MICRO ECONOMICS FOR BUSINESS

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Definition of Economics: Economics can be defined as the study of efficient utilization of scarce resources to satisfy unlimited human wants. Adam Smith the Father of Economics defined - as a science of wealth. He titled his book as Enquiry into the Nature and cause of the Wealth of Click to edit Master subtitle style Nations Dr. Amartya Kumar Sen our Indian Economist awarded the 1998 Noble Prize in Economic Sciences for his contribution to Welfare Economics
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Wants-efforts-satisfaction are the subject matter of economics. Wants are starting point of economic activity. Economics is a social science and art Economics deals the various aspects of production, distribution, consumption of limited resources in an economy in order to satisfy human wants efficiently. Economics explains the day to day activities of people like spending buying etc.

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The two most important areas in the society today are business and the economics, they act a two pillars in the development of any country. The economics of business growth widened too much in recent years. Distinction between Economic Growth and Economic Development. Resources are limited but human wants are unlimited. Scarcity of Natural resources, scarcity of Human resources and scarcity of Capital resources

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Market Economy USA(Firms and consumers decides in free market economy) Command Economy USSR (Gove decides) Mixed Economy Public sector vs. Private Sector ( India )

Usefulness of Economics for Human Life: a. Intellectual value b. Human Behavior c. Economic System d. Planning e. Study of Economic Problems f. Business man g. Statesmen h. Consumers Click to edit Master subtitle style i. Laborers j. Citizens k. International Economic Problems like Foreign trade, Inflation and Unemployment etc..

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Economics classified into Micro and Macro Economics

Micro Economics
1.

Macro Economics

Studies the economic 1. Studies Economy as a behavior of individual whole entities such as 2. Explains total National Individuals, firms, house income, Aggregate holds etc. demand and supply, 2. Explains the Inter General Price level, Total relationships between employment etc. Economic Units like 3. Fluctuations and trends in consumers, the overall economic commodities , firms, activity in a country or industries, markets . between countries in the 3. Analyses the conditions world. Click to edit Master subtitle style for efficiency in 4. Describes the theory of consumption and income and employment, production. inflation, Economic 4. Describes product pricing growth etc.. which explains theories of 5. Macro economics study demand, production and vital in the formation and cost. execution of economic 5. Understanding Micro policies by Govt. Economics helps a great 3/21/12 deal in individual decision

Micro and Macro Economics both deals with the Economic issues. Scope and Purpose of Micro Economics, Price Theory studies: a) How resources are allocated to the production of goods and services. b) How the goods are distributed. c) How efficiently they are distributed. These problems are determined by relative prices of goods and services. Therefore Micro Economics called as Price Theory or Value Theory.
I.

II.

A study of interacting units: Interaction between consumers market, Producers market, Resources Owners Market. A study of welfare Economics: Studies how efficiently goods and services are distributed. Click to edit Master subtitle style

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Importance of Micro Economics 1. Explain how prices are determined: like wages, interests, profit and rent are determined. 2. Explains the conditions of efficiency in production and distribution. 3. Provide tools for Economics for policies. 4. Helps in the efficient employment of resources. 5. Helps business executives: to attain maximum productivity with resources. 6. In understand the problems of taxation. 7. Helpful in International trade and Foreign exchange. 8. To examine the conditions of economic welfare: Elimination wastages and bring maximum social welfare. As per the above Micro Economics is highly important. Click to edit Master subtitle style

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Limitations of Micro Economics 1. Based on unrealistic assumptions 2. Neglects the whole gives an incomplete picture 3. It may be misleading.

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Production Possibility Curve The PPC helps us understand the problem of scarcity better , by showing what can be produced with given resources and technology.

Assumptions in Constructing a PPC a) The economic resources available for the use in the year are fixed. b) These economic resources can be 3/21/12 used to produce two broad classed

Production possibility schedule and Curve

Production Possibilities A B C D E F Rice (in tons) 0+ 4 tons 7 tons 10 tons 11 tons 12 tons Cloth (in 000 meters) 15000 meters 14000 meters 12000 meters 9000 meters 5000 meters 0

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To increase the production of one item, we have to forgo the production of some units of the other item. An increase in the production or consumption of one good can be achieved only through the opportunity cost of the other good. Opportunity costs are result of scarcity. Best Example: A child with Rs.10 in hand can purchase a soft drink or a 3/21/12candy bar, both of which each

DEMAND
Demand means the desire for a commodity or service backed by willingness as well as ability to pay. (Mere desire is not demand) When we speak of demand, we must also state the price, the place and time. Demand is always at a price. The quantity demanded differs from market to market. At the same price demand may be more in market A 3/21/12

Demand and Supply Analysis

Based on purchasing power statistics, India is ranked as fourth largest economy in the world and ranked 3rd in terms of GDP (Gross Domestic Product is a measure of countries overall economic output) in Asia (after Japan & China) and the second largest economy (after China) among developing countries with high potential for economic development, inspite of political uncertainty, infrastructural bottlenecks and burocratic hassles. That isClick Multinational companystyle as Mc Donalds entered the why to edit Master subtitle such Indian market in mid 1990s and offered food products, which were not customarised to the Indian tastes. The company over estimated the demand for its products and almost all its operations ran into losses. Later the company made some changes in its minimum, which were more suited to the tastes and preferences of the Indian customers and captured the good market share in the Indian fast food market. 3/21/12

This example is the significance of analyzing the forces of demand and supply for any product. The demand for its product plays a major role to achieve the object of a firm is to maximize its revenues and profits. Law of Demand: states that an inverse relationship exists between the price of a good and its quantity demanded, keeping other factors constant. Benham, the Economist stated - Usually a larger quantity of a commodity will be demanded at a lower price than at a higher price

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Changes in Demand Curve

The demand curve always slopes downwards from left to right to indicate that demand for a product increase where there is decrease in price of particular product.

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Demand Schedule Table

Price of coffee per kilo (in Rs) Rs. 15 Rs.10 Rs.5 Rs.3

Quantity Demanded (in kilos) 10000 30000 40000 80000

The demand Schedule shows that demand is more at the lower price. Demand extends as the price falls and vice versa.

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Reasons why demand curve slopes downwards The demand curve sloped downwards from left to right because demand expands at a lower price . The reasons are : 1) Income Effect (old buyers buy more): Eg- A spend 1 rupee on apple if the price of the apple is 1 rupee A can get only one apple. If the price falls to 0.50 paise, A can buy 2 apples for the same rupee. Fall in the price means a saving in the money or increase in real income. This is called income effect. 2) Substition effect: When the price of a commodity falls it becomes cheaper Eg: If tea is very much cheaper than coffee, people may prefer to use tea instead of coffee. Therefore the demand for tea increase when the price falls. It is called Substitution effect. Click to edit Master subtitle style

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3) New Buyers: People who could not buy when the price is high begin to buy the commodity when the price falls. Thus the demand will be more at a lower price because new buyers purchase the commodity. 4) Different Uses: There are certain commodities that can be put to several uses like Wheat can be used as food, for cattle feed, for manufacture of alcohol etc. If the price is high it will be used only as an article of food 3/21/12

Individual Demand: Individual demand is the demand of an individual consumer for a product in a given period of time. A consumer purchased a commodity in a market at different places relates to Individual demand.

Market Demand : It is the sum of demand of all individual consumers in the market for a product in a given 3/21/12

Determinants of Demand
The demand for a commodity depends on several factors: 1) Price of the commodity 2) Population 3) Income 4) Tastes and preferences 5) Weather conditions 6) Price of substitutes (Tea / coffee) 7) Discovery of substitutes ( discovery of paper bags reduced demand of jute bags) 3/21/12

Quantity demanded changes when the price of the good changes. If the price of the good increases quantity demanded decreases. So demand curve is not shifting. A change in demand occurs when one or more of the determinants of demand changes. Determinants of demand include consumer 3/21/12 preferences, Income, and the price

Change in Quantity Demanded vs Change in Demand

A change in demand, due to factors other than price is classified as shift in demand.

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Elasticity of Demand

Elasticity is a measurement of the rate of change in demand for a given change in the price.

Prof. Marshall defined: The elasticity of demand in a market is great or small according to the amount demanded increases much or little PRICE a given fall in the Expenditure Nature of Elasticity Quantity Demand Total price and for (P) (Q) (P x Q) diminishes much or little for a given Rs. 4 rise in price. 1000 units Rs. 4000 Elastic Demand

Rs. 3

4000 units 6000 units 8000 units

Rs. 12000 Rs. 12000 Rs. 8000

Rs. 2 Rs.3/21/12 1

Unit Elasticity Inelastic Demand

Income Elasticity of Demand

Income Elasticity demand changes due to change in income also. Income Elasticity is the rate of change in the demand for a given change in the income. An increase in real income increases the demand for product, other factors remaining the same. If the percentage change in demand is greater than the percentage change in income it is high income elasticity of demand. 3/21/12

Price Elasticity of Demand

Defined as the percentage change in quantity demanded of a product due to the percentage change in its price, other things remain constant. Ep= Percentage change in Quantity demanded Percentage change in price If demand for petrol reduces by 2% as a result of an increase in petrol price by 10%. The price elasticity of demand for petrol is

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Usually the Govt. tries to raise income through indirect taxes such a excise duty or sales tax, which raises the price of the product sold in the market. Here the analysis of price elasticity plays crucial role. For Eg: If the Govt. increases the tax on plastic goods, its price will increase. The raise in price reduces the demand for that commodity. Cross Price Elasticity of Demand: is the ratio of percentage change in 3/21/12 quantity demanded for product to the

Cross Price elasticity can be positive or negative based on the change in the price of a substitute or complementary products. If two products are good substitutes, the value of cross elasticity is positive. For Ex: Close substitute products : Pepsi and coke. If the price of Pepsi increases, its customers may switch to coke. The change in the price of Pepsi and demand for coke are moving in the same direction hence the cross elasticity is positive. 3/21/12 For complementary products like Tea

Revenue Concepts: Total revenue means total profits received by a firm from the sale of product. Additional revenue received result from the sale of extra unit of product is called Marginal Revenue. Total revenue per unit of a product sold is Average Revenue. A clear understanding of cost demand price in micro level helps us the revenue of the particular firm to analyze future demand forecasting 3/21/12 and profit ratio.

SUPPLY: In economics the supply of product refers to the various quantities of the product, which a seller is willing and able to sell at different prices in a given period of time. LAW OF SUPPLY: states that other factors remaining constant, higher the price, greater the quantity supplied and lower the price, lower the quantity supplied. Price and qualities supplied 3/21/12 are positively related.

Supply Schedule of Situation Chocolates Price Quantity Supplied

( Rs. Per box) 50 40 30 20 10 (Million boxes per year) 22 15 9 4 0 A B C D E

In situation E, when the price per box is Rs.10, No firm is willing to produce and sell chocolates. Hence the quantity supplied is Zero. As the price increases he manufacturers are 3/21/12

The Supply Curve: At a very low price, the chocolates manufacturers might want to use their factories for producing other types of related products. But as the price of the chocolates increases the manufacturers find it more profitable to shift to chocolates. Higher the price of chocolates the greater the amount of chocolates supplied (upward raising curve). Higher the price, the larger is the supply. 3/21/12

 1)

2)

Exceptions: Price Changes: If sellers think that the price in the future going to fall, they sell more at lower price. More supply at the price is contrary to the Law. Labor supply: Some laborers may be satisfied with a certain minimum income. Until they get that minimum income they work more as wages raise. After that they work less.

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Govt. Policy Taxation: If taxes increase supply will fall. If taxes are reduced supply may increase. 6) In the case of Agricultural Commodities, failure of rains, droughts, floods, fires, etc. will reduce supply. 7) Means of communication and Transport: Improvement in the means of communication and transport increase supply. 8) Labor Troubles: Strikes, Lockouts, labor troubles may reduce supply. 3/21/12
5)

Elasticity of Supply: The law of supply states that supply increase as the price raises and falls as the price falls. But the change in supply in response to the change in price will not be the same for all commodities. Elasticity of supply is the measurement of the change. Formula: Es= % change in the quantity supplied of a product % change in its price 3/21/12 Factors that determine elasticity of

Market Equilibrium in economics means situation where the supply of an item is exactly equal to its demand. Since neither there is surplus nor shortage in the market, there is no tendency for the price of the item to change. It is the point at which quantity demanded and quantity supplied are equal.

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Consumer behavior is the study of when, why, how and where people do or do not buy product. Product means thing produced by labor or effort or result of an act or a process is product. Consumer behavior blends elements from economics, psychology, sociology, social anthropology. It attempts to understand the buyer decision making process, both individually and in 3/21/12 groups.

THEORY OF CONSUMER BEHAVIOUR

b) Indirect Consumption: Use of machinery, raw materials etc. is called Indirect Consumption or productive consumption . These goods are used to produce goods which satisfy human wants. C) Wasteful Consumption: The waste of materials through accidents such as fire or flood is called Wasteful consumption. When individual or community use goods that are not very useful, they are suppose to indulge in waste 3/21/12 consumption.

TOTAL UTILITY: The amount of utility a person derives from the consumption of a particular product is called Total Utility. In the initial stage of consumption the total utility increases after consumption of certain number of units the total utility becomes constant and beyond that it starts reducing. We can say that at a particular point of consumption, the consumer maximizes his satisfaction which is known as satisfaction quantity. Further consumption of that 3/21/12 particular product decreases his

Quantity of product Consumed 0 1 2 3 4 5 6

Total Utility

Marginal Utility

0 5 8 10 10 9 7

5 3 2 0 -1 -2

When first two units of a product are consumed total utility increases. When the consumer consumes the third unit, total utility reaches its maximum point 10. The utility remains constant even after the consumption of the fourth 3/21/12 unit but when the consumer starts

Total Utility Curve

Total utility is the total benefit that a person gets from the consumption of a good or service. Total utility generally increases as the quantity consumed of 3/21/12

Marginal Utility Theory

It economics the marginal utility of a good or service is the utility gained( or lost) from an increase (or decrease) in the consumption of that good or service. In the above table, it is clear that every increase in the consumption of a product reduces its marginal utility. Law of Diminishing Marginal Utility: A law of economics states as a person increases consumption of a product while keeping consumption of 3/21/12

Marginal Utility Curve

The general tendency for marginal utility to decrease as the quantity of a good consumed increases the principle of diminishing marginal utility

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Assumptions: 1) No time Interval, continuous assumption: The consumption of the commodity should be continuous without and time gap. 2) Identical Units: The unit of the commodity consumed should be of the same quality same size, taste color etc. They must be identical in all respects. 3) Standard Units: The size of the units consumed should not be too small or too large. For Eg: The 3/21/12

9)

No change in the Consumers Other Positions: When we can not buy a horse a carriage may be lying useless with us. But when we buy a horse the utility of carriage goes up. Therefore the law assumes that there is no change in the consumers stock of other goods. Goods should be of Ordinary Type: The law may not apply to extraordinary goods like diamonds.

10)

11)

Goods should be Divisible: In the 3/21/12 case of durable and indivisible

Indifference Curve Theory and its Application

An indifference curve reveals the various combinations of two products or services to which the customer is indifferent at a particular level of income. Any combination of products or services on an indifference curve will give the same level of utility. Assumptions: Indifference Curves have a Negative Slope: Indifference slopes 3/21/12 downwards to the right which reveals

Combination of two products that yield same level of Utility:

Utility Quantity of Apples consumed Quantity of Oranges consumed

20

11

20

20

20

11

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Indifference Curve Diagram

This shows three indifference schedules of the consumer L1, L2 and L3. L2 shows a higher level of satisfaction than L1. Similarly L3 shows higher level of satisfaction than L2. The consumer may have different indifferent schedules each showing a 3/21/12

Consumer Surplus

Consumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods. Consumer surplus is the difference between the total amount that consumers are willing and able to buy for a good or service(indicated by the demand curve) and the total amount that they actually do pay (i.e. the 3/21/12 market price for the product) The

CONSUMER SURPLUS IS THE DIFFERENCE BETWEEN THE PRICE THAT A CONSUMER IS PREPARED TO PAY AND THE ACTUAL PRICE PAID.

Consumer Surplus is the difference between price to consumer has to pay and the price the consumer prepared to pay. Eg: He may be prepared to pay of Rs.200 for a ticket of the movie which 3/21/12

Applications of Consumer Surplus: Consumer surplus is useful for designing Govt. policies and implementing welfare programmes. The Govt. can use the concept of consumer surplus to fix taxes since the rich or the upper middle class people have more consumer surplus compared to the rest. Consumer surplus also reveals the purchasing pattern of the economy. For Eg: More taxes can be levied on costly or luxury goods since they would be brought by 3/21/12 consumers who have more surplus.

Consumer Price Index: A CPI measures changes through time in the price level of consumer goods and services purchased by households. CPI in India comprises multiple services classified based on different economic groups therefore a series: The CPI UNME (Urban non- Mannual Employee), CPI AL (Agricultural Labor), CPI RL (Rural Labor) and CPI IW (Industrial Worker). While the CPI UNME series is published by the Central Statistical Organization, the 3/21/12 others are published by the

THEORY OF PRODUCTION AND COST

Production: Production refers to the output of goods and services produced by businesses within a market. This production creates the supply that allows our needs and wants to be satisfied. 1) Short run Production: The short run is a period of time when there is at least one fixed factor input. This is usually the capital input such as plant 3/21/12 machinery and the stock of and

What is Production Function: Production function deals with the maximum output that can be produced with a limited and given quantity of inputs.

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The meaning of Productivity: When economists and Govt. Ministers talk about productivity they are referring to how productive labor is. But productivity is also about other inputs. For ex: A company could increase productivity by investing in new machinery with latest technological progress, which reduces the number of workers required to produce the same amount of output. The Govt. objective is to improve labor and capital productivity.