Concept of Economics

for Managers

12/19/2024 1
Contents
 Module I : Introduction of Economics & Demand
& Supply Analysis and Theory of Consumer
Behaviour
 Module II : Theory of Production & Market
Structure
 Module III : National Income & Consumption
and Investment Functions
 Module IV : Introduction to Money and Interest
 Module V: Recent Trends & Policies

Class test, Mid-Term Test and PSDAs

12/19/2024 2
References
 Principles of Microeconomics: H L
Ahuja

 Macro-Economic Theory: M L Jhingan

 Macroeconomics: Theory and Policy:

Dwivedi

12/19/2024 3
Module 1
 Introduction to Economics: Meaning,
Definition, Nature and Scope of economics.
 Demand and Supply
◼ Law of demand and supply
◼ Elasticity of demand and supply
◼ Determinants of demand and supply
 Utility Analysis
◼ Marginal utility theory
◼ Consumer’s surplus
◼ Indifference curve theory
12/19/2024 4
Economics
 Economics is the study of how individuals and
societies choose to use the scarce resources.

 Economics is the study of scarcity and its implications

for the use of resources, production of goods and
services, growth of production and welfare over time,
and a great variety of other complex issues of vital
concern to society.

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Economics
 Our activities to generate income are
termed as economic activities which are
responsible for the origin and
development of Economics as a subject:
Inquiry into the nature and cause of
wealth of nations (Adam Smith)
 It is, in total, concerned with the
production, consumption, distribution
and investment of goods and services

12/19/2024 6
Why Economic Problem Arises
 Unlimited Wants (budget/income
constraint)
 Scarce Resources – Land, Labour,
Capital (limited means - Goods are
limited and wants are limitless).
 Resource Use (alternative uses)
 Choices (multiplicity of wants and
different priorities)

12/19/2024 7
Basic Economic Problems

 What to produce

 How much to produce

 How to produce

 For whom to produce

What to produce
 This problem involves selection of goods
and services to be produced

 Every economy has limited resources and

thus, cannot produce all the goods

 Do we opt for capital goods or consumer

goods?
How much to Produce
 How much quantity to be produced of each
commodity

 More of one good or service usually means less of

others.

 Allocate the resources in a manner which gives

maximum aggregate satisfaction/benefit/profit.

 It depends on the principle of marginalism

How to produce
 The production of a good is possible by various
methods. For example, you can produce cotton cloth
using handlooms, power looms or automatic looms.
While handlooms require more labour, automatic
looms need higher power and capital investment
(Labour or capital intensive).

 The choice depends on the availability of different

factors of production and their prices.

 Usually, a society opts for a technique that optimally

utilizes its available resources
For whom to produce
 Can a society satisfy each and every human
wants? Certainly not.

 Selection of the category of people who will ultimately

consume the goods, i.e. whether to produce goods for
more poor and less rich or more rich and less poor.

 Goods are produced for those people who have the

paying capacity. The capacity of people to pay for
goods depends upon their level of income.
Market Demand and Supply
The Price Mechanism

 Demand and Supply decisions by

consumers and producers are
transmitted to each other through their
effect on prices or price mechanism
 Prices respond to shortages and
surpluses
 Demand and Supply are the two
components to understand Price
Mechanism
Demand

Relationship between price and

quantity demanded at a given price
Quantity demanded is the
amount (number of units) of a
product that a household would buy
in a given time period if it could
buy all it wanted at the current
market price.
Demand
 The demand curve is a relationship
between the quantity demanded and
its price
 Holding all else constant –
 quality is constant
 consumers’ incomes are unchanged
 the prices of other goods are unchanged
 Consumer tastes are unchanged, etc.
Demand
 A demand schedule is a table
showing how much of a given
product a household would be
willing to buy at different prices.
 Demand curves are usually derived
from demand schedules.
Demand

P ◼ The demand curve is

P1
A
a graph illustrating
how much of a given
B
P2 product a household
would buy at different
Q1 Q2 prices.
Q
The Law of Demand

 The law of demand states that

there is a negative, or inverse,
relationship between price and the
quantity of a good demanded and
its price
• Demand curves slope downward.
Determinants of Household
Demand
A household’s decision about the quantity of a
particular output to demand depends on:
• The price of the product in question.
• The income available to the household.
• The household’s amount of accumulated
wealth.
• The prices of related products available to
the household.
• The household’s tastes and preferences.
• The household’s expectations about future
prices.
Shift of Demand Versus
Movement Along a Demand
Curve
• A change in demand is
not the same as a
change in quantity
demanded.
• In this example, a higher
price causes lower
quantity demanded.

• Changes in determinants
of demand, other than
price, cause a change in
demand, or a shift of
the entire demand curve,
from DA to DB.
A Change in Demand Versus a
Change in Quantity Demanded
• When demand shifts
to the right, demand
increases. This causes
quantity demanded
to be greater than it
was prior to the shift,
for each and every
price level.
A Change in Demand Versus a
Change in Quantity Demanded
Change in price of a good or service
leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
(Shift of curve).
Supply
• Relationship between price and
quantity supplied at a given price
• A supply schedule is a table showing
how much of a product firms will
supply at different prices.

• Quantity supplied represents the

number of units of a product that a
firm would be willing and able to offer
for sale at a particular price during a
given time period.
The Supply Curve and
the Supply Schedule
• A supply curve is a graph illustrating
how much of a product a firm will supply
at different prices.
Price of soybeans per bushel ($)

6
5
4
3
2
1
0
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
 The Law of Supply
 The law of
Price of soybeans per bushel ($)

6
5 supply states that
4 there is a positive
3 relationship
2 between price and
1 quantity of a good
0 supplied.
0 10 20 30 40 50
Thousands of bushels of soybeans  This means that
supply curves
produced per year

typically have a
positive slope.
Determinants of Supply
• The price of the good or service.
• The cost of producing the good, which in
turn depends on:
• The price of required inputs (labor,
capital, and land),
• The technologies that can be used to
produce the product,
• Government policies (Tax and
Subsidies)
• The profit of related products.
• Nature, random shocks and other
unpredictable events
• Expectations of future prices
A Change in Supply Versus
a Change in Quantity Supplied
• A change in supply is
not the same as a
change in quantity
supplied.
• In this example, a
higher price causes
higher quantity
supplied, and a move
along the demand
curve.
• In this example, changes in determinants of supply,
other than price, cause an increase in supply, or a
shift of the entire supply curve, from SA to SB.
A Change in Supply Versus
a Change in Quantity Supplied
• When supply
shifts to the right,
supply increases.
This causes
quantity supplied
to be greater than
it was prior to the
shift, for each and
every price level.
A Change in Supply Versus
a Change in Quantity Supplied
Change in price of a good or service
leads to

Change in quantity supplied

(Movement along the curve).

Change in costs, input prices, technology, or

prices of related goods and services
leads to

Change in supply
(Shift of curve).
Market Equilibrium
 The operation of the market
depends on the interaction
between buyers and sellers.
 An equilibrium is the
condition that exists when
quantity supplied and
quantity demanded are
equal.
 At equilibrium, there is no
tendency for the market
price to change.
Market Equilibrium

 Only in equilibrium
is quantity supplied
equal to quantity
demanded.

• At any price level

other than P0, the
wishes of buyers
and sellers do not
coincide.
E-Content on Law of Demand
and Supply
[Link]
Yq3RGsNo

12/19/2024 33
Types of Elasticity
 Price elasticity of demand

 Income elasticity of demand

 Cross elasticity of demand

 Price elasticity of supply

Elasticity – the concept
 The responsiveness of one variable to
changes in another
 When price rises, what happens to
demand? -- Demand falls BUT! How much
does demand fall?
 If price rises by 10% - what happens to
demand? It decreases by more than 10%?
Or by less than 10%? Or equal to 10%?

It is the extent to which demand will

change in response to change in price
Price elasticity of demand
 Price elasticity of demand is defined as:
◼ the % change in the quantity of a good demanded
resulting from a one % change in its price
◼ the price elasticity of demand is negative,
 for convenience we will take the absolute value
Price Elasticity of Demand
◼ The responsiveness of demand to
changes in price
 Where % change in demand is greater than
% change in price – elastic
 Where % change in demand is less than %
change in price - inelastic
Price Elasticity- Three
particular Case
 Elastic Demand
◼ price elasticity is greater than one
 Because the % change in quantity sold exceeds the %
change in prices, change in quantities dominates

 Inelastic Demand
◼ price elasticity is less than one
 Because the % change in prices exceeds the % change
in quantities, change in prices dominates

 Unit elastic Demand

◼ price elasticity equals one (dividing line case)
 % change in price = % change in quantity sold
Price Elasticity of Demand

Perfectly Inelastic Perfectly Elastic Unitary Elastic

Elastic and Inelastic Demand
Examples of Price Elasticity
Good Price elasticity

Inelastic demand

Eggs 0.1
bread 0.4
Stationery 0.5
Petrol 0.5

Elastic demand

Housing 1.2
Restaurant meals 2.3
Airline travel 2.4
Foreign travel 4.1
Price Elasticity of Supply
◼ The responsiveness of supply to changes in
price
◼ If Pes is inelastic - it will be difficult for
suppliers to react swiftly to changes in price
◼ If Pes is elastic – supply can react quickly to
changes in price

% Δ Quantity Supplied
Pes = ____________________
% Δ Price
Examples of Price
Supply Elasticities
 When the price of DaVinci paintings
increases by 1% the quantity supplied
doesn’t change at all, so the quantity
supplied of DaVinci paintings is
completely insensitive to the price.
◼ Price elasticity of supply is 0.
 When the price of beef increases by
1% the quantity supplied increases by
5%, so beef supply is very price
sensitive.
◼ Price elasticity of supply is 5.
Income Elasticity of Demand
 Income Elasticity of Demand:
◼ The responsiveness of demand to
changes in incomes

Yed = % change in demand

% change in income
Income Elasticity of
Demand:
 Normal Good – demand rises as
income rises and vice versa

 Inferior Good – demand falls as

income rises and vice versa
Look out for the sign…!
 A positive sign (+) denotes a normal
good
◼ Necessity Good: <1
◼ Luxury Good: >1

 A negative sign (-) denotes an

inferior good
Income Elasticity
 Normal goods have a  Luxuries have an
positive income income elasticity of
elasticity of demand demand > +1

 So the demand rises

 As consumers’ income more than
rises, so more is proportionate to a
demanded at each price change in income
level

 Inferior goods have a

 Normal goods have an negative income
income elasticity of elasticity of demand.
demand of between 0  Demand falls as income
and +1 rises
Look for the signs!
◼NORMAL GOODS
 LUXURY

+ +
GOODS
BETWEEN 0 & 1 GREATER THAN 1
+0.5 +0.9 + 0.1 +2 +5 +27

◼INFERIOR GOODS

- CAN BE A DECIMAL OR A VALUE

GREATER THAN 1
Cross Elasticity

 The responsiveness of demand

of one good to changes in the price of
a related good – either a substitute or
a complement

% Δ Qd of good t
__________________
Xed =
% Δ Price of good y
Cross Elasticity
 Goods which are complements:
◼ Cross Elasticity will have negative sign
(inverse relationship between the two)
 Goods which are substitutes:
◼ Cross Elasticity will have a positive sign
(positive relationship between the two)
Class Exercise- Identify Product
(Substitute or Complementary)

2023 Product A Product B

Price 10 10
Quantity Demanded 30 60

2024 Product A Product B

Price 12 10
Quantity Demanded 15 75

12/19/2024 51
Class Exercise- Identify Product
(Substitute or Complementary)

2023 Product A Product B

Price 10 10
Quantity Demanded 30 60

2024 Product A Product B

Price 12 10
Quantity Demanded 27 54

12/19/2024 52
Utility

Utility is the quality of the good to satisfy a want

OR wants satisfying power of a commodity is
utility.

 The more satisfaction a product gives, the

higher price buyers are willing to pay.

 Students who like butter are willing to pay

more for buttered popcorn than non-buttered
popcorn because it offers more total utility.
utility
◼Subjective

◼Relative

◼Not essentially useful

◼Ethically neutral
Utility
◼ Consumers, however, cannot have every thing
they wish to have. Consumers’ choices are
constrained by their budget/incomes.

◼ Utility Maximization –people try to allocate their

incomes to maximize their satisfaction/utility

◼ Within the limits of their incomes, consumers

make their consumption choices by evaluating
and comparing consumer goods with regard to
their “utilities.”
Cardinal vs Ordinal Utility
Cardinal utility:
Marshalling Approach: Satisfaction provided by any
bundle can be assigned a numerical value by a utility
function: Total and Marginal Utility Analysis

Ordinal utility:
Hickson Approach: People are able to rank each
possible bundle in order of preference-
Indifference Curve Analysis
Total and Marginal Utility
 Total Utility refers to the total satisfaction
derived by the consumer from the consumption
of a given quantity of a good.

TUn= U1+U2+U3+U4+…..+Un

 Marginal utility is the change in total utility

resulting from a one-unit change in
consumption of a good

MU = TUn- TUn-1
Total utility and marginal
utility from consumption

Commodity A Total utility Marginal utility

__
0 0
1 50 50
2 90 40
3 120 30
4 140 20
5 150 10
6 140 -10
Total and Marginal Utility
Law of Diminishing Marginal
Utility

 The law of Diminishing Marginal Utility

states that for a given time period, the
marginal utility gained by consuming
equal successive units of a good will
decline as the amount consumed
increases.
 The more of a good an individual
consumes per time period, other things
constant, the smaller the increase in total
utility from additional consumption.
Exceptions to Law of
Diminishing Marginal Utility

 Money
 Hobbies and Rare Things
 Liquor and Music
 Things of Display
Utility and Choice

 The Logic of Consumer Choice: Based on

Marginal utility per rupee of expenditure
 Each consumer allocates a specific budget to
expenditure, and then allocates the
expenditure to maximize utility.
 Consumers allocate their income among
goods and services in order to maximize
utility according to the equi-marginal
principle.
Utility and Choice

 Equi-marginal principle: To maximize utility,

consumers allocate their incomes among goods
so as to equate the marginal utilities per rupee
(MU/P) of the expenditure on the last unit of
each good purchased.

MUCD MUgas MUmovie MU X

= = ==
PCD Pgas Pmovie PX
Utility and Choice
 A change in the price of any good disturbs the
consumer’s equilibrium—the ratio of MU to P on the
last unit of each good will no longer be equal.

 The consumer must reallocate income across goods.

 With income fixed, if the price of one good rises, the

consumer is able to buy fewer goods and services,
causing demand to fall.
Rational Spending Rule
 What should you do if: MUc/Pc > MUs/Ps ?

 E.g. you get 20 units of utility per rupee spent on C

and only 16 units of utility per rupee spent on S.

 You should buy more C and less S to increase total

utility without spending any more money.

 But, what happens when you do this??

Rational Spending Rule
 As you buy more of the higher MU/P good its
MU decreases (law of DMU).
 As you buy less of the lower MU/P good its MU
increases (law of DMU in reverse).
 Eventually, the MU/P will be equal. Equilibrium
will be achieved when there is no way to
increase utility by relocating the budget.
 Diamond-Water Paradox
◆ Diamonds
◆ Not a necessity; expensive; relatively scarce
◆ Water
◆ Necessity; cheap; abundant
◆ Diamonds-Water paradox
◆ TUwater >TUdiamonds
◆ Last gallon of water MUwater very low
◆ Last diamond MUdiamond high
◆ Pdiamond > Pwater

◆ Total utility of water is high but marginal

utility of diamond is high; value/price is
according to marginal utility
Marshallian Consumer’s Surplus
 Marshall defined Consumer’s Surplus as “the excess
of the Price which a Consumer would be willing to Pay
rather than go without the thing”.

 Consumer surplus- consumer willing to pay according

to total utility but actually pay according to marginal
utility.

CS= What a Consumer is Willing to Pay – What he Actually

Pays.
68
 Consumer Surplus
Rs8 At P=Rs. 4:
•1st commodity valued at Rs. 7
7
•2nd commodity valued at Rs. 6
Price per unit

6
•3rd commodity valued at Rs. 5
5 •4th commodity valued at Rs. 4
4 •Willing to pay Rs. 22 for 4 subs
3 •Pays only Rs.16 for 4 subs
2 •Consumer surplus
1 Rs.22- Rs.16 = Rs.6
D

0 1 2 3 4 5 6 7 8 Commodity
Indifference Curves
 Marginal utility analysis requires some
numerical measure of utility in order to
determine the optimal consumption
combinations

 Hicks and Allen have developed another,

more general, approach to utility and
consumer behavior

 This approach does not require that

numbers be attached to specific levels of
utility
 Indifference Curves
 All this new approach requires is that
consumers be able to rank their preferences
for various combinations of goods

 Specifically, the consumer should be able to

say whether
◼ Combination A is preferred to
combination B
◼ Combination B is preferred to
combination A. or
◼ Both combinations are equally preferred
 Indifference Curves
 Indifference curve shows all
combinations of goods that
provide the consumer with the
same satisfaction, or the same
utility

 Thus, the consumer finds all

combinations on a curve equally
preferred

 Since each of the alternative

bundles of goods yields the same
level of utility, the consumer is
indifferent about which
combination is actually consumed
Properties of
Indifference Curves

 A particular indifference curve reflects

a constant level of utility ➔ the
consumer is indifferent among all
consumption combinations along a
given curve
 Higher indifference curves represent
higher levels of utility
 If total utility is to remain constant, an
increase in the consumption of one
good must be offset by a decrease in
the consumption of the other good ➔
indifference curves slope downward
 Properties of
Indifference Curves
 Indifference Curve are Convex to Origin: Marginal rate
of substitution (MRS) between the two Goods
Decreases as a Consumer moves along an
Indifference Curve

 The MRS measures the consumers willingness to trade

commodity A for commodity B ➔ depends on the
amount of each good the consumer is consuming at
the time
 Diminishing MRS
 In general, people tend to value more what
they have less of:
◼ I. e) If a person has 25 burger and 1
fanta, he/she is willing to give up burgers
for another fanta. If he/she has 10
burger and 2 fanta, he/she is less willing
to give up burger for fanta
 Therefore MRSx,y diminishes as x increases
along the indifference curve
 Properties of Indifference Curves

Indifference Curves Do Not Intersect

• If indifference curves
crossed, such as point i,
then every point on

Commodity A
indifference curve I and k
every point on curve I'
would have to reflect the j
same level of utility as at i
point i I'
• But point k is a
combination with more
commodity A and more I
commodity B than point j
and must represent a higher 0
level of utility Commodity B
• If indifference curves
crossed, it would violate the
“prefer-more-to-less”
principle.
Indifference Curves and Budget
Constraints

 A consumer will maximize her utility by

consuming on the highest indifference curve
as possible, given her budget constraint.
 The best combination is the point where the
indifference curve and the budget line are
tangent.
 Budget Line

• Depicts all possible combinations of commodity

A and B, given prices and budget or income
P1X1 + P2X2 = Y
• Suppose coke price is Rs.4, pizza sells for Rs. 8,
and the budget is Rs 40
• If entire Rs. 40 spent on coke, consumer can
purchase 10 cokes (Y/Pc)
• If spent only on pizzas person can afford 5
(Y/Pp)
 BUDGET LINE

Budget line: all combinations of pizza and coke that

Y/P 10 can be purchased at fixed prices with a given income.
c
coke

Slope = -pp / pv = -Rs.8/Rs.4 = -2

5
Slope = -2: the price of 1 pizza is 2 coke.

0 5 10
Y/P Pizzas
p
 Utility Maximization

• The utility-maximizing
consumer will select a
combination along the
budget line that lies on the
highest attainable
indifference curve

• Given prices and income,

this occurs at point e,
where I2 just touches or is
tangent to the budget line

•Other attainable
combinations along the
budget line reflect lower
levels of utility
 Consumer Equilibrium
 Consumer equilibrium occurs where the
slope of the indifference curve is equal to
the slope of the budget line
 The absolute value of the slope of the
indifference curve is the marginal rate of
substitution, and the absolute value of
the slope of the budget line equals the
price ratio. Thus, MRS = Pp / Pv
 Further, the marginal rate of substitution
of pizzas for coke can be found from the
marginal utilities of pizza and coke➔ MRS
= MUp / MUv
 Consumer Equilibrium
 In fact, the absolute value of the slope of the
indifference curve equals MUp/MUv and the slope
of the budget line equals pp / pv ➔ the
equilibrium condition for the indifference curve
approach can be written as
MUP = MUV
PP PV
A consumer is in equilibrium when he or she derives
the same marginal utility per rupee for both goods.
Class Test
 Show the changes in price of a
product due to shift in demand and
supply curves

12/19/2024 83
Thank you