Marginal rate of Technical substitution ( MRTS)

It is the rate at which a factor of production can be substituted for another at the margin without affecting any change in the quantity of output is known as the marginal rate of technical substitution (MRTS).

If there are two factors X and Y, then the quantity of Y for which one unit of X is a substitute, if the output remains unchanged.

Autonomous investment VS Induced investment.

Autonomous investment

It is an investment which is independent of the general economic situations. It is income inelastic. 

Induced Investment

It is an investment which is dependent on the general economic situations in the country, like general price level, national income, national consumption etc. It is income elastic.

Marginal rate of substitution

What is marginal rate of substitution?

 The indifference curve analysis is based on the principle of marginal rate of substitution.

 

It is the rate at which an individual will exchange successive units of one commodity for another.

For example, if a consumer has more of apples than oranges, then he will be willing to give more of oranges for an extra unit of 

apple.

It is the ratio between the marginal utilities of two commodities, which guides the consumer's choice. 

Production Function

Production Function

Is the relationship between the physical inputs and output of a firm is often referred to as the Production Function. 

The Production function shows for a given state of technological knowledge and managerial ability, the maximum rates of output that can be obtained from different combinations of the productive factors during a given period of time. 

Production Function is simply a catalouge of different output possibilities.

LAW OF VARIABLE PROPORTION

Law of Variable Proportions.

This law explains the effects on output of variations in factor - proportions.

It refers to the amount of extra output produced by adding to a fixed input more and more of variable input. 

There are three stages to the law,

Stage 1: Increasing Returns Stage. The output increases at an increasing rate.

Stage2: Diminishing Returns Stage. The output increases at a diminishing rate. 

Stage 3: Negative Returns Stage. The Total Product declines and the marginal product becomes negative cutting the x - axis.

This the Total Product, Marginal Product and Average Product pass through three different stages.

COST AND COST CURVES

The Fixed capital of the firm,eg, equipment, machinery, building etc. is part of the fixed cost. The cost that does not vary with the change in output is called FIXED COST. 

VARIABLE COST is the cost that varies with output. For eg. labour, raw materials, fuel, power. As the output increases the variable cost also increases.

Total cost= Total Fixed Cost+ Total Variable Cost.

OR

                     TC= TFC+ TVC

TFC is constant and this cost is born by the producer even if his production is zero. Therefore, this curve is parallel to x axis.

TVC is a rising curve because as the output increases there is more requirement for variable input. 

TC is the total of both TFC and TVC.

Theory of Production- Laws of Returns

Theory of Production- Laws of Returns.

In these laws the economic unit is the individual firm which tries to maximize it's producf-- output through a rational combination of the factors of production at its disposal.

The theory of production is divided into two heads : 1) laws of Returns and 2) Production Function.

Production

It is the result of the co-operative working of the various factors of production- land, labour, capital and entrepreneurship.

Marginal Revenue

Marginal Revenue is the change in total revenue resulting from an increase in sale by an additional unit of the product in a particular time. 

Average Revenue Curve

Average Revenue is the revenue per unit of the commodity sold. It can be calculated by dividing total revenue by the number of units sold to the customers.

Average Revenue= Total Revenue÷Number of units sold to the customers.

Consumer Surplus.

Consumer Surplus may be defined as the excess of utility obtained by the consumer over utility obtained by the consumer over utility forgone or disutility suffered.

It is measured by the difference between the maximum price which the consumer is willing to pay for a commodity rather than go without it and the price which he actually pays for it .

Marshall defined it as " The excess of price which a person would be willing to pay rather than go without the thing, over that which he actually does pay is the economic measure of this surplus of satisfaction. It may be called as

Consumer Surplus".

Elasticity of Supply.

Elasticity of Supply.

It is a parallel concept like the Elasticity of Demand. It may be defined as the responsiveness of the sellers to a change in the price of the commodity. It relates to the reaction of sellers to a particular change in price of the commodity.

Cross Elasticity of Demand

Cross Elasticity of demand.

It is the change in quantity demanded of commodity A due to the change in price of commodity B. The commodities can be either substitute or complementary. It tells us who the demand for any commodity depends upon the price of related goods.

Ec= proportionate change in quantity demanded of commodity A/ proportionate change in price of commodity B

Cross Elasticity of Demand for two goods may be positive ( substitute), negative ( complementary) and zero( not related).

1. Case of positive Cross Elasticity of Demand.

2. Case of negative Cross Elasticity of Demand

3. Case of Zero Elasticity of Demand

Income Elasticity of Demand and its cases.

Income Elasticity of Demand:

It can be defined as the proportionate change in quantity demanded of the commodity to a given proportionate change in Income of the consumer.

Ei= proportionate change in quantity demanded / proportionate change in Income.

We can classify into five cases:

1) Zero Income Elasticity of Demand.

In this case the quantity purchased of a commodity will remain unchanged irrespective of the change in Income.  Ei=

2) Negative Income Elasticity of Demand.

In this case, when the money- income of the consumer increases the quantity demanded by the consumer decreases. For eg. Inferior goods  Ei<0

3) Unitary Income Elasticity of Demand.

In this case when the money- income of the consumer increases, the quantity demanded by the consumer increases by the same amount.  Ei = 1 For eg. Comfort goods.

4) Income Elasticity greater than unity.

When the consumer spends a larger proportion of his increased income on the commodity when he becomes richer. For eg. Luxuries. Ei>1

5) Income Elasticity of Demand less than unity: when the consumer spends less proportion of his income on the puchase of a commodity. For eg. Necessities.Ei<1

Types of Elasticities

The term elastic and inelastic are  only  relative terms. Elasticity is a matter of degree only. Based on these, there are five classifications of Elasticities are given below:-

1) Perfectly Elastic demand.

2) Perfectly Inelastic demand.

3) Relatively Elastic demand.

4) Relatively Inelastic demand.

5) Unit Elasticity of demand.

1) Perfectly elastic demand: when a small change in price results in in an infinite Lee large change in demand it is a case of perfectly elastic demand.

In the above diagram, at a given price OP the quantity demanded remains infinite. Any price above or below OP , the demand becomes zero.

2) Perfectly Inelastic demand: This is a case when there is almost no change in demand with a change in price.

 In the given figure, there is no change in the quantity demanded. When the price is zero people demand the same amount of the commodity. For eg. Necessities ( salt)

3) Relatively Elastic demand:- In this case a small change in price leads to a more than proportionate change in demand.

In the figure given above, , when the fall in price from P to P1 causes a more than proportionate change in demand from M to M1.For eg. Luxury goods.

4) Relatively Inelastic demand:-  In this case, when a large change in price results in less than proportionate change in demand. 

In the figure given above, when the price falls from P1to P2 , there is a less than proportionate increase in quantity demanded.

5) Unit Elasticity of demand:- In this case, when a change in price in followed by an equally proportionate change in Demand. 

In the figure given above, when the price decreases from P1 to P2, the quantity demanded also increases in equal propotion, from A to B. 

Price Elasticity of Demand

Price Elasticity of demand is the ratio of proportionate changes in the quantity demanded of a commodity to a given proportionate change in price. In other words , it is the ratio of relative change in quantity demanded to the relative change in price.

E= Relative Change in Quantity /Relative Change in Price.

Indifference Map

Indifference map

An indifference map of a consumer represents his tastes and preferences as between different combinations of them. It represents his scale of preferences. The map changes when his taste and preferences change. 

 In the above diagram, curves1,2,3,4 are the various indifference curves and any combination of wheat and rice on curve 1 will give the same satisfaction on the curve 1. Whereas point A gives lower satisfaction than point B, B lower than point C and C lower than point D.A<B<C<D. The higher the curve the higher the satisfaction. 

Indifference schedule

Indifference schedule is a statement of various combinations of two goods that will be equally acceptable to the consumer. The various combinations give equal satisfaction so he becomes indifferent to various other combinations

Indifference curve analysis

Indifference curve analysis is based on ordinal approach. The curve shows different combinations of two commodities which give the consumer an equal satisfaction. The combination of commodities can vary but for simplicity two commodities have been taken.

Exceptions to the law of demand

1) Veblen Effect: The law of demand does not hold on goods that have a snob appeal or prestige value. Economist Veblen calls this as conspicuous consumption. Certain goods are demanded by rich people because of their social prestige.

2) Speculative Effect: It applies in stock market when people buy maximum stocks when the price is the lowest. Although it's a short term phenomenon.

3) Giffen Goods or Giffen paradox:  He poor people will buy more of inferior goods if there price rises and demand less if the price rises. In the 19 th century, in Ireland, Giffen observed that a major part of their income was spent on  potatoes ( inferior good). When the price of potato increased they reduced the purchase of meat to continue buying the same amount of potato.

4) Scarcity, inflation, price delusion...  etc: Expectation of price to increase in the future, buyers will buy more at higher price .

Types of Demand

There are three types of demand 1) price demand 2); Income demand 3) cross demand.

1) Price demand refers to various quantities of a commodity that a consumer buys  at a given point of time at different prices in a

 market.it is assume that other things like income of the consumer, prices of other related goods etc. remain the same. 

2) income demand refers to different quantities of commodity on service which consumer will be at different levels of income other things remaining the same. Income demand changes with the change in the nature of the commodity . For normal goods the income demand will be positive meaning thereby when the income increases people buy more of these goods. For inferior goods the slope will be negative, which means as income increases people buy less of these goods.

3) Cross demand refers tothe quantities of the commodities or service which would be purchased with reference to change in not of that particular commodity but of other inter- related commodities other things remaining the same. For eg. Quantity Demanded for tea changes when price of coffee changes .(substitute goods). Likewise if the price of pen increases then the quantity demanded for ink also falls ( complementary goods).

Negative slope of the demand curve.

Why is the demand curve downward sloping?

 The demand curve is downward sloping because of two effects;

 1) Income effect  and 2) Substitution effect 

1) Income effect is because of a fall in the price of a commodity, there is a  rise  in the real income of the  consumers. As his real income increases he can buy the same good or other goods from the same income. Likewise when the price of the commodity increases his real income falls and therefore the consumer purchases less commodities. 

2 . Substitution effect:  Likewise when the price of a commodity falls but the price of its substitutes does not fall, then the commodity becomes more attractive for the consumer and there is an extension in its demand.

Law of demand

Law of demand :

 Under the same conditions of demand, the quantity of a commodity bought tends to vary e inversely with its price.  At  a higher price less of the commodity would be purchased and at a lower price more of it will be bought, provided  the conditions of demand remain unchanged.

Assumptions of the law are :

People's income, taste, prices of other related goods remain unchanged. No substitute of the commodity being consumed, no expectations of future increase in price.......

Meaning of Demand

The demand for any commodity at a given price is the the quantity of it which will be bought per unit of time at that price. Two things become important first is the price of the commodity and second is the importance of time element in the concept of demand.

Demand function : it shows the functional relationship between two variables i.e. price of the commodity and the physical quantity demanded.

Dx=f(Px)

Law of diminishing marginal utility

Law of Diminishing Marginal Utility.

In the words of Boulding , " As a consumer increases the consumption of any commodity keeping constant the consumption of all other commodities, Marginal Utility of the variable commodity must eventually decline." 

In other words ,as more and more of a commodity is consumed, at a given point of time, its utility starts diminishing.

Total Utility and Marginal Utility

Total Utility is the amount of utility derived from the consumption of all the units of the commodity at the disposal of the consumer.

Marginal Utility is the utility of an additional or extra unit or change in total Utility due to consumption of one extra unit.

Types of Utility

Cardinal Utility: 

It gives numbers 1,2,3,.... It assumes that utility can be measured and utility from the two  i commodities can be compared. For eg. Let's take two commodities orange and apple. Orange gives utility of 20 units where as apple gives utility of 10 units. Orange is giving 2 X  more utility as compared to apples.

Ordinal Utility: 

The consumer gives order or rank to the utility. It does not give numbers but order, for eg , 1st, 2nd,3rd........etc. It gives the preference of the consumer when he ranks commodities according to the utility derived.

Utility Analysis

Cardinal Utility: 

It gives numbers 1,2,3,.... It assumes that utility can be measured and utility from the two  i commodities can be compared. For eg. Let's take two commodities orange and apple. Orange gives utility of 20 units where as apple gives utility of 10 units. Orange is giving 2 X  more utility as compared to apples.

Ordinal Utility: 

The consumer gives order or rank to the utility. It does not give numbers but order, for eg , 1st, 2nd,3rd........etc. It gives the preference of the consumer when he ranks commodities according to the utility derived .

Concept of Utility.

Utility : means the power of a commodity or service to satisfy a human want. It relates to inner sentiments. It is a subjective concept.

Difference between utility and satisfaction.

Utility is expected satisfaction whereas satisfaction is realised satisfaction. Utility is before consuming a commodity or service while satisfaction is after.

Methodology in Economics

Inductive Method: relates to the historical School. For analysis of economic problem this method follows the practical approach. It uses experiments and statistical tools for analysis This method bridges the gap between theory and practice.

Deductive Method: This method has a very abstract approach towards analysis of economic problems. Inferences are drawn  starting from indisputable human behaviour.

Concept of Equilibrium.

Equilibrium is an important part of Economics also known as Equilibrium Analysis. It signifies a state of rest or balance. Equilibrium , in Economics, means as professor, JK Mehta says "equilibrium denotes in economics, absence of change in movement while in physical sciences it denotes absence of movement  itself.

 Stable, unstable and neutral equilibrium.

 Equilibrium can be stable neutral and unstable. As professor AC Pigou summarised ;"a system is in stable equilibrium if when any small disturbance takes place forces come into play to re-establish the initial position.

 It is Neutral equilibrium, if when such a disturbance takes place, no re-establishing forces but it also know for the disturbing forces are evolved, so that the system remains at rest in the position to which it has moved; and it is unstable equilibrium if the small disturbance calls out for the disturbing forces which act in a cumulative manner to drive the system from its initial position". 

Approaches to Economics

Approaches to economics:

Micro and macro economics

1) Micro economics : Micro means a millionth part. It is defined as that branch of economic analysis which studies the economic behaviour of an individual unit maybe a person, a particular household or a specific firm. It is the study of one /single/ particular unit than all the units combined together. It gives a worm view of the entire economy.

2) Macro economics: it is that branch of economic analysis which studies the behaviour of not one particular unit but all the units combined together. It is a study of 'aggregates'.

A brief note on the classification of definitions in Economics.

A brief understanding of the plethora of definitions given by the economists-

1) Wealth definition : it was considered to be a study of people who were engaged in the production and consumption of wealth. It unfortunately was viewed in a very narrow sense because it seemed to exclude people not engaged in wealth creation activity. So this definition was rejected by the end of 19th century.

2) Welfare definition : focus shifted from wealth to welfare wealth was not the end but a means to attain welfare. Marshall who was the first economist who shifted the focus from wealth to welfare this definition was also criticized for being rigid as it talked only of humans coma more in nature rather than analytical.

3) Scarcity definition: marshalls definition seemed to be accepted largely until Robins came up with the new concept of scarcity which are billed to many thinkers as more real and logical. He studies human behaviour in relationship between ends and scares means, having alternative uses. he highlighted the concept of cost and choice as the basis of the study of Economics.

4) Growth definition: scarcity definition was also criticized for being static in nature. Also mention give the most popular definition of growth in economics which was widely accepted the great merit of examinations definition is is that he takes into consideration the dynamic changes taking place both in the means as well as the end with respect to time.

Introduction to Economics

My blog, Fundamentals of Economics, aims to help students understand the complex and abstract concepts, theories and models in Economics. As the subject is very comprehensive, therefore the scope of elaboration increases.The blog will be using real life examples to help you understand the key concepts of Economics.

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DEFINITION OF ECONOMICS

Economics as a science was born in 1776, with Adam Smith's magnum opus- An Inquiry into the nature and causes of Wealth of Nations. Economics was derived from the Greek words 'Oikos' (a house) and  'nemein' ( to manage) which meant, managing a household with the limited available resources in the best possible manner. 

There are are there are are plenty of definitions of Economics but broadly they can be classified into four groups;

1) Wealth,

2) Welfare,

3) Scarcity and

4) Growth.