MANAGERIAL ECONOMICS

AND
FINANCIAL ACCOUNTANCY
(MEFA)
• UNIT I
Introduction to Managerial Economics and demand Analysis: Definition of Managerial Economics –
Scope of Managerial Economics and its relationship with other subjects –Concept of Demand, Types
of Demand, Determinants of Demand- Demand schedule, Demand curve, Law of Demand and its
limitations- Elasticity of Demand, Types of Elasticity of Demand and Measurement- Demand
forecasting and Methods of forecasting, Concept of Supply and Law of Supply.

• UNIT II

Theories of Production and Cost Analyses: Theories of Production function- Law of Variable
proportions-Isoquants and Isocosts and choice of least cost factor combination-Concepts of Returns
to scale and Economies of scale-Different cost concepts: opportunity costs, explicit and implicit
costs Fixed costs, Variable Costs and Total costs –Cost –Volume-Profit analysis-Determination of

Breakeven point(problems)-Managerial significance and limitations of Breakeven point.

• UNIT III
Introduction to Markets, Theories of the Firm & Pricing Policies: Market Structures:
Perfect Competition, Monopoly, Monopolistic competition and Oligopoly – Features – Price
and Output Determination – Managerial Theories of firm: Marris and Williamson’s models –
other Methods of Pricing: Average cost pricing, Limit Pricing, Market Skimming Pricing,
Internet Pricing: (Flat Rate Pricing, Usage sensitive pricing) and Priority Pricing, Business
Cycles : Meaning and Features –Phases of a Business Cycle. Features and Evaluation of Sole
Trader, Partnership, Joint Stock Company – State/Public Enterprises and their forms.
• UNIT IV
Introduction to Accounting & Financing Analysis: Introduction to Double Entry System,
Journal, Ledger, Trail Balance and Preparation of Final Accounts with adjustments –
Preparation of Financial Statements-Analysis and Interpretation of Financial Statements-
Ratio Analysis – Preparation of Funds flow and cash flow analysis (Problems)
• UNIT V
Capital and Capital Budgeting: Capital Budgeting: Meaning of Capital-Capitalization-
Meaning of Capital Budgeting-Time value of money- Methods of appraising Project
profitability: Traditional Methods (pay back period, accounting rate of return) and modern
methods(Discounted cash flow method, Net Present Value method, Internal Rate of Return
Method and Profitability Index)
 UNIT - I

Introduction to Managerial
Economics and Demand analysis
Why Study Economics?
• A good grasp of economics is vital for managerial decision making, for
designing and understanding public policy, and to appreciate how an
economy functions. The students need to know how economics can
help us to understand what goes on in the world and how it can be
used as a practical tool for decision making. Managers and CEO’s of
large corporate bodies, managers of small companies, nonprofit
organizations, service centers etc., cannot succeed in business
without a clear understanding of how market forces create both
opportunities and constraints for business enterprises.
Introduction
• Businesses need to make crucial decisions on a day to day basis.
These decisions can be about an investment opportunity, a new
product, a new competitor, or a company’s direction. For such
important decisions, businesses need to rely on experts. These
experts come from the background of Managerial Economics.
Managerial Economists get to sit at the table with the executives
rather than be a part of the company’s executive branch. They are the
experts who provide monetary value to the different opportunities
and then urge the company to proceed.
• In simple, Managerial economics is minimising the cost and
maximising the returns.
• Economics is the science of making decisions in the presence of scarce
resources. Resources are simply anything used to produce a good or
service to achieve a goal. Economic decisions involve the allocation of
scarce resources so as to best meet the managerial goal. The nature of
managerial decision varies depending on the goals of the manager.
• A Manager is a person who directs resources to achieve a stated goal
and he/she has the responsibility for his/her own actions as well as for
the actions of individuals, machines and other inputs under the
manager’s control.
Introduction to Economics
• Economics is a study of human activity both at individual and national
level.

• It is the Science of wealth.

• Activities of earning and spending money are called ‘economic

activites’ like food, clothing, shelter etc.
• Managerial economics is the study of how scarce resources are
directed most efficiently to achieve managerial goals. It is a valuable
tool for analyzing business situations to take better decisions.
• Definitions:
• Prof. Evan J Douglas defines Managerial Economics as “Managerial
Economics is concerned with the application of economic principles
and methodologies to the decision making process within the firm or
organization under the conditions of uncertainty”
• According to Milton H Spencer and Louis Siegelman “Managerial
Economics is the integration of economic theory with business
practices for the purpose of facilitating decision making and forward
planning by management”
• Adam Smith, the Father of Economics defined economics as ‘the
study of nature and uses of national wealth’
• Dr Alfred Marshell, “Economics is a study of man’s actions in the
ordinary business of life; it enquires how he gets his income and how
he uses it”. (His opinion is to promote ‘human welfare’, but not
wealth)
• Prof. Lionel Robbins defined Economics as “the science, which studies
human behaviour as a relationship between ends and scarce means
which have alternative uses”. With this, the focus of economics
shifted from ‘wealth’ to human behaviour’.
• Micro Economics:

• ‘Micro’ means small. It studies the behaviour of the individual units and small
groups of units. It is a study of particular firms, particular households, individual
prices, wages, incomes, individual industries and particular commodities. Thus
micro-economics gives a microscopic view of the economy.

• It is the study of an individual consumer or a firm is called micro economics (also

called the Theory of Firm).

• Microeconomics deals with behavior and problems of single individual and of micro
organization. Managerial economics has its roots in microeconomics and it deals
with the micro or individual enterprises. It is concerned with the application of the
concepts such as price theory, Law of Demand and theories of market structure
and so on.
• Macroeconomics:
• ‘Macro’ means large. It deals with the behaviour of the large aggregates in the economy. The
large aggregates are total saving, total consumption, total income, total employment, general
price level, wage level, cost structure, etc. Thus macro-economics is aggregative economics.

• The study of ‘aggregate’ or total level of economic activity in a country is called

macroeconomics. It studies the flow of economics resources or factors of production (such as
land, labour, capital, organisation and technology) from the resource owner to the business
firms and then from the business firms to the households. It deals with total aggregates, for
instance, total national income total employment, output and total investment.

• It is concerned with the level of employment in the economy. It discusses aggregate

consumption, aggregate investment, price, level, and payment, theories of employment, and
so on.
Management:
• Management is the science and art of getting things done through
people in formally organized groups. It is necessary that every
organisation be well managed to enable it to achieve its desired
goals.
Management includes a number of functions: Planning, organizing,
staffing, directing, and controlling. The manager while directing the
efforts of his staff communicates to them the goals, objectives, policies,
and procedures; coordinates their efforts; motivates them to sustain
their enthusiasm; and leads them to achieve the corporate goals.
Managerial Economics
• Managers, in their day-to-day activities, are always confronted with several
issues such as how much quantity is to be supplied; at what price; should
the product be made internally; or whether it should be bought from
outside; how much quantity is to be produced to make a given amount of
profit and so on. Managerial economics provides us a basic insight into
seeking solutions for managerial problems.
• In a nutshell, Managerial economics is a stream of management studies that
emphasizes primarily solving business problems and decision-making by
applying the theories and principles of microeconomics and
macroeconomics. It is a specialized stream dealing with an organization’s
internal issues using various economic theories. Economics is an
indispensable part of any business. This single concept derives all the
business assumptions, forecasting, and investments.
Managerial Economics
• Introduction:
• Managerial Economics refers to the firm’s decision making process. It
could be also interpreted as “Economics of Management”. Managerial
Economics is also called as “Industrial Economics” or “Business
Economics”.

• Managerial Economics as a subject gained popularity in USA after the

publication of the book “Managerial Economics” by Joel Dean in 1951.
• As Joel Dean observes managerial economics shows how economic
analysis can be used in formulating polices.
Meaning & Definition:
• In the words of E. F. Brigham and J. L. Pappas Managerial Economics is
“the applications of economics theory and methodology to business
administration practice”.
• M. H. Spencer and Louis Siegel man explain the “Managerial
Economics is the integration of economic theory with business
practice for the purpose of facilitating decision making and forward
planning by management”.
Scope of Managerial Economics:
• Managerial economics refers to its area of study. It provides
management with a strategic planning tool that can be used to get a
clear perspective of the way the business world works and what can
be done to maintain profitability in an ever-changing environment.
• Managerial economics is primarily concerned with the application of
economic principles and theories to five types of resource decisions
made by all types of business organizations.
• a. The selection of product or service to be produced.
• b. The choice of production methods and resource combinations.
• c. The determination of the best price and quantity combination
• d. Promotional strategy and activities.
• e. The selection of the location from which to produce and sell goods or service to
consumer.
The Scope of managerial economics covers two areas of decision
making

• a. Operational or Internal issues

• b. Environmental or External issues
a. Operational or Internal issues:
Operational issues refer to those, which within the business organization
and they are under the control of the management. Those are:
1. Theory of demand and Demand Forecasting
2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation
5. Profit analysis
6. Capital or Investment analysis
7. Strategic planning
B. Environmental or External Issues:
An environmental issue in managerial economics refers to the general business
environment in which the firm operates. They refer to general economic, social
and political atmosphere within which the firm operates. A study of economic
environment should include:
a. The type of economic system in the country.
b. The general trends in production, employment, income, prices, saving and
investment.
c. Trends in the working of financial institutions like banks, financial
corporations, insurance companies
d. Magnitude and trends in foreign trade;
e. Trends in labor and capital markets;
f. Government’s economic policies viz. industrial policy, monetary policy, fiscal
policy, price policy etc.
Managerial economics relationship with other
disciplines:
• Many new subjects have evolved in recent years due to the interaction
among basic disciplines. While there are many such new subjects in
natural and social sciences, managerial economics can be taken as the
best example of such a phenomenon among social sciences. Hence it
is necessary to trace its roots and relation ship with other disciplines.
• Managerial economics has its relationship with other disciplines for
propounding its theories and concepts for managerial decision
making. Essentially it is a branch of economics. Managerial economics
is closely related to certain subjects like statistics, mathematics,
accounting and operations research.
• 1. Managerial economics and Operations Research:

• Mathematicians, statisticians, engineers and others join together and

developed models and analytical tools which have grown into a specialised
subject known as operation research. The basic purpose of the approach is
to develop a scientific model of the system which may be utilised for policy
making and solving business problems.
• The development of techniques and concepts such as Linear
Programming, Dynamic Programming, Input-output Analysis, Inventory
Theory, Information Theory, Probability Theory, Queuing Theory, Game
Theory, Decision Theory and Symbolic Logic are extensively used in
decision-making.
• Managerial economics gives special emphasis to the problems involving
maximisation of profits and minimisation of costs, while operational
research focuses attention on the concept of optimisation.
2. Managerial economics and economics
• Managerial Economics is economics applied to decision making. It is a
special branch of economics, bridging the gap between pure
economic theory and managerial practice. Economics has two main
branches—micro-economics and macro-economics.

• The relation between Managerial Economics and Economics is as

close as is Engineering to Physics and Medicines to Biology.
3. Managerial economics and Mathematics
• For the derivation and exposition of economic analysis, we require a
set of mathematical tools. Mathematics has helped in the
development of economic theories.
Mathematical approach to economic theories makes them more
precise and logical. For the estimation and prediction of economic
factors for decision making and forward planning, mathematical
method is very helpful.
The mathematical concepts used by the managerial economists are the
logarithms and exponential, vectors and determinants, input-out
tables, geometry, algebra and calculus.
4. Managerial economics and Accountancy
• Managerial economics is closely related to accounting. It is recording the
financial operation of a business firm. A business is started with the main
aim of earning profit. The buying of goods, sale of goods, payment of
cash, receipt of cash and similar dealings are called business transactions.
• Capital is invested / employed for purchasing properties such as building,
furniture, etc. and for meeting the current expenses of the business.
• A business manager needs a lot of accounting information data for
logical analysis in decision-making and policy formulation at the level of
firm. The accounting data and information has to be presented in a
methodological manner worthy of analysis and interpretation for
decision-making and future planning.
5. Managerial economics and Psychology
• Consumer Psychology is the basis on which managerial economist
acts upon. Customer reacts to a given change in price or supply and
its consequential effect on demand/profits is the main focus of study
in managerial economics.
• Psychology contributes towards understanding the behaviorial
implications; attitudes and motivations of each of the microeconomic
variables such as consumer, supplier/seller, investor, worker or an
employee.
6. Managerial economics and Organisational
behaviour
• Organisational behaviour enables the managerial
economist to study and develop behavioural models
of the firm integrating the manager’s behaviour with
that of the owner.
Demand
Demand for a product implies
• a. a desire to acquire it;
• b. willingness to pay for it; and
• c. ability to pay for it.

All these three conditions must be satisfied to establish demand. A

poor man’s desire to buy a car is not a demand because he lacks the
necessary purchasing power to buy a car. When the desire is backed up
by ability to buy and willingness to pay the price, it becomes effective.
Such effective desire is called demand.
Definitions of Demand by different economists
• Demand means the desire for an object. But in economics demand is something
more than this.
• “Demand means the various quantities of goods that would be purchased per time
period at different prices in a given market”. - Hibdon
• According to Stonier and Hague, “Demand in economics means demand backed up
by enough money to pay for the goods demanded”.
• In the words of “F. Beham” “The demand for anything at a given price is the
amount of it which will be bought per unit of time at that Price”. (Thus demand is
always at a price for a definite quantity at a specified time.)
• From the above definitions, it is clear that demand requires 3 things –
• i. the price, because demand at one price is different from demand at another
price,
• ii. the quantity bought at the given price, and
• iii. the period of time.
Nature and Types of Demand
• a. Individual Demand and Market Demand
• b. Demand for Consumer Goods and Producer Goods
• c. Demand for Durable and Perishable Goods
• d. Derived Demand and Autonomus Demand
 a. Individual Demand and Market Demand
The quantity of commodity that an
individual demands at a particular
price during a given period is
known as individual demand.
The total quantity of the
commodity that all buyers in the
market buy at a given price during
a given period is called market
demand for the commodity. It is
the sum total of individual
demands.
b. Demand for Consumer
Goods and Producer Goods
• Consumers’ goods are meant for final consumption
eg. Bread, apple, rice, television etc., Producers’ goods are those used for production
of other goods eg. raw materials, machineries etc..
• The demand for consumers’ goods is known as direct demand, for they are used
directly for final consumption. The demand for producers’ goods is a derived
demand as the demand of the same depends on the demand for consumers’ goods.
• The demand for the consumer goods is ‘direct’ whereas the demand for the
producer goods is ‘indirect’. The distinction between the two depends upon the
intention in buying. The same product can be considered as consumer good or
producer good.
• A microwave oven at home is a consumer good and the same in a hotel is a
producer good.
c. Demand for Durable and Perishable Goods
• Durable goods • Perishable goods
• These goods are used more than • These goods can be consumed once.
once. It can be used repeatedly or Utility is exhausted by single use.
continuously over a period of time. • Perishable goods also can be
• Durable goods can be classified as consumer goods and producer
producer durable goods and goods.
consumer durable goods. • eg. Food items like dairy products,
• Eg. Fridge, mobile, Clothes, shoes, car, meat, baked foods, fruits and
T.V. etc. are consumer durable goods. vegetables etc. are perishable
• Eg. Machinery, office furniture, plant consumer goods.
etc. are producer durable goods. • eg. Raw materials, fuel, power etc.
• Easily stored and Replacement can be are perishable producer goods.
postponed. • frequently changed.
d. Derived Demand and Autonomous Demand
• When demand for a product is tied to the purchase of some parent
product, the demand is called derived. Here demand for a commodity
arises because of the demand for some other commodity.
• For eg. Demand for bricks is derived demand as it is directly related to
building of a house; Demand for tiers is derived from the demand for
automobiles.
• When the demand for a commodity is entirely independent of demand
for any other commodities it is autonomous demand.
• eg. demand for food, clothing, housing etc.
• Derived demand is less elastic than autonomous demand
Determinants / Factors of Demand
• The factors on which the market demand and individual demand for a
product is known as determinants of demand.

• The knowledge of the determinants of market demand for a product

and the nature of relationship between the demand and its
determinants proves very helpful in analyzing and estimating demand
for the product. The factors are
1. Price of the Product
• The price of a product is one of the most important determinants of
its demand in the long run and the only determinants in the short
run. The quantity of the product demanded by the consumer
inversely depends upon the price of the product. If the price rise
demand falls and vice versa. The relation between price and demand
is called Law of demand.
• It is not only the existing price but also the expected changes in price
which affect demand.
2. Price of related goods
• The demand for a commodity also affects the change in price of its
related goods. Related goods are substitutes or complementary goods.

• a. Substitutes
• Two commodities are substitutes for one another, if change in the
price of one affects the demand for the other in the same direction.
For example. X and Y are substitutes for one another. If the price for X
increases, demand for Y increases and vice versa. eg. Tea and coffee,
Coke and Pepsi, hamburgers and hot dogs, petrol vehicles and battery
vehicles etc.
• b. Complements

Complementary goods are those goods which complete the demand

for each other. such as car and petrol, pen and ink. There is an inverse
or negative relationship between the demand for first good and price of
the second which is the complementary to the first.

For example an increase in the price of petrol causes a decrease in the

demand of car and other petrol run vehicles and other things remain
same.
3. Income of the Consumer
• Income is the basic determinant of quantity of product demanded as
it determines the purchasing power of consumer. Income as
determinant of demand is equally important in both short and long
run.
• In simple, When income rises, so the quantity demanded.
When income falls, so will demand.
• Observations shows that numerically there is a positive relationship
between income of the consumer and his demand for a good.
• a. Essential consumer goods (ECG)

• These goods are those which serves the basic needs and consumed by
all persons of a society.
• Eg. food grains, vegetable oils, cooking fuel, salt, minimum clothing,
housing etc.
• Quantity demanded of this category of goods increases with increase
in consumer’s income but only upto a certain limit, even though the
total expenditure may increase in accordance with the quality of
goods consumed, other factors remain same.
• b. Inferior goods (IG)

• With these goods, the demand for which tends to decline with
increase in consumer’s income and tends to increase with fall in his
income. So, there is an inverse relationship between income of the
consumer and demand for the commodity.
• Eg. Every consumer knows that kerosene is inferior to cooking gas,
travelling by bus is inferior to travelling by taxi.
• Demand for such goods rises only upto a certain level of income and
declines as income increases beyond this level.
• c. Normal goods (NG)

• Normal goods are those which tends to increase with the increase in
consumer’s income and tends to decrease with decrease in his
income. so there is a positive relationship between consumer’s
income and quantity demanded.
• Eg. Clothing, household furniture and automobiles
• Demand for the normal goods increases rapidly with the increase in
consumer’s income and slows down with further increases in income.
• d. Luxury and Prestige goods (LG)

This type of goods add prestige and pleasure of the consumer without
enhancing his earning fall in the category of luxury goods.
eg. Stone studded jewellery, costly cosmetics, luxury cars, 5 star hotel
stay etc. are luxury goods.
Demand for such goods arises beyond a certain level of consumer’s
income.
4. Consumer’s taste and preferences
• The demand for any goods and services depends on individual’s taste
and preferences. They include fashion, habit, custom etc. Taste and
preferences of the consumers are influenced by advertisement,
changes in fashion, climate , new invention. Other things being equal,
demand for those goods increases for which consumers develop taste
and preferences.
• Unfavourable change in consumer preferences and tastes for a
product will cause demand to decrease.
5. Advertisement expenditure
• Advertisement costs are incurred with the objective of promoting sale
of the product. Ads changed the lifestyle of people.
• Ads help in increasing the demand by following ways.
• 1. By informing potential consumers about the product and its
availability.
• 2. By showing its superiority over rival product
• 3. By influencing consumer’s choice against the rival products.
• 4. By setting new fashions and changing tastes.
eg. Cadbury Dairy milk “Kuch mitha ho jai”
6. Consumer’s Expectations of future Income
and Price
• Consumers do not make purchases only on the basis of current price
structure. In case of durables, when demand can be postponed,
consumers decide their purchase on the basis of future price and
income.
• Eg. Purchase of cars and other durable increases before budget is
announced if consumers fear that prices may rise after budget. or
when they expect pay revisions, they wait for major purchases till pay
is revised.
 7. Demonstration Effect
• When new commodities or new models exist in the market rich people buy
them first. Eg. New model car. Rich people would be mostly be the first to
buy . Some people buy new model goods as they have genuine need or have
excess purchasing power. Some buy to exhibit there affluence, jealousy,
competition and equality in peer group. Purchases made on these factors
are called “demonstration effect” or “bad wagon effect”. These effects have
positive effect on demand.
• When commodity becomes a thing of common use, rich decrease or give up
the consumption of such goods. This is known as “Snob effect”. It is a
negative effect on the demand for the related goods.
8. Distribution of National Income
• The level of national income is the basic determinant of the market
demand for a product. The higher the national income, the higher the
demand for all normal goods and services.
• Distribution pattern of national income is also an important
determinant of a product. If national income is unevenly distributed
i.e. majority of the population belongs to lower income groups,
market demand for include inferior ones, will be the largest.
• Whereas the demand for the other kinds of goods will be relatively
lower.
• Demand Schedule:
• The demand schedule in economics is a table of quantity demanded of a
good at different price levels. Given the price level, it is easy to
determine the expected quantity demanded. This demand schedule can
be graphed as a continuous demand curve on a chart where the Y-axis
represents price and the X-axis represents the quantity.

• According to PROF. ALFRED MARSHALL, “Demand schedule is a list of

prices and quantities”. In other words, a tabular statement of price-
quantity relationship between two variables is known as the demand
schedule.

• The demand schedule in the table represents different quantities of

commodities that are purchased at different prices during a certain
specified period (it can be a day or a week or a month).
• The demand schedule can be
classified into two categories:
• 1. Individual demand schedule;
• 2. Market demand schedule.

Price of Oranges Quantity of Orange

• 1. Individual Demand Schedule: (Rs. per kg.) Demanded (kgs)
100 2
• It represents the demand of an
80 3
individual’ for a commodity at
60 4
different prices at a particular time
40 5
period. The adjoining table shows a
30 6
demand schedule for oranges.
• 2. Market Demand Schedule:
• Market Demand Schedule is defined as the
quantities of a given commodity which all
consumers will buy at all possible prices at given
Price of Demand Demand of Market
moment of time. In a market, there are several Milk per of Mr. X Mr. Y (in Demand
consumers, and each has a different liking, taste, litre (in Litres) Litres) (in Litres)
(in Rs.)
preference and income. Every consumer has a
50 1 2 1+2=3
different demand.
40 2 3 2+3=5
30 3 4 3+4=7
• The market demand actually represents the 20 4 5 4+5=9
demand of all the consumers combined together. 10 5 6 5+6=11
When a particular commodity has several brands
or types of commodities, the market demand
schedule becomes very complicated because of
various factors.

• The market demand schedule for milk in table

• Demand Curves (Diagram):

• The demand curve is a graphic statement or presentation of the relationship

between product price and the quantity of the product demanded. It is drawn
with price on the vertical axis of the graph and quantity demanded on the
horizontal axis.
• Demand curve does not tell us the price. It only tells us how much quantity of
goods would be purchased by the consumer at various possible prices.

• Depending upon the demand schedule, the demand curve can be as follows:

• 1. Individual Demand Curve

• 2. Market Demand Curve
• 1. Individual Demand Curve:

• An Individual Demand Curve is a

graphical representation of the
quantities of a commodity that an
individual (a particular consumer)
stands ready to take off the market
at a given instant of time against
different prices.

• In Fig., an Individual Demand Curve

is drawn on the basis of Individual
Demand Schedule given.
• 2. Market Demand Curve:

• A Market Demand Curve is a graphical

representation of the quantities of a
commodity which all the buyers in
the market stand ready to take off at
all possible prices at a given moment
of time.

• In the Figure a Market Demand Curve

is drawn on the basis of Market
Demand Schedule given in Table .
• Both, the individual consumer’s
demand curve is a straight line. A
demand curve will slope
downward to the right.

• It is not necessary, that the

demand curve is a straight line. A
demand curve may be a convex
curve or a concave curve. It may
take any shape provided it is
negatively sloped.
• Law of Demand:
• The law of demand expresses functional relationship between price and the quantity. It has
been universally observed that people buy more quantity of goods when, they are available at
a lower price and the quantity purchased declines with an increase in its price.
• “A rise in the price of a commodity or service is followed by a fall in quantity demanded, and
a fall in price is followed by an increase in quantity demanded”. Thus, lower the price, the
larger is the quantity demanded of a commodity and vice-versa.
• The law thus, states that other things being equal the quantity demanded varies inversely
with price. Lower the price, greater is the effective demand; higher the price; lesser is the
effective demand.

• Characteristics of Law of Demand:

• The law of demand has three specific characteristics:

• 1. General Tendency,
• 2. Relation to Time, and
• 3. Price and Demand Relationship.
• 1. General Tendency:
• The law simply indicates a general tendency of changes in quantity demanded
with the changes in prices. However, it does not mention any specific
propositions of changes in quantity demanded with changes in prices.
• 2. Relation to Time:
• The law of demand is always related to time, because the price changes from
time to time and these are never fixed. Thus, the co-relation between the
prices and the quantities demanded should be considered for a specific time
or at particular instant.
• 3. Price and Demand Relationship:
• The increase or decrease in the prices does affect the quantity demanded at a
particular time. Thus, the change in the quantity demanded cannot be
considered without change in prices. It must, therefore, be noted that the
relationship between price and quantity demanded is relative.
• Assumptions of Law of Demand:

• i. The income of the consumer remains same during the period under consideration.

• ii. The prices of related goods remain unchanged during the period.

• iii. The preferences and tastes of consumers must remain the same during the period of
consumption.

• iv. The quality of similar goods available in the market is almost unchanged.

• v. During the period under study, it is presumed that prices are not likely to change in near future.

• vi. No substitutes for the commodity are available.

• Exceptions to the Law of
Demand:

• There are certain exceptions to the

law of demand. It means that under
certain circumstances, consumers
buy more when the price of a
commodity rises and less when the
price falls. In such case the demand
curve slopes upward from left to
right i.e. demand curve has a
positive slope as is shown in Fig.
Many causes can be attributed to an
upward sloping demand curve.
• 1. Ignorance:
• Sometimes consumers are fascinated with the high priced goods from the idea of getting a superior
quality. However, this may not be always true. Superior/deceptive packing and high price deceive the
people. This can be called as ‘Ignorance effect’.
• 2. Speculative Effect:
• When the price of a commodity goes up, people may buy larger quantity than before, if they
anticipate or speculate a further rise in its price. On the other hand, when the price falls, people may
not react immediately and may still purchase the same quantity as before, waiting for another fall in
the price. In both the cases, the law of demand fails to operate. This is known as speculative effect.
• 3. The Giffen Effect:
• A fall in the price of inferior goods (Giffen Goods) tends to reduce its demand and a rise in its price
tends to extend its demand. This phenomenon was first observed by SIR ROBERT GIFFEN, popularly
known as Giffen effect.
• He observed that the working class families of U.K. were compelled to curtail their consumption of
meat in order to be able to spend more on bread Mr. Giffen, British economist, observed that rise in
the price of bread caused the low paid British workers to buy more bread.
• These workers lived mainly on the diet of bread, when price rose, as they had to spend more for a
given quantity of bread, they could not buy as much meat as before. Bread still being comparatively
cheaper was substituted for meat even at its high price.
• 4. Fear of Shortage:
• People may buy more of a commodity even at higher prices when they fear of a
shortage of that commodity in near future. This is contrary to the law of demand.
It may happen during times of war and inflation and mostly in the case of goods
which fall in the category of necessities of life like sugar, kerosene oil, etc.

• 5. Prestigious Goods:
• This is explained by Prof. Thorsfein Vebler Veblen. If consumers measure the
desirability of a good entirely by its price and not by its use, then they buy more of
a good at high price and less of a good at low price, Diamond, Jewellery and big
cars etc., are such prestigious goods. In their case demand relates to consumers
who use them as status symbol.
• As their prices go up and become costlier, rich people think it is more prestigious
to have them. So they purchase more. On the other hand, when their prices fall
sharply, they buy less, as they are no more prestigious goods. This is known as
(Veblen effect) or (Demonstration effect).
• 6. Conspicuous Necessities:
• Another exception occurs in use of such commodities as due to their constant use, have
become necessities of life. For example, inspite of the fact that the prices of television sets,
refrigerators, washing machines, cooking gas, scooters, etc., have been continuously rising,
their demand does not show any tendency to fall. More or less same tendency can be
observed in case of most of other commodities that can be termed as ‘Upper-Sector Goods’.

• 7. Bandwagon Effect:
• The consumer’s demand for a good may be affected by the tastes & preferences of the social
class to which he belongs. If purchasing diamond becomes fashionable, then, as the price of
diamond rises, rich people may increase their demand for diamonds in order to show that
they are rich.

• 8. Snob Effect:
• People sometimes buy certain commodities like diamonds at high prices not due to their
intrinsic worth but for a different reason. The basic object is to display their riches to the
other members of the community to which they themselves belong. This is known as Snob
appeal.
• Elasticity of Demand:
• Demand extends or contracts respectively with a fall or rise in price. This quality of
demand by virtue of which it changes (increases or decreases) when price changes
(decreases or increases) is called Elasticity of Demand.

• “The elasticity (or responsiveness) of demand in a market is great or small according as

the amount demanded increases much or little for a given fall in price, and diminishes
much or little for a given rise in price”. – Dr. Marshall.

• Elasticity means sensitiveness or responsiveness of demand to the change in price.

• This change, sensitiveness or responsiveness, may be small or great. Take the case of
salt. Even a big fall in its price may not induce an appreciable extension in its
demand. On the other hand, a slight fall in the price of oranges may cause a
considerable extension in their demand. That is why we say that the demand in the
former case is ‘inelastic’ and in the latter case it is ‘elastic’.
• The demand is elastic when with a small change in price there is a great
change in demand; it is inelastic or less elastic when even a big change in price
induces only a slight change in demand. In the words of Dr. Marshall, “The
elasticity (or responsiveness) of demand in a market is great or small
according as the amount demanded increases much or little for a given fall in
price, and diminishes much or little for a given rise in price.” But the demand
cannot be perfectly ‘elastic’ or ‘inelastic’.

• Price inelastic – a change in price causes a smaller % change in demand.

• Egs. Petrol, salt, diamonds, cigarattes, apple iphones.

• Price elastic – a change in price causes a bigger % change in demand.

• Egs. Newspaper, kitkat, porsche car etc. there are more alternatives to this
products.
• Types of Elasticity:
• Distinction may be made between Price Elasticity, Income Elasticity and Cross
Elasticity.
• Price Elasticity is the responsiveness of demand to change in price; Price
elasticity is always negative which indicates that the customer tends to buy
more with every fall in price. eg. apple iphone, dell computers
• Income elasticity means a change in demand in response to a change in the
consumer’s income; eg. luxurious goods
• and Cross elasticity means a change in the demand for a commodity owing
to change in the price of another commodity or related good, which may be
substitute or complement. eg. substitutes coffee and tea
• Degrees of Elasticity of Demand:

• (a) Infinite or Perfect Elasticity of Demand:

• When it is infinite or perfect.

• Elasticity of demand is infinity when even a
negligible fall in the price of the commodity
leads to an infinite extension in the demand
for it. In Fig. 10.1 the horizontal straight line
DD’ shows infinite elasticity of demand. Even
when the price remains the same, the
demand goes on changing.
• Eg. Pizza, bread, books, jewels, gold, car etc.
• (b) Perfectly Inelastic Demand:
• It means that howsoever great the rise or fall in
the price of the commodity in question, its
demand remains absolutely unchanged. In Fig.
10.2, the vertical line DD’ shows a perfectly
inelastic demand. In other words, in this case
elasticity of demand is zero. No amount of
change in price induces a change in demand.
• In the real world, there is no commodity the
demand for which may be absolutely inelastic,
i.e., changes in its price will fail to bring about
any change at all in the demand for it. Some
extension/contraction is bound to occur that is
why economists say that elasticity of demand is a
matter of degree only. In the same manner, there
are few commodities in whose case the demand
is perfectly elastic. Thus, in real life, the elasticity
of demand of most goods and services lies
between the two limits given above, viz.,
infinity and zero. Some have highly elastic
demand while others have less elastic demand.
• Eg. Life saving drug
• (c) Unitary elastic Demand:
• Unitary Elastic Demand
(e=1): When proportionate or
percentage change in quantity
demanded is exactly equal to
proportionate or percentage
change in price, then demand is
said to be unitary elastic. For
instance a 10% fall in price of a
commodity leads to 10% rise in
demand of that commodity.
• For example, if the price of
bananas decreases, the
number of people buying it
may increase because now
they can afford to buy more
since prices have decreased
• (d) Relatively Elastic Demand:

• Demand is said to be relatively

elastic when even a small change in
the price of a commodity leads to a
considerable extension/contraction
of the amount demanded of it.
• In the Fig. DD’ curve illustrates such
a demand. As a result of change of T
in the price, the quantity demanded
extends/contracts by MM’, which
clearly is comparatively a large
change in demand.
• eg. TV, designer brands (discounts
20%)
• (e) Relatively Inelastic Demand:

• When even a substantial change in

price brings only a small
extension/contraction in demand, it
is said to be relatively inelastic. In
the Fig., DD’ shows less elastic
demand. A fall of NN’ in price
extends demand by MM’ only,
which is very small.
• such as salt, medical care,
tobacco products and petrol
(fuel). This means that the
quantity demanded is not highly
sensitive to a change in the
price.
Demand Forecasting
• An organization faces several internal and external risks, such as high
competition, failure of technology, labor unrest, inflation, recession, and
change in government laws.

• Therefore, most of the business decisions of an organization are made under

the conditions of risk and uncertainty.
• An organization can lessen the adverse effects of risks by determining the
demand or sales prospects for its products and services in future.

• Demand forecasting is a systematic process that involves anticipating the

demand for the product and services of an organization in future under a set of
uncontrollable and competitive forces.
• Some of the popular definitions of demand forecasting are as follows:

• According to Evan J. Douglas, “Demand estimation (forecasting) may be

defined as a process of finding values for demand in future time periods.”

• In the words of Cundiff and Still, “Demand forecasting is an estimate of sales

during a specified future period based on proposed marketing plan and a set
of particular uncontrollable and competitive forces.”
• Demand forecasting enables an organization to take various business
decisions, such as planning the production process, purchasing raw
materials, managing funds, and deciding the price of the product.

• An organization can forecast demand by making own estimates called guess

estimate or taking the help of specialized consultants or market research
agencies.
 Significance of demand forecasting
• i. Fulfilling objectives:
• Implies that every business unit starts with certain pre-decided objectives. Demand
forecasting helps in fulfilling these objectives. An organization estimates the
current demand for its products and services in the market and move forward to
achieve the set goals.
• For example, an organization has set a target of selling 50,000 units of its products.
In such a case, the organization would perform demand forecasting for its
products. If the demand for the organization’s products is low, the organization
would take corrective actions, so that the set objective can be achieved.
• ii. Preparing the budget:
• Plays a crucial role in making budget by estimating costs and expected revenues.
For instance, an organization has forecasted that the demand for its product, which
is priced at Rs. 10, would be 1,00,000 units. In such a case, the total expected
revenue would be 10* 1,00,000 = Rs. 10, 00, 000. In this way, demand forecasting
enables organizations to prepare their budget.
• iii. Stabilizing employment and production:
• Helps an organization to control its production and recruitment activities.
Producing according to the forecasted demand of products helps in avoiding the
wastage of the resources of an organization. This further helps an organization to
hire human resource according to requirement. For example, if an organization
expects a rise in the demand for its products, it may opt for extra labor to fulfill
the increased demand.
• iv. Expanding organizations:
• Implies that demand forecasting helps in deciding about the expansion of the
business of the organization. If the expected demand for products is higher, then
the organization may plan to expand further. On the other hand, if the demand
for products is expected to fall, the organization may cut down the investment in
the business.
• v. Taking Management Decisions:
• Helps in making critical decisions, such as deciding the plant capacity, determining
the requirement of raw material, and ensuring the availability of labor and capital.
• vi. Evaluating Performance:
• Helps in making corrections. For example, if the demand for an
organization’s products is less, it may take corrective actions and
improve the level of demand by enhancing the quality of its products
or spending more on advertisements.

• vii. Helping Government:

• Enables the government to coordinate import and export activities and
plan international trade.
Techniques of Demand Forecasting
• The main challenge to forecast demand is to select an effective technique.

• There is no particular method that enables organizations to anticipate risks

and uncertainties in future. Generally, there are two approaches to demand
forecasting.

• The first approach involves forecasting demand by collecting information

regarding the buying behavior of consumers from experts or through
conducting surveys.
• On the other hand, the second method is to forecast demand by using the
past data through statistical techniques.
• The techniques of demand
forecasting are divided into
survey methods and statistical
methods.
• The survey method is generally
for short-term forecasting,
whereas statistical methods are
used to forecast demand in the
long run.
Survey Method:
• Survey method is one of the most
common and direct methods of
forecasting demand in the short
term. This method encompasses the
future purchase plans of consumers
and their intentions.
• In this method, an organization
conducts surveys with consumers to
determine the demand for their
existing products and services and
anticipate the future demand
accordingly.
• i. Opinion Survey or Experts’ Opinion Poll:

• Refers to a method in which experts are requested to provide their

opinion about the product. Generally, in an organization, sales
representatives act as experts who can assess the demand for the
product in different areas, regions, or cities.

• Sales representatives are in close touch with consumers; therefore, they

are well aware of the consumers’ future purchase plans, their reactions
to market change, and their perceptions for other competing products.
They provide an approximate estimate of the demand for the
organization’s products. This method is quite simple and less expensive.
• ii. Delphi Method:

• Refers to a group decision-making technique of forecasting demand. In this method,

questions are individually asked from a group of experts to obtain their opinions on
demand for products in future. These questions are repeatedly asked until a consensus
is obtained.
• In addition, in this method, each expert is provided information regarding the estimates
made by other experts in the group, so that he/she can revise his/her estimates with
respect to others’ estimates. In this way, the forecasts are cross checked among experts
to reach more accurate decision making.
• Every expert is allowed to react or provide suggestions on others’ estimates. However,
the names of experts are kept anonymous while exchanging estimates among experts
to facilitate fair judgment and reduce halo effect. (the tendency for an impression
created in one area to influence opinion in another area)
• The main advantage of this method is that it is time and cost effective as a number of
experts are approached in a short time without spending on other resources. However,
this method may lead to subjective decision making.
iii. Expert survey
• Expert survey is an opinion taken by the experts. Distributors and
agents are the outside experts who give their opinion about the
products. this survey is helpful for demand forecasting.
iv. Consumers interview method
• Consumers are contacted personally to find out their opinion
about their products, their demands, changes in product, tastes
and preferences etc.,
 Statistical Methods:
• Statistical methods are complex set of methods
of demand forecasting. These methods are
used to forecast demand in the long term. In
this method, demand is forecasted on the basis
of historical data and cross-sectional data.

• Historical data refers to the past data obtained

from various sources, such as previous years’
balance sheets and market survey reports.
• On the other hand, cross-sectional data is
collected by conducting interviews with
individuals and performing market surveys.
Unlike survey methods, statistical methods are
cost effective and reliable as the element of
subjectivity is minimum in these methods.
• Time series or Trend Projection Method:

• Trend projection or time series method is the

classical method of business forecasting. In
this method, a large amount of reliable data
is required for forecasting demand. In
addition, this method assumes that the
factors, such as sales and demand,
responsible for past trends would remain the
same in future.

• In this method, sales forecasts are made

through analysis of past data taken from
previous year’s books of accounts. In case of
new organizations, sales data is taken from
organizations already existing in the same
industry. This method uses time-series data
on sales for forecasting the demand of a
product.
• Barometric Method:

• In barometric method, demand is predicted on the basis of past events or key

variables occurring in the present. This method is also used to predict various
economic indicators, such as saving, investment, and income. This method was
introduced by Harvard Economic Service in 1920 and further revised by National
Bureau of Economic Research (NBER) in 1930s.
• This technique helps in determining the general trend of business activities. For
example, suppose government allots land to the XYZ society for constructing buildings.
This indicates that there would be high demand for cement, bricks, and steel.
• The main advantage of this method is that it is applicable even in the absence of past
data. However, this method is not applicable in case of new products. In addition, it
loses its applicability when there is no time lag between economic indicator and
demand.
• This method is done with the help of economic and statistical indicators. i.e., personal
income, agricultural income, employment etc.,
Regression and Co-relation method
• The goal of a correlation analysis is to see whether two measurement
variables co vary, and to quantify the strength of the relationship
between the variables, whereas regression expresses the relationship
in the form of an equation.
• the function is denoted by f(x)
• f(x) - Single independent variable is correlation
• f(x) - Multiple independent variables is multiple correlation
• f(x) - demand is dependent variable and demand determinants are
independent is regression
Concept of Supply
• Concept of supply refers to the quantity of a commodity that a firm is
willing to offer for sale at a given price during a given period of time.
the definition of supply highlights its four essential elements

• 1. Quantity of a commodity
• 2. Willingness to sell
• 3. Price of the commodity
• 4. Period of time
• Supply Schedule

• Supply schedule is a series of Quantities which the Producer would like

to sell per unit at different prices and time.

• Two Aspects of Supply schedule

• - Individual Supply schedule

• - Market Supply schedule
Individual Supply Schedule
• It is defined as Quantities of a Price (Rs.)
(Per kg)
Quantity
Supplied (kg)
given commodity which an
individual producer will sell at all 1 10
possible prices at a given Time.
2 30

3 50

4 70

5 80
Market Supply Schedule
• The quantities of a given commodity Price of Supply by Supply by Market
commodity A B Supply
which all producers will sell at all ‘X’ (in Rs.) (Units)
possible prices at a given moment of
time. In Market there are many 100 40 50 40+50=90
producers of a single commodity. By 200 60 70 60+70=130
aggregating the individul supply, the 300 65 80 65+80=145
market supply schedule is constructed.
400 80 100 80+100=180
• The table indicates that when price of
‘X’ is Rs. 100 per unit, A’s supply is of 40
units and that of ‘B’ is of 50 units. thus
the market supply is 90 units. As the
price increases, quantity supplied
increases.
Features of Supply
• 1. The concept of supply is a desired quantity. it indicates only the
willingness i.e., how much the firm is willing to sell and not how much it
actually sells.
• 2. Supply of a commodity does not comprise the entire stock of the
commodity. It indicates the quantity that the firm is willing to bring into
the market at a particular price.
• 3. Supply is always expressed with reference to price. the supply of a
commodity is always at a price because with a change in price the
quantity supplied may also change.
• 4.Supply is always with respect to a period of time. The quantity of the
commodity which the firm is willing to supply during a specific period of
time.
Concept of Supply and Stock
• Stock is the total quantity of the commodity that is held by the firm at a
particular point of time.
• Supply is that portion of the stock of the commodity that the producer
is willing to bring to the market for sale. Stock can never be less than
supply.
• For eg. if a seller has 50 tons of sugar in his warehouse and he is willing
to sell 30 tons at rs. 30/kg then the supply is 30 tons and the stock is 50
tons.
Law of Supply
• Law of Supply states that other • The Law of supply states that
things being equal, the Higher other things being equal, the
the price, the Greater the quantities of any commodity
Quantity Supplied that firms will produce and offer
• or the Lower the Price, the for sale, is positively related to
Smaller the Quantity supplied. the commodities own price,
rising when price rises and
• falling when price falls.
• - Dooley
• - Lipsey
Law of Supply
• There is a Direct relationship between Price and Quantity supplied:

• - Quantity supplied rises as Price rises, other things are constant.

• - Quantity supplied falls as Price falls, other things are constant.

• The Law of Supply is accounted for by 2 factors:

• - When Prices rise, firms substitute production of one good for another.
• - Assuming firms’ costs are constant, a higher price means higher profits.
Behaviour of supply depends upon:

• Phenomenon (something extraordinary) considered.

• Degree of possible adjustment in supply.

• Time taken into consideration i.e., short run and long run.
Assumptions of Law of Supply
• There is no change in the price of the factors of production
• There is no change in the techniques of production
• There is no change in the goods of the firm
• There is no change in the price of the related goods
• Investors have full confidence over business
 Why does law of Supply operate?
• Profit Motive:
• As Price rises, supplier’s profit margin also rises
• Increased profit motivates to supply more

• Change in the number of Firms:

• High prices generally imply a higher profit margin
• High margin of profit makes the particular business lucrative to new innovations
• Hence number of firms increases in the market, causing supply to rise
simultaneously

• Reduction in Stock
• As price rises the production are willing to supply more from their accumulated
stocks causing stocks to deplete and supply to increase
Exceptions to Law of Supply
• Agricultural Goods:
• As the supply depands on climate conditions an not on price
• Perishable Goods:
• Fruits, Vegetables, milk and milk products cannot be held for long time
• Suppliers willing to supply these products even when prices are less for fear that
they would be useless
• Antique Goods, Paintings:
• Supply affected by factors other than price
• Future Expectations regarding prices
• If price are rising, but sellers anticipate that they would rise further then they
would not increase their supply now
• Lack of resources:
• Underdeveloped economies – supply cannot be increased due to lack
of resources
• Labour Market:
• As wage rate rises workers tend to work for less hours so as to enjoy
leisure so supply decreases