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Submitted By: Tambaoan, Angelica Rose D.
BSIT-IIB Drafting Technology
Submitted To: Mrs. Torralba, Bridgeta
Chapter I Economics: Its meaning and
importance

Introduction:
Enomics is the theories, principles, and models that deal with how the
market process works. It attempts to explain how wealth is created and
distributed in communities, how people allocate resources that are scarce
and have many alternative uses, and other such matters that arise in dealing
with human wants and their satisfaction.

Economics as science:
At its core, the field of economics tries to uncover basic universal facts.
Like many sciences, economics has a strong foundation in mathematics, and
it is developed by testing hypotheses. In many ways, economics can be
viewed as a field of applied psychology. Understanding how humans behave
in certain situations and respond to changes is essential for the field's
development.

Econimics as social science:

Economics involves human participation in communicating what their
needs and wants are, what the government is doing to ensure the society's
needs and wants are met, how production is structured so that it is able to
adequately cater to the needs of the society and how rules and regulations
are formulated in order to foster a fair exchange of goods and services within
the society.

Below are some of the most important factors considered when it comes to
economics:

Land: this is a vital factor of production without which a society may

end up facing tough times. Land is used for producing raw materials
and establishing industrial buildings.

Labor: the main contributors here are human beings. Labor may be in
three forms which are mainly unskilled, semiskilled and professional
labor.

Capital: before production and distribution can begin, some resources

must be available. These resources include factories, infrastructure and
transportation equipment, among other things.

Entrepreneurship: this mainly involves human innovation or ability

to organize the other factors of production in order to meet set goals or
achieve solutions to societal needs with regards to goods and services.
Division of Economics:
Microeconomics studies the small picture -- the behavior of
individuals and companies and the market for each type of
product. For example, microeconomists study the influence of
supply and demand on the price of shoes. Although "micro" is a
prefix meaning "small," the worldwide market for a particular
product, such as wheat, is also of interest to microeconomists.
Microeconomics is based on the assumptions of Adam Smith, an
18th-century philosopher who is widely considered to be the
father of economics, wherein market conditions -- supply,
demand, production and selling -- are in equilibrium, and, if
perturbed, quickly return to equilibrium. Everyday concerns, such
as price supports, taxes and minimum wages, are part of
microeconomics, according to G. Chris Rodrigo of the
International Monetary Fund.

Macroeconomics studies the function of the economy of a

nation as a whole. Its domain includes how government policies
and the markets for various products affect inflation,
employment and economic growth. However, the macro side also
extends beyond national borders because international trade and
investment impact the economies of many nations. Important
areas of study in macroeconomics include short- and long-term
trends. Macroeconomics originated with John Maynard Keynes in
his attempts to explain the "market failure" that characterized
the Great Depression, according to Rodrigo.

History of Economics:
Evolution of Economics as a Discipline

A brief History of Economics:

The modern Economics, which we still study now, is the result of the efforts
of ancient or Pre classical (384BC-1776), classical (1776-1871) , Neoclassical
(1871-Today) and Islamic Economists.

Ancient or Pre classical (384BC-1776):

The study of the economy in western civilization was begun largely
with the Greeks, particularly Aristotle (384-322 BC) and Xenophon (420?-
355? BC). The ancient economic thinkers concerned with the theories of
money, Taxation, usury, property rights, Entrepreneurship, Price differentials,
Justice in economic exchange and analyzed the impact of ethics in
economics.
 Famous economists of the ancient school include St. Thomas
Aquinas(1225-1274?),John Duns Scotus (1265-1308), Jean Buridan(1295
1358), Jean Buridan, (1295 1358),Nicole de Oresme, (1320-1382),Gabriel
Biel, (1425-1495), Sir William Petty (1623-1687).

Classical (1776-1871):

The classical economists developed the theories about how markets

and market economies work focusing the dynamics of economic growth
which stressed economic freedom and promoted ideas such as laissez-faire
and free competition. They introduced the labor theory of value, theory of
distribution (Smith),, Principles of Political Economy and Taxation((Ricardo
1817, Mill 1848), the theory of surplus value(Karl Marx), principle of
comparative advantage ,international-trade theory (Ricardo) and Monetary
theories.

Famous economists of the classical school include Adam Smith, David

Ricardo, W. Jevons, Jean-Baptiste Say, John Stuart Mill, Thomas Malthus,
Professor Pigou, and Alfred Marshall.

Neoclassical (1871-Today):

Neoclassical economists first introduced the theories of Rationality &

individual preferences, utility maximization (Utilitarianism, Jeremy Bentham)
and Information economics, Theories of market forms and industrial
organization, general equilibrium theory, indifference curves and the theory
of ordinal utility. Neoclassical economics also increased the use of
mathematical equations in the study of various aspects of the economy.

Famous economists of the Neoclassical school are William Stanley

Jevons (Theory of Political Economy (1871), Carl Menger (Principles of
Economics (1871), Leon Walras (Elements of Pure Economics (1874 1877),
Joan Robinson (The Economics of Imperfect Competition (1933), Edward H.
Chamberlin (the Theory of Monopolistic Competition (1933), Paul Samuelson
and so on.

Islamic Economics:

The practice of Islamic Economics was begun in the state of Medina in

the 6th century. After that, the process of Development of this discipline was
handled by the different scholars and Economists in different centuries.
many of them are Abu Yusuf (731-798), Al Farabi (873-950), Al Ghazali
(1058-1111), Al mawaridi (1675-1158), Nasir Al-Din Al-Tusi (1201-1274), Ibn
Taymiyyah (1263-1328), Ibn Khaldun (1334-1406) History of the World (Kitab
al-Ibar), Asaad Davani (1444). They amplified the Ideas of consumer theory,
supply and demand, Elasticity, Taxation (Khaldun-Laffer Curve (the
relationship between tax rates and tax revenue) etc in the light of Islamic
Economics. Ibn Khaldun was considered as a Forerunner of modern
economics.

The tools of Islamic economics are also employed in modern economics

by some economic thinkers. Among of them, the contributions of M .Umer
chapra (Islam &economic challenges), Monzer Kahf. Najat Ullah Siddiqui, M.A.
Mannan, Fahim Khan,Anas Zarqa are well known to the recent world.

The basic Economic problem:

The relationship between scarcity and choices can be seen in many
everyday examples. For instance, when a consumer contemplates a
purchase, he must make a choice between buying the object and losing the
money spent on it, or not obtaining the object and keeping the money. In
either case, something is gained and something is lost. The thing that is lost
or foregone when making a choice is known as the opportunity cost, another
basic economic concept.
Conversely, if there was no scarcity, there would be no need to make choices
that involve opportunity costs. For example, if there was a machine that
could produce anything that a person desired, then the only limit to what
that person could own would be the person's imagination. It is easy to see
that money would not be necessary if such a machine existed, and thus the
science of economics would be radically altered and cease to exist in its
current state. This is why scarcity is considered to be the fundamental
problem of economics.

The Economic system and model:

The Models
Scarcity forces people to make economic choices about how to use
their resources. Throughout history people working alone, or in groups, have
come to grips with this reality by forming economic systems. An economic
system is the sum total of all economic activity that takes place within a
society. That is, economic systems are comprised not only of the tangible
economic institutions such as business firms, banks, and stock exchanges,
but also the more subtle nuances that underlie business activity such as
values, practices, customs, and traditions.
Economic systems also answer the three basic economic questions.
What goods and services should be produced and in what quantity? How
should these products be produced? For whom should these products be
produced? Responses to the basic economic questions help distinguish
between different types of economic systems: traditional economies,
command economies, and market economies. In reality, virtually all
economies today are mixed economieseconomies that adopt features
mainly from the command and market models.
The Economic System:
An economic system is a system of production, resource allocation, and
distribution of goods and services within a society or a given geographic area. It
includes the combination of the various institutions, agencies, entities, decision-
making processes, and patterns of consumption that comprise the economic
structure of a given community. As such, an economic system is a type of social
system. The mode of production is a related concept. All economic systems have
three basic questions to ask: what to produce, how to produce and in what
quantities, and who receives the output of production.

The study of economic systems includes how these various agencies and
institutions are linked to one another, how information flows between them,
and the social relations within the system (including property rights and the
structure of management).

The analysis of economic systems traditionally focused on the dichotomies

and comparisons between market economies and planned economies, and
on the distinctions between capitalism and socialism. Subsequently, the
categorization of economic systems expanded to include other topics and
models that do not conform to the traditional dichotomy. Today the dominant
form of economic organization at the world level is based on market-oriented
mixed economies.

4 Types of Economic System:

1. Traditional Economic System
A traditional economic system is the best place to start because it is, quite
literally, the most traditional and ancient type of economy in the world.
There are certain elements of a traditional economy that those in more
advanced economies, such as Mixed, would like to see return to prominence.
Where Tradition Is Cherished: Traditional economies still produce products
and services that are a direct result of their beliefs, customs, traditions,
religions, etc. Vast portions of the world still function under a traditional
economic system. These areas tend to be rural, second- or third-world, and
closely tied to the land, usually through farming. However, there is an
increasingly small population of nomadic peoples, and while their economies
are certainly traditional, they often interact with other economies in order to
sell, trade, barter, etc. Learn about the complexities of globalization and how
it shapes economic relationships and affects cultures with this great class on
the geography of globalization.
Minimal Waste: Traditional economies would never, ever, in a million years
see the type of profit or surplus that results from a market or mixed
economy. In general, surplus is a rare thing. A third-world and/or indigenous
country does not have the resources necessary (or if they do, they are
controlled by wealthier economies, often by force), and in many cases any
surplus is either distributed, wasted, or paid to some authority that has been
given power.
Advantages And Disadvantages: Certainly one of the most obvious
advantages is that tradition and custom is preserved while it is virtually non-
existant in market/mixed economies. There is also the fact that each
member of a traditional economy has a more specific and pronounced role,
and these societies are often very close-knit and socially satisfied. The main
disadvantage is that traditional economies do not enjoy the things other
economies take for granted: Western medicine, centralized utilities,
technology, etc. But as anyone in America can attest, these things do not
guarantee happiness, peace, social or, most ironically of all, economic
stability.
2. Command Economic System
In terms of economic advancement, the command economic system is the
next step up from a traditional economy. This by no means indicates that it is
fairer or an exact improvement; there are many things fundamentally wrong
with a command economy.
Centralized Control: The most notable feature of a command economy is
that a large part of the economic system is controlled by a centralized
power; often, a federal government. This kind of economy tends to develop
when a country finds itself in possession of a very large amount of valuable
resource(s). The government then steps in and regulates the resource(s).
Often the government will own everything involved in the industrial process,
from the equipment to the facilities.
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CFA Level 1 Economics curriculum.
Supposed Advantages: You can see how this kind of economy would, over
time, create unrest among the general population. But there are actually
several potential advantages, as long as the government uses intelligent
regulations. First of all, a command economy is capable of creating a healthy
supply of its own resources and it generally rewards its own people with
affordable prices (but because it is ultimately regulated by the government,
it is ultimately priced by the government). Still, there is often no shortage of
jobs as the government functions similarly to a market economy in that it
wants to grow and grow upon its populace.
Hand In The Cookie Jar: Interestingly or maybe, predictably the
government in a command economy only desires to control its most valuable
resources. Other things, like agriculture, are left to be regulated and run by
the people. This is the nature of a command economy and many communist
governments fall into this category.
You should also consider this micro and macro economics program. Its been
approved by the CFA institute and focuses on the impact of economic
variables on the financial market and industry.
3. Market Economic System
A market economy is very similar to a free market. The government does not
control vital resources, valuable goods or any other major segment of the
economy. In this way, organizations run by the people determine how the
economy runs, how supply is generated, what demands are necessary, etc.
Capitalism And Socialism: No truly free market economy exists in the
world. For example, while America is a capitalist nation, our government still
regulates (or attempts to regulate) fair trade, government programs, moral
business, monopolies, etc. etc. The advantage to capitalism is you can have
an explosive economy that is very well controlled and relatively safe. This
would be contrasted to socialism, in which the government (like a command
economy) controls and owns the most profitable and vital industries but
allows the rest of the market to operate freely; that is, price is allowed to
fluctuate freely based on supply and demand. If you want to know how the
global economy works and the role you play in it, check out this sweet class
on Economics Without Boundaries.
Market Economy And Politics: Arguably the biggest advantage to a
market economy (at least, outside of economic benefits) is the separation of
the market and the government. This prevents the government from
becoming too powerful, too controlling and too similar to the governments of
the world that oppress their people while living lavishly on controlled
resources. In the same way that separation of church and state has been to
vital to Americas social success, so has a separation of market and state
been vital to our economic success. Yes, there is something wary about a
system which to be successful must foster constant growth, but as a result
progress and innovation have occurred at such incredible rates as to affect
the way the world economy functions.
4. Mixed Economic System
A mixed economic system (also known as a Dual Economy) is just like it
sounds (a combination of economic systems), but it primarily refers to a
mixture of a market and command economy (for obvious reasons, a
traditional economy does not typically mix well). As you can imagine, many
variations exist, with some mixed economies being primarily free markets
and others being strongly controlled by the government. Learn more about
an essential part of our economy with this free post on understanding the
stock market.
Benefits Of A Mixed Economy: In the most common types of mixed
economies, the market is more or less free of government ownership except
for a few key areas. These areas are usually not the resources that a
command economy controls. Instead, as in America, they are the
government programs such as education, transportation, USPS, etc. While all
of these industries also exist in the private sector in America, this is not
always the case for a mixed economy.
Disadvantages Of A Mixed Economy: While a mixed economy can lead to
incredible results (America being the obvious example), it can also suffer
from similar downfalls found in other economies. For example, the last
hundred years in America has seen a rise in government power. Not just in
imposing laws and regulations, but in actually gaining control, becoming
more difficult to access while simultaneously becoming less flexible. This is a
common tendency of mixed economies.
Please Respect The Thin Line: A current, pivotal debate between
Democrats and Republicans is the amount of governmental control. Can a
true balance exist? Where should there be more government regulation?
Where should there be less? These questions have no real answer; it is
subjective, and therefore only a relatively small portion of the population will,
at any given time, agree with the state of a mixed economy. It must be a
strong form of government indeed to avoid collapsing under this constant
pressure.
Chapter II The Demand and Supply concepts
Market:
A market is any arrangement that enables buyers and sellers to get
information and do business with each other.
A competitive market is a market that has many buyers and many sellers
so no single buyer or seller can influence the price.
The money price of a good is the amount of money needed to buy it.
The relative price of a goodthe ratio of its money price to the money
price of the next best alternative goodis its opportunity cost.

Demand:
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
The quantity demanded of a good or service is the amount that
consumers plan to buy during a particular time period, and at a particular
price.
The Law of Demand
The law of demand states:
Other things remaining the same, the higher the price of a good, the
smaller is the quantity demanded; and the lower the price of a good, the
larger is the quantity demanded.
The law of demand results from:
Substitution Effect: When the relative price (opportunity cost) of a
good or service rises, people seek substitutes for it, so the quantity
demanded of the good or service decreases.

Income Effect: When the price of a good or service rises relative to

income, people cannot afford all the things they previously bought, so the
quantity demanded of the good or service decreases.
Demand Curve and Demand Schedule
The term demand refers to the entire relationship between the price
of the good and quantity demanded of the good.
A demand curve shows the relationship between the quantity
demanded of a good and its price when all other influences on consumers
planned purchases remain the same.
Demand Curve for energy bars:

A rise in the price, other things remaining the same, brings a decrease
in the quantity demanded and a movement up along the demand curve.
A fall in the price, other things remaining the same, brings an increase
in the quantity demanded and a movement down along the demand curve.
Willingness and Ability to Pay
A demand curve is also a
willingness-and-ability-to-pay curve.
The smaller the quantity available,
the higher is the price that someone is
willing to pay for another unit.
Willingness to pay measures
marginal benefit.
A Change in Demand
Six main factors that change demand are:
Prices of Related Goods-
substitute is a good that can be used in place of another good.
complement is a good that is used in conjunction with another
good.
When the price of substitute for an energy bar rises or when the
price of a complement of an energy bar falls, the demand for energy
bars increases.
Expected Future Prices
If the expected future price of a good rises, current demand for the
good increases and the demand curve shifts rightward.
Income
When income increases, consumers buy more of most goods and the
demand curve shifts rightward.
normal good is one for which demand increases as income
increases.
inferior good is a good for which demand decreases as income
increases.
Expected Future Income and Credit
When expected future income increases or when credit is easy to
obtain, the demand might increase now.
Population
The larger the population, the greater is the demand for all goods.
 Preferences
People with the same income have different demands if they have
different preferences.

Figure shows an increase in demand.

Because an energy bar is a normal
good, an increase in income increases the
demand for energy bars.

A Change in the Quantity

Demanded Versus a Change in Demand
Figure illustrates the distinction
between a change in demand and a
change in the quantity demanded.

Movement Along the Demand Curve

When the price of the good changes and everything else remains
the same, the quantity demanded changes and there is a movement along
the demand curve.
 A Shift of the Demand Curve
If the price remains the same but one
of the other influences on buyers plans
changes, demand changes and the demand
curve shifts.

Supply:
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible to produce.
Supply reflects a decision about which technologically feasible items to
produce.
The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular price.

The Law of Supply

The law of supply states:
Other things remaining the same, the higher the price of a good, the
greater is the quantity supplied; and the lower the price of a good, the
smaller is the quantity
supplied.
The law of supply results from the general tendency for the marginal
cost of producing a good or service to increase as the quantity produced
increases.
 Producers are willing to supply a good only if they can at least cover
their marginal cost of production.
Supply Curve and Supply Schedule
The term supply refers to the entire
relationship between the quantity supplied and
the price of a good.
The supply curve shows the relationship
between the quantity supplied of a good and its
price when all other influences on producers
planned sales remain the same.
Figure shows a supply curve of energy
bars.
A rise in the price of an energy bar, other things remaining the same,
brings an increase in the quantity supplied.

Minimum Supply Price

A supply curve is also a minimum-supply-
price
curve.
As the quantity produced increases,
marginal cost increases.
The lowest price at which someone is
willing to sell an additional unit rises.
This lowest price is marginal cost.

A Change in Supply
The six main factors that change supply of a good are:

a. The prices of factors of production

b. The prices of related goods produced
c. Expected future prices
d. The number of suppliers
e. Technology
f. State of nature
 Figure shows an increase in supply.
An advance in the technology for producing
energy bars increases the supply of energy bars
and shifts the supply curve rightward.

A Change in the Quantity Supplied

Versus a Change in Supply
Figure illustrates the distinction
between a change in supply and a change in
the quantity supplied.

Movement Along the Supply Curve

When the price of the good changes
and other influences on sellers plans
remain the same, the quantity supplied
changes and there is a movement along
the supply curve.

A Shift of the Supply Curve

 If the price remains the same but
some other influence on sellers plans
changes, supply changes and the supply
curve shifts.
The price system:
In economics, a price system is a component of any economic system
that uses prices expressed in any form of money for the valuation and
distribution of goods and services and the factors of production. Except for
possible remote and primitive communities, all modern societies use price
systems to allocate resources, although price systems are not used
exclusively for all resource allocation decisions.
A price system may be either a fixed price system where prices are
administered by a government body, or it may be a free price system where
prices are left to float "freely" as determined by supply and demand
uninhibited by regulations. A mixed price system involves a combination of
both administered and unregulated prices.

The role of the government:

The government supports the economy when it facilitates transport
and communication via the postal service and highways and establishes the
police and military to safeguard life and property. Local or state governments
support the economy by funding education and building roads.
Governments devise rules that ensure businesses operate in the best
interests of the public. For instance, the government may allow a monopoly
to operate in a market or industry with little competition, such as in utility
services, but limit the companys freedom to increase prices to avoid hurting
consumers who would have no recourse.
A government devises monetary policies to keep the economy growing
at the desired pace. By controlling circulation of money, adjusting interest
rates and tax rates, and controlling access to credit, the government can
control the inflation or the decline of the economy. Likewise, the economy is
affected when the government gives certain businesses preferential
treatment, such as by limiting foreign competition in a specific market or
imposing higher taxes on imports to boost domestic production.
Chapter III Basic Element of demand and supply
Market Equilibrium:
Equilibrium is a situation in which opposing forces balance each
other. Equilibrium in a market occurs when the price balances the plans of
buyers and sellers.
The equilibrium price is the price at which the quantity demanded
equals the quantity supplied.
The equilibrium quantity is the quantity bought and sold at the
equilibrium price.

Price regulates buying and selling plans.

Price adjusts when plans dont match.
Price as a Regulator
If the price is $2.00 a bar, the quantity supplied exceeds the quantity
demanded.
There is a surplus of 6 million energy bars.
If the price is $1.00 a bar, the quantity demanded exceeds the quantity
supplied.
There is a shortage of 9 million energy bars.
If the price is $1.50 a bar, the quantity demanded equals the quantity
supplied.
There is neither a shortage nor a surplus of energy bars.
Price Adjustments
At any price above the equilibrium price, a surplus forces the price
down.
At any price below the equilibrium price, a shortage forces the price
up.
At the equilibrium price, buyers plans and sellers plans agree and the
price
doesnt change until some event changes either demand or supply.
Chapter IV Demand Supple Elasticity
Elasticity:
In economics, elasticity is the measurement of how responsive an
economic variable is to a change in another. It gives answers to questions
such as:

"If I lower the price of a product, how much more will sell?"

"If I raise the price of one good, how will that affect sales of this other
good?"
"If the market price of a product goes down, how much will that affect
the amount that firms will be willing to supply to the market?"
An elastic variable (with elasticity value greater than 1) is one which
responds more than proportionally to changes in other variables. In contrast,
an inelastic variable (with elasticity value less than 1) is one which changes
less than proportionally in response to changes in other variables. A variable
can have different values of its elasticity at different starting points: for
example, the quantity of a good supplied by producers might be elastic at
low prices but inelastic at higher prices, so that a rise from an initially low
price might bring on a more-than-proportionate increase in quantity supplied
while a rise from an initially high price might bring on a less-than-
proportionate rise in quantity supplied.
Elasticity can be quantified as the ratio of the percentage change in one
variable to the percentage change in another variable, when the latter
variable has a causal influence on the former. A more precise definition is
given in terms of differential calculus. It is a tool for measuring the
responsiveness of one variable to changes in another, causative variable.
Elasticity has the advantage of being a unitless ratio, independent of the
type of quantities being varied. Frequently used elasticities include price
elasticity of demand, price elasticity of supply, income elasticity of
demand, elasticity of substitution between factors of
production and elasticity of intertemporal substitution.
Elasticity is one of the most important concepts in neoclassical economic
theory. It is useful in understanding the incidence of indirect
taxation, marginal concepts as they relate to the theory of the firm,
and distribution of wealth and different types of goods as they relate to
the theory of consumer choice. Elasticity is also crucially important in any
discussion of welfare distribution, in particular consumer surplus, producer
surplus, or government surplus.
In empirical work an elasticity is the estimated coefficient in a linear
regression equation where both the dependent variable and the independent
variable are in natural logs. Elasticity is a popular tool among empiricists
because it is independent of units and thus simplifies data analysis.

Determinants:
Determinants of Demand
When price changes, quantity demanded will change. That is a
movement along the same demand curve. When factors other than price
changes, demand curve will shift. These are the determinants of the demand
curve.
1. Income: A rise in a persons income will lead to an increase in demand
(shift demand curve to the right), a fall will lead to a decrease in demand for
normal goods. Goods whose demand varies inversely with income are called
inferior goods (e.g. Hamburger Helper).
2. Consumer Preferences: Favorable change leads to an increase in demand,
unfavorable change lead to a decrease.
3. Number of Buyers: the more buyers lead to an increase in demand; fewer
buyers lead to decrease.
4. Price of related goods:
a. Substitute goods (those that can be used to replace each other): price of
substitute and demand for the other good are directly related.
Example: If the price of coffee rises, the demand for tea should increase.
b. Complement goods (those that can be used together): price of
complement and demand for the other good are inversely related.
Example: if the price of ice cream rises, the demand for ice-cream toppings
will decrease.
5. Expectation of future:
a. Future price: consumers current demand will increase if they expect
higher future prices; their demand will decrease if they expect lower future
prices.
b. Future income: consumers current demand will increase if they expect
higher future income; their demand will decrease if they expect lower future
income.
Determinants of Suppply
When price changes, quantity supplied will change. That is a
movement along the same supply curve. When factors other than price
changes, supply curve will shift. Here are some determinants of the supply
curve.
1. Production cost: Since most private companies goal is profit
maximization. Higher production cost will lower profit, thus hinder supply.
Factors affecting production cost are: input prices, wage rate, government
regulation and taxes, etc.
2. Technology: Technological improvements help reduce production cost and
increase profit, thus stimulate higher supply.
3. Number of sellers: More sellers in the market increase the market supply.
4. Expectation for future prices: If producers expect future price to be
higher, they will try to hold on to their inventories and offer the products to
the buyers in the future, thus they can capture the higher price.

Econimic Significance:
A finding in economics may be said to be of economic significance (or
substantive significance) if it shows a theory to be useful or not useful, or if
has implications for scientific interpretation or policy practice (McCloskey and
Ziliak, 1996).

Elasticity of Supply:
Price elasticity of supply
The price elasticity of supply measures how the amount of a good that
a supplier wishes to supply changes in response to a change in price. In a
manner analogous to the price elasticity of demand, it captures the extent of
horizontal movement along the supply curve relative to the extent of vertical
movement. If the price elasticity of supply is zero the supply of a good
supplied is "totally inelastic" and the quantity supplied is fixed.
Elasticities of scale
Elasticity of scale or output elasticity measures the percentage change
in output induced by a collective percent change in the usages of all
inputs. A production function or process is said to exhibit constant returns to
scale if a percentage change in inputs results in an equal percentage in
outputs (an elasticity equal to 1). It exhibits increasing returns to scale if a
percentage change in inputs results in greater percentage change in output
(an elasticity greater than 1). The definition of decreasing returns to scale is
analogous.

Types of Responses of Producers to Price Changes:

Background- This paper reports on a range of laboratory-style studies
into the effects of price differences and price changes. This is in the scientific
tradition of artificial laboratory work which would later be followed by
validation and calibration studies. Hall or Central Location Tests were
designed to investigate whether there are any results about pricing that can
be generalised across different conditions, such as for products, brands, price
levels, higher and lower price and so on. The background is that there seems
to be no body of general understanding about how pricing works. It is
difficult to learn about pricing from real life. This is because in-market prices
either dont change much, or tend to change together. And they are usually
complicated by other marketing activity. Disentangling the various factors
and attributing effects is difficult. Pricing experts stress that price is very
sensitive to context but without systematic findings. Some say that
successful prediction of pricing effects depends on recreating the
circumstances as accurately as possible (Blamires 1997), but we (and others
e.g. Nagle and Holden 1995) have doubts. Other researchers build price into
complex logit-style regression models, with many parameters. Thus Mela,
Gupta and Lehmann (1997) have 348 plus and yet have to make simplifying
assumptions (such as that elasticities are the same for price rises and cuts).
If a model fits better with a certain variable included, it is considered to have
a causal role in the choice process. But this modelling process usually reveals
little about the size of the effect, and nothing about how it may apply in
other cases. In contrast, our approach tries to be both simpler and more
general. The aim was to establish whether, under experimental conditions,
there are consistent patterns in consumers brand choice when faced with
price changes. What is special is that we did not just do one or two tests, but
30 major ones with 4000 respondents, using 25 products (including
groceries, durables and services), 100 brands, 1,000+ price scenarios, in 3
countries, with various major and other minor technique variations. This
could be done because compared with in-store tests or test markets,
individual Hall Tests are more flexible and less expensive. The main outcome
was the range of consistent results that we are describing here.
 A Brief Summary of Method- The methodology, and the results are
described in much greater depth in our working paper (Scriven and
Ehrenberg 1999). We used several versions of a traditional Hall or Central
Location test procedure to measure consumers expressed intentions to buy
a brand. We did not try to measure sales directly, or seek to mimic normal
buying situations. Instead, the aim was to expose consumers to various
choice situations under a variety of controlled conditions. Individual
consumers, who were mostly buyers of the product category, visited a series
of tables where the same four brands were displayed at various controlled
prices. At each table they had simply to respond to the on-going question
Which one of these would you buy, if any? Initially, the four prices were set
at implicitly normal prices N, mainly reflecting available in-market prices
(and therefore not necessarily the same for each brand). At successive
tables, the price changed by say plus or minus 15% from N, for any one of
the four brands in turn, whilst the other three brands were displayed at their
initial normal N price. These price changes were usually not highlighted, but
we also experimented with situations where the price changes would be
either more or less self-evident to participants. We calculated price
elasticities (E) for the numbers of participants who chose the given brand at
its normal price N and at its changed price (E is the percent change in
brand choice or sales, divided by the percent change in the brands price
see working paper for precise calculation. Elasticities were all negative: we
call 6 a bigger E than 3.) The main elasticities thus produced were
summarised as averages across various combinations of (i) product
categories, (ii) brands, (iii) 15% higher or lower prices, (iv) relative price
positions (e.g. passing a reference point or not), (v) subgroups of
demographic, usership, and experimental variables. Within this we have
checked in particular the consistency of the detailed findings across the
different tests, products, brands, etc.
Findings- Throughout the tests, there have been five brand-related
factors that consistently led to bigger price elasticities (e.g. bigger for
smaller bands). There were also three demographic or usage sub-groups who
consistently had bigger elasticities. These factors sometimes combined in
complex hierarchical ways that we do not yet fully understand. Instead of
pricing effects being an idiosyncratic characteristic of a brand, the
experimental results show how there can be consistent and simplifying
patterns. The level of elasticities was mostly not dramatically higher than the
2 or so at times reported in real-life studies (Bolton 1989; Tellis 1986). But
some much higher values occurred which can often be accounted for by the
pricing context (e.g when all the base N prices are the same).
Discussion- Individual price elasticities for different brands and price
changes can appear varied and irregular. We have shown that pricing is not
too complex for highly consistent patterns to have emerged. In particular,
responses to price changes depend more on the context than on the brand
as such. Five main factors have consistently affected the level of elasticities
found: brand size, relative position to a reference price, how close
competitive prices were to start with, whether price is moving higher or
lower, and how overt the price change is. Not everyone responds to price
changes (if elasticity is 2 say, then for a 15% price increase, 70% of buyers
(100-2x15) stay with their choice). Light brand buyers, self-claimed price
conscious and younger consumers are consistently more responsive to price
changes. Some of the results may seem unsurprising. But so might the
opposite findings (e.g. if we had found that heavy brand buyers were more
price-sensitive: they would gain more from a lower price and lose more from
a higher one). Some have at least been touched on in isolation previously
(e.g. the seminal Guadagni and Little paper on logit modelling (1983) notes
in passing that big brands have lower price elasticities). There is an
extensive literature on reference prices, and transaction effects (as in our
overt price effect). We have shown across a wide range of results, which
factors are consistently important, with some measure of by how much.

Determinants of Supply Elasticity:

A product's supply is considered inelastic if changes in its market price
have little or no impact on the amount of the product that is supplied.
Agricultural products, for example, are relatively inelastic because farmers
cannot react to a price change by increasing supply, since the supply has a
lengthy production period.

Theory of Consumer behavior:

1. Rationality:
The consumer is assumed to be rational he aims at the maximization
of his utility, given his income and market prices. It is assumed he has full
knowledge (certainty) of all relevant information.
2. Utility is ordinal:
It is taken as axiomatically true that the consumer can rank his
preferences (order the various baskets of goods) according to the
satisfaction of each basket. He need not know precisely the amount of
satisfaction. It suffices that he expresses his preference for the various
bundles of commodities. It is not necessary to assume that utility is
cardinally measurable. Only ordinal measurement is required.
3. Diminishing marginal rate of substitution:
 Preferences are ranked in terms of indifference curves, which are
assumed to be convex to the origin. This implies that the slope of the
indifference curves increases. The slope of the indifference curve is called
the marginal rate of substitution of the commodities. The indifference-curve
theory is based, thus, on the axiom of diminishing marginal rate of
substitution.
4. The total utility of the consumer depends on the quantities of the
commodities consumed
U = f (q1, q2,, qx, qy,.. qn)
5. Consistency and transitivity of choice:
It is assumed that the consumer is consistent in his choice, that is, if in
one period he chooses bundle A over B, he will not choose B over A in
another period if both bundles are available to him.

Budget Line:
The Budget Line, also called as Budget Constraint shows all the
combinations of two commodities that a consumer can afford at given
market prices and within the particular income level.
We know that the higher the indifference curve, the higher is the
utility, and thus, utility maximizing consumer will strive to reach the highest
possible Indifference curve. But, he has two strong constraints: limited
income and given the market price of goods and services. The income in
hand is the main constraint (budgetary) that decides how high a consumer
can go on the indifference map. In a two commodity model, the budgetary
constraint can be expressed in the form of the budget equation:
Px . Qx + Py . Qy =M
Where,
Px and Py are the prices of commodity X and Y and Qx, and Qy is their
respective quantities.
M= consumers money income
The Budget equation states that the consumers expenditure on
commodity X and Y cannot exceed his money income (M). Thus, the
quantities of commodities X and Y that a consumer can buy from his income
(M) at given prices Px and Py can be calculated through the budget equation
given below:
The values of Qx
and Qy are plotted
on the X and Y
axis, and a line
with a negative
slope is drawn
connecting the
points so obtained.
This line is called
the budget line or price line.

The Equilibrium of Consumer:

The point at which a consumer reaches optimum utility, or satisfaction,
from the goods and services purchased given the constraints
of income and prices. This is based on
the assumption that consumers attempt to get maximum utility from
their purchases and that competition exists for the item in
question. Equilibrium is reached when the consumer purchases the
assortment of goods which best meets his satisfaction requirements given
his financial constraints.
Chapter V Production and Cost
The Concept of Production:
This concept is the oldest of the concepts in business. It holds that
consumers will prefer products that are widely available and
inexpensive. Managers focusing on this concept concentrate on achieving
high production efficiency, low costs, and mass distribution. They assume
that consumers are primarily interested in product availability and low
prices. This orientation makes sense in developing countries, where
consumers are more interested in obtaining the product than in its features.
When the production concept was found, a production orientation
business dominated the market from the beginning of Capitalism to the mid
1950s. During the era of the Production concept, Business concerned itself
primarily with production, manufacturing, and efficiency issues. This view
point was encapsulated in Says Law which states Supply creates its own
demand (from the French economist Jean Baptiste Say.) To put it another
way, If a product is made, somebody will want to buy it. The reason for the
predominance of this orientation is there was a shortage of manufactured
goods (relative to demand) during this period so goods sold easily.
The basic proposition of the production concept is that customers will
choose products and services that are widely available and are of low cost.
So business is mainly concerned with making as many units as possible. By
concentrating on producing maximum volumes, such a business aims to
maximise profitability by exploiting economies of scale. Managers try to
achieve higher volume with low cost and intensive distribution strategy. This
seems a viable strategy in a developing market where market expansion is
the survival strategy for the business. Companies interested to take the
benefit of scale economies purse this kind of orientation.
In a production-orientated business, the needs of customers are
secondary compared with the need to increase output. Such an approach is
probably most effective when a business operates in very high growth
markets or where the potential for economies of scale is significant. It is
natural that the companies cannot deliver quality products and suffer from
problems arising out of impersonal behavior with the customers.
Chapter VI Essential of Production
Factors of Production:
The factors of production are resources that are the building blocks of the
economy; they are what people use to produce goods and services.
Economists divide the factors of production into four categories: land, labor,
capital, and entrepreneurship.

The first factor of production is land, but this includes any natural resource
used to produce goods and services. This includes not just land, but anything
that comes from the land. Some common land or natural resources are
water, oil, copper, natural gas, coal, and forests. Land resources are the raw
materials in the production process. These resources can be renewable, such
as forests, or nonrenewable such as oil or natural gas. The income that
resource owners earn in return for land resources is called rent.

The second factor of production is labor. Labor is the effort that people
contribute to the production of goods and services. Labor resources include
the work done by the waiter who brings your food at a local restaurant as
well as the engineer who designed the bus that transports you to school. It
includes an artist's creation of a painting as well as the work of the pilot
flying the airplane overhead. If you have ever been paid for a job, you have
contributed labor resources to the production of goods or services. The
income earned by labor resources is called wages and is the largest source of
income for most people.

The third factor of production is capital. Think of capital as the machinery,

tools and buildings humans use to produce goods and services. Some
common examples of capital include hammers, forklifts, conveyer belts,
computers, and delivery vans. Capital differs based on the worker and the
type of work being done. For example, a doctor may use a stethoscope and
an examination room to provide medical services. Your teacher may use
textbooks, desks, and a whiteboard to produce education services. The
income earned by owners of capital resources is interest.

The fourth factor of production is entrepreneurship. An entrepreneur is a

person who combines the other factors of production - land, labor, and
capital - to earn a profit. The most successful entrepreneurs are innovators
who find new ways produce goods and services or who develop new goods
and services to bring to market. Without the entrepreneur combining land,
labor, and capital in new ways, many of the innovations we see around us
would not exist. Think of the entrepreneurship of Henry Ford or Bill Gates.
Entrepreneurs are a vital engine of economic growth helping to build some of
the largest firms in the world as well as some of the small businesses in your
neighborhood. Entrepreneurs thrive in economies where they have the
freedom to start businesses and buy resources freely. The payment to
entrepreneurship is profit.

You will notice that I did not include money as a factor of production. You
might ask, isn't money a type of capital? Money is not capital as economists
define capital because it is not a productive resource. While money can be
used to buy capital, it is the capital good (things such as machinery and
tools) that is used to produce goods and services. When was the last time
you saw a carpenter pounding a nail with a five dollar bill or a warehouse
foreman lifting a pallet with a 20 dollar bill? Money merely facilitates trade,
but it is not in itself a productive resource.

Remember, goods and services are scarce because the factors of production
used to produce them are scarce. In case you have forgotten, scarcity is
described as limited quantities of resources to meet unlimited wants.
Consider a pair of denim blue jeans. The denim is made of cotton, grown on
the land. The land and water used to grow the cotton is limited and could
have been used to grow a variety of different crops. The workers who cut and
sewed the denim in the factory are limited labor resources who could have
been producing other goods or services in the economy. The machines and
the factory used to produce the jeans are limited capital resources that could
have been used to produce other goods. This scarcity of resources means
that producing some goods and services leaves other goods and services
unproduced.

It's time to test your knowledge with a little game I like to call, Name That
Resource. I will say the name of an item and you will identify it as one of the
four possible resources that form the factors of production: land, labor,
capital, or entrepreneurship.

Coal... land

Forklift... capital

Factory... capital

Oil... land

Michael Dell... entrepreneur

It's time to wrap things up, but before we go, always remember that the four
factors of production - land, labor, capital, and entrepreneurship - are scarce
resources that form the building blocks of the economy.

Production of function:
In economics, a production function relates physical output of a
production process to physical inputs or factors of production. The production
function is one of the key concepts of mainstream neoclassical theories, used
to define marginal product and to distinguish allocative efficiency, the
defining focus of economics.The primary purpose of the production function
is to address allocative efficiency in the use of factor inputs in production and
the resulting distribution of income to those factors, while abstracting away
from the technological problems of achieving technical efficiency, as an
engineer or professional manager might understand it. Production function
denotes an efficient combination of inputs and outputs.
In macroeconomics, aggregate production functions are estimated to
create a framework in which to distinguish how much of economic growth to
attribute to changes in factor allocation (e.g. the accumulation of capital)
and how much to attribute to advancing technology. Some non-mainstream
economists, however, reject the very concept of an aggregate production
function

Factors of Production Classification:

A factor of production may be defined as "that good or service which is
required for production." A factor of production is indispensable for
production because without it no production is possible. It is customary to
attribute the process of production to four factors, land, labour, capital and
organisation.

Land
Land not only consists of mere surface of land but also includes all the
natural sources such as oceans, mountains, forests etc. Marshall defines land
as " By land is meant materials and forces which nature gives freely for
man's aid, in land, water, in air, light and heat." Thus land is a significant
part of production which facilitates in the production of goods and services in
one way or the other.
Labour
Labour refers to the act of working for some monetary benefits against
physical and mental activity. It does not comprise of any leisure activity. It
includes the services of a factory worker, any professional workers such as
engineers, doctors, teachers, lawyer etc. If a person paints or sings in order
to please someone or himself without any target or for monetary benefits he
won't be called a labour. But if he intends to sell the painting or sing against
any monetary reward then it involves labour. Thus labour forms an essential
aspect of production.

Capital
Capital means all human-made materials such as tools, equipments,
infrastructure, machinery, seeds, plants, modes of transportation such as
rail, road and air etc. In general it encompasses all affluences eliminating
land as land is utilised for supplementary production of affluence. Now-a-
days, capital not only includes physical capital but also involves human
capital which is defined as "process of increasing knowledge, the skills and
capacities of all people of the country." Human capital is more vital than the
physical capital since without human's interference the materialistic capital
cannot be utilised effectively. Prof. Galbraith defines as "We now get the
larger part of our industrial growth not from more capital investment but
from investment in men and improvements brought about by improved
men."

Organisation
The prime aspects of production such as land, labour and capital are
correspondingly nature, man and material modes of production. Without
these factors it is unfeasible to produce and making use of these factors
effectively there has to some source. This source is nothing but the
organisation which hires them from their owners by paying rent, salary and
interest and makes a decision upon the amount of each required for
production. Organisation refers to the services of an entrepreneur who
controls, organises and manages the policy of a firm, innovates and
undertakes all risks.

Criticisms
o Several economists have criticisms for the above factors of production
economist Benham has objected to a broader meaning of land as a
 factor of production. As per him, it is convenient to consider only land
as factor of production, rather than such elements as sunshine, climate
etc. which does not enter directly into costs. Likewise, it is incorrect to
group together the services of an untalented worker with that of
professionals. Yet again, there is tiny tip in syndicating mutually as
capital, as assorted as canals, diesel, seeds and machinery. It would
consequently, be more appropriate to chunk collectively all
standardized units, whether hectares of land, workers or capital goods
and to regard each group as an individual factor of production. This
method gives us a hefty integer of factors of production and each
group is regarded as a separate factor.

o Over and again, the distinction amidst land, labour and capital are not
apparent. To take land and capital, it is said that land is a gift of nature
whose supply cannot be amplified while capital is human made whose
supply is amendable. This is not correct for the reason that the supply
of land can also be greater than before by cleaning it, draining and
irrigating it and fertilising it by the pains of human and capital. The
supply of land does not consign to its area alone, but to its productivity.

o We might regard each unit of a factor as discrete from other units of

that factor, but one factor can be substituted for some other factor. For
instance, land can be used intensively by employing more labour or
more capital in the form of fertilisers, better seeds and superior
techniques. By doing so, we substitute labour or capital for land.
Likewise labour can be substituted for capital and capital for labour in a
factor. In the former case, labour intensive techniques are used. The
level of swap of one factor for another will, nevertheless depend on the
most competent scheme of production to be used relatively to the cost
of the factor to be substituted.

o Moreover, we find that land, labour and capital frequently get mingled
into one another and it is tricky to specify the involvement of each
individually. For example, when land is vacant canals are dug and
fences are erected, the efficiency of land enhances. But all these
development on land are feasible by making capital investments and
through labour. In such a condition, it is feasible to stipulate the
involvement of land, labour and capital escalating efficiency. Likewise,
the sum of money spent on cultivating and exercising workers is
integrated under capital. So when such workers produce articles by
 functioning machines in a factory, they put in their labour as well as
ability by using raw materials which are also the product of labour and
machines used on land. Thus it is hard to unravel the contribution of
land, labour and capital in such cases.

o The complexity begins as to whether the contribution of land, labour

and capital should be taken as such, or of their services. If the
community is to plan for the prospect or find out the production
possibilities open to it, then the contribution of the factors of
production should be measured. Keeping the outlook in view, land may
be put to more fruitful uses, labour may be trained for diverse
occupations requiring higher skills and capital may be used for
producing more roundabout means of production and machinery. Thus
"the central economic problem for any community is how to make the
best use of its labour and other resources and for this purpose the
community must consider the various alternatives. It must consider
what the men and the land and the capital might contribute towards
output if they were used in different ways and not merely what in fact
they are contributing now."

o Finally, it is habitual not to treat organisation as discrete from labour.

This is ambiguous and misjudges the role of the entrepreneur as a
factor of production. As a substance of statement, labour and
entrepreneur are quite dissimilar from each other. An entrepreneur is a
man of special managerial aptitude who controls, organises and
manages the entire business of a firm. It is he who utilizes all types of
workers and puts them at the places where they are the most
appropriate by quality of their education and training.
Significance
o The concept of the factor of production is of great significance in
modern economic study. It is used in the theory of production in which
the a range of combinations of factors of production help in generating
output when a firm functions under rising or declining costs in the
short-run and when the proceeds to scale boosts or shrinks in the long
run. Moreover, we can also know how the least cost combination of
factors can be attained by a firm.
 o The theory of cost of production also depends upon the combination of
factors engaged in business and the prices that are paid to them. From
the point of view of the theory of costs of production, factors of
production are divided as fixed factors are variable factors.

o Fixed factors are those whose costs do not vary with the variation in
output, such as machinery, tube well etc. Variable factors are those
whose quantities and costs vary with the variation in output. Larger
outputs entail larger quantities of labour, raw materials power etc. So
long as a firm covers the costs of production of the variable factors it
employs, it will persist to produce even if it fails to cover the costs of
production of the hired factors and sustains loss. But this is only
feasible in the short-run; in the long-run it must cover the costs of
production of both the fixed and variable factors. Thus the distinction
amidst fixed and variable factors is of much value for the theory of the
firm.

o Finally the concept of factor of production is used in elucidating the

theory of factor-pricing. For this idea, factors of production are divided
into specific and non-specific. A factor of production which is specific in
use earns a higher reward than a non-specific factor. This also solves
the problem of distribution of earnings to the various resource owners.

Law of Diminishing Return:

A concept in economics that if one factor of production (number of
workers, for example) is increased while other factors (machines and
workspace, for example) are held constant, the output per unit of the
variable factor will eventually diminish.
Although the marginal productivity of the workforce decreases as output
increases, diminishing returns do not mean negative returns until (in this
example) the number of workers exceeds the available machines or
workspace. In everyday experience, this law is expressed as "the gain is not
worth the pain."

Cost of Production:
Production cost refers to the cost incurred by a business when
manufacturing a good or providing a service. Production costs include a
variety of expenses including, but not limited to, labor, raw materials,
consumable manufacturing supplies and general overhead. Additionally, any
taxes levied by the government or royalties owed by natural resource
extracting companies are also considered production costs.

Economic Cost:
Economic cost is the combination of gains and losses of any goods that
have a value attached to them by any one individual. Economic cost is used
mainly by economists as means to compare the prudence of one course of
action with that of another. The goods to be taken into consideration are e.g.
money, time and resources.
The comparison includes the gains and losses precluded by taking a
course of action, as those of the course taken itself. Economic cost differs
from accounting cost because it includes opportunity cost.
Aspects of economic costs:

Variable cost: Variable costs are the costs paid to the variable input.
Inputs include labour, capital, materials, power and land and buildings.
Variable inputs are inputs whose use vary with output. Conventionally
the variable input is assumed to be labor.
Total variable cost (TVC) total variable costs is the same as
variable costs.

Fixed cost (TFC) fixed costs are the costs of the fixed assets those
that do not vary with production.
Total fixed cost (TFC)

Average cost (AC) average cost are total costs divided by output. AC
= TFC/q + TVC/q

Average fixed cost (AFC) = fixed costs divided by output. AFC

= TFC/q. The average fixed cost function continuously declines
as production increases.

Average variable cost (AVC) = variable costs divided by

output. AVC =TVC/q. The average variable cost curve is typically
U-shaped. It lies below the average cost curve and generally has
the same shape - the vertical distance between the average cost
curve and average variable cost curve equals average fixed
costs. The curve normally starts to the right of the y axis because
with zero production
 Marginal cost (MC)

Cost curves

The Relation between the Average Cost and Marginal

Cost:
The relationship between the marginal cost and average cost is the
same as that between any other marginal-average quantities. When
marginal cost is less than average cost, average cost falls and when
marginal cost is greater than average cost, average cost rises.
This marginal-average relationship is a matter of mathematical truism
and can be easily understood by a simple example. Suppose that a cricket
players batting average is 50. If in his next innings he scores less than 50,
say 45, then his average score will fall because his marginal (additional)
score is less than his average score.
If instead of 45, he scores more than 50, say 55, in his next innings,
then his average score will increase because now the marginal score is
greater than his previous average score. Again, with his present average
runs of 50, if he scores 50 also in his next innings, then his average score will
remain the same because now the marginal score is just equal to the
average score.
Likewise, suppose a producer is producing a certain number of units of
a product and his average cost is Rs. 20. Now, if he produces one unit more
and his average cost falls, it means that the additional unit must have cost
him less than Rs. 20. On the other hand, if the production of the additional
unit raises his average cast, then the marginal unit must have cost him more
than Rs. 20.
And finally, if as a result of production of an additional
unit, the average cost remains the same, then marginal unit
must have cost him exactly Rs. 20, that is, marginal cost and
average cost would be equal in this case.
On the other hand, if the marginal cost (MC) is below
the average cost (AC); average cost falls, that is, the marginal cost pulls the
average cost downwards. When marginal cost (MC) stands equal to the
average cost (AC), the average cost remains the same, that is, the marginal
cost pulls the average cost horizontally.
Now, take Fig. 19.5 where short-run average cost curve AC and
marginal cost curve MC are drawn. As long as short-run marginal cost curve
MC lies below short-run average cost curve, the average cost curve AC is
falling. When marginal cost curve MC lies above the average cost curve AC,
the latter is rising.
At the point of intersection L where MC
is equal to AC, AC is neither falling nor rising,
that is, at point L, AC has just ceased to fall
but has not yet begun to rise. It follows that
point L, at which the MC curve crosses the AC
curve to lie above the AC curve is the
minimum point of the AC curve. Thus,
marginal cost curve cuts the average cost
curve at the latters minimum point.
It is important to note that we cannot
generalise about the direction in which
marginal cost is moving from the way average cost is changing, that is, when
average cost is falling we cannot say that marginal cost will be falling too.
When average cost is falling, what we can say definitely is only that the
marginal cost will be below it but the marginal cost itself may be either rising
or falling.
Likewise, when average cost is rising, we cannot deduce that marginal
cost will be rising too. When average cost is rising, the marginal cost must be
above it but the marginal cost itself may be either rising or falling. Consider
Fig. 19.5 where up to the point K, marginal cost is falling as well as below the
average cost.
As a result, the average cost is falling. But beyond point K and up to
point L marginal cost curve lies below the average cost curve with the result
that the average cost curve is falling. But it will seen that between K and L
where the marginal cost is rising, the average cost is falling.
This is because though MC is rising between K and L, it is below AC. It
is therefore clear that when the average cost 4 is falling, marginal cost may
be falling or rising. This can also be easily illustrated by the example of
batting average.
Suppose a cricket players present batting average is 50. If in his next
innings he scores less than 50, say 45, his batting average will fall. But his
marginal score of 45, though less than the average score may itself have
risen.
For instance, he might have scored 40 in his previous innings so that
his present marginal score of 45 is greater than his previous marginal score.
Thus one cannot deduce about marginal cost as to whether it will be falling
or rising when average cost is falling or rising.

Economics of Scale:
In microeconomics, economies of scale are the cost advantages that
enterprises obtain due to size, output, or scale of operation, with cost per
unit of output generally decreasing with increasing scale as fixed costs are
spread out over more units of output.
Often operational efficiency is also greater with increasing scale,
leading to lower variable cost as well.
Economies of scale apply to a variety of organizational and business
situations and at various levels, such as a business or manufacturing unit,
plant or an entire enterprise. For example, a large manufacturing facility
would be expected to have a lower cost per unit of output than a smaller
facility, all other factors being equal, while a company with many facilities
should have a cost advantage over a competitor with fewer.
Some economies of scale, such as capital cost of manufacturing
facilities and friction loss of transportation and industrial equipment, have a
physical or engineering basis.
The economic concept dates back to Adam Smith and the idea of
obtaining larger production returns through the use of division of labor.
Diseconomies of scale are the opposite.
Economies of scale often have limits, such as passing the optimum
design point where costs per additional unit begin to increase. Common
limits include exceeding the nearby raw material supply, such as wood in the
lumber, pulp and paper industry. A common limit for low cost per unit weight
commodities is saturating the regional market, thus having to ship product
uneconomical distances. Other limits include using energy less efficiently or
having a higher defect rate.
Large producers are usually efficient at long runs of a product grade (a
commodity) and find it costly to switch grades frequently. They will therefore
avoid specialty grades even though they have higher margins. Often smaller
(usually older) manufacturing facilities remain viable by changing from
commodity grade production to specialty products.
Some of the economies of scale recognized in engineering have a
physical basis, such as the square-cube law, by which the surface of a vessel
increases by the square of the dimensions while the volume increases by the
cube. This law has a direct effect on the capital cost of such things as
buildings, factories, pipelines, ships and airplanes.
In structural engineering, the strength of beams increases with the
cube of the thickness.
Drag loss of vehicles like aircraft or ships generally increases less than
proportional with increasing cargo volume, although the physical details can
be quite complicated. Therefore, making them larger usually results in less
fuel consumption per ton of cargo at a given speed.
Heat losses from industrial processes vary per unit of volume for pipes,
tanks and other vessels in a relationship somewhat similar to the square-
cube law.

Capital and operating cost

Overall costs of capital projects are known to be subject to economies
of scale. A crude estimate is that if the capital cost for a given sized piece of
equipment is known, changing the size will change the capital cost by the 0.6
power of the capacity ratio (the point six power rule).
In estimating capital cost, it typically requires an insignificant amount
of labor, and possibly not much more in materials, to install a larger capacity
electrical wire or pipe having significantly greater capacity.
The cost of a unit of capacity of many types of equipment, such as
electric motors, centrifugal pumps, diesel and gasoline engines, decreases as
size increases. Also, the efficiency increases with size.
Crew size and other operating costs for ships, trains and
airplanes
Operating crew size for ships, airplanes, trains, etc., does not increase
in direct proportion to capacity. (Operating crew consists of pilots, co-pilots,
navigators, etc. and does not include passenger service personnel.) Many
aircraft models were significantly lengthened or "stretched" to increase
payload.
Many manufacturing facilities, especially those making bulk materials
like chemicals, refined petroleum products, cement and paper, have labor
requirements that are not greatly influenced by changes in plant capacity.
This is because labor requirements of automated processes tend to be based
on the complexity of the operation rather than production rate, and many
manufacturing facilities have nearly the same basic number of processing
steps and pieces of equipment, regardless of production capacity.
Economical use of byproducts
Karl Marx noted that large scale manufacturing allowed economical use
of products that would otherwise be waste. Marx cited the chemical industry
as an example, which today along with petrochemicals, remains highly
dependent on turning various residual reactant streams into salable
products. In the pulp and paper industry it is economical to burn bark and
fine wood particles to produce process steam and to recover the spent
pulping chemicals for conversion back to a usable form.

Appropriate Technique of Production:

A choice between alternative techniques of production is a major
problem in the planning for developing countries. This is because a particular
choice of technique of production affects not only the magnitude of
employment but also the rate of economic growth.

Several alternative techniques of production are available to produce a

commodity and these differ with regard to the amount of capital being used
with a unit of labour for production. In other words, the various techniques
differ with regard to capital-intensity which is generally measured by the
magnitude of capital-labour (K/L) ratio. Thus, the higher the capital-intensity,
the more quantity of capital as compared to labour will be used to produce a
given level of output.

Figure of Maximation:
A business can produce as many goods as its labor, equipment and
other resources will allow, but running at full production isnt always the best
approach. The optimum level of output is the one that generates the highest
profit, which is called the profit-maximizing output. A companys profit
begins to diminish beyond this level. You can figure your business profit-
maximizing output level by determining the profit your business makes at
each level of output you can produce.
Determine the different levels of output your business can
produce in a certain time period, such as one day or one week. Write the
output levels in ascending order in the first column of a sheet of paper. For
example, assume your business can produce zero, one, two, three, four or
five hats daily. Write "0" through "5" in ascending order in the first column on
a sheet of paper.
Determine the total revenue your business would generate at
each output level. Write each revenue amount next to its corresponding
output level in the second column. In this example, assume that your selling
price per hat decreases as you make more hats. Assume you generate $0,
$50, $100, $150, $160 and $175 in total revenue if you make zero, one, two,
three, four and five hats, respectively. Write each amount in the second
column.
Determine the total economic costs you incur at each output
level, and write them in the third column. Economic costs include explicit
costs and opportunity costs. Explicit costs are those for which you actually
pay money, such as supplies. An opportunity cost is something you give up,
but for which you dont actually pay money. This might be a salary you forgo
by choosing to run your small business instead of working a job. In this
example, assume you incur $20, $30, $40, $52, $67 and $85 in total
economic costs when you make zero, one, two, three, four and five hats,
respectively. Write the costs in the third column.
Subtract each amount of total economic costs in the third
column from each corresponding amount of total revenue in the
second column to determine the total profit for each output level. Write each
amount of profit in the fourth column. Continuing with the example, subtract
$20 from $0 to get negative $20, or a $20 loss, at an output of zero. Subtract
$30 from $50 to get $20 in profit at an output of one. Calculate the
remaining profit levels to get $60, $98, $93 and $90 in profit when you make
two, three, four and five hats respectively. Write these amounts in the fourth
column.
Find the greatest amount of profit in the fourth column and
identify the corresponding output level in the first column to
determine your profit-maximizing output. Concluding the example, the
highest profit in the fourth column is $98, which corresponds to an output of
three in the first column. Therefore, your small businesss profit-maximizing
output would be three hats daily.