Engineering Economics

UNIT-1

Created By: Vikash Chauhan

ME Dept (NIET G. Noida)
 What is Economics?
• Various economists have defined economics
based on their perception towards this.
• Definition may be categorized under three
heads:
i) Economics as a study of “wealth”.
ii) Economics as a study of “welfare”.
iii) Economics as a study of the problem arising
out of the “scarcity of resources”.
 Wealth Perspective
• Adam Smith: Economics is defined as the
study of nature and cause of the generation of
wealth of a nation.
• J. B. Say: Economics is defined as the science
which deals with wealth.
 Welfare Perspective
• Marshall: Economics is a study of man’s
actions in the ordinary course of life. It
enquires how he gets his income and how he
spends it. Thus, it is on the one hand, a study
of wealth and on the other and more
important side, a part of the study of man.
Efficiency Perspective [Based on scarcity of
resources]
• Robbins: Economics is the science which
studies human behavior as a relationship
between “ends” and “scarce means” which
have alternative uses.
 Other Definitions
• Professor Samuelson: Economics is the study
of how men and society choose, with or
without the use of money, to employ scarce
productive resource which could have
alternative uses, to produce commodities over
time, and distribute them for consumption
now and in future among various people and
groups of society.
 Concept of Efficiency
• Efficiency denotes the ratio of outputs to
inputs.
• Efficiency is correlated with productivity. More
efficiency means more productivity and vice
versa.
• High efficiency in the use of resources leads to
high productivity.
• Ways of improving level of productivity:
a) Increasing output with the same amount of
input.
b) Reducing input for existing level of output.

* First one can be achieved by better utilization of

resources. This can be called increase in efficiency
* Second one is achieved by economy in the use of
resources. This is due to saving and conservation
of resources. This can be called economy
 Managerial Economics
• McNair and Meriam: Managerial economics
consists of the use of economic modes of
thoughts to the analysis of business situation.
• Spencer and Siegelman: Managerial
economics is the integration of economic
theory with business practices for the purpose
of facilitating decision-making and forward
planning by management.
• Two fundamental managerial aspects
concerned with managerial economics:

i) Decision making: Choosing a course of action from a

number of available alternative.

ii) Forward planning: Making operational and strategic

plans for the future for survival and growth in the
market.
 Scope of managerial economics
• Product policy, Sales Promotion and Market
strategy.
• Demand analysis and forecasting.
• Cost analysis.
• Production analysis
• Pricing Decisions, policies and practices
• Profit management
• Management of Capital
 Application of Managerial Economics
• Demand Decision/Forecasting
• Price-output Decisions.
• Production Decisions.
• Investment Decisions.
• Advertisement Decisions
 Tools and Techniques of managerial
Economics
1. Scarcity Principle:
• Limited resources but unlimited human
wants.
• Needs efficient use of available resources.
2. Opportunity Cost Principle:
• The cost involved in any decision consists of
the sacrifices of alternatives required by that
decision is called opportunity cost
• Opportunity cost are the cost of sacrificed
alternatives.
3. Incremental principle of Marginalism:
• In micro-Economics, “marginal” stands for
“extra” or “additional” output or return.
• Marginal cost:::Extra cost input for producing
one extra unit of commodity.
• Marginal Production::: The extra output
produced from increasing the input by one
unit.
• Marginal revenue:::Additional revenue
generated from increasing the sales by one
unit.
• Similarly “marginal output of labour”,
marginal output of machine, marginal return
on investment, marginal utility of
consumption have their corresponding
meaning.
• So, the incremental principle involves
estimation the effect of decision alternatives
on cost and revenue e.g. change in total cost
and total revenue due to change in price,
products, investment or other decision
alternatives.
• For example, For profit maximization, firm
should manufacture products unless marginal
revenue must be greater than marginal cost.
4. Principle of Time Perspective:
• This principle indicates coordination of past,
present and future facts, figures and
observations for decision making.
• Time element may be temporary-run(fixed
FP), short-run (FP may be changed slightly),
long-run (all FP variable)
5. Discounting Principle: “If a decision affects
cost and revenues at future dates, it is
necessary to discount those cost and revenues
to present values before a valid comparison of
alternatives is possible.
• Equi-marginal Principle: “An input should be
allocated in such a way that the value added
by the last unit of the input is same in all its
users”.
 Theory of Demand
• Definition of demand: Demand may be defined as quantity of
goods and services required or requested by customers
having ability and willingness to pay for those goods and
services in a given period of time.

Demand for a commodity or service is the quantity of it which

a consumer is able and willing to buy at a given price in a
given period of time
• Three essential element of demand:
1. Quantity of commodity
2. Price of commodity
3. Period of time

• For generation of demand, a consumer must have following

characteristics:
1. Desire for the Goods
2. Ability to pay for the desired goods
3. Willingness to pay for the desired goods.
• Types of Demand:

1. Individual and Market Demand:

Individual Demand: Quantity demanded by
individual at a given price in a given period of time.
Market Demand: Total quantity demanded by all
the buyers at various price in given period of time.

In case of monopsony, there is only one buyer, so

individual demand and market demand coincide.
2. Industry Demand and Company Demand:

Industry Demand: It is the total demand for the

product of a particular industry.
Example: Demand for tooth paste.

Company Demand: It is the demand for any

particular brand of commodity.
Example: Demand for any particular brand of tooth
paste
3.Autonomous Demand and Derived Demand:

Autonomous Demand: This refers to demand for a

product which is wanted for itself. It is also called
direct Demand.
Example: Demand for food, clothes, house and other
finished goods.

Derived Demand: It is derived from direct demand.

Example: Land, Labor, capital and other factor of
production.
4. Joint Demand and Rival Demand:

Joint Demand: In this type, two or more goods are

used together to satisfy a particular demand.
Demand for these products are interdependent.
Example: demand for coffee, milk and suger

Rival Demand/Composite Demand: When a product

is demanded for two or more purposes, this is called
rival demand.
Example: Steel, water, cement etc
 Other types of Demand
• Price Demand: Price demand is the demand of
various quantities of a commodity that an individual
is willing to buy at a given market price in a given
period of time, other factors being unchanged.

It indicate functional relationship between price of

commodity and quantity of commodity demanded.
• Income Demand: It refers to various quantities of a
commodity demanded by a consumer at various
level of his income, other thing being unchanged.

It indicates the functional relationship between

income of the consumer and quantity of commodity
demanded.

Income demand may increase or decrease depending

on whether goods are superior or inferior.
• Superior Goods/Normal Goods: Demand for such
type goods will increase with increase in income.

Example:
• Inferior Goods: Demand for such goods will decrease
when income of individual increases.

Example:
• Cross Demand: It refers to various quantity of
commodity that a consumer is willing to buy when
price of other related commodity changes.

It indicates functional relationship between demand

for a particular commodity and the prices of other
related commodities.

This type of demand can arise for substitute goods

and complementary goods
• Substitute Goods: Demand of one commodity
increase due to increase in price of other commodity.

Example:
• Complementary Goods: Demand of one commodity
decrease due to decrease in demand of other
commodity (due to increase in price) and vice versa.

Example:
 Determinants of Demand/ Factor affecting
Demand
• Price of commodity: Generally increase in price
decrease demand of commodity and vice versa.
• Price of related commodities: This affects demand
depending on whether goods are complementary or
substitute.
• Level of income: This affects demand depending on
whether goods are superior(normal) or inferior.
• Taste and preferences of customers: It dominantly
affects the demand of commodity and may change
over time with change in psychological conditions
and Demonstration effects.
• Distribution of wealth: If there is equal distribution of
wealth in society, demand will be higher, otherwise
lower.
• Government Policies: It may increase or decrease
demand of commodity.
Example: Effect of tax and subsidies on commodity
• Other factors:
1. Size of population: Generally larger size of
population will induce larger demand for commodity.
2. Demography: A particular age group/gender will
attract particular type of commodities.
Example: Toys by children, walking stick by senior
citizen, Makeup goods by women.
 Demand Function
• Demand function indicates the relationship between
the demand for a commodity and the factors
affecting demand.

• The relation between demand and its determinant

can be represented as follows:
Dx = f(Px, Pr, I, T, A, U)
 Law of Demand
• Statement: If price of commodity rises, its quantity
demand will decline and if price of commodity falls ,
the quantity demanded of it will rises provided other
factors remains same.
 Assumptions of law of Demand
• No change in income of the consumer
• No change in taste and preference of consumer
• Price of related commodities should remain unchanged.
• The commodity should be normal/ Superior.
• No change in demography and size of population.
• Distribution of income and wealth should be uniform.
• There should be continuous demand.
• There should be perfect competition in the market.
 Individual Demand Schedule
• A demand schedule is a tabular statement which shows
different quantity of product demanded at various prices.
So it indicated the relation between demand of commodity
and price of it.
 Market Demand Schedule
• In market demand schedule, the demand schedule of
all individual household is added horizontally.
 Exception of Law of Demand
• Conspicuous Needs: Commodities which have
become necessities of life do not follow law of
demand. Even the price of commodities such as TV,
refrigerator, washing machines, etc are increasing,
their demand in middle class family is not reducing,
i.e. increasing.
 Giffin Goods: In this type of goods, demand of commodity
decrease, when the price of commodity decrease and vice
versa.
• In this type of goods, income effect dominates over the
substitution effect.
• The extra purchasing power achieved by reduction in price of
inferior commodity is used to buy superior commodity. This
will further decrease the demand of the superior good.
So law of demand is failed.
Future Expectation: Expectation of rising price in
future may increase the demand in present
irrespective of present price.
Example: News of increasing price of petrol in future
will increase its demand although its present price
will not increase.

Change in Fashion and Tastes: People do not like to

buy obsolete and old fashion commodities. They are
ready to pay even at higher price for latest fashioned
commodities.
• Status Symbol: Some goods are purchased not for
their actual requirement but because of status or
prestige value.
• Lack of information and phobia: People don’t know
that same quality of product with lower price is also
available in market.
Some people think that products with higher price
are always good.

• Emergency: The law of demand do not apply during

emergencies like famine, flood, war and internal
disturbances. Commodities are sold in large quantity
even at higher price.
Some Important Terms:

1. Income Effect: A change in quantity of a commodity

demanded as a result of change in real income
caused by change in price is called income effect.

2. Substitution effect: Between substitute goods, use

of one in place of other, when former becomes
relatively cheaper is called substitution effect.
3. Price Effect: Price effect denotes changes in
demand of a commodity caused by change in its
price.
Price Effect=Income effect+ substitution
effect.
4. Expansion of Demand: When as a result of decrease
in price, the quantity demanded increases, this is
called expansion of demand.
5. Contraction of Demand: When as a result of increase
in price, the quantity demanded decreases, this is
called contraction of demand.
6. Increase in Demand: Increase in demand refers to a
situation when there is more demand at the same
price.
• This is due to change in factors other than price of
commodity

• In this case, there will be shift in demand curve in the

upward direction.
7. Decrease in Demand: Decrease in demand refers to a
situation when there is less demand at the same
price.
• This is due to change in factors other than price of
commodity.

• In this case, there will be shift in demand curve in the

downward direction.
 Change in Quantity Demanded vs Change in
Demand
• Change in quantity Demanded: This is due to
change in price of the commodity with the condition
that other factors remain constant.

• This represents the movement along the demand

curve.
• In graphical representation, movement along left or
right is termed as contraction or expansion.
• Change in Demand: This is due to change in
determinants of demand at each possible price.

• This represent shift of whole demand curve toward

left or right.
• In graphical representation, shift of demand curve
along left indicates decrease in demand while shift
along right represent increase in demand at each
possible price
Click to play video
 Elasticity of Demand
• Elasticity: This is the measurement of
proportionate change in one variable to a
proportionate change in other variable.
• It represents the responsiveness of dependent
variable to the change in one of the
independent variable. Other independent
variable will remain constant.
• Elasticity of Demand: This is defined as the
responsiveness of quantity demanded of a good to
change in one of the variable on which demand
depends.

• Elasticity of Demand may also be defined as “

percentage change in quantity demanded divided by
percentage change of the variables on which
demand depends.
• Unless specified, Elasticity of demand means price
elasticity of demand.
 Difference between Law of demand & Elasticity of
Demand

Law of demand Elasticity of Demand

1. Statement 1. Definition
2. Qualitative 2. Quantitative
3. States only direction of Demand 3. measures prop.
change in Demand
4. No formula or mathematical tool 4. formula & tools exist
• Three Type of demand:
1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand.
 Price Elasticity of Demand
• It is the measurement of response of quantity
demanded of a good to change in its price.
• It is the ratio of percentage change in the quantity
demanded to the percentage change in price, other
thing remaining equal.
Price elasticity (Ep)= % change in quan. deman.
% change in price
 Type of Elasticity of demand
• Perfectly Inelastic: In this case, there is no change at all in
quantity demanded when price changes. The quantity
demanded does not respond to price change. In this case :
Ep=0
• Inelastic: In this case, percentage change in quantity
demanded is less than change in price. In this case:
0<Ep<1
• Unit Elasticity: In this case :
Percentage Change in quantity Demanded= Percentage
change in price
Ep=1
• Elastic: In this case:
Percentage change in quantity demanded> Percentage
change in price.
1 <Ep<infinity

• Perfectly Elastic: In this case, Small rise reduction raises the

demand from zero to infinity.
In this case: Ep=Infinity
 Application of Elasticity of Demand
• For Monopolist: If the demand is inelastic, monopolist fixes
higher price and sell slightly smaller quantity.
If the demand is elastic, he will keep the price low to
maximize profit.
• Useful in Factor Pricing: Price elasticity of demand help in
indentifying relative output of factor of production. The
factors which have inelastic demand renders high price as
compared to factor of production having elastic demand.
• For Government: Higher rates of taxation on goods with
inelastic demand brings higher amount of revenues whereas
the same on goods having elastic demand may not fetch the
desired revenue to the government.
• For international Relation: One country can obtain higher
price for commodities from its export to other country if that
country’s demand for that commodity is inelastic.
• Explanation of Paradox of poverty of farmer: A good harvest,
instead of bringing riches, fetches poverty to the farmers.
A rich harvest of an agriculture product, whose demand is
inelastic, may ultimately fetch less price due to increased
production.
 Determinants of Price Elasticity of Demand
• Nature of goods: Necessities of life have inelastic demand
because they are purchased even though their price elevate.
Luxurious goods have elastic demand.
• Availability of Substitute: Demand for commodity is elastic
which have large number of substitute. Ex-tooth paste
Demand for commodity is inelastic which have no good
substitute. Ex- Salt
• Multiple uses of commodity: Demand of commodity having
many uses is generally elastic. Ex-Milk
If the commodity has fewer uses, demand is inelastic. Ex-Pan
drive
• Level of Prices: Demand for low priced commodities will
be inelastic. Demand for high priced income will be
elastic.
• Level of income: If income level of customer is high, the
demand will less elastic. If income level is low, the
demand will be more elastic.
• Taste, preference and habits of customers: Different type
of customers may render different type of elasticity.
• Share in total expenditure: Demand for a commodity is
inelastic if proportion of total expenditure incurred on
that commodity is very small. If expenditure of
commodity in a consumer’s budget is high, the elasticity
is likely to be high.
 Methods of Measurement of Price Elasticity of
Demand
• Percentage method : In this method, elasticity is
measured by ratio of percentage change in demand
to percentage change in price.
Ep = % change in Demand
% change in price
= Change in demand* 100
Original Demand
Change in price*100
original price
= Q
Q
P
P
• Total Outlay Method: In this method, change in total
expenditure before and after the change in price is
considered.
 If P E OR P E Ep>1
 If P E OR P E Ep<1
 If E is unchanged when price rise or fall Ep=1
Ep>1
• Ep<1
Ep =1
 INCOME ELASTICITY OF DEMAND
• It is measure of responsiveness of the demand to change in
income.
• It is the ratio of percentage change in quantity of commodity
demanded and percentage change in income of individual.

• Income Elasticity (Ei)= Q

Q
I
I
• Income elasticity of demand can also be represented
in terms of change in expenditure in place of change
in commodity purchased or demanded.

• If % change of expenditure = % change of price Ei=1

• If % change of expenditure > % change of price Ei>1

• If % change of expenditure < % change of price Ei<1

• For commodity having Ei>1 are luxury goods.

• For commodities having Ei<1 are necessities.
 Cross Elasticity of Demand
• It is the ratio of proportionate change in quantity demanded
of Y to a given proportionate change in price of the related
commodity X.
Cross Elasticity of Demand (Ec)= Qy
Qy
Px
Px

• Ec= infinity if slight change in price of X cause substantial

change in quantity demanded of Y.
• Ec=0 if change in price of commodity X will not affect the
quantity demanded of Y.
 Law of Supply
• Supply: It means the quantity of a commodity offered for sale
in the market.
• Supply of commodity is defined as the quantity of commodity
that a seller is willing to sell in the market at a given price in a
given period of time.
 Factors affecting Supply
1. Price of the commodity: Other things being equal, the higher
the relative price of a good, the greater the quantity of it that
will be supplied.
2. Price of other commodity: An increase in price of other
goods induce the firm to produce more of other goods
leading to reduction in supply of goods whose price has
remained unchanged.
3. Price of factors of production: An increase in factors of
production leads to reduction in supply if the price of the
commodity remain constant.
4. State of Technology: With the advancement of technology,
more and more goods may be produced efficiently. So supply
is also increase.
5. Objective of the firm: A firm may increase supply of
commodity taking into consideration various goals such as
profit maximization, maximum sales, or status and prestige in
the market.
6. Government Policies: Taxes increase the cost of production. So
supply will be increased only when there is an increase in
price.
Subsidies decrease the cost of production, thus provide
incentive to the firm to increase supply.
7. Miscellaneous factors: Other factors may include change in
season, future expectation of rise in price, agreement among
producers, natural factors, means of transport and
communication etc.
Supply function: This represents the relationship between the
supply and factor determining supply of commodity.
Sn= f(Pn, Pr, F, T, G)
 Law of Supply: Other things being equal, quantity supplied of
commodity increase with increase in price of the commodity
and decrease with decrease in price of the commodity.

Supply Schedule: A supply schedule is a tabular statement

which shows different quantities of a commodity offered for
sale at different price.
Supply Curve: A supply curve represents the relationship
between supply and price of commodity graphically.
Example of supply schedule and supply curve
Individual and Market Supply Schedule: An individual supply
schedule indicates different quantities offered for sale by an
individual firm at different prices.
A market supply schedule indicates total of various quantity
of commodities offered for sale by all the individual firms at
different prices.
• Expansion and Contraction of supply: Rise in quantity
supplied due to rise in price of the commodity , other things
being equal is called expansion of supply.

Fall in supply due to fall in price, other things being equal , is

called contraction of supply.
 Expansion

Contraction
Increase and Decrease in Supply: Rise in supply due to change
in factor other than the price of the commodity is called
increase in supply.

Fall in supply due to change in factors other than the price of

commodity is called decrease in supply.
Example of increase in supply:
Example of decrease in Supply:
 Elasticity of Supply
• Elasticity of Supply: This represents the degree of
responsiveness of the supply for a commodity to a change in
its price.

• Es = Percentage change in quantity supplied

Percentage change in price
 Types of Elasticity of Supply
1. Perfectly Inelastic Supply: Es=0
2. Less than unit Elastic Supply: Es<1
3. Unit Elastic Supply: Es=1
4. More than Unit Elastic Supply: Es>1
• Perfectly Elastic Supply: Es= infinity
Types of Elasticity of supply
 Factors Affecting Elasticity of Supply
• Nature of commodity: Perishable commodity have inelastic
supply. Durable goods have elastic supply.
• Time factor: Longer time period for production of commodity,
more elastic is the supply of commodity and vice versa.
• Technique of production: Supply of commodity involving
simpler techniques have elastic supply and for complex
techniques have inelastic supply.
• Future expectation: If price are expected to rise in future,
producer will withhold the supply and so supply will be
inelastic. If the same is expected to fall in future, the supply
will be elastic.
 Indifference Curve
• An indifference curve is a curve which represents different
combination of goods which give same satisfaction to the
consumer.

Indifference Schedule
Indifference Curve
 Assumption of Indifference curve
• Rationality
• Ordinal utility
• Consistency of choice
• Transitivity
• Non-satiety
 Indifference Map
• Indifference Map is the graphical representation of two or
more indifference curve showing several combination of
different quantity of commodities which consumer consumes.
 Properties of Indifference curve
• It slopes downward from left to right.

• Indifference curve are always convex to the origin.

• Higher indifference curve represents higher level of

satisfaction

• Indifference curve do not intersect each other.

 Budget Line
A budget line shows all those combination of two goods which
the consumer can buy spending his given money income on
the two goods at their given prices.
 Slope of Budget Line
• Let there are two goods X and Y.
• Let price of X be Px and quantity purchased be Qx and of Y be
Py and Qy .

• Budget constraint of consumer or Total income of customer

M=PxQx+PyQy

or Qy= M/Py- (PxQx)/Py

• If Qx=0, Qy= M/Py

• If Qy=0, Qx= M/Px
• Thus Slope of the budget line :
m=-(OA)/(OB)= -Px/Py
 Welfare Analysis
• Economic welfare is the total benefit available to society from
an economic transaction or situation.
• Economic welfare is also called community surplus.
• Welfare is the area shown in the diagram by green colour (for
consumer ) and blue colour (for producer)

Equilibrium price
• Consumer Surplus: When a consumer actually pays less than
what he is ready to pay, the additional benefit is called
consumer surplus.
• Producer surplus: When a producer gets a price more than
what he is ready to supply for, the additional benefit to
producer is called producer surplus.

click to play video

• Economic welfare which is also called community surplus is
the sum of consumer surplus, producer surplus and
government revenue.

• Welfare analysis considers whether economic decision by

individual, organization or government increase or decrease
economic welfare.

• Increase in market price decrease consumer surplus and

increase producer surplus, so increase in market price need
not reduce overall social welfare .
 Assignment-1
1. Define managerial economics and explain its scope in the context of present day
business environment.
2. Explain briefly techniques and application of managerial economics.
3. Write short notes on the following:
(i) Law of Demand (ii) Expansion and contraction of demand (iii) Increase and
decrease of demand (iv) normal, inferior, substitute, complementary and Giffin
goods.
4. What is price elasticity of demand? Briefly explain types of price elasticity of
demand with suitable graphs.
5. State law of supply. Briefly explain various types of elasticity of supply with
suitable graphs.
6. What is indifference curve. What are its properties?
7. What is budget line? Determine the slope of budget line.
8. Discuss welfare analysis.
9. When price of a commodity falls by 2 per unit, its quantity demanded increases
by 10 units. Its Price elasticity of demand is (-) 1. Calculate its quantity
demanded at a price before change which was 10 per unit.