Some Concepts Of Economics

8/7/2019 Some Concepts Of Economics

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Some Concepts OfEconomics,

Relevent To

Business


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some of the concepts from the Science

of Economics which are absolutely

relevant to business

Wants,

Demand,

Supply,

Production,

Distribution,

Consumption and

Consumption Function,

Cost,

Price,

Competition,

Monopoly,

Profit,

Optimization,

Average and Margin,

Elasticity,

Micro and Macro Analysis


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WANTS

Human wants are the starting point of all

economic activities. Want refers to thelack of satisfaction, a state of

discomfort which every individual

desires to eliminate.


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Human wants may be in the form of

o Necessities,

o Comforts &o Luxuries.


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Necessities

Necessities may be the necessities for life (i.e.

to live), necessities for efficiency (i.e. to live

efficiently) & conventional necessities arising

out of habit.

Wants are unlimited. All wants cannot be

satisfied simultaneously & fully. Although a

single want at a time may be satiable, yet

wants are recurring in nature


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economic problem

Lionel Robbins has indicated that economic

problem mainly arises because,, human wants

are unlimited whereas the means or

resources to satisfy these wants are limited

or scarce & these scarce means have

alternative uses.


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problem of economics

The allocation of scarce means having

alternative uses o meet our unlimited wants is

fundamentally the problem of economics.


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Utility


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Utility

Utility is the capacity of a good tosatisfy a human want.

Utility is a relative concept as well as asubjective concept because the samecommodity appears to possess

different degrees of utility to differentindividual consumers at different placesand at different times.


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Total Utility and Marginal Utility.

Total Utility is the

aggregate of utilitiesderived by the consumer

from all the units of thecommodity consumed;


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Total Utility

TUn = MU1 st + MUZnd + MU3ro +

MUnm .'. TU = summn.MUS i.e. Total Utility is the

summation of all MarginalUtilities


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Marginal Utility

whereas Marginal Utilityrefers to the addition tototal utility made by theconsumption of an

additional unit of thecommodity.


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Marginal Utility

.

Whereas,MUn = TUn - TUn- i


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Marginal Utility

goes on diminishing


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:Marginal Utility goes on diminishing

Marginal Utility goes ondiminishing as the consumer

goes on consuming unit after unitof that commodity.

This gives rise to the MarshallianLaw of Diminishing MarginalUtility.


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Assumptions of the Law

Of course, the Law assumes that

all units of the commodity

consumed are homogenous; they

are consumed in quick

succession and the consumerbehaves rationally.


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4 DEMAND

Demand = Desire to buy

+ Ability to pay +Willingness to pay


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Demand for milk is 30 litres.


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This is not a complete statement ofdemand. It

leads us to question

a) whose demand?,

b) at what price?, c) for what period of time?


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Therefore we have to specify the

1) market dimension,

2) the price dimension,

3) the time dimension,

to formulate a completestatement of demand.


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For example: We have in mind,

a) family A's demand for milk,

b)at some price say Rs 23 perlitre &

c) the period of time being amonth.


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Now let us frame the complete statement as

follows :

When price of milk is Rs23 then family A demands

30 litres of milk permonth.


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SUPPLY


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SUPPLY

Mere prevalence of demand is

meaningless without the reciprocating

supply. Supply of any commodity refersto various amounts of the commodity

which the sellers are willing to sell at

different possible prices at any giventime.


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SUPPLY

Even in case of supply we must make an effort

to give a complete statement of supply i.e.

the quantity of the commodity supplied at the

given price in the given market at the given

point of time. Without these dimensions

being narrated the statement of supply will be

incomplete.


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PRODUCTION

The primary & the ultimate aim of the

economic activity is the satisfaction ofhuman wants. In order to satisfy these

wants individuals have to put in efforts to

produce goods & services Without production there cannot beWithout production there cannot be

satisfaction of wants.satisfaction of wants.


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production

production refers to creation of something

tangible which can be used to satisfy human

want.

However matter already exists.


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production

We cannot create matter, we can only

add utilities to the existing matter by

either changing its form, place orkeeping it over time & create values. For

example: We can transform a log of

wood into a piece of furniture, therebyadding utility.


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production

This process ofaddition of utilities

to the existing matter by changing

its form, place and keeping it overtime is referred to as Production in

Economics.


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Production

Technologically production is

referred to as the process of

transforming inputs into output.


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Factors ofProduction

In order to undertake production werequire certain Factors ofProduction

such as Land,

Labour,

Capital &

Organization.


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DISTRIBUTION

The term distribution in Economic Theory

refers to the sharing of thewealth produced in the

community among thevarious factors of production.


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DISTRIBUTION

Since land, labour, capital &

organization participateparticipate inthe process of production,

they get their respectiverewards


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DISTRIBUTION

Land gets rent,

Labour commands wages,Capital earns interest &

Organization enjoysprofits.


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DISTRIBUTION

Thus according toChapman "Theeconomics of distributioneconomics of distribution,

accounts for the sharing ofwealth produced by acommunity among the agents oramong the agents or

the owners of the agentsthe owners of the agents whichhave been active in itsproduction."


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DISTRIBUTION

The share that each factor of

production receives for its

services is in a way its price.

Thus, the Theory of

Distribution relates to theTheory ofFactor Pricing.


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DISTRIBUTION

However, in general the term

distribution is loosely used to

denote the process by which the

goods & services produced are

made to reach through differentstages to the final consumers


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CONSUMPTION&

CONSUMPTION

FUNCTION


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CONSUMPTION

Consumption, in Economics implies

destruction or use of utilities for

satisfying human wants.,


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Law of Diminishing Marginal Utility

As the consumer goes on consuming more

and more units of the commodity The

total utility from the commodityincreases although

the marginal utility from the additional

unit of the, commodity consumed goeson diminishing

&


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the consumer goes on consuming unit after

unit till total utility becomes maximum

& marginal utility becomes zero (evenif the commodity is available

free of cost.)


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Any additional unit consumed

will reduce total utility & the

marginal utility of that unit will

become negative.


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If the price of the commodity is tobe considered, the consumer will

go on buying the units ofcommodity till

the Marginal Utility (MU) of X =

Price of X.


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The consumer will not be justconsuming a single commodity

always but will be consumingcombination of commodities &

at that stage he will consider the prices ofthese commodities as well as the incomeat his disposal .


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Law of Equi-MU

the Law of Equi-MUwillindicate that the consumer will maximize

satisfaction from combination ofcommodities consumed when:

Mux

MUY

MUZ

------------- = -------------- = ----------

P X PY PZ


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CONSUMPTION

FUNCTION


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CONSUMPTIONFUNCTION

John Maynard Keynes has elaborately

explained consumption function in his book

'The General Theory of Employment, Interest

& Money.' In words of Alvin Hansen

"Keynesian analysis of consumption function

is a major landmark in the history of economicdoctrines


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CONSUMPTIONFUNCTION

The level of consumption depends

on several factors. Income is singled

out as the main determinant ofconsumption.

&

factors other than income influencing

the level of consumption are treated in

another category.


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CONSUMPTIONFUNCTION

Thus, the factors influencing consumption arebroadly classified into two:

1. Income (Y)

2 Factors other than income (Y) The Psychological Law ofConsumption as given

by Keynes indicates that as income goes onincreasing, the consumption also increases but

at a rate less than increase in income, in such away that the savings will also be increasing withthe increase in income.


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Consumption function &Saving

Function.

Consumption Function reads: C = f(Y)

Saving Function reads : S = f(Y)


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Average Propensity to Consume (APC)

APC is the ratio ofConsumption to

Income:

APC = C / Y


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Marginal Propensity to Consume

(MPC).

MPC is the ratio of change in

Consumption to change in

Income: MPC = C/ Y


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Average Propensity to Save (APS)

APS is the ratio ofSaving to Income:

APS = S / Y


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Marginal Propensity to Save (MPC).

MPC is the ratio of change in Saving

to change in Income:

MPC = S / Y


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Income Consumption Saving MPC MPS

Rs 1000

Rs 900 Rs 100

Rs 1500 Rs 1300 Rs 200

Rs 2000 Rs 1600 Rs 400

Rs 2500 Rs 1800 Rs 700


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CONSUMPTIONFUNCTION

1. As income increases, consumption also

increases.

2. Absolute increase in consumption is less

than increase in income.

3. With increase in income, consumption

increases & so also savings rise.


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CONSUMPTIONFUNCTION

4. As income goes on increasing, the MPC

goes on falling.

5. As income increases MPS goes on rising.

6

. MPC

+ MPS

=1


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Factors other than IncomeFactors other than Incomeinfluencing consumption are

further classified as subjectivefactors (endogenous) as well

as objective factors(exogenous factors).


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Keynes

Keynes has listed eight motives governingindividual's propensity to consume viz;

Motives ofPrecaution,

Foresight, Calculation,

Improvement,

Independence,

Enterprise,

Pride and Avarice'.


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Keynes has also listed four subjective factors

which influence behaviour pattern of Business

Corporation and Government bodies. They are

i) Motive of Enterprise;

ii) Motive ofLiquidity;

iii) Motive ofImprovement and

iv) the Motive offinancial prudence.


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The Objective factors

The Objective factors or Exogenous factors or

External factors which influence Propensity to

Consume are:

Windfalls,

change in Rate of Interest,

levels of prices,

expectations about future change in Incomes

etc.


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COST


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COST

Production involves cost.

The cost of production may bedefined as the aggregate of theexpenditure incurred by the

producer in the process ofproduction.


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Payments made by the

producer to the factors of

production for their

participation in process of

production emerge as cost ofproduction.


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Cost, therefore is the

valuation placed on the use of

resources.


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concepts of costs

We have several concepts of costs such as

Fixed Cost,

Variable Cost,

Average Cost, Marginal Cost,

Money Cost,

Real Cost,

Opportunity Cost, Private Cost,


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PRICE


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10 PRICE

Whenever an interaction

takes place between thebuyer and the seller in the

market, price becomes the

mechanism for the purpose

of exchange..


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'Price'

The value of any thing

expressed in terms ofmoney is the 'Price' of

that thing.


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PRICE UNDER

COMPETITION&MONOPOLY

In fact, the price under competition is

determined by the interaction offorces of

demand and supply whereas

under conditions ofmonopoly, the

monopolist generally fixes the price of his

product depending upon the elasticity of

demand for his product in the market.


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PRICE UNDER MONOPOLY

If the demand for the product is relatively

inelastic then that. product commands a

relatively high price .

But if demand for the product is relatively

elastic then such a product will be sold at a

relatively low price.


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There are two concepts of Price namely,

Market Price and the Normal Price.

Market Price is the price which actually

prevails in the market at a given point of time

. It is the result of temporary equilibrium

between demand and supply.


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Normal Price

Whereas Normal Price is that

price which is normally

expected to prevail in the long

run.


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The Market Price is moreinfluenced by the demand

side because in the veryshort period the supply is

assumed to be almostinelastic.


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Normal Price

However, the Normal Price is more influenced

by the supply side because in the long run

supply is capable of adjusting itself to demand

and will thereby influence the price.


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Further the Market Price goes on

fluctuating from time to time, whereas

N

ormalP

rice is relatively stable.

Normal Price is more or less

hypothetical in nature whereas the Market Price is

more real.

COMPETITION


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COMPETITION

In a market category, in the absence of

monopoly there is bound to prevail the

element of competition i.e.

each producer tries to compete- with the

other producer by way of fixing the price or

the output.


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COMPETITION


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COMPETITION

Competition takes two forms.i.e. either

perfect competition or

imperfect competition.


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Imperfect competition

Imperfect competition may againhave several forms such as

Monopoly,Duopoly,

Oligopoly,Monopolistic competition, etc.


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MONOPOLY

MONOPOLY


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MONOPOLY

Monopoly is that market category in which

there is a single seller. In the strictest sense of

the term, monopoly occurs when there is only

one producer of a commodity for which there

is no substitute. This condition is referred to as

Absolute Monopoly.


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features of monopoly

1. Existence of a single firm.

2. Firm is itself an industry.

3. Absence of close substitute.

4. Barriers to entry.

5. A monopolist can either fix theeither fix the

price or the output,price or the output, not both.


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PROFIT

2 13 PROFIT


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2.13 PROFIT

Profit refers to the excess ofrevenue over the cost.

T Represent Profit

TR- Total Revenue

TC -Total Cost

Then T = TR - TC


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profits

In Economics we refer to

profits as a reward which goes

to the organization

(entrepreneur) as a factor of

production for itsparticipationin the process of

production.


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Gross Profit and Net

Profit


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Gross Profit

Gross Profit = Total Revenue -Explicit Costs

Where, Explicit Costs are costs shown in the

Books of Accounts as payments made in theform of

rent,

wages,

interests and

for the purchase of raw material.


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Net Profit

; whereas, Net Profit is arrived at taking into

consideration not only explicit cost but also

depreciation as well as the amount of tax

paid.

Net Profit = Gross Profit -

(Depreciation +Tax)


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OPTIMISATION

2 14 OPTIMISATION


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2.14 OPTIMISATION

The objective as such is Optimization i.e.

making the best possible use of available

resources to obtain the maximum possible

desired quality of output.


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Therefore there is the basic difference

between maximization and

optimization(EG.COST-

MINIMISATION)


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AVERAGE AND

MARGINAL

2 15 AVERAGE AND MARGINAL


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2.15 AVERAGE AND MARGINAL

The concepts of Average and Marginal are

both related to the concepts of Total Cost as

well as Revenue, Propensity to Consume and

Propensity to Save, Average and MarginalProduct.


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For example:

Given total cost of producing unit after unit of

some commodity we can obtain the Average

Cost & the Marginal Cost as follows:

Average cost =Total Cost

Units of Output Produced


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Marginal Cost

Marginal Cost is the additional

cost for producing additional

unit of output .

MCn = TCn - TCn-1

ELASTICITY


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ELASTICITY

By Elasticity we mean the degree

of responsiveness of change inone variable brought about by

change in some other variable


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Price Elasticity of Demand

degree ofresponsiveness

of quantity demanded of X

to the change in price of X,

which is called as Price

Elasticity of Demand.

MICRO AND MACRO ECONOMICS


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MICRO AND MACRO ECONOMICS

There are mainly two approaches to the study

of the Science of Economics, namely the

Micro Economic Approach and the Macro

Economic Approach. The terms MicroEconomics and Macro Economics were coined

by Ragner Frisch of the Oslo University in

1920's


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. In Micro Economics we analyze the behavior

of individual economic units such as

individual consumer or individual producer,


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Macro Economics

whereas in Macro Economics we are

concerned with the aggregates i.e. the

behavior of the economy as a whole.

For example: we study

National Income,

National Output,Output,

Business Cycle etc.Business Cycle etc.


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Following are the assumptions of Micro Economic Analysis:

1. Economic man:, This term implies that every individual under,consideration behaves in an economically rational manner i.e. arational consumer tries to maximize his level of satisfaction, ofcourse within certain constraints like income and prices. The

individual producer will try to maximize his profits. 2. Mobile resources:. There are no rigid restrictions imposed onmobility of economic units. For example: Labour is free to enterthat occupation which fetches highest possible price for hisservices.

3. Free flow of information: Micro Economic Analysis assumes

free flow of complete and reliable information about marketconditions.


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, Diminishing returns: Production over a period of timeis subject to diminishing etums. Similarly consumptionof additional homogenous units of commodity issubject to the law of diminishing marginal utility.

5

. Assumption of

full

employment: While conductingeconomic analysis on the basis of Micro Approachgenerally an assumption of full employment in theeconomy as a whole is made. This is a very seriouslimitation of Micro Economics because accordingg to

Keynes "what prevails in reality is not full employmentbut less than full employment."

Full employment may be an exception but not a ru

Distinction between Micro and Macro


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Economics:Micro Macro

1. Unit of study : Individual Aggregate

2. Method : Slicing Lumping

3. Subject matter: Study of product andfactor pricing etc.

Study of National

Income, general level

of prices, trade cycles

etc.

4. Basis : Based on

independence.

Based on inter-

dependence.5. Advocated by: Alfred Marshall John Maynard Keynes

6. Vision: Worms eye view-study

of a tree.

Birds eye view- forest

as a whole.

WHY TWO APPROACHES ?


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WHY TWO APPROACHES ?

The justification for two approaches

lies in the fact that what is true in

case of an individual need notnecessarily be true for the economy

as a whole. Keynes gave the example

with regard to saving. To quoteKeynes "Saving is a private virtue

b t it is a p blic ice "

Some Concepts Of Economics

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