FUNDAMENTALS OF AGRICULTURAL ECONOMICS: AEC 101 (2+0)

ECONOMICS- MEANING AND SUBJECT MATTER

The word economics has been derived from the Greek word “OIKONOMICAS” with
“OIKOS” meaning a household and “NOMOS” meaning management.

The beginning was made by the Greek philosopher Aristotle who in his book “ECONOMICA”
focused that the field of economics deals with household management.

Definitions of Economics

a) Wealth definition of Economics: Adam Smith (1776) regarded as “Father of

Economics” in his book “Wealth of Nations” he defined economics as “ An enquiry into
the nature and cause of the Wealth of Nations”

J. S. Mill (1750-1850) classical economist defined economics as “The practical science of

production and distribution of wealth”.

These definitions invited the criticism of Carlyl as he called economics as a “Dismal Science”.

b) Welfare definition of Economics: Alfred Marshall defined economics as “A study of

mankind in the ordinary business of life, it examines that part of individual and social
action which is most closely connected with the attainment and with the use of the
material requisites of well-being”.

The idea of Marshall was condemned by Lionel Robbins.

c) Scarcity definition of economics: Lionel Robbins defined “Economics is the science

which studies human behavior as a relationship between ends and scare means which
have alternative uses”.
“Ends” indicates human wants. “Means” are the resources with which wants are fulfilled.

Note: Robbins definition is superior to “Wealth” & “Welfare” definitions because “Welfare
aspect is embodies in the definition & “Wealth” is represented as means which is always scare.

d) Growth definition of economics: Samuelson defined “Economics is the study of how

men and society choose, with or without money, to employ scare productive resources
which could have alternative uses, to produce various commodities over time, &
distribute them for consumption now and in future among various people & groups of
society”.

Keynes defined economics as “The study of administration of scarce resources and of the
determinants of employment and income”.

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Subject Matter of Economics

People engaging themselves in the economics activity, aim at maximizing their satisfaction from
their scare resources. Thus, Scarcity is the pivot for the economic activity of the people.

The field of economics constitutes wants, efforts & satisfaction. These also form the subject
matter of economics.

Traditional Approach

The subject matter of economics can be studied under four divisions.

1. Consumption: It means the use of wealth to satisfy innumerable wants. It also means the
destruction of utility. All the goods that are produced are consumed immediately (or)
some time in future.
2. Production: It is an activity that helps to create utility. It simply means the addition of
utilities. Hence production is defined as the “Creation of Utility”.
3. Exchange: It implies transfer of goods from one person to the other. The exchange of
goods leads to an increase in the welfare of the individuals through creation of higher
utilities for goods and services.
4. Distribution: It refers to the sharing of wealth produced by the community among the
agents of production.

Modern Approach

1. Microeconomics: It is derived from Greek word “MICROS” meaning small. In other

words micro means a millionth part.
➢ It is otherwise known as “Price Theory”.
➢ It deals with economic behavior of individual economic unit such as consumer, resource
owner and business firm.
➢ It covers theory of consumer behavior, theory of value and theory of economic welfare.

2. Macroeconomics: It is derived from Greek word “MAKROS” meaning large.

➢ It is otherwise known as “Income Theory”.
➢ It treats the economic system as a whole, rather than treating the individual economic unit
of which it is composed.
➢ It covers theory of income and employment, theory of distribution, general equilibrium
analysis, policy formulation and analysis,
➢ Thus it is concerned with the study of Aggregates.

Is economics a science or art?

Science is a systematized body of knowledge having an empirical correspondence

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An art is also systematized body of knowledge, it directs through a system of procedure to attain
a given objective or goal.

Treating economics as a science, a given theory is formed through conduct of experiments,

recording observations, analysis of data recorded, drawing the conclusion and finally testing
them. Hence economics is as good as any science (lab versus factor).

As an art economics shows solutions to the problems .it helps us how to do a thing. Given a
problem, the field of economics guides us to solve the same. Thus, the field of economics has the
attributes of science and art .economics therefore is a science as well as an art.

Economics-a social science

Economics studies human beings as members of the society participating in the economic
activities. It does not study humans as isolated individuals. Thus economics is a social science.

Economics- Positive science or Normative science

Positive economics is completely objective and is limited to the cause and effect
relationship of economic activity. It is simply concerned with the way the economic relationships
are present in different economic activities (What they are).

Normative economics studies the way that economic relations ought to be. It evaluates,
policy makers, a conscious intervention in the economy for the welfare of the people is
essentially a normative in character

Methods of Economic Analysis:

An economic theory derives laws or generalizations through two methods:
(1)Deductive Method and (2) Inductive Method.

1. Deductive Method: The deductive method involves reasoning from a few fundamental
pro-positions, the truth of which is assumed.
i. Starts from the general and moves to the particular.
ii. Begins with general assumptions and moves to particular conclusions.
iii. Develops a theory, and then examines the facts to see if they follow the theory.
iv. Economists belonging to classical school viz., J. S. Mill and Bacon advocated this
method.

2. Inductive Method: The inductive method involves collection of facts, drawing conclusions
from them and testing the conclusions by other facts.
i. Starts from the particular and moves to the general.
ii. Begins with particular observations and moves to general explanations.
iii. Collects observations, then develops a theory to fit the facts.
iv. Economists belonging to historical school like Roscher, Frederick, etc., advocated this
method.

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 NATURE OF ECONOMIC THEORY

Basic Assumptions of Economics

a) Rationality assumption: This is related to the behavoiur of individuals e.g., consumers,

producers, workers, etc. We assume that the consumers act in a rational (ವಿವೇಕದ) manner
and seek maximum satisfaction. In Mrs. Joan Robinson’s words, “The fundamental
assumption of economic analysis is that every individual acts in sensible manner and it is
sensible for the individual to balance marginal cost and marginal gain”. This sensible
conduct results in maximization of money gains. Actually the principle may not work.
But, in order to simplify things, we have to assume all these things.
b) Taste remains unchanged: The consumers’ tastes remain unchanged for fairly long
periods of time. It is worthwhile making this assumption because it helps us in
constructing a simple theory of firm and industry.
c) Perfect competition: The assumption of perfect competition on which the working of a
competitive economy stands. It is assumed that there are large number of buyers and
sellers in the market, the commodity is homogeneous in character, that there is perfect
knowledge and perfect mobility of resources and that none of the individual buyers and
sellers are in a position to influence price.
d) Concept of equilibrium: We discuss consumers’ equilibrium, equilibrium of the firm
and industry. A firm is said to be in equilibrium when it is making maximum profit and an
industry is in equilibrium when it gives only normal profit. When these positions have
been attained, there is no incentive to make any change.
e) Ceteris paribus: This means that the law will hold good if there are no other changes
taking place at the same time in the related economic phenomena. That is, economic laws
are based on the assumption of ‘no other change’. Actually, the world is dynamic and
changes are simultaneously taking place. But this assumption isolates a particular change
and thus facilitates understanding of the principles under discussion.

Concept of Equilibrium
Equilibrium refers to the market condition which, once achieved, tends to persist. In
economics this occurs when the quantity of a commodity demanded in the market per unit of
time equals the quantity of the commodity supplied to the market over the same time
period.

Geometrically, equilibrium occurs at the intersection of the commodity market demand

curve and market supply curve. The price and quantity at which equilibrium exists are known,
respectively, as the equilibrium price and the equilibrium quantity.

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 Fig: Market Equilibrium
OQ is the equilibrium quantity and OP is equilibrium price
Economic Laws/Laws of Economics
Economic laws are the principles that govern the actions of the individuals in their
economic activities. What economists do is that they consider the basic factors into account while
developing a theory, keeping other factors influencing the theory as constant. There is an
important role for assumptions.

“Economic laws are statements of uniformities, which govern human behavior concerning the
utilization of limited resources for the achievement of unlimited ends”. (Robbins)
Characteristics/ Nature of Economic laws
1. Economic laws are not the governmental laws: The laws of government are very stringent
and any violation of these laws amounts to punishment. Economic laws on the other hand
are applicable only if certain conditions are satisfied.
2. Economic laws are merely the statements of tendencies: There are based on the tendencies
of human who behave in a particular way to a given phenomenon. Certainty is one thing,
which is not guaranteed with regard to economic laws.
3. Economic laws are hypothetical: These hold good under the assumption of a number of
things. Economic laws are characterized by the phrase ceteris paribus (other factors are
held constant).
4. Economic laws are positive but not normative: They only describe the economic
phenomenon but do not prescribe how it should be.
5. Some economic laws are axiomatic in character: It means that they are self-evident as that
of law of diminishing marginal utility and generalization drawn are universally valid.
6. Economic laws lack exactness of the laws of science: This prompted Marshall to compare
the economic laws to the laws of tides rather than the simple laws of gravitation.
However, the economic laws are more exact than those of any other social sciences,
because the economic phenomena are capable of being measured in money price. The
measuring rod of money is not available to any other social like history and political
science.
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 BASIC CONCEPTS

Goods and Services

Good: Anything that can satisfy a human want is called a “good” in economics. Goods are
tangible and material outcome of production.
Ex: Foodgrains, seeds, fertilizers, book, pen, etc.

Service: It is any act or performance that one party can offer to another. Or services refer to the
work that a person may do. Services are intangible, non-material, inseparable, variable and
perishable.
Ex: The advice of a lawyer or doctor, service rendered by labourers, etc.

Classification of goods

i. Based on Supply: Goods are classified into Economic and Free goods
a) Economic goods are those goods, which are produced through human efforts and are
to be purchased at a given price. Supply is less than demand. They have value in use
and value in exchange. Ex: Buildings, machinery, furniture etc.
b) Free goods are the gift of nature. Their supply is more than demand and one can get
to the extent they need. They are freely available in nature; no price needs to be paid.
They have value in use but no value in exchange. Ex: air, sunshine, rainfall etc.

The distinction between economic and free goods is lost under certain situations (Water, Sand
etc.)

ii. Based on Transferability (by Marshall):

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 iii. Based on Consumption: Consumer goods and producer goods.
a) Consumers goods are those from which consumer directly derive the satisfaction
using the goods. These are known as goods of the first order. Ex: food, clothes, ink,
etc.
b) Producer/Capital goods are those that help to produce other goods. They give
satisfaction indirectly. They also called goods of the second order. Ex: Machines,
buildings, raw materials, etc.
c) Intermediate goods: In between the consumption and capital goods are the
intermediate goods. They are the raw materials used in the production of the final or
consumption goods. Ex: cotton or silk. (Clothes -- Consumption good, Machinery —
Capital goods, Silk or Cotton – Intermediate good).
iv. Based on durability: Mono period and poly period goods.
a) Mono period goods are used only once to satisfy a need. Ex: all food grains, seeds,
etc.
b) Poly period goods are used time and again. They can be made use of several times.
Ex: Machinery, implements, etc.
v. Private and public goods (Ownership)
a) Private goods are the property of private individuals, e.g. land, buildings, etc. owned
by them exclusively and not shared with others.
b) Public goods are those which are common to all and are owned by society
collectively, e.g. a town hall, a college etc.
vi. Personal and impersonal goods
a) Personal good: It refers to the personal qualities of a person. Ex: his ability and skills.
They are non-material and exist inside him. They are what he is and not what he has.
b) Impersonal: They are not personal. They are external and lie outside a person. They
are what he has. Ex: land, house etc.

Desire: defined as a strong feeling of wanting something or someone. A desire is the craving to
apprehend your want.

Want: A want is something that you desire and something that an individual does not possess
yet. Economic wants are desires that can be satisfied by consuming a good, service, or leisure
activity.

Demand: means the desire or willingness for a good. Demand is the quantity of a good that
consumers are willing and able to purchase at various prices during a given period of time.

Utility: Want satisfying quality in a good is called utility. / The capacity of a good that satisfies a
human want. Or Want satisfying power of a good/the power of a commodity to satisfy a human
want is called utility.

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Characteristics of Utility
1. Utility is subjective (Non-veg: regular or irregular consumers)
2. Utility varies with purpose (water for irrigation or for drinking)
3. Utility varies with time (ice cream: summer or winter)
4. Utility varies with ownership (machine: owned or hired)
5. Utility is not synonymous with pleasure (medicine: bitter to swallow)
6. Utility does not mean satisfaction (consumer choice)

Kinds/forms/types of utility
1. Form utility: By changing the form of an article/good, we can give it greater utility. Ex:
processing of paddy into rice, butter into ghee etc.
2. Place utility: Utility can also be increased by transporting a good from one place to
another. Spatial movement of the goods i.e., moving a good from one place or market to
another place or market increases its utility. Ex: fertilizers are made available to farmers
by transporting them from the factories.
3. Time utility: any time lag between production and consumption of commodities creates
time utility. Through storage over time, greater utility is created for the product. Storage
helps to create time utility.
4. Possession utility: Commodities in the transaction process, changes the hands from one
person to another person. Commodities in the hands of producers have some utility and by
time they reach consumers through the traders their utility is increased. Such utility due to
possession or transfer of ownership of the commodity is called possession utility. Ex:
Utility of paddy in farmers hand to that of consumers hands in form of rice.

Value: It is the capacity of a good to command other things in exchange. It is the rate of
exchangeability (value in exchange).

Attributes of Value:
1. Goods must possess utility
2. Goods must be scare and
3. Goods must be transferable or marketable.

Cost and price

Cost: refer to the amount of money paid to produce a product or a service.

Price: when the value of a good is expressed in terms of money, it is called price. Price expresses
value in terms of money.

Wealth: In ordinary language, “Wealth” conveys an idea of prosperity and abundance. A man of
wealth understood as a rich person. But in Economics Wealth is synonymous with economic
goods. In short, Wealth means anything which has value.
According to J. M. Keynes: Wealth consists of all potentially exchangeable means of satisfying
human wants.

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Characteristics of wealth
1. Wealth should possess utility
2. Wealth must be scare
3. Wealth must be transferable
4. Wealth must be external to person

Types of wealth
Wealth can be classified as personal wealth, social wealth or collective wealth, national
wealth, cosmopolitan wealth and negative wealth.

1. Personal Wealth (Individual Wealth): The wealth of a person consists of both material
and non-material goods. Wealth of the person includes such material things as land,
houses, furniture, machinery and so on. The goodwill of his firm may be considered as his
non-material wealth.
2. Social Wealth (Collective Wealth): Social wealth consists of all those goods that can be
enjoyed by all members of a society. Social wealth includes public roads, public parks,
public schools, government hospitals, public libraries, museums and so on.
3. National Wealth: National wealth includes individual wealth as well as the collective
wealth of its members. That is, it includes besides individual wealth all kinds of public
property, such as roads and canals, buildings and parks and water works. Economists like
Marshall feel the inclusion of free gifts of nature like mountains, rivers, etc., in national
wealth.
4. Cosmopolitan Wealth: Cosmopolitan wealth is the wealth of the world. It belongs to no
one nation in particular. A common example of cosmopolitan wealth is the ocean.
5. Negative wealth: It is the exclusive debts owned by the individuals and the nation.

Capital: It is produced means of production. Or it is defined as that of a person’s wealth, other

than land, which yields an income or which aids in the production of further wealth.
According to Karl Marx: Capital is “Crystallized labour”. In his book “Das Kapital”.

Income: It is the return accruing for a person, or a nation, derived from the "factors of
production". Or the amount of money which those (wealth) assets yield is called income.
“Wealth is a stock, Income is a flow”

Money income: Income of a person expressed in terms of money per month or year is his money
income.

Real income: real income of a person consists of goods and services that he purchases with his
money income.

Welfare: It is the well being of individual or community. It refers to the condition of mind.
“Wealth is the mean and Welfare is the end”

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 AGRICULTURAL ECONOMICS: MEANING AND DEFINITION

Meaning
Agriculture is derived from the Latin word “AGER”, referring to the soil, and
“CULTURA” refers to its cultivation.
Agriculture is defined as the cultivation and/or production of crops plants or livestock products.
Economics: It is the science that studies as to how people choose to use scarce productive
resources to produce various goods and to distribute these goods to various members of society
for their consumption.
Definition
Agricultural Economics: It is an applied field of economics in which the principles of choice are
applied in the use of scarce resources such as land, labour, capital and management in farming
and allied activities.
Characteristics of Agriculture
1. Uneven distribution of land
2. Fragmentation of holding
3. Existence of small and marginal farmers
4. Regional variation
5. Dependence of seasonal rainfall
6. Production of different kind of crops
7. Low productivity of land
8. Increasing of disguised unemployment
9. Disorder in marketing of agricultural products
10. Weak land reformation
Importance of Agricultural Economics
a) The field of agricultural economics finds to seek relevance between cause and effect using
the most advanced methods viz., production functions and programming models.
b) It uses theoretical concepts of economics to provide answers to the problems of
agricultural and agri-business.
c) The subject of agricultural economics is enriched in many directions and fields taking the
relevant tools of sciences particulars mathematics statistics.
d) Agricultural economists play a major role in understanding the complex details involved
in the foundation systems.
e) The students of agricultural economics are taught the subject disciplines viz.,
microeconomics, macroeconomics, agricultural production economics, farm management,
agricultural marketing, price analysis etc., to fulfill their requirements.
f) Economics principles guide the farmers to balance the link between farm and household.
g) It also helps in guiding in the formation of policies influencing agricultural growth and
development at the macro level.
h) A major part of the planning and implementation input is contributed by agricultural
economics.

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 DEMAND

Demand normally means the desire or willingness for a good. But in economics simple
desire or willingness for a good alone may not represent demand. Desire and ability to buy are
the key components of demand. Demand is likely to vary over time and also among the markets.

Demand is defined as a schedule that shows the amounts of a product or service the
consumers are willing and able to purchase at each price in a set of possible prices during some
specified time in a specified market.

According to Bowden: Demand means “propensity of the consumers to buy different quantities
of a particular good at different unit prices”.

Individual demand schedule

The various quantities of a commodity that a consumer would be willing to purchase at all
possible prices in a given market at a given point in time, other things being equal is called
individual demand.
Table: Hypothetical demand schedule for onion
Price (Rs./kg) Quantity demanded per week (in kg)
20 0.25
16 0.50
12 0.75
8 1.00
4 1.25
2 1.50

Demand curve: It is the graph depicting the relationship between the price of a certain
commodity and the amount of it that consumers are willing and able to purchase at any given
price. It is a graphic representation of a demand schedule. The relationship between price and
quantity demanded is also known as demand curve.

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Market demand
It is the sum of the demand of all the consumers in a market for a given commodity at a
specific point of time.

Table: Market demand schedule for onion

Individual demand schedule / week Market demand
Price (Rs./kg)
A B C (A+B+C)
20 0.25 0.50 0 0.75
16 0.50 1.00 0 1.50
12 0.75 1.50 0 2.25
8 1.00 2.00 1 4.00
4 1.25 2.50 2 5.75
2 1.50 3.00 3 7.50

Assume that in a market there are only three consumers, viz., A, B and C, with individual
demand schedule as presented in the above table. For example, consumer C is not willing to buy
onions for any price higher than Rs. 8/kg. Given the individual demand schedules, market
demand schedule can be worked out at each price level as indicated in the last column of the
table. It is the horizontal summation of the demand of individual consumer at each unit price.

Autonomous demand and Derived demand

Autonomous demand: The goods, whose demand is not linked with the demand of other goods
are supposed to have autonomous demand. Ex: Consumer goods.

Derived demand: The demand for certain goods is related with the demand for other goods,
which is called derived demand. Ex: Fertilizers, Pesticides.

The goods which are demanded for their own sake have autonomous demand, while the
goods that are required to produce other goods have derived demand.

Kinds of Demand

1. Price demand: It refers to various quantities of a good or service that a consumer would
be willing to purchase at all possible prices in a given market at a given point in time,
ceteris paribus.
2. Income demand: It refers to various quantities of a good or service that a consumer
would be willing to purchase at different levels of income, ceteris paribus.
3. Cross demand: It refers to various quantities of a good or service that a consumer would
be willing to purchase not due to changes in the price of the commodity under
consideration, but due to change in the price of related commodities.

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Law of Demand

The law of demand explains the functional relationship between the quantity demanded of
a commodity and its unit price i.e., rise in the price of a commodity or service is followed by
reduction in the quantity demanded and fall in the price is followed by an extension in demand,
with other conditions remaining the same. Demand various inversely with the price, other things
being equal.

The other things refers to: Price of related goods, income of the consumers, taste, preferences and
fashion.

Exceptions to the law of demand

1. Giffen goods (Inferior goods): Giffen Paradox: This phenomenon says that rise in price
is followed by an extension of demand, while a fall in price is followed by a reduction in
demand for the good.

Ex: Poor ---Bajra—If the price of bajra increases---purchase bajra by cut amount on other
items.

Other items----If price of bajra falls---purchases same quantity of bajra and spends on
other items.

2. Prestigious goods: When the possession of a good brings in social distinction, consumers
would go for the same even if its price is higher. Ex: Diamonds—Prestigious to rich
people.
3. High priced commodities: When the consumers view that those products which are
superior are sold at higher prices, they do not mind to buy more of the same at higher
prices.
4. Fear of shortage: If the existing price is higher and it is expected to increase further,
consumers would buy more of it even at higher price, fearing for the shortage.

Determinants of Demand

1. Price of the product

2. Income of the consumers
3. Price of related goods
4. Taste, preferences, fashion etc.

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Movement along the demand curve

It refers to change in quantity demanded due to change in price. It can be either extension
or contraction of demand.

Extension of Demand Contraction of Demand

Other things remaining the same, when more Other things remaining the same, less of
of a commodity is demanded at a lower price, commodity is demanded at higher price, then
then the change in demand is known as the change in demand is known as contraction
extension of demand of demand
It refers to movement along the dem`111and It refers to movement along the demand curve
curve from left to right from right to left

Note: Extension and contraction of demand represents the “change in quantity demand. (Increase
and decrease of demand represent the “change in demand”).

It is purely a price resulted phenomenon of demand changes for a commodity, while other factors
influencing demand are assumed to be at fixed level.

Shift in the Demand Curve

It refers to change in demand not due to change in price but due to change in the values of
other variables influencing demand. It can increase or decrease in demand. [Shift factors—
income, price of related goods, taste, preferences, fashion etc.].

Increase in Demand Decrease in Demand

Increase in demand means more demand at the Decrease in demand means less demand at the
same price or same demand at higher price. same price or same demand at lower price.
The demand curve shifts upwards to right side The demand curve shifts towards left
of the initial demand curve downwards to the initial demand curve.

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Elasticity of Demand (Alfred Marshall developed this concept)

Elasticity means sensitiveness or responsiveness of demand to the change in price.

Elasticity of demand is defined as “the relative change in the quantity demanded to the relative
change in the price”.

Types of elasticity

1. Price elasticity of demand (Ed): The responsiveness of quantity demanded of a

commodity, when price of that commodity change, with other factors being constant.
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐸𝑑 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
(Or)
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
=
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑝𝑟𝑖𝑐𝑒
2. Income elasticity of demand (EI): The responsiveness of demand due to changes in the
income of the consumers in terms of percentage, when other factors influencing demand
viz., price of the commodity, price of substitutes, tastes, preferences, etc., are kept at
constant level.
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐸𝐼 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
(Or)
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
=
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒

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 3. Cross elasticity of demand (Exy): Demand for one good (X) is also influenced by the
price of other related good (Y). These may be substitutes or complements. It is the ratio of
percentage change in quantity demanded of commodity (x) and percentage change in
price of related commodity (Y).
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 (𝑋)
𝐸𝑋𝑌 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 (𝑌)
(Or)
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 (𝑋)
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 (𝑋)
=
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 (𝑌)
𝑋 100
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑝𝑟𝑖𝑐𝑒 (𝑌)

Degrees of Elasticity of Demand

Based on the magnitudes of elasticity of demand, categorized into five degrees.

1. Perfectly/Infinite Elastic Demand:

➢ A slightest change in price of a commodity leads to an infinite change in quantity
demanded.
➢ The demand is hypersensitive and the elasticity of demand is infinite
➢ The demand curve will be a horizontal line parallel to x-axis.
➢ Elasticity of demand is infinite.

2. Perfectly Inelastic Demand

➢ The price of the commodity may increase or decrease, but the quantity demanded
remains the same.
➢ The demand is insensitive and elasticity of demand is zero.
➢ The demand curve is vertical to x-axis.
➢ Elasticity of demand is zero.

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3. Relatively Elastic Demand
➢ It means that lesser proportionate change in the price of a commodity is followed by a
larger proportionate change in the quantity demanded.
➢ Elasticity of demand is greater than unity.

4. Relatively Inelastic Demand

➢ It means that lesser proportionate change in price of a commodity is followed by a
smaller proportionate change in the quantity demanded.
➢ Elasticity of demand is less than unity.

5. Unitary Elastic Demand

➢ When a given proportionate change in price results in the same proportionate change
in the quantity demanded.
➢ Elasticity of demand is one.

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 METHODS OF MEASURING ELASTICITY
(1) The Percentage Method: The price elasticity of demand is measured by its coefficient Ep.
This coefficient Ep measures the percentage change in the quantity of a commodity demanded
resulting from a given percentage change in its price.

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞
𝐸𝑝 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝

Where q refers to quantity demanded, p to price and Δ to change. If Ep > 1, demand is elastic. If
Ep < 1, demand is inelastic, it Ep = 1 demand is unitary elastic.

2) Total outlay or expenditure method: In this method, by comparing the total expenditure of a
purchaser both before and after the change in price, it can be known whether his demand for a
good is elastic, unity or less elastic. Total outlay is price multiplied by the quantity of a good
purchased: Total Outlay = Price x Quantity Demanded.
• Demand is elastic: when with the fall in price the total expenditure increases and with the
rise in price the total expenditure decreases.
• Unitary Elastic Demand: when with the fall or rise in price, the total expenditure
remains unchanged; the elasticity of demand is unity.
• Less Elastic Demand: Demand is less elastic if with the fall in price the total expenditure
falls and with the rise in price the total expenditure rises.

3) The Point Method: Prof. Marshall devised a geometrical method for measuring elasticity at a
point on the demand curve. It is used when price and quantity changes are extremely small.

Let RS be a straight line demand curve in Figure 11.2. If the price falls from PB(=OA) to
MD(=OC). The quantity demanded increases from OB to OD. Elasticity at point P on the RS
demand curve according to the formula is: E = Δq/Δp x p/q.

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Where Δ q represents changes in quantity demanded, Δp changes in price level while p and q are
initial price and quantity levels.

With the help of the point method, it is easy to point out the elasticity at any point along a
demand curve. Suppose that the straight line demand curve DC in Figure 11.3 is 6 centimeters.
Five points L, M, N, P and Q are taken oh this demand curve. The elasticity of demand at each
point can be known with the help of the above method. Let point N be in the middle of the
demand curve. So elasticity of demand at point.

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We arrive at the conclusion that at the midpoint on the demand curve the elasticity of demand is
unity. Moving up the demand curve from the midpoint, elasticity becomes greater. When the
demand curve touches the Y-axis, elasticity is infinity. Any point below the midpoint towards the
X-axis will show elastic demand. Elasticity becomes zero when the demand curve touches the X-
axis.

4) The Arc Method: When elasticity is measured between two points on the same demand curve,
it is known as arc elasticity. In the words of Prof. Baumol, “Arc elasticity is a measure of the
average responsiveness to price change exhibited by a demand curve over some finite stretch of
the curve.”

The following formula is used to compute arc elasticity.

𝑄1 − 𝑄2 ∆𝑄
(𝑄1 + 𝑄2)/2 𝑄1 + 𝑄2
𝐸𝑑 = =
𝑃1 − 𝑃2 ∆𝑃
(𝑃1 + 𝑃2)/2 𝑃1 + 𝑃2

Where, Q1 stands for the first quantity observed and Q2 for second quantity. Similarly, P1 is the
first observed price and P2 is the second price.

Factors determining elasticity of demand

1. Type of goods
2. Goods having several uses
3. Existence of substitutes
4. Possibilities of postponement
5. Range of prices

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Prepared by Dr. Satishkumar, M.
 UTILITY THEORY OR CONSUMER BEHAVIOUR THEORY/ DEMAND ANALYSIS

Human wants

Economic activity of the humans is directed towards the satisfaction of their wants. The
fulfillment of human wants generally is considered as the goal of economic activity.

Characteristics of Human wants

1. Wants are unlimited

2. Wants recur
3. A given want is satiable (Eg: water-Thirsty)
4. Wants are complimentary (ex: bread and butter, tractor and driver)
5. Wants are competitive (ex: urgent wants)
6. Wants have alternative means (ex: Thirsty- water or cold drink)
7. Wants varies with time, place and person
8. Wants multiply with civilization
9. Wants change into habits
10. Wants are influenced by income, salesmanship and advertisement etc.

Classification of wants

Wants are broadly divided into 3 categories viz, necessaries, comforts and luxuries.

1. Necessaries: The goods which are used to satisfy basic needs of humans are called
necessaries. They are further classified into necessaries of existence, necessaries of
efficiency and conventional necessaries.
a. Necessaries of existence: Those goods which are essential for living. Human
existence is not possible without fulfilling the necessaries of existence. Ex: food,
water, clothes, shelter etc.
b. Necessaries of efficiency: These are essential in improving the efficiency of an
individual. Ex: Nutritious food, table with chair to a student etc.
c. Conventional necessaries: These are necessaries which arise out of customs or
habits. Ex: Customs like celebrations of functions, habits like smoking, drinking,
gambling etc.
2. Comforts: are those which fall between necessaries and luxuries. The comforts also
increase the efficiency. Ex: cushion chair in a classroom, revolving chair in the saloons
etc.
3. Luxuries: are those which satisfy superfluous wants of individuals. These are neither
essential for life nor increase the efficiency. Luxuries represent wasteful expenditure of
the individuals.

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 Luxuries are classified as
a. Harmless luxuries: are those, the expenditure on which will not cause any harm to
the individual. Ex: well furnished bungalow, expensive food habits etc,.
b. Harmful luxuries: are those which are injurious to the health of the users. Ex:
Alcohol, smoking etc,.
c. Defense luxuries: are those which protect the user during the period of crisis. Ex:
expenditure on gold ornaments, jewellery etc.

Note: Though demarcation is made among necessaries, comforts and luxuries, in reality these are
interchangeable.

Consumer Behaviour Theoary/ Demand Analysis

Two techniques are used in the analysis of consumer behavior viz.

i) Utility analysis or the Marshallian approach through which utility can be measured.
This approach is called “Cardinal approach”. The LDMU, LEMU, CS etc falls under
this approach.
ii) The indifference curve technique. This approach is called “Ordinal approach”.

Law of Diminishing Marginal Utility (LDMU) - Unlimited resources

This law was initially formulated by German economist H. H. Gossen. The law says that
more a commodity that an individual possesses the less is the utility that is derived from it.

Marshall defined the law as “The additional benefit a person derives from a given increase of his
stock of anything diminishes with the growth of the stock he has”.

Assumptions

i. The units of commodity consumed in succession should be identical in size, colour,

taste, freshness, maturity etc. Homogeneity of the commodity is the basic requirement
of the law.
ii. Consumption of the unit of the commodity should be continuous without interval.
iii. It also assumed that tastes, preferences, incomes etc remain unchanged.

Explanation of Law
Before looking into the law, two basic concepts need to be understood viz., marginal
utility and total utility.

Marginal utility: It is the additional utility derived by an individual, by the consumption of one
more unit of the commodity.

Total utility: It is the sum amount of satisfaction derived from the consumption of different units
of the commodity.

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Tabular Representation

The case of an individual consuming “rasgullas” at a point of time and the related utilities
are presented in the table.

Table: Utility schedule for rasgullas

No. of rasgullas Total utility Marginal utility
0 0 0
1 15 15
2 28 13
3 38 10
4 46 8
5 50 4
6 52 2
7 52 0
8 50 -2
9 45 -5

As per the table, consumption of first rasgulla gives a marginal utility of 15 utils, while
the second 13 utils, the third 10 utils and so on. The consumption of successive units of rasgulla
results in declining marginal utility but remains positive till marginal utility becomes zero. Any
further consumption of rasgullas makes the marginal utility negative.

With regard to the total utility, it goes on increasing; right from the consumption of first
unit till the point of satiety (max satisfaction) is reached. At this point, the total utility is
maximum. This attained at 7th unit of rasgulla. Consumption of further units of rasgullas results
in declining total utility.

Graphical Representation

As per the graph, along OX are represented the units of the commodity rasgullas and
along OY is measured the MU & TU corresponding to the consumption of each unit. It can be
Prepared by Dr. Satishkumar, M.
seen that at each unit consumption, the additional MU becomes smaller and smaller. At some unit
there is no addition at all i.e., MU is zero and then it become negative.

The graph indicates that MU is falling throughout, while TU is increasing at decreasing

rate till MU becomes zero. TU starts falling when MU becomes negative.

Relationship between MU & TU

The relation between MU & TU is that as the MU is falling, TU is increasing at

decreasing rate. When MU is zero the TU is maximum and finally the negative MU results in
declining TU.

Law of Equi-Marginal Utility (LEMU)- Limited resources

Also known as the law of substitution/Max satisfaction. Marshall defined “The law
implies that if a person has a thing which he can put to several uses, he will distribute it between
those uses in such a way that it has the same marginal utility in all”.

The consumer aims at maximizing total utility by consuming possible goods and services
given the income constraints. In this process the consumer substitutes the goods having greater
utility for those which have lesser utility. This process is continued till the marginal utilities of
the commodities purchased are equalized.

Assumptions

1. The consumer behaves rationally

2. He has full knowledge about the commodities, their attributes, prices etc, in the market
3. Utility is measurable cardinally in terms of utils.
4. Commodities that are chosen are divisible and substitutable.

Explanation of the law

Tabular representation

Table: Equi-Marginal Utility

No. of units Marginal utilities per unit of Rs.5

(Rs.5 per unit) Potato Tomato Ridge gourd

1 19(IV) 22(I) 18 (V)
2 16 21(II) 17
3 14 20(III) 15
4 10 16 12
5 05 14 11

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 Let us assume that consumer has got Rs.25 to spend (Income constraint). He has option of
spending this amount on three vegetables viz., potato, tomato and ridge gourd. The MU that is
derived from the consumption of these vegetables and the amount of money spent are presented
in the table. [Each unit of money is equal to Rs.5].

First unit of Rs.5 gives a MU of 19, 22 & 18 utils from potato, tomato & ridge gourd
respectively. So, first unit is spent on tomato, which brought in the max satisfaction among
alternatives. To spend the second unit of Rs.5, the three opportunities are first unit to potato (19),
second unit to tomato (21) and first unit to ridge gourd (18). Among three opportunities for the
second unit of Rs.5, tomato gives max satisfaction. In the same manner third unit for tomato,
fourth unit for potato and fifth unit for ridge gourd are spent.

The total utility through this combination would be 100 (22+21+20+19+18). No other
combination of vegetables gives as high as 100 utils.

Consumer’s Equilibrium

One commodity equilibrium: When a consumer is purchasing one commodity, he stops buying
when its price and utility have been equated. At this point, his total utility is maximum. He is said
to be equilibrium. i.e MUx=Px1.

More than one commodity: According to Marshallian utility analysis, “when expenditure of a
consumer has been completely adjusted, that is, when MU in each direction of his purchases is
the same, it is called consumer’s equilibrium.

The consumer allocates his expenditure in such a way that the marginal utilities of the
goods purchased would be in proportion to their prices. Thus, consumer will be in equilibrium
when,
𝑀𝑈 𝑜𝑓 𝑋 𝑀𝑈 𝑜𝑓 𝑌 𝑀𝑈 𝑜𝑓 𝑍
= = =𝐾
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑋 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑌 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑍

This also called the principal of proportionality.

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Concept of Consumer’s Surplus
According to Alfred Marshall, It is measured in monetary terms.
Consumer’s surplus is the difference between what the consumer is willing to pay and what he
actually pays.

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 PRODUCTION: PROCESS, CREATION OF UTILITY, FACTORS OF PRODUCTION,
INPUT OUTPUT RELATIONSHIP.
Production: Production means creation of value in the goods.
“The process through which some goods and services called inputs are transformed into other
goods called products or output is called production”.
Production is “a process whereby some goods and services called inputs are transformed into
other goods and services called output, which in turn creates utilities”.
Results of the production process
a) Creation of want satisfying goods and services (creation of utility)
b) Creation of exchange value
Factors of production: means the productive resources required to produce a given product.
Fraser defined factors of production as “a group or class of original productive resources”.
Factors of production are as follows,
a) Land Original factors of production
b) Labour
c) Capital Man made factors of production
d) Organization
a) Land: It stands for all natural resources which yield an income. (Natural resources which
are useful and scare).
According to Marshall, land means “the material and forces which nature gives freely for
mans aid, in land and water, in air and light and heat.
Characteristics
1. It is natures gift and fixed in quantity
2. Geographical supply of land cannot be increased but economic supply can be
increased by putting the land under intensive and higher use. Land has no supply
price. Price of land prevailing in the market cannot affect its supply.
3. It is indestructible and permanent
4. It is immovable and immobile
5. Institution of property exits in land, as it can be divided and sold like any other
property
6. Land has enormous variability in its structure and fertility. (No two piece of land are
exactly alike).
b) Labour: Any physical work or mental work that it done by a person with an aim of earning
money. (Ex: - Farmers, workers, the service of teacher, doctors, actors etc,.)

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Characteristics
1) Labour is inseparable from the human being as it is a living thing.
2) Without the aid of labour, no land can be productive
3) Labour does not last and is a highly perishable commodity
4) Change in price affects labour supply and labour cost. A fall in price (wages) below a
certain point may increase the supply in the long run.
5) In short run, labour supply cannot be adjusted with demand.
c) Capital: It is not an original factor like land, but it is the result of man-made efforts.

• Wealth which is used in producing further wealth or which yields an income is called
capital. All capital is necessarily wealth, but all wealth is not necessarily capital.
• Capital is produced mean of production.
• Capital is “crystallized labour” (Karl Max in his book Das Kapital)
Characteristics
1. Capital is productive
2. It yields income
3. Capital is prospective (for future) in the sense that we postpone the present use of it for
future in anticipation of rewards.
Forms of capital
a) Fixed capital- land, building etc.
b) Working capital- fertilizers, wages etc.,
c) Sunk capital- when capital is used to purchase of highly specialized equipments or
machinery, which can be used for only one purpose and cannot be used for other purpose.
Ex: purchase of textile machinery, paddy harvester etc,.
d) Organization/Enterprise: The role of organization or enterprise is co-ordinating and
correlating the other factors of production. The entrepreneur organizes and supervises the
production process.
The three chief function of entrepreneur
a) Organizing
b) Risk taking or uncertainty bearing and
c) Innovating
Forms of organization
1) Individual producer
2) Partnership
3) Joint stock enterprise (different amount of shares of the company stock can be bought and
sold by shareholders)
4) Cooperative enterprise
5) State enterprise (Ex: Karnataka state seed certification agency)

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Input-Output (Factor-Product) relationships
It is a basic relationship between the inputs and output. This is mainly concerned with
resource use and its efficiency. It guides the producer in deciding how much to produce. The
relationship is explained by the law of diminishing returns.
Production function
The relationship between inputs and outputs can be characterized as a production function.
Output (y) is a function of input (x) used, given by Y= f(X)
Law of returns
In the process of production, the farmers combine the required input factors in various
proportions. This type of usage of inputs by the farmers gives way for the operation of the law of
returns.
There can be three types of input-output relationships in the production of a commodity,
where one input is varied and the quantities of all other inputs are fixed. The nature of
relationship between a single input and a single output can be either the one or a combination of
the types given below
1. Law of constant returns (Constant Marginal Productivity)
2. Law of increasing returns (Increasing Marginal Productivity)
3. Law of decreasing returns (Decreasing Marginal Productivity)S
Law of constant returns
The addition of each successive unit of the variable factor to the fixed factors adds the
same to the output as observed for the previous unit i.e., each successive unit of variable factor
results in an equal quantity of additional output.
Ex: Fertilizer usage
Table: Law of constant returns
Marginal
Fertilizer (kg) Total output (Q)
∆X ∆Y output
(X) (Y)
∆Y/∆X
1 5 - - -
2 10 1 5 5
3 15 1 5 5
4 20 1 5 5
5 25 1 5 5

This relationship is termed as a linear function (straight line) is not very common in agriculture.
When the data graphed the resultant curve is straight line to X-axis.
∆1Y1/∆1X1=∆2Y2/∆2X2…….=∆nYn/∆nXn

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 Fig: Law of constant returns
Law of increasing returns
For each additional or marginal unit of input results in a larger increase in the product
than the proceeding unit i.e., increasing returns from the input. (Or)
The addition of each successive unit of the variable factor to the fixed factors in the
production processes, adds more to the total output than the previous unit.
Table: Law of increasing returns

Fertilizer (kg) Total output (Q) Marginal output

∆X ∆Y
(X) (Y) ∆Y/∆X
1 3 - - -
2 8 1 5 5
3 15 1 7 7
4 23 1 8 8
5 35 1 12 12

When the data graphed the resultant curve is convex to X-axis.

∆1Y1/∆1X1 < ∆2Y2/∆2X2<….….< ∆nYn/∆nXn
Law of increasing returns

Fig: Law of increasing returns

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Law of decreasing returns
The addition of each successive unit of the variable factor to the fixed factors in the
production process, adds less to the total output then the previous unit.
“This function exists in almost every practical situation of agriculture”
Table: Law of decreasing returns

Fertilizer (kg) Total output (Q) Marginal output

∆X ∆Y
(X) (Y) ∆Y/∆X
1 15 - - -
2 27 1 12 12
3 35 1 8 8
4 41 1 6 6
5 45 1 4 4

When the data graphed the resultant curve is concave to X-axis.

∆1Y1/∆1X1 > ∆2Y2/∆2X2>….….> ∆nYn/∆nXn

Fig: Law of decreasing returns

Economic theory gives two types of input-output relationship in a production function,
a) Proportionality relationship (involves the short run production function)
b) Scale relationship (long run production function)
Law of variable proportions/ Law of diminishing returns
If the quantity of one productive service is increase by equal increments, with the quantity
of other resources services held constant, the increments to total product may increase at first but
will decrease after a certain point (E.O. Heady).

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Returns to scale
It refers to the change in output as a result of a given proportionate change in all the
factors of production simultaneously.
When all the factors or inputs involved in a production process are increased or decreased
simultaneously, in a certain fixed proportion, the response of output to such an increase or
decrease in the input levels is explained through the concept of returns to scale.
Table: returns to scale

Labour Capital Total output Increment in Nature of

(L) (C) (Q) output returns to scale
0 0 0
1 1 8 8
Increasing
2 2 17 9
3 3 28 11
4 4 38 10
5 5 48 10
Constant
6 6 58 10
7 7 68 10
8 8 76 8
9 9 82 6 Decreasing
10 10 86 4

Fig: Returns to scale

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 Difference between the law of variable proportions and returns to scale

Sl. No Law of variable proportions Returns to scale

Describes the behaviour of output when Examines the behaviour of output, when all
1
one input is varied inputs are varied at the same time
2 Some factors of production are constant All factors are varies
3 The proportion among factories varies Remains same
4 It is a short run production function It is a long run production function
Here increasing, constant and Here increasing, constant and decreasing
5 decreasing returns to a factor are returns to a scale are observed
observed
Increasing returns are due to the Increasing returns to scale are due to scale
efficient utilization of fixed resources as economies of production
6
a result of application of sufficient
quantity of variable resources
Optimum output is the result of best The optimum output is the result of
7 proportion among fixed and variable optimum size of the plant
resources
The diminishing returns are due to over Diminishing returns to scale are due to the
8
exploitation of fixed factor operation of diseconomies of scale
9 Y=f(X1/X2,X3,…Xn) Y= f(X1,X2,X3,…..Xn)
10 It is a reality It is a myth

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 COST: COST CONCEPTS
Cost: refers to the amount of expenditure incurred in acquiring something.
In the cost theory, economists use different names for costs concepts under different
contexts. They are money costs or nominal costs, real costs, opportunity costs, economic costs,
implicit costs, explicit costs, deflated costs, social costs, short run costs, long run costs, separable
costs, etc,.
Nominal or Money costs: Nominal costs of production refer to per unit cost of production of
output at current market prices.
Real costs: When the costs of inputs, input services are expressed at constant prices they become
real costs.
Opportunity cost/ alternative cost/ displayed cost/ transfer cost: It is the value of return
sacrificed or foregone from the next best alternative activity. In farming farmers don’t have to
pay for their owned resources, viz., family labour, owned bullock labour, owned seeds etc. but
still in the cost analysis the value of these owned resources are considered on the basis of
opportunity cost.
Economic cost (Explicit and implicit cost)
a) Explicit costs/paid out costs/cash costs: It includes payments made by the entrepreneurs
for purchasing and hiring of inputs and input services.
b) Implicit costs: Entrepreneurs do not pay for the use of owned resources. The value of
such resources is called implicit costs. Costs of self-owned and self-employed resources.
Deflated costs: Costs if deflated by general price index are called deflated costs. By deflating the
effect of inflation in an economy is taken out. (Ex: real cost of commodities)
Social costs: These are also called externalities. The firms will give rise to some additional costs
to the society in the form of environmental degradation, water, air or noise pollution.
Separable costs: They are the costs which can exclusively be attributed to production of output
separately. Common costs are those which cannot be separated to the production of the output.
So they are called joint costs. (Ex: electricity generation, ground water use etc,.)
Historical costs and replacement costs: Historical costs are the costs involved in the purchase
of durable goods like land, building, etc,.
Replacement costs refer to the difference between the purchase price of the asset and the current
price of the same asset.
Establishment costs/First phase costs: construction of plant in any business activity entails
some costs. Such construction costs are called establishment costs in the business analysis. (Ex:
licenses, purchase of equipment, furniture etc.

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Production Costs

Production costs refer to the total amount of money spent in the production of goods.
Selling Costs

Selling costs are the costs of marketing, advertisement and salesmanship. These costs are
incurred to attract customers, expand market and capture more business and retain the existing
business.
Cost concepts
The cost functions are very much essential for optimal managerial decisions to be taken
by the firm as well as the government. In the short run, pricing and output decisions are based on
short run cost curves, while in the long run, long run cost curves have crucial implications for
development and growth of the firm and investment policies of the firm.
Profit maximization rule is determined with the help of cost curves, cost functions and
production functions. This rule is popularly known as marginal analysis at which MC=MR.
There are seven costs, which explain the behaviour of the firm in the production of
requisite products.
1) Fixed Costs: Fixed costs remain the same irrespective of level of production. These costs
remain invariant in the short run but in the long run there are no fixed costs as all the
inputs can be varied. These are also known as indirect cost, sunk cost and overhead costs.
The summation of all these costs is called total fixed costs (TFC). TFC is a horizontal
straight line parallel to x-axis.
Ex: taxes, insurance, buildings, depreciation on machinery etc,.

Fig: Total fixed costs

2) Variable Costs: As per definition vary with the level of output. These include costs of
raw materials, labour, power, repairs etc,. These are also known as working costs,
operating costs, direct cost, prime costs, circulating costs and running costs. These are

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 second phase costs. The summation of these cost refer to total variable costs (TVC).
Graphically TVC is inverse ‘S’ shape (Cubical parabola).

Fig: Total variable costs

3) Total Costs (TC): These include total fixed costs as well as total variable costs. Its shape
is similar to that of TVC.
TC= TFC+TVC

Fig: Total cost

4) Average Variable Cost (AVC): It is the amount spent on the variable inputs to produce a
unit of output.
𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑇𝑉𝐶
𝐴𝑉𝐶 = =
𝑂𝑢𝑡𝑝𝑢 𝑄
When a small amount of output is produced, cost of variable input per unit of
output becomes very high. The productivity of variable input increases when greater
amounts are used in the production of the commodities due to economics of scale. This
causes AVC to have ‘U’ shape when it is graphed.
AVC falls to minimum level at the output where APP is maximum. There after
due to production of greater amount of output, AVC rises again and becomes vertical at
certain level of maximum output.

Prepared by Dr. Satishkumar, M.

 Fig: Average variable cost

5) Average Fixed Cost (AFC): It is the cost of fixed resources or inputs required for
producing one unit of output.
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 𝑇𝐹𝐶
𝐴𝐹𝐶 = =
𝑂𝑢𝑡𝑝𝑢𝑡 𝑄
AFC curve is declining with the increased output because TFC is constant. Due to this it
is continuously falling up to its maximum output. It is having the shape of hyperbola.

Fig: Average fixed cost

6) Average Total Cost or Average Cost (ATC or AC): When the total costs are divided by
output, we get ATC.
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 𝑇𝐶 𝑇𝐹𝐶 + 𝑇𝑉𝐶
𝐴𝑇𝐶 = = =
𝑂𝑢𝑡𝑝𝑢𝑡 𝑄 𝑄
Minimum point of ATC curve indicates Break Even Point (BEP).

Prepared by Dr. Satishkumar, M.

 Fig: Average total cost

7) Marginal Cost (MC): It is the change in the total cost due to the change in output.
∆𝑇𝐶 ∆𝑇𝑉𝐶
𝑀𝐶 = 𝑂𝑅
∆𝑄 ∆𝑄

Relation between Marginal Cost and Average Cost

The following diagram, A represents the average cost and M represents the
marginal cost. It can be clearly seen that when marginal cost (M) is above the average cost (A),
the average cost rises which is shown by the rising arrow. On the other hand, when the marginal
cost (M) is below the average cost (A), then the average cost falls, as is shown by the falling
arrow. But when the marginal cost is the same as the average cost (i.e., AM), the average cost
remains constant, as if M is pulling A along horizontally

Average – Marginal Relationship

The marginal cost (MC) and the average cost (AC) are shown in the diagram. It will be
seen that as output increases, both AC and MC fall, but MC is below AC, i.e., MC is less than the
AC. The fall is due to the economies of scale. But beyond a point (M). i.e., when output is
expanded too much, both AC and MC start rising and now MC is above AC, i.e., the marginal
cost is greater than the average cost. That is way MC cuts AC from below at its lowest point.

Prepared by Dr. Satishkumar, M.

 This relationship should be carefully understood. When the average cost is falling, the
marginal cost is less than the average cost and when average cost is rising, the marginal cost
is higher than the average cost. But if marginal cost neither goes up comes down, the average
and marginal costs are equal.

Fig: Average cost and Marginal cost

It is clear (Fig) that as output is increased, the cost per unit decreases due to various
internal economies. That is way AFC, AVC and hence ATC all start falling. But if the output is
expanded beyond proper limit, diseconomies will result, and all these costs will go up, which is
shown by the rising portions of these curves. This is the third stage of the Law of Variable
Proportions (discussed in the previous chapter). It will be seen that AFC continues to fall, it never
rises, rather it helps AVC to fall too for some time, but after some time AVC starts rising quickly
and raises ATC too. MC and AVC fall and rise at the same time. But it is to be carefully noticed
that when MC and AVC are falling, MC is below AVC, but when they rise. MC is above AVC.
When AVC is constant, MC is equal to it. In other words, MC cuts AVC and ATC at their lowest
points.

Fig: Average, variable, fixed and marginal costs

Prepared by Dr. Satishkumar, M.
 SUPPLY
Supply of a commodity refers to the quantity of a product which a seller is willing and
able to sell at a given price per unit of time. It is the amount that is actually offered for sale in the
market at a price per unit of time.

Meyers defined supply as “ a schedule of the amount of good that would be offered for sale at all
possible prices at any one instance of time in which the condition of supply remains same”.

Stock and supply

Stock is a potential supply and therefore it is at the back of supply. Supply is drawn from
the stock of the commodity. Supply is the actual quantity that a seller is willing to sell at a
particular price, while stock is the amount of output that exists in a market.

Depending on the demand for a commodity stock is converted into supply. For perishable
commodities stock and supply are the same. For durable commodities stock and supply are
different.

Individual supply schedule

A detailed amount of the supply of any commodity at a given time at different prices is
known as the supply schedule. It shows that the volume of sales would be at a series of prices.

Price of rice (Rs/Kg) Units offered for sale

Rs. 36 15 Q
Rs. 35 12 Q
Rs. 34 8Q
Rs. 33 4Q
Rs. 32 3Q
Rs. 31 1Q

Prepared by Dr. Satishkumar, M.

It is clear from the above schedule that less
Y S
and less quantity of rice is being offered for sale as the
price of rice declines. When this schedule is translated on a
diagram, we get a curve and this curve is known as the
supply curve. A long OX-axis we measure the quantity of
rice supplied at different pries. Along OY-axis price of the
commodity is indicated. SS is the supply curve which S

indicates that a fall in price leads to a contraction in the

O
quantity supported and vice-versa. X

Market supply

It is the sum of the quantity of commodity that is brought into a market for sale by the
sellers in a given market at a specific point of time. Assume that there are three sellers in a
market viz., A, B, C & D with individual supply schedules as shown in the table.

Table: Market supply schedule of Rice

Price Individual seller’s supply / week Market supply

(Rs/q)
A B C D Q=(A+B+C+D)

2800 30 35 20 0 85

3000 40 50 30 0 120

3250 50 65 70 50 235

3500 60 80 90 70 300

3750 70 95 100 90 355

4000 80 105 105 100 390

4250 100 115 110 110 435

Prepared by Dr. Satishkumar, M.

 The price quantity relationship of the four sellers reveals that at Rs. 2800 per quintal,
seller ‘A’ is prepared to sell 30 Q, while seller ‘B’ 35 Q seller C 20 Q and seller D is not prepared
to sell at all at this particular price. The seller ‘C’ is not prepared to sell the commodity at any
price less than Rs. 3250/Q. Market supply is the sum total of output that is sold by the four
sellers as presented in the last column of the table. Thus the market supply is 85, 120, and 235
and so on. It is the horizontal or lateral summation of the supply of individual sellers at each unit
price.

Law of supply

Normally, at higher price suppliers will be ready to supply more units of a commodity and
vice-versa. This tendency of the producers to supply more units at a higher price and less
units at a lower price is known as the law of supply. In other words, the law of supply states
that, ceteris paribus, more will be produced and offered for sale as the price increases.

“The quantity supported varies directly with the price; when the price falls, supply will
contract and when the price rises, supply will extend”.

Exceptions to the law of supply

1) Auction sale: In the case of an auction, the law of supply does not apply. The auctioneer
is not interested in maximizing profits by selling more units at a higher price. Here the
price is determined by the bidders. While selling the commodity in an auction, auctioneer
may have other motives to sell the commodity. Therefore, an auction sale is an exception
to the law of supply.
2) Fear of future fall in price: When the sellers are afraid of a function fall in the price of a
commodity, they may sell more units even at a lesser price and get rid of the supply of a
commodity.
Extension and Contraction of supply (Change in quantity supply)

Extension and contraction of supply refers to the movement of product supply on the
same supply curve. Extension of supply means offering more quantity for sale at a higher price,
while contraction means offering less quantity at a lower price.

Prepared by Dr. Satishkumar, M.

 Graphically when it is depicted, it shows that the upward movement from A to B is
extension and downward movement from B to A is contraction of supply.

Increase and decrease in supply (shift in supply)

Increase in supply implies more supply at the same price and decrease in supply means
less supply at the same price. The change in supply (increase and decrease in supply) results in a
shift of the supply curve.

An increase in supply results in the shift of the supply curve towards right side of the
initial supply curve SS i.e S’S’ and a decrease in supply causes a shift of supply curve towards
the left side of the initial supply curve SS i.e S”S” in the fig below.

Prepared by Dr. Satishkumar, M.

Factors causing changes in supply (shift factors)

1) Changes in technology: Technological innovations viz., new varieties of crops and their
consequent increased yields per unit area, help to increase the supply of the commodity.
2) Reduction in prices of inputs: When the prices of input factors become cheaper than
before, it encourages producers to use more them in producing more output. Supply curve
shifts towards the right side.
3) Reduction in relative prices of other products: A reduction in relative prices of other
related products compel the producers to increase the production of that particular
commodity whose prices are relatively higher.
4) Market infrastructure: When good communication and transport network increases, the
supply of the commodity also increases.
5) Number of producers: Changes that are found regarding number of producers producing
a given commodity influence the supplies. More the number of producers, greater the
supply and vice versa.
6) Producers’ expectations about future prices : Price expectations influence the sales
strategies of the producers positively.
Elasticity of supply

Elasticity of supply of a commodity is the responsiveness, or sensitiveness of supply to

the charges in price.

Supply is said to be elastic, if a small change in price causes considerable change in the
quantity supplied. The supply is inelastic when a given change in price leads to litter or less
change or no change in the quantity supplied. In short, elasticity measures the adjustability of
supply of a commodity to price.

Elasticity of supply is expressed as the rational percentage change in quantity of good

supplied and percentage change in the price of the goods, ceteris paribus.

% change in quality of good supplied

Es =
% change in price of good supplied

Algebraically, Es is expressed as

Prepared by Dr. Satishkumar, M.

 ∆Q
Q × 100
∆P
P × 100

∆Q× 𝑃
𝑄 × ∆𝑃

∆Q× 𝑃
∆𝑃 × 𝑄

Degree of Elasticity of supply

There are five degrees of elasticity of supply. They are as follows

1) Perfectly elastic supply

Y
When the supply of commodity increases to infinite
quantity or unlimited quantity even though there is
invisible rise or minute rise in the price, theS S

elasticity of supply is said to be infinity (ES=∞)

O X

2) Perfectly Inelastic supply Y S

It means that the quantity supplied is not responsive
Price

to change in prices. Elasticity of supply in this case

is zero (Es=0)
S X
O

Quantity

3) Relatively elastic supply

Supply is referred as relatively elastic, when the
percentage change in quantity supplied is more than
the corresponding percentage change in price. It is
also called elastic supply (Es>1).

Prepared by Dr. Satishkumar, M.

 4) Relatively inelastic supply
Supply is said to be relatively inelastic, when the
change in quantity supplied is less than the
corresponding percentage change in price. In this
case the elasticity of supply is less than one (ES<1).

5) Unitary elastic supply

Y
S
When percentage change in quantity supplied equals

Price
the percentage change in price, it is called unitary P1

elastic supply. Here the elasticity of supply is equal P

to one Es = 1. X
O S
Quantity
Factors influencing elasticity of supply

1. Availability of inputs of production:

If the needful inputs are available as per the requirement, the supply is elastic. If any one
of the factors is not available which is absolutely necessary supply would be inelastic.

2. Length of time period:

It is the period of time required to adjust the supplies to the changes in prices. The
biological characteristics of the product dictate the changes of responsiveness.

3. Diversification of production activity:

When the producers is engaged in production of a number of products and facilities exist
for shifting of production from one product to the other, in such a case for each product the
supply is elastic.

4. Availability of alternative markets:

Suppose there exists several markets for the producer to sell the goods, a fall in price in one
market would prompt him to shift his goods to another markets and a rise in price in one market
induces him to shift his goods to that market. In such a case the supply is elastic.

Prepared by Dr. Satishkumar, M.

5. Flexibility in starting and winding up the business
If a particular production activity is quickly taken up and quickly wound up, the supply of
the goods is elastic.

Importance of the elastic of supply

The concept of elasticity of supply is of greater use to the finance minister while imposing
the tax. If the supply is inelastic, the imposition of tax may not bring about any change in the
supply. If supply is elastic, reasonable taxes are to be levied.

Joint supply

Some commodities are produced together, so that change in the supply of one can be
brought about only by changing the supply of the other. Wool and mutton are joint products of
sheep, beef and hides are joint products of oxen. Similarly, gas and coke, wheat and straw are
also produced jointly. Therefore, the supply of these inter-related goods is called the joint supply.

Composite Supply

When there are different sources of supply of a commodity or a service, we say that the
supply is composed of all these sources. For example we get light from electricity, kerosene oil,
candles, etc. Whenever there are other sources of supply or substitutes supply is composite.

Prepared by Dr. Satishkumar, M.

 MARKET STRUCTURE
Market: It refers to a particular place where goods are purchased and sold.
In economics: The Term “market” does not mean a particular place but the whole area where the
buyers and sellers of a product are spread.
Marketing: It is the economic process by which goods and services are exchanged between the
producers and the consumers and their values determined in terms of money prices.
Market structure: It refers to the nature and degree of competition in the market for goods and
services. The structures of market both for goods and services are determined by the nature of
competition prevailing in a particular market.
Types of markets
Based on the nature of competition, we have perfect and imperfect markets.
1. Perfect markets/ perfect competition: It is a market in which every firm is too small to
affect the market price.
2. Imperfect market/imperfect competition: It is a market in which a firm can appreciably
affect the market prices of the product.
Types under imperfect market
a) Monopoly
b) Duopoly
c) Oligopoly
d) Monopolistic
e) Monopsony
f) Oligopsony
Basic features of perfectly competitive markets
1. Larger numbers of buyers and sellers
2. Homogeneous product (identical products)
3. Free entry and exit of firms
4. No government regulations
5. Perfect mobility of factors of production (one firm to another)
6. Perfect knowledge (conditions of the market)
7. Profit maximization
Basic features of imperfectly competitive markets

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 1. Few sellers selling a differentiated product
2. Heterogeneous product
3. Restriction of free entry and exit of the firms
4. Absence of price information
5. Existence of transportation cost
Monopoly: It is a market structure in which there is a single seller, there are no close substitutes
for the commodity it produces and there are barriers to entry.
Duopoly: It is a market structure in which there are two sellers, selling either a homogeneous
product or a differentiated product.
Oligopoly: Greek word olig means “a few” and poly means “sellers”.
A market form, in which there are only a few sellers, is called oligopoly. They producing
and selling either homogeneous (perfect oligopoly) or differentiated (imperfect oligopoly)
products. Eg: motor cars, petrol etc.
Monopolistic competition:
➢ The number of dealers is quite large but not as large as under perfect
➢ It is a market situation in which transacted products of various firms are not perfect
substitutes.
➢ Firms in the industry produce heterogeneous products.
➢ The products look rather similar but possess some distinguishing features. They are not
identical. Therefore product differentiation is important feature.
➢ The production of goods under different brand names is another important features
Monopsony: It is a market structure in which there is only one buyer.
Oligopsony: It is a market structure in which there are only few buyers.
Bilateral monopoly: It is a market structure in which a single seller faces a single buyer.

Prepared by Dr. Satishkumar, M.

 PRICE DETERMINATION UNDER PERFECT COMPETITION
Price under conditions of perfect competition is determined by the interaction of demand
and supply. The demand of all consumers and the supply of all firms together determine the
prices. The price at which demand and supply are equal is known as an equilibrium price.
Market price is determined by the equilibrium between demand and supply in a period or very
short period.
Market price of a perishable commodity

• The supply is limited by the available quantity on that day and it cannot be kept back for
the next period.
• The supply curve of good will be a vertical straight line (MS).
• With perfect competition between buyers and sellers an equilibrium price OP will be
determined at which the quantity demand is equal to the available supply.
• There is a sudden increase in demand from DD to D’D’ with supply of goods remaining
unchanged the larger demand will raise the market price sharply and vice verse.

Market price of a non-perishable and reproducible goods

• Supply curve cannot be a vertical straight line throughout its length because some of
the goods can be preserved or kept back from the market and carried over to the next
market period.
• If price is very high the seller will be prepared to sell the whole stock.
• If price is low the seller would not sell any amount in the present market period but
will hold back the whole stock for some better time.
• The price below which the seller will refuse to sell is called the reserve price.

Prepared by Dr. Satishkumar, M.

 The supply curve of a seller will slope upward to the right. Beyond a price at which he is
prepared to sell the whole stock, the supply curve will be a vertical straight line whatever the
price. In a perfectly competitive market, the product is homogeneous and no buyer has any
preference for a particular seller, therefore a single uniform market price will be established in
the market.

Prepared by Dr. Satishkumar, M.

 DISTRIBUTION THEORY

“Distribution” refers to the sharing of the wealth that is produced among the different factors of
production.

In the process of distribution the returns obtained through the production activity are
apportioned to the factors that are employed in the production process. Consequently land gets
rent, labour gets wages, interest is paid to capital and finally organisation is rewarded with
profit. Such an apportionment of returns among different factors of production is called
distribution. It is also called factor pricing.

Distribution Theory: The systematic attempt to account for the sharing of the national income
among the owners of the factors of production –Land, Labour, Capital and Organisation.

Concepts

Rent: It is the return for the fertility status of the land. Rent is almost zero for the public owned
resources because one cannot use it for one’s own purpose. Rent is expresses in two forms i.e.,
economic rent and contract rent.

a) Economic rent: It is the rent received exclusively from the use of land only. In farming
the rent paid by a tenant to the landlord is not economic rent.
b) Contract rent: the money paid by the tenant to the landlord for cultivating the land in a
given year. Rent is charged by a farmer not only for land but also for making availability
of certain infrastructure on land. Then it is not exclusively rent for the land only.
Economic rent is a part of contract rent.

Wages: wages are the rewards paid for the labourers for sparing their productive services.

A wage may be defined as a sum of money paid under contract by an employer to a

worker for services rendered (Benham).

Interest: It is the amount paid by the borrower to the lender for the use of capital.

Profit: It is the reward for entrepreneurial function of decision making and uncertainty bearing.
Profit can be either positive or negative, since it is a residual income.

Prepared by Dr. Satishkumar, M.

 NATIONAL INCOME

National income means the total value of goods and services produced annually in a country.
National income accounting: It attempts to measure the value of all goods and services of the
economy produced in a well conceived way i.e aggregate way.
Definitions of National Income
According to Alfred Marshall: “The labour and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material and immaterial
including services of all kinds. This is the true net annual income or revenue of the country or
national dividend.”

A. C. Pigou: ”National income or National Dividend is that part of objective income of the
community including of course income derived from abroad which can be measured in money.”

Prof. Simon Kuznet’s Definition (modern): “The Net Output of Commodities and Services
flowing in a year from the country’s productive system in the hands of ultimate consumers or into
net addition to the country’s capital goods”.

Importance of National income accounting

1. It provides the valuable information about basic structure in the economy and also
contribution made by the various sector to the nation produce.
2. It helps us to ascertain the overall performance of the economy over a period of time.
3. It also helps to compare between two economies. Hence it is basis for the economic
planning and macro-economic policies.
4. It shows distribution of income in society.
5. It also gives an indication about what percent of population receives what percent of
income.

Circular flow of income

It includes all economic transactions in a nation. In any economy economic transaction
are complex.

Circular flow income is the continuous flow of goods and services and income taking place
between the firms and household in economy overtime.

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Concepts of National Income

1. Gross National Product (GNP)

2. Net National Product (NNP)
3. Personal Income (PI)
4. Disposable Income (DI)

1) Gross National Product (GNP): It is a basic measure of social accounting of total

production of goods and services in an economy.

It is defined as the total market value of all goods and services produced in a year.

2) Net National Product (NNP)

a) Net National Product (NNP) at market prices
It is nothing but GNP minus depreciation.
i.e NNP = GNP- Depreciation
The amount of decline in the value of capital goods due to wear and tear is called
depreciation. Therefore NNP is the market value of all final goods after duly accounting
for the depreciation, hence the name national income at market prices.
b) National income or NNP at factor cost: It implies the sum of all incomes earned by
resource suppliers for their contribution of land, labour, capital and entrepreneurial
ability, which go into the net production in a year.
NNP at factor cost = NNP- Indirect taxes + Subsidies
3) Personal Income (PI): It is the sum of all the incomes actually received by all individuals or
households during a given year.
4) Disposable Income (DI): It is the amount of money available with the private individuals to
spend.
Disposable Income (DI) = Personal income- personal taxes (or)
= consumption expenditure + savings

Prepared by Dr. Satishkumar, M.

Methods to measure National Income

1. Income Method
2. Expenditure method
3. Product/ Value added method
1. Income method

In this method national income can be measured by aggregating the annual flow of factor
earning generated by the production of final output.
The final flow of factor earning in a form of rent, wages, interest and profit accrued from
land, labour, capital and organisation respectively are taken into account in the income approach.
𝑛

𝑁𝐼 = ∑(Wi + Ri + Ii + Pi)
𝑖=1
2. Expenditure method:
GNP is the sum total of expenditure incurred on goods and services during a period of one
year. Expenditure includes personal consumption expenditure, gross domestic private
investment, net foreign investment and government expenditure on goods and services.
GNE= C+I+G+[X-M]
Where, GNE= Gross National Expenditure
C= Consumption
I= Investment
G= Government expenditure
X= Exports
M= Imports
3. Product/ Value added method
This method consists of adding of the quantity of final goods and services produced in
different sectors of economy during a year.
Quantity produced- Q1, Q2, Q3,……..Qn
Respective prices- P1, P2, P3,………Pn
Therefore GNP= P1Q1+ P2Q2+P3Q3+……PnQn
𝑛

𝐺𝑁𝑃 = ∑ PiQi
𝑖=1

Difficulties in measuring National Income

1. Prevalence of Non-monetized transactions
2. Problem of double accounting: It is very difficult to distinguish between final goods and
intermediate goods and services.
3. Lack of reliable statistics: correct statistical information regarding agriculture and allied
occupation, consumption, expenditure and savings of either rural or urban population is
not available.

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4. Choice of method of measuring NI: It is difficult to decide which method is to be used in
estimating NI.
5. Difficulty in assessing the depreciation allowance.
6. Absence of proper accounts
7. Self consumed production.

Prepared by Dr. Satishkumar, M.

 POPULATION THEORIES

1. Malthusian theory of population (Thomas Robert Malthus)

He says “by nature human food increases in a slow arithmetical ratio; man himself
increases in a quick geometrical ratio unless want and vice stop him”.

“The increase in numbers is necessarily limited by the means of subsistence population invariably
increases when the means of subsistence increase, unless prevented by powerful and obvious
checks”.

The theory propounded by Malthus can be summed up in the following propositions:-

1. Population is necessarily limited by the means of subsistence (i.e., food)

2. Population increases faster than food production, whereas population increases in
geometric progression, food production increases in arithmetic progression.
3. Population always increases when the means of subsistence increase, unless prevented by
some powerful checks.
4. There are two types of checks which can keep population on a level with the means of
subsistence. They are the preventive and positive checks.

Preventive checks
They influence on the growth of population by bringing down the birth rate. They are
those checks which are applied by man.
Ex: late marriages, family planning etc.

Positive checks
They influence on the growth of population by increasing the death rate. They are applied
by nature.
Ex: Extreme poverty, diseases, earthquakes, wars and famines etc.

2. Modern theory of population: The optimum theory

“Given the natural resources, stock and capital and the state of technical knowledge there will
be a definite size of population with the per capita income. The population which has the
highest per capita income is known as optimum population”.

Under population
If the per capita income is low due to too few people, the population is then under
population.

Over population
If the per capita income is low due to too many people, the population is then over
population.

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Optimum population

The concepts of optimum population, under and over population are represented in the
figure given below.

The size of population is measured on X-axis and output per capita on Y-axis. In the
beginning as population increases, output per capita also increases, output per capita goes on
increasing with very increase in population till OM is reached. At OM level of population, output
per capita is the highest and is equal to MP. If population now increase beyond OM, output per
capita falls.
If population is less than OM -Under populated
If population is more than OM – Over populated

Dalton’s formula for maladjustment of population

It means the extent of deviation of population from optimum size of population. To
measure maladjustment, Dalton gave the following formula,
M= (A-O)/A
Where M = Maladjustment
A = Actual population
O = optimum population
A positive ‘M’ indicates that the country is over populated
A negative ‘M’ indicates that the country is under populated
A zero value of ‘M’ indicates that the actual population is equivalent to optimum population.

Malthusian theory of population vs. Optimum theory of population

1. Malthusian theory is based on the relationship between food production and the size of
population, while modern theory is based on the relationship between total production of
a country and the size of population.
2. Malthusian theory is more a pessimistic theory, while optimum theory is an optimistic
one.
Malthusian theory has a limitation in its application as it is applicable to over populated countries
only, whereas optimum theory is applicable universally.

Prepared by Dr. Satishkumar, M.

 MONEY: BARTER EXCHANGE
Meaning of Barter
‘Direct exchange of goods against goods without use of money is called barter
exchange.’
Alternatively, economic exchanges without the medium of money are referred to as barter
exchanges. An economy based on barter exchange (i.e., exchange of goods for goods) is called
C.C. Economy, i.e., commodity for commodity exchange economy.
Inconveniences (Problems) of Barter Exchange
1. Lack of double coincidence of wants: Double coincidence of wants means what one
person wants to sell and buy must coincide with what some other person wants to buy and
sell.
2. Lack of common measure of value: In barter, there is no common measure (unit) of
value. Even if buyer and seller of each other commodity happen to meet, the problem
arises in what proportion the two goods are to be exchanged.
3. Lack of standard of deferred payment: There is problem of borrowing and lending. It
is difficult to engage in contracts which involve future payments due to lack of any
satisfactory unit.
4. Difficulty in storing wealth (or generalised purchasing power): It is difficult for the
people to store wealth or generalised purchasing power for future use in the form of goods
like cattle, wheat, potatoes, etc.
5. Indivisibility of goods: lack of divisibility of goods makes barter exchange impossible.
Evolution of money
Money is anything which is used as a medium of exchange.
According to modern approach “money is defined on the basis only of its function as medium of
exchange.”
Evolution of money
The word “money” is derived from the Latin word “Monet”
The origin of money is lost
Hunting society, skin of wild animals were used as money
Pastoral society used livestock
Agriculture society used grain and foods
The Roman used cattle and salt.
Evolution of money
Money was developed according to needs & Requirements. Main aim was to remove the
shortcomings of the Barter System.
Different stages of evolution of money
1. Commodity money
2. Metalic money
3. Paper money
4. Credit money
5. Electronic money
1. Commodity Money: When different commodities were used as a medium of exchange
(Barter System) Eg: Cow , Goats, Axes, Dried Fishes etc were used as medium of
exchange.
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 2. Metallic money: The next step in the evolution was the discovery of precious metals like
Gold, Silver, Copper. “Metallic Money consists of coins made of Gold, Silver, Copper or
nickel as a mode of payment.” Metals were not used as a coin but as Bullion. This created
the problem of measuring the weight & Value. Supply of money also became problem
when the mines were fully used up or new mines were discovered. Later metallic money
is used as coined Metals. As a next step, standard coins were created. They had a standard
weight & value. Problem of uncoined metals dissolved by the use of coined metals.
Metallic money can be: Fully bodied/Standard money: Whose face value is equal to
the value of metal contained in it. Token money: Its face value is higher than intrinsic
value (Value of Metal).
3. Paper Money: When paper currency was introduced as a mode of payment. Originated as
a receipt issued by Goldsmiths. These receipts were then later on used for payments.
Difference in the value of receipts was becoming a problem then. It refers to the Notes
issued by the State or by the Bank, usually the Central bank.

Paper Money can be:

1. Representative Paper Money.
2. Convertible Paper Money.
3. Fait Paper Money.
Representative Paper Money: It is that money which is fully backed by equivalent metallic
reserves.
Convertible Paper Money: Which is convertible into coins on demand.
Fait Paper Money: This is not redeemable or convertible into Gold or Silver on demand. It is
accepted because it is declared legal tender by the issuing authority and has general acceptance as
a medium of exchange. The intrinsic value of Fait money is Nil.

4. Credit Money: Includes Bank money (different instruments offered by the Banks.).
Cheques, Drafts, etc are examples. Convenient, Safe and easily convertible into cash. Its
like Near Money.
5. Electronic Money: Electronic money (also known as e-money, electronic cash, electronic
currency, digital money, digital cash or digital currency) refers to money or scrip which is
exchanged only electronically. Typically, this involves use of computer networks, the
internet and digital stored value systems.
Functions of Money
1. Medium of exchange-It should be accepted by all. It can be commonly used to obtain
goods and services.
2. Measure of value-Value of goods can be expressed in terms of money. This has made
assessing the values of different commodities possible.
3. A store of value-Since money is not perishable producers of perishable goods e.g.
farmers can sell their produce and store the money for future use.
4. Standard for future payment-Money is relatively stable in value. This means it is very
convenient for future or differed payments.

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 INFLATION AND DEFLATION: MEANING, DEFINITION, KINDS AND
CONTROL MEASURES

Inflation

• Too much money chasing too few commodities is termed as inflation.

• Inflation is a persistent and appreciable rise in the general price level.

The rate of inflation is defined as the rate of change of the price level as measured by the
consumer price index (CPI).

Rate of inflation in tth period= price level (tth year) (t-1th year)/price level (t-1th year)

Inflation and other forms

1. Deflation: opposite to inflation is deflation, which is found when the general level of
prices is falling. It is the situation in which supply of money at a particular point of time is
less than the demand.
2. Reflation: It refers to a moderate degree of controlled inflation.
3. Disinflation: It indicates the decline in the rate of inflation.
4. Stagflation: It is inflation accompanied by stagnation on the development. Stagflation is
associated with high prices and high unemployment.

Types/ kinds of inflation

1. Creeping Inflation: a sustained rise of less than 3 per cent in prices per annum is called
creeping inflation.
2. Walking inflation: This type of strong, or pernicious, inflation is between 3-10 percent a
year. It is harmful to the economy because it heats up economic growth too fast.
3. Running inflation: when the sustained rise in prices is about 10 per cent per annum it is
called running inflation.
4. Galloping or hyperinflation: this is the most dangerous type of inflation and prices rise by
16 per cent or more per annum.

Others

Demand pull inflation or excess demand inflation: When the aggregate demand increases at a
faster rate than aggregate supply, it is known as demand-pull inflation. Caused by Monetary
and real factors.

Cost-push inflation: When there is an increase in the price of inputs, resulting in decrease in
the supply of outputs, is known as cost-push inflation. Caused by Monopolistic groups of the
society.

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 Control measures (Quantitative Measures)

a) Monetary measure
i. Rise in Bank Rate
ii. Making the borrowing of money costlier
iii. Direct Control on Credit Creation (Performing Open Market Operations,
Changing Reserve Ratios)
b) Fiscal measures
i. Reduction of government spending
ii. Imposition of new taxes
iii. Encouragement of saving or introducing compulsory saving schemes.

Selective or Qualitative measures.

i. Moral Suasion
ii. Fixation of margin requirements
iii. Rationing of credit
iv. Direct Action

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 BANKING

“A bank is a financial institution licensed to receive deposits and make loans”. Banks may
also provide financial services, such as wealth management, currency exchange and safe deposit
boxes. Therefore, Bank “a factory of credit”.

Role of banks in Modern Economy

1. Removing the deficiency of capital formation

2. Provision of finance and credit
3. Extension of the size of the market
4. Act as an engine of balanced regional development
5. Financing agriculture and allied activities
6. Improving the standard of living of the people by providing consumption loans

Types of banks

Banks according to the functions they perform.

1. Commercial Banks: Their business mainly consists of receiving deposits, giving loans
and financing the trade of a country. They provide short term credit i.e., lend money for
short period (special feature).
2. Exchange Banks: They finance mostly the foreign trade of a country. Their main
function is to discount, accept and collect foreign bills of exchange. They also buy and
sell foreign currencies and help businessmen to convert their money into any foreign
currency they needed.
3. Agricultural or Cooperative Banks: The main business of these banks is to provide
funds to farmers. Long term capital is provided by land mortgage banks, now-a-days
called land development banks, while short term loans are given by cooperative societies
and cooperative banks.
4. Savings Banks: These banks perform the useful services of collecting small savings. The
idea is to encourage thrift and discourage hoardings. Post offices saving banks in India are
doing this useful work.
5. Industrial Banks: There are a few industrial banks in India. But in some other countries,
notably Germany and Japan, these banks perform the function of advancing loans to
industrial undertakings.
6. Central Bank: Over and above the various types of banks mentioned above, there exists
in almost all countries today a central bank. Controlled by government of the country.
They perform very important services. The Reserve Bank of India (RBI) is such a bank in
our country.

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Commercial Banks

Commercial bank is formed on the basis of banking company laws. It is established under
both government and private ownership and it main purpose is to earn profit.

Functions of Commercial Banks

Banks act as intermediaries between those who have surplus money and those who need
it. To receive deposits and to advance loans are thus the two main functions of all commercial
banks.

1. Accepting deposits: Banks attract the idle savings of people in the form of deposits.
a. Demand deposits also known as current account: These are repayable on demand
without any notice. No interest is paid on them and a little commission is charged for the
services rendered.
b. Fixed or time deposits: These deposits can be withdrawn only after the expiry of the
period for which these deposits have been made. Highest interest is paid on them and the
rate rising with the length of the period and the amount of deposit.
c. Saving bank deposit: These deposits stand midway between current and fixed account.
These deposits are not as freely withdrawable as current account.
2. Giving loans: Money is lent to businessmen and traders usually for short period only.
a. By allowing an overdraft: Customers can get more than they have deposited but they
have to pay interest on the extra amount which has to be repaid within a short period.
b. By creating a deposit (cash credit): In the form of loan, the person has to satisfy the
manager about his ability to repay, the soundness of the venture and his honesty of
purpose.
c. Discounting bills: The bank purchase these bills through bill brokers and discount
companies or discount them directly for the merchants.
d. Remitting funds: Bank remit funds for their customers through bank draft to any place
where they have branches or agencies.
3. Safe custody: Ornamental and valuable documents can be kept in safe deposit with a
bank.
4. It performances the agency function
5. They provide reference about the financial position of their customers.

Central bank

It is sole banking institution which is established through ordinance or special law of the
government. It has government ownership and its main purpose is to control credit system and
money market.

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Functions of Central Bank

1. Acts as the note issuing agency

2. Acts as the banker to the state
3. Acts as the bankers bank
4. As the guardian of the money market through control of credit
5. As the lender of last resort
6. It undertakes to maintain the external value of the domestic currency
7. It ensures the stability of the internal value of the currency i.e., the price level.
8. It undertakes exchange control operations
9. It fights crisis and fluctuations and ensures economic stability of the country.

Credit creation policy

The power of commercial banks to expand deposits through loans, advances and
investment is known as credit creation.

Two ways- creating credit money by commercial bank

1. By Giving Loan: bankers know that all the currency that depositors withdraw soon
returns to the bank. They also know that all depositors will not withdraw all deposits at
the same time.
2. By Purchase of Securities: banks buy securities at the stock exchange and also buy real
assets. When the bank does so, it does not pay the seller in cash rather it credits the prices
of the security. Therefore bank creates a deposit with it.

Limitations on credit creation

1. The total amount of cash in the country

2. The amount of cash which the public wishes to hold
3. The minimum percentage of cash to deposit which the banks consider safe.

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 AGRICULTURAL FINANCE & PUBLIC FINANCE

Generally means studying, examining and analyzing the financial aspects pertaining to
farm business, which is the core sector of the country.

Definition: It is a branch of agricultural economics, which deals with the provision and
management of bank services and financial resources related to individual farm units. (Tandon
and Dhondyal, 1962)

Public finance

It is the branch of economics which assesses the government revenue and government
expenditure of the public authorities and the adjustment of one or the other to achieve desirable
effects and avoid undesirable ones.

Dalton puts it,” public finance is “concerned with the income and expenditure of public
authorities and with the adjustment of one to the other.”

Micro vs. Macro finance

Micro finance is specially framed for the need of an individual, a small industry or any type of
small business unit.

Macro finance is designed for the large section of the economy like big business corporations or
a whole economy.

Micro finance

• A micro finance is a narrow concept which includes the various services like micro credit,
micro savings, micro insurance and many more schemes.
• The purpose of micro finance is to help the small section of a society like low-income
level people or a below poverty line who are not able to serve their needs just because of
unavailability fund.
• Those who are not able to take a financial help by the conventional way of putting a
security as a guarantee.
• A micro finance helps people to start their own business by proving finance with a low
rate of interest and help to make them independent.

Macro finance

• Macro finance is a broad concept and works on a large scale and its advantages are
widespread.
• Macro finance is an initiative which deals with the large section of an economy and
covers all the financial need and how to provide it to the needed one.
• A macro finance includes the drafting policy, subsidies, multi-year expansion plans.
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 • The main aim of macro finance is to help an economy to grow and to generate
employment and expand an economy.
• A government provides macro finance in any form to the business like tax benefits or a
subsidy because it will benefit the economy in future.

Micro financing: It is a type of banking service that provided to unemployed or low income
individuals or groups who otherwise have no other access to financial services. The services
includes micro-credit, micro saving and micro insurance.

Need for Agricultural Finance

Very few farmers will have capital of their own to invest in agriculture. Therefore a need arises to
provide credit to all those farmers who require it. Credit enables farmers to advantageously use
seeds, fertilizers, irrigation etc.

Productive needs refer to finance for purchase Development of Fertilizers and Implement and
also digging and Deeping of wells.

Unproductive needs: The productive purposes for which the farmer also get loan are celebration
of marriages, birth and death.

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 PUBLIC EXPENDITURE

Public expenditure is the expenditure incurred by the government in the various sectors of
economy viz., agricultural sector, industrial sector, infrastructural sector, export-import sector
etc.
• Economic overheads viz., roads and buildings, railways, irrigation, power projects,
educational institutions, etc.
• Social overheads viz., hospitals, service institutions etc.

PUBLIC REVENUE
This is the revenue accrued to the government from different sources viz., direct taxes, indirect
taxes and non-tax revenue such as prices and other miscellaneous receipts. Thus the government
would have two major sources of revenue i.e. taxes and prices.

Major sources of public revenue

1. Taxes: taxes are compulsory contributions levied upon persons, corporations etc.
I. Taxes are classified as proportional, progressive, regressive and degressive.
a) Proportional tax: It is one in which same percentage is levied as tax irrespective of tax
base on the size of the income.
b) Progressive tax: It means the rate of tax increases as taxable income increases. Ex:
Income tax
c) Regressive: A tax is said to be regressive, when it is affecting the poor rather than rich.
Ex: all commodity taxes
d) Degressive: A tax is called degressive, when the higher income groups do not make due
sacrifice.

II. Taxes also classified as direct and indirect taxes

a) Direct tax: They are taxes directly paid by the persons. Incidence and impact are on the
same person. Ex: Income tax.
b) Indirect tax: Indirect taxes are the commodity taxes. They are indirectly paid by the
consumer through the dealers. Incidence is on one person and impact is on the other
person. Ex: sales tax

III. Taxes also classified as specific, Advalorem and value added tax (VAT)
a) Specific tax: The amount of tax to be paid depends on the amount of commodity
purchased.
b) Advalorem tax: The amount to be paid is proportionate to the value of the commodity.
Ex: Stamp duty
c) Value Added Tax (VAT): A tax levied on the value of each of the processes carried out
by a business is called VAT.
2. Price: when the public authorities sell a commodity or render a service to the consumer
who avails or buys the commodity on a charge is called price.
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 Ex: Railway fare, bus charges, electricity tariffs, water cess etc.

Minor sources of public revenue

1. Fee: It is defined as compulsory contribution of money paid by the persons, corporations

etc., under the authority of public power. Ex: License fee, educational fee etc.
2. Special assessment: This is compulsory contribution levied on persons in proportion to
special benefits derived. Ex: watershed development
3. Rates: Rates are certain kinds of taxes levied by local bodies viz., municipalities,
panchayat, district boards etc on people for local purpose.
4. Fines: These are the penalties imposed on persons for infringement of laws or break
down of laws.
5. Escheat: Suppose an individual dies without successor his property will go to the state
government. This claim of the state to the deceased’s assets is called escheat.
6. Tributes and Indemnities: Tributes are paid by the conquered countries. Indemnities are
paid for any damage done to the country by way of war of aggression.
7. Grants, gifts and donations.

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 AGRICULTURAL TAXATION

Agricultural income in India is categorized as a valid source of income and basically

includes income from sources that comprise agricultural land, buildings on or related to an
agricultural land and commercial produce from an agricultural land.

Section 2 (1A) of the Income tax Act details out the conditions wherein sources can be
considered to be generating agricultural income. The section’s definitions basically point out the
following as the sources for agricultural income –

1. Revenue generated through rent or lease of a land in India that is used for agricultural purposes
2. Revenue generated through the commercial sale of produce gained from an agricultural land
3. Revenue generated through the renting or leasing of buildings in and around the agricultural
land

Key points to remember while considering if an income is actually a valid agricultural income –
1. Income should be from an existent piece of land
2. Income should be from a piece of land that is used for agricultural operations
3. Income should stem from produce achieved after cultivation of the land
4. Income can be from a land that is not under the assessee’s ownership

Is Agricultural Income Taxable

By default, agricultural income is exempted from taxation and not included under total income.
The Central Government can’t impose or levy tax on agricultural income. The exemption clause
is mentioned under Section 10 (1) of the Income Tax Act of India.

However, state governments can charge agricultural tax. As of the latest amendment, income
from agriculture, if within INR 5000 in a financial year, will not be accounted for tax purposes.
Anything above that will be taxable as per the applicable rates.

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 GOODS AND SERVICE TAX (GST)

GST is an Indirect Tax which has replaced many Indirect Taxes in India. The Goods and
Service Tax Act was passed in the Parliament on 29th March 2017. The Act came into effect on
1st July 2017; Goods & Services Tax Law in India is a comprehensive, multi-stage, destination-
based tax that is levied on every value addition.
In simple words, Goods and Service Tax (GST) is an indirect tax levied on the supply of
goods and services. This law has replaced many indirect tax laws that previously existed in India.
GST is one indirect tax for the entire country.

Components of GST: There are 3 taxes applicable under this system: CGST, SGST & IGST.
CGST: Collected by the Central Government on an intra-state sale (Eg: transaction
happening within Karnataka)
SGST: Collected by the State Government on an intra-state sale (Eg: transaction happening
within Karnataka)
IGST: Collected by the Central Government for inter-state sale (Eg: Karnataka to Tamil
Nadu)
Illustration:
Let us assume that a dealer in Gujarat had sold the goods to a dealer in Punjab worth Rs.
50,000. The tax rate is 18% comprising of only IGST. In such case, the dealer has to charge Rs.
9,000 as IGST. This revenue will go to the Central Government.
The same dealer sells goods to a consumer in Gujarat worth Rs. 50,000. The GST rate on
the good is 12%. This rate comprises of CGST at 6% and SGST at 6%. The dealer has to collect
Rs. 6,000 as Goods and Service Tax. Rs. 3,000 will go to the Central Government and Rs. 3,000
will go to the Gujarat government as the sale is within the state.

Advantages of GST
• GST eliminates the cascading effect of tax
• Higher threshold for registration
• Composition scheme for small businesses
• Simple and easy online procedure
• The number of compliances is lesser
• Defined treatment for E-commerce operators
• Improved efficiency of logistics
• Unorganized sector is regulated under GST

Disadvantages of GST
• Increased costs due to software purchase
• Being GST-compliant
• GST will mean an increase in operational costs
• GST came into effect in the middle of the financial year
• GST is an online taxation system

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 ECONOMIC SYSTEMS

An economic system is a mechanism which deals with the production, distribution and
consumption of goods and services in a particular society.

The economic system is composed of peoples, institutions and their relationships. It addresses the
problems of economics like the allocation of resources.

Types of Economic systems

1. Capitalism (Market economy)

2. Socialism (Planned economy)
3. Mixed economy (Socialism+Capitalism)

1. Capitalism (Business controlled privately Ex: America): It is an economic system in

which the means of production are privately owned and operated for profit, usually in
competitive markets.

The chief features of capitalism:

1. The rights of private property and system of inheritance
2. Freedom of enterprise (Free to take up any occupation)
3. Freedom of choice of commodities by the consumers
4. Profit motive
5. Competition (the producers compete with one another in selling the commodity)
6. Importance of price system
7. There is class-conflict
8. Labor as a commodity
9. Freedom of price determination

2. Socialism (Business controlled by the government Ex: China, USSR): It is an economic

organization of society in which the materials means of production are owned by the whole
community and operated by organs by the whole community and operated by organs
representative according to a general plan.
In socialism the production and distribution of goods are controlled substantially by the
government rather than by private enterprise, and in which cooperation rather than competition
guides economic activity.

The chief features of socialism

1. Common ownership or social ownership/state ownership of means of production.
2. It implies equality of incomes and equality.
3. Economic planning is an essential feature of socialism.
4. Social welfare and social security.
5. Classless society

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3. Mixed Economy (Capitalism + Socialism Ex: India, Bangladesh, Pakistan):
Mixed economy means that it is opened both by private enterprise and public enterprise.
That is mixed economy is the mixture of capitalism & socialism. In a mixed type economy, both
the private ownership as well as the state takes part in the means of production, distribution and
other types of economic activities. The mixed economy allows private participation in the field of
production in an environment of competition with an objective of attaining profit.

The main features of a mixed economy:

1. Co-existence of the public and private sectors.
2. The govt. is mixed economies take necessary steps for the reduction of inequalities of
income & wealth.
3. The allocation of productive resources is partly determined by the price system and partly by
the govt. directives.
4. The sovereignty of the consumers is protected.
5. The govt. tries to control & regulate monopoly.

Difference between capitalism and socialism

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