921-Economic Analysis Unit 1

Mr. J.JERLIN RAJAN, M.A.,MBA., M.Phil., BGL.
,
Assistant Professor, Dept of MBA
St. Xavier’s Catholic College of Engineering- Nagercoil
ECONOMICS ANALYSIS FOR BUSINESS
UNIT 1
NATURE AND SCOPE OF ECONOMIC ISSUES
Micro and Macro economic variables – law of demand,
elasticity, demand forecasting-diminishing marginal utility-
consumer surplus, break even -point perfect and imperfect
competition – market equilibrium. Role of economic planning-
Indian economic planning
Meaning of Economics:
Economics can be called as social science dealing with economics problem and
man’s economic behavior. It deals with economic behavior of man in society in
respect of consumption, production; distribution etc. economics can be called
as an unending science.
Example:
For e.g. most of us want to lead an exciting life i.e. life full of excitements,
adventures etc. but unluckily we do not always have the resources necessary to
do everything we want to do. Therefore choices have to be made or in the
words of economists ‚individuals have to decide-----‚how to allocate scarce
resources in the most effective ways”.
BA 7103 Economic Analysis For Business

JJR/MBA/SXCCE/BA7103/EAB/MBA-I/U.A/IN
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Mr. J.JERLIN RAJAN, M.A.,MBA., M.Phil., BGL.,
Economics can be studied under two heads:
1) Micro Economics
2) Macro Economics
Micro Economics:
It has been defined as that branch where the unit of study is an individual, firm
or household. It studies how individual make their choices about what to
produce, how to produce, and for whom to produce, and what price to charge.
It is also known as the price theory is the main source of concepts and
analytical tools for managerial decision making.
Various micro-economic concepts such as demand, supply, elasticity of
demand and supply, marginal cost, various market forms, etc. are of great
significance to managerial economics.
Macro Economics:
It’s not only individuals and forms who are faced with having to make choices.
Governments face many such problems.
For e.g.
How much to spend on health
How much to spend on services
How much should go in to providing social security benefits.
Following are the various economic concepts which are useful for managers for
decision making:
• Price elasticity of demand
• Income elasticity of demand

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• Cost and output relationship
• Opportunity cost
• Multiplier
• Propensity to consume
• Marginal revenue product
• Production function
• Demand theory
• Theory of firm—price, output and investment decisions
• Money and banking
• Public finance and fiscal and monetary policy
• National income and • Theory of international trade
CONCEPT OF ECONOMICS IN DECISION MAKING
Meaning of decision making:
Decision making may be defined as the process of selecting the suitable action
from among several alternative courses of action.
The problem of decision making arises whenever a number of alternatives are
available. Such as:
What should be the price of the product?
What should be the size of the plant to be installed?
How many workers should be employed?
What kind of training should be imparted to them?
What is the optimal level of inventories of finished products, raw material,
spare parts, etc.?

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Therefore we can say that the problem of decision making arises due to the
scarcity of resources. We have unlimited wants and the means to satisfy those
wants are limited, with the satisfaction of one want, another arises, and here
arises the problem of decision making.
The main reasons behind uncertainty and risks are uncertain behavior of the
market forces which are as follows: The demand and supply
Changing business environment
Government policies
External influence on the domestic market
Social and political changes
Economic problem
Meaning of Economic problem:
To know the meaning of the term economic problem we have to put together
the four characteristics i.e.
Human wants are unlimited.
Human wants vary in their intensity.
The means or resources are relatively limited.
There are alternative uses of the limited resources.
Therefore economic problem can be called as the problem related to the
unlimited wants with limited resources. Problem arises due to this unlimited
wants only. Resources used to satisfy one want cannot be used to satisfy the
other want – it means that every man begins to face the problem of
economizing his means.

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The problem of economy is how to use the relatively limited resources with
alternative uses in the face of unlimited wants.
NATURE AND SCOPE OF MANAGERIAL ECONOMICS

Scope of Managerial Economics
ME deals with Demand analysis, Forecasting, Production function, Cost
analysis, Inventory Management, Advertising, Pricing System, Resource
allocation etc.
Following aspects are to be taken into account while knowing the scope of ME:
1. Demand analysis and forecasting:
Unless and until knowing the demand for a product how can we think of
producing that product. Therefore demand analysis is something which is
necessary for the production function to happen. Demand analysis helps in
analyzing the various types of demand which enables the manager to arrive at
reasonable estimates of demand for product of his company. Managers not
only assess the current demand but he has to take into account the future
demand also.
2. Production function:
Conversion of inputs into outputs is known as production function. With
limited resources we have to make the alternative uses of this limited resource.
Factor of production called as inputs is combined in a particular way to get the
maximum output. When the price of input rises the firm is forced to work out a
combination of inputs to ensure the least cost combination.
3. Cost analysis:

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Cost analysis is helpful in understanding the cost of a particular product. It
takes into account all the costs incurred while producing a particular product.
Under cost analysis we will take into account determinants of costs, method of
estimating costs, the relationship between cost and output, the forecast of the
cost, profit, these terms are very vital to any firm or business.
4. Inventory Management:
What do you mean by the term inventory? Well the actual meaning of the term
inventory is stock. It refers to stock of raw materials which a firm keeps. Now
here the question arises how much of the inventory is ideal stock. Both the high
inventory and low inventory is not good for the firm. Managerial economics
will use such methods as ABC Analysis, simple simulation exercises, and some
mathematical models, to minimize inventory cost. It also helps in inventory
controlling.
5. Advertising:
Advertising is a promotional activity. In advertising while the copy,
illustrations, etc., are the responsibility of those who get it ready for the press,
the problem of cost, the methods of determining the total advertisement costs
and budget, the measuring of the economic effects of advertising ---- are the
problems of the manager.
There’s a vast difference between producing a product and marketing it. It is
through advertising only that the message about the product should reach the
consumer before he thinks to buy it.

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Advertising forms the integral part of decision making and forward planning.
6. Pricing system:
Here pricing refers to the pricing of a product. As you all know that pricing
system as a concept was developed by economics and it is widely used in
managerial economics. Pricing is also one of the central functions of an
enterprise. While pricing commodity the cost of production has to be taken into
account, but a complete knowledge of the price system is quite essential to
determine the price. It is also important to understand how product has to be
priced under different kinds of competition, for different markets.
Pricing = cost plus pricing and the policies of the enterprise
Now it is clear that the price system touches the several aspects of managerial
economics and helps managers to take valid and profitable decisions.
7. Resource allocation:
Resources are allocated according to the needs only to achieve the level of
optimization.
As we all know that we have scarce resources, and unlimited needs. We have
to make the alternate use of the available resources. For the allocation of the
resources various advanced tools such as linear programming are used to
arrive at the best course of action.
NATURE OF MANAGERIAL ECONOMICS

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• Managerial economics aims at providing help in decision making by
firms. It is heavily dependent on microeconomic theory. The various concepts
of micro economics used frequently in managerial economics
Elasticity of demand
Marginal cost
Marginal revenue
Market structures and their significance in pricing policies.
• Macro economy is used to identify the level of demand at some future
point in time, based on the relationship between the level of national income
and the demand for a particular product. It is the level of national income only
that the level of various products depends.
In managerial economics macro economics indicates the relationship between
(a) the magnitude of investment and the level of national income, (b) the level
of national income and the level of employment, (c) the level of consumption
and the level of national income.
• In managerial economics emphasis is laid on those prepositions which
are likely to be useful to management.
DEMAND ANALYSIS
“Demand for a product is the desire for that product backed by willingness as
well as ability to pay for it. It is always defined with reference to a particular
time, place, price and given values of other variables on which it depends.”
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Demand for product implies:
a) Desires to acquire it,
b) Willingness to pay for it, and
c) Ability to pay for it.
For example:
 A poor man’s desires to stay in a five-star hotel room and his willingness
to pay rent for that room is not ‘demand’, because he lacks the necessary
purchasing power; so it is merely his wishful thinking.
 Similarly, a miser’s desire for and his ability to pay for a car is not
‘demand’, because he does not have the necessary willingness to pay for
a car.
 One may also come across a well-established person who processes both
the willingness and the ability to pay for higher education. But he has
really no desire to have it, he pays the fees for a regular cause, and
eventually does not attend his classes. Thus, in an economics sense, he
does not have a ‘demand’ for higher education degree/diploma.
TYPES OF DEMAND
Till now we have that may specify demand in the form of a function. Much of
this specification and its form depend on the nature of demand itself – its type
and determinants. From this standpoint, we can talk about a few other distinct
concepts of demand:
i) Direct and Derived Demands

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Direct demand refers to demand for goods meant for final consumption; it is
the demand for consumers’ goods like food items, readymade garments and
houses. By contrast, derived demand refers to demand for goods which are
needed for further production; it is the demand for producers’ goods like
industrial raw materials, machine tools and equipments. Thus the demand for
an input or what is called a factor of production is a derived demand; its
demand depends on the demand for output where the input enters. In fact, the
quantity of demand for the final output as well as the degree of
substituability/complementarty between inputs would determine the derived
demand for a given input.
For example, the demand for gas in a fertilizer plant depends on the amount of
fertilizer to be produced and substitutability between gas and coal as the basis
for fertilizer production. However, the direct demand for a product is not
contingent upon the demand for other products.
ii) Domestic and Industrial Demands
The example of the refrigerator can be restated to distinguish between the
demand for domestic consumption and the demand for industrial use. In case
of certain industrial raw materials which are also used for domestic purpose,
this distinction is very meaningful.
For example, coal has both domestic and industrial demand, and the
distinction is important from the standpoint of pricing and distribution of coal.
iii) Autonomous and Induced Demand
When the demand for a product is tied to the purchase of some parent product,
its demand is called induced or derived.

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For example, the demand for cement is induced by (derived from) the demand
for housing. As stated above, the demand for all producers’ goods is derived or
induced. In addition, even in the realm of consumers’ goods, we may think of
induced demand. Consider the complementary items like tea and sugar, bread
and butter etc. The demand for butter (sugar) may be induced by the purchase
of bread (tea). Autonomous demand, on the other hand, is not derived or
induced. Unless a product is totally independent of the use of other products, it
is difficult to talk about autonomous demand. In the present world of
dependence, there is hardly any autonomous demand. Nobody today
consumes just a single commodity; everybody consumes a bundle of
commodities. Even then, all direct demand may be loosely called autonomous.
iv) Perishable and Durable Goods’ Demands
Both consumers’ goods and producers’ goods are further classified into
perishable/non-durable/single-use goods and durable/non-
perishable/repeated-use goods. The former refers to final output like bread or
raw material like cement which can be used only once. The latter refers to
items like shirt, car or a machine which can be used repeatedly. In other words,
we can classify goods into several categories: single-use consumer goods,
single-use producer goods, durable-use consumer goods and durable-use
producer’s goods.
This distinction is useful because durable products present more complicated
problems of demand analysis than perishable products. Non-durable items are
meant for meeting immediate (current) demand, but durable items are
designed to meet current as well as future demand as they are used over a

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period of time. So, when durable items are purchased, they are considered to
be an addition to stock of assets or wealth. Because of continuous use, such
assets like furniture or washing machine, suffer depreciation and thus call for
replacement. Thus durable goods demand has two varieties – replacement of
old products and expansion of total stock. Such demands fluctuate with
business conditions, speculation and price expectations. Real wealth effect
influences demand for consumer durables.
v) New and Replacement Demands
This distinction follows readily from the previous one. If the purchase or
acquisition of an item is meant as an addition to stock, it is a new demand. If
the purchase of an item is meant for maintaining the old stock of capital/asset,
it is replacement demand. Such replacement expenditure is to overcome
depreciation in the existing stock.
Producers’ goods like machines. The demand for spare parts of a machine is
replacement demand, but the demand for the latest model of a particular
machine (say, the latest generation computer) is anew demand. In course of
preventive maintenance and breakdown maintenance, the engineer and his
crew often express their replacement demand, but when a new process or a
new technique or anew product is to be introduced, there is always a new
demand.
You may now argue that replacement demand is induced by the quantity and
quality of the existing stock, whereas the new demand is of an autonomous
type. However, such a distinction is more of degree than of kind. For example,
when demonstration effect operates, a new demand may also be an induced

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demand. You may buy a new VCR, because your neighbor has recently bought
one. Yours is a new purchase, yet it is induced by your neighbor’s
demonstration.
vi) Final and Intermediate Demands
This distinction is again based on the type of goods- final or intermediate. The
demand for semi-finished products, industrial raw materials and similar
intermediate goods are all derived demands, i.e., induced by the demand for
final goods. In the context of input-output models, such distinction is often
employed.
vii) Individual and Market Demands
This distinction is often employed by the economist to study the size of the
buyers’ demand, individual as well as collective. A market is visited by
different consumers, consumer differences depending on factors like income,
age, sex etc. They all react differently to the prevailing market price of a
commodity. For example, when the price is very high, a low-income buyer may
not buy anything, though a high income buyer may buy something. In such a
case, we may distinguish between the demand of an individual buyer and that
of the market which is the market which is the aggregate of individuals.
You may note that both individual and market demand schedules (and hence
curves, when plotted) obey the law of demand. But the purchasing capacity
varies between individuals. For example, A is a high income consumer, B is a

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middle-income consumer and C is in the low-income group. This information
is useful for personalized service or target-group-planning as a part of sales
strategy formulation.
viii) Total Market and Segmented Market Demands
This distinction is made mostly on the same lines as above. Different individual
buyers together may represent a given market segment; and several market
segments together may represent the total market. For example, the Hindustan
Machine Tools may compute the demand for its watches in the home and
foreign markets separately; and then aggregate them together to estimate the
total market demand for its HMT watches. This distinction takes care of
different patterns of buying behavior and consumers’ preferences in different
segments of the market. Such market segments may be defined in terms of
criteria like location, age, sex, income, nationality, and so on
x) Company and Industry Demands
An industry is the aggregate of firms (companies). Thus the Company’s
demand is similar to an individual demand, whereas the industry’s demand is
similar to aggregated total demand. You may examine this distinction from the
standpoint of both output and input.
For example, you may think of the demand for cement produced by the
Cement Corporation of India (i.e., a company’s demand), or the demand for
cement produced by all cement manufacturing units including the CCI (i.e., an
industry’s demand). Similarly, there may be demand for engineers by a single
firm or demand for engineers by the industry as a whole, which is an example
of demand for an input. You can appreciate that the determinants of a

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company’s demand may not always be the same as those of an industry’s. The
inter-firm differences with regard to technology, product quality, financial
position, market (demand) share, market leadership and competitiveness---- all
these are possible explanatory factors. In fact, a clear understanding of the
relation between company and industry demands necessitates an
understanding of different market structures.
What determines demand?
 There are a number of factors which influence housework demand for a
commodity.
(I) Price of the commodity,
(ii) Prices of other related commodities,
(iii) Level of income of the household,
(iv) Tastes and preferences of consumers,
(v) Size and composition of population,
(vi) Distribution of income,
Demand and supply analysis
Economics may appear to be the study of complicated tables and charts,
statistics and numbers, but, more specifically, it is the study of what constitutes
rational human behavior in the endeavor to fulfill needs and wants.
As an individual, for example, you face the problem of having only limited
resources with which to fulfill your wants and needs, as a result, you must
make certain choices with your money. You'll probably spend part of your

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money on rent, electricity and food. Then you might use the rest to go to the
movies and/or buy a new pair of jeans. Economists are interested in the choices
you make, and inquire into why, for instance, you might choose to spend your
money on a new DVD player instead of replacing your old TV. They would
want to know whether you would still buy a carton of cigarettes if prices
increased by $2 per pack. The underlying essence of economics is trying to
understand how both individuals and nations behave in response to certain
material constraints.
We can say, therefore, that economics, often referred to as the "dismal science",
is a study of certain aspects of society. Adam Smith (1723 - 1790), the "father of
modern economics" and author of the famous book "An Inquiry into the
Nature and Causes of the Wealth of Nations", spawned the discipline of
economics by trying to understand why some nations prospered while others
lagged behind in poverty. Others after him also explored how a nation's
allocation of resources affects its wealth.
To study these things, economics makes the assumption that human beings
will aim to fulfill their self-interests. It also assumes that individuals are
rational in their efforts to fulfill their unlimited wants and needs. Economics,
therefore, is a social science, which examines people behaving according to
their self-interests.

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Market demand for potatoes
(monthly)(1) (2) (3) (4)
Price Babu’s Latha's Total

(per kg) demand demand market
(kg) (kg) demand
(tonnes: 000s)
A 20 28 16 700
B 40 15 11 500
C 60 5 9 350
D 80 1 7 200
E 100 0 6 100
The definition set out at the turn of the twentieth century by Alfred Marshall,
author of "The Principles Of Economics" (1890), reflects the complexity
underlying economics: "Thus it is on one side the study of wealth; and on the
other, and more important side, a part of the study of man."
Supply and demand
Supply and demand is perhaps one of the most fundamental concepts of
economics and it is the backbone of a market economy. Demand refers to how
much (quantity) of a product or service is desired by buyers. The quantity
demanded is the amount of a product people are willing to buy at a certain

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price; the relationship between price and quantity demanded is known as the
demand relationship. Supply represents how much the market can offer. The
quantity supplied refers to the amount of a certain good producers are willing
to supply when receiving a certain price. The correlation between price and
how much of a good or service is supplied to the market is

known as the
supply relationship. Price, therefore, is a reflection of supply and demand.

Market supply of potatoes ( monthly )
100 e
Supply
d P Q
80
a 20 100
Pri b 40 200
) 60
ce
c c 60 350
d 80 530
e 100 700
( b
pe 40
r 20 a
kg
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s )
Law of Demand

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A microeconomic law that states that, all other factors being equal, as the price
of a good or service increases, consumer demand for the good or service will
decrease and vice versa.
This law summarizes the
effect price changes have on
consumer behavior. For
example, a consumer will
purchase more pizzas if the
price of pizza falls. The
opposite is true if the price of
pizza increases.
A, B and C are points on the demand curve. Each point on the curve reflects a
direct correlation between quantities demanded (Q) and price (P). So, at point
A, the quantity demanded will be Q1 and the price will be P1, and so on. The
demand relationship curve illustrates the negative relationship between price
and quantity demanded. The higher the price of a good the lower the quantity
demanded (A), and the lower the price, the more the good will be in
demand (C).
B. The Law of Supply

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Like the law of demand,
the law of supply
demonstrates the
quantities that will be
sold at a certain price. But
unlike the law of
demand, the supply
means that the higher the
price, the higher the quantity supplied. Producers supply more at a higher
price because selling a higher quantity at higher price increases revenue
A, B and C are points on the supply curve. Each point on the curve reflects a
direct correlation between quantity supplied (Q) and price (P). At point B, the
quantity supplied will be Q2 and the price will be P2, and so on.
Time and Supply
Unlike the demand relationship, however, the supply relationship is a factor of
time. Time is important to supply because suppliers must, but cannot always,
react quickly to a change in demand or price. So it is important to try and
determine whether a price change that is caused by demand will be temporary
or permanent.

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Let's say there's a sudden increase in the demand and price for umbrellas in an
unexpected rainy season; suppliers may simply accommodate demand by
using their production equipment more intensively. If, however, there is a
climate change, and the population will need umbrellas year-round, the change
in demand and price will be expected to be long term; suppliers will have to
change their equipment and production facilities in order to meet the long-
term levels of demand.
C. Supply and Demand Relationship
Now that we know the laws of supply and demand, let's turn to an example to
show how supply and demand affect price.
Imagine that a special edition CD of your favorite band is released for $20.
Because the record company's previous analysis showed that consumers will
not demand CDs at a price higher than $20, only ten CDs were released
because the opportunity cost is too high for suppliers to produce more. If,

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however, the ten CDs are demanded by 20 people, the price will subsequently
rise because, according to the demand relationship, as demand increases, so
does the price. Consequently, the rise in price should prompt more CDs to be
supplied as the supply relationship shows that the higher the price, the higher
the quantity supplied.
If, however, there are 30 CDs produced and demand is still at 20, the price will
not be pushed up because the supply more than accommodates demand. In
fact after the 20 consumers have been satisfied with their CD purchases, the
price of the leftover CDs may drop as CD producers attempt to sell the
remaining ten CDs. The lower price will then make the CD more available to
people who had previously decided that the opportunity cost of buying the CD
at $20 was too high.
D. Equilibrium
When supply and demand are equal (i.e. when the supply function and
demand function intersect) the economy is said to be at equilibrium. At this
point, the allocation of goods is at its most efficient because the amount of
goods being supplied is exactly the same as the amount of goods being
demanded. Thus, everyone (individuals, firms, or countries) is satisfied with
the current economic condition. At the given price, suppliers are selling all the
goods that they have produced and consumers are getting all the goods that
they are demanding.
As you can see on the chart, equilibrium occurs at the intersection of the
demand and supply curve, which indicates no allocative inefficiency. At this
point, the price of the goods will be P* and the quantity will be Q*. These

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figures are referred to as equilibrium price and quantity.
In the real market place equilibrium can only ever be reached in theory, so the
prices of goods and services are constantly changing in relation to fluctuations
in demand and supply.
E. Disequilibrium
Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.
1. Excess Supply
If the price is set too high, excess supply will be created within the economy
and there will be allocative inefficiency.
At price P1 the quantity of goods that the producers wish to supply is indicated
by Q2. At P1, however, the quantity that the consumers want to consume is at
Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is
being produced and too little is being consumed. The suppliers are trying to
produce more goods, which they hope to sell to increase profits, but those
consuming the goods will find the product less attractive and purchase less

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because the price is too high.
2. Excess Demand
Excess demand is created when price is set below the equilibrium price.
Because the price is so low, too many consumers want the good
while producers are not making enough of it.
In this situation, at price P1, the quantity of goods demanded by consumers at
this price is Q2. Conversely, the quantity of goods that producers are willing to
produce at this price is Q1. Thus, there are too few goods being produced to
satisfy the wants (demand) of the consumers. However, as consumers have to
compete with one other to buy the good at this price, the demand will push the
price up, making suppliers want to supply more and bringing the price closer
to its equilibrium.

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F. Shifts vs. Movement
For economics, the ‚movements‛ and ‚shifts‛ in relation to the supply and
demand curves represent very different market phenomena:
1. Movements
A movement refers to a
change along a curve. On
the demand curve, a
movement denotes a
change in both price and
quantity demanded from
one point to another on
the curve. The movement implies that the demand relationship remains
consistent. Therefore, a movement along the demand curve will occur when
the price of the good changes and the quantity demanded changes in
accordance to the original demand relationship. In other words, a movement
occurs when a change in the quantity demanded is caused

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Only by a change in price, and vice versa. Like a movement along the demand
curve, a movement along the supply curve means that the supply relationship
remains consistent. Therefore, a movement along the supply
curve will occur when the price of the good changes and the quantity supplied
changes in accordance to the original supply relationship. In other words, a
movement occurs when a change in quantity supplied is caused only by a
change in price, and vice versa.
2. Shifts
A shift in a demand or supply curve
occurs w
demanded or supplied changes even
though price remains the same. For
instance, if the price for a bottle of beer
was $2 and the quantity of beer
demanded increased from Q1 to Q2,
then there would be a shift in the

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demand for beer. Shifts in the demand curve imply that the original demand
relationship has changed, meaning that quantity demand is affected by a factor
other than price. A shift in the demand relationship would occur if, for
instance, beer suddenly became the only type of alcohol available for
consumption.
Conversely, if the price for a bottle of beer was $2 and the quantity supplied
decreased from Q1 to Q2, then there would be a shift in the supply of beer.
Like a shift in the
demand curve, a shift in
the supply curve
implies that the original
supply curve has
changed, meaning
that the quantity
supplied is effected by a
factor other than price.
A shift in the supply curve would occur if, for instance, a natural disaster
caused a mass shortage of hops; beer manufacturers would be forced to supply
less beer for the same price.
The degree to which a demand or supply curve reacts to a change in price is
the curve's elasticity. Elasticity varies among products because some products
may be more essential to the consumer. Products that are necessities are more
insensitive to price changes because consumers would continue

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buying these products despite price increases. Conversely, a price increase of a
good or service that is considered less of a necessity will deter more consumers
because the opportunity cost of buying the product will become too high. A
good or service is considered to be highly elastic if a slight change in price
leads to a sharp change in the quantity demanded or supplied. Usually these
kinds of products are readily available in the market and a person may not
necessarily need them in his or her daily life. On the other hand, an inelastic
good or service is one in which changes in price witness only modest changes
in the quantity demanded or supplied, if any at all. These goods tend to be
things that are more of a necessity to the consumer in his or her daily life. To
determine the elasticity of the supply or demand curves, we can use this
simple equation:
Elasticity = (% change in
quantity / % change in price)
If elasticity is greater than or
considered to be elastic. If it is
less than one, the curve is said to
be inelastic.
As we mentioned previously, the
demand curve is a negative slope, and if there is a large decrease in the
quantity demanded with a small increase in price, the demand curve looks
flatter, or more horizontal. This flatter curve means that the good or service in
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question is elastic.
Meanwhile, inelastic demand
is represented with a much
quantity changes little with a
Elasticity of supply works similarly. If a change in price results in a big change
in the amount supplied, the supply curve appears flatter and is considered
elastic. Elasticity in this case would be greater than or equal to one.
On the other hand, if a big change in price only results in a minor change in the
quantity supplied, the supply curve is steeper and its elasticity would be less
than one.
A. Factors Affecting Demand Elasticity
There are three main factors that influence a demand's price elasticity:
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1. The
availability of substitutes –
This is probably the most important factor influencing the elasticity of a good
or service. In general, the more substitutes, the more elastic the demand will
be. For example, if the price of a cup of coffee went up by $0.25, consumers
could replace their morning caffeine with a cup of tea. This means that coffee is
an elastic good because a raise in price will cause a large decrease in demand
as consumers start buying more tea instead of coffee.
However, if the price of caffeine were to go up as a whole, we would probably
see little change in the consumption of coffee or tea because there are few
substitutes for caffeine. Most people are not willing to give up their morning
cup of caffeine no matter what the price. We would say, therefore, that caffeine
is an inelastic product because of its lack of substitutes. Thus, while a product
within an industry is elastic due to the availability of substitutes, the industry
itself tends to be inelastic. Usually, unique goods such as diamonds are
inelastic because they have few if any substitutes.

30
2. Amount of income available to spend on the good –
This factor affecting demand elasticity refers to the total a person can spend on
a particular good or service. Thus, if the price of a can of Coke goes up from
$0.50 to $1 and income stays the same, the income that is available to spend on
coke, which is $2, is now enough for only two rather than four cans of Coke. In
other words, the consumer is forced to reduce his or her demand of Coke. Thus
if there is an increase in price and no change in the amount of income available
to spend on the good, there will be an elastic reaction in demand; demand will
be sensitive to a change in price if there is no change in income.
3. Time - The third influential factor is time. If the price of cigarettes goes up $2
per pack, a smoker with very few available substitutes will most likely
continue buying his or her daily cigarettes. This means that tobacco is inelastic
because the change in price will not have a significant influence on the quantity
demanded. However, if that smoker finds that he or she cannot afford to
spend the extra $2 per day and begins to kick the habit over a period of time,
the price elasticity of cigarettes for that consumer becomes elastic in the long
run.
B. Income Elasticity of Demand
In the second factor outlined above, we saw that if price increases while income
stays the same, demand will decrease. It follows, then, that if there is an
increase in income, demand tends to increase as well. The degree to which an
increase in income will cause an increase in demand is called income elasticity
of demand, which can be expressed in the following equation:

31
If EDy is greater than one, demand for the item is considered to have high
income elasticity. If however EDy is less than one, demand is considered to be
income inelastic. Luxury items usually have higher income elasticity because
when people have a higher income, they don't have to forfeit as much to buy
these luxury items.
Let's look at an example of a luxury good: air travel.
Babu has just received a $10,000 increase in his salary, giving him a total of
$80,000 per annum. With this higher purchasing power, he decides that he can
now afford air travel twice a year instead of his previous once a year. With the
following equation we can calculate income demand elasticity:
Income elasticity of demand for Babu's air travel is seven - highly elastic.

32
With some goods and services, we may actually notice a decrease in demand as
income increases. These are considered goods and services of inferior quality
that will be dropped by a consumer who receives a salary increase. An
example may be the increase in the demand of DVDs as opposed to video
cassettes, which are generally considered to be of lower quality. Products for
which the demand decreases as income increases have an income elasticity of
less than zero. Products that witness no change in demand despite a change in
income usually have an income elasticity of zero - these goods and services are
considered necessities.
UTILITY
We have already seen that the focus of economics is to understand the problem
of scarcity: the problem of fulfilling the unlimited wants of humankind with
limited and/or scarce resources. Because of scarcity, economies need to allocate
their resources efficiently. Underlying the laws of demand and supply is the
concept of utility, which represents the advantage or fulfillment a person
receives from consuming a good or service. Utility, then, explains how
individuals and economies aim to gain optimal satisfaction in dealing with
scarcity.
Utility is an abstract concept rather than a concrete, observable quantity. The
units to which we assign an ‚amount‛ of utility, therefore, are arbitrary,
representing a relative value. Total utility is the aggregate sum of satisfaction
or benefit that an individual gains from consuming a given amount of goods or
services in an economy. The amount of a person's total utility corresponds to

33
the person's level of consumption. Usually, the more the person consumes, the
larger his or her total utility will be. Marginal utility is the additional
satisfaction, or amount of utility, gained from each extra unit of consumption.
Although total utility usually increases as more of a good is consumed,
marginal utility usually decreases with each additional increase in the
Consumption of a good.
This decrease demonstrates the law of diminishing marginal utility. Because
there is a certain threshold of satisfaction, the consumer will no longer receive
the same pleasure from consumption once that threshold is crossed. In other
words, total utility will increase at a slower pace as an individual increases the
quantity consumed.
Take, for example, a chocolate bar. Let's say that after eating one Chocolate bar
your sweet tooth has been satisfied. Your marginal utility (and total utility)
after eating one chocolate bar will be quite high. But if you eat more chocolate
bars, the pleasure of each additional chocolate bar will be less than the pleasure
you received from eating the one before - probably because you are starting to
feel full or you have had too many sweets for one day.

34
This table shows that total utility will increase at a much slower rate as
marginal utility diminishes with each additional bar. Notice how the first
chocolate bar gives a total utility of 70 but the next three chocolate bars
together increase total utility by only 18 additional units.
The law of diminishing marginal utility helps economists understand the law
of demand and the negative sloping demand curve. The less of something you
have, the more satisfaction you gain from each additional unit you consume;
the marginal utility you gain from that product is therefore higher, giving you
a higher willingness to pay more for it. Prices are lower at a higher quantity
demanded because your additional satisfaction diminishes as you demand
more.
In order to determine what a consumer's utility and total utility are, economists
turn to consumer demand theory, which studies consumer behavior and
satisfaction. Economists assume the consumer is rational and will thus
maximize his or her total utility by purchasing a combination of different

35
products rather than more of one particular product. Thus, instead of spending
all of your money on three chocolate bars, which has a total utility of 85, you
should instead purchase the one chocolate bar, which has a utility of 70, and
perhaps a glass of milk, which has a utility of 50. This combination will give
you a maximized total utility of 120 but at the same cost as the three chocolate
bars.
DEMAND FORECASTING
 Demand Forecasting is the activity of estimating the quantity of a
product or service that consumers will purchase.
 Demand forecasting involves techniques including both informal
methods, such as educated guesses, and quantitative methods, such as
the use of historical sales data or current data from test markets.
 Demand forecasting may be used in making pricing decisions, in
assessing future capacity requirements, or in making decisions on
whether to enter a new market.
Necessity for forecasting demand
Stock effects:
 lack of availability.
 Demand is also untapped when sales for an item are decreased due to a
poor display location, or because the desired sizes are no longer
available.
 For example, when a consumer electronics retailer does not display a

36
particular flat-screen TV, sales for that model are typically lower than the
sales for models on display.
 And in fashion retailing, once the stock level of a particular sweater falls
to the point where standard sizes are no longer available, sales of that
item are diminished.
Market response effects
 The effect of market events that are within and beyond a retailer’s
control.
 Demand for an item will likely rise if a competitor increases the price or
if you promote the item in your weekly circular.
 The resulting sales increase reflects a change in demand as a result of
consumers responding to stimuli that potentially drive additional sales.
 Regardless of the stimuli, these forces need to be factored into planning
and managed within the demand forecast
LAW OF DIMINISHING MARGINAL UTILITY
A law of economics stating that as a person increases consumption of a
product - while keeping consumption of other products constant
[Ceteris paribus (meaning: other factors are constant)] - there is a decline in the
marginal utility that person derives from consuming each additional unit of
that product.

37
For example, say you go to a Hotel and the first plate of food you eat is very
good. On a scale of ten you would give it a ten. Now your hunger has been
somewhat tamed, but you get another full plate of food.
Since you're not as hungry, your enjoyment rates at a seven at best. Most
people would stop before their utility drops even more, but say you go back to
eat a third full plate of food and your utility drops even more to a three.
If you kept eating, you would eventually reach a point at which your
eating makes you sick, providing dissatisfaction, or 'dis-utility'.
CONSUMER SURPLUS
An economic measure of consumer satisfaction, which is calculated by
analyzing the difference between what consumers are willing to pay for a good
or service relative to its market price.
A consumer surplus occurs when the consumer is willing to pay more
for a given product than the current market price.
Consumers always like to feel like they are getting a good deal on the goods
and services they buy and consumer surplus is simply an economic
measure of this satisfaction.
For example, assume a consumer goes out shopping for a CD player and he or
she is willing to spend $250. When this individual finds that the player is on
sale for $150, economists would say that this person has a consumer surplus of
$100.
SETTING A PRICE
 Psychology of Pricing:

38
Pricing can involve a complicated decision-making process on the part of the
consumer, and there is plenty of research on the marketing and psychology of
how consumers perceive price.
Pricing Methods
It is a mix of quantitative and qualitative factors. If you’ve created a brand
new, unique product, you should be able to charge a premium price, but if
you’re entering a competitive industry, you’ll have to keep the price in line
with the going rate or perhaps even offer a discount to get customers to switch
to your company.
 Cost-based pricing", is which calls for figuring out how much it will cost
to produce one unit of an item and setting the price to that amount plus
a predetermined profit margin. This approach is frowned upon since it
allows competitors who can make the product for less than you to
easily
undercut you on price.
 ‚Price-based costing" encourages business owners to "start with the price
that consumers are willing to pay (when they have competitive
alternatives) and cut down costs to meet that price." That way if you
encounter new competition, you can lower your price and still turn a
profit.
MONOPOLIES, OLIGOPOLIES AND PERFECT COMPETITION
Market Structure and Perfect Competitive Firm
Market structure – identifies how a market is made up in terms of:

39
• The number of firms in the industry The nature of the product
produced
• The degree of power each firm has
• The degree to which the firm can influence price
• Profit levels
• Firms’ behaviour – pricing strategies, non-price competition, output
levels
• The extent of barriers to entry
• The impact on efficiency
Types of Market
For any particular market, we ask
How many buyers and sellers are there in the market?
Is each seller offering a standardized product, more or less indistinguishable
from that offered by other sellers?
Are there any barriers to entry or exit, or can outsiders easily enter and leave
this market?
• Four basic types of market
 Perfect competition
 Monopoly
 Monopolistic competition
 Oligopoly

40
Market Structure
Perfect Pure
Competition
Monopoly
Monopolistic Competition Oligopoly Duopoly
The further right on the scale, the greater the degree of

monopoly power exercised by the firm.
Part II. The Three Requirements of Perfect Competition
• Large numbers of buyers and sellers
• Each buys or sells only a tiny fraction of the total quantity in the market
• Sellers offer a standardized product
• Sellers can easily enter into or exit from market
• Significant barriers to entry and exit can completely change the
environment in which trading takes place .
i. A Large Number of Buyers and Sellers
• In perfect competition, there must be many buyers and sellers
• How many?
• Number must be so large that no individual decision maker can

41
significantly affect price of the product by changing quantity it buys or
sells
ii. Selling Standardized Products
• Buyers do not perceive significant differences between products of one
seller and another
• For instance, buyers of wheat do not prefer one farmer’s wheat over
another
iii. Easy Entry into and Exit from the Market
• Easy Entry
• no significant barriers to discourage new entrants
• any firm wishing to enter can do business on the same terms as firms
that are already there
• Easy exit
A firm suffering a long-run loss must be able to sell off its plant and equipment
and leave the industry for good, without obstacles
In many markets there are significant barriers to entry
Legal barriers
Existing sellers have an important advantage that new entrants can not
duplicate
Brand loyalty
Cost advantage of existing firms from significant economies of scale
Price Taker
• A firm in a perfectly competitive market is said to be a price taker
because the price of the product is determined by market supply and

42
demand, and the individual firm can do nothing to change that price.
• Both buyers and sellers are price takers.
• A price taker is a firm or individual who takes the market price as given.
• In most markets, households are price takers – they accept the price
offered in stores.
• A retail store is not a price taker but a price maker.
The Necessary Conditions for Perfect Competition
• The number of firms is large.
• Large means that what one firm does has no bearing on what other firms
do.
• Any one firm's output is tiny when compared with the total market.
There are no barriers to entry.
• Barriers to entry are social, political, or economic impediments that
prevent other firms from entering the market.
• Barriers sometimes take the form of patents granted to produce a certain
good.
• Technology may prevent some firms from entering the market.
• Social forces such as bankers only lending to certain people may create
barriers.
The firms' products are identical.
• This requirement means that each firm's output is indistinguishable from
any competitor's product.
There is complete information.

43
• Firms and consumers know all there is to know about the market –
prices, products, and available technology.
• Any technological breakthrough would be instantly known to all in the
market.
A perfectly competitive firm’s demand schedule is perfectly elastic even
though the demand curve for the market is downward sloping.
The result is that the individual firm perceives the demand curve for its
product as being perfectly horizontal
Market Demand versus Individual Firm Demand Curve
Market Firm
Price Market supply Price
$10 $10
8 8 Individual firm
demand
6 6
4 Market 4
2 demand 2
0 0
1,000 3,000 Quantity 10 20 30 Quantity
MONOPOLY
Pure monopoly – where only one producer exists in the industry
In reality, rarely exists – always some form of substitute available!
Monopoly exists therefore where one firm dominates the market

44
Firms may be investigated for examples of monopoly power when market
share exceeds 25%
Monopoly
Monopoly power – refers to cases where firms influence the market in some
way through their behaviour – determined by the degree of concentration in
the industry
• Influencing prices
• Influencing output
• straight barriers to entry
Origins of monopoly:
Natural monopoly – usually on a network or grid… wasteful to duplicate!
Geographical factors – where a country or climate is the only source of supply
of a raw material…quite rare. However, consider a single grocery store in a
isolated village…
• Government created monopolies – now sold off!
• Through growth of the firm
• Through amalgamation, merger or takeover
• Through acquiring patent or license
• Through legal means – Royal charter, nationalisation, wholly owned plc
Monopolistic Competition

45
characterized by:
• A large number of
firms
• Easy entry
• Differentiated
products, because
each firm’s product

producer of that specific product. is slightly different,
each firm is kind of a
mini-monopoly—the only
• This allows the firm to be a price maker.
The firm’s demand curve is downward sloping and depending on the
differentiation of the firm’s product, it may be fairly inelastic.
Oligopoly
Oligopoly is a market structure in which there are a few interdependent firms.
There are often significant barriers to entry.
Oligopoly is characterized by:
• Few firms—more than one, but few enough so each firm alone can affect
the market.
• Entry is more difficult, but can occur.

46
• The firms are interdependent—each is affected by what others do.
The demand curve is downward sloping for each firm.
Demand for Various Markets

Competition among Consumers
Monopsony
A market structure in which there is a single buyer (e.g., rural area granary)
Oligopsony
A market structure in which there are only a few buyers (e.g., tobacco market)
Monopsonistic competition
A market structure in which there are many buyers offering differentiated
conditions to sellers (e.g., toy manufacturers)
DEMAND FORECASTING
NEED FOR DEMAND FORECASTING

47
Business managers, depending upon their functional area, need various
forecasts. They need to forecast demand, supply, price, profit, costs,
investment, and what have you. In this unit, we are concerned with only
demand forecasting. The reason is, the concepts and techniques of demand
forecasting discussed here can be applied anywhere.
The question may arise:
Why have we chosen demand forecasting as a model?
What is the use of demand forecasting?
The significance of demand or sales forecasting in the context of business
policy decisions can hardly be overemphasized. Sales constitute the primary
source of revenue for the corporate unit and reduction for sales gives rise to
most of the costs incurred by the fir.
Thus sales forecasts are needed for production planning, inventory planning,
and profit planning and so on. Production itself requires the support of men,
materials, machines, money and finance, which will have to be arranged.
Thus, manpower planning, replacement or new investment planning,
working capital management and financial planning—all depend on sales
forecasts.
Thus demand forecasting is crucial for corporate planning. The survival and
growth of a corporate unit has to be planned, and for this sales forecasting is
the most crucial activity.
There is no choice between forecasting and no-forecasting. The choice exists
only with regard to concepts and techniques of forecasting that we employ. It

48
must be noted that the purpose of forecasting in general is not to provide an
exact future data with perfect precision, the purpose is just to bring out the
range of possibilities concerning the future under a given set of assumptions.
In other words, it is not the ‘actual future’ but the ‘likely future’ that we build
up through forecasts. Such forecasts do not eliminate, but only help you to
reduce the degree of risk and uncertainties of the future. Forecasting is a step
towards that kind of ‘gursstimation’; it is some sort of an approximation to
reality. If the likely state comes close to the actual state, it means that the
forecast is dependable.
A sales forecast is meant to guide business policy decision. Without
forecasting, forward planning by a corporate unit will be directionless.
STEPS IN DEMAND FORECASTING
Demand or sales forecasting is a scientific exercise. It has to go through a
number of steps. At each step, you have to make critical considerations. Such
considerations are categorically listed below:
1) Nature of forecast:
To begin with, you should be clear about the uses of forecast data- how it is
related to forward planning and corporate planning by the firm. Depending
upon its use, you have to choose the type of forecasts: short-run or long-run,
active or passive, conditional or non-conditional etc.
2) Nature of product:

49
The next important consideration is the nature of product for which you are
attempting a demand forecast. You have to examine carefully whether the
product is consumer goods or producer goods, perishable or durable, final or
intermediate demand, new demand or replacement demand type etc. A couple
of examples may illustrate the importance of this factor. The demand for
intermediate goods like basic chemicals is derived from the final demand for
finished goods like detergents. While forecasting the demand for basic
chemicals, it becomes essential to analyse the nature of demand for detergents.
Promoting sales through advertising or price competition is much less
important in the case of intermediate goods compared to final goods. The
elasticity of demand for intermediate goods depends on their relative
importance in the price of the final product.
Time factor is a crucial determinant in demand forecasting. Perishable
commodities such as fresh vegetables and fruits can be sold over a limited
period of time. Here skilful demand forecasting is needed to avoid waste. If
there are storage facilities, then buyers can adjust their demand according to
availability, price and income. The time taken for such adjustment varies from
product to product. Goods of daily necessities that are bought more frequently
will lead to quicker adjustments. Whereas in case of expensive equipment
which is worn out and replaced after a long period of time, adaptation of
demand will be spread over a longer duration of time.
3) Determinants of demand:
Once you have identified the nature of product for which you are to build a
forecast, your next task is to locate clearly the determinants of demand for the

50
product. Depending on the nature of product and nature of forecasts, different
determinants will assume different degree of importance in different demand
functions. In the preceding unit, you have been exposed to a number of
priceincome factors or determinants-own price, related price, own income-
disposable and discretionary, related income, advertisement, price expectation
etc. In addition, it is important to consider socio-psychological determinants,
specially demographic, sociological and psychological factors affecting
demand. Without considering these factors, long-run demand forecasting is
not
possible.
Such factors are particularly important for long-run active forecasts. The size of
population, the age-composition, the location of household unit, the
sexcomposition-all these exercise influence on demand in. varying degrees. If
more babies are born, more will be the demand for toys; if more youngsters
marry, more will be the demand for furniture; if more old people survive, more
will be the demand for sticks. In the same way buyers’ psychology-his need,
social status, ego, demonstration effect etc. –also effect demand. While
forecasting, you cannot neglect these factors.
4) Analysis of factors &determinants:
Identifying the determinants alone would not do, their analysis is also
important for demand forecasting. In an analysis of statistical demand
function, it is customary to classify the explanatory factors into (a) trend
factors, which affect demand over long-run, (b) cyclical factors whose effects
on demand are periodic in nature, (c) seasonal factors, which are a little more

51
certain compared to cyclical factors, because there is some regularly with
regard to their occurrence, and (d) random factors which create disturbance
because they are erratic in nature; their operation and effects are not very
orderly.
An analysis of factors is specially important depending upon whether it is the
aggregate demand in the economy or the industry’s demand or the company’s
demand or the consumers; demand which is being predicted. Also, for a
longrun demand forecast, trend factors are important; but for a short-run
demand forecast, cyclical and seasonal factors are important.
5) Choice of techniques:
This is a very important step. You have to choose a particular technique from
among various techniques of demand forecasting. Subsequently, you will be
exposed to all such techniques, statistical or otherwise. You will find that
different techniques may be appropriate for forecasting demand for different
products depending upon their nature. In some cases, it may be possible to use
more than one technique. However, the choice of technique has to be logical
and appropriate; for it is a very critical choice. Much of the accuracy and
relevance of the forecast data depends accuracy required, reference period of
the forecast, complexity of the relationship postulated in the demand function,
available time for forecasting exercise, size of cost budget for the forecast etc.
6) Testing accuracy:
This is the final step in demand forecasting. There are various methods for
testing statistical accuracy in a given forecast. Some of them are simple and
inexpensive, others quite complex and difficult. This stating is needed to

52
avoid/reduce the margin of error and thereby improve its validity for practical
decision-making purpose. Subsequently you will be exposed briefly to some of
these methods and their uses.
BREAKEVEN ANALYSIS
 Breakeven Analysis in the context of Production planning addresses the
decision of whether to make or buy a product.
 Making the product involves two cost elements:
– Fixed costs such as machine renting cost and operation expenses
– Variable costs such as raw material cost
 Buying the product involves only one cost element, the selling price.
However, the price may either be constant or variable based on the

53
Cost
Mr. J.JERLIN RAJAN, M.A.,MBA., M.Phil., BGL., Buy Cost (BC) = pQ
Assistant Professor, Dept of MBA Making is better
Make Cost (MC) = FC + vQ
Buying is better
Savings : S = BC– MC = pQ – FC – vQ
Breakeven: S = 0,pQ = FC + vQ
Quantity (Q)
Q’
quantity.
Breakeven Point = Fixed Costs
(Unit Selling Price - Variable Costs)

Variable cost: vQ
Fixed Cost: FC
ECONOMIC PLANNING
Meaning and Need for Planning:
The 20th century was an era of planning. Almost every country had some sort
of planning. In socialist countries, planning is almost a religion. Even in
countries like the U.S.A. and the U.K. with a capitalistic system, they have
partial planning. The 19th century State was a Laissez faire state. It followed a
policy of non –intervention in economic affairs. But the modern State is a

54
Welfare State. The two World Wars, the Great Depression of 1930s and the
success of planning in former Soviet Russia have underlined the need for
planning. Planning is a gift of former Soviet Russia to the world.
For, it was the first country to practice economic planning on a national scale.
According to Lionel Robbins, ‚strictly speaking, all economic life involves
planning…. To plan is to act with a purpose, to choose and choice is the
essence of economic activity‛.
In the words of Barbara Wootten, ‚Planning may be defined as the conscious
and deliberate choice of economic priorities by some public authorities‛. Many
economists today agree that planning is an organized, conscious and
continuous attempt to select the basic available alternatives to achieve specific
goals. Planning involves the economizing of scarce resources.
Most of the underdeveloped countries of the world became independent only
fifty or sixty years back and most of them were poor at that time. So it became
the main business of the Governments of the newly emergent nations to
provide food, clothing and shelter to their people. For that, first of all, they had
to increase their national income. Since most of them were agricultural
countries, they had to evolve some programmes for agricultural development.
Not only that, they had to industrialize their economies. And they had to
provide more jobs to their people. That means, they had to do something for
expanding employment opportunities. Further, as most of them were wedded
to some kind of socialism, they had to reduce inequalities of income and
wealth. All these things, the poor countries attempted to do by means of
economic planning.

55
Laissez faire policy is a luxury for modern governments. So they have economic
plans. In the developed nations of the world, they plan for economic stability.
But in the underdeveloped nations, they plan for economic growth and
development.
Another main reason for the emergence of planning in underdeveloped
countries is the failure of the market mechanism. The capitalist economy is
basically a market economy and price mechanism works through the market
system. The price system is a basic institution of capitalism. The allocation of
resources and distribution of rewards are done through the price system. All
decisions of the businessmen, farmers, industrialists and so on are guided by
the profit motive. If the market is perfect, price system is good. But if there is
monopoly and other types of imperfect competition, the market system fails.
And it calls for government intervention by way of planning.
The dispute between planning and Laissez faire is essentially about efficiency.
The case against Laissez faire rests on the following grounds:
1. Under Laissez faire, income is not fairly distributed. As a consequence,
less important and less urgent goods are produced for the wealthy people
while the poor lack basic goods like education, health, housing, good food and
ordinary comforts. Under such a situation, the State can control economic
activity by means of planning and reduce inequalities of income and wealth.
2. The market economy is a victim of trade cycles. And there will be
alternating periods of prosperity and depression. And during depression, there

56
will be bad trade, falling prices and mass unemployment. So there is need for
state
intervention. By means of proper planning, the State can control trade cycles as
they did in the case of former Soviet Russia. During the latter half of the 20th
century, planning was popular in many underdeveloped countries, in addition
to former Soviet Russia and Eastern European countries. It does not mean that
they believed in complete central planning. The central issue in planning is not
whether there shall be planning but what form it shall take. The debate, in fact,
centered on whether the State shall operate through the price system or by
getting rid of it.
Problems of Planning in backward countries
Planning is much more necessary and much more difficult to execute in
backward than in advanced countries. First of all, ‚planning requires a strong,
competent and incorrupt administration‛.But most of the economically
backward nations have weak, incompetent and corrupt administration.
Further, they have democratic planning. So they cannot do things in a quick
manner as was done in former Soviet Russia. They have to go slow. And
agriculture is the main stay of their economies. Since agriculture depends upon
natural factors which are uncertain, there is a lot of uncertainty about their
agricultural programmes. Over–population and low capital formation are
some other important problems of planning in underdeveloped nations.
Characteristics of Economic Planning
In a planned economy, major economic decisions such as what and how much
is to be produced, when and where it is to be produced and to whom it is to be

57
allocated will be determined by a central authority such as the State, through
the Planning Commission.
And the Government will have the powers of implementation. Before the Plan
is drawn up, a detailed survey of all available resources – physical resources,
financial resources and human resources – has to be made. For example, in the
former Soviet Russia, after the Revolution in 1917, there was War Communism
between 1918 – 1921. And there was New Economic Policy (NEP) from 1921 to
1924. And from 1924, the Government made a detailed survey of all available
resources and only in 1928, it implemented its First Five Year Plan. After the
survey of resources, the objectives of planning will be determined. For
example, one of the long term objectives of Soviet Planning was that Soviet
Russia should catch up with the production levels of the leading capitalist
nation of the world, namely U.S.A., in steel, coal and electricity. Keeping in
mind, the objectives of the Five Year Plan, the physical targets will be fixed.
And ways and means of mobilizing financial resources will be explored. The
Plan will also spell out the details in which the fruits of planning will be
distributed in a fair and just manner.
The nature of planning is determined by the type of economic system –
capitalism, socialism, mixed economy - in which it is practiced.
There will be partial planning in a capitalist economy, (e.g., U.K.) but a socialist
economy is a totally planned economy (e.g., Former Soviet Russia). In a mixed
economy like India, both public sector and private sector play important roles
in economic planning.

58
Usually, the period of a Plan is five years. The Plan has to be drawn in advance.
It is done by the Planning Commission in India. A plan will be of a definite size
and it will fix the targets for the Plan period and it will also indicate the ways
by which the financial resources are to be mobilized for the Plan.
The first step in drawing up a Plan is to determine a growth target for an
economy over the Plan period. The planners then divide the economy into a
number of sectors such as agriculture, industry and service sector. The
planners will fix the physical targets for the sectors and also decide how much
investment must be made in each sector to achieve the targets. Then they will
decide the right type of investment projects and production techniques. As the
UDCs are poor, labour-intensive techniques will expand employment
opportunities. But some heavy industries like steel have to be capital –
intensive. The success or failure of a Plan depends upon the choices that are
made.
Types of Planning
1. Centralized Planning :
In a socialist economy (eg. Former Soviet Russia), there was centralized
planning; it was planning by direction. In a socialist state, most of the means of
production are owned by the State. All basic economic decisions such as
whether priority is to be given for industrialization or for development of
agriculture ; if it is decided to give importance to industrialisation, whether to
give importance to basic and heavy industries or for consumer goods
industries will be made by the central authority.
2. Planning by Inducement:

59
In a democracy, Planning is done by inducement. For example, ours is a mixed
economy where there is a public sector and a private sector. The government
has to persuade the industries in the private sector to fulfil the goals of the Plan
through inducements such as tax concessions and by providing incentives.
3. Indicative planning – In this type of planning, the government invites
representatives of industry, and business and discuss with them in advance
what it proposes to do in the Plan under question and indicates to them its
priorities and goals. Then the Plan is formulated after detailed discussions
with varied interests. Planning in France is a good example of indicative
planning. After we embraced liberalization and privatization policies in 1991,
even Indian planning, in a way, has become indicative planning.
Economic plans can also be divided into midterm plans, shorterm plans and
perspective plans. Our Five Year Plans are in fact, midterm plans. Short term
plans are Annual Plans. During the period of implementation, Five Year Plans
operated by dividing them into Annual Plans. Perspective Plans are long term
plans and the period ranges from 20 to 25 years. The Five Year Plans are
formulated by taking into account the long term objectives of the Perspective
Plan.
Rolling Plan :
Unlike the Five Year Plan with fixed targets, in the case of the rolling plan, at
the end of each year, targets will be fixed by adding one more year to the Plan.
That is, without fixed targets for all the five years, depending upon the
performance of the Plan in the current year, targets will be fixed for one more

60
year. Like this, it will go on a continuous basis. That is the idea behind the
rolling plan.
A great advantage of centralized planning is that plans can be implemented
with great speed and targets and goals can be achieved. For example, by means
of planning, former Soviet Russia transformed its economy, which was
predominantly agricultural into a predominantly industrial nation, within a
short span of 12 years. But a demerit of centralized planning is that as the State
enjoys a considerable degree of monopoly, in the absence of competition, it is
rather difficult to test the productive efficiency of state owned units. Under
planning by inducement (democratic planning), though there is a good deal of
freedom for people, because of the procedures and delays associated with the
democratic process and because of Parliamentary democracy, there will be a lot
of delay in the implementation of programmes and economic growth will be
slow.
Evolution and Objectives of Planning in India
The National Planning Commission was set up in India in 1950. A major
function of the Planning Commission was to ‚formulate a plan for the most
effective and balanced utilization of the country’s resources‛. The Planning
Commission formulated the First Five Year Plan for the period (1951–56). Since
then, we completed nine Five Year Plans and we are now in the midst of Tenth
Five Year Plan (2002–2007).
Objectives of Planning in India

61
The central objective of planning in India is to raise the standard of living of the
people. Our Five Year Plans aim at increasing output. At the same time, they
aim at reducing inequalities of income and wealth and providing equal
opportunities for all. Growth with social justice is our basic goal.
The major objectives of developmental planning in India may
be listed as follows:
1.To raise the national income. This is known as Growth Objective;
2.To increase investment to a certain level within a given time ; 3.To
reduce inequalities in the distribution of income and wealth and to
reduce concentration of economic power over resources ;
4.To expand employment opportunities ; and
5.To remove bottlenecks in agriculture, manufacturing industry
(especially capital goods) and the balance of payments.
In the agricultural sector, the main objective was increasing agricultural
productivity and attaining self–sufficiency in foodgrains. In the industrial
sector, the emphasis was on basic and heavy industries. In the foreign trade
sector, the emphasis was on having a ‘viable balance of payments position’.
The strategy adopted in Indian Planning is often referred to as ‘Mahalanobis
strategy’. In this strategy, emphasis was laid on rapid industrialization with
priority for basic and heavy industries.
Though achieving regional balance is mentioned in our plans, we have not
succeeded much in reducing regional imbalances. In agriculture, there are
surplus states and deficit states, with reference to foodgrains. In manufacturing

62
industry, there are advanced regions and backward regions. Not only that,
industrial growth is concentrated in and around Mumbai, Kolkata and
Chennai. Our Five Year Plans pay attention to the problems of poverty and
unemployment. The average Indian is among the poorest of the world. So, our
Plans want to remove poverty and improve the lot of the common man and the
weaker sections like SC/STs, OBCs, women and children. The standard of
living depends upon per capita consumption and per capita consumption
depends upon per capita income. And this in turn depends upon employment.
So our plans have looked at employment as an integral part of the problem of
the removal of poverty.
In the rural sector, there is concentration of land in the hands of a few persons
even today. In spite of our land reform programmes, nearly 50 percent of
agricultural land is owned by 10 percent of the population. And Green
Revolution has helped largely big landlords. Even the ownership of industrial
assets is concentrated. Of course, the basic causes of poverty in India are low
agricultural productivity and rapid growth of population resulting in low
savings and disguised unemployment. The Government has not succeeded
much in solving the problems of rural unemployment and underemployment
by giving support to cottage and small scale industries.
There is an urban bias in Indian Planning. Agriculture did not receive enough
funds in the past. But we cannot say the planners have neglected agriculture.
India began the process of planned economic development five decades back.
The First Five Year (1951-56) stated that the purpose of planning in India was
to initiate ‚ a process of development which will raise living standards and

63
open out to the people new opportunities for a richer and more varied life‛.
The Second Five Year Plan (1956-61) aimed at rapid industrialization with
particular emphasis on the development of basic and heavy industries. It was
during the Second Plan period, the Government embraced the goal of
democratic socialism.
The Third Five Year Plan aimed at self – reliant and self – generating economy.
After the Third Plan, we had a “Plan Holiday”. The Fourth Plan did not
commence immediately after the Third Plan. We had three Annual Plans (1966-
69).
The Fourth Five Year Plan (1969 – 74) had two basic objectives:
1. Growth with stability, and
2. Progressive achievement of self-reliance.
The Fifth Plan (1974-79) focused on growth with social justice. The slogan
during the period was Garibi Hatao (Removal ofPoverty). So, the two main
objectives of the Fifth Plan were removal of poverty and attainment of self–
reliance. When Janata Party was in power at Centre, it formulated the Sixth
Plan (1978 – 83). But when the Congress came back to power, it discarded it
and formulated a new sixth Five Year Plan (1980 – 85). It aimed at a direct
attack on poverty by creating conditions for an expanding economy.
The Seventh Five Year Plan (1985-90) emphasized on accelerating agricultural
growth in foodgrains production, increasing employment opportunities and
raising productivity in all sectors. When the final version of the Eighth plan
(1992 – 97) was formulated, there were major changes in our economic policy

64
marked by liberalization, privatization and globalization. The Eighth Plan 1992
– 97 reflected these changes and aimed at accelerating economic growth and
improving the quality of life of the common man.
The main objectives of Planning in India may be grouped under four heads:
Growth, modernization, self–reliance and social justice.
Growth
In the first 30 years of planning, the trend rate of growth of national income
was 3.5 percent. Eminent economist Raj Krishna called it the Hindu rate of
growth. Agricultural production increased at an average rate of 2.7 percent and
industrial production at 6.1 percent. And per capita income increased at the
trend rate of 1.3 percent. Though these rates appear rather small, we must
remember that throughout the British period, for almost a century, there was
stagnation in the Indian economy. For example, in the undivided India from
1901 – 46, the trend growth rate of the national income was only 1.2 percent. So
one of the achievements of planning in Indian economy is that it has overcome
stagnation and we have had a slow
but steady economic growth.

65
Table 5.1Growth Rates of National Income(in percentage)
First plan (1951-1956)
The first Indian Prime Minister, Jawaharlal Nehru presented the first five-year
plan to the Parliament of India on December 8, 1951. The total plan budget of
206.8 billion INR (23.6 billion USD in the 1950 exchange rate) was allocated to
seven broad areas: irrigation and energy (27.2 percent), agriculture and
community development (17.4 percent), transport and communications (24
percent), industry (8.4 percent), social services (16.64 percent), land
rehabilitation 4.1 percent), and other (2.5 percent).
The target growth rate was 2.1 percent annual gross domestic product (GDP)
growth; the achieved growth rate was 3.6 percent. During the first five-year
plan the net domestic product went up by 15 percent. The monsoons were
good and there were relatively high crop yields, boosting exchange reserves
and per capita income, which went up 8 percent. Lower increase of per capita
income as compared to national income was due to rapid population growth.

66
Many irrigation projects were initiated during this period, including the
Bhakra Dam, Hirakud Dam, and Mettur Dam in South India. The World
Health Organization, with the Indian government, addressed children's health
and reduced infant mortality, contributing to population growth.
At the end of the plan period in 1956, five Indian Institutes of Technology (IITs)
were started as major technical institutions. University Grant Commission was
set up to take care of funding and take measures to strengthen the higher
education in the country.
Contracts were signed to start five steel plants; however these plants did not
come into existence until the middle of the next five-year plan.
Second plan (1956-1961)
The second five-year plan focused on industry, especially heavy industry.
Domestic production of industrial products was encouraged, particularly in
the development of the public sector. The plan followed the Mahalanobis
model, an economic development model developed by the Indian statistician
Prasanta Chandra Mahalanobis in 1953. The plan attempted to determine the
optimal allocation of investment between productive sectors in order to
maximise longrun economic growth .
Hydroelectric power projects and five steel mills at Bhilai, Durgapur, and
Jamshedpur were established. Coal production was increased. More railway
lines were added in the north east.
The Atomic Energy Commission was formed in 1957 with Homi J. Bhabha as
the first chairman. The Tata Institute of Fundamental Research was established

67
as a research institute. In 1957 a talent search and scholarship program was
begun to find talented young students to train for work in nuclear power.
Third plan (1961-1966)
The third plan stressed on agriculture and improving production of rice, but
the brief Sino-Indian War in 1962 exposed weaknesses in the economy and
shifted the focus towards defense. In 1965-1966, the Green Revolution in India
advanced agriculture. The war led to inflation and the priority was shifted to
price stabilization. The construction of dams continued. Many cement and
fertilizer plants were also built. Punjab begun producing an abundance of
wheat.
Many primary schools were started in rural areas. In an effort to bring
democracy to the grassroot level, Panchayat elections were started and the
states were given more development responsibilities.
State electricity boards and state secondary education boards were formed.
States were made responsible for secondary and higher education. State road
transportation corporations were formed and local road building became a
state responsibility.Gross Domestic Product rate during this duration was
lower at 2.7% due to 1962 Sino-Indian War and Indo-Pakistani War of 1965.
Fourth plan (1969-1974)
At this time Indira Gandhi was the Prime Minister. The Indira Gandhi
government nationalized 19 major Indian banks. In addition, the situation in
East Pakistan (now independent Bangladesh) was becoming dire as the
IndoPakistani War of 1971 and Bangladesh Liberation War took place.

68
Funds earmarked for the industrial development had to be used for the war
effort. India also performed the Smiling Buddha underground nuclear test in
1974, partially in response to the United States deployment of the Seventh Fleet
in the Bay of Bengal to warn India against attacking West Pakistan and
widening the war.
Fifth plan (1974-1979)
Stress was laid on employment, poverty alleviation, and justice. The plan also
focused on self-reliance in agricultural production and defense. In 1978 the
newly elected Morarji Desai government rejected the plan. Electricity Supply
Act was enacted in 1975, which enabled the Central Government to enter into
power generation and transmission.
Sixth plan (1980-1985)
Called the Janata government plan, the sixth plan marked a reversal of the
Nehruvian model.
When Rajiv Gandhi was elected as the prime minister, the young prime
minister aimed for rapid industrial development, especially in the area of
information technology. Progress was slow, however, partly because of caution
on the part of labor and communist leaders.
The Indian national highway system was introduced for the first time and
many roads were widened to accommodate the increasing traffic. Tourism also
expanded.
The sixth plan also marked the beginning of economic liberalization. Price
controls were eliminated and ration shops were closed. This led to an increase
in food prices and an increased cost of living.

69
Family planning also was expanded in order to prevent overpopulation. In
contrast to China's harshly-enforced one-child policy, Indian policy did not
rely on the threat of force. More prosperous areas of India adopted family
planning more rapidly than less prosperous areas, which continued to have a
high birth rate.
Seventh plan (1985-1989)
The Seventh Plan marked the comeback of the Congress Party to power. The
plan lay stress on improving the productivity level of industries by
upgradation of technology.
Period between 1989-91
1989-91 was a period of political instability in India and hence no five year plan
was implemented. Between 1990 and 1992, there were only Annual Plans. In
1991, India faced a crisis in Foreign Exchange (Forex) reserves, left with
reserves of only about $1 billion (US). Thus, under pressure, the country took
the risk of reforming the socialist economy. P.V. Narasimha Rao)(28 June 1921
– 23 December 2004) also called Father of Indian Economic Reforms was the
twelfth Prime Minister of the Republic of India and head of Congress Party,
and led one of the most important administrations in India's modern history
overseeing a major economic transformation and several incidents affecting
national security. At that time Dr. Manmohan Singh (currently, Prime Minister
of India) launched India's free market reforms that brought the nearly
bankrupt nation back from the edge. It was the beginning of privatization and
liberalization in India.
Eighth plan (1992-1997)

70
Modernization of industries was a major highlight of the Eighth Plan. Under
this plan, the gradual opening of the Indian economy was undertaken to
correct the burgeoning deficit and foreign debt. Meanwhile India became a
member of the World Trade Organization on 1 January 1995.This plan can be
termed as Rao and Man Mohan model of Economic development. The major
objectives included, containing population growth, poverty education,
employment generation, strengthening the infrastructure, Institutional
building, Human Resource development, Involvement of Panchayat raj,
Nagarapalikas, N.G.OSand Decentralization and people’s participation. Energy
was given priority with 26.6% of the outlay. An average annual growth rate of
6.7%against the target 5.6% was achieved.
Ninth plan (1997-2002)
During the Ninth Plan period, the growth rate was 5.35 per cent, a percentage
point lower than the target GDP growth of 6.5 per cent.
Tenth plan (2002-2007)
• The main objectives of the 10th Five-Year Plan were:

71
Reduction of poverty ratio by 5 percentage points by 2007;
• Providing gainful and high-quality employment at least to the addition
to the labour force;
• All children in india in school by 2003; all children to complete 5 years of
schooling by 2007;
• Reduction in gender gaps in literacy and wage rates by at least 50% by
2007;
• Reduction in the decadal rate of population growth between 2001 and
2011 to 16.2%;
• Increase in Literacy Rates to 75 per cent within the Tenth Plan period
(2002-3 to 2006-7);
• Reduction of Infant mortality rate (IMR) to 45 per 1000 live births by
2007 and to 28 by 2012;
• Reduction of Maternal Mortality Ratio (MMR) to 2 per 1000 live births

by
2007 and to 1 by 2012;
• Increase in forest and tree cover to 25 per cent by 2007 and 33 per cent
by 2012;
• All villages to have sustained access to potable drinking water within
the Plan period;
• Cleaning of all major polluted rivers by 2007 and other notified stretches
by 2012;
• Economic Growth further accelerated during this period and crosses
72
over 8% by 2006.
Eleventh plan (2007-2012)
The eleventh plan has the following objectives:
Income & Poverty
• Accelerate GDP growth from 8% to 10% and then maintain at 10% in the
12th Plan in order to double per capita income by 2016-17
• Increase agricultural GDP growth rate to 4% per year to ensure a

broader
spread of benefits
• Create 70 million new work opportunities.
• Reduce educated unemployment to below 5%.
• Raise real wage rate of unskilled workers by 20 percent.
• Reduce the headcount ratio of consumption poverty by 10 percentage
points.
Education
• Reduce dropout rates of children from elementary school from 52.2% in
2003-04 to 20% by 2011-12
• Develop minimum standards of educational attainment in elementary
school, and by regular testing monitor effectiveness of education to
ensure quality
• Increase literacy rate for persons of age 7 years or more to 85%
• Lower gender gap in literacy to 10 percentage points
• Increase the percentage of each cohort going to higher education from
73
the present 10% to 15% by the end of the plan
Health
• Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per
1000 live births
• Reduce Total Fertility Rate to 2.1
Provide clean drinking water for all by 2009 and ensure that there are no
slip-backs
• Reduce malnutrition among children of age group 0-3 to half its present
level
• Reduce anaemia among women and girls by 50% by the end of the plan
Women and Children
• Raise the sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by
2016-
17
• Ensure that at least 33 percent of the direct and indirect beneficiaries of
all government schemes are women and girl children
• Ensure that all children enjoy a safe childhood, without any compulsion
to work
Infrastructure
• Ensure electricity connection to all villages and BPL households by 2009
and round-the-clock power.
• Ensure all-weather road connection to all habitation with population
1000 and above (500 in hilly and tribal areas) by 2009, and ensure
74
coverage of all significant habitation by 2015
• Connect every village by telephone by November 2007 and provide
broadband connectivity to all villages by 2012
• Provide homestead sites to all by 2012 and step up the pace of house
construction for rural poor to cover all the poor by 2016-17
Environment
• Increase forest and tree cover by 5 percentage points.
• Attain WHO standards of air quality in all major cities by 2011-12.
Treat all urban waste water by 2011-12 to clean river waters.
• Increase energy efficiency by 20 percentage points by 2016-17.
75
76
77

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Mr. J.JERLIN RAJAN, M.A.,MBA., M.Phil., BGL.

ECONOMICS ANALYSIS FOR BUSINESS

man’s economic behavior. It deals with economic behavior of man in society in

respect of consumption, production; distribution etc. economics can be called

do everything we want to do. Therefore choices have to be made or in the

words of economists ‚individuals have to decide-----‚how to allocate scarce

resources in the most effective ways”.

BA 7103 Economic Analysis For Business

or household. It studies how individual make their choices about what to

analytical tools for managerial decision making.

Various micro-economic concepts such as demand, supply, elasticity of

significance to managerial economics.

Governments face many such problems.

How much to spend on health

How much to spend on services

How much should go in to providing social security benefits.

• Price elasticity of demand

• Income elasticity of demand

BA 7103 Economic Analysis For Business

• Marginal revenue product

• Theory of firm—price, output and investment decisions

• Money and banking

• Public finance and fiscal and monetary policy

• National income and • Theory of international trade

CONCEPT OF ECONOMICS IN DECISION MAKING

Meaning of decision making:

from among several alternative courses of action.

The problem of decision making arises whenever a number of alternatives are

available. Such as:

What should be the price of the product?

What should be the size of the plant to be installed?

How many workers should be employed?

What kind of training should be imparted to them?

What is the optimal level of inventories of finished products, raw material,

spare parts, etc.?

BA 7103 Economic Analysis For Business

arises the problem of decision making.

market forces which are as follows: The demand and supply

Changing business environment

External influence on the domestic market

Social and political changes

Meaning of Economic problem:

the four characteristics i.e.

Human wants are unlimited.

Human wants vary in their intensity.

The means or resources are relatively limited.

There are alternative uses of the limited resources.

Therefore economic problem can be called as the problem related to the

economizing his means.

BA 7103 Economic Analysis For Business

alternative uses in the face of unlimited wants.

NATURE AND SCOPE OF MANAGERIAL ECONOMICS

ME deals with Demand analysis, Forecasting, Production function, Cost

analysis, Inventory Management, Advertising, Pricing System, Resource

1. Demand analysis and forecasting:

producing that product. Therefore demand analysis is something which is

necessary for the production function to happen. Demand analysis helps in

reasonable estimates of demand for product of his company. Managers not

Conversion of inputs into outputs is known as production function. With

Factor of production called as inputs is combined in a particular way to get the

combination of inputs to ensure the least cost combination.

BA 7103 Economic Analysis For Business

mathematical models, to minimize inventory cost. It also helps in inventory

Advertising is a promotional activity. In advertising while the copy,