Engineering Economics PDF

Engineering Economics Demand Demand is regarded as the lifeline of a business enterprise. Demand analysis seeks to identify and measure the forces that determine sales. Demand is the want of a person, which will become demand when he is ready to buy the goods at a give...

Engineering Economics Demand Demand is regarded as the lifeline of a business enterprise. Demand analysis seeks to identify and measure the forces that determine sales. Demand is the want of a person, which will become demand when he is ready to buy the goods at a given price and at a given point of time. Demand is the quantity of a commodity which a consumer is willing and able to purchase at a given price, during some specific period of time. Seven Essentials of Demand 1. Desire for a commodity. 2. Capacity to pay for it. 3. Willingness to pay for it. 4. Quantity bought and sold. 5. At a given price. 6. At a given time. 7. At a given place. Definition of Demand Veera Anstey “The demand for a particular good is the amount that will be purchased at a given time and at a given price.” Ferguson “Demand refers to the quantities of a commodity that the consumers are able and willing to buy at each possible price during a given period of Law of Demand Law of demand states that other things being equal, the demand for a good extends with a fall in price and contracts with a rise in price. There is an inverse relationship with a price and the quantity demanded. Definition of Law of Demand Samuelson “The law of demand states that people will buy more at lower prices and buy less at higher prices, ceteris paribus, or the other things remaining the same.” Marshall “The law of demand states that amount demanded increases with a fall in price and diminishes when price raises, other things Assumptions Used in Defining Demand (iv) The (iii) There should consumer does (i) There should (ii) There should be no change in not expect any be no change in be no change in the taste and change in the the price of the income of the preference of the price of the related goods. consumer. consumer. commodity in the near future. (vi) There is no (viii) There is no (v) There is no (vii) There is no change in the change in income change in size or change in range of goods of the consumer age-composition government available to the and the of the population. policy. consumers. community. Assumptions Used in Defining Demand (i) There should be no change in the price of related goods. (ii) There should be no change in the income of the consumer. (iii) There should be no change in the taste and preference of the consumer. (iv) The consumer does not expect any change in the price of the commodity in the near future. (v) There is no change in size or age-composition of the population. (vi) There is no change in the range of goods available to the consumers. (vii) There is no change in government policy. (viii) There is no change in income of the consumer and the Demand Curve Determinants of Demand 1. Price of the commodity 2. Prices of the related goods 3. Income of the consumer 4. Taste and preference of the consumer 5. Expectation of price change of the commodity 6. Size and composition of population 7. Distribution of income Determinants of Demand Price of commodity – If the price rises, the demand falls, and if the price falls, the demand rises. Price of related goods - The demand for a commodity is also influenced by changes in the price of related goods like substitutes and complements. Substitute goods: The demand of tea depends not only on its price, but also on the price of its substitute, coffee. If the price of coffee falls, while that of tea remains the same, the demand of tea falls. Complementary goods: The demand for petrol depends not only on its own price, but also on the price of cars and scooters. Income of the consumer - In case of normal goods, if income rises, demand increases and if income falls demand decreases. Determinants of Demand Price expectations - If people anticipate a rise in price in the future, they buy more now and store the commodities, and vice-versa. Taste and preference - They include fashions, habits, customs, etc. Demand for those goods goes up for which consumers develop a taste. Population - Increase in population leads to more demand for all types of goods and services and decrease in population leads to a fall in demand. Distribution of income - If income is equitably distributed, there will be more demand, if the income is not evenly distributed, then there will be less demand. Elasticity of Demand Elasticity of demand is a measure of the sensitiveness of demand to changes in factors affecting demand. Elasticity of demand is classified into following broad categories: (i) Price elasticity of demand (ii) Income elasticity of demand (iii) Cross elasticity of demand Price Elasticity of Demand Price elasticity can be defined as the responsiveness in the quantity demanded of a commodity to a change in its price. Total revenue (and hence the profits) of a firm can either increase or decrease due to change in price of the commodity which the firm produces. Thus, it is necessary to measure the probable effect of price changes on total revenue in order to minimize the uncertainty involved in the pricing decision made by the firm. Point & Arc Price Elasticity of Demand Point Elasticity Point elasticity is an approach used to evaluate the effect of very small price changes or to compute the price elasticity at a particular price. Arc Elasticity Arc elasticity is an approach used to analyze the effect of discrete changes in price. Point & Arc Price Elasticity of Demand Determinants of Price Elasticity Availability of substitutes - Price elasticity of demand is relatively higher for goods or services for which a large number of substitutes are available. This is because the customer has more choice to select from the existing substitutes in case price of the goods or services changes. Proportion of income spent - Goods or services on which a small proportion of income is spent exhibit inelastic demand as compared to those which require expenditure of a high proportion of income. Length of time - Demand is more elastic in the long run than in the short run. Price Elasticity and Decision Making Price elasticity of demand provides useful information to the managers, on the basis of which they can take appropriate decision related to the price. For example, if at the existing price, the demand is elastic, then a small reduction in the price will result in substantial increase in the demand and, consequently, revenue will increase. In contrast, if the demand is inelastic at the existing price, then to increase revenue, price can be increased. Income Elasticity of Demand Income elasticity is defined as the responsiveness in the quantity demanded of a commodity to the change in income. Income elasticity gives a measure of change in quantity demanded due to change in income when other factors affecting demand are kept constant Income Elasticity of Demand Inferior Goods, Necessities and Luxuries A negative E indicates that an increases in income leads to decrease in the quantity demanded and the goods and services for which it happens are categorized as inferior goods and services. If 0 < E < 1, the percentage change in demand is positive, but less than or equal to the percentage change in income. Such goods and services are categorized as necessities and for these goods and services, demand is relatively unaffected by changes in income. Goods and services for which E > 1 are classified as luxury goods and services. Income Elasticity and Decision Making Based on the value of income elasticity of demand, the management of a business firm can take appropriate decisions at different stages of the business cycle. For example, when the economy is rising, the business of firms dealing in luxury goods and services will increase at a relatively faster rate than the rate of income growth and therefore they can increase their annual production yearly profit. However, during economic recession, the demand for luxury goods and services may decreases substantially. Cross Elasticity Demand for a product is also affected by the price of the related product. The responsiveness in the quantity demanded of a particular good and services to the change in the price of a related good and service is referred to as cross elasticity of demand. Cross Elasticity Substitutes and Complements A positive value of Ec indicates that an increase in the price of y causes an increase in the quantity demanded of x and the two goods are related to each other as substitutes. When the relationship is that of substitutes, one product can be used in place of the other. For example, Maruti Swift and Hyundai i20 cars can be considered as close substitutes. In case of increase in the price of Maruti Swift, it becomes relatively expensive and people will prefer to buy Hyundai i20, which will be relatively cheap and therefore, the demand for Hyundai i20 will increase. Substitutes and Complements A negative value, i.e., Ec < 0 is observed when an increase in the price of y leads to a decrease in the quantity demanded of x and this would happen when x and y are complements. Petrol and petrol-driven cars, tea and sugar, tennis balls and tennis rackets are pairs of goods that are complementary goods. Two goods x and y are classified as complementary goods when a person uses good y as he possesses good x. Thus, cross elasticity of demand defines relationship between two goods as either substitutes or complements. Cross Elasticity and Decision Making There are many firms that produce several products and they can compute cross elasticity of demand between them to establish the relationship between the products. Depending upon the relationship, the firm can take appropriate pricing decisions. When a company sells related products, the price of one product can influence the demand for the other products. For example, a company producing men’s razors and razor blades will be able to sell more razor blades if it reduces the price of its razor. Supply Supply means the amount offered for sale at a given price during a certain period of time. Thomas “The supply of goods is the quantity offered for sale in a given market at a given time at various prices.” Factors Aff ecting Supply Price of commodity – Sellers of a commodity are normally willing to sell more if its price is higher, than if it is low. Price of related goods - If the price of substitutes goes up, producers would be tempted to direct their customers to their products by increasing their supply. Price of factor inputs - If there is an increase in the cost of production due to the increase in the cost of various factors of production like raw material and intermediate products, there will be a decrease in supply. Factors Aff ecting Supply Improved technology - Improvement in techniques of production lowers the cost of production and, in turn, increases the supply over time. Number of sellers - Entry of more sellers will increase and exits will decrease the supply. Price expectations - If the sellers fear that the trend of a fall in price will continue in the future, they will adopt panic- selling and the supply will increase. Government policy - A reduction in quotas and tariffs on foreign goods will open up the market to foreign producers and will tend to increase the supply. Law of Supply Other things being equal, when price rises, supply extends and when price falls, supply contracts. Dooley The law of supply states that, other things being equal, the higher the price, the greater the quantity supplied or the lower the price, the smaller the quantity supplied. Supply Curve Consumer and Producer Goods & Services Consumer Goods and Services Consumer goods and services are those products or services that are directly used by consumers to satisfy their desire. Producer Goods and Services Producer goods and services are those products or services that are used to produce consumer goods and services or other producer goods. Cost Concepts Investment Cost The investment cost, or first cost, refers to the capital required to start a project. For example, if we want to purchase a new car, then the investment cost for acquiring it is the sum of the down payment, taxes and other charges involved in obtaining the ownership of the car. Cost Concepts Fixed, variable and incremental costs Fixed costs associated with a new or existing project are those costs that do not change over a wide range of activities of the project. Fixed costs are, at any time, the inevitable costs that must be paid regardless of the level of output and of the resources used. For example, interest on borrowed capital, rental cost of a warehouse, administrative salaries, license fees, property insurance and taxes are fixed costs. Cost Concepts Fixed, variable and incremental costs Fixed costs associated with a new or existing project are those costs that do not change over a wide range of activities of the project. For example, interest on borrowed capital, rental cost of a warehouse, administrative salaries, license fees, property insurance and taxes are fixed costs. Cost Concepts Fixed, variable and incremental costs The costs that vary proportionately to changes in the activity level of a new or existing project are referred to as variable costs. Examples of variable costs include raw material cost, direct labor cost, power cost, shipping charges, etc. Cost Concepts Fixed, variable and incremental costs The additional cost that will result from increasing the output of a system by one or more unit(s) is called incremental cost. For example, if the cost of manufacturing 10 pieces is 2,000 and that of 11 pieces is 2,200, then the incremental cost is 200. Cost Concepts Sunk cost Sunk cost refers to the cost that has occurred in the past and does not have any impact on the future course of action. Cost Concepts Opportunity cost Opportunity cost or implicit cost refers to the value of the resources owned and used by a firm in its own production activity. The firm, instead of using the resources for its own purpose, could sell or rent them out and in turn can get monetary benefits. The amount that the firm is not getting by renting or selling the owned resources as it is using them for its own purpose represents the opportunity cost of the resources. Thank you