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SUBJECT – COMMERCE

SUBJECT CODE – 08

UNIT - III

9935 058 417

0522-4006074

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S. No. Chapter Name

1- Basics of Business Economics

2- Demand Analysis

3- Consumer Behaviour

4- Law of Variable Proportions

5- Cost Theories

6- Market Types & Price Determination

7- Pricing Strategies

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CHAPTER – 1

BASICS OF BUSINESS ECONOMICS

1. Meaning & Definition of Business Economics

The word Economics originates from the Greek Word „Oikonomia‟ means

„Household‟. Previously Economics used to part of Politics and Political Economics was

prevalent.

Business economics is also known as Managerial Economics. The application of

principles, theories and concepts of Economics in Business is known as Business Economics.

“the integration of economic theory with business practice for the purpose

offacilitating decision-making and forward planning by management.” – Siegel

“Business economic consists of theuse of economic modes of thought to analyse

business situations.” – Mc Nair & Meriam

These theories and concepts help in decision making required for business. These decisions

include:

Demand Analysis and Forecasting

Cost & Production Analysis

Pricing Decisions

Profit Management; and

Capital Management

Demand Analysis and Forecasting:

Business firms are involved in economic activities and they add value against which

these organizations earn profits. For smooth functioning these organizations need to analyse

the demand for their product/ services and forecast the same for the period to be covered in

the decision.

Cost and Production Analysis:

This refers to the study of economic as well as accounting costs of a firm‟s activities.

This study helps in making significant management decisions. The analysis classifies the

costs into controllable – uncontrollable and relevant – irrelevant cost for decision making

purposes. This analysis also helps in deciding the production levels, capacity expansion, etc.

related to the production.

Pricing Decisions:

Once we are done with Cost and Production Analysis; we have sufficient data to

compare decide on pricing while considering the other market factors and the firm‟s targets.

These decisions are taken considering the long-term perspective and anticipating the changes

in pricing and market trends.

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Profit Management:

The basic concepts of economics state that the objective of the firm is Profit

Maximisation. To attain this objective, the businesses are required plan its activities and take

many decisions to manage the profits as per owners‟ expectations.

Capital Management:

In managerial economics, capital management refers to the decision related to the

investment of huge sum of money for business purposes. These decisions may be related to

the capacity expansion, acquisition of other business, backward or forward integration,

diversification, modernisation etc.

2. Factors of Production

3. Important Theories

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4. Application of Microeconomics in Business Environment

Business Economics deals with the theories and principles of Traditional Economics

which are used for business decision making. This also involves the ideas from psychology

(e.g. consumer behaviour) and sociology, etc. to make the decision more specific and

objective oriented.

Business economics helps in various type of decision making which require

application of many micro-economic theories such as Elasticity of Demand, Marginal Cost,

Pricing Strategies, etc.

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CHAPTER – 2

DEMAND ANALYSIS

1. Meaning & Definition of Demand

Demand may be referred to the quantity of a product or service that is desired by the

buyers of that product or service. If this is accumulated for entire market for that particular

product or service, then it is known as industry demand.

There are 3 essential features which this demand has to fulfil to qualify as a genuine

demand. These factors are as follow:

Desire for that product or service

Ability to pay; and

Willingness to pay

If demand is not supported by the above three factors, it won‟t be considered as real

demand, but hypothetical demand.

2. Types of Demand:

3. Meaning of Demand Analysis

Demand analysis is the process of study of factors affecting the demand to find out

the market potential for a product or service in a particular market.

4. Objectives of Demand Analysis

Some of the major objectives of Demand Analysis are as follow:

Forecasting Sales

Production Planning

Performance Appraisal of Sales Personnel

Analysing company‟s competitive position

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5. Law of Demand

There are multiple factors affecting the buying decision of consumers. These factors

include Income, Taste, Preference, Culture, Fashion, etc. The Law of demand assumes these

factors to remain constant during the period under consideration. The assumptions for Law of

Demand are as follow:

Market Size to remain constant.

Disposable income to remain constant.

Taste and Preference of the consumer to remain constant.

There is no change in market conditions and competition.

The Law:

Price is the most significant factor for change in demand. Price and Demand have

inverse relationship, which means, if we want to sell large quantity of product or services, the

price must be low to find the desired number of buyers. This may be stated as “other things

remaining constant, the demand will be higher at lower price and lower at higher price”. This

relationship may also be stated with the help of the following graph, known as demand curve:

This may also be presented with the help of an equation known as „Demand Function‟:

𝐷𝑥 = 𝑓 (𝑃𝑥 ,𝑌,𝑇)

Here:

Dx = Demand

Px = Price

Y = Income

T = Taste and Preferences

The „Demand Schedule‟ is another way to represent the changes in demand with change in

price level. This is prepared inform of a table as shown below:

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Price per Unit (Rs.) Demand in Units

100 5000

120 4000

150 2500

170 2000

200 1800

250 1000

The various factors that affect the demand of any commodity create the elasticity of

demand.

6. Elasticity of Demand

Elasticity of demand refers to the change in demand taking place due to change in any

of the factor(s) affecting the demand. For understanding purpose, elasticity of demand is

classified into the following categories:

a. Price Elasticity of Demand

Price elasticity of demand establishes the relationship between change in price and

change in demand as a result of price change. The price elasticity of demand may be

classified into 5 categories.

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i. Perfectly Elastic Demand

Perfectly elastic demand refers to the demand which has got very high price

sensitivity. A small change in price of the commodity will result in Zero demand of that

commodity. This may exist only in perfect competition market. This elasticity is presented

with the help of the following diagram:

ii. Relatively Elastic Demand

Relatively elastic demand is the demand that will increase or decrease to a greater

proportion than the proportion of price change. This is explained with the help of the

following graph:

In the above graph, we can see that small change in price is leading to a greater

change in quantity demanded.

iii. Unit Elastic Demand

Unit elastic demand is the demand that will increase or decrease in the same

proportion at which the price changes, means 10% increase in the price will lead to a 10%

decrease in the demand. This is explained with the help of the following graph:

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It is clearly evident in the above graph that price and demand are changing in the

same proportion.

iv. Relatively Inelastic Demand

Relatively Inelastic demand shows lesser change in demand as compared to the

change in price. Means, the %age change in demand will be lesser than the %age change in

price. This relationship is explained with the help of the following graph:

We can see that in the above graph, % age change is higher than the % age change in

demand.

v. Perfect Inelastic Demand

This refers to the demand that reman unaffected with the change in price level.

Means, the change in price has no impact on demand of the commodity. This situation

prevails in the Monopoly market of essential and/ or life saving commodities. This

relationship may be explained with the help of the following graph:

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As we can see from the above graph, price change has no impact on the demand.

a. Cross Elasticity of Demand

Cross Elasticity is applicable on the commodities or firm‟s with substitute or

complementary products.

“The cross elasticity of demand is the proportional change in the quantity of X good

demanded resulting from a given relative change in the price of a related good Y” –

Ferguson

“The cross elasticity of demand is a measure of the responsiveness of purchases of Y

to change in the price of X” –Leibafsky

Types of Cross Elasticity of Demand:

There are three types of Cross Elasticity of Demand:

• Positive;- This elasticity of demand takes place in case of substitute products. for instance

there are two substitute commodities 'A' and 'B'; the increase in price of 'A' will result in

increase of demand of 'B'. If these are close substitute the degree of elasticity will be

higher.

• Negative;- In case of complementary commodities, we find negative cross elasticity. E.g.

'A' and 'B' are complementary commodities; the price increase of 'A' will result in

decreased demand of 'B'. In case of compulsory complementary commodity degree of

elasticity will be higher.

• Zero;- This elasticity states that the change of price of one commodity will not affect the

demand of another commodity. It occures when both the commodities are unrelated.

Means, they are neither substitute nor complementary

b. Income Elasticity of Demand

“Income elasticity of demand shows the way in which a consumer‟s purchase of any

good changes as a result of change in his income.” – Stonier & Hague

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There are many commodities which a customer doesn‟t want to buy if his/ her income

increases and there are certain commodities which he/ she will like to buy with the increase

of income. E.g. in most of the cases a customer won‟t prefer to buy an entry segment car if

his/ her disposable income increases. That person will certainly prefer to buy a premium car.

The change in demand because of increase in income of customer is known as „Income

Elasticity of Demand‟.

This relationship is expressed with the help of the following formula:

𝐸𝑦 = %𝑎𝑔𝑒 𝑐𝑕𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑

%𝑎𝑔𝑒 𝑐𝑕𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒 𝑜𝑓 𝐶𝑢𝑠𝑡𝑜𝑚𝑒𝑟

Here:

Ey = Income Elasticity of demand

Types of Income Elasticity of Demand:

Positive Income Elasticity of Demand: (Ey>0)

This is the case of direct relationship between Income and demand of the commodity.

This elasticity is prevalent in case of luxury commodities. There are three types of

Positive Income Elasticity of Demand:

o Greater than Unity (Ey> 1): When %age change in demand is greater than the % age

change in income, the elasticity is greater than unity. This relationship can be presented

with the help of the following graph:

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o Unity Elastic (Ey=1): When % age change in demand is equal to the % age change in

income. This relationship can be presented with the help of the following graph:

o Less than Unity (Ey< 1): when % change in demand is less than the % age change in

income. This relationship can be presented with the help of the following graph:

c. Exceptions

Though, the law of demand is applicable on most of the commodities, there are two

categories on which the law of demand is not applicable.

Giffen Goods:- Giffen goods have unique feature of increased demand with the increase in

price of the commodity/ goods. In 19th century Sir Robert Giffen has conducted a research

and stated that British Workers purchased more bread with the increase in price of bread.

Veblen Goods:- This exception to Law of Demand was discovered by Thorstein Veblen and

is named after him. He established that the demand of commodities which have become

status symbol or symbol of pride remain unaffected with the change in price level

The above two are exception to the Law of Demand.

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vi. Relationship between Average Revenue & Marginal Revenue

Average Revenue:

Average revenue may be calculated by dividing the total revenue with number of

units sold. The formula is as follow:

𝐴𝑅 = 𝑇𝑅 𝑄

Here:

AR = Average Revenue

TR = Total Revenue

Q = Quantity Sold

Marginal Revenue:

The revenue earned by selling one additional unit of the commodity is known as the marginal

revenue. This can be calculated with the help of the following formula:

𝑀𝑅 = 𝑇𝑅(𝑛+1) − 𝑇𝑅(𝑛)

Here:

MR = Marginal Revenue

TR (n+1) = Total Revenue on sale of (n+1) units

TR (n) = Total Revenue on sale of (n) units

The relationship between AR and MR have shown different dimensions under

different market form.

Under Perfect Competition:

Under perfect competition market, there is almost no scope for price change or price

leadership. The margins of the firms are very low and there is negligible scope of quantity

discounts. Hence, the Average Revenue and the Marginal Revenue are same under this

market structure. This relationship can be presented with the help of following graph:

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Under Monopoly or Imperfect Competition:

The relationship between AR and MR under Monopoly can be understood with the

help of the following table:

Qty. Price (AR) TR MR

1 20 20 20

2 18 36 16

3 16 48 12

4 14 56 8

5 12 60 4

6 10 60 0

7 8 56 -4