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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 𝑐𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑
%𝑎𝑔𝑒 𝑐𝑎𝑛𝑔𝑒 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