Вы находитесь на странице: 1из 49

CO

MP

ILA

TI

ON

Submitted By: Tambaoan, Angelica Rose D. BSIT-IIB Drafting Technology Submitted To: Mrs. Torralba, Bridgeta

Chapter I Economics: It’s meaning and importance

Introduction:

Enomics is the theories, principles, and models that deal with how the market process works. It attempts to explain how wealth is created and distributed in communities, how people allocate resources that are scarce and have many alternative uses, and other such matters that arise in dealing with human wants and their satisfaction.

Economics as science:

At its core, the field of economics tries to uncover basic universal facts. Like many sciences, economics has a strong foundation in mathematics, and it is developed by testing hypotheses. In many ways, economics can be viewed as a field of applied psychology. Understanding how humans behave in certain situations and respond to changes is essential for the field's development.

Econimics as social science:

Economics involves human participation in communicating what their needs and wants are, what the government is doing to ensure the society's needs and wants are met, how production is structured so that it is able to adequately cater to the needs of the society and how rules and regulations are formulated in order to foster a fair exchange of goods and services within the society.

Below are some of the most important factors considered when it comes to economics:

Land: this is a vital factor of production without which a society may end up facing tough times. Land is used for producing raw materials and establishing industrial buildings.

Labor: the main contributors here are human beings. Labor may be in three forms which are mainly unskilled, semiskilled and professional labor.

Capital: before production and distribution can begin, some resources must be available. These resources include factories, infrastructure and transportation equipment, among other things.

Entrepreneurship: this mainly involves human innovation or ability to organize the other factors of production in order to meet set goals or achieve solutions to societal needs with regards to goods and services.

Division of Economics:

Microeconomics studies the small picture -- the behavior of individuals and companies and the market for each type of product. For example, microeconomists study the influence of supply and demand on the price of shoes. Although "micro" is a prefix meaning "small," the worldwide market for a particular product, such as wheat, is also of interest to microeconomists. Microeconomics is based on the assumptions of Adam Smith, an 18th-century philosopher who is widely considered to be the father of economics, wherein market conditions -- supply, demand, production and selling -- are in equilibrium, and, if perturbed, quickly return to equilibrium. Everyday concerns, such as price supports, taxes and minimum wages, are part of microeconomics, according to G. Chris Rodrigo of the International Monetary Fund.

Macroeconomics studies the function of the economy of a nation as a whole. Its domain includes how government policies and the markets for various products affect inflation, employment and economic growth. However, the macro side also extends beyond national borders because international trade and investment impact the economies of many nations. Important areas of study in macroeconomics include short- and long-term trends. Macroeconomics originated with John Maynard Keynes in his attempts to explain the "market failure" that characterized the Great Depression, according to Rodrigo.

History of Economics:

Evolution of Economics as a Discipline

A brief History of Economics:

The modern Economics, which we still study now, is the result of the efforts of ancient or Pre classical (384BC-1776), classical (1776-1871) , Neoclassical (1871-Today) and Islamic Economists.

Ancient or Pre classical (384BC-1776):

The study of the economy in western civilization was begun largely with the Greeks, particularly Aristotle (384-322 BC) and Xenophon (420?- 355? BC). The ancient economic thinkers concerned with the theories of money, Taxation, usury, property rights, Entrepreneurship, Price differentials, Justice in economic exchange and analyzed the impact of ethics in economics.

Famous economists of the ancient school include St. Thomas Aquinas(1225-1274?),John Duns Scotus (1265-1308), Jean Buridan(1295 – 1358), Jean Buridan, (1295 – 1358),Nicole de Oresme, (1320-1382),Gabriel Biel, (1425-1495), Sir William Petty (1623-1687).

Classical (1776-1871):

The classical economists developed the theories about how markets and market economies work focusing the dynamics of economic growth which stressed economic freedom and promoted ideas such as laissez-faire and free competition. They introduced the labor theory of value, theory of distribution (Smith),, Principles of Political Economy and Taxation((Ricardo 1817, Mill 1848), the theory of surplus value(Karl Marx), principle of comparative advantage ,international-trade theory (Ricardo) and Monetary theories.

Famous economists of the classical school include Adam Smith, David Ricardo, W. Jevons, Jean-Baptiste Say, John Stuart Mill, Thomas Malthus, Professor Pigou, and Alfred Marshall.

Neoclassical (1871-Today):

Neoclassical economists first introduced the theories of Rationality & individual preferences, utility maximization (Utilitarianism, Jeremy Bentham) and Information economics, Theories of market forms and industrial organization, general equilibrium theory, indifference curves and the theory of ordinal utility. Neoclassical economics also increased the use of mathematical equations in the study of various aspects of the economy.

Famous economists of the Neoclassical school are William Stanley Jevons (Theory of Political Economy (1871), Carl Menger (Principles of Economics (1871), Leon Walras (Elements of Pure Economics (1874 – 1877), Joan Robinson (The Economics of Imperfect Competition (1933), Edward H. Chamberlin (the Theory of Monopolistic Competition (1933), Paul Samuelson and so on.

Islamic Economics:

The practice of Islamic Economics was begun in the state of Medina in the 6th century. After that, the process of Development of this discipline was handled by the different scholars and Economists in different centuries. many of them are Abu Yusuf (731-798), Al Farabi (873-950), Al Ghazali (1058-1111), Al mawaridi (1675-1158), Nasir Al-Din Al-Tusi (1201-1274), Ibn Taymiyyah (1263-1328), Ibn Khaldun (1334-1406) History of the World (Kitab al-Ibar), Asaad Davani (1444). They amplified the Ideas of consumer theory, supply and demand, Elasticity, Taxation (Khaldun-Laffer Curve (the

relationship between tax rates and tax revenue) etc in the light of Islamic Economics. Ibn Khaldun was considered as a Forerunner of modern economics.

The tools of Islamic economics are also employed in modern economics by some economic thinkers. Among of them, the contributions of M .Umer chapra (Islam &economic challenges), Monzer Kahf. Najat Ullah Siddiqui, M.A. Mannan, Fahim Khan,Anas Zarqa are well known to the recent world.

The basic Economic problem:

The relationship between scarcity and choices can be seen in many everyday examples. For instance, when a consumer contemplates a purchase, he must make a choice between buying the object and losing the money spent on it, or not obtaining the object and keeping the money. In either case, something is gained and something is lost. The thing that is lost or foregone when making a choice is known as the opportunity cost, another basic economic concept.

Conversely, if there was no scarcity, there would be no need to make choices that involve opportunity costs. For example, if there was a machine that could produce anything that a person desired, then the only limit to what that person could own would be the person's imagination. It is easy to see that money would not be necessary if such a machine existed, and thus the science of economics would be radically altered and cease to exist in its current state. This is why scarcity is considered to be the fundamental problem of economics.

The Economic system and model:

The Models

Scarcity forces people to make economic choices about how to use their resources. Throughout history people working alone, or in groups, have come to grips with this reality by forming economic systems. An economic system is the sum total of all economic activity that takes place within a society. That is, economic systems are comprised not only of the tangible economic institutions such as business firms, banks, and stock exchanges, but also the more subtle nuances that underlie business activity such as values, practices, customs, and traditions.

Economic systems also answer the three basic economic questions. What goods and services should be produced and in what quantity? How should these products be produced? For whom should these products be

produced? Responses to the basic economic questions help distinguish between different types of economic systems: traditional economies, command economies, and market economies. In reality, virtually all economies today are mixed economies—economies that adopt features mainly from the command and market models.

The Economic System:

An economic system is a system of production, resource allocation, and distribution of goods and services within a society or a given geographic area. It includes the combination of the various institutions, agencies, entities, decision- making processes, and patterns of consumption that comprise the economic structure of a given community. As such, an economic system is a type of social system. The mode of production is a related concept. All economic systems have three basic questions to ask: what to produce, how to produce and in what quantities, and who receives the output of production.

The study of economic systems includes how these various agencies and institutions are linked to one another, how information flows between them, and the social relations within the system (including property rights and the structure of management).

The analysis of economic systems traditionally focused on the dichotomies and comparisons between market economies and planned economies, and on the distinctions between capitalism and socialism. Subsequently, the categorization of economic systems expanded to include other topics and models that do not conform to the traditional dichotomy. Today the dominant form of economic organization at the world level is based on market-oriented mixed economies.

4 Types of Economic System:

1. Traditional Economic System

A traditional economic system is the best place to start because it is, quite literally, the most traditional and ancient type of economy in the world. There are certain elements of a traditional economy that those in more advanced economies, such as Mixed, would like to see return to prominence.

Where Tradition Is Cherished: Traditional economies still produce products and services that are a direct result of their beliefs, customs, traditions, religions, etc. Vast portions of the world still function under a traditional economic system. These areas tend to be rural, second- or third-world, and closely tied to the land, usually through farming. However, there is an increasingly small population of nomadic peoples, and while their economies are certainly traditional, they often interact with other economies in order to sell, trade, barter, etc. Learn about the complexities of globalization and how it shapes economic relationships and affects cultures with this great class on the geography of globalization.

Minimal Waste: Traditional economies would never, ever, in a million years see the type of profit or surplus that results from a market or mixed

economy. In general, surplus is a rare thing. A third-world and/or indigenous country does not have the resources necessary (or if they do, they are controlled by wealthier economies, often by force), and in many cases any surplus is either distributed, wasted, or paid to some authority that has been given power.

Advantages And Disadvantages: Certainly one of the most obvious advantages is that tradition and custom is preserved while it is virtually non- existant in market/mixed economies. There is also the fact that each member of a traditional economy has a more specific and pronounced role, and these societies are often very close-knit and socially satisfied. The main disadvantage is that traditional economies do not enjoy the things other economies take for granted: Western medicine, centralized utilities, technology, etc. But as anyone in America can attest, these things do not guarantee happiness, peace, social or, most ironically of all, economic stability.

2. Command Economic System

In terms of economic advancement, the command economic system is the next step up from a traditional economy. This by no means indicates that it is fairer or an exact improvement; there are many things fundamentally wrong with a command economy.

Centralized Control: The most notable feature of a command economy is that a large part of the economic system is controlled by a centralized power; often, a federal government. This kind of economy tends to develop when a country finds itself in possession of a very large amount of valuable resource(s). The government then steps in and regulates the resource(s). Often the government will own everything involved in the industrial process, from the equipment to the facilities.

Interested in earning CFA certification? Get all the training you need from this CFA Level 1 Economics curriculum.

Supposed Advantages: You can see how this kind of economy would, over time, create unrest among the general population. But there are actually several potential advantages, as long as the government uses intelligent regulations. First of all, a command economy is capable of creating a healthy supply of its own resources and it generally rewards its own people with affordable prices (but because it is ultimately regulated by the government, it is ultimately priced by the government). Still, there is often no shortage of jobs as the government functions similarly to a market economy in that it wants to grow and grow upon its populace.

Hand In The Cookie Jar: Interestingly – or maybe, predictably – the government in a command economy only desires to control its most valuable resources. Other things, like agriculture, are left to be regulated and run by the people. This is the nature of a command economy and many communist governments fall into this category.

You should also consider this micro and macro economics program. It’s been approved by the CFA institute and focuses on the impact of economic variables on the financial market and industry.

  • 3. Market Economic System

A market economy is very similar to a free market. The government does not control vital resources, valuable goods or any other major segment of the economy. In this way, organizations run by the people determine how the economy runs, how supply is generated, what demands are necessary, etc.

Capitalism And Socialism: No truly free market economy exists in the world. For example, while America is a capitalist nation, our government still regulates (or attempts to regulate) fair trade, government programs, moral business, monopolies, etc. etc. The advantage to capitalism is you can have an explosive economy that is very well controlled and relatively safe. This would be contrasted to socialism, in which the government (like a command economy) controls and owns the most profitable and vital industries but allows the rest of the market to operate freely; that is, price is allowed to fluctuate freely based on supply and demand. If you want to know how the global economy works and the role you play in it, check out this sweet class on Economics Without Boundaries.

Market Economy And Politics: Arguably the biggest advantage to a market economy (at least, outside of economic benefits) is the separation of the market and the government. This prevents the government from becoming too powerful, too controlling and too similar to the governments of the world that oppress their people while living lavishly on controlled resources. In the same way that separation of church and state has been to vital to America’s social success, so has a separation of market and state been vital to our economic success. Yes, there is something wary about a system which to be successful must foster constant growth, but as a result progress and innovation have occurred at such incredible rates as to affect the way the world economy functions.

  • 4. Mixed Economic System

A mixed economic system (also known as a Dual Economy) is just like it sounds (a combination of economic systems), but it primarily refers to a mixture of a market and command economy (for obvious reasons, a traditional economy does not typically mix well). As you can imagine, many variations exist, with some mixed economies being primarily free markets and others being strongly controlled by the government. Learn more about an essential part of our economy with this free post on understanding the stock market.

Benefits Of A Mixed Economy: In the most common types of mixed economies, the market is more or less free of government ownership except for a few key areas. These areas are usually not the resources that a command economy controls. Instead, as in America, they are the

government programs such as education, transportation, USPS, etc. While all of these industries also exist in the private sector in America, this is not always the case for a mixed economy.

Disadvantages Of A Mixed Economy: While a mixed economy can lead to incredible results (America being the obvious example), it can also suffer from similar downfalls found in other economies. For example, the last hundred years in America has seen a rise in government power. Not just in imposing laws and regulations, but in actually gaining control, becoming more difficult to access while simultaneously becoming less flexible. This is a common tendency of mixed economies.

Please Respect The Thin Line: A current, pivotal debate between Democrats and Republicans is the amount of governmental control. Can a true balance exist? Where should there be more government regulation? Where should there be less? These questions have no real answer; it is subjective, and therefore only a relatively small portion of the population will, at any given time, agree with the state of a mixed economy. It must be a strong form of government indeed to avoid collapsing under this constant pressure.

Chapter II The Demand and Supply concepts

Market:

A market is any arrangement that enables buyers and sellers to get information and do business with each other. A competitive market is a market that has many buyers and many sellers so no single buyer or seller can influence the price. The money price of a good is the amount of money needed to buy it. The relative price of a good—the ratio of its money price to the money price of the next best alternative good—is its opportunity cost.

Demand:

If you demand something, then you

  • 1. Want it,

  • 2. Can afford it, and

  • 3. Have made a definite plan to buy it.

The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.

The Law of Demand

The law of demand states:

Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the larger is the quantity demanded.

The law of demand results from:

Substitution Effect: When the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded of the good or service decreases.

Income Effect: When the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded of the good or service decreases.

Demand Curve and Demand Schedule

The term demand refers to the entire relationship between the price of the good and quantity demanded of the good.

A demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same.

Demand Curve for energy bars:

Demand Curve and Demand Schedule The term demand refers to the entire relationship between the price

A rise in the price, other things remaining the same, brings a decrease in the quantity demanded and a movement up along the demand curve.

A fall in the price, other things remaining the same, brings an increase in the quantity demanded and a movement down along the demand curve.

Willingness and Ability to Pay

A demand curve is also a willingness-and-ability-to-pay curve.

The smaller the quantity available, the higher is the price that someone is willing to pay for another unit.

Willingness to pay measures marginal benefit.

A Change in Demand

Six main factors that change demand are:

Willingness and Ability to Pay A demand curve is also a willingness-and-ability-to-pay curve. The smaller the

Prices of Related Goods- substitute is a good that can be used in place of another good. complement is a good that is used in conjunction with another good.

When the price of substitute for an energy bar rises or when the price of a complement of an energy bar falls, the demand for energy bars increases.

Expected Future Prices

If the expected future price of a good rises, current demand for the good increases and the demand curve shifts rightward.

Income

When income increases, consumers buy more of most goods and the demand curve shifts rightward.

normal good is one for which demand increases as income increases.

inferior good is a good for which demand decreases as income increases.

Expected Future Income and Credit

When expected future income increases or when credit is easy to obtain, the demand might increase now.

Population

The larger the population, the greater is the demand for all goods.

Preferences

People with the same income have different demands if they have different preferences.

Figure shows an increase in demand.

Because an energy bar is a normal good, an increase in income increases the demand for energy bars.

Preferences People with the same income have different demands if they have different preferences. Figure shows

A Change in the Quantity Demanded Versus a Change in Demand

Figure illustrates the distinction between a change in demand and a change in the quantity demanded.

Movement Along the Demand Curve

Preferences People with the same income have different demands if they have different preferences. Figure shows

When the price of the good changes and everything else remains the same, the quantity demanded changes and there is a movement along the demand curve.

A Shift of the Demand Curve

If the price remains the same but one of the other influences on buyers’ plans changes, demand changes and the demand curve shifts.

Supply:

A Shift of the Demand Curve If the price remains the same but one of the

If a firm supplies a good or service, then the firm

  • 1. Has the resources and the technology to produce it,

  • 2. Can profit from producing it, and

  • 3. Has made a definite plan to produce and sell it. Resources and technology determine what it is possible to produce.

Supply reflects a decision about which technologically feasible items to produce.

The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.

The Law of Supply

The law of supply states:

Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity

supplied.

The law of supply results from the general tendency for the marginal cost of producing a good or service to increase as the quantity produced increases.

Producers are willing to supply a good only if they can at least cover their marginal cost of production.

Supply Curve and Supply Schedule

The term supply refers to the entire relationship between the quantity supplied and the price of a good.

The supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers’ planned sales remain the same.

Figure shows a supply curve of energy

bars.

Supply Curve and Supply Schedule The term supply refers to the entire relationship between the quantity

A rise in the price of an energy bar, other things remaining the same, brings an increase in the quantity supplied.

Minimum Supply Price A supply curve is also a minimum-supply- price

curve.

As the quantity produced increases, marginal cost increases.

The lowest price at which someone is

willing to sell

an additional unit rises.

This lowest price is marginal cost.

A Change in Supply

Supply Curve and Supply Schedule The term supply refers to the entire relationship between the quantity

The six main factors that change supply of a good are:

  • a. The prices of factors of production

  • b. The prices of related goods produced

  • c. Expected future prices

  • d. The number of suppliers

  • e. Technology

  • f. State of nature

Figure shows an increase in supply.

An advance in the technology for producing energy bars increases the supply of energy bars and shifts the supply curve rightward.

Figure shows an increase in supply. An advance in the technology for producing energy bars increases

A Change in the Quantity Supplied Versus a Change in Supply

Figure illustrates the distinction between a change in supply and a change in the quantity supplied.

Figure shows an increase in supply. An advance in the technology for producing energy bars increases

Movement Along the Supply Curve

When the price of the good changes and other influences on sellers’ plans remain the same, the quantity supplied changes and there is a movement along the supply curve.

Figure shows an increase in supply. An advance in the technology for producing energy bars increases

A Shift of the Supply Curve

If the price remains the same but some other influence on sellers’ plans changes, supply changes and the supply curve shifts.

If the price remains the same but some other influence on sellers’ plans changes, supply changes

The price system:

In economics, a price system is a component of any economic system that uses prices expressed in any form of money for the valuation and distribution of goods and services and the factors of production. Except for possible remote and primitive communities, all modern societies use price systems to allocate resources, although price systems are not used exclusively for all resource allocation decisions.

A price system may be either a fixed price system where prices are administered by a government body, or it may be a free price system where prices are left to float "freely" as determined by supply and demand uninhibited by regulations. A mixed price system involves a combination of both administered and unregulated prices.

The role of the government:

The government supports the economy when it facilitates transport and communication via the postal service and highways and establishes the police and military to safeguard life and property. Local or state governments support the economy by funding education and building roads.

Governments devise rules that ensure businesses operate in the best interests of the public. For instance, the government may allow a monopoly to operate in a market or industry with little competition, such as in utility services, but limit the company’s freedom to increase prices to avoid hurting consumers who would have no recourse.

A government devises monetary policies to keep the economy growing at the desired pace. By controlling circulation of money, adjusting interest rates and tax rates, and controlling access to credit, the government can control the inflation or the decline of the economy. Likewise, the economy is affected when the government gives certain businesses preferential treatment, such as by limiting foreign competition in a specific market or imposing higher taxes on imports to boost domestic production.

Chapter III Basic Element of demand and supply

Market Equilibrium:

Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers.

The equilibrium price is the price at which the quantity demanded equals the quantity supplied.

The equilibrium quantity is the quantity bought and sold at the equilibrium price.

Price regulates buying and selling plans.

Price adjusts when plans don’t match.

Price as a Regulator

If the price is $2.00 a bar, the quantity supplied exceeds the quantity demanded.

There is a surplus of 6 million energy bars.

If the price is $1.00 a bar, the quantity demanded exceeds the quantity supplied.

There is a shortage of 9 million energy bars.

If the price is $1.50 a bar, the quantity demanded equals the quantity supplied.

There is neither a shortage nor a surplus of energy bars.

Price Adjustments

At any price above the equilibrium price, a surplus forces the price down. At any price below the equilibrium price, a shortage forces the price

up.

At the equilibrium price, buyers’ plans and sellers’ plans agree and the price

doesn’t change until some event changes either demand or supply.

Chapter IV Demand Supple Elasticity

Elasticity:

In economics, elasticity is the measurement of how responsive an economic variable is to a change in another. It gives answers to questions such as:

"If I lower the price of a product, how much more will sell?"

"If I raise the price of one good, how will that affect sales of this other good?"

"If the market price of a product goes down, how much will that affect the amount that firms will be willing to supply to the market?"

An elastic variable (with elasticity value greater than 1) is one which responds more than proportionally to changes in other variables. In contrast, an inelastic variable (with elasticity value less than 1) is one which changes less than proportionally in response to changes in other variables. A variable can have different values of its elasticity at different starting points: for example, the quantity of a good supplied by producers might be elastic at low prices but inelastic at higher prices, so that a rise from an initially low price might bring on a more-than-proportionate increase in quantity supplied while a rise from an initially high price might bring on a less-than- proportionate rise in quantity supplied.

Elasticity can be quantified as the ratio of the percentage change in one variable to the percentage change in another variable, when the latter variable has a causal influence on the former. A more precise definition is given in terms of differential calculus. It is a tool for measuring the responsiveness of one variable to changes in another, causative variable. Elasticity has the advantage of being a unitless ratio, independent of the type of quantities being varied. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution.

Elasticity is one of the most important concepts in neoclassical economic theory. It is useful in understanding the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, and distribution of wealth and different types of goods as they relate to the theory of consumer choice. Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus.

In empirical work an elasticity is the estimated coefficient in a linear regression equation where both the dependent variable and the independent variable are in natural logs. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data analysis.

Determinants:

Determinants of Demand

When price changes, quantity demanded will change. That is a movement along the same demand curve. When factors other than price changes, demand curve will shift. These are the determinants of the demand curve.

  • 1. Income: A rise in a person’s income will lead to an increase in demand

(shift demand curve to the right), a fall will lead to a decrease in demand for

normal goods. Goods whose demand varies inversely with income are called inferior goods (e.g. Hamburger Helper).

  • 2. Consumer Preferences: Favorable change leads to an increase in demand,

unfavorable change lead to a decrease.

  • 3. Number of Buyers: the more buyers lead to an increase in demand; fewer

buyers lead to decrease.

  • 4. Price of related good s:

    • a. Substitute goods (those that can be used to replace each other): price of

substitute and demand for the other good are directly related. Example: If the price of coffee rises, the demand for tea should increase.

  • b. Complement goods (those that can be used together): price of

complement and demand for the other good are inversely related.

Example: if the price of ice cream rises, the demand for ice-cream toppings will decrease.

  • 5. Expectation of future :

    • a. Future price: consumers’ current demand will increase if they expect

higher future prices; their demand will decrease if they expect lower future prices.

  • b. Future income: consumers’ current demand will increase if they expect

higher future income; their demand will decrease if they expect lower future

income.

Determinants of Suppply

When price changes, quantity supplied will change. That is a movement along the same supply curve. When factors other than price changes, supply curve will shift. Here are some determinants of the supply curve.

  • 1. Production cost: Since most private companies’ goal is profit

maximization. Higher production cost will lower profit, thus hinder supply. Factors affecting production cost are: input prices, wage rate, government regulation and taxes, etc.

  • 2. Technology: Technological improvements help reduce production cost and

increase profit, thus stimulate higher supply.

  • 3. Number of sellers: More sellers in the market increase the market supply.

  • 4. Expectation for future prices: If producers expect future price to be

higher, they will try to hold on to their inventories and offer the products to

the buyers in the future, thus they can capture the higher price.

Econimic Significance:

A finding in economics may be said to be of economic significance (or substantive significance) if it shows a theory to be useful or not useful, or if has implications for scientific interpretation or policy practice (McCloskey and Ziliak, 1996).

Elasticity of Supply:

Price elasticity of supply

The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price. In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement. If the price elasticity of supply is zero the supply of a good supplied is "totally inelastic" and the quantity supplied is fixed.

Elasticities of scale

Elasticity of scale or output elasticity measures the percentage change in output induced by a collective percent change in the usages of all inputs. A production function or process is said to exhibit constant returns to scale if a percentage change in inputs results in an equal percentage in

outputs (an elasticity equal to 1). It exhibits increasing returns to scale if a percentage change in inputs results in greater percentage change in output (an elasticity greater than 1). The definition of decreasing returns to scale is analogous.

Types of Responses of Producers to Price Changes:

Background- This paper reports on a range of “laboratory-style” studies into the effects of price differences and price changes. This is in the scientific tradition of artificial laboratory work which would later be followed by validation and calibration studies. Hall or Central Location Tests were designed to investigate whether there are any results about pricing that can be generalised across different conditions, such as for products, brands, price levels, higher and lower price and so on. The background is that there seems to be no body of general understanding about how pricing “works”. It is difficult to learn about pricing from real life. This is because in-market prices either don’t change much, or tend to change together. And they are usually complicated by other marketing activity. Disentangling the various factors and attributing effects is difficult. Pricing experts stress that price is very sensitive to context but without systematic findings. Some say that successful prediction of pricing effects depends on recreating the circumstances as accurately as possible (Blamires 1997), but we (and others e.g. Nagle and Holden 1995) have doubts. Other researchers build price into complex logit-style regression models, with many parameters. Thus Mela, Gupta and Lehmann (1997) have 348 plus and yet have to make simplifying assumptions (such as that elasticities are the same for price rises and cuts). If a model fits better with a certain variable included, it is considered to have a causal role in the choice process. But this modelling process usually reveals little about the size of the effect, and nothing about how it may apply in other cases. In contrast, our approach tries to be both simpler and more general. The aim was to establish whether, under experimental conditions, there are consistent patterns in consumers’ brand choice when faced with price changes. What is special is that we did not just do one or two tests, but 30 major ones with 4000 respondents, using 25 products (including groceries, durables and services), 100 brands, 1,000+ price scenarios, in 3 countries, with various major and other minor technique variations. This could be done because compared with in-store tests or test markets, individual Hall Tests are more flexible and less expensive. The main outcome was the range of consistent results that we are describing here.

A Brief Summary of Method- The methodology, and the results are described in much greater depth in our working paper (Scriven and Ehrenberg 1999). We used several versions of a traditional “Hall” or “Central Location” test procedure to measure consumers’ expressed intentions to buy a brand. We did not try to measure “sales” directly, or seek to mimic normal buying situations. Instead, the aim was to expose consumers to various choice situations under a variety of controlled conditions. Individual consumers, who were mostly buyers of the product category, visited a series of tables where the same four brands were displayed at various controlled prices. At each table they had simply to respond to the on-going question “Which one of these would you buy, if any?” Initially, the four prices were set at implicitly normal prices N, mainly reflecting available in-market prices (and therefore not necessarily the same for each brand). At successive tables, the price changed by say plus or minus 15% from N, for any one of the four brands in turn, whilst the other three brands were displayed at their initial normal N price. These price changes were usually not highlighted, but we also experimented with situations where the price changes would be either more or less self-evident to participants. We calculated price elasticities (E) for the numbers of participants who chose the given brand at its normal price N and at its changed price (“E” is the percent change in brand choice or “sales”, divided by the percent change in the brand’s price – see working paper for precise calculation. Elasticities were all negative: we call –6 a bigger E than –3.) The main elasticities thus produced were summarised as averages across various combinations of (i) product categories, (ii) brands, (iii) 15% higher or lower prices, (iv) relative price positions (e.g. passing a reference point or not), (v) sub–groups of demographic, usership, and experimental variables. Within this we have checked in particular the consistency of the detailed findings across the different tests, products, brands, etc.

Findings- Throughout the tests, there have been five brand-related factors that consistently led to bigger price elasticities (e.g. bigger for smaller bands). There were also three demographic or usage sub-groups who consistently had bigger elasticities. These factors sometimes combined in complex hierarchical ways that we do not yet fully understand. Instead of pricing effects being an idiosyncratic characteristic of a brand, the experimental results show how there can be consistent and simplifying patterns. The level of elasticities was mostly not dramatically higher than the –2 or so at times reported in real-life studies (Bolton 1989; Tellis 1986). But some much higher values occurred which can often be accounted for by the pricing context (e.g when all the base N prices are the same).

Discussion- Individual price elasticities for different brands and price changes can appear varied and irregular. We have shown that pricing is not

too complex for highly consistent patterns to have emerged. In particular, responses to price changes depend more on the context than on the brand as such. Five main factors have consistently affected the level of elasticities found: brand size, relative position to a reference price, how close competitive prices were to start with, whether price is moving higher or lower, and how overt the price change is. Not everyone responds to price changes (if elasticity is –2 say, then for a 15% price increase, 70% of buyers (100-2x15) stay with their choice). Light brand buyers, self-claimed price conscious and younger consumers are consistently more responsive to price changes. Some of the results may seem unsurprising. But so might the opposite findings (e.g. if we had found that heavy brand buyers were more price-sensitive: they would gain more from a lower price and lose more from a higher one). Some have at least been touched on in isolation previously (e.g. the seminal Guadagni and Little paper on logit modelling (1983) notes in passing that big brands have lower price elasticities). There is an extensive literature on reference prices, and transaction effects (as in our overt price effect). We have shown across a wide range of results, which factors are consistently important, with some measure of by how much.

Determinants of Supply Elasticity:

A product's supply is considered inelastic if changes in its market price have little or no impact on the amount of the product that is supplied. Agricultural products, for example, are relatively inelastic because farmers cannot react to a price change by increasing supply, since the supply has a lengthy production period.

Theory of Consumer behavior:

  • 1. Rationality:

The consumer is assumed to be rational he aims at the maximization of his utility, given his income and market prices. It is assumed he has full knowledge (certainty) of all relevant information.

  • 2. Utility is ordinal:

It is taken as axiomatically true that the consumer can rank his preferences (order the various ‘baskets of goods’) according to the satisfaction of each basket. He need not know precisely the amount of satisfaction. It suffices that he expresses his preference for the various bundles of commodities. It is not necessary to assume that utility is cardinally measurable. Only ordinal measurement is required.

  • 3. Diminishing marginal rate of substitution:

Preferences are ranked in terms of indifference curves, which are assumed to be convex to the origin. This implies that the slope of the indifference curves increases. The slope of the indifference curve is called the marginal rate of substitution of the commodities. The indifference-curve theory is based, thus, on the axiom of diminishing marginal rate of substitution.

4. The total utility of the consumer depends on the quantities of the commodities consumed

U = f (q 1 , q 2 ,…, q x , q y ,…………

..

q n )

5. Consistency and transitivity of choice:

It is assumed that the consumer is consistent in his choice, that is, if in one period he chooses bundle A over B, he will not choose B over A in another period if both bundles are available to him.

Budget Line:

The Budget Line, also called as Budget Constraint shows all the combinations of two commodities that a consumer can afford at given market prices and within the particular income level.

We know that the higher the indifference curve, the higher is the utility, and thus, utility maximizing consumer will strive to reach the highest possible Indifference curve. But, he has two strong constraints: limited income and given the market price of goods and services. The income in hand is the main constraint (budgetary) that decides how high a consumer can go on the indifference map. In a two commodity model, the budgetary constraint can be expressed in the form of the budget equation:

P x . Q x + P y . Q y =M

Where, P x and P y are the prices of commodity X and Y and Q x , and Q y is their respective quantities. M= consumer’s money income

The Budget equation states that the consumer’s expenditure on commodity X and Y cannot exceed his money income (M). Thus, the quantities of commodities X and Y that a consumer can buy from his income (M) at given prices P x and P y can be calculated through the budget equation given below:

The values of Qx and Qy are plotted on the X and Y axis, and a line with a negative slope is drawn connecting the points so obtained. This line is called the budget line or price line.

The values of Qx and Qy are plotted on the X and Y axis, and aoptimum utility , or satisfaction , from the goods and services purchased given the constraints of income and prices . This is based on the assumption that consumers attempt to get maximum utility from their purchases and that competition exists for the item in question. Equilibrium is reached when the consumer purchases the assortment of goods which best meets his satisfaction requirements given his financial constraints. " id="pdf-obj-33-5" src="pdf-obj-33-5.jpg">

The Equilibrium of Consumer:

The values of Qx and Qy are plotted on the X and Y axis, and aoptimum utility , or satisfaction , from the goods and services purchased given the constraints of income and prices . This is based on the assumption that consumers attempt to get maximum utility from their purchases and that competition exists for the item in question. Equilibrium is reached when the consumer purchases the assortment of goods which best meets his satisfaction requirements given his financial constraints. " id="pdf-obj-33-9" src="pdf-obj-33-9.jpg">

The point at which a consumer reaches optimum utility, or satisfaction, from the goods and services purchased given the constraints of income and prices. This is based on the assumption that consumers attempt to get maximum utility from their purchases and that competition exists for the item in question. Equilibrium is reached when the consumer purchases the assortment of goods which best meets his satisfaction requirements given his financial constraints.

Chapter V Production and Cost

The Concept of Production:

This concept is the oldest of the concepts in business. It holds that consumers will prefer products that are widely available and inexpensive. Managers focusing on this concept concentrate on achieving high production efficiency, low costs, and mass distribution. They assume that consumers are primarily interested in product availability and low prices. This orientation makes sense in developing countries, where consumers are more interested in obtaining the product than in its features.

When the production concept was found, a production orientation business dominated the market from the beginning of Capitalism to the mid 1950’s. During the era of the Production concept, Business concerned itself primarily with production, manufacturing, and efficiency issues. This view point was encapsulated in Says Law which states Supply creates its own demand (from the French economist Jean – Baptiste Say.) To put it another way, If a product is made, somebody will want to buy it. The reason for the predominance of this orientation is there was a shortage of manufactured goods (relative to demand) during this period so goods sold easily.

The basic proposition of the production concept is that customers will choose products and services that are widely available and are of low cost. So business is mainly concerned with making as many units as possible. By concentrating on producing maximum volumes, such a business aims to maximise profitability by exploiting economies of scale. Managers try to achieve higher volume with low cost and intensive distribution strategy. This seems a viable strategy in a developing market where market expansion is the survival strategy for the business. Companies interested to take the benefit of scale economies purse this kind of orientation.

In a production-orientated business, the needs of customers are secondary compared with the need to increase output. Such an approach is probably most effective when a business operates in very high growth markets or where the potential for economies of scale is significant. It is natural that the companies cannot deliver quality products and suffer from problems arising out of impersonal behavior with the customers.

Chapter VI Essential of Production

Factors of Production:

The factors of production are resources that are the building blocks of the economy; they are what people use to produce goods and services. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship.

The first factor of production is land, but this includes any natural resource used to produce goods and services. This includes not just land, but anything that comes from the land. Some common land or natural resources are water, oil, copper, natural gas, coal, and forests. Land resources are the raw materials in the production process. These resources can be renewable, such as forests, or nonrenewable such as oil or natural gas. The income that resource owners earn in return for land resources is called rent.

The second factor of production is labor. Labor is the effort that people contribute to the production of goods and services. Labor resources include the work done by the waiter who brings your food at a local restaurant as well as the engineer who designed the bus that transports you to school. It includes an artist's creation of a painting as well as the work of the pilot flying the airplane overhead. If you have ever been paid for a job, you have contributed labor resources to the production of goods or services. The income earned by labor resources is called wages and is the largest source of income for most people.

The third factor of production is capital. Think of capital as the machinery, tools and buildings humans use to produce goods and services. Some common examples of capital include hammers, forklifts, conveyer belts, computers, and delivery vans. Capital differs based on the worker and the type of work being done. For example, a doctor may use a stethoscope and an examination room to provide medical services. Your teacher may use textbooks, desks, and a whiteboard to produce education services. The income earned by owners of capital resources is interest.

The fourth factor of production is entrepreneurship. An entrepreneur is a person who combines the other factors of production - land, labor, and capital - to earn a profit. The most successful entrepreneurs are innovators who find new ways produce goods and services or who develop new goods and services to bring to market. Without the entrepreneur combining land, labor, and capital in new ways, many of the innovations we see around us would not exist. Think of the entrepreneurship of Henry Ford or Bill Gates.

Entrepreneurs are a vital engine of economic growth helping to build some of

the largest firms in the world as well as some of the small businesses in your

neighborhood. Entrepreneurs thrive in economies where they have the

freedom to start businesses and buy resources freely. The payment to

entrepreneurship is profit.

You will notice that I did not include money as a factor of production. You

might ask, isn't money a type of capital? Money is not capital as economists

define capital because it is not a productive resource. While money can be

used to buy capital, it is the capital good (things such as machinery and

tools) that is used to produce goods and services. When was the last time

you saw a carpenter pounding a nail with a five dollar bill or a warehouse

foreman lifting a pallet with a 20 dollar bill? Money merely facilitates trade,

but it is not in itself a productive resource.

Remember, goods and services are scarce because the factors of production

used to produce them are scarce. In case you have forgotten, scarcity is

described as limited quantities of resources to meet unlimited wants.

Consider a pair of denim blue jeans. The denim is made of cotton, grown on

the land. The land and water used to grow the cotton is limited and could

have been used to grow a variety of different crops. The workers who cut and

sewed the denim in the factory are limited labor resources who could have

been producing other goods or services in the economy. The machines and

the factory used to produce the jeans are limited capital resources that could

have been used to produce other goods. This scarcity of resources means

that producing some goods and services leaves other goods and services

unproduced.

It's time to test your knowledge with a little game I like to call, Name That

Resource. I will say the name of an item and you will identify it as one of the

four possible resources that form the factors of production: land, labor,

capital, or entrepreneurship.

Coal

...

land

Forklift

capital

...

 

Factory

capital

...

Oil

...

land

 

Michael Dell

...

entrepreneur

It's time to wrap things up, but before we go, always remember that the four

factors of production - land, labor, capital, and entrepreneurship - are scarce

resources that form the building blocks of the economy.

Production of function:

In economics, a production function relates physical output of a

production process to physical inputs or factors of production. The production

function is one of the key concepts of mainstream neoclassical theories, used

to define marginal product and to distinguish allocative efficiency, the

defining focus of economics.The primary purpose of the production function

is to address allocative efficiency in the use of factor inputs in production and

the resulting distribution of income to those factors, while abstracting away

from the technological problems of achieving technical efficiency, as an

engineer or professional manager might understand it. Production function

denotes an efficient combination of inputs and outputs.

In macroeconomics, aggregate production functions are estimated to

create a framework in which to distinguish how much of economic growth to

attribute to changes in factor allocation (e.g. the accumulation of capital)

and how much to attribute to advancing technology. Some non-mainstream

economists, however, reject the very concept of an aggregate production

function

Factors of Production Classification:

A factor of production may be defined as "that good or service which is

required for production." A factor of production is indispensable for

production because without it no production is possible. It is customary to

attribute the process of production to four factors, land, labour, capital and

organisation.

Land

Land not only consists of mere surface of land but also includes all the

natural sources such as oceans, mountains, forests etc. Marshall defines land

as " By land is meant materials and forces which nature gives freely for

man's aid, in land, water, in air, light and heat." Thus land is a significant

part of production which facilitates in the production of goods and services in

one way or the other.

Labour

Labour refers to the act of working for some monetary benefits against

physical and mental activity. It does not comprise of any leisure activity. It

includes the services of a factory worker, any professional workers such as

engineers, doctors, teachers, lawyer etc. If a person paints or sings in order

to please someone or himself without any target or for monetary benefits he

won't be called a labour. But if he intends to sell the painting or sing against

any monetary reward then it involves labour. Thus labour forms an essential

aspect of production.

Capital

Capital means all human-made materials such as tools, equipments,

infrastructure, machinery, seeds, plants, modes of transportation such as

rail, road and air etc. In general it encompasses all affluences eliminating

land as land is utilised for supplementary production of affluence. Now-a-

days, capital not only includes physical capital but also involves human

capital which is defined as "process of increasing knowledge, the skills and

capacities of all people of the country." Human capital is more vital than the

physical capital since without human's interference the materialistic capital

cannot be utilised effectively. Prof. Galbraith defines as "We now get the

larger part of our industrial growth not from more capital investment but

from investment in men and improvements brought about by improved

men."

Organisation

The prime aspects of production such as land, labour and capital are

correspondingly nature, man and material modes of production. Without

these factors it is unfeasible to produce and making use of these factors

effectively there has to some source. This source is nothing but the

organisation which hires them from their owners by paying rent, salary and

interest and makes a decision upon the amount of each required for

production. Organisation refers to the services of an entrepreneur who

controls, organises and manages the policy of a firm, innovates and

undertakes all risks.

Criticisms

o

Several economists have criticisms for the above factors of production

economist Benham has objected to a broader meaning of land as a

factor of production. As per him, it is convenient to consider only land

as factor of production, rather than such elements as sunshine, climate

etc. which does not enter directly into costs. Likewise, it is incorrect to

group together the services of an untalented worker with that of

professionals. Yet again, there is tiny tip in syndicating mutually as

capital, as assorted as canals, diesel, seeds and machinery. It would

consequently, be more appropriate to chunk collectively all

standardized units, whether hectares of land, workers or capital goods

and to regard each group as an individual factor of production. This

method gives us a hefty integer of factors of production and each

group is regarded as a separate factor.

o

Over and again, the distinction amidst land, labour and capital are not

apparent. To take land and capital, it is said that land is a gift of nature

whose supply cannot be amplified while capital is human made whose

supply is amendable. This is not correct for the reason that the supply

of land can also be greater than before by cleaning it, draining and

irrigating it and fertilising it by the pains of human and capital. The

supply of land does not consign to its area alone, but to its productivity.

o

We might regard each unit of a factor as discrete from other units of

that factor, but one factor can be substituted for some other factor. For

instance, land can be used intensively by employing more labour or

more capital in the form of fertilisers, better seeds and superior

techniques. By doing so, we substitute labour or capital for land.

Likewise labour can be substituted for capital and capital for labour in a

factor. In the former case, labour intensive techniques are used. The

level of swap of one factor for another will, nevertheless depend on the

most competent scheme of production to be used relatively to the cost

of the factor to be substituted.

o

Moreover, we find that land, labour and capital frequently get mingled

into one another and it is tricky to specify the involvement of each

individually. For example, when land is vacant canals are dug and

fences are erected, the efficiency of land enhances. But all these

development on land are feasible by making capital investments and

through labour. In such a condition, it is feasible to stipulate the

involvement of land, labour and capital escalating efficiency. Likewise,

the sum of money spent on cultivating and exercising workers is

integrated under capital. So when such workers produce articles by

functioning machines in a factory, they put in their labour as well as

ability by using raw materials which are also the product of labour and

machines used on land. Thus it is hard to unravel the contribution of

land, labour and capital in such cases.

o

The complexity begins as to whether the contribution of land, labour

and capital should be taken as such, or of their services. If the

community is to plan for the prospect or find out the production

possibilities open to it, then the contribution of the factors of

production should be measured. Keeping the outlook in view, land may

be put to more fruitful uses, labour may be trained for diverse

occupations requiring higher skills and capital may be used for

producing more roundabout means of production and machinery. Thus

"the central economic problem for any community is how to make the

best use of its labour and other resources and for this purpose the

community must consider the various alternatives. It must consider

what the men and the land and the capital might contribute towards

output if they were used in different ways and not merely what in fact

they are contributing now."

o

Finally, it is habitual not to treat organisation as discrete from labour.

This is ambiguous and misjudges the role of the entrepreneur as a

factor of production. As a substance of statement, labour and

entrepreneur are quite dissimilar from each other. An entrepreneur is a

man of special managerial aptitude who controls, organises and

manages the entire business of a firm. It is he who utilizes all types of

workers and puts them at the places where they are the most

appropriate by quality of their education and training.

Significance

o

The concept of the factor of production is of great significance in

modern economic study. It is used in the theory of production in which

the a range of combinations of factors of production help in generating

output when a firm functions under rising or declining costs in the

short-run and when the proceeds to scale boosts or shrinks in the long

run. Moreover, we can also know how the least cost combination of

factors can be attained by a firm.

o

The theory of cost of production also depends upon the combination of

factors engaged in business and the prices that are paid to them. From

the point of view of the theory of costs of production, factors of

production are divided as fixed factors are variable factors.

o

Fixed factors are those whose costs do not vary with the variation in

output, such as machinery, tube well etc. Variable factors are those

whose quantities and costs vary with the variation in output. Larger

outputs entail larger quantities of labour, raw materials power etc. So

long as a firm covers the costs of production of the variable factors it

employs, it will persist to produce even if it fails to cover the costs of

production of the hired factors and sustains loss. But this is only

feasible in the short-run; in the long-run it must cover the costs of

production of both the fixed and variable factors. Thus the distinction

amidst fixed and variable factors is of much value for the theory of the

firm.

o

Finally the concept of factor of production is used in elucidating the

theory of factor-pricing. For this idea, factors of production are divided

into specific and non-specific. A factor of production which is specific in

use earns a higher reward than a non-specific factor. This also solves

the problem of distribution of earnings to the various resource owners.

Law of Diminishing Return:

A concept in economics that if one factor of production (number of

workers, for example) is increased while other factors (machines and

workspace, for example) are held constant, the output per unit of the

variable factor will eventually diminish.

Although the marginal productivity of the workforce decreases as output

increases, diminishing returns do not mean negative returns until (in this

example) the number of workers exceeds the available machines or

workspace. In everyday experience, this law is expressed as "the gain is not

worth the pain."

Cost of Production:

Production cost refers to the cost incurred by a business when

manufacturing a good or providing a service. Production costs include a

variety of expenses including, but not limited to, labor, raw materials,

consumable manufacturing supplies and general overhead. Additionally, any

taxes levied by the government or royalties owed by natural resource

extracting companies are also considered production costs.

Economic Cost:

Economic cost is the combination of gains and losses of any goods that

have a value attached to them by any one individual. Economic cost is used

mainly by economists as means to compare the prudence of one course of

action with that of another. The goods to be taken into consideration are e.g.

money, time and resources.

The comparison includes the gains and losses precluded by taking a

course of action, as those of the course taken itself. Economic cost differs

from accounting cost because it includes opportunity cost.

Aspects of economic costs:

Variable cost: Variable costs are the costs paid to the variable input.

Inputs include labour, capital, materials, power and land and buildings.

Variable inputs are inputs whose use vary with output. Conventionally

the variable input is assumed to be labor.

Total variable cost (TVC) total variable costs is the same as

 

variable costs.

Fixed cost (TFC) fixed costs are the costs of the fixed assets those

that do not vary with production.

Total fixed cost (TFC)

Average cost (AC) average cost are total costs divided by output. AC

= TFC/q + TVC/q

Average fixed cost (AFC) = fixed costs divided by output. AFC

= TFC/q. The average fixed cost function continuously declines

as production increases.

Average variable cost (AVC) = variable costs divided by

output. AVC =TVC/q. The average variable cost curve is typically

U-shaped. It lies below the average cost curve and generally has

the same shape - the vertical distance between the average cost

curve and average variable cost curve equals average fixed

costs. The curve normally starts to the right of the y axis because

with zero production

The Relation between the Average Cost and Marginal Cost:

The relationship between the marginal cost and average cost is the

same as that between any other marginal-average quantities. When

marginal cost is less than average cost, average cost falls and when

marginal cost is greater than average cost, average cost rises.

This marginal-average relationship is a matter of mathematical truism

and can be easily understood by a simple example. Suppose that a cricket

player’s batting average is 50. If in his next innings he scores less than 50,

say 45, then his average score will fall because his marginal (additional)

score is less than his average score.

If instead of 45, he scores more than 50, say 55, in his next innings,

then his average score will increase because now the marginal score is

greater than his previous average score. Again, with his present average

runs of 50, if he scores 50 also in his next innings, then his average score will

remain the same because now the marginal score is just equal to the

average score.

Likewise, suppose a producer is producing a certain number of units of

a product and his average cost is Rs. 20. Now, if he produces one unit more

and his average cost falls, it means that the additional unit must have cost

him less than Rs. 20. On the other hand, if the production of the additional

unit raises his average cast, then the marginal unit must have cost him more

than Rs. 20.

And finally, if as a result of production of an additional

unit, the average cost remains the same, then marginal unit

must have cost him exactly Rs. 20, that is, marginal cost and

average cost would be equal in this case.

On the other hand, if the marginal cost (MC) is below

 <a href=Marginal cost (MC)  Cost curves The Relation between the Average Cost and Marginal Cost: The relationship between the marginal cost and average cost is the same as that between any other marginal-average quantities. When marginal cost is less than average cost, average cost falls and when marginal cost is greater than average cost, average cost rises. This marginal-average relationship is a matter of mathematical truism and can be easily understood by a simple example. Suppose that a cricket player’s batting average is 50. If in his next innings he scores less than 50, say 45, then his average score will fall because his marginal (additional) score is less than his average score. If instead of 45, he scores more than 50, say 55, in his next innings, then his average score will increase because now the marginal score is greater than his previous average score. Again, with his present average runs of 50, if he scores 50 also in his next innings, then his average score will remain the same because now the marginal score is just equal to the average score. Likewise, suppose a producer is producing a certain number of units of a product and his average cost is Rs. 20. Now, if he produces one unit more and his average cost falls, it means that the additional unit must have cost him less than Rs. 20. On the other hand, if the production of the additional unit raises his average cast, then the marginal unit must have cost him more than Rs. 20. And finally, if as a result of production of an additional unit, the average cost remains the same, then marginal unit must have cost him exactly Rs. 20, that is, marginal cost and average cost would be equal in this case. On the other hand, if the marginal cost (MC) is below the average cost (AC); average cost falls, that is, the marginal cost pulls the average cost downwards. When marginal cost (MC) stands equal to the average cost (AC), the average cost remains the same, that is, the marginal cost pulls the average cost horizontally. Now, take Fig. 19.5 where short-run average cost curve AC and marginal cost curve MC are drawn. As long as short-run marginal cost curve " id="pdf-obj-43-70" src="pdf-obj-43-70.jpg">

the average cost (AC); average cost falls, that is, the marginal cost pulls the

average cost downwards. When marginal cost (MC) stands equal to the

average cost (AC), the average cost remains the same, that is, the marginal

cost pulls the average cost horizontally.

Now, take Fig. 19.5 where short-run average cost curve AC and

marginal cost curve MC are drawn. As long as short-run marginal cost curve

MC lies below short-run average cost curve, the average cost curve AC is

falling. When marginal cost curve MC lies above the average cost curve AC,

the latter is rising.

At the point of intersection L where MC

is equal to AC, AC is neither falling nor rising,

that is, at point L, AC has just ceased to fall

but has not yet begun to rise. It follows that

point L, at which the MC curve crosses the AC

curve to lie above the AC curve is the

minimum point of the AC curve. Thus,

marginal cost curve cuts the average cost

curve at the latter’s minimum point.

It is important to note that we cannot

generalise about the direction in which

MC lies below short-run average cost curve, the average cost curve AC is falling. When marginal

marginal cost is moving from the way average cost is changing, that is, when

average cost is falling we cannot say that marginal cost will be falling too.

When average cost is falling, what we can say definitely is only that the

marginal cost will be below it but the marginal cost itself may be either rising

or falling.

Likewise, when average cost is rising, we cannot deduce that marginal

cost will be rising too. When average cost is rising, the marginal cost must be

above it but the marginal cost itself may be either rising or falling. Consider

Fig. 19.5 where up to the point K, marginal cost is falling as well as below the

average cost.

As a result, the average cost is falling. But beyond point K and up to

point L marginal cost curve lies below the average cost curve with the result

that the average cost curve is falling. But it will seen that between K and L

where the marginal cost is rising, the average cost is falling.

This is because though MC is rising between K and L, it is below AC. It

is therefore clear that when the average cost 4 is falling, marginal cost may

be falling or rising. This can also be easily illustrated by the example of

batting average.

Suppose a cricket player’s present batting average is 50. If in his next

innings he scores less than 50, say 45, his batting average will fall. But his

marginal score of 45, though less than the average score may itself have

risen.

For instance, he might have scored 40 in his previous innings so that

his present marginal score of 45 is greater than his previous marginal score.

Thus one cannot deduce about marginal cost as to whether it will be falling

or rising when average cost is falling or rising.

Economics of Scale:

In microeconomics, economies of scale are the cost advantages that

enterprises obtain due to size, output, or scale of operation, with cost per

unit of output generally decreasing with increasing scale as fixed costs are

spread out over more units of output.

Often operational efficiency is also greater with increasing scale,

leading to lower variable cost as well.

Economies of scale apply to a variety of organizational and business

situations and at various levels, such as a business or manufacturing unit,

plant or an entire enterprise. For example, a large manufacturing facility

would be expected to have a lower cost per unit of output than a smaller

facility, all other factors being equal, while a company with many facilities

should have a cost advantage over a competitor with fewer.

Some economies of scale, such as capital cost of manufacturing

facilities and friction loss of transportation and industrial equipment, have a

physical or engineering basis.

The economic concept dates back to Adam Smith and the idea of

obtaining larger production returns through the use of division of labor.

Diseconomies of scale are the opposite.

Economies of scale often have limits, such as passing the optimum

design point where costs per additional unit begin to increase. Common

limits include exceeding the nearby raw material supply, such as wood in the

lumber, pulp and paper industry. A common limit for low cost per unit weight

commodities is saturating the regional market, thus having to ship product

uneconomical distances. Other limits include using energy less efficiently or

having a higher defect rate.

Large producers are usually efficient at long runs of a product grade (a

commodity) and find it costly to switch grades frequently. They will therefore

avoid specialty grades even though they have higher margins. Often smaller

(usually older) manufacturing facilities remain viable by changing from

commodity grade production to specialty products.

Some of the economies of scale recognized in engineering have a

physical basis, such as the square-cube law, by which the surface of a vessel

increases by the square of the dimensions while the volume increases by the

cube. This law has a direct effect on the capital cost of such things as

buildings, factories, pipelines, ships and airplanes.

In structural engineering, the strength of beams increases with the

cube of the thickness.

Drag loss of vehicles like aircraft or ships generally increases less than

proportional with increasing cargo volume, although the physical details can

be quite complicated. Therefore, making them larger usually results in less

fuel consumption per ton of cargo at a given speed.

Heat losses from industrial processes vary per unit of volume for pipes,

tanks and other vessels in a relationship somewhat similar to the square-

cube law.

Capital and operating cost

Overall costs of capital projects are known to be subject to economies

of scale. A crude estimate is that if the capital cost for a given sized piece of

equipment is known, changing the size will change the capital cost by the 0.6

power of the capacity ratio (the point six power rule).

In estimating capital cost, it typically requires an insignificant amount

of labor, and possibly not much more in materials, to install a larger capacity

electrical wire or pipe having significantly greater capacity.

The cost of a unit of capacity of many types of equipment, such as

electric motors, centrifugal pumps, diesel and gasoline engines, decreases as

size increases. Also, the efficiency increases with size.

Crew size and other operating costs for ships, trains and

airplanes

Operating crew size for ships, airplanes, trains, etc., does not increase

in direct proportion to capacity. (Operating crew consists of pilots, co-pilots,

navigators, etc. and does not include passenger service personnel.) Many

aircraft models were significantly lengthened or "stretched" to increase

payload.

Many manufacturing facilities, especially those making bulk materials

like chemicals, refined petroleum products, cement and paper, have labor

requirements that are not greatly influenced by changes in plant capacity.

This is because labor requirements of automated processes tend to be based

on the complexity of the operation rather than production rate, and many

manufacturing facilities have nearly the same basic number of processing

steps and pieces of equipment, regardless of production capacity.

Economical use of byproducts

Karl Marx noted that large scale manufacturing allowed economical use

of products that would otherwise be waste. Marx cited the chemical industry

as an example, which today along with petrochemicals, remains highly

dependent on turning various residual reactant streams into salable

products. In the pulp and paper industry it is economical to burn bark and

fine wood particles to produce process steam and to recover the spent

pulping chemicals for conversion back to a usable form.

Appropriate Technique of Production:

A choice between alternative techniques of production is a major

problem in the planning for developing countries. This is because a particular

choice of technique of production affects not only the magnitude of

employment but also the rate of economic growth.

Several alternative techniques of production are available to produce a

commodity and these differ with regard to the amount of capital being used

with a unit of labour for production. In other words, the various techniques

differ with regard to capital-intensity which is generally measured by the

magnitude of capital-labour (K/L) ratio. Thus, the higher the capital-intensity,

the more quantity of capital as compared to labour will be used to produce a

given level of output.

Figure of Maximation:

A business can produce as many goods as its labor, equipment and

other resources will allow, but running at full production isn’t always the best

approach. The optimum level of output is the one that generates the highest

profit, which is called the profit-maximizing output. A company’s profit

begins to diminish beyond this level. You can figure your business’ profit-

maximizing output level by determining the profit your business makes at

each level of output you can produce.

Determine the different levels of output your business can

produce in a certain time period, such as one day or one week. Write the

output levels in ascending order in the first column of a sheet of paper. For

example, assume your business can produce zero, one, two, three, four or

five hats daily. Write "0" through "5" in ascending order in the first column on

a sheet of paper.

Determine the total revenue your business would generate at

each output level. Write each revenue amount next to its corresponding

output level in the second column. In this example, assume that your selling

price per hat decreases as you make more hats. Assume you generate $0,

$50, $100, $150, $160 and $175 in total revenue if you make zero, one, two,

three, four and five hats, respectively. Write each amount in the second

column.

Determine the total economic costs you incur at each output

level, and write them in the third column. Economic costs include explicit

costs and opportunity costs. Explicit costs are those for which you actually

pay money, such as supplies. An opportunity cost is something you give up,

but for which you don’t actually pay money. This might be a salary you forgo

by choosing to run your small business instead of working a job. In this

example, assume you incur $20, $30, $40, $52, $67 and $85 in total

economic costs when you make zero, one, two, three, four and five hats,

respectively. Write the costs in the third column.

Subtract each amount of total economic costs in the third

column from each corresponding amount of total revenue in the

second column to determine the total profit for each output level. Write each

amount of profit in the fourth column. Continuing with the example, subtract

$20 from $0 to get negative $20, or a $20 loss, at an output of zero. Subtract

$30 from $50 to get $20 in profit at an output of one. Calculate the

remaining profit levels to get $60, $98, $93 and $90 in profit when you make

two, three, four and five hats respectively. Write these amounts in the fourth

column.

Find the greatest amount of profit in the fourth column and

identify the corresponding output level in the first column to

determine your profit-maximizing output. Concluding the example, the

highest profit in the fourth column is $98, which corresponds to an output of

three in the first column. Therefore, your small business’s profit-maximizing

output would be three hats daily.