UNIT-II

• A firm is an organization that transforms resources (inputs) into products (outputs).
Firms are the primary producing units in a market economy.
• An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.
• Households are the consuming units in an economy.

The Circular Flow of Economic Activity
• The circular flow of
economic activity shows the connections between firms and households in input and output markets.

• Output, or product,
markets are the markets in which goods and services are exchanged.
• Payments flow in the opposite direction as the physical flow of resources, goods, and services
• Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged.
(counterclockwise).

Input markets include:
• The labor market, in which households supply work for wages to firms that demand labor.
• The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.
• The land market, in which households supply land or other real property in exchange for rent.

Determinants of Household Demand
A household’s decision about the quantity of a particular output to demand depends on:
• The price of the product in question.
• The income available to the household.
• The household’s amount of accumulated wealth.
• The prices of related products available to the household.
• The household’s tastes and preferences.
• The household’s expectations about future income, wealth, and prices.

• Quantity demanded is the amount
(number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price.

ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
PRICE
(PER
$
CALL)
0
0.50
3.50
7.00
10.00
15.00
QUANTITY
DEMANDED
(CALLS PER
MONTH)
30
25
7
3
1
0
• A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.
• Demand curves are usually derived from demand schedules.

ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
$
PRICE
(PER
CALL)
0
0.50
3.50
7.00
10.00
15.00
QUANTITY
DEMANDED
(CALLS PER
MONTH)
30
25
7
3
1
0
• The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

• The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.
• This means that demand curves slope downward.

Other Properties of Demand Curves
• Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility.
• Demand curves intersect the
(Y)-axis, as a result of limited incomes and wealth.

Income and Wealth
• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.
• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.

Related Goods and Services
• Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower.
• Inferior Goods are goods for which demand falls when income rises.

Related Goods and Services
• Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products.
• Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

Shift of Demand Versus Movement Along a Demand
Curve
• A change in demand is not the same as a change in quantity demanded .
• In this example, a higher price causes lower quantity demanded .
• Changes in determinants of demand, other than price, cause a change in demand , or a shift of the entire demand curve, from D
A to D
B
.

A Change in Demand Versus a Change in Quantity
Demanded
• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level.

A Change in Demand Versus a Change in Quantity
Demanded
To summarize :
Change in price of a good or service leads to
Change in quantity demanded
( Movement along the curve ).
Change in income, preferences, or prices of other goods or services leads to
Change in demand
( Shift of curve ).

• Higher income decreases the demand for an inferior good
• Higher income increases the demand for a normal good

The Impact of a Change in the Price of Related Goods
• Demand for complement good
(ketchup) shifts left
• Price of hamburger rises
• Quantity of hamburger demanded falls
• Demand for substitute good (chicken) shifts right

From Household to Market Demand
• Demand for a good or service can be defined for an individual household, or for a group of households that make up a market.
• Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

From Household Demand to Market
Demand
• Assuming there are only two households in the market, market demand is derived as follows:

electronic

Demand curve of mobile phone(electronic product)

It is three types
*price elasticity
*income elasticity
*cross elasticity

Definition Of Price Elasticity Of Demand
• The change in the quantity demanded of a product due to a change in its price is known as Price elasticity of demand. Thus, the sensitiveness or responsiveness of demand to change in price is as called elasticity of demand

Kinds Of Price Elasticity Of Demand
1) Perfectly elastic demand
2) Relatively elastic demand
3) Elasticity of demand equal to utility
4) Relatively inelastic demand
5) Perfectly inelastic demand
Let Us See Some Views On Them

y
I
C
E
P
R
D
0
Perfectly elastic demand
Perfectly elastic demand curve
D
When the demand for a product changes
–increases or decreases even when there is no change in price, it is known as perfect elastic x demand.

0
I
C
E
P
R y
D demand
Relatively elastic demand curve
D x
When the proportionate change in demand is more than the proportionate changes in price, it is known as relatively elastic demand
.

Elasticity of demand equal to utility
I
C
E
P
R y
D
0 demand
Elasticity of demand equal to utility curve
D x
When the proportionate change in demand is equal to proportionate changes in price, it is known as unitary elastic demand

I
C
E
P
R
Y
O
D
Relatively inelastic demand curve
When the proportionate change in demand is less than the proportionate changes in price, it is known as relatively inelastic demand
D
X demand

I
C
E
P
R
Y
D
Perfectly inelastic demand curve
When a change in price, howsover large, change no changes in quality demand, it is known as perfectly inelastic demand
0
D demand
X

ALL KINDS OF DEMAND CAN BE SHOWN
IN ONE DIAGRAM AS FOLLOW
Y
P
I
R
D
C
E
0 D5
DEMAND
D4
D3
X
D2
D1
WHERE
D1) Perfectly elastic demand
D2)Relatively elastic demand
D3)Elasticity of demand equal to utility
D4)Relatively inelastic demand
D5)Perfectly inelastic demand

Price elasticity survey on mobile phone 11 year

Practical Importance of the Concept of
Price Elasticity Of Demand
• The concept is helpful in taking Business
Decisions
• Importance of the concept in formatting Tax
Policy of the government
• For determining the rewards of the Factors of
Production
• To determine the Terms of Trades Between the Two Countries

• Positive Income elasticity of demand
• Negative Income elasticity of demand
• Zero Income elasticity of demand

P
A
Y
Positive Income elasticity of demand
D
D
O
B S
Quantity Demanded X

Positive Income elasticity of demand
• Income Elasticity Equal to Unity or One
• Income Elasticity Greater Than Unity Or
One
• Income Elasticity Less Than Unity or One

A
P
Negative Income elasticity of demand
Total Revenue
B
Quantity Demanded (000s)
S

Y
D
O
D
Quantity Demanded
X

Case study of income elasticity of demand of electronic product(mobile phone)

Y
F
E
D
C
B
A
O X
Quantity Demanded

Measurement Of Income Elasticity Of
Demand
Income Elasticity Of Demand =
Proportionate change in Demand
Proportionate change in Income i.e.
Income Elasticity Of Demand =
∆q
Q
+
∆ y
Y

Measurement Of Income Elasticity Of
Demand
• Here , ∆q = Change in the quantity demanded.
Q = Original quantity demanded.
∆y = Change in income.
Y = Original income.
• For e.g. ,when Income of the consumer =
2,500/- , he purchases 20 units of X, when income = 3,000/- he purchases 25 units of X

Measurement Of Income Elasticity Of
Demand
• Thus
Income Elasticity of Demand
∆q
= +
∆ y
Q
Y
= (5/20) + (500/2500)
= 1.5
therefore here the IED is 1.5 which is more than one.

• Income Itself Only.
• Price Of the Commodity

Y
E4
E3
O
E5
E2
E1
Change in PRICE ratio of good x & y
X

Price elasticity of demand depends on:
• Proportion of income spent on particular good say X.
• Income elasticity of demand.
• Elasticity of substitution.
• Proportion of income spent on product other than X.

• Cross elasticity of demand express a relationship between the change in the demand for a given product in response to a change in the price of some other product
• E.g. if the X tea demand reduces tremendously than it effect could be seen in demand of sugar and milk.

Cross elasticity of demand of mobile phone survey in mobile industry

• Cross Elasticity of Demand Equal to Unity or
One
• Cross Elasticity of Demand Greater than Unity or one
• Cross Elasticity of demand less than unity or one

Cross Elasticity of Demand = i.e.
Proportionate change in Demand for product X
Proportionate change in Price of product Y
Cross Elasticity of Demand =
∆qx
Qx
+
∆p y
Py

Y
D
O
D
Demand for Y
X

Y
Cross Elasticity of Demand For
Complementary Products
D
O
Demand for Y
D
X

Y
D
O
Demand for Y
X

• The concept is of very great importance in changing the price of the products having substitutes and complementary goods .
• In demand forecasting
• Helps in measuring interdependence of price of commodity .
• Multiproduct firms use these concept to measure the effect of change in price of one product on the demand of their other product

• Advertising elasticity of demand is the measure of the rate of change in demand due to change in advertising expenditure
• The amount of change in demand of goods due to advertisement is known as
Advertisement Elasticity of Demand .

Advertising by HTML playback of mobile phone

• It is useful in competitive industries.
• Though advertisement shifts the demand curve to right path but it also increases the fixed cost of the firm.

Other electronic product( laptops) elasticity of demand

CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
$
PRICE
(PER
BUSHEL)
2
1.75
2.25
3.00
4.00
5.00
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
0
10
20
30
45
45
• A supply schedule is a table showing how much of a product firms will supply at different prices.
• Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

The Supply Curve and the Supply Schedule
• A supply curve is a graph illustrating how much of a product a firm will supply at different prices.
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
$
PRICE
(PER
BUSHEL)
2
1.75
2.25
3.00
4.00
5.00
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
0
10
20
30
45
45
6
5
4
3
2
1
0
0 10 20 30 40 50
Thousands of bushels of soybeans produced per year

6
5
4
3
2
1
0
0 10 20 30 40 50
Thousands of bushels of soybeans produced per year
• The law of supply states that there is a positive relationship between price and quantity of a good supplied.
• This means that supply curves typically have a positive slope.

• The price of the good or service.
• The cost of producing the good, which in turn depends on:
– The price of required inputs (labor, capital, and land),
– The technologies that can be used to produce the product,
• The prices of related products.

A Change in Supply Versus a Change in Quantity Supplied
• A change in supply is not the same as a change in quantity supplied .
• In this example, a higher price causes higher quantity supplied , and a move along the demand curve.
• In this example, changes in determinants of supply, other than price, cause an increase in supply , or a shift of the entire supply curve, from S
A to S
B
.

A Change in Supply Versus a Change in Quantity Supplied
• When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level.

A Change in Supply Versus a Change in Quantity Supplied
To summarize :
Change in price of a good or service leads to
Change in quantity supplied
( Movement along the curve ).
Change in costs, input prices, technology, or prices of related goods and services leads to
Change in supply
( Shift of curve ).

From Individual Supply to Market Supply
• The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.
• Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.

• As with market demand, market supply is the horizontal summation of individual firms’ supply curves.

• The operation of the market depends on the interaction between buyers and sellers.
• An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.
• At equilibrium, there is no tendency for the market price to change.

• Only in equilibrium is quantity supplied equal to quantity demanded.
• At any price level other than P
0
, the wishes of buyers and sellers do not coincide.

• Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price.
• When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

• Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.
• When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

• Higher demand leads to higher equilibrium price and higher equilibrium quantity.
• Higher supply leads to lower equilibrium price and higher equilibrium quantity.

• Lower demand leads to lower price and lower quantity exchanged.
• Lower supply leads to higher price and lower quantity exchanged.

• The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

• When supply and demand both increase, quantity will increase, but price may go up or down.