Module 1 IEFT PDF

BASIC CONCEPTS AND DEMAND AND SUPPLY ANALYSIS Scarcity and choice - Basic economic problems- PPC – Firms and its objectives – types of firms Utility – Law of diminishing marginal utility – Demand and its determinants – law of demand– elasticity of demand – measurement...

BASIC CONCEPTS AND DEMAND AND SUPPLY ANALYSIS Scarcity and choice - Basic economic problems- PPC – Firms and its objectives – types of firms Utility – Law of diminishing marginal utility – Demand and its determinants – law of demand– elasticity of demand – measurement of elasticity and its applications – Supply, law of supply and determinants of supply – Equilibrium – Changes in demand and supply and its effects – Consumer surplus and producer surplus (Concepts) – Taxation and deadweight loss.  Lionel Robbins (1898-1984) defined economics as “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”.  Here end is wants and means resources, which have alternative uses.  A benefit, profit or value of something, a person must be given up in order to achieve or acquire something else.  Cost of next best alternative that is foregone when the best one is chosen.  It facilitates the most efficient utilisation of available resources  Suppose a farmer can cultivate either rice or wheat in his farm. If he decides to produce rice, the value of wheat given up is the opportunity cost of rice production.  When a decision is made on the basis of opportunity cost, resource allocation becomes optimum and efficient.  showing alternative production possibilities of two sets of goods with the given resources and technique of production.  Assumptions  Fixed resources  Fixed technology  Produce two goods in different combinations  A point on the PPC(point A,B,C) shows efficient utilisation of resources.  Any point outside (point N) the frontier shows unattainable combination.  Any point inside the frontier (point M) shows underutilisation of resources.  Limited resources and unlimited wants leads to three problems  What to produce?  How to produce?  For whom to produce?  Choice of product.  What type of goods and services to be produced and in what quantities?  The problem of selection of Choice of technique  Labour intensive or capital intensive technique  Labour intensive means more labour and less machines.  Capital intensive means more machines and less labour.  How the total national product should be distributed among the people of a country.  A firm is a commercial enterprise, a company that buys and sells products and/or services to consumers with the aim of making a profit.  Single Ownership/Sole proprietorship  Partnership  Joint stock Companies  Cooperative Society  It is a voluntary association of individuals for profit, having a capital divided in to transferable shares, the ownership of which is the condition of membership.  A cooperative society is a voluntary association that started with the aim of the service of its members. It is a form of business where individuals belonging to the same class join their hands for the promotion of their common goals.  Want satisfying power of a commodity.  Pleasure or satisfaction derived from the consumption of a commodity.  Concepts in Utility-Total Utility and Marginal Utility  Total benefit or satisfaction derived from consumption of goods or services.  As consumption increases T U increases up to a certain level.  MU is the extra utility obtained from consuming one additional unit of a commodity, other things remaining constant.  MU is maximum at first unit of consumption after that it decreases.  MU=TUn- TUn-1  The Law states that the quantity consumed of a commodity goes on increasing, the utility derived from each successive unit goes on diminishing.  Gossen’s first law  Unit of consumption must be a standard one.  Consumption must be continuous.  Multiple units of commodity should be consumed.  Taste and preference of the consumer should remain unchanged.  The good should be a normal one.  Demand may be defined as the quantity of a commodity that a person willing to purchase at a price over a period of time.  It explains the relationship between demand and price of a commodity.  Law of demand states that “all other things remaining constant, when price increases, quantity demanded decreases and when price decreases quantity demanded increases”.  A demand curve is a graphical representation of demand schedule.  It slopes downward to the right. It has a negative slope.  D =f(Px,Y,Po,T,A,Ef,N) x  Px=Price of good x  Y=Income of the buyer  Po=Price of related goods  T=Taste and Preferences  A=Advertisement  Ef=Future Expectations  N=Population  Giffen’s Paradox  Veblen Effect  Sir Robert Giffen of England observed that in the 19th century low-paid British workers were buying more bread when its price was rising. When the price of bread was falling, instead of buying more bread they were buying less and used additional savings for buying meat.  According to Veblen, some people buy a commodity for the sake of enhancing their prestige and status in the society. They would like to hold it only when they are costly and rare. The examples of such commodities are diamonds, jewellery, luxury cars etc.  This type of consumption is called Conspicuous consumption  Supply means the quantity of a commodity, the producers or sellers offer for sale at a given price, per unit of time.  Higher the price, higher the supply of goods.  “The supply of a product increases, with increase in its price and decreases, with decrease in its price, other things remaining constant”.  Cost of factors of production  State of technology  Factors outside economic sphere  Tax and subsidy  It refers to Increase or decrease in demand for a commodity.  When more of a commodity is bought than before at a given price, there is an increase in demand.  Similarly, with price remaining unchanged less of a commodity is bought than before there is a decrease in demand.  Demand=Supply  Equilibrium price is the price at which the quantity demanded equals quantity supplied.  Equilibrium Price  Quantity Demanded=Quantity Supplied  It measures the degree of responsiveness of demand for a commodity to a change in any determinant of demand like price, income of the buyer, Advertisement expenditure, price of related goods etc.  Price Elasticity of demand  Income Elasticity of demand  Cross Elasticity of demand  Promotional Elasticity of demand  1.Price elasticity-It measures the percentage change in demand due to a percentage change in its price.  2.Income elasticity-It measures the percentage change in demand due to a percentage change in consumer’s income..  3Cross elasticity-It measures the percentage change in demand for a good due to the change in the price of other good.  4.Promotional elasticity-It measures the percentage change in demand due to a percentage change in advertisement expenditure.  Perfectly elastic demand  Perfectly inelastic demand  Highly elastic demand  Relatively inelastic demand  Unitary elastic demand  Elasticity of supply measures the degree of responsiveness of quantity supplied of any commodity to a change in its price.  Perfectly Elastic-In this case, at the prevailing price unlimited quantities of the commodity can be supplied. (price elasticity is infinity)  Perfectly Inelastic- Quantity supplied is totally unresponsive to changes in price. (price elasticity is zero)  Highly Elastic- Proportionate change in quantity supplied is more than a given change in price. (price elasticity is greater than one)  Relatively Inelastic-Proportionate change in quantity supplied is less than proportionate change in price. (price elasticity is less than one)  Unitary Elastic-Proportionate change in price brings about an equally proportionate change in quantity supplied. (price elasticity is equal to one)  Nature of the commodity  Availability of substitutes  Alternative uses of the commodity  Proportion of income spent on the commodity  Large number of substitutes available-Elastic demand  Less number of substitutes-Inelastic demand  Different Uses for a commodity- elastic  Single use for a commodity-Price elastic  Large share of income-Price elastic example clothes, electronic appliances etc.  Small share-Price inelastic example- salt,match box  Producer surplus is the difference between what price producers are willing and able to supply a good for and what price they actually receive from consumers.  It is the extra money, benefit, and/or utility producers get from selling a product at a price that is higher than their minimum accepted price, as shown by the supply curve.  The area below the equilibrium price and above the supply curve is producer surplus  Consumer surplus + Producer surplus The sum of producer surplus and consumer surplus. This sum is called social surplus, also referred to as economic surplus or total surplus.  Taxes lower the value of transactions to both buyers and sellers, in that the buyer pays somewhat more for the product and the supplier receives less.  Therefore, the economy as a whole loses some value from taxation, a complete loss called the deadweight loss of taxation.  Deadweight loss consists of the loss of consumer surplus for buyers plus the loss of producer surplus for sellers who do not participate in the market for reasons other than the price of the product or service, resulting in less total surplus for the economy.