DEFINATIONS IN EARM-1

1. Demand: Desire to have, Capability to pay, Willingness to pay and Quantity,

price, place, person(s), period of time
2. Law of Demand: Other things remaining the same (ceteris paribus), demand for
a product increases with a decrease in its price and vice versa
3. Price Elasticity of demand: Percentage change in demand for a product caused
by one per cent change in its price, ceteris paribus
4. Income Elasticity: Percentage change in demand caused by one percent change
in income, ceteris paribus
5. Cross Price Elasticity: Percentage change in demand for product-A caused by
one percent change in price of product-B, ceteris paribus
6. Indifference curves represent all bundles of goods that provide same level of
satisfaction
7. They are convex to the origin (ΔX1/ΔX2↓ or declining Marginal Rate of
Technical Substitution (MRS))
8. Substitution effect is because of change in the price of other good. It is always
positive
9. Income effect is the effect of increased income on the quantities demanded. It is
generally positive. i.e. increase↑ in price results ↑ in demand for products
Exception: Giffen goods. Here increase in income has negative income effect.
10. Total effect on price = Income effect + Substitution Effect
11. In Giffen goods Income effect is negative and greater than Substitution effect
12. So in Giffen goods quantity demanded decreases with increase in income. Giffen
goods do not follow Law of demand.
13. Production: Creation of utility by change of form, place, time, etc. Examples:
crop production, storage, transport, retailing
14. Production Function: Indicates the maximum possible levels of output that can
be produced by using different combination of required inputs
15. Diminishing Marginal Returns: With the amount of other inputs fixed at a given
level, the marginal product of a variable input declines with an increase in the
level of this variable input.
16. Marginal Revenue Product of X1 = Price of X1
(MR)*(MP1) = P1
17. The Production Isoquant: An Isoquant is the set of all combinations of two or
more inputs that yield a given output level
18. The Production Isocost: An Isocost is the set of all combinations of two or more
inputs that imply the same total cost
19. Minimization of cost for a given level of output
ΔK / ΔL = w / r , Also MRPK / r = MRPL / w
20. Maximization of output with a given budget
ΔK / ΔL = w / r
21. Maximization of profit
MRPK = r
MRPL = w
Also implies : ΔK / ΔL = w / r
22. Expansion Path: Indicates the least cost combinations of two or more inputs for
producing different levels of output
23. Optimal Employment of More than Two Inputs
MRP1/MEI1 = MRP2/MEI2 = ……= MRPN/MEIN
24. Returns to Scale: Proportionate change in output in relation to proportionate change in
all factors of production.
25. Economies of Scope: Per unit cost reductions that occur when a firm produces two or
more products instead of just one
TC (QA) + TC (QB) – TC (QA, QB)
S = ------------------------------------------------- = TC(A∪B) / TC (A∩B)
TC(QA, QB)

26. Total Factor Productivity:

Average production per rupee of total expenditure on inputs

Q
TFP = ----------------------------
P1 X1 + P2 X2
27. Cobb-Douglas production function
Q = A Kα Lβ where α and β are the elasticities of factors of production
28. Fertilizer Problems: (ceteris paribus / Experimental Conditions)
Profit Maximization: MRPN = PN & MRPP = PP Solve the two equations
simultaneously to get the P and N
Expansion Path:
MRPN / MRPP = PN/ PP
Other constraints (if there) like below should be adjusted
• yield discount due to field conditions------Æ multiply LHS in the above
simultaneous equations
• share cropper--------Æ multiply LHS in the above simultaneous equations
by factor which farmer gets
• risk of crop failure ---------Æ multiply LHS in the above simultaneous
equations
• return on investment of fertilizers needed --------Æ multiply RHS in the
above simultaneous equations

29. Demand for Nitrogen

Can be calculated from MRPN = PN
By separating N from the equation below we can find Demand for Nitrogen if other
values are given
PY (12.98 + 0.196 P – 0.208 N) = PN.
N = 62.404 – 30.334 PN + 0.942 P
30. Price elasticity of nitrogen = (dN/d PN) * (PN / N).
31. Opportunity Cost: The value of the next best alternative that must be foregone
32. Explicit cost are those costs that involve an actual payment
33. Implicit costs represent the value of foregone opportunities but do not involve an actual
cash payment
34. Marginal cost refers to the change in total cost associated with a unit change in output,
e.g., producing an additional quintal of wheat
35. Incremental cost refers to the total additional cost of implementing a managerial
decision, e.g., adding a new product line
36. Marginal cost may be considered as a sub-category of incremental cost
37. Sunk Costs: Expenditures that have been made in the past or that must be paid in the
future as part of a contractual agreement. Sunk costs are irrelevant in making decisions
38. Economic Cost of Long Lived Assets: The difference between the market value of the
asset at the beginning and end of the period
39. Economic profit is defined as revenue minus all costs (explicit & implicit)
Economic profit is also known as super normal profit
40. Normal profit means a normal payment to all inputs, including managerial and
entrepreneurial skills and capital supplied by the owners of the firm, to keep them from
moving to other firms and industries
41. Fixed cost is the cost of fixed inputs. It does not change with the level of output
42. Variable cost is the cost of variable inputs. It changes with the level of output
43. Short Run Cost Functions: Short run is the period in which at least one factor of
production remains fixed. Cost function relates cost to the rate of output
44. Long Run Cost Functions: No fixed factors of production. Firms operate in short run
but plan in long run
45. Breakeven Level of Production: Minimum size of business required to avoid
losses. Two types of break evens:
a). Price Break even
PBE = (TFC / Q) + AVC
b). Quantity (or sales) Break even:
QBE = TFC / (P – AVC)
P – AVC = Profit contribution or just contribution
46. Margin of Safety Ratio (MSR):
• MSR = (QA – QBE) / QA
• QA = Actual level of production
• QBE = Breakeven level of production
MSR = 0.2
• Even if actual production reduces by 20%, it will breakeven
Breakeven at MSR=0
47. Operating Leverage: A firm is said to be highly leveraged if fixed costs are
large relative to variable costs
48. Leverage can be analyzed using the concept of profit elasticity(E Π)
(E Π) = % change in Π / % change in unit sales

Q (P – AVC)
49. E Π = ----------------------------
Q (P – AVC) – TFC

TFC ↓ EΠ↑
50. Perfect Competiton:
• Market Demand: sum of individual demands
• Consumer Surplus
Difference between total “willingness to pay” on the part of consumers
and the actual payment made by the consumers for a product CS = ∫ p(Q)
dQ – (P.Q ) where p(Q) represents the demand function, i.e., P = p(Q)
• Producer Surplus
Difference between the minimum acceptable payment by the producers
and the actual payment received by the producers for a product PS = (P.Q)
– TVC
• Economic Welfare: Total Surplus = CS + PS
• Lowest cost of production Minimum AC
• Lowest possible market price: MC = MR = AR
• Only normal returns to producers: P = AC
• Maximum surplus to the economy P = MC
51. Monopoly Market
• Objective: Profit Maximisation (MC=MR)
• Deadweight loss: neither consumer nor producer benefits from this
52. Oligopoly
• The Kinked Demand Model: Explains rigidity of prices in an oligopoly
market
• Oligopolies are also found to follow price increase
• The Cournot Model: A firm decides its profit maximising output based on
expectation about the output level of other firms
• Perfect Collusion Model
• Joint profit maximisation:
Π = TR – TC1 – TC2
MR = MC1 & MR = MC2

53. Advertising is one way of achieving product differentiation

54. Supply Cooperatives
Objectives:
Maximisation of profit
Minimisation of price paid by members
Business at cost
55. MARKETING COOPERATIVES:
Possible objectives:
Highest price to members for their produce
Maximization of profit to the cooperative
Business at cost by the cooperative
56. Transfer Pricing: Pricing of a product being transferred from one division to
another within an organization
57. Peak-Load Pricing
Pricing based on both capacity and operating costs during peak-load periods and
based on operating costs alone during off-peak or slack periods
58. Economic rent is a payment to a factor of production in excess of the minimum
amount necessary to induce that factor into employment
59. Reservation price of an input is the minimum acceptable price to that input
60. When market price of a input is above its reservation price, there is economic rent
earned by the input
61. Floor Prices: These are the minimum prices declared by the regulatory bodies
Example: Support prices declared for wheat, paddy and sugarcane by Agriculture
Price Commission
62. Ceiling prices: These are the maximum prices declared by regulatory bodies
63. Capital budgeting is the process of planning capital projects, raising funds, and
efficiently allocating resources to those capital projects
64. Capital projects are the projects that are expected to generate return for more
than one year
65. Pay back Period: The number of years it takes for the net cash flows
(undiscounted) to equal the initial investment cost
66. Internal Rate of Return: The rate of return from the project