MEFA

UNIT – 1

1.What is economics? Explain the salient features of economics?

ANS:
Economics is a study of human activity both at individual and national level. The economist
of early age treated economics merely as the science of wealth. Everyone of us is involved in
efforts aimed at earning and spending this money to satisfy our wants such as food, clothing,
shelter, and others. Such activities of earning and spending money are called ‘economic’
activities.

It was only during 18th century that Adam smith, the father of economics, defined economic
as the study of human nature and uses of national wealth.

Dr Alfred Marshall one of the greatest economist of 19th century writes economics is study
of man’s actions in the ordinary business of life, it enquires how he gets his income and how
he uses it .it is the study of man. As Marshall observed, the chief aim of economics is to
promote human welfare, but not wealth.

The definition given by A C pigou endorses the opinion of marshall.pigou defines economics
as the study of economic welfare that can be brought directly and indirectly into relationship
with measuring rod of money.

Prof Lionel Robbins defined economics as the science, which studies human behaviour as a
relationship between ends and scarce means, which have alternative, uses. The focus of
economics has shifted from wealth to human behaviour. The salient features of economics
according to prof Robbins are as follows.

1.UNLIMITED WANTS
Every human have unlimited number of wants or ends and it is difficuklt to satisfy all these.

2. SCARCE RESOURCES
We have limited or scarce resources. The resources are said to be scarce when they are
limited in supply with relation to total demand. Economic problems arise only because the
resources we have scarce.

3.ALTERNATIVE USES
Scarce resources can be put to alternative uses. A particular commodity can be put to
different alternative uses. For example, if I have one thousand rupees in my pocket, I can use
it for different purposes, such as payment of college fee, purchase of journals or visiting a
five star hotel with my family and so on. All these are the alternative uses of the money I
have. Scarcity is the root cause of all economic problems of choice.

4. CHOICE
Of all the above alternatives, which one do I chose? How do I behave in satisfying my
unlimited wants with the scarce resources?
Most of the problems, including that a manager are essentially economic in nature and hence
involve a problem of choice. The managers constantly match the given ends with the limited
means.

Lord Keynes defined economics as the study of administration of scarce means and the
determinants of employment and income.

Economics is divided into two parts,

1.MICRO ECONMICS
The study of an individual consumer or a firm is called microeconomics (also called as theory
of firm). Microeconomics deals with behaviour and problems of single individual and micro
organization. Managerial economics has its roots in microeconomics and it deals with the
micro or individual enterprises. It is concerned with the application of the concepts such as
price theory, law of demand and theories of market structure and so on.

2. MACRO ECONOMICS
The study of aggregate or total level of economic activity in a country is called
macroeconomics. It studies the flow of economic resources or factors of production (such as
land, labour, capital, organization and technology) from the resource owner to the business
firms and then from the business firms to hoouseholds.it deals with total aggregates for
instance total national income. Total employment output and total investment. It deals with
the price level in general, instead of studying the prices of individual commodities. It is
concerned with the level of employment in the economy. The important tools of
macroeconomics include national income analysis, balance of payments, theories of
employment and so on.

What is management?
ANS:
Management is the process of getting things done through people in formally organized
groups. It is necessary that every organization is well managed to enable it to achieve its
desired goals. Management includes a number of activities includes a number of functions,
planning, organizing, straffing, directing, and controlling. The manager while directing the
efforts of his staff communicates to them to sustain their enthusiasm and leads them to
achieve the corporate goals.

What is managerial economics? Explain its nature?

ANS:

Spencer and Siegelman define managerial economics as “the integration of economic theory
with business practice for the purpose of facilitating decision – making and forward planning
by management.”
2. Brigham and Pappas believe that managerial economics is “the application of economics
theory and methodology to business administration practice”.

3. Salvatore observes that managerial economics refers to the application of economic theory
and the tools of analysis of decision science to examine how an organization can achieve its
aims and objectives most effectively.
NATURE OF MANGERIAL ECONOMICS

Managerial economics is the youngest of all the social sciences. It originate4s from
economics and it has the features of economics, such as assuming the other things remaining
the same (or the Latin equivalent ceteris paribus). This assumption is made to simplify the
complexity of the managerial phenomenon under study in a dynamic business environment
because so many things are changing simultaneously. These sets a limitation that we cannot
really hold other things remaining the same. In such a case, the observation’s made out of
such a study will have a limited purpose or value.

The other features of managerial economics are explained as below,

1.CLOSE TO MICROECONOMICS
Managerial economics is concerned with finding the solutions for different managerial
problems of a particular firm. Thus it is more close to microeconomics.

2. OPERATES AGAINST THE BACKDROP OF MACRO ECONOMICS

The macroeconomics conditions of the economy are also seen as limiting factors for the firm
to operate. The managerial economist has to be aware of the limits set by the macroeconomic
conditions such as government industrial policy, inflation, and so on.

3. NORMATIVE STATEMENTS
A normative statement usually includes the words ought or should. They reflect people’s
moral attitudes and are expressions of what a team of people ought to do. It deals with
statements such as ‘government of India should open up the economy’. Such statements are
based on value judgments and express views of what is ‘good’ or ‘bad’, right or wrong. The
problem with normative statement is that they cannot be verified by looking at the facts,
because they mostly deal with the future.

4. PRESCRIPTIVE ACTIONS
It is goal oriented. Given a problem and the objectives of the firm, it suggests the course of
action from the available alternatives for optimal solution. It does not merely mention the
concept, it also explains whether the concept can be applied in a given context or not. For
instance the fact that variable cost and marginal cost can be used to judge the feasibility of an
export order.

5. APPLIED IN NATURE
Prescriptive action is goal oriented. Given a problem and the objectives of the firm, it
suggests the course of action from the available alternatives for optimal solution. It does not
merely mention the concept, it also explains whether the concept can be applied in a given
context or not. For instance, the fact that variable costs are marginal costs can be used to
judge the feasibility of an export order.

6. OFFERS SCOPE TO EVALUATE EACH ALTERNATIVE

Managerial economics provides an opportunity to evaluate each alternative in terms of its
costs and revenues. The managerial economist can decide which is the better alternative to
maximize the profits for the firm.
 7. INTERDISCIPLINARY
The contents, tools and techniques of managerial economics are drawn from different
subjects such as economics, management, mathematics, statistics, accountancy, psychology
organizational behaviour, sociology, etc.

8. ASSUMPTIONS AND LIMITATIONS

Every concept and theory of managerial economics is based on certain assumptions and as
such their validity is not universal. Where there is change in assumptions, the theory may not
hold good at all.

WHAT IS MANAGERIAL ECONOMICS? EXPLAIN THE SCOPE OF

MANAGERIAL ECONOMICS?
ANS:

1. Spencer and Siegelman define managerial economics as “the integration of economic

theory with business practice for the purpose of facilitating decision – making and forward
planning by management.”
2. Brigham and Pappas believe that managerial economics is “the application of economics
theory and methodology to business administration practice”.

3. Salvatore observes that managerial economics refers to the application of economic theory
and the tools of analysis of decision science to examine how an organization can achieve its
aims and objectives most effectively.

SCOPE OF MANAGERIAL ECONOMICS

The main focus in managerial economics is to find an optimal solution to a given managerial
problem. The problem may relate to production, reduction or control of costs, determination
of price of a given product or service, make or buy decisssions, inventory decisions, capital
management or profit planning and management, investment decisions or human resource
management. Managerial economics is concerned with the economic behaviour of the firm.
At each stage of economic decision variable, certain assumptions are made. The economist is
concerned with analysis of the economy as a whole where as the managerial economist is
essentially concerned with making decisions in the context of a single firm.

Managerial Decision Areas

- Production
- Reduction of cost
Applied - Determination of price
Concepts and to of a given product for
techniques of Optimum
- Make or buy decision
managerial - Inventory decision solutions
economics - Capital management
and profit planning
management
- Investment decision
THE MAIN AREAS OF MANAGERIAL ECONOMICS
1.DEMAND DECISSION
The analysis and forecasting of demand for a given product and service is the first task of the
managerial economist. Demand at different price levels at different points of time is to
forecast to plan the supply accordingly and initiate changes in price, if necessary to enlarge
customer base and gain more profits. Determination of elasticity of demand and demand
forecasting constitute the strategic issues that the managerial economist handles in a scientific
way.

2. INPUT - OUTPUT DECISSION

The costs of inputs in relation to output are studied to optimize the profits. Production
function and cost functions are estimated given certain parameters. The behaviour of costs at
different levels of production are assessed here. Some costs are fixed, some are semi- variable
and others are perfectly variable. The quantity of production increases remains constant or
decreases with additional increase in inputs. This decision deals with changes in the
production following changes in inputs, which could be substitutes, or complimentary. The
entire focus of this decision is to optimize the output at minimum cost. It is necessary for the
manger to know the relationship between the cost and output both in the short-run and long-
run to position his products amidst the competitive environment.

3. PRICE – OUTPUT DECISIONS

The production is ready and the task is to determine price these in different market situations
such as perfect market and imperfect markets ranging from monopoly, monopolistic
competition, duopoly and oligopoly. The pricing policies, methods, strategies and practices
constitute crucial part of managerial economics.

4. PROFIT – RELATED DECISIONS

Firms or companies employ the techniques such as break-even analysis, cost reduction and
cost control and ratio analysis to ascertain the level of profits. In break-even analysis the
organizations are concerned with profit planning and control. We determine break-even point
beyond which the firm starts getting profits. If the firm produces less than break-even point it
loses. Cost reduction and cost control deal with the strategies to reduce the wastage and there
by reduce the costs. Ratio analysis helps to determine the liquidity, solvency and profitability
of the activities of the firm.

5. INVESTMENT DECISIONS
Investment decisions are also called capital budgeting decisions. These involve commitment
of large funds, which determine the fate of the firm. Hence the manager needs to be more
attentive while committing his scarce funds, which have alternative uses. The allocations of
utilization of the investments have paramount importance. It is necessary to study the cost of
capital, choice of capital structure and investment projects before the funds are committed.

6. ECONOMIC FORECSTING AND FORWARD PLANNING

Economic forecasting leads to forward planning. The firms operate in an environment, which
is dominated by the external and internal factors. The external factors include major forces
such as government policy, competition, employment, labour, price and income levels so on.
These influence its decisions relating to production, human resources, finance and marketing.
The internal factors include its policies and procedures relating to finance, people, market and
products. It is necessary to forecast the trends in the economy to plan for the future in terms
of investments, profits, products and markets. This will minimize the risk and uncertainty
about the future.

WHAT IS MANAGERIAL ECONOMICS? BRIEFLY EXPLAIN THE LINKAGES

WITH OTHER DISCIPLINES?
ANS:

1. Spencer and Siegelman define managerial economics as “the integration of economic

theory with business practice for the purpose of facilitating decision – making and forward
planning by management.”
2. Brigham and Pappas believe that managerial economics is “the application of economics
theory and methodology to business administration practice”.

3. Salvatore observes that managerial economics refers to the application of economic theory
and the tools of analysis of decision science to examine how an organization can achieve its
aims and objectives most effectively.
LINKAGES WITH OTHER DISCIPLINES
Managerial economics is closely linked with many other disciplines such as economics,
accountancy, mathematics, statistics, operations research, psychology and organizational
behaviuor. They are,

1.ECONOMICS
Managerial economics is the offshoot of economics and hence all the concepts of managerial
economics are basically economic concepts. If economics deals with theoretical concepts,
managerial economics is the application of these in the real life. In the process of addressing
various managerial problems, several empirically estimated functions such as demand
function, cost function, revenue function and so on are extensively used. Economics and
managerial economics both are concerned with the problems of scarcity and resource
allocation. If the economist is concerned with study of markets, the managerial economist is
interested in studying the impact of such markets on the performance of a given firm.
Economics provides to the managerial economist
 An understanding of general economic environment within which the firm operates.
 A framework to solve the resource allocation problems.

2.OPERATIONS RESEARCH
Decision making is the main focus in operations research and managerial economics. If
managerial economics focuses on ‘problems of decision making’ operations research focuses
on solving managerial problems. It is used to establish economic and logical relationships
among the variables. The operation research models such as linear programming, queing,
transporatation, optimization techniques and so on, are extensively used in solving the
managerial problems.

3.MATHEMATICS
Managerial econo0mist is concerned with estimating and predicting the relevant economic
factors for decision making and forward planning. In this process, he extensively makes use
of the tools and techniques of mathematics such as algebra, calculus, exponentials, vectors,
input-output tables and such other. Mathematics facilitates derivation and exposition of
economic analysis.

4. STATISTICS
Statistics deals with different techniques useful to analyze the cause and effect relationships
in a variable or phenomenon. The business environment for the managerial economist is full
of risk and uncertainty and he extensively makes use of the statistical techniques such as
averages, measures of dispersion, correlation, regression, time series, interpolation,
probability and so on.

5. ACCOUNTANCY
The accountant provides accounting information related to costs, revenues, receivables,
payables, profits/losses etc and this form the basis for the managerial economist to act upon.
This forms an authentic data about the performance of the firm. The managerial economist
profusely depends upon accounting data for decision making and forward planning.

6. PSYCHOLOGY
Consumer psychology is the basis on which managerial economist acts upon. How the
customer reacts to a given change in price pr supply and its consequential effect on demand/
profits is the main focus of study in managerial economics. Psychology contributes towards
understanding the behavioural implications, attitudes and motivations of each of the
microeconomic variables such as consumer, supplier/ seller, investor, worker or an employee.

7. ORGANISATIONAL BEHAVIOUR
Organizational behaviour enables the managerial economist to study and develop behavioural
models of the firm integrating the manager’s behaviour with that of the owner.
DEAMAND ANALYSIS

BRIEFLY EXPALIN THE SCOPE OF ECONOMICS?

ANS:
The scope of economics broadly comprises (a) consumption (b) production (c) exchange (d)
distribution.

Consumption deals with the behaviour of consumers. To plan his operations, a producer has
to understands the consumer behaviour pattern before he commits his funds for production.

Exchange deals with how the goods, once procduced, are sold for a price to the consumer.
Distribution deals with how the sale proceeds of the goods sold are distributed among the
various factors of production towards the rent, wages, interest and profits.

WHAT IS CONSUMPTION? EXPLAIN THE BASIC LAWS OF CONSUMTION?

ANS:

Consumption deals with the behaviour of consumers. To plan his operations, a producer has
to understand the consumer behaviour pattern before he commits his funds for production.

A basic law of consumption deals with the salient aspects of consumer behaviour.the
consumer behaviour, on certain assumptions, has been generalized and accordingly certain
laws have been formulated based on this.

1. LAW OF DIMINISHING MARGINAL UTILITY

The law of diminishing marginal utility states that the marginal utility derived on the
consumption of every additional unit goes on diminishing, other things remaining same.
Marginal utility refers to the additional derived from consumption of an additional unit. For
instance, the first sweet will give more utility, the second sweet gives lesser utility and the
third one gives still lesser utility. If additional units of the same sweets are consumed the
amount of total utility goes on increasing but at a diminishing rate. This implies that the
marginal utility is reducing from one level to the other level of consumption. This is shown in
the following table

Number of sweets Amount of total quality Marginal utility(in units)

1 20 ---
2 35 15
3 47 12
4 55 8
5 55 0
6 48 -7

This Law holds good only when other things remain the same. Here other things include size
and quality of the sweets. Zero time intervals between any given tow level of consumption,
the price of the related goods, tastes and preferences of the consumer, and so on. Any change
in these factors will invalidate the law.

Exceptions to the law of diminishing marginal utility

There are certain exceptions to this law.

1.For instance, imagine a person wants to become a millionaire and he is short by just one
rupee. This additional rupee will make him a millionaire; therefore, the satisfaction he derives
on possessing this additional rupee is very significant. In such a case, the law does not hold
good.

2.Similarly, given water spoon by spoon a thirsty man will not quench his thirst. On the other
hand his thirst increases. If you give water in a glass, then the situation is altogether different.

3.We assume that the consumer behaves rationally, that is to maximize utility. This is a very
important law, which describes the consumption pattern of the consumer. It forms the basis
for many decisions relating to production, pricing and investments.

The law of Equi-Marginal Utility

The law of Equi-Marginal Utility explains the prerequisite for the consumer to be in
equilibrium. It states that the consumer is in equilibrium when the marginal utilities obtained
from the products bought are equal. In other words, the consumer maximizes his total utility
by allocating his income among the goods and services available to him in such a way that
the marginal utility from one good equals the marginal utility from the other good. In other
words:
Marginal utility of product X = Marginal utility of product
Product X Product Y

Where X and Y refer to the product bought.

units bought Marginal utility from

Paints shirts
1 40 35
2 32 28
3 28 20
4 20 10
5 10 8

Suppose each pant or shirt costs Rs.100. The consumer C has Rs.500 with him. What
combination will give him maximum satisfaction? Or when he will be in equilibrium? He
will not buy all pants or shirts with the money available. A combination of three pants and
two shirts will give him, maximum satisfaction. It is because the marginal utility derived on
the third pant is equal to that obtained on the second shirt.

From the above table, the following inferences are drawn,

1. The first buy will be a pant because it provides higher marginal utility. The customer
prefers to buy a pant first.

2. The second unit will be shirt only. Why? The second unit of a pant gives 32 units of
marginal utility whereas the shirt gives 35 units.

3. In case the customer has extra 100 rupees, he would buy either pant or shirt because both
yield equal marginal utility.
Consumer Surplus
Consumer surplus is defined as the difference between the price that the consumer is prepared
to pay and the price that he is exactly paying. In other words, it is the value consumers get
from a good with out paying for it.

In many cases, the consumer is prepared to pay a higher price for the product because of
many reasons-such as he wants the product badly, or he likes the particular design and hence
wants to pay even higher price, and so on. Take the case of for instance, salt. Can we take
food with out salt? . No. If the price of salt goes up to Rs.10 per kg, the consumer would be
prepared to pay for it. If the salt is available for Rs.5per kg, then the consumer surplus is Rs.5
per kg.

The concept of consumer’s surplus is very significant for the monopolist or the trader to
assess where the customer is prepared to pay a higher price. And at what point exactly he is
paying a low price. In such a case, the trader can marginally increase the price without losing
the demand.
The Indifference Curve
An indifference curve is curve is a curve, which reveals certain combination of goods, or
services, which yields him the same utility. The consumer is indifferent to particular
combinations as every combination is yielding him the same utility.

Product ‘x’ 1c 400

B 1c 300

C 1c 200

0 D E F
Product ‘Y’

From the given figure it is clear that any combination of AD, or BE or CF of goods X and Y
yield the consumer 200 units of satisfaction. When the consumer is indifferent for a particular
combination, it is called an indifference curve. In case he wants higher satisfaction, he has to
operate on the next level of indifference curve, which yields him 300 units.

Assumptions underlying indifference curves:

1.The consumer behaves rationally (to maximize his satisfaction)

2.The Price and incomes of the consumer are defined for analysis
(Taste and preference of the consumer do not change during the analysis).

Properties of Indifference Curve

1.IT SLOPES DOWNWARDS FROM LEFT TO RIGHT
To maintain the total units of satisfaction, if the consumption of product A is increased, the
consumption of product B has to be reduced. This leads to downward slope in the curve.

2.IT IS CONVEX TO ORIGIN

The consumer is substituting the one product for the other. So the rate at which the
substitution takes place determines the degree of convexity. This is called marginal rate of
substitution, which implies the quantity of product A given up to obtain certain quantity of
product B.

3.IT CANNOT INTERSECT WITH ANOTHER INDIFFERENCE CURVE

Two indifference curves cannot intersect with each other because each is defined at a
particular level of satisfaction. In case the consumer wants higher or lesser satisfaction he
chooses that particular indifference curve to operate. Two indifference curves can neither
touch, nor have a common point and they cannot intersect.

CONSUMER EQUILIBRIUM
A consumer is said to be in equilibrium when he maximizes his utility, given the budget
constraint. When the budget line is tangential to any of the indifference curves, then he is said
to be in equilibrium. As it is seen in the figure,

Good‘x’ 1c 400
B 1c 300

C 1c 200

BUDGET LINE

0 D E F
Good ‘Y’

It can be seen that the budget line is tangential to the indifference curve which yields the
consumer a satisfaction of 200 units.

LIMITATIONS OF UTILITY THEORY

All the above theories are based on the utility concept. There is one limitation of the utility
concept. It can be ranked only. It cannot be measured absolutely.

WHAT IS DEMAND? EXPALIN THE NATURE AND TYPES OF DEMAND?

ANS:
Every want supported by the willingness and ability to buy constitutes demand for a
particular or service. In other words, if I want a car and I cannot pay for it, there is no
demand for the car from may side.
A product or service is said to have demand when three conditions are satisfied:
 Desire on the part of the buyer to buy
 Willingness to pay for it
 Ability to pay the specified price for it.
Unless all these conditions are fulfilled, the product is not said to have any demand.
Nature and Type of Demand
Demand always implies at a given price. How much is the quantity demanded at a given level
of price? This is the volume of demand. The use and characteristics of different product
affect their demand.

The nature of demand is better understood when we see these variations given below:

1.Consumer Goods vs Producer Goods:

Consumer goods refer to such products and services, which are capable of satisfying human
need. Goods can be grouped under consumer goods and producer goods. Consumer goods
are those, which are available for ultimate consumption. These give direct and immediate
satisfaction. Examples are bread, apple, rice, and so on. Producer goods are those, which are
used for further processing or production of goods/services to earn income. Examples are
machinery or a tractor, and such others. These goods yield satisfaction indirectly. These are
used to producer consumer goods. There could be cases where a given product may be both a
producer good and also a consumer good. For instance, take the case of paddy. A farmer
having ten bags of paddy may use five bags for his personal consumption and the case of
paddy. A farmer having the bags of paddy may use five bags for his personal consumption
and the other five bags as seeds for the next crop. In such a case, paddy is both producer good
and a consumer good. The demand for producer goods is ‘indirect’ whereas the demand for
the consumer goods is ‘direct’. Also, it is possible that consumer good for one can become
producer good for another. A microwave oven at home is a consumer good and the same in a
hotel is a producer good.

2. AUTONOMOUS DEMAND vs. DERIVED DEMAND

Autonomous demand refers to the demand for products and services directly. The demand for
the services of a super specialty hospital can be considered as autonomous demand whereas
the demand for the hotels around that hospital is called a derived demand. In case of a derived
demand, the demand for a product arises out of the purchase of a parent product. If there is no
demand for houses, there may not be demand for steel, cement, bricks, and so on. Demand
for houses is autonomous whereas demand for these inputs is derived demand.

3. DURABLE vs. PERISHABLE GOODS

Here the demands for goods is classified based on their durability. Durable goods, which give
service relatively for a long period. The life of perishable goods is very less, may be in hours
or days. Examples of perishable goods are milk, vegetables, fish and such. Rice, wheat, sugar
and such others can be examples of durable goods. Given certain freezing facilities, the life of
perishable goods can be extended for some time. Products such as TV, refrigerator and
washing machines and so on are useful for a longer period and hence they are classified as
consumer durables.

4. FIRM DEMAND vs INDUSTRY DEMAND

The firm is a single business unit whereas industry refers to the group of firms carrying on
similar activity. The quantity of goods demanded by a single firm is called firm demand and
the quantity demanded by the industry as a whole is called industry demand. One
construction company may use 100 tonnes of cement during a given month. This is firm
demand. The construction industry in a particular state may have used ten million tones. This
is industry demand.

A demand schedule presents the details of the quantity demanded at different prices. A
demand schedule may be for an individual or firm, and also for a market or industry. The
individual demand table shows the quantity of rice demanded at different price levels. It is
observed that as the price decreases, the quantity demanded is increasing.
In market demand schedule, the aggregate quantity demanded by all the firms or the
customers is furnished. The given market schedule table.

Price(Rs) Quantity Demanded(kg of rice) Price(Rs) Quantity Demanded(kg of rice)

15 10 15 100
14 12 14 120
13 15 13 150
12 20 12 200
11 25 11 250
10 30 10 300

5. SHORT – RUN vs LONG – RUN DEMAND

Joel dean defines short-run demand as the demand with its immediate reaction to price
changes, income fluctuations and so on. Long- run demand is that demand which will
ultimately exist as a result of the changes in pricing, promotion, or product improvement,
after enough time is allowed to let the market adjust itself to the given situation.

The short – run and long – run cannot be clearly defined other than in terms of duration of
time. The demand for a particular product or service in a given region for a particular day can
be viewed as short- run demand. The demand for a longer period for the same region can be
viewed as long – run demand. The demand that can be created in the long – run changes in
the design as a result of changes in technology is long – run demand.

6. NEW DEMAND vs REPLACEMENT DEMAND

New demand refers to the demands for the new products and it is the addition to the existing
stock. In replacement demand, the item is purchased to maintain the asset in good condition.
The demand cars is new demand and the demand for the spare parts is replacement demand.
Replacement demand may also refer to the demand resulting out of the replacing the existing
assets with the new ones. Many companies announce exchange schemes for TVs, washing
machines and so on. They would like to tap the replacement demand.

7. TOTAL MARKET DEMAND AND SEGMENT MARKET DEMAND

Let us take the consumption of sugar in a given region. The total demand for sugar in the
region is the total market demand. The demand for sugar from the sweet-making industry
from this region is the segment market demand. A market segment can be defined in terms of
specific criteria such as location, age, sex, or income and so on. The aggregate demand of all
the segment is called the total market demand.
WHAT IS DEMAND? WHAT ARE THE FACTORS DETERMINING DEMAND?
ANS:
the demand for a particular product depends upon several factors. The following factors
determine the demand for a given product:
1. Price of the product (P).
2. Income levels of the consumer (I).
3. Tastes and preferences of the consumers (T).
4. Price of related goods, which may be substitutes/ complimentary (PR).
5. Expectations about the prices in future (EP).
6. Expectations about the incomes in future (EI).
7. Size of population (SP ).
8. Distribution of consumers over different regions (DC).
9. Advertising efforts (A).
10. Any other factor capable of effecting the demand (O).

WHAT IS DEMAND FORECASTING? HOW DO YOU DETERMINE IT?

ANS:
Demand function is a function, which describes a relationship between one variable and its
determinants. It describes how much quantity of goods is bought at alternative prices of good
and related goods, alternative income levels, and alternative values of other variables
affecting demand. Thus, demand function for a good relates the quantity of a good which
consumers demand during a given period to the factors, which influence the demand.
Mathematically, the demand function for a product A can be expressed as follows
Qd = f (P, I, T, PR, EP, EI, SP, DC, A, O)
Where Qd refers to quantity of demand and it is a function of the following variables,

 P refers to the Price of the product .

 I refers to the Income levels of the consumer .
 T refers to the Tastes and preferences of the consumers (T).
 PR refers to the Price of related goods, which may be substitutes/ complimentary (PR).
 EP refers to the expectations about the prices in future (EP).
 EI refers to the Expectations about the incomes in future (EI).
 SP refers to Size of population (SP ).
 Distribution of consumers over different regions (DC).
 Advertising efforts (A).
 Any other factor capable of effecting the demand (O).

The impact of some of these determinants on demand can be described as follows,

1.PRICE OF THE PRODUCT

Demand for a product is inversely related to its price. In other words, if price rises, the
demand falls and vice versa. This is the price demand function showing the price effect on
demand.

2. INCOME OF THE CONSUMER

As the income of the consumer or the household increases, there is tendency to buy more and
more upto a particular limit. The demand for product X is directly related to the income of the
consumer.
3.PRICES OF SUBSTITUTES OR COMPLIMENTARIES
The demand for product X is determined by the prices of its related products, substitutes or
complimentaries.if there is an increase in the price of a substitute, the demand for product X
will go up and vice versa. Similarly, if the price of complimentary goods (to product X) goes
up, the demand for product X will fall.
4. TASTES AND PREFERENCES
If the tastes and preferences of the consumer change, then there is a change in product
demanded also. Most of the companies keep changing their products and services, as and
when the customer’s tastes and preferences change. In some cases, the companies take
advantage of technological changes and upgrade their products and services. Such changes in
the technology can be advantageously used to meet the specific requirements of the
customers. Thus, they try to change the tastes ad preferences of the consumer through public
awareness campaign, advertisement in the media.
WHAT IS DEMAND? EXPLAIN THE EXCEPTIONS OF LAW OF DEMAND?
ANS:
The law of demand states that other things remaining the same, the amount of quantity
demanded rises with every fall in the price and vice versa. The law of demand states the
relationship between price and demand of a particular product or service. It makes an
assumption that all other demand determinants remain the same or do not change.
ASSUMPTIONS OF THE LAW OF DEMAND
The phrase ‘other things remaining the same’ is the assumption under the law of demand.
Here, other things include income level of the consumer, tastes and preferences of the
consumer, prices of related goods, expectations about the prices of incomes in the future, size
of population, advertising efforts, and any other factor capable of affecting demand.
The study the impact of change in demand because of changes in price, it is assumed that all
the above factors affecting demand are assumed to remain the same. The law does not hold
good if any one these factors tend to change. Such an assumption also forms the limitation of
the law of demand.
Operation of the law of Demand
The laws of demand explain that with every fall in the price of a particular product. It is
demand goes o increasing and vice versa. This holds good as long as other determinants of
demand do not change. Once there is change in the other demand determinants. The law does
not hold good.

P
Prices of
Product ‘x’

P1 D

Q Q1
Quantity
There are certain exceptions to this law. In other words, the law does not hold good in the
following cases.

1.Where there is shortage of necessities feared

If the customers fear that there could be shortage of necessities. Then this law does not
hold good. They may tend to buy more that what they require immediately, even if the
price of the product increases.

2.Where the product is such that it confers distinction products such as jewels, diamond
and so on, confer distinction o the part of the user. In such a case, the consumer tends to
buy (to maintain their prestige) even though there is increase in its price. Such products
are called ‘veblen’ goods.

3.Giffens’ paradox people whose incomes are low purchase more of a commodity such
as broken rice, bread etc (which is their staple food) when its price rises. Conversely
when its price falls, instead of buying more, they buy less of this commodity and use the
savings for the purchase of better good such as meat. This phenomenon is called Giffens’
paradox and such goods are called inferior or giffen goods.

4.In case of ignorance of price changes at times, the customer may not keep track of
changes in price. In such a case, he tends to buy even if there is increase in price.

Change in Demand the increases or decreases in demand due to change in the factors
other than price is called change in demand. Change in demand leads to a shift in the
demand curve to the right or to the left.

Increase in Demand
If the consumers are willing and able to buy more of Rainbow shirts at the same price, the
result will be an increase in demand. The demand curve will shift to the right as shown in
figure

Decrease in Demand
A decrease in demand occurs when buyers are ready to buy less of a product atr the same
price because of factors like fall I income, rise in price of complementary goods and so on. A
decrease in demand will shift the demand curve to the left as shown in figure
It can be seen from figure that the demand curve DD decrease to D1 D1 at the same price
level OP. the quantity demand also decrease from OQ to OQ1.

In crease or decrease in demand involves a shift in the demand curve.

Extension and contraction in demand

An extension is the downward movement along a demand curve, which indicates that a
higher quantity is demand for a given fall in the price of the good. A contraction is the
upward movement along a demand curve. Which indicates that a lower quantity is demanded
for a given increase in the price of the good?

From the given Figure it can be seen that at OP, the quantity demanded is OQ. When the
price decreases from OP to OP1, the quantity demanded extends from OQ to OQ1 along the
same demand curve. There is no shift, here I the demand curve. This is called extension in
demand.

Contraction refers to movement upwards along the same demand curve. When the price
increases from OP to OP1 , the demand contracts from OQ to OQ2 along the same demand
curve. This is called contraction in demand.

SIGNIFICANCE OF LAW OF DEMAND

The law of demand is the primary law of consumption theory in economics. It indicates the
consumer behaviour for a given change in the variables in the study. Despite the assumption
that other things remaining same, the results of law of demand are time tested and have been
the basis for further decisions relating to costs, output, investment appraisals and so on. This
provides the basis for analysis of other economic laws.