MANAGERRIAL ECONOMIC S

UNIT-I

BASIC CONCEPTS AND PRINCIPLE OF ECONOMICS:-

Economics is not only a subject but also a regular practice in every individual's
life. It is a way of balancing the financial inputs and outputs. Whether it is a
small family or large family, small business firm or a big organization, and
individuals pocket money, etc. whatever it is one should plan before the month
or count at the end of the month or year. This is what economics is trying to
balance the unlimited requirements with limited resources.

With this being said, we will begin our discussion on the subject ‘Economics’.
This content is readable for especially those students who just started their
journey of Commerce in class XI. In short, we can say that Economics is a
scoring and intellectual subject which will be a worthy study for the quest for
knowledge.

Definition of Economics
Economics is defined as a technique or a tool of balancing most of the needs
which can be termed as a credit and the limited resources, which can be
termed as a debit. Keeping a proper and healthy balance between these two
terms is nothing but economics. It is one of the Economics basic definitions.
Apart from this, we have different basic definitions of Economics there, based
on the scenario. Before going to the fundamentals of economics, it has two
streams. Namely- macroeconomics and microeconomics.

Macroeconomics: Macro means large. Macroeconomics deals with large

economic-related issues like a whole entity or a big organization or the entire
nation or the whole city or a complete project etc. Inflation, annual budgets,
scarcity, poverty, etc. can come under macroeconomics.
Microeconomics: On the other hand, micro means small. Microeconomics
deals with small units, single apartments, individual plants, household
activities, part of your project, a single event, etc. that come under the
microeconomics.

List and Explain the Basic Concepts of Economics

Along with the meaning and the definition of economics, it is important to
understand the basic economic terms and concepts in detail to get the
awareness of maintaining a proper budget for the house or task or any
organization. We have five fundamental economic concepts in general. They
are as follows-
 1. Supply and demand
2. Scarcity
3. Opportunity cost
4. Time value of money
5. Purchasing power

 Supply and Demand: - It is one of the basic economic concepts and

theories. Supply and demand can be seen everywhere in our daily life.
To understand this concept more clearly, let's take a common example
like food products. If we take food and drinks, they need to travel from
the farmer to the consumer with multiple mediators. So, the price may
vary. The price of a particular product depends upon the supply and
demand of that product.
 Scarcity: - This is also the basic concept of economics, which also acts
as a factor of demand and supply. Because the supply doesn't meet the
demand, then the condition is termed as a scarcity of that particular
utility, whether it is food or product or money or any other.
 Opportunity Cost: - It is one of the 5 basic concepts of economics. It is
like a trade-off market. It is also termed as an exchange policy like if we
want something we need to give others in the form of cash or product or
whatever it is. We are creating an opportunity to sell our goods in return
for getting our requirements.
 Value for Money: - It is one of the important concepts in economics
because the value of money may vary from time to time based on
different factors. It refers to utility that is derived from every money a
consumer spends.
 Purchasing Power: - Another fundamental economic concept is the
purchasing power of consumers because if we take gold as an
example, even though the price of gold is reduced, the buyer may not
have the ability to purchase food at that particular time. If he can
purchase some amount of gold, the price may increase. That ability of
the consumer is called the purchasing power.

These are some basic concepts of economics. As it is a wide concept, its

scope spreads broadly and can derive several definitions in different
scenarios. Among the five basic concepts, 3 fundamentals of economics were
most important. Supply and demand, the value of money, scarcity. So, it is
always important to have a good knowledge of economics to maintain equality
in our balanced budgets.

FIRMS AND THEORIES OF FIRM:-

MANAGERIAL THEORIES OF THE FIRM

Managerial theories of the firm place emphasis on various incentive

mechanisms in explaining the behaviour of managers and the
implications of this conduct for their companies and the wider
economy.

According to traditional theories, the firm is controlled by its owners

and thus wishes to maximise short run profits. The more
contemporary managerial theories of the firm examine the
possibility that the firm is controlled not by its owners, but by its
managers, and therefore does not aim to maximise profits. Although
profit plays an important role in these theories as well, it is no longer
seen as the sole or dominating goal of the firm. The other possible
aims might be sales revenue maximisation or growth.

Traditional theory of the firm

The traditional theory of the firm is based on classical economics
and the work of early economists, such as David Ricardo and Leon
Walras. The basic assumptions of the traditional theory of the firm
are

 Firms seek to maximise profits.

 Information symmetry. Owners and workers of the firm have
access to good information which enables them to maximise
profits.
 Firms act as an homogenous unit with owners wishing to
maximise profits and these aims being achieved by managers
and workers.
 To maximise profits a firm makes use of marginal analysis. In
particular profit maximisation occurs at an output where
marginal revenue = marginal cost.
 Firms and managers are rational. With their rational
objectives being to maximise profits.
Profit maximisation

It is assumed that firms wish to maximise profits because this will

enable the owners and managers to maximise their own salary,
bonus and dividends. To maximise profits, they will seek to cut
costs and set the profit maximising price and level of output.
This is a model to show that a firm will maximise profits by setting
the output at five and setting price where MR-MC (£5)

Whilst the traditional theory of the firm provides a starting point for
investigating the behaviour of firms, the traditional theory of the
firm is increasingly questioned by modern economists.

Criticisms of the traditional theory of the firm include

Criticisms of the traditional theory of the firm include

 Firms are not a homogenous unit. Owners may want profit
maximisation, but managers and workers may have different
objectives.
 Other objectives to profit maximisation. Profit maximisation is
not the only goal of a firm, it could include maximising sales,
maximising market share, social responsibility (e.g. looking
after the environment) and co-operatives which seek to
improve the welfare of all society.
 Marginal approach to firms is not replicated in the real world.
businessmen do not have time or the ability to work out the
marginal cost and marginal revenues. They tend to use a
rough ‘rule of thumbs’ such as average cost + profit margin.
Prices may also be sticky (not change) even if marginal cost
and marginal revenue changes.
 Imperfect information. Firms have imperfect information
about prices, costs and competitors. Also, workers are not like
a typical factor of production. They may become demotivated
or discouraged if work appears boring or lacking in interest.
This can affect the objectives of firms.
 Behavioural economics. Recent behavioural economists,
Thaler and Aversky state the importance of human psychology
in determining the behaviour of firms – a much more complex
set of circumstances than simple profit maximisation
UNIT-II
UTILITY AND DEMAND ANALYSIS
MEANING AND DEMAND ANALYSIS:-
What is Demand Analysis?
It is the process of assessing the demand for a particular product or
service in a market. It examines factors influencing consumer
purchasing decisions, such as price, preferences, and market
conditions. By understanding these factors, businesses can make
informed decisions about production, marketing strategies, and sales
forecasts.

Types of Demand
Multiple standards can categorise various demand types. These
categories aid analysts’ and businesses understanding of how changes
in various variables may impact market demand for goods and
services.

Complete Inelastic Demand

It does not adjust in response to price fluctuations. This is when buyers

are prepared to pay any price for a certain amount of the good or
service.

Inelastic Demand

Demand is inelastic when it fluctuates less than the price. Customers

are willing to pay more for necessities. Hence, there is typically
inelastic demand for these goods and services.

Elastic Demand

The quantity desired fluctuates more than the price. This is usually the
case for products or services that are viewed as largely optional or for
which there are easily accessible alternatives.

Cross Demand
Cross-demand describes how the price of a related good and the
demand for a particular good are related. The demand for one
connected good may decrease when its price increases.

Complementary Demand

Demand for one commodity that is favourably correlated with the

demand for another is known as complementary demand. For instance,
there is a complementary need for gasoline and cars.

Competing Demand

A situation known as competing demand occurs when two or more

products try to meet the same customer need. Price adjustments for
one product may impact the other’s demand.

Importance of Demand Analysis

Conducting this type of analysis is vital for several reasons:

1. Informed Decision-Making: It provides businesses with data-driven

insights, enabling them to make informed decisions regarding production
levels, pricing strategies, and market entry.
2. Identifying Market Opportunities: Analysing demand can help
businesses identify potential market opportunities and gaps, which can be
used to launch new products or enter new markets.
3. Optimising Resource Allocation: Understanding demand helps
optimise resource allocation, ensuring that production meets market
needs without overproducing or underproducing.
4. Risk Mitigation: It helps anticipate market changes and potential risks,
allowing businesses to prepare and adapt accordingly.
5. Enhancing Customer Satisfaction: Analysis helps businesses to
understand consumer preferences and needs better, allowing them to
customise their products and services to meet customer satisfaction and
loyalty.
Methods of Demand Analysis
Several methods are used to gauge market demand, each with its strengths
and applications. Below are some common methods:

Method Description

Gathering information directly from customers via online

surveys, interviews, and questionnaires.Provides first-hand
Survey Method
information about consumer preferences, buying behaviour,
and expectations.
 Testing a product in a small market segment to gauge its
Market
potential demand through pilot launches, test marketing, or
Experimentation
focus groups.

Analysing historical sales data and market trends to forecast

Statistical
future demand using techniques such as regression analysis,
Analysis
time series analysis, and econometric models.

Consulting a panel of experts to predict future demand,

Delphi Method relying on the knowledge and experience of industry
specialists.

Steps to Conduct Demand Analysis

Conducting this analysis involves several key steps:

1. Define Objectives: The first step is to define the objectives clearly.

What specific information does the business need? This could include
understanding consumer preferences, estimating market size, or
predicting future sales.
2. Data Collection: The gathering of appropriate information is the next
stage. Data can be collected through surveys, market reports, sales data,
or other sources. The quality and reliability of the data are crucial for
accurate analysis.
3. Data Analysis: Once the data is collected, it must be analysed to extract
meaningful insights. Various statistical techniques and patterns are used
to identify trends and relationships.
4. Forecasting: Based on the analysis, businesses can forecast future
demand. This involves predicting how price changes, economic
conditions, and consumer trends will impact demand.
5. Strategy Formulation: The final step is formulating strategies based on
the insights gained. This could involve adjusting pricing, altering
marketing strategies, or changing production levels.
Application of Demand Analysis
It has several varieties of applications. Here are a few examples:

1. New Product Development: Businesses must understand the potential

demand before launching a new product. This analysis helps assess
whether there is a market for the product and how it should be
positioned.
2. Pricing Strategies: Pricing is a critical factor that influences demand. By
analysing how price changes affect demand, businesses can set optimal
pricing strategies that maximise revenue and market share.
3. Inventory Management: Reliable projections are necessary for efficient
inventory control. By understanding demand patterns, businesses can
ensure they have the right stock to meet customer needs without
overstocking or understocking.
4. Marketing and Sales Planning: Analysis provides insights into
consumer preferences and buying behaviour. This information is valuable
 for developing targeted marketing campaigns and sales strategies that
resonate with the target audience.
Challenges in Demand Analysis
While analysing according to the demand is a powerful tool, it comes
with its own set of challenges:

1. Data Quality: The accuracy of the analysis heavily depends on the

quality of the data collected. Only accurate or complete data can lead to
correct conclusions and better decision-making.
2. Changing Conditions in the Market: The market is dynamic and ever-
changing. Economic shifts, technological advancements, and changing
consumer preferences can impact demand, making it challenging to
predict accurately.
3. Complexity of Analysis: This analysis often involves complex statistical
methods and models. Businesses need skilled analysts who can interpret
the data and derive actionable insights.
4. Cost: Conducting a thorough analysis can be costly, especially involving
extensive data collection and sophisticated analytical tools.
Conclusion
This analysis is essential for any business looking to succeed in a
competitive market. Companies can make informed decisions, identify
opportunities, and mitigate risks by understanding demand factors.

While the process can be challenging, the benefits far outweigh the
costs. Whether developing new products, setting pricing strategies,
managing inventory, or planning marketing campaigns provides the
insights needed to drive business success.

Incorporating this method into business operations can lead to more

effective resource allocation, better customer satisfaction, and
improved profitability. As markets continue to evolve, this type of
analysis will only grow, making it a critical skill for businesses of all
sizes.

DEMAND ANALYSIS:-

Meaning of Demand
Demand means the desire backed by the willingness to buy a commodity
and the purchasing power to pay.
As stated by Stonier and Hague, in economics, “demand” signifies a
request for goods that is supported by sufficient funds to cover the
requested items.

According to Prof. Bober, “Demand refers to 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 or at various incomes or at various
prices of related goods.”

What is Demand Analysis?

Demand Analysis involves the management’s decision-making process
concerning production, cost distribution, advertising, inventory
management, pricing, and related matters. Although, how much a firm
produces depends on its production capacity how much of The production
effort should be aligned with the potential demand for the product.

Law of demand
The Law of Demand asserts that there’s an inverse relationship between
the price, and the volume demanded, similar to when the price increases
the demand for the commodity decreases and when the price decreases
the demand for the commodity increases, other effects remaining
unchanged.

Assumptions of Law of Demand

Law is demand is grounded on certain assumptions which are as follows:

This is no significant difference in consumers’ tastes and preferences.

Income should remain constant.
Prices of other goods shouldn’t change.
There should be no cover for the commodity
The commodity shouldn’t confer at any distinction
The demand for the commodity should be nonstop
People shouldn’t anticipate any change in the price of the commodity
Demand Schedule
A demand schedule most generally consists of two columns. The first
column consists of the price for a product in ascending or descending
order. The other column consists of the volume of the product asked or
demanded at that price. The price is determined based on research on the
market.

When the data in the demand schedule is graphed to produce the demand
curve, it supplies a visual demonstration of the relationship between price
and demand, allowing easy estimation of the demand for goods or services
at any point with the curve.

Demand Function
The demand function is the relationship between different factors affecting
the demand. There are numerous economic, social as well and political
factors affecting demand. The effect of all the factors on the amount
demanded for the commodity is called the Demand Function. The demand
function is of two types which are as follows:
PRICE QUANTITY
DEMANDED
500 30
800 18
1000 10

In this example, the demand schedule shows the quantities of

“Refrigerators” that consumers are willing to purchase at different price
levels. As the price increases, the quantity demanded generally decreases,
which is a typical pattern represented by a downward-sloping demand
curve.

Demand Curve
A demand curve is a graphical representation of the relationship between
the price of a product or service and the quantity of that product or service
that consumers are willing and able to purchase at various prices, all else
being equal. In economics, it is one of the fundamental tools used to
understand how changes in price affect consumer behaviour in a market....

LAW OF DIMINISHING MARGINAL UTILITY:-

In economics, the law of diminishing marginal utility states that the

added benefit of consuming more of a product or service declines
as its consumption increases. That is, the satisfaction or utility they
derive from the product wanes as they consume more and more of
it.
Understanding the Law of Diminishing Marginal Utility
To understand how the law of diminishing marginal utility affects both
consumers and businesses, it can be helpful to break down its
components.
Utility
Utility is the degree of satisfaction or pleasure a consumer gets from an
economic act. For example, when hungry, a consumer can purchase a
sandwich to eat so they are no longer hungry. Thus, the sandwich
provides some utility.
Marginal Utility
Marginal utility is the enjoyment a consumer gets from each additional unit
of consumption. It calculates the utility beyond the first product consumed.
If you buy a bottle of water and then a second one, the utility gained from
the second bottle of water is the marginal utility.
Diminishing Marginal Utility
The law of diminishing marginal utility directly relates to the concept of
diminishing prices. As the utility of a product decreases, consumers are
only willing to pay smaller dollar amounts for more of the product.
INDIFFERENCE CURVE CONSUMERS EQUILIBRIUM AND CONSUMER
SURPLUS:-
An indifference curve depicts all the combinations of two goods that
provide the consumer with equal satisfaction. When the Budget line
is tangent to the indifference curve, a consumer will be in
equilibrium, according to the indifference curve approach.

Determinants of Demand
There are many determinants of demand, but the top five determinants of
demand are as follows:

Product cost: Demand of the product changes as per the change in the
price of the commodity. People deciding to buy a product remain constant
only if all the factors related to it remain unchanged.

The income of the consumers: When the income increases, the

number of goods demanded also increases. Likewise, if the income
decreases, the demand also decreases.

Costs of related goods and services: For a complimentary product, an

increase in the cost of one commodity will decrease the demand for a
complimentary product. Example: An increase in the rate of bread will
decrease the demand for butter. Similarly, an increase in the rate of one
commodity will generate the demand for a substitute product to increase.
Example: Increase in the cost of tea will raise the demand for coffee and
therefore, decrease the demand for tea.

Consumer expectation: High expectation of income or expectation in

the increase in price of a good also leads to an increase in demand.
Similarly, low expectation of income or low pricing of goods will decrease
the demand.
Buyers in the market: If the number of buyers for a commodity are
more or less, then there will be a shift in demand.

ELASTICITY OF LAW OF DEMAND AND EXCEPTIONS

Elasticity of Demand

A change in the price of a commodity affects its demand. We can

find the elasticity of demand, or the degree of responsiveness of
demand by comparing the percentage price changes with the
quantities demanded. In this article, we will look at the concept of
elasticity of demand and take a quick look at its various types.

Elasticity of Demand
To begin with, let’s look at the definition of the elasticity of demand:
“Elasticity of demand is the responsiveness of the quantity demanded
of a commodity to changes in one of the variables on which demand
depends. In other words, it is the percentage change in quantity
demanded divided by the percentage in one of the variables on which
demand depends.”

The variables on which demand can depend on are:

 Price of the commodity

 Prices of related commodities
 Consumer’s income, etc.

ypes of Elasticity of Demand

Based on the variable that affects the demand, the elasticity of
demand is of the following types. One point to note is that unless
otherwise mentioned, whenever the elasticity of demand is
mentioned, it implies price elasticity.
Price Elasticity
The price elasticity of demand is the response of the quantity
demanded to change in the price of a commodity. It is assumed that
the consumer’s income, tastes, and prices of all other goods are
steady. It is measured as a percentage change in the quantity
demanded divided by the percentage change in price. Therefore,

$$\text{Price Elasticity} = E_p = \frac{\text{Percentage change in

quantity demanded}}{\text{Percentage change in price}}$$

Or,

Ep=Change in Quantity×100Original QuantityChange in Price×100Original

Price

=Change in QuantityOriginal Quantity×Original

PriceChange in Price
Income Elasticity
The income elasticity of demand is the degree of responsiveness of
the quantity demanded to a change in the consumer’s income.
Symbolically,

EI=Percentage change in quantity

demandedPercentage change in income
Cross Elasticity
The cross elasticity of demand of a commodity X for another
commodity Y, is the change in demand of commodity X due to a
change in the price of commodity Y. Symbolically,

Ec=ΔqxΔpy×pyqx
Demand Forecasting

Demand forecasting is a combination of two words; the first one is

Demand and another forecasting. Demand means outside
requirements of a product or service. In general, forecasting means
making an estimation in the present for a future occurring event. Here
we are going to discuss demand forecasting and its usefulness.

Demand Forecasting
It is a technique for estimation of probable demand for a product or
services in the future. It is based on the analysis of past demand for
that product or service in the present market condition. Demand
forecasting should be done on a scientific basis and facts and events
related to forecasting should be considered.

Therefore, in simple words, we can say that after gathering

information about various aspect of the market and demand based on
the past, an attempt may be made to estimate future demand. This
concept is called forecasting of demand.

For example, suppose we sold 200, 250, 300 units of product X in the
month of January, February, and March respectively. Now we can
say that there will be a demand for 250 units approx. of product X in
the month of April, if the market condition remains the same.

Usefulness of Demand Forecasting

Demand plays a vital role in the decision making of a business. In
competitive market conditions, there is a need to take correct decision
and make planning for future events related to business like a sale,
production, etc. The effectiveness of a decision taken by business
managers depends upon the accuracy of the decision taken by them.
Demand is the most important aspect for business for achieving its
objectives. Many decisions of business depend on demand like
production, sales, staff requirement, etc. Forecasting is the necessity
of business at an international level as well as domestic level.

UNIT-III

SUPPLY

MEANING LAW OF SUPPLY:-

The law of supply is a basic economic concept. It states that an

increase in the price of goods or services results in an increase in
their supply. Supply is defined as the quantity of goods or services
that suppliers are willing and able to provide to customers

What is Law of Supply?

Economists have studied the behaviour of both buyers and sellers. They
have discovered the law of supply as a result of their findings. The law of
supply describes the relationship between price and amount supplied
when all other variables remain constant (ceteris paribus).
Assumptions of Law of Supply
The phrase “keeping other factors constant or ceteris paribus” is used
when describing the law of supply. This expression refers to the following
presumptions that the law is based on:
1. The price of other commodities is constant.
2. The state of technology has not changed.
3. The price of factors of production is constant.
4. The taxation laws remain the same.
5. The producer’s objectives are constant.
Graphical Presentation of Law of Supply
The Law of Supply can be better understood with the help of the following
table and graph.

The above table indicates that when the price of the commodity rises, an
increasing number of units are offered for sale.
In the above graph, the rising slope of the supply curve (SS) indicates a
clear relationship between price and quantity supplied.
Important Points about Law of Supply
 The law of supply states the positive relationship between price and
quantity supplied of a commodity after assuming that the other factors
remain constant.
 As the law of supply indicates the direction of the changes in quantity
supplied of a commodity and not the magnitude of the change. It is
considered as a quantitative statement.
 The law of supply does not establish any proportional
relationship between the change in price and the respective change in
quantity supplied of the commodity.
 The law of supply is one sided. It is because the law explains only the
effect of change in price on the supply of the commodity and not the
effect of change in supply on the price of the commodity.
Reason for Law of Supply
The main reasons behind the law of supply are as follows:
1. Profit Motive:
Maximising profits is the primary goal of producers when they supply
a good or service. Their profits grow when the price of a commodity rises
without a change in costs. Therefore, by increasing production,
manufacturers increase the commodity’s supply. On the other hand, as
price fall, supply also declines since low price result in lower profit
margins.
2. Change in Number of Firms:
When the price of a specific commodity increases, potential producers are
encouraged to enter the market and produce the good to make money.
The market supply rises as the number of businesses increases.
However, once the price begins to decline, some businesses that do not
anticipate making any money at a low price may stop production or cut it
back. As the number of businesses in the market declines, it decreases
the supply of the given commodity.
3. Change in Stock:
When the price of an item rises, sellers are eager to supply additional
things from their stocks. However, the producers do not release significant
amounts from their stock at a significantly cheaper price. They work on
building up their inventory in anticipation of potential price increases in the
future.
Exceptions to the Law of Supply

Generally, the slope of the supply curve is upwards, showing that with the
rise in the price of a commodity, its quantity supplied also rises. However,
there may be some cases when there is no positive relationship between
the supply and price of a commodity. These cases are as follows:
1. Future Expectations:
The law of supply is not valid if sellers expect a fall in the price in the
future. The sellers will be willing to sell more in this situation, even at a
cheaper price. However, if sellers expect an increase in the future price,
they will reduce supply to deliver the item later at a higher price.
2. Agricultural Goods:
Agricultural products are exempted from the rule of supply as they are
produced in response to climatic circumstances. If the production of
agricultural goods is low because of unexpected weather changes, supply
cannot be expanded, even at higher prices.
3. Perishable Goods:
Sellers are willing to offer more perishable commodities, such as fruits,
vegetables, and other foods, even if prices are dropping. This occurs
because sellers cannot keep such things for an extended period.
4. Rare Articles:
The law of supply does not apply to precious, rare, or artistic items. For
example, even if the price increases, the number of rare items like the
Mona Lisa artwork cannot be increased.
5. Backward Countries:
Due to the scarcity of resources, output and supply cannot be enhanced
in economically underdeveloped countries.

he Elasticity of Supply Definition

The price elasticity of supply is a measure of the degree of
responsiveness of the quantity supplied to the change in the price of
a given commodity. It is an important parameter in determining how
the supply of a particular product is affected by fluctuations in its
market price. It also gives an idea about the profit that could be
made by selling that product at its price difference. In this article, we
will discuss the elasticity of the supply formula, different types of
elasticity of supply, the supply curve characteristics, and many
more.

The price elasticity of supply refers to the response to a change in a

good or service's price by the supply of that good or service.
According to basic economic theory, the supply of goods decreases
when its price increases.

Similarly, one can also study the price elasticity of demand. This
illustrates how easily the demand for a product can change based
on changes in price. Price changes fairly rapidly if the price of a
product changes. This is known as price elasticity of demand.

Price Elasticity of Supply Formula

After having understood the elasticity of supply definition in
economics, we now move to the elasticity of supply formula which is
based on its definition.

ES=%ΔP%ΔQ

Here,

ES
denotes the elasticity of supply which is equal to the percentage
change in quantity supplied divided by the percentage change in the
price of the commodity.

The Law of Supply

Since producers compete for profits in a free market, profits are
never constant over time or across different goods. Entrepreneurs,
therefore, shift resources and labor efforts towards products that are
more profitable and away from those that are less profitable.

The law of supply refers to the tendency for price and quantity to be
related. For instance, assume that consumers demand more oranges
and fewer apples. More dollars are bidding for oranges, but fewer for
apples, resulting in higher orange prices.

5 Types of Elasticity of Supply

Price elasticity of supply is of 5 types; perfectly elastic, more than
unit elastic, unit elastic supply, less than unit elastic, and perfectly
inelastic. Read below to know them in more detail.
1. Perfectly Elastic Supply: A commodity becomes perfectly
elastic when its elasticity of supply is infinite. This means that
even for a slight increase in price, the supply becomes infinite.
For a perfectly elastic supply, the percentage change in the
price is zero for any change in the quantity supplied.
2. More than Unit Elastic Supply: When the percentage
change in the supply is greater than the percentage change in
price, then the commodity has the price elasticity of supply
greater than 1.
3. Unit Elastic Supply: A product is said to have a unit elastic
supply when the change in its quantity supplied is
proportionate or equal to the change in its price. The elasticity
of supply, in this case, is equal to 1.
4. Less than Unit Elastic Supply: When the change in the
supply of a commodity is lesser as compared to the change in
its price, we can say that it has a relatively less elastic supply.
In such a case, the price elasticity of supply is less than 1.
5. Perfectly Inelastic Supply: Product supply is said to be
perfectly inelastic when the percentage change in the quantity
supplied is zero irrespective of the change in its price. This
type of price elasticity of supply applies to exclusive items. For
example, a designer gown styled by a famous personality.
The point to be noted is that the elasticity of supply is always a
positive number. This is because the law of supply states that the
quantity supplied is always directly proportional to the change in the
price of a particular commodity. This means that the supply of a
product either increases or remains the same with the increase in its
market price.

PRODUCTION ANALSIS

What is Production Function?

The production function of an enterprise is an association between inputs
utilised and output manufactured by an enterprise. For various quantities
of inputs utilised, it gives the utmost quantity of output that can be
manufactured.

Contemplate the farmer is mentioned in the introduction to the concept

Production And Costs. Let us presume that the farmer utilises only 2
inputs to manufacture rice: labour and land. A production function
explains us the utmost quantity of rice he can manufacture for a provided
amount of land that he utilises and a given number of hours of labour that
he performs. Suppose that he uses 2 hours of labour per day and 1
hectare of land to manufacture an utmost of 2 tonnes of rice. Then, a
function that explains this association is called a ‘Production Function’.
One feasible instance of the form this could take is: q = K × L, Whereas, q
is the amount of rice manufactured, K is the area of land in hectares, L is
the number of hours of work performed in a day.

A production function is elucidated for a provided technology. It is the

technological knowledge that regulates the utmost degrees of output that
can be manufactured using various combinations of inputs. If the
technology enhances, the utmost levels of output achievable for different
input combinations go up. We now have a new production function.

Production Concepts and Analysis:

Production concepts and analysis involve studying the various aspects of
production, such as inputs, outputs, production processes, costs, and
efficiency. It helps businesses understand how to optimize their production
activities to achieve maximum output with minimum resources.
Key Concepts in Production Analysis:
1. Inputs: Inputs are the resources used in the production process, such as
labor, capital, raw materials, and technology. Production analysis focuses on
understanding how inputs are combined and transformed into outputs.
2. Outputs: Outputs are the final goods or services produced by a company.
Production analysis examines the relationship between inputs and outputs to
determine the efficiency and effectiveness of production processes.
3. Production Function: The production function represents the relationship
between inputs and outputs. It shows how different combinations of inputs
result in various levels of output. The production function can be represented
mathematically or graphically.
4. Total Product, Average Product, and Marginal Product: These are important
measures derived from the production function:
 Total Product (TP) is the total quantity of output produced for a given
combination of inputs.
 Average Product (AP) is the output per unit of input. It is calculated by
dividing the total product by the quantity of input.
 Marginal Product (MP) is the additional output generated by using one
additional unit of input. It is calculated as the change in total product
resulting from a one-unit change in input.
5. Short-Run and Long-Run Production: Production analysis distinguishes
between the short run and the long run. In the short run, some inputs are
fixed,
6. and only certain inputs can be adjusted to change output levels. In the
long run, all inputs can be varied to optimize production.
7. Economies of Scale and Diseconomies of Scale: Economies of scale
occur when an increase in production leads to a proportionately
greater increase in output, resulting in lower average costs.
Diseconomies of scale occur when an increase in production leads to a
proportionately smaller increase in output, resulting in higher average
costs.
8. Cost Analysis: Cost analysis examines the relationship between inputs
and the costs incurred in the production process. It includes various
cost concepts, such as total cost, fixed cost, variable cost, average
cost, and marginal cost.
Methods of Production Analysis:
1. Production Efficiency Analysis: This involves assessing the efficiency of
production processes to identify areas for improvement. It includes analyzing
factors such as resource utilization, productivity, and production bottlenecks.
2. Cost-Volume-Profit Analysis: This method examines the relationship between
costs, volume of production, and profits. It helps businesses determine the
breakeven point, analyze cost structures, and make pricing decisions.
3. Productivity Analysis: Productivity analysis measures the efficiency of
production by comparing the ratio of outputs to inputs. It helps identify
factors that contribute to productivity growth and enables benchmarking
against industry standards.
4. Production Planning and Control: Production analysis assists in planning and
controlling production activities. It involves capacity planning, scheduling,
quality control, and inventory management to ensure optimal utilization of
resources and meet customer demand.
Uses of Production and Cost Analysis for Managerial Decision
Making:
1. Optimal Resource Allocation: Production and cost analysis provide insights
into the efficient allocation of resources. Managers can identify the optimal
combination of inputs, such as labor and capital, to achieve maximum output
and minimize costs.
2. Pricing Decisions: Understanding production costs helps managers set
appropriate prices for products or services. By considering cost structures,
managers can determine the pricing strategy that ensures profitability while
remaining competitive in the market.
3. Capacity Planning: Production analysis helps managers evaluate
production capacity requirements. By analyzing production processes
and demand forecasts, managers can determine if additional capacity
is needed or if existing capacity can be better utilized.
4. Cost Control: Cost analysis allows managers to identify

Cost output relationship refers to the relationship between the

quantity of output produced and the cost incurred in the production
process. In general, as the level of output increases, the total cost
of production also increases. This relationship is known as the "law
of increasing costs."
UNIT FOUR:-

REVENUE ANALYSIS AND PRICING POLICIES:-

Objectives of Pricing Policy Five main objectives of pricing are: (i) Achieving a Target
Return on Investments (ii) Price Stability (iii) Achieving Market Share (iv) Prevention of
Competition and (v) Increased Profits! Before determining the price of the product, targets of
pricing should be clearly stated. Objectives of a properly planned pricing policy should be
logically related to overall managerial goals.

(i) Achieving a Target Return on Investments: This is the most important

objective which every concern wants to achieve. The objective is to
achieve a certain rate of return on investments and frame the pricing
policy in order to achieve that rate. For example, the concern may have
a set target of 20% return on investment and 10% return on
investments after taxes. The targets may be a short term (usually for a
year) or a long term. It is advisable to have a long term target.
Sometimes, it is observed that the actual profit rates may be more than
the target return. This is because the targets already fixed are low and
new opportunities and demand of the product exceeding the return rate
already fixed.
(ii) (ii) Price Stability: This is another important objective of an enterprise.
Stability of prices over a period reflects the efficiency of a concern.
But in practice, on account of changing costs from time to time, price
stability cannot be achieved. In the market where there are few sellers,
every seller wants to maintain stability in prices. Price is set by one
producer and others follow him. He acts as a leader in price fixation..
(iii) (iii) Achieving Market Share: Market share refers to the share of the
company in the total sales of the product in the market. Some of the
concerns when introduce their product in the competitive market want
 to achieve a certain share in the market in the initial stages. In the long
run the concern may aim at achieving a sizeable portion of the market
by selling its products at lower prices. The main objective of achieving
larger share in the market is to enjoy more reputation and goodwill
among the people. The other consideration of widening the markets by
lowering prices is to eliminate competitors from the market..
(iv) (iv) Prevention of Competition: Modern industrial set up is confronted
with cut throat competition. Pricing can be used as one of the effective
means to fight against the competition and business rivalries. Lesser
prices are charged by some firms to keep their competitors out of the
market. But a firm cannot afford to charge fewer prices over a long
period of time.
(v) (v) Increased Profits: Maximisation of profits is one of the main
objectives of a business enterprise. A firm can adopt such a price
policy which ensures larger profits. However, such enterprises are also
expected to discharge certain social obligations also.

Cost plus pricing method:

- The cost plus pricing means fixing the price of one unit of
product equal to the total cost per unit plus the desired profit on
the unit.

2. Marginal cost or incremental cost pricing method:

- Marginal cost is the increase in total costs resulting from

producing one additional unit of a product or service.

3. Break even point or B.E.P. pricing method:

- Break even point pricing is the practice of setting price point at

which a business will earn zero profits on a sale.

- This method ignore demand and the price elasticity of demand

- It also ignores the competitive situation i.e. what competitor are

charging for their products.
LIMITATIONS OF COST BASED PRICING

- Does not take advantage of market potential. For eg. If a

product is new and innovative such as iPad; when it was
introduced company has a potential to charge a high price.

- The consumer is likely to suffer as the manufacturer will

calculate the cost of production and recover the cost from the
consumers. He will not make any efforts to reduce the cost of
production.

- It is not suitable in highly competitive market.

ADVANTAGES OF COST BASED PRICING

1) Simplicity:

- Cost based pricing is a simple and easy method of pricing.

Unlike demand, cost is more certain, stable and comparatively
easy to estimate.

2) Socially fair:

- Cost based pricing is socially fair. It does not take advantage of

the rising demand.

- Many public sector companies in India use cost based pricing

method.
3) Safety:

- Cost based pricing is safe for the company as it guarantees

recovery of cost of production from the price charged

- It does not allow the company to play with seasonal or cyclical

shifts in demands

4) Competitive Harmony:

- There is greater competitive harmony and less of price wars

amongst competitors when all units in the industry base their
prices more or less on similar cost and add uniform mark-up

marginal-cost pricing, in economics, the practice of setting

the price of a product to equal the extra cost of producing an
extra unit of output. By this policy, a producer charges, for each
product unit sold, only the addition to total cost resulting from
materials and direct labour. Businesses often set prices close to
marginal cost during periods of poor sales. If, for example, an
item has a marginal cost of $1.00 and a normal selling price is
$2.00, the firm selling the item might wish to lower the price to
$1.10 if demand has waned. The business would choose this
approach because the incremental profit of 10 cents from the
transaction is better than no sale at all.

Cyclical pricing refers to the pricing decisions of the firm which are
taken to suit the fluctuations in the business conditions. To simplify
decision making in response to the alterations in the entire
economic system, it is necessary for the firm to have some kind of
policy based on cyclical price behaviour.

What Is Price Leadership?

Price leadership occurs when a leading firm in a given industry is able to
exert enough influence in the sector that it can effectively determine the
price of goods or services for the entire market. This type of firm is
sometimes referred to as the price leader. This level of influence
oftentimes leaves the rivals of the price leader with little choice but
to follow its lead and match the prices if they are to hold onto their market
share.
This phenomenon is common in industries that have oligopolistic market
conditions, such as the airline industry. In the airline industry, a dominant
company typically sets the prices, and other airlines feel compelled to
adjust their prices to match the prices of the leading firm.

Price skimming, also known as skim pricing, is a pricing strategy in

which a firm charges a high initial price and then gradually lowers
the price to attract more price-sensitive customers. The pricing
strategy is usually used by a first mover who faces little to no
competition.

Transfer pricing is an accounting and taxation practice that allows

for pricing transactions internally within businesses and between
subsidiaries that operate under common control or ownership. The
transfer pricing practice extends to cross-border transactions as
well as domestic ones.

What Is Market Structure?

Market structure refers to the way that various industries are classified and differentiated in
accordance with their degree and nature of competition for products and services. It consists
of four types: perfect competition, oligopolistic markets, monopolistic markets, and
monopolistic competition.
Types of Market Structures

According to economic theory, market structure describes how firms are differentiated and
categorized by the types of products they sell and how those items influence their operations.
A market structure helps us to understand what differentiates markets from one another.

In economics, market structure is the number of firms producing identical products which are
homogeneous. The types of market structures include the following:

1. Monopolistic competition, also called competitive market, where there is a large number of
firms, each having a small proportion of the market share and slightly differentiated products.

2. Oligopoly, in which a market is by a small number of firms that together control the majority of
the market share.

3. Duopoly, a special case of an oligopoly with two firms.

4. Monopsony, when there is only one buyer in a market.

5. Oligopoly, a market in which many sellers can be present but meet only a few buyers.

6. Monopoly, in which there is only one provider of a product or service.

7. Natural monopoly, a monopoly in which economies of scale cause efficiency to increase

continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire
market demand at a lower cost than any combination of two or more smaller, more specialized
firms.

8. Perfect competition, a theoretical market structure that features no barriers to entry, an

unlimited number of producers and consumers, and a perfectly elastic demand curve.

A break-even analysis is a financial calculation that weighs the

costs of a new business, service or product against the unit sell
price to determine the point at which you will break even. In other
words, it reveals the point at which you will have sold enough units
to cover all of your costs.

NEED OF GOVERNMENT IMTERVENTION IN MARKET

Government Intervention in Markets (
ere are structured study notes for A-level economics on the topics of
government intervention with reference to market failure, including indirect
taxation (ad valorem and specific), subsidies, maximum and minimum
prices, as well as other methods of government intervention such as trade
pollution permits, state provision of public goods, provision of information,
and regulation, with real-world examples where applicable:
A) Purpose of Intervention with Reference to Market Failure
1. Indirect Taxation
a) Ad Valorem Taxation
 Ad valorem taxes are taxes calculated as a percentage of the price of
a good or service.
 The purpose of imposing ad valorem taxes is to internalize external
costs (negative externalities) or generate government revenue.
Example: In many countries, cigarettes are subject to ad valorem taxes to
discourage smoking (negative externality) and raise revenue for healthcare
programs.
b) Specific Taxation
 Specific taxes are fixed amounts per unit of a good or service.
 They are often used to target specific industries or products.
 Specific taxes can also be imposed to address negative externalities
or generate revenue.
Example: In the context of specific taxation, gasoline is often taxed at a
fixed amount per gallon or liter to address environmental concerns
(negative externality) and fund infrastructure projects.
2. Subsidies
 Subsidies are financial assistance provided by the government to
encourage the production or consumption of certain goods or
services.
 Subsidies aim to correct market failures by promoting the provision of
public goods, correcting positive externalities, or supporting strategic
industries.
Example: Agricultural subsidies are common worldwide to ensure a stable
food supply, support farmers, and prevent market failures related to food
scarcity.
3. Maximum and Minimum Prices
a) Maximum Prices (Price Ceilings)
 Maximum prices are government-imposed limits on the price of a
good or service.
 They are typically set below the equilibrium price to protect
consumers from high prices.
Example: Rent control policies in cities like New York and San Francisco
impose maximum rents to make housing more affordable for low-income
residents.
b) Minimum Prices (Price Floors)
 Minimum prices are government-imposed limits on the price of a
good or service.
  They are typically set above the equilibrium price to support
producers, ensuring they receive a fair income.
Example: The U.S. government sets a minimum price for milk to ensure
that dairy farmers receive a reasonable income.
B) Other Methods of Government Intervention
1. Trade Pollution Permits
 Tradeable pollution permits are a market-based approach to reducing
pollution.
 Governments allocate a limited number of permits to firms, allowing
them to emit a certain amount of pollution.
 Firms can buy and sell permits, creating incentives to reduce
emissions efficiently.
Example: The European Union's Emissions Trading System (EU ETS)
allows companies to trade carbon emissions permits, encouraging the
reduction of greenhouse gas emissions.
2. State Provision of Public Goods
 Governments provide public goods, which are non-excludable and
non-rivalrous.
 Public goods are typically funded through taxation.
Example: Public goods like national defense, street lighting, and public
parks are provided by governments to benefit all citizens.
3. Provision of Information
 Governments often provide information to consumers to ensure
informed decision-making.
 Information provision can improve market efficiency and protect
consumers.
Example: Food labeling regulations require manufacturers to provide
information about ingredients and nutritional content on food packaging,
helping consumers make healthier choices.
4. Regulation
 Regulation involves government rules and standards to ensure
market participants follow specific guidelines.
 It can address issues like safety, environmental protection, and
consumer rights.
Example: Financial regulations such as the Dodd-Frank Act in the United
States aim to safeguard the financial system from excessive risk-taking and
promote transparency.
Understanding the purpose of government intervention in various contexts,
along with the methods employed, is essential for analyzing the impact of
government policies on markets and economic outcomes. These
interventions are often designed to correct market failures, ensure fairness,
and promote public welfare.
UNIT-V

CONSUMPTION AND INVESTMENT FUNCTION:-

The consumption function deals with how households spend, or

what their behavior is when it comes to spending, when changes in
their disposable income occur, whereas the investment function
deals with how firms choose to allocate resources for capital
expenditures, given some determinants.

Consumption Function: Formula, Assumptions, and

Implications
What Is the Consumption Function?
The consumption function is an economic formula that represents the
relationship between total consumption and gross national income (GNI) . It
was first introduced by British economist John Maynard Keynes, who
argued that the function could be used to predict total aggregate
consumption expenditure.
The consumption function is a valuable tool for understanding the
economic cycle and guiding economists and policymakers as they make
key decisions about investments, as well as monetary and fiscal policy.
KEY TAKEAWAYS
 The consumption function is an economic formula that measures the
relationship between income and total consumption of goods and
services in the economy.
 The consumption function was introduced by John Maynard Keynes.
 Keynes argued that the consumption function could track and predict
total aggregate consumption spending.
 Economists and leaders can use the consumption function to make
important economic and investment decisions.
 Other economists have come up with variations of the consumption
function over time, including those developed by Franco Modigliani
and Milton Friedman.
BUSINESS CYCLE:-

What is a Business Cycle?

A business cycle is a cycle of fluctuations in the Gross Domestic

Product (GDP) around its long-term natural growth rate. It explains the
expansion and contraction in economic activity that an economy
experiences over time.
A business cycle is completed when it goes through a single boom and a
single contraction in sequence. The time period to complete this sequence
is called the length of the business cycle.
A boom is characterized by a period of rapid economic growth, whereas a
period of relatively stagnated economic growth is a recession. These are
measured in terms of the growth of the real GDP, which is inflation-
adjusted.
Stages of the Business Cycle
In the diagram above, the straight line in the middle is the steady growth
line. The business cycle moves about the line. Below is a more detailed
description of each stage in the business cycle:
1. Expansion

The first stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income,
output, wages, profits, demand, and supply of goods and services.
Debtors are generally paying their debts on time, the velocity of the
money supply is high, and investment is high. This process continues as
long as economic conditions are favorable for expansion.
2. Peak

The economy then reaches a saturation point, or peak, which is the

second stage of the business cycle. The maximum limit of growth is
attained. The economic indicators do not grow further and are at their
highest. Prices are at their peak. This stage marks the reversal point in the
trend of economic growth. Consumers tend to restructure their budgets at
this point.
3. Recession

The recession is the stage that follows the peak phase. The demand for
goods and services starts declining rapidly and steadily in this phase.
Producers do not notice the decrease in demand instantly and go on
producing, which creates a situation of excess supply in the market. Prices
tend to fall. All positive economic indicators such as income, output,
wages, etc., consequently start to fall.
4. Depression

There is a commensurate rise in unemployment. The growth in the

economy continues to decline, and as this falls below the steady growth
line, the stage is called a depression.
5. Trough

In the depression stage, the economy’s growth rate becomes negative.

There is further decline until the prices of factors, as well as the demand
and supply of goods and services, contract to reach their lowest point. The
economy eventually reaches the trough. It is the negative saturation point
for an economy. There is extensive depletion of national income and
expenditure.
6. Recovery

After the trough, the economy moves to the stage of recovery. In this
phase, there is a turnaround in the economy, and it begins to recover
from the negative growth rate. Demand starts to pick up due to low prices
and, consequently, supply begins to increase. The population develops a
positive attitude towards investment and employment and production
starts increasing.
Employment begins to rise and, due to accumulated cash balances with
the bankers, lending also shows positive signals. In this phase,
depreciated capital is replaced, leading to new investments in the
production process. Recovery continues until the economy returns to
steady growth levels.
This completes one full business cycle of boom and contraction. The
extreme points are the peak and the trough.

Explanations by Economists
John Keynes explains the occurrence of business cycles is a result of
fluctuations in aggregate demand, which bring the economy to short-term
equilibriums that are different from a full-employment equilibrium.
Keynesian models do not necessarily indicate periodic business cycles but
imply cyclical responses to shocks via multipliers. The extent of these
fluctuations depends on the levels of investment, for that determines the
level of aggregate output.
In contrast, economists like Finn E. Kydland and Edward C. Prescott, who
are associated with the Chicago School of Economics, challenge the
Keynesian theories. They consider the fluctuations in the growth of an
economy not to be a result of monetary shocks, but a result of technology
shocks, such as innovation.

MACRO ECONOMIC ASPECTS

MATIONAL INCOME

National Income – Defining a Country’s Richness

To simply understand what National Income is, it can be represented
as - National Income defines a country's wealth. This income depicts
the value of goods and services which are produced by an economy.
This gives effect to the net result of all the economic activities
performed in the country.

Imagine how you would define a country’s wealth without any

economic term? In that case, there would be no accountability and
responsibility linked with the production in the country. The
resources would go uncalculated and there would be a vague
economic atmosphere. Thus, let us indulge in this study which talks
about National Income.

Understanding National Income

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National income is the sum total of the value of all the goods and
services manufactured by the residents of the country, in a year.,
within its domestic boundaries or outside. It is the net amount of
income of the citizens by production in a year.

To be more precise, national income is the accumulated money

value of all final goods and services produced in a country during
one financial year. Computation of National Income is very vital as it
indicates the overall health of our economy for that particular year.
The aggregate economic performance of a nation is calculated with
the help of National income data. The basic purpose of national
income is to throw light on aggregate output and income and
provide a basis for the government to formulate its policy,
programs, to maximize the national welfare of the people. Central
Statistical Organization calculates the national income in India.

Definition of National Income

The definition of National Income if of two types-
 Traditional Definition of National Income
 Modern Definition

Traditional Definition of National Income-

According to Marshall: “The labor 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.”

Modern Definition
This definition has two subparts
 GDP
 GNP

Gross Domestic Product

Gross Domestic Product, abbreviated as GDP, is the aggregate value
of goods and services produced in a country. GDP is calculated over
regular time intervals, such as a quarter or a year. GDP as an
economic indicator is used worldwide to measure the growth of
countries economy.

Goods are valued at their market prices, so:

 All goods measured in the same units (e.g., dollars in the U.S.)
 Things without exact market value are excluded.

Constituents of GDP
 Wages and salaries
 Rent
 Interest
 Undistributed profits
  Mixed-income
 Direct taxes
 Dividend
 Depreciation

The Formula for Calculation of GDP

GDP = consumption + investment + government spending +

exports - imports.

Gross National Product

Gross National Product (GNP) is an estimated value of all goods and
services produced by a country’s residents and businesses. GNP
does not include the services used to produce manufactured goods
because its value is included in the price of the finished product. It
also includes net income arising in a country from abroad.

Components of GNP
 Consumer goods and services
 Gross private domestic income
 Goods produced or services rendered
 Income arising from abroad.

Formula to Calculate GNP

GNP = GDP + NR (Net income from assets abroad or Net Income

Receipts) - NP (Net payment outflow to foreign assets).

Importance of National Income

Setting Economic Policy
National Income indicates the status of the economy and can give a
clear picture of the country’s economic growth. National Income
statistics can help economists in formulating economic policies for
economic development.

Inflation and Deflationary Gaps

For timely anti-inflationary and deflationary policies, we need
aggregate data of national income. If expenditure increases from
the total output, it shows inflammatory gaps and vice versa.

Budget Preparation
The budget of the country is highly dependent on the net national
income and its concepts. The Government formulates the yearly
budget with the help of national income statistics in order to avoid
any cynical policies.

Standard of Living
National income data assists the government in comparing the
standard of living amongst countries and people living in the same
country at different times.

Defense and Development

National income estimates help us to bifurcate the national product
between defense and development purposes of the country. From
such figures, we can easily know, how much can be set aside for the
defense budget.

Sets of methods for measuring National Income

There are four methods of measuring national income. The type of
method to be used depends on the availability of data in a country
and the purpose which is attempted for.

Income Method
In this method, we add net income payments received by all citizens
of a country in a particular year. Net incomes that result in all the
factors of production like net rents, wages, interest, and profits are
all added together, but income received in the form of transfer
payments are omitted.

Product Method
According to this method, the aggregate value of final goods and
services produced in a country during a financial year is computed
at market prices. To find out GNP, the data of all the productive
activities-agricultural products, Minerals, Industrial products, the
contributions to production made by transport, insurance,
communication, lawyers, doctors, teachers. Etc are accumulated
and assessed.

Expenditure Method
The total expenditure by the society in a financial year is summed
up together and includes personal consumption expenditure, net
domestic investment, government expenditure on goods and
services, and net foreign investment. This concept is backed by the
assumption that national income is equal to national expenditure.

Value Added Method

The distinction between the value of material outputs and material
inputs at every stage of production is Value added.

GDP Vs GNP
The Gross Domestic Product and the Gross National Product are the
two most widely used measures in a country’s calculation of
aggregate economic unit.

GDP is the measure of the value of goods and services that are
being produced within a country's borders, by the citizens and the
non-citizens. While GNP determines the value of goods and services
that are being produced by the country's citizens in the domestic
and abroad spectrum. GDP is popularly used by the global
economies at large. While, the United States eliminated the use of
GNP in the year 1991, thereby adopting GDP as the measure to
compare their economy with other economies.

India’s Richness: National Income of India 2020-2021

In the year 2020-2021, India had a total NI of 135.13 lakh crore, well
this is a provisional estimate only. However, in the round of the
fourth quarter (in the month of January-March), the country had an
economic growth of 1.6%, while the GDP was calculated at Rs. 38.96
lakh crore in the fourth quarter in the year 2020-21, this is count is
slightly different to Rs 38.33 lakh crore in the fourth quarter of 2019-
20.
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MONEY SUPPLY AND INFLATION:-

 Money Supply And
Inflation
Under normal economic conditions, inflation can occur if the
money supply expands faster than economic output. Other
factors can influence inflation or the pace at which the
average price of goods or services rises over time.

Share

The country’s central bank is solely responsible for supplying money to the market (Reserve
Bank of India in case of India). The RBI prints money and distributes it to the economy. The
Ministry of Finance mints coins, but the RBI distributes them throughout the country. The rate of
inflation in the economy is determined by the supply of money. When the supply of money in the
economy increases, so does inflation, and vice versa.
The central bank’s currency is a liability of both the central bank and the government. As a result,
this debt must be backed up by an equal value of assets, primarily gold and foreign exchange
reserves, particularly in terms of high-power foreign currencies.

Money Supply
The total amount of money (currency plus deposit money) in an economy at any given time is
referred to as the money supply. Currency in circulation and demand deposits are two common
measurements used to define money.
The country’s Central Bank maintains a record of the total money supply. The price level of
securities, inflation, exchange rates, and company practices can all be affected by changes in the
amount of money in an economy.
Monetary aggregates
 M1– M1 is referred to as “narrow money” since it only comprises 100% liquid deposits, which is a
relatively limited definition of the money supply.
 M2- M2 is made up of M1 and only savings account deposits made at post offices. M2 = M1 +
Post Office deposits(savings account)
 M3- M3 is known as wide money since it comprises both liquid and time deposits, making it a
broad category of money. M1 + TD = M3 (Broad Money) Time Deposits with Banks (TD) Fixed
deposits, recurring deposits, and the time liabilities of savings accounts are all included. M3 is
the most commonly used money supply indicator.
 M4- M4 = M3 + Total Post Office Deposits There isn’t much of a difference between M3 and M4
because the total deposits with the post office are so little.
Control of money supply
Monetary policy is a series of actions aimed at regulating the flow of money in the economy with
the overall purpose of guaranteeing economic and financial stability, as well as sufficient financial
resources for development. In India, these monetary policy objectives have developed through
time and may now include price stability, proper credit flow to productive sectors, encouragement
of productive investments and trade, export promotion, and economic growth. For example,
1. Repo Rate: The rate of interest is the repo rate, at which the Reserve Bank of India (RBI), lends
short-term money to banks.
2. Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity from
commercial banks.
Inflation
Inflation is a numerical measure of the rate at which the general price level of a basket of goods
and services rises over time. Inflation reduces the purchasing power of a certain quantity of
money compared to previous periods. The loss of purchasing power of money owing to inflation
has an impact on the overall cost of living for the general public, resulting in a slowdown in
economic growth.
Ways to measure inflation
 Consumer Price Index: Consumer price indexes (CPIs) are index numbers that track changes in
the costs of goods and services purchased or obtained by households, which they use directly or
indirectly to meet their own needs and desires. CPIs solely track consumer inflation.
 The Wholesale Price Index: The Wholesale Price Index (WPI) tracks the price changes of items
sold by wholesalers across India. The greater the impact on consumer inflation, the higher this
value is.
 GDP Deflator: Because the deflator includes the complete spectrum of goods and services
generated in the economy, as opposed to the narrow commodity baskets used in the wholesale
and consumer price indices, it is seen as a more comprehensive indicator of inflation.
Relation between money supply and inflation:
According to Quantity Theory: Inflation is caused when the rate of increase in the money supply
is faster for example printing more notes than the growth of real output. Because there is more
money pursuing the same quantity of commodities, this is the case. As a result, as monetary
demand rises, enterprises raise their prices. There is an assumption that prices will always
remain constant if the growth of the money supply is the same as the rate of real output.
Money supply vs Inflation (No
dependence on each other):
Conventional interpretations of the quantity theory are rejected by Keynesians and other non-
monetarist economists. Their definitions of inflation place a greater emphasis on actual price
increases, whether or not the money supply is taken into account.
Inflation can be divided into two types, according to Keynesian economists: demand-pull and
cost-push. Desire-pull inflation occurs when customers demand things at a higher rate than
production, maybe due to a bigger money supply. Cost-push inflation occurs when input prices
for items rise faster than consumer tastes change, sometimes as a result of a higher money
supply.
Conclusion
Monetary policy used to control the money supply has always had limitations, and it’s past time
we recognized them. The quantity theory of money is correct, but the functional link between M
and P does not hold in India. As a result, when inflation occurs, it does not have to be attributed
solely to the money supply.

I What Is Inflation?
Inflation is a gradual loss of purchasing power that is reflected in a broad
rise in prices for goods and services over time. The inflation rate is
calculated as the average price increase of a basket of selected goods and
services over one year. High inflation means that prices are increasing
quickly, while low inflation means that prices are growing more slowly.
Inflation can be contrasted with deflation, which occurs when prices
decline and purchasing power increases.
KEY TAKEAWAYS
 Inflation measures how quickly the prices of goods and services are
rising.
 Inflation is classified into three types: demand-pull inflation, cost-
push inflation, and built-in inflation.
 The most commonly used inflation indexes are the Consumer Price
Index and the Wholesale Price Index.
 Inflation can be viewed positively or negatively depending on the
individual viewpoint and rate of change.
 Those with tangible assets may like to see some inflation as it raises
the value of their assets.
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What Is Inflation?

Understanding Inflation
An increase in the money supply is the root of inflation, though this can
play out through different mechanisms in the economy. A country’s money
supply can be increased by the monetary authorities by:
 Printing and giving away more money to citizens
 Legally devaluing (reducing the value of) the legal tender currency
 Loaning new money into existence as reserve account credits
through the banking system by purchasing government bonds from
banks on the secondary market
Inflation is the rate of increase in prices over a given period of time.
Inflation is typically a broad measure, such as the overall increase
in prices or the increase in the cost of living in a country.

What causes inflation?

Monetary policy is a critical driver of inflation over the long term. The current high rate of
inflation is a result of increased money supply, high raw materials costs, labor mismatches,
and supply disruptions—exacerbated by geopolitical conflict.
In general, there are two primary types, or causes, of short-term inflation:
 Demand-pull inflation occurs when the demand for goods and services in the economy
exceeds the economy’s ability to produce them. For example, when demand for new cars
recovered more quickly than anticipated from its sharp dip at the beginning of the COVID-19
pandemic, an intervening shortage in the supply of semiconductors made it hard for the
automotive industry to keep up with this renewed demand. The subsequent shortage of new
vehicles resulted in a spike in prices for new and used cars.
 Cost-push inflation occurs when the rising price of input goods and services increases the
price of final goods and services. For example, commodity prices spiked sharply during the
pandemic as a result of radical shifts in demand, buying patterns, cost to serve, and
perceived value across sectors and value chains. To offset inflation and minimize impact on
financial performance, industrial companies were forced to increase prices for end
consumers.