net exam economics notes

7/27/2019 net exam economics notes

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Micro & Macro Economics Mikros means small--- that branch of economics

which studies particular firm, household,individualprices,wages ,particular commodities

Macro means large-----


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Economics is a study of mankind in the ordinarybusiness of life-----Alfred Marshall

It teaches the art of rational decision making which iscore of business

Managerial eco is a separate discipline by itself, havingits own selection of economic principles & methods

Knowledge of fundamentals of economics & economictheories is useful in business.


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Meaning of Business Economics B.E is concerned with the application of economic

concepts and economics to the problems offormulating rational decision making------ Mansfield

B.E is integration of economic theory with businesspractice for the purpose of decision making & forwardplanning-----Spencer & Siegelman


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M.E

BusinessManagement

Traditionaleco & Tools &techniques of

decisionsciences


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M.E relates to overlapping area of economics along withtools of decision sciences such as maths,eco,statistics,accounts and econometrics as applied tobusiness mgt problems.

Primarily analysing economic aspect of businessproblem & decision making


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Elements of Business Economics

Demand Supply Cost

Market Price


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Elements of Business Economics

ProductCapital

budgeting


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Nature of B.E

Basically micro in nature ---level of firm

Uses macro economics----- Pragmatic----does not deal with abstract theories

It is concerned with only those aspects of economicswhich can be applied in practice

Basically Normative Economics not positive economicsThat is, it studies things as they should be/ought to be

It is essentially prescriptive in nature rather thandescriptive in nature.In economic theory laws areformulated while in B.E we apply laws in policyplanning at the level of firm

Identifies problem & provides soln

Choosing the best soln consistent with firms objectives


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Positive eco explains eco phenomena as----What is, whatwas, & what will be?

Normative eco prescribes what it ought to be Marshall ,Pigou normative eco

Eco suggest policy measures to politicians

M.E===Pure/positive sci with applied/normative sci.

It is positive when it is restricted to statements aboutcause & effects & to functional ralations of economicvariables.

It is normative when it involves norms &standards,mixing them with cause-effect analysis.


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Micro MIKROS SMALL- individual ecounit/variables

Particular eco qty like prices,wages,income etc & their

determination

How individual consumers & producers behave &interact.

Macro-MAKROS-AGGREGATE- study of economicsystem as a whole


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Scope of B.EMicro economics deals with small individual units ofeconomy such as consumer, producer etc.

Choice of business,size ofbusiness,technology,price,market,investment,

theory of demand,nature of product etc.


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Analysis of market structure & pricing theory

Macro-economics applied to business environment

includes Type of economic system of particular country

Trends in production,income ,saving ,prices etc.

Political environment

Trends in labour

Industrial policy,monetary policy


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Scope of B.E Demand Analysis & Forecasting

Cost & Production analysis

Pricing practices & policies Profit mgt

Capital Budgeting

Competition

Firm


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Application of B.E Predicting economic quantities

Estimating economic relationship

Understanding external forces Implementation of business policies


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Concept of Profit &

Wealth Maximisation Profit excess of income over all expenses

Profit helps in predicting behaviour of firms as well as

price & output under different markets. 2 profit maximising conditions

MR=MC

MC must be rising & MR must be decreasing/MC

intersects MR from below


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Demand Analysis & Elasticity of

Demand Demand is Number of units of a particular goods or

service the customers are willing & able to purchaseduring a given set of conditions.

qty price time Place


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Demand means effective desire for a commoditybacked by ability & willingness to pay for it.

The amt the buyers are willing to purchase at a givenprice & over a given period of time.


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Determinants of demand

Price of Commodity Income of the consumer

Price of substitute good

Price of complementary good

Special influences like climate

Price expectations

Demonstration effect

Consumer taste,fashion etc.


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Basic objective of demand theory is to identify &analyse the basic determinants of customer

needs & wants.

Individual demand is demand for particular good atdifferent prices by single consumer

Market demand is total demand by all individuals atparticular price or different prices


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DemandSchedule

DemandCurve


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Types of DemandDirect & Derived

Joint Demand

Composite


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Types of Demand

Consumer Goods & Producer Goods

Competitive/Substitute

Firm & Company


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Law of Demand Other things remaining the same, demand for a

commodity will increase when its price falls & viceversa Alfred Marshall

There is inverse or negative relationship between price& quantity demanded.

Demand curve normally slopes downwards.


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Assumptions of law of demand Other things like income, taste, habit, fashion,climatic

conditions etc is assumed to remain the same.

Normal good not Giffen goood

Good not a Veblen good

Rational human being


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Why Demand curve slopes

downward? IncomeEffect

SubstitutionEffect

DiminishingMarginal

Utility

DifferentUses

Number ofCustomers


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Exceptions to Law of Demand

Demand curve may shift upwards

VeblenGoods

GiffenGoods Inflation

Speculation Informationasymmetry

Bandwagoneffect


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Elasticity of Demand Degree of responsiveness of demand for a commodity

due to a change in its price.

Elasticityof

demand

Price

Income

Cross


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Foundations of Managerial Economics by BN Ghosh

Anes Student Edition


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Price Elasticity of demand Ratio of relative change in demand and price .

It is the extent of response of demand for a commodityto a given change in price ,other determinantsremaining the same.

Types o f price elasticity of demand


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Income Elasticity of Demand Proportionate change in qty demanded due to change

in income

Types

Unitary,

Relatively Elastic,

Relatively Inelastic,

Zero income elasticity Negative income elasticity


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Cross Elasticity of Demand Degree of responsiveness of demand for acommodity

due to a given change in the price ofsome relatedcommodity.

A positive cross elasticity shows that the two products aresubsitutes

A negative cross elasticity shows that the two products are

complementary


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Measurement of Elasticity of

Demand1) Percentage method

Percentage change in Qty demanded/Percentage changein price

2)Point MethodLower segment of the demand curve/Upper segment of the

demand curve

3) Total Expenditure Method

Pg306 net com


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Utility Analysis of Demand The theory of consumer behaviour or the demand

theory explains decision making behaviour of theconsumer in demanding a particular commodity .Thereare two major approaches regarding the measurementof utility

1)Cardinal utility theory/Neoclassical DemandAnalysis - Alfred Marshall

2)Ordinal utility theory/Indifference curve-Edgeworth,Pareto,, J. R. Hicks & R.G.D Allen


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Production Transformation of input into output

Rate of output per unit of time

The technological physical relationship betweeninputs & outputs is called as production function

Functional relationship under given technologybetween physical rates of input & output of a firm per

unit of time.


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Flow concept

Physical term

State of technology &inputs

Short run & long run production function/TimeElement

Laws of production

aw o var a e propor ons aw o


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aw o var a e propor ons aw odiminshing marginal returns

One factor is variable & other factors are fixed

British economist Malthus,Ricardo,Mill

It was refined by Neo classical economist Marshall ---- Benham

Originally exp with reference to agri but applicable tomining ,fishing etc.

Law of variable proportions is modern version of LDMR

It is assumed that only one factor is variable while


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It is assumed that only one factor is variable whileothers are constant.

As the amount of variable factor increases, other

things remaining the same, output or returns tothe factor will increase more than proportionateto increase in input ,then it will increase in sameproportion and finally output will increase less

than proportionate.Assumptions---------

It is based upon the fact that all factors of productioncannot be substituted for one another.


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Total Product, Average product & Marginal Product

Pg 237 of mithani

Law is explained with MARGINAL PRODUCT PRODUCTION SCHEDULE

GRAPH

INCREASING RETURNS---machinery may require

minimum number of workers for full &Efficient operation.

So,when number of workers is increased machine isproperly.------Indivisibility of fixed factors


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DIMINISHING RETURNS------ When fixed factors areoverutilised there are internal problems/diseconomies& marginal product falls. MP falls becoz given qty of

fixed factors are combined with larger & larger amountof variable factors.--------imperfect substitutability offactors.

NEGATIVE RETURNS----- When input of variablefactor is much more than fixed factors.

Eg excessive use of chemical fert. on farms

Overstaffing in store


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Law of Returns to Scale/Long runAdjustment among different factors can be brought about

in the long run. All factors become variable.

Size of plant can be enhanced.

As a firm in the long run increases the quantities of all

factors employed, other thing being equal,output may riseinitially at rapid rate than the rate of increase in inputs,then output may increase in same proportion as input &finally output may increase less than proportionately.


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Assumptions Technique of prod remains same

All units of factor are homogeneous

Returns are measured in physical terms


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Three stages

Law of increasing returns

Law of constant returns

Law of diminishing returns


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There are increasing returns to scalewhen a givenpercentage increase in input will lead to greater relativepercentage increase in resultant output.

Internal economies of scale----------------etc with theexpansion of size of firm.


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Utility Analysis of Demand The theory of consumer behaviour or the demand

theory explains decision making behaviour of theconsumer in demanding a particular commodity .Thereare two major approaches regarding the measurementof utility.

1)Cardinal utility theory/Neoclassical Demand

Analysis - Alfred Marshall2)Ordinal utility theory/Indifference curve-

Edgeworth,Pareto,, J. R. Hicks & R.G.D Allen


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Law of Diminishing Marginal

Utility& Law of Demand/Cardinal Utility is the level of satisfaction derived by theconsumer from purchase of commodity.

Marginal utility is the addition to the total utility as aresult of consuming additional unit of a commodity.

A consumer tries to equalise Mux=Px so that

satisfaction is maximum.

It implies that by increasing the stock of acommodity its MU is diminished. Hence aconsumer would buy more when the price falls.


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Marginal Utility Slices of Pizza Total Utility Marginal

Utility

0 0 utils X

1 50 utils 50 utils2 90 utils 40

utils

3 110 utils 20

utils 4 115 utils 5

utils


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Graph


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Law of Equi-marginal Utility The Law of Equi-Marginal Utility is an extension to the

law of diminishing marginal utility.

The principle of equi-marginal utility explains thebehaviour of a consumer in distributing his limitedincome among various goods and services.

This law explains how a consumer allocates hismoney income between various goods so as toobtain maximum satisfaction.


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Law of Equi-marginal UtilityA consumer will be at equilibrium when

Mux/Px=Muy/Py That is MU & Price are equalised while purchasing

various commodities.

If Px falls equilibrium will be disturbed.Therefore toachieve equilibrium, consumer will have to reduce hisMUx & increase MUy till some extent.

Therefore he purchases more of x and less of y. That is

he substitutes commodity x for y when price of xfalls.----

Substitution effect----psychological attitude.


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Income Effect---changes in real income of the consumerdue to changes in price of the commodity.When price of

the commodity falls the purchasing power of moneyincreases i.e ,consumer can buy same amount of commoditywith less money or he can buy more with same money.

Income effect may be positive, negative or zero.

Income effect is positive (when commodity has relatively ahigher MU) when more of the commodity is purchasedwhose price has fallen.

Income effect is negative when the quantity purchased is lessthan before with a fall in the price of a given commodity.

Zero when ----when income is spent on some othercommodity


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Assumptions of Marshallian Utility Analysis

Cardinal Utility Independent Utility

Additive Utility

Constant MU of money

DMU

Rationality

I diff C T h i


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Indifference Curve Technique Ordinal measurement implies comparison & ranking of

satisfaction enjoyed by the consumer without quantification .

Utility is seen as level of satisfaction rather than amount ofsatisfaction.

People are not interested in any one commodity at a time .

People are interested in number of commodities & satisfactionresulting from their combinations.

People can compare the level of satisfaction given by one

particular combination of goods with that of anothercombinations.

Level of satisfaction is a function of increasing stock ofgoods.A larger stock of goods apparently gives higher level of

satisfaction than that of a smaller stock of goods.


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A consumer conceptually arranges goods & their

combinations in the order of their significance or

level of satisfaction

Scale of Preference


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Combinationbetween pen /pencil

Level ofsatisfaction

Ranking orderbased onpreference

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10 /9

5 / 5

Scale of Preference


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Indifference Schedule It is list of alternative combinations in the stock of two

goods which gives equal satisfaction to the consumer.

All combinations in the set of goods gives him equal/same satisfaction.

The consumer may come across some

combinations which give the same level ofsatisfaction to him, so he prefers them equally.

He is said to be indifferent to such combination.


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Combination Pen X Pencil Y MRS

a 1 12 -----

b 2 8 -4/1c 3 6 -2/1

d 4 5 -1/1

Indifference schedule


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Indifference schedule


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Indifference Curve


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Indifference Curve It is graphical representation of indifference schedule It is the locus of points representing different

combinations of two goods (say x & y) which giveequal satisfaction to the consumer.

Different points on IC curve shows differentcombinations of two goods ( total stock same),butall combinations are of equal significance to him.

Therefore he is indifferent to them.

One IC shows one level of satisfaction.


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Indifference MapA group/set of IC is called an indifference map.

It represents scale of preference of a consumerregarding different combinations of the given twogoods.

It is pictograph of consumers choice & scale ofpreference.

Higher IC shows higher level of satisfaction &lower IC shows lower level of satisfaction.

Each IC shows a different level of satisfaction.


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AssumptionsA consumer is interested in buying two goods in

combination. Rank his preference

Non-satiation

Rational

Ordinal measurement of utility

properties

Negativelysloped

Convex MRS

Never Intersect


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Marginal Rate of Substitution The amount ofy that must be given up to get one

more unit ofx inorder to maintain same level ofsatisfaction (same IC)

Downward slope of IC measures MRS.


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Budget line

Income

Prices oftwo goodsx

& y

BudgetConstraint


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The Consumer Equilibrium Consumer equilibrium is achieved when, given his budget

constraint ,the consumer reaches the highest possible pointon the indifference curve.

Price line is tangent to the indifference curve.

Indifference curve is convex to origin

MRSxy is diminishing

Atpoint e consumer is in equilibrium.


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Income EffectAssume taste,preference ,prices of two goods to remain the

same,

If income of the consumer changes the effect it willhave on his buying pattern is called income effect.

If income of the consumer increases his budget line will shiftupwards to the right parallel to the original budget line.

Substitution effect ------

Uses of IC -------SUBSIDY & RATIONING


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Indifference of Return

Iso quant Iso costProducers

Equilibrium


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Production Function through Isoquants/ Isoproduct Curves

In the long run, as all factors are variable the firm has awider choice of using different factors.

Factors can be substituted to some extent so that levelof output can be maintained at a particular level.

Eg.10 units of output X can be produced as follows

2L +9 k

3l + 6k

4L +4k


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Production Function through Isoquants/ Isoproduct Curves

This is similar to the concept of indifference curve. Isoquant shows different combinations of two

factors which produce same/given quantity ofoutput

An isoquant shows different combinations of factorsproducing same output.

Therefore the producer will be indifferent as regards

choice between two factor combinations.


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Isoquant schedule/CurveCombination ofLabour & Capital

Units of Labour Units of Capital Output

A 1 15 200

B 2 11 200

C 3 8 200

D 4 6 200


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Isoquant map It shows set of isoquants/isoproductsA higher isoquant shows a higher level of output &

a lower isoquant shows a lower level of output.

Marginal rate of technical substitution of any twofactors say labour & capital, is the number of units ofcapital which can be replaced by one of labour, theoutput remaining the same.

Isocostline shows various combinations of twofactors which a producer can purchase with a given

outlay/expenditure.


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ProducersEquilibrium

Leastpossible

Cost

Desiredoutput


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Producers Equilibrium Equal product/Isoquant curves shows variouspossibilities of combining two factors

A rational firm is interested in least cost

combination of factors Compare a production map with cost line/Cost

constraint

Cost line is determined by factor prices

Assume some fund/Money & factor prices Point of tangency between isoquant & cost line is

producers equilibrium


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Cost of production--Types It is the aggregate of price paid for the factors of

production used in producing the commodity

Money

Real

Opportunity/Alternative

Implicit

Economic

Fixed/Supplementary

Variable/Prime

Marginal& Average


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Private Cost The cost incurred by the firm in producing a

commodity or service

Social Cost

Total cost which includes direct & indirect

cost that the society has to pay for the outputof the commodity


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Nominal cost is the money cost of production i.e theexpenditure incurred on producing the product.

Real cost pain & scarifice by labourAdam Smith

Physical quantities of various factors used in producing acommodity.

Opportunity cost /Social cost of production is the nextbest alternative use of the factor which is sacrificed.For eg.

Opportunity cost of producing one unit of commodity xis the amount of commodity y that must be sacrificedinorder to use resources to produce x rather than y.


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Explicit/Accounting costs are direct contactual monetarypayments incurred through market transactions.It is out of

pocket expenses incurred to buy/hire resources required forproduction.

Implicit cost are the opportunity cost of the use offactorswhich a firm does not buy or hire but already owns

It is the cost of the factors owned by entrepreneur himself.

Economic cost= Explicit cost + Implicit cost


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TP(Q) TFC TVC TC AFC AVC AC MC

O 100 0 100 ----- --------- ------- -----

1 25 125 100 25 125 25

2 40 140 50 20 70 15

3 50 150 33.3 16.6 50 10

4 60 25 15 40 10

5 80 20 16 36 20

6 110 16.3 18.3 35 30

7 150 14.2 21.4 35.7 40

8 300 12.5 37.5 50 150


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Traditional Theory of cost Short Run Cost TFC/TVC/TC

AFC/AVC/AC/MC

Relationship between AC & MC

Refer Business Economics by DM Mithani


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Long Run Average Cost Can change all factors of production

LAC curve is regarded as the long run planningcurve/envelope curve.

LAC is drawn by joining minimum points of SAC curves. It is drawn on the basis of three possible plant sizes

LAC curve is U-shaped. It implies that when a firmadopts a larger scale of output, its long run averagecost in the beginning decreasing (economies of scale),then reaches minimum & finally startsrising(diseconomies of scale).


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It shows law of increasing returns to scale.

A rational entrepreneur will select the optimum scaleof plant.

The optimal scale of plant is that plant at which aSAC is tangent to LAC, & BOTH CURVES HAVEMINIMUM POINTS.


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Revenue Concepts

Total Revenue is the total sales receipt. It depends ontwo factors-price of the product & quantity of theproduct sold.

Average Revenue is revenue obtained per unit of

output sold. TR/Q It is price of the product.Price is always per unit.

Marginal re venue is the addition made to the totalrevenue by selling one more unit of product.


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Perfect Competition

Characteristics of perfect competition:There are many sellers.The products sold by the firms in the industry are identical.Entry into and exit from the market are easy, and there are manypotential entrants.Buyers (consumers) and sellers (firms) have perfect information.Price Taker

A firm in a perfectly competitive market is said to be a price takerbecause the price of the product is determined by market supplyand demand, and the individual firm can do nothing to change thatprice.Both buyers and sellers are price takers.

Aprice taker is a firm or individual who takes the market price asgiven.In most markets, households are price takers they accept the priceoffered in stores.


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There are no barriers to entryBarriers to entry are social, political, or economic impediments that prevent other firmsfrom entering the market.

Barriers sometimes take the form of patents granted to produce a certain good.Technology may prevent some firms from entering the market.Social forces such as bankers only lending to certain people may create barriers.

The firms' products are identical.This requirement means that each firm's output is indistinguishable from any competitor'sproduct.

There is complete information/Perfect KnowledgeFirms and consumers know all there is to know about the market prices, products, andavailable technology.

Any technological breakthrough would be instantly known to all in the market.

There is difference between Firm and the IndustryThe demand curves facing the firm is different from the industry demand curve.A perfectly competitive firms demand schedule is perfectly elastic even though the

demand curve for the market is downward sloping.


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Revenue scheduleQuantity Price/AverageRevenue

Total Revenue MarginalRevenue

1 250 250 -----

2 250 500 250

3 250 750 250


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Market supply

Marketdemand

1,000 3,000

Price

$108

6

4

2

0Quantity

Market Firm

Individual firm

demand

10 20 30

Price

$108

6

4

2

0Quantity


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Two conditions for Equilibrium MC=MR MC curve should intersect MR curve from below & not

from above


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MonopolyQty price TR MR1 25 25 ---

2 24 48 23

3 23 69 21

4 22 88 19


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Monopolistic CompetitionQty price TR MR1 25 25 ---

2 23 46

3 22 66

4 21 84


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Oligopoly Competition among few---Fellned

Workable Competition----Clark

Quasi monopoly----Samuelson

Interdependence--------any change in price,output,quality of

product or advertising expenditure by any firm is likely toevoke retaliation from others


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Elements/Features of Oligopoly Few ( large )sellers dominate the market Each seller has sizeable influence on the market

Consider action & reaction of rivals

Mutual interdependence

Not able to visualise consequences of its policy

Demand curves keeps shifting

Strong barriers High cross elasticity

Homogeneous or differentiated product


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Collusive Oilgopoly Collusion reduces the degree of competition betweenthe firms & helps them act monopolistically in theireffort of profit maximisation.

Collusion reduces uncertainty surrounding the marketsince cartel members are not suppose to actindependently & in the manner which will harminterest of members.

Cartels are the perfect form of collusion.

Collusion through price leadership is an imperfectform of collusion between oligopoly firms.


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Price leadership is an informal position of a firm anoligopolistic setting to lead other firms in

pricing.(partial oligopoly) Sometimes price leadership is barometric.i.e one of the

firms not necessary dominant one, takes lead inannouncing change in price,paricularly when such a

change is due ,but not affected due to uncertainty inmarket.


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Sweezys Model


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Cournot Model

Assumptions Two independent firms selling homogenous product

Both operate with zero cost & face downward slopinglinear demand curve

Each firm expects no reaction from other firm inresponse to a change in its own behaviour.

Though in practice each firm does change its ownoutput, but no firm learns from past experience ormistake & continues to believe that the rival will notreact.


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Price Discrimination The act of selling the output of the same product at

different prices in different markets or to different buyers. Discriminating monopoly FORMS DEGREES INGREDIENTS/CONDITIONS ESSENTIAL Price discrimination is categorized into three types: First degree price discrimination - charging what ever the

market will bear, Second degree price discrimination - quantity discounts Third degree price discrimination - separate markets and

customer groups.


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First degree This first type of product pricing is based on the sellers

ability to determine exactly how much each and everycustomer is willing to pay for a good.

Different consumers have different preferences and levels

of purchasing power and thus the amount they would bewilling to pay for a good often exceeds a single competitiveprice.

This difference between what a consumer is willing topay and the price actually paid is known, of course, as

consumers surplus. Thus a firm engaging in first degree price discrimination is

attempting to extract all the consumers surplus fromits customers as profits


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Second Degree In this case the seller charges a higher per-unit price

for fewer units sold and a lower per-unit price forlarger quantities purchased. In this case the seller is

attempting to extract some of the consumer's surplus Common examples of second degree price

discrimination include quantity discounts for energyuse; the variations in price for different sizes of boxed

cereal, packaged paper products;


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Third Degree Third Degree Price Discrimination

The last type of price discrimination exists where the firmis able to segment its customers into two or more separate

markets Each market defined by unique demand characteristics.

Some of these markets might be less price sensitive (priceinelastic) relative to other markets where quantitydemanded is more sensitive to price changes (price elastic).

Examples of third degree price discrimination include:business vs. tourist airfares, business vs. residentialtelephone service, and senior discounts.

D f i di i i ti


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Degrees of price discrimination Pigou

First degree

Monopolist charges different prices to different buyersfor each different unit of same product

The price charged for each product & each buyer dependson MU the buyer estimates & what max price he is willing topay

The entire consumer surplus of buyer is converted into

producers profits.


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Second Degree Price Discrimination

The monopolist sells blocks of output at different prices

Max. possible price is charged for some given minimumblock of output purchased by the buyer & then additional

blocks are sold at successively lower prices.

Monopolist captures a part of consumers surplus

Public Utilities


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Third degree price discrimination The firm divides its total output into many sub-

markets

It sets different prices for its product in each market in

relation to the demand elasticities. Different prices are charged in different market,but in

each market buyers are treated equally.

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