BCOC-134

Business Mathematics
and Statistics
School of Management Studies

PART A : BUSINESS MATHEMATICS

MATRICES
Unit 1 : Introduction to Matrices 5
Unit 2 : Determinants 21
Unit 3 : Inverse of Matrices 35
Unit 4 : Application of Matrices in Business and 57
Economics
DIFFERENTIALS CALCULUS
Unit 5 : Mathematical Functions 75
Unit 6 : Limit and Continuity 100
Unit 7 : Concept of Differentiation 115
Unit 8 : Maxmima and Minimima of Functions 135
Unit 9 : Application of Derivatives 150
BASIC MATHEMATICS OF FINANCE
Unit 10 : Interest Rates 175
Unit 11 : Compounding and Discounting 195
PROGRAMME DESIGN COMMITTEE B.COM (CBCS)
Prof. Madhu Tyagi Prof. D.P.S. Verma (Retd.) Prof. R. K. Grover (Retd.)
Former Director Department of Commerce SOMS, IGNOU, New Delhi
SOMS, IGNOU University of Delhi, Delhi
Faculty Members
Prof. R.P. Hooda Prof. K.V. Bhanumurthy (Retd.) SOMS, IGNOU
Former Vice-Chancellor Department of Commerce
Prof. N V Narasimham
MD University, Rohtak University of Delhi, Delhi
Prof. Nawal Kishor
Prof. B. R. Ananthan Prof. Kavita Sharma
Former Vice-Chancellor Department of Commerce Prof. M.S.S. Raju
Rani Chennamma University University of Delhi, Delhi
Belgaon, Karnataka Dr. Sunil Kumar
Prof. Khurshid Ahmad Batt
Prof. I. V. Trivedi Dean, Faculty of Commerce & Dr. Subodh Kesharwani
Former Vice-Chancellor Management Dr. Rashmi Bansal
M. L. Sukhadia University, University of Kashmir, Srinagar
Udaipur Dr. Madhulika P Sarkar
Prof. Debabrata Mitra
Prof. Purushotham Rao (Retd.) Department of Commerce Dr. Anupriya Pandey
Department of Commerce University of North Bengal,
Osmania University, Hyderabad Darjeeling

COURSE DESIGN AND PREPARATION TEAM

Prof. Madhu Tyagi Prof. G.P. Singh (Retd.) Faculty Members
Former Director University of Swarashtra, SOMS, IGNOU
SOMS, IGNOU Gujarat (Units 1 to 4) Prof. N V Narasimham
Prof. Nawal Kishor
Dr. H. K. Dogi Dr. Sarabjit Singh Kaur
University of Delhi, Delhi Dayal Singh College Prof. M.S.S. Raju
Units 10 to 11 University of Delhi, Delhi Dr. Sunil Kumar
Units 5 to 9 Dr. Subodh Kesharwani
Dr. Vidya Ratan Dr. Rashmi Bansal
Sriram College of Commerce Dr. O.P. Gupta Dr. Madhulika P Sarkar
University of Delhi, Delhi University of Delhi, Delhi Dr. Anupriya Pandey
Prof. Brahmha Bhatt Dr. C.R. Kothari
School of Commerce Rajsthan University, Course Coordinators and
Gujarat University Ahemdabad Jaipur Editors
Prof. M.S. Senam Raju
Prof. M.S. Senam Raju Prof. (Mrs.) Sarla Achuthan SOMS, IGNOU, New Delhi
SOMS, IGNOU, New Delhi Gujarat University, Ahemdabad Dr. Anupriya Pandey
(Unit 15,16,17 & 18) SOMS, IGNOU, New Delhi
Content Editing (Part-A)
Prof. Gopinath Pradhan (Retd.)
SOSS, IGNOU, New Delhi
Part-B adopted from ECO-07 & MCO-03

MATERIAL PRODUCTION
Mr. Y.N. Sharma Mr. Sudhir Kumar
Assistant Registrar (Publication) Section Officer (Pub.)
MPDD, IGNOU, New Delhi MPDD, IGNOU, New Delhi
January, 2020
© Indira Gandhi National Open University, 2020
ISBN:
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COURSE INTRODUCTION
This is one of the core courses in B.Com programme under CBCS scheme. The
main objective of this course is to familiarize the students with the application of
Mathematics and Statistical techniques which will facilitate in business decision
making. This course consists of two parts, viz., PART- A: Business Mathematics
comprising of 11 units and PART B: Business Statistics comprising of 7 units
(unit 12 to unit 18). The brief introduction of Part-A is as follows:
PART A: BUSINESS MATHEMATICS
This Part of the course, Business Mathematics, aims at introducing the learners to
basic mathematical applications in the area of matrices, differential calculus and
financial mathematics to solve simple business and economic problems. This part
consists of 11 Units.
MATRICES
Unit 1 : Introduction to matrices discusses the concept, types of matrices, matrix
algebra, Transpose of Matrix and its calculation.
Unit 2: Determinants explains computation of the value of determinants, its
properties minors and cofactors and application of cramer’s rule to solve system of
linear equations.
Unit 3: Inverse of Matrices defines the inverse matrix, its properties and
computation of methods of: i) determinant and Adjoint Route, ii) Elementary
Operations Route, explains inverse and Rank of a Matrix and systems of equations.
Unit 4: Application of Matrices in Business and Economics discusses
application and use of matrices for Business and Economic decision making.
DIFFERENTIAL CALCULUS
Unit 5: Mathematical Functions and Types defines functions and there types
such as algebraic, transcendental, and inverse and composite functions. Its also
deals with graph of some functions and functions relating to Business and
Economics.
Unit 6: Limit and continuity deals with the limit of a function its properties,
method of factorization and properties of continuity.
Unit 7: Differentiation covers the differentiation by first principle rule of
differentiation, standard derivatives. It also discusses differentiation of implicit
functions, using logarithms and parametric function.
Unit 8: Maxima & Minima Functions explains the higher order derivatives,
increasing and decreasing functions and also the function of maxima and minima.
Unit 9 Applications of differentials deals with demand and supply functions,
elasticity of demand and supply functions, average and marginal costs, revenue
functions and profit maximization.
BASIC MATHEMATICS OF FINANCE
Unit 10: Interest rates discusses meaning and concept of interest, different types
of interest and special cases of compound rate of interest.
Unit 11: Compounding and Discounting covers the calculation of normal and
effective rates of interest, present value and types of discounts.
s Introduction to

UNIT 1 INTRODUCTION TO MATRICES Matrices

Structure
1.0 Objectives
1.1 Introduction
1.2 Matrix
1.2.1 Types of Matrices
1.3 Matrix Algebra
1.3.1 Equality of Matrices
1.3.2 Addition and subtraction of two Matrices
1.3.3 Multiplication of Matrix by a scalar quantity
1.3.4 Multiplication of Two Matrices
1. 4 Transpose of a Matrix
1.4.1 Symmetric Matrices
1.4.2 Skew Symmetric Matrices
1.4.3 Orthogonal Matrices
1.5 Let Us Sum Up
1.6 Key Words
1.7 Some Useful Books
1.8 Answer or Hints to Check Your Progress
1.9 Exercises with Answer/Hints

1.0 OBJECTIVES
After going through this unit, you will be able to understand:
i) Basic concept of matrix;
ii) Types of the matrices;
iii) Basic operations of matrix algebra; and
iv) Transpose of a matrix.

1.1 INTRODUCTION
Matrix (matrices in plural) is an arrangement of numbers into rows and
columns. Because of its features of (i) compact notation for describing sets of
data and (ii)efficient methods for manipulating data sets, it becomes a handy
tool for finding solutions to problems which can be represented in linear
equation system. Needless to say, matrix algebra finds wide applications
covering the fields such as Engineering, Economics and Business, Sociology,
Statistics, Physics, Medicine and Information Technology. For a better
understanding of the applications, consider the following examples:
sociologists use matrices to study the dominance within a group;
demographers use these to study births and survivals, industries and
businesses take the help of matrices for fast and accurate in decision making
in the areas like evaluation of customers preferences to produce and sell.
Some use linear programming techniques that is based on matrix
formulations of data to maximise profit and thus plan production or 5
 Business Mathematics availability of raw materials. Use also is made of the matrices to arrive at a
decision on the location of business, marketing of the products or arranging
financial resources. Economists use matrices to examine Inter-Industry flows,
for studying game theory and to construct the system of social accounting.
Moreover, in medical studies, scientists use data in matrix form to determine
a statistically valid rate of efficacy of a drug before prescribing it in hospitals
and pharmacies. Many IT companies also use matrices as data structures to
track user information, perform search queries, and manage databases.

Check Your Progress 1

1) What is a matrix?
2) Why would industries and businesses use matrices?
3) Matrix formulation of data that is used in linear programming is used
for what purposes?

1.2 MATRIX
Definition: A matrix is defined as a rectangular array of numbers arranged in
rows and columns enclosed by a pair of brackets viz., [ ] or ( ) . For
example, the following array of numbers shows a matrix as

11 42 22 84

10 15 60 25

41 28 45 51

On the basis of number of rows and columns that a matrix has, we decide its
dimension or its order. By convention, rows are expressed first while
columnssecond in a matrix. Since the above matrix has 3 rows and 4
columns, we say that its dimension (or order) is 3 x 4,
The numbers that appear in the rows and columns are called elements of the
matrix. In the matrix above, the element in the first column of the first row is
11; the element in the second column of the first row is 42. Following the
same logic, we can identify the other elements.

A matrix is usually denoted by a capital letter and it’s elements by

corresponding small letters with two subscripts which indicate row and
column. For example, an element represented as a23 in a matrix, is read as its
to be position in 2nd row and 3rd column. Thus, a matrix having m rows and n
columns can be written as

��� ��� ��� . ���

� ��� ��� ��� . ��� �
� ��� ��
� = � ��� ��� ��� .
� . . . . . �
���� ��� ��� . ��� �

6
s The above matrix can also be written as Introduction to
Matrices
A = [aij}mxn where I = 1,2,3…m
J=1,2,3…..n
Indicating a m x n order matrix.

1.2.1 Types of Matrices

We will discuss the most commonly used matrices to be able to use these in
business related problems. Some other types will be taken up once we get
familiar with transpose of matrix.
1) Rows Matrix: A matrix which has only one row ora matrix of order 1
x n is called row matrix.
Example 1:
�−3 0 1�
2) Columns Matrix: A matrix which has only one column ora matrix of
order m x 1 is called column matrix.
Example2:

−2
0
� �
2
1
3) Rectangular Matrix: A matrix is said to be rectangular if the number
of rows is not equal to the number of columns.
Example 3:
3 7 9
� �
4 6 9
4) Square Matrix: A matrix in which the number of rows is equal to the
number of columns is called square matrix i.e., the matrix of order m x
n is a square matrix, if m = n.
Example 4:
1 −2 1 −3
−3 0 5 1
� �
2 2 1 −2
1 1 −1 2
5) Diagonal Matrix: A square matrix in which all the elements except the
diagonal elements are zero is called diagonal matrix.
Square Matrix A = [aij] is a diagonal matrix if aij = 0 for all I≠j
Example5:
1 0 0 0
0 −3 0 0
� �
0 0 1 0
0 0 0 2
7
 Business Mathematics 6) Scalar Matrix: A diagonal matrix in which all the diagonal elements
are the same is called scalar matrix.
Example 6:
−3 0 0 0
0 −3 0 0
� �
0 0 −3 0
0 0 0 −3
7) Identity Matrix (Unit matrix):A scalar matrix in which all the
diagonal elements are one is called unit matrix or an identity matrix. An
identity matrix is denoted by capital letter I.
Example 7:
1 0 0 0
0 1 0 0
� �
0 0 1 0
0 0 0 1
8) Triangular Matrix: A square matrix is said to be triangular if all of its
elements above the main diagonal are zero (lower triangular
matrix) or all of its elements below the main diagonal are zero (upper
triangular matrix).
Example 8:
i) Lower Triangular Matrix
1 0 0 0
3 2 0 0
� �
5 −1 −1 0
−2 3 2 1

ii) Upper Triangular Matrix

1 3 1 −2
0 2 1 5
� �
0 0 −1 3
0 0 0 1

9) Null or Zero Matrix: A square matrix in which all the elements are
zero is called zero matrix or null matrix. It is denoted by capital
letter O.
Example 9:
0 0 0 0
0 0 0 0
� �
0 0 0 0
0 0 0 0

10) Symmetric Matrix: Square Matrix A = [aij] is a Symmetric Matrix if

aij = aji for all i&j. we will revisit this matrix after covering the
transpose of matrix in this unit.

8
s 1 3 5 Introduction to
Example10: �3 2 −1� Matrices

5 −1 −1

11) Sub Matrix: A matrix obtained by deleting some rows or columns or

both of a given matrix is called sub matrix of the given matrix.
Example 11:
1 3
1 5
Matrices �3 2 � and � � are the Sub matrix of
5 −1
5 −1
1 3 5
�3 2 −1�
5 −1 −1

Check Your Progress 2

1) What are diagonal elements of a matrix?
2) Find the elements a21, a34, a24 and a11 in the following matrix

−5 12 5 9
7 6 3 1
� �
3 2 0 5
8 7 −4 2
Also find diagonal elements.
3) Find x and y if
�+� 2 3 2
� � =� �
1 �−� 1 7
4) Classify the following matrices:
−5
1 0 0 1 0 0
7
(i)�0 1 0� (ii) �3 2 0 � (iii)� �
3
0 0 1 5 −1 −1
8

0 0 0 1 3 5
(iv)�7 6 3 1� (v)�0 0 0� (vi) �0 2 −1�
0 0 0 0 0 −1

8 0 0 0 1 3 5
0 8 0 0 1 3 5 3 2 −1
(vii)� � (viii)� � (ix)� �
0 0 8 0 5 −1 −1 5 −1 −1
0 0 0 8 2 1 3

1.3 MATRIX ALGEBRA

In this section we will discuss the basic operations of matrices. We start with
the idea of matrix equality before taking up the operations of addition and
multiplication. In matrix algebra, the elements are ordered numbers and
9
 Business Mathematics therefore operations on them have to be done in ordered manner. It may be
useful to note that while we deal with the main operations such as addition
and multiplication. Other operations viz., subtraction and division are derived
out of those.

1.3.1 Equality of Matrices

Two matrices are equal if the following three conditions are met:
i) Each matrix has the same number of rows.
ii) Each matrix has the same number of columns.
iii) Corresponding elements within each matrix are equal.
The above conditions simply require that matrices under consideration are
exactly the same.
Example 12:
Consider the two matrices given below:
2 � 2 3
�= � � and B =� �
� 3 4 3
If A = B,then x = 3 and y = 4, since corresponding elements of equal matrices
have to be equal.
Further, suppose that we are given a matrix as follows:
� � �
� = �� � ��. Then C is neither equal to A nor to B as C has three
columns. Consequently, matrix C is not equal to either A or B.

1.3.2 Addition and Subtraction of two Matrices

• Matrices can be added or subtracted if and only if they are of the same
order.
• The sum or difference of two (m x n) matrices is another (m x n) matrix
whose elements are the sum or difference of the corresponding
elements of the given matrices.
For two matrices A = [aij]m x n and B = [bij]m x n
A±B=C
where C = [cij]m x n and cij = aij ± bij for all i & j.
Example 13:
0 2 3 7 3 5
For A = � � and B=� �
2 1 4 5 −1 −3
Here
0 2 3 7 3 5
A+B= � � + � �
2 1 4 5 −1 −3

0+7 2+3 3+5 7 5 8

=� � = � �
2 + 5 1 + (−1) 4 + (−3) 7 0 1

10
s And Introduction to
Matrices
0 2 3 7 3 5
A - B =� � - � �
2 1 4 5 −1 −3
0−7 2−3 3−5 −7 −1 −2
=� � = � �
2 − 5 1 − (−1) 4 − (−3) −3 2 7
Negation of a Matrix: The negation of a Matrix A is denoted by –A which is
obtained by replacing all the elements of A by their negation. For example, if

1 3 5 −1 −3 −5
A=� � then –A = � �
5 −1 −1 −5 1 1
So, the subtraction of two matrices A and B can be expressed as the sum of A
and the negation of matrix B.
A – B = A + (-B)

1.3.3 Multiplication of Matrix by a Scalar Quantity

If a Matrix is multiplied by a scalar quantity, then all the elements are
multiplied by that quantity.
If a Matrix A = [aij]m x n is multiplied by some scalar quantity λ then
λA = λ[aij]m x n
= [λaij}m x n
7 3 5 7 3 5
For example, if A = � �, then 3A = 3� � =
5 −1 −1 5 −1 −1
21 9 15
� �
15 −3 −3
Properties of Addition of Matrices
1) Addition of Matrices is Commutative: If A and B are two matrices of
same order, then
A+B=B+A
2) Addition of Matrices is Associative: If A, B and C are three matrices
of same order, then
(A + B) + C = A + (B + C)
3) Existence of Additive Identity: If A is a matrix and O is the null
matrix of the same order as that of A, then
A+O=O+A=A
4) Existence of Additive Inverse:For any Matrix,
A + (-A) = (-A) + A = O
The following example illustrates these properties:

1 3 5 5 1 3 6 1 −7
Let A = � �, B=� �, C=� �
5 −1 −1 6 −1 2 −2 0 5
0 0 0
and O = � �. Then
0 0 0
11
 Business Mathematics 1 3 5 5 1 3 6 4 8
A+B=� �+� � =� �;
5 −1 −1 6 −1 2 11 −2 1
5 1 3 1 3 5 6 4 8
B+A=� � +� �=� � = A + B;
6 −1 2 5 −1 −1 11 −2 1
6 4 8 6 1 −7 12 5 1
(A +B) + C = � �+� �=� �;
11 −2 1 −2 0 5 9 −2 6
5 1 3 6 1 −7 11 2 −4
B+C=� � + � �=� �;
6 −1 2 −2 0 5 4 −1 7
1 3 5 11 2 −4 12 5 1
A + (B+C) = � �+� �=� � = (A + B)
5 −1 −1 4 −1 7 9 −2 6
+C;

1 3 5 0 0 0 1 3 5
A+O=� �+� � =� � = A and
5 −1 −1 0 0 0 5 −1 −1
1 3 5 −1 −3 −5 0 0 0
A + (-A) = � �+� � =� � = O.
5 −1 −1 −5 1 1 0 0 0

1.3.4 Multiplication of Two Matrices

Two matrices meet the requirement of multiplication if the number of
columns of first matrix is equal to the number of rows of second matrix. If
the matrix � is of order � � � i.e.,it has � rows and � columns, then matrix
� must be of order � � � where � is number of rows and � is number of
columns which is not necessarily equal to �. Then the product �� is another
matrix � = � � � of the order � � � (number of rows of � and number of
columns of �).
Let A = [aij]mxnand B = [bij]nxp be two matrices.Then the product AB is the
Matrix C,
where C = [cij]mxp,cij = ∑���
��� ��� ��� for i =1,2,3….m & j=1,2,3,4……p

where

12
s Remark: In the matrix product AB, the matrix A is called the pre-factor and Introduction to
Matrices
matrix B is called post-factor.
Example 14:
0 1 2
1 3 5
Let A = � � and B = � 5 2 1�
5 −1 −1
−1 2 1
Here the order of matrix A is 2 x 3 and the order of matrix B is 3 x 3, so the
product AB is defined.
��� ��� ���
AB = �� ��� ��� �
��

Where c11 = (1x0) + (3x5) + (5x-1) = 0 + 15 – 5 = 10

c12 = (1x1) + (3x2) + (5x2) = 1 + 6 + 10 = 17
c13 = (1x2) + (3x1) + (5x1) = 2 + 3 + 5 = 10
c21 = (5x0) + (-1x5) + (-1x-1) = 0 - 5 + 1 = -4
c22 = (5x1) + (-1x2) + (-1x2) = 5 - 2 - 2 = 1
c23 = (5x2) + (-1x1) + (-1x1) = 10 - 1 - 1 = 8

10 17 10
Thus, AB = � �
−4 1 8
Consider these matrices A and B to see whether the product BA is defined.
You will find that it is not. Why? Because the number of columns in B is not
equal to the number of rows in A. This shows that matrix multiplication is
not commutative.
For two matrices A and B, if AB and BA both are defined, then it is not
necessary that they are equal.

1 3 1 2
For example, if A = � � and B = � � then
2 −1 3 4
10 14 5 1
AB = � � and BA = � �
−1 0 11 5
Here AB ≠ BA
For two matrices A and B if AB = O, then it is not necessary that either of
A, B is a null matrix.
Example 15:

1 0 0 0
Let A = � � and B = � �
0 0 0 1
0 0
Here AB = � � = O but neither A = O nor B = O.
0 0
Properties of Matrix Multiplication
1) Associativity: Matrix multiplication is associative. For three matrices
A, B and C of order m x n,n x p and p x q respectively,
(AB) C = A (BC)

13
 Business Mathematics 2) Distributive over Addition: Matrix Multiplication is distributive over
matrix addition. For three matrices A, B and C of order m x n, n x p
and p x q respectively,
A (B+C) = AB + AC
3) Identity: For any matrix A of order m x n, there is an identity matrix In
of order n x n and an identity matrix Im of order m x m such that Im A =
A = A In.
For a square matrix A of order nxn, In A = A In = A
Example 16:
1 2 1 0 1 −1
If A = � �, B = � � and C = � �, then show that
3 4 2 −3 0 1
(I) (AB) C= A (BC)
(II) A (B+C) = AB + AC
(III) AI = IA = A
Solution:

1 2 1 0 5 −6
i) AB = � �� �=� �
3 4 2 −3 11 −12
5 −6 1 −1 5 −11
(AB) C = � �� �=� �
11 −12 0 1 11 −23
1 0 1 −1 1 −1
BC = � �� �=� �
2 −3 0 1 2 −5
1 2 1 −1 5 −11
A (BC) = � �� �=� �
3 4 2 −5 11 −23
Therefore, (AB) C= A (BC)

1 0 1 −1 2 −1
ii) B+C= � � +� �= � �
2 −3 0 1 2 −2
1 2 2 −1 6 −5
A (B+C) = � �� �= � �
3 4 2 −2 14 −11
1 2 1 0 5 −6
AB = � �� �=� �
3 4 2 −3 11 −12
1 2 1 −1 1 1
AC = � �� � =� �
3 4 0 1 3 1
5 −6 1 1 6 −5
AB + AC = � �+� �=� �
11 −12 3 1 14 −11
Therefore, A (B+C) = AB + AC

1 0 1 2 1 2
iii) IA= � �� �= � � =A
0 1 3 4 3 4
1 2 1 0 1 2
AI= � �� � = � � =A
3 4 0 1 3 4

14 Hence, AI = IA = A
s Introduction to
Check Your Progress 3 Matrices
1) Check the following two matrices. State if they are equal. Give reason
to support your answer.
1 3 1 3 6
� � and � �
5 4 5 4 8
2) Suppose that the following two matrices are equal. What are the values
of x and y?
1 3 � 3
�= � �, B=� �
5 4 5 �
3) When do you say matrix multiplication is defined?
4) Explain with example the Properties of Matrix Multiplication.
5) When would you say a matrix operation is not commutative?
6) Why would you say that matrix addition is associative?

1.4 TRANSPOSE OF A MATRIX

The new matrix obtained by interchanging rows and columns of the original
matrix is called its transpose. Suppose we have a matrix A= ���� �of order
� × �. We interchanged its raw and column. The matrix thus derived is
known as transpose of A and denoted by �� or �′ . Thus, if
3 2
3 4 7
A = �4 1 �, then A’ = � �.
2 1 −5
7 −5
For any Matrix A, AA’ and A’A are always defined but need not to be equal.
In the above matrices AA’ and A’A are defined but not equal because the
order of AA’ is 3 x 3 while the order of A’A is 2 x 2.
Properties of Transpose of a Matrix
i) (A’)’ = A
ii) (kA)’ = k A’ where k is some scalar quantity.
iii) (A + B)’ = A’ + B’
iv) I’ = I
v) (AB)’ = B’ A’

Example17:

2 3 3 4 1 0
Let A = � �, B = � � and I = � �
0 1 2 1 0 1
2 0 2 3
A’ = � � and (A’)’ = � �=A
3 1 0 1
2 3 6 9
3A = 3 � �=� �
0 1 0 3
6 0 2 0 6 0
(3A)’ = � � and 3A’=3� �=� � = (3A)’
9 3 3 1 9 3
15
 Business Mathematics 2 3 3 4 5 7
A+B=� �+� � = � �
0 1 2 1 2 2
5 2
(A + B)’ =� �
7 2
2 0 3 2 2 0 3 2 5 2
A’ = � � and B’ = � � so, A’ + B’ =� �+ � � =� � =
3 1 4 1 3 1 4 1 7 2
(A + B)’

2 3 3 4 12 11 12 2
AB = � �� � =� � and (AB)’ = � �
0 1 2 1 2 1 11 1
3 2 2 0 12 2
B’A’ = � �� � =� � = (AB)’
4 1 3 1 11 1

1.4.1 Symmetric Matrix

Matrix A is called symmetric matrix if A’ = A. For example, if
1 5 4
A = �5 2 −1�,
4 −1 3

1 5 4
A’ = �5 2 −1� = A. So A is a Symmetric Matrix.
4 −1 3

1.4.2 Skew Symmetric Matrix

Matrix A is called skew symmetric matrix if A’ = -A. For example, if

0 5 4
A = �−5 0 −1�,
−4 1 0
0 −5 −4 0 5 4
A’ = �5 0 1 � = -�−5 0 −1� = -A. So A is a skew symmetric
4 −1 0 −4 1 0
matrix.

1.4.3 Orthogonal Matrix

Matrix A is called orthogonal matrix if AA’ = A’A = I. For example, if

1 2 2
�
A = �� 2 1 −2�,
−2 2 −1
1 2 −2
�
A’ = � �2 1 2 �.
2 −2 −1

1 2 2 1 2 −2
� �
Now, AA’ = � � 2 1 −2� � �2 1 2�
−2 2 −1 2 −2 −1
16
s 9 0 0 1 0 0 Introduction to
� Matrices
= � �0 9 0� = �0 1 0� = I
0 0 9 0 0 1
Similarly, it also can be proved that A’A = I

Check Your Progress 4

1) What do you mean by is transpose of a matrix?
2 3 4
2) You are given a matrix A=� �. Verify that ��′ �′ = A.
1 −5 9
3) How do you get an orthogonal matrix using transpose rule?

1.5 LET US SUM UP

In this unit we have discussed matrices which help find unique solution to
problems when expressed in equations of linear forms. The basic operations
viz., additions and multiplications have been taken up after introducing the
concept of a matrix and types of matrices. We have seen that matrix defined
as a rectangular array of numbers arranged in rows and columns. There are
matrices such as row and column matrices, identity, diagonal, null,
symmetric, rectangular, triangular and orthogonal. The unit closes with a
brief discussion on transpose of matrix which means obtaining a new matrix
by interchanging rows and columns of the original matrix. Some special
matrices like orthogonal and skew symmetric have been discussed in this
part.

1.6 KEY WORDS

Diagonal Matrix:Non-zero elements only in the diagonal running from the
upper left to the lower right.
Equality of Matrices:Two matrices are equal if each matrix has the same
number of rows, columns and corresponding elements within each are also
equal.
Identity matrix:A matrix usually written as I, with 1 (ones) on the main
diagonal and zeros elsewhere.
Lower Triangular Matrix: A special kind of square matrix with all its
entries above the main diagonal aszero.
Matrix Multiplication: A feasible operation when the number of columns
in a first matrix is equal to number of rows in a second matrix.
Matrix:A way of representing data in a rectangular array.
Negation of a Matrix: Elements of a matrix with their replacement by their
negation.
Orthogonal Matrix:Matrix A is called orthogonal matrix if AA’ = A’A = I
Rectangular Matrix:A matrix with the number of rows not equal to the
number of columns.
Scalar Matrix: A diagonal matrix in which all the diagonal elements are the
same.
Scalar: A single constant, variable, or expression.
17
 Business Mathematics Skew Symmetric Matrix:Matrix A is called Skew Symmetric matrix if A’ = -A
Square Matrix:A matrix in which the number of rows is equal to the number
of columns.
Sub Matrix:A matrix obtained by deleting some rows or columns or both of
a given matrix is called sub matrix of a given matrix.
Symmetric Matrix:A matrix is symmetric if it equals its own transpose.
Dimension(s) or Order: The number of rows and the number of columns in
a matrix.
Transpose of Matrix:New matrix obtained by interchanging the rows and
columns of the original.
Upper Triangular Matrix:A special kind of square matrix with all its
entries below the main diagonal as zero.
Zero (or null) Matrix:Matrix whose elements are all zeros.

1.7 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
• Archibald, G.C., Richard G.Lipsey. “An Introduction to a
Mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems ofMathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.
• Wegner, Trevor. (2016). Applied Business Statistics: Methods and Excel-
Based Applications, Juta Academic. ISBN 9781485111931
• Yamane, Taro, “Mathematics for Economists: An Elementary
Survey”,New Delhi: Prentice Hall of India Private Limited, 1970.

1.8 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Matrix is an arrangement of numbers into rows and columns.
2) Matrices are used by industries and businesses to arrive at a decision on
the location of business, marketing of the products or arranging
financial resources.
3) To plan production or availability of raw materials.

18
s Check Your Progress 2 Introduction to
Matrices
1) Diagonal Elements:All the elements aijare called diagonal elements if
i=j. The elements a11, a22, a33 …ann are diagonal elements. In the above
matrices the diagonal elements are 1, 4 in matrix A and 2, 0, -2 are in
matrix B and 1, 0, 1, 2 are in matrix C.
2) a21 = 7, a34 = 5, a24 = 1 and a11 = -5. Diagonal Elements are -5, 6, 0, 2.
3) x = 5, y = -2.
4) (i) Identity Matrix (ii) Lower Triangular Matrix (iii) Column Matrix
(iv) Row Matrix (v) Null Matrix (vi) Upper Triangular Matrix (vii)
Scalar Matrix (viii) 2 x 3 Matrix (ix) 4 x 3 Matrix
Check Your Progress 3
1) These two matrices are not equal since they are not of the same dimensions.
2) � =1 and � =4
3) The matrix multiplication AB is defined only when the number of
columns in A is equal to the number of rows in B.
4) Explain associativity, distributive and identity properties.
5) Consider matrices A and B to see whether the product BA is defined. If
not, that could be due to the number of columns in B is not equal to the
number of rows in A. Such a result indicates that matrix multiplication
is not commutative.
6) Because (A+B) +C = A +(B+C)
Check Your Progress 4
1) The new matrix obtained by interchanging rows and columns of the
original matrix is called its transpose.
2 1
2 3 4
2) Get ���′
=�3 −5�, then transpose it to get ��′ �′ = � �
1 −5 9
4 9
3) Take an example such that ��′ = �′ �=I

1.9 EXERCISES WITH ANSWER/HINTS

1) You are told that the following two matrices are equal. What are the
values of x, y, and z?

4 0 � 0
� = �6 −2� , � = �6 � + 4�
�
3 1 �
1

Ans.: Given that A = B, we must have all the corresponding entries

equal. So, we know that a1,1 = b1,1, a1,2 = b1,2, a2,1 = b2,1, and so forth.
Thus, 4 = x, –2 = y + 4 and 3 = z/3

4 0 � 0
Rewriting the matrices as �6 −2� = �6� � + 4�, then we solve for
3 1 �
1
x= 4, y = –6, and z = 9.
2) Why is matrix multiplication not commutative? 19
 Business Mathematics Ans.: When we do not use square matrices, we cannot even try to
commute multiplied matrices as the sizes wouldn't match. But even
with square matrices, we don't have commutative feature always. For
example, consider case of 2×2 matrices A and B.
��� ��� ��� ���
Let � = �� ��� � and � = ���� �,
�� ���
��� ��� + ��� ��� ��� ��� + ��� ���
then, AB = � �
��� ��� + ��� ��� ��� ��� + ��� ���
��� ��� + ��� ��� ��� ��� + ��� ���
BA= � �
��� ��� + ��� ��� ��� ��� + ��� ���
It may be noted that these matrices are not be the same unless we make
some very specific restrictions on the values for A and B. Since we take
the rows from the first matrix and multiply by columns from the
second, such a process switching the order changes the values.
2 −5 1 3 4 0 7 −6 2
3) If A = � �, B = � � and C =� �,
−2 −1 4 5 −2 3 1 −4 11
then evaluate
i) A+B
ii) B–C
iii) 2A + B – C
5 −1 1 −4 10 −2
Ans.: (i)� � (ii)� �
3 −3 7 4 2 −8
0 0 0
(iii)� �
0 0 0
4) Find the matrices A and B from the following relations
6 −6 0 3 2 5
2A – B = � � and 2B + A = � �
−4 2 1 −2 1 −7
3 −2 1 0 2 2
Ans.: A = � � B=� �
−2 1 −1 0 0 −3
9 1 1 5
5) If A =� � and B =� �, find the matrix X such that 3A + 5B +
4 3 7 12
2X = O
−16 −14
Ans. X= � �
−47/2 −69/2
1 2 1 0 1 −1
6) If A =� � , B =� � and C =� � then show that
3 4 2 −3 0 1
(i) A (B + C) = AB + AC (ii) (AB)C = A(BC)
4 2
7) If A = � �, find (A – 2I) (A – 3I).
−1 1
1 2
8) If A = � �, show that products AA’ and A’A are symmetric but not
3 4
equal.

20
 Determinants
UNIT 2 DETERMINANTS
Structure
2.0 Objectives
2.1 Introduction
2.2 Computation of Value of a Determinant
2.3 Properties of Determinants
2.4 Minors and Cofactors
2.5 Use of Cramer’s Rule in Determinants to Solve System of Linear
Equations
2.6 Let Sum Up
2.7 Key Words
2.8 Some Useful Books
2.9 Answer or Hints to Check Your Progress
2.10 Exercises with Answer/Hints

2.0 OBJECTIVES
After going through this unit, you will be able to understand:
1) Basic concept of Determinant
2) Difference between matrix and determinant
3) Cofactors and Minors of a Determinant
4) Application of determinant in solving a system of linear equations
(Cramer’s Rule)

2.1 INTRODUCTION
In the preceding unit, we have seen simple operations of matrices which can
be used as a background material for obtaining solution in linear form
problems. In the present unit, we extend the discussion to determinant which
was discovered by Cramer during solving of system of linear equations.Note
that determinant is a numerical value and can be computed from the elements
of a square matrix.
The determinant of a matrix A is denoted det(A), det A, or |A|. Seen
geometrically, it can be viewed as the volume scaling factor of the linear
transformation described by the matrix. We get a determinant in positive or
negative value form.

Check Your Progress 1

1) Distinguish between matrix and determinant
2) How Cramer discovered determinant?
3) Determinant can be computed only from which type of matrix?
21
Business Mathematics
2.2 COMPUTATION OF VALUE OF A
DETERMINANT
The value of determinant can be calculated by the following procedure:
Consider a square matrix. For each element of its first row or first column get
its submatrix. Next multiply each of the selected elements with the
corresponding determinant of the submatrix. Finally, add them with alternate
signs.
Determinant of a Matrix whose order is one(n=1)

As a base case, the value of determinant of a 1*1 matrix is the single value
itself.

That is to say that if the Matrix A has only one element, then the element
itself is the determinant of matrix A, i.e.,

if A = [a], then |A| = a.

For Example, if A = [2] then |A| = 2.
Determinant of a Matrix whose order is two (n=2)
If the order of square matrix A is 2, then|A| = (multiplication of diagonal
elements) – (multiplication of off diagonal elements), i.e.,
��� ��� ��� ���
if A = �� ��� �, then |A| = ���� ��� � = (a11 x a22) – (a21 x a12).
��

2 3
For example, if A = � �then |A| = (2 x 2) – (1 x 3) = 4 – 3 = 1.
1 2
Determinant of a Matrix whose order is three (n=3)
� � �
Let A = �� � � �,
� ℎ �
� � � � � �
� �
Then ��� (�) = ��� � � � � � = �� � � � = � �� �
�−�� �+
ℎ � � �
� ℎ � � ℎ �
� �
�� �.
� ℎ
In other words, go across the first row of the matrix ,(� � �) . Multiply
each entry by the determinant of the2 × 2 matrix obtained from by
crossing out the row and column containing that entry.Then we add and
subtract the resulting terms, alternating signs (add the -term, subtract the
-term, add the -term.)
2 1 −1
For example, if � = �1 1 1 �, then
1 −2 −3

1 1 1 1 1 1
|A| = +2� � -1� �+ (-1)� �
−2 −3 1 −3 1 −2
= 2(-3 + 2) -1(-3 - 1) – 1(-2 - 1) = -2 + 4 + 3 = 5.
22
We can use the same method to compute the determinant of a 4 × 4 matrix.In Determinants
fact, the method seen above can be applied for any square matrix of any size.
Note that you don't have to use the first row only; you can use any row or any
column, as long as you know where to put the plus and minus signs. Thus,

��� ��� ��� . ���

���� ��� ��� . ��� �
� �
if � = ���� ��� ��� . ��� �then |A| = ∑���� (-1)i+jaij|Mij|, Where
� . . . . . �
���� ��� ��� . ��� �
Mijis the sub matrix of A obtained by striking off ithrow and jtht column.

Check Your Progress 2

1) What is the value of the determinant of a matrix with a single element?
� �
2) You are given the following matrix:� �.
� �
Find the value of its determinant.
3) What formula would you use to find the determinant of a square matrix
of any size?

2.3 PROPERTIES OF DETERMINANTS

i) If all the rows and columns of a determinant are interchanged then the
value of determinant does not change, i.e.,|A| = |At|

1 6 5 1 3 −2
For example,� 3 2 1 � = �6 2 0 �
−2 0 −3 5 1 −3

ii) If any two rows/columns of a determinant are interchanged, the value of

determinant remains the same but the sign is reversed.

1 6 5 −2 0 −3
For example,� 3 2 1 �=- � 3 2 1 �
−2 0 −3 1 6 5

iii) If any two rows/columns of a determinant are identical, the value of

determinant is zero.

1 6 5
For example,� 3 2 1� = 0
3 2 1

iv) If all the elements of a row/column of determinant are multiplied by

some number (say, k) then the value of the determinant is multiplied by
that number.
1 6 5 2�1 2�6 2�5
For example,� 3 2 1 �= 56and � 3 2 1 �
−2 0 −3 −2 0 −3
23
Business Mathematics 1 6 5
=2x� 3 2 1 � =2x56 =112.
−2 0 −3

v) If all the elements of a row/column of a determinant are

added/subtracted k-times the corresponding elements of another
row/column, the value of determinant remains unchanged.

1 6 5 1 + (2�6) 6 5
For example,� 3 2 1 � = 56 and � + (2�2)
3 2 1 �=
−2 0 −3 −2 + (2�0) 0 −3
13 6 5
�7 2 1 � = 56
−2 0 −3

vi) If all the elements of a row/column of a determinant are sum/difference

of two or more elements then determinant can be expressed as the
sum/difference of two or more determinants.

1 6 5 1 6 2+3 1 6 2
For example,� 3 2 1 �=� 3 2 0+1 �=� 3 2 0� +
−2 0 −3 −2 0 2 + (−5) −2 0 2
1 6 3
�3 2 1 �= - 24 + 80 = 56
−2 0 −5

Check Your Progress 3

1) You have interchanged two rows/columns of a determinant. What
happens to its value?
2) John is doing some manipulation with the rows and columns of a
determinant but getting the same value of it. What do you think he is
doing?
3) Seeta has multiplied all the elements of the last row of the square
matrix A with a constant �. What value of the corresponding
determinant should she get because of her action?
4) Smith made changes in a determinant so as to obtain two identical
columns. What value would he get of such a determinant?

2.4 MINORS AND COFACTORS

Minor of an element of a determinant
Let |A| = |��� | be a determinant of order n. The minor of the element ���
which exists in ithrow and jth column of the determinant |A|, is the
determinant left by striking off ithrow and jth column of |A|.

��� ��� ���

For a determinant ���� ��� ��� �of order 3,
��� ��� ���

24
 ��� ��� st st Determinants
the minor of a11 is �� ��� �, which is obtained by deleting 1 row and 1
��
column of

��� ��� ���

�
� �� ��� ��� �
��� ��� ���

��� ��� nd
Similarly the minor of a22 is �� ��� � which is obtained by deleting 2
��
row and 2nd column of

��� ��� ���

�
� �� ��� ��� �
��� ��� ���
Illustration:
7 5 9
Given matrix = �3 8 4� , find the minors of a32and a23.
6 2 1

7 9
The minor of a32 is � � = (7x4) – (9x3) = 28 – 27 = 1.
3 4

7 5
The minor of a23 is � � = (7x2) – (5x6) = 14 – 30 = -16.
6 2
Cofactor of an element of a determinant
The cofactor of an element of a determinant is the signed minor of that
element. The sign of minor is determined on the value of � and �, i.e., the
row and column in which the element exists. The cofactor of element��� is
denoted by ��� .

The cofactor of ��� = (−1)��� minor of ��� .

��� ��� ���

�
For a determinant � �� ��� ��� �of order 3,
��� ��� ���

��� ��� 2 ��� ��� ��� ���

the cofactor of a11 is A11 = (-1)1+1�� ��� � = (-1) ���� ��� � =���� ��� �
��

��� ��� 5 ��� ���

Similarly, the cofactor of a32 is A32 = (-1)3+2�� ��� � = (-1) �� ��� �
�� ��
��� ���
= – �� �
�� ���

The sign of minor is + if i + j is even and the sign of minor is – if i + j is odd.

25
Business Mathematics Illustration:
1 6 5
For the matrix � = � 3 2 1 �, let us find out the cofactors of all the
−2 0 −3
elements of the corresponding determinant of the matrix.
2 1
A11 = (-1)1+1� � = (-1)1+1(2x-3 – 0x1) = -6 – 0 = -6.
0 −3
3 1
A12 = (-1)1+2� � = (-1)1+2(3x-3 – 1x-2) = -(-9 + 2) = 7.
−2 −3
3 2
A13 = (-1)1+3� � = (-1)1+3(3x0 – 2x-2) = (0+ 4)= 4.
−2 0
6 5
A21 = (-1)2+1� � = (-1)2+1(6x-3 – 5x0) = -(-18 –0) = 18.
0 −3
1 5
A22 = (-1)2+2� � = (-1)2+2(1x-3 – 5x-2) = (-3+10) = 7.
−2 −3
1 6
A23 = (-1)2+3� � = (-1)2+3(1x0 – 6x-2) = -(0+12) = -12.
−2 0
6 5
A31 = (-1)3+1� � = (-1)3+1(6x1 – 2x5) = 6 – 10 = -4.
2 1
1 5
A32 = (-1)3+2� � = (-1)3+2(1x1 – 5x3) = -(1 – 15)= 14.
3 1
1 6
A33 = (-1)3+3� � = (-1)3+3(1x2 – 6x3) = 2 – 18 = -16.
3 2
Miscellaneous Examples:
1 2 0 −1
3 −1 4 1
Example1: If A = � � , find |A|.
−2 0 −3 3
4 3 1 2
Solution:
1 2 0 −1
3 −1 4 1
�=� �
−2 0 −3 3
4 3 1 2
−1 4 1 3 4 1 3 −1 1
|A| = 1� 0 −3 3� - 2�−2 −3 3� + 0�−2 0 3� – (-
3 1 2 4 1 2 4 3 2
3 −1 4
1)�−2 0 −3�
4 3 1
|A| = 1M11 – 2M12 + 0M13 +1M14

−1 4 1
M11 = � 0 −3 3� = (-1)(-6 – 3) -4(0 – 9) + 1(0 +9) = 9 + 36 + 9 = 54
3 1 2

26
 3 4 1 Determinants
M12 = �−2 −3 3� = 3(-6 – 3) - 4(-4 – 12) + 1(-2 + 12) = -27 +64 +10 =47
4 1 2

3 −1 1
M13 = �−2 0 3� = 3(0 – 9) +1(-4 – 12) + 1(-6 – 0) = -27 -16 - 6 = -49
4 3 2

3 −1 4
M14 = �−2 0 −3� = 3(0 + 9) +1(-2 + 12) + 4(-6 – 0) = 27 + 10 - 24 =
4 3 1
13.
|A| = 1M11 – 2M12 + 0M13 +1M14
|A| =1x54 – 2x47 + 0x(-49) + 1x13
= 54 – 94 + 0 + 13 = -27.
0 �� � �� �
Example2: Evaluate ��� � 0 �� � �
�� � ��� 0
Solution:
Take common a from first row, b from second row and c from third row.

0 �� � �� � 0 �� ��
��� � � � = abc� �
0 �� � 0 ���
�� � ��� 0 �� �� 0

Now, take common a2 from first column, b2 from second column and c2 from
0 1 1
third column. We obtain a3b3c3�1 0 1� = a3b3c3 [0(0 – 1) – 1(0 – 1) + 1(1
1 1 0
-0)] = a3b3c3[0+1+1) = 2 a3b3c3.

Check Your Progress 4

1) What do you mean by a minor of a square matrix?
2) What is a cofactor of a square matrix?
3) How would you get a cofactor in a square matrix?
4) You are given following determinant:
1 −2
� �.
4 3
Find, for all its elements, minors and cofactors.

27
Business Mathematics
2.5 USE OFCRAMER’S RULEIN
DETERMINANTS TO SOLVE SYSTEM OF
LINEAR EQUATIONS
Cramer’s Rule:
This method was given by Swiss mathematician Gabriel Cramer to solve a
system of � linear equations in � variables using determinants.
Let the system of n linear equations with n variable x1, x2, x3, x4,……xn be
a11x1 + a12x2 + a13x3 + …………..+ a1nxn = b1
a21x1 + a22x2 + a23x3 + …………..+ a2nxn = b2
.
.
.
an1x1 + an2x2 + an3x3 + …………..+ annxn= b. The above system can be written in
Matrix form
AX = B
��� ��� ��� . ��� �� ��
���� ��� ��� . ��� � � �� � � �
��
�
where A= ���� ��� ��� . ��� �� , X = ���� �� and B = ���� ��
� . . . . . � � . � � . �
���� ��� ��� . ��� � ��� � ��� �

��� ��� ��� . ���

��� ��� ��� . ���
Let D = |A| =����� ��� ��� . ��� ��
. . . . .
��� ��� ��� . ���

Apply the property of determinant C1→x1 C1

�� ��� ��� ��� . ���

�� ��� ��� ��� . ���
x1 D = ���� ��� ��� ��� . ��� ��
. . . . .
�� ��� ��� ��� . ���

Apply the property of determinant C1→C1 + x2C2 + x3C3 +……..+xnCn

We have
��� �� + ��� �� + ⋯ . . ��� �� ��� ��� . ���
��� �� + ��� �� + ⋯ . . ��� �� ��� ��� . ���
x1 D = �� ��� �� + ��� �� + ⋯ . . ��� �� ��� ��� . ��� �� =
. . . . .
��� �� + ��� �� + ⋯ . . ��� �� ��� ��� . ���

28
 �� ��� ��� . ��� Determinants
� ��� ��� . ���
� � �
� �� ��� ��� . ��� � = D1
. . . . .
�� ��� ��� . ���
��
� �
�
� ��
Where D1 is the determinant of A after replacing first column by ��� �
� . �
��� �
��
So x1 D = D1 which provides x1 = �

Similarly, it can be shown that x2 D = D2

��
� �
�
� ��
Where D2 is the determinant of A after replacing 2nd column by � �� �
� . �
��� �
�� ��
Which provides x2 = �
similarly xn = �

��
� �
�
� ��
where Dnis the determinant of A after replacing nth column by ��� �
� . �
��� �

Note: For any system of linear equations

If D ≠ 0, the system has unique solution and system is consistent.
If D = 0 and all D1, D2, D3, D4…… Dn are also equal to zero, then the system has
infinite solutions and system is consistent.
If D = 0 and at least one of D1, D2, D3, D4…… Dn is not equal to zero, then the system
has no solution and system is inconsistent.

Illustrations:
i) Solve the following system of equations by Cramer’s Rule.
x – 4y –z = 11
2x – 5y +2z = 39
-3x + 2y + z = 1
Solution:
1 −4 −1
We have D = � 2 −5 2 � = 1(-5 -4) + 4(2 + 6) -1(4 – 15) = -9 +32 + 11 = 34
−3 2 1
Here D ≠ 0, so solution is unique and can be obtained as
�� �� ��
x= �
,y= �
,z= �
29
Business Mathematics 11 −4 −1
D1 = �39 −5 2 � = 11(-5 – 4) + 4(39 – 2) - 1(78 + 5) = -99 + 148 - 83 = -34
1 2 1
1 11 −1
D2 = � 2 39 2 � = 1(39 –2) – 11(2 + 6) – 1(2 + 117) = 37 – 88 –119 = -170
−3 1 1
1 −4 11
D3 = � 2 −5 39� = 1(-5 –78) + 4(2 + 117) +11(4 –15) = -83 + 476 –121 = 272
−3 2 1
�� ��� �� ���� �� ���
So, x = �
= ��
= -1, y = �
= ��
= -5 and z = �
= ��
=8

ii) Solve the following system of equations by Cramer’s Rule.

x – 3y –8z = -10
3x + y - 4z = 0
2x + 5y + 6z = 13
Solution:
1 −3 −8
We have D = �3 1 −4� = 1(6 + 20) + 3(18 + 8) -8(15 – 2) = 26 +78 - 104 = 0
2 5 6
−10 −3 −8
D1 =� 0 1 −4� = -10(6 +20) +3(0 + 52) – 8(0 – 13) =-260 + 156 + 104 = 0
13 5 6
1 −10 −8
D2 =�3 0 −4� = 1(0 + 52) +10(18 + 8) -8(39 –0) = 52 + 260 – 312 = 0
2 13 6
1 −3 −10
D3 =�3 1 0 � = 1(13 –0) + 3(39 – 0) - 10(15 – 2) = 13 + 117 – 130 =0
2 5 13
Here D = D1 = D2 = D3 = 0, the system is constent with infinite solutions.
II) Solve the following system of equations by Cramer’s Rule.
x – 3y + 4z = 3
2x -5y +7z = 6
3x -8y + 11z = 11
Solution:
1 −3 4
We have D = �2 −5 7 � = 1(-55 + 56) + 3(22-21) + 4(-16+15) = 1 +3 - 4 =0
3 −8 11
3 −3 4
D1 = � 6 −5 7 � =3(-55 + 56) +3(66–77) + 4(-48 + 55) = 3 – 33 + 28 = -2≠0
11 −8 11

30
Since D = 0 and D1 ≠ 0, so the system has no solution. The system is Determinants
inconsistent.

Check Your Progress 5

1) What is Cramer’s Rule?

2) While using Cramer’s rule, when would you say that the system of
linear equations is inconsistent?
3) Give an example of system of linear equations.
4) What is the meaning of inconsistent system of linear equations?

2.6 LET US SUM UP

In this unit we have discussed the solution mechanism involved in a
determinant. It is seen that determinant is a numerical value and can be
computed from the elements of a square matrix.
We have learnt to compute the value of determinant which can be calculated
by the following procedure: take a square matrix; for each element of its first
row or first column we get its submatrix. Next, multiply each of the selected
elements with the corresponding determinant of the submatrix. Finally, add
them with alternate signs.
We started value of determinant of a 1*1 matrix is the single value itself. If
the order of square matrix A is 2, then |A| = (multiplication of diagonal
elements) – (multiplication of off diagonal elements). In case of a square
matrix of order 3 × 3we need to go across the first row of the matrix.
Multiply each entry by the determinant of the 2 × 2 matrix obtained by
crossing out the row and column containing that entry. Then we add and
subtract the resulting terms, alternating signs (add the -term, subtract the
-term, add the -term.)The method seen in case of a 3 × 3can be extended to
any square matrix of any size. We have also noted that there no need to
confine ourselves to use the first row or column only while computing the
value of a determinant. Any row or column can be used after ascertaining its
position to include the plus and minus signs.
Discussing the properties of the determinant we have seen that interchanging
of two rows/columns leaves the value unchanged with only its sign reversed;
the value of determinant equals zero when two of its rows or columns are
identical; the value of the determinant remains unchanged when all the rows
and columns are interchanged. The same result is obtained by
adding/subtracting all the elements of a row / column of a determinant
� − �����the corresponding elements of another row/column;the value of
the determinant is �-time, if we multiply all elements of a row or column
with a constant �.
We are introduced to the concept of minor and cofactor of a square matrix to
compute the value of determinant. Whereas the value obtained from the
determinant of a square matrixby deleting out a row and a column
corresponding to the element of a matrix is called its minor, the cofactor is
defined as the signed minor. Towards the last part of the unit we have been
exposed to the use of determinants to solve a system of linear equations and
learnt the Cramer’s rule in that context.
31
Business Mathematics
2.7 KEY WORDS
Cofactor:The signed minor.
Cramer’s Rule:Methodof solving a system of � linear equations in �
variables using determinants.
Determinant:A numerical value computed from the elements of a square
matrix
Linear Equation System:A collection of two or more linear
equations involving the same number of variables.
Minor:Value obtained from the determinant of a square matrixby deleting
out a row and a column corresponding to the element of a matrix.

2.8 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
• Archibald, G.C., Richard G.Lipsey. “An Introduction to a
Mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems of Mathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.
• Yamane, Taro, “Mathematics for Economists: An Elementary
Survey”, New Delhi: Prentice Hall of India Private Limited, 1970.

2.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) A matrix is a simply an ordered arrangement of elements in a tabular
form while determinant is a single numerical value which is associated
to a square matrix only.
2) During solving of system of linear equations.
3) Square matrix.
Check Your Progress 2
1) The determinant of a 1×1 matrix is that number itself.
2) proceed along the first row, starting with the upper left component a.
We multiply the component a by the determinant of the “submatrix”
formed by ignoring a's row and column. In this case, this submatrix is
32
 the 1×1 matrix consisting of d, and its determinant is just d. So the first Determinants
term of the determinant is ad.
Next, proceed to the second component of the first row, which is the
upper right component b. Multiply b by the determinant of the
submatrix formed by ignoring b's row and column, which is c. So, the
next term of the determinant is bc. The total determinant is simply the
first term ad minus the second term bc.
3) Let the matrix be ��×� . Then |A| = ∑���� (-1)i+jaij|Mij|, Where Mijis
the sub matrix of A obtained by striking off ithrow and jtht column.
Check Your Progress 3
1) The value of determinant remains the same with its sign reversed.
2) He is interchanging (i). all the rows and columns of the determinant;
and (ii) adding/subtracting all the elements of a row/column of a
determinant � − ����� to the corresponding elements of another
row/column.
3) She should get the value of the determinant �-times of the original
value.
4) He would get the value of determinant equal zero.
Check Your Progress 4
1) Value obtained from the determinant of a square matrixby deleting out
a row and a column corresponding to the element of a matrix.
2) The cofactor is defined as the signed minor. Cofactor of an element aij,
denoted by Aijis defined by A�� = (–1)i+j M��, where M�� is minor of aij.
3) A cofactor is the number one gets by removing the column and row of
a designated element in a matrix. The cofactor is always preceded by a
positive (+) or negative (-) sign, according as the element is in a + or −
position.
4) Minor of the element aij is Mij.
Here a11 = 1. So M11 = Minor of a11 = 3
M12 = Minor of the element a12 = 4
M21 = Minor of the element a21 = –2
M22 = Minor of the element a22 = 1
Next go over to cofactor of aij which is written asAij. So,
A11 = (–1)1+1 M11 = (–1)2 (3) = 3
A12 = (–1)1+2 M12 = (–1)3 (4) = –4
A21 = (–1)2+1 M21 = (–1)3 (–2) = 2
A22 = (–1)2+2 M22 = (–1)4 (1) = 1.

Check Your Progress 5

1) Methodof solving a system of � linear equations in � variables using
determinants.
2) When determinant D = 0 and at least one of D1, D2, D3, D4…… Dn is
not equal to zero.

33
Business Mathematics 3) Take 2� + � = 5 and −� + � = 2. When working together, we have a
system.
4) A system of linear equations is called inconsistent if it has no solutions.

2.10 EXERCISES WITH ANSWER/HINTS

Solve the following system of equations using Cramer’s rule.
i) 5x – 7y + z = 11; 6x – 8y - z = 15; 3x +2y - 6z = 7;
ii) x +2y -2z = -7; 2x - y + z = 6; x - y - 3z = -3;
iii) 6x + y -3z = 5; x +3y – 2z = 5; 2x + y +4z = 8
iv) 2x – 3y - 4z = 29; -2x + 5y – z = -15; 3x – y + 5z = -11
v) 2x - y + z = 4; x +3y + 2z = 12; 3x + 2y + 3z = 10;
Answers (i) x = 1; y = -1; z = -1; (ii) x = 1; y = -2; z = 2; (iii) x = 1; y = 2; z
= 1; (iv) x = 2; y = -3; z = -4; (v) No solution

34
 Inverse of Matrices
UNIT 3 INVERSE OF MATRICES
Structure
3.0 Objectives
3.1 Introduction
3.2 Inverse Matrix
3.2.1 Definition of Inverse Matrix
3.2.2 Properties of Inverse Matrix
3.2.3 Inverting a 2 × 2 Matrix
3.2.4 Computing Inverse of Bigger Matrices
3.3 Matrix Inverse Method: Determinant and Adjoint Route
3.3.1 Adjoint of a Matrix
3.3.2 Computation of Inverse using Adjoint of a Matrix
3.4 Matrix Inverse Method: Elementary Operations Route
3.4.1 Elementary Matrix Operations
3.4.2 Computation of Inverse using Elementary Row Operations
3.5 Inverse and Rank of a Matrix
3.5.1 Rank of a Matrix
3.5.2 Linear Independence
3.5.3 Invertibility and Rank of a Matrix
3.6 Solving System of Linear Equations by Matrix Inverse
3.6.1 Systems of Equations
3.7 Let Us Sum Up
3.8 Key Words
3.9 Some Useful Books
3.10 Answer or Hints to Check Your Progress
3.11 Exercises with Answer/Hints

3.0 OBJECTIVES
After going through this unit, you will be able to understand:
1) Concept of the inverse of a matrix
2) Finding Inverse of a matrix using adjoint
3) Elementary operations
4) Finding Inverse of a matrix using elementary operations
5) Rank of a matrix

3.1 INTRODUCTION
In the first unit of this block under the title, ‘Introduction to Matrices’, we
have seen matrix operations of addition, subtraction and multiplication.
However, as it may be recalled, there was no discussion on division of a 35
Business Mathematics matrix. It is because of the underlying reason that a matrix cannot be divided.
While we cannot do that, there is a related concept to work with for that
purpose. It is called "inversion" of a matrix.
To get an intuitive idea of inverse, it is useful to recall that a simple equation
like 4� = 8 is solved if divided both the sides by 4. The result of such a
move is the solution of x=2. Just note that instead of dividing by 4, we could
have resorted to multiplication of ¼ in both the sides of the equation to solve
the problem and the answer could have been 2. What is done is to take the
help of reciprocal of 4/1 in the multiplication. Thus, reciprocal ¼ is the
inversion of 4/1.We get 1 on multiplying 4/1 with its reciprocal 1/4. Matrix
inversion can be thought of similar to such an operation with reciprocal
numbers.

3.2 INVERSE MATRIX

Let � be a matrix. Then inverse of � is written as��� . Since we cannot divide
a matrix, we do not write in reciprocal form of 1/�. Our search for similarity
of inverse matrix with scalar number system will show that just as
multiplication of 4 and its reciprocal, ¼, yields 1, our multiplication of a
matrix by its inverse will give the Identity Matrix. That is, � × ��� =
�which would be a square matrix with 1 in the diagonal.

3.2.1 Definition of Inverse Matrix

The inverse of a square � × �matrix �, is another � × �matrix denoted by
��� such that
���� = ��� � = �
where Iis� × �identity matrix. That is, multiplying a matrix by its inverse
producesan identity matrix. Note, however, that not all square matrices have
an inverse matrix. If the determinant of thematrix is zero, then it will not have
an inverse. Since matrix whose determinant is zero is known as singular, we
stipulate the condition that only a non-singular matrix will have an inverse.
Such a matrix is also called invertible matrix.

3.2.2 Properties of Inverse Matrix

1) A square matrix is invertible if and only if it is non-singular.
2) The inverse of the inverse of a matrix is matrix itself i.e., (A-1)-1 = A
3) The inverse of the transpose of a matrix is same as the transpose of its
inverse i.e., (A’)-1 = (A-1)’
4) If A and B are two invertible matrices of the same order then AB is also
invertible which holds true (��)�� = � �� . ��� .

3.2.3 Inverting a � × � Matrix

With a view to familiarize ourselves with the idea of computation of inverse,
we discuss below, as an example, a 2 × 2 matrix.
� �
Let � = � �
� �
where a, b, c and d are numbers. Its inverse is written as
36
 � � �� � � −� Inverse of Matrices
��� = � � = � � where(�� − ��)is the determinant
� � ����� −� �
value. It needs to be not equal to zero for moving forward with process of
inversion. Thus,wecould do the computation only when we have a square
matrix and a non-zero determinant.
4 5
Example 1: Invert the matrix � = � �
2 3
Solution:
4 5 �� � 3 −5 � 3 −5 1.5 −2.5
��� =� � =����� � �= � �=� �.
2 3 −2 4 � −2 4 −1 2
Similar to solving single equation like 4x=8, we can solve for unknown value
of a matrix X, using the inversion technique. For example, if we are given
that �� = �where matrices � and� are known, we can use inversion to find
the matrix �.To do that write
����� = ���� . Since ���� = �, we get
�� = ���� or, � = ���� (due to multiplication � with identity matrix).
Remember that all the conditions of inversion like � is a square matrix and
invertible and order of � is amenable to multiplication rule are satisfied to get
the required solution.

3.2.4 Computing Inverse of Bigger Matrices

We have seen above the inverse of a 2x2matrix. Compared to larger matrices
such as a 3x3, 4x4, …, it is easy to compute the inverse. Forlarger matrices,
however, we will have to use two main methods while working out the
inverse. Such methods are
i) inverse of a matrix using Minors, Cofactors and Adjugate (or, Adjoint)
and
ii) inverse of a matrix using Elementary Row Operations.
We have not included the use a computer, such as the Matrix Calculator, in
the present unit which can be used for inverting a matrix.
Note: Inversion of a diagonal matrix is obtained by replacing each element in
the diagonal with its reciprocal. For example, take a diagonal matrix
�
3 0 0
�=� �. Then � �� = � � � �. Verify that �� �� = � where � is identity
0 4 0 �
matrix.

Check Your Progress 1

1) How would you explain the idea of inversion of a matrix?
2) What is the result of multiplying a square matrix with its inverse?
3) You can apply the operation of inverse to which type of matrix?
4) Write the definition of inverse of a matrix.
5) What is a singular matrix?
6) How would you identify an invertible matrix? 37
Business Mathematics 7) How do you verify that you have correctly calculated an inverse
matrix?
8) Can you perform division operation on matrix?

3.3 MATRIX INVERSE METHOD:

DETERMINANT AND ADJOINT ROUTE
In the following, we discuss one of the two methods mentioned above
on inverting a matrix. As a background for that the concept of adjoint of a
matrix which is transpose of a cofactor in a square matrix is covered first.
The inverse which is obtained by dividing the adjoint with determinant is
given as a second step under a separate subsection.

3.3.1 Adjoint of a Matrix

To invert a matrix using first of the two methods mentioned above, it is
needed to understandthe concept adjoint of a matrix.
If� = [aij]isa square matrix of order n, then adjoint of � is defined to be
transpose of matrix [Aij] of order n, where Aij is cofactor of aijin |A|. In other
words, let
��� ��� ��� . ���
���� ��� ��� . ��� �
� ��� ��
� = ���� ��� ��� .
� . . . . . �
���� ��� ��� . ��� �

��� ��� ��� . ���

�� ��� ��� . ��� �
� �� �
���(�) = transpose of ���� ��� ��� . ��� �
� . . . . . �
���� ��� ��� . ��� �

��� ��� ��� . ���

�� ��� ��� . ��� �
� �� �
= � ��� ��� ��� . ��� �
� . . . . . �
���� ��� ��� . ��� �

Here A11 is the cofactor of a11 in |A|

A12 is the cofactor of a12 in |A| and so on.
Remarks
1) If � be a square matrix of order �, then �. ���(�) = ���(�). � =
|�|. �� , where �� is an identity matrix of order �.
2) ���(��) = ���(�). ���(�)
3) ���(�’) = (���(�))’
38
Example 2:Find the adjoint of the matrix Inverse of Matrices

1 6 5
�=� 3 2 1 �
−2 0 −3
and verify the theorem �. ���(�) = ���(�). � = |�|. ��
Solution:
��� ��� ���
���(�) = transpose of ���� ��� ��� �
��� ��� ���
1 6 5
Given that � = � 3 2 1 �, let us find out the cofactors of all the elements
−2 0 −3
of the matrix.
2 1
A11 = (-1)1+1� � = (-1)1+1(2x-3 – 0x1) = -6 – 0 = -6.
0 −3
3 1
A12 = (-1)1+2� � = (-1)1+2(3x-3 – 1x-2) = -(-9 + 2) = 7.
−2 −3
3 2
A13 = (-1)1+3� � = (-1)1+3(3x0 – 2x-2) = (0 + 4) = 4.
−2 0
6 5
A21 = (-1)2+1� � = (-1)2+1(6x-3 – 5x0) = -(-18 – 0) = 18.
0 −3
1 5
A22 = (-1)2+2� � = (-1)2+2(1x-3 – 5x-2) = -3 +10 = 7.
−2 −3
1 6
A23 = (-1)2+3� � = (-1)2+3(1x0 – 6x-2) = -(0 + 12) = -12.
−2 0
6 5
A31 = (-1)3+1� � = (-1)3+1(6x1 – 2x5) = 6 – 10 = -4.
2 1
1 5
A32 = (-1)3+2� � = (-1)3+2(1x1 – 5x3) = -(1 – 15) = 14.
3 1
1 6
A33 = (-1)3+3� � = (-1)3+3(1x2 – 6x3) = 2 – 18 = -16.
3 2
−6 7 4
So ���(�) = transpose of � 18 7 −12�
−4 14 −16
−6 18 −4
���(�) = � 7 7 14 �
4 −12 −16
Also |�| = 1(-6 – 0) – 6(-9 + 2)+5(0 + 4)
= -6 + 42 + 20 = 56
Now,
1 6 5 −6 18 −4
�. ���(�) = � 3 2 1 �� 7 7 14 �
−2 0 −3 4 −12 −16

39
Business Mathematics −6 + 42 + 20 18 + 42 − 60 −4 + 84 − 80
= �−18 + 14 + 4 54 + 14 − 12 −12 + 28 − 16�
12 + 0 − 12 −36 + 0 + 36 8 + 0 + 48
56 0 0
=�0 56 0 �……………………………………………. (I)
0 0 56
Similarly,
−6 18 −4 1 6 5
���(�). � = � 7 7 14 � � 3 2 1 �
4 −12 −16 −2 0 −3
−6 + 54 + 8 −36 + 36 − 0 −30 + 18 + 12
= � 7 + 21 − 28 42 + 14 + 0 −12 + 28 − 16�
12 + 0 − 12 −36 + 0 + 36 8 + 0 + 48
56 0 0
=� 0 56 0 � ……………………………………………….. (II)
0 0 56
56 0 0 1 0 0
�0 56 0 � = 56 �0 1 0� = |�|. �� ………………….. (III)
0 0 56 0 0 1
From (I), (II) and (III),
���(�). � = �. ���(�) = |�|. ��

3.3.2 Computation of Inverse using Adjoint of a Matrix

Let � be a square matrix of order n. The square matrix � of order � is called
the inverse matrix of � if
� × � = � × � = ��
The inverse of � is denoted by ��� , i.e.,� = ��� so that
� × ��� = ��� × � = ��
In the preceding subsection we have seen that �. ���(�) = |�|. �� ,
���(�) ���(�)
which gives �. |�|.
= �� .Thus � is invertibleand ��� = |�|.
where
|�| ≠ 0
So,only non-singular matrices are invertible.
1 −2 3
Example3: Find the inverse of matrix � = �3 −1 4 � and hence show
2 1 −2
that � × ��� =��� × � = ��
Solution:
1 −2 3
� = �3 −1 4 �
2 1 −2
|A|= 1(2 – 4) +2(-6 -8) +3(3 +2) = -2 – 28 +15 = -15

40
The cofactors of elements of matrix � are Inverse of Matrices

A11 = (2 – 4) =-2
A12 = -(-6 – 8) =14
A13 = (3+2) =5
A21 = -(4 – 3) = -1
A22= (-2 – 6) =-8
A23 = -(1 + 4) =-5
A31 = (-8 + 3) =-5
A32 = -(4 – 9) = 5
A33 = (-1 + 6) = 5
��� ��� ���
���(�) = transpose of � ��
� ��� ��� �
��� ��� ���
−2 14 5
= transpose of �−1 −8 −5�
−5 5 5
−2 −1 −5
=� 14 −8 5 �
5 −5 5
���(�)
Since ��� = |�|.
,

−2 −1 −5
�
��� = − �� � 14 −8 5 �
5 −5 5
1 −2 3 −2 −1 −5
�
So, � × ��� = �3 −1 4 �.( − ��) � 14 −8 5 �
2 1 −2 5 −5 5
−2 − 28 + 15 −1 + 16 − 15 −5 − 10 + 15
�
=− �� �−6 − 14 + 20 −3 + 8 − 20 −15 − 5 + 20�
−4 + 14 − 10 −2 − 8 + 10 −10 + 5 − 10
−15 0 0 1 0 0
�
=− �� � 0 −15 0 � = �0 1 0� = I3
0 0 −15 0 0 1
Similarly, it also can be proved that ��� × � = ��
2 3 10 4
Example 4: Find the matrix � such that � �� = � �
−1 4 −5 9
Solution:
2 3 10 4
Let � = � � and B = � �.
−1 4 −5 9
So, the above relation can be rewritten as �� = �
Consequently, � = ��� �
41
Business Mathematics Here |�|= (2x4 – (-1x3) = 8+3 = 11.
��� ���
���(�) = transpose of � �
��� ���
4 1
= transpose of � �
−3 2
4 −3
=� �
1 2
���(�) � 4 −3
��� = , so, A-1=�� � �
|�|. 1 2
� = ��� �
Hence,
� 4 −3 10 4
= �� � �� �
1 2 −5 9
� 40 + 15 16 − 27
= �� � �
10 − 10 4 + 18
� 55 −11
= �� � �
0 22
5 −1
=� �.
0 2
Example 5: If �is a square matrix of order 3 and ���� = 5 then what is
��� [(2�)�� ]?
Solution: If � is of order 3 then, ��� is also of order 3. Again, ��� (��) =
� � (det A) where � is the order of the matrix. A determinant being a scalar
�
number, ��� � = ��� ���. Thus, ��� [(2�)�� ] = 2� ���[�] and ���[��� ] =
� �
�.�
= �� .

Check Your Progress 2

1) If �is a square matrix of order �, then what is �.adj(�)?
2) You have two adjoint matrices ��� (�) and ��� (�). State how would
you find out ���(��).
3) How can you show that ���(�’) = (���(�))’?

3.4 MATRIX INVERSE METHOD:

ELEMENTARY OPERATIONS ROUTE
Elementary operations play a crucial role in finding the inverse. Take a
matrix� such that its inverse (��� ) exists. To find the inverse of a matrix using
elementary row or column operations, write � = ��and apply a sequence of
row or column operations on � = �� till we get, � = ��. The matrix � will
be the inverse matrix of �.
3.4.1 Elementary Matrix Operations
An elementary matrix is a square matrix that has been obtained by
performing an elementary row or column operation on an identity matrix. In
42
other words, when elementary operations are carried out on identity matrices, Inverse of Matrices
they give rise to elementary matrices.
Example 6: If we take the identity matrix and multiply its first row by 3, we
obtain the elementary matrix.
3 0 0
� = �0 1 0�
0 0 1
Thus, the following two matrices are also considered elementary matrices:
1 0 0
0 1
(�)�� = � � and (���)�� = �2 1 0�.
1 0
0 0 1
To see the method of obtaining these matrices you need to
1 0
i) interchange two rows of matrix � � and get �� and
0 1
1 0 0
ii) take the second row of the identity matrix �0 1 0�and add 2 times
0 0 1
of first row to it for getting �� .
There are three kinds of elementary matrix operations.
1) Interchange two rows (or columns).
2) Multiply each element in a row (or column) by a non-zero number.
3) Multiply a row (or column) by a non-zero number and add the result to
another row (or column).
When these operations are performed on rows, they are called elementary
row operations; and when they are performed on columns, they are
called elementary column operations.
The transformations on a given matrix into basic operations are written as,
1) Interchange of any two rows (columns)
Ri↔Rj / Ci↔Cj
2) Multiplication of any row (column) by a non-zero scalar
Ri→kRi / Ci→kCi
3) Addition to one row (column), of another row (column) multiplied by
any non-zero scalar
Ri→ Ri + kRj / Ci→ Ci + kCj
If square matrix � is obtained from matrix � by applying one or more
elementary operations, then matrices � and � are called equivalent matrices
and denoted as � ~ �.

3.4.2 Computation of Inverse using Elementary Row

Operations
Let � be a non-singular square matrix. So, we have
� = �� 43
Business Mathematics If elementary row operations are applied on �from left hand side and
on �from right hand side and we obtained a new form like
� = � × �,
then matrix � is the inverse of matrix �.
1 2 −2
Example 7: Find the inverse of the matrix �−1 3 0 � using elementary
0 −2 1
operations.
Solution:
1 2 −2
� = �−1 3 0�
0 −2 1
1 2 −2 1 0 0
So, �−1 3 0 � = �0 1 0� �
0 −2 1 0 0 1
Apply R2→ R2 + R1
1 2 −2 1 0 0
�0 5 −2� = �1 1 0� �
0 −2 1 0 0 1
�
Apply R2→�R2

1 2−2 1 0 0
� � �
�0 1− �� = � � � 0� �
0 −2 1 0 0 1
Apply R1→� 1 - 2R2
� � �
�1 0 − �� �
−� 0
�0 1 − �� = � �
0�
�
� �� � �
�0 – 2 1 � 0 0 1
Apply R3→� 3 + R1
� � �
�1 0 − �� �� − � 0�
� �� �� � �
�0 1 − �� = �� � 0� �
� � � �� � �
�0 0 � � �� � 1�
Apply R3→5R3
� � �
1 0 −� �
−� 0
�0 �� = � �
0� �
�
1 − � � �
0 0 1 2 2 5
�
Apply R1→� 1+� R3 and
�
R2→� 2 + � R3

44
 1 0 0 3 2 6 Inverse of Matrices
�0 1 0� = �1 1 2� �
0 0 1 2 2 5

3 2 6
So, A-1 = �1 1 2�
2 2 5
Check Your Progress 3
1) What is an elementary matrix?
2) When would you get elementary matrices?
3) List the three kinds of elementary matrix operations
4) James obtained a square matrix from another matrix by applying
elementary operations. Then he said of deriving a rectangular matrix
due to operations. Would you say James is correct? Give reasons to
support your answer.
5) State the meaning of elementary operators.

3.5 INVERSE AND RANK OF A MATRIX

There are two ways to determine whether the inverse of a square matrix
exists, viz.,
i) Compute its determinant and find that it is not equal to zero, and
ii) Determine its rank and see if it is invertible.
We have already seen the first of the two ways above. Let us look into the
other way, i.e., rank of a matrix now. Note that the rank of a matrix is a
unique number associated with a square matrix. If the rank of an n x n matrix
is less than n, the matrix does not have an inverse.

3.5.1 Rank of a Matrix

The maximum number of linearly independent rows in a matrix is called
the row rank. Similarly, the maximum number of linearly independent
columns in a matrix is called the column rank.
If � is an � × � matrix, that is, if � has m rows and n columns, then its
Row rank of � ≤ � and column rank of � ≤ � ----------------(1)
It is not so obvious, however, that for any matrix �,
the row rank of � = the column rank of � ---------------------(2)
Because of this, there is no point in distinguishing between row rank and
column rank.
Therefore, if � is order m x n, it follows from the inequalities in (1) that

����(��×� ) ≤ min (�, �) where ���( �, �) denotes the smaller of the two
numbers m and n (or their common value if m = n). For example, the rank of
a 3 x 5 matrix can be no more than 3, and the rank of a 4 x 2 matrix can be no
more than 2. Note that the rank of matrix A is denoted by ρ(A).
45
Business Mathematics Remarks
• A zero matrix or Null matrix is said to have rank zero.
• The elementary transformations do not alter the rank of a matrix.
As linear independence is associated with the identification of the rank of a
matrix, it seems pertinent to understand the concept clearly.

3.5.2 Linear Independence

One vector(i.e., variable representing both a magnitude and a direction) is
dependent on other vectors if it is a linear combination of the other vectors.
That is, if we take scalar multiples of some vectors and add these up to get a
new vector, then it is said to be a linear combination of the other vectors.
Example 8: Let � = 2� + 3� be given with
37 9
� = � �,� = � �and� = � �.
5
26 7 4
Operate on y and z to get
5 9 2∗5+3∗9 .
2� � + 3� � = � �
7 4 2∗7+3∗4
It may be noted that 2� and3� are scalar multiples. Therefore, � is a linear
combination of �and �.
Thus, a set of vectors is linearly independent if no vector in the set under
consideration is
i) a scalar multiple of another vector in the set,
or,
ii) a linear combination of other vectors in the set;
Conversely, a set of vectors is linearly dependent if any vector in the
set is
i) a scalar multiple of another vector in the set, or,
ii) a linear combination of other vectors in the set.
Consider the row vectors
� = [1 2 3], � = [5 6 7], � = [6 8 10],
� = [2 4 6], � = [0 0 1], � = [0 1 0]
We can make the following observations:

i) � and � are linearly Neither is a scalar multiple

independent of the other
ii) � and � are linearly dependent 2a=x
iii. �, � and � arelinearly � is a linear combination of
dependent � and � as � + � = �
iv. � ,�and � are independent Neither is a scalar multiple
nor a linear combination of
other

46
3.5.3 Invertibility and Rank of a Matrix Inverse of Matrices

Once we determine the linearly independent rows or columns, the rank of a

matrix is known. Since one of our concerns in this present unit is to draw
inference on invertibility of a matrix on the basis of its rank, we deal with
linearly independent rows or columns of a square matrix and ascertain its
rank. Such a result will indicate the invertibility of the matrix under
consideration.
For example, take the matrix
1 2 .
�=� �
2 −1
It may be seen that neither the columns nor the rows of this 2x2 matrix could
be amenable to conditions linear dependency. So, the rank of the matrix is
equal to 2 and is full ranked. On the basis of this result, we can say that it is
an invertible matrix.
To check that the matrix indeed has an inverse apply the elementary row
operation.
To use elementary row operations, we may write A = IA, i.e.,
1 2 1 0
� �=� ��
2 −1 1 1
Apply �� → �� − 2�� such that
1 2 1 0
� �=� � �.
0 −5 −2 1
Again, apply �� → − � �� to get
�

1 0
1 2
� � = �2 1� �
0 1 −
5 5
Further, taking
�� → �� − 2�� we get
1 0 1/5 2/5
� �=� ��
0 1 2/5 −1/5
giving ��� = 1/5 2/5 .
� �
2/5 −1/5
Also we can assess that less than full rank square matrix is not invertible.
Example 9: Let � is the 4 x 4 matrix of

1 −2 0 4 A is the 4x4 matrix

�= � 3 1 1 0 �
−1 −5 −1 8
3 8 2 −12

Its four row vectors are,

�� = ( 1, − 2, 0, 4)
�� = ( 3 1, 1 ,0)
47
Business Mathematics �� = (−1, −5, −1,8) and
�� = (3, 8,2, −12).
It may be seen that
�� = 2�� − ��
and
�� = 3�� + 2��
Thus, vectors �� and �� can be written as linear combinations of �� and �� .
That means the maximum number of independent rows is 2 and the rank of
this matrix is 2. Hence the matrix is not invertible.
Example10: Determine the rank of the following 4 by 4 matrix and see if it
has an inverse:
1 −1 1 −1
�=� −1 1 −1 1 �
1 −1 1 −1
−1 1 −1 1

Since �� = �� = −�� and �� = ��, all rows but the first will vanish. As only 1
nonzero row remains, rank C = 1. So, the matrix is not invertible.

Check Your Progress 4

1) How would you determine the rank of a matrix on the basis of its
minors?
2) Stuart has a 3x3 matrix whose rank is 2. Can he invert the matrix?
3) What is a vector?
4) State the meaning of linear combination of vectors.
5) When would you say that a set of vectors is linearly dependent?

3.6 SOLVING SYSTEM OF LINEAR EQUATIONS

BY INVERSE MATRIX
This section will explain the method used to solve a system of linear
equations by using inverse matrices. To help understand this method, we will
largely rely on examples.

3.6.1 Systems of Equations

Suppose your family is going to National Zoological Park, New Delhi. The
family members consisted of one adult and two children for which the total
cost of entry fee is Rs.50. Your friend's family joins you in this trip. They
have three adults and five children and their total cost of entry fee is Rs.140.
Your task is to find out the cost of ticket per each child and adult.
To solve the problem,you need to have two equations to be able to find two
unknowns. So, you have a system of equations. For that purpose, you have
to set up the system of equations, using x as the cost of one adult ticket,
and y as the cost of one child ticket.
System of equations:
� + 2� = 50
48
 3� + 5� = 140 Inverse of Matrices

Although there are many ways to solve systems of linear equations like the
ones at our disposal, we solve systems of equations by using inverse
matrices.
Note that the present method of solution can be obtained by going through
two steps, viz.,
i) find the coefficient matrix and its inverse matrix and
ii) use the inverse matrix to solve the equations.
The coefficient matrix is consisted of coefficients, or, numbers in front of
each variable in the system of equations.
Seen in terms of the above example, in the first equation the coefficients are 1
of � and 2 of �. In the second equation, we have 3 of � and 5 of �. Their
arrangement in matrix form will generate a 2x2 matrix. Let us call it
matrix A. Thus, we have the coefficient matrix of
1 2
�=� �
3 5
In the coefficient matrix, the elements of first row are the coefficients of the
first equation whereas the second row is composed of the coefficients from
the second equation. Again, the first column of the matrix is formed from the
coefficients of the �'s and the second column are the coefficients of the �'s.
Since we have two variables, we will have a 2x1 matrix called variable
matrix. So, the variable matrix is
�
� = �� �
A third matrix, called the constant matrix, contains the constants of the
system of equations. Let us call this matrix �,whichis a 2x1 matrix because it
has two rows and one column.
Write it as
50
�=� �
140
With these arrangements, we have a system of equations inmatrix form which
can be used to solve the system and find the answer.
Now that we know the required matrices, putting them together, a matrix
equation is obtained. Such an equation contains a coefficient matrix, a
variable matrix and a constant matrix, making use of which the system be
solved. Essentially, we know that if we multiply matrix � times matrix �, it
will equal matrix �.

So, we write the matrix equation as �(�) = �

1 2 � 50
i.e., � �� � = � �
3 5 � 140
� 1 2 �� 50
or, ��� = � � � �
3 5 140
� −5 2 50
or, ��� = � �� � (applying adjoint method of inversion)
3 −1 140 49
Business Mathematics � 30
or, ��� = � �.
10
Hence the solution is the cost of ticket per child is Rs. 10 while it is Rs. 30
per adult.
Keeping the above discussion in mind, we generalise the method to solve the
system of linear equations for � variables in the following.
Let the system of � linear equations with � variable x1, x2, x3, x4,……xn be
a11x1 + a12x2 + a13x3 + …………..+ a1nxn = b1
a21x1 + a22x2 + a23x3 + …………..+ a2nxn = b2
.
.
.
an1x1 + an2x2 + an3x3 + …………..+ annxn= bn
The above system can be written in Matrix form
�� = �
��� ��� ��� . ��� �� ��
���� ��� ��� . ��� � � �� � � �
��
�
where � = ���� ��� ��� . ��� � , � = ��� � and � = ��� ��
� � � �
� . . . . . � � . � � . �
���� ��� ��� . ��� � ��� � ��� �
From �� = �
� = ��� �
So, the multiplication of matrix ��� and � gives the solution of the system.
��� can be obtained by any method (either adjoint or elementary row
operations method).
Example 11:
Solve the following equations
x + 2y - 2z = -7
2x - y + z = 6
x - y - 3z = -3
1 2 −2 � −7
Solution: Here � = �2 −1 1 � , � = ��� and � = � 6 �
1 −1 −3 � −3
Now, we find out ��� by taking into account
1 2 −2 1 0 0
�2 −1 1 � = �0 1 0� �
1 −1 −3 0 0 1
From R2→ R2 - 2 R1 and
R3→ R3 - R1,

50
 1 2 −2 1 0 0 Inverse of Matrices
�0 −5 5 � = �−2 1 0� �
0 −3 −1 −1 0 1
��
From R2→ � R2

1 2 −2 1 0 0
� �
�0 1 −1� = � � − � 0� �
0 −3 −1 −1 0 1
From R1→ R1 - 2 R2 and
R3→ R3 + 3 R2
� �
1 0 0 �� � 0�
�� � �
�0 1 −1� = �� − � 0� �
0 0 −4 �� � �
�� − � 1�
��
From R3→ � R3 ,
� �
� � 0�
1 0 0 �
� � � �
�0 1 −1� = � � −� 0 ��
0 0 1 � � � ��
�− �� �� − ��
From R2→ R2 + R3
� �
0�
1 0 0 � �� �
� � ��
�0 1 0� = � �� − �� − �� �
0 0 1 � � � ��
�− �� �� − ��
� �
� � �
0�
� � � ��
So,��� = � �� − �� − ��
� � � ��
�− �� �� − ��
Taking � = ��� �, we get
� �
0�
� � � � −7
� � � ��
��� = � �� − �� − �� � 6 �
� � � � �� −3
�− �� �� − ��
�� ��
� � + � +0�
� �� � ��
=�− �� − �� + ��
� � �� � �
� �� + �� + � �
�
� � �
� ���
=�− ���
� �� �
� �� � 51
Business Mathematics � 1
�
� �=�−2�
� 2
So, x=1; y=-2; and z=2.

Check Your Progress 5

1) What do you mean by system of equations?
2) What is a coefficient matrix?
3) State the meaning of constant matrix.
4) How do you solve system of equations?

3.7 LET US SUM UP

In this unit we have discussed inverse of a matrix. It is said that the intuitive
idea behind the concept is related to that ofdivision operation in scalar
number system, where division of a number � yields the same result as
multiplication of 1/�. A matrix, which does not have the operation of
division, can be thought of such a multiplication of reciprocals in number
�
system and written for a matrix � as��� instead of �.

We have seen that inverse of a matrix A, written as ��� , is derived from

another matrix � such that ���� = �, where � is the identity matrix. The
inversion however, is confined to square matrices. As some square matrices
do not have non-zero determinants, only a non-singular matrix will have an
inverse and such a matrix is called invertible matrix.
Two methods of matrix inverse have been presented. They are inverse of
matrix using (i). Minors, Cofactors and Adjoint and (ii)Elementary Row
Operations. While the first of these two requires computation of an adjoint
matrix which is transpose of a cofactor matrix, the second takes the help of
transformation to a square matrix that has been obtained by performing an
elementary row or column operation on an identity matrix.
We have been exposed to find rank of a matrix. Using the rank, we attempt to
determine inverse of a square matrix. In the process,it is explained that the
rank of matrix which refers to a number according the maximum number of
linearly independent rows/columns in a matrix. The rank of a square matrix,
if less than full, indicates that the matrix is not invertible.
In the last part of the unit, we learnt to find the solution of a system of
equations using an inverse matrix. In the process, we discussed the
conversion of a system of linear equations into matrix format and worked out
the values of unknown variables.

3.8 KEY WORDS

Adjoint (Adjugate) Matrix:A square matrix that is the transpose of the
cofactor matrix of the given matrix.
Coefficient Matrix:Coefficients of the variables in a set of linear equations.
Constant Matrix:Constants of the system of equations.
52
Elementary Matrix: A square matrix that has been obtained by performing Inverse of Matrices
an elementary row or column operation on an identity matrix.
Elementary Operators: Each type of elementary operation performed by
matrix multiplication, using square matrices.
Inverse Matrix: a square matrix ��� derived from another square matrix
� such that ���� = �, where I is the identity matrix.
Linear Combination: Scalar multiples of some vectors added to get a new
vector.
Linearly Dependent: A set of vectors such that at least one of them can be
written as a linear combination of the others.
Linearly Independent: A set vectors in which no vector cannot be written as
a linear combination of the others.
Non-Singular Matrix: A square matrix with its determinant non-zero.
Rank of a Matrix:Maximum number of linearly independent rows/columns
in a matrix.
Singular Matrix: A square matrix whose determinant is zero.
Systems of Equations: Collection of equations that are dealt with together.

3.9 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
• Archibald, G.C., Richard G.Lipsey. “An Introduction to a
Mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems of Mathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.
• Yamane, Taro, “Mathematics for Economists: An Elementary Survey”,
New Delhi: Prentice Hall of India Private Limited, 1970.

3.10 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) There is no division operation of a matrix as it is done in case of
scalars. To meet the requirement of division it can be thought of
multiplication of reciprocals in number system which produces the
�
same result. So, if there is a matrix �, one can write ��� instead of �.
53
Business Mathematics 2) An identity matrix.
3) Square matrix.
4) The inverseof a square matrix ��� , is another matrix denoted by
��� such that���� = ��� � = �,where Iisa� × �identity matrix.
5) Matrix whose determinant is zero
6) A square matrix that has a non-zero determinant (or, a non-singular
matrix).
7) Multiply it by the original matrix to get the identity matrix.
8) No. There is no matrix operation equivalent of division. The closest we
can get to division by a matrix is multiplying by its inverse.
Check Your Progress 2
1) |�|. �� , where � n is an identity matrix of order �.
2) By multiplying ���(�) with ���(�).
3) Take a matrix � and find adjoint of � and �’. Use your results to
establish the stated equality.
Check Your Progress 3
1) A matrix which differs from the identity matrix by one single
elementary row operation.
2) When elementary operations are carried out on identity matrices.
3) i.Interchange two rows (or columns); ii. multiply each element in a row
(or column) by a non-zero number; and iii. multiply a row (or column)
by a non-zero number and add the result to another row (or column).
4) James is wrong. He would get equivalent matrices.
5) Each type of elementary operation may be performed by matrix
multiplication, using square matrices called elementary operators.
Check Your Progress 4
1) Rank of a non-zero matrix is defined as r if at least one of its r-rowed
minors is not equal to zero while every (r+1)-rowed minor, if any, is
zero.
2) No. A square matrix not full rank is singular.
3) Variable representing both a magnitude and a direction
4) Take scalar multiples of some vectors and add these up to get a new
vector.
5) If any vector in the set is
i) a scalar multiple of another vector in the set, or,
ii) a linear combination of other vectors in the set.
Check Your Progress 5
1) A collection of two or more equations with a same number of unknown
as the number of equations.

54 2) The matrix formed by the coefficients in a linear system of equations.

3) A matrix that contains the constants of the system of equations. Inverse of Matrices

4) Find values for each of the unknowns that will satisfy every equation in
the system.

3.11 EXERCISES WITH ANSWER/HINTS

1 1 1
1) if A = �1 2 −3� , find adj(A).
2 −1 3
1 4 5
2) if A = �3 2 6 � , verify A.adj(A) = adj(A).A = |A|.I
0 1 −3
4 1 22 6 1 0
3) A=� �, Find matrix B, if AB equals (I)� � (II)� � (III)
7 2 11 3 0 1
−2 0
� �
0 −2
−1 2 3
4) B=� � and C = � �
1 −1 1
Find X, if BX = C
1 −2 3
5) If A = �3 −1 4 � , find A-1
2 1 −2
6) Solve the following equations using inverse of a matrix
5x – 6y + 4z = 15
7x + 4y – 3z = 19
2x + y + 6z = 46
7) Solve the following equations
2x + 6y + 11 = 0
6x + 20y -6z – 3 = 0
6y – 18z +1 = 0
8) What do you understand by the term rank of a matrix? Find out the
rank of the following matrix:
7 −1 0
A=�1 1 4�
13 −3 −4
9) Find the value of x such that the rank of the following matrix is less
than 3.
3 5 0
�3 x 2�
9 −1 8
10) Taking the following matrix, what would you comment on its
invertibility? Give reasons in support of your answer.

55
Business Mathematics 1 2 3
A = �3 4 5�
4 6 8
11) Given the following matrix, examine its rank and find its inverse
using the method of adjoint. Comment on its invertibility.
2 2 −1
�4 0 2�
0 6 −3
Answers
3 −4 −5
1) �−9 1 4�
−5 3 1
32 9 2 −1 −4 2
3) (I) � � (II)� � (III)� �
−110 −30 −7 4 14 −8
�

4) ����
�
� � �
� �� �� � �
� �� � ��
5) If A = �− �� ��
− ��
� � � ��
�−� �
− ��

6) x = 3; y = 4; z = 6
7) Equations have no solution.
8) 2
9) x=1
10) Since A is a square matrix of order 3 so ρ(A)≤ 3
Now,
|A|= 1(32 – 30) - 2(24 – 20) + 3(18-16) = 2 – 8 + 6 =0
|A| is the only minor of order 3 which is zero however a minor of
order 2 is not equal to zero, viz.
1 2
� � = 4 – 6 = -2 ≠ 0.
3 4
So, a square matrix with less than full rank is not invertible.
11) The matrix is linearly independent with a rank 3. Determinant is -24
and inverse of the matrix is
0.5 0 −0.17
�−0.5 0.25 0.33 � .
−1 0.5 0.33

56
 Application of
UNIT 4 APPLICATION OF MATRICES IN Matrices in Business
and Economics
BUSINESS AND ECONOMICS
Structure
4.0 Objectives
4.1 Introduction
4.2 Matrix Representation of Data
4.3 Market Demand and Supply Equilibrium
4.4 National Income Model
4.5 Input-Output Analysis
4.5.1 Assumptions
4.5.2 Input-Output Table
4.5.3 Technological Coefficient Matrix
4.5.4 Hawkins-Simon Conditions
4.5.5 Closed and Open Input-Output Models
4.6 Let Us Sum Up
4.7 Key Words
4.8 Some Useful Books
4.9 Answer or Hints to Check Your Progress
4.10 Exercises with Answer/Hints

4.0 OBJECTIVES
After going through this unit, you will be able to understand application of
matrices to
• Matrix Representation of Data;
• Market demand and supply Equilibrium;
• National Income Model; and
• Input-Output Analysis.

4.1 INTRODUCTION
In the preceding Unit 3, we have learnt Solving System of Linear Equations
by matrix algebra. The present unit discusses application of the tool to some
of the themes in business and economics. It may be useful to note that matrix
algebra is widely used many areas including those of demand-supply
equilibrium, national income determination and input-output analysis. We see
such applications in the following.

4.2 MATRIX REPRESENTATION OF DATA

Matrices are the most convenient way to compactly represent the data. To see
this feature let us take the following examples:
57
Business Mathematics Example 1: A firm has three factories (F1, F2 and F3) and four warehouses
(W1, W2, W3, W4). It wants to find the minimum per unit transport cost
from each factory to each warehouse. Given the cost data in matrix form in
the following, find the minimum as well as maximum unit cost for each
factory to transport its product to warehouses.

����������
� �� �� �� ��
�� 15 17 20 12
Factories �� 21 10 17 19
�� 10 27 18 16
Answer:
i) Per unit cost is minimum from F1, F2 and F3 to W4, W2 and W1
respectively.
ii) Per unit maximum cost from F1, F2 and F3 to W3, W1 and W2
respectively.
Example 2: In an elocution contest, a participant can speak either of the five
languages, viz., Hindi, English, Punjabi, Gujarati and Tamil. A college (say,
No.1) sent 30 students of which 10 offered to speak in Hindi, 9 in English, 6
in Punjabi, 3 in Gujarati and rest in Tamil. Another college (say, No.2) sent
25 students of which 7 spoke in Hindi, 8 in English, 10 in Punjabi. Out of 22
students from third college (say, No.3), 12 offered to speak in Hindi, 5 in
English and 5 in Gujarati.
Write the information given above in matrix form.
Answer:
Hindi English Punjabi Gujarati Tamil
College 1 10 9 6 3 2
College 2 7 8 10 0 0
College 3 12 5 0 5 0

Example 3: A finance company has offices located in every division, every

district and every taluka in a certain state in India. Assume that there are five
divisions, 30 districts and 200 talukas in the state. Each office has 1 head
clerk, 1 cashier, 1 clerk and 1 peon. A divisional office has, in addition, an
office superintendent, 2 clerks, 1 typist, and 1 peon. A district office has, in
addition 1 clerk, 1 peon, The basic monthly salaries ( in Rs.) are as follows:

Office superintendent 15000

Head clerk 12000
Cashier 11750
Clerks and typists 11500
Peons 7500

58
Using matrix notation, find Application of
Matrices in Business
i) The total number of posts of each kind in all the offices taken together. and Economics

ii) The total basic monthly salary bill of each kind of office and,
iii) The total basic monthly salary bill of all the offices taken together.
Answer:
The number of offices can be arranged in a row matrix:
Division District Taluka
� = [ 5 30 200 ]
Staff compostion can be arranged in 3 x 6 matrix
O H C T Cl P
1 1 1 1 3 2
� = �0 1 1 0 2 2�
0 1 1 0 1 1
where O = Office Superintendent
H = Head Clerk
C = Cashier
T = Typist
Cl = Clerk
P = Peon
The column matrix D will have the elements that correspond to basic
monthly salary
� 15000
� �12000�
� �11750��
�= �
� �11500�
�� �11500�
� � 7500 �

i) Total Number of posts of each kind in all the offices are the columns of
the matrix ��
1 1 1 1 3 2
�. � = [5 30 200] �0 1 1 0 2 2� =
0 1 1 0 1 1
[3 235 235 5 275 270]
ii) Total basic monthly salary bill of each kind of offices is the elements of
matrix ��
15000
�12000�
1 1 1 1 3 2 � � 99750
11750�
�. � = �0 1 1 0 2 2� � = �61750�
�11500�
0 1 1 0 1 1 42750
�11500�
� 7500 �

59
Business Mathematics iii) Total bill of all the offices is the element of the matrix
99750
[5 30 200] �61750� = [10901250]
42750
Check Your Progress 1
1) Why would you prefer to store data of a business operation in matrix
form?
2) You use two modes of travel, bus and train, while commuting between
home and your study centre. The cost of travel for the last two days is
recorded as follows:
Day one: Rs. 20 (in bus)+Rs. 30(in train)=Rs.50 (total)
Day two: Re.0 (in bus)+ Rs. 60 (in train)=Rs. 60 (total)
Write the above data in matrix format.
3) The total cost of manufacturing three types of motor car is given by the
following table:

Type of motor Labour Materials Subcontracted

Car (hrs) (units) Work (units)
Car A 40 100 50
Car B 80 150 80
Car C 100 250 100

Labour cost Rs 2 per hour, units of material cost Rs 1 each and unit of
sub-contracted work cost Rs 3 per unit. Find the total cost of
manufacturing 3000, 2000 and 1000 vehicles of type A, type B and
type C respectively using matrices.

4.3 MARKET DEMAND AND SUPPLY

EQUILIBRIUM
It is seen in microeconomics that the demand for a commodity and its supply
are expressed as functions of its own price only. The resultant equilibrium of
such a relation is given by the equality between demand and supply
equations. To see the process of determination of equilibrium price and
quantity, let us consider a hypothetical example of car industry.
Example 4: If demand and supply curves for car are:
� = 100 − 6�, � = 28 + 3� , where � is the price of cars, what is the
quantity of car bought and sold at equilibrium?
Answer: We know that the equilibrium quantity will be where supply equals
demand. So first we'll set supply equal to demand:
100 - 6P = 28 + 3P. Re-arranging we get:
72 = 9� ⇒ � = 8.

60
Since we have worked out the equilibrium price, we can solve for the Application of
Matrices in Business
equilibrium quantity by simply substituting � = 8 into the supply or the and Economics
demand equation. That is, if � is substituted into the supply equation to get:
S = 28 + 3x8 = 28 + 24 = 52.
Thus, the equilibrium price = 8, and the equilibrium quantity = 52.
However, this simple market formulation presupposes that the demand for
and the supply of a commodity are not influenced by other factors such as
prices of substitutes and complementary goods. In reality such types of
assumptions do not hold good. To accommodate such scenarios a better
option could be an inclusion of prices of other commodities also into demand
and supply equations.
It may be useful to point out that the above-mentioned approach to demand-
supply equilibrium can be extended to a larger number of interrelated markets
of related commodities. In such a framework, the equilibrium prices and
quantities of the included commodities comprising a large number of supply
and demand equations can be obtained using a system of simultaneous
equations. We do not undertake such an exercise at present. But to
understand the underlying process, let us consider a two-commodity market
model and solve for equilibrium price-quantity combinations with the help of
techniques of matrix algebra.
Example 5: Consider a two-commodity (x and y) market model given by
Demand Equations:
�� = 11 − 2�� + �� ;
�� = 8 + �� − �� .
Supply Equations:
�� = 1 + 3�� ;
�� = 6 + �� .
where,�� and �� →quantity demanded for xandy;
�� ��� �� → quantity supplied of xandy;and
�� and �� → price of x and y.
Find the equilibrium prices and quantities.
Equilibrium condition for x:
�� = �� = �� .
Therefore, in terms of the given equations we have
11 − 2�� + �� = 1 + 3��
or, 3�� + 2�� − �� = 11 − 1
or,5�� − �� = 10 --- (1)
Again, set the equilibrium condition for y, i.e.,
�� = �� = ��
61
Business Mathematics or, 8 + �� − �� = 6 + ��
or, �� − 2�� = 6 − 8
or, −�� + 2�� = 2 --- (2)
Writing equations (1) and (2) together in the matrix form, we have
5 −1 �� 10
� �� � = � �
−1 2 �� 2
Next, solve the above equation system for the two prices by the matrix
inverse method.

�� 5 −1 �� 10
Hence,�� � = � � � �.
� −1 2 2

5 −1 5 −1 2 1
As Determinant of � � = 9 and adjoint of � �=� �.
−1 2 −1 2 1 5

5 −1 �� 0.22 0.11
� � =� �.
−1 2 0.11 0.56

5 −1 �� 10 2.42
Thus, � � � �=� �
−1 2 2 2.22
�� 2.42
So, �� � = � �,
� 2.22
yielding equilibrium prices, �� = 2.42 and �� = 2.22.
Plugging these prices into demand equations we get the equilibrium
quantities of x and y.
Thus, �� = 8.38 and �� = 8.20.
Besides the matrix inversion method used above in solving for equilibrium
price-quantity, we may also be used Cramer’s rule to obtain the results.

Check Your Progress 2

1) You are asked to compute the equilibrium demand and supply price-
quantity combination using matrix inversion. How would you like to
formulate the demand supply equations?
2) While computing demand-supply equilibrium using matrix algebra,
what other method can be used besides matrix inversion?
3) In demand-supply analysis, what condition must be met for establishing
equilibrium?

4.4 NATIONAL INCOME MODEL

The national income model is another area of application of matrix
algebra.We will consider a simple two-equation national income model for
an economy. In order to keep the exposition simple, we have not included
government and trade relationship with external countries in the present
analysis.
62
Basically, our objective is geared towards the computation of equilibrium Application of
Matrices in Business
national income as well as consumption of an economy. For that purpose, we and Economics
start with two equations given below:
� = � + �� (1)
� = � + �� (2)
where, � is national income, � is consumption, �� is autonomous investment,
� and � are constants.
Out of these two equations, first one shows that the total value of national
income is seen from expenditure approach. That is, the total expenditure of
the economy incurred on goods and services is equal to consumption
expenditure and investment expenditure. The other equation depicts a linear
relationship between income and consumption. In the present context, ′�′, the
intercept term of the linear line is assumed to be greater than zero as it is
generally postulated that consumption remains positive even when there is no
income; the slope coefficient ′�′ is taken to be greater than zero but less than
one as general psychological tendency of the human beings is to consume
less than the total income.
To compute the values of income and consumption at equilibrium we
rearrange (1) and (2) as follows:
� − � = �� (3)
−�� + � = � (4)
Writing equations (3) and (4) together in the matrix form we get
1 −1 � �
� � � � = � ��
−� 1 � �
� 1 −1 �� ��
or, � �=� � � � (5)
� −� 1 �
Now, we can obtain equilibrium Y as well as C from (5) either by Cramer's
rule or matrix inversion method.
Example 6:
Given the following national income model
Y=C+I
�
C=5 + � �

I= 10
Find Y and C.
Putting the value of I from the third equation into the first equation
Y = C + 10
or,Y - C = 10 (6)
�
Again, the second equationC= 5 + � �can be rearranged as
�
-� � +C=5 (7)

63
Business Mathematics Equations (6) and (7) can be written in the matrix equation as

1 −1 � 10
�−� 1 � �� � = � 5 � (8)
�

Using Creamer's rule to we get

10 − 1
� � 15
�= 5 1 = � = 60
1 −1
�− � 1 � �
�
� ��
��� � �
��.�
and � = �
� �� = � = 50, i.e., the required equilibrium values.
�� �
�� �
�

Check Your Progress 3

1) What conditions are imposed on consumption equation � = � + ��
in the national income model?
2) In the national income model you have studied, which variables have
been computed while determining equilibrium?
3) Take the Example 6 of Section 4.4 given above and solve for
equilibrium values of income and consumption using inverse matrix
method.

4.5 INPUT-OUTPUT ANALYSIS

Input-Output(I-O) analysis is another area where matrix algebra becomes
handy in the derivation of results. We discuss the process involved in it to
start with. I-O analysis is also known as the inter-industry analysis as it
explains the interdependence and interrelationship among various industries.
For example, in the two-industry model, coal is an input for steel industry
and steel is an input for coal industry, though both are the output of
respective industries.

4.5.1 Assumptions
The economy is divided into finite number of sectors (industries) on the basis
of the following assumptions:
i) Each industry produces only one homogeneous output.
ii) Production of each sector is subject to constant returns to scale, i.e.,
two-fold change in every input will result in an exactly two-fold change
in the output.
iii) Input requirement per unit of output in each sector remains fixed and
constant. The level of output in each sector (industry) uniquely
determines the quantity of each input, which is purchased. Moreover, if
5 men per Rs. 100000 of investment are required at any level of
operation, it is assumed that the same ratio will be required no matter
how much the size of the firm expands or contracts.

64
iv) The final demand for the commodities is given from outside the Application of
Matrices in Business
system. The total amount of the primary factor (e.g., labour) is also and Economics
given. Presence of these two assumptions makes the system open ended
and for this, the model is called ‘open model’. In contrast to this, in the
‘closed model’, all the variables are determined within the system.

4.5.2 Input-Output Table

I-O table shows the disposition of the total products and total inputs among
the different industries. Let us assume that an economy consists of 2
producing sectors only. In addition, the production of each sector is being
used as the input in all the sectors and used for final consumption. Suppose,
i) X1 and X2 are total outputs of 2 sectors;
ii) F1 and F2 are the amounts of final demand, consumption for output of
these sectors.
iii) Xij be the amount of output of the ith Industry used up as an
intermediary input by the jth industry ( i,j = 1,2)
iv) L represents the given amount of primary factor (here, labor) and Li is
the amount of primary factor used in the ith Industry.
Then the following table represents the I-O table for the simplified economy.

Input requirements Requirements

Producing Total output of producing sectors for final uses
sector number of the sector
X1 X2
1 X1 X11 X12 F1
2 X2 X21 X22 F2

Primary input Total primary L1 L2

(labor) input = L

It is important to note that items in the above table are physical units per
year. Since the entries in any row are all measured in the same physical units,
there is no problem in undertaking addition across the rows. The ‘total
output’ column gives output of each commodity and the overall input of
labor. However, items in the same column are not measured in the same
units, so that it would not be correct to add down the columns.
It may be seen from the table that requirements of the first industry are
recorded in the third column: X1 units of output of the first industry was
produced with the use of X11 units of first good, X21 units of second good and
L1 units of labor. Similar meanings will follow for other column, i.e.,
Columns 2 and 4. The ‘final demand’ i.e., Column (5), shows the commodity
available for consumption. It is assumed that labor is not consumed directly.
If we suppose that each unit of output of each industry has a price of Re.1
and each unit of labor receives a wage rate of Re.1, then each entry of the
above table can be expressed in terms of money value (rather than being a
physical unit). It is then possible to add down the columns. The sum of each
column gives the total cost of the corresponding industry. Thus, revenue of
65
Business Mathematics industry 1 accrues from the sale of X1 units (= X11 + X12+ F1) and cost of that
industry is (X11 + X21 + L1) units. It is true for the other industry also.
Taking into account the producing sectors we can write the total output in
each as
�� = X11 + X12 + F1 (1)
X2 = X21 + X22 + F2 (2)
and
L = L1 + L2
That is, �� = ∑���� ��� + �� and � = ∑���� ��
Here, Xi = total output of the ith sector, Xij = output of ith sector used as input
in jth sector, and Fi = final demand for ith sector.
The above identity states that all the output of a particular sector could be
utilised as an input in one of the producing sectors of the economy and/or as
a final demand. Basically, therefore, I-O analysis is nothing more than
finding the solution of these simultaneous equations.

4.5.3 Technological Coefficient Matrix

From the assumption of fixed input requirements, we see that in order to
produce 1 unit of jth commodity, the input used of ith commodity must be a
Xij
fixed amount, which we denote by aij; thus aij = . If Xj represents the total
Xj
output of the jth commodity (or jth producing sector) the input requirements of
the ith commodity will be equal to aijXj or, Xij = aijXj. We call aijaninput
coefficient.
Let us consider ��� and �� in terms of value. So, aij gives the value of input
per unit of output. Thus, aij, = 0.02 indicates that to produce one-rupee worth
of the jth commodity 20 paise worth of the ith commodity would be required.
It may be noted that the sum of elements in each column gives the
requirement of secondary input to produce a rupee worth of output in that
producing sector. Therefore, the sum of the elements in each column of the
input coefficient matrix should be less than 1. This is because it does not
include the cost of the primary inputs. In the two-sector example we have
considered,∑���� ��� with � = 1,2.
If we take the value of output at Re. 1, it must be fully absorbed by the
payment to all factors of production. Without an inclusion of the amount of
payment made to primary input (labour here), the column sum must be less
than Re. 1. Thus, the value of the primary input needed in producing a unit of
the jth commodity should be
1 − ∑���� ��� .
For The economy considered above, if the cost of primary inputs per rupee
worth of output for the two producing sectors are l1 and l2, we write
�� = 1 − (��� + ��� )
and
66
�� = 1 − (��� + ��� ). Application of
Matrices in Business
The total output for each producing sector can be expressed in terms of the and Economics

input coefficients, by replacing ��� = ��� �� in equations (1) and (2). Thus,
for out two producing sector economy,
�� = ��� �� + ��� �� + ��
or, �� − ��� �� − ��� �� = ��
or, (1 − ��� )�� − ��� �� = �� (3)
Similarly,
�� = ��� �� + ��� �� + ��
or, −��� �� + �� − ��� �� = ��
or, −��� �� + (1 − ��� )�� = �� (4)
Writing equations (3) and (4) in the matrix form
1 − ��� −��� �� �
� � � � = � �� (5)
−��� 1 − ��� �� ��
1 − ��� −���
See that matrix � � can be obtained by subtracting
−��� 1 − ���
��� ��� 1 0
A=�� �, an input coefficient matrix from � = � �,an identity
�� ��� 0 1
1 0 ��� ���
matrix, i.e., � − � = � � − �� �.
0 1 �� ���

So, equation (5) can be written as

(I - A) X = F (6)
where
��
�=� �
��
and
�
� = � �� .
��
Note that order of matrices A, X and F is according to number of sectors we
have considered.
The matrix (I-A) is called the technology matrix.
If (I -A) is non-singular (that is, |� − �| ≠ 0, equation (6) can be solved for X.
Thus,
X= (� − �)�� � (7)
If D = | I-A | = determinant of matrix [I-A] and D ≠ 0, then the inverse matrix
����� ���
� � 1 1 − ��� ���
can be written as [� − �]�� = � ����� �= D � �
��� ��� 1 − ���
� �

�� � 1 − ��� ��� �
Therefore, � �= � � � ��
�� � ��� 1 − ��� ��
67
Business Mathematics (����� )�� ������ ����� �(����� )��
or, �� = , �� = where, D
� �
1 − ��� −���
=� �= (1 − ��� ) (1 − ��� ) – ��� ���
−��� 1 − ���

4.5.4 Hawkins-Simon Conditions

If the I-O solution gives negative outputs, then it means that more than one
unit of a product is used up in the production of every one unit of that
product; it is not realistic and such a system is not a viable. Hawkins-Simon
condition guards against such eventualities. For our basic equation � =
[� − �]�� � not to give negative numbers as a solution, we need to have the
matrix [� − �] such that
i) the determinant of the matrix must always be positive, and
ii) the diagonal elements: (1 − ��� ), (1 − ��� ) should all be positive. In
other words, elements, ��� , ��� should all be less than one. That means
one unit of output of any sector should use not more than one unit of its
own output. These are called Hawkins-Simon conditions. Moreover,
the first condition,� > 0, implies that (for 2 industry case)
1 − a11 − a12
> 0, or, (1 − ��� ) (1 − ��� ) – ��� ��� > 0
− a 21 1 − a 22

This condition stipulates that the direct and indirect requirement of any
commodity to produce one unit of that commodity must also be less than one.
0.1 −0.1
Example 7: Suppose [I-A] =� �
−0.8 0.2
0.1 −0.1
Then from [I-A] = � � we can get the value of the determinant [I-
−0.8 0.2
A] = (-) 0.06, which is less than zero. As the Hawkins-Simon conditions are
not satisfied, no solution will be possible in this case.

4.5.5 Closed and Open Input-Output Models

In the above example, besides two industries, our model contains exogenous
sector of final demand, which supplies primary input factors (labor services,
which are not produced by these two industries) and consumes the output of
two producing industries (not as input). Such an I-O model is known as ‘open
model’. It includes exogenous sectors in terms of ‘final demand bill’ along
with the endogenous sectors in terms of � producing sectors. I-O model,
which has endogenous final demand sector, is known as ‘closed model’.

Check Your Progress 4

1) What is an input coefficient matrix?
2) What is an open input-output model?
3) The input coefficient matrix is given as
 a11 a12 a13   0.2 0.3 0.2 
   
=A =a21 a22 a23   0.4 0.1 0.2  . Get the technology matrix.
a   0.1 0.3 0.2 
 31 a32 a33   

4) Discuss the importance of Hawkins-Simon conditions in an input-

output model.
68
 Application of
4.6 LET US SUM UP Matrices in Business
and Economics
In this unit we discussed some of the applications of matrix algebra in
business and economics. We learnt the presentation of data in matrix form
taking the help of examples. Computation of demand-supply equilibrium
from the simultaneous equationsusing matrix was shown for our
understanding. The technique for solving national income model by matrix
methods was explained.
In the last part of the unit we were exposed to input-output analysis and were
shown the use of technique of matrix algebra in deriving the solution. In the
process we learnt the formulation of input-out transaction matrix and
technology matrix before the steps required for solving an open input-output
model was demonstrated.

4.7 KEY WORDS

Closed Input-Output Model: Exogenous sector of the open input-output
model is absorbed into the system as just another industry such that the entire
output of each producing sector is absorbed by other producing sectors as
secondary inputs or intermediate products. Essentially, the household sector
is treated as one of the industries and no portion of the output is sold in the
market as final product.
Endogenous Variable: Dependent variable generated within a model and,
therefore, its value is changed (determined) by one of the functional
relationships in that model.
Exogenous Variable: A variable whose value is determined from outside a
given model.
Hawkins-Simon Condition: More than one unit of a product cannot be used
up in the production of every unit of that product. Condition requires that all
principal minors of the technology matrix must be positive.
Input Coefficient Matrix: A matrix of different secondary inputs required
by producing sectors per unit of output.
Input-Output Model: An economic model that represents the
interdependencies between different sectors (industries) of a national
economy.
Input-Output Transaction Matrix: A matrix showing the distribution of
total output of one industry to all other industries as inputs and for final
demand.
Model: A set of equations, functional relationships and identities that seek to
explain some economic phenomenon.
Open Input-Output Model: A model in which the producing sectors interact
with household sector of an economy through their purchase of primary
inputs and sales of final products.
Primary Inputs: Basic inputs of a production process such as labour.
Technology Matrix: A matrix obtained by subtracting a given input
coefficient matrix from an identity matrix.
69
Business Mathematics
4.8 SOME USEFUL BOOKS
• Abraham, W.I., National Income and Economic Accounting: Prentice-
Hall Inc., New Jersey, Chapter 7 (including the Appendix, 1969.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Stafford, L.W.T., Mathematics for Economists: The English
Language Book society and Macdonald & Evans Ltd., London,
Chapter 17, 1977.
• Wisniewski, M., Introductory Mathematical Methods in Economics:
McGraw-Hill Book Company, London, Chapter 7, 1991.

4.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Because of its compact and convenient feature.

2) Day Bus Train Total

1 20 30 50

2 0 60 60

3) Labour hours, material used and sub-contracted work for three types of
cars A, B, and C matrix:
40 100 50
X =� 80 150 80 �, labour cost per unit, material cost and cost of
100 250 100
2 330
sub-contracted work Y = �1�, cost of each car A, B, C = XY=�550�,
3 750
total cost of manufacturing three cars A, B, C is given by the matrix
330
XYZ = [3000 2000 1000] �550� =[990000 + 1100000 + 750000]
750
= [2840000]
Check Your Progress 2
1) Consider demand and supply equations which include factor(s)
influencing quantity of supply and demand besides own price of the
commodity.
2) Use Cramer’s rule.
3) Demand equals supply.
Check Your Progress 3
1) � > 0 and 0 < � < 1.

70
2) Income and consumption. Application of
Matrices in Business
3) Do yourself after reading the method given in Section 4.3. and Economics

Check Your Progress 4

1) A matrix of different secondary inputs required by producing sectors
per unit of output.
2) Model contains exogenous sector of final demand, which supplies
primary input factors (labor services-which are not produced by these
two industries) and consumes the output of two producing industries
(not as input).
(1 − ��� ) −��� −��� 0.8 −0.3 −0.2
3) � = � −��� (1 − ��� ) −��� � = �−0.4 0.9 −0.2�
−��� −��� (1 − ��� ) −0.1 −0.3 0.8
4) More than one unit of a product cannot be used up in the production of
every unit of that product.

4.10 EXERCISES WITH ANSWER/HINTS

1) A large energy company produces electricity, natural gas, and oil.
The production of a rupee's worth of electricity requires inputs of Rs.
0.30 from electricity, Rs. 0.10 from natural gas and Rs. 0.20 from oil.
The production of a rupee's worth of natural gas requires inputs of Rs.
0.30 from electricity, Rs.0.10 from natural gas and Rs.0.20 from oil.
Production of a rupee's worth of oil requires inputs of Rs. 0.10 from
each sector. Find the output for each sector that is needed to satisfy a
final demand of Rs. 25 crore for electricity, Rs. 15 crore for natural gas
and Rs. 20 crore for oil.
2) The daily cost of operating a hospital C is a linear function of the
number of in-patients I and out-patients P plus a fixed cost �, i.e.,
� = � + �� + ��
Given the following data of 3 days, find the values of a, b and d by
setting up a system of linear equations and using the matrix inverse.
Day Cost (Rs) No. of Inpatients No.of outpatients
1 6950 40 10
2 6725 35 9
3 7100 40 12
3) A trust fund has Rs 10000 that is to be invested into two types of
bonds. The first bond pays 5% interest per year and the second bond
pays 6% interest per year. Using matrix algebra, determine how to
divide Rs 10000 among the two types of bonds so as to obtain an
annual interest Rs 550.
4) A man invested Rs 30000 into three different investments at the annual
rate of interest 2%, 3% and 4% respectively. The total annum income is
Rs 1000. If the income from the first and second investment together is
71
Business Mathematics Rs. 50 more than the income from third, find the amount of each
investment by using matrix algebra.
5) Given the national income model
Y=C+I+G (G: Government expenditure)
�
C = 5 + ��

I = 10
G = 10
Using matrix inverse method, find Y and C.
Answers
1) Let �� = the total output of the electric company (�)
�� = the total output of the natural gas company (�)
�� = the total output of the oil company (�)
Total amount of electricity needed is the sum of amounts of electricity
needed to produce electricity, natural gas and oil (internal demand) plus
the final (external) demand of electricity.
�� =.30�� + .30�� + .10�� + 25
Total amount of natural gas needed is the sum of amounts of natural
gas needed to produce electricity, natural gas and oil (internal demand)
plus the final (external) demand of natural gas.
�� =.10�� + .10�� + .10�� + 15
Total amount of oil needed is the sum of amounts of oil needed to
produce electricity, natural gas and oil (internal demand) plus the final
(external) demand of oil.
�� =.20�� + .20�� + .10�� + 20
Using the technology matrix �, the final demand matrix �and total
demand matrix �, we get
� = �� + �, with solution� = [� − �]�� D

�� .3 . 3 . 1 �� 25
�
� � � = �. 1 �
. 1 . 1� � � � + �15�
�� .2 . 2 . 1 �� 20

1 0 0 .3 .3 .1 .7 −.3 −.1
� − � = �0 1 0 � − �. 1 . 1 . 1� = �− . 1 . 9 −.1�
0 0 1 .2 .2 .1 −.2 −.2 −.9

1.58 0.58 0.24

[� − �]�� = �0 . 22 1.22 1,16�
0.4 0.4 1.2

72
 1.58 0.58 0.24 25 53 Application of
��
[� − �] � = �0 . 22 1.22 Matrices in Business
1,16� �15�=�27� and Economics
0.4 0.4 1.2 20 40
That is, the total output of electricity is Rs. 53 crore, the total output of
natural gas is Rs. 27 crore, the total output of oil is Rs. 40 crore.
2) Substituting the tabulated values in � = � + �� + ��, we obtain the
following set of linear equations
� + 10� + 40� = 6950
� + 9� + 35� = 6725
� + 12� + 40� = 7100
The above system of equations in the matrix form is
1 10 40 � 6950
�1 9 35� �� � = �6725� …………………….(I)
1 12 40 � 7100
1 10 40
-1 ���(�)
Now A = |�|. Where |A| = �1 9 35� = -10
1 12 40
60 −80 10
andadj (A) = � 5 0 −5�
−3 2 1
So, from the relation (I), we get
� 60 −80 10 6950 −50000 5000
� �
�� � = -�� � 5 0 −5� �6725� = �� � −750 � = � 75 �
� −3 2 1 7100 −300 30
Hence a = 5000, b = 75 and d = 30.
3) Suppose Rs.� and (10000 – �) be invested in the first and second types
of bonds respectively. So the value of these bonds can be written in the
row matrix form
A = [� (10000- �)]
and the amount received from two bonds as interest can be written in
the form of column matrix
5% 0.05
B=� �=� �
6% 0.06
Hence the total interest = AB
0.05
=[ � (10000 − �)] � � = [600 – 0.01a]
0.06
But total annual interest = Rs 550 (given)
Thus, 600 – 0.01 � = 550
0.01 � = 50
a = 5000
Investment in first bond = Rs. 5000
73
Business Mathematics Investment in second bond = 10000 – 5000 = Rs 5000
4) Let x, y and z be the amount of three investments. The given data can
be expressed in the following system of linear equations
x + y + z = 30000 ……………………(i)
.02x + .03y + .04z = 1000 ………..(ii)
.02x + .03y - .04z = 50 …………….(iii)
The equation (ii) and (iii) may be rewritten as
2x +3y + 4z = 100000 ……………(ii)
2x + 3y – 4z = 5000 …(iii)
These equations are expressed in matrix form AX = B
1 1 1 � 30000
Where A = �2 3 4 �, X = ��� and B = �100000�
2 3 −4 � 5000
1 1 1
Here |A| = �2 3 4 � = -8
2 3 −4
−24 7 1
Adj(A) = � 16 −6 −2�
0 −1 1
−24 7 1
-1 ���(�) �
Now A = |�|. = - � � 16 −6 −2�
0 −1 1
X = A-1B
−24 7 1 30000
�
= - � � 16 −6 −2� �100000�
0 −1 1 5000
1875
= �16250�
11875
Hence the investments at 2%, 3% and 4% are Rs 1875, Rs 16250, Rs 11875
respectively.
5. Y=100; C=80.

74
 Mathematical
UNIT 5 MATHEMATICAL FUNCTIONS Functions

Structure
5.0 Objectives
5.1 Introduction
5.2 Functions and Their Types
5.2.1 Definition of Function
5.2.1.1 Domain, Codomain and Range
5.2.2 F u n c t i o n T yp e s : A l g e b r a i c
5.2.2.1 Polynomial Function
5.2.2.2 Rational Function
5.2.2.3 Piecewise Function
5.2.3 F u n c t i o n T yp e s : T r a n s c e n d e n t a l
5.2.3.1 Exponential Function
5.2.3.2 Logarithmic Function
5.2.4 Function Types: Inverse and Composite
5.2.4.1 Inverse Function
5.2.4.2 Composite Function
5.3 Functions and Cartesian Coordinates
5.4 Graph of Some Functions
5.4.1 Graphing Functions of Straight-Line Types
5.4.1.1 Linear Function:
5.4.1.2 Absolute Value Function
5.4.1.3 Step Function
5.4.2 Graphing Functions: Curvy Types
5.4.2.1 Quadratic Functions
5.4.2.2 Cubic Function
5.4.3 Graphing Functions: Asymptotic Types
5.4.3.1 Square Root Function
5.4.3.2 Exponential Function
5.4.3.3 Logarithmic Function
5.5 Functions related to Business and Economics
5.5.1 Demand Function
5.5.2 Supply Function
5.5.3 Cost Function
5.5.4 Revenue Function
5.5.5 Profit Function
5.5.6 Consumption Function
5.6 Let Us Sum Up
5.7 Key Words
5.8 Some Useful Books
5.9 Answer or Hints to Check Your Progress
5.10 Exercises with Answers/Hints

75
Business Mathematics
5.0 OBJECTIVES
After going through this unit, you will be able to understand:
• meaning of a function;
• different types of functions; and
• use of functions in Business and Economics.

5.1 INTRODUCTION
A function relates an input (or, argument) to an output. Notice the three main
components, viz., input, relation and output present in describing a function.
For example, in producing an output, you have used an input. It may so
happen that you have got the output whose value is doubled the value of the
input. That means the relationship between input and output is a simple
function of multiplying 2, viz., ����� × 2 = ������.
We use "�" or any other letter like � … to name a function. To read a
function, for example, we say "� �� � ������ � �������" and write it
as�(�) = � � . Here input �, if takes a value 3, output becomes 9 and we can
write �(3) = 9.
The format of the function as output depends on inputs is useful represent
many relations in the form of graphs. In this unit we discuss graphic forms of
some mathematical function.

5.2 FUNCTIONS AND THEIR TYPES

On the basis of general idea of a function seen above, it can be defined
formally.Some important functions find application in economics and
business. We take these up in this section.

5.2.1 Definition of Function

A function relates each element of a set with exactly one element of another
set. In defining the function as above, we need to note following:
i) “each element” implies every element in a set, say X, is related to some
element of another set say, Y;
ii) “exactly one” implies that a function is single valued. That is, �(3) =
8 or 9 is not right.
If a relationship does not follow those two rules, then it is not a
function although it is still a relationship. In that event, the elements of both
the sets are simply ordered pairs. They are called ordered pairs because the
input always comes first, and the output second.
Example1: Let the relationship be � → � � as given in the figure below:
Figure 5.1: Relation between X and Y

76
 Mathematical
Functions

Source: Math is Fun (taken from Internet)

In the relationship given above, set X contains the elements of � and set Y
has the element of � � . It is a function as
• every element in X is related to Y
• no element of X has two or more relationship.
5.2.1.1 Domain, Codomain and Range
In the example given above
the set "X" is called the Domain,
• the set "Y" is called the Codomain, and
• the set of elements that get pointed in Y (the actual values produced by
the function) is called the Range.

A function is uniquely represented by its graph which is the set of

order pairs (x, f (x)). When the domain and the codomain are sets of numbers,
each such pair may be considered as the Cartesian coordinates of a point in
the plane. In general, these points form a curve, which is also called the graph
of the function. This is a useful representation of the function, which is
commonly used everywhere. For example, graphs of functions are commonly
used in newspapers for representing the evolution of price indexes and stock
market indexes.

Sometimes a relation or a function does not follow directly the stated pattern
discussed above. The case of implicit function falls in this category. We see
it before going further.
A function is explicit is when it shows us how to go directly from
independent input � to dependent output �.
For example, take� = � � – 5. See that if you know �, then you can find �.
That is how we write � = �(�).
Implicit function is one where the independent input and its dependent
output are not given directly as is done with � = �(�).
Example 2: � � − 5�� + � � = 0
As you may notein case of the above equation, it is difficult to go directly
from � to �. 77
Business Mathematics Out of many types, we will discuss the following functions which are
commonly used.

��������
� �
� ���������� � ������
���������� ���������
� �
��������� � ��������
� � ���������
� �����
� �����������
�������������� �
� �������ℎ���

5.2.2 Function Types: Algebraic

The following discussion introduces the important functions often used to
solve problems. As summarised above, we have two broad groups of
functions, viz., algebraic and transcendental.Let us attempt to understand
these accordingly.
There is a group of functions called algebraic functions where a
function�(�) satisfies���, �(�)� = 0as a polynomial in� and� with integer
coefficients. These functions can be constructed using only a finite number
of elementary operations, such as plus, minus, multiplication and division.

5.2.2.1 Polynomial Function

A polynomial in the variable x is a function that can be written in the form,
�(�) = �� � � + ���� � ��� + ⋯ + �� � � + �� � + �� ,
where �� , ���� , … �� , �� , �� are constants. We call the term containing the
highest power of � (i.e., �� � � ) the leading term, and �� the leading
coefficient. The degree of the polynomial is the power of � in the leading
term i.e., degree �. Again, its degree 0, 1, and 2 are polynomials which are
constant, linearand quadratic functions while degree 3, 4, and 5 are
polynomials with special names: cubic, quartic, and quintic functions.
Polynomials with degree � > 5 are just called ��� degree polynomials. See
examples of polynomials in the following:
�� (�) = 2� + 5,
�� (�) = 2� � − � + 5,
�� (�) = 2� � − 5� � +5� � .
Constant Function: A constant function is a linear function for which
the range does not change no matter which member of the domain is
used. That is,�(�� ) = �(�� ) for any �� and �� in the domain.
Linear Function: Linear functions are those whose graph is a straight line.
A linear function has the following form. y = f(x) = a + bx.
Quadratic Function: A quadratic function is one of the forms: �(�) =
�� � + �� + �, where �, �, and � are numbers with a ≠ 0.

78
Power Function: A power function is a function that can be represented in Mathematical
Functions
the form:
�(�) = �� � ,
where � and � are real numbers, and � is known as the coefficient. See that
this function is constituted of a variable base raised to a fixed power just like
you find in a single term of a polynomial function.
All the functions given below are power functions:
The constant and only x term functions are power functions because they can
be written as�(�) = � � and �(�) = �� .
The quadratic and cubic functions are power functions with whole number
powers �(�) = � � and �(�) = � � .
The reciprocal and reciprocal squared functions are power functions with
negative integral powers because they can be written as �(�) =
� �� ��� �(�) = � ��
The square and cube root functions are power functions with fractional
� �
powers because they can be written as�(�) = � � and �(�) = � � .
5.2.2.2 Rational Function
A rational function is defined by a rational fraction, i.e., an algebraic
fraction such that both the numerator and the denominator are polynomials.
Example 3: The function �(�) = (−2� � + 4� � − 1) / � � is a
rational function since the numerator and the denominator are polynomials.
Note that the value of denominator should not be equal to zero.
5.2.2.3 Piecewise Function
We can have functions that behave differently depending on the input value.
That is, it is defined on a sequence of intervals. The absolute value function
as given below is an example of a piecewise function.
Example 4:
−� ��� � < 0
|�| = � 0 ��� � = 0
� ��� � > 0
We may consider the rate structure of Indian income tax to appreciate such a
function. It may be seen from the income tax rates for 2019-20 is given
below.

Income tax Slabs Tax rate

Income up to Rs.2.5 lakh No tax
Income above Rs. Rs.2.5 to 5 lakh 5%
Income more than Rs.5 to 10 lakh Rs.12500 plus 20% of total income
exceeding Rs. 5 lakh
Income above Rs. Rs. 10 lakh Rs.1,12,500 + 30% of total income
exceeding Rs.10,00,000

79
Business Mathematics Taking rate of tax in the table above as a function of income level, we can
construct the piecewise function.

5.2.3 Function Types: Transcendental

This class of functions is not expressible as a finite combination of the
algebraic operations of addition, subtraction, multiplication, division, raising
to a power, and extracting a root. Examples of these types include
the logarithmic and exponential functions.

5.2.3.1 Exponential Function

If � is any number such that � > 0 and � ≠ 1, then we have an exponential
function in the form,
�(�) = � � , where � is called the base and � can be any real number.

Notice that in the function above,� is in the exponent and the base is a fixed
number. This is exactly the opposite from what we’ve seen in algebraic
functions. There the base has been the variable, � in most cases, and the
exponent was a fixed number. We will see some examples of exponential
functions shortly.
Before we proceed further, we should address the restrictions on �. We avoid
taking one and zero as the function would be,
�(�) = 0� = 0 and �(�) = 1� =1.
Such constant functions won’t have many of the properties that general
exponential functions have.
Next, we do not take negative numbers. Such numbers would result in getting
complex values out of the function. For example, taking � = −4, the
function would be,
�
�(�) = (−4)� ⇒ �(1/2) = (−4)� = √−4 ,

a complex number. As we only want real numbers to arise from function

evaluation, we require that �not be a negative number.
Note that taking a function

�(�) = � � , where � is the " Euler’s Number " = 2.718281828459...

we get the natural version of exponential function.

5.2.3.2 Logarithmic Function
The function � = ���� �, where �, � > 0 and � ≠ 1 gives the basic logarithm
function, which is read “ � equals the log of �, base �” or “ � equals the log,
base �, of �.”
The above function is equivalent to � = � � . Note that when no base is
shown, the base is understood to be 10. Also note that the domain of the
logarithmic function is the set of all positive real numbers and the range is the
set of all real numbers.

80
While evaluating logarithmic functions, the bases used most often are base 10 Mathematical
Functions
and base �. ��� base 10,i.e ��� 10 is known as the common logarithm and is
written as log.
The logarithm of a number is the exponent to which we must raise the base to
get the number. e.g.,
log2 8 = 3 because 23 =8.
log3 27 = 3 because 33 = 27
log10 100 = 2 because 102 = 100.
If ��� base e, i.e., ���e, is used, it is known as the natural logarithm and is
written as l�.
Having seen both exponential and logarithm function above, it would be
useful to note the relationship between the two. That is, a logarithmic
function is inverse of an exponential function, and vice versa. Thus, � � (an
exponential function) is the inverse function of ���� (�) (a logarithm
function).
If �, � and � be positive numbers, then important properties of logarithmic
functions are:
1) log (m.n) = log m + log n; logarithm of product is the sum of logarithms.
2) log ( m/n) = log m - log n; logarithm of quotient is the difference of
logarithms.
3) log (mn) = n log m; logarithm of power of a number is the exponent
times the logarithm of that number.
4) loge (ex) = x
5) loge e = 1
6) loga 1 = 0
7) loga a = 1.

5.2.4 Function Types: Inverse and Composite

In addition to algebraic and transcendental functions, it would be useful to
know two more types of functions, viz., inverse and composite. These two
functions figure in algebraic and transcendental functions.
5.2.4.1 Inverse Function
Inverse functions are defined asf(x) = y �� ��� ���� �� g(y) = x.In other
words, a function � has an inverse function only if for every � in
its range there is only one value of � in its domain for which �(�) = �. This
inverse function is unique and is frequently denoted by � �� and called
“� inverse.”
Example 5: Let the � be a function withdomain �, � and � and with
codomain 1, 2 and 3 (see figure below). See that � �� is inverse of �. The
reason is element � maps to 3 in � while 3 maps to � in � �� . The same is true
for other elements.

81
Business Mathematics

Fig. 5. 2: Inverse Function

Source: Wikipedia

Example 6: Consider function �(�) = 5� − 7. To reverse it means we

need to get � back from some output value, say �. This is given by the
function,
���
�(�) = �
.{\displaystyle g(y)={\frac {y+7}{5}}.}

Example 7: Find the inverse function for f(x) = 3x − 7.

Answer: Write y = 3x − 7 and solve for x as a function of y.
���
That is, � = �
.

Example 8: Find the inverse function for

�
�(�) =
�+1
Answer: Let � = �/(� + 1), and solve for �in terms of �.
We have from above �� + � = �,so that � = �(1 − �)
�
or, � = ���
�
Thus, � �� (�) = ���
.

Example 9: Find the inverse of function �(�) = � ���

Answer:
Given y = ex-3
82
Taking �� of both sides we obtain Mathematical
Functions
� − 3 = ln �
or, � = �� � + 3
Change � into � and � into � to obtain the inverse function.
� �� (�) = � = �� � + 3
Example10: Find the inverseof the function given by
�(�) = 3 ��(4 � − 6) − 2
Answer:
• Write � as an equation, change from logarithmic to exponential form.
� = 3 ��( 4 � − 6) − 2 ,
which gives ��( 4 � − 6) = ((� + 2) / 3
• Changing from logarithmic to exponential form we get
���
4� − 6 = � � �
�
.
• Solving for � yields
���
� �
4� = � � +6
���
� �
and finally,� = (1/4)� � + 3/2
• Changing � into � and � into � to obtain the inverse function.
���
� �� (�) = � = (1/4)� � �
�
+ 3/2

5.2.4.2 Composite Function

Composite function implies applying one function to the results of another.
That is, the result of f( ) is sent through g( ) and written as (g º f)(x), which
means g(f(x)).Thus,iff we have two functions �(�) and �(�), then we can
define a composite function ℎ(�) �(�(�))
For example,if �(�) = � � and �(�)
( ) = 2� − 1, then
ℎ(�) = (2� − 1)� = 8� � − 12� � + 6� − 1
On the other hand, if we define the composite function �(�) �(�(�)), then
we write �(�) = 2(� � ) − 1 Notice that ℎ(�) and �(�) are different
functions.
Taking into account natural exponential and logarithm functions, we evaluate
their relationship with composite function the following:
Given f(x) = ex and g(x) = ln x,, then
f(g(x)) = eln x = x
g(f(x)) = ln (ex) = x.
When composing functions, the order matters. For example, consider the
function
�(�) = 2� + 3 and �(�) = � � . Let

�(�) = (2� + 3)� . Now reverse the order �

�g º f�(�) = �(�(�)).Thus, �g º f�(
and �. So, 83
Business Mathematics (f º g)(�) = ���(�)� = �(� � )
Since �(�) = 2� + 3, �(� � ) = 2� � + 3.
We get a different result due to change of order of � and �.
Example 11: Given f(x) = 2x + 3 and g(x) = –x2 + 5, find (f o g)(x).
Answer: Plugging the formula for g(x) into the formula for f(x), we get
(f o g)(x) = f (g(x))
= f (–x2 + 5)
= 2( )+3
= 2(–x2 + 5) + 3
= –2x2 + 10 + 3
= –2x2 + 13.

Check Your Progress 1

1) What are functions?
2) Explain the difference between domain and range.
3) State the meaning of an inverse function.
4) What does a composite function imply?
5) What do you understand by linear functions?
6) What do you understand by Quadratic functions?
7) Explain the difference between Exponential and Logarithm functions.
8) What is the difference between common logarithm and natural
logarithm functions?

5.3 FUNCTIONS AND CARTESIAN

COORDINATES
We have already seen that a function is a technical term used to define
relations between variables. A variable � is called a function of � if for every
value of � there is a definite value of �.
For example,� = 2� + 3,
where � is independent variable and �dependent variable as its value depends
upon the value of �.
For a better understanding of the functional relationship between the
variables let us return to cartesian coordinate system that is composed of a
horizontal line and a vertical line perpendicular to each other (see Figure 3).
Remember that these lines are called coordinate axes. The point where they
intersect each other is called the origin (0). Distance of a point from
horizontal axis or �-axis is called the coordinate, coordinate and the distance
of the point from vertical axis or �-axis is called the x-coordinate(abscissa).
To the right of �-axis,� coordinates are positive and to the left of it, x-
coordinates are negative. Above the �-axis � coordinates are positive and
below it they are negative.

84
 Mathematical
Functions

Fig. 5.3: Cartesian Coordinate System

The sign of the coordinate in each quadrant is shown in the figure. Note that
quadrants are numbered anticlockwise.
Each point in the coordinate system is associated with ordered pair of
numbers known as coordinates, showing the location of point in relation to
origin. For example, the point (2, 1) is 2 units on�-axis and 1 unit on-axis
measured from the origin.

Check Your Progress 2

1) What is a cartesian coordinate system?
2) How would you describe each point in the coordinate system?
3) Taking a point on horizontal axis, what would you can measure?

5.4 GRAPH OF SOME FUNCTIONS

Writing a function as � = �(�), we take the elements of the domain (�� ) as
independent variable and that of range �� as dependent variable. It helps
record the values of � and � while plotting the graphs.

5.4.1 Graphing Functions of Straight-Line Types

5.4.1.1 Linear Function
To see the graph of a linear function consider depicting the relationship
between price(�) and market demand (�) for a commodity which is often
depicted by a straight line.To plot the graph for evaluating the relationship, it
is convenient to prepare a table called, t chart, comprising the values of � and
�as a first step. If a function takes the form of� = � – ��, then the� −
chart is as under:
Table: t-chart of � = � – ��

� � = 7 − 5�
-1 12
0 7
85
Business Mathematics
1 2
2 -3
3 -8

Plotting the values of the chart we get the following graph.

Fig.5.4: Graph of Function � = � − ��

Source: Internet

The graph has x-intercept on a point where y is zero and y-intercept on a

point where x is zero. For example, to find the x and y intercepts of the
equation
3� + 4� = 12, proceed as follows:
To find the x-intercept, set y = 0 and solve for x. That is,
3� + 4( 0 ) = 12 ��, � = 12/3 = 4. Similarly, to find the y-intercept, set
x = 0 and solve for y.
That is, 3( 0 ) + 4� = 12 ��, � = 12/4 = 3. Thus,the x-intercept is (4,
0) and the y-interceptis (0, 3).
5.4.1.2 Absolute Value Function
Absolute Value Function is given as f(x) = |x| indicating that we need to
consider modulus |x| of a real number keeping it as the non-negative value
without regard to its sign. That is, |x| = x for a positive x, |x| = −x for a
negative x (in which case −x is positive), and |0| = 0. Thus, the absolute value
of 2 is 2, and the absolute value of −2 is also taken as 2. The graph of such as
function is as follows:

Fig.5.5: Graph of Absolute Value Function

Source: Internet
86
For example, ��� � is a function given by (�) = |� − 2| . The � intercept is Mathematical
Functions
given by
�0 , �(0)� = (0 , |−2|) = (0 , 2); � intercept is at the point (2 , 0) since we
solve for|� − 2| = 0. Since |� − 2| is either positive or zero for x = 2, the
domain of � is the set of all real numbers andthe range of � is given by the
interval [0 , +∞).
5.4.1.3 Step Function
A step function (or, staircase function) is a piecewise function containing all
constant "pieces". The constant pieces are observed across the adjacent
intervals of the function, as they change value from one interval to the next.
A step function is discontinuous (not continuous). You cannot draw a step
function without removing your pencil from your paper.
Features of step functions are: open circles and/or closed circles on the graph
(open = point not on graph; closed = point is on graph);
• horizontal "pieces"
• discontinuous (cannot be drawn without removing your pencil from the
paper)
• may or may be a function.
• Domain: all reals; Range: all integers; y-intercept = 0; x-intercept: [0,1).

−3; �<2
Consider the function �(�) = �0; −2 ≤ � ≤ 1 . Its graph is given below:
3; �>1

Fig.5.6: Graph of Step Function

Source: Internet

5.4.2 Graphing Functions: Curvy Types

Determining the nature of the function that produces curves requires
additional considerations compared to linear types. When you graphed
straight lines, you only needed two points to graph the line, though you
generally plot three or more points just to be on the safe side. However, three
points will almost certainly not be enough points for graphing curves of
quadratic or cubic functions.

87
Business Mathematics 5.4.2.1 Quadratic Functions
Quadratic functions help describing demand, cost, revenue and profit which
you will find while covering microeconomic analysis. The general technique
for graphing quadratics is the same as for graphing linear equations.
However, since quadratics graph are curvy lines (called "parabolas"), rather
than the straight lines generated by linear equations, there will have to be
some additional considerations.
The most basic quadratic function is y = x2. We will use the following F
chart to draw the graph.
Table: T-chart of � = � �

� � = ��
0 0
1 1
2 4

Based only on this experiment the plotted graph will produce a straight line.
Thus, the graph is not correct presentation of the function. More points need
to be considered. By extending the above table with more points we construct
the following table.
Table: t-chart of � = � �

X -3 -2 -1 0 1 2 3
Y 9 4 1 0 1 4 9

With this table, we draw the following graph:

Fig.5.7: Graph of Equation � = ��

Source: Internet

See that the graph is a parabola.

Note that the parabola does not have a constant slope. In fact, as xincreases
by 1, starting with x = 0, yincreases by 1, 3, 5, 7,… . As xdecreases by 1,
starting with x = 0, yagain increases by 1, 3, 5, 7,… .
Consider a quadratic function of the form: �(�) = �� � + �� + � with
� ≠ 0. The graph of such a function takes one of the two general forms
shown in the following figure, depending on the sign of a.
88
 Mathematical
Functions

Fig.5.8: Graph of Quadratic Function

Source: Internet

For example, let us sketch the graph of function � = 2� � − 8� + 6. The

coefficient of � � is positive, so the graph is � − �ℎ����. The function is
sketched in the following figure.

Fig.5.9: Graph of Function � = ��� − �� + �

Source: Internet

Computation of Vertex
Consider a generic quadratic expression:� = �� � + �� + �.Start with
completing the square on the equation to have � = �[� � + ��/� + �/�] or,
� = �[(� + �/2�)� − (�/2�)� + �/�]
The expression −(�/2�)� + �/� is a constant and it does not depend on �.
So, we can replace it with �. Thus, we write � = �[(� + �/2�)� + �].
Now, depending on whether � is positive or negative, the parabola given by �
will either have a maximum or minimum. Since � and � are fixed, this must
occur when (� + �/2�)� = 0. Hence, � = −�/2� which implies that the
function y is at a minimum or a maximum when this is true.
Since parabolas are symmetric over a vertical line, let us call that line � = �.
This means that if the graph crosses the x-axis, then, �� � + �� + � = 0 to
have real solutions they must be equidistant from � = �.So (�, 0) must be
the midpoint of the segment with endpoints at the zeros of the quadratic or, �
is the average of the zeros. From the quadratic formula, the two zeros of the
��±√� � ���� �� �
quadratic are, ��
so their sum is �
and their average is � = − �� .
�
That means, the � − ���������� of the vertex must be − �� .

Example 12: Find the vertex of � = 3� � + � – 2 and graph the parabola.

Ans: To find the vertex, look at the coefficients�,�, and �. The formula for
�� �(�) ��
the vertex gives: ℎ = �� = ��� = � .
89
Business Mathematics
Then k is obtained by evaluating �at ℎ = – 1/6:
� = 3(– 1/6) � + (– 1/6 ) – 2 = 3/36 – 1/6 – 2
= 1/12 – 2/12 – 24/12 = – 25/12
� ��
Since the vertex is at (– � , – ��)T-chart can be prepared as follows:

� � = 3� � + � − 2
-2 8
-1 0
0 -2
1 2
2 12

The graph can be drawn with the specification vertex as follows:

Fig.5.10: Graph of � = ��� + � − �

Source: Internet

5.4.2.2 Cubic Function

Cubic functions are encountered in the discussion of total cost in
microeconomic analysis. Consider a cubic function of the form�(�) =
�� � + �� � + �� + �. Its graph is as follows:
The "basic" cubic function is�(�) = � � . The graph is:

Fig.5.11: Graph of Cubic Function

Source: Internet

Let f is a cubic function given by � (�) = � �

90 a) Find the � and � intercepts of the graph of �.

b) Find the domain and range of �. Mathematical
Functions
c) Sketch the graph of �.
a) The y intercept is given by (0, �(0)) = (0 , 0) . The � coordinates of
the � intercepts are the solutions to � � = 0. The x intercept is at the point
(0 , 0).
b) The domain of � (�) is the set of all real numbers. Since the leading
coefficient of x3 is positive, the graph of � is up on the right and down on
the left and hence the range of � is the set of all real numbers.
c) Table of values are:

� -2 -1 0 1 2
�(�) = � � -8 -1 0 1 8

Now, the graph can be drawn with this values.

5.4.3 Graphing Functions: Asymptotic Types

We are familiar with exponential growth models such as population growth
and compound interest. The functions representing such behaviour will be
used to see the graphs.
5.4.3.1 Square Root Function
As the name indicates we take a variable x to write the function in the form
of f(x) = √x.
Because the domain of f is the set of all positive real numbers and zero, we
might construct a table of values as follows:
X 0 1 4 9 16
√x 0 1 2 3 4
Plotting its graph yields the following figure:

Fig.5.12: Graph of Square Root Function

Source: Internet

5.4.3.2 Exponential Function

Consider natural exponential of the form � → � � where e is Euler's number, a
transcendental number approximately 2.718281828. Since x is an exponent
and the exponent can be any real number, the domain is all real numbers. The
range is the y-values. Since the graph never intersects or goes below the x-
axis, the y-values are not zero or negative. Its graph is given below.
91
Business Mathematics Draw a graph so that at any point (x, y) on the graph the slope is equal to y,
the vertical coordinate of the point. Notice that the higher up the point on the
graph is (the larger the y value), the steeper the slope. So, we make this
graph, starting at the point (x, y) =(0, 1) (where the graph has slope equal to
1). So, the graph starts out going up as we move to the right. You will see
that as you draw the graph from left to right it keeps going up faster and
faster.

Fig.5.13: Graph of Exponential Function

Source: Internet

5.4.3.3 Logarithmic Function

The logarithmic function slowly goes to positive infinity as the variable
increases and slowly goes to negative infinity as itapproaches 0. Afunction
given by � = ���� �, where � is any number such that � > 0, � ≠
1, ��� � > 0 is called a logarithmic function the function is read "log
base b of x". Its graph crosses the x-axis at (1, 0). When b> 1, the graph
increases; 0 <b< 1, the graph decreases.
In thelogarithmic function, the domain is all positive real numbers (never
zero) while the range is all real numbers. The graph is asymptotic to the y-
axis - gets very, very close to the y-axis but does not touch it or cross it.
The graph of � = ���� �, �> 1 with
• Domain: (0, ∞)
• Range: (−∞ , ∞ )
• x-intercept: (1, 0)
• Increasing
may be seen below:

Fig.5.14: Graph of Logarithmic Function

Source: Internet
92
 Mathematical
Check Your Progress 3 Functions

1) Draw the graph of � = (– 5/3)� – 2.

2) List two graphs that would be of curvy-type.
3) How do you describe the shape taken by a logarithmic function?
4) What is a vertex?

5.5 FUNCTIONS RELATED TO BUSINESS AND

ECONOMICS
In recent years, economic decision making has become more and more
mathematically oriented. Faced with huge masses of statistical data,
depending on hundreds or even thousands of different variables, business
analysts and economists have increasingly turned to mathematical methods to
help them describe what is happening, predict the effects of various policy
alternatives, and choose reasonable courses of action from the large of
possibilities. In this section some functions which are useful in business and
economics are discussed.

5.5.1 Demand Function

Demand is a function of price. For each price level of a good, there is a
corresponding quantity demanded that consumer will demand. If p is the
price per unit and � is the demand for a good, then demand function can be
written as:
x= f(p)
where � is dependent variable and p is the independent variable. Here, � and
p are positive because negative prices and quantity are meaningless.
Normally, there is a negative and linear relation between price and demand.

5.5.2 Supply Function

Supply is a function of price. For each price level of a good, there is a
corresponding quantity supplied by a producer. If p is the price per unit and �
is the supply for a good, then supply function can be written as:
x= g(p)
where � is dependent variable and p is the independent variable. Here, � and
p are positive because negative prices and quantity are meaningless.
Normally, there is a positive and linear relation between price and supply.

5.5.3 Cost Function

Total cost is the sum of fixed cost(FC) and variable cost(VC). Fixed cost is
the sum of all cost that is independent of the level of output, e.g., rent,
salaries of permanent workers etc. Variable cost is dependent on output. It
increases with an increase in output and vice versa.e.g., raw material, salaries
of temporary workers etc.
Let C be the total cost, then total cost function is defined as:
C= C(x),
93
Business Mathematics where � is the total units of output.

5.5.4 Revenue Function

Revenue function shows the relation between price of the commodity and
output sold. If �units of an output are sold at a price p per unit, then the total
revenue R(x) is given by
R(x) = x· p

5.5.5 Profit Function

Profit function is derived by considering profit earned and prices of inputs
and output. If R(x) and C(X) be the total revenue and total cost functions
respectively, then profitP(x) = R(x) – C(X), where P(x) = profit, and � is
units of output.
The point where revenue from sales is equal to the cost of production is
called as break-even point i.e., no profit, no loss point. In other words, profit
is equal to zero (i.e., total revenue is equal to total cost).

5.5.6 Consumption Function

It is proposed that consumption is the function of national income. If C
denotes total consumption in the economy and � denotes the total national
income, then
C= f(Y)
is called as the consumption function.
Example 13: A business man sells 2000 items per month at a price of Rs.10
each. It is estimated that monthly sales will increase by 250 items for each
Re. 0.25 reduction in price. Find the demand function corresponding to this
estimate.
Answer From the estimate, increases 250 units each time drops Re. 0.25
from the original cost of Rs.10. This is described by the equation
����
� = 2000 + ( �.�� )

= 1200 – 1000p
�
or, p= 12 - ����

Check Your Progress 4

1) What is a demand function?
2) How would you describe a revenue function?
3) How would you formulate a consumption function?

5.6 LET US SUM UP

In this unit we have discussed the mathematical functions used to study
economic and business themes. For that purpose, we started with a broad
understanding of function used to define relations between variables. A
variable � is called a function of � if for every value of � there is a definite
94
value of �. Coming to types of functions, we have tried to categorized these Mathematical
Functions
into algebraic (containing ordinary numbers, variables and operators like
addition, subtraction, multiplication and division) and transcendental (not
expressible as a finite combination of the algebraic operations). Thereafter we
have been exposed to the graphs of some important functions. There is a brief
preliminary discussion on application of functions in the themes of demand,
supply, cost, revenue, profit and consumption in the last section of the unit.

5.7 KEY WORDS

Algebraic: Expression or equation in which a finite number of symbols are
combined using only the operations of addition, subtraction, multiplication,
division, and exponentiation with constant rational exponents.
Asymptotic: A curve and a line that get closer but do not intersect.
Codomain:Set of all possible output values of a function.
Domain:Set of values of the independent variable(s) for which a function or
relation is defined.
Ordered Pair: Two elements, say, input and output(�, �), must follow the
ordering such that the input always comes first, and the output second in a
relation.
Parabola:A curve where any point is at an equal distance from a fixed point;
and a fixed straight line.
Range: All the output values of a function.
Rational Number: Number that can be represented as the ratio of
two integers.
Real Number: A value that represents a quantity along a number line.
Transcendental: A function which "transcends," i.e., cannot be expressed in
terms of algebra.
Vertex: A corner or a point where lines meet.

5.8 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
• Bhardwaj, R.S.,”Mathematics for economics and business”, Delhi:
Excel Books, 2005.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems ofMathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Archibald, G.C., Richard G.Lipsey. “An Introduction to A
mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984
• Yamane, Taro, “Mathematics for Economists: An Elementary
Survey”,New Delhi: Prentice Hall of India Private Limited, 1970.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002. 95
Business Mathematics
5.9 ANSWER/HINTS TO CHECK YOUR
PROGRESS
Check Your Progress 1
1) A function is a technical term used to define relations between
variables.
2) The set of all possible value of independent variable in a function is
called the domain of function and the set of all values of dependent
variable is called range of a function.
3) A function � has an inverse function only if for every � in
its range there is only one value of � in its domain for which �(�) = �.
4) Composite function implies applying one function to the results of
another.
5) Linear functions are functions with highest power 1.
6) Having the highest degree ‘2’.
7) Logarithmic and exponential functions are inverse of each other
8) Logarithms to the base 10 are called common logarithms and
logarithms to the natural base are called natural logarithms.
Check Your Progress 2
1) System that is composed of a horizontal line and a vertical line
perpendicular to each other.
2) By ordered pair of numbers known as coordinates.
3) Distance from vertical axis or �-axis (abscissa).
Check Your Progress 3
1) Do yourself after reading Sub-Section 5.4.1.1
2) Quadratic and cubic functions.
3) The logarithmic function goes slowly to positive infinity as the variable
increases and slowly goes to negative infinity as itapproaches 0.
Check Your Progress 4
1) Relation between quantity demanded and price of a commodity. It is
postulated that quantity demanded depends on price.
2) Revenue earned depends on price of the commodity sold.
3) By taking consumption as the dependent variable while income as the
independent variable.
4) Parabola has a vertical axis of symmetry and a turning point called
vertex.

5.10 EXERCISES WITH ANSWERS/HINTS

1) A business man sells 2000 items per month at a price of rupees10 each.
96 It is estimated that monthly sales will increase by 250 items for each
 Rs. 0.25 reduction in price. Find the demand function corresponding to Mathematical
Functions
this estimate.
2) Suppose the cost to produce some commodity is known to be linear.
Find cost as a function of output if costs are Rs. 4000 for 250 units and
Rs. 5000 for 350 units.
3) A garment manufacturer is planning production of new variety of t-
shirts. It involves initially a fixed cost of Rs. 1.5 lacs and a variable cost
of Rs. 150 for producing each shirt. If each shirt can be sold at Rs. 350,
then find: i) the cost function ii) the revenue function iii) the profit
function and iv) the break-even point
4) Suppose there is demand of 60 units of a product when its price is Rs.
18 per unit and 40 units when its price is Rs. 28 each. Find the demand
function, assuming that it is linear.
5) When the unit price of an item is Rs. 5, the daily supply will be 100.
When the price is increased to Rs. 10, the daily supply is found to be
200. Find the supply function, assuming that it is linear.
6) A company decides to set up a small production plant for
manufacturing electronic clocks. The total cost for initial set-up (fixed
cost) is Rs. 9 lakhs. The additional cost (i.e., variable cost) for
producing each clock is Rs. 300. Each clock is sold at Rs. 750. During
the first month, 1,500 clocks are produced and sold:
i) Determine the cost function C(x) for the total cost of producing x
clocks.
ii) Determine the revenue function R(x) for the total revenue from
the sale of x clocks.
iii) Determine the profit function P(x) for the profit from the sale �
clocks.
iv) What profit or loss the company incurs during the first month
when all the 1,500 clocks are sold?
v) Determine the break-even point.
7) A manufacturer earns Rs. 5500 in the first month and Rs. 7000 in the
second month. On plotting these points, the manufacturer observes a
linear function may fit the data.
i) Find the linear function that fits the data.
ii) Using your model make a prediction of the earning for the fourth
month.
8) A salesman earns Rs. 380 in the first week, Rs. 660 in the second week
and Rs. 860 in the third week. On plotting the points (1, 380), (2, 660)
and (3, 860), the salesman feels that a quadratic function may fit the
data.
i) Find the quadratic function that fits the data.
ii) Using the model make a prediction of the earning for the fourth
week.

97
Business Mathematics 9) A firm wants to launch a new product. It observes that the fixed cost of
the new product is Rs. 35000 and the variable cost per unit is Rs. 500.
The revenue function of the new product is 5000x – 100x2. Find i)
Profit ii) Break-even values iii) the values of � results in loss.
Answers
1) p= 12- x/1000; x>2000
2) C (x)= 10x +1500
3) i) C (x)= 150000 +150x;
ii) R(x) = 350x
iii) P(x) =200x – 150000
iv) 750
4) p = 48 -1/2 x.
5) p = 1/20 x.
6) i) C(x) = 9,00,000 + 300x
ii) R(x) = 750x
iii) 450x – 9,00,000
iv) P(1500) = - 2,25,000
v) x = 2,000
7) i) Take y = mx + c, where � denotes earnings, � denotes the months
and m and c are constants. From given data obtain,
5500 = m + c …1
7000 = 2m + c …2
Solve these to get, 1500 = m and c = 4000 and linear equation is
y = 1500x + 4000.
ii) Earning for the fourth month is
y = 1500 x 4 + 4000
= 6000 + 4000 = 10000
8) i) Let the quadratic function is
y= ax2 + bx + c
where y stand for earnings and � for weeks.
From above data to obtain
380 = a. 12 + b. 1 +c
660 = a. 22 + b. 2 +c
860 = a. 32 + b. 3 +c.
Solve these to get a= -40, b = 400 and c= 20.
Therefore, the required function is:
98
 y = -40 x2 + 400 x +20 Mathematical
Functions
ii) The predicated earning for the fourth week is:
y = -40 x 16 + 400 x 4 + 20
= Rs. 980.
9) i) Given R(x) = 5000x – 100x2 (revenue function)
C(x) = FC + VC (Cost Function)
= 35000 + 500x
P(x) = R(x) – C(x) (Profit Function)
= 5000x – 100x2 – (35000 + 500x)
= -100x2 +4500x -35000
ii) For break-even values, P(x) = 0
P(x)= -100x2 +4500x -35000 = 0
x2 – 45x + 350 = 0
(x-10)(x-35) = 0
x= 10,35
iii) For loss making values; P(x)<0
-100x2 +4500x -35000 < 0
i.e., (x-10)(x-35) > 0
This is possible if x<10 and x>35.

99
Business Mathematics
UNIT 6 LIMIT AND CONTINUITY
Structure
6.0 Objectives
6.1 Introduction
6.2 Limit of a Function
6.2.1 Properties of Limit
6.2.2 Some Standard Limits
6.2.3 Method of Factorization
6.3 Continuity
6.3.1 Properties of Continuity
6.4 Let Us Sum Up
6.5 Key Words
6.6 Some Useful Books
6.7 Answer or Hints to Check Your Progress
6.8 Exercises with Answer/Hints

6.0 OBJECTIVES
After going through this unit, you will be able to:
• Understand the concept of limit of a function and
• Explain the concept of continuous function.

6.1 INTRODUCTION
The present unit discusses two basic concepts, viz., limit and continuity,
which are adopted widely in differential calculus. We consider these two
themes together as the concept of a limit is closely connected to that
of continuity. We will see later that a function is continuous at a point, if
the limit exists at that point and is equal to the corresponding value of the
function.
Idea of Limits of Functions
When we discussed about functions in the preceding unit, we tried to see the
values of functions at specific points. For example, our concern was to
discern the value of f(x) if, say, x=1.
The idea behind limit is to analyze the value that function is "approaching"
when its input "approaches" a specific value. To appreciate underlying idea,
see the following Graph 1:

100
 Limit and Continuity

Fig. 6.1: Approximation of Limit

It may be seen that when � approaches the value "�" in the � axis, the
function �(�) approaches "�" in the � axis. Let us pay attention to the
hole at the point (�, �) given in the form of a small circle. Around that
area, we don't necessarily know the value of function � at � = �. That is,
we cannot work out the exact value of the function but can see what it
should be as we get closer and closer. Such a situation is expressed as
lim�→� �(�) = � .
� � ��
Example 1: Let us take a function�(�) = ���
and try to solve it for � = 1.
� � �� �
Plugging the value � = 1 into ���
we get �. There is a difficulty in the
�
solution obtained. We do not know the value as � is indeterminate.
Therefore, we need to find some other way toderive an answer.
Instead of working out for � = 1, we try approaching 1 closer and closer
in the following way:

� �� − 1
�−1
0.5 1.50000
0.9 1.90000
0.99 1.99000
0.999 1.99900
0.9999 1.99990
0.99999 1.99999

101
Business Mathematics � � ��
See that as � gets closer to 1, the value of ��� gets closer to 2. With such a
result, an interesting situation is obtained. For, when x=1, we don't know the
answer as it is indeterminate. But in another approach, we could see that it
is going to be 2. That is to say, we want to give the answer "2" but can't do
(� � ��)
so. Instead, we say, the limit of ��� = 2 as � approaches 1. Essentially, we
are saying, ignoring what happens when we get there, weknow of getting
closer and closer to 2 as � goes closer and closer to 1.
The Idea of Continuous Functions
Basically, we say a function is continuous when we can graph it without
lifting a pencil from the paper. Here's an example of what a continuous
function looks like Graph 2:

Fig. 6.2: Continuous Curve

If there is a break in the curve shown above in the graph, then the function is
not continuous. Intuitively, a continuous function indicates that small
changes in the input of the function would result in small changes in the
output.
We will return to see the precise definitions of limit and continuity concepts
introduced above.

Check Your Progress 1

1) What is the intuitive idea behind limit of a function?
2) List the commonly understood idea behind continuity of a function.
3) How would you like to explain the relation between limit and
continuity of function?

6.2 LIMIT OF A FUNCTION

We have seen above in the introduction section that a function may have a
limiting value as the independent variable approaches a particular real
number. This limiting value is known as a limit, provided it exists.
Symbolically,
lim�→� �(�) = �

102
Above equation implies that as � approaches �, the limit of �(�) equals �. Limit and Continuity
Here � approximately equals to � (i.e., � can be less than � or greater than �
but x≠ �).
To find out the limit, we need to work on the value of function for two
different values of � - one for � greater than c (right-hand limit) and other for
� less than c (left-hand limit) and verify whether both of these are equal or
not. The limit of a function will exist if and only if both left-hand and right-
hand limits are equal, i.e.,
If, lim�→�� �(�) = � and lim�→�� �(�) = �, then lim�→� �(�) = �
Example 2: Find out the limit of � � when � → 2.
Solution: To find out the limit, following tables are created with assumed
values of � and the corresponding values of �(�):
When � < 2,

� 1 1.4 1.7 1.8 1.9 1.99 1.995 1.999

f(�) 1 1.96 2.89 3.24 3.61 3.9601 3.98 3.996

When � > 2,

� 3 2.6 2.4 2.2 2.1 2.01 2.005 2.001

f(�) 9 6.76 5.76 4.84 4.41 4.0401 4.02 4.004

It is clear from above tables, when � is approximately equal to 2, the f(�) is

approximately equal to 4, i.e.,
lim�→�� � � = 4 and lim�→�� � � = 4
Therefore,
lim � � = 4
�→�

� � ��
Example 3: Find out the limit of f(�)= ���
when �→2.

Solution: when �<2 then �(�) equals

� 1 1.4 1.7 1.8 1.9 1.99 1.995 1.999

f(�) 1 3.4 3.7 3.8 3.9 3.99 3.995 3.999

When �>2, the f(�) equals

� 3 2.6 2.4 2.2 2.1 2.01 2.005 2.001

f(�) 5 4.6 4.4 4.2 2.1 4.01 4.005 4.001

It is clear from above tables, when � is approximately equals 2, the �(�) is

approximately equals 4.
lim�→�� �(�) = 4 and lim�→�� �(�) = 4
Hence,
lim �(�) = 4
�→�
103
Business Mathematics The method of finding limiting values of a function at a given point by putting the
values of the variable very close to that point may not always be convenient.
We, therefore, need other methods for calculating the limits of a function as
�(independent variable) tends to a finite quantity, say,�.
� � ��
Example 4: Find lim�→� �(�), �ℎ��� �(�) = ���

Solution:
We can solve it by the method of substitution,steps of which are as follows:
1) We consider a value of �close to,say,� = � +
ℎ,whereℎisaverysmallpositive number. Clearly, as �→�, ℎ → 0
� � ��
For �(�) = , we write � = 3 + ℎ, when � → 3 then ℎ → 0.
���

2) Simplify �(� ) = �(� + ℎ)

(���)� ��
Now, � (3 + ℎ) = (���)��

���� �����
= �

�� ���
= �

= ℎ+6
3) Putℎ = 0
�(3 + 0) = �(3) = 6
i.e., lim�→� �(�) = lim�→� (ℎ + 6) = 6.
In the above while defining limit we have seen a condition on existence of a limit. When
we say the limit does not exist, it means that the limit is either infinity or not
defined. In case of the limit of a function 'tends to infinity’, its value gets
arbitrarily larger. If it doesn't get closer to any value, the limit does not exist.
If the variable tends to a finite value, then the function must get closer to a
number as the variable gets closer to the finite value. Again, if it doesn't get
closer to any value, then the limit does not exist. It could be because the left-
and right-hand limits are not equal, or because they're equal to infinity.

6.2.1 Properties of Limit

If � be any constant and lim�→� �(�) then the following are true:
1) The limit of a constant is constant, i.e., lim�→� � = �, where k is
constant.
2) lim�→� ��(�) = � lim �(�)
�→�

3) The limit of a sum or difference is the sum or difference of the limits.

i.e., �lim [ �(�) ± �(�)� = lim �(�) ± lim �(�)
�→� �→� �→�

4) The limit of a product is the product of limits. i.e., lim [�(�). �(�)] =
�→�
lim �(�). lim �(�).
�→� �→�
104
 �(�) ��� �(�) Limit and Continuity
5) lim �(�) = �→�
��� �(�)
given, lim �(�) ≠ 0
�→� �→�
�→�

�
6) lim ��(�) = �� lim �(�) for all positive integer values of n
�→� �→�

7) lim � � = �� for all positive integer values of n

�→�

8) lim log[�(�)] = log[ lim �(�)]

�→� �→�

9) lim exp [�(�)] = exp[ lim �(�)]

�→� �→�

6.2.2 Some Standard Limits

� � ���
1) lim�→� ���
= ����� , � be positive integer

2) lim(1 + �)�/� = �
�→�
�� ��
3) lim �
= log � � (where a>0)
�→�
� � ��
4) lim �
=1
�→�
��� (���)
5) lim �
=1
�→�

Examples 5: Evaluate the following limits

1) lim 9
�→�

2) lim 3� �
�→�

3) lim( 5� � + 3� + 7)
�→�

4) lim [(� � + 4)(3� − 2)]

�→�

�� � � ���
5) lim ��� �
�→�

Solutions:
1) lim 9 = 9
�→�

2) lim 3� � = 3. lim�→� � � = 3. (2)� = 3 × 4 = 12

�→�

3) lim( 5� � + 3� + 7) = lim5� � + lim 3� + lim 7 = 5(2)2 + 3(2) + 7 = 33

�→� �→� �→� �→�

4) lim [(� � + 4)(3� − 2)] = lim (� � + 4). lim (3� − 2)

�→� �→� �→�

= [ lim � � + lim 4]. [ lim 3� − lim 2]= (1 + 4) (3 – 2) = 5

�→� �→� �→� �→�

�� � � ��� ��� (�� � � ���) �� ��� �

5) lim ��� �
= �→�
��� (� � � �)
= ���
= ��
=0
�→� �→�

Check Your Progress 2

1) Explain the left-hand and right-hand limit.

105
Business Mathematics 2) Is the limiting value of a function exist when left-hand limit is not equal
to the right-handlimit?
3) What is lim�→� ��(�) = � lim �(�)?
�→�
� � ��
4) What is value of lim �
?
�→�

6.2.3 Method of Factorization

If f(�) and g(�) are two functions such that lim�→� �(�) = lim�→� �(�) = 0
�(�) �
and we have to find lim�→� �(�), then we obtain a � form, which is
�
meaningless. Note that �is called as indeterminate form. Other indeterminate
form is ±∞/±∞. Such limits are solved by method of factorization.
� � ������
Consider the example lim�→� � � ����� , as �→5, both numerator and
denominator approach zero. This is an indeterminate form. In such case, we
follow the following steps:
1) Factorise�(�) and �(�)to get,
� � − 3� − 10 (� + 2)(� − 5)
lim = lim
�
�→� � − 6� + 5 �→� (� − 1)(� − 5)

2) Simplify the equation

(� + 2)(� − 5) (� + 2)
lim = lim
�→� (� − 1)(� − 5) �→� (� − 1)

3) Putting the values of �, we get

(� + 2) 7
lim =
�→� (� − 1) 4
√����√���
Example 6: Evaluate lim�→� �

Here, we do the following steps:

Step 1. Rationalise the factor containing square root.
Step 2. Simplify
Step 3. Put the value of � and get the required result.
√����√���
Solution: given, lim�→� �

√����√��� √����√��� √����√���

Rationalising,lim�→� �
= lim�→� �
x
√����√���
� �
√��� �√���
= lim�→� ��√����√����
�������
=lim�→� ��√����√����
��
=lim�→� ��√����√����
�
=lim�→� �
√����√����
106
Putting the value � = 0, we get Limit and Continuity

2 2 2
lim = = =1
�→� �√1 + � + √1 − �� √1 + 0 + √1 − 0 2
�� � �����
Example 7: Evaluate lim�→� ��� �����

Solution: As � approaches ∞, both the numerator and denominator approach

�
∞.Therefore, the given function takes the indeterminate form �. However, we
can change the form of the quotient so that a conclusion can be drawn as to
whether or not it has a limit. This is done by dividing both numerator and
denominator by the highest power of � that occurs in the denominator. Thus,
dividing both the numerator and denominator by x3, we get
� � �
2� � + 5� + 1 + �+ �
lim � = lim � �� ��
�→� 3� − 2� + 4 �→� 3 − + �� ��
� � �
����→� � ��� � � ��� �
= � �→��
�
�→��
�
��� �� ��� � � ��� �
�→� �→�� �→��

����� �
= ����� = � = 0
�
Example 8: For the demand function � = ��� (where � is price, � is
quantity demanded and � and � are constants), show, by using the concept of
limit, that the demand increases to infinitely large amount as the price falls.
Also, show that total revenue reaches a limiting value as the quantity demand
increases.
�
Solution: Given, � = ���

Rearranging equation,
�
� = − �
�
Putting the limit � → 0,
�
lim�→� � = lim [� − �] = ∞
�→�

Therefore, demand approaches ∞, when price approaches 0

� ��
Now, �� = �� = �[���] = ���
�� �
lim�→� ��= lim = lim � =�
�→� ��� �→� ��
�

Thus, �� reaches a limiting value ‘�’ as quantity demanded increases.

Check Your Progress 3

1) Explain the indeterminate forms of limit.
2) What is the limiting value of constant when � approaches �?
3) When would you like to use factorization method of finding the limit of
a function?
107
Business Mathematics
6.3 CONTINUITY
We have seen above in the introduction section that a function is said to be
continuous if the graph of the function has no breaks, i.e., if its graph can be
drawn without lifting pencil off the paper. The graph of a continuous function
and discontinuous function are given below:

a: Continuous function b:Discontinuous function

Fig. 6.3: Continuous and Discontinuous Function

In other words, a function is continuous if minor changes in the independent

variable generate minor changes in the function values. Mathematically, a
function � is said to be continuous at � = � if
i) the function is defined at � = �, and
ii) lim�→� �(�) = �(�), �. �, lim�→�� �(�) = lim�→�� �(�) = f(c)
If �(�) is continuous for every value of � in its domain, it is said to be
continuous throughout the interval.
A function, which is not continuous at a point, is said to have a discontinuity
at that point.
A function � is a continuous over an interval (�, �) if it is continuous at every
point within the interval.
Example 9: Examine the continuity of the function �(�) = � − � at � = �
Solution: Put � = � + ℎ,so that when � → � then ℎ → 0. Now,
lim �(�) = lim �(� + ℎ)and at � = �,
�→� �→�

lim �(� + ℎ) = lim ((� + ℎ) − �)

�→� �→�

= 0
Also, �(�) = � − � = 0
Hence, �(�) = ��� �(� + ℎ) = 0
�→�

Thus �(�) is continuous at � = �.

6.3.1 Properties of Continuity

1) �(�) = � (constant) is continuous for all real number�.
2) �(�) = � � ,� is natural number, is continuous for all real number �.
108 3) polynomial functions are continuous for all real numbers.
4) If �(�) and �(�) are two continuous function then, �(�) ± �(�) are Limit and Continuity
also continuous. i.e., sum and difference of two continuous functions
are also continuous.
5) If �(�) and �(�) are two continuous function, then �(�)x �(�) is also
continuous. i.e., product of two continuous functions is also continuous.
6) If �(�) and �(�) are two continuous function, then �(�)/�(�) is also
continuous (provided �(�) ≠ 0), i.e., quotient of two continuous
functions is also continuous.
Example 10: A function �(�) is defined as
� + 1, �� − 1 ≤ � < 0
�(�) = � �, �� 0 ≤ � ≤ 1
2 − � �� 1 ≤ � ≤ 2
Show that it is discontinuous at � = 0 but is continuous at � = 1.
Solution: When � = 0,we get
�(0) = 0
lim �(�) = lim � = 0
�→�� �→��

lim �(�) = lim (� + 1) = 1

�→�� �→��

Since, lim�→�� �(�) ≠ lim�→�� �(�),� is not continuous at � = 0.

When � = 1,
�(1) = 1. Now,
lim �(�) = lim�→�� (2 − �) = 2 − 1 = 1;
�→��

lim �(�) = lim � = 1.

�→�� �→��

Since lim �(�) = lim �(�) = 1 = �(1),

�→�� �→��

� is continuous at � = 1.
Example 11: Find the points of discontinuity of the function
2� � + 6� − 5
12� � + � − 20
Solution: The given function will be discontinuous at the point where
denominator is equal to zero. i.e.,
12x2 + x – 20 = 0
or, 12x2 + 16x -15x – 20 = 0
or, 4x (3x + 4) -5 (3x + 4) = 0
or, (4x – 5) (3x + 4) = 0. So
� �
x = �or, − �
which are the points of discontinuity.
Example 12: Examine the continuity at � = 0 of the function �(�) defined
as under: 109
Business Mathematics �
�(�) = � at x≠0
�� � �

= 0 at x = 0
��� �
Solution: R.H.L. lim�→�� �(�) = lim�→� � = lim� →� � =0
�� � � �� � �
��� ��
L.H.L. lim�→�� �(�) = lim�→� �
� = lim� →� �
� =0
�� � � �� � �

Also, f(0) =0
Since R.H.L. = L.H.L = 0 = f(0), the given function is continuous at � = 0.
Example 13: A function is defined as under
� � � ����
� = �(�) = ���

i) Evaluate the limit of y when � → 4

ii) Is the function continuous at � = 4? why?
Solution: Given the function,
� � − � − 12
� = �(�) =
�−4
i) Applying the limit at � = 4, we get
� � − � − 12 (� − 4)(� + 3)
lim � = lim �(�) = lim = lim
�→� �→� �→� �−4 �→� �−4
lim(� + 3)
= =4+3=7
�→4

ii) At � = 4, function is evaluated as

� � � ���� �� � ���� �
� = �(�) = ���
= ���
= �
(Not defined)

Since, the function y is not defined at � = 4, the function is not continuous at

� = 4.
Example14: A shopkeeper charges Rs. 25 per item for buying 20 or less
items. He gives some rebate if items bought are more. If the items bought are
50 or less, then a rebate of Re. 1 per item and for purchase of more than 50
items, rebate of Rs. 2 per item. Find the cost function. What are the points at
which this is not continuous?
Solution: let ‘x’ denotes the number of items then the cost function C(x) is
shown as
25� 1 ≤ � ≤ 20
C(x) = � 24� 20 < � ≤ 50
23 � � > 50
At x = 20,C(20) = 25 x 20 = 500
L.H.L = lim�→��� �(�) = lim�→��� �(20) = lim�25� = 25�20 = 500 (left
�→��
hand limit)
R.H.L = lim�→��� �(�) = lim�→��� 24� = 24 �20 = 480 (right hand
110 limit)
Since, LHL ≠ RHL,the function C(x) is not continuous at x = 20-0 Limit and Continuity

At x = 50, C(50) = 24 x 50 = 1200

L.H.L = lim�→��� �(�) = lim�→��� �(50) = lim� 24� = 24 �50 = 1200
�→��
(left hand limit)
R.H.L = lim�→��� �(�) = lim�→��� 23� = 23 �50 = 1150 (right hand limit)
Since, LHL ≠ RHL, the function C(x) is not continuous at x = 50.
Therefore, the function is discontinuous at x = 20 and x = 50.
Example 15: Anelectric company charges from its customers the following
amount for services: Rs. 5 for first 20 kilowatt hours or less, 25 paise per
kilowatt hour for the next 80-kilowatt hours and 10 paise per kilowatt for any
hours above 100 kilowatt hours. If x is the number of kilowatt hours, express
the total cost C as a function of x. Also test the continuity of �at x = 20 and
x = 100.
Solution: Given,
5, �� � ≤ 20
�
�5 + 1 ( � − 20), �� 20 < � ≤ 100
�(�) = 4
�
� 25 + 1 �(� − 100) , �� � > 100
� 10
At x = 20, C(20) = 5
L.H.L = lim�→��� �(�) = lim�→��� 5 = 5
�
R.H.L = lim�→��� �(�) = lim�→��� 5 + �
( � − 20) = 5
Hence, lim�→�� �(�) = 5 = �(20)
Therefore, the �(�) is continuous at x =20.
Similarly, we can show that � is continuous at x = 100.

Check Your Progress 4

1) Explain continuous and discontinuous functions.
2) Are polynomial functions continuous for all real numbers?
3) Construct a function that is discontinuous at � = 0 but is continuous at
� = 1.

6.4 LET US SUM UP

In this unit we have been exposed to the concepts of limit and continuity of a
function. We have learnt that the intuitive idea of a limit is one of analyzing
the value which a function is "approaching" when its input "approaches" a
specific value. On the other hand, we say a function is continuous when we
graph it without lifting the pencil from the paper. That is, to be qualified as a
continuous function, it should not have breaks. With such a feature in place, a
continuous function indicates that small changes in the input of the function
would result in small changes in the output. Along with these, we have been
told the properties of limit of a function.
111
Business Mathematics Discussing the formal definition of limit of a function, we learnt that the
limiting value is known as a limit, provided it exists. To understand such a
concept, we need to find out the limit of a function from two different sides
called right-hand limit and left-hand limit. Once computing these, we have to
proceed for verifying whether both of them are equal. For, the limit of a
function would exist if and only if both left-side and right-side limits are
equal. We also learnt the method of finding limit through factorization when
the value of a function attains indeterminate form.
Coming to the concept of continuity we have seen that a function � is said to
be continuous at � = � if conditions
i) the function is defined at � = �, and
ii) lim�→� �(�) = �(�), �. �, lim�→�� �(�) = lim�→�� �(�) = f(�) are
satisfied. We have been also showed the properties of a continuous
function.

6.5 KEY WORDS

Continuity:A function f(x) is continuous provided its graph is continuous.
More formally, a function f(x) is said to be continuous at x = a, provided
����→� �(�) exists, finite and is equal to f (�).
Indeterminate Forms:whose limit cannot be determined solely from the
limits of the individual functions.
Limit: Value that a function (or sequence) "approaches" as the input
"approaches" some value.
Method of Factorization:It is a technique to finding limits that works by
cancelling out common factors. It is normally used to transform an
indeterminate form into one that allows for direct evaluation.
Method of Substitution:is a method of determining limits where the
approaching value is substituted into the function and the result is evaluated.
Natural Number: Those used for counting.
Real Number: A continuous quantity that can represent a distance along a
line. Thus, the real numbers include all the rational numbers, such as the
integer −5 and the fraction 4/3, and all the irrational numbers, such as √2.
Real Valued Function: whose values are real numbers.

6.6 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London, English
Language Book Society and Macmillan, 1974.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.

112
 Limit and Continuity
6.7 ANSWER/HINTS TO CHECK YOUR
PROGRESS
Check Your Progress 1
1) Value that a function approaches as the input approaches some value.
2) When we can graph a function without lifting a pencil from the
paper.
3) A function �(�) is continuous at a point �� if the limit exists at �� and
is equal to �(�� ).
Check Your Progress 2
1) For RHS limit, value of a function is just greater than the limit
whereasfor LHS limit, value of a function is just less than the limit.
2) no
3) It is a property of limit of a function.
4) 1
Check Your Progress 3
� �
1) the value of the equation is of the form of �
��� �
.
2) Constant
�
3) In cases of functions with two indeterminate forms viz., 0/0 and �.

Check Your Progress 4

1) A function f is a continuous over an interval (�, �) if it is continuous at
every point within the interval, otherwise discontinues.
2) Yes
3) See the discussion given in Sub-Section 6.3.1 and answer.

6.8 EXERCISES WITH ANSWER/HINTS

1) Find the limit of the following functions:
a) lim�→� 7
b) lim �
�→�

c) lim(3� + 4)
�→�

d) lim(3� � − 2� � + 4� � + 5� − 7)
�→�

e) lim [(� � + 5)/(� − 1)]

�→�
�� � � ���
f) lim [��� � ����]
�→�
�� � � �� � � �
g) lim [��� � � �����]
�→�

113
Business Mathematics 2) Discuss whether the following functions are continuous or not:
a) lim(2� � − 3� + 5)
�→�

b) lim [(� � − 7)/(� + 3)]

�→�

3) Examine the continuity at x = 0 for the following function

�� �/�
, �� � ≠ 0
f(x) = ���� �/�
0 , �� � = 0
� � � ����
4) Given, y = f(x) = ���

a) Evaluate the limit of � as � → 5.

b) Is this function continuous at � = 5? Why?
5) Discuss the continuity of the function �, where
� + 2, ��� � < 1
4� − 1 , ��� 1 ≤ � ≤ 3
f(x) = �
� � + 5, ��� � > 3

Answers:
1) a) 7 b) 0 c) 13 d)3 e) 9 f) 2/3 g) -2/5
2) a)continuous b)continuous
3) continuous
4) a) 4 b) No, since it is not defined at � = 5.
5) Continuous at � = 1, discontinuous at � = 3.

114
 Concept of
UNIT 7 CONCEPT OF DIFFERENTIATION Differentiation

Structure
7.0 Objectives
7.1 Introduction
7.2 Differentiation by First Principle
7.3 Rules of Differentiation
7.4 Standard Derivatives
7.5 Differentiation of Implicit Functions
7.6 Differentiation using Logarithms
7.7 Derivative of Inverse Function
7.8 Differentiation of Parametric Function
7.9 Let Us Sum Up
7.10 Key Words
7.11 Some Useful Books
7.12 Answer or Hints to Check Your Progress
7.13 Exercises with Answer/Hints

7.0 OBJECTIVES
After studying this unit, you will be able to:
• understand the concept of derivative, its meaning,
computation and interpretation;
• comprehend several rules for calculating derivatives; and
• use logarithm in differentiation.

7.1 INTRODUCTION
The rate of change of one variable of function with respect to another on
which it depends is called the derivative of the function. Differentiation is the
process of the finding out the derivative of a continuous function. A
derivative is the limit of the ratio of the small increment in one variable of
the function corresponding to a small increment in the argument (other
variable) as the later tends to zero.

7.2 DIFFERENTIATION BY FIRST PRINCIPLE

Differentiating a function from "first principles" means we start from scratch
and use algebra to find a general expression for the slope of a curve, at any
value x. To appreciate the underlying idea, we start with some general idea of
the concept.

115
Business Mathematics Let � = �(�) be a function defined in an interval (�, �). Let � = � be any
point of the interval, so that �(�) is the corresponding value of the function.
Let( � + ℎ) be any other point of this interval which lies to the right or left of
� according as ℎ is positive or negative. The corresponding value of the
function is �(� + ℎ). Then �(� + ℎ) − �(�) is the change in the dependent
variable � corresponding to the change ℎ in the independent variable �.
�(���)��(�)
Consider the ratio: �
of these two changes whichis a function of ℎ
and is not defined for ℎ = 0, � being a fixed point.
Definition: A function � = �(�) is said to be differentiable at � = � if
��� f(c + h) − f(c)
h �� 0
h
exists and the limit is called the derivative of the function �(�) at � = �. it is
denoted by �’(�) or �� (�).
Steps
1) Put the given �(�) equal to � i.e.,
� = �(�) (1)
2) Increase � by a small quantity ∆� and corresponding increase in ∆�
So � + ∆� = �(� + ∆�) (2)
3) Subtracting (1) from (2)
� + ∆� − � = �(� + ∆�) – �(�)
or, ∆� = �(� + ∆�) − �(�)
4) �ividing both sides by ∆�
Δ� �(� + ∆x) − f(x)
=
Δ� ∆x
���
5) Put ∆x �� 0 both sides such that
��� �� ��� �(��∆�)� �(�)
∆x �� 0 �� = ∆ x �� 0 ∆�

Expression on LHS represents the derivative which is the instantaneous rate

of change in the dependent variable corresponding to a change in the
independent variable. The function is differentiable only if the limit exists
and the function must be continuous at that point.

Check Your Progress 1

1) What is derivative of a function?
2) When would you say that a function is differentiable?
3) What do you mean by differentiation from first principle?

7.3 RULES OF DIFFERENTIATION

In this section, we will discuss the rules and properties for finding derivatives
for different kinds of functions. Importantly, we will learn the Product Rule
116
and the Power Rule that offer shortcuts to differentiation. See the Concept of
Differentiation
accompanied figure for computing important derivatives.

Fig. 7.1: Rules for Computing Derivatives

Rule 1:Constant function rule

Derivative of a constant is zero.
That is, if � = �(�) = �, then
��
��
=0

If Y= constant, Y will not change for any value of X

Example1:Find the derivative of the following functions:
i) y=8
ii) y = 6000c
iii) y = 5/6
Solution:i) y = 8
��
=0
��
(ii) y = 6000c
��
��
=0

(iii) y = 5/6
��
��
=0

Rule 2: Power Function Rule

�
If� is any real number, and � = �(�) = � � , then �� � � = � � ���

Derivative of Power function= powerx coefficientx Variablepower-1

117
Business Mathematics Example 2:
i) y= x3/2

�
�� � �
Solution: ��
= � � ��� = � x1/2

ii) y=x

��
Solution: ��
= 1. ���� = 1
�
iii) y=
√�

Solution: y = x-1/2
� �
�� � �
��
= − � � ���� = − � � ��

iv) y = 2 x6

��
Solution: ��
= 2.6 x6-1

=12 x5
�
v) y = �.x 2/3

�
�� � � ��
Solution: �� = . � ��� =
� � �
. x -1/3
���
vi) y= �
√�

Solution: y= 100. � ��/�

�
�� �
��
= 100. - � � ����
���
=- �
x -4/3

Rule 3: The Linear Function Rule

The derivative of a linear function, � = �� + �,is equal to �, the
coefficient of �.
��
If � = �� + �, then �� = � � � + 0
��
That is, �� = �

Example 3:
If � = 3� + 7, then ��/�� = 3 + 0
or,dy/dx = 3
The derivative of a linear function, � = �� + � = ����������� �� �.
Rule 4: Rule of Sums and Differences

118
If f and g are differential functions, and Concept of
Differentiation
� (�) = � (�) ± � (�) then, we have:
�’(�) = �’(�) ± �’(�)
The derivative of a sum or a difference of two functions is the same as
the sum or difference of their individual derivatives.
Example 4:
i) y = x8 + x2/3
Solution:
�� � � � �
= .� + . ��
�� �� ��
�
�� � �
or, �� = 8. � ��� + � . � ��� = 8. � � + � . � ��/�

ii) y= 3x3 + 4x2 -5x + 5

Solution:
�� � � � �
��
= �� . 3 x3 + ��. 4x2- ��.5x+��.5

= 3.3 x3-1 + 4.2 x2-1 - 5 x1-1 + 0

= 9x 2+8x –5

��� �
iii) y= �

Solution:
�� � �� + 1
= � �
�� �� �

� �� � �
= �� . �
+ �� . �

� � �
= �� � � + �� . �

� �
= �� � � + �� � ��

= 2x - x-2
�
= 2x - � �

Rule 5: The Product Rule

The derivative of a product, � = �(�). �(�) is equal to the first function
multiplied by the derivative of the second function plus the second
function multiplied by the derivative of the first function, i.e.,

119
Business Mathematics � � �
[ �(�). �(�)] = �(�). [�(�)] + �(�). [ �(�)]
�� �� ��
�
or,�� [ �(�). �(�)] = �(�). [�′(�)] + �(�). [ �′(�)]

Example 5:
i) y = 5x4(3x − 7)
Solution:
� � �
[5� � (3� − 7)] = 5� � . [3� − 7] + (3� − 7). [5� � ]
�� �� ��
��
or, �� = 5� � . 3 + (3� − 7). 20� �
��
or, �� = 15x4+ 60x4- 140x3
��
or, �� = 75� � − 140� �

ii) y= (4x3 – 5x +7)(3x4 -2x3+2)

Solution:
�
[(4x � – 5x + 7). (3x � − 2x � + 2)]
��
�
= (4x � – 5x + 7). [(3x � − 2x � + 2)]
��
�
+ (3x � − 2x � + 2). �� (4x � – 5x + 7
��
��
= �4x � – 5x + 7�( 12x� − 6 x � ) + (3x � − 2x � + 2). (12 x � − 5)

= 84 x6 -48 x5 – 75 x4 +120 x3 -18 x2 -10

Rule 6: The Quotient Rule
�(�)
The derivative of the given expressionis y= �(�) equal to the denominator
times the derivative of the numerator, minus the numerator times the
derivative of the denominator, all divided by the square of the
denominator (where g(x)≠0). i.e.,
� �
� �(�) �(�). �� �(�) − �(�) �� �(�)
� �=
�� �(�) [�(�)]�
� �(�) �(�). ��(�)� �(�) ��(�)
i.e., �� ��(�)� = [�(�)]�

Example 6:
Find dy/dx from
����
i) y= ���

120
 Solution: Concept of
Differentiation
� �
�� (� − 1) �� (2� + 1) − (2� + 1) �� (� − 1)
=
�� (� − 1)�
(���)(�)� (����)(�) ��
= (���)�
= (���)�

� � �� � ��
ii) y= � � ��

Solution:
� � � � � � � �
�� (� + 1) �� (� − � + 1) − (� − � + 1) �� (� + 1)
=
�� (� � + 1)�
�� � ������� ����� ��� �� � ��� (��) � � ��� � ���
= (� � ��)�
= (� � ��)�

Rule 7:Chain Rule

The derivative (��/��) of a functionof a function, � = �(�), where
� = �(�), is equal to the derivative of the first function with respect to �
times the derivative of the second function with respect to �. i.e.,

�� �� ��
= .
�� �� ��

��
Example 7: Find �� of the following

i) if y = u2 and u = 2x3+ 5x + 1
Solution:
�� � �
= �
�� ��
��
or, ��
= 2�

�� �
����, = . (2� � + 5� + 1)
�� ��
��
or, �� = 6� � + 5
�� �� ��
or, �� = �� ��
. = 2u. (6x2 +5)2
��
Putting the value of u in �� ,

��
= 2(2� � + 5� + 1). (6� � + 5)
��
ii) y= 4u3 and u = 12x2 + 5
Solution:
dy/du = 12u2
du/dx = 24x
So, dy/dx = 12u2(24x) 121
Business Mathematics or, dy/dx = 288xu2
putting the value of u in dy/dx,
dy/dx= 288x(12x2+5)2

iii) y= √� and u= 5 + 7x + x3
Solution:
�� � �
= . ��
�� ��
�
�� �
or, �� = �
. � ��
�� � ��
��� ��
= ��
. (5 + 7� + � � ) or, �� = 0 + 7 + 3� � = 3� � + 7
�
�� �� �� �� �
Thus, �� = �� . �� or, �� = �� . ��� � . (3� � + 7 )
��
������� �ℎ� ����� �� � �� �� ,

�� 1 �
= � . (5 + 7� + � � )�� � . (3� � + 7 )
�� 2
�� (�� � � � )
��, �� =
��(����� � � )

Note: The chain rule is particularly helpful in finding the derivative of

quantities raised to powers, as the derivative of [�(�)]� . Let � = �� and
� = �(�). Applying the chain rule, we obtain,
�� �� ��
��
= �� . �� = ����� . �’(�)

�
Therefore, �� . [�(�)]� = � [�(�)]��� . �(�)

(����)�
iv)
(����)�

Solution:
(����)� ����
Let y = (����)� . Then � can be written as � = �� , where � = ����
.

Thus, by chain rule,

�� �� ��
= .
�� �� ��
��
Now,�� = 4��
�� � ����
Also, �� = .
�� ����
.

122
 Applying quotient rule, Concept of
Differentiation
�� (5� − 7)(2) − (2� + 5)(5)
=
�� (5� − 7)�
�� (10� − 14) − (10� + 25) −39
⇒ = �
=
�� (5� − 7) (5� − 7)�
�� ���
Thus, �� = 4�� . (����)�

Putting the value of u,

�� 2� + 5 � −39 (2� + 5)�
= 4( ) . = −156
�� 5� − 7 (5� − 7)� (5� − 7)�

Check Your Progress 2

�
1) Find �� (3� + 5)

2) Compute is the derivative of xn

3) What is the Product Rule?
4) Using chain rule differentiate � = (3� + 1)� .
5) What is quotient rule of differentiation?

7.4 STANDARD DERIVATIVES

Logarithmic and exponential functions are the most commonly used
functions after algebraic functions. The standard derivatives of
logarithmic and exponential functions are given below:
i) Derivative of logarithm function
If y = log x
�� �
then,�� = �

(When base of the log is not mentioned, it is taken as e)

ii) Derivative of exponential function
If y = � �
then,dy/dx= � �
iii) Derivative of ax, where a is constant
If y = ax
then, dy/dx = ax. logea

123
Business Mathematics
Note:the chain rule is also useful in finding the derivative of y = log u and
y = eu where u is an appropriate function of x. then we can find
differentiation by applying chain rule. For example, if y = log u and u=
f(x), then
�� �� �� 1 ��
= . = .
�� �� �� � ��
and if y = eu, u = f(x)
�� ��
= ��
�� ��

Example 8:
��
Find �� of the following

i) y = log (5x2 + 7)
Solution: This function is of the form y = log u, where u = 5x2 + 7.
Thus,
�� 1 � �
1
= . (5� + 7) = . (10�)
�� 5� � + 7 �� 5� � + 7
10�
=
5� � + 7
ii) y = x2 log (3x + 7)
Solution: applying product rule
�� � �
= �� ���(3� + 7) + log(3� + 7) � �
�� �� ��
�� � �� �
or, �� = � � ������ (3) + log(3� + 7). (2�) = ���� + 2� log(3� + 7)

� �����
iii) y = � ��
Solution:
�� � ����� � � �����
��
= � �� ��
. (5� � + 4� + 8) = � �� (10� + 4)

��� �
iv) y= ��

Solution: Applying the quotient rule,

� � �
�� ��. .(��� �)���� � . �� � � � � .� ����� � .�� ������� � ��� ��� �
= ��
��
��
= �
= =
�� �� �� ��

v) y = x3 + 8x + log x
�� � � � �
Solution: �� = ��
�� + ��
8� + ��
log � =3� � + 8� log � � + �

124
 Concept of
Check Your Progress 3 Differentiation
1) Find the derivative of �(�) = 5�
2) What is the derivative of � = 3� � + 2� � ?
����
3) Differentiate �(�) = �� (�)

7.5 DIFFERENTIATION OF IMPLICIT

FUNCTIONS

Given a relation �(�, �) = 0, if it is not possible to express � in terms of �

or vice-versa, then that relation is called an implicit function. To determine
��/�� in such an equation, we differentiate both sides of the equation and
obtain an expression for ��/�� from resulting equation. The method is best
illustrated with the help of following examples:
Example 9: Find ��/�� of the following:
i) �3 + �3 = ��
Solution: By treating � as a function of � and differentiating both sides
with respect to x, we get
� � � � �
(� ) + (� ) = (��)
�� �� ��

�� ��
��, 3� � + 3 � � . = �. + �
�� ��

�� ��
Rearranging,3� � �� − � �� = � − 3� �
��
or, (3� � − �) �� = � − 3� � .

�� � − 3� �
�ℎ��, =
�� 3� � − �

ii) ax2 + 2hxy + by2 + 2gx + 2fy +c = 0

Solution: differentiating both sides with respect to (w.r.t.) x, we get,

� � � � � � �� �
�. (� ) + 2ℎ (��) + � (� ) + 2� (�) + 2� + �
�� �� �� �� �� ��

�
= 0
��

�� �� ��
or, 2�� + 2ℎ � � �� + �� + 2�� ��
+ 2� + 2� �� + 0 = 0

��
or, ��
(2ℎ� + 2�� + 2�) + ( 2�� + 2ℎ� + 2�) = 0
125
Business Mathematics ��
or, �� (2ℎ� + 2�� + 2�) = − ( 2�� + 2ℎ� + 2�)
�� �( ����������) �������
or, �� = ����������
= − �������

iii) ��1 + � + �√1 + � = 0

Solution:Rearrange the equation

��1 + � = − �√1 + �

Squaring both sides, we get

x2 (1 + y) = y2 (1+ x)

or, x2 + x2y = y2 + y2x

or, x2 - y2 + x2y - y2x = 0

or, (x-y) (x+y) + xy (x-y) = 0(as x2 - y2 = (x-y)(x+y))

or, (x - y)(x + y + xy) = 0

or ( x + y + xy) = 0

(because � ≠ � �ℎ�� � − � ≠ 0

Now, differentiating both sides,

�� � �
= �− ( )�
�� �� 1+�
�� (���).���.� �
or, ��
= − (���)�
= − (���)�

Check Your Progress 4

1) How to differentiate an implicit function?
��
2) Find �� , if you have 3x+2y=4
�� �
3) Explain the method of finding �� , if given � � = 1

7.6 DIFFERENTIATION USING LOGARITHMS

The method of logarithm differentiation is used to differentiate functions of
the form � = �(�) �(�) . With the help of this method, take natural log on
both sides of the equation � = �(�) �(�) to obtain ��� � = ��� [�(�) �(�) ].
By using the properties of logarithm, we simplify the equation �� � =
��� [�(�) �(�) ] and then differentiate both sides with respect to � and then
solve for ��/��. This method can also be used to differentiate functions
which are the product of several functions.

126
 Concept of
Differentiation
Note:Important properties of logarithm
log (m.n) = log m + log n
log ( m/n) = log m - log n
log (mn) = n log m
log (ex) = x
log e = 1

Example 10: Find dy/dx:

i) y = xx
Solution:
Taking log on both sides of the equation y = xx, we get
log y =log [ xx]
logy= x log x
Differentiating both sides of the equation,
1 �� � �
=� (log �) + log � �
� �� �� ��
� �� �
or, � �� = �. � + log �
� ��
or, � �� = 1 + log �
��
or, �� = � ( 1 + log �).
��
Putting the value of y, ��
= � � ( 1 + log �)

(���)�� (���)(���)
ii) �= (���)�

Solution: Taking log on both sides of the given equation,

(���)�� (���)(���)
log � = log � (���)�
�

log y = log (x+1)10 + log (x+5) + log (x+6) – log (x+7)2

log y =10 log (x+1) + log (x+5) + log (x+6) – 2 log (x+7)
Differentiating both sides w.r.t.�, we get,
1 �� 10 1 1 2
. = + + −
� �� � + 1 � + 5 � + 6 � + 7
�� �� � � �
or, ��
= �. ���� + ��� + ��� − ����
(���)�� (���)(���) �� � � �
=� (���)�
� . ���� + ��� + ��� − ����

127
Business Mathematics iii) xy = yx
Solution: Taking log on both sides
log xy = log yx
y log x = x log y
Differentiating w.r.t.�, we get
� �� � �
�. log � + log � = �. ���� + ���� �
�� �� �� ��
� �� � ��
or, �. � + log � �� = �. � �� + log �
�� � �� �
or, log � �� − �. � �� = log � − �
� �� �
or, �log � − �� �� = log � − �
[� ��� ���] �� � ��� ���
or, � ��
= �

�� � ��� ��� �
or, �� = ���� ��� . �

iv) y = (3x2+5)1/x
Solution:Take log on both sides to get
log y = log (3x2+5)1/x
�
log y = � log (3x2+5)

Differentiating both sides w.r.t.�

� �� � � � �
� ��
= � . �� log(3� � + 5) + log(3� � + 5). �� . �
� �� �
or, � ��
= � . (6�) + log( 3� � + 5) . (−� �� )

� �� ���( �� � � �)
or,� �� = 6 − ��

�� ���( �� � � �)
or,�� = �. �6 − ��
�
�� ���( �� � � �)
or, �� = (3x2+5)1/x �6 − ��
�

Check Your Progress 5

1) When would you prefer differentiation using logarithms?
2) Explain the steps you would follow to differentiate the function
��
� = (�����)√�� .
��

3) Simplify the natural logarithm of 10x?

128
 Concept of
7.7 DERIVATIVE OF INVERSE FUNCTION Differentiation

Let � = �(�) be a function of � and suppose that we can solve this equation
for � in terms of �.So, we may write � as a function of �, i.e., � = �(�).
Then �(�) is called the inverse of �(�). If � = �(�) is a differentiable
function at � such that �’ (�) ≠ 0, then � = �(�) is also differentiable at
�� �
the corresponding value of � and �� = �� .
��

Example 11:Find ��/�� from the following

����
i) � = ���
,

Solution: Differentiating � w.r t. �

�� (� + 1)(3) − (3� + 2). 1
=
�� (� + 1)�
�� 1
=
�� (� + 1)�
�� 1 1
= = � = (� + 1)�
�� ��/��
(���)�

ii) � = (� + 2)�/�
Solution: Differentiating � w.r t. �
�� � �
= (� + 2)�
�� ��
�
�� �
or, ��
= � . (� + 2)�� . 1
�� �
or, �� = �
�(���)�
�� �
or, �� =
��(���)

�� �
or, �� = ��/�� = 2�(� + 2)

Check Your Progress 6

1) What is an inverse function?
�
2) Prove that derivative of � = � �� (�) with respect to � is �� (�)

3) If � = �(�) is a differentiable function at � such that �’ (�) ≠ 0, and

�� �
��
= �� , you are dealing with what kind of function?
��

7.8 DIFFERENTIATION OF PARAMETRIC

FUNCTION
In parametric functions we use to express curves that can't be written in
single-equation form. In the process, rather than defining � and � in terms of
one another, we define these in terms of another variable t (known as the 129
Business Mathematics parameter). So, we have� = �(�) and � = �(�). These functions are then
related to one another through the parameter. We can differentiate parametric
equations using the chain rule.
Let � = �(�) and � = �(�) be two derivable functions where � is a
�� �� ��
parameter.See that��/�� and ��/�� both exist. So, �� = �� / �� ,provided
��/�� ≠ 0.
��
Example 12: Find �� for the following:

i) y= t3 and x = t2
��
Solution:Since y= t3, �� = 3� � .

Again from � = � � we get ��/�� = 2�

�
Hence,��/�� = (��/��)/(��/��) = (3� � )/2� = � �

ii) � = (1 − �)/(1 + �) and � = 2� � + 4�

Solution: � = (1 − �)/(1 + �)
��/�� = ((1 + �)(−1) − (1 − �).1)/(1 + �)�
��/�� = (−2)/(1 + �)�
� = 2� � + 4�
��/�� = 6� � + 4� ���4
Therefore,
��/�� = (��/��)/(��/��)
��/�� = (6� � + 4� ���4)/((−2)/(1 + �)� )
�� (6� � + 4� ���4). (1 + �)�
=
�� −2
Check Your Progress 7
1) What is a parametric function?
2) How parametric functions are differentiated?
3) Differentiate the following parametric function:
� = 2�� � and � = 4��.

7.9 LET US SUM UP

In this unit we have discussed the techniques of differentiation. Starting
with the meaning of derivative of a function as the rate of change in the
values of a function, we went on to learn that derivative can be expressed
as ��/�� or �’(�) or �� when � is differentiated with respect to � for the
function, � = �(�).
There are certain basic rules that can be used to find or compute the
derivative of several types of functions viz., The Constant Function rule, The
Power Function Rule, The Linear Function Rule, The Rule for Sums and
130
Differences, The Product Rule, The Quotient Rule,Rule for a Function of a Concept of
Differentiation
Function. Further, we are exposed to Derivative of a Logarithmic Function
(i.e., if � = ����, then ��/�� = 1/�)as well as derivative of an
exponential function (viz., � = � � ⇒ �� / �� = � � ). Towards the
concluding part of the unit we have covered the differentiation of inverse
function and parametric function. In the process it is seen that in case of an
inverse function, if y = f(x) is a differentiable function at x such that f’ (x) ≠
�� �
0, then x = g(y) is differentiable at the corresponding value of y and �� = �� .
��
Considering differentiation of the parametric function, we have learnt that if
� = �(�) and � = �(�) are two derivable functions with � is a parameter,
�� �� ��
��
= �� / �� ,provided ��/�� ≠ 0.

7.10 KEY WORDS

Chain Rule: A method for finding the derivative of a composition of
functions.
Derivative: Measuring rate of change of function.
Exponential Function:Afunction of the following form: � (�) = � �
where x is a variable and a is a constant called the base of the function.
Implicit Differentiation: A method for finding the derivative of
an implicitly defined function or relation.
Implicit Function: Defined implicitly by an implicit equation, i.e., by
associating one of the variables with the others.
Inverse Function: A function that "reverses" another function.
Limit of a Function: Analysis of the behavior of a function near a
particular point.
Logarithmic Differentiation: A method for finding the derivative of
functions such as y = xsin x .
Logarithmic Function: A function such as y = loga x or y = ln x. It is
inverse of an exponential function such as y = ax or y = ex.
Parametric Function: A set of equations that expresses a set of quantities as
explicit functions of a number of independent variables, known as
"parameters."
Power Function: A function written as � = �(�) = �� � where k and n are
real numbers.
Power Rule: The formula for finding the derivative of a power of a variable.
Product Rule: A formula for the derivative of the product of two functions.
Quotient Rule: A formula for the derivative of the quotient of two functions.

7.11 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
131
Business Mathematics • Archibald, G.C., Richard G.Lipsey. “An Introduction to a
Mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and Problems
of Mathematics for Economists”, New York: McGraw Hill Book
Company, 1986.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.
• Yamane, Taro, “Mathematics for Economists: An Elementary Survey”,
New Delhi: Prentice Hall of India Private Limited, 1970.

7.12 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Rate of change of functions of one variable with respect to another on
which it depends.
2) Function is differentiable only if the limit exists and the function must
be continuous at that point.
3) Use of algebra to find a general expression for the slope of a curve.
Check Your Progress 2
1) 3
2) �� ���
3) Take � = �(�). �(�) and find the derivative equals to the first
function is multiplied by the derivative of the second function plus the
second function multiplied by the derivative of the first function.
4) Differentiate ``the square'' first, leaving (3x+1) unchanged. Then
�� �
differentiate (3x+1). You will get �� = 2(3� + 1)��� . �� (3� + 1) =
2(3� + 1). (3) = 6(3� + 1)
5) The quotient rule is a formal rule for differentiating functions where
one function is divided by another.
� �
� �(�) �(�). �(�)� �(�) �(�)
Thus, �
�� �(�)
�= ��
[�(�)]�
��

Check Your Progress 3

1) (��5)5�
2) 6� + 2� �
�
� ��(�)�(����)� �
3) [�� (�)]�
�

132
Check Your Progress 4 Concept of
Differentiation
1) Differentiate both sides of the equation and obtain an expression for
dy/dx from resulting equation.
2) -3/2
�
3) First, solve the equation for y to get � � = �. So � = � � . Then get
�
�� �
= � ��
�� �

Check Your Progress 5

1) When required to find the derivatives of some complicated functions,
we can simplify these by using logarithms.
2) Take logarithms of both sides and simplify to get
ln � = ��(� � ) − ��(1 − 10�) − ��(√� � + 2). Then proceed just as
��/�� �
you do for differentiation of implicit function to get � = � +
�� �
�����
− � � ��.
3) �
Check Your Progress 6
1) Inverse function is a function that reverses another function. That is,
�(�) = � if and only if �(�) = �.
2) Take � = �(�). Differentiate both sides with respect to � such that
�� � �� �� �
��
= �� (�(�), i.e., �� = � � (�) or, �� = �� (�).

3) Inverse function.
Check Your Progress 7
1) A class of functions exists which defined in terms of another
variable t (known as the parameter).
2) Through chain rule.
�� �� ��
3) ��
= ��
× ��
�� �� �
Since �� = 4��, we get ��
= ���.
�� �� � �
Again, ��
= 4�. Hence �� = 4� × ���= �

7.13 EXERCISES WITH ANSWER/HINTS

1) Differentiate with respect to x
i) y = 3 x5
ii) y = x3 + 3x
iii) f(x) = 7x2 – 8x + 5
iv) f(x) = 8 (10 – x4)
2) Find the derivative of the following functions:
����
i) y= ����
133
Business Mathematics � � �� � ���
ii) y = � � � ��
�� √�
iii) y =
√���

3) Use the chain rule to find dy/dx of the following functions

i) y = 2u2 – 7u and u = 5x – x3
���
ii) y = u2 and u = ���

iii) y = log u and u = √� + 1/√�

iv) y = eu and u = x6 – x2 + 1
4) Find dy/dx of the following
i) log (logx)
ii) log x3
iii) (log x)3
iv) Log (3x2 + 2x -5)
v) Log (xex)
vi) (e3x +1)4
� ���
vii) 4��
�
viii) � � log �
�� �
5) if y = log�� + √1 + � � �, prove that �� = √��� �
�� �
6) if y = �√� + 1 + √� − 1�, prove that √� � − 1 �� = � �
Answers to Exercises
1) i) 15 x4 ii) 3x2 +3 iii) 14x – 8 iv) 32 x3
�
�� � � ��� � ���� � ���� �
2) i) 23/( 4x-5)2 ii) (� � ���)�
iii) √�
�
�√����
�� (���) (���) � �� � ��
3) i)(20x – 4x3 – 7) ( 5- 3x2) ii) (���)�
iii) �� (���) iv) (6x5-2x) � �
�(����)� ����
4) i)1/ (xlogx) ii) 3/x iii) �
iv) ��� � ���� v) (x+1)/x vi) 12e3x(e3x+1)3
� ��� � �
vii) log 4 (6x2+5) 4�� viii) � � �� + 2� �����

134
 Maxima and Minima

UNIT 8 MAXIMA AND MINIMA OF of Functions

FUNCTIONS
Structure
8.0 Objectives
8.1 Introduction
8.2 Higher Order Derivatives
8.3 Increasing and Decreasing Functions
8.3.1 Increasing Functions
8.3.2 Decreasing Functions
8.4 Maxima and Minima
8.4.1 First Derivative Test for Local Extreme Values
8.4.2 Second Derivative Test for Local Extreme Values
8.4.3 Steps for Maxima/Minima Using Second Order Derivative
8.5 Let Us Sum Up
8.6 Key Words
8.7 Some Useful Books
8.8 Answer or Hints to Check Your Progress
8.9 Exercises with Answer/Hints

8.0 OBJECTIVES
After going through this unit, you will be able to:
• Understand higher order derivatives;
• Find the intervals on which a given function is increasing or decreasing;
and
• Find the maximum and minimum values of the function.

8.1 INTRODUCTION
In the preceding unit, we have seen the derivatives of functions. Going
further from that level, an attempt is made in the present unit to use
derivatives for finding the extreme points of the graph of a function. For
example, we will show how the sign of the derivative is used to settle
questions about intervals over which the graph of a function is rising or
falling. The principal application of this is in locating high or low points on
graphs and, in turn, these points are used to determine the maximum and
minimum values attained by the function.

8.2 HIGHER ORDER DERIVATIVES

��
If �(�)is a differentiable function of ‘�’, then �′(�) or �� is the first
derivative or first order derivative of � = �(�)with respect to (w.r.t) ‘�’.
135
Business Mathematics Since the derivative of function is also a function, another derivative can also
be found. The second order derivative, or second derivative, is the derivative
of the first derivative of the function �(�). Other notations are:
��
� ( ��� ) � (� � (�)) �� �
or, or, �� � or, �� or �′′(�).
�� ��

Since �′′(�) is also a function, its derivative can also be found which is
denoted as �′′′ (�). For higher order derivatives, superscripts can be used i.e.,
f4 = fourth derivative etc.
Example 1: �(�) = 5x4 + 6x3+2x+1
�’(�) = 20x3 + 18x2 + 2
�’’(�) = 60x2 + 36x
�′′′(�) = 120x + 36
Example 2: �= 9x4+ 7x3+ 2x2+ 5x + 7
Find all possible order of derivatives.

Solution:
Y1= dy/dx= 36x3 + 21 x2+4x+5
Y2 = d2y/dx2 = 108x2 + 42x + 4

Y3 =d3y / dx3 = 216x + 42

y4= d4 y / dx4= 216

Y5= d5 y / dx5 = 0
y6=d6 y / dx6=0
Derivatives of fifth and higher orders will be zero.
� �
Example 3: If �= ��� find out second order derivative
� �
Solution: Given y= ��� , take log on both sides to get
�
log � = � log�

= �(log1 – log �)
= -xlogx (as log1 = 0)
Differentiating both sides w.r.t. �
1 �� 1
. = − �� � � + log � .1�
� �� �
= - (1+ logx)
��
or,�� = −�. (1 + ����)

Again, differentiating w.r.t. �,

136
��� 1 �� Maxima and Minima
�
= − �� � � + (1 + log �) . � of Functions
�� � ��
Putting the value of ��/��,
�� � 1
= − �� � � + (1 + log �) . (−�. (1 + ����))�
�� � �
�� � �
or, �� � = − �� − (1 + ����)� ��
�� � �
or, �� � = −� �� − (1 + ����)� �

Putting the value of �

��� 1 � 1
= − � � � − (1 + ����)� �
�� � � �
Interpretation of Derivatives of Different Orders
The first derivative of the function � = �(�) i.e., ��/��, measures the rate
of change of � due to change in �. It gives the slope of the curve at a point.
1) If first order derivative is positive, i.e., if dy/dx > 0 at a point, then it
implies that � increases for a small increase in the value of �.
2) If first order derivative is zero, i.e., if dy/dx = 0 at a point, then it
implies � does not change for a small increase in the value of �.
3) If first order derivative is negative, i.e., dy/dx< 0 at a point, then �
decreases for a small increase in the value of �.
The second derivative, d2y/dx2gives the rate of change of dy/dx. Thus,
if:
a) d2y/dx2>0, the function has increasing slope.
b) d2y/dx2<0, the function has decreasing slope.

Check Your Progress 1

1) What do you look in a derivative to draw your inference on rising or
falling graph of a function?
2) If the value of a function is decreasing when its input is increasing, then
the graph is showing what curve?
3) The slope of a curve at a point can be known from which order
derivative of a function?
4) You are given the second order derivative of a function. What can you
comment on the slope of a curve on the basis of such a piece of
information?
5) You are given the profit function of a business activity and asked to
offer your suggestion on the rate of change of profit. What would you
do?
6) Make a list of signs of derivatives to draw your inference on increasing
and decreasing curves of a function.

137
Business Mathematics
8.3 INCREASING AND DECRE
DECREASING
ASING
FUNCTIONS
Broadly spspeaking, a function, say, �(�), is increasing when y increases
as � gets larger (i.e., looking left to right) and �((�)is decreasing when y
decreases as � gets larger. Such functions are of interest to us for determining
rate of change of a variable. For example, we would be interested to know the
speed of a car, or, rate of growing and declining population of a country.

8.3.1 Increasing Function

A function � = �(�) is said to be increasing in an interval [�, �], if �
increases as � increases from � to �.
If �� and �� ∈[�, �] and �� ≥�� , then, f(�� )≥ f(�� )
Thus, a function is said to be an increasing function in [�, �] if first
order derivative is greater than zero (i.e.,
(i.e.,�’(�)>
> 0) for all values of � in
an interval [�, �]. If �’(�) > 0, then the curve � = �(�) increasesfrom
left to right at the point � = �.

Fig.8.1: Increasing Function

8.3.2 Decreasing Function

A function � = �(�) is said to be decreasing in the interval [�, �] if �
decreases as value of � increases in [�, �] or vice versa. That is,
�(�� ) ≤ �(�� ), when �� � �� and �� and �� ∈[�
�, �]
If first order derivative is less than zero i.e., �′ (�) < 0 for all values of � in
an interval [�, �], then the function � = �(�) is a decreasing function in [�, �]
or if f’(q) < 0, then the curve � = �(�) falls from left to right at the point � =
q.

Fig. 8.2: Downward Sloping Curve

138
Example 4: Show that the function � = �(�) = 3x3+ 3x2+ � – 1 is Maxima and Minima
of Functions
increasing for allvalues of �.
Solution:��/��=�′(�) = 9x2+ 6x + 1
= (3x + 1)2
So, ��/�� > 0for all values of �.
Thus, the given function is increasing for all values of �.
Example 5: Find the interval in which �(�) is (i)increasing (ii) decreasing
�(�)= 2x3+ 9x2+12 � – 1.
Solution:��/�� = �′(�) = 6� � + 18 � + 12
= 6(�2+3 �+2)= 6(�+1)( �+2)
i) For �(�) to be increasing, �’(�)>0
i.e., 6(� + 1)(� + 2) > 0.
If � < −2, then �’(�)= 6 (-) (-)>0. That is, �(�) is increasing
and if � > −1, then �’(�)= 6 (+) (+)>0. That is, �(�) is increasing.
Hence, �(�) is increasing when � ∈ (−∞, −2)�(−1, ∞)
ii) If�(�)is decreasing, then �’(�)<0
i.e., 6(x+1)(x+2)<0.
If -2<x<-1, then �’(�)= 6 (-)(+)<0. �(�) is decreasing when x∈(-2,-1).
Therefore, �(�) is increasing when x∈(-∞,-2)U(-1,∞) and �(�) is
decreasing when x∈(-2,-1).
Example 6: Find the value of � for which the given function
f (�) =2x2− 8x+80
is decreasing.
Solution: For the function to be decreasing, its first derivative, �’(�)
should be less than 0. That is
�′(�) = 4� – 8 < 0 for the function to be decreasing. So,

4x –
8<0,
or,

4x < 8

x<2
Thus, the function is decreasing for � less than 2 and increasing for
more than 2 and has a stationary value at � = 2.
Example 7: Find the interval in which �(�)
�(�)=-2x3 + 3x2+12 x – 1
139
Business Mathematics is (i)increasing (ii) decreasing.
Solution: �’(�) = -6x2 +6x+12
= -6(x2-x-2)=-6 (x+1) (x-2).
i) For �(�) to be increasing, �’(�)>0
i.e., -6(x+1)(x-2)>0.
If -1<x<2, then �’(�)= (-) (+) (-)>0. That is, �(�) is increasing.
Hence, �(�) is increasing when x∈(-1,2)
ii) For �(�) to be decreasing, �’(�)<0
i.e., -6(x+1)(x-2)<0.
If x<-1, then �’(�)= (-) (-)(-)<0. So, �(�) is decreasing
and if x>2, then �’(�)= (−)(+)(+) < 0. That is, �(�) is decreasing
when x∈(-∞,-1)U(2,∞).
Therefore, �(�) is increasing when x∈(-1,2)and �(�) is decreasing
when x∈(-∞,-1)U(2,∞).
Example 8: Find the interval in which the function
�(�) = x4 – 2x2 is
i) increasing
ii) decreasing
Solution: �(�) = x4 – 2x2
⇒ �’(�)= 4x3 – 4x
= 4x(x2-1)
= 4x(x-1)(x+1)
i) For �(�) to be increasing, �’(�) should be greater than zero.
�’(�) = 4x(x-1)(x+1)>0
If -1< � < 0 then �’(�)= 4 (-) (-)(+)>0. So, �(�) is increasingand
if x>1, then �’(�)= 4(+) (+) (+)>0⇒�(�) is increasing.
Hence, �(�) is increasing when x∈(-1,0)U(1,∞).
ii) For �(�) to be decreasing, �’(�)<0
i.e., 4x(x-1)(x+1)<0.
If -∞<x<-1, then �’(�)= 4(-) (-)(-)<0. and if 0<x<1, then �’(�) = 4(+)(-)(+)
<0. Therefore, �(�) is decreasing when x∈(-∞,-1) U(0,1).
Thus, �(�) is increasing when x∈(-1,0)U(1,∞) and �(�) is decreasing when
x∈(-∞, -1) U(0,1).
Example 9: The Revenue function of a firm is given by
R = [8,00,000 + (� –300)2]

140
Determine the values of � for which total Revenue function is increasing Maxima and Minima
of Functions
and decreasing.
Solution: R’(x) = +2 (� – 300)
For revenue function to be increasing R’(�) > 0
i.e., + 2(� − 300) >0
Hence revenue function is increasing for more than/greater than 300
i.e., � > 300. For the Revenue function to be decreasing
R’(�) < 0
i.e., + 2(� − 300) <0
when �=0 then R’(�) < 0
and �− 300 < 0
�< 300.
Hence, the revenue function is decreasing for � = 0 ��� lying between 0
and 300 i.e., 0 ≤ �< 300.and it is stationary value at � = 300.

Check Your Progress 2

1) If a function is said to be an increasing function in interval [�, �],what
would you do to verify the claim?
2) Which order of derivative explains the slope of the function?
3) Explain a decreasing function on the basis of results obtained on first
and second order derivatives.

8.4 MAXIMA AND MINIMA

The maxima or minima of a function is the largest orthe smallest value of the
function, definedeither within a given range (the local or relativeextrema) or
on the entire domain of a function. Maximum means upper bound or the
largest possible value. The absolute maximum of a function is the largest
number contained in the range of the function. That is, if �(�) is greater than
or equal to �(�), for all � in the domain of the function, then �(�) is the
absolute maximum. On the other hand, minimum means lower bound or least
possible value. The absolute minimum of a function is the smallest number in
its range and corresponds to the value of the function at the lowest point of its
graph. If �(�) is less than or equal to �(�), for all � in the domain of the
function, then �(�) is an absolute minimum.

8.4.1 First Derivative Test for Local Extreme Values

i) Find �′(�)
ii) Find all critical values of the function �(�),i.e., all the values of �
where � � (�)=0.
iii) Each critical value of �, say � = �, determine the sign of the first
derivative. If sign of the first derivative, � � (�), changes from positive to
negative as � increases through �, then the function attains a local
maximum at � = �. If � � (�) changes from negative to positive as 141
Business Mathematics increases through �,, then the function attains a local minimum at
�increases
� = �.
iv) If � � (�) does not change its sign as � increases through �, then there is
no local extremum at � = �.. Such a point is called as point of
inflection.

8.4.2 Second Derivative Test forLocal Extreme Values

A function, �(�), is said to be
• maximum, if � ′(�) = 0 and � ′′ (�) < 0,, at a critical value of � = �
• minimum, if � ′(�) = 0 and � ′′ (�) > 0,, at a critical value of � = �
A point where � ′′ (�) = 0 and � ′′′ (�) � 0 is called a point of inflection.
Thus,

Points of maxima and minima are shown in diagram below

A function is increasing at those points, where the first derivative is

positive, i.e., at the point A & E in the diagram. A function is decreasing
at those points where the first derivative is negative, i.e., at the point C &
F in the diagram. At those points B & D, where the function is at a
relative maximum or minimum, the first derivative of the functio function or
slope of the function is equal to zero. This is essential condition for both a
relative maximum and a relative minimum.
The second derivative measures the rate of change in the marginal
function. If the first derivative is zero, indicating a zero slope and hence a
plateau in the function, while second derivative is negative, it means the
function is moving down from the pla plateau
teau and should have been at a
relative maximum. If the first derivative is zero and the second derivative
is positive, it means that the function is moving upward from a valley
and the function has a relative minimum. A point at which the first
142 derivative
ve equals zero is called a critical value or, a stationary value or an
extreme value point. If the second derivative is equal to zero, but the third Maxima and Minima
of Functions
derivative does not equal zero, then the critical value is neither a
maximum nor a minimum. There will be an inflexion point at which the
function alters its rate of change. Point A in the figure is an inflexion
point.

8.4.3 Steps for Maxima/Minima Using Second Order

Derivative
i) Find the first derivative of the function �(�). i.e., Calculate �’(�).
ii) Set the first derivative equal to zero and find the real roots of the
equation �’(�)= 0 to find the critical points of the independent
variable, � = �.
iii) Find the second derivative �”(�) of the function.
iv) Substitute each critical value in the second derivative. After the
substitution of critical values, second derivative can be positive,
negative or zero.
v) If �”(�) = 0, find �”’(�), the third-order derivative of the
function. Third Derivative can either be zero or non-zero.
Information regarding maximization or minimization of a function
can only be gathered at an even-ordered derivative whereas
information regarding point of inflexion can be collected at an odd-
ordered derivative.
Example 10: Find all the points of local maxima and minima of the function
�(�) = x4 -8x3 -22x2 -24x+ 1 by using first derivative rule.
Solution: Given,�(�) = x4 -8x3 -22x2 -24x+ 1,
�’(�) =4x3 -24 x2- 44x -24
= 4(x-1)(x-2)(x-3).
Putting �’(�)=0,
4(x-1)(x-2)(x-3) = 0. So,
either x=1, x=2 or x=3.
If x<1, then �’(�) = 4 (-)(-)(-)<0;
If 1<x<2, then �’(�) = 4 (+)(-)(-)>0;
If 2<x<3, then �’(�) = 4 (+)(+)(-)<0;
If x>3, then �’(�) = 4 (+)(+)(+)>0.
When � = 1,�’(�) changes sign from negative to positive as � increases
through
1. Hence, local minimum is at � = 1. The corresponding minimum value
of the function �(�) is �(1) = 1-8+22-24+1 = -8.
When � = 2,�’(�) changes sign from positive to negative as � increases
through
2. Hence, local maximum is at � = 2. The corresponding maximum value
of the function �(�) is �(2) = 16-64+88-48+1 = -7. 143
Business Mathematics When � = 3,�’(�) changes sign from negative to positive as x increases
through
3. Hence, local minimum is at � = 3. The corresponding minimum value
of the function is �(3) = 81-216+198-72+1 = -8.
Example 11: Find all the points of local maxima and minima of the function
�(�) = 2x3 -15x2 -36x + 60 by using first derivative rule.
Solution: given,�(�) = 2x3 -15x2+36x + 60,
�’(�)= 6x2 – 30x +36
= 6(x2 – 5x +6)
= 6 (x-2)(x-3).
Put �’(�)=0
i.e., 6 (x-2)(x-3)=0.
Hence, �’(�)=0 when x=2 or x=3.
If x<2, then �’(�)= 6 (-)(-)>0;
if 2<x<3, then �’(�)= 6 (+)(-)<0 and
if x>3, then �’(�)= 6 (+)(+)>0.
Since �’(�) changes sign from + to - as x increases through 2, � = 2
is a point of local maximum. Similarly, �’(�) changes sign from – to
+ as � increases through 3.Therefore, � = 3, is a point of local
minimum.
Example 12:Use second order derivative test to find all the points of maxima
and minima of the function �(�) = x3 -3x2 -9x+60.
Solution: Given�(�) = x3 -3x2 -9x+60,
�’(�) = 3x2-6x-9
= 3 (x2-2x-3)
= 3(x+1)(x-3).
Put �’(�) =0
i.e., 3(x+1)(x-3) = 0. Hence,
either x= -1 or x=3.
Therefore, x= -1 and x=3 are the critical values of the function
�(�). Take �’’(�) = 6x-6
when x= -1, �’’(�)= �’’(−1) = 6(-1) -6 = -6 -6 = -12.
Since, �’’(�)<0 at x= -1, the function has maxima at point x=-1.
When x=3, �’’(�)= �’’(3)= 6(3) -6 = 18-6 = 12
Since, �’’(�)>0 at x= 3, the function has minima at x=3.
Example 13:Use second order derivative test to find all the points of maxima
and minima of the function �(�) =x5 -5x4 + 5x3 -18.
144
Solution: Given �(�) =x5 -5x4 + 5x3 -18, Maxima and Minima
of Functions
�’(�) = 5x4 -20x3 +15x2
= 5x2 (x2 -4x +3)
= 5x2 (x-1)(x-3)
Putting �’(�) =0
=5x2 (x-1)(x-3).
Solving the above equation gives x=0, x=1 and x=3.
We have �’’(�) = 20x3 – 60x2 +30 x.
If x=1, then �’’(�)= -10<0, therefore, there is a local maximum at x=1;
if x=3, then �’’(�)= 90>0, therefore, there is a local minimum at x=3;
if x= 0, �’’(�)=0.Here second derivative test fails.
Now, finding third order derivative,
�’’’(�)= 60 x2 -120 x + 30. So,
�’’’(0)= 30>0
Since third order derivative is an odd number, function has neither a
maximum value nor a minimum at x=0. Hence, function has point of
inflexion at x=0.
Example 14:Find all the points of local maxima and minima of the function
�(�) = (1-x)2 ex. Also find the corresponding maximum and minimum
values.
Solution: �(�) = (1-x)2.ex = (1- 2x + x2) ex
�’(�) = (1- 2x + x2) ex + ex (-2 +2x)
= (1- 2x + x2 -2 + 2x) ex
= (x2 – 1) ex
Putting �’(�)= 0,
(x2 – 1) ex = 0
x=±1 (because ex≠0)
�’’(�) = ex 2x + (x2 -1) ex
= ex( x2 + 2x -1)
If x = +1, then �’’(�) = e(1 + 2 -1) = 2e>0. Therefore, there is a local
minimum at x =1.
Putting x=1 in �(�) to find out corresponding value, we get
�(1) = (1-1)2 e1 = 0
If x = -1, then �’’(�) = e -1(1 - 2 -1) = -2e-1<0. Therefore, there is a
local maximum at x =-1.
Putting x=-1 in �(�) to find out corresponding value,
145
Business Mathematics f(-1) = (1+1)2 e-1 = 4/e.

Check Your Progress 3

1) What do you mean by maxima or minima of a function?
2) State the meaning of absolute minimum of a function.
3) Which are the steps would you follow to do a first derivative test for
local extreme values?
4) State the meaning of an inflexion point.
5) What is a stationary point of a function?
6) How would you propose to determine the extreme values,
Maxima/Minima, of a function using second order derivative?
7) Explain the steps for finding Maxima and Minima of a function.
8) How critical value is found while working on maxima and minima of
function?

8.5 LET US SUM UP

In this unit we have discussed the application of derivative of a function to
find out the maximum and minimum points of a curve. In the process we
have learnt the presentation of higher order derivatives and interpretation of
some of these. For example, it is seen that first order derivative of a function
indicates the rate of change of a variable giving thereby the slope of a point
on a curve. The second derivative, on the other hand, provides information on
the rate of change of a slope. Importantly, the increasing or decreasing slope
can be known on the basis of the positive or negative sign of the first as well
as second order derivative.
Signs of derivatives can also be used to know the increasing and
decreasing curves. While a function is said to be an increasing function in
interval [�, �] if first order derivative is greater than zero (i.e.,�’(�)> 0)
for all values of � in an interval [�, �], it is decreasing when first order
derivative is less than zero i.e., �′ (�) < 0 for all values of � in same
interval. If the first derivative is equal to zero, then we have a stationary
point indicating neither increase nor decrease of the curve.
We have covered maxima and minima of a function as the largest and the
smallest value of the function, defined either within a given range or on
the entire domain of a function. When considered the values within a
given range, we get the local or relative maxima or minima, while we
reach to global or absolute extrema by taking into account entire domain
of a function.
In order to compute the relative maxima and minima values, we learnt the
first and second derivative tests where assessments are made on the basis
of signs of first and second order derivatives. In addition, we are
introduced to the identification of inflexion points where the sign of the
curvature changes considering the signs of first and second order
derivatives. Towards the last part of the unit, steps required to compute
maxima/minima with the help of second order derivatives have been
discussed.
146
 Maxima and Minima
8.6 KEY WORDS of Functions

Absolute (Global) Minimum or Maximum: The smallest or the largest

value of the function on the entire domain of a function.
Local (Relative) Minimum or Maximum: The smallest or the largest value
of the function within a given range.
Point of Inflection:A point on a curve at which the sign of the curvature
changes.
Revenue:The income which a producer earns from its normalactivities,
usually from the sale of goods and services.
Slope: The slope of a curve is a number that describes steepness of the curve.
Stationary Point:A point where the function stops increasing or decreasing.

8.7 SOME USEFUL BOOKS

• Allen, R.G.D., “Mathematical Analysis for Economists”, London:
English Language Book Society and Macmillan, 1974.
• Bhardwaj, R.S.,”Mathematics for economics and business”, Delhi:
Excel Books, 2005.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems of Mathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Archibald, G.C., Richard G.Lipsey. “An Introduction to A
mathematical Treatment of Economics”, Delhi: All India Traveller
Bookseller, 1984
• Yamane, Taro, “Mathematics for Economists: An Elementary Survey”,
New Delhi: Prentice Hall of India Private Limited, 1970.
• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.

8.8 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Sign of the derivative
2) A decreasing curve.
3) First order derivative
4) Rate of change of a slope.
5) Get the first derivative of the function
6) Read Section 8.2 of the present unit and answer.

147
Business Mathematics Check Your Progress 2
1) Find that the first order derivative is greater than zero (i.e.,�’(�)> 0) for
all values of � in an interval [�, �].
2) Second order derivative
3) Check Sub-Section 8.3.2.
Check Your Progress 3
1) The largest and the smallest value of the function, defined either within
a given range or on the entire domain of a function.
2) The smallest number in defined range and corresponds to the value of
the function at the lowest point of its graph.
3) Read Sub-Section 8.4.1 and answer.
4) A point at which the function alters its rate of change.
5) In a differentiable function of one variable a point on the graph of the
function where the function's derivative is zero. Informally, it is a point
where the function stops increasing or decreasing.
6) Read Sub-Section 8.4.2 and answer.
7) Check Sub-Section 8.4.3
8) A critical point is an interior point in the domain of a function at
which � ′(�) = 0 or �′ does not exist.

8.9 EXERCISES WITH ANSWER/HINTS

1) Find the second order derivative of the following
i) �= ax3 + bx2 + cx+ d
ii) �= ALα
2) If � = ex + logx, then prove that y3 = ex + 2/x3
����
3) If �= ���� , prove that 2 y1y3 = 3y22

4) If �= 5x4 +9x3 – 8x -100 then show that y5 = 0

5) Find the intervals on which the following functions are increasing or
decreasing
i) �(�)= x3 -6x2 – 36 x +2
ii) �(�) = 2x3 -15 x2 +36x +1
iii) �(�)= (x+1)3 (x-3)3
iv) �(�) = x2 ex
6) Examine for the maximum and minimum values of the following
functions:
i) �(�)= 3x4 -4x3 +1
ii) �(�) = 2x3 +3x2 -36x +10
148
7) Examine the function �(�) = x3 -3x2 +3x +7 is i) maximum ii) Maxima and Minima
of Functions
minimum iii) neither maximum nor minimum.
8) Show that the function �(�) = 4x3 – 18 x2 +27x -7 has neither
maximum nor a minimum by using second derivative test.
9) Show that the function �(�) = x3 – 9 x2 +30x +5 has neither maximum
nor a minimum.
10) Show that the function �(�) = x3 – 6x2 +12x -5 has neither maximum
nor a minimum.
����
11) Show that the function �(�) = �
has a maximum value at x=e.

Answers
1) i) 30x2 -30x +7 ii) Aα(α-1)Lα-2
2) i) Increasing on (-∞, -2) and (6,∞), decreasing on (-2,6)
ii) Increasing on (-∞,2) and (3,∞), decreasing on (2,3)
iii) Increasing on (1,∞), decreasing on (-∞,1)
iv) Increasing on (-∞, -2) and (0, ∞), decreasing on (-2,0)
3) i) Local maximum at x=1, value 0, point of inflection at x=0
ii) Local maximum at x= -1/2, value 81/16, local minimum at x=2,
value -10,point of inflection at x=0.
7) iii) Neither maximum nor minimum.

149
Business Mathematics
UNIT 9 APPLICATION OF DERIVATIVES

Structure
9.0 Objectives
9.1 Introduction
9.2 Demand Function and Supply Function
9.2.1 Slope of Demand Curve
9.2.2 Slope of Supply Curve
9.3 Elasticity: Demand and Supply Functions
9.3.1 Price Elasticity of Demand
9.3.2 Income Elasticity of Demand
9.3.3 Supply Elasticity of Demand
9.3.4 Cross-Elasticity of Demand
9.4 Average and Marginal Cost
9.5 Revenue Function
9.5.1 Relationship between AR, MR and Price Elasticity of Demand
9.5.2 Maximizing Revenue
9.6 Profit Maximization
9.7 Let Us Sum Up
9.8 Key Words
9.9 Some Useful Books
9.10 Answer or Hints to Check Your Progress
9.11 Exercises with Answers/Hints

9.0 OBJECTIVES
After going through this unit, you will be able to understand
• application of derivatives to elasticity of demand as well as supply; cost
and revenue functions; profit maximization; and
• the importance of derivatives in maximum-minimum problems.

9.1 INTRODUCTION
In the preceding two units, we have discussed the techniques of
differentiation and extreme values of a function. In the present unit, we
extend differentiation techniques for applying to select business and
economic themes. Basically, an attempt is made here to learn the use of
derivatives to understand the rate of change as well as change in rate of
change, which is the corner stone of marginal analyses in economics as well
as business studies.

150
 Application of
9.2 DEMAND FUNCTION AND SUPPLY Derivatives
FUNCTION
In microeconomic analysis, it is postulated that demand and supply are
functions of price. While the quantity demanded is related to price inversely,
in case of supply it has a direct relationship with price. Because of such a
proposition, we have a downward sloping demand curve and upward sloping
supply curve. For the sake of simplicity, we often assume the demand curve
and supply curve for a good or service to be a linear line, although other non-
linear types are also considered. The consequent slopes of demand and
supply curves are, respectively, negative and positive. Let us use derivatives
to see the process of deriving these results.
We know that a linear equation is of the form � = �� + �, where � is the
slope of the line and � is the � intercept. We can model a demand function as
� = −�� + �(or, the inverse demand function as � = −�� + �),where �
and � represent price and quantity respectively. In such a format, we move
the price to the horizontal (�) axis and quantity to the vertical (�) axis as we
think of quantity demanded or supplied as a function of price. In the event of
presenting inverse demand function, we consider quantity in horizontal axis
and price in vertical axis. You will see the use of this form when we come to
derivation of marginal revenue.
The slope is negative in case of a normal demand curve, which slopes
downward. Similarly, a supply curve is modelled by another linear equation
of the form � = �� + � where � is the slope of supply curve with a positive
sign.

9.2.1 Slope of Demand Curve

In case of the equation of demand curve,� = −�� + �, differentiating �
��
with respect to (w.r.t.) �, we get �� = −�. The slope is −� and it gives the
rate of change in quantity demanded in response to change in price. See that
the downward sloping demand curve is represented by the negative slope.
Reasons for this feature could be threefold, viz.,
Substitution effect: Consumer will substitute other goods to buy more or less
according as price falls or rises.
Income effect: Rise or fall in real income as prices falls or rise
Law of diminishing utility: At a lower price, consumers are willing to
consume more as they compare the price with the satisfaction that is derived
from the consumption of that good.

9.2.2 Slope of Supply Curve

Considering the equation � = �� + � above and differentiating � w.r.t. �,
��
we get the slope of the supply curve. So, �� = � is the slope of supply curve
and it is positive, indicating a positive relationship between quantity supplied
and price.
Reason for this may be as follows:
1) Profit motive: With rise in prices following an increase in demand, it
becomes more profitable for businesses to increase their output; 151
Business Mathematics 2) Production and costs: Firm's production cost tends to rise as output
expands. Consequently, a higher price is needed to cover these extra
costs of production.
3) Incentive for new entrants: Higher prices may create an incentive for
other businesses to enter the market leading to an increase in total
supply.

Check Your Progress 1

1) Why the slope of the supply curve is positive for normal goods?
2) What reasons would you list for a negative slope of demand curve?
3) If you intend to consider an inverse demand function, then in what way
you would have to write the demand function?

9.3 ELASTICITY: DEMAND AND SUPPLY

FUNCTIONS
Elasticity refers to the responsiveness of the dependent variable of a function
to changes in the independent variable. It is measured in terms of percentage
changes instead of absolute changes. For example, we consider first the
percent change in a variable X and write,
�ℎ���� �� �ℎ� �������� �
������� �ℎ���� �� � =
�������� ����� �� �
Thus, we can say that the change in � is ��. If X changes from X to � + ��,
∆�
then proportion change in � = � .

Seen in terms of numerical value, we would say that the value of X changes
from 20 to 30. So, the proportion change is
��� ��
� = �� = 0.5. This is a percentage change in X of 50%. If concerned
with elasticity, then we say the elasticity of Y with respect to X. And we need
to find the ratio of the percentage change in Y to the percentage change in X.
That is,
������� ������ �� �
Elasticity of Y with respect to � = ���������� ������ �� �.

Sometimes the elasticity is defined with a negative sign while at other in

absolute values. For convenience, let us stick to the sign to emphasize the
nature of the percent changes. When an elasticity negative and say, greaten
than -1, it indicates that a percent increase in X corresponds to a greater
percent decrease in Y. In such a case, we would say that the variable Y is
elastic with respect to variable X.
An elasticity between -1 and 0 indicates that a percent increase in X
corresponds to a smaller percent decrease in Y. So, the variable Y is inelastic
with respect to the variable X. If the elasticity is of -1, then a percent increase
in X corresponds to an identical percent decrease in the variable Y. In that
case, the variable Y is said to be unit-elastic with respect to the variable X.

152
9.3.1 Price Elasticity of Demand Application of
Derivatives
The most common use of elasticity in economics and business studies is price
elasticity of demand (PED) or elasticity of demand with respect to price.
Such a concept helps us explore the responsiveness of the consumer demand
for some product to changes in the price of that product. If the price of a cup
of coffee were to increase, the quantity sold will be influenced. To see the
point, suppose that in 2016, Nestle increased the price of coffee from Rs.
4.95 to Rs. 5. 00. Due to such a change, the demand for coffees dropped
from 440 units per day to 438 units per day. The percent change in price P is
∆� �.�� ��.��
�
= �.��
= 0.01

or about 1%. The percent change in the demand Q is

∆� �������
�
= ���
= −0.0045 or about -0.45%. That is, with 1% increase in price
there is 0.45% decrease in the quantity demanded of coffee. Thus,
the price elasticity of demand is
Percent change in Q −0.0045
� = = = −0.45
Percent change in P 0.01
The result shows that 1% increase in price corresponds to a 0.45% drop in
demand for coffee. On the other hand, we may also say that 1% drop in price
corresponds to a 0.45% increase in demand.
Taking into account the relationship between demand and price in a
functional form, we can use derivative of the demand function to calculate
the price elasticity of demand. If we write that the change in price as being
from �to ∆Pand the corresponding change in demand as being from � to ∆�,
∆� ∆�
then corresponding percent changes in price and demand are � and � . The
definition of elasticity gives
Percent change in Q
�� =
Percent change in P
∆�
�
= ∆�
�
∆�
� ∆� � � ∆�
= ∆� = � .∆�=� ∆� .
�

∆�
It may be noted that ∆� represents the average rate of change of demand Q
with respect to price P. If we assume the change in price is small, we can
replace the average rate of change with the instantaneous rate of change, viz.,
��
��
.

Let the demand function be Q = f (P). Then, the price elasticity �� of demand
is
� ��
�� =
� ��

153
Business Mathematics Specifically, we may also define point price elasticity of demand at a point
(�� , �� ) on the demand curve as ��� = (��/��) (�� /�� ).
��
Example 1: Let the demand curve be � = −5 � + 30. Then �� = −5 . If a
point (P0, q0) = (1,25) is on the demand curve, how do we compute the PED
at (1,25).

Using the formula, we get

PED = (-5)(1/25) = -1/5 = -0.20.
Further, if a point p=3 and q =15 is on the demand curve, then the PED at
(3,15) is equal to (-5)(3/15) = -1;
if a point � = 5 and � = 5 is on the demand curve, then the PED at
(5,5) is (-5)(5/5) = -5.
Thus, with the help of calculus, we see that the PED changes for every point
on a straight-line demand curve.
Note the simple mathematical relationship:
��
� �� � �
��
= × = (�/�����) ×
�� � �
�

Example 2: To find the point price elasticity of demand,let us consider the

following example of a demand function:
� = 15,000 − 50�
Given this demand curve, we need to find out price elasticity of demand at
two different prices, P = 100 and P = 10.
So, take the derivative of the demand function when it's expressed with Q as
a function of P. Since quantity (Q) goes down by 50 each time price (P) goes
up by 1, we get, (∆Q/∆P)= -50
To find the quantity demanded at each price level we consider the price
quantity combinations of : (100; 10,000), (10; 14,500)

Then point elasticity of demand yields,

�� = -50(100/10,000) = -.5
�� = -50(10/14,500) = -.034
Results obtained show that both elasticities are negative. That imply a
downward sloping demand relationship. Moreover, they are relatively more
elastic.
Deriving Elasticity using Log Functions
Here is another expression for elasticity that is sometimes useful. It turns out
that elasticity can also be expressed as
� ���
����
.

154
The proof involves repeated application of the chain rule. We start by noting Application of
Derivatives
that
� ��� � ��� ��
= .
���� �� ����
� ��
= � ����
(1)
�� �� � ��� �� �
We also note that ��
= ���� ��
= ���� �
�� ��
⇒ ���� = � �� .

Substituting this into equation (1), we have

� ��� ���
����
= � �� � = �� .

9.3.2 Income Elasticity of Demand

The income elasticity of demand (YED) measures how effect of the change in a
consumer’s income on the demand for a specific product. It is defined as the
ratio of proportionate change in quantity demanded due to proportionate
change in income (�). There is a positive relation between income and
demand in case of normal goods; hence, sign of income elasticity of demand
is positive. Thus, we define
������������� ������ �� ������
�� = ������������� ������ �� ������

∆�/�
= ∆�/�

� ∆�
= � ∆�
� ��
In case of instantaneous change income,�� = � ��

Example 3: If x=4y2, where x is quantity demanded of a good and y is the

consumer’s income. Find the income elasticity of demand.
Solution: Given the demand function
x= 4y2;
�� �
�� = �� . �
��
��
= 4.2 � = 8�

Therefore,
�
�� = 8�. ��� = 2

The higher the income elasticity of demand for a specific product, the more
responsive it becomes to the change in consumers’ income.
Now, we can measure the income elasticity of demand for different products by
categorizing them as inferior goods and normal goods.

155
Business Mathematics Normal Goods
The YED for a product can be elastic or inelastic based on its category—
whether it is an inferior good or a normal good. When YED is more than zero,
the product is income-elastic. Normal goods have a positive YED. That is,
when the consumers’ income increases, the demand for these goods also
increases.
Inferior Goods
Inferior goods are called so because these have superior alternatives. Such
goods have a negative income elasticity, that is, YED is less than 0. If the
consumers’ income increases, they demand less of these goods.
Note: If sign of income elasticity of demand is negative, then the
commodity is inferior.
9.3.3 Elasticity of Supply (Es)
It is defined as the ratio of proportionate change inquantity supplied to a
proportionate change in its price.
������������� ������ �� ������
�� = ������������� ������ �� �����

= (-) (∆�� /�� )/(∆�/�)

� ∆�� � ���
= (-) � ∆�
or = �� ��
�

If a supply curve is given as � = 2� + 20, then ��/�� = 2. If a point

� = 1 and � = 22 is on the supply curve then the PES at (1,22) is (2)(1/22)
= 1/11. If a point � = 5 and � = 30 is on the supply curve, then the PES at
(5,30) is (2)(5/30) = 1/3.
Example 5:Forthe supply function x=5 +2p2, find the elasticity of supply at
p=2.
Solution:Given the supply curve
x = 5 + 2p2, differentiating w.r.t.�
��
��
= 4�. Thus,
� �� �
�� = � . �� = ����� . 4�

���
= �����

When p=2; �� is equal to

�� ��
�� = ��� = ��

9.3.4 Cross Elasticity of Demand

Cross elasticity of demand is the responsiveness of demand for a product in
relation to the change in the price of another related product. Mark word
“related” product. Note that unrelated products have zero elasticity of demand.
For example, an increase in the price of black gram will have no effect on the
demand for ice cream.
156
We can measure the cross elasticity of demand by dividing the percentage of Application of
Derivatives
change in the demand for one product by the percentage of change in the price
of another product. Thus,
����� ���������� �� ������
% �� �ℎ���� �� �ℎ� ������ ��� ������� �
=
%�� �ℎ���� �� �ℎ� ����� �� ������� �
or, (�� / ��′) ∗ (�′/�), where Q= quantity demanded, �� =price of a related
product of Q.
It is useful to note that the cross elasticity of demand depends on whether the
related product is a substitute or a complement (see below).
Substitute and Complementary Products
As mentioned earlier, cross elasticity measures the responsiveness of demand in
relation to related products. And these related products can be either substitutes
or complementary products. Let us understand the difference between the two.
Substitute Products
In case of substitute products an increase in the price of one will lead to an
increase in demand for the competing product. For instance, an increase in the
price of petrol will force consumers to go for diesel and increase the demand for
diesel. Thus, the cross-price elasticity value for two substitute goods is always
positive.
Complementary Products
In case of complementary goods, demand for two or more goods move together.
For example, see the demand for coffee beans and coffee paper filters. If the
price of coffee increases, then the demand for filters would reduce because the
demand is reduced for coffee. The cross elasticity of demand for two
complementary products is always negative.
Example 4:
We have a demand equation of � = 2000 − 4� + 5��(�′), find the cross-
price elasticity of demand.
Differentiate with respect to �′ and get:
��/��′ = 5/�′.
Substituting ��/��′ = 5/�' and � = 2000 − 4� + 5��(�′) into cross-
price elasticity of demand equation, we get
�
Cross-price elasticity of demand = ��� � × (�′/(2000 − 4� + 5��(�′)))

To find the cross-price elasticity of demand at � = 5 and �′ = 10,

substitute these into cross-price elasticity of demand equation:
Cross-price elasticity of demand
= (5/P') × (P'/(2000 -4P + 5ln(P')))
= (5/10) × (10/(2000 - 20 + 5ln(10)))
= 0.5 × (10 / 2000 - 20 + 11.51) (as ��(10) = 2.302585)

157
Business Mathematics = 0.5 × (10 / 1991.51)
= 0.5 × 0.002008
= 0.001004
Thus, cross-price elasticity of demand is 0.000502. Since it is greater than 0,
goods are substitutes.

Check Your Progress 2

1) Explain the idea behind elasticity of demand or supply.
2) Why would you say that the cross elasticity of demand for two
complementary products is always negative?
3) How do you identify an inferior good on the basis of income elasticity
of demand?
4) What is cross elasticity of demand?
5) How would you interpret the elastic, inelastic and unit-elastic character
of � = �(�)?
6) What is price elasticity of supply?

9.4 AVERAGE AND MARGINAL COST:

In this section we will discuss the cost of output production and see the
process of applying derivatives for finding solutions to different cost related
concepts.Let us start with the following cost concepts:
1) Total Cost: Total cost is the sum of two components, viz., fixed cost
and variable cost. Symbolically, TC= FC+ VC, where TC= total cost,
FC= fixed cost and VC= variable cost.
2) Fixed Cost: The cost remains constant for all levels of output (i.e.,
independent of quantity produced). For example, cost of machinery or
rent of factory building fall in this category.
3) Variable Cost: The cost varies with level of output. For example, cost
of raw materials forms a part of variable cost.
Given the total cost, we can derive the
Average Cost, which is defined as per unit cost of production and
written as
��
AC = �
, where � is units of output;and

Marginal Cost, which is the rate of change in total cost when � units
are produced and defined as
���
MC= ��
.

Relation between AC and MC

Relation between AC and MC can be explained with the help of
diagram below:

158
 Application of
Derivatives

Example 6:If TC = 2q2 + 8q +60,

calculate AC and MC at q=3
=3 and interpret the result.
Solution: Given TC = 2q2 + 8q +60.
��
Therefore,AC = �

��� � �� �
���
= �
��
= 2q + 8 + �
.
���
MC = ��

����� � �� �����
= ��

= 4q+ 8.
When q= 3, MC = 4x3 + 8 = 20.
Interpretation:It It means when production increases by 1 unit from 3rd
unit to 4th unit, then the total cost increases by Rs.20,approximately.
Example 7:: Total Cost of the firm is
C(x) = 0.005x3 – 0.002 x2 -30x
30x +5000, where x is the output
Find out
159
Business Mathematics i) Fixed Cost
ii) Variable Cost
iii) Average Cost
iv) Average Variable Cost
v) Marginal Cost
vi) Marginal Cost when 50 units are produced, interpret the results.
vii) Actual Cost of producing 51st unit.
viii) Rate of change in Marginal Cost w.r.t. x
ix) Marginal Average Cost
Solution: Given C(x) = 0.005x3 – 0.002 x2 -30x +5000, we have to find
out
i) Fixed cost by putting x=0 (i.e., output = 0)and get
FC = 5000
ii) VC= TC – FC
= 0.005x3 – 0.002 x2 -30x +5000 -5000
= 0.005x3 – 0.002 x2 -30x
�.����� – �.��� �� ���� �����
iii) AC= TC/x = �
= 0.005x � – 0.002 x −
����
30 + �

iv) Average Variable Cost = AVC= VC/x

�.����� – �.��� �� ����
= �

= 0.005x � – 0.002 x − 30
��� �
v) MC = �� = ��
�0.005x � – 0.002 x � − 30x + 5000� = 0.015 x2 –
0.004x -30.
vi) When x= 50, MC= 0.015 (50)2 – 0.004(50) -30 = 7.3
Interpretation: It means if production increases by 1 unit from 50th
unit to 51th unit, then the total cost increases by Rs.7.3,
approximately.
vii) C(51) = 0.005(51)3 – 0.002 (51)2 -30(51) +5000 = 4128.05
C(50) = 0.005(50)3 – 0.002 (50)2 -30(50) +5000 = 4120
Actual cost of producing 51th unit = C(51) – C(50) = 4128.05 –
4120
= 8.05
��� �
viii) Rate of change in MC = ��
= ��
�0.015x� – 0.004 x − 30�

= 0.030x – 0.004

160
 ��� � Application of
ix) Marginal Average Cost = ��
= �� �0.005x � – 0.002 x − 30 + Derivatives
����
��
�
����
= 0.010x -0.002 - �
�
Example 8:Prove that slope of average cost curve is �
( MC − AC) for the
TC= ax3 + bx2 +cx +d.
Solution: GivenTC= ax3 + bx2 +cx +d,
��� ���� �����
AC= �
= ax2 +bx + c + d/x
��� � �
Slope of AC = �� = �� �ax � + bx + c + � �

= 2ax +b – d/x2
��� �
MC = ��
= �� (ax � + bx � + cx + d )

= 3ax2 + 2bx +c.

� � �
Now, � ( MC − AC) = �
� 3ax � + 2bx + c − ax � − bx − c − � �
� �
= � � 2ax � + bx − � �

= 2ax +b –d/x2
= slope of AC
Hence proved.

Check Your Progress 3:

1) When AC is minimum then value of MC is equal to what?
2) Name the cost which is incurred by the firm when firm produces zero
output.
3) What are the components of total cost of production?

9.5 REVENUE FUNCTION

A revenue function depicts the relation between revenue and output. Note
that revenue is the product of price(�) and output (�), i.e., the price of the
product and its quantity sold.Needless to say, if the price of a good increases,
then the quantity sold decreases. So, revenuemay increase or decrease. To see
this, let us write the total revenue (��) = �� = ��(�), where � is the
price per unit of the good and � is the number of units of the commodity sold.
If we want to the see the nature of relation between revenue and output, we
have to examine the price elasticity of demand. Indeed, there is a very useful
relationship between price elasticity andrevenue change. To examine such an
insight, let the total revenue be expressed as
�� = ��.
If we let the price change to be � + ��and the quantity change to be� + ��,
then revenue obtained becomes
161
Business Mathematics � = (� + ��)(� + ��)
= �� + ��� + ��� + ����.
Subtracting ��from �we have
��� = ��� + ��� + ���q.
For small values of ��and ��, we can neglect the last term and get the
revenue as ��� = ��� + ���.
The rate of change of revenue per unit change in price is
��� ��
∆�
= � + � ∆�.

Thus, revenue increases when price increases if the elasticity of demand

is less than 1 in absolute value. Similarly, revenue decreases when price
increases if the elasticity of demand is greater than 1 in absolute value.
To see this is to return tothe formula for ��/��and rearrange
it as follows:
��� ��
= �+ �
∆� ∆�
� ��
= � �1 + �
� ∆�
= �[1 + �� ]
Since demand elasticity is stated be negative, we can also write this
expression
as �[1 − [|�� |]]
In this formulation, it is easy to see how revenue responds to a change in
price:
���
if the absolute value of elasticity is greater than 1, then ∆�
must be negative
and vice versa.
Intuitively, if demand is very responsive to price—that is, it is very elastic—
then an increase in price will reduce demand so much that revenue will fall.
If demand is very unresponsive to price—it is very inelastic—then an
increase in price will not change demand very much, and overall revenue will
increase. Taking the dividing line of an elasticity of −1, we can say that in
such a point, if the price increases by 1 percent, then the quantity will
decrease by 1 percent,so overall revenue doesn’t change at all. We have unit
elasticity.

9.5.1 Relationship between AR, MR and Price Elasticity of

Demand
We may extend the above result on revenue and price elasticity further to find
its relationship with marginal revenue and average revenue. To work in that
direction, let us define these terms first.
162
Average Revenue (AR) is the per unit revenue and can be computed as Application of
Derivatives
�� ��
AR= �
=� =�

Marginal Revenue (MR)is the change in total revenue resulting from an

additional unit of output sold. Thus,
���
�� = ��
.

Elasticity and Marginal Revenue:

We have seen above that for small changes in price and quantity, the change
in revenue is given by
��� ��
= �+ �
∆� ∆�
or, ��� = �∆� + � ��
Dividing both the sides by ��, we get
��� ∆� ��
∆�
= � ∆� + � ∆�, or
��� ∆�
MR= ∆� = � + � ∆�, or

� ∆�
�� = � �1 + �
� ∆�
Remembering we are trying to derive the relationship between MR and
�� , let usdo undertake some refinement on the second term in �� =
� ∆�
� �1 + � ∆� �. Broadly, it looks like inverse of �� . So, we can write �� =
�
� �1 + � �. Since we have used to write �� attaching a negative sign, we do
�
�
so here by writing �� = � �1 − |� |�, i.e., writting the �� in absolute term.
�

In interpreting such a result, we can say,

if elasticity of demand is −1, then marginal revenue is zero, i.e., revenue
doesn’t change when we increase output.
If demand is inelastic, then |�� | is less than 1, which means 1/|�� | is greater
than 1. Thus, 1−1/|�� | is negative. So, revenue would decrease when we
increase output.
Elasticity, Average Revenue and Marginal Revenue: To see the relation
between elasticity, average revenue and marginal revenue we simply work
� �
with �� = � �1 − |� |�. Just multiply (�) in the right-hand side to get
�

� 1 �� 1
�� = � � � �1 − �= �1 − �
� |�� | � |�� |
�� �
= � �1 − |� |�
�
�
=�� �1 − |� |�
�

��
��, �� − �� = �− �
|�� | 163
Business Mathematics ��
��, −�� + �� = � �
|�� |
�� − �� 1
��, =
�� |�� |
��
��, ����� = |�� |.

9.5.2 Maximizing Revenue

It is seen above that total revenue is influenced by price variation. In a market
structure with monopoly, the producer controls the price. This is in contrast
to pure competition, where price remains constant and it’s independent from
output. In that case, price, AR and MR are exactly the same. Let us see the
revenue maximization issue under a monopoly market.
Example 9: Find the total revenue and marginal revenue of the perfect
competitive firm with current price of Rs. 10 per unit.
Solution: Given, P= 10.
If q units are sold in the market then,
�� = �. � = 10�
��
�� = = 10
�
���
�� = ��
= 10

Therefore, � = �� = �� = 10 which is constant.

Under monopoly, price is determined by the firm and not given to it by the
market. The total revenue will be maximum at a level of output where first
order differentiation of total revenue is zero and second order derivative is
less than zero, i.e.,��’(�) = 0 ( �. �. , �� = 0) and ��’’(�) < 0.
Example10: If demand function of the firm is given as p = 5000 -20x – x2,
find TR,MR and comment on the nature of the firm.
Solution: Given, p=AR = 5000 -20x – x2
TR = p.x
= (5000 -20x – x2) x
= 5000x – 20x2 – x3
��� �
MR = ��
= �� (5000x – 20x2 – x3)

= 5000 – 40x – 3x2

Since, AR≠ MR, hence, firm is monopolist firm.
��
Example 11: Show that Ed = �����
at p = 5, where the demand function is
given by p = 50 – 3x.
Solution: p = 50 – 3x
Differentiating both side w.r.t.x
164
 �� Application of
��
= −3 Derivatives

Taking reciprocal
dx 1
= −
dp 3
� �� ����� � �����
�� = - � �� = − �
.−� = ��

If p= 5, then
5 = 50 – 3x
x= 45/3= 15
Putting the value of x in Ed

������ ����� �
�� = ���
= ��
= �.

TR = p.x = (50 – 3x)x

= 50x – 3x2
AR = TR/x = p.x/x= p =50 – 3x
When x= 15,
AR= 50 – 3×15 = 50- 45= 5.
���
MR = ��
= 50 – 6x

When x=15,
MR = 50- 6×15 = 50 – 90 = -40

�� � � �
�����
= ��(���) = �� = � =� d

Hence proved.

Check Your Progress 4

1) What is a revenue function?
2) State the relationship between AR, MR and Price Elasticity of Demand.
3) How is price elasticity related with rate of revenue change?
4) Revenue maximization is not important in a firm under which market
structure? Why?

9.6 PROFIT MAXIMIZATION

Economic theory normally uses the profit maximization assumption in
studying the behaviour of firm just as it uses the utility maximization
assumption for the individual consumer. This approach is taken to satisfy the
need for a simple rational objective for the firm.

165
Business Mathematics The profit-maximizing firm chooses both inputs and outputs so as to
maximize the difference between total revenue and total cost, i.e., � =
�(�) – �(�)
The firm will adjust variables under its control such that it can no longer
increase the profit further. Thus, the firm looks at each additional unit of
input or output with respect to its effect on profit.
Let us define revenue as �(�) = �(�) × �, where � and � are functions of
�. Note that we are taking inverse demand function �(�), which depicts price
as a function of quantity for getting the revenue function. As we will see
below it helps calculate MR quickly, which is required for getting the profit-
maximizing condition for firms regardless of market structure.
Profit function is the function of total revenue and total cost and it can be
expressed as:
� = �(�) = ��(�) − ��(�), i.e.,
� = �(�) × � − �(�).
To maximise profit take
�� �� ��
��
= ��
− �� =0

�� ��
⇒ = =0
�� ��
⇒ �� = ��.
Such an equality specifies the first order condition and we must add the
second order condition of profit maximisation. So, we need to have
�� �
< 0.
�� �
That is, at the optimal quantity (q*), marginal profitmust be declining. In
�� �
terms of �� and ��, weget �� �
< 0 ��,

��’’(�) − ��’’(�) < 0, or,

��’’(�) < ��’’(�), or,
(��)� < (��)�,
which means that the slope of marginal revenue must be less than the slope of
MC curve at the profit maximizing output.
Example 12: The total cost of a firm is C= 1/3x3– 6x2+40x+15. Find the
equilibrium output if price is fixed at Rs.20 per unit.
Solution: Given
price (p) = 20,
Revenue (TR) = px
Thus, Revenue = R(x) = 20x
Profit = �(x) = TR(x)- TC(x)
= 20x – (1/3x3– 6x2+40x+15)
166
 = 20x - 1/3x3+ 6x2- 40x – 15 Application of
Derivatives
= -1/3x3+ 6x2- 20x-15
Differentiating with respect to x
�’(x) = - x2 +12x – 20
For maximization �’(x)= 0
That is, - x2 +12x – 20 =0
or, x(x-10) – 2(x-10) =0
or, (x-10)(x-2) =0
Therefore, either x= 10 or x = 2
Calculating second-order derivative of the profit function with respect to x,
we get,
�’’(x) = -2x +12
When x=10
�’’(10) = -2(10) +12
= -20 + 12= -8<0
When x=2
�’’(2) = -2(2) +12 = 8>0
Since, second order derivative is less than zero at x = 10, profit is maximum
when firm produces 10 units of output.
Example 13: A monopolist has the following demand and cost functions:
C = 20 +2x + 3x2 and p= 50-x
Find the output level and price at which the profit is maximized.
Solution: Revenue (TR) = px = x(50-x) = 50x – x2
Profit (�) = TR – TC
= 50x – x2 -20 -2x -3x2
= 48x –4x2 – 20
Differentiating w.r.t. �
��/�� = �’ = 48 – 8� = 0
x= 48/8 = 6
Calculating second order derivative
�’’= -8<0
Hence, profit is maximum at x = 6, and equilibrium price is:
P = 50-x= 50 – 6 = 44
Hence, equilibrium output is 6 units and equilibrium price is 44.

167
Business Mathematics Example 14: A stereo manufacturer determines that in order to sell x units of
a new stereo, the price per unit, in rupees, must be p(x)= 1000 - x. The
manufacturer also determines that the total cost of producing x units is given
by C(x) = 3000 + 20x.
a) Find the total revenue R(x).
b) Find the total profit P(x).
c) How many units must the manufacturer produce and sell in order to
maximize profit?
d) What is the maximum profit?
e) What price per unit must be charged in order to make this maximum
profit?
Solution:
a) Revenue = quantity × price
�(�) = � × �
�(�) = �(1000 − �)
�(�) = 1000� − � �
b) Profit = Total Revenue - Total Cost
P(x) = R(x)- C(x)
P(x) = 1000x- x2- (3000 + 20x)
P(x) = - x2+ 980x - 3000
c) P′(x) = -2x + 980 = 0
-2x = -980
x = 490
Since there is only one critical value, we can use the second derivative to
determine whether or not it yields a maximum or minimum.
P’’(x) = -2
Since P’’(x) is negative, x = 490 yields a maximum.
Thus, profit is maximized when 490 units are produced and sold.
d) The maximum profit is given by
P(490) = -(490)2+ 980(490) - 3000
P(490) = 237,100.
Thus, the stereo manufacturer makes a maximum profit of 237,100 when 490
units are produced and sold.
e) The price per unit to achieve this maximum profit is
p(490) = 1000 - 490
p(490) = 510.

168
 Application of
Check Your Progress 5 Derivatives
1) How do you get profit of a firm?
2) What are the two conditions to be satisfied for profit maximization?
3) Interpret the second order condition of profit maximization.

9.7 LET US SUM UP

This unit deals with application of derivatives to economic and business
studies. For that purpose, it covers some select themes that find frequent use.
Atthe outset, the negative slope of downward sloping demand curve and
positive slope of a supply curve are shown by using the first order derivative.
We have learnt the derivation of elasticity of demand as well as supply
function. Introducing the concept, it is said that elasticity refers to the
responsiveness of the dependent variable of a function to change in the
independent variable. We have seen the derivation of price elasticity of
� ��
demand as �� = � �� along with small changes in price and quantity.
Another expression for elasticity in terms of log functions has been
explained.
Stating that income elasticity of demand measures the effect of the change in a
consumer’s income on the demand for a specific product, we are also told that
this category of elasticity helps identify normal goods (positive elasticity) and
inferior goods (negative elasticity).
We are exposed to the concept of cross elasticity of demand which is defined as
the responsiveness of demand for a product in relation to the change in the price
of another related product. Use of this idea helps in knowing the elasticity of
substitute goods (positive cross elasticity) and that of complementary goods
(negative cross elasticity). At the last part of the section, the supply elasticity
has been discussed. The ratio of proportionate change inquantity supplied to a
proportionate change in its price is demonstrated using the derivative.
The process of applying derivatives for finding solutions different categories
of cost has been covered. Relation between average and marginal costs has
been derived using differentiation. An attempt is made to deal with revenue
function, which depicts the relation between revenue and output. The rate of
change of revenue per unit change in price is derived through technique of
derivative and relation between marginal revenue, average revenue and
elasticity of demand specified.
In the last part of the unit, the application of derivative to find first and
second order conditions of profit maximization is discussed. We have learnt
to derive the equality of marginal revenue and marginal cost in the first order
condition. The derivation of rate of change in the slope of marginal revenue,
which has to be less than the rate of change in the slope of marginal cost to
satisfy the second order condition is explained.

9.8 KEY WORDS

Complement Goods: A good for which the demand increases as the price of
an associated good decreases.
169
Business Mathematics Cost of Output: Increase in cost as production increase.
Elasticity of Demand: Sensitiveness the demand for a good to changes in
other economic variables, such as prices and income. It is calculated as the
percent change in the quantity demanded divided by a percent change in
another economic variable.
Equilibrium: A situation in which supply and demand are matched and price
remains stable.
Fixed Cost:Cost that remains constant for all levels of output.
Inverse Demand Function: Demand function viewing price as a function of
quantity demanded.
Monopoly: Market, with only one seller selling unique product and earn
super normal profit.
Perfect Competition: A market with a large number of buyers and seller.
Sellers sell homogenous product and earn normal profit. There is free entry
and exit in the market.
Price Elasticity of Supply: Responsiveness to the supply of a good or
service after a change in its market price.
Profit: Excess of total revenue over total costs.
Substitute Goods: As the price of one good increases, the demand for an
alternative good meeting the same consumer needs, increases.
Total Cost: Combination of fixed cost and variable cost.
Total Revenue: Product of price/demand function and output.
Variable Cost: Cost that varies with the level of output.

9.9 SOME USEFUL BOOKS

• K. Sydsaeter and P. Hammond, Mathematics for Economic Analysis,
PearsonEducational Asia, Delhi, 2002.
• Dowling, Edward,T. “Schaum’s Outline Series: Theory and
Problems of Mathematics for Economists”, New York: McGraw Hill
Book Company, 1986.
• Chiang, A. and Kalvin Wainwright, Fundamental Methods of
Mathematical Economics (Paperback), Mac Grow Hill, 2017.
• Varian , Hal R., Intermediate Microeconomics: A Modern Approach,
Springer (India) Pvt. Ltd. India, 2010.

9.10 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Read Sub-Section 9.2.2 and answer.
2) Law of diminishing utility, income and substitution effects.
3) Ans.: � = �(�)
Check Your Progress 2
1) Elasticity refers to the responsiveness of the dependent variable in a
function to change in the independent variable.
170
2) Due to requirement of complimentary goods moving together to satisfy Application of
Derivatives
demand.
3) Income elasticity of demand will be less than zero.
4) Cross elasticity of demand is the responsiveness of demand for a product
in relation to the change in the price of another related product.
5) ������� > −1;���������=in between -1 and 0; ���� ������� = −1.
6) Proportionate change inquantity supplied to a proportionate change in
its price.
Check Your Progress 3
1) AC = MC
2) Fixed cost
3) Fixed cost and variable cost.
Check Your Progress 4
1) A function that depicts the relation between revenue and output.
��
2) � d=�����.
∆�� �
3) ∆�
= � �1 − |� |�.
�

4) Firm operating under perfect competition. There is the optimum

situation of P=AR=MR.
Check Your Progress 5
1) Taking the difference between the total revenue and total cost.
2) First order condition of �� = �� and second order condition of
(��)� < (��)�,
3) Slope of marginal revenue must be less than the slope of MC curve at
the profit maximizing output.

9.11 EXERCISES WITH ANSWERS/HINTS

1) The demand function for a commodity is given by p= 20 - 2x. Find
total revenue. Compute average revenue and marginal revenue at
x=3 and interpret the results. Find the output level at which total
revenue is maximum and the maximum revenue. Is marginal
revenue rising at x=3?
2) A manufacturer finds her yearly uniform demand for her product to
be 40,000 units. The cost of setting up a production run is Rs. 200
and the cost of carrying one unit in inventory is Re.1 per annum.
Find the economic lot size that should yield a minimum total cost.
3) A firm produces x number of units at a total cost
C=Rs. (x3/10 – 5x2 +10x+5)
At what level of output will the marginal cost and the average
variable cost attain their respective minimum?
4) The total revenue(R) and total cost(C) functions of a firm are given
by: R= 30x – x2, C=20 + 4x, where x is the output. Find the output
which maximizes profit and the maximum profit.
171
Business Mathematics 5) If f(x) = ax2 + bx +c, show that supply relation is linear. Show that
p must exceed b +2√ac if total costs are to be covered but that, if
only variable costs are to be covered, p need exceed only b.
6) The demand q as a function of income y is given by 30q = 10 +3y.
Obtain the expression for the income elasticity of demand and its
value at y = Rs.250.
7) If MR= 100 and elasticity of demand with respect to output is 3,
find AR.
8) For what value of q, the elasticity of demand for the given demand
function p = 4 – 3q2becomes unitary.
9) What is the marginal revenue for a demand curve which has infinite
elasticity?
Find out the elasticity of demand whenthe demand curve is p =
50/(x +3).
10) Given the total cost function C = x3 –6x2+15x+10; find the
marginal cost function. At what output will MC be an increasing
function?
11) If the total manufacturing cost 'y' of making x units of a product
is: y = 20x + 5000,
a) What is the variable cost per unit?
b) What is the fixed cost?
c) What is the total cost of manufacturing 4000 units?
d) What is the marginal cost of producing 2000 units?
12) The profit function of a company can be represented by � = � (�) =
� – 0.00001� � , where x is units sold. Find the optimal sales volume
and the amount of profit to be expected at that volume.
13) What does Price Elasticity mean? Elaborate your answer.
14) The corn flakes industry decides to reduce the price of its product, from
Rs.100 to Rs. 75. The company expects that the sales of corn flakes
will increase from 10,000 units a month to 20,000 units a month.
Calculate and comment on the price elasticity of demand.
15) A demand function is given as � = 50 – 5�. Compute the price
elasticity of demand at p=5.
�
16) If the demand curve is x = ; then show that the price elasticity of
√�
demand is constant and equals to -1/2.
Answer of questions
1) x=5, TR=50, yes
2) 4000
3) 50/3; 25
4) x= 13, Rs. 149
5) Hint: p=MC; p≥ minimum AC; p≥ minimum AVC
6) 75/76
7) 150
172
8) 2/3 Application of
Derivatives
9) MR=AR
10) –x/(x+3)
11) We have the cost-output equation: y = 20x + 5000. We know that, if the
production increases, only total variable cost will increase in direct
proportion but the fixed cost will remain unchanged in total. So, the
derivative of y with respect to the increase in x by 1 unit will give the
variable cost per unit.
� �
a) Variable cost per unit =��(cost-output equation)=�� (20x + 5000)
= 20. Variable cost per unit is 20.
b) Total fixed cost will remain unchanged even if we don't produce
any unit. If we don't produce any unit, there will be no variable
cost and only fixed cost will be the total cost. So, if we put x=0 in
the cost-output equation, we will get the fixed cost. Fixed Cost =
y = [20.(0) + 5,000] = 5000
c) If we put x=4000 in the cost-output equation, we will get the total
cost of producing 4,000 units. Total cost of producing 4000 units
= y = 20 (4,000) + 5,000 = 85,000.
d) We know that the marginal cost of 'n'th unit = TCn–TCn–1
Marginal cost of 2000th unit
= TC of 2000 units – TC of (2000–1) units
= [20 (2000) + 5000] – [20 (1999) + 5000] = [45,000 – 44,980] = 20.
12) The necessary condition for the optimal sales volume is that the first
derivative of the profit function is equal to zero and the second
derivative must be negative. Where the profit function is:
P = x – 0.00001� �
�� �
= (x – 0.00001� � )
�� ��
Marginal Profit = 1 – 0.00002x
To get maximum profit now we put marginal profit = 0
So, 1 – 0.00002x = 0
or, 0.00002x = 1
�
So, x = = 50,000 units.
�.�����
The second derivative of profit function, i.e.,
��� �
= (1– 0.00002�)
�� � ��
Now by putting the value of x in profit function we get maximum
profit.
P = x – 0.00001� �
= 50,000 – 0.00001(50,000)2 = 50,000 – 0.00001(2500000000)
MR is defined as the change in the total revenue for the sale of an extra
unit.
173
Business Mathematics = 50,000 – 25,000 = 25,000.
The optimum output for the company will be 50,000 units of x and
maximum profit at that volume will be 25,000.
13) Price elasticity of demand is defined as the negative of the ratio of
proportionate change in quantity demanded to a proportionate
change in price,
������������� ������ �� ������
i.e., �� = (-) ������������� ������ �� �����

∆�/�
= (-) ∆�/�
� ∆� � ��
= (-) � ∆� or =(-) � ��

For price elasticity of demand, we will use the relevant formula.

14) First, we need to calculate the percentage change in quantity demanded
and percentage change in price. So,
% Change in Price = (Rs. 75-100)/(Rs.100) = -25%
% Change in Demand = (20,000-10,000)/(10,000) = 100%
Therefore, the Price Elasticity of Demand = 100%/-25% = -4.
This means the demand is relatively elastic.
15) The given demand function is
� = 50 – 5�
Differentiating w.r.t.’�’, we get
��
��
= −5
Hence, elasticity of demand is:
� ��
�� = (-)� ��
� �� �
= (-)����� . �
= ����
� �
When p=5; then �� = ���� = � = 1

16) Given the demand curve,

�
x= = 9 p-1/2
√�
�
�� �
��
= − � � ��
�
� �
� �� � � � �� �
�� = − � �� = − � . − � � � = ��
�
�
�� � �
= � = �which is a constant.
�
��� �

174
 Interest Rates
UNIT 10 INTEREST RATES
Structure
10.0 Objectives
10.1 Introduction
10.2 Meaning and Concept of Interest
10.3 Simple Interest
10.4 Compound Interest
10.5 Special Cases of Compound Rate of Interest
10.6 Let Us Sum Up
10.7 Key Words and List of Symbols
10.8 Some Useful Books
10.9 Answer or Hints to Check Your Progress
10.10 Exercises with Answers/Hints
Appendix Tables

10.0 OBJECTIVES
After studying this unit, you will be able to:
• understand the concept of interest;
• define simple interest and calculate simple interest;
• define compound interest and calculate compound interest;
• perform continuous compounding calculations; and
• perform changing compound rate calculations.

10.1 INTRODUCTION
In this unit, we will study about different kinds of interest rates and the
methods of calculating interests. For that purpose, we will discuss the
concepts of simple interest and compound interest along with their
computations.

10.2 MEANING AND CONCEPT OF INTEREST

Money can be lent or borrowed from one entity to another. The price to be
paid for the use of a certain amount of money for a certain period of time is
known as interest. It is considered as an expense to the borrower and income
for the lender. The money borrowed or lent is called principal. The interest
may be payable yearly, half-yearly, quarterly or monthly.
The idea of interest is based on the time value of money. It means that the
money available at the present point of time is worth more than the same
175
Business Mathematics amount of money at future point of time. One rupee of today is not equal to
one rupee of tomorrow. So, interest is actually the amount charged for the
borrowing of money to compensate the lender for the lost opportunity cost of
not having the money and also for various risks of lending money such as
default risk.

10.3 SIMPLE INTEREST

Simple interest (I) is the interest calculated on the original amount borrowed.
Thus, for the entire period of computation, interest is calculated on the
principal amount. Rates of interest are usually expressed as percentage.
Formula for calculation of simple interest-
Simple interest = Principal ×Rate ×Time

I = P × r× t

where
I: Interest, the amount of money that you pay to borrow money or the
amount of money that you earn on a deposit.
P: Principal which is the original sum of money
t: Time duration for which the money is borrowed/ deposited.
r: Rate of interest which is usually expressed as percent that is paid for
money borrowed, or earned for money deposited.
Calculating Amount:
Amount (�) = � + �
= � + (� × � × �) ��, � (1 + ��)
(Amount is the total amount due at the end of the period)

Example 1: To buy a new car, Ramesh borrowed Rs. 5,00,000 at 8% annual

simple interest for 3 years. How much interest will he pay?

Solution: Here, P = 5,00,000, r = 8/100=0.08, t = 3 years, I =?

Using the formula� = � × � × �,
simple interest (I) = 500000 × 0.08 × 3
= Rs. 1,20,000.
Ramesh will pay Rs. 1,20,000 as interest for the car loan.
Example 2: Aditya deposited Rs. 1,50,000 to a bank at 9.8% interest p.a.
Find the total interest that he will receive at the end of 5 years. Also find the
amount he will get.
Solution: Here, P = 1,50,000, r = 0.098, t = 5, I=?A =?
Since I=P×r×t,
I= 150000 × 0.098 × 5 = Rs. 73,500.
Aditya will get Rs. 73,500 as interest.
176
Amount = P + I Interest Rates

or,A= 150000 + 73500 = Rs. 2,23,500.

Aditya will receive Rs. 73,500 as interest and amount of Rs. 2,23,500 after 5
years.
Note: We can also calculate amount using formula A = P (1+ rt)
A = 150000 [1 + (0.098×5)]
or, A = Rs. 2,23,500
Example 3: Himanshi lends Rs. 45,000 to Rama. Find the time required for
this amount to yield Rs. 9,900 in simple interest at 11% per annum.
Solution: Here, I = 9,900,P = 45,000,r = 0.11,t =?
From I= P×r×t, we get
t = I/Pr
or, t = 9900/ (45000) (0.11)
= 2 (years).
Example 4: In how many years will a sum be double of itself at 5% p.a.
simple interest?
Solution: Amount = 2 × Principal
Given r = 0.05, t=?
From A = P + P×r×t,
A = P (1 + rt).
According to question, 2P = P [1 + t(0.05)]
or, 2 = 1 + t (0.05)
or, t = 1/0.05
or, 20.
A sum will be double of itself at 5% p.a. simple interest in 20 years.
Example 5: A sum of Rs. 1,20,000 was lent out for 2 years at simple interest.
The lender got Rs.1,53,600 in all. Find the rate of interest per annum (p.a).
Solution: Here, P = 1,20,000,A = 1,53,600,t= 2,r=?
A = P (1 + rt)
That is, 153600=120000 (1 +2r)
or, 153600 = 120000 + 240000 r
or,240000r = 153600 – 120000
or,r=33600/240000
or,r= 0.14 or 14%.
The required rate of interest is 14% p.a.

177
Business Mathematics Example 6: Find the principal that will yieldRs. 500.50 as interest in 2 years
at 5% p.a. simple interest.
Solution:Here,I= 500.50,t = 2, r = 0.05,P =?
From I = P×r×t, we get
500.50 = P × 0.05 × 2
or, 500.50 = 0.10P
or,P = 5,005.
The required Principal isRs. 5,005.
Example 7:
In how much time will Rs. 17,000 become Rs. 22,100 at 10% p.a. simple
interest?
Solution:
P = 17,000, A = 22,100,r = 0.10,t =?
Since 22100 = 17000 [1+ t (0.10)],
22100 = 17000 + 1700 t
or,1700 t = 5100
t = 3 years.

Check Your Progress 1

1) Why is interest paid?
�
2) How long will it take Rs. 10,000 to yield Rs. 2,200 at 5�% per annum
simple interest?
3) A certain sum of money at simple interest amounts to Rs. 1,120 in 3
years and to Rs. 1,200 in 5 years. Find the principal and the annual rate
of interest.

10.4 COMPOUND INTEREST

Another type of interest is compound interest. Compound interest is
calculated not only on the initial principal amount but also on the
accumulated interest of previous periods. In other words, compound interest
is calculated on interest as well as on principal. Therefore, compound interest
is sometimes described as ‘interest on interest’.
For example, if Rs. 5,000 is deposited at 5% per annum interest for 1 year, at
the end of the year the interest is Rs. 250.The amount at the end of year is Rs.
5,000 + Rs. 250 = Rs. 5,250. If this amount is lent at 5% per annum interest
for another year, the interest is calculated on Rs. 5,250 instead of the original
Rs. 5,000.So the amount in the account at the end of the second year is Rs.
5,250 + (5,250 × 0.05 × 1)= 5,250 + 262.50 = Rs. 5,512.50. Note that simple
interest would produce a total amount of 5,000 + (5,000 × 0.05 × 2) = 5,000+
500 = Rs. 5,500. The additional Rs. 12.50 is the interest on Rs. 250 at 5% for
one year.
178
Some concepts related to compound interest: Interest Rates

Compound Interest – It is the difference between the compound amount and

original principal amount.
Compound Amount - The total amount due at the end of the last period.
Frequency of Compounding - It indicates the number of times the interest is
compounded in one year.
Compounding Period - The time period between two consecutive points in
time at which interest is compounded.
Formula for calculation of compound amount
� = � (� + �)� ,
wherei = r/k or,
annual rate of interest
number of compounding period per year
and n = k×t; (number of compounding period per year × number of years).
A: Amount at the end of t periods
P: Principal which is the original sum of money
r: Annual rate of interest
k: Number of compounding periods per year
t: Time duration in years
n: Total number of compounding periods
i: Interest rate per compounding period
For example,if annual rate of interest is 10% and the compounding is
quarterly, then there are 4 compounding periods per year.
Thus, i = 0.10/4 = 0.025
If annual rate of interest is 24% and the compounding is monthly, then there
are 12 compounding periods per year. So,
i = 0.24/12 = 0.02.
Note: The value of (1 + i)ncan be found out using compound interest table
Some Formulae for Compound Interest
Compound Interest may be calculated yearly, half-yearly, quarterly, monthly
or continuously.
Formulas for different cases have been given below:

Time Amount
Yearly A = P (1+i)n where i = r and n = t
n
Half- yearly A = P (1+i) where i= r/2 and n = 2t
n
Quarterly A = P (1+i ) where i = r/4 and n = 4t
Monthly A = P (1+i)nwhere i= r/12 and n = 12t
Compound Interest (in all cases) I = A–P.
179
Business Mathematics Example 8: Bank pays compound interest at the rate of 5% p.a. Yogi
deposited a principal amount ofRs. 5,000 in bank for 4 years. Find the
interest that Yogi will receive.
Solution:Here,P = 5,000, n = 4, i = 0.05, A =?
We have A = P (1 + i)n
So, A = 5000 (1+ 0.05)4
or, A = 5000 (1.215506) (Using CompoundInterest Table)
or,A = Rs. 6,077.53.
We get,I= 6077.53 - 5000
or, I= Rs. 1,077.53.
Yogi will get Rs. 1,077.53 as interest from bank.
Example 9: Mehak deposited Rs. 50,000 in a finance account that pays 8%
interest, compounded annually. How much amount will be in her finance
account after 10 years?
Solution: Here, P = 50,000, i = 0.08, n = 10, A =?
As,A = P (1 + i)n,
A = 50000 (1 + 0.08)10
or, A = 50000 (2.158925) (Using Compound Interest Table)
or, A = 1,07,946.25
Mehak will have Rs. 1,07,946.25 in her finance account after 10 years.
Example10: Find the compound interest on Rs. 8,000 for 5 years at 6% per
annum interest compounded (i) semi-annually and (ii) monthly
Solution: Here, P = 8,000,t = 5, r = 0.06,A =?
A = P (1 + r/k)kt
(i) A = 8000(1+0.06/2)2×5
or, A = 8000(1+ 0.03)10
or, A = 8000 (1.343916) (Using Compound Interest Table)
or, A = Rs. 10,751.33.
We get,I= 10751.33 – 8,000
or, I= Rs. 2,751.33
(ii) A = 8000(1+0.06/12)12×5
i.e., A = 8000(1+ 0.005)60
or,A =8000 (1.348850) (Using Compound Interest Table)
or, A =Rs. 10,790.80.
So,I = 10790.8 – 8000
or, I = Rs. 2,790.80.
180
Example 11: If an amount of Rs. 86,400 is invested at 8% p.a. compounded Interest Rates
quarterly, how long will it take to accumulate Rs. 2,06,500.60?
Solution: Here, P = 86,400,r = 0.08,A = 2,06,500.60, t =?
As A = P (1 + r/k)kt,
206500.60 = 86400 (1 + 0.08/4)n
or, 206500.60/86400 =(1.02)n
or, (1.02)n=2.39005
or, n log 1.02 = log 2.390056
or, n(0.0086) = 0.378408
or, n = 0.378408/0.0086
= 44 quarters or 11 years.
The required time is 11 years.
Example 12: If interest is compounded annually at an interest rate of 6% p.a.,
then how long will it take a principal to double itself?
Solution: Here, P = P, A = 2P, r = 0.06,n =?
AsA = P (1 +r)n,
2P = P(1 +0.06)n
or, 2 = (1.06)n
or, log 2 = n log 1.06
or, n = log 2/ log 1.06 = 0.3010/0.0253
or, n = 11.9 years (approx.).
Example 13: A sum of money is deposited by Krishna which compounds
interest annually. The amount at the end of 2 years is Rs. 5,000 and at the end
of 3 years is 5,200. Find the money deposited and the rate of interest.
Solution: Here A(1) =5,000,n = 2 and A(2) = 5,200, n = 3, P = ?,r = ?
Now A = P (1 + r)n
That is, 5000= P (1 + r)2 … eq. (i)
and 5200= P(1 + r)3 …eq. (ii)
Dividing (ii) by (i)
5200/5000 = P(1 + r)3/ P (1 + r)2
or,(1 + r) = 5200/5000
or, r = 5200/5000 – 1
or, r = 1.04 - 1 = 0.04.
That is, required Rate of interest = 4%.
Now,from eq (i), P = 5000/ (1 + 0.04)2
or, P = 5000/(1.04)2
181
Business Mathematics or, log P = Log 5000 – 2 Log 1.04
= 3.69897 – 2 (0.0170) = 3.69897 – .0340 = 3.66497
or, P = antilog (3.66497)
= Rs.4,623 (approx).
Example 14:
Vidya’s savings account has a balance of Rs. 2,654.39. The annual interest
rate is 3% compounded monthly. Find the original principal amount
deposited two years ago.
Solution: Here, A= 2,654.39,r = 3%,t=2, P =?
Since, i= 3%/12 = 0.0025
and n = 2×12 = 24, from
A = P (1+i)n,
we have 2654.39 = P (1 + 0.0025)24
or, 2654.39 = P (1.061757) (Using Compound Interest Table)
or, P = 2654.39/1.061757
or, P = Rs. 2,500.

10.5 SPECIAL CASES OF COMPOUND RATE

OF INTEREST
Continuous Compounding
In the previous section, we discussed various cases where interest was
compounded monthly, quarterly, semi-annually and annually. But what if
interest is compounded daily or hourly? When the compounding period
becomes very tiny and the number of compounding periods per year grows
infinitely large, it is called a case of continuous compounding. In such cases,
the interest is calculated and added to the principal amount every extremely
small time period such as hourly or minutely.
Formula for Continuous compounding
A = Pert
A: Amount at the end of t periods
P: Principal amount which is original sum of money
r: Annual rate of interest
t: Time duration in years
Compounding at Changing Rates
We have discussed situations when the rate of interest is constant for the
entire time period. However, in real life, interest rate can change from time to
time. For example – Rashmi lends money to a friend for 2 years at 5% per
annum rate of interest. Her friend fails to pay the money after 2 years.
Rashmi increases the loan tenure for 2 more years but now at 7% per annum.
So, the final amount she will receive is the product of original principal and
182
two factors of form (1 + i)nor ert(with proper values of i and n or r and t for Interest Rates
each factor).
Example 15: If a businessman invests Rs. 50,000 at an annual interest rate of
5% per annum compounded continuously, calculate the amount he will have
in the account after five years.
Solution: Here, P = 50,000, r = 0.05, t = 5, A =?
As A = Pert,
we have A = 50000 e(0.05×5)
or, A = 50000 (1.2840) (using exvalue table)
or, A = Rs. 64,200.
Example 16: The difference between simple and compound interest on a
principal deposited for 8 years at 3% per annum is Rs. 267.7. Find the
principal amount.
Solution: Here, r = 0.03,t = 8, C.I.- S.I. =Rs. 267.7. Let the principal
amount be ‘x’
Simple interest on Rs.x for 8 years at 3% p.a. = x × 8 × 0.03 = 0.24 x
Compound Interest = [ x (1+ 0.03)8 –x] = (1.03)8 × – x = 1.266770 x
= 0.266770x
According to question, 0.26677 x- 0.24 x = 267.7
Or, 0.02677 x = 267.7
or,x = 267.7/0.02677
or,x =Rs. 10,000.
Example 17: Find the principal amount that will become Rs. 16,000 in 9
years if money can be deposited at 2% p.a. compounded semi-annually.
Solution: Here, A =16,000, t = 9, r = 0.02, P =?
Therefore, i = 0.02/2 = 0.01 and
n = 2 × 9 = 18.
From A = P (1 + i)nwe get 16000 = P (1 + 0.01)18
or,P = 16000/(1.01)18
or, P = 16000/ 1.19614748
or, P = Rs.13,376.28.
Example 18: If interest is compounded continuously at an annual rate of 5%,
how long will it take a principal to double itself?
Solution: Here, P = P,A = 2P, r = 0.05, t =?
Since A = Pert, so
2P = P e0.05t.
or, e0.05t= 2
183
Business Mathematics 0.05 t log e = Log 2
or,0.05 (0.4343)t = 0.301 (log e =0.4343)
or,t = 0.301/0.021715
or,t = 13.86 years = 14 years (approx.).
Example 19: If interest is compounded continuously, at what annual rate will
Rs. 3,000 amount to Rs. 3,00,000 in 25 years?
Solution: Here, P = 3,000,A = 3,00,000,t = 25, r =?
As A = Pert
We have 300000 = 3000 e25r
or, e25r=300000/3000 = 100
or, 25 r log e = log 100
or, 25 (0.4343)r = 2(log e =0.4343)
or, r = 2/10.8575
or, r = 0.1842044
or, r = 18.42 % (approx.).
Example 20: Mr. Arvind deposited Rs. 20,000 in a bank savings account for
3 years. Bank pays 6% p.a. compounded semi-annually for the first year,
12% p.a. compounded quarterly for the second year and 13% per annum
compounded continuously for the third year. Find the compound amount in
his bank account at the end of 3 years.
Solution: Here, P =20,000,A=?
Amount at the end of 3 years = 20000 (1 + 0.06/2)2 (1 + 0.12/4)4(e0.13), so
A = 20000 (1.03)2 (1.03)4 (e0.13)
or, A = 20000 (1.03)6 (e0.13)
or, A = 20000 (1.19405) (1.13882) (Using ex value table)
or, A = Rs. 27,196.16.

Check Your Progress 2

1) Fill in the Blanks
i) The time period between two consecutive points in time at which
interest is calculated is called.....................(frequency of
compounding/compounding period).
ii) When the number of compounding per year grows infinitely large,
it is a case of.....................(continuous compounding/ compounding
at changing rates)
iii) Interest on accumulated interest is called.........................(simple
interest/compound interest).
2) Find the compound amount in following cases:
i) Rs. 1,000 at 10% per annum deposited for 5 years;
184
 ii) Rs. 2,000 at 6% per annum for 4 years compounded quarterly; and Interest Rates

iii) Rs. 1,800 at 5 % per annum compounded semi-annually for 8

years.
3) Deepak deposited Rs.1,000 in bank account for 5 years at 12% simple
interest per year. If the same amount had been deposited for the same
period at 10% compound interest per year, how much more interest
would he get?
4) In what time, will Rs. 1,000 amount to Rs. 5,000, if it is invested at 7%
compounded continuously?

10.6 LET US SUM UP

In this unit, two basic concepts of interest, viz., simple interest and compound
interest have been discussed. Starting with the intuitive idea that it is a
payment made to lender by a borrower, it is observed that the difference
between initial investment and the accumulated value at a future time point of
time would show the amount of interest. While simple interest is paid only on
the original principal, not on the interest accrued, in case of compound
interest, the calculation would be not only on the initial principal but also
the accumulated interest of prior periods. Two special cases of compounding-
continuous compounding and compounding at changing rates have been
explained.

10.7 KEY WORDS AND LIST OF SYMBOLS

Compound Interest: It refers to the interest on the principal amount as well
as the interest due.
Continuously Compounded Interest: It is the interest on the principal
amount that is constantly compounded, essentially leading to an infinite
amount of compounding periods.
Interest: It is a payment for use of money. It is paid on borrowing money and
is received on lending the money.
Simple Interest: It refers to the interest which is chargeable on principal
amount only.
Time Value of Money: Money available at the present time is worth more
than the identical sum in the future.
List of Symbols
The symbols used in writing different formulas in your study material are the
one which are widely used. In the list given below, they are given as the first
symbols under various words. Many textbooks have given symbols different
from these. Most of the commonly used symbols are also given in the list
below. Whenever you read a book it is important to clearly understand the
meaning of various symbols used there. For writing different formulas you
may use any set of symbols you like, but along with them it is always
desirable to explain their meanings
Amount at the end of t periods A, S, An
Annual rate of interest r, i
185
Business Mathematics Interest I
Interest Rate per compounding period i
Number of compounding periods per year k, m
Principal which is the original sum of money P, A0
Time duration in years t
Total number of compounding periods n

10.8 SOME USEFUL BOOKS

Ayres, Frank Jr. Theory and Problems of Mathematics of Finance. Schaum’s
Outlines Series. McGraw Hill Publishing Co., New York, 1963.
Mizrahi and Sullivan, John. Mathematics for businesss and Social Sciences.
Wiley and Sons., New Jersey, 1987.
Singh, J.K.,Business Mathematics. Himalaya Publishing House., New
Delhi,2010.
Prasad, Bindra. and Mittal, P.K.,Fundamentals of Business Mathematics.
Har-Anand Publications., New Delhi, 2007.

10.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Towards the charge of using lender’s money.
2) 4 years.
3) Rs. 1,000; 4% per annum
Check Your Progress 2
1) (i) compounding period, (ii) continuous compounding,(iii)compound
interest
2) (i) Rs.1,610.51, (ii) Rs. 2,537.97, (iii) Rs.2,672.10.
3) Rs. 162.
4) 23 years (approx.)

10.10 EXERCISES WITH ANSWERS/HINTS

1) Differentiate between simple and compound interest with examples.
2) What is continuous compounding? Explain with the help of an example.
3) Find the simple interest on Rs. 12,000 borrowed for 8 months. The rate
of simple interest is 9% p.a.
(Ans: Rs. 720)
4) Monica paid Rs. 675 as interest on a loan of Rs. 5,000. Interest was
charged at 9% per annum simple interest. Find the length of the loan.
(Ans: 1.5 Years)
186
5) Find the compound amount and compound interest if Rs. 700 is lend for Interest Rates
15 years at 7% per annum compounded semi-annually.
(Ans: Rs. 1964.76, Rs.1264.76)
6) Mohan deposits Rs. 600 in his bank account. He wants to accumulate Rs.
900 in his account. Find the time it will take to accumulate the amount at
the rate of 8% per annum compounded quarterly.
(Ans: 5.12 Years)
7) If invested for three years, which investment yields the largest compound
amount? (a) Rs. 5,000 at 6% per annum compounded annually (b) Rs.
5,125 at 5% per annum compounded continuously or (c) Rs.4,950 at
6.5% per annum compounded annually?
(Ans: (a) Rs. 5,978.09, (b) Rs. 5,954.40, (c) Rs. 5979.35).
8) How long would it take for a principal P to double if rate of interest is
14% per annum compounded monthly?
(Ans: 4.98 Years)
9) A bank pays 5% per annum compounded continuously. Rs. 4,000 has
been deposited for 6 years. Find the amount at the end of 6 years.
(Ans: Rs.5399.44)

187
Business Mathematics Appendix: Amount at Compound Interest Table

n 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 2.00%

1 1.002500 1.005000 1.007500 1.010000 1.012500 1.015000 1.020000
2 1.005006 1.010025 1.015056 1.020100 1.025156 1.030225 1.040400
3 1.007519 1.015075 1.022669 1.030301 1.037971 1.045678 1.061208
4 1.010038 1.020151 1.030339 1.040604 1.050945 1.061364 1.082432
5 1.012563 1.025251 1.038067 1.051010 1.064082 1.077284 1.104081
6 1.015094 1.030378 1.045852 1.061520 1.077383 1.093443 1.126162
7 1.017632 1.035529 1.053696 1.072135 1.090850 1.109845 1.148686
8 1.020176 1.040707 1.061599 1.082857 1.104486 1.126493 1.171659
9 1.022726 1.045911 1.069561 1.093685 1.118292 1.143390 1.195093
10 1.025283 1.051140 1.077583 1.104622 1.132271 1.160541 1.218994
11 1.027846 1.056396 1.085664 1.115668 1.146424 1.177949 1.243374
12 1.030416 1.061678 1.093807 1.126825 1.160755 1.195618 1.268242
13 1.032992 1.066986 1.102010 1.138093 1.175264 1.213552 1.293607
14 1.035574 1.072321 1.110276 1.149474 1.189955 1.231756 1.319479
15 1.038163 1.077683 1.118603 1.160969 1.204829 1.250232 1.345868
16 1.040759 1.083071 1.126992 1.172579 1.219890 1.268986 1.372786
17 1.043361 1.088487 1.135445 1.184304 1.235138 1.288020 1.400241
18 1.045969 1.093929 1.143960 1.196147 1.250577 1.307341 1.428246
19 1.048584 1.099399 1.152540 1.208109 1.266210 1.326951 1.456811
20 1.051206 1.104896 1.161184 1.220190 1.282037 1.346855 1.485947
21 1.053834 1.110420 1.169893 1.232392 1.298063 1.367058 1.515666
22 1.056468 1.115972 1.178667 1.244716 1.314288 1.387564 1.545980
23 1.059109 1.121552 1.187507 1.257163 1.330717 1.408377 1.576899
24 1.061757 1.127160 1.196414 1.269735 1.347351 1.429503 1.608437
25 1.064411 1.132796 1.205387 1.282432 1.364193 1.450945 1.640606
26 1.067072 1.138460 1.214427 1.295256 1.381245 1.472710 1.673418
27 1.069740 1.144152 1.223535 1.308209 1.398511 1.494800 1.706886
28 1.072414 1.149873 1.232712 1.321291 1.415992 1.517222 1.741024
29 1.075096 1.155622 1.241957 1.334504 1.433692 1.539981 1.775845
30 1.077783 1.161400 1.251272 1.347849 1.451613 1.563080 1.811362
31 1.080478 1.167207 1.260656 1.361327 1.469759 1.586526 1.847589
32 1.083179 1.173043 1.270111 1.374941 1.488131 1.610324 1.884541
33 1.085887 1.178908 1.279637 1.388690 1.506732 1.634479 1.922231
34 1.088602 1.184803 1.289234 1.402577 1.525566 1.658996 1.960676
35 1.091323 1.190727 1.298904 1.416603 1.544636 1.683881 1.999890
36 1.094051 1.196681 1.308645 1.430769 1.563944 1.709140 2.039887
37 1.096787 1.202664 1.318460 1.445076 1.583493 1.734777 2.080685

188
 Interest Rates

38 1.099528 1.208677 1.328349 1.459527 1.603287 1.760798 2.122299

39 1.102277 1.214721 1.338311 1.474123 1.623328 1.787210 2.164745
40 1.105033 1.220794 1.348349 1.488864 1.643619 1.814018 2.208040
41 1.107796 1.226898 1.358461 1.503752 1.664165 1.841229 2.252200
42 1.110565 1.233033 1.368650 1.518790 1.684967 1.868847 2.297244
43 1.113341 1.239198 1.378915 1.533978 1.706029 1.896880 2.343189
44 1.116125 1.245394 1.389256 1.549318 1.727354 1.925333 2.390053
45 1.118915 1.251621 1.399676 1.564811 1.748946 1.954213 2.437854
46 1.121712 1.257879 1.410173 1.580459 1.770808 1.983526 2.486611
47 1.124517 1.264168 1.420750 1.596263 1.792943 2.013279 2.536344
48 1.127328 1.270489 1.431405 1.612226 1.815355 2.043478 2.587070
49 1.130146 1.276842 1.442141 1.628348 1.838047 2.074130 2.638812
50 1.132972 1.283226 1.452957 1.644632 1.861022 2.105242 2.691588
51 1.135804 1.289642 1.463854 1.661078 1.884285 2.136821 2.745420
52 1.138644 1.296090 1.474833 1.677689 1.907839 2.168873 2.800328
53 1.141490 1.302571 1.485894 1.694466 1.931687 2.201406 2.856335
54 1.144344 1.309083 1.497038 1.711410 1.955833 2.234428 2.913461
55 1.147205 1.315629 1.508266 1.728525 1.980281 2.267944 2.971731
56 1.150073 1.322207 1.519578 1.745810 2.005034 2.301963 3.031165
57 1.152948 1.328818 1.530975 1.763268 2.030097 2.336493 3.091789
58 1.155830 1.335462 1.542457 1.780901 2.055473 2.371540 3.153624
59 1.158720 1.342139 1.554026 1.798710 2.081167 2.407113 3.216697
60 1.161617 1.348850 1.565681 1.816697 2.107181 2.443220 3.281031
61 1.164521 1.355594 1.577424 1.834864 2.133521 2.479868 3.346651
62 1.167432 1.362372 1.589254 1.853212 2.160190 2.517066 3.413584
63 1.170351 1.369184 1.601174 1.871744 2.187193 2.554822 3.481856
64 1.173277 1.376030 1.613183 1.890462 2.214532 2.593144 3.551493
65 1.176210 1.382910 1.625281 1.909366 2.242214 2.632042 3.622523
66 1.179150 1.389825 1.637471 1.928460 2.270242 2.671522 3.694974
67 1.182098 1.396774 1.649752 1.947745 2.298620 2.711595 3.768873
68 1.185053 1.403758 1.662125 1.967222 2.327353 2.752269 3.844251
69 1.188016 1.410777 1.674591 1.986894 2.356444 2.793553 3.921136
70 1.190986 1.417831 1.687151 2.006763 2.385900 2.835456 3.999558
71 1.193964 1.424920 1.699804 2.026831 2.415724 2.877988 4.079549
72 1.196948 1.432044 1.712553 2.047099 2.445920 2.921158 4.161140
73 1.199941 1.439204 1.725397 2.067570 2.476494 2.964975 4.244363
74 1.202941 1.446401 1.738337 2.088246 2.507450 3.009450 4.329250
75 1.205948 1.453633 1.751375 2.109128 2.538794 3.054592 4.415835

189
Business Mathematics

1.4609
76 1.208963 01 1.764510 2.130220 2.570529 3.100411 4.504152
1.4682
77 1.211985 05 1.777744 2.151522 2.602660 3.146917 4.594235
1.4755
78 1.215015 46 1.791077 2.173037 2.635193 3.194120 4.686120
1.4829
79 1.218053 24 1.804510 2.194768 2.668133 3.242032 4.779842
1.4903
80 1.221098 39 1.818044 2.216715 2.701485 3.290663 4.875439

n 3.00% 4.00% 5.00% 6.00% 7.00% 8.00%

1 1.030000 1.040000 1.050000 1.060000 1.070000 1.080000
2 1.060900 1.081600 1.102500 1.123600 1.144900 1.166400
3 1.092727 1.124864 1.157625 1.191016 1.225043 1.259712
4 1.125509 1.169859 1.215506 1.262477 1.310796 1.360489
5 1.159274 1.216653 1.276282 1.338226 1.402552 1.469328
6 1.194052 1.265319 1.340096 1.418519 1.500730 1.586874
7 1.229874 1.315932 1.407100 1.503630 1.605781 1.713824
8 1.266770 1.368569 1.477455 1.593848 1.718186 1.850930
9 1.304773 1.423312 1.551328 1.689479 1.838459 1.999005
10 1.343916 1.480244 1.628895 1.790848 1.967151 2.158925
11 1.384234 1.539454 1.710339 1.898299 2.104852 2.331639
12 1.425761 1.601032 1.795856 2.012196 2.252192 2.518170
13 1.468534 1.665074 1.885649 2.132928 2.409845 2.719624
14 1.512590 1.731676 1.979932 2.260904 2.578534 2.937194
15 1.557967 1.800944 2.078928 2.396558 2.759032 3.172169
16 1.604706 1.872981 2.182875 2.540352 2.952164 3.425943
17 1.652848 1.947900 2.292018 2.692773 3.158815 3.700018
18 1.702433 2.025817 2.406619 2.854339 3.379932 3.996019
19 1.753506 2.106849 2.526950 3.025600 3.616528 4.315701
20 1.806111 2.191123 2.653298 3.207135 3.869684 4.660957
21 1.860295 2.278768 2.785963 3.399564 4.140562 5.033834
22 1.916103 2.369919 2.925261 3.603537 4.430402 5.436540
23 1.973587 2.464716 3.071524 3.819750 4.740530 5.871464
24 2.032794 2.563304 3.225100 4.048935 5.072367 6.341181
25 2.093778 2.665836 3.386355 4.291871 5.427433 6.848475
26 2.156591 2.772470 3.555673 4.549383 5.807353 7.396353
27 2.221289 2.883369 3.733456 4.822346 6.213868 7.988061
28 2.287928 2.998703 3.920129 5.111687 6.648838 8.627106
190
 Interest Rates

29 2.356566 3.118651 4.116136 5.418388 7.114257 9.317275

30 2.427262 3.243398 4.321942 5.743491 7.612255 10.062657
31 2.500080 3.373133 4.538039 6.088101 8.145113 10.867669
32 2.575083 3.508059 4.764941 6.453387 8.715271 11.737083
33 2.652335 3.648381 5.003189 6.840590 9.325340 12.676050
34 2.731905 3.794316 5.253348 7.251025 9.978114 13.690134
35 2.813862 3.946089 5.516015 7.686087 10.676581 14.785344
36 2.898278 4.103933 5.791816 8.147252 11.423942 15.968172
37 2.985227 4.268090 6.081407 8.636087 12.223618 17.245626
38 3.074783 4.438813 6.385477 9.154252 13.079271 18.625276
39 3.167027 4.616366 6.704751 9.703507 13.994820 20.115298
40 3.262038 4.801021 7.039989 10.285718 14.974458 21.724521
41 3.359899 4.993061 7.391988 10.902861 16.022670 23.462483
42 3.460696 5.192784 7.761588 11.557033 17.144257 25.339482
43 3.564517 5.400495 8.149667 12.250455 18.344355 27.366640
44 3.671452 5.616515 8.557150 12.985482 19.628460 29.555972
45 3.781596 5.841176 8.985008 13.764611 21.002452 31.920449
46 3.895044 6.074823 9.434258 14.590487 22.472623 34.474085
47 4.011895 6.317816 9.905971 15.465917 24.045707 37.232012
48 4.132252 6.570528 10.401270 16.393872 25.728907 40.210573
49 4.256219 6.833349 10.921333 17.377504 27.529930 43.427419
50 4.383906 7.106683 11.467400 18.420154 29.457025 46.901613
51 4.515423 7.390951 12.040770 19.525364 31.519017 50.653742
52 4.650886 7.686589 12.642808 20.696885 33.725348 54.706041
53 4.790412 7.994052 13.274949 21.938698 36.086122 59.082524
54 4.934125 8.313814 13.938696 23.255020 38.612151 63.809126
55 5.082149 8.646367 14.635631 24.650322 41.315001 68.913856
56 5.234613 8.992222 15.367412 26.129341 44.207052 74.426965
57 5.391651 9.351910 16.135783 27.697101 47.301545 80.381122
58 5.553401 9.725987 16.942572 29.358927 50.612653 86.811612
59 5.720003 10.115026 17.789701 31.120463 54.155539 93.756540
60 5.891603 10.519627 18.679186 32.987691 57.946427 101.257064
61 6.068351 10.940413 19.613145 34.966952 62.002677 109.357629
62 6.250402 11.378029 20.593802 37.064969 66.342864 118.106239
63 6.437914 11.833150 21.623493 39.288868 70.986865 127.554738
64 6.631051 12.306476 22.704667 41.646200 75.955945 137.759117
65 6.829983 12.798735 23.839901 44.144972 81.272861 148.779847
66 7.034882 13.310685 25.031896 46.793670 86.961962 160.682234

191
Business Mathematics

67 7.245929 13.843112 26.283490 49.601290 93.049299 173.536813

68 7.463307 14.396836 27.597665 52.577368 99.562750 187.419758
69 7.687206 14.972710 28.977548 55.732010 106.532142 202.413339
70 7.917822 15.571618 30.426426 59.075930 113.989392 218.606406
71 8.155357 16.194483 31.947747 62.620486 121.968650 236.094918
72 8.400017 16.842262 33.545134 66.377715 130.506455 254.982512
73 8.652018 17.515953 35.222391 70.360378 139.641907 275.381113
74 8.911578 18.216591 36.983510 74.582001 149.416840 297.411602
75 9.178926 18.945255 38.832686 79.056921 159.876019 321.204530
76 9.454293 19.703065 40.774320 83.800336 171.067341 346.900892
77 9.737922 20.491187 42.813036 88.828356 183.042055 374.652964
78 10.030060 21.310835 44.953688 94.158058 195.854998 404.625201
79 10.330962 22.163268 47.201372 99.807541 209.564848 436.995217
80 10.640891 23.049799 49.561441 105.795993 224.234388 471.954834

192
Appendix: ex and e-x value table Interest Rates

x ex e-x

0.00 1.0000 1.0000

0.01 1.0101 0.99005

0.02 1.0202 0.98020

0.03 1.0305 0.97045

0.04 1.0408 0.96079

0.05 1.0513 0.95123

0.06 1.0618 0.94176

0.07 1.0725 0.93239

0.08 1.0833 0.92312

0.09 1.0942 0.91393

0.10 1.1052 0.90484

0.11 1.1163 0.89583

0.12 1.1275 0.88692

0.13 1.1388 0.87810

0.14 1.1503 0.86936

0.15 1.1618 0.86071

0.16 1.1735 0.85214

0.17 1.1853 0.84366

0.18 1.1972 0.83527

0.19 1.2092 0.82696

0.20 1.2214 0.81873

0.21 1.2337 0.81058

0.22 1.2461 0.80252

0.23 1.2586 0.79453

0.24 1.2712 0.78663

0.25 1.2840 0.77880

193
Business Mathematics
0.26 1.2969 0.77105

0.27 1.3100 0.76338

0.28 1.3231 0.75578

0.29 1.3364 0.74826

0.30 1.3499 0.74082

0.31 1.3634 0.73345

0.32 1.3771 0.72615

0.33 1.3910 0.71892

0.34 1.4049 0.71177

0.35 1.4191 0.70469

0.36 1.4333 0.69768

0.37 1.4477 0.69073

0.38 1.4623 0.68386

0.39 1.4770 0.67706

0.40 1.4918 0.67032

194
 Compounding and
UNIT 11 COMPOUNDING AND Discounting

DISCOUNTING
Structure
11.0 Objectives
11.1 Introduction
11.2 Nominal and Effective Rates of Interest
11.3 Present Value
11.4 Equation of Value
11.5 Discount
11.5.1 Types of Discounts
11.6 Let Us Sum Up
11.7 Key Words and List of Symbols
11.8 Some Useful Books
11.9 Answer or Hints to Check Your Progress
11.10 Exercises with Answers/Hints
Appendix Tables

11.0 OBJECTIVES
After studying this unit, you should be able to:
• understand the concept of Nominal and Effective rates of interest;
• explain theinter-relationship of Nominal and Effective Rates of Interest;
• understand the concept and calculation of Present Value;
• use equation of value;
• understand the concept of discount; and
• perform calculation of various types of discounts.

11.1 INTRODUCTION
In the preceding, unit we have introduced the concept of interest and
discussed the method of computing simple as well as compound interest. The
present unit included some more themes useful for studying interest.
Often, we end up paying at an interest rate that is different from stated rate.
Such scenario arises because nominal rate of interest may be different from
effective rate of interest. In the previous unit, we learnt that although interest
has been quoted as a percentage per annum but it can be compounded more
than once a year. But what if we want to find whether interest rate of 5% per
annum (p.a.) compounded biannually is higher or lower than an interest rate
of 5% p.a. compounded quarterly? Calculation of effective rate of interest
facilitates comparison between different alternative opportunities. This unit
also elaborates the concept of present value and equation of value.
Discounting which is opposite to the concept of compounding introduced and
195
Business Mathematics its various types have been explained. Compounding is used to the find the
future value of a present amount whereas discounting is used to find value of
an amount which is to be received in future at an earlier date.

11.2 NOMINAL AND EFFECTIVE RATES OF

INTEREST
An interest rate is only meaningful in the context of time. In general it is
understood as – per year rate- which may be called the nominal interest rate.
With other periods of time than the year - like month, week, or day - the
interest rate may be called the effective interest rate.
To begin, remember the way in which compound interest works. Suppose an
amount A is invested at interest rate i per year and this interest is
compounded annually. After 1 year, the amount will be A + iA= A(1 + i), and
this total amount will earn interest the second year. Thus, after n years the
amount will be �(1 + �)� . The factor (1 + �)� is called the accumulation
factor. If interest is compounded daily after the same n years the amount will
�
be �(1 + ��� )���� . This� is the case of nominal annual rate of interest.

The effective annual rate of interest is the amount of money that one unit
invested at the beginning of the year will earn during the year, when the
amount earned is paid at the end of the year. In the daily compounding
�
example, the effective annual rate of interest is (1 + ��� )��� − 1. This is the
rate of interest which compounded annually would provide the same return.
When the time period is not specified, both nominal and effective interest
rates are assumed to be annual rates.
Example 1:What is the effective rate of interest corresponding to an interest
rate of 5% per annum compounded quarterly?
The equation to be solved is (1 + 0.05/4)� = 1 + �, where iis the
effective rate of interest. Two different investment schemes with two
different nominal annual rates of interest may in fact be equivalent, that is,
may have equal value at any fixed date in the future.
Formula for Calculation of Effective Rate of Interest:
� = (� + �)� – � ��, (� + �/�)� – �
R: Effective rate of interest
r: Annual rate of interest
k: Number of compounding periods per year
i: Interest rate per conversion period
Note: In case nominal interest is compounded continuously, the formula for
effective rate will become
� = �� – �
Example2: Find the effective rate which is equivalent to a nominal rate of
24% compounded monthly.
Solution: Here, k = 12, r = 0.24, R=?

196
 i = 0.24/12 Compounding and
Discounting
R = (1 + r/k)k– 1
= (1 + 0.24/12)12 – 1
= (1.02)12 – 1
= 1.268241-1
= 0.268241
= 26.82 %.
The equivalent effective rate is 26.82%.
Example 3: Find the effective rate which is equivalent to a nominal rate of
12 % compounded quarterly.
Solution: Here, k = 4, r = 0.12, R=?
i = 0.12/4
R = (1 + r/k)k–1
= (1 + 0.12/4)4 – 1
=(1.03)4 – 1
=1.1255088 – 1
=12.55 %.
The equivalent effective rate is 12.55%
Example 4: Find the compound interest rate when compounded continuously
is equivalent to an effective rate of 6%.
Solution: Here, R=0.06, er=?

R= er– 1

0.06 = er– 1

er=1.06

r log e = log (1.06)

or, r (0.4343) = 0.0253

or, r= 0.0253 /0.4343

= 0.05825 or, 5.82%.

The required rate of interest is 5.82%.

Example5: A local post office charges interest at the rate of 5 rupees per 100
rupees per quarter payable in advance. Find the effective rate of interest per
annum.
Solution: Since the rate is charged in advance, it can be treated like 5 rupees
on 95 rupees per quarter. Here, i = 5/95, k =4, R=?

197
Business Mathematics Now, R = (1 + i) k – 1
= (1 + 5/95)4 – 1
= (1 + 0.053)4 – 1
= (1.053)4 – 1
=1.2295 – 1
=22.95 %.
The effective rate of interest is 22.95% per annum.
Example 6: Radheshyam wants to borrow money for buying a motorcycle.
His bank charges 8% per annum interest compounded semi-annually. A
neighbourhood money lender charges 7.9% per annum interest compounded
monthly. In which case will he pay the lesser amount of interest?
Solution: We will compare the effective rates in both cases
R = (1 + i) k – 1 or, (1 + r/k) k – 1
Case A:
r = 0.08, k = 2, R =?
R= (1 + 0.08/2)2 – 1
=(1.04)2 – 1
= 1.081600 – 1
= 8.16%.
Case B:
r = 0.079, k = 12, R =?
R= (1 + 0.079/12)12 – 1
=(1.00658)12 – 1
= 1.081924 – 1
= 8.19% (Approx.).
The bank has lower effective rate of interest and thus charges lower effective
interest than the money lender.
Example 7: Anita wants to deposit Rs. 75,000 for 3 years. She has two
options: Option (A)- 10% per annum compounded semi-annually. Option
(B)- 9.5% per annum compounded continuously. Which option should Anita
choose?
Solution: We will calculate effective rate for both options:
R = (1 + i) k – 1 or, (1 + r/k) k – 1
Option (A), r = 0.1, k = 2, R =?
R= (1 + 0.1/2)2 – 1
=(1.05)2 – 1
= 1.1025 – 1
= 0.1025 or, 10.25%
Option (B), er = 0.095, R =?
198
R= er– 1 Compounding and
Discounting
=e0.095 – 1
=1.0997 - 1
=0.0997 or 9.97%.
Anita should choose option A.
Nominal interest rates are not comparable unless their compounding periods
are the same.Effective rate of interest is the rate of interest per annum
compounded only once in a year. Effective rate should not be confused with
simple interest. When the conversion period is a year, the effective rate of
interest and nominal rate of interest are same. So, when compounding is done
annually, both rates are equal. But if compounding is done more than once in
a year, effective rate of interest will be different from nominal rate of interest.
For example – If the interest rate is 15% per year, compounded annually. In
this case, the nominal interest rate is 15%, and the effective interest rate is
also 15%. However, in case the compounding is more frequent than once per
year, then the effective interest rate will be greater than 15%. The more often
compounding occurs, the higher is the effective interest rate.
The nominal rate of interest compounded continuously and equivalent to a
given effective rate of interest is called theforce of interest.
For example, if interest is compounded n times per year, then the amount
after t years is given by
� ��
�1 + � .
�
If we let � → ∞,then this expression is � �� . That is the case of notion of
instantaneous compounding of interest. In thiscontext denote by �the rate of
instantaneous compounding which is equivalentto interest rate i. Here �is
called the force of interest.
Example 8:Show that � = ln(1 + �).
Taking � � = � �� (���) = (1 + i).
Example 9: Find the force of interest which is equivalent to 5%
compoundeddaily.
Here � � = (1 + 0.05/365)���, so that d= 0.4999.
So as a roughapproximation when compounding daily the force of interest is
the same as thenominal interest rate.
Note: Nominal rate is also known as Annual percentage rate and Effective
rate is also known as Annual percentage yield.

Check Your Progress 1

1) State whether the following statements are True or False.
i) Nominal interest rate is always less than or equal to effective rate
of interest.
ii) The formula for compound discount is same as formula of
compound interest.
199
Business Mathematics iii) Force of interest is effective rate of interest compounded
annually.
iv) Equation of Value is used to equate value of obligations at a focal
point of time.
2) Fill in the blanks with appropriate words given in the brackets.
i) When the conversion period is ...........................the effective rate is
the same as the nominal rate. (year, continuous).
ii) ....................is good for comparison between alternative investment
opportunities. (Nominal rate/ Effective Rate)
iii) Nominal rate is also known as.........................(Annual percentage
yield/ Annual percentage rate)
3) Bank A pays a nominal interest rate of 10% compounded semi-annually.
Bank B pays a nominal interest rate of 10.5% compounded
quarterly. Which bank offers better effective interest rate?
4) What nominal rate has an effective rate of 8%, if compounded (a) Semi-
annually (b) Quarterly and (c) Monthly
5) What is force of interest?

11.3 PRESENT VALUE

Present value describes how much a future sum of money is worth today. To
see the underlying idea, suppose the objective is to have an amount �after
� yearsfromtoday.If the interest rate is�, how much should be deposited now
so as to achieve the set target? See that the amount required is �(1 + �)�� .
Such a quantity iscalled the present value of A. The factor (1 + �)�� is
called the discount factor.
Example10:Suppose the annual interest rate is 5%. What is the present value
ofa payment of Rs.2000 payable 10 years from now?
The present value is ��. 2000(1 + 0.05)��� = ��. 1227.83.
This example depicts the following idea: If you were given thechoice of
either receiving Rs. 1227.83 today or Rs. 2000 after10 years from now, then
you should be indifferent between these two choices. Thus, under the
assumption of an interest rate of 5% per annum, the payment of Rs. 2000 in
10 years can be replaced by a payment of Rs. 1227.83 today.
Formula:
� = � (� + �)�� ��, � (� + �/�)���
P = Principal Amount
A= Amount at future point of time
r: Annual rate of interest
k: Number of compounding periods per year
t: Time duration in years
i: Interest rate per conversion period
n = Number of Compounding periods
200
(Note: (1+i)-nor, (1+r/k)-tkis known as the discount factor. It represents the Compounding and
Discounting
present value of Rs.1 due after n periods at the interest rate of i per period).
Present Value: Continuous Compounding
Formula
� = �����
P = Principal Amount
A= Amount at future point of time
r: Annual rate of interest
t: Time duration in years
Example 11: What is the present value of Rs. 1,000 due in 2 years at 5% per
annum compound interest, if the interest is paid (a) yearly, (b) half-yearly?
Solution:(a) Here A = 1,000,i = 0.05,n = 2,P =?
P =A (1+i)-n
= 1000 (1+ 0.05)-2
= 1000 (1.05)-2
= 1000 (0.907029)
= Rs. 907.03
The present value is Rs. 907.03
b) Here A = 1,000,i = 0.05/2 = 0.025, n = 2×2
P =A (1+i)-n
=1000 (1+ 0.025)-2×2
= 1000 (1.025)-4
= 1000(0.905950)
= Rs. 906.
The present value is Rs. 906.
Note: Value of (1.05)-2 and (1.025)-4 can be calculated using calculator or
using Present value table.
Example 12: Monica deposits money in a bank paying 16% per annum
interest rate compounded quarterly. If she wants to have Rs. 15,000 in her
account after 5 years. How much should she deposit today?
Solution: Here, A = 15,000, i = 0.16/4 = 0.04, n = 5 × 4,P =?
P = A (1 + i)-n
= 15000 (1 + 0.04)-20
= 15000 (1.04) -20
= 15000(0.456386) (Using Present Value Table)
= Rs. 6,845.80.
201
Business Mathematics Monica should deposit Rs. 6,845.80 in her account today.
Example13: Find the present value of Rs.100 which is due at the end of 3
years. The rate of interest is 5% per annum compounded continuously.
Solution:A =100, t = 3, r = 0.05, p = ?
P = Ae-rt
= 100 e-(0.05)(3)
= 100 e-0.15 (Using e-xvalue table)
= 100 (0.86071)
= 86.07.
The present value is Rs. 86.07.
Example 14: Rahul has won a prize. He was given two options either to
receive Rs.8,000 today or Rs.10,000 after 2 years. The market interest rate is
12% and the interest is compounded on monthly basis. Which option should
Rahul choose?
Solution: Option (A) Rs. 8,000
Option (B) Here, A = 10,000,n = 2 × 12 = 24,r = 0.12,i = 0.12/12 = 0.01
P = 10000 (1 + 0.01)-24
= 10000 (1.01)-24
= 10000 (0.787566) (Using Present Value Table)
= Rs. 7,875.66- (Value of Option B).
Rahul should choose option A.
Example 15: Find the present value of Rs. 4,500 due after 3 years from now.
The interest is compounded continuously at the interest rate of 6%.
Solution: Here,A = 4,500,t =3,r = 0.06,P =?
P = Ae-r×t
= 4500 e-0.06×3
= 4500 e-0.18
= 4500 (0.83527) (Using e-xvalue table)
= Rs. 3,758.72.
The present value is Rs. 3,758.72.

Check Your Progress 2

1) What do you mean by the term present value?
2) What is the present value of Rs. 5,000 after 6 years from now. The rate
of interest is 8% per annum compounded quarterly?
3) Tarunis going to receive return of Rs. 10,000on an investment three
months from now. What would be the present value of return if the
continuous compounding interest rate is 16% p.a.?

202
 Compounding and
11.4 EQUATION OF VALUE Discounting

We have seen that in calculations of interest, the value of an amount of

money at any given point in time depends upon the time length since the
money was paid in the past or upon time which will elapse in the future
before it is paid. This principle is often called the time value of money.
We assume that this principle rejects only the effect of interest and does
not include the effect of inflation. Inflation reduces the purchasing power
of money over time.So, investors expect a higher rate of return to
compensate for inflation.
As a consequence of the above principle, various amounts of money
payable at different points in time cannot be compared until all the
amount are accumulated or discounted to a common date, called the
comparison date/focal date/valuation date, is established. The equation
which accumulates or discounts each payment to the comparison date is
called the equation of value.
The time diagram is helpful to solve the equation of value. Note that a
time diagram is one-dimensional diagram where the only variable is time.
We may show values of money intended to be associated with different
funds on a time line. Note that a time diagram is not a formal part of a
solution. However, it may be very helpful in visualizing the solution.
Example 16:In return for a payment of Rs.1,200 at the end of 10 years, a
lender agrees to pay Rs.200 immediately, Rs.400 at the end of 6 years,
and a final amount at the end of 15 years. What is the amount of the final
payment at the end of 15 years if the nominal rate of interest is 9% per
annum converted semiannually?
Ans.: The comparison date is chosen to be� = 0. The time diagram is
given in Figure1.

Rs. 200 Rs. 400

Rs. X

Lender

Borrower
0 1 2 3 4 5 6 7 8 9 10 11 12

Rs. 1200

Figure 1: Time Diagram for Payment

The equation of value is 200 + 400(1 + 0.045)��� + �(1 +

0.045)��� = 1200(1 + 0.045)��� .
Solving this equation for � we get � = ��. 231.11 (approx.).
To solve equation of value problems, we need to
1) Select a focal date;
2) Calculate the value of all obligations on the focal date using the stated
interest; 203
Business Mathematics 3) Set up the equation of value and then solve.
Example 17: You owe a debt that is to be paid by payments of Rs.1,800 after
one month, Rs.1,600 after two months and Rs.1,000 after three months. Find
the single payment that would repay the entire debt today. The simple rate of
interest is 5.75% per annum.
Solution: Focal Point: Today
Old obligation Value at focal point New Value at
obligation focal point
Rs. 1800 after 1 1800(1+0.0575×1/12)-1 Rs. x today x
month
Rs.1600 after 2 1600(1+ 0.0575 × 2/12)-1
months
Rs.1000 after 3 1000 (1+ 0.0575× 3/12)-1
months

Setting up Equation of value:

x =1800(1 + 0.0575 ×1/12)-1 + 1600(1+ 0.0575× 2/12)-1 + 1000 (1+ 0.0575× 3/12)-1
= 1791. 58 + 1584. 94 + 981.45
= 4357.97.
You have to pay Rs. 4,357.97 today to discharge the entire debt.
Example 18: Sita has two debts due: A debt of Rs. 800 is due in four months
and another debt of Rs. 1,000 is due in nine months. She wants to settle both
debts by a single payment at the end of six months. The rate of simple
interest is 6% p.a. Find the amount of this payment using (a) the present date
as the focal date, (b) the date of settlement as the focal date.
Solution: Let theamount of payment be x.
a) Focal point: Present date
Old Value at focal point New Value at focal
obligation obligation point

Rs. 800 after 800(1+0.06 ×4/12)-1 Rs. x after 6 x (1+ 0.06 × 6/12)-1
4 months months
Rs.1000 after 1000(1+ 0.06 × 9/12)-1
9 months

Setting up equation of Value:

800(1 + 0.06 ×4/12)-1 + 1,000(1+0.06× 9/12)-1 =x (1+ 0.06 × 6/12)-1
784.31 + 956.94 = 0.97087 x
or, x = 1741.25/0.97087
= 1793.49.
Hence, the amount required to pay today to settle both debts is Rs. 1,793.49.
b) Focal point: Six months

204
 Compounding and
Old Value at focal point New obligation Value at
Discounting
obligation focal point

Rs. 800 after 800(1+0.06 ×2/12) 1 Rs. x after 6 x

4 months months
Rs.1000 after 1000(1+ 0.06 × 3/12)-1
9 months

Setting up equation of Value:

1 1
2 3
800 1 0.06 1000 1 0.06 x
12 12
808 + 985.22 = x
or, x= 1793.22
Hence the amount required to pay after 6 months to settle both debts is Rs.
1,793.22.
Example 19: Vidya has a debt of Rs. 2,000 which is due after 12 years.
Instead of a lump sum payment, she is willing to pay Rs. 500 now and Rs.
500 at the end of six years and a final payment at the end of 12 years. If the
rate of interest charged is 2% per annum effectively, what should be her the
final payment to pay off the debt?
Solution: Let x be Vidya’s final payment towards payment of debt. Focal
point = 12 years
Calculation Table:

Old obligation Value at focal New obligation Value at focal

point point
Rs. 2000 2000(1 + 0.02)�� Rs.500 now 500(1 + 0.02)��

Rs. 500 at the end of 500(1 + 0.02)�

6 years
Rs. x at the end of X
12 years

Equation of Value becomes

500 (1 + 0.02)12 + 500(1 + 0.02)6 + x= 2000 (1 + 0.02)12
or, 500 (1.02)12 + 500(1.02)6 + x = 2000 (1.02) 12
or, 500 (1.268242)+ 500(1.126162)+x = 2000 (1.268242)
or, 634.121 + 563.081 + x = 2536.484
or, x =Rs. 1339.282
Vidya should pay Rs. 1339.28 to settle her debt.
Example 20: Satnam borrowed Rs. 15,000 from a money lender. He pays
Rs.4,000 at the end of 6 months and Rs. 6,000 at the end of one year. What
205
Business Mathematics should he pay at the end of two years to settle his debt? The rate of interest
charged is 18% compounded continuously.
Solution: Let the final payment by Satnambex. The focal point is present
date i.e., 0.
Equation of Value:
15000 = 4000 e-0.09 + 6000 e-0.18 + xe-0.36
or,15000 = 4000 (0.91393) + 6000 (0.83527)+ x (0.69768) (Using e-x value table)
or, 15000 = 3655.72 + 5011.62 + 0.69768 x
or, 0.69768 x = 6332.66
or, x = Rs.9,076.74.
Satnam should pay Rs.9,076.74 to settle his debt.

Check Your Progress 3

1) What do you mean by equation of value?
2) State the meaning of a time diagram.
3) Write the meaning of focal date.

11.5 DISCOUNT
Discounting is the opposite of compounding. When we know the future value
of some amount or obligation, we apply discount rate to find its value at
some earlier date. So, discounting is about moving backwards in time.
11.5.1 Types of Discounts
Simple Discount:
Sometimes interest is paid or deducted upfront in the financial transactions.
Such interest is called simple discount. For example, Anuj went to a money
lender to ask for a loan ofRs. 2,000. The money lender agrees to provide him
the loan and gives him Rs. 1,700 and says that Rs. 300 is the 15% interest
(2000 × 0.15 =300). Now Anuj will have to pay back only Rs.2,000 to the
money lender. Simple discount is different from simple interest as simple
interest is a percentage of principal while simple discount is a percentage of
the maturity amount.
Note: Another name for simple discount is bank discount.
Formula for Simple Discount:
� = � × � × �,
where
D =Discount Amount
A = Amount at the end of t periods
d = Discount percentage
t = Time period
Formula for Present Value at a Discount Rate:
206
� = � (� − �)� , Compounding and
Discounting
where
P = Present value of amount
A = Amount at the end of n periods
d = Discount rate per period
n = Number of time periods
Discount (D) = A - P
Nominal rate of discount and Effective rate of discount
The concept of nominal rate of discount and effective rate of discount is
similar to compounding. The stated rate of discount, when the discount is
converted more than once in a year is known as nominal rate of discount. On
the other hand, effective rate of discount is the rate of discount per annum
compounded only once in a year. Effective rate of discount is lower than the
nominal rate of discount.The nominal discount rate converted continuously
and equivalent to a given effective rate is known as force of discount. The
value of nominal rate of discount is not dependent on principal amount or
maturity amount.
The relationship between nominal discount rate and effective discount rate is
given by

�� = � – ��� ,
where
De = Effective discount rate
d = Nominal discount rate
Compound Discount:
Compound discount is the inverse of compound interest and is used to
calculate the value of future value of an amount at an earlier date.
Formula for Compound Discount:
� = � (� + �)�� ,
where
P = Present value of amount
A = Amount at the end of n periods
i = Interest rate per period
n = Number of time periods
Continuous Discount:
Continuous discount is used to find the present value of an asset or an
obligation whose value is known at some future time when interest is
compounded continuously. The concept of continuous discounting has wide
application in valuation of futures and forwards contracts.

207
Business Mathematics Formula for Continuous Discount:
� = ����� ,
where
P = Present value of amount
A = Amount at the end of n periods
i = Interest rate per period
n = Number of time periods
Example 21: Find the present value ofRs. 5,000 due in 2 years at 4% rate of
discount compounded quarterly.
Solution: Here, A = 5000, n = 2 × 4,d = 0.04/4 = 0.01, P=?
P = A (1- d)n
= 5000 (1- 0.01)8
= 5000 (0.99)8
= 5000 (0.9227446)
= Rs. 4,613.72.
The required present value is Rs. 4,613.72.
Example 22: Find the effective discount rate when nominal rate of discount
is 10% compounded continuously.
Solution: Here d = 0.10, De =?
De = 1 – e-d
= 1- e-0.10
= 1 – 0.90484 (Using e-xvalue table)
= 0.09516 or, 9.52%.
The required effective rate of discount is 9.52 %.
Example 23: Find the present value of Rs. 4,500 due after 3 years from now.
The interest is compounded continuously at the interest rate of 6%.
Solution: Here,A = 4,500,t =3,r = 0.06,P =?
P = Ae-r×t
= 4500 e-0.06×3
= 4500 e-0.18
= 4500 (0.83527) (Using e-xvalue table)
= Rs. 3,758.72.
The present value is Rs. 3,758.72.

Check Your Progress 4

1) Spell out the difference between effective rate of discount and
effective rate of interest.
208
2) What is the relationship between nominal rate of discount and effective Compounding and
Discounting
rate of discount?
3) When would you use continuous discount?

11.6 LET US SUM UP

In this unit we have discussed the concepts of nominal and effective interest
rates; present value, equation of value and discount that are used in course of
interest rate computation. In the process we have learnt that nominal interest
rate is annual percentage rate while effective annual rate of interest is the
amount of money that one unit invested at the beginning of the year will earn
during the year. The idea of present value is used to get the current value of a
future sum of money at given rate of return. We have seen that equation of
value is used to equate the value of obligations at a focal point of time and
discounting is opposite to compounding.

11.7 KEY WORDS AND LIST OF SYMBOLS

Discount Factor: Present value of Re.1 due after n periods at the interest rate
of i per period.
Discount Rate: The interest rate used to find the value of an amount at an
earlier period than its given future value period.
Effective Rate of Discount: Rate of discount per annum compounded only
once in a year.
Equation of Value: Equation of value equates value of different obligations
at focal point. At the focal date, value of debts = value of payments.
Focal Point of Time: A common date to which various amounts of money
payable at different points in time is fixed to compare all the amounts.
Nominal Rate of Discount: The stated rate of discount when the discount is
converted more than once in a year.
Present Value: Current value of a future sum of money or obligation at
given rate of return.
List of Symbols
The symbols used in writing different formulas in your study material are the
one which are widely used. In the list given below, they are given as the first
symbols under various words. Many textbooks have given symbols different
from these. Most of the commonly used symbols are also given in the list
below. Whenever you read a book it is important to clearly understand the
meaning of various symbols used there. For writing different formulas you
may use any set of symbols you like, but along with them it is always
desirable to explain their meanings.
Amount at the end of � periods A, S, An
Annual rate of interest r, R
Discount Amount D
Discount rate per period d
Effective rate of interest R, reff,rE, f
209
Business Mathematics Effective Discount Rate De
Interest rate per conversion period i
Number of compounding periods per year k, m
Number of time periods n
Principal Amount, Present Value of Amount P, A0
Time duration in years t

11.8 SOME USEFUL BOOKS

Ayres, Frank Jr., Theory and Problems of Mathematics of Finance. Schaum’s
Outlines Series, McGraw Hill Publishing Co., New York, 1963.
Mizrahi and Sullivan, John, Mathematics for Businesss and Social Sciences.
Wiley and Sons., New York, 1977.
Williams, W.E., and Reed, J.H. Fundamentals of Business Mathematics.,
Iowa 2014.
Singh, J.K. Business Mathematics. Himalaya Publishing House., New Delhi,
2018.
Prasad, Bindra, and Mittal, P.K. Fundamentals of Business Mathematics.
Har-Anand Publications., New Delhi, 2007.

11.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) (i)True (ii) False (iii)False (iv) True
2) (i) year (ii) Effective Rate (iii) Annual Percentage rate
3) Bank A - 10.25%, Bank B - 10.92%
4) a) 7.85% b) 7.77% c) 7.72%
5) Nominal rate of interest compounded continuously and equivalent to a
given effective rate of interest.
Check Your Progress 2
1) How much a future sum of money is worth today.
2) Rs. 3,108.60
3) Rs. 9,607
Check Your Progress 3
1) Equation that accumulates or discounts each payment to the
comparison date.
2) One-dimensional diagram, where the only variable is time, shown on a
single coordinate axis. In the coordinate of a point on the time-axis,
values of money intended to be associated with different funds are
shown.

210
3) A common date to which various amounts of money payable at Compounding and
Discounting
different points in time is fixed to compare all the amounts of
accumulation or discount.
Check Your Progress 4
1) The effective rate of discount, denoted by�, is a measure of interest
where the interest is paid at the beginning of the period. It is a
contrast to the effective rate of interest which is a measure of the
interest paid at the end of the period.
2) Rate of discount, when the discount is converted more than once in a
year is known as nominal rate of discount. The effective rate of
discount is the rate of discount per annum converted only once in a
year.
3) To find the present value of an asset whose value is known at some
future time when interest is compounded continuously.

11.10 EXERCISES WITH ANSWERS/HINTS

1) Distinguish between the nominal rate of interest and effective rate of
interest.
2) How compounding is different from discounting? Explain with the help
of an example.
3) Interest on a savings account is quoted as 23% p.a. compounded
monthly. Find the effective annual interest rate for the savings account.
(Ans: 25.586%)
4) Find the effective annual interest rate if the nominal interest rate of 9%
is:
(a) compounded monthly (b) compounded quarterly (c) yearly (d) semi-
annually
(Ans: (a) 9.381%, (b) 9.308%, (c) 9%, (d) 9.202%)
5) A deposit of Rs. 1,300 earns Rs.339.45 as interest in 3years. If the
interest is compounded monthly, what is the effective rate?
(Ans: 8.04%)
6) Saloni deposits an amount today in her account that earns 5% interest,
compounded annually. If her goal is to have Rs. 5,000 in the account at
the end of six years, how much she must deposit in the account today?
(Ans: Rs. 3731.08)
7) Sagar has to make payment of Rs. 500 due today and Rs.750 in four
months from now. Instead he wants to settle the payments by paying
Rs. 600 in three months and a final payment in seven months from
today. The rate of interest is 7% p.a. Find the final payment using seven
months from now as focal point.
(Ans.:669.55)

211
Business Mathematics 8) An IT Company’s bond will be worth Rs. 10,000 in 10 years. What
should the investor pay for it today in order to earn 6.5% annually?
(Ans: Rs. 5327.26)
9) Find the discount on Rs. 3000 due in 3 years at 6% rate of discount
converted semi-annually.
(Ans.: Rs. 501.09)
10) What is the effective discount rate when nominal rate of discount is
12% compounded continuously?
(Ans.:11.31 %)

212
 Appendix: Present Value Table Compounding and
Discounting
n 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 2.00%
1 0.997506 0.995025 0.992556 0.990099 0.987654 0.985222 0.980392
2 0.995019 0.990075 0.985167 0.980296 0.975461 0.970662 0.961169
3 0.992537 0.985149 0.977833 0.970590 0.963418 0.956317 0.942322
4 0.990062 0.980248 0.970554 0.960980 0.951524 0.942184 0.923845
5 0.987593 0.975371 0.963329 0.951466 0.939777 0.928260 0.905731
6 0.985130 0.970518 0.956158 0.942045 0.928175 0.914542 0.887971
7 0.982674 0.965690 0.949040 0.932718 0.916716 0.901027 0.870560
8 0.980223 0.960885 0.941975 0.923483 0.905398 0.887711 0.853490
9 0.977779 0.956105 0.934963 0.914340 0.894221 0.874592 0.836755
10 0.975340 0.951348 0.928003 0.905287 0.883181 0.861667 0.820348
11 0.972908 0.946615 0.921095 0.896324 0.872277 0.848933 0.804263
12 0.970482 0.941905 0.914238 0.887449 0.861509 0.836387 0.788493
13 0.968062 0.937219 0.907432 0.878663 0.850873 0.824027 0.773033
14 0.965648 0.932556 0.900677 0.869963 0.840368 0.811849 0.757875
15 0.963239 0.927917 0.893973 0.861349 0.829993 0.799852 0.743015
16 0.960837 0.923300 0.887318 0.852821 0.819746 0.788031 0.728446
17 0.958441 0.918707 0.880712 0.844377 0.809626 0.776385 0.714163
18 0.956051 0.914136 0.874156 0.836017 0.799631 0.764912 0.700159
19 0.953667 0.909588 0.867649 0.827740 0.789759 0.753607 0.686431
20 0.951289 0.905063 0.861190 0.819544 0.780009 0.742470 0.672971
21 0.948916 0.900560 0.854779 0.811430 0.770379 0.731498 0.659776
22 0.946550 0.896080 0.848416 0.803396 0.760868 0.720688 0.646839
23 0.944190 0.891622 0.842100 0.795442 0.751475 0.710037 0.634156
24 0.941835 0.887186 0.835831 0.787566 0.742197 0.699544 0.621721
25 0.939486 0.882772 0.829609 0.779768 0.733034 0.689206 0.609531
26 0.937143 0.878380 0.823434 0.772048 0.723984 0.679021 0.597579
27 0.934806 0.874010 0.817304 0.764404 0.715046 0.668986 0.585862
28 0.932475 0.869662 0.811220 0.756836 0.706219 0.659099 0.574375
29 0.930150 0.865335 0.805181 0.749342 0.697500 0.649359 0.563112
30 0.927830 0.861030 0.799187 0.741923 0.688889 0.639762 0.552071

213
Business Mathematics
31 0.925517 0.856746 0.793238 0.734577 0.680384 0.630308 0.541246
32 0.923209 0.852484 0.787333 0.727304 0.671984 0.620993 0.530633
33 0.920906 0.848242 0.781472 0.720103 0.663688 0.611816 0.520229
34 0.918610 0.844022 0.775654 0.712973 0.655494 0.602774 0.510028
35 0.916319 0.839823 0.769880 0.705914 0.647402 0.593866 0.500028
36 0.914034 0.835645 0.764149 0.698925 0.639409 0.585090 0.490223
37 0.911754 0.831487 0.758461 0.692005 0.631515 0.576443 0.480611
38 0.909481 0.827351 0.752814 0.685153 0.623719 0.567924 0.471187
39 0.907213 0.823235 0.747210 0.678370 0.616019 0.559531 0.461948
40 0.904950 0.819139 0.741648 0.671653 0.608413 0.551262 0.452890
41 0.902694 0.815064 0.736127 0.665003 0.600902 0.543116 0.444010
42 0.900443 0.811009 0.730647 0.658419 0.593484 0.535089 0.435304
43 0.898197 0.806974 0.725208 0.651900 0.586157 0.527182 0.426769
44 0.895957 0.802959 0.719810 0.645445 0.578920 0.519391 0.418401
45 0.893723 0.798964 0.714451 0.639055 0.571773 0.511715 0.410197
46 0.891494 0.794989 0.709133 0.632728 0.564714 0.504153 0.402154
47 0.889271 0.791034 0.703854 0.626463 0.557742 0.496702 0.394268
48 0.887053 0.787098 0.698614 0.620260 0.550856 0.489362 0.386538
49 0.884841 0.783182 0.693414 0.614119 0.544056 0.482130 0.378958
50 0.882635 0.779286 0.688252 0.608039 0.537339 0.475005 0.371528
51 0.880433 0.775409 0.683128 0.602019 0.530705 0.467985 0.364243
52 0.878238 0.771551 0.678043 0.596058 0.524153 0.461069 0.357101
53 0.876048 0.767713 0.672995 0.590156 0.517682 0.454255 0.350099
54 0.873863 0.763893 0.667986 0.584313 0.511291 0.447542 0.343234
55 0.871684 0.760093 0.663013 0.578528 0.504979 0.440928 0.336504
56 0.869510 0.756311 0.658077 0.572800 0.498745 0.434412 0.329906
57 0.867342 0.752548 0.653178 0.567129 0.492587 0.427992 0.323437
58 0.865179 0.748804 0.648316 0.561514 0.486506 0.421667 0.317095
59 0.863021 0.745079 0.643490 0.555954 0.480500 0.415435 0.310878
60 0.860869 0.741372 0.638700 0.550450 0.474568 0.409296 0.304782
61 0.858722 0.737684 0.633945 0.545000 0.468709 0.403247 0.298806
62 0.856581 0.734014 0.629226 0.539604 0.462922 0.397288 0.292947
63 0.854445 0.730362 0.624542 0.534261 0.457207 0.391417 0.287203
64 0.852314 0.726728 0.619893 0.528971 0.451563 0.385632 0.281572
65 0.850188 0.723113 0.615278 0.523734 0.445988 0.379933 0.276051
66 0.848068 0.719515 0.610698 0.518548 0.440482 0.374318 0.270638
67 0.845953 0.715935 0.606152 0.513414 0.435044 0.368787 0.265331
68 0.843844 0.712374 0.601639 0.508331 0.429673 0.363337 0.260129
69 0.841739 0.708829 0.597161 0.503298 0.424368 0.357967 0.255028
70 0.839640 0.705303 0.592715 0.498315 0.419129 0.352677 0.250028
71 0.837547 0.701794 0.588303 0.493381 0.413955 0.347465 0.245125
72 0.835458 0.698302 0.583924 0.488496 0.408844 0.342330 0.240319

214
73 0.833374 0.694828 0.579577 0.483659 0.403797 0.337271 0.235607 Compounding and
Discounting
74 0.831296 0.691371 0.575262 0.478871 0.398811 0.332287 0.230987
75 0.829223 0.687932 0.570980 0.474129 0.393888 0.327376 0.226458
76 0.827155 0.684509 0.566730 0.469435 0.389025 0.322538 0.222017
77 0.825093 0.681104 0.562511 0.464787 0.384222 0.317771 0.217664
78 0.823035 0.677715 0.558323 0.460185 0.379479 0.313075 0.213396
79 0.820982 0.674343 0.554167 0.455629 0.374794 0.308448 0.209212
80 0.818935 0.670988 0.550042 0.451118 0.370167 0.303890 0.205110

n 3.00% 3.50% 4.00% 4.50% 5.00% 6.00% 7.00%

1 0.970874 0.966184 0.961538 0.956938 0.952381 0.943396 0.934579
2 0.942596 0.933511 0.924556 0.915730 0.907029 0.889996 0.873439
3 0.915142 0.901943 0.888996 0.876297 0.863838 0.839619 0.816298
4 0.888487 0.871442 0.854804 0.838561 0.822702 0.792094 0.762895
5 0.862609 0.841973 0.821927 0.802451 0.783526 0.747258 0.712986
6 0.837484 0.813501 0.790315 0.767896 0.746215 0.704961 0.666342
7 0.813092 0.785991 0.759918 0.734828 0.710681 0.665057 0.622750
8 0.789409 0.759412 0.730690 0.703185 0.676839 0.627412 0.582009
9 0.766417 0.733731 0.702587 0.672904 0.644609 0.591898 0.543934
10 0.744094 0.708919 0.675564 0.643928 0.613913 0.558395 0.508349
11 0.722421 0.684946 0.649581 0.616199 0.584679 0.526788 0.475093
12 0.701380 0.661783 0.624597 0.589664 0.556837 0.496969 0.444012
13 0.680951 0.639404 0.600574 0.564272 0.530321 0.468839 0.414964
14 0.661118 0.617782 0.577475 0.539973 0.505068 0.442301 0.387817
15 0.641862 0.596891 0.555265 0.516720 0.481017 0.417265 0.362446
16 0.623167 0.576706 0.533908 0.494469 0.458112 0.393646 0.338735
17 0.605016 0.557204 0.513373 0.473176 0.436297 0.371364 0.316574
18 0.587395 0.538361 0.493628 0.452800 0.415521 0.350344 0.295864
19 0.570286 0.520156 0.474642 0.433302 0.395734 0.330513 0.276508
20 0.553676 0.502566 0.456387 0.414643 0.376889 0.311805 0.258419
21 0.537549 0.485571 0.438834 0.396787 0.358942 0.294155 0.241513
22 0.521893 0.469151 0.421955 0.379701 0.341850 0.277505 0.225713
23 0.506692 0.453286 0.405726 0.363350 0.325571 0.261797 0.210947
24 0.491934 0.437957 0.390121 0.347703 0.310068 0.246979 0.197147
25 0.477606 0.423147 0.375117 0.332731 0.295303 0.232999 0.184249
26 0.463695 0.408838 0.360689 0.318402 0.281241 0.219810 0.172195
27 0.450189 0.395012 0.346817 0.304691 0.267848 0.207368 0.160930
28 0.437077 0.381654 0.333477 0.291571 0.255094 0.195630 0.150402
29 0.424346 0.368748 0.320651 0.279015 0.242946 0.184557 0.140563
30 0.411987 0.356278 0.308319 0.267000 0.231377 0.174110 0.131367
31 0.399987 0.344230 0.296460 0.255502 0.220359 0.164255 0.122773
32 0.388337 0.332590 0.285058 0.244500 0.209866 0.154957 0.114741

215
Business Mathematics
33 0.377026 0.321343 0.274094 0.233971 0.199873 0.146186 0.107235
34 0.366045 0.310476 0.263552 0.223896 0.190355 0.137912 0.100219
35 0.355383 0.299977 0.253415 0.214254 0.181290 0.130105 0.093663
36 0.345032 0.289833 0.243669 0.205028 0.172657 0.122741 0.087535
37 0.334983 0.280032 0.234297 0.196199 0.164436 0.115793 0.081809
38 0.325226 0.270562 0.225285 0.187750 0.156605 0.109239 0.076457
39 0.315754 0.261413 0.216621 0.179665 0.149148 0.103056 0.071455
40 0.306557 0.252572 0.208289 0.171929 0.142046 0.097222 0.066780
41 0.297628 0.244031 0.200278 0.164525 0.135282 0.091719 0.062412
42 0.288959 0.235779 0.192575 0.157440 0.128840 0.086527 0.058329
43 0.280543 0.227806 0.185168 0.150661 0.122704 0.081630 0.054513
44 0.272372 0.220102 0.178046 0.144173 0.116861 0.077009 0.050946
45 0.264439 0.212659 0.171198 0.137964 0.111297 0.072650 0.047613
46 0.256737 0.205468 0.164614 0.132023 0.105997 0.068538 0.044499
47 0.249259 0.198520 0.158283 0.126338 0.100949 0.064658 0.041587
48 0.241999 0.191806 0.152195 0.120898 0.096142 0.060998 0.038867
49 0.234950 0.185320 0.146341 0.115692 0.091564 0.057546 0.036324
50 0.228107 0.179053 0.140713 0.110710 0.087204 0.054288 0.033948
51 0.221463 0.172998 0.135301 0.105942 0.083051 0.051215 0.031727
52 0.215013 0.167148 0.130097 0.101380 0.079096 0.048316 0.029651
53 0.208750 0.161496 0.125093 0.097014 0.075330 0.045582 0.027711
54 0.202670 0.156035 0.120282 0.092837 0.071743 0.043001 0.025899
55 0.196767 0.150758 0.115656 0.088839 0.068326 0.040567 0.024204
56 0.191036 0.145660 0.111207 0.085013 0.065073 0.038271 0.022621
57 0.185472 0.140734 0.106930 0.081353 0.061974 0.036105 0.021141
58 0.180070 0.135975 0.102817 0.077849 0.059023 0.034061 0.019758
59 0.174825 0.131377 0.098863 0.074497 0.056212 0.032133 0.018465
60 0.169733 0.126934 0.095060 0.071289 0.053536 0.030314 0.017257
61 0.164789 0.122642 0.091404 0.068219 0.050986 0.028598 0.016128
62 0.159990 0.118495 0.087889 0.065281 0.048558 0.026980 0.015073
63 0.155330 0.114487 0.084508 0.062470 0.046246 0.025453 0.014087
64 0.150806 0.110616 0.081258 0.059780 0.044044 0.024012 0.013166
65 0.146413 0.106875 0.078133 0.057206 0.041946 0.022653 0.012304
66 0.142149 0.103261 0.075128 0.054743 0.039949 0.021370 0.011499
67 0.138009 0.099769 0.072238 0.052385 0.038047 0.020161 0.010747
68 0.133989 0.096395 0.069460 0.050129 0.036235 0.019020 0.010044
69 0.130086 0.093136 0.066788 0.047971 0.034509 0.017943 0.009387
70 0.126297 0.089986 0.064219 0.045905 0.032866 0.016927 0.008773
71 0.122619 0.086943 0.061749 0.043928 0.031301 0.015969 0.008199
72 0.119047 0.084003 0.059374 0.042037 0.029811 0.015065 0.007662

216
73 0.115580 0.081162 0.057091 0.040226 0.028391 0.014213 0.007161 Compounding and
Discounting
74 0.112214 0.078418 0.054895 0.038494 0.027039 0.013408 0.006693
75 0.108945 0.075766 0.052784 0.036836 0.025752 0.012649 0.006255
76 0.105772 0.073204 0.050754 0.035250 0.024525 0.011933 0.005846
77 0.102691 0.070728 0.048801 0.033732 0.023357 0.011258 0.005463
78 0.099700 0.068336 0.046924 0.032280 0.022245 0.010620 0.005106
79 0.096796 0.066026 0.045120 0.030890 0.021186 0.010019 0.004772
80 0.093977 0.063793 0.043384 0.029559 0.020177 0.009452 0.004460
n 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% 14.00%
1 0.925926 0.917431 0.909091 0.900901 0.892857 0.884956 0.877193
2 0.857339 0.841680 0.826446 0.811622 0.797194 0.783147 0.769468
3 0.793832 0.772183 0.751315 0.731191 0.711780 0.693050 0.674972
4 0.735030 0.708425 0.683013 0.658731 0.635518 0.613319 0.592080
5 0.680583 0.649931 0.620921 0.593451 0.567427 0.542760 0.519369
6 0.630170 0.596267 0.564474 0.534641 0.506631 0.480319 0.455587
7 0.583490 0.547034 0.513158 0.481658 0.452349 0.425061 0.399637
8 0.540269 0.501866 0.466507 0.433926 0.403883 0.376160 0.350559
9 0.500249 0.460428 0.424098 0.390925 0.360610 0.332885 0.307508
10 0.463193 0.422411 0.385543 0.352184 0.321973 0.294588 0.269744
11 0.428883 0.387533 0.350494 0.317283 0.287476 0.260698 0.236617
12 0.397114 0.355535 0.318631 0.285841 0.256675 0.230706 0.207559
13 0.367698 0.326179 0.289664 0.257514 0.229174 0.204165 0.182069
14 0.340461 0.299246 0.263331 0.231995 0.204620 0.180677 0.159710
15 0.315242 0.274538 0.239392 0.209004 0.182696 0.159891 0.140096
16 0.291890 0.251870 0.217629 0.188292 0.163122 0.141496 0.122892
17 0.270269 0.231073 0.197845 0.169633 0.145644 0.125218 0.107800
18 0.250249 0.211994 0.179859 0.152822 0.130040 0.110812 0.094561
19 0.231712 0.194490 0.163508 0.137678 0.116107 0.098064 0.082948
20 0.214548 0.178431 0.148644 0.124034 0.103667 0.086782 0.072762
21 0.198656 0.163698 0.135131 0.111742 0.092560 0.076798 0.063826
22 0.183941 0.150182 0.122846 0.100669 0.082643 0.067963 0.055988
23 0.170315 0.137781 0.111678 0.090693 0.073788 0.060144 0.049112
24 0.157699 0.126405 0.101526 0.081705 0.065882 0.053225 0.043081
25 0.146018 0.115968 0.092296 0.073608 0.058823 0.047102 0.037790
26 0.135202 0.106393 0.083905 0.066314 0.052521 0.041683 0.033149
27 0.125187 0.097608 0.076278 0.059742 0.046894 0.036888 0.029078
28 0.115914 0.089548 0.069343 0.053822 0.041869 0.032644 0.025507
29 0.107328 0.082155 0.063039 0.048488 0.037383 0.028889 0.022375
30 0.099377 0.075371 0.057309 0.043683 0.033378 0.025565 0.019627
31 0.092016 0.069148 0.052099 0.039354 0.029802 0.022624 0.017217

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Business Mathematics
32 0.085200 0.063438 0.047362 0.035454 0.026609 0.020021 0.015102
33 0.078889 0.058200 0.043057 0.031940 0.023758 0.017718 0.013248
34 0.073045 0.053395 0.039143 0.028775 0.021212 0.015680 0.011621
35 0.067635 0.048986 0.035584 0.025924 0.018940 0.013876 0.010194
36 0.062625 0.044941 0.032349 0.023355 0.016910 0.012279 0.008942
37 0.057986 0.041231 0.029408 0.021040 0.015098 0.010867 0.007844
38 0.053690 0.037826 0.026735 0.018955 0.013481 0.009617 0.006880
39 0.049713 0.034703 0.024304 0.017077 0.012036 0.008510 0.006035
40 0.046031 0.031838 0.022095 0.015384 0.010747 0.007531 0.005294
41 0.042621 0.029209 0.020086 0.013860 0.009595 0.006665 0.004644
42 0.039464 0.026797 0.018260 0.012486 0.008567 0.005898 0.004074
43 0.036541 0.024584 0.016600 0.011249 0.007649 0.005219 0.003573
44 0.033834 0.022555 0.015091 0.010134 0.006830 0.004619 0.003135
45 0.031328 0.020692 0.013719 0.009130 0.006098 0.004088 0.002750
46 0.029007 0.018984 0.012472 0.008225 0.005445 0.003617 0.002412
47 0.026859 0.017416 0.011338 0.007410 0.004861 0.003201 0.002116
48 0.024869 0.015978 0.010307 0.006676 0.004340 0.002833 0.001856
49 0.023027 0.014659 0.009370 0.006014 0.003875 0.002507 0.001628
50 0.021321 0.013449 0.008519 0.005418 0.003460 0.002219 0.001428
51 0.019742 0.012338 0.007744 0.004881 0.003089 0.001963 0.001253
52 0.018280 0.011319 0.007040 0.004397 0.002758 0.001737 0.001099
53 0.016925 0.010385 0.006400 0.003962 0.002463 0.001538 0.000964
54 0.015672 0.009527 0.005818 0.003569 0.002199 0.001361 0.000846
55 0.014511 0.008741 0.005289 0.003215 0.001963 0.001204 0.000742
56 0.013436 0.008019 0.004809 0.002897 0.001753 0.001066 0.000651
57 0.012441 0.007357 0.004371 0.002610 0.001565 0.000943 0.000571
58 0.011519 0.006749 0.003974 0.002351 0.001398 0.000835 0.000501
59 0.010666 0.006192 0.003613 0.002118 0.001248 0.000739 0.000439
60 0.009876 0.005681 0.003284 0.001908 0.001114 0.000654 0.000385
61 0.009144 0.005212 0.002986 0.001719 0.000995 0.000578 0.000338
62 0.008467 0.004781 0.002714 0.001549 0.000888 0.000512 0.000296
63 0.007840 0.004387 0.002468 0.001395 0.000793 0.000453 0.000260
64 0.007259 0.004024 0.002243 0.001257 0.000708 0.000401 0.000228
65 0.006721 0.003692 0.002039 0.001132 0.000632 0.000355 0.000200
66 0.006223 0.003387 0.001854 0.001020 0.000564 0.000314 0.000176
67 0.005762 0.003108 0.001685 0.000919 0.000504 0.000278 0.000154
68 0.005336 0.002851 0.001532 0.000828 0.000450 0.000246 0.000135
69 0.004940 0.002616 0.001393 0.000746 0.000402 0.000218 0.000118
70 0.004574 0.002400 0.001266 0.000672 0.000359 0.000193 0.000104
71 0.004236 0.002201 0.001151 0.000605 0.000320 0.000170 0.000091

218
72 0.003922 0.002020 0.001046 0.000545 0.000286 0.000151 0.000080 Compounding and
Discounting
73 0.003631 0.001853 0.000951 0.000491 0.000255 0.000133 0.000070
74 0.003362 0.001700 0.000865 0.000443 0.000228 0.000118 0.000062
75 0.003113 0.001560 0.000786 0.000399 0.000204 0.000105 0.000054
76 0.002883 0.001431 0.000715 0.000359 0.000182 0.000092 0.000047
77 0.002669 0.001313 0.000650 0.000324 0.000162 0.000082 0.000042
78 0.002471 0.001204 0.000591 0.000292 0.000145 0.000072 0.000036
79 0.002288 0.001105 0.000537 0.000263 0.000129 0.000064 0.000032
80 0.002119 0.001014 0.000488 0.000237 0.000115 0.000057 0.000028

219
Business Mathematics
Appendix: ex and e-x value table
x ex e-x
0.00 1.0000 1.0000
0.01 1.0101 0.99005
0.02 1.0202 0.98020
0.03 1.0305 0.97045
0.04 1.0408 0.96079
0.05 1.0513 0.95123
0.06 1.0618 0.94176
0.07 1.0725 0.93239
0.08 1.0833 0.92312
0.09 1.0942 0.91393
0.10 1.1052 0.90484
0.11 1.1163 0.89583
0.12 1.1275 0.88692
0.13 1.1388 0.87810
0.14 1.1503 0.86936
0.15 1.1618 0.86071
0.16 1.1735 0.85214
0.17 1.1853 0.84366
0.18 1.1972 0.83527
0.19 1.2092 0.82696
0.20 1.2214 0.81873
0.21 1.2337 0.81058
0.22 1.2461 0.80252
0.23 1.2586 0.79453
0.24 1.2712 0.78663
0.25 1.2840 0.77880
0.26 1.2969 0.77105
0.27 1.3100 0.76338
0.28 1.3231 0.75578
0.29 1.3364 0.74826
0.30 1.3499 0.74082
0.31 1.3634 0.73345
0.32 1.3771 0.72615
0.33 1.3910 0.71892
0.34 1.4049 0.71177
0.35 1.4191 0.70469
0.36 1.4333 0.69768
0.37 1.4477 0.69073
0.38 1.4623 0.68386
0.39 1.4770 0.67706
0.40 1.4918 0.67032

220
 BCOC-134
Business Mathematics
and Statistics
School of Management Studies

PART B : BUSINESS STATISTICS

UNI-VARIATE ANALYSIS
Unit 12 : Introduction to Statistics 5
Unit 13 : Measures of Central Tendency 19
Unit 14 : Measures of Dispersion 96
BI-VARIATE ANALYSIS
Unit 15 : Simple Linear Correlation 139
Unit 16 : Simple Linear Regression 154
TIME-BASED DATA ANALYSIS
Unit 17 : Index Numbers 169
Unit 18 : Time Series Analysis 193
PROGRAMME DESIGN COMMITTEE B.COM (CBCS)
Prof. Madhu Tyagi Prof. D.P.S. Verma (Retd.) Prof. R. K. Grover (Retd.)
Former Director Department of Commerce SOMS, IGNOU, New Delhi
SOMS, IGNOU University of Delhi, Delhi
Faculty Members
Prof. R.P. Hooda Prof. K.V. Bhanumurthy (Retd.) SOMS, IGNOU
Former Vice-Chancellor Department of Commerce
Prof. N V Narasimham
MD University, Rohtak University of Delhi, Delhi
Prof. Nawal Kishor
Prof. B. R. Ananthan Prof. Kavita Sharma
Former Vice-Chancellor Department of Commerce Prof. M.S.S. Raju
Rani Chennamma University University of Delhi, Delhi
Belgaon, Karnataka Dr. Sunil Kumar
Prof. Khurshid Ahmad Batt
Prof. I. V. Trivedi Dean, Faculty of Commerce & Dr. Subodh Kesharwani
Former Vice-Chancellor Management Dr. Rashmi Bansal
M. L. Sukhadia University, University of Kashmir, Srinagar
Udaipur Dr. Madhulika P Sarkar
Prof. Debabrata Mitra
Prof. Purushotham Rao (Retd.) Department of Commerce Dr. Anupriya Pandey
Department of Commerce University of North Bengal,
Osmania University, Hyderabad Darjeeling

COURSE DESIGN AND PREPARATION TEAM

Prof. Madhu Tyagi Prof. G.P. Singh (Retd.) Faculty Members
Former Director University of Swarashtra, SOMS, IGNOU
SOMS, IGNOU Gujarat (Units 1 to 4) Prof. N V Narasimham
Prof. Nawal Kishor
Dr. H. K. Dogi Dr. Sarabjit Singh Kaur
University of Delhi, Delhi Dayal Singh College Prof. M.S.S. Raju
Units 10 to 11 University of Delhi, Delhi Dr. Sunil Kumar
Units 5 to 9 Dr. Subodh Kesharwani
Dr. Vidya Ratan Dr. Rashmi Bansal
Sriram College of Commerce Dr. O.P. Gupta Dr. Madhulika P Sarkar
University of Delhi, Delhi University of Delhi, Delhi Dr. Anupriya Pandey
Prof. Brahmha Bhatt Dr. C.R. Kothari
School of Commerce Rajsthan University, Course Coordinators and
Gujarat University Ahemdabad Jaipur Editors
Prof. M.S. Senam Raju
Prof. M.S. Senam Raju Prof. (Mrs.) Sarla Achuthan SOMS, IGNOU, New Delhi
SOMS, IGNOU, New Delhi Gujarat University, Ahemdabad Dr. Anupriya Pandey
(Unit 15,16,17 & 18) SOMS, IGNOU, New Delhi
Content Editing (Part-A)
Prof. Gopinath Pradhan (Retd.)
SOSS, IGNOU, New Delhi
Part-B adopted from ECO-07 & MCO-03

MATERIAL PRODUCTION
Mr. Y.N. Sharma Mr. Sudhir Kumar
Assistant Registrar (Publication) Section Officer (Pub.)
MPDD, IGNOU, New Delhi MPDD, IGNOU, New Delhi
January, 2020
© Indira Gandhi National Open University, 2020
ISBN:
All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any other
means, without permission in writing from the Indira Gandhi National Open University.
Further information on the Indira Gandhi National Open University courses may be obtained from the
University’s office at Maidan Garhi, New Delhi-110 068.
Printed and published on behalf of the Indira Gandhi National Open University, New Delhi, by the
Registrar, MPDD, IGNOU.
Laser typeset by Tessa Media & Computers, C-206, A.F.E-II, Jamia Nagar, New Delhi-110025

Printed at:
COURSE INTRODUCTION
This is one of the core courses in B.Com programme under CBCS scheme.
The main objective of this course is to familiarize the students with the
application of Mathematics and Statistical techniques which will facilitate in
business decision making. This course consists of two parts, viz., PART- A:
Business Mathematics comprising of 11 units and PART-B: Business
Statistics comprising of 7 units (unit 12 to unit 18). The brief introduction of
Part-B is as follows:

PART B : BUSINESS STATISTICS

This Part-B dealt with comprises of 7 Units (Unit 12 to Unit 18). i) Uni-
variate Analysis covering measures of central tendency and measures of
dispersion with brief introduction to statistics, ii) Bi-variate Analysis
covering simple correlation and regression, finally, iii) Time-Based Data
Analysis pertaining to index numbers and time series. The brief description
of each unit is given below:

UNI-VARIATE ANALYSIS
Unit 12: Introduction to Statistics deals with meaning, definitions,
functions, importance, scope and limitations of statistics.
Unit 13 : Measure of Central Tendency describes the meaning of central
tendency, list out its various measures such as Arithmetic Mean, Geomantic
Mean, Harmonic Mean, Median, Partition Values and Mode. It also discusses
the concept, method of computation, properties, uses and limitations of these
measures.
Unit 14 : Measures of Dispersion discuses the need of dispersion. It further
explains the meaning computation and uses of three measures of dispersion
viz., Range, Quartile Deviation, Mean Deviation, Standard Deviation, and Co
efficient of Variation.

BI-VARIATE ANALYSIS
Unit 15: Simple Linier Correlation introduces the concepts of co relation,
its calculations, their merits and limitations.
Unit 16: Simple Linier Regression introduces the concept of regression,
with its computation and applications thereof.

TIME-BASED DATA ANALYSIS

Unit 17 : Index numbers discusses meaning, concept, uses, and issues in
construction of index numbers along with the methods of constructing it.
Unit 18: Time Series Analysis explain the basic concepts, utility,
components of time series, along with the methods of measurement of trend
to forecast the future from the historical time series data.
 Introduction to
UNIT 12 INTRODUCTION TO STATISTICS Statistics

Structure
12.0 Objectives
12.1 Introduction
12.2 Meaning of Statistics
12.2.1 Statistics Defined in Plural Sense
12.2.2 Statistics Defined in Singular Sense
12.3 Descriptive and Inferential Statistics
12.4 Functions of Statistics
12.5 Importance of Statistics
12.6 Limitations of Statistics
12.7 Distrust of Statistics
12.8 Classification According to Variables
12.9 Let Us Sum Up
12.10 Key Words
12.11 Answers to Check Your Progress
12.12 Terminal Questions

12.0 OBJECTIVES
After studying this unit, you should be able to:
• define the word ‘statistics’,
• distinguish between descriptive and inferential statistics,
• describe the different functions of statistics,
• explain the importance of statistical methods in different fields,
• appreciate the limitations of statistical methods,
• explain the reasons for distrust in statistics, and
• explain the usages and importance of statics in business.

12.1 INTRODUCTION
So far, we have discussed business mathematics. In this unit, we will discuss
business statistics and its usage and importance in business. Statistics is not a
new discipline but is as old as the human activity itself. Its sphere of utility,
however, has been increasing over the years. In the olden days, it was
considered as the ‘science of statecraft’ and was regarded as a by-product of
the administrative activity of the State thereby limiting its scope. The
governments in those days used to keep records of population, birth, deaths,
etc., for administrative purposes. In fact, the word ‘statistics’ seems to have
been derived from the Latin word ‘status’ or Italian word ‘statista’ or the
German word ‘Statistik’ each of which means a political state. Statistical 5
Business Statistics methods are now widely used in various diversified fields such as agriculture,
economics, sociology, business management, etc. In this unit you will study
the meaning and definition of statistics, distinction between descriptive and
inferential statistics, functions of statistics, importance and limitations of
statistics, and distrust of statistics.

12.2 MEANING OF STATISTICS

We have come across the statistics all the time for instance,
- the inflation rate has gone up 20% since last year.
- the crime rate has reduced by 5% thane that of last year.
All the above statements are statistical conclusions. These statistical
statements are very convenient type of communication to understand the
readers and also helps in formulating specific policies pertaining to that area.
The word ‘statistics’ has been used in a variety of ways. Sometimes it is used
in the plural sense to refer to numerical statements of facts or data. On the
other hand it is also used in the singular sense to refer to a subject of study
like any other subject such as mathematics, economics, etc. For instance,
when we refer to a few ‘statistics’ relating ‘to our country like – there are 932
females per 1,000 males in India, the per capita national product at current
prices has increased from Rs. 246 in 1950-51to Rs. 2,596 in 1985-86 here we
are using the word statistics in the plural sense (meaning data). To prepare
these numerical statements, one must be familiar with those methods and
techniques which are used in data collection, organisation, presentation,
analysis and interpretations. A study of these methods and techniques is the
science of statistics. The use of the word statistics here is in the singular
sense. In this sense the word statistics means statistical methods or the
science of statistics. Now let us study in detail about these two approaches.
12.2.1 Statistics Defined in Plural Sense
In its plural connotation, statistics means data or numerical figures pertaining
to any given situation or a phenomenon. These may be quantitative or
qualitative data.
Quantitative data may represent the numerical observations in relation to a
continuous variable. A continuous variable is the one which can assume any
value between any two points on a line segment. All characteristics such as
weight, length, height, thickness, velocity, temperature, and the like are all
continuous variables. Discrete data, on the other hand, refer to values
assumed by a discrete variable. A discrete variable is represented by fixed
values, generally integers such as 1,2,3,…… . These are count data collected
by making a count of the number of items possessing or not possessing a
certain characteristic. For example, the number of incoming flights at an
airport, or the number of defective items in a consignment received for sale.

Qualitative data may be nominal or ranked. The Nominal data arise due to
classification into two or more categories of a certain number of items
according to some quality characteristic. For example, classification of
6
students according to sex. (as males and females) or according to the level of Introduction to
Statistics
education (as matriculates, undergraduates, and postgraduates). Such data
are also count data. The ranked data, on the other hand, are the result of
assigning ranks according to the level of performance in any competitive test,
contest, or interview. Candidates appearing in an interview, for instance,
may be assigned ranks in integers ranging from 1 to n, depending on their
performance in the interview. The ranks so assigned may be viewed as
continuous values of a variable which may be any quality characteristic under
observation.

Statistics has been defined differently by different writers. According to

Webster “statistics are the classified facts representing the conditions of the
people in a state…. specially those facts which cay be stated in numbers or
any tabular or classified arrangement.” To Bowley statistics “numerical
statements of facts in any department of enquiry placed in relation to each
other.” According to Yule and Kendall statistics means “quantitative data
affected to a marked extent by multiplicity of causes.” These definitions are
too narrow as they confine the scope of statistics to only such facts or figures
which either relate to the conditions of the people in a state or specify some
characteristics of the data.

A more comprehensive definition of statistics was given by Horace Secrist.

According to him statistics means “aggregate of facts affected to marked
extent by multiplicity of causes, numerically expressed, enumerated Dr
estimated according to a reasonable standard of accuracy, collected in a
systematic manner for a predetermined purpose and placed in relation to each
other.” This definition is quite comprehensive and points out the
characteristics that numerical facts (data) must possess so that they may be
called statistics. Let us discuss about these characteristics one by one.

a) They must be aggregate of facts: Individual and isolated figures cannot

be called statistics. They should form a part of aggregate of facts relating
t o any particular field of enquiry. For example, Ram’s monthly income is
Rs. 2,000. This is not a statistical statement. However, when we say that
monthly incomes of Ram, Mohan, and Sohan are Rs. 2,000,2,500 and Rs.
3,000 respectively, they will be called statistics.

b) They are affected by multiplicity of factors: There are several factors

that affect a phenomenon. For instance, the consumption of a household
on any item would be affected by several factors as income, taste,
education, etc. Similarly, production of wheat is affected by soil, seeds,
rainfall, temperature, etc. The data relating to such phenomenon can be
called statistics. But if we write the numbers one to ten along with their
squares, then these figures though more than one, cannot be called
statistics. These figures are not affected by multiplicity of causes.

c) They must be numerically expressed: To call a statement as statistics, it

must be expressed numerically. Therefore, qualitative characteristics such
as beauty, colour of eyes, etc., cannot be measured directly and hence, in
general, they do not fall under the purview of statistics. We have to
quantify these characteristics before they become statistics. For example,
7
Business Statistics in a college we may count the number of girls having black eyes or blue
eyes or brown eyes.

d) They are enumerated or estimated according to a reasonable

standard of accuracy: Statistics are either enumerated or estimated, but
reasonable standards of accuracy must be maintained. The degree of
accuracy will depend on the nature and the object of the study being
undertaken. Suppose, as the Principal of a College you are interested in
understanding the average level of performance of the students who take
admission to B.Com. class. For this purpose you must collect the marks
obtained by the students at the senior secondary level. It may be done in
two ways. First you can have a complete enumeration of the marks of all
the students and derive their average. Secondly if complete enumeration
is not possible due to some reason, you may select a sample. On the basis
of the result of the sample, you may then estimate the average level of
performance of all students. Thus, statistics may be obtained by
enumeration or estimation. Let us take another example to understand the
point reasonable standard of accuracy. If you are estimating .the total
production of food crop in India the appropriate units of measurement (or
the level of accuracy) may be lakhs of tons. But if you are reporting the
total production of gold, the appropriate unit of measurement may be
kilograms. Thus, degree of accuracy depends on nature and objective of
the study.

e) They must be collected in a systematic manner for a predetermined

purpose: The data should be collected in a systematic manner. Data
collected in a haphazard manner will not serve much purpose. The
purpose for which data is collected, must be decided in advance. The
purpose should be specific and well defined. If the purpose of the enquiry
is not specified, either we may collect too much or too little data.

f) They must be placed in relation to each other: The numerical facts

should be comparableif they are to be called statistics. For instance,
statistics on production and export of an item during a year are related.
What they put together are statistics. But if you have three figures: 1)
production of rice in India in 1986, 2) number of children born in USA in
1987, and 3) number of cars registered in UK in 1988. These figures may
be facts alright, but taken together they cannot be called statistics as they
have no relation among themselves.

It is, thus, clear that all statistics are numerical statements of facts but all
numerical statements of facts are not statistics. They will be called
statistics only if the above characteristics are present in them.
12.2.2 Statistics Defined in Singular Sense
Numerical information must be collected, organised, presented, analysed and
interpreted if it has to be used for making wise decisions. We require
methods that help us in this regard. Thus, statistics, when used in the singular
sense, has been defined as a body of methods which provides tools for data
collection, analysis and interpretation. Here too, different writers have
8
interpreted statistics differently. Now let us also discuss about some of these Introduction to
Statistics
definitions.

Bowley, for instance, has given a number of definitions. But none of them is
comprehensive. They in fact point to the development of science of statistics
over time. Some of these definitions are:
i) Statistics may be called the science of counting.
ii) Statistics may rightly be called the science of averages.
iii) Statistics is the science of measurement of social organism, regarded as
a whole in all manifestations.
Croxton and Cowden have given a simple and precise definition of statistics.
According to them “statistics may be defined as the collection, presentation,
analysis and interpretation of numerical data.”

The definition given by Selligrnan is equally simple but comprehensive.

According to him “statistics is the science which deals with the methods of
collecting, classifying, presenting, comparing and interpreting numerical data
collected to throw some light on any sphere of enquiry.”

The last two definitions are quite precise, comprehensive, and point out the
scope of statistical methods. The science of statistics teaches us the methods
and techniques which are required for 1) collection of data, 2) classification
and tabulation of data, 3) presentation of data, 4) analysis of data, and 5)
interpretation of data.

Thus, from the above discussion, we can conclude that the word ‘statistics’
may be used either in plural sense to refer to data or in singular sense to refer
to a body of methods for making wise decisions in the face of uncertainty.

12.3 DESCRIPTIVE AND INFERENTIAL

STATISTICS
Statistics as a subject is very wide. If consists of methods of handling
massive data in a variety of problem situation.

As you know, when used in singular sense, statistics is a study of the

principles and methods used in the collection, presentation, analysis and
interpretation of data in any sphere of enquiry. These methods and techniques
are so diverse that statisticians generally categorise them into two: 1)
descriptive statistics, and 2) inferential statistics.

Descriptive Statistics refer to various measures that are used to describe the
characteristic features of the data. Such measures include measures of central
tendency, measures of dispersion, etc. Graphs, tables and charts that display
data are also examples of descriptive statistics. Suppose the number of first
year B.Com. students is 100 and you compute the average marks of these
students. Here you are using descriptive statistics. Similarly, when you are
computing the average marks of a sample of 25 students from the same class
9
Business Statistics but without attempting any generalisation about the entire class, you are still
using descriptive statistics.

Inferential Statistics on the other hand refer to statistical process of drawing

valid inferences about the characteristics of population data on the basis of
sample data. The word population in statistics does not mean only human
population. It stands for totality of items related to any field of study. If the
teacher, in the above example, decides to estimate the average marks of the
entire class on the basis of the sample average, we would say that he is using
inferential statistics. It is not worthy that most of the time we use sample data
to understand the features of the population data. Inferences about population
drawn from sample measures may involve some error or discrepancy. The
magnitude of such errors can be estimated on the basis of probability theory.

Check Your Progress A

1) Are the following statements statistical data?
i) Weekly wages of 100 workers of a factory.
ii) Height of Ram is six feet.
iii) Mohan’s weight is 70 Kgs, Sohan’s height is 6.2 feet, and
Ram’s monthly income is Rs. 1,500.
iv) Sales of a company during the past 10 years.
2) Comment on the following statements in not more than one line.
i) Webster and Secrist defined descriptive statistics.
ii) Definition of statistics given by Yule and kendall is contained
in the one by Secrist.
iii) Qualitative data cannot be studied under statistics.
iv) Methods of statistics relate to collection and analysis of the
data only.
v) The definition of science of statistics by Bowley covers the
different stages of statistical methodology.
vi) Inferential statistics is related to the study of samples.

12.4 FUNCTIONS OF STATISTICS

You have studied the meaning and definitions of statistics. You have also
learnt the Difference between descriptive statistics and inferential statistics.
Let us now discuss some of the important functions of statistics:
1) To present facts in a proper form: Statistical methods present general
statementsin a precise and definite form. For example, you may say that
in India average yield of cotton per hectare is 180 Kg. This statement is
more precise and convincing than saying that the average yield of cotton
in India is very low.

10
2) To simplify unwieldy and complex data: Statistical methods simplify Introduction to
Statistics
unwieldy and complex data to make them understandable easily. The raw
data is often unintelligible. One cannot grasp their characteristics unless
the data is classified according to somecommon characteristics, Suppose,
you are given the weekly wages of 1,000 workers in a factory. You will
not be in a position to draw any inference from the data unless they are
condensed through classification such as the following:

Weekly Wages (Rs.) No. of Workers

Below-600 100
600-700 200
700-800 400
800-900 200
Above 900 100
Total 1000

3) To provide techniques for making comparison: The primary purpose

of statistics is to facilitate a comparative study of different phenomena
either over time or space, For instance, the estimation of national income
is not done for its own sake. But it is done to compare the income over
time to get an idea whether the standard of living of people is rising or
not. Suppose, as compared to 2005, the per-capita income in India has
increased by 10% in 2005. On the basis of this information, we shall be
in a position to throw some light on the standard of living of an Indian in
2006.

4) To study relationship between different phenomena: Statistical

measures such as correlation and regression are used to study
relationships between variables. Such relationships are important for
making decisions. For instance, you may find a relationship between the
demand of a product and its, prices. In general, if the prices rise, the
demand for the product is likely to decline.

5) To forecast future values: Some of the statistical techniques are used

for forecasting future values of a variable. O n the basis of sales figures
of the last 10 years, a marketing manager can estimate the likely demand
for his product during the next year.

6) To measure uncertainty: With the help of probability theory, you can

measure the chance of occurrence of uncertain event. Probability
concepts are quite useful in decision-making. Suppose, if you are
interested in estimating the chance of your passing the B.Com
examination, you may get an idea about it by studying the pass
percentages of students during the last 10 years.

7) To test a hypothesis: Statistical methods are extremely useful in

formulating and testing hypotheses and for the development of new
theories. For instance, a company is desirous of knowing the
11
Business Statistics effectiveness of its new drug to control malaria. It could do so by using a
statistical technique called Chi-square Test.

8) To draw valid inferences: Statistical methods are also useful in drawing

inferences regarding the characteristics of the universe (population) on
the basis of sample data.

9) To formulate policies in different fields: Statistical methods are very

useful in formulating various policies in social, economic, and business
fields. The Government, for instance, utilises vital statistical data for
formulating family planning programme. Similarly, the government
utilises the information on consumer price indices for granting dearness
allowance to its employees.

12.5 IMPORTANCE OF STATISTICS

In the ancient times statistics was used as the science of statecraft only. Data
on a wide range of activities such as population, births and deaths were
collected by the State for administrative purposes. However, in recent years,
the scope of statistics has widened considerably to bring to its fold social and
economic phenomena. The developments in the statistical techniques over the
years also widened its scope considerably. It is no longer considered to be a
by-product of the administrative setup of the State but now it embraces
practically all sciences, social, physical, and natural sciences. As a matter of
fact, now statistics finds its applications in various diversified fields such as
agriculture, business and industry, sociology; economics, biometry, etc. Thus,
these days statistics finds its application in almost all spheres of human
activity.

Statistics and State

In earlier times, the role of the State was confined to the maintenance of law
and order. For that purpose, it used to collect data relating to manpower,
crimes, income and wealth, etc., for formulating suitable military and fiscal
policies. But the role of, State has enlarged considerably with the inception of
the concept of Welfare State. Thus, today statistical data relating to prices,
production, consumption, income and expenditure, etc., are extensively used
by the governments world over for formulating their economic and other
policies. To raise the standards of living of its population, developing
countries such as India are following the policy of planned economic
development. For that purpose the government must base its decisions on
correct and sound analysis of statistical data. For instance, in formulating its
five year plans, the government must have an idea about the availability of
raw materials, capital goods, financial resources, the distribution of
population according to various characteristics such as age, sex, income, etc.,
to evolve various policies.

Statistics in Economics
Statistical analysis is immensely useful in the solution of a variety of
economic problems such as production, consumption, distribution, etc. For
12
example, an analysis of data on consumption may reveal the pattern of Introduction to
Statistics
consumption of various commodities by different sections of the society.
Data on prices, wages, consumption, savings and investment, etc., are vital in
formulating various economic policies. Likewise, data on national income
and wealth are useful in formulating policies for reducing disparities of
income. Use of statistics in economics has led to the formulation of several
economic laws such as Engel’s Law of Consumption, Law of Income
Distribution, etc. Statistical tools of index numbers, time series analysis,
regression analysis, etc., are vital in economic planning. For instance, the
consumer price index is used for grant of dearness allowance (DA) or bonus
to workers. Demand forecasting could also be made by using time series
analysis. For testing various economic hypotheses, statistical data is now
being increasingly used.

Statistics in Business and Management

With the growing size and increasing competition, the activities of modern
business enterprises are becoming more complex and demanding. The
separation of ownership and management in the case of big enterprises has
resulted in the emergence of professional management. The success of the
managerial decision-making depends upon the timely availability of relevant
information much of which comes from statistical data. Statistical data has,
therefore, been increasingly used in business and industry in all operations
like sales, purchases, production, marketing, finance, etc. Statistical methods
are now widely applied in market and production research, investment
policies, quality control of manufactured products, economic forecasting,
auditing and many other fields. One element common to all problems faced
by managers is the need to take decisions under uncertainty. And statistical
methods provide techniques to deal with such situations. It is, therefore, not
surprising when Wallis and Roberts say that “statistics may be regarded as a
body of methods for making wise decisions in the face of uncertainty.”

Check Your Progress B

1) Enumerate the functions of statistics.
2) Write brief comments in one line on the following statements.
i) Statistics only perform the function of simplifying complexities.
ii) Statistics help in testing the laws of other sciences.
iii) Future course of events is uncertain, so statistics can hardly be of
any help in, their study.
iv) Planning is not conceivable without statistics.
v) A personnel officer of a big corporation can draw a workable
personnel plan without the knowledge of statistics.

13
Business Statistics
12.6 LIMITATIONS OF STATISTICS
In spite of its important functions, statistics has its limitations too. These
limitations should be kept in mind while using the various statistical methods.
Now, we shall discuss some of the limitations of statistics.

1) Statistics deals only with the quantitative characteristics: Statistics

deals with facts which are expressed in numerical terms. Therefore, those
phenomena that cannot be described in numerical terms do not fall under
the scope of statistics. Beauty, colour of eyes, intelligence, etc., are
qualitative characteristics and hence cannot be studied directly. These
characteristics can be studied only indirectly, by expressing them
numerically after assigning particular scores. For example, we can study
the level of intelligence of a group of persons by using intelligence
quotients (I.Qs).

2) Statistics does not deal with individuals: Since statistics deals with
aggregate of facts, a single and isolated figure cannot be regarded as
statistics. For example, the height of one individual is not of much
relevance but the average height of a group of people is relevant from
statistical point or view. In this context, you may recall the definition
given by Secrist here.

3) Statistical laws are not exact: Unlike the laws of natural sciences,
statistical laws are not exact. They are true under certain conditions and
always some chance factor is associated with them for being true.
Therefore, conclusions based on them are only approximate and not
exact. They cannot be applied universally. Laws of pure sciences like
Physics and Chemistry are universal in their application.

4) Statistical results are true only on an average: Statistical methods

reveal only the average behaviour of a phenomenon. The average income
of employees of a company will, therefore, not throw much light on the
income of a specific individual. They are therefore, useful [or studying a
general appraisal of a phenomenon.

5) Statistics is only one of the methods of studying a problem: A

problem can be studied by several methods. Statistical methods arc only
onc o l them. Under all circumstances, statistical tools do not provide the
best solution. Quite often it is necessary to consider a problem in the
light of social considerations like culture, region, etc. Therefore,
statistical conclusions need to be supplemented by other evidences.

6) Statistics can be misused: The various statistical methods have their

own limitations. If used without caution they are subject to wrong
conclusions. So one of the main limitations of statistics is that, if put into
wrong hands, it can be misused. This misuse can be, at times, accidental
o r intentional. Many government agencies and research organisations
are tempted to use statistics to misrepresent the facts to prove their own
point of view. Suppose you are told that during a year the number of car
14 accidents in a city by women drivers is 10 while those committed by men
 drivers is 40. On the basis of this information, you may conclude that Introduction to
Statistics
women are safe drivers. If you conclude like that you are misinterpreting
the information. You must know the total number of drivers of both
types before you could arrive at a correct conclusion.

12.7 DISTRUST OF STATISTICS

Despite its importance and usefulness the science of statistics is looked upon
with suspicion. Quite often it is discredited, by people who d o not know its
real purpose and limitations. We often hear statements such as:

“There are three types of lies: lies, damned lies, and statistics”. “Statistics can
prove anything”. “Statistics cannot prove anything”. “Statistics are lies of the
first order”. These are expressions of distrust in statistics. By distrust of
statistics, we mean lack of confidence in statistical data, statistical methods
and the conclusions drawn. You may ask, why distrust in statistics? Some of
the important reasons for distrust in statistics are as follows:

1) Arguments based upon data are more convincing. But data can be
manipulated according to wishes of an individual. To prove a particular
point of view, sometimes arguments are supported by inaccurate data.

2) Even if correct figures are used, they may be incomplete and presented in
such a manner that the reader is misled. Suppose, it has been found that
the number of traffic accidents is lower in foggy weather than on clear
weather days. It may be concluded that it is safer to drive in fog. The
conclusion drawn is wrong. To arrive at avalid conclusion, we must take
into account the difference between the rush of traffic under the two
weather conditions.

3) Statistical data does not bear on their face the label of their quality.
Sometimes even unintentionally inaccurate or incomplete data is used
leading to faulty conclusions.

4) The statistical tools have their own limitations. The investigator must use
them with precaution. But sometimes these tools or methods are handled
by those who have little or no knowledge about them. As a result, by
applying wrong methods to even correct and complete data, faulty
conclusions may be obtained. This is not the fault of statistical methods,
but of the persons who use them.

We may conclude by taking an illustration. Suppose a child cuts his finger

with a knife. His parents started blaming the knife. Here the fault does not lie
with the knife but with the child who misused the knife. It should be kept in
mind that statistics neither proves anything nor disproves anything. It is only
a tool (i.e. a method of approach) which should be used with caution and by
those who are knowledgeable in the subject.

15
Business Statistics
12.8 CLASSIFICATION ACCORDING TO
VARIABLES
Variables refer to quantifiable characteristics of data and can be expressed
numerically. Examples of variable are wages, age, height, weight, marks,
distance, etc. As you know, all these variables can be expressed in
quantitative terms. In this form of classification, the data is shown shown in
the form of a frequency distribution. A frequency distribution is a tabular
presentation that generally organises data into classes, and shows the number
of observations (frequencies) falling into each of these classes. Based on the
number of variables used, there are three categories of frequency distribution
: 1) uni-variate frequency distribution, 2) bi-variate frequency distribution,
and 3). multivariate frequency distribution. In this unit we will discuss uni-
variate analysis and bi-variate analysis only.
1) Uni-variate Frequency Distribution: The frequency distribution with
one variable is called a uni-variate frequency distribution. For example,
the students in a class may be classified on the basis of marks obained by
them.
2) Bi-variate Frequency Distribution: The frequency distribution with
two variable is called bi-variate frequency distribution. If a frequency
distribution shows two variables i.e., marks in statistics and age, it is
known as bi-variate frequency distribution.

12.9 LET US SUM UP

The word statistics can be used either plural sense or in singular sense. When
used in plural sense, the word statistics refers to numerical statements of facts
or data. To be called statistics, numerical data should possess the following
characteristics: 1) they must be aggregate of facts, 2) they must be affected
by multiplicity of factors, 3) they must be numerically expressed, 4) they
must be enumerated or estimated according to a reasonable standard of
accuracy, 5) they must be collected in a systematic manner for a
predetermined purpose, and 6) they must be placed in relation to each other.
The word statistics, when used in singular sense, refers to a body of
knowledge which provides methods and techniques required for, 1) collection
of data, 2) classification and tabulation of data, 3) presentation of data, 4)
analysis of data, and5) interpretation of data.
Statistical methods can be divided into: 1) descriptive statistics, and 2)
inferential statistics. Statistical methods are helpful in: 1) presenting facts in
proper form, 2)simplifying unwieldy and complex data, 3) providing
techniques for making comparison, 4) formulating policies in different fields,
5) studying relationships between different phenomena, 6) forecasting future
values, 7) measuring uncertainty of events, 8) testing statistical hypotheses,
and 9) drawing valid inferences. Statistical methods are useful in various
fields such as state administration, economics, business management, etc.
With the growing complexity of managing today’s business, statistical tools
are proving quite handy and useful in the decision-making process. However,
16 there are limitations in using these tools. Statistics does not study qualitative
phenomenon nor does it study individuals. Statistical laws are not exact and Introduction to
Statistics
may be misused. A blind fold application of these tools, particularly by those
who are no fully conversant with them, has resulted in lot of distrust. The
science of statistics is a useful servant to those who understand its proper use.

12.10 KEY WORDS

Data: A collection of measurements or reservations on one or more variables.
Descriptive Statistics: Refers to methods and techniques of summarising and
describing the characteristics of the data.
Inferential Statistics: Refers to those methods which are helpful in drawing
inferences about the characteristics of the population on the basis of sample
data.
Statistical Data: Information expressed in quantitative or numerical form is
called statistical data. All statistical data is numerical statements of facts but
all numerical statements of facts are nor statistics. Numerical statements must
possess certain characteristics in order that they may be called data.
Statistical Methods: A body of methods and principles that are helpful in the
collection, summarisation, description, analysis and interpretation of
numerical data.
Statistics: When used in plural sense, refer to numerical statements of facts
or data. When used in singular sense, refers to a body of methods which
provides tools for data collection, analysis and interpretation.

12.11 ANSWERS TO CHECK YOUR PROGRESS

A) 1) i) Yes ii) No iii) No iv) Yes
2) i) No. Their definitions related to data.
ii) Yes.
iii) Yes. Not directly, after quantifying them.
iv) No. Other aspects are also there.
v) Yes.
vi) No. They are methods to derive population values from
sample results.
B) 2) i) No. There are other functions also.
ii) Yes. By collecting relevant data.
iii) No. Probability theory and methods of forecasting helps.
iv) Yes. Lots of Statistics are required.
v) No. Statistical methods will be used.

17
Business Statistics
12.12 TERMINAL QUESTIONS
1) Why it is necessary to have knowledge on statistics?
2) “Statistics are numerical statements of facts but all facts numerically
stated are not statistics.” Comment.
3) What do you mean by statistics? Explain its importance to Economics
and Business.
4) Define statistics and discuss the various functions of statistics.
5) Discuss the usefulness of statistics and explain the limitations of
statistics.
6) What do you understand by distrust of statistics? Is the science of
statistics to be blamed for it?

Note: These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the university. These
are for your practice only.

18
 Measures of Central
UNIT 13 MEASURES OF CENTRAL Tendency

TENDENCY
Structure
13.0 Objectives
13.1 Introduction
13.2 Concept of Central Tendency
13.3 Objectives of Averages or Central Tendency
13.4 Essentials of an Ideal Average
13.4.1 Different Measures of Central Tendency
13.5 Arithmetic Mean
13.5.1 Computation of Arithmetic Mean
13.5.2 Weighted Arithmetic Mean
13.5.3 Uses of Weighted Arithmetic Mean
13.5.4 Properties of Arithmetic Mean
13.5.5 Merits and Limitations of Arithmetic Mean
13.6 Geometric Mean and Harmonic Mean
13.6.1 Computation of Geometric Mean
13.6.1.1 Properties of Geometric Mean
13.6.1.2 Uses and Limitations
13.6.2 Computation of Harmonic Mean
13.6.2.1 Properties of Harmonic Mean
13.6.2.2 Uses and Limitations
13.7 Median
13.7.1 Computation of Median
13.7.2 Properties of Median
13.7.3 Merits and Limitations of Median
13.8 Partition Values
13.8.1 Quartiles
13.8.2 Deciles
13.8.3 Percentiles
13.9 Mode
13.9.1 Computation of Mode
13.9.2 Merits and Limitations of Mode
13.9.3 Some Illustrations
13.10 Choice of a Suitable Average
13.11 Let Us Sum Up
13.12 Key Words
13.13 Answers to Check Your Progress
13.14 Terminal Questions/Exercises
19
Business Statistics
13.0 OBJECTIVES
After studying this unit, you should be able to:
• understand concept of central tendency,
• appreciate the purpose of calculating averages
• enumerate the qualities of ideal average
• define and compute the arithmetic mean, geometric mean, harmonic
mean, median, partition values and mode for different types of data
• explain the properties, merits and limitations of different measures of
central tendency or averages, and
• identify the suitable average for a given purpose.

13.1 INTRODUCTION
We have discussed why it is important and relevant to study statistics as a
commerce students. Statistics broadly means data or numerical figures
pertaining to any given situation or a phenomenon. To make life easier we
need to present data properly and understand its characteristics behaviour and
treatment. If the characteristics of the data are to be properly understood, it is
necessary to summarise and analyse the data further. The first step in that
direction is the computation of Averages or Central Tendency for obtaining a
single value that represent the entire data, which gives a bird’s-eye view of
the entire data.
In this unit you will study the purpose of calculating averages, the essentials
of an ideal average, and identify different measures of average. You will
further learn in detail the calculations, properties, merits, and limitations of
measures of averages, viz. Arithmetic Mean, Weighted Arithmetic Mean,
Geometric Mean, Harmonic Mean, Median, Partition Values (Quartile,
Deciles and percentiles) and Mode.

13.2 CONCEPT OF CENTRAL TENDENCY

For a proper appreciation of various statistical measures used in analysing a
frequency distribution, it is necessary to note that most of the statistical
distributions have some common features. If we move from lowest value to
the highest value of a variable, the number of items at each successive stage
increases till we reach a maximum value, and then as we proceed further they
decrease. The statistical data which follow this general pattern may differ
from one variable to another in the following three ways:
1) They may differ in the values of the valuables around which most of
the items cluster (i.e., Average)
2) They may differ in the extent to which items are dispersed (i.e.,
Dispersion).
3) They may differ in the extent of departure from some standard
distributions called normal distribution (i.e., Skewness and Kurtosis).
20
Accordingly, there are three sets of statistical measures to study these three Measures of Central
Tendency
kinds of characteristics. Let us discuss the first set of measures which are
called Averages or Measures of Central Tendency or Measures of
Location. We discuss about the other set of measure (i.e., measures of
dispersion) in next unit of this Block.
In the general pattern of distribution, in the data we may identify a value
around which many other items of the data congregate. This is a value which
is somewhere in the central part of the range of all values. When this typical
item of the data is towards the central part of the data, it is known as Central
Tendency.
Let us see some definitions of central tendency:
Clark defined it as “Average is an attempt to find one single figure to
describe whole of figures”. Croxtan and Cowden defined as “An average
value is a single value within the range of the data that is used to represent all
of the values in the series. Since an average is somewhere within the range
of the data, it is something called a measure of central value.”
The above definitions explain us that the average or central value is a single
value which represents the entire complex mass of data. Therefore, central
value lies somewhere in between the highest value and the lowest value of
the given data. Thus an average of a given data is frequently referred to as a
measure of central tendency.

13.3 OBJECTIVES OF AVERAGES OR CENTRAL

TENDENCY
You have studied the concept of central tendency. Now let us discuss the
major objectives of computing averages. The following are the main
objectives:
1) To supply one single value that describes the characteristics of the
entire data: An average reduces the complex mass of data into a single
representative value which enables us to grasp the salient features of
data, without getting lost in its details. Thousands or lakhs of values can
be, thus, represented by a single value. For example, it is almost
impossible to remember monthly salary of each and every worker of a
big factory. But if the average salary is obtained by dividing the total pay
bill of all the workers by the number of workers, it enables us to know,
on an average, how much the worker is getting.
2) To facilitate comparison: It is not easy to compare the two sets of huge
raw data. But the two different data sets could be easily compared by
working out their averages. Comparison can be made either at a point of
time or over a period of time. For example, the current year sales of two
business firms A and B can be compared by comparing their average
sales. The current year sale of a unit can be compared with its own sales
in the previous year by working out the average sale during the previous
year and the current year's average. It is important to note that the same
measure of average should be used for comparing the average of two
21
Business Statistics data sets, the same method of computation should be followed. For
example, comparing the mean income of the people of one locality with
the median income of the people of another locality is not reasonable.
3) To facilitate statistical inference: To draw inferences about the
unknown measures or ‘parameters’ of the population, we depend on
values calculated from sample. This process is known as statistical
inference. An average obtained from a sample is helpful in estimating the
average of the population.
4) To help the decision-making process: The averages are computed to
help the, managers in decision-making. The managers are often
interested in knowing normal output of a plant, representative sales
volume, overall productivity index, price index, etc. These all are the
connotations of an average.

13.4 ESSENTIALS OF AN IDEAL AVERAGE

Keeping in view of the objectives of averages, let us try to understand the
requisites of an ideal average
As suggested by the eminent statisticians Yule and Kendall, an ideal average
should possess the following characteristics:
1) Easy to understand and simple to compute: It should be easy to make
out an average and its computation should also be simple.
2) Rigidly defined: An average should be rigidly defined by a
mathematical formula so that the same answer is derived by different
persons who try to compute it. It should not depend on the personal
prejudice or bias of a person computing it.
3) Based on all items in the data: For calculating an average, each and
every item of the data set should be included. Not a single item should be
dropped, otherwise the value of the average may change.
4) Not to be unduly affected by extreme items: A single extreme value
i.e., a maximum value or a minimum value, can unduly affect the
average. A too small item can reduce the value of an average, and a too
big item can inflate its value to a large extent. If the average is changing
with the inclusion or exclusion of an extreme item, then it is not a truly
representative value of the data set.
5) Capable of further algebraic treatment: An average should be
amenable to further algebraic treatment. That should add to its utility.
For example, if we are given the averages of three data sets of similar
type, it should be possible to obtain the combined average of all those
three data sets.
6) Sampling stability: The average should have the same ‘sampling
stability’. This means that if we take different samples from the
aggregate, the average of any sample should approximately turn out to be
the same as those of other samples.
22
13.4.1 Different Measures of Central Tendency Measures of Central
Tendency
Following are the various measures of averages or central tendency:
1) Mathematical Averages
i) Arithmetic Mean; ii) Geometric Mean; iii) Harmonic Mean
All these measures can be either simple or weighted.
2) Averages of Position
i) Median; ii) Partition Values – quartiles, deciles and percentiles; iii)
Mode

13.5 ARITHMETIC MEAN

The word average, we use every frequently in day-to-day expressions. Such
as average price, average income, average weight etc. In these expressions
the word average is nothing but arithmetic mean. Generally a layman call an
average but a statistician call the arithmetic mean.
The arithmetic mean is commonly known as mean. It is a measure of central
tendency because other figures of the data congregate around it. Arithmetic
mean is obtained by dividing the sum of the values of all observations in the
given data set by the number of observations in that set. It is the most
commonly used statistical average in the disciplines such as commerce,
management, economics, finance, production, etc. The arithmetic mean is
also called as simple Arithmetic Mean.

13.5.1 Computation of Arithmetic Mean

As you know, the collected data is classified by arranging into different
classes or groups on the basis of their similarities and resemblances.
Arithmetic mean can be computed for the unclassified or ungrouped 'data
(raw data) as well as classified or grouped data. But the methods of
computation are different. Now let us understand the methods of computing
the arithmetic mean for unclassified data and classified data. Normally,
arithmetic mean is denoted by � which is read as ‘X bar’
Ungrouped Data
Method 1: Computation of arithmetic mean is very simple when the data is
ungrouped, i.e. when frequency distribution is not done. Just add all the
values of the observations and divide it by the number of observations. This
can be explained and expressed in the form of a formula as follows:
X� + X � + … … + X �
�=
�
Where � (X bar) is the arithmetic mean of the variable x
x� , x� , ..., x� are the various values of the variable x
n is the number of observations
This formula can be simplified as follows:
23
Business Statistics ∑ X�
�=
�
Where, the ∑ (read it as sigma) is the Greek symbol denoting the summation
over all values of x.

∑x is sum of the value of observations; n is the number of the

observations.
Steps to compute
1) Add all values of the given observations (∑ x); 2) Obtain the total number
of observations (n); 3) Apply the formula.
Illustration 1: The grocery store sells five different products. The profit per
unit on the sales of each of these products is given below. Find out the
average profit.
Product 1 - Rs. 4; Product 2 - Rs. 9; Product 3 - Rs. 6; Product 4 - Rs. 2;
and Product 5 - Rs. 9
Solution: Average profit can be computed as follows:
∑ ��
�= �

4+9+6+2+9 30
= = = Rs. 6.00
5 5
Method 2: When the values of the observations in the given data are too
large or they are in fractions, this method may be followed. This method is
based on the fact that the algebraic sum of the deviations of a series of
individual observations from their mean is always equal to zero. For
example, the arithmetic mean of 8, 14, 16, 12 and 20 is 14. The difference of
each of these items from the mean would be – 6, 0, +2, – 2, +6 and their total
is zero. This is true always. To compute arithmetic mean under this
method, the following steps are to be followed.
1) Assume any arbitrary mean (A) to find out the deviations of items from
their assumed mean. 2) Compute the deviation (d) of each individual value
(x) from the assumed mean i.e., d = x – A. 3) Obtain the sum of all
deviations ( ∑d called sigma d). 4) Compute the arithmetic mean by using
the following formula:
∑d
� = A+
�
Where, � is the arithmetic mean of the variable x; A is the assumed mean;
∑d is the sum total of the deviations of each individual value from the
assumed mean; n is the number of observations
Illustration 2: Monthly sales of scooters of 10 dealers is presented below.
Calculate the average sales per month:
Dealer : 1 2 3 4 5 6 7 8 9 10
Sales : 23 8 14 31 6 28 11 27 32 46
24
Solution : Calculation of Arithmetic Mean Measures of Central
Tendency

Dealer Sales (x) d=x–A

1 23 –2
2 8 – 17
3 14 – 11
4 31 –6
5 6 – 19
6 28 3
7 11 – 14
8 27 2
9 32 7
10 46 21
n = 10 ∑d = – 24

Assumed mean (A) = 25; ∑d = – 24 ; n = 10

∑d – 24
� =A+ = 25 + = 25 – 2.4 = 22.6 (������� ������� ����)
� 10

Grouped Data: Variables can be categorised as discrete variables and

continuous variables. The frequency distribution prepared for discrete
variable is called discrete distribution and the frequency distribution prepared
for continuous variable is called continuous distribution. Methods of
computing arithmetic mean for these two types of distributions are different.
Now let us study these methods.
Arithmetic Mean for Discrete Series:
Method 1: It is also called Direct Method. Under this method the mean for
grouped data can be obtained by using the following formula:
�� �� + �� �� +. . . �� ��
�=
�� + �� + . . . ��
where, x,, x� , x� etc., refer to the values of the variable in classes 1 , 2 , 3etc.,
respectively. Similarly, f,, f� , f� , etc., refer to the frequency of classes 1,2, 3
etc., respectively. Here f� x� indicates the multiplication of the frequency of
the first class (f� ) by the value of the variable in that class (x� ). f� x� , f� x� ....f
x indicate the same meaning.
∑�� ∑��
This formula can be simplified as : � = ∑�
�� �

Where, f is the frequency; x is the value of the variable.

Steps to compute:
1) Multiply the frequency of each row with the value of variable and obtain
the total i.e. ∑fx; 2) Obtain the sum of frequency ( ∑f ); It is also termed as
the number of observations (n); 3) Apply the formula.
25
Business Statistics Method 2: It is also called short-cut method. When the number of classes in
the given frequency distribution is large, this method is preferred. The
procedure followed in this method is almost the same as it is for ungrouped
data. Steps to be followed in this method are as follows:
1) Take an assumed mean A. 2) Find the deviations of the variable x from
the assumed mean and denote it by d = x – A, Any value can be taken as an
assumed mean, but the value of variable x in centrally located class of the
given distribution should be chosen. 3) Obtain ∑fd by multiplying
deviations (d) with their respective class frequencies (f) and summing it. 4)
Obtain the number of observations (n) i.e., total frequency (∑f) 5) Compute
the mean by applying the following formula:
∑fd ∑fx
� =A+ �� � = � +
∑f n
Where, A is the assumed mean; ∑f denotes the total number of items, it can
also be denoted by ‘n’; ∑fd is the sum total of the deviations (d = x – A)
multiplied with their respective class frequencies.
Now let take an illustration and study how arithmetic mean is computed
under these two methods.
Illustration 3: Calculate the arithmetic mean for the following data by using
the two methods:

Marks: 10 20 30 40 50 60 70 80

No. of 8 21 23 17 15 9 5 2
Students:

Solution : Calculation fo Arithmetic Mean

Marks No. of Students d = x – 40 Fd fx

x f
10 8 – 30 – 240 80
20 21 – 20 – 420 420
30 23 – 10 – 230 690
40 17 0 0 680
50 15 10 150 750
60 9 20 180 360
70 5 30 150 350
80 2 40 80 160
Total ∑f = 100 ∑fd = –330 ∑fx = 3,670

In this case assumed mean (A) is 40 marks.

∑�� �,���
Method 1: � = �
= ���
= 36.70 marks

26
 ∑�� ���� Measures of Central
Method 2: � = � + �
= 40 + ���
= 40 − 3.30 = 36.70 marks Tendency

Arithmetic Mean for Continuous Series

For continuous series (i.e. when the data is classified according to class
intervals), arithmetic mean can be calculated by the following methods:
Method 1: This method is also called direct method. While computing the
mean, it is to be kept in mind that it is not necessary to convert inclusive
classes into exclusive classes and there is no need to exchange the unequal
classes into equal classes. Under this method the arithmetic mean is obtained
by using the following formula:
∑fm ∑fm
�= �� � =
∑f n
Where, � is the arithmetic mean; ∑f or n is the total frequency or total
number of items; m is the mid-value of the class.
Steps to compute:
1) Get the mid value of each class and denote it by m (i.e.,) m-class
interval÷ 2
2) Multiply these mid-values by its respective frequency of each class and
obtain the total i.e., ∑fm
3) Obtain the total frequency i.e. ∑f or n
4) Apply the formula
Method 2: This is also known as short-cut method or deviation method. The
same formula as used for discrete series can be used here also, with a slight
change in obtaining ‘d’. Here, deviation of mid-values from assured mean
are obtained (i.e., d = m –A).
∑fd ∑fd
� =A+ �� � = � +
∑f n
Where, � is the assumed mean; f is the frequency; d is the deviation.
Steps to compute:
1) Obtain the mid value of each class (m). 2) Choose any mid-value as
assumed mean (A). You are advised to choose the balanced value from the
two exreems as assumed mean. 3) Subtract the assumed mean from each
mid-value (m –A) i.e., d. 4) Obtain the sum of frequency i.e. ∑f or n 5) Apply
the formula
Method 3: This is known as Step Deviation Method. The formula of
previous two methods can be used conveniently if the value of variable (x)
and values of frequencies (f) are small. If the values of x and f are large
computation of mean by using the above methods are quite tedious and time
consuming. In such a situation the calculations can be reduced to a greater
extent by using step-deviation method. If the deviations from assumed mean
have some common factor. Common factor is the highest value which can
divide all the deviations (d) without remainder a further reduction in the size 27
Business Statistics of deviation is possible by dividing deviations by the common factor (c) and
denoting these step deviations by �� i.e. �� = (m –A) ÷ c. The symbol �� has
been introduced to differentiate it from d i.e., (m –A) = d. It is to be noted
that this method is applicable in discrete and continuous series, secondly, if
all the class intervals are equal than, the class interval will be the common
factor. Under this method, arithmetic mean will be computed by the
following formula.
∑f�� ∑f��
� =A+ × � �� � = � + ×�
∑f n
where A is assumed mean; f is the frequency, �� is the reduced deviation by
dividing the deviation (d = m –A) with common factor (c); ∑f is the sum of
frequencies or total number of observations (n).
Steps to compute the mean:
1) find the mid value of each class (m) and select assumed mean (A) from
any mid-value.
2) Find the deviations by subtracting the assumed mean (A) from each mid-
value i.e. (m –A) = d.
3) Find the common factor (c) and divide the above deviation (d) by the
common factor and denote by �� .
4) Multiply the reduced deviation (�� ) in step 3, with their corresponding
frequencies (f) and obtain the total i.e. ∑f�� .
5) Obtain the total number of observation (sum of frequencies) i.e. ∑f or n
6) Apply the formula of step deviation method.
Illustration 4: Weekly sales of 50 salesmen of a company are given below.
Calculate the arithmetic mean by following the direct method, short-cut
method and the step deviation method.

Total Sales (Rs. ‘000) : 0-5 5-10 10-25 25-50

No. of Salesmen : 3 6 25 10

Solution: Calculation of Arithmetic mean

Sales No. of Mid Deviatio Step deviation fm fd f��
per week Sales point n (m- ��
Rs. ‘000s men (m) 17.5) � − ��. �
(f) (d) =
�
0-5 3 2.5 – 15 –3 7.5 – 45 –9
5-10 12 7.5 – 10 –2 90.0 – 125 – 24
10-25 25 17.5 0 0 437.5 0 0
25-50 10 37.5 20 4 375.0 200 40
1
Total ∑f = 50 ∑fm = 910 ∑fd = 35 ∑fd = 7

28
Method 1: Measures of Central
Tendency
∑��
�= �
, ∑fm =910, n = 50
���
�= ��
= 18.2 Mean of sales is Rs.18.2 thousand per week.

Method 2: It is apparent from deviation column that here assumed Mean (A)
is 17.5.
∑��
Now, � = � + �

A= 17.5, ∑fd = 35, n = 50

��
� = 17.5 + ��
= 18.2 (Mean of sales is Rs. 18.2 thousand per week.)

Method 3: Step deviation method here the common factor (c) is 5.

∑���
Now, � = � + �
�
�
� = 17.5 + ��
×5

= 17.5 + 0.7 = 18.2 (Arithmetic Mean of sales is Rs. 18.2 thousand

per week.)
We understand from the above solution that the three different methods of
calculation from arithmetic mean give us the same result. It is clear that the
step-deviation method minimises the calculations. Thus, this method makes
the calculation easier than the other two methods, though the method 1 is
simplest. Method 3 is the suitable when mid-values and frequencies are very
large.
Illustration 5: Find the average number of hours worked by the employees
of the Yamto Machine Co. from the data given below:

Hours worked No. of employees

36.0 - 37.8 6

37.8 - 39.6 7

39.6 - 41.4 24

41.4 - 43.2 7

43.2 - 45.0 2

45.0 - 46.8 4

Total 50

Solution: First obtain the mid-values (m) of all the clauses and take
deviations from assumed mean ‘A’ (i.e. 42.3). The common factor ‘C’ is 1.8
which is equal to the class interval of different groups.

29
Business Statistics Calculation of Arithmetic Mean

Hours M f m ̶A d1 = (m-A)/C f��

worked (� − ��. �) � − ��. �
�� =
�. �
36.0 - 37.8 36.9 6 – 5.4 –3 – 18
37.8 - 39.6 38.7 7 – 3.6 –2 – 14
39.6 - 41.4 40.5 24 – 1.8 –1 – 24
41.4 - 43.2 42.3 7 0 0 0
43.2 - 45.0 44.1 2 + 1.8 1 2
45.0 - 46.8 45.9 4 + 3.6 2 8
Total n = 50 ∑fd1 = 46

∑f��
�=�+ �
n
���
� = 42.3 + ��
× 1.8 = 42.3 + (−0.92) × 1.8 = 42.3 − 1.656 = 40.644
(Arithmetic mean of the hours worked is 40.6 hours.)

You may notice when class intervals are all equal, d1 values will be 1, 2, 3,
and – 1, – 2, – 3, … etc. But when class intervals are not equal, the d1 values
need not be in numbers in order. In such a case it is necessary to make the
column m–A, and then divide it by ‘C’. However, when class intervals are
all equal, writing of the column m – A may be avoided and the values of d1
may be written directly.
It is important to note that when the classes are given in inclusive method it is
not necessary to adjust the classes into exclusive method for calculation of
arithmetic mean, geometric mean and harmonic mean because the mid-value
remain the same. However, in case of positional averages, such as median
and mode, adjustment is essential.

Check Your Progress A

1) i) If the sum of the deviations of 6 items taken from an assumed
mean 12 is – 6, find their mean.
ii) Write the formulas for the methods used in computing the
arithmetic mean of the grouped data of continuous series.
iii) Wherever possible, step-deviation method should be preferred,
why?
iv) For the given data set if: � = 33, ∑fd1 = – 20, ∑f = 100 and c =
10; find the assumed mean A.
v) What is the major assumption we make while computing a mean
from grouped data?
2) The monthly income of twelve families in a town is given below.
Calculate the arithmetic mean.
30
 Measures of Central
Family : 1 2 3 4 5 6 7 8 9 10 11 12 Tendency

Monthly : 280 180 96 98 104 75 80 84 100 75 600 200

Income Rs.

3) In 12 consecutive months the number of rejected pieces produced by the

operator of a machine was 82,74,65,67,62,73,68,63,65,62,69,and 66.
i) What was the average number of rejects?
ii) What is the sum of the deviations from this average?
4) Calculate arithmetic average of the following data by using alternative
methods:

Weekly wages No. of Workers

of workers (Rs.)

100-105 200

105-110 210

110-115 230

115-120 320

120-125 350

125-130 320

130-135 410

135-140 320

140-145 280

145-150 210

150-155 160

155-160 90

5) Find the mean from the following distribution by step deviation

Class Interval : 15-25 25-35 35-45 45-55 55-65 65-75

Frequency : 4 11 19 14 8 2

13.5.2 Weighted Arithmetic Mean

You have studied various methods of computing arithmetic mean for
different types of data sets. In all these methods we presume that all the items
of the given data set have equal importance. But it is not necessarily true in
all situations. In practical situations some items are of greater importance
31
Business Statistics than the others. For example, while constructing the cost of living index for a
particular class, the commodities they consume have varying importance.
The simple arithmetic mean of the prices of such commodities will not depict
a true picture of their living pattern. Different commodities are to be assigned
weights and a weighted arithmetic mean is to be worked out in such
situations. In a factory where unit cost of manufacturing is to be worked out,
a weighted average is more appropriate. Thus the term weight refers the
relative importance of the different items.
Computation: To compute weighted arithmetic mean, the formula is:
∑wx
�� =
∑w
Where, � is weighted arithmetic means; ∑wx is sum of the product of
weights (w) multiplied with the respective variables (x); and ∑w is sum of
the weights.
Steps: 1) If weights are not given assign arbitrary weights as per the
situation; 2) Multiply the weights (w) with the respective variables (x) and
obtain total i.e. ∑wx; 3) Obtain the sum of weights i.e., ∑w; 4) Apply the
formula.
The main difficulty in the computation of weighted arithmetic mean is with
regard to selection of weights. These weights may be either actual or
estimated. If actual weights are available, they must be used. If they are not
available, some arbitrary weights may be assigned depending upon the
situation.
Illustration 6: Prices of three commodities viz., A, B & C rised by 40 %, 60
% and 90 % respectively. Commodity A is six times more important than C,
and B is three times more important than C. What is the mean rise in price of
these three commodities?
Solution: As the mean rise in price is to be determined, the figures of rise in
price will be denoted as x. The relative importance of A : B : C is 6 : 3 : 1. So
these figures will be taken as weights 'w'.

Commodity Percentage rise Weights wx

in prices (x) (w)
A 40 6 240
B 60 3 180
C 90 1 90
Total ∑w= 10 ∑wx = 510
∑��
Weighted Arithmetic Mean = ∑�

���
= ��
= 51% (Mean rise in the prices is 51%)

32
It may be noted that for computation purpose, weights of items are treated in Measures of Central
Tendency
the same way as the frequencies of the items. In fact weights are not
frequencies. Frequency means number of times an item is repeated in the
data, whereas weights only give the relative importance of various items. The
items actually occur only once in the data.
Weighted arithmetic mean is also called Weighted Average. The word
'Average' in statistics, as pointed out earlier, is also used for other measures
of central tendency viz., geometric mean, harmonic mean, etc. So, in broader
sense, weighted average also includes weighted geometric mean and
weighted harmonic mean.
Comparison with Simple Arithmetic Mean: Weighted arithmetic mean
differs from simple arithmetic mean because we use weights in the former
case. Inter-relationship between weighted mean and simple mean is as
follows:
1) If all items are given equal importance, weighted mean will be equal to
simple mean. 2) If large items are given large weights and small items given
small weights, then weighted mean is greater than simple mean. 3) If large
items are given small weights and small items given large weights, then
weighted mean is less than simple mean.
Illustration 7: To understand this inter-relationship clearly, let us take up
some illustrations. Let us take Illustration 6 once again and find out mean rise
in price by taking the following two sets of weights.
A:B:C as 1 : 3 : 6 set w1
A:B:C as 10 : 10 : 10 set w2
Solution
Calculation of Weighted Arithmetic Mean

Commodity % rise Set 1 Set 2

x w1 xw1 w2 xw2
A 40 1 40 10 400
B 60 3 180 10 600
C 90 6 540 10 900
Total ∑x= 190 ∑w1= 10 ∑xw1= 760 ∑w2= 30 ∑xw2= 1900

∑�� ���
1) Weighted Mean for set 1 = ∑�
= ��
= 76%

∑�� ����
2) Weighted Mean for Set 2 = ∑�
= ��
= 63.3%

∑� ���
3) Simple Mean = �
= �
= 63.3%

33
Business Statistics If we compare the results carefully, we can notice the following points:
i) Under weights Set 2, all commodities are given equal weights. Here
weighted mean (63.3) is equal to simple mean (63.3).
ii) Under weights Set 1, large value 90 is given a large weight 6 and small
item 40 is given small weight 1. Here weighted mean (76) is greater
than simple mean (63.3).
iii) Under the original set of weights (look at Illustration 6) large value 90
was given a small weight 1 and small value 40 was given a large
weight 6. In that case weighted mean (51) was less than simple mean
(63.3).
These three properties of weighted average (as they are true for all kinds of
weighted averages) point out the following important fact. The weighted
mean is not only the mean of items, but also it gives the average of two
things: (i) average of items, and (ii) how items are affected by the pattern of
weighting. Thus, when items are of unequal importance, calculation of
weighted average is a must for finding out proper average.

13.5.3 Uses of Weighted Arithmetic Mean

Weighted arithmetic mean is mainly useful under the following situations:
1) When the given items are of unequal importance
2) When averaging percentages which have been computed by taking
different number of items in the denominators
3) When statistical measures such as mean of several groups are to be
combined
To be more specific, weighted arithmetic mean is used in the following cases:
1) Construction of Index Numbers.
2) Computation of standardised birth and death rates.
3) Finding out an average output per machine, where machines are of
varying capacities.
4) Determining the average wages of skilled, semi-skilled and unskilled
workers of a factory.

13.5.4 Properties of Arithmetic Mean

You have studied the meaning and methods of computing the arithmetic
mean. You have also studied how a weighted arithmetic mean is different
from simple arithmetic mean. Now let us study the main properties of
arithmetic mean.
1) The sum of the deviations of the iqdividual items from the arithmetic
mean is always zero i.e., ∑ (x - � ) = 0. This is explained in the
following illustration.

34
 Measures of Central
x (x - � ) Tendency
5 –1
6 0
7 1
9 3
3 –3
30 ∑ (x - � ) = 0

� = ∑ x/n = 30/5 = 6
In this illustration you should note that the sum of positive deviations from
the mean is equal to the sum of negative deviations. Precisely, therefore,
mean is also known as the centre of gravity. This is true for all kind; of data
with class intervals or without class intervals.
2) The sum of the square of deviations from the arithmetic mean is
minimum i.e. it is always less than the sum of squares of deviations of
the items taken from any other value. In other words, ∑(x – X)� is
always minimum. We can verify this for the illustration discussed
above.

Squared Deviations taken Squared deviations taken

from mean (X = 6) from any other values say 5
x (x – �) (x– �)� X (x– 5) (x – 5)�
5 –1 1 5 0 0
6 0 0 6 1 1
7 1 1 7 2 4
9 3 9 9 4 16
3 –3 9 3 –2 4
20 25

It is clear that ∑( � − �)� < ∑( � − 5)�

3) If the number of items and mean are known, the total of the items can
be obtained by multiplying the mean by the number of items, i.e., ∑X =
n�, where 'n' is the number of items.
This property has a great practical significance. For example, if we
know the number of workers in a factory, say 100, and average
monthly wage is Rs. 400, we can easily obtain the total monthly wage
bill as Rs. 400 x 100 = Rs. 40,000.
4) If we add or delete an observation which is equal to mean, the
arithmetic mean remains unaffected. For example, let us assume the
arithmetic mean of 10 observations is 15 and the 11th observation value
is 15. Now, the revised mean would be 15 i.e. (10×15)+15÷11.
35
Business Statistics 5) If each of the values of a variable 'x' is increased or decreased by some
constant C, the arithmetic mean also increases or decreases by C.
Similarly, when the values of a variable '�' are multiplied by a constant,
say k, the arithmetic mean is also multiplied by the same quantity k.
For example, take the previous illustration, and add 2 to each observation and
multiply each of them by 3, the new mean will be: (original mean + 2) x 3 =
(6 + 2) x 3 = 24. Let us verify it.

x x+2 3(x+2)
5 7 21
6 8 24
7 9 27
9 11 33
3 5 15
30 40 120

Mean of x = 30/5 = 6
Mean of x+2 = 40/5 = 8 = 6 + 2 i.e., old mean +2
Mean of 3(x+2) = 120/5 = 24 or 8 × 3 or (6+2) × 3 i.e., (old mean +2) × 3.
6) If we have the arithmetic mean and number of items of two or more
related groups, we can have a combined mean of these groups as
follows:

�� X� + �� X�
X� =
(�� + �� )
Where X� and X� are the arithmetic mean of group 1 and group 2
respectively, and �� and �� are the number of items in group 1 and group 2
respectively.
For example, arithmetic mean of the production of a commodity during the
period January to August is 400 tonnes per month, and the arithmetic mean
for the period September to December is 430 tonnes per month. Now, we
can compute the mean production for the whole year as follows.

X� = 400; X� = 430; �� = 8 (January to August – 8 months)

�� = 4 (September to December – 4 months)
The average for the whole year

�� X� + �� X� 8 × 400 + 4 × 430 4920

X� = = =
(�� + �� ) 8+4 12
= 410 tonnes per month.

The logic behind the formula is: �� X� is the total value of all the items
belonging to the first group and �� X� is the total for the second group. Thus,
�� X� + �� X� is the total of all the items in both the groups. In other words,
36
the combined mean is the weighted average of the mean of different groups, Measures of Central
Tendency
weights being the number of items in each group.
Check Your Progress B
1) Distinguish between weighted arithmetic mean and simple arithmetic
mean.
2) Calculate the simple mean and weighted mean of price from the
following and state the reasons for the different between the two.
Price per tonns (Rs.) : 45.60 40.70 42.75
Tonnes purchased : 135.00 40.00 25.00
3) From the results of two college A and B, state which of them is better

Name of College A College B

the Exam.
Appeared Passed Appeared Passed
M.A. 30 25 100 80
M.Com. 50 45 120 95
B.A. 200 150 100 70
B.Com. 120 75 80 50
Total 400 295 400 295

4) The marks of the student in written oral tests in subject A, B and C are
as follow:

Subject A B C
Written (Out of 75 Marks) 43 32 29
Oral (out of 25 marks) 15 12 18

Find out the mean marks in written examinations taking the percentage
of marks in oral is weights.

13.5.5 Merits and Limitations of Arithmetic Mean

The arithmetic mean has the following merits and limitations:
Merits:
1) It is easy to understand and simple to compute. It is the widely used
summary measure.
2) It is rigidly defined.
3) It acts as a single representative figure of the whole data set.
4) It is based on all items of the data. It does not depend on its position in
the series.
5) It leads itself to further mathematical treatment.

37
Business Statistics 6) It is useful in further statistical analysis. It is used in computation of
other statistical measures like standard deviation, coefficient of
variation, co-efficient of skewness, etc.
7) It is characterised as a centre of gravity – a point of balance.
8) For various sampling methods, the simple mean is an unbiased estimate
of the population mean.
Limitations:
1) It is unduly affected by extreme values. Very small and very big values
in the data unduly affect the value of mean. Therefore, for the
distribution where concentration is on small or big values, the mean
will not be a proper average to yield a representative figure.
2) For the open-ended distributions, mean cannot be computed with
accuracy. For example, in an income distribution starting with the class
‘below 500’ and ending with the class ‘above 5,000’ mean cannot be
computed without making assumptions regarding the values of two
extremes. As a result, error may creep in.
3) Mean is not useful for studying the qualitative phenomena e.g., beauty,
honesty, intelligence, etc.
4) For the reasonably norms (bell shaped) distribution, mean can act as a
good measure of central tendency. But for a U-shaped distribution
(which has high frequency in the beginning, low in the middle and
again high towards the end) it hardly succeeds to be a point of location
around which other individual values congregate.
5) Mean does not lead a life of its own. For example, the statement that
the average number of children in Indian family is 4.8 does not imply
that there is even a single family having 4.8 children. Nor was a duck
ever killed by the average of two shots – one a yard in front of it and
one a yard behind it.
6) For non-homogeneous data, average may give misleading conclusion.
For example, sales (in lakh rupees) of two business units A and B
during the last five years are as follows:
A: 30 25 20 15 10
B: 10 15 20 25 30
Here it is clear that the average sales of both the units are exactly the same
and yet unit B is thriving whereas unit A is flickering.

13.6 GEOMETRIC MEAN AND HARMONIC

MEAN
You have already studied about arithmetic mean which belongs to the
category of mathematical averages. Now, you will study about the two other
mathematical averages viz, Geometric Mean and Harmonic Mean.
38
13.6.1 Computation of Geometric Mean Measures of Central
Tendency
In the situations where we deal with quantities that change over a period of
time, we may be interested to know the average rate of change. In such cases
the simple arithmetic mean is not suitable and we have to resort to the
geometric mean.
Computation: Like other averages, computation procedure of geometric
mean is different for grouped data and ungrouped data. Let, us now, study
these methods.
Ungrouped Data: If there are two items in the data series, the square root of
the product of these two items is the geometric mean. If there are three items,
the cube root of the product of three items is their geometric mean. If there
are 'n' items in the series, its geometric mean is the nth root of the product of
those items. Let us express it symbolically:

Geometric Mean = ���� , �� … … . . ��

where ��, ��, �� refer to the 'n' items of the series. For example, we have
three numbers 4, 8, and 16, the geometric mean of these three numbers would
be:
� �
G.M. - √4 × 8 × 16 = √518 = 8
Thus, geometric mean is an average based on the product of items. When the
number of items is three or more, finding their product and extracting its
roots becomes difficult. Therefore, computations can be simplified by the
use of logarithm.
Symbolically it can be expressed as:
1
log �. �. = log(�� , �� … … . . �� )
�
log �� + log �� + … … … . . log �� ∑ log �
= =
� �
∑ ��� �
Therefore, G.M.= ������� �

Steps to calculated GM: 1) Obtain the logarithm of the different values of

the variable and take their total i.e., ∑log x. 2) Divide it by ‘n’ (the number
of items) and take the antilogarithm of the value so obtained. That gives the
Geometric Mean. How to find logarithm and antilogarithm of a value is
explained clearly and also provided logarithms and antilogarithms tables
at the end of this unit.
For example, geometric mean of four numbers 20,65,83 and 135 will be:

��� ������ ������ ������ ���

G.M. = ������� �
�.������.���� ��.������.����
= ������� �
= ������� 1.7908
G.M. = 61.77

39
Business Statistics Illustration 1: Compared to the previous year, the overhead expenses went
up by 32% in 1987, by 40% in 1988 and by 50% in 1989. Calculate the
average rate of increase in overhead expenses over the three years.
Solution: The increase in overhead expenses is 32%, 40% and 50% in
1987,1988 and 1989 respectively. This means successively expenses become
132%, 140% and 150% of the previous level. Therefore, at the end of three'
��� × ��� ×���
years the final level will be ��� × ��� per cent of the original level.

As these figures are multiplicative in nature, their average will be given by

geometric mean.
�� = 132, ��= 140, ��= 150 and n = 3
∑ ��� � ��� ������� ������� ���
Now, G.M. Antilog = �
= ������� �
�.��.����.������.���� �.����
= ������� �
= ������� �
= ������� 2.1476

G.M = 140.5
On an average overhead expenses become 140.5% of previous year's level.
Therefore, average rate of increase in overhead expenses is 40.5% (i.e., 140.5
- 100).
Grouped Data
You know how to compute geometric mean for ungrouped data. Now we
should discuss the procedure for grouped data. As you know, the grouped
data can be in the form of either discrete series or continuous series, we have
to follow different procedures for these two types of series.
Discrete Series: When the data is grouped data i.e., in the form of a
frequency distribution, the geometric mean is computed as follows:

�� � �
G.M. = ���� ��� … … . ���

where �� , �� … … . . �� , are the different values of the variate x with their

respective frequencies �� , �� … … . . �� and � = �� , �� … … . . �� = ∑�
� � ∑� ��� �
log G.M. = � ( �� log �� + �� log �� +. . . . . �� log �� ) = � � �
�

∑� ��� �
The above expression can be simplified as: G.M. = Antilog � �
�

Steps to calculate G.M.:

1) Find the logarithms of the given observations i.e. ∑log x; 2) Multiply
these logarithms (logx) with the corresponding, frequency and obtain the
total i.e., ∑f Logx; 3) Obtain the total of observations i.e., n or ∑f; 4)
Apply the formula.
Let us, Now consider the following illustration:

40
Illustration 2: Calculate the geometric mean from the following Measures of Central
Tendency
distributions.

Marks : 5 15 25 35 45

No. of Students : 5 7 15 25 8

Solution: Calculation of G.M.

Marks (x) No. of Students (f) log x f logx

5 5 0.6990 3.4950

15 7 1.1761 8.2327

25 15 1.3979 20.9685

35 25 1.5441 38.6025

45 8 1.6532 13.2256

n = 60 ∑f logx = 84.5243

∑� ��� �
G.M. = Anti log � �
�
��.����
= Anti log � ��
� = Anti log 1.4087

G.M. =25.63 marks

Continuous Series: The only change in the earlier formula of geometric
mean is that you replace 'x' by 'm' which is the mid-value of classes.
∑� ��� �
Here, G.M. =Antilog � �
�

Steps to be followed: 1) Find the mid-value of the classes i.e., m; 2) Find

the logarithms of the mid-values i.e., log.m; 3) Multiply the logarithms of
mid-values with the respective frequencies and get the total i.e., ∑f log.m;
4) Apply the formula.
Illustration 3: Find out the geometric mean for the following data :

Size Frequency
7.5-10.5 5
10.5-13.5 9
13.5 - 16.5 19
16.5 - 19.5 23
19.5 - 22.5 7
22.5 - 25.5 4
25.5 - 28.5 1
41
Business Statistics Solution: Calculation of geometric mean

Class interval Mid-Point(m) Log.m f flog.m

7.5-10.5 9 0.9542 5 4.7710
10.5-13.5 12 1.0797 9 9.71 28
13.5-16.5 I5 1.1761 19 22.3459
16.5-19.5 18 1.2553 23 28.8719
19.5-22.5 21 1.3222 7 9.2554
22.5-25.5 24 1.3802 4 5.5208
25.5-28.5 27 1.4314 1 1.4314
n=68 ∑f log.m = 81.9092

∑� ��� �
G.M. = Antilog � �
�
��.����
= Antilog � ��
� = Antilog 1.2045

G.M. =16.02
Geometric Mean for Computing Average Rate of Change
More often we are interested in the average rate of change in a variable
between any two time periods such as annual rate of increase in population,
annual rate of increase in GNP, average rate of increase in profit, etc. The
methods of computing such rates is similar to that of finding the geometric
mean.
For a given series assume �� is the value at the beginning of the period and
�� ,is the value at the end of the period. Now, the average growth rate (r) can
be obtained by using the following compound interest formula:
�� = �� (1 + �)� , where 'n' is the time-span
��
(1 + �)� =
��

� ��
(1 + �) = �
��

� ��
�= � − 1
��

Let us now take an illustration to understand the calculation of the percentage

compound growth rate per annum.
Illustration 4: The population of a country was 300 millions in1951. It
became 520 millions in 1969. Calculate the percentage compound rate of
growth per annum.
Solution: Here �� is 300: �� is 520 and n is 18. Let 'r' be the growth rate per
annum.
42
 � � Measures of Central
Here, 1 + � = � �� Tendency
�

�� ���
= ���� using logarithms

log 520 − ��� 300

log(1 + �) =
18
2.7160 − 2.477
1 + � = ������� � �
18
�.����
= ������� � ��
� = ������� 0.0133 = 1.031

� = 1.031 − 1 = 0.031
���������� �������� �����ℎ ���� �� 100 × � = 3.1%

Weighted Geometric Mean

Like weighted arithmetic mean, we can also calculate the weighted geometric
mean. The computational procedure is as follows:
∑�
Weighted G.M. = ���.�� , ���� … … . ����

Where �� , �� … … . . �� are the values of the variate and �� , �� … … . . �� are

the corresponding weights
�� ��� �� ,� �� ��� �� �.....�� ��� ��
Taking logarithms, Log Weighted G.M. = ∑�

∑� ��� �
Or, log Weighted G.M. = ∑�

The above expression can be simplified as: Weighted G.M. = Antilog

∑� ��� �
� ∑� �

Steps for calculation: 1) Find the logarithms of value of variables i.e., logx;
2) Multiply the above logarithms with respective weights (w.log x) and
obtain the total i.e., ∑w.logx; 3) Obtain the total of weights i.e. ∑W; 4)
Apply the formula.
Let us consider an illustration to understand the calculation:
Illustration 5: Calculate the weighted Geometric Mean from the following
information:

Group Index No. Weight

Food 300 40
Fuel 200 10
Cloth 250 10
House Rent 150 15

43
Business Statistics Solution: Calculation of weighted Geometric Mean

Group Index No. Weight Logx W.Log x

Food 300 40 2.4771 99.084
Fuel 200 10 2.3010 23.01
Cloth 250 10 2.3979 23.979
House Rent 150 15 2.1761 32.6415
∑W=75 ∑Wlogx = 178.7145

∑� ��� �
Weighted G.M. = Antilog � ∑�
�
���.����
= Antilog � ��
�

= Antilog 2.3829 = 241.50

Therefore, weighted geometric mean of index numbers is 241.50
13.6.1.1 Properties of Geometric Mean
Geometric mean has the following important properties:
1) In a given series, if each item is substituted by geometric mean of the
series, the product of the items remains unaltered or example, the
geometric mean of the items.4, 8 and 16 is 8. Therefore 4 × 8 × 16 = 8 ×
8 × 8 = 512.
2) The value of geometric mean balances the ratio deviations of the
observations from it. In other words, the geometric mean of two numbers
'a' and 'b' is 'G', and the two ratios a : G and G : b are equal . It means a/G
is equal to G/b. For example, geometric mean of 4 and 16 is √4 × 16 or
8. The ratio 4/8 and 8/16 should be equal, which is a fact.
3) It lends itself to algebraic treatment. If geometric means of two or more
groups are given, the geometric mean of the combined group can be
obtained, as follows:
�� ��� ��� � �� ��� ��� � …..�� ��� ���
Combined G.M. = Antilog � �� � �� � …….��
�

Where, ��� = Geometric Mean of the first group; ��� = Geometric Mean of
the second group; ��� Geometric mean of the nth group.
For example, let 100 items have GM = 50 and 200 items have GM = 40.
Then the combined geometric mean will be:
��� ��� �� � ��� ��� ��
Combined G.M. = Antilog � �������
�
��� �.�������� �.����
= Antilog � ���
�

= Antilog 1.6344 = 43.09

44
4) As compared to arithmetic mean, the geometric mean is less affected by Measures of Central
Tendency
large items. It may be stated that the geometric mean has bias towards
small items while arithmetic mean has bias towards large items. For
example, let us take the five items: 2, 3, 5, 10 and 100.
������������
Arithmetic mean = �
= 24
��� ����� ����� ����� ������ ���
Geometric mean = Antilog � �
�
�.������.������.������.������.����
= Antilog � �
�

4.4771
= Antilog = Antilog 0.8954
5
G.M. = 7.86 approximately
You may note that arithmetic mean is 24 which is sufficiently larger than
geometric mean 7.86. So geometric mean has a tendency to be pulled
towards small items, while arithmetic mean has a tendency to be pulled
towards large items.
13.6.1.2 Uses and Limitations
Uses:
1) For computing the averages of ratio and percentages, geometric mean is
the most suitable average.
2) As it has bias towards lower values, it is particularly useful when a given
phenomenon has a limit for lower values but no such limit for upper
values. For example, price cannot be below zero.
3) In the construction of index numbers, geometric mean is considered to be
the best average. It is especially used in developing Fisher’s Ideal
Formula that satisfies time reversal and factor reversal tests. (The study
of these concepts is beyond the scope of this course.)
4) When large weights are desired to be assigned to small items and small
weights are to be assigned to large items, it is a more suitable average
than arithmetic mean.
Limitations:
1) Even if the single item of the given series is zero, geometric mean will be
zero. Hence, it cannot be computed. For example, geometric mean of
�
the three items 0, 10, 100 will be: √0 × 10 × 100 = 0.
2) If any of the items is negative, geometric mean does not exist.
3) The computational procedure is difficult especially when the items are
very large.
4) Its bias for lower values obstructs its use in the situations where
disparities are to be highlighted as the case of income distributions

45
Business Statistics
Check Your Progress C
1) Money invested in NSC VI issue becomes double in 6 years. What is
the percentage rate of growth per year:
2) Marks secured by 70 students in a test (maximum marks 75) are given
below. Compute geometric mean and compare it with arithmetic mean.

Marks : 5-15 15-25 25-35 35-45 45-55 55-65

No. of Students : 12 15 25 10 6 2

3) The price of a commodity increased by 5% from 1978 to 1979. 8%

from 1979 to 1980 and 77% from 1980 to 1981. The average increase
from 1978 to 1981 is quoted as 26% and not 30%. Verify this
statement.
4) A machine is assumed to depreciate 40% in value in the first year, 25%
in the second year and 10% per annum for the next three years. Each
percentage is calculated on the diminishing value. What is the average
percentage depreciation for the five years?

13.6.2 Computation of Harmonic Mean

As you know, generally, the data is in varied forms. The manner in which
the data is given counts heavily for judging the appropriateness of the use of
the measures of central tendency. For example, when the total distance is
constant and the speed per unit time is given, harmonic mean is a more
appropriate measure to find out the average speed. Suppose the data is given
in terms of articles produced per hour and we are interested in knowing the
average time per unit, then harmonic mean is preferable.
Computation: The method of computing harmonic mean is different for
ungrouped data and grouped data. Let, us now, study these methods
separately.
Ungrouped Data
If there are ‘n’ values of variate x viz., �� , �� … … . . �� their harmonic mean
(HM) is calculated as follows:
� �
Harmonic Mean = � � � = �
� � …..�
�� �� ��
Σ�

In simplest expression the formula is as follows:

�
� Σ
H.M. = � or H.M. = Reciprocal of �
�
�
Σ� �

= Reciprocal of (arithmetic mean of reciprocals of n values

(�� , �� . . �� ).
Therefore, harmonic mean is the reciprocal of the arithmetic mean of
reciprocals. Like logarithms, we can find the reciprocals of the given
value by consulting the reciprocal tables provided at the end of this unit.
46
The procedure for finding the reciprocal in the table is similar of finding Measures of Central
Tendency
logarithms. But you should keep in mind the value in the mean
difference column must be subtracted.
In individual series first we have to find the reciprocals of the value of
observations. Then apply the above formula to obtain the H.M. For example,
harmonic mean of two values 12 and 15 cañ be computed as follows:
� � ���
H.M. = � � = ��� = �
= 13.34
�
�� �� ��

Illustration 6: A motorist travelled for three days at the rate of 480 kms. A
day. On the first day. he traveller for 10 hours at a speed of 48 kms. per hour,
on the second day he travelled for 12 hours at a speed of 40.kms. per hour
and on the third day for 15 hours at a speed of 32 kms. per hour. What was
his average speed?
Solution: Here the total distance travelled per day s constant, and time and
speed are variable. We are required to compute the average speed. Therefore,
harmonic mean is the appropriate average. ’
� � ����
H.M. = � � � = �� = ��
= 39 ���. ��� ℎ��� (�������������).
� �
�� �� �� ���

Here, now does the harmonic mean become the appropriate average? It can
be verified easily as below:
The total distance travelled in 3 days = 480 + 480 + 480 = 3 × 480 kms. The
total time taken = l0 + 12 + 15= 37
����
Therefore, The average speed= ��
= 39 kms. per hour approximately.

Now you should note that the result obtained by this logical method is equal
to the harmonic mean. Hence, in averaging speeds, when total distance is
constant and time is variable, harmonic mean is the appropriate average.
Grouped Data
As you know, there are two types of grouped data: 1) Discrete series, and 2)
Continuous series. Now, let us study the methods of computing harmonic
mean for these two types of data sets.
Discrete Series: For a discrete series, harmonic mean is calculated as
follows:
�
� � Σ� �
H.M. = �(����������� �� �) = � �� ����������
Σ �� �

Where, symbols have their usual meaning.

Steps for calculations: 1) Take the reciprocal of various values of variate x.
2) Multiply the reciprocals by the respective frequencies and obtain the total
� �
product i.e.( Σ� �); 3) Take a ratio of the total frequency (n) to Σ� � .

Illustration 7: person buys 10 kgs of commodity A at the rate of 2 kg. per

rupee, 20 kg. of commodity B at the rate of 5 kg. per rupee and 30 kg. of
47
Business Statistics commodity C at the rate of 10 kg. per rupee. Find the average price in kgs per
rupee.
Solution: We have to find out the average price. So let us denote the items to
be averaged out as ‘x'. The quantities bought are similar to frequencies. So
denote them by ‘f’. Now harmonic mean would be calculated as below:

Commodity Price in Kg. Quantity � �

per Rupee �
bought (f) � �
(x)
A 2 10 0.5 5.0
B 5 20 0.2 4.0
C 10 30 0.1 3.0
Total N = Σf = 60 �
Σ� � = 12.0

� ��
H.M. = � = ��.� = 5.0
Σ ��

Therefore, the average price is 5 kgs. Per Rupee.

Note: You may ask why harmonic mean has been calculated in this
illustration. The answer is that to find out average price you need total
money spent and the total quantity (kgs.) bought. Then the average price in
kgs. per rupee will be the total quantity bought divided by total money spent.
Column l/X gives price of one kg. in rupees and column ‘f’ gives the quantity
�
bought. So column � � gives total money spent in buying quantity ‘f’ of
different commodities. Now, Σf or n gives the total kg. bought by spending
� �
total money Σ� �. Hence, the required average is � which is same as
Σ ��
harmonic mean.
From this illustration also you should note that while averaging prices
expressed in quantity units, the correct average is the harmonic mean. In
general, we can say, that while finding the combined effect of the items to be
averaged, if their reciprocals are used, harmonic mean is the right method of
averaging.
Continuous Series: The computational procedure for continuous series is the
same as prescribed for discrete series. The only difference is that in the case
of continuous series we take the reciprocals of the mid-values (m) of different
classes. Then multiply them with the respective class frequencies and obtain
the total of that product i.e. (Σ f.m). Then take the ratio of total frequency (n)
to the total product obtained.
�
� Σ ��
Therefore, H.M. = Σ�.�
or Reciprocal of �

Illustration 8: Calculate harmonic mean for the following information:

48
 Measures of Central
Class Interval f Tendency

0-10 5
10-20 8
20-30 10
30-40 12
40-50 7
50-60 6
60-70 3

Solution: Computation of Harmonic Mean

Class Interval f Mid-Value (m) 1/m �

f�

0-10 5 05 0.2 1.0

10-20 8 15 0.067 0.536
20-30 10 25 0.04 0.40
30-40 12 35 0.029 0.348
40-50 7 45 0.022 0.154
50-60 6 55 0.018 0.108
60-70 3 65 0. 015 0.045
n=51 �
Σ f� = 2.591

� ��
H.M. = � = �.��� = 19.68
Σ�
�

Weighted Harmonic Mean

There are situations where we need to calculate weighted harmonic mean
rather than simple harmonic mean. For example, a person walks first 10 kms.
at a speed of 4 kms. an hour, next 5 kms. at 3 kms. an hour, and then 4 kms.
at 2 kms. an hour. His average speed is to be found out. The kilometres
walked by him at three phases would be considered as weighty. The formula
to be used here is:
Σ�
Weighted H.M. = � where, ‘W’ refers to weights
Σ�
�
Σ�
Alternatively, Weighted H.M. = Reciprocal of Σ�

In the above example x : 4 3 2

w: 10 5 4
������ �� ��
Weighted H.M. = �� � � = �.���.���� = �.�� = 3.08 ���. ��� ℎ���
� �
� � �

49
Business Statistics In this Illustration, the weighted harmonic mean is the appropriate method. It
can be verified by calculating the average speed by ordinary arithmetic
method.

Case Distance. Speed Time taken Hours

First 10 kms. 4 km. p.h. 10/4 2.50
Second 5 kms. 3km.p.h. 5/3 1.67
Third 4 kms. 2km.p.h. 4/2 2.00
Total 19 Kms 6.17

Average speed = 19/6.17 = 3. 08 kms. per hour. The two results are exactly
the same. So, when harmonic mean is to be calculated for items which differ
in relative importance also, weighted harmonic mean should be calculated.
Illustration 9: Mr. Rakesh started for a village at a distance of six kms. He
travelled in his car at a speed of 40 kms. per hour. After travelling for 4 kms.
the car stopped running. He then travelled in a rickshaw at a speed of 10 kms.
per hour. After travelling a distance of 1.5 kms. he left the rickshaw and
covered the remaining distance on foot at a speed of 4 kms. per hour. Find his
average speed per hour and verify the result.

Solution: Here speeds are �� = 40 , �� = 10; ��= 4 and the weights are the
distance travelled i.e., �� = 4, �� = 1.5, �� = 0.5
� ���.���.� � �
H.M. = � = � � � = �.���.����.���
= �.��� = 16
�� �.�� �.�
� �� �� �

Therefore, the average speed of Rakesh is 16 kms. per hour. Let us verify the
answer by calculating the time taken.

Mode of Conveyance Distance Speed Time Taken

Car 4 kms. 40 km.p.h. 6 minutes
Rickshaw 1.5 kms. 10 km.p.h. 9 minutes
On Foot 0.5 kms. 4 km.p.h. 7.5 minutes
Total 6 kms 22.5 minutes

In 22.5 minutes he covered 6 kms. Therefore, in 60 minutes he would cover

16 kms. (i.e. 6 x 60/ 22.5).

13.6.2.1 Properties of Harmonic Mean

1) If each value of the narrate is replaced by harmonic mean, the total of
reciprocals of values of the narrate remains the same.
2) Harmonic mean is the reciprocal of the arithmetic mean of the
reciprocals of the individual observations.
3) Like arithmetic mean and geometric mean, it lends itself to further
algebraic treatment.

50
4) Amongst the three means (viz., arithmetic mean, harmonic mean and Measures of Central
Tendency
geometric mean), harmonic mean is the least i.e., AM ≥ GM ≥ HM.
To illustrate this, let us calculate the harmonic mean of five items 2, 3, 5, 10
and 100, and compare it with the arithmetic mean and geometric mean.
� � �
H.M. = � � � � � = �.����.����.����.����.��
= �.�� = 4.39
� � � �
� � � �� ���

As computed either under properties of G.M., the arithmetic mean is 24 and

geometric mean is 7.86. This illustrates that for a set of positive items AM >
GM > HM. This property may also be stated as that harmonic mean has bias
towards small items.
Note: When all the given items have exactly the same value, then only AM =
GM = HM. In such a case, median and mode will also be equal to this
common value.
13.6.2.2 Uses and Limitations
Uses:
1) For the rates and ratios involving speed, time and distance, harmonic
mean is used to find out the average speed.
2) For the rates and ratios involving price and quantity (both amount of
money spent and the units per rupee are given), harmonic mean is used.
In general, if reciprocals of items are used in obtaining their combined
effect, harmonic mean is to be used for averaging them.
3) In a given data set if there are a few large values, the reciprocals will
tone down the effect of large numbers. In such cases harmonic mean is to
be used.
4) When it is desired to assign greater weight to smaller values and smaller
weight to larger values of a variate, its use is recommended.
Limitations
1) It is difficult to compute and understand.
2) It cannot be computed when one or more items are zeros. In fact in such
a case HM will be always zero whatever may be the value of other items.
For example, harmonic mean of 0, 10 and 100 will be:
� � �
� � � = ���.����.��
=�=0
� �
� �� ���

Note: The sign ∞ means ‘infinity’. It is the concept of the greatest

number.
3) To assign the largest weight to the smallest item, it is not always a
desirable feature and has a limited scope in the analysis of economic
data.
Harmonic Mean Versus Arithmetic Mean
In order to derive averages of the rates and ratios (that involve speed, time
and distance or price, quantity and amount of money spent, etc.) making a 51
Business Statistics choice between the harmonic mean and arithmetic mean is not very easy. In
some situations harmonic mean seems to be more proper, whereas in other
situations harmonic mean is found more suitable to derive the correct answer.
Such a choice mainly depends on the nature of the data. Based on it, some
general guidelines for a judicious choice can be prescribed.
1) For the rates and ratios involving speed, time and distance, if the distance
is given, harmonic mean is preferred. But if the time is given, arithmetic
mean will be more suitable. In general, if the given ratios are in the form
of x units per y, use harmonic mean when X’s are given, and use
arithmetic mean when Y’s are given. Let us understand it more clearly
through an illustration.
Illustration 10: A person travels 100 kms. distance by car at an average
speed of 30 kms. per hour. Then he makes return trip at an average
Speed of 20 kms. per hour. What is his average speed?
Solution: Here the speed is given in kms. per hour and the total distance
travelled is also known (i.e., 100 kms. each side). Therefore, weighted
harmonic mean with equal weight 100 each or simple harmonic mean is
a more suitable average.
� � � ��
H.M. = � � = ��� = �
= 24 kms. per hour
�
�� �� ��

Now, let us slightly change the above information. Suppose for the same
trip the person travels at 30 kms. per hour for half of the time and at 20
kms. per hour for the other half of the time. Since the times of the trip are
given, arithmetic mean will be chosen as an average. Further as two time
periods are equal, simple arithmetic mean is suitable.
�����
Arithmetic Mean = �
= 25 kms. p. h.

You can verify here whether the arithmetic mean is the correct average
or not. With the arithmetic mean speed of 25 kms. per hour, he can cover
200 kms. in 8 hours. If he travels for half of the time i.e., 4 hours with a
speed of 39 kms. per hour and 4 hours with a speed of 20 kms. per hour
he would cover exactly 200 kms. Hence, in this case the correct average
speed is arithmetic mean.
2) The second distinguishing point is that the arithmetic mean is affected by
the extreme items, whereas harmonic mean is more sensitive to low
values. Therefore, for an uneven distribution use of arithmetic mean is
not suggested, whereas for the analysis of economic data, use of
harmonic mean is not used.

Check Your Progress D

1) What is harmonic mean?
2) Monthly expenditure of a group of students is given below. Compute
the harmonic mean. 125, 75, 10, 130, 45, 500, 150, 80, 65, 100.
3) Compute the harmonic mean from the following data:
52
 Measures of Central
Tendency

Size of Items : 0-10 10-20 20-30 30-40 40-50

Frequency : 5 10 7 3 2

4) An investor buys Rs. 1,200 worth of shares in a company each month.

During the first five months, he bought shares at a price of Rs. 10, Rs.
12, Rs. 15, Rs. 20 and Rs. 24 per share. What is the average price paid
per share?
5) A person, to reach his native place, covers first 1200 kms. by train at an
average speed of 80 kms. per hour. Then 20 kms. by bus at a speed of
40 kms. per hour and finally 5 kms. by cycle rickshaw at an average
speed of 8 kms. per hour. What is the average speed for the total
journey?

13.7 MEDIAN
The median is also a measure of central tendency. Unlike arithmetic mean,
this median is based on the position of a given observation in a series
arranged in an ascending or descending order. Therefore, it is called a
positional average. It has nothing to do with the magnitude of all the
observations, as in the case of arithmetic mean. Simply, median refers to the
middlemost value of the variable when they are arranged in order of
magnitude. The position of the median in a series is such that an equal
number of items lie on either side of it. Median of a given series is the value
of the variable that divides the series-into two equal parts. It is the most
central point of a series where half of the items lie above this value and
the remaining half lie below this value. In the case of a frequency curve the
median is that value of the variable which splits the area into two equal parts.
The median is usually denoted by '�� '. Canor defined the median as “The
median is that value of the variable which divides the group in two equal
parts, one part comprising all the values greater and other all values less than
the median.

13.7.1 Computation of Median

Median can be computed for both ungrouped and grouped data. But the
methods are different. Now, let us study the methods of computing median
for grouped and ungrouped data separately.
Ungrouped Data: Having arranged the data in ascending order or
���
descending order, the median is calculated as � th item, where ‘n’ is the
total number of items. This process is to be followed in the following both
situations.
1) When n is odd: When the number of observations is an odd number, the
procedure to find the median is as follows.
For example takes the series 6, 7, 4, 8,11, 5,3, 9, 10. In this case the
number of observations is nine which is an odd number. Now, the
53
Business Statistics ��� ���
median is �
th item �
th item = 5th item, it mean that when the given
series is arranged in a ascending order, the fifth item will be the median.
Now, we can arrange the data is ascending order and identify the fifth
item. The arranged series is 3, 4, 5, 6,7, 8, 9,10,11, and the 5th item is 7.
Therefore median (�� ) is 7
2) When n is even: When the number of observations (n) is an even
���
number, � will involve a fraction. In such cases the median is taken as
arithmetic mean of two middle values. Let us take an example to
understand the procedure to find the median in this situation.
For example, take the seies 8, 11, 13, 16, 20, 32, 41, 36. In this series, the
number of observations is eight which is an even number. So the median
��� ���
(�� ) is � th item = � = 4.5th item. This involves a fraction 0.5. You
should not that there is no item with the serial number 4.5. Hence, you have
to take the average of the items 4th and 5th as median. This happens with the
series when ‘n’ is an even number. Now, we arrange the series in ascending
order as shown here: 3, 8,11,16, 20, 32, 36, 41. The median (�� ) is the
arithmetic mean of items 4th and 5th in this series are 16 and 20 respectively.
�����
Therefore, �� is 18 ��. �. , �
�.
���
Even when n is an even number, median can be taken as �
th item. But for
this purpose you have to give a special meaning to interpret the fraction 0.5
���
in the value of � . In the illustration given above, 4.5th item is to be found
out. By convention 4.5th item will be taken as 4th item plus half of the
difference between the 4th and 5th items. In the given data arranged in
ascending order, 4th item is 16 and 5th item is 20. Thus, Median (�� ) is 18
�
��. �. ,16 + � (20 − 16)�. This value is same as obtained earlier. Hence, we
���
can define median for ungrouped data as �
th item whether n is an odd
number or an even number.
You should not that when n is an even number, it is easy to find median as
arithmetic mean of two middle items. But the meaning given to fraction size
of the item as indicated above is very much useful in calculations of other
partition values about which you will learn later in this unit. Moreover, this
formulat helps us in giving a general definitions to median for ungrouped
data.
Grouped Data: As you know, when the data is the form of frequency
distribution, it can be either in the form of discrete series or continuous
series. The method of computing median is different for these two types of
frequency distributions. Now, let us study them separately.
Discrete Series: In this case, the following steps to be followed to calculate
median.
1) Arrange the value of observations (x) either in ascending order or in
descending order along with their respective observations
(frequencies).
54
2) Convert the frequency (f) into cumulative frequencuy (cf). Measures of Central
Tendency
���
3) Apply the formula i.e., (�� ) = �
th item.
���
4) Now, locate the value of �
th item in the cumulative frequency and
determine the value of the variable corresponding to that cumulative
frequency locate as above.
5) This value of the variable is the median value.
Let us understand the computation of median by an illustration.
Illustration 1: Calculate the median marks from the following data:

Marks : 40 15 25 5 30 35 10 50 45 20

No. of : 9 75 72 20 45 39 43 6 8 76
Students

Solution: Examine the solution carefully by referring the above explained

steps. First rearrange the data in the ascending order of magnitude of marks,
and then prepare the cumulative frequency as shown below:

Marks : 5 10 15 20 25 30 35 40 45 50
No. of : 20 43 75 76 72 45 39 9 8 6
Students

Calculation of Cumulative Frequency

Marks No. of Students Cumulative Frequency

5 20 30
10 43 63
15 75 138
20 76 214
25 72 286
30 45 331
35 39 370
40 9 379
45 8 387
50 6 393

Here, n = 393
��� �����
Median = �
th item = �
th item = 197th item

The 197th item falls in the class with cumulated frequency 214. The value of
the variable in that class is 20. Therefore, median marks are 20,
55
Business Statistics

Continuous Series: In the case of frequency distribution of continuous

series, exact values of various items are not known. So the value of a
particular item cannot be found. What can be done is, to find out a value
which has half the items below or the above it. Thus in order to locate
���
median class N/2 is taken in place of � and the rest of the procedure is the
same as the procedure followed in the case of discrete series. Having located
the median class, the exact value of the variable can be interpolated from the
class by any of the following two methods:
Method 1: When cumulative frequency is formed in “less than” method.
�
��
�� = � + �
�
�

Where, l = lower limit of the median class

C = cumulative frequency of a class preceding the median class
f = simple frequency of the median class
i = the class-interval of the median class
N/2 = half of the number of observations, it is also denoted ‘m’
The above formula can also be expressed in the following manner:
���
�� = � + �
× (� − �)

Where, l = lower limit of the median class; u= upper limit of the median
�
class; f = frequency of the median class; m = � th item; c = cumulative
frequency of the class preceding the median class.
Steps to calculate the median in continuous series data:
1) If the classes are given in inclusive form they must be converted into
exclusive method or it is enough to convert the median class only. The
procedure will be explained latter in this unit. It is not necessary to
convert unequal classes into equal classes.
2) Calculate less than cumulative frequency (cf).
3) Find the n/2th item and locate the value of that item where it lies in the
cumulative frequency then find the corresponding class of the
cumulative frequency. This class is the median class.
4) Interpolate the value of median from the median class by using any
formula as presented above under the method.
Method 2: the assumption in the formula used in the first method is that
cumulated frequencies are calculated from lower values side. In case
cumulated frequencies are circulated from higher values side. i.e., “more
than” method the above formula can be slightly modified as:
�
��
�� = � + � � × �
56
 Measures of Central
Tendency
Where, U = lower limit of the median class; C= cumulative frequency of a
class next to the median class; f = simple frequency of the median class; i =
the class-interval of the median class
You should note that the procedure for computation of median under this
method is same as the procedure explained under method 1, except in step
No.2, i.e., in this method we have to calculate more than cumulative
frequency instead of less than cumulative frequency.
These two methods produce exactly the same result. The assumption and the
logic for interpolating median by these two methods are almost the same.
Now, let us explain the assumptions for the formula under Method 1.
If items are counted from the lower values side, ‘C’ items will be completed
upto the lower limit I of the median class. But to reach the median point, N/2
�
items must be covered. Therefore � − � items are to be covered. Therefore
�
�
− � item are to be covered in the median class. There are ‘f’ items spread
over a class intervals ‘i’ of this median class. It is now assumed that all these
‘f’ items are uniformly distributed over the range ‘i’. Thus, to cover N/2 – C
� �
items in the median class, a distance of � × � � − �� has to be travelled from
‘l’ limit (i.e., the lower limit) onwards.
� �
Therefore, median �� = � + � × � � − ��

You should note the difference in the assumptions behind the median and the
mean. In case of median the assumption is that items are uniformly spread
Out in a class intervals, whereas in the case of arithmetic mean it is assumed
that the values of all items of a class interval are equal to the mid-point of
that class interval. Let us take up an illustration to understand the calculation
of median by using both the methods.
Illustration 2: The manager of a departmental store compiled information on
200 accounts receivable which were delinquent. For each account he has
noted the number of days passed after the due date. He then grouped the data
as shown in the following frequency distribution. Determine the median.

No. of Days Passed No. of

After Due Date Accounts
30-44 40
45-59 45
60-74 40
75-89 25
90-104 25
105-119 20
120-134 5
57
Business Statistics

Solution: Let us examine carefully the calculations in both the methods to

determine the median by referring the steps explained above.

No. of Days No. of Accounts Cumulative Cumulative

Passed After (f) Frequency Frequency
Due Date (Less than) (More than)
30-44 40 40 200
45-59 45 85 160
60-74 40 125 115
75-89 25 150 75
90-104 25 175 50
105-119 20 195 25
120-134 5 200 5

Here, N/2 = 200/2 = 100 . This implies that there are 100 items below
median. Therefore, 60-74 is the class where the median lies. Now, as per the
first step, we have to convert the Inclusive form of the class into Exclusive
form to obtain the real limits of the median class 60-74. The procedure for
conversion is as follows: obtain the difference between the lower limit of a
class and upper limit of the preceding class here it is 1 (one), divide the
difference by 2 i.e., ½ = 0.5.
Now, subtract the result (0.5) from the lower limit of the median class i.e.,
60-0.5 = 59.5 and add the same result to upper limit of the same class i.e., 74
+ 0.5 = 74.5. Accordingly, the real limit of the median class is 59.5 – 74.5.
Now compute the median using the first method.
�
��
�� = � + �
�
�

Where, l = 59.5; c= 85; f = 40; i = 15; N = 200.

������
�� = 59.5 + ��
× 15

= 59.5 + (15/40) × 15 = 59.5 + 225/40

= 59.5 + 2.625 = 65.125 (Median = 65.1 days)
You can obtain the median by using the alternative formula expressed in
method-1.
���
�� = � + �
× (� − �)

Where, l = 59.5; u = 74.5; f = 40; ,=N/2 = 200/2 = 100; C = 85

��.����.�
�� = 59.5 + ��
× (100 − 85)

= 59.5 + (15/40) × 15 = 65.125 (Median = 65.1 days)

Now, let us compute the median by using the second method.
58
 �
�� Measures of Central
�� = � + �
�
� Tendency

Where, u = 74.5; f = 40; c=75; i = 15; N = 200

���
���
∴ �� = 74.5 + �
��
× 15

= 74.5 – (25/40) × 15 = 74.5 – 375/40

= 74.5 – 9.375 = 65.125 (Median is 65.1 days).
You should not that the two methods discussed above produced the same
result.
Illustration 3: Find the median income from the following income
distribution.

Monthly Income (Rs.) No. of Families

Below 100 50
100-200 500
200-300 555
300-500 100
500-800 3
800 and above 2

Solution:

Monthly Income No. of Cumulative

(Rs.) Families Frequency

Below 100 50 50
100-200 500 550
200-300 555 1,105
300-500 100 1,205
500-800 3 1,208
800 and above 2 1,210
Median has N/2th item below it which mean 1,210/2 = 605th items below it.
Therefore, the median lies in the 200-300 class. Now applying the formula
of interpolation.
�
��
�� = � + � � × �

Where, l = 200; c= 550; f = 555; i = 100; N = 1,210.

�������
�� = 200 + ���
× 100
= 200 + (55/555) × 100 = 200 + 9.91 = 209.91
Median Monthly Income is Rs. 209.91
59
Business Statistics Note: You may note that the class intervals in this illustration are unequal
and the data is open-ended. This does not affect the calculation of the
median. The length of the class interval (i) in the formula corresponds only
to the median class.
Illustration 4: Determine the median wage from the following data:

Wages More Than (Rs.) No. of Workers

20 58
40 54
60 48
80 38
100 22
120 10
140 3
160 0

Solution: Computation of Median

Wages More No. of Workers Simple

Than (Rs.) (Cumulative Fre.) Frequency

20 58 58-54 = 4
40 54 54-48 = 6
60 48 48-38 = 10
80 38 38-22 = 16
100 22 22-10 = 12
120 10 10-3 = 7
140 3 3-0 = 3
160 0 0

Cumulative frequency (more than method) is given in this illustration. So,.

We have calculated simple frequency. Now median has N/2th items i.e., 58/2
= 29th, items above it. Therefore, median lies in the ‘more than 80’ class i.e.,
80 -100 class. We can interpolate median by using the following formula:
�
��
�� = � + �
�
�

Where, u = 100; c=22; f = 16; i = 20

�����
�� = 100 + ��
× 20

= 100 – (7/16) × 20 = 100 – 8.75 = 91.25. Median wage is Rs.91.25.

60
Finding the missing frequency: It is possible to find the missing frequencies Measures of Central
Tendency
with the help of the value of median and the total number of observations
(N). Let us consider the following illustration.
Illustration 5: You are given the following incomplete frequency
distribution. It is known that total frequency is 1,000 and that the median is
413.11. Estimate the missing frequencies.

Values Frequency
300-325 5
325-350 17
350-375 80
375-400 -
400-425 326
425-450 -
450-475 88
475-500 9

Solution: Let us assume that the frequency of the class is 375-400 is F.

Now, the frequency of the class 425-450 become 1,000 – (525 –F) = 475 – F
(525 being the total given frequencies).

Values Frequency c.f.

300-325 5 5
325-350 17 22
350-375 80 102
375-400 F 102 + F
400-425 326 425 +F
425-450 425 - F 903
450-475 88 991
475-500 9 1000

Since the median is given as 413.11, the formula must be in 400-425 class.
�
��
Now �� = � + � � × �

Where, l = 400; f = 326; C= 102+F; i = 25; �� = 413.11.

����(�����)
413.11 = 400 + ���
× 25
�����
413.11 − 400 = ���
× 25

13.11 × 326 = (398-F) × 25

61
Business Statistics 4,273.86 = 9,950 – 25F
25 F = 5,676.14; F = 227.04
As frequency should be an integral value F = 227. Therefore, frequency for
the class 375-400 = 227 and the frequency for the class 425-450 is 475 – 227
= 248.

13.7.2 Properties of Median

You have studied the methods of computing median. Now, let us discuss the
properties of median.
1) An important property of the median is that the sum of the absolute
deviations (i.e., deviations ignoring signs) from the median is minimum
i.e., ∑|x-�� | is the minimum. This property entails the use of median
in various practical situations. For example, take the item 5, 7, 8, 9,21.
(���)
In this case the median � is 8. Let us calculate absolute
deviations from (i) median, (ii) any other value say 7, and (iii) from
����������
arithmetic mean. ��. �. , �
� = 10

Item X |x-�� | |x-7| |x-�|

X |x-8| |x-10|
5 3 2 5
7 1 0 3
8 0 1 2
9 1 2 1
21 13 14 11
Total 18 19 22

If you study the above table carefully, you will notice that the least total is
18, which is the sum of absolute deviations from median.
2) It is not affected by the extreme items. It is of course affected by the
number of items.
3) For an open ended distributions, median is the more suitable average,
For example, since the income distribution is an open-ended
distributions, median income would be a more representative figure.
4) For the qualitative information, median is probably the only suitable
measure of central tendency. For example, a respondent may be asked
to rate his evaluation of the corporate image, in the order of
importance, an dynamic, prestigious, cooperative (business-wise),
successful and withdrawn. Suppose he ranks them exactly as given
here. The third adjective viz. cooperative (business-wise) is the median
of his five ratings.
5) The median can also be located graphically.

62
6) It is easily to compute the lucid to understand. In some cases it is Measures of Central
Tendency
obtained even by an inspection.

13.7.3 Merits and Limitations of Median

You have studied the meaning, methods of computation and properties of
median. Now, let us discuss the merits and limitations of median.
Merits:
1) For an open-ended distribution, such as income distribution, the median
gives a more representative value.
2) Since median is not distorted by the extreme items, in some cases it is
preferred over mean as the latter is likely to be distorted by extreme
values.
3) For dealing the qualitative phenomena, median is the most suitable
average,
4) Since median minimises the total absolute deviations, median is
preferred in the situations wherein the total geographical distance is to
be minimised. For example, there is a conference of five tope
executives from five different cities of India lying almost in a straight
line. The city located at a median distance would be a more proper
place for the conference.
5) While taking a decision to buy a particular brand of tyre, when only
one or two tyres are to be bought, the brand with greater median run
will be preferred. Similarly, in buying a washing machine, the machine
with greater median life will be preferred, rather than one with a greater
mean life.
Limitations:
1) Median is not capable of algebraic treatment. That means we cannot
have a combined median of two or more groups, unless all the items of
the groups are known.
2) It is described, sometimes, as an insensitive measure as it is not based
on all items of the series.
3) It is affected more by sampling fluctuations than the value of mean.
4) The computational formula of a median is in a way an interpolation
under the assumption that the items in the median class are uniformly
distributed which is not very true.
5) The impression created by median in some cases may be illusory and
deceptive because its value is determined strictly by the value of middle
observations(s). For example, in lotteries the median value of the prize
won by a ticket is always zero when all tickets are considered (more
than 50% of the tickets will not get any prize). This median value of
prize will not help in analysing the prizes offered by lotteries as the
matter of interest may be the first prize out of a number of prizes
offered. 63
Business Statistics
Check Your Progress E
1) Find the median for the following data sets:
a) 1, 2, 4, 8, 16 32, 64, 128, 256
b) 1, 1/2, 1/3, 1/4, 1/6, 1/7, 1/8, 1/9, 1/10
2) What is the formula for computing median for continuous data, when
cumulated frequencies are calculated from higher values side?
3) In a given distributions, if the class intervals are of unequal width,
which class interval would you use for computing median?
4) Heights (in inches) of a group of students are given below. 61, 62, 62,,
63, 61, 63, 64, 64, 60, 65, 63, 64, 65, 66, 64. Calculate the median.
Now suppose, another group of students whose heights are 60, 66,59,
68, 67 and 70 inches is added to the previous group. Find the median
of the combined group.
5) Calculate the median from the following frequency distribution of
marks in Economics:

Marks 5 10 15 20 25 30 35 40 45 50

No. of 20 43 75 76 72 45 39 9 8 6
Students

6) The following information is about the life (in hours) of 100 new-type
light bulbs. Find the median life.

Life (in Hours) Number failed

1-50 2
51-100 8
101-150 15
151-200 20
201-250 25
251-300 20
301-350 10

13.8 PARTITION VALUES

As you know median is the middle value of the variable when the items are
arranged in the order of magnitude. Thus, median splits the series into two
equal parts. Hence, it is called positional average. In fact there are other
positional measures that partition the series into still more number of equal
parts, say four equal parts or 10 equal parts or 100 equal parts. Such measures
are generally known as Partition Values. There are three partition values: 1)
Quartiles, 2) Deciles and 3) Percentiles, which are in much use. They are, of
64
course, the measures of non-central location. Now, let us study about them Measures of Central
Tendency
one by one.
Note: You must keep in mind that the procedure for calculation of these
partition values is same as the procedure of median. However, application is
slightly differ. You should try to understand the procedure of expressions
carefully by comparing the expressions of the median.

13.8.1 Quartiles
The values of a variate that divide the series or the distribution into 4 equal
parts are known as Quartiles. Since three points are required to divide the
data into 4 equal parts, we have three quartiles ��, �� , and �� .
The first quartile (��), known as a, lower quartile, is the value of a variate
below which there are 25% of the observations and above which there are
75% of the observations.
The second quartile (�� ) h the.value of a variate which divides the
distribution into two equal parts. It means, there are 50% observations above
it and 50% below it. Therefore, �� is the same as median.
The third quartile (�� ), known as an upper quartile,'is the value of a variate
below which there are 75% observations and above which there are 25%
observations.
It is clear that ��< �� < ��
Computation of Quartiles
i) Discrete Series (i.e. Individual Values Known): When the data is
expressed in less than cumulative frequency i.e., assigned in the
ascending order:
���
��= size of �
�ℎ item
�(���)
�� = size of �
�ℎ item
�(���)
�� = size of �
�ℎ item

ii) Continuous Series (i.e. Data with Class Intervals)

�
�� ���
�
�� = � + � � = 1, 2, 3
�

Where, l =Lower limit of quartile class

C = Cumulated frequency preceding the quartile class
f = Simple frequency in the quartile class
i = Class-interval of quartile class
j = Position of the partition value.

65
Business Statistics
13.8.2 Deciles
The values of a variate that divide the series or the distribution into 10 equal
parts are called Deciles. Each part contains 10% of total observations.
Obviously there should be nine such values denoted as �� , �� ..... �� . They
are called first decile, second decile, etc. The 5th decile (�� ) is the median.
Computation of Deciles
i) Discrete Series (i.e. Individual Values Known).
���
�� = Size of � ��
�ℎ item. J = 1 to 9

ii) Continuous Series (i.e. Data with Class Intervals)

�
�� ���
�� = size of � + ��
� J = 1 to 9
�

where, C is the cumulated frequency preceding the Jth decile class, the other
symbols have usual meaning.

13.8.3 Percentiles
The value of a variate which divides a given series or distribution into 100
equal parts are known as percentiles. Each percentile contains 1% of the total
number of observations. The percentile P. is that value of the variate upto
which lie exactly j % of the total number of observations. For example:
��� = Value of a variate upto which lies exactly 10% of observations. This
is same as �� .
��� = Value of a variate upto which lies exactly 20% of observations.
��� = Value of a variate upto which lies exactly 25% of the total number of
observations. This is same as �� .
��� = Value of a variate upto which lies exactly 50%of the total number of
observations. This is the same as �� or �� or median.
Similarly, ��� = ��
Computation of Percentiles
i) Discrete Series (i.e. Individual Values Known).
���
�� = Size of � ���
�ℎ item.
�� (���)
e.g., ��� = Size of ���
�ℎ item

ii) Continuous Series (i.e. Data with Class Intervals)

�
�� ���
���
�� = � + � � = 1 �� 99
�

Where, C is the cumulated frequency preceding the jth percentile class. The
remaining symbols have usual meaning. Let us understand the computation
of partition values by two illustrations.

66
Illustration 6: Marks of 16 students in a class,test (maximum marks 20) are Measures of Central
Tendency
as follows:
2, 3, 6, 7, 10, 10, 11, 11, 11, 12, 12, 14, 15, 16, 18, 19.
Calculate ��, ��� , ��
Solution: Marks are already arranged in ascending order in the illustration.
(���)
�� = Size of �
th item
���� �
= �
th item = 4 �th item
�
�� = 4th item + � (5th item – 4th item)
�
= 7 � = 7.75
��(���)
��� = Size of ���
th item
�� (����) ��
= ���
th item = 5 ��� �ℎ item
��
��� = 5th item + ��� (6th item – 5th item)
��
= 10 + ��� �10– 10� = 10 + 0 = 10
�(���) �
�� = Size of ��
= 15 �� �ℎ item
�
�� = 15th item + �� (16th item – 15th item)
�
= 18 + �� �19– 18� = 18 + 0.3 = 18.3

You may note that there is no student who has obtained 7.75 or 18.3 marks.
When the size of item to be selected involves fraction, such hypothetical
values can arise. The interpretation of such values become valid if the given
data is a continuous series and not a discrete series.
Illustration 7: The following table gives the distribution of monthly income
of 600 families in Ahmedabad city.

Monthly Income Rs. Families

Below 75 69
75- 150 167
150-225 207
225-300 65
300-375 58
375-450 24
450 and above 10

a) Find �� , �� , ��� , ��� , �� and Median.

b) Obtain the lirnits of income of central 50% of observed families.
67
Business Statistics c) Interpret the results.
Solution:

Monthly Income Rs. Families Cumulative frequency

Below 75 69 69
75- 150 167 236
150-225 207 443
225-300 65 508
300-375 58 566
375-450 24 590
450 and above 10 600

a) �� has 2N/10 items below it. It means 2 × 600/10 = 120 items below it.
Therefore, �� falls in the 75-150 class.
��
��
Now, �� = 1 + ��� × �

������ ��
= 75 + ���
× 75 = 75 + ��� × 75

= 75 + 22.9 = 97.9 �� = 97.90

�� has 5N/10 items below it. It means 5 × 600/10 = 300 items below
it. Therefore, �� falls in the 150-225 class.
��
��
Now, �� = 1 + ��� × �

������� ��
= 150 + ���
× 75 = 75 + ��� × 75

= 150 + 23.19 = 173.19 �� = 173.19

��� has 25N/100 items below it. It means 25 × 600/100 = 150 items
below it. Therefore, ��� falls in the 75-150 class.
���
��
Now, ��� = 1 + ���
�
�

������ ��
= 75 + ���
× 75 = 75 + ��� × 75

= 75 + 36.38 = 111.38 ��� = 111.38

��� has 75N/100 items below it. It means 75 × 600/100 = 450 items
below it. Therefore, ��� falls in the 225-300 class.
���
��
Now, ��� = 1 + ���� �
68
 ������� Measures of Central
= 225 + ��
× 75 Tendency

= 225 + 8.077 = 233.077 ��� = 233.078

�� has 3N/4 items below it, which means 3 × 600/4 = 450 items
below it. ��� also has 450 items below it. So �� must be same as ��� .
�� = Rs. 233.08.
Median has N/2 items below it, which means 600/2 = 300 items
below it. So it falls in the 150-225 class intervals

�
��
Now, �� = � + � � × �

������� ��
= 150 + ���
× 75 = 150 + ��� × 75

= 150 + 23.19 = 173.19 which is same as ��

Therefore, Median is Rs. 173.19

b) Central 50% of observations are given by an interval �� to �� as ��
has 25% of items below it and �� has 25% of items above it.
Here ��= ��� = Rs. 111.38 and �� = ��� Rs. 233.08. Required limits
of income of central Median 50% of observed families are Rs. 111.38
to Rs. 233.08
c) Interpretation
�� = 20% of the families have monthly income of Rs. 97.90 or less
and 80% of the families have monthly income of Rs. 97.90 or
more.
D� = 50% of the families have the monthly income of Rs. 173.19 or
less, and 50% have the monthly income of Rs. 173.19 or
more. Median being the same as D� both have same
interpretation.
P��= 25% of the families have monthly income of Rs. 111.38 or
less and 75% of the families have Rs. 111.38 or more.
P��= 75% of the families have monthly income of Rs. 233.08 or
less and 25% of the families have Rs. 233.08 or more. �� and
P�� being the same, they have the same interpretation.

Check Your Progress F

1) Define partition values. Name the partition values used in statistics.
2) Write the formulas for finding different partition values.
3) From the following data calculate ��, �� , �� , ��� , ��� how many
students have obtained less than 12 marks and how many have more than
95 marks.
69
Business Statistics
Marks No. of Students
0-12 40
12-23 85
23-38 75
38-45 50
45-60 65
60-73 60
73-83 75
83-95 35
95-100 15

13.9 MODE
Mode is also a measure of central tendency. Mode is the value of a variate
which is repeated most often in the data set. The genesis of the word 'mode'
lies in the French word ‘le mode’ that means fashion. Mode is, therefore,
considered to be the most common or most fashionable value.
Mode is often considered to be that value of the variate which occurs most
frequently. But it is not exactly true for every frequency distribution. Rather
it is that value of the variate around which the other items tend to concentrate
most heavily. It shows the centre of concentration of the frequency in and
around a given value. If is not the centre of gravity like mean. It is a
positional measure similar to median. It is commonly denoted by �� .
For example, take the case of a shopkeeper who sells shoes or garments. He
is interested to know the sizes of shoes or garments which are commonly
demanded. Here in such a situation, mean would indicate a size that may not
fit any person. Median may not provide a representative size because of the
unevenness in the distribution. It is the mode which will help in making a
choice of approximate size for which an order can be placed. Similarly mode
is also useful and appropriate average in problems related to the expression of
preferences in a situation where it is not possible to measure in quantity.
Such as design of garments, preferences on different advertisements etc. In
such situations, we can consider the model preferences only for decision
making but not arithmetic mean and median.

13.9.1 Computation of Mode

The method of computing mode is different for grouped data and ungrouped
data. Now, let us study those methods separately.
Ungrouped Data : For an ungrouped data mode is found out simply by
inspection. The value that occurs most frequently in the given distribution is
taken as a mode. For example, the ages (in years) of 10 boys are as follows:
5, 6, 4, 10, 7, 6, 9, 2, 8, 6. Here the number six appeared thrice. Therefore,
mode age is six years.
70
Mode does not exist as such in some cases. For example, take the following Measures of Central
Tendency
data set: 5, 10, 15, 20, 25, 30. In this case there is no mode because none of
the numbers is repeated.
In some cases there may be more than one mode. For example, one typist
typed 10 pages and the number of mistakes per page are as follows: 5, 1, 0, 1,
2, 2, 3, 2, 4. In this case, both the numbers 1 and 2 appear equal number of
times. Therefore, there are two modes: 1 and 2 which is called bi-model.
Similarly, the distribution can be a tri-modal or even multi-model. For such
distributions, the mode as a measure of central tendency has little
significance. Mode has very limited use for ungrouped data.
Grouped Data: The method of computing mode is different between discrete
distribution and continuous distribution. Let us now study those methods in
detail.
Discrete Series: For discrete distribution, i.e., when the values of individual
items are known, mode can be determined just by inspection. By inspection
you can find out the value of the variate around which the items are most
heavily concentrated. For example, study the following frequency
distribution:

Size of Item 20 21 22 23 24 25
Frequency 15 20 25 45 30 12

In this frequency distribution, 23 has the highest frequency, not only highest
frequency but also implying that there is a heavy concentration of items at
this value. Therefore, mode is 23.
In a series like this it is easy to obtain mode. Difficulty arises when nearly
equal concentrations are found in two or more neighbouring classes; i.e.,
there is a small difference between the maximum frequency and the
frequency preceding it or succeeding it. To locate a modal class in such
situations, there is a need for Grouping and Analysis of the distribution.
Grouping Table: A grouping table has six columns as explained below:
Column 1 : It is of class frequencies written against each class and the
highest frequency is masked or circled.
Column 2 : Frequencies are grouped in this column in two's, and totals
are found. Then the highest total is marked or circled.
Column 3 : Leaving first frequency from the top, the remaining
frequencies are grouped in two’s their tables are obtained
and the highest total is marked.
Column 4 : Starting from the top, frequencies are grouped in three's,
their totals are obtained and the highest total is marked.
Column 5 : Leaving first frequency from the top, remaining frequencies
are again grouped in three's. Their totals are obtained and
the highest total is marked.

71
Business Statistics Column 6 : Leaving the first two frequencies from the top,
remaining frequencies are grouped in three's. Their
totals are calculated and the highest total is marked.
Analysis Table : After preparing a grouping table, an analysis table is
prepared by considering the highest tables (observation) in each column. It is
two fold :
1) vertical (i.e., stubs) where the column numbers, as obtained in a
grouping table, are taken.
2) horizontal (i.e., captions) where the values of the variate (or the
classes) are taken.
Now, you take the grouping table, where you have marked or circled highest
frequencies in every column, Take these circled frequencies in turns along
with the corresponding values of the variate. In the analysis table under these
values and in the row corresponding to relevant column number, tally bars
are placed. The number of bars placed in each column of an analysis table
are totalled. The maximum of these totals is marked. The value of the variate
corresponding to it is the mode or the modal class. Let us study the
preparation of grouping and analysis tables by taking an illustration.
Illustration 1: Find the mode (�� ) for the following information on the
marks obtained by the students:

Marks 55 60 61 62 63 64 65 66 68 70
No. of 4 6 5 10 20 22 24 6 2 1
Students

Solution: As you notice here, the difference between the highest frequency
(i.e. 24) and the two frequencies preceding it (i.e., 22 and 20) is very small.
The frequency which is next to the highest frequency (i.e., 6) also is very
small. Therefore, grouping has to be done to ascertain the modal class.

Grouping Table

Marks Col.1 Col.2 Col.3 Col.4 Col.5 Col.6

55 4
10
60 6 15
11
61 5 21
15
62 10 35
30
63 20 52
42
64 22 46 66
65 24 52
30
66 6 8 32
68 2 3 9
70 1

72
Analysis Table Measures of Central
Tendency

Marks
Col. No. 55 60 61 62 63 64 65 66 68 70
1 I
2 I I
3 I I
4 I I I
5 I I I
6 I I I
Total 1 3 5 4 1

Now, look at the analysis tables, highest total table is five. The value of
variable corresponding to it is 64. Therefore the mode (�� ) is 64. It may be
noted here that the highest frequency (as shown in data) is for 65, whereas
grouping and analysis tables indicated concentration of frequencies around
64. Thus, the correct value of mode is 64.
Continuous Series: In the case of continuous series, (i.e. data with class
intervals) which have equal class intervals throughout, there be two major
steps in computing the mode.
Step 1: Ascertain the modal class by preparing grouping table and analysis
table exactly in the same way as discrete series. The minor difference in the
procedure is that different classes of the given frequency distribution are
taken vertically.
Step 2: Having located correctly a model class, the value of mode (�� ) is
obtained by interpolation by using any of the following formulas:
∆�
Formula 1: �� = � ∆� � ∆�
�

Where l = lower limit of the model class; i = class interval ; ∆�= �� − �� ; ∆�

= �� − �� ; �� = is the frequency of the model class; �� = is the frequency of
the model class preceding the model class; �� = is the frequency of the model
class succeeding the model class.
By substituting the value of ∆�and ∆� in the above formula it can also be
presented in the following forms:
�� � ��
i) �� = � + (�� � �� )� (�� � �� )
�
�� � ��
ii) �� = � + ��� � �� � ��
�

Note: if (2�� − �� − �� ) is zero, the formula becomes meaningless. If any

numerator or denominator becomes negative, then the formula does not give
valid result In that case it should be taken as:
|�� � �� |
Formula 2: �� = � + |�� � �� |� |�� � �� |
�

73
Business Statistics Where, |�� − �� | and |�� − �� | mean absolute values of the difference i.e.,
difference neglecting signs.
Where, the modal class is other than the one containing the maximum
frequency, the following formula is more suitable:
��
Formula 3: �� = � + �� � ��
�

Notes:
1) If the very first class of the frequency distribution is the modal class,
the �� is taken as zero. If modal class is the last group, then f2 is taken
as zero.
2) These formulas hold good only for the distributions with equal class
intervals. Why is it so? The reason is simple. If two class intervals of
size 10 and 20 have frequencies 15 and 18 respectively, then on simple
comparison it appears frequency 18 is larger than 15. But mode is
concerned with concentration of items. Concentration for the first
group is 15/10 or 1.5 items per unit length of class interval. While in
the second case it is only 18/20 or 0.9 items per unit length of class
interval. Thus, from the point of view of determining mode, frequency,
l8 for class interval size 20 is less than the frequency 15 for the class
interval size 10. Therefore, direct comparisons of frequencies can
only be made when class intervals are equal.
3) For the distributions with unequal class intervals, first the class intervals
are made equal assuming that frequencies are uniformly distributed or by
combining classes or land splitting classes and then apply the usual
formula. The procedure will be explained in illustration 11.
4) If the distribution is given in inclusive method, the model class should
be converted into ‘exclusive’ method. The procedure of this
conversion is explained in the previous unit.
Illustration 2 : For the following frequency table, calculate the mode:

Monthly Rent No. of Families

Paid Rs. Paying the Rent
20-40 6
40-60 9
60-80 11
80-100 14
100-120 20
120-140 15
140-160 15
160-180 8
180-200 7
100
74
Solution: By inspection the model class appears to be 100-120, but let us Measures of Central
Tendency
verify by grouping.
Grouping Table

Monthly Col.1 Col.2 Col.3 Col.4 Col.5 Col.6

Rent
(Rs.)
20-40 6
15
40-60 9 26
20 34
60-80 11
25
50-100 14 45
34
100-120 20 49
35
120-140 15 45
25 33
140-160 10
18
160-180 8 25
15
180-200 7
Analysis Table

Monthly Rent (Rs.)

Col. No. 20- 40- 60- 80- 100- 120- 140- 160- 180-200
40 60 80 100 120 140 160 180
1 I
2 I
3 I I
4 I I
5 I I
6 I I I
Total 1 3 6 1

The highest total being 6, the modal group is 100-120.

�� � ��
Applying the formula: �� = � + ��� � �� � ��
�
�����
= 100 + �(��)� �����
× 20
�
= 100 + ��
× 20 = 100 + 10.91 = 110.91

∴ mode of monthly rent is Rs. 110.91

75
Business Statistics Illustration 3: Calculate the mode from the following data:

Size 0-9 10-19 20-29 30-39 40-49 50-59

Frequency 3 4 8 7 6 3
Solution: By inspection, it is difficult to ascertain the modal class.
Therefore, we have to resort to grouping.
Grouping Table

Size Col.1 Col.2 Col.3 Col.4 Col.5 Col.6

0-9 3
7
10-19 4 15
12
20-29 8 19
15
30-39 7 21
13
40-49 6 16
9
50-59 3

Analysis Table

Marks
Col. No. 0-9 10-19 20-29 30-39 40-49 50-59
1 I
2 I I
3 I I
4 I I
5 I I
6 I I I
Total 4 5 3

From the analysis table, it is obvious that 30-39 is the modal class. But the
maximum frequency lies in class 20-29. Therefore, a more suitable formula
for calculating the mode is:
��
�� = � + �� � ��
�
�
= 29.5 + ���
× 10
��
= 29.5 + ��
= 29.5 + 4.29 = 33.79

Therefore, mode is 33.8. You may note that a different result will be obtained
if mode is calculated by the following formula:
76
 |�� � �� | Measures of Central
�� = � + |�� � �� |� |�� � �� |
� Tendency

|���|
= 29.5 + |���|� |���|
× 10
�
= 29.5 + ���
× 10 = 29.5 + 10/2 = 34.5

You should note that the mode is 34.5 under this method whereas under the
� ��
earlier method it is 33.8. If you use the formula �� = � + �� �� � �� � × �
� � �
denominator will become zero and the numerator will be negative and
therefore, this formula is not applicable. It is important to note at unlike
arithmetic mean and median, the different methods of calculating mode can
give different results.
Smooth Data: When the data shows more or less uniform movement, it is
called the smooth data. For such data mode can be obtained easily without
using any of the above formulas. It can be worked out by a very simple
calculation. The rules to be followed for computing mode for smooth data
are as under: when �� = �� i.e., the frequencies neighbouring the modal etc.
frequency are equal, the mode is the mid-point of two limits of the modal
class. Study the following illustration carefully,

Size (x) : 0-10 10-20 20-30 30-40 40-50 50-60 60-70

Frequency (f) : 1 6 15 20 15 6 1

The highest frequency being 20, the modal class here is 30-40. Since each of
the two frequencies neighbouring the maximum frequency are equal (i.e.,
15), the mode is the simple mean of 30 to 40
�����
Therefore, �� = �
= 35

You may verify whether the result obtained by this formula is the same as the
result obtained by the methods suggested earlier for the grouped data.
Whenever �� = �� for both �� and �� less than �� this will always happen.
When �� ≠ �� (i.e., the two frequencies neighbouring the modal frequency
and the modal frequency is not very large, the mode is the weighted mean of
the two limits – upper (u) and the lower (l) of modal class – the weights being
the neighbouring frequencies falling on either side of a modal class.
��� � ���
Therefore �� = �� � ��
.

For an example, study the following illustration:

x: 0-10 10-20 20-30 30-40 40-50 50-60 60-70

f: 500 610 740 748 745 690 500

Here the modal class is 30-40 corresponding to the highest frequency 748
(�� ). Two neighbouring frequencies are 740 (�� ) and 745 (�� ) which are not
equal and they do not differ much from �� . The medal class is 30-40, ‘l’ is 30
and u is 40.
�����������
∴�� = ������� 77
Business Statistics ��,���
= �,���
= 35.02

The result derived by this method will always be the same as obtained by
�
using the formula : �� = � + � �� � × �. You may verify it.
� �

Illustration 4: For the data given below, find the mode.

Age in 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60

Years
No. of 50 70 80 180 150 120 70 50
Persons

Solution: The highest frequency is in the group 35-40. But concentration of

frequency appears to be around the group 40-45. So we do grouping for
ascertaining the modal class.
Grouping Table
Age Col.1 Col.2 Col.3 Col.4 Col.5 Col.6
20-25 50 ×
120
25-30 70 200
150
30-35 80 330
260
35-40 180 410
330
40-45 150 450
270
45-50 120 340
190
50-55 70 240
120
55-60 50
We observe here that class 40-45 participates in maximum frequency in
Columns 2, 3, 4, 5 and 6, (i.e., 5 times out of six columns) and class 35-40
participates only 4 times. You may verify it by analysis table.
�� � ��
using the formula �� = � + ��� � �� � ��
�
������� ���
�� = 40 + �×��� – ��� � ���
× 5 = 40 + �
×5

So mode cannot be determined as 2�� − �� − �� = 2 × 150 ̶ 180 ̶ 120 =0

Therefore, we will use the following formula:
|�� � �� |
�� = � + |�� � �� |� |�� � �� |
�
|�������|
= 40 + |�������|� |�������|
×5
��
= 40 + ��� ��
×5
�
= 40 + = 40 + 1.67 = 41.67 ∴ Modal age = 41.67
78 �
Illustration 5: Find the mode from the following table: Measures of Central
Tendency

Size of the 40-49 50-59 60-69 70-79 80-89 90-59 100-

Item 109
Frequency 7 9 10 6 13 10 12

Solution: By inspection, the modal class is not clear. Hence, we have to do

grouping and analysis.
Grouping Table
Age Col.1 Col.2 Col.3 Col.4 Col.5 Col.6
40-49 7
16
50-59 9 26
19
60-69 10 25
16
70-79 6 29
19
80-89 13 29
23
90-99 10 35
22
100-109 12 29
19
110-119 7
Analysis Table

Marks
Col. No. 60-69 70-79 80-89 90-99 100-109 110-119

1 I
2 I I
3 I I
4 I I I
5 I I I
6 I I I I I I
Total 1 2 5 5 3 1

In the analysis table maximum total occurs twice. The mode, therefore, is ill-
defined and is to be determined empirically by using the formula:

�� = 3�� − 2X . You may check yourself that here Median = 83.84 and X
= 80.14.
∴�� = 3 (83.84) – 2(80.14).
= 251.52 – 168.28 = 91.24 ∴Mode = 91.24.
79
Business Statistics
Check Your Progress G
1) Define mode.
2) State the various formulas for the computation of mode
3) What is empirical relationship between arithmetic mean, median, and
mode?
4) For a frequency distribution, the mean is 26.8 and the median is 27.9,
Find the mode.
5) Calculate mean, median and mode from the following data:

X 20- 40- 60- 80- 100- 120- 140- 160- 180-

40 60 80 100 120 140 160 180 200
F 6 9 11 14 12 15 10 8 7

13.9.2 Merits and Limitations of Mode

Merits:
1) In certain situations mode is the only suitable average, e.g., modal size
of garments modal size of shoes, modal wages, modal balance of
depositors in a bank, etc.
2) It is used to describe qualitative phenomena. For instance, if a printing
press turns out five impressions which we rate very sharp, sharp, sharp,
blurred and sharp, then the modal value is sharp.
3) For the preference of consumers' product, the modal preference is
regarded. A restaurant owner who specialises in one dish may wish to
know the modal preference of his potential clientele.
4) In the case of skewed distribution, mode is the indicator of the point of
heaviest concentration.
5) It is very profitably used in market research.
6) Even if one or more classes are open-ended, mode can be used.
Limitations:
1) Too often, there is no modal value. It is a useless measure, when there
are more than one mode.
2) It is not capable of further algebraic treatment.
3) It is an ill-defined measure. Therefore, different formulas yield
somewhat different answers.
4) It is not based on all the items of the data.
5) The value of the mode is affected significantly by the size of the class-
intervals,
6) Although a mode is the value of a variate that occurs most frequently,
its frequency does not represent a majority of the total frequencies.
80
13.9.3 Some Illustration Measures of Central
Tendency
Illustration 6: Estimate the value of arithmetic mean if mode is 15.3 and
median is 14.2.
Solution: The empirical relation between mean, median and mode is:
�� = 3�� − 2X
Substituting the value of �� , and ��
15.3 = 3 × 14.2 − 2X
2X = 42.6 – 15.3
2X = 27.3
��.�
X= �
= 13.65
Illustration 7: With the help of empirical relation between �� , �� and X
shows that
�
i) �� = �� + �
(X − �� )
�
ii) X = �� + �
(�� − �� )
The empirical relation between mean, median and mode is:
i) �� = 3�� − 2X
�� − 2X = 3��
1
(� − 2X) = 3��
2 �
1
(� − 2X) = 3��
2 �
1 2
�� = �� + X
3 3
2 2
= �� − �� + X
3 3
2
= �� + (�� − X)
3
2
= �� + (X − �� )
3
2
∴ �� = �� + (X − �� )
3
2
������ = ���� + (Mean − ����)
3
ii) �� − 2X = 3��
2X = 3�� − ��
3 1 1
X = �� − �� = �� + (�� − �� )
2 2 2
1
���� = ������ + (������ − ����)
2
Illustration 8: Finding the missing frequency
The following table gives the age (in years) of employees of a firm. The
modal age is 32 years. Find the missing frequency. 81
Business Statistics
Age in Years 20-25 25-30 30-35 35-40 40-45
No. of Employees 5 - 18 9 6

Solution: Let us assume that the missing frequency is ‘F’. As the mode is
32, the modal group is 30-35.
�� � ��
Now, �� = � + ��� � �� � ��
�

Where, l = 30, �� = F, �� = 18, �� = 9, i = 5 and �� = 32

Substituting the x values:
��� �
32 = 30 + � × �� � �� �
×5
��� �
2= ����
× 5

54 − 2� = 90 − 5�
3� = 36
� = 12 ∴ Missing frequency is 12.
Illustration 9: Unequal class interval
Calculate mode from the data given below:

Profit (Rs. in lakhs) 0-5 5-10 10-20 30-40 40-50

No. of Companies 4 6 15 18 20

Solution: Here the class interval are not equal. In such cases two methods
can be used:
i) Rewriting the data with equal class intervals, ii) Using empirical
relationship.
i) On combining the first two groups class intervals will become 0-10.
Next two class intervals are of size 10. The last class interval is of size
20. It can be divided into two i.e., 30-40 and 40-50. Assuming
frequencies as uniformly distributed, both such groups will have
frequencies of 10 each. Thus, the given data can be written as:

Profit (Rs. In lakhs) 0-10 10-20 20-30 30-40 40-50

No. of Companies 10 15 18 10 10

It is clear that the modal class is 20-30

�� � ��
Now, mode = � + ��� � �� � ��
�

Substituting the values of l, �� , �� , �� , i

�����
�� = 20 + � × �� – �����
× 10
�
= 20 + ��
× 10 = 20 + 2.7 − 22.7

82
 ∴ Mode of the profit is Rs. 22.7 lakhs. Measures of Central
Tendency
ii) You may verify arithmetic mean = Rs. 24.3 lakhs and the median is Rs.
23.6 lakhs.
Now, mode = 3 Median – 2 Arithmetic Mean
= 3 × 23.6 − 2 × 24.3
= 70.8 − 48.6 = 22.2
∴ Mode of profit is Rs. 22.2 lakhs.
Illustration 10: As a manager of a transport company you want to buy 100
tyres from either producer A or producer B. The price of the two tyre types is
same. The following information is available about the average distance run
by these two types of tyres:

Firm Average distance run

Arithmetic Mean Mode (Km)
(Km)
Type A 35,000 32,000
Type B 32,000 35,000

i) which type would you buy?

ii) If you want to buy one tyre for your own car, will your decision be the
same?
Solution:
i) AM x No. of Items = Total value of items. So if you buy tyres from
producer A, the total distance run by all 100 tyres would be 100 x
35,000 = 35,00,000 kms. If you buy from producer B, the total distance
run would be 100 x 32,000 = 32,00,000. As the total distance run in
first case is greater, you would prefer tyres of producer A.
ii) When you are buying only one tyre, it is not necessary that the tyre
bought will give the same mileage as arithmetic mean. On the other
hand, it is quite likely that the tyre you bought may give mileage equal
to mode, the value around which you have maximum concentration of
items. As the mode of producer B is higher in this case, you will prefer
producer B product.
It may be noted that when large number of tyres are bought, some tyres
may give mileage equal to arithmetic mean and others may give more
than arithmetic mean. If the selection is done randomly, the mean of the
distance run by the selected tyres would be almost same as the mean
value claimed by the producer. Hence, in the case (i) arithmetic mean
was used to assess which type of purchase gives greater service,

83
Business Statistics
13.10 CHOICE OF SUITABLE AVERAGE
Starting from Unit 13, we have discussed various averages viz., mean,
geometric mean, median, partition values and mode etc. You have studied
merits, demerits, and specific uses of each of these averages separately.
Now, we should know how to make choice of a suitable average for a given
purpose. Examining from the point of view of essential qualities of a good
measure of central tendency, arithmetic qualities. Given the situation,
however, the choice of a suitable average poses a problem. If the choice is
not proper, the conclusions will not be much dependable. With an improper
choice of an average, the comparative scene that emerges will be far from
reality. Therefore, while making the choice of an average, you should keep
in mind the following aspects.
1) The Purpose: The choice is to be made in accordance with the purpose
that an average is designed to serve. If the purpose is to give all the
items of the series an equal importance, arithmetic mean will be a proper
average. If the purpose is to find the most common or most fashionable
item, the mode will be a suitable average. If the purpose is to locate a
position of an item in relation to other items, it would be the median that
serves the purpose. When small items are to be given a little more
importance than big items, the choice falls on geometric mean. If
sufficiently greater weights are to be assigned to smaller values,
harmonic mean should be used.
2) Nature and the Form of the data Set: If the distributions are skewed,
mode or mean will be preferred. For an open-ended distribution, again
mode or median would be more suitable. In case of j-shaped or reverse
j-shaped distribution i.e., which highly deviate from symmetry, the
median is the most arithmetic mean will be an appropriate average. Price
distribution and income distribution are two examples of it. If the data is
evenly spread out and does not display wide variations, the arithmetic
mean will be an appropriate average. Average cost of production is an
example if it. When the ratios or percentages are to be averaged,
geometric mean is the most appropriate measures. The data set in which
the value of a variable is compared with another variable which is
constant, harmonic mean is the most suitable average. Examples are
varying speed with constant distance, varying quantities bought per
rupee, etc.
3) Amenability to further Algebraic Treatment: If an average is to be
used for further algebraic treatment, arithmetic mean is considered to be
the best as it is very widely used.
4) Qualitative Phenomena: For the characteristics which are qualitative in
nature such as honesty, beauty, intelligence, etc., median seems to be
proper average.
5) Special Purpose: For calculating trend in time-series analysis, the
moving average would be most suitable average.

84
Though the above considerations act as a guiding principle in making a Measures of Central
Tendency
choice of a suitable average, in many cases it is arbitrary. If the higher value
is required to prove the hypothesis, it is tempting to use the measure which
give the higher value. Since we can select the measures of central tendency
to sit our fancy, there is a possibility of selecting the average which produces
the result we want. When use unscrupulously or incompetently, the user is at
fault not the tool.

13.11 LET US SUM UP

The main characteristics of the data are represented by a single figure known
as ‘an average’ or ‘a main’. It is the point of location around which
individual values cluster. An ideal average must satisfy certain properties
such as case of calculation, rigidity in its dyination, should be based on all
items, should remain unaffected by extreme items, should be capable of
further algebraic treatment and should have sampling stability. On average
gives a bird’s eye view of the entire data, facilitates comparison and becomes
useful in statistical inference. There are easy formulas for obtaining mean for
ungrouped and grouped data. When value in the data set are unequal
importance, a weighted arithmetic mean will be a truly representative
average.
There are a few other measures of central tendency such as geometric mean
and harmonic mean which are used in specific situations. For averaging
ratios or percentages, geometric mean is use. Geometric mean is computed
for both ungrouped and grouped data (discrete and continuous series) by
using different formulas. Geometric mean is very widely used for computing
average rate of change in the variable during a particular time span.
Weighted geometric mean also can be calculated which is used in the
construction of index numbers. Geometric mean has some mathematical
properties that enhance its use in averaging ratios and percentages.
The data set in which the value of a variable is compared with another
variable which is constant, harmonic mean is used. For example, harmonic
mean is used for averaging rates and rations involving speed, time and
distance. It is the reciprocal of the arithmetic mean of reciprocals of the
individual observations. It can be computed fro ungrouped and grouped data.
Like weighted geometric mean weighted harmonic mean also can be
calculated.
The median is a positional average, referring to the middlemost value of the
variate above and below which half of the items lie. There are different
formulas of computing the median from ungrouped as well as grouped data.
Similarly, in grouped data itself methods are different for discrete series and
continuous series. Like median, there are other optional measures known as
partition values which partition the series into still more number of equal
parts. They are: 1) Quartiles, 2) deciles, and 3 percentiles. Quartiles are the
three values of the variate dividing the series into four equal parts, each
occupying 25% of the total observations. Deciles are the nine values of the
variate dividing the series into 10 equal parts, each occupying 10% of the
total observations. Percentiles are the values of the variate that divide the
85
Business Statistics variate into 100 equal parts. Almost similar procedures is followed in the
computation of the partition values, as prescribed for median.
The mode is the value of the variate around which the other items tend to
concentrate most heavily. It can be computed for both ungrouped and
grouped data. However, for ungrouped data it has a limited use. For a
discrete distribution, mode is that value of the variate around which the items
are most heavily concentrated. Where there are nearly equal concentrations
in two or more neighbouring classes to a class with highest frequency, it is
difficult to determine the mode. In such cases ‘grouping and analysis tables’
are prepared to ascertain the modal class. For a continuous distribution, after
having located a modal class, mode is calculated by using different
interpolative formulas.
The choice of a suitable measure of central tendency depends on the purpose
that an average designed to serve as the nature and the form of the data set, its
amenability to further algebraic central tendency, however, is to be made
cautiously and competently.

13.12 KEY WORDS

Key Words:
Analysis Table: The table which helps to ascertain the modal class showing
the maximum frequency occurring in different columns.
Bi-modal Distribution: A Distribution of data in which two values occur
more frequently than the rest of the values in the data set.
Central Tendency: A single value that has a tendency to be somewhere at
the centre and within the range of all values.
Deciles: The values of the variate that divide the series or distribution into ten
equal parts.
Empirical Relationship of averages: The relationship that exists between
average in a moderately skewed distribution viz, �� = 3�� − 2��
Extreme Values: The items that are too big or too small in comparison with
the other terms of data. The unduly influence the mean.
Geometric Mean: If there are N items in the series, the geometric mean is
the Nth root of their product.
Grouping Table: The table which has six columns, used for ascertaining a
modal class.
Harmonic Mean: The reciprocal of the arithmetic mean of reciprocal of the
individual observations.
Mean: The value obtained by dividing the sum of value of act observations
in the given data set by the number of observations.
Measure of Location: A measure which is a point of location around which
other individual values of data set congregate.
86
Median: The value of the variate that divides the series into two equal parts. Measures of Central
Tendency
Mode: The value of the variate around which the other items tend to
concentrate most heavily.
Partition Values: The values of the variate that divide the distribution into a
fixed number of equal parts.
Percentiles: The value of the variate that divide the series or distribution
into 100 equal parts.
Positional Average: An average based on the position of a given derivation
in a series arranged in the order of magnitude.
Quartiles: The values of the variate that divide the series or distribution into
four equal parts.
Weighted Arithmetic Mean: An average whose component items are
assigned weights according to their relative importance.

13.13 ANSWERS TO CHECK YOUR PROGRESS

∑�� ∑�� ∑��
A) 1) i) 11; ii) �� = , �� = � + , �� = � + �
∑� � �

iv) 31
2) Rs. 164.33
3) i) 68; ii) 0
4) Rs. 128.33 by both methods
5) 40.2

B) 2) Simple Average = 42.92; Weighted Average = 44.23

3) Both are equal to 73.7%
4) 34.47
C) 1) 12.3% approximately
2) GM = 25.3 marks, AM = 28.4 marks
4) 29%
D) 2) HM = 50.55
3) 13
4) Rs. 14.63
5) 75.45 km.p.h.

E) 1) (a) 16, (b) 0.18

�
��
2) M= U− �
�
3) Class interval of median class is considered.
4) First Case 63. Second Case 64.
5) 30
6) 210.5
87
Business Statistics F) 3) ��= 23, �� = 73, �� = 38, ��� = 60, ��� = 83. And 8% of
students have obtained less than 12 marks. 3% of students
have obtained more than 95 marks.
G) 4) 30.1
5) �� = 110, Median = 110, Mode = 110.9

13.14 TERMINAL QUESTIONS/ EXERCISES

Questions
1) Explain the qualities of a good measure of Central Tendency.
2) Give the properties and limitations of Arithmetic Mean.
3) What is weighted average? Under what conditions weighted averageis
preferable to a simple average?
4) Compare arithmetic mean, geometric mean and harmonic mean in point
out their relative merit and limitations.
5) How do you make a choice of suitable measure of central tendency?
6) What is median? Explain its merits and limitations.
7) Explain the methods of computing median.
8) Compare the arithmetic mean and median as measures of average?
9) Compare and contrast between Quartiles, Deciles and Percentiles?
10) ‘Arithmetic Mean Median and Mode all try to give one main
characteristic of the data but in their own way’. Discuss.
11) What is mode? Explain its limitations and uses as a measure of
average?
Exercises
1) Number of skilled and unskilled labourers and their average hourly
wages in two cities are given below. Determine the average hourly
wage for each city.

Labour Bombay Kolkatta

Number Wage per hr. Rs. Number Wage per hr.
Rs.
Skilled 150 1.80 350 1.75
Unskilled 850 1.30 650 1.25

(Ans: Rs. 1.38 and Rs. 1.43)

2) An investor buys Rs. 120 worth of shares in a company every month.
During the first 5 months he bought the stock at a price of Rs. 10, 12,
15, 20, and 24 per share. After 5 months what is the average price
paid for the share in his portfolio?
(Ans.: Rs. 14.63)
88
3) A factory which is running in two shifts has a total of 100 workers. Measures of Central
Tendency
Average wage paid to the workers is Rs. 38 per day. In the first shift
60 persons are working and their average wages is Rs.40 per day.
What is the average wage paid to the remaining 40 workers who are
working in the second shift?
(Ans.: Rs. 35)
4) Arithmetic mean of 50 items was found as 28.5. It was later found
that item 39 was taken extra. Find the correct mean of 49 items.
(Ans.: Rs. 28.3)
5) The following table shows the number of workers in various trade
categories who workedfrom Monday to Friday in a week for
varyingnumber of hours each day. The hourly pay for categories I, II,
III, IV and V workers is Rs. 0.97, Rs. 0.77, Rs. 1.01, Rs. 0.67 and Rs.
0.75 respectively. Calculate the average wage per hour per workers
for the whole week for all categories together.

Categories Number of Wrokers

Monday Tuesday Wednesday Thursday Friday
(7 hrs) (6 hrs) (5 hrs) (4 hrs) (5 hrs)
I 30 20 25 15 30
II 25 25 30 20 20
III 30 25 30 25 20
IV 20 20 20 20 25
V 25 20 25 15 25

(Hint: Find total hours under each category and take it as weight)
(Ans.: Rs. 0.84 per hour)
6) A State authority as estimated the age of households in two districts
as given below. Calculate the mean age for?
i) Area ‘A’
ii) Area ‘B’ and
iii) Two areas taken together
Estimated age (in Years) Percentage of Houses
Area ‘A’ Area ‘B’
0-20 16 13
20-40 37 35
40-80 35 46
80-100 12 6

(Ans.: Area A = 58.45, Area B = 58.48 combined area = 58.47)

89
Business Statistics 7) If the population has doubled itself in twenty years, is it correct to say
that the rate of growth has been 5% per annum? If not, what is the
true rate of growth?
(Ans.: No. 1.035%)
8) The annual growth rate of production of a factory in 5 years is 5.0,
7.5, 5.0, 2.5, and 10 per cent, respectively. What is the compound
rate of growth of production per annum for the period.
(Ans.: 5.9 per annum)
9) Geometric mean of 8 items is 3 and geometric mean of 12 items is 11.
What will be the geometric mean of all 20 items?
(Ans.: Rs. 6.54)
10) Find the Harmonic mean for the following data:
i) 1, 2, 3, 4, 5, 6, 7, 8, 9
ii) 1, 1/2, 1/3, 1/4, 1/5, 1/6, 1/7, 1/8, 1/9
(Ans.: i) 3.184; ii) 4.505)
11) You take a trip which entails travelling 900 miles by train at an
average speed of 60 km.p.h.; 3000 miles by boat at an average speed
of 25 km.p.h.; 4,000 km. by plane at 350 km.p.h.; and finally 15 miles
by taxi at 25 km.p.h. What is the average speed for the entire
distance?
(Ans.: Rs. 31.6 km.p.h.)
12) The number of books issued at the counter of a university library on
10 different days are: 180, 95, 75, 70, 80, 102, 100, 94 75, 400.
Which average would represent this data best? Calculate it?
(Ans.: Median 97.5)
13) Information on insurance claims for automobile accidents is given
below. Determine the median.

Amount of Claim (Rs.) Frequency

Less than 150 52
150-199.99 108
200-249.99 230
250-299.99 528
300-34999 663
350-399.99 816
400-449.99 993
450-499.99 825
500 and above 650
(Ans.: Approximately Rs. 402)

90
14) Calculate the median from the following data, taking mean value as Measures of Central
Tendency
45.5.

Marks No. of Students

70-80 10
60-70 10
50-60 20
40-50 -
30-40 12
20-30 7
10-20 8
0 -10 5
(Ans.: Rs. 50)
15) Calculate: i) median from the following data and ii) obtain the range
of marks obtained by middle 80%of the students.

Marks No. of Students

Less than 10 4
Less than 20 10
Less than 30 30
Less than 40 40
Less than 50 47
Less than 60 50
(Ans. I) Rs. 27.5 ii) 11.7 to 47.1)
16) Find the missing frequency if median is 25.

Marks 0-10 10-20 20-30 30-40 40-50

No. of Students 14 - 27 - 15

(Ans.: 23, 21)

17) A laundary uses two different brands of washing machines.

According to its past experience, the following results have been
recorded.

Brand Median Life Mean Life

A 6,500 hours 6,000 hours

B 6,000 hours 6,500 hours

If both brands are the same price, which brand should be purchased
by the laundry.
(Ans.: Rs. 6.54)
91
Business Statistics 18) Calculate ��, ��� , �� from the given data given below:
Size of collar worm : 14” 14.5” 15: 15.5” 16”
No. of Students : 20 37 43 26 14
(Ans.: �� = 14.5”, ��� = 14.5”, �� = 15.5”)
19) Calculate the values of �� , Median, ��� , ��, and �� from the
following data.

Marks No. of Students

Below 10
10-20 25
20-30 40
30-40 70
40-50 90
50-60 40
60-70 20
Above 70

(Ans.: �� = 44.4, Median = 41.1, ��� = 27.5, ��, = 30.7; �� = 49.4)

20) Find the modal age of married women at first child birth:

Age 13 14 15 16 17 18 19 20 21 22 23 24 25
(years)
No. of 37 162 343 390 256 433 161 355 65 85 49 49 40
Women

(Ans.: 18 years)
21) The following tables gives the relative distribution of sales calls made
on Amar Pharmaceuticals in the past months. Fin the modal calls.

No. of Sales Calls 0 1 2 3 4 5

Related Frequency 0.21 0.18 0.38 0.19 0.03 0.01

(Ans.: 2 sales calls)

22) Calculate the mode for the following data:

Class 10-20 20-30 30-40 40-50 50-60 60-70 70-80

Frequency 24 42 56 66 108 130 154

(Ans.: 71.34)

92
23) Estimate the median when arithmetic mean is 27.9 and mode is 25.2. Measures of Central
Tendency
Give the assumption, if any.?
(Ans.: 27)
24) Calculate Mode from the following distribution:

Class 10-20 20-30 20-24 24-30 30-50 50-52 52-60

Frequency 4 9 6 9 52 2 8

(Ans.: 40)

FINDING THE LOG VALUE OF A NUMBER

The procedure to find the log value of a number involves three major steps.
They are: 1) finding characteristic, 2) finding mantissa, and 3) finding anti-
logarithm. The integral part of a common logarithm is called characteristic
and the fractional part is called mantissa. Note that the characteristics can
be zero, positive or negative, but the mantissa is always positive. Now let
us discuss these three steps in detail.
1. Finding Characteristic: In the first stage, we have to find out the
characteristic. As discussed earlier, if the digits in the number are more
than one, the will be one less than the number of digits to the left of the
decimal place. For example, the characteristic of 415.42 is 2, as the
number of digits to the left of the decimal place is 3. Similarly,
characteristic of 17.23 is 1 and 7.23 is 0.

In the case of the numbers which are less the characteristic is equal to
one more than the number of zeros after the decimal point and before any
significant digit. Thus, characteristic of 0.98 is −1,10.098 is −2, 0.00908
is −3 so on and so forth.

2. Finding Mantissa: To find out the mantissa of a number, you have to

use logarithm table. Logarithm tables are presented at the end of this
unit. For example, you want to find mantissa of the number 3451. First
you have to look at the log tables at the row corresponding to 34 (the first
two digits of the given number) and the column corresponding to 5 (the
third digit of the given number). The mantissa is 5378. Now look at the
mean difference 1 (the fourth digit in the given number) in the same row.
The value is Add this 1 to 5378 to obtain 5379. So, for the number 3451,
the mantissa part is 0.5379. You already know that the characteristic is 3
for this number. So the log 3451 is 3.5379.

Note that mantissa is always positive. It is not affected by the position of the
decimal point. That is to say, the mantissa of would be the same. Looking at
the table, it can be seen that the mantissa value of 245 is 0.3892. The
characteristic of a number can be decided upon by looking at the digits in that
number itself and the mantissa can be obtained from the table using the first
four significant digits. Look at the following table and observe how the
characteristic is changing without a change in the mantissa value.
93
Business Statistics

Number Log Value

2450.0 2.3892
245.0 3.3892
24.5 1.3892
2.45 0.3892
0.245 1.3892
0.0245 12.3892
0.00245 13.3892

Note: For some log values, you can find a bar over the characteristic.
Putting bar over the characteristic indicates that the part where the bar
appeared is negative and mantissa (the decimal part) is positive.
3. Anti Logarithms: As you know the logarithm tables give the value of
mantissa in the logarithms of Whereas the antilog tables give the
value of the number whose log value is known. Suppose in the above
example, log value 3.3892 is known. We are now interested in finding
out the corresponding actual number whose log value is 3.3892 the
number 2450. Here, we can say that the antilog of 3.3892 is 2450. Now
let us learn how this antilog value is found from antilog tables.
In order to find the antilog of 3.3892, first consider only the mantissa
part, Look at the antilog tables at the row corresponding to .38 and
column corresponding to number is 2449. Look at the mean column at
2in the same row, and the value is 1. By adding 1 to 2449, the digits in
the antilog value will be 2450. The next task is to decide the decimal
position. In the log value of 3.3892 the characteristic is 3. So according
to rules earlier, there should be four digits in the antilog number.
Therefore, place a decimal value after four digits. That means, 2450.0 is
the original value. To find the number corresponding to log 2.3892, the
digits in antilog value obtained from the table will have to be the same as
in the earlier case. Only the position of decimal point will change, which
will have to be decided by the characteristic. In this case, characteristic is
So according to rules given earlier, the antilog must be less than ‘1’ and
there must be one zero after the decimal and before the first significant
digit in the result. Thus antilog 2.3892 would be 0.0245.

FURTHER READINGS
Arora, P.N. Sumeet Arora and Arora. A., 2007, Comprehensive Statistical
Methods. S. Chand and Company Ltd., New Delhi.
Beri, G.C., 2005, Business Statistics, Tata Mc Graw-Hill Publishing
Company, Ltd., New Delhi.

94
Elhance, D.N. and Veena Elhance, 1988. Fundamentals of Statistics, Kitab Measures of Central
Tendency
Mahal: Allahabad. (Chapters 9, 10 & 18)
Gupta, C.B., An Introduction to Statistical, Methods, Vikas Publishing
House: New Delhi. (Chapters 10, 11 & 17)
Gupta, S.P., 1989, Elementary Statistical Methods, Sultan Chand & Sons :
New Delhi. (Chapters 8 & 9)
Sancheti, D.C., and Kapoor, V.K., 1989, Statistics Theory Methods and
Applications, Sultan Chand & Sons : New Delhi.
Simpson, G, and.Kafka, F. Basic Statistics, Oxford & IBH Publishing 1 New
Delhi.

95
Business Statistics
UNIT 14 MEASURES OF DISPERSION
Structure
14.0 Objectives
14.1 Introduction
14.2 Concept of Dispersion
14.3 Significance of Measuring Dispersion
14.4 Properties of a Good Measure of Dispersion
14.5 Absolute and Relative Measures of Dispersion
14.6 Measures of Dispersion
14.6.1 Range
14.6.2 Quartile Deviation
14.6.3 Mean Deviation
14.6.4 Standard Deviation
14.6.4.1 Properties
14.6.4.2 Merits and Limitations

14.7 Coefficient of Variation

14.8 Some Illustrations
14.9 Let Us Sum Up
14.10 Key Words
14.11 Answers to Check Your Progress
14.12 Terminal Questions/ Exercises

14.0 OBJECTIVES
After studying this unit, you should be able to :
• explain the concept of dispersion and significance of measuring it,
• differentiate between absolute and relative measures of variation,
• compute several measures of dispersion such as the range, quartile
deviation and mean deviation for different types of data, and
• decide the use of appropriate measures under different situations.
• define & compute standard deviation and narrate its properties, means
and limitations
• define and compute variance and coefficient of variation for different
kinds of data
• compare different measures of dispersion and use them at appropriate
situations

96
 Measures of
14.1 INTRODUCTION Dispersion

In Unit 13 you have studied about different measures of central tendency. In

the unit you studied, the measures of central tendency give us one single
value that represents the entire data. But central tendency alone is not
sufficient to analyse different characteristics of the data unless all the
observations are having the same value. For more meaningful analysis of the
data, it is necessary to study dispersion i.e., the spread of the data or the
extent to which items deviate from central tendency. In this unit, you will
study the meaning and significance of dispersion. You will also learn in
detail about the three measures of dispersions viz., range, quartile deviation
and mean deviation. Besides these, you will also learn about the month of
computing standard deviation and its coefficient for different kind of data,
their merits and uses.

14.2 CONCEPT OF DISPERSION

In order to understand the concept of dispersion, let us consider some
important definition of dispersion.
- The Degree to which numerical data tend to spread about an average
value is called the variation or dispersion of the data (Spiegel)
- The measurement of scatterness of the mass of figures in a series about
an average is called measures of variation or dispersion (Simpson and
Kafka)
- Dispersion or spread is the degree of the scatter or variation of the
variables about a central value (Brook and Dick)
From the above definitions, it is clear that the word, dispersion (also termed
as variation or spread or scatter) is used to denote the degree of
heterogeneity in the data. It is an important characteristic indicating the
extent to which observations vary among themselves. A measure of
dispersion describes the spread or scattering of individual values around the
central value. It gives an average of the differences of various observations
from a central value (an average). Thus, the significance of an average is
determined in the light of dispersion. In order to understand the concept of
dispersion more clearly, study the following Illustration carefully.
Illustration 1: Daily sales of three different firms (in Rs.)

Firm A Firm B Firm C

60,000 62,500 51,000
60,000 60,000 32,000
60,000 52,250 22,000
60,000 56,500 18,000
60,000 60,500 27,000
60,000 68,250 2,10,000
�� = 60,000 X� = 60,000 X� = 60,000
97
Business Statistics Since the average sales of firms A, B, and C are the same, we are likely to
conclude that the three distributions of the sales are similar. But you should
note that the variations in the sales are different from firm to firm. Daily sales
are the same for all the days in the case of Firm A whereas there is some
variation in the daily sales of Firm B and greater amount of variation for Firm
C. Here, although these three data sets have the same mean, they differ in
terms of scatter of items. Therefore, different sets of data may have the same
measure of central tendency, but may differ greatly in terms of spread or
scatter of the items i.e. dispersion.
The word dispersion can be interpreted in another sense also. When all items
of the data are not equal to central tendency, then the various items differ
from central tendency by a certain amount. Dispersion gives, on an average,
by how much amount of items differ from central tendency. You may note
that in the case of Firm B, deviations of individual sales from the mean sale
(i.e., 60,000) are much smaller than the deviations of Firm C. This implies
that the average of the deviations from the mean sales will be smaller for
Firm B compared to Firm C. In other words, Firm B has smaller dispersion
than Firm C. In firm A, there is no dispersion.

14.3 SIGNIFICANCE OF MEASURING

DISPERSION
Measures of dispersion (variations) are calculated to serve the following
purposes:
1) Measuring variability determines the reliability of an average by
pointing out to what extent the average is representative of the entire
data. In Illustration 1 discussed earlier, mean sales Rs. 60,000 is the
perfect representative of sales for different days tor Firm A. In case of
Firm B , the variation is low as the mean sale is quite close to sales
figures of different days. Therefore, in this case, the mean can be
considered as representative of the sales for each day. But in case of
Firm C the variation in individual figures is very large so the average of
Rs. 60,000 is hardly a representative of all high and low figures such as
Rs. 2,10,000 and Rs. 18,000.
2) Measures of dispersion enable comparisons of two or more
distributions with regard to their variability.
3) Another purpose of measuring variability is to determine the nature and
cause of variation in order to control the variation itself.
4) Measuring variability facilitates the use of other statistical measures
like correlation, regression, statistical inference, etc.

14.4 PROPERTIES OF A GOOD MEASURE OF

DISPERSION
As you know, a measure of dispersion is the average of the deviations of
items from its mean i.e., it is an average of second order. Hence, it should
98
also possess all the qualities of a good measure of an average. According to Measures of
Dispersion
Yule and Kendall the qualities of a good measure of dispersion are as
follows:
1) Statistical measures are used even by layman. So complicated
definitions and calculations are not desirable. It should be simple to
understand and easy to calculate.
2) It should be rigidly defined. For the same data, all the methods should
produce the same answer. Different methods of computation leading to
different answers are not proper.
3) It should be based on all items. Where it is based on all items, it will
produce a more representative value. Thus, good measure of dispersion
should be based on the entire data.
4) It should be amenable to further algebric treatment. This means
combining groups, calculations of missing values, adjustment for
wrong entries, etc., which are possible without the knowledge of actual
values of all items. Such treatment should be possible with a good
measure of dispersion also.
5) It should have sampling stability. It means that the average difference
between the values obtained from the sample and the corresponding
values from the population should be the least. If it is so far a measure
of dispersion, it is the best Measure.
6) It should not be unduly affected by the extreme items. Extreme items,
many times, are not true representatives of the data. So their presence
should not affect the calculation to a large extent.
This list is not a complete-list of the properties of a good measure of
dispersion. But these are the most important characteristics which a
good measure of dispersion should possess.

14.5 ABSOLUTE AND RELATIVE MEASURES

OF DISPERSION
The measure of dispersion which are expressed in terms of the original units
of data are termed as Absolute Measures. For example, in Illustration 1
discussed earlier, the daily sales of the Firm B range between Rs. 52,250 to
Rs. 68,250. So the spread of the data is of the order Rs. 68,250-52,250 or Rs.
16,000. This is the absolute measure of the spread of the sales. Such
measures expressed in units of data are not suitable for comparing the
variability of the distributions or series expressed in different units of
measurement. Relative Measures of dispersion, on the other hand, are
obtained as ratios or percentages. Therefore, relative measures are pure
numbers independent of the unit of measurement. A measure of relative
dispersion is the ratio of a measure of absolute dispersion to an appropriate
average or the selected items of the data. Hence, it is also known as
Coefficient of Dispersion. For example, in illustration 1 discussed earlier, if
one expresses the spread Rs. 16,000 as the ratio of average sales Rs. 60,000
i.e., 16,000/60,000 it becomes a relative measure. This value is a simple 99
Business Statistics number and has no specific units of measurement with it. Similarly, the
spread Rs. 16.000 could also be expressed as the ratio of sum of two extreme
��,���
sales i.e., ��,������,��� . This will also give a relative measure of the spread of
the sales.
Sometimes, even when data are in the same units, the comparison of variation
by absolute measure of variation is not worth comparing. A variation of one
kilometre (1,00,000 cm) in measuring distance from Delhi to Mumbai is
hardly of any significance. But a variation of 10 cm in measuring a piece o f
cloth of 1.40 meters is of very great significance. So, whenever comparisons
of variability in two sets of data are done, it is always done in terms of
relative measures.

Check Your Progress A

1) What is the meaning of the term Dispersion?
2) Differentiate between absolute measures and relative measures of
dispersion.

14.6 MEASURES OF DISPERSION

The following measures of absolute dispersion are in common use :
1) Based on selected items of the data
i) Range - spread for entire data
ii) Inter Quartile Range - spread for middle 50% data. More commonly
Quartile Deviation is used in its place, which is half of inter quartile
range.
2) Based on all items of the data
i) Mean Deviation - mean of the absolute deviations from central
tendency.
ii) Standard Deviation or Root Mean Square Deviation about
arithmetic mean
3) A Graphic Method - Lorenz Curve (This, however, is not a part of
discussion in this course).
The relative measures of dispersion corresponding to the measures of
absolute dispersion are :

Absolute Measures of Relative Measures of

Dispersion Dispersion
i) Range Coefficient of Range
ii) Quartile Deviation Coefficient of Quartile Deviation
iii) Mean Deviation Coefficient of Mean Deviation
iv) Standard Deviation Coefficient of Standard
Deviation
100
Coefficient of standard deviation when expressed in percentages is called Measures of
Dispersion
coefficient of variation.
Study Figure 14.1 carefully for classification of measures of dispersion. You
will study Range, Quartile Deviation and Mean Deviation and Standard
Deviation.

Measure of Dispersion

Measure Based Measures based

on Selected Items on all Items of
of Data Data

Measure of
Quartile Mean Standard
Absolute Range Deviation Deviation Deviation
Dispersion

Measure of Cooefficient Coefficient Coefficient

Relative Coefficient of Quartile of Mean of Standard
Dispersion of Range Deviation Deviation Deviation

Figure 14.1: Classification of Measures of Dispersion

14.6.1 Range
The range is defined as the difference between the highest (numerically
largest) value and the lowest (numerically smallest) value in a set of data.
Thus, Range = X��� − X���
Where, X��� = highest value, X��� = lowest value.
From Illustration 1 discussed earlier (section 14.2), consider the daily sales
data for the three firms and compute the range.
For Firm A, Range = 60,000 − 60,000 = 0; For Firm B, Range = 68,250 −
52,250 = 16000; For Firm C, Range = 2,10,000 − 18,000 = 1,92,000
The interpretation of the value of range is very simple. In this illustration, the
variation is zero in case of daily sales for Firm A, the variation is small in
cases of Firm B, and the variation is very large in case of Firm C.
For grouped data, the range may be determined, in discrete series, as the
difference between the highest value and lowest value of the observation. In
case of continuous series, the range may be approximated as the difference
between the upper limit of the largest class and the lower limit of the smallest
class. The relative measure corresponding to range, called the coefficient of
range, is obtained by expressing range as the ratio of sum of two extreme
items. In this case ratio is not expressed in terms of average, as the range
does not depend on average. It relates only to two selected items of the data.
So the coefficient of range is defined as:
� ��
Coefficient of Range = ���� � ����
��� ���
101
Business Statistics Study Illustration 2 carefully and understand the procedure involved in the
computation of the coefficient of range.
Illustration- 2 Calculate the coefficient of range from the following data :
Sales (Rs. in Lakhs) No. of Days
30 - 40 12
40 - 50 18
50 - 60 20
60 - 70 19
70 - 80 13
80 - 90 8

Solution: Range = X��� − X���

X��� = upper limit of largest class interval
X��� = lowest limit of smallest class interval
= 90 − 30
= 60
� ��
Coefficient of Range = ���� � ����
��� ���

90 − 30
=
90 + 30
60
=
120
= 0.5.
You should note that the frequency of the distribution should not be taken
into account for computing range.
The range is very easy to calculate and it gives us some idea about the
variability of the data. Since only two extreme values are used for computing
range, it is a crude measure of variation. It fails to disclose the characteristics
of the distribution and it is not applicable in case of open-end distribution.
Applicability: The concept of range is extensively used in statistical quality
control. Range is helpful in studying variations in the prices of shares,
debentures and agricultural commodities which are very sensitive to price
changes. The range is a good indicator for weather forecast.

14.6.2 Quartile Deviation

Quartile deviation is defined as half the difference between the upper quartile
and lower quartile. You have already studied the methods of computing
Quartiles in Unit 13 at partition values.
�� � ��
Quartile Deviation = �

Where, Q� is the first quartile (lower quartile) and Q� is the third quartile
102 (upper quartile).
To understand the procedure for computing Q� and Q� , you are advised to Measures of
Dispersion
refer unit 13 once again where we discussed the methods of computing
quartiles under the section Partition Values.
As the difference between Q� , and Q� is the distance between the two
quartiles, this may be called Inter Quartile Range and half of this, Semi-
Inter Quartile Range is called Quartile Deviation.
Quartile Deviation (QD) is dependent on the two quartiles, and does not take
into account the variability of the largest 25% and the smallest 25% of
observations. It is, therefore, unaffected by extreme values. Another
advantage of quartile deviation is that it is the only measure of variability
which can be used for open-end distribution. The main limitation of quartile
deviation is that it does not depend on the magnitudes of all observations. It
is based on the middle 50% of the observations.
The relative measure of dispersion based on quartile deviation is called
coefficient of quartile deviation. The coefficient of quartile deviation is
defined as:
� ��
Coefficient of Quartile Deviation = �� � ��,
� �

This is because quartiles are also two selected items of the data and they have
nothing to do with the average of the data. Study the following Illustrations
carefully, you will understand the procedure involved in the calculation of
Quartile Deviation from ungrouped and grouped data.
Ungrouped Data (Individual Observations):
Illustration 3: Calculate the value of quartile deviation and its coefficient
from the following data relate the marks obtained by 7 students.
Marks : 40 10 26 32 15 49 25
Solutions : As we discussed in unit 13 (Quartiles) we have to arrange the
value of variables either in ascending or in descending order. Here, the marks
are arranged in ascending order as follows:
Marks : 10 15 25 26 32 40 49
��� ���
Q� = size of �
th observation = size of �
= 2nd observation

The size of 2nd observation = 15 marks; Q� = 15.

��� �� ���
Q� = size of 3 � �
� observation = size of 3 � �
� = 6th observation

The size of 6th observation = 40 marks; Q� = 40.

�� � �� ��� ��
Quartile Daviation (Q.D) = �
= �
= 12.5 Marks
� �� �����
Coefficient of Q.D = �� � �� = �����= 0.45
� �

Illustration 4: Calculate quartile deviation and its coefficient from the

following data:

103
Business Statistics Weight(in Kgs): 60 61 62 63 65 70 75 80
No. of Workers : 1 3 5 7 10 3 1 1
Solution: Computation of Quartile Deviation and its Coefficient
Weight in Kgs Frequency Cumulative Frequency
60 1 1
61 3 4
62 5 9
63 7 16
65 10 26
70 3 29
75 1 30
80 1 31 = n
��� ��
Q� = size of � �
� = 8th observation

= 62 kgs. (because 5th observation falls in this category as it lies in 9

cumulative frequency)
��� ��
Q� = size of 3 � �
� observation = 24th observation

= 65 kgs. (because 24th observation falls in this category as it lies in 26

cumulative frequency)
�� � �� �����
Quartile Deviation = �
= �
= 1.5 kgs.
� �� ����� �
Coefficient of Quartile Deviation = �� � �� = =
����� ���
� �

= 0.024.
Continuous distribution
Illustration 5: Calculate semi-interquartile range and its coefficient from the
following data:
Marks : 0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90
No. of
Students: 11 18 25 28 30 33 22 15 22
Solution: To compute quartile deviation, we need the values of the first
quartile and the third quartile which can be obtained from the following table:
Marks Frequency(f) Cumulative
Frequency (c.f.)
0-10 11 11
10-20 18 29
20-30 25 54
30-40 28 82
40-50 30 112
104
 50-60 33 145 Measures of
Dispersion
60-70 22 167
70-80 15 182
80-90 22 204
� ���
Q� has �
th observation i.e., �
= 51 th observation. 51th observation which
lies in 54 cumulative frequency. So Q� lies in the 20-30 class.
�
��
Q� = � + �
�
× �

Where, � = lower limit of the lower quartile class; c = cumulative frequency

of the class proceedings to the lower quartile class; f = simple frequency of
the lower quartile class; i = class-interval of the lower quartile class
51 − 29
Q� = 20 + × 10
25
= 20 + 8.8 = 28.8
�� ���
Q� has �
th observation i.e., 3 × �
= 153 th observation. 153th
observation which lies in 167 cumulative frequency. So, Q� (upper quartile)
class is 60-70 class.
��
��
Q� = � + �
�
× �

Here, the value of �, �, � and � are relate to the upper quartile (Q� )
�������
Thus, Q� = 60 + ��
× 10 = 63.64.

Semi-inter Quartile Range or Quartile Deviation is given by:

�� � �� ��.�� – ��.� ��.��
Q.D = �
= �
= �
= 17.42 Marks

The relative measure corresponding to quartile deviation, called the

coefficient of quartile deviation, is calculated as follows:
� �� ��.�����.�
Coefficient of Q.D. = �� � �� = ��.�����.� = 0.37 marks
� �

Illustration 6: Compute an appropriate measure of dispersion for the data

given below:
Monthly Expenditure (Rs.) No. of Families
Below 850 12
850-900 16
900-950 39
950-1,000 56
1,000-1,050 62
1,050-1,100 75
1,100-1,150 30
1,150 and above 10
105
Business Statistics Solution : Since the frequency distribution has open-end class, quartile
deviation will be the most appropriate measure of dispersion.
Monthly Expenditure (Rs.) No. of Families Cumulative Frequency
Below 850 12 12
850-900 16 28
900-950 39 67
950-1,000 56 123
1,000-1,050 62 185
1,050-1,100 75 260
1,100-1,150 30 290
1,150 and above 10 300 = n
N = 300
� ���
Q� has �
th observation i.e., �
= 75 th observation, which lies in 67
cumulative frequency. So Q� lies in the 950-1,000 class.
��
��
Q� = 1 + �
�
× �
���
� ��
= 950 + �
��
× 50

= Rs. 957.14.
�� � � ���
Q� has �
th observation i.e., �
= 225 th observation which lies in 260
cumulative frequency. So, Q� class in the class 1050-1100.
��
�� ���� ���
Q� = 1 + �
�
× � = 1,050 + ��
× 50 = Rs. 1,076.67.
�� � �� �,���.�� – ���.��
Q.D = �
= �
= Rs.59.760.

Check Your Progress B

1. Distinguish between the absolute and relative measures of dispersion.
2. Define quartile deviation.
3. Distinguish between range and the coefficient of range.
4. Compute the range and quartile deviation for the following data on the
number of patients treated at the Hospital emergency room per day.
45, 50, 36, 59, 28, 42, 55, 57, 33, 35, 40, 50
5. Compute range, quartile deviation and related coefficients from the
following data:
Size : 5-7 8-10 11-13 14-16 17-19
Frequency : 14 24 38 20 4

14.6.3 Mean Deviation

As you know, one of the characteristics of an ideal measure of dispersion is
that it should be based on all items. From this point of view, range and
106
quartile deviations are not ideal as they are not based on all the observations Measures of
Dispersion
of the data. This is the reason these two methods of dispersion do not show
the scatterness around of central value. But, the measure of mean (or
average) deviation is ideal in this sense as this measure is based on all
observations in the given data set. This measure is computed as the arithmetic
mean of the absolute deviations of the individual observations from the
average of the given data. The average which is frequently used in computing
the mean deviation is mean or median, though sometimes mode can also be
used. Absolute deviations means the deviations are treated as positive
regardless of the actual sign. Hence, these deviation should be written as |D|
(it is pronounced as ‘Modules D’). Hence, |D| means deviation are taken
from an average by ignoring their actual signs. It is, therefore, also called
mean absolute deviation. An important property of Mean Deviation
(M.D.) is that it has the minimum value when deviations are taken from
median, i.e., Mean Deviation about median is the least.
The relative measure corresponding to the mean deviation, called the
coefficient of mean deviation, is obtained by dividing mean deviation by the
particular average used in computing the mean deviation. Thus, if mean
deviation has been computing from median, the coefficient of mean deviation
shall be obtained by dividing the mean deviation by the median.
�.�.����� ������
Coefficient of M.D. about M� = ������

�.�.����� �
Similarly a coefficient of M.D. about Mean(�) = �

You should keep in mind that the procedure to compute mean deviation from
ungrouped and grouped sets of data is different, but computing coefficient of
mean deviation is the same.
Mean deviation is based on all observations and hence takes into account the
variability of each of the items in the data set. However, the practice of
neglecting algebraic signs and taking absolute deviations makes it difficult to
be treated algebraically. Although, the average deviation is a good measure of
variability, its use is limited. If one desires only to measures and compare
variability among several sets of data, the average deviation may be used.
The computation of mean deviation from different sets of data will become
clear if you study the following illustration carefully.
Calculation of mean deviation – Ungrouped data
∑|�|
Formula = M.D. = �

Where, ∑|D| = Sum of the deviations (ignoring signs) from an average

n = Number of observations or items.
Procedure to compute: 1) Compute an average (mean or median or mode);
2) Find the absolute deviations of the value of observations from the chosen
average (in step 1) i.e. |D| and obtain the total of |D|, i.e., ∑|D|; 3) Obtain the
total number of observations (n); 4) Apply the formula.

107
Business Statistics Illustration 7: Calculate the mean deviation and its co-efficient from the
following values about the Mean, median and mode:
18, 25, 63, 59, 29, 72, 17, 25, 105, 87.
Solution: Calculation of �, M� and M� :
∑� ���
Mean (�) = �
= ��
= 50

Median: Since there are ten observations which is an even number, the
median is the average of the two middle most observations, when arranged in
order of magnitude as follows:
17, 18; 25, 25, 29, 59, 63, 72, 87, 105
��� �� ����
Median (M� ) = Size of � �
� item = � �
�= 5.5th item
�����
(M� ) = � � = 44
�

Mode (�� ) = 25, since it appears maximum number of times in the

distribution.
Calculation of Mean Diviation about mean, median and mode

X Deviation from Deviation Deviation from

Mean (50) |D| from Median Mode (25) |D|
(44) |D|
18 32 26 7
25 25 19 0
63 13 19 38
59 9 15 34
29 21 15 4
72 22 28 47
17 33 27 8
25 25 19 0
105 55 61 80
87 37 43 62
N = 10 ∑|D| = 272 ∑|D| = 272 ∑|D| = 280
∑|�|
Mean Deviation about mean = �
���
= ��
= 27.2
�.�. ��.�
Coefficient of M.D. = �
= ��
= 0.544
∑|�| ���
Mean deviation about Median = �
= ��
= 27.2
�.�. ��.�
Coefficient of M.D. = ������ = ��
= 0.62

108
 ∑|�| ��� Measures of
M.D. about mode = �
= ��
= 28 Dispersion
�.�. ��
Coefficient of M.D. = ��
= �� = 1.12

Calculation of Mean Deviation – Group Data (Discrete Series)

∑�|�|
M.D. = �

Where, ∑f|D| = sum of the products, which is obtained by multiplying the

absolute deviations (ignoring signs) with its corresponding frequencies.
N = Number of items or total of the frequency

Steps to solve the problem: 1) Compute average (� or M� or M� ); 2) Take

the deviations of the value of items from the average ignoring algebraic (±)
signs and denote them |D|; 3) Multiply these deviations with there respective
frequencies and obtain the total i.e., ∑f|D|; 4) Obtain the total of frequency
(n) 5) Apply the formula
Illustration 8: Find Mean Deviation about Mean and Median, and their
coefficients.
Marks : 20 30 40 50 60 70
No. of students : 8 12 20 10 6 4
Solutions: Calculation of Mean deviation and its coefficient about �and Md.

Marks No. of cumulative deviations Deviation

X Students fx frequency about f|D| about f|D|
f (c.f.) Mean Median
(41) |D| (40)|D|
20 8 160 8 21 168 20 160
30 12 360 20 11 132 10 120
40 20 800 40 1 20 0 0
50 10 500 50 9 90 10 100
60 6 360 56 19 114 20 120
70 4 280 60 29 116 30 120
N=60 ∑fx=2,240 ∑f|D|=640 ∑fd=620

∑�� �,���
Mean (�) = �
= ��
= 41marks

��� ��
Median (M� ) = Size of � �
� item
����
=� �
�= 30.5th item

Size of 30.5th item lies in the 40th item of the cumulative frequency, its
corresponding value is 40 marks.
Hence, Median = 40 marks
∑�|�| ���
Mean Deviation about mean = �
= ��
= 10.67 marks
�.�. ��.��
Coefficient of M.D. (about Mean) = ���� = ��
= 0.26 109
Business Statistics ∑�|�| ���
Mean deviation about Median = �
= ��
= 10.33 marks
�.�. ��.��
Coefficient of M.D. (about Median) = ������ = ��
= 0.26

Here, you may notice that, as we discussed earlier, the mean deviation about
median is least.
Illustration 9: From the following grouped data relating to the sales of 100
Companies, find the Coefficient of Mean Deviation by using mean (�) .

Sales(Rs.’000) 40-50 50-60 60-70 70-80 80-90 90-100

No. of 5 15 25 30 20 5
Companies

Solution: To construct average deviation, we have to construct the following

table .:

Sales Mid No. of fX |� − �| f| � − �|

(Rs.’000) Values (X) Companies (f) i.e., |� – 71|
40- 50 45 5 225 26 130
50- 60 55 15 825 16 240
60- 70 65 25 1,625 6 150
70- 80 75 30 2.250 4 120
80- 90 85 20 1.700 14 280
90- 100 95 5 475 24 120
Total n = 100 ∑fX = 7,100 ∑f|D|= 1,040
∑�� �,���
(� = �
= ���
= 71
∑�|�|
Mean Deviation (about mean) = �
�,���
= ���
= 10.40 or Rs/ 10.4 thousands
���� ��������� ����� � ��.��
Coefficient of Mean Deviation = �
= ��
= 0.146

Illustration 10: The following is the age-distribution of 80 LIC Policy

holders insured through an agent. Calculate the coefficient of mean deviation
from the median.
Age Group (in Years) Frequency
16 - 20 8
21 - 25 15
26 - 30 13
31-35 20
36 - 40 11
41 -45 7
46 - 50 3
51-55 2
56-60 1
110
Solution: Calculation of Mean Deviation from Median Measures of
Dispersion
Age-Group Frequency Cumulative Class |X-�� | f|X–�� |
(in Years) (f) Frequency Mid-Point i.e., |X-31.5| f|D|
(Cf) (M) |D|
16 - 20 8 8 18 13.5 108.0
21 - 25 15 23 23 8.5 127.5
26 - 30 13 36 28 3.5 45.5
31-35 20 56 33 1.5 30.0
36 - 40 11 67 38 6.5 71.5
41 -45 7 74 43 11.5 80.5
46 - 50 3 77 48 16.5 49.5
51-55 2 79 53 21.5 43.0
56-60 1 80 58 26.5 26.5
Total N=80 ∑f|d| =582.0
� ��
Median has �
= �
= 40�ℎ observation. So it lies in the 56 cumulative
frequency and its corresponding class interval is 31-35. Converting into
�
�� �����
exclusive class 30.5–35.5 Median = � + � � × � = 30.5 + ��
× 5 = 31.5
years
∑�|�| ���
Mean Deviation (About Median) = �
= ��
= 7.275 years
�.�.����� ��
Coefficient of Mean Deviation about median = ��

�.���
= ��.�
= 0.23.

14.6.4 Standard Deviation

As discussed earlier, while computing the mean deviation we ignore the
negative signs of the deviations of the items from the central tendency. This
is because in dispersion we are interested only in knowing how much, on an
average, items deviate from central tendency irrespective of the fact that items
are less than or more than central tendency. This ignoring of signs which
arise during calculations, introduces some limitations on the measure. A
mathematical solution for ignoring signs is squaring. As the square of any
negative item becomes positive, a new measure of dispersion is defined in
which deviations are first squared (to ignore the signs) and then averaged out.
The value so obtained gives the average of the squares of the deviations and
not of deviations directly. So, finally a square root of this value is extracted.
Thus the result obtained will give an indirect average of deviations arithmetic
mean or median or mode. Out of these three values, in every data, root mean
square deviation about arithmetic mean is the least. So it is called Standard
Deviation.
Thus, the standard deviation is defined as the position square root of the
variance. This concept was introduced by Karl Pearson in 1893. It is widely
used measure of studying dispersion. Its significance lies in the fact that it is
free from those defects from which the earlier methods suffer. As this
measure is calculated by finding square root of the mean of the squares of the
111
Business Statistics deviation of items from the arithmetic mean, it is also called Root mean
Square Deviation. Standard Deviation is usually denoted by the Greek letter
‘σ’ (read as sigma). Now, let us study the meaning, method of computation,
merits and limitations of standard deviation.
Computation
There are two methods of calculating standard deviation for ungrouped and
grouped distributions. They are: 1) direct method and 2) short cut method.
Let us study these two methods.
1. Direct method: under this method, standard deviation is calculated by
taking deviations of the items from the actual arithmetic mean of the
distributions.
2. Short-Cut method: Under this method, standard deviation is
calculated by taking deviations of the items from the assumed mean.
Among the above two methods, short cut method is convenient when the size
of items and their numbers are large or the arithmetic mean comes out in
fractions. If mean is with fractional value, it is a time consuming process to
find the deviations and its square deviations to compute the standard
deviation.
Let us study the formulas and consider some illustrations to understand the
procedure involved in direct and short –cut methods and computation of the
standard deviation under ungrouped and grouped distributions.
Ungrouped data (individual distribution): Direct Method

∑��
Formula: σ = � �

Where, σ = Standard deviation; ∑�� = Sum of the squared deviation

from actual mean; N = Number of items.
Steps for computing standard deviation by direct method:

1) Calculate: the arithmetic mean of the data (�); 2) Take the deviations by
subtracting the arithmetic mean from each and every value of the items (X -
�). Denote it by ‘d’; 3) Square the deviations (� � ) and obtain the total i.e.,
∑�� ; 4) Obtain the number of items (n) and apply the formula.

∑�� ∑� �
Short-cut Method: Formula: σ = � �
−���

Where, σ = Standard deviation; ∑� = Sum of the deviation from assumed

mean; ∑�� = Sum of the squared deviation from assumed mean; n = Number
of items.
Steps to compute standard deviation by short-cut method:
1) Take a balanced value from the given data as assumed mean, and calculate
the deviation of the items from the assumed (X – Assumed mean). Denote
these deviations by ‘d’ and obtaing the total i.e. ∑�; 2) Square the deviation
(� � ) and obtain the total i.e. ∑�� ; 3)Take the number of items (n) and apply
112 the formula
Examine Illustration-11 carefully to understand the procedure involved in the Measures of
Dispersion
calculation of standard deviation by direct method as well as short-cut
Method.
Illustration 11
Calculate standard deviation for the following distribution by direct method
and short-cut method.

Serial No. of Workers : 1 2 3 4 5 6 7 8 9 10

Wage (Rs.) : 20 22 27 30 31 32 35 45 40 48

Solution : Direct Method : Calculation of Standard Deviation. Here

deviations are taken from Actual Mean.

S.No. of Wages (Rs.) (X - �) �� − ��

�

workers X
��
1 20 -13 169
2 22 -11 121
3 27 -6 36
4 30 -3 9
5 31 -2 4
6 32 -1 1
7 35 2 4
8 40 7 49
9 45 12 144
10 48 15 225
n = 10 ∑X = 330 ∑�� = 762
∑� ���
Now, � = �
= ��
= 33

∑�� ���
σ=� �
= � �� = √76.2 = Rs. 8.73

Short-cut Method : calculation of Standard Deviation. Here, Rs. 32 is taken

as assumed mean.

S.No. of workers Wages (Rs.) X d = X-32 ��

1 20 -12 144
2 22 -10 100
3 27 -5 25
4 30 -2 4
5 31 -1 1
6 32 0 0
7 35 3 9 113
Business Statistics
8 40 8 64
9 45 13 169
10 48 16 256
n = 10 ∑d = 10 ∑�� = 772

∑�� ∑� �
Now, σ =� �
−���

��� �� �
= � �� − ���� = √77.2 − 1 = √76.2 = Rs. 8.73

You may note that the results obtained by both the methods are the same.
You should also note that if you take any value as assumed mean, you would
get the same result. To test this , you are advised to find the standard
deviation by choosing different values of assumed mean say 27, 35, ….. so
on.
Grouped Data-Discrete distribution: Direct method

∑���
Formula for σ =� �

Where ∑�� � is the sum of the products, which obtained by multiplication of

the squared deviations from actual mean with it respect frequencies; and n is
the number of the item (sum of the frequency).
Steps to compute S.D. for discrete series by direct method:
1) Calculate Arithmetic mean of the series; 2) Take the deviations of the
items from the arithmetic mean (x); 3) Square the deviation (� � ); 4)
Multiply the squared deviations with their corresponding frequencies (�� � );
5) Obtain the total of the frequency (n) and apply the formula.
Short-cut Method:

∑��� ∑�� �
Formula = σ = � �
−� �
�

Where, ∑�� � is the sum of the products which obtained by the multiplication
of squared deviation from assumed mean (� � ) by its respective frequency;
∑�� is the sum of the products which obtained by the multiplication of the
deviations from assumed mean to its respective frequencies; and n is the total
of the frequency.
Steps to compute S.D. for discrete series by short-cut method:
1) Select a value as assumed mean and take deviations of the items from the
assumed mean (X-A) denote these deviations by ‘d’; 2) Square the above
deviation (�� ); 3) Multiply the deviations with its corresponding frequency
(fd) and obtain (∑fd); 4) Multiply the squared deviation (� � ) with its
corresponding frequency and denote it as �� � ; 5) Obtain the total (i.e.,
∑��� ); 6) Obtain the total of the frequency (n) and 7) apply the formula.
Study Illustration 12 carefully to understand the procedure clearly.

114
Illustration 12: Calculate the standard deviation from the following Measures of
Dispersion
frequency distribution by direct and short-cut methods using 14 as assumed
mean.

Daily wages (Rs.) : 10 12 14 16 18 20 22

No. of workers : 3 5 9 16 8 7 2

Solution: Calculation of Standard Deviation and Variance: Direct Method

Daily Wages No. of fX d �� ���

(Rs.) Workers (X - �)
X f
�=16
10 3 30 -6 -36 108
12 5 60 -4 -16 80
14 9 126 -2 -4 36
16 16 256 0 0 0
18 8 144 2 4 32
20 7 140 4 16 112
22 2 44 6 36 72
n = 50 ∑fX = 800 ∑��� = 440

Now, � = ∑��
�
=
���
��
= Rs. 16

∑��� ���
�= � �
= � �� = √8.8 = Rs. 2.97

Short-Cut Method: Taken Assumed Mean as 14.

Daily Wages (Rs.) No. of Workers D=X-14 fd ���

X f
10 3 -4 -12 48
12 5 -2 -10 20
14 9 0 -0 0
16 16 2 32 64
18 8 4 32 128
20 7 6 42 252
22 2 8 16 128
n = 50 ∑fd = 100 ∑��� = 640

∑��� ∑�� �
Now, σ =� �
−� �
�

��� ��� �
= � �� − � �� �

= √12.8 − 4 = √8.8 = Rs. 2.97

You may note that when arithmetic mean is in whole numbers, there is not
much simplification in calculations by short-cut method. 115
Business Statistics Continuous distribution: Direct Method

∑���
Formula: σ = � �

Where, ∑fd2 is the sum of the products, which obtained by multiplying the
squared deviations (taken from actual mean to midvalues) with its respective
frequencies; n = total of the item
Steps to compute S.D. for continuous series by direct method:
1) Find out the mid values; 2) Compute of the arithmetic mean; 3) Take the
deviations of the mid values form the arithmetic mean (M-X) i.e., d; 4)
Square the deviation i.e., d2; 5) Multiply the squared deviations (d2)with its
respective frequencies (f) and obtain the total i.e., ∑fd2 ; 6) Obtain the total
of items (n) and apply the formula.
Short Cut Method

∑��� ∑�� �
Formula : σ =� �
−� �
�

Where ∑fd2 = sum of products, which obtained by multiplying the squared

deviations (taken from assumed mean to midvalues) corresponding to its
frequencies; ∑fd = Sum of the products obtained by multiplying the
deviations (d) with its corresponding frequencies and n = total of the items
Steps to compute SD for continuous series by short-cut method:
1) Find out the mid-values; 2) Select any mid values as an assumed mean
and find the deviation by deducting the assumed mean from the values (M-A)
these are denoted by d; 3) Square the deviations, denoted by d2; 4) Multiply
the deviations with corresponding frequencies and obtain the total i.e., ∑fd;
5) Multiply the squared deviations with its corresponding frequencies and
obtain the total i.e., ∑f d2; 6) Obtain the total of the variables (n) and apply
the formula.
Illustration 13: The profits (in Rs. Lakhs) earned by 100 companies during
1998-99 are shown below. Compute Standard Deviation by using Direct and
Short-Cut methods.

Profits (Rs. Lakhs) No. of Companies

20-30 4
30-40 8
40-50 18
50-60 30
60-70 15
70-80 10
80-90 8
90-100 7

116
Solution: Direct Method Measures of
Dispersion
Calculation of Standard Deviation
Classes Mid No. of �� � �� ���
(Profit Values Companies
(X - �)
Rs. in X f
lakhs)
20-30 25 4 100 -34.1 1162.81 4651.24
30-40 35 8 280 -24.1 580.81 4646.48
40-50 45 18 810 -14.1 198.81 3578.58
50-60 55 30 1650 -4.1 16.81 504.30
60-70 65 15 975 5.9 34.81 522.15
70-80 75 10 750 15.9 252-81 2525.10
80-90 85 8 680 25.9 670.81 5366.48
90-100 95 7 665 35.9 1288.81 9021.67
n = 100 ∑fx = 5,910 ∑��� = 30819.00

∑�� ����
�= �
= ���
= Rs. 59.10 lakhs

∑��� �����
σ=� �
= � ���
= √308.19 = Rs. 17.56 lakhs

Short-cut Method: Here the assumed mean is 55

Classes (Profit Mid No. of �−� �� �� ���

Rs. in lakhs) Values Companies �
X f (A-55)
20-30 25 4 -30 900 -120 3600
30-40 35 8 -20 400 -160 3200
40-50 45 18 -10 100 -180 1800
50-60 55 30 0 0 0 0
60-70 65 15 10 100 150 1500
70-80 75 10 12 400 200 4000
80-90 85 8 30 900 240 7200
90-100 95 7 40 1600 280 11200

n = 100 ∑fd = 410 ∑��� = 32,500

∑��� ∑�� � ��,��� ��� �

σ =� �
−� �
� = � ��� − �����

= √325 − 16.81 = √908.19 = Rs. 17.56 lakhs

1. Now, we will compare the procedure for calculation of standard
deviation in discrete and continuous series. Formulas are same and the
steps also same except one step in continuous series, i.e., finding mid
values, thus, the only difference in procedure is that in case of
continuous series is to find mid values of the various classes.

117
Business Statistics 2. By comparing illustration 13 the computation of standard deviation by
Direct and short-cut methods you could may notice the difficult and
time consuming calculations in direct method if the arithmetic mean is
in fraction. This difficulty can overcome in short-cut method.

The short-cut method is further simplified which is termed as step deviation

method. Let us, now, study the importance and procedure of step deviation
method to compute standard deviation.

Step Deviation Method: The formulas of direct and short-cut methods could
be used conveniently, if the value of X and f are small. If the values of X and
f are large, the calculation standard deviation through the above discussed
methods are quite tedious and time consuming. In such a case, the calculation
can be reduced to a greater extent by step deviation method. This method
may be applied for grouped data. It is applicable when there is constant gap
in between the values of items. In case of continuous series, if class intervals
are equal then only it is applicable. Now, you study the procedure carefully
to understand this method.

∑���� ∑��� �
Formula: σ = � �
−� �
� �

Here, C is the common factor.

Steps to compute SD by step deviation method:

1) Find mid value of various classes; 2) Select a mid value as the assumed
mean and take the deviation of the mid values from the assumed mean (M-A)
and denote these deviations by ‘d’; 3) Take the common factor of the
deviations and divide the deviations by the common factor, denote these
deviation by �� ; 4) Square the deviations and denote by � �� ; 5) Multiply the
respective frequencies with their deviations (� � ) obtained in step 3 and get the
total i.e., ∑��� ; 6) Multiply the squared deviation (� �� ) with the respective
frequencies and obtain the total i.e., ∑�� �� ; 7) Get the sum of the items (n)
and apply the formula.

Note: Instead of squaring the deviations (in step 4) you may also multiply the
��� values with its respective deviations (� � ) to find ���� . The clarifications
is that:

���� means f (��� ); ��� = (�� ) (�� ); Therefore ���� = f (�� ) (�� ) i.e.
��� (�� )

Illustration 14: Find the standard deviation of the following distribution:

Income per month (Rs.) : 0-500 500-1000 1000-1500 1500-2000 2000-3000

No. of Employees : 90 218 86 41 15

118
Solutions : Calculation of Standard Deviation Measures of
Dispersion
Income per No. of Mid-point (x-750) �� =
����� ��� f(��� )
month (Rs.) employees (m) (d)
���

x (f)
0-500 90 250 -500 -2 -180 360
500-1000 218 750 0 0 0 0
1000-1500 86 1250 500 2 172 344
1500-2000 41 1750 1000 4 164 656
2000-3000 15 2500 1750 7 105 735
N = 450 - - - �
∑�� = 261 ��
∑�� = 2095

Here, assumed mean (A) is 750 and common factor (C) is 250.

∑���� ∑��� �
S.d. =� �
−� �
� × �

���� ��� �
= � ��� − ����� × 250

= �4.6556 − (0.58)� × 250

= √4.3192 × 250 = 519.2 approximately.

You may note that when class intervals are not equal the step deviation � �
may not be integers in order i.e., 1, 2, 3, ...... or -1, -2, -3, .... etc.

Check Your Progress C

1) Define Standard deviation.
2) Write the formulae used and the procedure for computing standard
deviation by direct, short-cut and step deviation methods.
3) Computing standard deviation by using direct method and short-cut
method from the following set of observations.
245, 322, 192. 310, 231
4) Calculate standard deviation by using direct, short-cut and step
deviation methods from the following data:
Value 130-139 140-149 150-159 160-169 170-179 180-189 190-199
F 1 4 14 20 22 12 2

14.6.4.1 Properties of Standard Deviation

You have learnt the meeting and methods of computing standard deviation.
Let us, now, study the important properties of standard deviation.
1) The value of standard deviation remains the same if each of the
observations in a series is increased or decreased by a constant value.
Thus, if Y = X + K, where K is a constant quantity, then standard
deviation Y is equal to standard deviation of X. In other words,
standard deviation is independent of change of origin.
119
Business Statistics For example :
X X-� �� − ��
� Let Y = X + 10 Y-� �� − ��
�

1 -2 4 1 + 10 = 11 -2 4
2 -1 1 2 + 10 = 12 -1 1
3 0 0 3 + 10 = 13 0 0
4 1 1 4 + 10 = 14 1 1
5 2 4 5 + 10 = 15 2 4
Total 15 0 10 65 0 10

∑� ��
Arithmetic mean of X = �
= �
=3

∑(� − �)2 ��
σ of X = � �
= � � = √2 = 1.414

∑� ��
Arithmetic mean of Y = �
= �
=3

∑(� − �)2 ��
σ of Y = � �
= � � = √2 = 1.414

Hence, S.D. of X = S.D. of Y.

2) For a given series, if each observation is multiplied or divided by a
constant value, standard deviation will also be similarly affected. Thus,
if Y = A X , where A is a constant, then S.D. of Y = (S. D. of X) x A .
For example,
X X -� �� − ��
� Let Y = 10X (Y - �) �� − ��
�

1 -2 4 10 -2 4
2 -1 1 20 -1 1
3 0 0 30 0 0
4 1 1 40 1 1
5 2 4 50 2 4
Total 15 0 10 150 0 10

∑� ��
�= = =3
� �
∑� ���
�= = = 30
� �

∑(� − �)2 ����

σ of Y =� �
= � �
= √200 = 10√2 = 14.14

σ of Y = 10 (σ of x)
Thus, you may conclude that the standard deviation is independent of any
change of origin but is not independent of the change of scale.

120
3) For a given set of observations, standard deviation is never less than Measures of
Dispersion
mean deviation about arithmetic mean and quartile deviation. In fact
� �
mean deviation is � � and quartile deviation is � � for normal data.

4) It two groups contain �� and �� observations with means �� and �� and

standard deviation �� and �� respectively, then the standard deviation of
the combined
(�� ��� � �� ��� ) � �� ��� � �� ���
��� =� (�� � ��

Where ��� = combined standard deviation of the two groups

�� = ��� − �� ; �� = ��� − ��

��� = combined arithmetic mean of the two groups.

To understand the properties 3 and 4, study Illustrations 20 and 21 given
under Section 14.8 (Some Illustrations) presented later in this unit.
5) Root mean square deviation calculated about a value other than
arithmetic mean will always be higher than standard deviation. For
explaining this let us again take the values of X same as under (1)
above, and calculate root mean square about 4, a value different from
mean (�)which is 3.
X : 1 2 3 4 5
X–4 : -3 -2 -1 0 1
(X − 4)� : 9 4 1 0 1
Now, ∑(X − 4)� = 15

∑(� � �)�
Root Mean Square Deviation about 4 =� �

��
= � � = √3 = 1.732

But standard deviation of X is√2 or 1.414. So, root mean square deviation
about a value other than arithmetic mean is than standard deviation.
6) In an ordinary type data or normal type data the number of items
between the range A. M. ± σ is about 68%, in the range A.M. ± 2 σ is
about 95% and in range A.M. ± 3 σ is almost all the items of the data
lie.
To explain it, let us consider the data of Illustration 12. For this data A.M. is
16 and σ is 2.97. So the range A.M. ± σ will be 16 ± 2.97 or 13.03 to 18.97.
In the data, number of items lying between 13.03 to 18.97 are 9+16+8 or 33
i.e., 66% of total items (i.e., 50) which is quite close to 68%. Similarly, the
range A.M. ± 2 σ will be 16 ± 2 x 2.97 o r 10.06 to 21.94.
All items except the items of the first and the last group fall in this range.
Thus, total number of items in the range 10.06 to 21.94 are 45 i.e., 90%, a
value not very much different from 95%. You can also verify whether or not
100% items lie within the range A.M. 23 σ. 121
Business Statistics The percentages of items' lying between different ranges calculated above are
not exactly the same as stated in the property. This only points out that the
data of Illustration 12 is not perfectly normal but is quite close to it.

14.6.4.2 Merits and Limitations

Merits: Among all the measures of dispersion, standard deviation is
considered superior because it possesses almost all the requisites of a good
measure of dispersion. Standard deviation had the following merits :
i) It is rigidly defined and is based on all observations of the series.
ii) The unique property which makes standard deviation superior t o other
measures of dispersion is that it is amenable to algebraic treatment.
Thus, if we are given the number of observations, mean and standard
deviation for each of several groups, we can easily calculate the
standard deviation of the composite group.
iii) Standard deviation is least affected by the fluctuations of sampling.
iv) In a normal distribution the mean ± S.D . covers 68.36%,of the values
whereas only 50% values are covered by quartile deviation and 57% by
mean deviation. Because of this reason, standard deviation is called a
‘standard measure’ .
Limitations : The main limitations or demerits of standard deviation as a
measure of dispersion are as follows:
i) The major limitation of SD is that it cannot be used for comparing the
dispersion of two o r more series of observations given in different
units. A coefficient of standard deviation has to be defined for this
purpose.
ii) The process of squaring deviations from mean and then taking the
square-root of the mean of these squared deviations seems to be a
complicated affair.
In fact this gives rise to another limitation i.e., standard deviation is
very much affected by the extreme values. The process of squaring
deviations give undue importance to large deviations from arithmetic
mean which are obtained only from extreme items and it gives less
importance to items which are nearer to mean.
iii) The standard deviation cannot be computed for a distribution with
open-and classes.

14.7 COEFFICIENT OF VARIATION

The coefficient of variation, also known as coefficient of standard deviation
expressed in percentages, is based on the ratio of the standard deviation to the
arithmetic mean of a series. Thus, coefficient of variation may be expressed.
as:
�������� ��������� (�)
Coefficient of Variation (c.v) = ���������� ���� (�)
× 100
122
The coefficient of variation is a relative measure of dispersion and is usually Measures of
Dispersion
expressed in the form of percentage. So it can be conveniently used for
comparing the variability or dispersion between the two sets of the
observations given indifferent units or if units are same, have wide variations
in the average value. It may thus, be used to measure or compare the
precision of two or more sets of observations.
To understand this point let us take an example. Suppose we measure the
distance between Delhi and Bombay and make a deviation of 1 km. or
1,00,000 cms., in the actual distance of 1540 kms. This deviation is of hardly
any significance as compared to a deviation of 10 cm., in measuring a piece
of one meter cloth. This fact is not revealed when 1,00,000 cm deviation in
first case is compared directly with 10 cms., deviation of the second case.
As, 1,00,000 cms., is larger than 10 cms., one may be tempted to conclude
that deviation of measurement in first case is very much important. But if we
compute coefficients, the picture becomes clear. In first case coefficient is
�
only ���� × 100 = 0.065% used in the second case the coefficient is
��
����
× 100 or 1%. So deviation in second case is relatively larger. Thus,
whenever comparisons of variations is to be done it must be done in
terms of coefficient of variation only.
Variance
In 1913 F.A. Fisher used the measure of variance to describe the square of
the Standard deviation. Variance is defined as “the square of standard
deviation”. This concept is useful in advanced work where it is possible to
split the sum into several pasts each attributable to one of the factors causing
variation in the original data set.
Variance = � � or σ = √��������
Thus, the formula can be present as follows:
In ungrouped data:
Variance (direct method) = ∑� � / �
∑� � ∑� �
Variance (sort-cut method) = �
− ���

In group data: discrete series

Variance (direct method) = ∑�� � / �
Variance (sort-cut method) = ∑��� / � (∑��� / � )�
Continuous Series
The formulas presented in discrete series are same in continuous series also.
In step deviation method:
�
∑���� ∑���
Variance: �
−� �
� � ��

Illustration 15: The following is the record of goals scored by Team A in a

football season.
123
Business Statistics
No. of goals scored in a match : 0 1 2 3 4
Number of matches : 1 9 7 5 3

For Team B, the average number of goals scored per match was 2.5 with a
standard deviation of 1.25 goals. Find which team is more consistent.
Solution: Computation of Arithmetic Mean and Standard Deviation of Team A

No of Goals No. of Matches (f) Deviation (d) fd fd2

0 1 -2 -2 4
1 9 -1 -9 9
2 7 0 0 0
3 5 1 5 5
4 3 2 6 12
N = 25 ∑fd= 0 ∑fd2 = 30
∑�� �
Arithmetic Mean of Team A: =A+ �
= 2 + �� = 2 goals

∑��� ∑�� �
Standard Deviation of Team A: =� �
−� �
�

�� � �
= ��� − ����

= √1.2 − 0 = √1.2
= 1.1
�.�. �.�
Coefficient of Variation of Team A : = �
× 100 = �
× 100 = 55%
�.�. �.��
Coefficient of Variation of Team B: = �
× 100 = �.�
× 100 = 50%

The coefficient of variation of 'Team B is less than that of Team A . So,

Team B is considered to be more consistent than Team A .
Illustration 16: From the data given below, state which series is more
variable:

Variable Series A Series B

10-20 10 18
20-30 18 22
30-40 32 40
40-50 40 32
50-60 22 18
60-70 18 10

124
Solution: Computation of Arithmetic Mean and Standard Deviation of Measures of
Dispersion
Series-A
Class-Interval Mid- Frequency Step fd Fd2
(Variable) Value (f) Deviation
(m) (d)
(x)
10-20 15 10 -2 -20 40
20-30 25 18 -1 -18 18
30-40 35 32 0 0 0
40-50 45 40 1 40 40
50-60 55 22 2 44 83
60-70 65 18 3 54 162
N = 140 ∑fd= 0 ∑fd2 = 30

Here, assumed mean (A) is 35 and C is 10.

∑��
�� = A + �
+ C
���
= 35 + ��� + 10 = 35 + 7.143 = 42.1 approximately.

∑��� ∑�� �
σA = � �
−� �
� × �

��� ��� �
= ���� − ����� × 10

= √2.486 − 0.510 × 10
= 1.4057 × 10 = 14.057
�
C.V. (Series A) = � × 100
��.��
= ��.�
× 100 = 33.3%

∑��� ∑�� �
Variance (Series A): = �
−� �
� × ��

��� ��� �
= ��� − ����� × 10�

= 2.486 − (0.510)� × 100

= 1.976 × 10
= 197.6
We can also compute the variance as follows:
Variance = ��
σ of A Series = 14.057
Variance (A) = 14.057� = 197.6

125
Business Statistics Computation of Arithmatic Mean and Standard Deviation of Series-B
Class-Interval Mid- Frequency Step fd Fd2
(Variable) Value (f) Deviation
(m) (d)
(x)
10-20 15 18 -2 -36 72
20-30 25 22 -1 -22 22
30-40 35 40 0 0 0
40-50 45 32 1 32 32
50-60 55 18 2 36 72
60-70 65 10 3 30 90
N = 140 ∑fd= 40 ∑fd2 = 288

Here, assumed mean (A) is 35 and C is 10.

∑��
�� = A + �
+ C

��
= 35 + ��� + 10 = 35 + 2.85 = 37.85 approximately.

∑��� ∑�� � ��� �� �

σB = � �
−� �
� × � = ���� − ����� × 10

= √2.057 − 0.0784 × 10 = √1.9786 × 10

= 1.4057 × 10 = 14.057
� ��.��
C.V. (Series B) = � × 100 = ��.�� × 100 = 37.1%

Variance (Series B) = ��

Standard deviation of B = 14.057

Variance = 14.057� = 197.6

Since the coefficient of variation of Series B is higher than that of Series A,

Series B is more variable. In this illustration you may notice that standard
deviation and variance of both the series is the same i.e., 14.057 and 197.6
respectively. From this fact, we should not conclude that two series have
same variation. The difference in arithmetic mean has to be taken into
account for correct interpretation.

14.8 SOME ILLUSTRATIONS

Illustration 17: The profits (in Rs. lakhs) earned by 100 companies during
1987-88 are shown below. Compute (a) Mean, (b) Variance, and (c)
Standard Deviation by using items and their squares.

126
 Measures of
Profits (Rs. lakhs) No. of Companies Dispersion
20-30 4
30-40 8
40-50 18
50-60 30
60-70 15
70-80 10
80-90 8
90-100 7

Solution : Computation

Class Mid-Point Frequency fX fX2

(X) (f)
20-30 25 4 100 2,500
30-40 35 8 280 9,800
40-50 45 18 810 36,450
50-60 55 30 1,650 90, 750
60-70 65 15 975 63,375
70-80 75 10 750 56,250
80-90 85 8 680 57,800
90-100 95 7 665 63,175
N = 100 ∑fX= 5,910 ∑fX2 = 3,80,100
∑�� �,���
a) �= �
= ���
= Rs. 59.10 Lakhs

∑�� � ∑�� �
b) Variance = �
−� �
�

�,��,��� ���� �
= ���
− � ��� �

= 3801.00 – 3492.81
= Rs. 308.19 Lakhs
c) Standard Deviation = √�������� = √308.19
= 17.56 Lakhs
In the above illustration you may notice that by using sums of items and their
squares to calculations involved are large. This method is a direct method in
the sense that we have used the items directly and not calculated their
deviation from any value. This method may be used only when size of items
are small and their total number is also small.
Illustration 18: Calculate Mean and Standard Deviation from the following
distribution:
127
Business Statistics
Class-Interval : 10-20 20-30 30-40 40-50 50-60 60-70 70-80

Frequency : 4 8 8 16 12 6 4

Solution: Let us use the short-cut method, a method which is most

commonly used and involves least amount of lengthy calculations. Like
calculations of arithmetic mean the assumed mean is taken as one of the mid-
points which is towards the middle and corresponds to a high frequency. The
deviations so obtained are divided by the common factor, if any. When we
divide them by the common factor, this method is also called step deviation
method.
Calculation of Mean and Standard Deviation
Class f Mid-point D = X-A �� =
� ��� ����
Interval (X) (X-45)
�
c = 10
10-20 4 15 -30 -3 -12 36
20-30 8 25 -20 -2 -16 32
30-40 8 35 -10 -1 -8 8
40-50 16 45 0 0 0 0
50-60 12 55 +10 1 12 12
60-70 6 65 +20 2 12 24
70-80 4 75 +30 3 12 36
n = 58 - - - ∑��� = 0 ∑���� = 148

∑��
Mean � =A + �
× C
�
= 45 + �� × 10 = 45

∑��� ∑�� �
Standard Deviation =� � �
−� �
�

��� � �
= 10 × � �� − ����

= 10 × √2.552 = 1.597 × 10 = 15.97

Illustration 19 : A state government decided to give old age pension to
people over sixty years of age. The scale of pension were fixed as follows:

Age Group Us. per month

60-65 250
65-70 300
70-75 350
75-80 400
80-85 450

128
The age of 25 persons who secured the pension rights are given below: Measures of
Dispersion
74 62 84 72 83 72 81 64 71 63 61
60 61 67 74 64 79 73 75 76 69 78
6 67 68
Calculate the monthly average pension payable and standard deviation,
variance and co-efficient of standard deviation.
Solution: Classification of Data

Age Group Talley Frequency

60-65 7
65-70 5
70-75 6
75-80 4
80-85 3
25

Calculation of Monthly Average Pension Payable and the Standard Deviation

Scale of Pension (Rs.) f �� =�

�����
� ��� ����
��

250 7 -2 -14 28
300 5 -1 -5 5
350 6 0 0 0
400 4 1 4 4
450 3 2 6 12
25 - −9 49

Here, A = 350, C = 50; ∑� or n = 25; ∑��′ = -9; and ∑��′� = 49

∑��′
� =A + �
× C
�
= 350 − �� × 50 = 332

∑��� ∑�� �
σ =� �
−� �
� × �

�� �� �
= ��� − � �� � × 50 = 1.353 × 50 = 67.65

= � � = 67.65� = 4576.52
�
Coefficient of σ = � × 100
��.��
= ���
× 100 = 20.04%

129
Business Statistics Thus, the monthly average pension is Rs. 332; standard deviation is Rs. 67.65
variance is 4776.52 and C.V. is 20.04%.
Illustration 20: For a Group of 50 male workers, the mean and standard
deviation of their daily wages are Rs. 72 and Rs. 9 respectively. For another
group of 40 female workers these are Rs. 54 and Rs. 6 respectively. Find the
standard deviation for the combined group of 90 workers.
Solution: In this data �� = 50 and �� = 40

��= 72 and �� = 54
σ� = 9 and σ� = 6
�� �� � �� �� ���� � ����
Combined mean for group of 90 (���) = �� ���
= ��
�,��� � �,���
= ��
= 64

Combined Standard Deviation for the group of 90

�� (��� ���� )� �� (��� ���� )
σ�� =� �� � ��

Now, �� = 64 − 72 = − 8 and �� = 54 − 72 = −18

��(�����)� ��(������) �,���� ��,���
σ�� =� ��
=� ��

��,���
=� ��
= √240.54 = 15.51

You may note that the combined mean of the two groups has a value in
between the means of the two groups but the combined standard deviation
has a value much greater than the greater of the given standard deviations.
Combined mean will always be in between the range of the given mean, but
there is nothing wrong in getting combined standard deviations with a value
outside the range of the given standard deviation. In fact, greater the
difference between the given mean, the combined standard deviation will be
more away from the largest given standard deviation. When all the given
groups have equal means, then only the combined standard deviation will be
between the range of the given standard deviations.
Illustration 21: Calculate mean deviation about mean for data given
previously in Illustration 18 and show that mean deviation is less than
standard deviation.
Solution: Calculation of Mean Deviation

Class Interval Frequency Mid- | � − �| �|�|

(f) point (X)
|d|
10-20 4 15 30 120
20-30 8 25 20 160
30-40 8 35 10 80
40-50 16 45 0 0
130
50-60 12 55 10 120 Measures of
Dispersion
60-70 6 65 20 120
70-80 4 75 30 120
n = 58 ∑ �|�|= 720

From Illustration 18, we have �= 45 and σ = 15.97

�|�| ���
Mean Deviation about � = �
= ��
= 12.41

Therefore, mean deviation about � is less than standard deviation. You

should note that mean deviation about mean will always be less than standard
deviation whatever may be data.

Check Your Progress D

1) The following table gives weight in pounds of fat bullocks and fat sheep.

Fat Bullocks Number Fat Sheep Number

(Weight in lbs.) (Weight in lbs.)
850-900 2 150-175 8
900-950 24 175-200 30
950-1000 45 200-225 59
1000-1050 120 225-250 70
1050-1100 110 250-275 98
1100-1150 140 275-300 60
1150-1200 66 300-325 37
1200-1250 42 325-350 23
1250-1300 20 350-375 15
1300-1350 15 375-400 5

Determine if the Bullocks or the sheep are more variable in weight.

2) In a co-educational college boys and girls formed separate groups on the
foundation day when every one had to put in physical labour. Compute
standard deviation for boys and girls separately and for the combined
group. Did the separation by sex make each work group more
homogeneous.

Minutes of labour given by No. of Girls No. of boys

each individual
60 20 120
55 60 100
50 100 200
45 450 355
40 450 350
35 300 500
30 250 350
25 100 20
131
Business Statistics
14.9 LET US SUM UP
Dispersion represents the Spread or the scatterness of the data. It is also used
to denote the average of deviation of items fr.om some measure of central
tendency. Dispersion is calculated to assess the reliability of an average or to
compare variability of two or more data or to control the variation itself. A
good measure of dispersion should be based on all observations, should
easily be calculated, least affected by sampling fluctuations and amenable to
further algebraic treatment. Relative measures of dispersion are computed to
compare variability in two or more sets of data. They are obtained by
expressing absolute measures of dispersion as the ratio of the appropriate
average or the sum of two selected items of the data.
The various measures of dispersion in common use are range, quartile
deviation, mean deviation and standard deviation. Range is defined as the
difference between the highest and the lowest items of the data. It gives the
spread of entire data. Quartile deviation is half the difference between �� and
�� and is based on middle 50% items only. Mean deviation is the arithmetic
mean of the absolute deviations of items from a measure of central tendency,
which could be mean or median or some times even mode.
Quartile deviation is a suitable measure for open-end data. Range is useful
when extreme items are important such as in quality control, price study or
meteorological data. As mean deviation is based on all items, in most of the
cases it is a better representative of the variability of the data than the other
two measures.
While calculating mean deviation, the signs of the deviations are ignored.
This introduces some limitations in the measure. To overcome such
limitations, a new measure called Root Meant Square Deviation is defined to
measure dispersion. It is the square root of the mean of the deviations of
items from central tendency.
Root mean square deviation about arithmetic mean is the least and is given
the name standard deviation. For computing standard deviation, there are two
methods: 1) direct method and 2) short-cut method. Short cut method, using
step deviations, is most common in use. The formula for it is : Standard
Deviation

∑���� ��� �
(σ)= � �
−� �
� × � Standard deviation is rigidly defined and based on
all items.

14.10 KEY WORDS

Coefficient of Variation: Standard deviation divided by arithmetic mean
expressed as a percentage.
Inter Quartile Range: A measure of dispersion which considers the spread
in the middle 50%. It is (Q� − Q� ) of the data.
Lorenz Curve: A double cumulative percentage graph used in determining
the extent of inequalities of items.
132
Mean Deviation: The arithmetic mean of the absolute deviations from the Measures of
Dispersion
mean median or the mode.
Quartile Deviation: One-half the distance between the first and the third
quartiles.
Range: The difference between the largest and the smallest value in a set of
data.
Root Mean Square Deviation: The square root of the mean of the squares of
deviation of items from central tendency.
Standard Deviation: The root mean square deviation about arithmetic mean.

14.11 ANSWERS TO CHECK YOUR PROGRESS

B 4) Range = 39, Q.D. = 9.25
5) Range = 14, Coefficient of Range = 0.58, Q.D. = 2.25,
Coefficient of Q.D. = 0.101
C) 3) 49.1; 4) 156.37;

D) 1) Bullocks: � = 1097.52; σ = 90.34; C.V. = 8.23%

Sheeps: � = 261.15; σ = 47.75; C.V. = 18.25%
2) Girls: � = 39.45; σ = 7.5; C.V. = 19.00%
Boys: � = 40.69; σ = 8.68; C.V. = 21.34%
���= 40.11; σ�� = 8.18

14.12 TERMINAL QUESTIONS/EXERCISES

Questions:
1) What do you understand by dispersion? What purpose does it serve?.
2) What is the mean deviation? Review its advantages and disadvantages.
3) What is standard deviation? Explain its superiority over other measures
of dispersion.
4) What is coefficient of variation? What is its role as a measure of
variation? How does it differ from variance.
5) Define various measures of dispersion and explain their relative merits
and limitations.
Exercises:
1). Calculate quartile deviation and mean deviation about for the following
data:
Age (in Years) : 20 30 40 50 60 70 80
No. of Members: 3 61 132 153 140 51 3
(Answer : R= 60 years, Q.D. =.10, M.D(�) = 9.52)
2). A frequency distribution for the duration of 20 long distance telephqne
calls are shown below :

133
Business Statistics
Calls Duration Frequency
4 but less than 8 4
8 but less than 12 5
12 but less than 16 7
16 but less than 20 2
20 but less than 24 1
24 but less than 28 1
Total 20

Compute the mean, median and quartile deviation.

(Answer : Mean = 12.8, Median = 12.6, Q.D. = 3.3)
3). Calculate the mean deviation about Median and coefficient of mean
deviation from the following data :

Sales (Rs. ' 00) No. of Companies

Less than 20 3
Less than 30 9
Less than 40 20
Less than 50 23
Less than 60 25

(Answer: M.D. about M = 8.9, Coefficient of M.D. about M = 0.29)

4). A. survey of domestic consumption of electricity gave the following
distribution of the units consumed. Compute the quartile deviation and
its coefficient.

No. of Units No. of Consumers

Below -200 9
200 - 400 18
400 - 600 27
600 - 800 32
800 - 1,000 45
1,000 - 1,200 38
1,200 - 1,400 20
1,400 and above 11

(Answer : Q.D. = 520.6, Coefficient of Q.D. = 0.317)

5). Calculate the mean deviation about the mean and median from the
following data:
Class Interval : 0-9 10-19 20-29 30-39 40-49 50-59
Frequency : 15 36 53 42 17 2
(Answer : M.D(�) = 9.10 , M.D. (�� ) = 9.08)
6). Calculate the mean deviation about Mode and its coefficient for the
following data:
134
 Measures of
Dispersion
No. or Detects per Item Frequency
0- 5 18
5-10 32
10-15 50
15-20 75
20-25 125
25-30 150
30-35 100
35-40 90
40-45 80
45-50 50
(Answer : M.D. (�� ) = 9.02, Coefficient M.D. (�� ) = 0.338)
7). Compute the mean deviation and its coefficient for the following data:

No. of Shares Applied for No. of Applicants

50-100 2,500
100 - 150 1,500
150-200 1,300
200 - 250 1,100
250 - 300 900
300- 350 750
350 - 400 675
400-450 525
450- 500 450

(Answer : M.D. (�� ) = 102.13, Coefficient of M.D. (�� ) = 0.011)

8). Compute the mean deviation about mean and its co-efficient from the
following data:

Marks No. of Students Marks No. of Students

0-10 4 30-40 10
10-20 6 40-50 6
20-30 10 50-60 4

(Answer: M.D(�) = 11.33 , Co-efficient of M.D. = 0.32)

9). The students of the B.Com. class of a college have obtained the
following marks in statistics out of 100 marks. Calculate the standard
deviation of marks obtained
Student : X B C D E F G H I J
Marks : 5 10 20 25 40 42 45 48 70 80
(Answer : 23.06)
10). Calculate standard deviation from the following data :
135
Business Statistics
Mid- 1 2 3 4 5 6 7 8 9
points
Frequency 2 60 101 152 205 155 79 40 1
(Answer : = 1.57)
11). Compute standard deviation for the following data which relate to the
profits of 100 companies:

Profit (Rs. 8-10 10-12 12-14 14-16 16-18 18-20

in lakhs)
No. of 8 12 20 30 20 10
Companies

(Answer : σ = 2.77)
12). An analysis of production rejects resulted in the following figures.
Calculate mean and standard deviation.

No. of 21-25 26-30 31-35 36-40 41-45 46-50 51-55

Rejects
per
Operator
No. of 8 15 28 42 15 12 3
Operators

(Answer : ��= 36.96; � = 6.735)

13). Two samples of size 40 and 50 have the same mean 53 but different
standard deviations 19 and 8 respectively. Find the standard deviation
of the combined sample of size 90.
(Answer : ��� = 14)
14). Find the standard deviation and the coefficient of variation from the
following data:

Marks No. of Students

Less than 10 12
Less than 20 30
Less than 30 65
Less than 40 107
Less than 50 202
Less than 66) 222
Less than 70 230

(Answer : σ = 13.9, C.V. = 37.3%)

15). You are given the data pertaining to kilowatt hours of electricity
consumed by100 persons in a certain city:
136
 Measures of
Consumption K. Watt Hours No. of Users Dispersion
0 but less than 10 6
10 but less than 20 25
20 but less than 30 36
30 but less than 40 20
40 but less than 50 13

Calculate i) mean, ii) standard deviation, and iii) range within which
middle 50% of the consumers fall.
(Answer : i) 25.9 ii) 10.96 iii) 34 to 17.6) .
16). In a small town, a survey was conducted in respect of profits made by
retail shops. The following results were obtained :

Profit (+)/Loss (-) No. of Shops

(In ’000 Rs.)
–4 to –3 4
–3 to –2 10
–2 to –1 22
–1 to 0 28
0 to 1 38
1 to 2 56
2 to 3 40
3 to 4 24
4 to 5 18
5 to 6 10
Calculate i) the average profit made by a retail shop, ii) total profit
made by all shops, and iii) the coefficient of variation of earnings.
(Answer : i) 1348 ii) 3,37,000 iii) 152.8%)
17). A factory produces two types of electric lamps A and B. In an
experiment relating to their life, the following results were obtained :
Length of Life (In hours No. of Lamps A No. of Lamps B
500-700 8 4
700-900 11 30
900-1100 26 12
1100-1300 10 9
1300-1500 8 16

Compare the variability of the life of the two varieties using

coefficient of variation.
(Answer: C.V.(A)= 21.64%, C.V.(B) = 23.41%)
18) In two factories A andB, engaged in the same activity, the average
weekly wage and standard deviation are as follows: 137
Business Statistics
Factory Average Weekly S.D. of No. of Wage
Wages (Rs.) Wages (Rs.) Earners
A 460 50 100
B 490 40 80

i) Which factory pays larger amount as weekly wages?

ii) Which factory shows greater variability in the distribution of
wages?
iii) What is the mean and standard deviation of all the workers in
these two factories taken. together.
Answer: i) Factory A
ii) C.V.(A) = 10.87%, C.V.(B) = 8.16%
iii) ���� = Rs. 473.33, ��� = 49.19
19) The arithmetic mean and standard deviation of 20 items were found as
20 and 5 respectively. But while calculating an item 13 was misread
as 30. Find correct arithmetic mean and standard deviation.
(Answer : AM = 19.15; � = 4.66)
20) The mean of two samples of size 50 and 100 are 54.1 and 50.3 and the
standard deviations are 8 and 7 respectively. Find the mean and
standard deviation of the sample of size 150 obtained b combining the
two samples.
(Answer : ���� = 51.57, ��� = 7.56)

Note: These questions and exercises will help you to understand the unit
better. Try to write answers for them. But do not submit your answers to the
University.

FURTHER READINGS
Arora, P.N. Sumeet Arora and Arora. A., 2007, Comprehensive Statistical
Methods. S. Chand and Company Ltd., New Delhi.
Beri, G.C., 2005, Business Statistics, Tata Mc Graw-Hill Publishing
Company, Ltd., New Delhi.
Elhance, D.N. and Veena Elhance, 1988. Fundamentals of Statistics, Kitab
Mahal: Allahabad. (Chapters 9, 10 & 18)
Gupta, C.B., An Introduction to Statistical, Methods, Vikas Publishing
House: New Delhi. (Chapters 10, 11 & 17)
Gupta, S.P., 1989, Elementary Statistical Methods, Sultan Chand & Sons :
New Delhi. (Chapters 8 & 9)
Sancheti, D.C., and Kapoor, V.K., 1989, Statistics Theory Methods and
Applications, Sultan Chand & Sons : New Delhi.
Simpson, G, and.Kafka, F. Basic Statistics, Oxford & IBH Publishing 1 New
Delhi.

138
 Simple Linear
UNIT 15 SIMPLE LINEAR CORRELATION Correlation

Structure
15.0 Objectives
15.1 Introduction
15.2 Simple Correlation
15.2.1 Meaning
15.2.2 Scatter Diagram
15.3 Correlation Coefficient
15.3.1 Karl Pearson’s Correlation Coefficient
15.3.2 Spearman’s Rank Correlation
15.4 Let Us Sum Up
15.5 Key Words
15.6 Answers to Self Assessment Exercises
15.7 Terminal Questions/Exercises
15.8 Further Readings

15.0 OBJECTIVES
After studying this unit, you should be able to:
• explain the concept of correlation,
• use scatter diagrams to visualize the relationship between two variables,
• compute the simple and rank correlation coefficients between two
variables,

15.1 INTRODUCTION
In previous units, so far, we have discussed the statistical treatment of data
relating to one variable only. In many other situations decision-makers need
to consider the relationship between two or more variables. For example, the
sales manager of a company may observe that the sales are not the same for
each month. He/she also knows that the company’s advertising expenditure
varies from year to year. This manager would be interested in knowing
whether a relationship exists between sales and advertising expenditure. If
the manager could successfully define the relationship, he/she might use this
result to do a better job of planning and to improve predictions of yearly sales
with the help of the regression technique for his/her company. Similarly, a
researcher may be interested in studying the effect of research and
development expenditure on annual profits of a firm, the relationship that
exists between price index and purchasing power etc. The variables are said
to be closely related if a relationship exists between them. In this unit we
discuss bi-variant analysis of Simple Linear Correlation and Simple Linear
Regression will be covered in the next unit i.e. Unit-16.
The word ‘bi-variate’ is used to describe the situation in which two
characteristics are measured on each variable or item, the characteristics
being represented by the variables or item.
139
Business Statistics This unit, therefore, introduces the concept of correlation and statistical
techniques of simple correlation.

15.2 SIMPLE CORRELATION

15.2.1 Meaning
If two variables, say x and y vary or move together in the same or in the
opposite directions they are said to be correlated or associated. Thus,
correlation refers to the relationship between the variables. Generally, we
find the relationship in certain types of variables. For example, a relationship
exists between income and expenditure, absenteesim and production,
advertisement expenses and sales etc. Existence of the type of relationship
may be different from one set of variables to another set of variables. Let us
discuss some of the relationships with the help of Scatter Diagrams.

15.2.2 Scatter Diagram

When different sets of data are plotted on a graph, we obtain scatter
diagrams. A scatter diagram gives two very useful types of information.
Firstly, we can observe patterns between variables that indicate whether the
variables are related. Secondly, if the variables are related we can get an idea
of the type of relationship that exists. The scatter diagram may exhibit
different types of relationships. Some typical patterns indicating different
correlations between two variables are shown in Figure 15.1.

Y Y
r=1 r = –1

X X
(a) (b)
Perfect Positive Correlation Perfect Negative Correlation

Y r>0 r<0
Y

X X
(c) (d)
Positive Correlation Negative Correlation
140
 Y Y Simple Linear
Correlation

X X
(e) (e)
Non-linear Correlation No Correlation

Figure 15.1 : Possible Relationships Between Two Variables, X and Y

If X and Y variables move in the same direction (i.e., either both of them
increase or both decrease) the relationship between them is said to be
positive correlation [Fig. 15.1 (a) and (c)]. On the other hand, if X and Y
variables move in the opposite directions (i.e., if variable X increases and
variable Y decreases or vice-versa) the relationship between them is said to
be negative correlation [Fig. 15.1 (b) and (d)]. If Y is unaffected by any
change in X variable, then the relationship between them is said to be un-
correlated [Fig. 15.1 (f)]. If the amount of variations in variable X bears a
constant ratio to the corresponding amount of variations in Y, then the
relationship between them is said to be linear-correlation [Fig. 15.1 (a) to
(d)], otherwise it is non-linear or curvilinear correlation [Fig. 15.1 (e)].
Since measuring non-linear correlation for data analysis is far more
complicated, we therefore, generally make an assumption that the association
between two variables is of the linear type.
If the relationship is confined to two variables only, it is called simple
correlation. The concept of simple correlation can be best understood with
the help of the following illustration which relates advertisement expenditure
to sales of a company.
Illustration 1
Table 15.1 : A Company’s Advertising Expenses and Sales Data (Rs. in crore)

Years: 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Advertisement 6 5 5 4 3 2 2 1.5 1.0 0.5
expenses (X)
Sales (Y) 60 55 50 40 35 30 20 15 11 10

The company’s sales manager claims the sales variability occurs because the
marketing department constantly changes its advertisement expenditure.
He/she is quite certain that there is a relationship between sales and
advertising, but does not know what the relationship is.
The different situations shown in Figure 15.1 are all possibilities for describing
the relationships between sales and advertising expenditure for the company.
To determine the appropriate relationship, we have to construct a scatter
diagram shown in Figure 15.2, considering the values shown in Table 15.1.
141
Business Statistics

60
50

Sales (Rs. Crore)

40
30
20
10
0
1 2 3 4 5 6
Advertising Expenditure (Rs. Crore)

Figure 15.2 : Scatter Diagram of Sales and Advertising Expenditure for a Company.

Figure 15.2 indicates that advertising expenditure and sales seem to be

linearly (positively) related. However, the strength of this relationship is not
known, that is, how close do the points come to fall on a straight line is yet to
be determined.
ermined. The quantitative measure of strength of the linear relationship
between two variables (here sales and advertising expenditure) is called the
correlation coefficient. In the next section, therefore, we shall study the
methods for determining the co coefficient
efficient of correlation.
Let us understand through another example.
Illustration 2:
A teacher is interested in studying the relationship between the performance
in Statistics and Economics of a class of 20 students. For this he compiles the
scores on these subjects of the students in the last semester examination.
Some data of this type are presented in Table 15.2.
Table 15.2: Scores of 20 Students in Statistics and Economics

Serial Score in Serial Score in

Number Statistics Economics Number Statistics Economics
1 82 64 11 76 58
2 70 40 12 76 66
3 34 35 13 92 72
4 80 48 14 72 46
5 66 54 15 64 44
6 84 56 16 86 76
7 74 62 17 &I 52
8 84 66 18 60 40
9 60 52 19 82 60
10 86 82 20 90 60

142
A representation of data of this type on a graph is a useful device which will Simple Linear
Correlation
help us to understand the nature and form of the relationship between the two
variables, whether there is a discernible relationship or not and if so whether
it is linear or not. For this let us denote score in Economics by X and the
score in Statistics by Y and plot the data of Table 15.1 on the xx-y plane. It
does not matter which is called X and which Y for this purpose. Such a plot
is called Scatter Plot or Scatter Diagram. For data of Table 15.2 the scatter
diagram is given in Fig. 15.3.

Fig. 15.3 Scatter Diagram of scores in Statistics and Economics

An inspection of Table 15.2 and Fig. 15.3 shows that there is a positive
relationship between x and y. This means that larger values of x are
associated with larger values of y anand smaller values of x with smaller values
of y. Further, the points seem to lie scattered around both sides of a straight
line. Thus it appears that a linear relationship exists between x and y.
However, this relationship is not perfect in the sense that tthere are deviations
from such a relationship. It would indeed be useful to get a measure of the
strength of this linear relationship.

Check Your Progress A

1) Suggest eight pairs of variables, four in each, which you expect to be
positively correlated and negatively correlated
2) How does a scatter diagram approach help in studying the correlation
between two variables?

15.3 CORRELATION COEFFICI

COEFFICIENT
The coefficient of correlation helps in measuring the degree of relationship
between two variables, X and Y. The methods which are used to measure the
degree of relationship will be discussed below.

15.3.1 Karl Pearson’s Correlation Coefficient

Karl Pearson’s coefficient of correlation (r) is one of the mathematical
methods of measuring the degree of correlation between any two variables X
and Y is given as:
∑����
�= (1)
�∑�� � �∑�� �

Where �� = � − ��; �� = � − ��, �� � = (� − �� )� and, �� � = (� − �� )�

143
Business Statistics This can also be written as:
∑����
�=
��� × ��
Note: The above formula is used when �� and �� are integers.
The following is the alternative formula, when �̅ and �� are not integers.

(∑�)(∑�)
∑���
�= �
�
�
(2)
(∑�)
�∑� � � �∑� � �(∑�)
� �

Before we proceed to take up an illustration for measuring the degree of

correlation, it is worthwhile to note some of the following important points.
i) ‘r’ is a dimensionless number whose numerical value lies between +1
to –1. The value +1 represents a perfect positive correlation, while the
value –1 represents a perfect negative correlation. The value 0 (zero)
represents lack of correlation. Figure 15.1 shows a number of scatter
plots with corresponding values for correlation coefficient.
ii) The coefficient of correlation is a pure number and is independent of
the units of measurement of the variables.
iii) The correlation coefficient is independent of any change in the origin
and scale of X and Y values.
Remark: Care should be taken when interpreting the correlation results.
Although a change in advertising may, in fact, cause sales to change, the fact
that the two variables are correlated does not guarantee a cause and effect
relationship. Two seemingly unconnected variables may often be highly
correlated. For example, we may observe a high degree of correlation: (i)
between the height and the income of individuals or (ii) between the size of
the shoes and the marks secured by a group of persons, even though it is not
possible to conceive them to be casually related. When correlation exists
between such two seemingly unrelated variables, it is called spurious or non-
sense correlation. Therefore we must avoid basing conclusions on spurious
correlation.
Illustration 3
Taking as an illustration, the data of advertisement expenditure (X) and sales
(Y) of a company for 10 years shown in Table 15.1, we proceed to determine
the correlation coefficient between these variables.

144
Solution: Table 15.3: Calculation of Correlation Coefficient Simple Linear
Correlation

Advertisement Sales Rs. (Y) XY X2 Y2

Expenditure
Rs. (X)
6 60 360.0 35 3600
5 55 275.0 25 3025
5 50 250.0 25 2500
4 40 160.0 16 1600
3 35 105.0 9 1225
2 30 60.0 4 900
2 20 40.0 4 400
1.5 15 22.5 2.25 225
1.0 11 11.0 1 121
0.5 10 5.0 0.25 100
∑X = 30 ∑Y = 326 ∑XY = 1288.5 ∑X2 = 122.50 ∑Y2 = 13696

We know that
(∑�)(∑�)
∑�� − �
�=
(∑�)� (∑�)�
�∑� � − �∑� � −
� �

����.��(��)(���)
�� 310.5
= =
(��)� (���)� 315.7
�122.5 − �13696 −
�� ��

=0.9835
The calculated coefficient of correlation r = 0.9835 shows that there is a high
degree of association between the sales and advertisement expenditure. For
this particular problem, it indicates that an increase in advertisement
expenditure is likely to yield higher sales. If the results of the calculation
show a strong correlation for the data, either negative or positive, then the
line of best fit to that data will be useful for forecasting (it is discussed in
Unit-16 on ‘Simple Linear Regression’).
Illustration-4
Calculate correlation coefficient for the data given in illustration 2.

145
Business Statistics Solution:
Table 15.4: Calculation of Correlation Coefficient

Observation No. X Y X2 Y2 ����

��
1 82 64 6724 4096 5248
2 70 40 4900 1600 2800
3 34 35 1156 1225 1190
4 80 48 6400 2304 3840
5 66 54 4356 2916 3564
6 84 56 7056 3136 4704
7 74 62 5476 3844 4588
8 84 66 7056 4356 5544
9 60 52 3600 2704 3120
10 86 82 7396 6724 7052
11 76 58 5776 3364 4408
12 76 66 5776 4356 5016
13 92 72 8464 5184 6624
14 72 46 5184 2116 3312
15 64 44 4096 1936 2816
16 86 76 7396 5776 6536
17 84 52 7056 2704 4386
18 60 40 3600 1600 2400
19 82 60 6724 3600 4920
20 90 60 8100 3600 5400
Total 1502 1133 116292 67141 87450

From Table 15.4 we note that:

ΣX 1502
�� = = = 75.1;
N 20
ΣY 1133
�� = = = 56.65;
N 20

1 (Σ�)� 1 (1502)�
σ__
� = �Σ� −
� = �116292 − = √174.59; = 13.21;
N � 20 20

1 (Σ�)� 1 1133�
σ__
� =
�Σ� � − = �67141 − = √147.83; = 12.16;
N � 20 20
146
 1 (ΣX)(ΣY) 1 1502 × 1133 Simple Linear
σ�y = �Σ�� − �= �87450 − � = 118.09 Correlation
N N 20 20
Thus using formula i.e.
σ��
�=
σ� σy
118.09
r= = 0.735
13.21 × 12.16
Now, let us use the another formula i.e.
(Σ�)(Σ�)
∑XY − �
�=
(Σ�)� (Σ�)�
�Σ� � − �Σ� � −
� �

87450 − 1502 × 1133

r= = 0.735
(����)� (����)�
��11292 − � ��67141 − �
�� ��

Thus, we see that both the formulae provide the same value of correlation
coefficient r.
Now, you can check yourself that the same value of coefficient of correlation
(r) is obtained by using the formula (1) as stated earlier. For this purpose you
need the values to be computed in the table 15.4 as follow with five columns.
(i) (� − ��) = ��; (ii) � − �� = ��; (iii) �� � ; (iv) �� � and, ����.

15.3.3 Spearman’s Rank Correlation

The Karl Pearson’s correlation coefficient, discussed above, is not applicable
in cases where the direct quantitative measurement of a phenomenon under
study is not possible. Sometimes we are required to examine the extent of
association between two ordinally scaled variables such as two rank
orderings. For example, we can study intelligence, efficiency, performance,
competitive events, attitudinal surveys etc. In such cases, a measure to
ascertain the degree of association between the ranks of two variables, X and
Y, is called Rank Correlation. It was developed by Edward Spearman, its
coefficient (R) is expressed by the following formula:
�∑� �
� = 1 − �� � � where, N = Number of pairs of ranks, and ∑�� = squares of
difference between the ranks of two variables.
The following example illustrates the computation of rank correlation
coefficient.
Illustration 5
Salesmen employed by a company were given one month training. At the end
of the training, they conducted a test on 10 salesmen on a sample basis who
were ranked on the basis of their performance in the test. They were then
posted to their respective areas. After six months, they were rated in terms of
their sales performance. Find the degree of association between them.
147
Business Statistics
1 2 3 4 5 6 7 8 9 10
Salesmen:
Ranks in training 7 1 10 5 6 8 9 2 3 4
(X):
Ranks on sales 6 3 9 4 8 10 7 2 1 5
Peformance (Y):

Solution: Table 15.5: Calculation of Coefficient of Rank Correlation.

Sales men Ranks Ranks Difference D2

Secured Secured in Ranks
in on Sales D = (X–Y)
Training Y
X
1 7 6 1 1
2 1 3 –2 4
3 10 9 1 1
4 5 4 1 1
5 6 8 –2 4
6 8 10 –2 4
7 9 7 2 4
8 2 2 0 0
9 3 1 4 4
10 4 5 –1 1
∑D2 = 24

Using the spearman’s formula, we obtain

6∑�� 6∑24
� =1− �
= 1− �
� − � 10 − 10
144
= 1− = 0.855
990
we can say that there is a high degree of positive correlation between the
training and sales performance of the salesmen.
Illustration 6
Table 15.6: Rank of 10 candidates by two Examiners.

S.No. Rank Given by Difference

Examiner 1 Examiner 2 D D2
1 6.0 6.5 –0.5 0.25
2 2.0 3.0 –1.0 1.00
3 8.5 6.5 2.0 4.00
148
 Simple Linear
4 1.0 1.0 0.0 0.00
Correlation
5 10.0 2.0 8.0 64.00
6 3.0 4.0 –1.0 1.00
7 8.5 9.5 –1.0 1.00
8 4.0 5.0 –1.0 1.00
9 5.0 8.0 –3.0 9.00
10 7.0 9.5 –2.5 6.25
∑D = 0 ∑D2 = 87.50

Like Karl Pearson's coefficient of correlation the Spearman's rank correlation

has a value + 1 for perfect matching of ranks, -1 for perfect mismatching of
ranks and 0 for the lack of relation between the ranks.
Sometimes the data, relating to qualitative phenomenon, may not be available
in ranks, but only in values. In such a situation it is necessary to assign the
ranks to the values. Ranks may be assigned by taking either from largest to
the smallest or vice versa. But the same method must be followed in case of
both the variables.
Sometimes there is a tie between two or more ranks in the first and/or second
series. For example, if the values of two items are same and presume that the
rank of one item may be 4th rank, then instead of awarding 4th rank to the
respective two observations, we award 4.5 [(4+5)/2] for each of the two
observations. Now we will take up an illustration to understand how to
award the ranks when the data is given in values and to calculate the rank,
correlation. The illustration will also give clarity how to award the ranks
when values of items in series are same.
Illustration 7
Calculate rank correlation from the following data related to a group of 10
students and percentage of marks secured.

Roll Nos. of the 21 22 23 24 25 26 27 28 29 30

students
% of marks in 45 66 55 45 80 75 50 55 60 45
statistics
% of marks in 70 81 75 75 70 85 65 80 45 60
Accountancy

Solution:
The above data was given in percentage of marks not in the ranks. Therefore,
for calculation of rank correlation, first, we have to assign the ranks to the
given values. As we discussed earlier the ranks may be assigned either from
the largest value to smallest value or visa-versa. Here, we assign the ranks
from largest to smallest value which is normally in practice.

149
Business Statistics Calculation of rank correlation:

Roll % of % of marks Ranks of % Ranks of Difference ��

Nos. marks in in of marks in Marks in in Ranks
statistics Accountanc Statistics Accountan D
y cy

21 45 70 9 6.5 2.5 6.25

22 66 81 3 2 1 1.00
23 55 75 5.5 4.5 1 1.00
24 45 75 9 4.5 4.5 20.25
25 80 70 1 6.5 −5.5 30.25
26 75 85 2 1 1 1.00
27 50 65 7 8 −1 1.00
28 55 80 5.5 3 2.5 6.25
29 60 45 4 10 −6 36.00
30 45 60 9 9 0 0
��=
103.00

��� � � ��� ���

� =1− �� � �
= 1 − ��� ��� = 1 − ��� = 1 − 0.10 = 0.90

Explanation of assigning ranks:

For the values of percentage of marks in statistics for 80, 75, 66, 60 there are
only single values. Therefore, ranks have been assigned 1,2,3,4. Whereas
the next value 55 repeated two times in the data, therefore, 5 + 6 ranks
divided by 2 = 5.5 rank has been allotted to the value of 55 two times.
Similarly, the value of 45 repeated three times in the data, therefore the ranks
8+9+10 divided by 3 equal to 9. Accordingly, the rank 9 has been allotted to
value of 45 (in between) value of 55, 45. There is a value of 50, hence rank
seven has been allotted to 50. In the same manner, you may try to observe the
assigning of ranks to the values of percentage of marks in accountancy.

Check Your Progress B

1) Compute the degree of relationship between price of share (X) and price
of debentures over a period of 8 years by using Karl Pearson’s formula.

Years: 1996 1997 1998 1999 2000 2001 2002 2003

Price of Shares: 42 43 41 53 54 49 41 55
Price of 98 99 98 102 97 93 95 94
debentures:

150
2) Consider the above exercise and assign the ranks to price of shares and Simple Linear
Correlation
price of debentures. Find the degree of association by applying
Spearman’s formula.

15.4 LET US SUM UP

In this unit, fundamental concepts, meaning and techniques of correlation (or
association) have been discussed. Scatter diagrams, which exhibit some
typical pattern indicating different kinds of relationships have been
illustrated. A scatter plot of the variables may suggest that the two variables
are related but the value of the Karl Pearson’s correlation coefficient (r)
quantifies the degree of this association. The closer the relation coefficient is
to ± 1.0, the stronger the linear relationship between the two variables.
Spearman’s rank correlation for data with rank is outlined. Finally, we
discussed the procedure of assigning the ranks to the variables, if the data is
in the values for computation of Rank correlation.

15.5 KEY WORDS

Correlation Analysis: Refer to a measure of association between two
random variables. If two random variables have been such that when one gets
changed the other will do so in a related manner, they are regarded to be
correlated. Variables which are independent are not correlated. The
correlation coefficient is a number between –1 and +1. It could be calculated
from a number of pairs of observations which are normally referred to a
points (x, y) a coefficient of 1 implies perfect positive correlation, -1 perfect
negative correlation and 0 no correlation.
Rank Correlation Coefficient: There happen to be many occasions when it
may not be convenient, economic or even possible to give value to variables.
However, various items can be ranked. In such cases, a rank correlation
coefficient may be used.
Scatter Diagram: A diagram showing the joint variation of two variables X
and Y. Each member is represented by a point whose coordinates, on
ordinary rectangular axes, are the values of the variables. A set of n
observations thus provides n points on the diagram and the scatter or
clustering of the points exhibits the relationship between X and Y.

15.6 ANSWERS TO SELF ASSESSMENT

EXERCISES
B) 1. �� = −0.071
2. R = –0.185

15.7 TERMINAL QUESTIONS/EXERCISES

1) What do you understand by the term correlation? Distinguish between
different types of correlation with the help of scatter diagrams?
151
Business Statistics 2) Explain the difference between Karl Pearson’s correlation co-effiecient
and spearsman’s rank correlations co-efficient. Under what situations,
in the latter preferred to the former?
3) With the help of an example, explain the procedure you would follow
in assigning the ranks when the data as given in values and same values
of the observations are common.
4) Calculate the co-efficient of correlation for the ages of husband and
wife:

Age of 23 27 28 29 30 31 33 35 36 39
husband
Age of wife 18 22 23 24 25 26 28 29 30 32

5) Determine the correlation coefficient between x and y

x 5 7 9 11 13 15
y 1.7 2.4 2.8 3.4 3.7 4.4

6) Ten students obtained the following marks in the mathematics and

statistics. Calculate the rank correlation coefficient:

Student 1 2 3 4 5 6 7 8 9 10
Marks in 78 36 98 25 75 82 90 62 65 39
Mathematics
Marks in 84 51 91 60 68 62 86 58 53 47
statistics

7) Ten competitors in a musical contest were ranked by 3 judges, A, B and

C in the following order:

Competitors: 1 2 3 4 5 6 7 8 9 10
Rank by A 1 6 5 10 3 2 4 9 7 8
Rank by B 3 5 8 4 7 10 2 1 6 9
Rank by C 6 4 9 8 1 2 3 10 5 7

Using rank correlation method, discuss which pair of judges has the nearest
approach to common liking in music.

15.8 FURTHER READINGS

A number of good text books are available for the topics dealt with in this
unit. The following books may be used for more indepth study.
Richard I. Levin and David S. Rubin, 1996, Statistics for Management.
Prentice Hall of India Pvt. Ltd., New Delhi.

152
Peters, W.S. and G.W. Summers, 1968, Statistical Analysis for Business Simple Linear
Correlation
Decisions, Prentice Hall, Englewood-cliffs.
Hooda, R.P., 2000, Statistics for Business and Economics, MacMillan India
Ltd., New Delhi.
Gupta, S.P. 1989, Elementary Statistical Methods, Sultan Chand & Sons:
New Delhi.
Chandan, J.S. - Statistics for Business and Economics, Vikas Publishing
House Pvt. Ltd., New Delhi.

153
Business Statistics
UNIT 16 SIMPLE LINEAR REGRESSION
Structure
16.0 Objectives
16.1 Introduction
16.2 The Concept of Regression
16.3 Simple Linear Regression Equations
16.3.1 Estimating the Linear Regression: Two Variable Case
16.3.2 Simple Linear Regression Equations
16.3.3 Using Regression for Prediction
16.3.4 Method of Least Squares
16.4 Relationship between Correlation, Coefficient and Regression.
16.5 Difference between Correlation and Regression
16.6 Let Us Sum up
16.7 Key Words
16.8 Answers to Check Your Progress Exercises
16.9 Terminal Questions
16.10 Further Reading

16.0 OBJECTIVES
After going through this unit, you shall be able to:
• explain the concept of regression
• estimate the linear regression
• explain the method of least squares
• apply linear regression methods to given data
• use regression equations for predictions; and
• identify the relationship and difference between correlation and
regression coefficient

16.1 INTRODUCTION
In the previous unit we have learnt about simple linear correlation and
understood that correlation tells whether exists a relationship between two
variable or not but it does not reflect cause and effect relationship between
two variables. Therefore, we cannot predict the value of one variable for a
given value for other variable. This limitation is removed by regression
analysis. In regression analysis, the relationship between variable are
expressed in the form of a mathematical equation. It is assumed that one
variable is cause and the other is the effect. Please note that regression is a
statistical tool which helps understand the relationship between variables and
predicts the unknown values of the dependent variable from known values of
the independent variable.

154
 Simple Linear
16.2 THE CONCEPT OF REGRESSION Regression

In regression analysis we have two types of variables: i) dependent (or

explained) variable, and ii) independent (or explanatory) variable. As the
name (explained and explanatory) suggests the dependent variable is
explained by the independent variable.
In the simplest case of regression analysis there is one dependent variable and
one independent variable. Let us assume that consumption expenditure of a
household is related to the household income. For example, it can be
postulated that as household income increases, expenditure also increases.
Here, consumption expenditure is the dependent variable and household
income is the independent variable.
Usually we denote the dependent variable as Y and the independent variable
as X. Suppose we took up a household survey and collected n pairs of
observations in X and Y. The next step is to find out the nature of
relationship between X and Y
The relationship between X and Y can take many forms. The general practice
is to express the relationship in terms of some mathematical equation. The
simplest of these equations is the linear equation. This means that the
relationship between X and Y is in the form of a straight line and is termed
linear regression. When the equation represents curves (not a straight line)
the regression is called non-linear or curvilinear.
Now the question arises, ‘How do we identify the equation form?’ There is
no hard and fast rule as such. The form of the equation depends upon the
reasoning and assumptions made by us. However, we may plot the X and Y
variables on a graph paper to prepare a scatter diagram. From the scatter
diagram, the location of the points on the graph paper helps in identifying the
type of equation to be fitted. If the points are more or less in a straight line,
then linear equation is assumed. On the other hand, if the points are not in a
straight line and are in the form of a curve, a suitable non-linear equation
(which resembles the scatter) is assumed.
We have to take another decision, that is, the identification of dependent and
independent variables. This again depends on the logic put forth and purpose
of analysis: whether ‘Y depends on X’ or ‘X depends on Y’. Thus there can
be two regression equations from the same set of data. These are: i) Y is
assumed to be dependent on X (this is termed ‘Y on X’ line), and ii) X is
assumed to be dependent on Y (this is termed ‘X on Y’ line).
You may by now be wondering why the term ‘regression’, which means
‘reduce’. This name is associated with a phenomenon that was observed in a
study on the relationship between the stature of father (x) and son (y). It was
observed that the average stature of sons of the tallest fathers has a tendency
to be less than the average stature of these fathers. On the other hand, the
average stature of sons of the shortest fathers has a tendency to be more than
the average stature of these fathers. This phenomenon was called regression
towards the mean. Although this appeared somewhat strange at that time, it
was found later that this is due to natural variation within subgroups of a
155
Business Statistics group and the same phenomenon occurred in most problems and data sets.
The explanation is that many tall men come from families with average
stature due to vagaries of natural variation and they produce sons who are
shorter than them on the whole. A similar phenomenon takes place at the
lower end of the scale. Let us discuss simple linear regression.

16.3 SIMPLE LINEAR REGRESSION

When we identify the fact that the correlation exists between two variables,
we shall develop an estimating equation, known as regression equation or
estimating line, i.e., a methodological formula, which helps us to estimate or
predict the unknown value of one variable from known value of another
variable. In the words of Ya-Lun-Chou, “regression analysis attempts to
establish the nature of the relationship between variables, that is, to study the
functional relationship between the variables and thereby provide a
mechanism for prediction, or forecasting.” For example, if we confirmed that
advertisement expenditure (independent variable), and sales (dependent
variable) are correlated, we can predict the required amount of advertising
expenses for a given amount of sales or vice-versa. Thus, the statistical
method which is used for prediction is called regression analysis. And, when
the relationship between the variables is linear, the technique is called simple
linear regression.
Hence, the technique of regression goes one step further from correlation and
is about relationships that have been true in the past as a guide to what may
happen in the future. To do this, we need the regression equation and the
correlation coefficient. The latter is used to determine that the variables are
really moving together.
The objective of simple linear regression is to represent the relationship
between two variables with a model of the form shown below:
Y = β0 + β1 X+ ei
wherein
Y = value of the dependent variable,
β0 = Y-intercept,
β1 = slope of the regression line,
X = value of the independent variable,
ei = error term (i.e., the difference between the actual Y value and the
value of Y predicted by the model.
i = represents the observation number, ranges from 1 to n. Thus Y3 is
the third observation of the dependent variable and X6 is the sixth
observation of the independent variable.

16.3.1 Estimating The Linear Regression: Two Variable

Case
If we consider the two variables (X variable and Y variable), as discussed
earlier, we shall have two regression lines. They are:
i) Regression of Y on X
ii) Regression of X on Y.
156
The first regression line (Y on X) estimates value of Y for given value of X. Simple Linear
Regression
The second regression line (X on Y) estimates the value of X for given value
of Y. These two regression lines will coincide, if correlation between the
variable is either perfect positive or perfect negative.
Illustration 1
The amount of rainfall and agricultural production for ten years are given in
Table 16.1
Table 16.1 Rainfall and Agricultural Production

Rainfall (in mm) Agricultural Production

(in tonnes)
60 33
62 37
65 38
71 42
73 42
75 45
81 49
85 52
88 55
90 57

X
Figure 16.1 Scatter Diagram

We plot the data on a graph paper. The scatter diagram looks something like
Figure 16.1 we observe from figure 16.1 that the prints do not like strictly on
a straight line. But they show an upward rising tendency where a straight
line on the fitted. Let us draw the regression line along with the scatter plot.

157
Business Statistics

X
Figure 16.2

When we draw the regression lines with the help of a scatter diagram as
shown earlier in Fig. 16.1, we may get an infinite number of possible
regression lines for a set of data points. We must, therefore, establish a
criterion for selecting the best line. The criterion used is the Least Squares
Method. According to the least squares criterion, the best regression line is
the one that minimizes the sum of squared vertical distances between the
observed (X, Y) points and the regression line, i.e., Σ(� − ��)� is the least
value and the sum of Σ�� − ��� = 0. It is important to note that the distance
between (X, Y) points and the regression line is called the ‘error’.

16.3.2 Simple Linear Regression Equations

As we discussed above, there are two regression equations, also called
estimating equations, for the two regression lines (Y on X, and X on Y).
These equations are, algebraic expressions of the regression lines, expressed
as follows:

Regression Equation of Y on X

�� = � + ��
where, �� is the computed values of Y (dependent variable) from the
relationship for a given X, ‘a’ and ‘b’ are constants (fixed values), ‘a’
determines the level of the fitted line at Y-axis (Y-intercept), ‘b’ determines
the slope of the regression line, X represents a given value of independent
variable.

The alternative simplified expression for the above equation is:

�� − �� = ��� (� − ��)

(Σ�)(Σ�)
�� (Σ��) −
�
��� = � = �
�� (Σ �)
Σ� � − �
158
Regression equation of X on Y Simple Linear
Regression
�� = � + ��

Alternative simplified expression is:

(Σ�)(Σ�)
�� Σ�� − �
��� = � = �
�� (Σ �)
Σ� � − �

It is worthwhile to note that the estimated simple regression line always

passes through �� and ��. The following illustration shows how the estimated
regression equations are obtained, and hence how they are used to estimate
the value of Y for given X value.

Illustration 2
From the following 12 months sample data of a company, estimate the
regression lines.
(Rs. in lakh)
Advertisement
Expenditure: 0.8 1.0 1.6 2.0 2.2 2.6 3.0 3.0 4.0 4.0 4.0 4.6
Sales: 22 28 22 26 34 18 30 38 30 40 50 46

Solution:

Table 16.2: Calculations for Least Square Estimates of a Company.

(Rs. in lakh)
Advertising Sales
(X) (Y) XY
�� ��
0.8 22 0.64 484 17.6
1.0 28 1.00 784 28.0
1.6 22 2.56 484 35.2
2.0 26 4.00 676 52.0
2.2 34 4.84 1156 74.8
2.6 18 6.76 324 46.8
3.0 30 9.00 900 90.0
3.0 38 9.00 1,444 114.0
4.0 30 16.00 900 120.0
4.0 40 16.00 1600 160.0
4.0 50 16.00 2,500 200.0
4.6 46 21.16 2,116 211.6

ΣX=32.8 ΣY=384 Σ� � =106.96 Σ� � =13368 ΣXY-1150.0

159
Business Statistics Now we establish the best regression line (estimated by the least square
method).

i) We know the regression equation of Y on X is:

�� − �� = ��� (� − ��)

384 32.8
�� = = 32; �� = = 2.733
12 12
(Σ�)(Σ�)
Σ�� − �
��� =
(Σ�)�
Σ� � − �

(��.�)(���)
1,150 − ��
= = 100.4/17.31 = 5.8
(��.�)�
106.96 − ��
Now Y on X equation is �� − �� = ��� (�� − ��)
�� − 32 = 5.8 (� − 2.733)
�� = 5.8 � − 15.85 + 32 = 5.8 � + 16.15
Or �� = 16.15 + 5.8�

which is shown in Figure 16.2. Note that, as said earlier, this line passes
through �� (2.733) and �� (32).

ii) We know the regression equation of X on Y is

�� − �� = ��� (� − ��)

(�)(�) (��.�)(���)
�� Σ�� − �
1,150 − �� 100.4
��� = � = � = = = 0.093
�� (Σ �) (���)� 1,080
Σ� � − � 13368 − ��
Now X on Y equation is :
�� − 2.733 = 0.093 (� − 32)
�� − 2.733 = 0.093� − 2.976
�� = 2.733 − 2.976 − 0.093�
�� = −0.243 + 0.093�
We have the values of �� = 2.733 and �� = 32
Now we calculate the bxy value:
(Σ�)(Σ�)
Σ�� − �
��� =
(Σ�)�
Σ� � − �

160
 Simple Linear
Regression

Figure 16.2: Least Squares Regression Line of a Company’s Advertising Expenditure

and Sales.

It is worthwhile to note that the relationship displayed by the scatter diagram

may not be the same if the estimating equation is extended beyond the data
points (values) considered in computing the regression equation.

16.3.3 Using Regression for Prediction

Regression, a statistical technique, is used for predictive purposes in
applications ranging from predicting demand sales to predicting production
and output levels. In the above illustration 2, we obtained the regression
models of the company. With these models estimate: i) the value of sales
when the company decided to spend Rs. 2,50,000 on advertising, and ii) the
cost of advertisement when the company desires to reach the target of Rs. 50
Lakhs during the next quarter.
Solution:
i) To find �� , the estimate of expected sales, we substitute the specified
advertising level into the regression model. For example, if we know
that the company’s marketing department has decided to spend Rs.
2,50,000/- (X = 2.5) on advertisement during the next quarter, the most
likely estimate of sales (��) is :
�� = 16.15 + 5.8 (2.5) = 30.65
= Rs. 30,65,000
Thus, an advertising expenditure of Rs. 2.5 lakh is estimated to
generate sales for the company to the tune of Rs. 65,000.
161
Business Statistics ii) To find ��, the estimate cost of advertisement, when company desires to
get the target of Rs. 50 lakhs sales during next quarter, the most likely
estimation of advertisement cost (��) is:
�� = −0.25 + 0.093 (50)
= −0.25 + 4.65 = 4.4
= Rs. 4,40,000.
Thus, the target sales of Rs. 50,00,000/- may be achieved with the estimated
cost of Rs. 4,40,000 on advertisement.

Check Your Progress A

You are given the following data relating to age of Autos and their
maintenance costs. Obtain the two regression equations by the method of
least squares and estimate the likely maintenance cost when the age of Auto
is 5 years.

Age of Auto (years) : 2 4 6 8

Maintainance Cost (Rs.00) : 10 20 25 30

16.3.4 Method of Least Squares

As discussed earlier that in the method of scattered diagram, we may get
infinite numbers of possible regression lines for a set of data points.
Therefore, it is necessary to establish a criterion for selecting the next line.
The criterion used in the Least Square Method under this method ∑(� − ��)2
is the least value and ∑(� − ��) is zero.
As we know the basic equation of least square method that y on x equation is:
�� = � + �� and x on y equation is �� = � + ��.
We can obtain the values of the coefficient a and b of the least square
regression line through the following equations:
∑� = �� + �∑�……… (i)
∑�� = �∑� + �∑� � ……… (ii)
Let us take the following illustration for formulation of best regression lines
i.e. least square regression lines.
Illustration – 3:
Assume that quantity of agricultural production depends on the amount of
rainfall and fit a linear regression to the data given.

Rainfall (in : 60 62 65 71 73 75 81 85 88 90
mm)
Agricultural : 33 37 38 42 42 45 49 52 55 57
Production
(in tones)

162
In this case dependent variable (Y) is quantity of agricultural production and Simple Linear
Regression
independent variable (X) is amount of rainfall. The regression equation to be
fitted is
�� = � + ���
For the above equation we find out the normal equations by the method of
least squares. Next we construct a table as follows:
Table 16.3: Computation of Regression Line
� � �� �� �� � − ��
60 33 3600 1980 33.85 -0.85
62 37 3844 2294 35.34 1.66
65 38 4225 2470 37.57 0.43
71 42 5041 2982 42.03 -0.03
73 42 5329 3066 43.51 -1.51
75 45 5625 3375 45.00 0.00
81 49 6561 3669 49.46 -0.46
85 52 7225 4420 52.43 -0.43
88 55 7744 4840 54.66 0.34
90 57 8100 5130 56.15 0.85

∑� = ��� ∑� = ��� ∑�
2
= ����� ∑�� = ����� � = ���
∑� ∑� � = �

Now we will solve the following equation

∑� = �� + �∑�……… (i)
∑�� = �∑� + �∑� � ……… (ii)
By substituting values from the above table (16.3) in the above normal
equation (i) and (ii), we will get following
450 = 10� + 750� ………… (iii)
34, 526 = 750� + 57,294� ……. (iv)
Before substituting the above values of the two equations (iii & iv) we have
to adjust the value connected with either a or b coefficient as equal by the
value of suitable multiplier.
Here, if we multiply the equation (iii) with the value 75 we may equalize the
value connected with coefficient a, we will get:
450 = 10� + 750� × 75
33,750 = 750� + 56,250� (adjusted of iii)
(-) 34,526 = 750� + 57,294� (�� (��)
– 776 = . – 1,044 b
����
Now, � = ��,��� = 0.743
163
Business Statistics We will find the value of coefficient a by considering the equation (iii) above
i.e.
450 = 10� + 750 (0.743)
450 = 10� + 557.25
−10� = 557.25 − 450
107.25
�= = −10.73
−10
So the regression line is �� = –10.73 + 0.743�.
Notice that the sum of errors ∑�� for the estimated regression equation is zero
(see the last column of Table 16.3).
The computation given in Table 16.3 often involves large numbers and poses
difficulty. Hence we have a short-cut method for calculating the values of a
and b from the normal equations.
Under this shortcut method:
� = �� − ���
� = ∑��/∑� �
Here, the denotion � = � − �� means deviation of X (independent variable)
from the value of ��
The denotion � = � − �� means the deviation of Y (dependent variable) from
the ��.
Hence �� = (� − ��)( � − ��)
Since these formulae are derived from the normal equations we get the same
values for a and b in this method also. For the data given we compute the
values of a and b by this method. For this purpose we construct Table 16.4.
Table 16.4 Computation of Regression Line (short-cut method)
� � (� − ��) ( � − ��) � − �� ��
60 33 –15 –12 225 180
62 37 –13 –8 169 104
65 38 –10 –7 100 70
71 42 –4 –3 16 12
73 42 –2 –3 4 6
75 45 0 0 0 0
81 49 6 4 36 24
85 52 10 7 100 70
88 55 13 10 136 130
90 57 15 12 225 180
Total 750 450 0 0 1044 776

164
 Simple Linear
750 750 Regression
�� = = 75 ��� �� = = 45
10 10
∑���� �� 776
�= � �= = 0.743
∑��� � 1044
� = �� − ��� = 45 − 0.743 × 75 = −10.73
Thus the regression line in this method also �� = – 70.73 + 0.743�
Coefficient b is called the regression coefficient. This coefficient reflects the
amount of increase in Y when there is a unit increase in X. In regression
equation the coefficient b = 0.743 implies that if rainfall increase by 1 mm.
agricultural production will increase 0.743 thousand tonne.
You might have observed that, it may be noted, this short cut method is the
easiest for calculation only when the arithmetic mean of both X and Y series
are having absolute value (10, 25,32 etc.) not in fraction value (i.e. 10.62,
53.12, 83.95 etc.).

Check you Progress B

From the following data, obtain the two regression equation by Least squares
method and estimate the sales if the purchases are 95 lakhs. The data is Rs.
In lakhs.

Sales : 91 97 108 121 67 124 51 73 111 57

Purchases : 71 75 69 97 70 91 39 61 80 47

16.4 RELATIONSHIP BETWEEN

CORRELATION AND REGRESSION
COEFFICIENTS
The following points about the regression should be noted:
1) The geometric mean of the two regression coefficients (byx and bxy)
gives coefficient of correlation.
That is, r = ±�(bxy) (byx)
Consider the values of regression coefficients from the previous
illustration to know the degree of correlation between advertising
expenditure and sales.
r = ±√0.093 × 5.801 = 0.734
2) Both the regression coefficients will always have the same sign (+ or –).
3) Coefficient of correlation will have the same sign as that of regression
coefficients. If both are positive, then r is positive. In case both are
negative, r is also negative. For example, bxy = –1.3 and byx = –0.65,
then r is:
±√−1.3x − 0.65 = − 0.919 but not + 0.919

165
Business Statistics 4) Regression coefficients are independent of change of origin, but not
of scale.

16.5 DIFFERENCE BETWEEN CORRELATION

AND REGRESSION
After having an understanding about the concept and application of simple
correlation (discussed in unit 15) and simple regression, we can draw the
difference between them. They are:
1) Correlation coefficient ‘r’ between two variables (X and Y) is a measure
of the direction and degree of the linear relationship between them,
which is mutual. It is symmetric (i.e., ��� = ��� ) and it is inconsiderable
which, of X and Y, is dependent variable and which is independent
variable. Whereas regression analysis aims at establishing the functional
relationship between the two variables under study, and then using this
relationship to predict the value of the dependent variable for any given
value of the independent variable. It also reflects upon the nature of the
variables (i.e., which is the dependent variable and which is independent
variable). Regression coefficients, therefore, are not symmetric in X and
Y (i.e., ��� ≠ ��� ).

2) Correlation need not imply cause and effect relationship between the
variables under study. But regression analysis clearly indicates the cause
and effect relationship between the variables. The variable corresponding
to cause is taken as independent variable and the variable corresponding
to effect is taken as dependent variable.
3) Correlation coefficient ‘r’ is a relative measure of the linear relationship
between X and Y variables and is independent of the units of
measurement. It is a number lying between ±1. Whereas the regression
coefficient byx (or bxy) is an absolute measure representing the change
in the value of the variable Y (or X) for a unit change in the value of the
variable X (or Y). Once the functional form of the regression curve is
known, by susbstituting the value of the dependent variable we can
obtain the value of the independent variable which will be in the unit of
measurement of the variable.
4) There may be spurious (non-sense) correlation between two variables
which is due to pure chance and has no practical relevance. For example,
the correlation between the size of shoe and the income of a group of
individuals. There is no such thing as spurious regression.
5) Correlation analysis is confined only to study of linear relationship
between the variables and, therefore, has limited applications. Whereas
regression analysis has much wider applications as it studies linear as
well as non-linear relationships between the variables.

16.6 LET US SUM UP

In this unit, fundamental concepts and techniques of simple linear regression
166 have been discussed i.e.in case of two variables only.
Once it is identified that correlation exists between the variables, an Simple Linear
Regression
estimating equation known as regression equation could be developed by the
least squares method for prediction. Relationship between correlation and
regression coefficient and the conceptual differences between correlation and
regression have been highlighted. The techniques of regression analysis are
widely used in business decision making and data analysis.

16.7 KEY WORDS

Linear Relationship: The relationship between two variables described by a
straight line.
Least Squares Criterion: The criterion for determining a regression line that
minimizes the sum of squared errors.
Simple Regression Analysis: A regression model that uses one independent
variable to explain the variation in the dependent variable.

16.8 ANSWERS TO CHECK YOUR PROGRESS

A) � �� � ∶ �� = 5 + 3.25�
� �� � ∶ �� = −3 + 0.297�
B) Y = 14.81 + 0.613x
X = -5.2 + 1.36y
Estimation = Rs. 124 lakhs

16.9 TERMINAL QUESTIONS

1) What do you understand by the term regression? Explain its
significance.
2) Distinguish between correlation and regression.
3) Discuss about least square method.
4) A personal manager of a firm is interested in studying as to how the
number of worker absent on a given day is related to the average
temperature on that day. A random sample of 12 days was used for
the study. The data is given below:
No. of Workers
absent 6 4 8 9 3 8 5 2 4 10 7 6
Average
temperature (0C) 12 30 15 18 40 30 45 35 23 15 25 35
a). State the independent variable and dependent variable.
b). Draw a scatter diagram.
c). Determine the regression lines (i) X on Y and (ii) Y on X
5) The following table gives the demand and price for a commodity for 6
days.
167
Business Statistics Price (Rs.): 4 3 6 9 12 10
Demand (mds): 46 65 50 30 15 25
a) Develop the estimating regression equations.
b) Predict demand for price (Rs.) = 5,8 and 11.
6) A sales manager of a soft drink company is studying the effect of its
latest advertising campaign. People chosen at random were called and
asked how many bottles they had bought in the past week and how
many advertisements of this product they had seen in the past week.

No. of ads (X) 4 0 2 7 3 4 2 6

Bottles
Purchased (Y) 6 5 4 16 10 9 6 14
a). Develop the regression equations that best fits the data through
the method of least squares.
b). Predict Y value when X = 78.
c). Predict X value when Y = 20.
7) Obtain the lines of regression from the following data.

X 25 22 28 26 35 20 22 40 20 18
Y 18 15 20 17 22 14 16 21 15 14

i) Estimate the value of Y if the value of X is 25, and

ii) Estimate the value of X if the value of Y is 45.

Note: These questions/exercises will help you to understand the unit better.
Try to write answers for them. But do not submit your answers to the
university for assessment. These are for your practice only.

16.10 FURTHER READINGS

A number of good text books are available for the topics dealt with in this
unit. The following books may be used for more indepth study.
Richard I. Levin and David S. Rubin, 1996, Statistics for Management.
Prentice Hall of India Pvt. Ltd., New Delhi.
Peters, W.S. and G.W. Summers, 1968, Statistical Analysis for Business
Decisions, Prentice Hall, Englewood-cliffs.
Hooda, R.P., 2000, Statistics for Business and Economics, MacMillan India
Ltd., New Delhi.
Gupta, S.P. 1989, Elementary Statistical Methods, Sultan Chand & Sons:
New Delhi.
Chandan, J.S. - Statistics for Business and Economics, Vikas Publishing
House Pvt. Ltd., New Delhi.

168
 Index Number
UNIT 17 INDEX NUMBERS
Structure
17.0 Objectives
17.1 Introduction
17.2 Meaning and Concept of Index Numbers
17.2.1 Characteristics of Index Number
17.3 Uses of Index Numbers
17.4 Issues in Construction of Index Numbers
17.5 Classification of Index Numbers
17.6 Methods of Constructing Numbers
17.6.1 Unweighted Index Numbers
17.6.2 Weighted Index Numbers
17.7 Tests for Index Numbers
17.7.1 The Time Reversal Test
17.7.2 The Factor Reversal Test
17.8 Consumer Price Index Number (CPI)
17.9 Let Us Sum Up
17.10 Key Words
17.11 Answers to Self Assessment Questions
17.12 Terminal Questions/ Exercises
17.13 Further Reading

17.0 OBJECTIVES
After studying this unit, you should be able to:
• define and explain the meaning of Index numbers,
• discuss the characterstics and uses of Index numbers
• identify and avoid various issues faced while developing index numbers
for some special purposes,
• discuss the classification of index numbers
• construct and calculate index numbers applying different methods, and
• describe the limitations of index numbers to avoid errors in
interpretations.

17.1 INTRODUCTION
In the previous block-5 we have learnt how to calculate the statistical data
relating bi-variant in nature by applying the statistical devices. They are
simple linear correlation and simple linear regression which provide to
establish the relationship between the two variables. In this unit we shall
discuss the methods of constructing various types of index numbers for
different purposes. This device is an extension of the time series analysis
169
Business Statistics because an index number combines two or more time series variables related
to non-comparable units. You would have read in newspapers or heard on the
television/the radio that the cost of living index has increased by so many
points, hence for government employees another slab of Dearness Allowance
has been declared. Probably you might have wondered what is this cost of
living index?
Many of you must also be aware of the Stock Exchange Share Price Index –
commonly referred to as BSE SENSEX or, more recently, NSE SENSEX. In
fact, these various types of index series have come to be used in many
activities such as industrial production, export, prices, etc. In this Unit, you
will study and understand the meaning and uses of index numbers, various
problems resulting from the incorrect use of index numbers, methods for
construction of various index numbers, and their limitations.

17.2 MEANING AND CONCEPT OF INDEX

NUMBERS
When we talk that the general level of industrial production has registered an
increase of 4 per cent, it is obvious that we are referring to the production of
all those items that are produced by the industrial sector. However,
production of some of these items may be increasing while that of others may
be decreasing or may remain constant. The rate of increase or decrease and
the units in which these items are expressed may differ. For instance, cement
may be quoted per kg, cloth may be per meters, cars may be per unit etc. In
such a situation, when the purpose is to measure the changes in the average
level of prices or production of industrial products for comparing over a time
or with respect to geographic location, it is not appropriate to apply the
technique of measure of central tendency because it is not useful when series
are expressed in different units or/and in different items.
It is in these situations, that we need a specialised average, known as index
numbers. These are often termed as ‘economic barometers’.
An index number may be defined as a special average which helps in
comparison of the level of magnitude of a group of related variables under
two or more situations.
Index numbers are a series of numbers devised to measure changes over a
specified time period (the time period may be daily, weekly, monthly, yearly,
or any other regular time interval), or compare with reference to one variable
or a group of related variables. Thus, each number in a series of specified
index number is:
a) A pure number i.e., it does not have any unit.
b) Calculated according to a pre-determined formula.
c) Generated at regular time intervals, sometimes during the same time
interval at different places.
d) The regular generation of numbers form a chronological series.

170
e) With reference to some specified period and number known as base Index Number

period and base number, the latter is always 100. For example, if the
consumer price index, with base year 1996 is calculated to be 180 for
the year 2003, it means that consumer prices have increased by 80 per
cent in 2003 as compared to the prices prevalent in 1996.

17.2.1 Characteristics of Index Number

Main Characteristics of the measurement of Index number is as follows:
1) Relative measurement
2) Specialized average
3) Measurement of changes not capable of direct measurement
4) Measurement of common characteristics of a group of items
5) Comparison on the basis of time or place
6) Expressed in percentage
7) Universal use
1) Relative measurement: Index number are used for comparing relative
change in a variable or group of variables at different point of time or
place.
2) Specialized average: Index number is a special type of average that
provides a measurement of relative changes in a variable or group of
variables.
3) Measurement of changes not capable of direct measurement: with
the help of index number, we can measure the changes in magnitude
which are not capable in direct measurement due to their complex
nature.
4) Measurement of common characteristics of a group of items: Index
express the common characteristics of a group of items change in index
does not always mean that there is a change in all the variables for
example, an increase in price index does not mean that price of all the
commodities are increased.
5) Comparison on the basis of time or place: Index number is used to
measure the relative changes either on the basis of time or on the basis
of place for example production of wheat in Uttar Pradesh for two
different period or production of wheat in Uttar Pradesh and Haryana in
the same period.
6) Expressed in percentage: Index numbers are expressed in percentages
to show the relative change through the sign of percentage (%) is never
used.
7) Universal use: The technique of Index number is being used
extensively in all the fields now a days be it changes in production,
trade, etc.

171
Business Statistics
17.3 USES OF INDEX NUMBERS
Though originally the index number was developed for measuring the effect
of change in prices, today they have become indispensable for analyzing the
data related to business and economic activity. This statistical tool can be
used in several ways as follows:
1) Decision makers use index numbers as part of intermediate
computations to understand other information better. Nominal income
can be transformed into real income. Similarly, nominal sales into real
sales & so on …, through an appropriate index number. Consumer
price index, also known as cost of living index, is arrived at for a
specified group of consumers in respect of prices of specific
commodities and services which they usually purchase. This index
serves as an indicator of ‘real’ wages (or income) of the consumers. For
example, an individual earns Rs. 100/- in the year 1970 and his
earnings increase to Rs. 300/- in the year 1980. If during this period,
consumer price index increases from 100 to 400 then the consumer is
not able to purchase the same quantity of different commodities with
Rs. 300, which he was able to purchase in the year 1970 with his
income of Rs. 100/-. This means the real income has declined. Thus
real income can be calculated by dividing the actual income by dividing
the consumer price index:
������ ������ �� 1980
���� ������ �� 1980 = × 100
�������� ����� ����� �� 1980
���
= ��� × 100 = ��. 75/− with respect to 1970 as base year

Therefore, the consumer’s real income in the year 1980 is Rs. 75/- as
compared to his income of Rs. 100/- in the year 1970. We can also say
that because of price increase, even though his income has increased,
his purchasing power has decreased.
2) Different types of price indices are used for wage and salary
negotiations, for compensating in price rise in the form of DA
(Dearness Allowance).
3) Various indices are useful to the Government in framing policies. Some
of these include taxation policies, wage and salary policies, economic
policies, custom and tariffs policies etc.
4) Index numbers can also be used to compare cost of living across
different cities or regions for the purpose of making adjustments in
house rent allowance, city compensatory allowance, or some other
special allowance.
5) Indices of Industrial Production, Agricultural Production, Business
Activity, Exports and Imports are useful for comparison across
different places and are also useful in framing industrial policies,
import/export policies etc.

172
6) BSE SENSEX is an index of share prices for shares traded in the Index Number

Bombay Stock Exchange. This helps the authorities in regulating the

stock market. This index is also an indicator of general business
activity and is used in framing various government policies. For
example, if the share prices of most of the companies comprising any
particular industry are continuously falling, the government may think
of changes in its policies specific to that industry with a view to helping
it.
7) Sometimes, it is useful to correlate index related to one industry to the
index of another industry or activity so as to understand and predict
changes in the first industry. For example, the cement industry can keep
track of the index of construction activity. If the index of construction
activity is rising, the cement industry can expect a rise in demand for
cement.
8) If you are informed that the price of one kilogram sunflower oil was
Rs.0.50 per kg. in the year 1940 and in the year 1980 it was Rs. 30 and
in the year 2004 it is reported to be Rs. 70, per kg in the year 2018 the
price was Rs. 160 per kg, and if you are asked this question: shall
sunflower oil be sold again in the future for either Rs.0.50 or Rs. 30 or
Rs. 70 per kg? Surely, you answer would be ‘No’.

17.4 ISSUES IN CONSTRUCTION OF INDEX

NUMBERS
There are three major issues which may be faced in the construction of index
numbers. They are: 1) Collection of Data; 2) Selection of Base Year and 3)
Selection of Appropriate Index. Let us discuss them in detail:
1) Collection of Data: Data collection through a sample method is one of
the issues in the construction of index numbers. The data has to be as
reliable, adequate, accurate, comparable, and representative, as
possible. Here a large number of questions need to be answered. The
answers ultimately depend on the purpose and individual judgement.
For example, one needs to decide the following:
i) Identification of Commodities to be Included: How many and
which category of commodities to include? A large number of
items may be present. It is not possible to include all of them,
only those items deserve to be included in the construction of an
index number as would make it more representative. For
example, if we are required to construct indices for shares on the
Bombay Stock Exchange, there are several shares listed and
traded, it is not possible to include all of them. Therefore, it has to
be decided which sample number of shares (may be 30 or 40)
should represent the general movement of share prices of the
Bombay Stock Exchnage. Therefore, it is worthwhile to note that
the selection of items must be deliberate and in keeping with the
relevance and significance of each individual item to the purpose
for which the index is constructed.
173
Business Statistics ii) Sources of Data: From where to collect data? It is an important and
difficult issue. The source depends on the information requirement. For
example, one may need to collect prices and quantities consumed
related to certain commodities for a consumer price index. However,
there may be a large number of retailers and wholesalers, selling the
commodities, and quoting different prices. To get the details, only a
few representative shops (which represent the typical purchasing points
of the people under question) need to be selected. Thus, based on a
representative sample survey, sources should be from where accurate,
adequate, and timely data can be available.
iii) Timings of Data Collection: It is also equally important to collect the
data at an appropriate time. Referring to the example of consumer price
index, prices are likely to vary on different days of the month. For
certain commodities prices may vary at different times of the same day.
Take an example, vegetable prices are usually high in the morning
when fresh vegetables arrive and are low in the late evening when
sellers are closing for the day and wish to clear the perishable stock.
For each commodity, individual judgment needs to be exercised to
represent reality and to serve the purpose for which an index is to be
used.
2) Selection of Base Year: A base period is the reference period for
comparing and analysing the changes in prices or quantities in a given
period. For many index number series, value of a particular time
period, usually a year, is taken as reference period against which all
subsequent index numbers in the series are calculated and compared.
In some other cases, especially when cost of living needs to be
compared across the cities, the value of cost of living prevailing in a
selected city is taken as a base against which cost of living in other
cities is compared.
In yet other cases, we may be required to compare one index number
series against another series. In such a context, a ‘base’ common to all
series is more appropriate.
In the light of the above considerations, therefore, the period/year
selected as base period/year must be a ‘normal’ period. Normal period
is a period with price or quantity figures neither too low, nor too high.
It should not have been affected by abnormal occurrences, such as
floods, (if interested in agricultural production), wars, sudden recession
etc. What is normal should also be decided keeping in view the purpose
of constructing an index number, and the specific situation.
3) Selection of an Appropriate Index: Different methods of indices give
different results, when applied to the same data. Utmost care must be
taken in selection of a formula which is the most suitable for the
purpose. Whether to use an unweighted or weighted index is a difficult
question to answer. It depends on the purpose for which the index
number is required to be used. For example, if we are interested in an

174
 index for the purpose of negotiating wages or compensating for price Index Number

rise, only a weighted index would be worthwhile to use.

Which weights to be used? Whether base year quantities or current year
quantities or some other weights are to be used is an important question
to answer. Weights which realistically reflect the relative importance of
items included in the construction of an index is perhaps the only
answer. The purpose for which an index is needed will of course
remain a vital factor to reckon with.

17.5 CLASSIFICATION OF INDEX NUMBERS

There are three principal types of indices: price indices, quantity indices, and
value indices.
Price Indices: This type of indices is the most frequently used. Price indices
consider prices of a commodity or a group of commodities and compare
changes of prices from one period to another period and also compare the
difference in price from one place to another. For example, the familiar
Consumer Price Index measuring overall price changes of consumer
commodities and services is used to define the cost of living.
Quantity Indices: The major focus of consideration and comparison in these
indices are the quantities either of a single commodity or a group of
commodities. For example, the focus may be to understand the changes in the
quantity of paddy production in India over different time periods. For this
purpose, a single commodity’s quantity index will have to be constructed.
Alternatively, the focus may be to understand the changes in food grain
production in India, in this case all commodities which are categorized under
food grains will be considered while constructing the quantity index.
Value Indices: Value indices actually measure the combined effects of price
and quantity changes. For many situations either a price index or quantity
index may not be enough for the purpose of a comparison. For example, an
index may be needed to compare cost of living for a specific group of persons
in a city or a region. Here comparison of expenditure of a typical family of
the group is more relevant. Since this involves comparing expenditure, it is
the value index which will have to be constructed. These indices are useful in
production decisions, because it avoids the effects of inflation.
The formula, therefore is:
∑�� ��
����� ������� �� = × 100
∑�� ��

Check Your Progress A

1) State with reasons, on your agreement or disagreement on the following
statements.
a) Index numbers are specialised averages.
b) The index number for a base year is always zero.
c) A value index measures either price or quantity changes.
175
Business Statistics d) In times of inflation, a quantity index provides a better measure
of actual output than a corresponding value index.
e) Through appropriate indices, normal increase can be
transformed into real income.
f) Probability sampling is the most appropriate method for
selecting commodities while constructing indices.
g) A base period may be described as a “normal” period if it is the
most recent period for which we have data.
2) In magazines and newspapers you might have come across many index
numbers. Name four such index numbers and briefly state what does
each one of them indicate?
3) List out the problems that arise in connection with the construction of an
index number.
4) Try to cite one example each where (a) price index, (b) quantity index,
and (c) value index is not appropriate.

17.6 METHODS OF CONSTRUCTING INDEX

NUMBERS
In the previous section, we have discussed different types of indices, i.e.,
price indices, quantity indices, and value indices. We shall now focus on the
construction of price and quantity indices and their limitations.
Different formulae have been introduced by statisticians for constructing
composite index numbers. They may be categorized into two broad groups as
given below:
I) Unweighted Indices; and
II) Weighted Indices
The formula and its use in constructing each category of indices, listed above,
are discussed in the following sections. Let us first acquaint ourselves with
the symbols used in construction of index numbers. They are as follows:
�� denotes price per unit of a commodity in the base period.
�� denotes price per unit of the same commodity in the current period
(current period is one in which the index number is calculated with reference
to the base period).
Similar measurements are assigned to �� , �� and ��, ��.
Capital letters P, Q, and V are used for denoting price index, quantity index,
and value index numbers, respectively.
Thus, ��� refers to price index for period 1. (�� ) with respect to base period
(�� ). Similar meanings are assigned to quantity (��� ) and value (���) indices.
It may be noted that indices are expressed in per cent.

176
17.6.1 Unweighted Index Numbers: Index Number

This type of indices are also referred to as simple index numbers. In this
method of constructing indices, weights are not expressly assigned. These are
further classified under two categories:
1) Simple Aggregative Index
2) Simple Average of Relatives Index
Let us study the construction of indices under these two methods:
1) Simple Aggregative Index: This is the simplest and least satisfactory
method of constructing indices. In the case of price indices, through this
method, the total of unit cost of each commodity in the current year is
divided by the total of unit cost of the same commodity in the base year
and the quotient is multiplied by 100. Symbolically,
∑�
��� = �∑�� � × 100
�

Similarly, the quantity index may be expressed as:

∑�
��� = �∑�� � × 100
�

Illustration 1: By considering the hypothetical data for the year 1990 and
2000 the following computation was done for construction of price index and
quantity index.
Table 17.1 Computation of Index by Simple Aggregative Method

Item Year 1990 Year 2000

Price (Rs.) Quantity Price (Rs.) Quantity
Wheat 700 4 qts 950 3.5 qts
Clothing 200 30 mts 300 35 mts
Gas 150 4 cylinder 220 6 cylinders
Electricity 0.80 800 units 1.10 1,000units
House Rent 400 1 dwelling 800 1 dwelling
1450.80 839 2271.1 1045.5
∑�� ∑�� ∑�� ∑��

The price index for the year 2000 with reference to base year 1990 the simple
aggregative method is
∑� ����.�
��� = �∑�� � × 100 = ����.� × 100 = 156.54
�

Thus, the prices in respect of commodities considered in the index have

shown an increase of 56.54 per cent in 2000 as compared to 1990.
This method suffers from the following two limitations:

177
Business Statistics 1) The unit size affects the index number. For instance, in the above
illustration if the price of wheat was quoted in terms of per kg. Rs. 7/- in
1990 and Rs. 9.5 in 2000) the index might be very different.
2) Relative importance of different commodities is not reflected in the
index. For example, in the above illustration a total of Rs. 2,800/- is
spent on wheat, which is the most important item of expenditure. This is
not reflected in this method.
Analogously, the Quantity Index by the simple aggregate method is:
∑�
��� = �∑�� � × 100
�

Consider the illustration 1 for quantity index

����.�
��� = ���
× 100 = 124.61

Here, you should note that the ‘P’ in the formulae of price index will be
replaced by ‘q’ in constructing index. This expression is applicable to the
formulae of different methods.
Limitation: The units of quantities being different cannot be added and
the quantities do not represent appropriate variables for the purpose of
comparing expenditure.
2) Simple Average of Relatives Index
In this method of constructing price index, first of all price relatives have
to be computed for the different items included in the index then the
average of these is calculated simbolically,
� ��� �� ���
∑� � ×����
�� ����� ���������
��� = �
or ��.�� �����

Using the same data by considering only prices given in the illustration-
1, the computation of price index as simple average of price relatives is
as follows:
Illustration 2
Table 17.2: Computation of Index by Simple Average of Relatives Method

Item Units Year Year Price relatives

1990 2000 ��
Price Price × ���
��
(Rs.) (Rs.)
Wheat Qts 700 950 (950 / 700) × 100 = 135.7
Clothing Mts 200 300 (300 / 200) × 100 = 150.0
Gas Cylinder 150 220 (220 / 150) × 100 = 140.7
Electricity Units 0.80 1.10 (1.10 / 0.80) × 100 = 137.5
House Rent dwelling 400 800 (800 / 400) × 100 = 200
N=5 ��
∑ � × 100� = 763.9
��
178
 Index Number
��
∑� × 100� 763.9
��
��� = = = 152.78
� 5
Thus, the index of simple average of price relatives shows 52.78 per cent
increase in price.
For construction of Quantity Index, quantity relatives should be obtained and
averaged. The formula for quantity index in this method is:
��
∑� × 100�
��
��� =
�
Which you may compute on your own by using the data given in Illustration-
1.
This method also has its limitations. First, each price/quantity relative is
given equal importance, which is not realistic. Secondly, the arithematic
mean is not the right type of average for ratios, and percentages.

Check Your Progress B

a) Calculate:
i) The price index number by simple aggregative and average of
relatives methods from the following data (price per kg).

Commodities Price in 2015 (Rs.) Price in 2018 (Rs.)

Apple 35 60
Mango 30 45
Watermelon 5 10

ii) What are the limitations of both the methods?

b) For the give data find:
Simple aggregative Index for the year 2017 over the year 2016.
(i) Simple Aggregative Index for the year 2018 over the year 2017.

Commodity 2016 (Rs.) 2017 (Rs.) 2018 (Rs.)

A (100 gm) 12 15 15.60
B (per piece) 3 3.60 3.30
C (per kg) 5 6 5.70
Aggregate 20 24.60 54.60

17.6.2 Weighted Index Numbers

In the earlier two methods each item received equal weight/importance in the
construction of an index, whereas in the weighted index methods, weights are
expressly assigned to each item which is included in an index construction.
179
Business Statistics This weighting allows us to consider more information than just the change
in price/ quantity over time. The problem only is to decide how much weight
(importance) to consider for each of the items included in the sample. This is
further divided into two methods.
1) Weighted Aggregative Index, and
2) Weighted Average of Relatives Index.
Let us discuss these two methods one after another.
1) Weighted Aggregative Index: In this group, we shall study three specific
methods commonly used in business research. They are: (a) Laspeyre’s
index, (b) Paasche’s index, and (c) Fisher’s ideal index. After understanding
the concepts of the three indices we will take up an illustration for
construction of these indices.
a) Laspeyre’s Index: In this method, weights assigned to each commodity
are the quantities consumed in the base year for price indices. For
quantity index weights used are the prices of commodities in the base
year. Thus, according to Laspeyre:
∑� �
Price Index (����� ) = �∑�� �� � × 100, and
� �

∑� �
Quantity Index = (����� ) = �∑�� �� � × 100,
� �

It is to be noted that this method is most popular for constructing “Consumer

Price Index”. It is, therefore, considered as aggregate expenditure method
which is one of the methods for constructing Consumer Price Index.
Since each index number depends upon price and quantity of the same base
year, the researcher can compare the index of one period directly with the
index of another period. For instance, assume that the cement price index is
115 in 1995 and 143 in 2001, taking 1991 as base year. The firm concludes
that the price level of cement has increased by 15 per cent from 1991 to 1995
and has increased 43% from 1991 to 2000.
b) Paasche’s Index: In this method, quantities consumed in the current year
are used as weights in construction of price indices, where as in construction
of quantity index, weights used are the prices of items in the current year.
Thus according to Paasche:
∑� �
Price Index (����� ) = �∑�� �� � × 100, and
� �

∑� �
Quantity Index = (����� ) = �∑�� �� � × 100,
� �

Comparison of Laspeyre’s and Paasche’s Indices

From the practical point of view, Laspeyre’s index is usually preferred over
Paasche’s index. This is because as long as base period is fixed, the weights
assigned will remain unchanged. Therefore, calculations and comparisons are
easier. On the other hand, weights in Paasche’s formula continue to change
with the change in the current year so that the price index for every year has
to be computed using fresh/different weights.
180
Another interesting property of Laspeyre’s index is that it tends to Index Number

overestimate the value of indices. It is argued that when prices increase, the
consumers reduce the consumption of commodities (which are price elastic)
for which price rise has been highest. Thus the use of base year quantities
increases the value of the numerator, thus increasing the value of index
number. The same is true when prices are falling. The Paasche’s index, on
the other hand, has a tendency to underestimate. This is because when prices
are rising, reduced current quantities are used as weights which reduces the
value of the index. When price changes are not very rapid, there is not much
difference between the index values given by the two methods.
c) Fisher’s Ideal Index: Irving Fisher used geometric mean of the
Laspeyre’s and Paache’s indices to overcome the shortcomings of the both.
Thus,
∑� � ∑� �
Price Index (���� ) = ��∑�� �� � �∑�� �� � × 100
� � � �

Analogously, Fisher’s quantity index is

∑� � ∑� �
Quantity Index = (� ��� ) = ��∑�� �� � �∑�� �� � × 100
� � � �

Thus fisher’s ideal index of price/quantity =

�Laspeyre’s Index × Paasche’s Index

Fisher’s index is superior because it uses geometric mean (which is best
applicable for average of ratios and percentages) of Laspeyre’s and Paache’s
indices. Also, because it is comparatively free from bias of over estimation
and under estimation. Fisher’s index satisfies the requirement of time reversal
test and factor reversal test. This index is, therefore, called ideal index. So far
we have discussed the three different indices of weighted aggregates method.
For illustration, let us observe the following data of 2013 and 2018, and also
required computation for construction of (i) Laspeyre’s, (ii) Paasche’s, and
(iii) Fisher’s indices made in the table.
Illustration 3: Table 17.3 Computation of Weighted Aggregated Index

Commodity Year 2013 Year 2018 �� �� �� �� �� �� �� ��

(Base Year) (Current
Year)
Prices Qty Prices Qty.
(�� ) . (�� ) (�� )
(�� )
A 800 6 950 8 4800 5700 6400 7600
B 600 3 800 4 1800 2400 2400 3200
C 400 5 425 4 2000 2125 1600 1700
D 250 2 300 2 500 600 500 600
∑�� �� ∑�� �� ∑�� �� ∑�� ��
= 9100 = = =
10824 10900 13100 181
Business Statistics ∑�� ��
i) Laspeyre’s Price Index or ����� = × 100
∑�� ��
�����
= ����
× 100 = 118.94

This shows that prices for the group (sample commodities) have
increased by 18.94 per cent in 2018 as compared to those prevailing in
2013.
The quantity index according to Laspeyre’s formula is computed as
shown below:
∑�� ��
(��� ) = ∑�� ��
× 100

The sum of �� �� and �� �� may be taken from the Table 17.3 as ∑�� �� =
∑�� ��, and ∑�� ��= ∑�� �� .
10900
����� = × 100 = 119.78
9100
This shows a 19.78 percent increase in aggregate quantity consumption
for this group in 2018 as compared to 2013.
∑�� ��
ii) Paache’s Price Index or (����� ) = ∑�� ��
× 100
�����
= �����
× 100 = 120.18

Thus, according to the Paache’s Index the price index reveals an increase
of 20.18 per cent in prices in 2018 as against 2013.
Analogously, Paasche’s quantity index is
∑�� ��
(����� ) = � � × 100
∑�� ��
The values of ∑�� �� and ∑�� �� in the Table 17.3, as they are equivalen to
∑�� �� and ∑�� �� respectively.
�����
Thus, (����� ) = �����
× 100 = 121.03

It shows a 21.03 per cent increase in quantity consumption for this group
in 2018 as compared to 2013.
∑� � ∑� �
iii) Fisher’s Index or (���� ) = ��∑�� ��� �∑�� �� � × 100
� � � �

����� �����
(���� ) = �� ���� � ������� × 100 = √1.43 × 100 = 119.55

Therefore, Fisher index value is comparatively free from bias of

underestimation and overestimation as in Laspeyre’s and Paachre’s indices.
However, it is more complicated to construct.
∑� � ∑� �
Fisher’s Quantity Index or (���� ) = ��∑�� �� � �∑�� ��� × 100
� � � �

which you may compute and interpret on your own using the data in the
182 Table 17.3.
Illustration-4: Construct Index Number of prices of items in the year 2018 Index Number

from the following data by:

1). Laspeyres method; 2). Paasche’s method; 3) Fisher’s method

Items Price (2011) Quantity (2011) Price (2018) Quantity (2018)

A 10 10 5 25
B 35 4 35 10
C 30 3 15 15
D 10 25 20 20
E 40 3 40 5

Solution: Table 17.4 (Computation of Index Numbers)

Items �� �� �� �� �� �� �� �� �� �� �� ��
A 10 10 5 25 100 250 50 125
B 35 4 35 10 140 350 140 350
C 30 3 15 15 90 450 45 225
D 10 25 20 20 250 200 100 80
E 40 3 40 5 120 200 120 200
Σ=700 Σ=1450 Σ=455 Σ=980
∑�� ��
1) Laspeyres method : (����� ) = ∑�� ��
× 100 = (455/700) × 100 = 65
∑�� ��
2) Paasche’s method: (����� ) = ∑�� ��
× 100 = (980/1450) × 100 = 67.58

∑� � ∑� �
3) Fisher’s method: (���� ) = ��∑�� �� � �∑�� ��� × 100
� � � �

= √0.43927 × 100 = 66.27

2) Weighted Average of Relatives Index: In this method, the construction
of the index number is similar to the simple average of relatives method,
in respect of computation of price relatives, as discussed in Section
17.6.1. However, to overcome the limitation of simple average of
relatives method, the weights used are the values of consumption for
each commodity either in the base period, or in the current period.
This method is also called as Family Budget method, which is
considered as one of the methods to construct consumer price index. It
can be defined symbolically as:
�
∑�� � ×���� �� �� � ∑ ��
��
(��� ) = , in simple
∑�� �� ∑�

As an illustration let us consider the data given in Table 17.5 which also
contains required computations for constructing index number through
weighted average of relatives method. 183
Business Statistics Illustration-5: Table 17.5: Computation of Index Number through
Weighted Average of Relatives Method

Items Year 2005 Year 2015 V P PV

(base Year) (Current Year) �� �� ��
� × 100�
Prices Qty. Prices Qty. ��
�� �� �� �� Price
Relatives
A 7 25 12 21 175 171.43 30000.2
5
B 2 12 2.5 12 24 125.00 3000.00
C 3 4 5 3 12 166.67 2000.04
∑V= 211 ∑PV = 35000.29
∑�� �����.��
Then, the price index (��� ) = ∑�
= ���
= 165.88

This means that according to this method, the rise in prices in 2015 as
compared to the base year 2005 is 65.88 per cent. In this method, the index of
quantity relatives is expressed as:
�
∑�� � ×������ �� � ∑��
��
(��� ) = =
∑�� �� ∑�

which you may compute and interpret on your own by using the data in Table
17.5.

Check Your Progress C

Compute price index number by Weighted Aggregates method (Laspeyre’s,
Paache’s and Fisher’s) and weighted Average of Relatives method, from the
following data (Price quoted in Rs. per kg. and production in qtls).

Items 1990 2000

Price Production Price Production
Wheat 8 700 12 900
Rice 7 900 16 1,400
Sugar 12 300 16 500

17.7 TESTS FOR INDEX NUMBERS

A perfect index number, which measures the change in the level of a
phenomenon from a specific period to another period, should satisfy certain
tests. In this section, we discuss the two types of tests of index numbers.
They are: (i) Time reversal test, and (2) factor reversal test.

17.7.1 The Time Reversal Test

If we observe the construction of index numbers, we found that there are two
aspects. They are period and/ or quantity. Therefore, if we reverse the time
subscripts, such as base period (0) and current period (1), of a price or/and
184
quantity index, the result should be the reciprocal of the original index Index Number

number.
Algebraically, it is expressed as: ��.� × ��.� = 1
Where, ��.�= Index number for current period (�� ) with the base period (�� )
��.� = Index number for base period (�� ) with the current period (�� )
As we discussed the three method of construction of indices under Weighted
Aggregative Index in Section 17.6.2, Fisher’s Ideal Index Satisfies this test.
Hence this method is considered as ideal index.
Now, let us discuss this as below:
∑� � ∑� �
Fisher’s Ideal Index ��.� = ��∑�� �� � �∑�� ���
� � � �

and if time subscripts are reversed i.e.,

∑�� �� ∑�� ��
��.� = �� �� �
∑�� �� ∑�� ��

With the above, now, we verify the result of time reversal test i.e.
��.� × ��.� = 1
Hence,
∑�� �� ∑�� �� ∑�� �� ∑�� ��
��.� × ��.� = � × × ×
∑�� �� ∑�� �� ∑�� �� ∑�� ��

17.7.2 The Factor Reversal Test

Irving Fisher suggested one more test i.e. Factor Reversal Test to be applied
to weighted index numbers to verify the validity. According to him “Just as
our formula should permit the interchange of the two times without giving
inconsistent results so it ought to permit interchanging the prices (P) and
quantities (q) without giving inconsistent results, i.e., the two results
multiplied together should give the true ratio”.
Thus, with the usual notations a ‘value index’ (��.� × ��.� ) formula is given
by:
∑�� ��
��.� × ��.� =
∑�� ��
Where, ��.� = The price change for the current period over the base period.
��.� = Quantity change for the current period over the base period.
∑�� �� = The total value in the current period.
∑�� �� = The total value in the base period.
The Fisher’s ideal index only satisfied this test, as shown below:

185
Business Statistics
�
∑�� �� ∑�� ��
��.� =� ×
∑�� �� ∑�� ��

and, if factors (part q) are reversed i.e.

∑�� �� ∑�� ��
��.� = � ×
∑�� �� ∑�� ��

Hence,

∑�� �� ∑�� �� ∑�� �� ∑�� ��

��.� × ��.� = � × × ×
∑�� �� ∑�� �� ∑�� �� ∑�� ��

∑�� �� ∑�� �� ∑�� ��

=� × = = ��.� × ��.�
∑�� �� ∑�� �� ∑�� ��

Illustration-6: We show the following data that Fisher’s ideal index satisfies
the Time Reversal Test and Factor Reversal Test:

Commodity Price No. of Units �� �� �� �� �� �� �� ��

2005 2018 2005( 2018
(�� ) (�� ) �� ) (�� )
I 6 10 50 56 300 500 336 560
II 2 2 100 100 200 200 240 240
III 4 6 60 60 240 360 240 360
IV 10 12 30 30 300 360 240 288
V 8 12 40 40 320 480 288 432
Total 1360 1900 1344 1880
i) Time Reverssal Test:

∑�� �� ∑�� �� 1900 1880

�
��.� =� × = � ×
∑�� �� ∑�� �� 1360 1344

∑�� �� ∑�� �� 1344 1360

��.� = � × = � × =1
∑�� �� ∑�� �� 1880 1900

1900 1880 1344 1360

��.� × ��.� = � × × × =1
1360 1344 1880 1900

186
ii) Factor Reversal Test: Index Number

∑�� �� ∑�� �� 1900 1880

Price ratio: ��� = � × = � ×
∑�� �� ∑�� �� 1360 1344

∑�� �� ∑�� �� 1344 1880

�������� �����: ��� = � × × � ×
∑�� �� ∑�� �� 1360 1900

1900 1880 1344 1880 1880

��� × ��� ����� � × × × =
1360 1344 1360 1900 1360

∑�� �� 1880
��� ����� ����� ��.� × ��.� = �� ����� ��
∑�� �� 1360

17.8 CONSUMER PRICE INDEX NUMBER (CPI)

This method is also known as Cost of Living Index Number (CPI). This
index is to serve as a measure of change in the prices of goods and services
commonly consumed by a homogeneous section of people, such as the
classes – lower middle, middle, upper middle, industrial workers, urban and
rural areas etc. These indices are helpful in deciding dearness allowances,
wages/ salaries, negotiations, framing price policy, taxation policy, other
economic and welfare policies.
The common method for selecting from the consumption basket is to conduct
a family living style survey among the population group (section) for which
the consumer price index is to be constructed. Prices of selected commonly
consumed items are also collected from various retail markets used by such
consumers and also the quantity of consumption [normally expressed in
terms of weights (w)]. When the price of one commodity varies, a simple
average is applied. For example, if index number is constructed for each of
five groups using weighted average of the price group, the weights used are
proportional to the expenditure on the consumed items by an average family.
The overall index (CPI) is computed as an weighted average of group indices
and the weights being again the proportional expenditure on different groups
(e.g. 30 per cent on food).
As stated in the explanation at Laspeyre’s Method and accordingly using the
formula of Laspeyre’s
�
∑�� � ×����
��
CPI: � = ∑�
� �
Where, w = ∑�� �� , is the weight of a group index.
� �

Illustration-7: Let us observe how to construct the Consumer Price Index for
food with the help of the following data pertains to current price, base price
and weights of seven items:
187
Business Statistics Construction of an Index for food

Items Price �� Weights Pw

�� × 100� (w)
�� �� ��

Wheat 50 40 125.0 30 3750.0

Pulses 45 30 150.0 20 3000.0
Rice 60 40 150.0 10 1500.0
Sugar 40 50 200.0 5 1000.0
Oil 75 60 125.0 15 1875.0
Potato 60 50 120.0 15 1800.0
Meat 200 150 133.3 5 666.5
Total 100 13591.5
�
∑�� � ×���� �����.�
��
CPI (Food) = = = 135.92
∑� ���

Check Your Progress D

Construct Consumer Price Index number from the data given belowL

Item : A B C D E
Price of Base Year (Rs.) : 85 15 45 55 17
Price of Current Year (Rs.) : 115 20 61 100 23
Weights : 35 15 10 25 15

17.9 LET US SUM UP

An index number is a specialised average which helps in comparison of the
level of magnitude of a group of related variables with respect to time,
geographical location or other characteristics such as production, income,
employment, etc. It combines two or more time series variables related to
non-comparable units.
Index numbers can be used in several ways, such as study trends and
tendencies of business activities, provide guidelines in framing suitable
policies, measure real purchasing power of money, help in transforming
nominal wage into real wage and so on. The researcher may face various
problems in the construction of different types of indices. They may be
selection of the base period, collection of data, selection of commodities,
choice of averages and weights, selection of an appropriate index. These
issues must be clarified before constructing indices.
There are three principal types of indices (i) price indices, (ii) quality indices,
and (iii) value indices. Among these three, price indices is the most common
in analysing the data.
There are different methods of constructing index numbers which is
188 illustrated through the following chart:
 Index Number

Choice of an appropriate method depends upon the purpose of constructing

indices.
You have been shown how to use the Laspeyre’s, Paache’s and Fisher’s
formulae for calculation of price as well as quantity indices. Only Fisher’s
Ideal Index number satisfies the Time Reversal Test and Factor Reversal
Test. We have also discussed how to measure change in consumer price or
cost of living.

17.10 KEY WORDS

Base period: It is the reference period against which comparisons are made.
Cost of Living Index: Numbers represent the average change in the prices
paid by the consumer on specified goods and services over a period of time,
popularly known as “Consumer Price Index Number”.
Index Number: A ratio for measuring differences in the magnitude of a
group of related variables over time.
Price Index: A measure of how much the price variables change over a
period of time.
Price Relative: In the construction of an index number, price relative for a
commodity in the ratio of the current year price to base year price of that
commodity.
Quality Index: A measure which studies the quantity of a variable changes
from one period to another period.
Value Index: A measure for changes in total monetary worth over a time.

17.11 ANSWERS TO CHECK YOUR PROGRESS

A 1) a) Agree b) Disagree c) Disagree d) Agree
e) Agree f) Disagree g) Disagree.
B a) (i) Simple aggregative ��� = 164.3
(ii) Average of Relatives ��� = 173.8
b) (i) Simple Aggregative Index for the year 2017 over the year
2018 = 123

189
Business Statistics (ii) Simple Aggrivative Index for the year 2018 over the year
2016 = 273
C Weighted Aggregates index number:
����� = 183.9; ����� = 180.4; ���� = 181.9;
Weighted Average of Relatives Index (��� ) = 183.9
D CPI = 146.65

17.12 TERMINAL QUESTIONS/EXERCISES

1) What do you mean by an index number? Explain the uses of index
numbers for analysing the data.
2) Discuss various issues that arise in connection with the construction of
an index number.
3) Briefly explain different methods for construction of indices and their
limitations.
4) Why do we consider Fisher’s index as an ideal index?
5) Write short notes on:
a) Price Index
b) Quantity Index
c) Value Indices
d) Consumer Price Index Numbers
6) A drug processing plant utilized four different materials in the
manufacturing of a medicine. The following data indicates the final
inventory levels (in tons) and prices (per kg) for these materials for the
years 2010 and 2015.

Items 2010 2015

Inventory Price (Rs.) Inventory Price (Rs.)
A 96 45 108 41
B 495 26 523 32
C 1,425 5 1,608 8
D 208 12 196 9

Find the price indices and quantity indices by using the methods of
unweighted index numbers and comment on the results.
7) A department of Statistics has collected the following data describing
the prices and quantities of harvested crops for the years 1990, 2000
and 2004 (Price in Qtls. and Production in tons).

190
 Index Number
Items 1990 2000 2004
Price Production Prince Production Prince Production
Paddy 200 1.050 500 1,300 600 1,450
Wheat 250 940 550 1,220 700 1,450
Groundnut 350 400 800 500 1,000 480

Construct the price and quantity indices of Laspeyre’s Index,

Paache’s Index and Fisher’s Index in 2000 and 2004, using 1990 as
the base period and verify whose index number satisfies the Time
Reversal Test and Factor Reversal Test. Give your comments on the
results.
8) From the given data in Problem No. 7, find out the following:
i) Weighted average of Relative Prices Index number for 2004
using 1990 and 2000 as base.
ii) Weighted average of Relative Quantity Index for 2004 using
2000 as the base.
iii) Give your comments on the price indices.
Given below is the annual income of an Engineer and the general index
number of prices during 2010-2017. Construct the index number to show the
change in the real income of the Engineer.

Year 2010 2011 2012 2013 2014 2015 2016 2017

Income: 255 265 286 312 336 380 405 420
(in 000’
Rs.)
Price 100 108 116 153 140 192 248 235
Index No.

9) A survey of the budget of working class families in an industrial area

gave the following information.

Expression : Food Rent Clothing Fuel Others

% 30% 15% 20% 10% 25%

Price in 2015 (Rs.) : 100 20 70 20 40

Price in 2016 (Rs.) : 90 20 60 15 55

What is the change in the cost of living in 2016, as compared with

2015?

Note: These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the university. These
are for your practice only.
191
Business Statistics
17.13 FURTHER READINGS
A number of good text books are available for the topics dealt with in this
unit.
The following books may be used for more indepth study.
Hooda, R.P, 2001. Statistics for Business and Economics, Macmillan India
Ltd.
Richard I. Levin and David S. Rubin, 1996, Statistics for Management,
Prentice Hall of India Pvt. Ltd.
Gupta, S.P., Statistical Methods, 2000, Sultan Chand and Sons.
Gupta, C.B. and Vijay Gupta, 2001. An Introduction to Statistical Methods,
Vikas Publishing House Pvt. Ltd., New Delhi.

192
 Time Series Analysis
UNIT 18 TIME SERIES ANALYSIS
Structure
18.0 Objectives
18.1 Introduction
18.2 Definition and Utility of Time Series Analysis
18.3 Components of Time Series
18.4 Decomposition of Time Series
18.5 Preliminary Adjustments
18.6 Methods of Measurement of Trend
18.6.1 Moving Average Method
18.6.2 Least Square Method
18.7 Let Us Sum Up
18.8 Key Words
18.9 Answers to Self Assessment Questions
18.10 Terminal Questions/ Exercises
18.11 Further Reading

18.0 OBJECTIVES
After studying this unit, you should be able to:
• define the concept of time series,
• appreciate the role of time series in short-term forecasting,
• explain the components of time series, and
• estimate the trend values by different methods

18.1 INTRODUCTION
In the previous unit, you have learnt types of the index numbers and various
methods in constructing index numbers. The nature of data varied from case
to case. You have come across quantitative data for a group of respondents
collected with a view to understanding one or more parameters of that group,
such as investment, profit, consumption, weight etc. But when a nation,
state, an institution or a business unit etc., intend to study the behavior of
some element, such as price of a product, exports of a product, investment,
sales, profit etc., as they have behaved over a period of time, the information
shall have to be collected from a fairly long period, usually at equal time
intervals. Thus, a set of any quantitative data collected and arrangement on
the basis of time is called ‘Time Series’. The unit of time may be a decade, a
year, a month, or a week etc.
Usually, the quantitative data of the variable under study are denoted by �� ,
�� ,….�� and the corresponding time units are denoted by �� , �� ,….�� . The
193
Business Statistics variable ‘y’ shall have variations, as you will see ups and downs in the
values. These changes account for the behavior of that variable.
Instantly it comes to our mind that ‘time’ is responsible for these changes, but
this is not true. Because, the time (t) is not the cause and changes in the
variable (y) are not the effect. The only fact, therefore, which we must
understand is that there are a number of causes which affect the variable and
have operated on it during a given time period. Hence, time becomes only
the forecasting any event helps in the process of decision making.
Forecasting is possible if we are able to understand the past behavior of that
particular activity. For understanding the past behavior, a researcher needs
not only the past data but also a detailed analysis of the same. Thus, in this
unit we will discuss the need for analysis of time series, fluctuations of time
series which account for changes in the series over a period of time, and
measurement of trend for forecasting.

18.2 DEFINITION AND UTILITY OF TIME

SERIES ANALYSIS
Based on the above discussion we can understand the definition given by a
few statisticians. They are:
“A time series consists of statistical data which are collected, recorded over
successive increments”.
“When quantitative data are arranged in the order of their occurrence, the
resulting statistical series is called a time series”.
The analysis of time series is of great utility not only to research workers but
also to economists, businessmen and scientists etc., for the following reasons:
1) It helps in understanding past behavior of the variables under study.
2) It facilitates in forecasting the future behavior with the help of the
changes that have taken place in the past.
3) It helps in planning future course of action.
4) It helps in knowing current accomplishment.
5) It is helpful to make comparisons between different time series and
significant conclusions draw therefrom.
Thus, we can say that the need for time series analysis arises because:
• we want to understand the behavior of the variables under study,
• we want to know the expected quantitative changes in the variable under
study, and
• we want to estimate the effect of various causes in quantitative terms
In a nutshell, the time series analysis is not only useful for researchers,
business research institutions, but also for Governments for devising
appropriate future growth strategies.
194
 Time Series Analysis
18.3 COMPONENTS OF TIME SERIES
If you are informed that the price of one kilogram sunflower oil was Rs.0.50
in the year 1940 and in the year 1980 it was Rs. 30 and in the year 2004 it is
reported to be Rs. 70, and if you are asked this question: shall sunflower oil
be sold again in the future for either Rs.0.50 and Rs. 30 per kg? Surely, you
answer would be ‘No’.
Another Question: Shall sunflower oil be sold again in future for Rs.60 per
kg? No doubt, you answer would be ‘Yes’. Have you ever thought about
how you answered the above two questions? Probably you have not! The
analysis of these answers shall lead us to arrive at the following observations:
– There are several causes which affect the variable gradually and
permanently. Therefore we are prompted to answer ‘No” for the first
question.
– There are several causes which affect the variable for the time being
only. For this reason we are prompted to answer ‘Yes’ for the second
question.
The causes which affect the variable gradually and permanently are terms as
“Long-Term Causes”. The examples of such causes are: increase in the rate
of capital formation, technological innovations, the introduction of
automation, changes in productivity, improved marketing etc. The effect of
long term causes is reflected in the tendency of a behavior, to move in an
upward or downward direction, termed as ‘Trend’ or ‘Secular Trend’. It
reveals as to how the time series has behaved over the period under study.
The causes which affect the variables for the time being only are labelled as
‘Short-Term Causes”. The short term causes are further divided into two
parts, they are ‘Regular’ and ‘Irregular’. Regular causes are further divided
into two parts, namely ‘cyclical causes’ and seasonal causes’. The cyclical
variations are also termed as business cycle fluctuations, as they influence the
variable. A business cycle is composed of prosperity, recession, depression
and recovery. The periodic movements from prosperity of recovery and back
again to prosperity vary both in time and intensity. The seasonal causes, like
weather conditions, business climate and even local customs and ceremonies
together play an important role in giving rise to seasonal movements to
almost all the business activities. For instance the yearly weather conditions
directly affect agricultural production and marketing.
It is worthwhile to say that the seasonal variations analysis will be possible
only if the season-wise data are available. This fact must be checked first.
For analysing the seasonal effect various methods are available. Among
them seasonal index by ‘Ratio to Moving Average Method’ is the most
widely used. However, if collected data provides only yearly values, there is
no possibility of obtaining seasonal variations. Therefore, the residual
amount after eliminating trend will be the effect or irregular or random
causes.
Irregular causes are also termed as ‘Erratic’ or ‘Random’ causes. Random
variations are caused by infrequent occurrences such as wars, strikes, 195
Business Statistics earthquakes, floods etc. These reasons either go very deep downwards or
very high upwards.
The foregoing paragraphs have, in a way, led us to enumerate the
components of the time series. The components from the basis for ‘Time
Series Analysis’.
Long-term causes : Secular Trend or Trend (T)
Short-term causes :
Regular : Cyclical (C)
: Seasonal (S)
Irregular or Random : Erratic (I)

18.4 DECOMPOSITION OF TIME SERIES

Decomposition and analysis of a time series are one and the same thing. The
original data or observed data ‘O’ is the result of the effects generated by the
long-term and short-term causes, namely (1) Trend = T, (2) cyclical – C, (3)
Seasonal = S, and (4) Irregular = I. Finding out the values for each of the
components is called decomposition of a time series. Decomposition is done
either by the additive model or the multiplicative model of analysis. Which
of these two models is to be used in analysis of time series depends on the
assumption that we might make about the nature and relationship among the
four components.
Additive Model: It is based on the assumption that the four components are
independent on one another. Under this assumption, the pattern of
occurrence and the magnitude of movements in any particular component are
not affect4ed by the other components. In this model the values of the four
components are expressed in the original units of measurement. Thus, the
original data or observed data ‘Y’ is the total of the four component values,
that is,
Y=T+S+C+I
where, T, S, C and I represents the trend variations, seasonal variations
cyclical variations, and erratic variations, respectively.
Multiplicative Model: It is based on the assumption that the causes giving
rise to the four components are interdependent. Thus, the original data or
observed data ‘Y’ is the product of four component values, that is:
Y=T×S×C×I
In this model the values of all the components, except trend values, are
expressed as percentages.
In business research, normally the multiplicative model is more suited and
used more frequently for the purposes of analysis to time series. Because, the
data related to business and economic time series is the result of interaction
of a number of factors which individually cannot be held responsible for
generating any specific type of variations.
196
Let us consider an example for construction of time series according to the Time Series Analysis

Multiplicative Model. Table 18.1 represents trend, seasonal and cyclical-

erratic components of a hypothetical series.
Table 18.1: Hypothetical time series and its components (quarterly)

Components
Year Quarter Series Trend Seasonal Cyclical –
(O) (T) (100 S) Irregular
(100 CI)
1 1 79 80 120 82
2 58 85 80 85
3 84 90 92 102
4 107 95 108 105
2 1 130 100 120 108
2 93 105 80 132
3 121 110 92 120
4 161 115 108 130
3 1 216 120 120 150
2 132 125 80 132
3 150 130 93 125
4 163 135 108 112
4 1 176 140 120 105
2 112 145 80 97
3 128 150 93 93
4 142 155 108 85

According to multiplicative model

Y=T×S×C×I
��� ��
Thus, 79 (1 year and 1 quarter) = 80 × ���
× ���
��� ���
130 (2 year and 1 quarter) = 100 × ���
× ���

Thus, each quarterly figure (Y) is the product of the T, S and CI. Such as
synthetic composition looks like an actual time series and has encouraged use
of the model as the basis of the analysis of time series data.

18.5 PRELIMINARY ADJUSTMENTS

Before we proceed with the task of analysing a time series data, it is
necessary to do relevant adjustments in the raw data. They are:
197
Business Statistics 1) Calendar Variations: As we are aware, all the calendar months do not
have the same number of days. For instance, all production in the month
of February may be less than other months because of fewer days and if
we take the holidays into account the variation is greater. Therefore,
adjustments for calendar variations have to be made.
2) Price Changes: As price level changes are inevitable, it is necessary to
convert monetary values into real values after taking into consideration
the price indices. In fact this is process of deflating which will be
discussed in Unit 17 (Index Numbers) of this course.
3) Population changes: Population grown constantly. This also calls for
adjustment in the data for the population changes. In such cases, if
necessary, per capita values may be computed (dividing original figures
by the total population).

Check Your Progress A

1) Do you agree or disagree on the following statement. Give reasons of
your opinion.
a) Time is cause for the ups and downs in the values of the variable
under study.
b) The variable under study in time series analysis is denoted by ‘y’.
c) ‘Trend’ values are major component of the time series.
d) Analysis of time series helps in knowing current accomplishment
e) Weather conditions, customs, habits etc., are causes for cuyclical
variations.
f) The analysis of time series is done to know the expected quantity
changes in the variable under study.
2) Why do we analyse a time series?
3) List out the components of a time series.

18.6 METHODS OF MEASUREMENT OF TREND

The effect of long-term causes is seen in the trend values we compute. A
trend is also known as ‘secular trend’ or ‘long-term trend’ as well. There are
several methods of isolating the trend of which we shall discuss only two
methods which are most frequently use in the business and economic time
series data analysis. They are: Moving Average Method, and Method of
Least Square.

18.6.1 Moving Average Method

While considering matters such as trend of prices, sales, profits, etc., a
particular type of average known as moving average is used. It is a measure
of trend (long-term tendency of the data) in the time series data. Moving
average is an arithmetic average of data arising over a period of time and is
198 calculated by replacing the first item in the average by the newly arising item.
Each moving average is based on values covering a fixed time span which is Time Series Analysis

called “Period of moving averages”.

The successive averaging process does a smoothing operation in the time
series data, i.e., it irons out fluctuations of uniform period and intensity.
They can be completely eliminated by choosing the period of moving
average that coincides with the period of the cycles i.e. periodic movements.
Even if the periodic move with the period of the cycle i.e., periodic
movements. Even if the periodic move merit is absent in the time series, the
irregularities of data can be reduced to a large extent by moving average
process. If we choose this method, we should select a period for calculation.
The period may be 3 years or 5 years or 6 years or 12 years etc., which is to
be decided by considering the duration of the cycle.
Computation
In the computation of moving average, the period of moving average is a
very important factor. For example, for yearly values A, B, C, D, E, and F,
the three yearly moving averages can be computed as shown in Table 18.2.
Table 18.2: Computation of Moving Averages

Yearly 3 Yearly Moving Totals 3 Yearly Moving

Values Averages
A ……………………. …………………….
B (A+B+C) (A+B+C)/3
C (B+C+D) (B+C+D/3
D (C+D+E) (C+D+E)/3
E (D+E+F) (D+E+F)/3
F ……………………. …………………….

We can have either an odd period of moving average (e.g., 3 years, 5 years, 7
years) or an even period of moving average (i.e., 2 years, 4 years 6 years).
As said above, the period of moving average is generally, determined in the
light of the length of the cycle in the data. Ordinarily, the moving average
period ranges between 3 to 10 years for business series.
Odd Period of moving average: When period of moving average is odd (say
3 years, 5 years 7 years etc.) the moving average is associated with mid point
of relevant time interval. Study Table 18.3 carefully to understand the
procedure.
Table 18.3: Computation of Odd Period Moving Average

Years Sales (*000 tonnes) 3 Yearly Moving 5 Yearly Moving

Totals Totals
2001 15 -- --
2002 25 72 24
2003 32 81 27 199
Business Statistics
2004 24 75 25
2005 19 60 20
2006 17 -- --

You should note that the moving average for the first three years (2001, 2002
and 2003) i.e., 72 is associated with the middle year 2002. Having dropped
the first year, the moving average of the next three years i.e. 2002, 2003 and
2004 is placed against 2003; and so on. You must also note that moving
average for the first year and the last year in the given data cannot be
obtained. If the period of moving average is 5 years, moving average for the
first two years and last two years cannot be obtained.
Even Period of Moving Average: If the period of moving average is even
(say 4 years, 6 years, 8 years etc.) the moving totals and moving averages
would not coincide with the original time period. It would not be possible to
place moving average exactly against some year. Therefore, you have to
resort to ‘Centering’. Centering is done in a manner that helps coincide the
moving average with the original data. Study Illustration-1 carefully and
understand the procedure involved in centering.
Illustration-1: Compute 4 yearly moving averages for the following data:

Years : 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Sales (Rs. In : 75 60 54 69 86 65 63 80 90 72
‘000)

Solution: Computation of 4 yearly moving average.

Year Sales (Rs. In 4 Yearly 4 Yearly 4 Yearly Moving

000s) Moving Total Moving Average Centered
Average
1997 75 -- -- --
1998 60 -- -- --
1999 54 258 64.20 --
2000 69 269 67.25 67.88
2001 86 274 68.50 69.62
2002 65 283 70.75 72.12
2003 63 294 73.50 73.50
2004 80 298 74.50 75.37
2005 90 305 76.25 --
2006 72 -- -- --

The total 258 of the first four figures (years 1997 to 2000) and their average
64.20 is written against the middle of this time period i.e., middle of the years
1998 and 1999. This middle time period is a specially designed year taking
200
last six months from 1998 and the first six months from 1999. Similarly, the Time Series Analysis

total 269 corresponding to year 1998 to 2001 and their average 67.25 is
written against the specially designed year i.e., the mid-year of 1999 and
2000. This process continues till the last average 76.25 and the total 305 is
noted against the mid-year of 2004 and 2005. To find out the first centred
moving average 65.72 (i.e., a figure of moving average which will coincide
with the year 1999), we have to find the mid-value 64.20 and 67.25, the first
two figures in Column 4. This can be easily seen with the help of diagram
given below:

The diagram shows that the figure which coincides with the year 1999 will
come from half of 64.20 and half of 67.25, which means that it is the mean of
the two moving averages. This mean value 65.72 is, therefore, called
centered moving average and is entered in the last column. The various
entered moving averages are, thus, calculated by taking successively mean of
the two consecutive figures from Column 4.

18.6.2 Least Square Method

This is also known as straight line method. This method is most commonly
used in research to estimate the trend of time series data, as it is
mathematically designed to satisfy two conditions. They are:
1) Sum of (� + �� ) = 0, and
2) Sum of (� + �� )�= least
The straight line method gives a line of best fit on the given data. The
straight line which can satisfy the above conditions and make use of
regression equation, is given by:
�� = a + bx
Where, ‘�� represents the trend value of the time series variable y, ‘a’ and ‘b’
are constant values of which ‘a’ is the trend value at the point of origin and
‘b’ is the amount by which the trend value changes per unit of time, and ‘x’ is
the unit of time (value of the independent variable).
The values of constant, ‘a’ and ‘b’ are determined by the following two
normal equations.
∑� = �� + � ∑� … … … . . (�)
∑�� = �∑� + � ∑� � … . . (��)
The process of finding values of constants a and b can be made simple by
using a shortcut method, that is, by taking the origin year in such a way that it
gives the toal of ‘x’ (∑x) equal to ‘zero’. This becomes possible if we take
the median year as origin period. Thus, the negative values in the first half of
201
Business Statistics the series balance out the positive values in the second half. Thus, the earlier
normal equation shall be changed as follows, with reference to ∑x = 0.
∑y = a (as ∑bx becomes zero)
∑xy = b∑x2 (as a∑x becomes zero)
Therefore, the values of two constants are obtained by the following
formulae:
∑� ∑��
�= �
, and � = ∑� �

It is to be noted that when the number of time units involved is even, the
point of origin will have to be chosen between the two middle time units.
Let us consider an illustration to understand the procedure for estimation of
the trend by using the method of least squares.
Illustration 2: The decision making body of a fertilizer firm producing
fertilizer wants to predict future sales trend for the year 2006 and 2008 based
on the analyses of its past sales pattern. The sales of the firm for the last 7
years, for this purpose are given below:

Year 1998 1999 2000 2001 2002 2003 2004

Sales (in ’000 tonnes) 70 75 90 98 85 91 100

Solution: to find the straight line equation (�� = a + bx) for the given time
series data, we have to substitute the values of already arrived expression,
that is:
∑� ∑��
�= �
, and � = ∑� �

In order to make the total of x = ‘zero’, we must take median year (i.e. 2001)
as origin. Study the following table carefully to understand the procedure for
fitting the straight line.
Table 18.4: Computation of Trend

Year Sales (in x x2 Xy Trend (��

’000 tonnes) = a + bx)
1998 70 –3 9 –210 74.5
1999 75 –2 4 –150 78.6
2000 90 –1 1 –90 82.8
2001 98 0 0 0 87.2
2002 85 1 1 85 91.2
2003 91 2 4 182 95.4
2004 100 3 9 300 99.5
N=7 ∑y = 609 ∑x = 0 ∑x2 = 28 ∑xy - 117 609.0

202
 ∑� ��� ∑�� ��� Time Series Analysis
�= �
= �
= 87, and � = ∑� �
= ��
= 4.18

Thus, the straight line trend equation is: �� = 87 + 4.18x

From the above equation, we can also find the monthly increase in sales as
follows:
�.���
��
= 348.33tons

The reason for this is that the trend values increased by a constant amount ‘b’
every year. Hence the annual increase in sales in 4:18 thousand tons.
Trend values are to be obtained as follow:
����� = 87+4.18 (–3) = 74.5
����� = 87+4.18(–2) = 78.6 and so on …..
Predicting with decomposed components of the time series: The
management wants to estimate fertilizer sales for the years 2006 and 2008.
Estimation of sales for 2006, ‘x’ would be 5 (because for 2004 ‘x’ was 3)
����� = 87 + 4.18 (5) = 1.7.9 thousand tonnes
Estimation of sales for 2008, ‘x’ would be 7.
����� = 87 + 4.18 (7) = 116.3 thousand tonnes
Illustration-3: Fit a straight line trend by the method of least square from the
following data and find the trend values.

Year 1958 1959 1960 1961 1962

Sales (in lakhs of 65 95 80 115 105
units)

Solution: We have n=5

∴ � �� ���
Taking middle year i.e. 1960 as the origin, we gets
Table 18.5: Computation

Year Sales X X� XY
1958 65 −2 4 −130
1959 95 −1 1 −95
1960 80 0 0 0
1961 115 1 1 115
1962 105 2 4 210
Total ΣY=460 ΣX=0 ΣX �=10 ΣXY=100

∴ � = 5, Σ� = 0, ΣX � = 10, Σ� = 460 ��� Σ�� = 100

203
Business Statistics � = Σ�� 460 ⇒ � = 460/5 = 92
100
� = Σ��ΣX � = = 10
10
∴ �ℎ� �������� �� ������ℎ� ���� ����� �� �� = � + �� ⇒ �� = 92 + 10�
��� �ℎ� ���� 1958, � = −2
⇒ Yc (1958) = 92 + 10(−2) = 92 − 20 = 72
��� �ℎ� ���� 1959, � = −1
⇒ Yc (1959) = 92 + 10(−1) = 92 − 10 = 82
��� �ℎ� ���� 1960, � = 0
⇒ Yc (1960) = 92 + 10(0) = 92 − 0 = 92
��� �ℎ� ���� 1961, � = 1
⇒ Yc (1961) = 92 + 10(1) = 92 + 10 = 102
��� �ℎ� ���� 1962, � = 2
⇒ Yc (1962) = 92 + 10(2) = 92 + 20 = 112
We have,

Year Trend Value And the straight line

trend is Yc = 92 + 10X
1958 72
1959 82
1960 92
1961 102
1962 112

Check Your Progress B

1) Do you agree or disagree the following statements. Justify your opinion.
a) The multiplicative model is based on the assumption that the
causes giving rise to the four components are dependent.
b) The total of the difference between original data and trend values
(obtained by straight line method) will never be zero.
c) In the least square trend equation �� = a + bx, if b is positive it
indicates a rising trend.
d) The additive model of time series analysis is expressed as: Y = T +
S + C + I.
2) Enumerate the methods of isolating trend.
3) What do you mean by moving average? Explain the procedure for
calculation of moving average when the data is given in odd and even
periods.
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4) Foodgrain production (in lakh tones) is given below (figures are Time Series Analysis

imaginary). Find the Trend by using a) 3 yearly and 4 yearly moving

average method b) Straight Line Method. Tabulate the trend values. C)
Predict the production for the year 2022.

Years Production
2008 40
2009 60
2010 45
2011 83
2012 130
2013 135
2014 150
2015 120
2016 200

18.7 LET US SUM UP

This unit has introduced you to the concept of time series and its analysis
with a view to making more accurate and reliable forecasts for the future.
A set of quantitative data arranged on the basis of TIME are referred to as
‘Time Series’. The analysis of time series is done to understand the dynamic
conditions for achieving the short-term and long-term goals of institution(s).
With the help of the techniques of time series analysis the future pattern can
be predicted on the basis of past trends.
The quantitative values of the variable under study are denoted by denoted by
�� , �� , �� ….. and the corresponding time units are denoted by �� , �� , �� ……
. The variable ‘y’ shall have variations, you will see ups and downs in the
values. There are a number of causes during the given time period which
affect the variable. Therefore, time becomes the basis of analysis. Time is
not the cause and the changes in the values of the variable are not effect.
The causes which affect the variable gradually and permanently are termed as
Long-term causes. The causes which affect the variable only for the time
being are termed as Short-term causes. The time series are usually the result
of the effects of one or more of the four components. These are trend
variations (T) seasonal variations (S), cyclical variations (C) and irregular
variations(I)
When we try to analyse the time series, we try to isolate and measure the
effects fo various kinds of these components one a series.
We have two models for analysing time series:

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Business Statistics 1) Addictive model, which considers the sum of various components
resulting in the given values of overall time series data and
symbolically it would be expressed as Y = T + C + S + I.
2) The multiplicative model assumes that the various components
interact in a multiplicative manner to produce the given values of the
overall time series data dn symbolically it would be expressed as : y =
T × C × S × I.
The trend analysis brings out the effect of long-term causes. There are
different methods of isolating trends, among these we have discussed only
two methods i.e., Moving Average Method and Least Square Method.
Long-term predictions can be made on the basis of trends, and only the least
square method of trend computation offers this possibility.

18.8 KEY WORDS

Cyclical Variations: A type of variation in time series, in which the values
of variables vary up and down around the secular trend line.
Irregular Variations: A type of element of a time series, refers to such
variations in business activity which do not repeat according to a definite
pattern and the values of variables are completely unpredictable.
Seasonal Variation: Pattern of change in a time series within a year and the
same changes tend to be repeated from year to year.
Secular Trend: A type of variation in a time series, the long-term tendency
of a time series to grow or decline over a period of time.
Time Series: is a data on any variable accumulated at regular time intervals.

18.9 ANSWERS TO SELF ASSESSMENT

EXERISES
A) 1) a) Disagree b) Agree c) Agree d) Agree
e) Disagree f) Agree
3) Secular trend, Seasonal variation, Cyclical variation, and Irregular
Variation
B) 1) a) Disagree b) Agree c) Disagree d) Agree
4) a) 3 years M.A. = 48.33, 62.67, 86, 116, 138.33, 101.67, 156.67
4 years M.A. = 273, 353, 433, 51135, 540, 570
b) �� = 107 + 18.03 x
c) Estimated production for 2022 is 287.3 lakh tonnes.

18.10 TERMINAL QUESTIONS

206 1) What is time series? Why do we analyse a time series?

2) Explain briefly the components of time series. Time Series Analysis

3) Explain briefly the additive and multiplicative models of time series.

Which of these model is more commonly used and why.
4) From the following data, compute trend values, using 3 yearly and 4
yearly moving average.

Years 2010 2011 2012 2013 2014 2015 2016 2017

Yields 24 28 38 33 49 50 66 68
(in tones)

5) The production (in thousand tons) in a sugar factory during 2010 to

2017 has been as follows:

Years 2010 2011 2012 2013 2014 2015 2016 2017

Production 35 38 49 41 56 58 76 75

i) Find the trend values by applying the method of least square.

ii) What is the monthly increase in production?
iii) Estimate the production of sugar for the year 2020.
6) The following data relates to a survey of use car sales in a city for the
period 2006-2014. Predict sales for 2022 by using the linear trend
equation.

Years 2006 2007 2008 2009 2010 2011 2012 2013 2014
Sales 214 320 305 298 360 450 340 500 520

7) Calculate 4 yearly and 5 yearly moving average for the following

time series data:

Quarter 2014 2015 2016 2017

I 62 68 75 80
II 58 62 68 75
III 72 74 81 85
IV 65 77 80 85

Note: These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the university. These
are for your practice only.

18.11 FURTHER READINGS

A number of good text books are available for the topics dealt with in this
unit. The following books may be used for more indepth study.

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Business Statistics Mentgomery, D.,C. and L.A. Johnson, 1996, ‘Forecasting and Time Series
Analysis’ McGraw Hill: New York.
Chandan, J.S., 2001, Statistics for Business and Economics, Vikas Publishing
House Pvt. Ltd., New Delhi
Gupta, S.P. and H.P. Gupta, 2001, Business Statistics, S. Chand, New Delhi.
C.B. Gupta & Vijay Gupta, Vikash Publishing Honk Pvt. Ltd., New Delhi.

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Time Series Analysis

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Time Series Analysis

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Time Series Analysis

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