5 75 5

2 4 20 5 100 5
Return to a Scale:
In the long run all factors of production are variable. No factor is fixed. Accordingly, the scale of
production can be changed by changing the quantity of all factors of production. Such an increase in all
the factors in the same proportion is called returns to scale.

“The term returns to scale refers to the changes in output as all factors change by the same
proportion.” -Koutsoyiannis

Returns to scale are of the following three types:

1. Increasing Returns to scale.

2. Constant Returns to Scale

3. Diminishing Returns to Scale

1. Increasing Returns to Scale:

Increasing returns to scale or diminishing cost refers to a situation when all factors of production are
increased, output increases at a higher rate. It means if all inputs are doubled, output will also increase
at the faster rate than double. Hence, it is said to be increasing returns to scale.
2. Constant Returns to Scale:
Constant returns to scale or constant cost refers to the production situation in which output increases
exactly in the same proportion in which factors of production are increased. In simple terms, if factors of
production are doubled output will also be doubled.
3. Diminishing Returns to Scale:
Diminishing returns or increasing costs refer to that production situation, where if all the factors of
production are increased in a given proportion, output increases in a smaller proportion. It means, if
inputs are doubled, output will be less than doubled.
 Economies and Diseconomies of scale
Economies of scale, As a firm expands its production capacity, the efficiency of production also
increases. It is able to draw more output per unit of input, leading to low average total costs. This
condition is termed as economies of scale.
Economies of scale result in cost-saving for a firm as the same level of inputs yields a higher level of
output. A higher level of output results in lower average costs as the total costs are shared over the
increased output.

Types of Economies of Scale

There are two types of economies of scale:

1. Internal economies of scale

2. External economies of scale

Internal economies of scale: Internal Economies of Scale refers to the economies that a firm achieves
due to the growth of the firm itself. When an organisation reduces costs and increases the production,
internal economies of scale are achieved.

Internal economies of scale refer to the lower per-unit cost that a firm obtains by increasing its capacity.

Types of internal economies of scale:

1. Bulk-buying economies

2. Technical economies

3. Financial economies

4. Marketing economies

5. Managerial economies

External economies of scale

Occur outside the organization.External economies of scale refer to the economies in production
that a firm achieves due to the growth of the overall industry in which the firm operates.

External economies of scale transpire outside a firm, within an industry. Therefore, when an
industry’s scope of operations expands, external economies of scale are said to have been achieved.
Types of external economies of scale:

1) Economies of Concentration
2) Economies of Information
3) Economies of Disintegration

Diseconomies of Scale
Diseconomies of scale refer to the disadvantages that arise due to the expansion of a firm’s
capacity leading to a rise in the average cost of production. Similar to the economies of scale,
diseconomies of scale can also be categorised into internal and external diseconomies of scale.

Types of Diseconomies of Scale

There are two types of diseconomies of scale:

1. Internal diseconomies

2. External diseconomies

Internal diseconomies of scale refer to the diseconomies that a firm incurs due to the growth of the firm
itself. These diseconomies of scale result in a decrease in the firm’s output and increase in the long-run
average cost.
Types of internal diseconomies of scale:

1) Labour inefficiency:

2) Managerial inefficiency

3) Poor communication

4) Lack of motivation

External diseconomies of scale refer to the disadvantages that arise due to an increase in the number
of firms in an industry-leading to overproduction.

Types of external diseconomies of scale:

1) Congestion of road
2) Scarcity of Raw Material
3) Over exploitation of skilled labour
4) Damage to the environment(pollution)