DSC 1.

2: Basic Economics – I (Economic Analysis -I)

Semester 1
 1

BA Economics

Semester 1
DSC 1.2: Basic Economics – I (Economic Analysis -I)
3 credits

Unit – 1 Basic Concepts in Economics

Chapter No. 1 Nature and Scope of Economics

• Meaning of Economics
• Nature of Economics
• Scope of Economics
• Methods of Economics
• Why Study Economics?
Meaning of Economics
Economics is a social science concerned with the production,
distribution, and consumption of goods and services. ...
Economics can generally be broken down into macroeconomics,
which concentrates on the behaviour of the economy as a
whole, and microeconomics, which focuses on individual people
and businesses.
It studies how individuals, businesses, governments, and
nations make choices about how to allocate resources.
Economics focuses on the actions of human beings, based on
assumptions that humans act with rational behaviour, seeking
the most optimal level of benefit or utility.
The principle (and problem) of economics is that human beings
have unlimited wants and occupy a world of limited means. For
this reason, the concepts of efficiency and productivity are held
paramount by economists. Increased productivity and a more

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efficient use of resources, they argue, could lead to a higher

standard of living.
Two major types of economics are microeconomics, which
focuses on the behavior of individual consumers and producers,
and macroeconomics, which examine overall economies on a
regional, national, or international scale.
The Timeline of Modern
Economic Schools

1. Mercantilists • Mercantilism was the economic philosophy

adopted by merchants and statesmen during the 16th and
17th centuries. Mercantilists believed that a nation's
wealth came primarily from the accumulation of gold and
silver. Mercantilism represented the elevation of
commercial interests to the level of national policy.

2. Physiocrats • Physiocrats, a group of 18th century French

philosophers, developed the idea of the economy as a
circular flow of income and output. They opposed the
Mercantilist policy of promoting trade at the expense of
agriculture because they believed that agriculture was the
sole source of wealth in an economy. the Physiocrats
advocated a policy of laissez-faire, which called for
minimal government interference in the economy.

3. The Classical School • The Classical School of economic

theory began with the publication in 1776 of Adam Smith's
monumental works, The Wealth of Nations. The book
identified land, labour, and capital as the three factors of
production and the major contributors to a nation's
wealth..

4. Marginalists •• Marginalists provided modern

macroeconomics with the basic analytic tools of demand

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and supply, consumer utility, and a mathematical

framework for using those tools.

5. Marxists • The Marxist School challenged the foundations

of Classical theory, Marx believed that all production
belongs to labour because workers produce all value
within society. He believed that the market system allows
capitalists, the owners of machinery and factories, to
exploit workers by denying them a fair share of what they
produce

6. Keynesians • Reacting to the severity of the worldwide

depression, John Maynard Keynes in 1936 broke from the
Classical tradition with the publication of the General
Theory of Employment, Interest, and Money. The Classical
view assumed that in a recession, wages and prices would
decline to restore full employment. Keynes held that the
opposite was true. Falling prices and wages, by depressing
people's incomes, would prevent a revival of spending. He
insisted that direct government intervention was
necessary to increase total spending.

7. OTHER New POPULAR SCHOOLS •

a) Monetarism
b) Supply-side Economics
DEFINITION OF
ECONOMICS
 . Adam Smith’s Wealth Definition:
His emphasis on wealth as a subject-matter of economics is
implicit in his great book— ‘An Inquiry into the Nature and
Causes of the Wealth of Nations or, more popularly known as
‘Wealth of Nations’—published in 1776.
“The great object of the Political Economy of every country is to
increase the riches and power of that country.”

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To him, wealth may be defined as those goods and services

which command value-in- exchange. Economics is concerned
with the generation of the wealth of nations.
 Marshall’s Welfare Definition:
Alfred Marshall in his book ‘Principles of Economics published in
1890 placed emphasis on human activities or human welfare
rather than on wealth. Marshall defines economics as “a study
of men as they live and move and think in the ordinary
business of life.” He argued that economics, on one side, is a
study of wealth and, on the other, is a study of man.

 . Robbins’ Scarcity Definition:

The most accepted definition of economics was given by Lord
Robbins in 1932 in his book ‘An Essay on the Nature and
Significance of Economic Science. According to Robbins, neither
wealth nor human welfare should be considered as the subject-
matter of economics. His definition runs in terms of scarcity:
“Economics is the science which studies human behaviour as a
relationship between ends and scarce means which have
alternative uses.”

Nature of Economics
The nature of economics deals with the question that whether
economics falls into the category of science or arts. Various
economists have given their arguments in favour of science
while others have their reservations for arts.

Economics as a Science
To consider anything as a science, first, we should know what
science is all about? Science deals with systematic studies that
signify the cause-and-effect relationship. In science, facts and
figures are collected and are analyzed systematically to arrive
at any certain conclusion. For these attributes, economics can
be considered as a science.

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 It involves a systematic collection of facts and figures.

 Like in science, it is based on the formulation of theories
and laws.
 It deals with the cause-and-effect relationship.
These points validate that the nature of economics is correlated
with science. Just as in science, various economic theories are
also based on logical reasoning.

Economics as an Art
It is said that “knowledge is science, action is art.” Economic
theories are used to solve various economic problems in
society. Thus, it can be inferred that besides being a social
science, economics is also an art.

Scope of Economics
Economists use different economic theories to solve various
economic problems in society. Its applicability is very vast.
From a small organization to a multinational firm, economic
laws come into play. The scope of economics can be
understood under two subheads: Microeconomics and
Macroeconomics.

Microeconomics
Microeconomics examines individual economic activity,
industries, and their interaction. It has SOME OF the following
characteristics:

1. Elasticity: It determines the ratio of change in the

proportion of one variable to another variable. For
example- the income elasticity of demand, the price
elasticity of demand, the price elasticity of supply, etc.

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2. Theory of Production: It involves an efficient conversion of

input into output. For example- packaging, shipping,
storing, and manufacturing.
3. Cost of Production: With the help of this theory, the object
price is evaluated by the price of resources.
Macroeconomics
It is the study of an economy as a whole. It explains broad
aggregates and their interactions “top down.” Macroeconomics
has some of the following characteristics:

1. Growth: It studies the factors which explain economic

growth such as the increase in output per capita of a
country over a long period of time.
2. Business Cycle: This theory emerged after the Great
Depression of the 1930s. It advocates the involvement of
the central bank and the government to formulate
monetary and fiscal policies to monitor the output over
the business cycle.
3. Unemployment: It is measured by the unemployment rate.
It is caused by various factors like rising in wages, a
shortfall in vacancies, and more.
4. Inflation and Deflation: Inflation corresponds to an
increase in the price of a commodity, while deflation
corresponds to a decrease in the price of a commodity.
These indicators are valuable to evaluate the status of the
economy of a country.

Methods of Economics

Methods of Economic Analysis: Deductive Method and Inductive

Method
1. Deductive Method: Generalisations in economics have been
derived in two ways:
a) Starts from the general and moves to the particular.

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b) Begins with general assumptions and moves to particular

conclusions.
c) . Develops a theory, and then examines the facts to see if
they follow the theory.

2. Inductive Method: The inductive method which is also called

empirical method derives economic generalisations on the
basis of experience and observations.

a) Starts from the particular and moves to the general.

b) Begins with particular observations and moves to general
explanations.
c) Collects observations, then develops a theory to fit the
facts.

Why Study Economics

More broadly, an economics degree helps prepare you for

careers that require numerical, analytical and problem-solving
skills – for example in business planning, marketing, research
and management. Economics helps you to think strategically
and make decisions to optimise the outcome.
Some key facts why we need to study economics?
1. Preparing you for an ever-changing world
The study of economics helps people understand the world
around them. It enables people to understand people,
businesses, markets and governments, and therefore better
respond to the threats and opportunities that emerge when
things change. Economics majors are well-positioned in an
ever-changing world because they have problem solving and
analytical skills that allow them to succeed in variety of career
paths—law, risk management, actuary, finance, foreign affairs,
public administration, politics, policy analysis, health

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administration, entrepreneurship, market analysis, journalism,

and unknown careers of the future.

2. Providing you with the knowledge and skills that

employers want
Economics, at its core, is the study of how to evaluate
alternatives and make better choices. It develops critical-
thinking and problem-solving skills to make good decisions. It
develops analytical skills to examine data to support good
decisions.

3. Ensuring your successful future

No matter what the future holds, an economics major helps
people succeed. Understanding how decisions are made, how
markets work, how rules affect outcomes, and how economic
forces drive social systems. This translates to success in work
and in life.

4. Enabling you to contribute to the greater good

Economics provides the primary framework for public policy
analysis. The major equips people to understand the
fundamental policy issues that shape market and social
outcomes. An economist understands the immediate issues like
tradeoffs, benefits versus costs, market failure, public finance,
but also understands the broader issues of generational
impacts, welfare impacts, and inequality.

5. Preparing you for higher studies

Economics provides a strong foundation for higher studies in
economics, public policy, development studies, MBA among
others.

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6. Enhancing other majors

Economics can be a valuable complement to most other
majors. The breadth and flexibility of an economics major can
be an invaluable way for people to diversify when paired with a
more career-specific business major like accounting, marketing,
finance, or computer information systems, and even more so
when paired with a non-business major like computer science,
healthcare management, journalism, environmental science,
building science, or design.

Chapter No. 2 Thinking Like an Economist

• Thinking Like an Economist

• The Economist as Scientist
• The Economist as Policy Adviser
• Economic Policy

Thinking Like an Economist

Thinking like an economist can help avoid irrational decision-
making, can aid professionals in improving the decisions that
affect their lives and can help you better understand the world
around you. Once you learn to think like an economist, you will
see how virtually all decisions—from something as small as
where to go to dinner to whether to begin a new career or go
back to school for a master’s degree—become clearer.

What does think like an economist mean?

At its most basic, thinking like an economist means evaluating
the facts without allowing opinion or logical fallacies to enter
into the calculation. Economic theory is fundamentally about
the idea of scarcity, the idea that everyone—individuals,
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corporations and governments—only have limited resources

and must decide how and where those resources will be
allocated. Economists evaluate the “cost” of individual and
social choices to determine the best choices for themselves or
others in the face of this scarcity.

Assembling an intellectual toolkit similar to that of the

economist can help you make smarter decisions in your
professional and personal life.
There are three basic concepts that form the foundation of
economic thinking:

I. The Cost of Something is What You Give Up

Opportunity cost is a fundamental economic theory and one of
the most important to understand if you want to think more like
an economist. Opportunity cost teaches that nothing in life is
free, even if it doesn't cost money. Understanding opportunity
cost can help those who want to think like an economist to
decide, for example, if going to graduate school is worth the
cost. If getting a master's degree is something you are
considering, think like an economist and weigh the costs and
benefits of that decision.
II. Incurred Costs Cannot Be Recovered

Sunk cost is one of the most pervasive fallacies that an

economist’s mindset can help you overcome. Simply stated, a
sunk cost is any cost that has already been incurred and
therefore cannot be recovered regardless of future outcomes.
Think of this example: You buy a ticket to a movie and settle in
only to realize halfway through that the movie is terrible—what
do you do? Most people will sit through to the end, thinking if
they leave their money will have been “wasted.” But if you
think like an economist, you know sunk costs are already gone.
Furthermore, you now understand the opportunity cost of
giving up more valuable time watching a movie you don’t
enjoy. The sunk cost bias is often talked about by economists
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as, “throwing good money after bad,” but it’s important to

remember that it isn’t just about money; any type of
investment you make—money, time, effort—is subject to this
type of thinking.
III. People Respond to Incentives
In An Introduction to the Economics of Information: Incentives
and Contracts, by Inés Macho-Stadler and David Peréz-Castrillo,
there is a brief mention of the Ukrainian pole vaulter Sergei
Bubka, who broke the world record in pole vaulting 35 times
from 1986 to 1995. By any measure that is an incredible feat,
but it becomes more rational (and more apropos to the subject
of thinking like an economist) when you understand Bubka's
incentives. The Soviet Union at the time was offering athletes
$30,000 every time they broke a world record. Bubka thought
like an economist and decided instead of breaking the world
record once, by a larger margin, he would break it 35 times,
earning himself more than $1 million. This incentive theory
plays out in daily life all the time. Evaluating how you respond
to incentives in the world you and thinking about how other
people respond to incentives you offer is an essential part of
thinking like an economist.
the economist as scientist

Economics is a science because it can be approached

scientifically, and its theories can be tested. However,
economists aren't scientists,
but Economists behave like scientists. They theorize, collect
data, and then analyse the data to see if their theories are
supported or not.
Example: Is printing too much money related to high prices? ...
Economists, like other scientists, make assumptions to make
the world easier to understand and to study
What is the role of economic scientist -if they are referred as
scientist
While you will not see an economist hunched over a boiling
beaker or running atoms through an accelerator, their field

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does rely on the scientific method. It is not a hard science, but

it is a social science. After all, not only are we working with
numbers, but with people. Unfortunately, we can't conduct
experiments in economics. It's unethical to set up a large-scale
test that winds up harming a large set of the population, just to
prove a hypothesis.

As a result of the scientific approach, an economist describes

things as they are. These statements are called positive
statements. For example, as an economist, you may state that
inflation has risen by 3% in the past fiscal year
Economists study the production and distribution of resources,
goods, and services by collecting and analysing data,
researching trends, and evaluating economic issues.
The Economist as Policy Adviser

An economist as a policy advisor, works with data and generate

positive statements, using facts that cannot be refuted and
normative statements about how the world should be
Economist as Policy professionals work at the heart of the Civil
Service to design, develop and propose appropriate courses of
action to help meet key government priorities and ministerial
objectives

Economic Policy

Economic policy refers to the actions that governments take in

the economic field. It covers the systems for setting interest
rates and government budget as well as the labour market,
national ownership, and many other areas of government
interventions into the economy.
Policy makers undertake three main types of economic policy :

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1. Fiscal policy: Changes in government spending or

taxation.
2. Monetary policy: Changes in the money supply to alter the
interest rate (usually to influence the rate of inflation).
3. Supply-side policy: Attempts to increase the productive
capacity of the economy.
Examples of economic policies include decisions made about
government spending and taxation, about the redistribution of
income from rich to poor, and about the supply of money.
The effectiveness of economic policies can be assessed in one
of two ways, known as positive and normative economics.
chapter No. 3 Economic System

• Types of Economic Activities

• Organisation of Economic Activities
• Circular Flow of Economic Activities
• Evolution of the Present Economic Systems
Types of Economic Activities

3 Types of Economic Activities

The production, distribution, and consumption of
commodities is economic activities
Economic activities exist at all levels within a society.

Economists say there are four basic types of economic

activities:

– The Primary Sector, i.e., raw materials.

– The Secondary Sector, which includes industry and
manufacturing.
– The Tertiary Sector, i.e., services.
– The Quaternary Sector, which we also call the
‘knowledge sector.’
- The Quinary Sector, managerial services
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5-
Quinary

4-
Quaternary

3-Tertiary

2-Secondary

1-Primary

1- Example: Agriculture, Fisheries, Forestry, Mining and

Quarrying [Red Collar Workers] Primary
2- Examples: Household and manufacturing Industries
[Blue Collar Workers] Secondary
3- Examples: Trade, Transport, Communication services
[Pink Collar Workers] Tertiary
4- Examples: Banking, Hospital Services, Teaching,
Research,
Information Services, Govt. Services [White Collar
Workers] Quaternary
5-Examples: Ministerial job, Planning, Management,
Decision making [Gold Collar Workers] Quinary

Organisation of Economic Activities

Organisation of economic activities is defined as:

All the economic pursuits are organised through the
market. A market is an organisation that organises free
interactions of individuals following their respective
economic pursuits.
It can be done centrally or through by market system

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A centrally planned economy, also known as a command

economy, is an economic system in which a central
authority, such as a government, makes economic
decisions regarding the manufacturing and the distribution
of products.
market economies are based on demand and supply. The
decisions are taken according to the flow of the free
market forces

Circular Flow of Economic Activities

The circular flow of economic activity is a model showing the

basic economic relationships within a market economy. ... In
the circular flow of the economy, money is used to purchase
goods and services. Goods and services flow through the
economy in one direction while money flows in the opposite
direction
The circular flow of economic activity is a model showing the
basic economic relationships within a market economy.
It illustrates the balance between injections and leakages in our
economy.
Injections into the economy include investment, government
purchases and exports.
while, leakages include savings, taxes and imports.
Half of the model includes injections, and half of the model
includes leakages. The circular flow model shows where money
goes and what it's exchanged for.
The model includes households, businesses and governments.
We also have the banking system that facilitates the exchange
of money and,
as well as it, helps to productively turn savings into investment
in order to grow the economy.
In the circular flow of the economy, money is used to purchase
goods and services.
Goods and services flow through the economy in one direction
while,
money flows in the opposite direction
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Evolution of the Present Economic Systems

An economic system includes the combination of the various

institutions, agencies, entities, decision-making processes and
patterns of consumption that comprise the economic structure
of a given community.
Always a new economic system evolves as the result of its
struggle against various forms of uncertainty generated
exogenously by its material environment
and endogenously by its institutional one.
It is transformed by a process of co-evolution between its
physical sphere and its psychical sphere, in which we find
Evolution of the Present Economic Systems.
Economic systems can be categorized into four main
types: traditional economies, command economies, mixed
economies, and market economies.

Traditional economic system. ...

Command economic system. ...
Market economic system. ...
Mixed system.
But today we have compassionate market economy as a new
economic system

Unit – 2 Supply and Markets

Demand

Chapter No. 4. Firms and

Household

Meaning of Firms and Household

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o Relationship Between Firms and Household

o Input Markets
o Output Markets

Meaning of Firms and Household

Households are the owners of factors of production [Factors of

production are land, labour capital and organisation] and the
firms are users of factors of production.
Households make consumption decisions and own factors of
production. They provide firms with factor services in
production, and buy finished goods from firms for consumption
Firms use households (factors of production) to pay factor
incomes which is rent, wages, interest and profit.
Firms make production decisions. These include what goods to
produce, how these goods are to be produced and what prices
to charge. They employ the various factors of production and
they sell the finished goods to the households for consumption
and to the government
Firms will use factor of production to produce output in the way
of goods and services, which will be purchased by the
household.

Relationship Between Firms and Household

The circular flow model shows the relation between two groups
of economic decision-makers—households and firms—and two
types of economic markets—the market for resources and the
market for goods and services.
In economics, the terms circular flow of income or circular flow
refer to a simple economic model which describes the
reciprocal circulation of income between producers and
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consumers. ... Firms provide consumers with goods and

services in exchange for consumer expenditure and factors of
production from households
Circular Income Flow in a Two Sector Economy:
Real flows of resources, goods and services have been shown in
Fig. 6.1. In the upper loop of this figure, the resources such as
land, capital and entrepreneurial ability flow from households to
business firms as indicated by the arrow mark.

In opposite direction to this, money flows from business firms to

the households as factor payments such as wages, rent,
interest and profits.
The relation between the two can be illustrated in the 2-sector
model

in the Circular Income Flow of a Two Sector Economy, money

flows from households to firms as consumption expenditure
made by the households on the goods and services produced
by the firms, while the flow of goods and services is in opposite
direction from business firms to households.

Thus, we see that money flows from business firms to

households as factor payments and then it flows from
households to firms. Thus, there is, in fact, a circular flow of
money or income. This circular flow of money will continue

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indefinitely week by week and year by year. This is how the

economy functions
input market

The input market is also called the factor market.

input market is the market for services needed to complete the
production process. Some examples are inputs like capital,
labour, raw material, entrepreneurship, and land. The factors
can be purchased and sold, and they're needed in order for the
goods and services market to complete a finished product
"Factor market" is a term economists use for all of the
resources that businesses use to purchase, rent, or hire what
they need in order to produce goods or services. Those needs
are the factors of production, which include raw materials, land,
labor, and capital.
The factor market is also called the input market. By this
definition, all markets are either factor markets, where
businesses obtain the resources they need, or goods and
services markets, where consumers make their purchases.

output Market

output Market consists of all products disposed of on the

market or intended for disposal on the market, either through
sale or barter
or
Output is a quantity of goods or services produced in a specific
time period
Chapter No. 5. Demand and Supply

 Individual Demand
• Market Demand

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• Demand Determinants
• Supply and its Determinants
• Market Equilibrium

Individual Demand

Individual demand refers to the demand for a good or a service

by an individual (or a household).
Individual demand comes from the interaction of an individual's
desires with the quantities of goods and services that he or she
is able to afford.
By desires, we mean the likes and dislikes of an individual.
For example, the quantity of detergent purchased by an
individual household, in a month, is termed as individual
demand.
Market Demand

Market demand is the total quantity demanded across all

consumers in a market for a given good. Aggregate demand is
the total demand for all goods and services in an economy.
Multiple stocking strategies are often required to handle
demand

the individual consumer's demand for a particular good—call it

good X—depicted by a downward‐sloping individual demand
curve.
The individual consumer, however, is only one of many
participants in the market for good X.
The market demand curve for good X includes the quantities of
good X demanded by all participants in the market for good X.
The market demand curve is found by taking the horizontal
summation of all individual demand curves.
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For example, suppose that there were just two consumers in

the market for good X, Consumer 1 and Consumer 2.
These two consumers have different individual demand curves
corresponding to their different preferences for good X. The two
individual demand curves are depicted in diagram below along
with the market demand curve for good X.

The market demand curve for good X is found by summing

together the quantities that both consumers demand at each
price.
For example, at a price of Rupee 1, Consumer 1 demands 2
units while Consumer 2 demands 1 unit; so, the market
demand is 2 + 1 = 3 units of good X.
Demand Determinants

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Demand is an economic principle referring to a consumer's

desire to purchase goods and services and willingness to pay a
price for a specific good or service.

The determinants of demand are factors that cause fluctuations

in the economic demand for a product or a service.
Factors which Determine the Demand for Goods
1. Tastes and Preferences of the Consumers:
2. Availability and price of substitute goods
3. Changes in the Prices of the Related Goods:
4. The Number of Consumers in the Market:
5. Changes in Propensity to Consume:
6. Consumers' Expectations with regard to Future Prices:
7. Levels of income. A key determinant of demand is the
level of income evident in the appropriate country or
region under analysis
8. Market Size

Supply and its Determinants

Supply is the quantity of a good which is offered for sale at a

given price at a particular time

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1. Cost of inputs. Cost of supplies needed to produce a good.

2. prices of other goods
3. Technology. Addition of technology will increase
production and supply.
4. the number of sellers in a market
5. change in expectations.
6. Government regulations.
7. specific Taxes and subsidies.
8. Transport Improvements
9. Calamities
10. Fiscal Policy.

Market Equilibrium

A market is in equilibrium if at the market price the quantity

demanded is equal to the quantity supplied.
Equilibrium is the state in which market supply and demand
balance each other, and as a result prices become stable.
Generally, an over-supply of goods or services causes prices to
go down, which results in higher demand—while an under-
supply or shortage causes prices to go up resulting in less
demand
When the supply and demand curves intersect, the market is in
equilibrium. This is where the quantity demanded and quantity
supplied are equal. The corresponding price is the equilibrium
price or market-clearing price, the quantity is the equilibrium

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quantity. ... Quantity supplied is equal to quantity demanded

( Qs = Qd).

Chapter 6 elasticity and its

measurement

 Types of Elasticity of Demand

• Price, Income and Cross Elasticities
• Measurement of Elasticity of Demand
• Determinants of Elasticity of Demand

What is Elasticity of Demand?'

In economics, elasticity of demand refers to how sensitive the
demand for a good is -to changes in other economic variables,
such as prices and consumer income.
“The elasticity (or responsiveness) of demand in a market is
great or small according as the amount demanded increases
much or little for a given fall in price, and diminishes much or
little for a given rise in price”. – Dr. Marshall.
This change, sensitiveness or responsiveness, may be small or
great. Take the case of salt. Even a big fall in its price may not
induce an appreciable ex appreciable extension in its demand.
On the other hand, a slight fall in the price of oranges may
cause a considerable extension in their demand. That is why we

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say that the demand in the former case is ‘inelastic’ and in the
latter case it is ‘elastic’.
Calculate the price elasticity of demand and determine the type
of price elasticity.
Solution:
P= 15
Q = 100
P1 = 20
Q1 = 90
Therefore, change in the price of milk is:
∆P = P1 – P
∆P = 20 – 15
∆P = 5
Similarly, change in quantity demanded of milk is:
∆Q = Q1 – Q
∆Q = 90 – 100
∆Q = -10
The change in demand shows a negative sign, which can be
ignored. This is because of the reason that the relationship
between price and demand is inverse that can yield a negative
value of price or demand.
Price elasticity of demand for milk is:
Ep = ∆Q/∆P * P/Q
Ep = 10/5 * 15/100
Ep = 0.3
The price elasticity of demand for milk is 0.3, which is less than
one. Therefore, in such a case, the demand for milk is inelastic
Thus, elasticity of demand can be elastic and inelastic
Types of Elasticity of Demand

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Forms/ types of elasticity of demand - price elasticity of

demand, income elasticity of demand and cross elasticity of
demand

Types of price elasticity of demand -

There are 5 types of price elasticity of demand:

a) Perfectly price Elastic Demand (Ed = ∞)
b) Perfectly price Inelastic Demand (Ed = 0)
c) Relatively price Elastic Demand (Ed> 1)
d) Relatively price Inelastic Demand (Ed< 1)
e) Unitary price Elastic Demand (Ed = 1)

(a) Perfectly price elastic demand:

Perfectly price elastic demand refers to a situation when due to
a very insignificant or small change in price the quantity
demanded changes infinitely. In such a case the demand curve
is horizontal and parallel to OX axis. In this case the value of
elasticity of demand is infinite (Ed = ∞). The Perfectly price
elastic demand are very rare in actual life and it is only a
theoretical case.

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In the above diagram DD, is the demand curve which is of

horizontal shape.
(b) Perfectly price inelastic demand:
This is a type of elasticity of demand which is just the reverse
of perfectly elastic demand. In such a situation whatever may
be the change in price the quantity demanded remains the
same.

In this case the demand curve DD1 is vertical and the value of
elasticity of demand is zero. Like perfectly elastic demand,
cases of perfectly inelastic demand are rare in real life and as
such are of any practical interest.
(c) Unitary price Elastic demand:
It refers to a situation when the percentage change in quantity
demanded is equal to percentage change in price. If price
doubles the quantity demanded will became half and vice-
versa. The value of elasticity of demand is unity (Ed = 1). The
following diagram will illustrate this situation.

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(d) Relatively more price elastic demand:

It refers to a situation when the percentage change in quantity
demanded is more than percentage change in price.
The diagram indicates that DD is the demand curve which
slopes downwards flatly.

(e) Relatively less price Elastic demand:

It refers to a situation when the percentage change in quantity
demand is less than percentage change in price. In this case
value of elastic demand is less than unity and demand curve is
steeper.

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The diagram indicates that DD is the demand curve which

slopes downward steeply
Methods of Measuring Price Elasticity of Demand
There methods are
1. Percentage method
2. Total outlay method
3. Point method
4. Arc method
1. Percentage Method
Percentage method is one of the commonly used approaches of
measuring price elasticity of demand under which price
elasticity is measured in terms of rate of percentage change in
quantity demanded to percentage change in price.
According to this method, price elasticity of demand can be
mathematically expressed as

For an example: When the price of a commodity was Rs 10 per

unit, its demand in the market was 50 units per day. When the
price of the commodity fell to Rs 8, the demand rose to 60
units. Here, price elasticity of demand can be calculated as

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2. Total Outlay Method

Total outlay method, also known as total expenditure method
of measuring price elasticity of demand was developed by
Professor Alfred Marshall. According to this method, price
elasticity of demand can be measured by comparing total
expenditure on a commodity before and after the price change.
While comparing the expenditure, we may get one of three
outcomes. They are
 Elasticity of demand will be greater than unity (Ep > 1)
When total expenditure increases with fall in price and
decreases with rise in price, the value of PED will be greater
than 1. Here, rise in price and total outlay or expenditure move
in opposite direction.
 Elasticity of demand will be equal to unity (Ep = 1)
When total expenditure on commodity remains unchanged in
response to change in price of the commodity, the value of PED
will be equal to 1.
 Elasticity of demand will be less than unity (Ep < 1)
When total expenditure decreases with fall in price and
increases with rise in price, the value of PED will be less than 1.
Here, price of commodity and total outlay move in same
direction.

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Total outlay Price

Quantity
Cases Price (P) or expenditure elasticity of
demanded (Q)
E=PxQ demand

(PED)

6 1 6 PED = 10/6, >

I
5 2 10 1

4 3 12 PED = 12/12,
II
3 4 12 =1

2 5 10 PED = 6/10, <

III
1 6 6 1

When the information from the above table is plotted in the

graph, we get graph like the one shown below.

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In the graph, total outlay or expenditure is measured on the X-

axis while price is measured on the Y-axis. In the figure, the
movement from point A to point B shows elastic demand as we
can see that total expenditure has increased with fall in price.
The movement from point B to point C shows unitary elastic
demand as total expenditure has remained unchanged with the
change in price. Similarly, the movement from point C to point
D shows inelastic demand as total expenditure as well as price
has decreased.
Total outlay method of measuring price elasticity of demand
does not provide us exact numerical measurement of elasticity
of demand but only indicates if the demand is elastic, inelastic
or unitary in nature. Therefore, this method has limited scope.
3. The Point Method:
Prof. Marshall devised a geometrical method for measuring
elasticity at a point on the demand curve. Let RS be a straight-
line demand curve in Figure 11.2. If the price falls from
PB(=OA) to MD(=OC). the quantity demanded increases from
OB to OD. Elasticity at point P on the RS demand curve
according to the formula is: Ep = ∆q/∆p x p/q

Where ∆ q represents changes in quantity demanded, ∆p

changes in price level while p and q are initial price and
quantity levels.
From Figure 11.2
∆ q = BD = QM
∆p = PQ
p = PB
q = OB
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Substituting these values in the elasticity formula:

With the help of the point method, it is easy to point out the
elasticity at any point along a demand curve. Suppose that the
straight-line demand curve DC in Figure is 6 centimetres. Five
points L, M, N, P and Q are taken oh this demand curve. The
elasticity of demand at each point can be known with the help
of the above method. Let point N be in the middle of the
demand curve. So, elasticity of demand at point.

We arrive at the conclusion that at the mid-point on the

demand curve the elasticity of demand is unity. Moving up the
demand curve from the mid-point, elasticity becomes greater.
When the demand curve touches the Y-axis, elasticity is

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infinity. Ipso facto, any point below the mid-point towards the
X-axis will show elastic demand.
Elasticity becomes zero when the demand curve touches the X-
axis.
4. The Arc Method:
We have studied the measurement of elasticity at a point on a
demand curve. But when elasticity is measured between two
points on the same demand curve, it is known as arc elasticity
Any two points on a demand curve make an arc. The area
between P and M on the DD curve in Figure 11.4 is an arc which
measures elasticity over a certain range of price and quantities.
On any two points of a demand curve the elasticity coefficients
are likely to be different depending upon the method of
computation. Consider the price-quantity combinations P and M
as given in Table 11.2.

Point Price (Rs.) Quantity (Kg)

P 8 10

M 6 12

If we move from P to M, the elasticity of demand is:

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If we move in the reverse direction from M to P, then

Thus the point method of measuring elasticity at two points on

a demand curve gives different elasticity coefficients because
we used a different base in computing the percentage change
in each case.
To avoid this discrepancy, elasticity for the arc (PM in Figure
11.4) is calculated by taking the average of the two prices [(p1,
+ p2 1/2] and the average of the two quantities [(p1, + q2)
1/2]. The formula for price elasticity of demand at the mid-point
(C in Figure 11.4) of the arc on the demand curve is

On the basis of this formula, we can measure arc elasticity of

demand when there is a movement either from point P to M or
from M to P.
From P to M at P, p1 = 8, q1, =10, and at M, P2 = 6, q2 = 12
Applying these values, we get

Thus whether we move from M to P or P to M on the arc PM of

the DD curve, the formula for arc elasticity of demand gives the
same numerical value. The closer the two points P and M are,
the more accurate is the measure of elasticity on the basis of
this formula. If the two points which form the arc on the
demand curve are so close that they almost merge into each
other, the numerical value of arc elasticity equals the numerical
value of point elasticity.
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Various factors which affect/ determine the elasticity of

demand of a commodity are:
1. Nature of commodity:
Elasticity of demand of a commodity is influenced by its nature.
A commodity for a person may be a necessity, a comfort or a
luxury.
i. When a commodity is a necessity like food grains, vegetables,
medicines, etc., its demand is generally inelastic as it is
required for human survival and its demand does not fluctuate
much with change in price.
ii. When a commodity is a comfort like fan, refrigerator, etc., its
demand is generally elastic as consumer can postpone its
consumption.
iii. When a commodity is a luxury like AC, DVD player, etc., its
demand is generally more elastic as compared to demand for
comforts.
iv. The term ‘luxury’ is a relative term as any item (like AC),
may be a luxury for a poor person but a necessity for a rich
person.
2. Availability of substitutes:
Demand for a commodity with large number of substitutes will
be more elastic. The reason is that even a small rise in its
prices will induce the buyers to go for its substitutes. For
example, a rise in the price of Pepsi encourages buyers to buy
Coke and vice-versa.
Thus, availability of close substitutes makes the demand
sensitive to change in the prices. On the other hand,
commodities with few or no substitutes like wheat and salt
have less price elasticity of demand.
3. Income Level:
Elasticity of demand for any commodity is generally less for
higher income level groups in comparison to people with low

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incomes. It happens because rich people are not influenced

much by changes in the price of goods. But, poor people are
highly affected by increase or decrease in the price of goods.
As a result, demand for lower income group is highly elastic.
4. Level of price:
Level of price also affects the price elasticity of demand. Costly
goods like laptop, Plasma TV, etc. have highly elastic demand
as their demand is very sensitive to changes in their prices.
However, demand for inexpensive goods like needle, match
box, etc. is inelastic as change in prices of such goods do not
change their demand by a considerable amount.
5. Postponement of Consumption:
Commodities like biscuits, soft drinks, etc. whose demand is not
urgent, have highly elastic demand as their consumption can
be postponed in case of an increase in their prices. However,
commodities with urgent demand like lifesaving drugs, have
inelastic demand because of their immediate requirement.
6. Number of Uses:
If the commodity under consideration has several uses, then its
demand will be elastic. When price of such a commodity
increases, then it is generally put to only more urgent uses and,
as a result, its demand falls. When the prices fall, then it is used
for satisfying even less urgent needs and demand rises.
For example, electricity is a multiple-use commodity. Fall in its
price will result in substantial increase in its demand,
particularly in those uses (like AC, Heat convector, etc.), where
it was not employed formerly due to its high price. On the other
hand, a commodity with no or few alternative uses has less
elastic demand.
7. Share in Total Expenditure:
Proportion of consumer’s income that is spent on a particular
commodity also influences the elasticity of demand for it.
Greater the proportion of income spent on the commodity,
more is the elasticity of demand for it and vice-versa.

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Demand for goods like salt, needle, soap, match box, etc. tends
to be inelastic as consumers spend a small proportion of their
income on such goods. When prices of such goods change,
consumers continue to purchase almost the same quantity of
these goods. However, if the proportion of income spent on a
commodity is large, then demand for such a commodity will be
elastic.
8. Time Period:
Price elasticity of demand is always related to a period of time.
It can be a day, a week, a month, a year or a period of several
years. Elasticity of demand varies directly with the time period.
Demand is generally inelastic in the short period.
It happens because consumers find it difficult to change their
habits, in the short period, in order to respond to a change in
the price of the given commodity. However, demand is more
elastic in long rim as it is comparatively easier to shift to other
substitutes, if the price of the given commodity rises.
9. Habits:
Commodities, which have become habitual necessities for the
consumers, have less elastic demand. It happens because such
a commodity becomes a necessity for the consumer and he
continues to purchase it even if its price rises. Alcohol, tobacco,
cigarettes, etc. are some examples of habit-forming
commodities.
Finally, it can be concluded that elasticity of demand for a
commodity is affected by number of factors. However, it is
difficult to say, which particular factor or combination of factors
determines the elasticity. It all depends upon circumstances of
each case.

Unit – 3 Cost and Market Structures

Chapter No. 7 Production and Costs

• Production Function
• Total Production Cost
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• Marginal Production Cost

• Average Production Cost
• Revenue Functions
 Production function, in economics, equation that
expresses the relationship between the quantities of
productive factors (such as labour, capital, land and
organisation) used and the amount of output obtained O f
(I)
 Production costs can include a variety of expenses, such
as labour, raw materials, consumable manufacturing
supplies, and general overhead.
Total product costs can be determined by adding together
the total INPUT costs as well as the total manufacturing
overhead costs.
 the marginal production cost is the change in total
production cost that comes from producing one additional
unit. To calculate marginal cost, divide the change in
production costs by the change in quantity

 The average cost is the total cost divided by the number

of goods produced. It is also equal to the sum of average
variable costs and average fixed costs
Average cost (AC), also known as average total cost (ATC),
is the average cost per unit of output. To find it, divide the
total cost (TC) by the quantity the firm is producing (Q)

Revenue Functions
 Total Revenue: The income earned by a seller or producer
after selling the output is called the total revenue. ...
 Average Revenue: Average revenue refers to the revenue
obtained by the seller by selling the per unit
commodity. ...
 Marginal Revenue: additional revenue realised by
additional sale

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Chapter No. 8. Accounting

and Economic Costs
• Cost in the Short run
• Fixed Costs and Variable Costs
• Long run AC and MC
Cost in the Short run
The cost of producing a firm’s output depends on how much
labour and physical capital the firm uses. The short run, states
that at a certain point in the future, one or more inputs will be
fixed, while others are variable.
When it relates to economics, the short run speaks to the idea
that an economy's behaviour will vary based on how much time
it has to absorb and react to stimuli.
When a firm looks at its total cost of production in the short
run, a useful starting point is to divide total cost into two
categories: fixed costs that cannot be changed in the short run
and variable costs that can be changed in the short run.

Fixed Costs and Variable Costs

Fixed costs are expenditures that do not change based on the

level of production, at least not in the short term. Whether you
produce a lot or a little, the fixed costs are the same.
One example is the rent on a factory or a retail space. Once
you sign an agreement, the rent is the same regardless of how
much you produce, at least until the lease runs out.
Fixed costs can take many other forms. For example, the cost
of machinery or equipment to produce the product, research
and development costs to develop new products, even
advertising to popularize a brand name are all fixed costs. The
level of fixed costs varies according to the specific line of
business.

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Fixed costs remain the same regardless of production output.

Fixed costs may include lease and rental payments, insurance,
and interest payments.

Variable costs, on the other hand, are incurred in the act of

producing—the more you produce, the greater the variable
cost.
Labour is treated as a variable cost since producing a greater
quantity of a good or service typically requires more workers or
more work hours.
Variable costs also include raw materials.
Variable costs vary based on the amount of output produced.
Variable costs may include labor, commissions, and raw
materials.
Long run AC and MC
the relation between long-run marginal cost and long run
average cost is similar to that of what it is in short run AC and
MC. But the only difference in LAC and LMC is that long run
marginal and average costs are flatter than that of SAC and
SMC.

Long run average cost (LAC) can be defined as the average of

the LTC curve or the cost per unit of output in the long run. It
can be calculated by the division of LTC by the quantity of
output.
Long run marginal cost is defined at the additional cost of
producing an extra unit of the output in the long-run i.e. when
all inputs are variable

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relation between LMC and LAC

. When LMC lies below LAC, LAC is falling, while when LMC is
above LAC, LAC is rising. At the point where LMC = LAC, LAC is
constant and minimum.
Chapter No. 9.
Market Structures
• Markets
• Perfect and Imperfect Competition
• Features of Perfect Competition
• Monopoly, Oligopoly and Monopolistic Competition
• Pricing Strategies
Markets
A market is an arrangement between buyers and sellers to
exchange goods or services for money
1. CLASSIFIED based on specialisation-
2. CLASSIFIED based on geography-
3. CLASSIFIED based on competition –
4.
Perfect and Imperfect Competition

Perfect Competition is a type of competitive market where

there are numerous sellers selling homogeneous products
or services to numerous buyers. Imperfect Competition is
an economic structure, which does not fulfil the conditions
of the perfect competition

Imperfect markets are characterized by having

competition for market share, high barriers to entry and
exit, different products and services, and a small number
of buyers and sellers. Perfect markets are theoretical and
cannot exist in the real world; all real-world markets are
imperfect markets

Features of Perfect Competition

1. Features of Perfect Competition in Economics

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2. Large number of buyers and Sellers.

3. Homogeneous Product.
4. Free entry and exit conditions.
5. Perfect knowledge on the part of buyers and sellers.
6. Perfect mobility of factors of production.
7. Absence of transport cost.
8. Absence of Government or artificial restrictions.
Monopoly, Oligopoly and Monopolistic Competition
In a monopoly, there is a single seller in a market.
1. One Seller and Large Number of Buyers:
2. No Close Substitutes:
3. Difficulty of Entry of New Firms:
4. Monopoly is also an Industry:
5. Price Maker:
In monopolistic competition, many firms sell close substitutes in
a market that is fairly easy to enter.
1. Large Number of Sellers: There are large numbers of firms
selling closely related, but not homogeneous products.
2. Product Differentiation:
3. Selling costs:
4. Freedom of Entry and Exit
5. Lack of Perfect Knowledge:
6. Pricing Decision:
7. Non-Price Competition:
In an oligopoly, a few firms produce most or all of the industry's
output.
1. A Few Firms with Large Market Share.
2. High Barriers to Entry.
3. Interdependence.
4. Each Firm Has Little Market Power In Its Own Right.
5. Higher Prices than Perfect Competition.
Pricing Strategy

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Primarily, pricing strategy takes into account the current

marketplace price of goods or services. Pricing strategy is also
about considering your costs and pricing your product
appropriately, so that you are able to make money off of your
sales
Pricing strategies refer to the processes and methodologies
businesses use to set prices for their products and services
1. Marketing Penetration. The price is set low in order to
increase sales and market share.
2. Marketing Skimming. ...
3. Psychological Pricing. ...
4. Premium Pricing. ...
5. Bundle Pricing. ...
6. Value Pricing. ...
7. Captive Pricing. ...
8. Cost Plus Pricing.
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