ECONOMICS FOR ENGINEERS

Module 1: Comprehensive Study Guide

UCHU346
Prepared by: Midhun M Nair, Assistant Professor, DCAI

Course Information

Course Objectives
1. To provide students with an understanding of fundamental economic principles essential
for effective decision-making in engineering contexts.
2. To enable students to apply economic analysis to production decisions, cost
management, and market strategies in engineering practice.
3. To equip students with the ability to evaluate macroeconomic scenarios, financial
methods, and investment decisions relevant to engineering projects.

Module 1: Economics - Comprehensive Concepts

1. Origin of Economics
Economics originated from the Greek word 'IOKONOMIA', which means Household
Management. Adam Smith is considered the Father of Economics (1776) and authored 'Wealth
of Nations', wherein he defined economics as 'An enquiry into the nature and causes of wealth
of nations.'
Definition
Economics is the study of how society and individuals use limited resources to satisfy unlimited
wants and needs. According to Lionel Robinson (1932), economics is 'a science which studies
human behaviour in relationship with given ends and scarce means.'

2. Scarcity and Choice

Scarcity
Scarcity means that resources are not available in the required quantity to satisfy all the wants
and needs. Since we face scarcity, people have to make choices between goods and services.
3. Economic Problems of an Economy
An economy is a system in which people earn their living by performing different economic
activities like production, consumption, and investment. According to Samuelson, there are
three fundamental and interdependent problems in an economic organization - What, How, and
For Whom - which are grouped under allocation of resources.
(a) What Goods to Produce and How Much?
Due to limited resources, every economy must decide what goods to produce and in what
quantities. An economy has to make a choice of wants which are important for the economy as
a whole. If the economy decides to produce more cloth, it must reduce the production of food.
The reason is that resources used to produce these goods are limited and given. Thus, an
economy must decide based on availability of technology, cost of production, and demand for
the commodity.
(b) How to Produce?
A technique of production which maximizes output or minimizes cost should be used. Two types
of production techniques are: Labour-intensive (more labour, less capital) and Capital-intensive
(more capital, less labour). Every economy must choose the most efficient technique of
producing a commodity.
(c) For Whom to Produce?
This question concerns how to distribute the product among various sections of society. The
guiding principle is that output of the economy be distributed in such a way that all sections get
a minimum level of consumption.

4. Production Possibility Curve (PPC)

The Production Possibility Curve (or frontier) shows the various alternative combinations of
goods and services that an economy can produce when resources are fully and efficiently
employed. It shows the obtainable options and demonstrates the maximum limit to the amount
of goods and services which an economy can produce with given resources and state of
technology.
Production Possibility Schedule

Features of Production Possibility Curve

• PPC slopes downward: The curve slopes downward from left to right because under
full employment of resources, production of one good can be increased only by
sacrificing production of another good. This occurs because resources are scarce.
• PPC is concave to the origin: The curve is concave due to increasing marginal rate of
transformation (MRT) or increasing marginal opportunity cost. This means that as we
 produce more of one good, we must sacrifice increasingly larger quantities of another
good.

Marginal Opportunity Cost

Slope of PPC = ΔY / ΔX = (Amount of Good Y Lost) / (Amount of Good X Gained) = MRT
(Marginal Rate of Transformation)
Marginal opportunity cost is the opportunity cost of good X gained in terms of good Y given up.
The concave shape means the slope increases, implying MRT increases, so the opportunity
cost of producing additional units goes on increasing.

Shifts in Production Possibility Curve

• PPC shifts RIGHT when: (a) New stock of resources is discovered, or (b) There is
advancement in technology
• PPC shifts LEFT when: (a) Resources are destroyed due to calamity (earthquake, fire,
war), or (b) There is use of outdated technology

5. The Law of Diminishing Marginal Utility

Definition of Utility
Utility refers to the want-satisfying power of a commodity. It is a subjective concept depending
on the intensity of consumer's desire or want for that commodity. Utility differs from person to
person, place to place, and time to time. Utility is a cardinal concept (i.e., it can be measured).
Benham formulated the unit of measurement of utility as 'utils'.
Total Utility (TU)
Total Utility is the sum of all utilities derived from consumption of a certain amount of a
commodity. TUn = MU1 + MU2 + ... + MUn
Marginal Utility (MU)
Marginal Utility is the addition made to total utility when consumption is increased by one more
unit. Mathematically: MUn = TUn - TUn-1 or MU = ΔTU / ΔX

Law of Diminishing Marginal Utility - Theory

Theory developed by: Prof. Alfred Marshall
Assumptions:
• Rationality
• Commodities should be homogenous and normal
• No time gap between consumption of goods
• No change in taste and preferences
• No change in price of the commodity
Statement of Theory: As the consumer consumes more and more units of the same good, the
additional utility (MU) from each additional unit goes on decreasing.
Relationship between TU and MU
Key Observations
4. As the consumer has more of the good, TU increases less than in proportion and MU
gradually declines but remains positive.
5. When TU is maximum (saturation point), MU is zero.
6. When TU falls, MU becomes negative (disutility).

When marginal utility becomes zero, total utility becomes maximum. If consumption continues
beyond this, MU becomes negative and TU falls, meaning the consumer gets disutility or
dissatisfaction. A rational consumer will not consume beyond zero MU.

6. Demand
Definition
• Demand is the desire backed by ability and willingness to pay for a commodity.
• Quantity demanded refers to the particular quantity buyers are willing and able to buy at
a given price during a given period of time.
• Demand for a commodity is the quantity that a consumer is willing to buy at a particular
price during a particular period of time.

Factors Affecting Individual Demand

7. Price of the Commodity: There is an inverse relationship between price and demand.
Demand is more at lower prices and less at higher prices (except for Giffen and Veblen
goods).
8. Income of the Consumer: If X is an inferior good, increase in income causes demand
to decrease (consumers switch to superior goods).
9. Prices of Related Goods:
• Substitutes: Demand moves in same direction as change in price of substitutes.
• Complements: Demand moves in opposite direction as change in price of
complementary goods.
10. Consumer's Tastes and Preferences: Change in tastes causes demand to change.
Favorable change = increase in demand.
11. Future Expectations: If price is expected to rise in future, consumers buy more now at
existing price.
12. Size of Population: Larger population means greater demand.

Demand Function
DX = f (PX, PZ, Y, T, E, N, Yd) where DX = Demand for commodity X, PX = Price of commodity
X, PZ = Prices of related goods, Y = Income, T = Tastes, E = Future expectations, N = Number
of consumers, Yd = Distribution of income

Law of Demand
The law of demand states that if all other things remain constant, as the price of a commodity
increases, demand for it decreases, and as price decreases, demand increases. Symbolically:
DX = f(PX), ceteris paribus
Demand Schedule and Demand Curve
Demand Schedule: A tabular presentation showing different quantities of a good that buyers
are willing to buy at different prices during a given period.
Demand Curve: The graphical representation of the demand function.

Changes in Demand
13. Movement along demand curve: Change in quantity demanded due to change in price
only. Causes expansion or contraction of demand.
14. Shift in demand curve: Change in demand due to factors other than price. Causes
increase or decrease in demand.

7. Elasticity of Demand
Elasticity of demand refers to the degree of responsiveness or change in quantity demanded of
a commodity due to change in price or any other factors. Introduced by Alfred Marshall, there
are three types of elasticity: Price Elasticity, Income Elasticity, and Cross Elasticity.
Price Elasticity of Demand
It measures the responsiveness of demand to a change in price. Calculated using the
percentage method:
eD = (Percentage change in qty demanded) / (Percentage change in price) = (ΔQ/ΔP) × (P/Q)
Types of Price Elasticity
15. Perfectly Elastic (eD = ∞): Demand rises or falls infinitely without any price change
(ideal/imaginary situation).
16. Perfectly Inelastic (eD = 0): Demand doesn't change regardless of price change. Exists
for essential goods like life-saving drugs.
17. Unit Elastic (eD = 1): Percentage change in demand equals percentage change in
price. Exists for normal goods.
18. Elastic (1 < eD < ∞): Change in demand is more than proportionate to price change.
Exists for luxuries.
19. Inelastic (0 < eD < 1): Change in demand is less than proportionate to price change.
Exists for necessities.

8. Supply
Supply refers to the quantities of a commodity which a seller offers for sale at a particular price
in a given period of time. It represents the desired quantity of commodity that the seller offers for
sale in the market.
Factors Affecting Supply
20. Price of the Commodity: Direct relationship - higher price means more supply, lower
price means less supply.
 21. Price of Related Goods: If price of substitute good increases, producers switch to it,
reducing supply of original good.
22. State of Technology: Improved technology reduces production cost, increasing supply.
23. Prices of Inputs: Increase in input costs reduces supply (shifts curve left).
24. Government Policy: Heavy excise taxes discourage production and reduce supply.

Supply Function
SX = f (PX, PZ, T, C, GP) where SX = Supply, PX = Price, PZ = Price of related goods, T =
Technological changes, C = Cost of inputs, GP = Government policy

Law of Supply
When other things remain constant, quantity supplied is directly related to price. When price
rises, quantity supplied increases; when price falls, quantity supplied falls. Symbolically: SX =
f(PX), ceteris paribus

Supply Schedule

Elasticity of Supply
Price elasticity of supply is the responsiveness of quantity supplied to changes in price. eS =
(ΔQ/ΔP) × (P/Q)
25. Perfectly Elastic (eS = ∞): Supply changes without price change.
26. Perfectly Inelastic (eS = 0): Supply doesn't change with price change.
27. Unit Elastic (eS = 1): Percentage change in supply equals percentage price change.
28. Elastic (1 < eS < ∞): Supply change is more than proportionate.
29. Inelastic (0 < eS < 1): Supply change is less than proportionate.

9. Market Equilibrium
Equilibrium means the state in which there is no tendency on the part of consumers and
producers to change. The two factors determining equilibrium price are demand and supply.
Equilibrium Price
Equilibrium price is the price at which sellers are willing to sell the same quantity which buyers
are willing to buy. At this price, Quantity demanded = Quantity supplied

Equilibrium between Demand and Supply

The forces of demand and supply determine the price of a commodity. Equilibrium price is
determined where quantity demanded equals quantity supplied. This is called market price. This
price has a tendency to persist. If market demand ≠ market supply, there will be either excess
demand or excess supply, and the price will change until it settles at equilibrium.
10. Production
Production is defined as the transformation of inputs into output. It includes production of
physical goods (cloth, rice, etc.) and services (doctor, teacher, lawyer services).
Production Function
A production function is the physical relationship between inputs used and resulting output. It
expresses the quantitative relation between change in inputs and resulting change in output.
Expressed as: Q = f (i1, i2, ..., in)
Simplified form with two inputs (Labour L and Capital K): Q = f (K, L)

Short-run vs Long-run Production

30. Short-run Production: At least one factor is in fixed supply and others are variable.
Production increases when more variable factors are used with fixed factor. Fixed
factors: land, plant, factory building, minimum electricity bill, etc.
31. Long-run Production: All factors are in variable supply. Production increases when all
factors are increased proportionally. Variable factors: raw materials, daily wages, etc.

Concepts of Product
32. Total Physical Product (TPP) or Total Product (TP): Total quantity of goods produced
by a firm with given inputs during a specified period.
33. Average Product (AP): Amount of output produced per unit of variable factor (labour).
AP = TP / L
34. Marginal Product (MP): Change in TP resulting from employment of one additional unit
of variable factor. MP = ΔTP / ΔL

Law of Variable Proportion

The law of variable proportion is a widely observed law in short-run production. It states: As we
employ more units of a variable input, keeping other inputs fixed, the total product increases at
an increasing rate initially, then at a diminishing rate, and finally starts falling.
Three Phases of Production
35. Phase I - Increasing Returns: From origin to point where MP is maximum. TP
increases at increasing rate. MP rises and reaches maximum. Non-economic (rational
producer won't operate here).
36. Phase II - Diminishing Returns: From maximum MP to where MP = 0. MP positive but
declining. TP increases at decreasing rate then reaches maximum. Most important
phase - rational producer operates here.
37. Phase III - Negative Returns: MP becomes negative. TP falls. Non-economic and
inefficient (irrational to operate).

Cobb-Douglas Production Function

Developed by Charles Cobb and Paul Douglas (1927-1947). The function is: Y = A L^β K^α
Where: Y = Total production, L = Labour input, K = Capital input, A = Total factor productivity, α
and β = Output elasticities of capital and labour
 • If α + β = 1: Constant returns to scale (doubling inputs doubles output)
• If α + β < 1: Decreasing returns to scale
• If α + β > 1: Increasing returns to scale

Key Formulas and Equations

Utility Concepts
• Total Utility (TU): TUn = MU1 + MU2 + ... + MUn
• Marginal Utility (MU): MUn = TUn - TUn-1 or MU = ΔTU / ΔX
Production Possibility Curve
• MRT (Marginal Rate of Transformation) = ΔY / ΔX = Slope of PPC
Elasticity Formulas
• Price Elasticity of Demand: eD = (ΔQ / ΔP) × (P / Q)
• Price Elasticity of Supply: eS = (ΔQ / ΔP) × (P / Q)
Product Concepts
• Average Product: AP = TP / L
• Marginal Product: MP = ΔTP / ΔL

Cobb-Douglas Function
• Production Function: Y = A L^β K^α

Important Points to Remember for Examinations

38. Economics originated from Greek word IOKONOMIA. Adam Smith is Father of
Economics (1776).
39. Scarcity forces choices - unlimited wants but limited resources.
40. Three fundamental economic problems: What to produce, How to produce, For whom to
produce.
41. PPC shows maximum combinations of two goods with full resource utilization.
42. PPC slopes downward due to resource scarcity and opportunity costs.
43. MRT increases (PPC concave to origin) due to increasing opportunity cost.
44. Law of Diminishing Marginal Utility: As consumption increases, MU declines but remains
positive until saturation.
45. At saturation point, TU is maximum and MU = 0.
46. Law of Demand: Inverse relationship between price and quantity demanded (ceteris
paribus).
47. Demand Schedule = tabular; Demand Curve = graphical representation.
48. Movement along curve = change in quantity demanded (price change); Shift of curve =
change in demand (non-price factors).
49. Substitute goods: demand moves same direction as price change; Complementary
goods: opposite direction.
50. Elasticity measures responsiveness of quantity change to price change.
51. Law of Supply: Direct relationship between price and quantity supplied (ceteris paribus).
52. Equilibrium price = price where Qd = Qs; no tendency to change.
53. Excess demand (Qd > Qs) causes price to rise; Excess supply (Qs > Qd) causes price
to fall.
54. Short-run: At least one factor fixed; Long-run: All factors variable.
55. Law of Variable Proportion: TP increases (increasing rate) → increases (decreasing
rate) → falls.
56. Phase I: MP rising (non-economic); Phase II: MP declining but positive (economic);
Phase III: MP negative (non-economic).
57. Rational producer operates in Phase II of variable proportion law.
58. Cobb-Douglas function: Y = A L^β K^α; α + β determines returns to scale.

End of Economics Module 1