CHAPTER 7

BUSINESS –
ECONOMIC
FUNDAMENTALS

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 Learning Objectives
 The meaning of economics
 The purpose of studying economics
 Types of economic theories
 Demand and supply concepts and their
relevance to the understanding
economic behaviour
 How market mechanism operates
 Concepts of elasticity, factors affecting
elasticity, and their implications to
economic decision-making

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 What is Economics?
 Economics (derived from the Greek words οίκω
(okos), ‘house’, and νέμω (nemo), ‘rules’ hence,
household management) is the social science
that studies the allocation of scarce resources.
This involves analysing the production,
distribution, trade, and consumption of goods
and services.
 Economics studies choice, decision-making, and
optimum allocation of limited resources to fulfil
unlimited human needs and wants.
 Economics involves analysing the production,
distribution, trade, and consumption of goods
and services with a view to suggest optimum
allocation of resources.

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 Why study Economics?
 Economics needs to be studied as
it provides a logical way of
diagnosis, analysis, and solution
to a variety of problems that arise
within an organization

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Classification of Economic Theories

Economics - is the study of choice and decision-making in

a world with limited resources to fulfill unlimited wants

Positive and Normative Economics

Micro-economics and Macro-economics

Descriptive Economics, Economic Theory, and

Applied Economics

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  Positive economics deals with causal
relationships and attempts to find out the
causes that lead to a given effect or the
vice versa.
 Normative economics is prescriptive in
nature and has more to do with values.
 Microeconomics deals with individual
behaviour of a householder, consumer,
businessperson, producer, etc
 Macroeconomics considers the economy as
a whole and deals with aggregate variables
such as aggregate demand and supply for
money, capital, and commodities.
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  Descriptive economics refers to the collection
of all the relevant facts related to an event and
aligning them coherently with emerging
implications .
 Economic theory or analysis helps simplifying
explanation of features of an economic systems
 Applied economics operates within the
framework of analysis provided by economic
theory. It attempts to test the economic
theories to ensure whether or not these
theories appear to be supported by statistical
evidence about the real world.

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 Demand
 Demand for a product is defined as the
various quantities of it per unit of a
time; daily, weekly, or monthly that
consumers are willing and able to
purchase at alternative prices, keeping
all other things affecting demand as
constant.
 The law of demand states that the
relationship between a good’s price
and its quantity demanded is negative

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 Demand can be expressed as:
XD = f ( Px, N, T, Y, Pn, R, E, )

Where:
X = Quantity of goods or services
Px = Price of X:
N = Number of consumers under consideration.
T = Taste and preferences of consumers:
Y = Consumers’ income and distribution:
Pn = Price of related goods:
R = Range of products available to consumers
E = Expectations of consumers:
Demand refers to a demand schedule that lists the different
quantities of the commodity that consumers are willing and able
to take at alternative prices, keeping all other factors affecting
the demand as constant , i.e., ceteris paribus

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 Change in Demand
 A change in the demand or a shift of the
entire demand curve is caused by a
change in any of the other factors other
than the price of the product under
consideration affecting the demand.
 When demand increases, the quantity
demanded by consumers increases at
every price.
 When demand decreases, the quantity
demanded by consumers falls at every
price.

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 Supply
The concept of supply is defined
as various quantities of a product
that the seller places in the
market per unit of time at
alternative prices, keeping all
other factors affecting supply as
constant.

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 Supply can be expressed

XS = f ( Px, Pn, T, E, Pi)

Where:
X = quantity of good or service
Px = price of X
N = Number of sellers under
consideration
T = Technology to produce the product
E = Future expectations of the sellers
Pi = is the price of inputs
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 Market Price
 Conventional microeconomic analysis states that
the price of a product or service and its output is
determined at the intersection of supply and
demand curves which is called the equilibrium
price.

 Any price above the equilibrium will result in a

situation where the quantity supplied exceeds the
quantity demanded. Due to their inability to clear
the market, producers may reduce prices.

 Any price below the equilibrium will see the

quantity demanded exceed the quantity supplied,
bidding the price upwards.

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 Price Elasticity of Demand
 Price elasticity of demand measures the
responsiveness of the quantity demanded as the
price of the product or service undergoes
changes, given the demand curve for the
product or service .
 If the quantity demanded is not too responsive
to the change in price, it would result in an
increase in the total expenditure on the product
for increase in price of the product and vice
versa.
 If a product or service is highly responsive to
change in price, it would result in a decrease in
the total expenditure on the product for increase
in its price and vice versa.

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 How to Measure Price Elasticity
Well-known British economist Alfred Marshall (1891), defined price
elasticity of demand as the percentage of change in quantity taken
divided by percentage change in price, when the price change is
small.
Percentage change in quantity
demanded
Price elasticity of Demand e = ------------------------------------------------
Percentage change in the price of the
product

Numerically, the price elasticity is expressed as :

p = (%Q)/(%P)

The elasticity of demand at a given point on the demand curve is

referred to as point elasticity of demand. Arc elasticity of demand is
computed between two points on the demand curve

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 Factors that Influence price
elasticity of demand
 Availability of close substitutes
within the market
 Degree of Necessity or Luxury
 Proportion of income spent on a
good
 Habit forming goods
 Permanent or temporary price
change
 Time period under consideration
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 Cross Elasticity of Demand
Cross elasticity of demand measures the
responsiveness of the quantity demanded of one
good to changes in the price of another.
Cross elasticity of demand for good X is expressed as:
% Change in quantity demanded of good X
= ---------------------------------------
% Change in price of another good Y

Two goods which are substitutes will have a positive

cross elasticity
Two goods which are complementary to each other
will have a negative cross elasticity

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