Business Economics Definitions Economics is the study of how people use scarce resources in an attempt to satisfy their unlimited

wants. Resources are inputs used to produce goods and services. They are also called factors of production. Economics is the social science that analyzes the production, distribution, and consumption of goods and services. Types of Economics: 2 types 1) Microeconomics examines the behavior of basic elements in the economy, including individual agents (such as households and firms or as buyers and sellers) and markets, and their interactions. Microeconomics (from Greek prefix mikro- meaning "small" and economics) is a branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources (see scarcity).Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services. This is in contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation, and unemployment."Microeconomics also deals with the effects of national economic policies (such as changing taxation levels) on the aforementioned aspects of the economy. Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations'i.e. based upon basic assumptions about micro-level behavior. One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect competition. 2) Macroeconomics analyzes the entire economy and issues affecting it, including unemployment, inflation, economic growth, and monetary and fiscal policy. Macroeconomics (from the Greek prefix makro- meaning "large" and economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, rather than individual markets. This

includes national, regional, and global economies. With microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). Macroeconomic models and their forecasts are used by both governments and large corporations to assist in the development and evaluation of economic policy and business strategy. NEED, WANT, DEMAND Needs -Human needs are the basic requirements and include food clothing and shelter. Without these humans cannot survive. An extended part of needs today has become education and healthcare. Generally, the products which fall under the needs category of products do not require a push. Instead the customer buys it themselves. But in todays tough and competitive world, so many brands have come up with the same offering satisfying the needs of the customer, that even the needs category product has to be pushed in the customers mind. Example of needs category products / sectors Agriculture sector, Real Estate (land always appreciates), FMCG, etc. Wants Wants are a step ahead of needs and are largely dependent on the needs of humans themselves. For example, you need to take a bath. But i am sure you take baths with the best soaps. Thus Wants are not mandatory part of life. You DONT need a good smelling soap. But you will definitely use it because it is your want. In the above image, the baby needs milk but it WANTS candy Example of wants category products / sectors Hospitality industry, Electronics, Consumer Durables etc, FMCG, etc. Demands You might want a BMW or a Mercedes for a car. You might want to go for a cruise. But can you actually buy a BMW or go on a cruise? You can provided you have the ability to buy a BMW or go on a cruise. Thus a step ahead of wants is demands. When an individual wants something which is premium, but he also has the ability to buy it, then these wants are converted to demands. The basic difference between wants and demands is desire. A customer may desire something but he may not be able to fulfill his desire. Example of demands Cruises, BMWs, 5 star hotels etc.

The needs wants and demands are a very important component of marketing because they help the marketer decide the products which he needs to offer in the market. Thus the flow is like this. Market >> Identify needs wants and demands >> Offer products to satisfy either needs wants or demands. MARKET A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services (including labor) in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established. Markets vary in form, scale (volume and geographic reach), location, and types of participants, as well as the types of goods and services traded. Examples include:

Physical retail markets, such as local farmers' markets (which are usually held in town squares or parking lots on an ongoing or occasional basis), shopping centers and shopping malls (Non-physical) internet markets (see electronic commerce) Ad hoc auction markets Markets for intermediate goods used in production of other goods and services Labor markets International currency and commodity markets Stock markets, for the exchange of shares in corporations Artificial markets created by regulation to exchange rights for derivatives that have been designed to ameliorate externalities, such as pollution permits (see carbon trading) Illegal markets such as the market for illicit drugs, arms or pirated products. Classification or Types of Market - Chart

The classification or types of market are depicted below.

On the basis of Place, market is classified into: 1. 2. 3. Local Market or Regional Market. National Market or Countrywide Market. International Market or Global Market.

On the basis of Time, market is classified into: 1. 2. 3. 4. Very Short Period Market. Short Period Market. Long Period Market. Very Long Period Market.

On the basis of Competition, market is classified into: 1. Perfectly competitive market structure. 2. Imperfectly competitive market structure. Both these market structure widely differ from each other in respect of their features, price etc. Under imperfect competition, there are different forms of markets like monopoly, duopoly, oligopoly and monopolistic competition.

What is a Market - Definition and Different types of Markets A set up where two or more parties engage in exchange of goods, services and information is called a market. Ideally a market is a place where two or more parties are involved in buying and selling. The two parties involved in a transaction are called seller and buyer. The seller sells goods and services to the buyer in exchange of money. There has to be more than one buyer and seller for the market to be competitive. Monopoly - Monopoly is a condition where there is a single seller and many buyers at the market place. In such a condition, the seller has a monopoly with no competition from others and has complete control over the products and services. In a monopoly market, the seller decides the price of the product or service and can change it on his own. Monopsony - A market form where there are many sellers but a single buyer is called monopsony. In such a set up, since there is a single buyer against many sellers; the buyer can exert his control on the sellers. The buyer in such a form has an upper edge over the sellers. Financial markets are of following types: 1. Stock Market - A form of market where sellers and buyers exchange shares is called a stock market. 2. Bond Market - A market place where buyers and sellers are engaged in the exchange of debt securities, usually in the form of bonds is called a bond market. A bond is a contract signed by both the parties where one party promises to return money with interest at fixed intervals. 3. Foreign Exchange Market - In such type of market, parties are involved in trading of currency. In a foreign exchange market (also called currency market), one party exchanges one countrys currency with equivalent quantity of another currency. 4. Predictive Markets - Predictive market is a set up where exchange of good or service takes place for future. The buyer benefits when the market goes up and is at a loss when the market crashes. Market Size The market size is directly proportional to two factors:

Number of sellers and Buyers

Total money involved annually

Imperfect competition In economic theory, imperfect competition is the competitive situation in any market where the sellers in the market sell different/dissimilar of goods, (heterogenous) that does not meet the conditions of perfect competition Forms of imperfect competition include:

Oligopoly, in which there are few sellers of a product. Monopolistic competition, in which there are many sellers producing highly differentiated products.

There may also be imperfect competition due to a time lag in a market. An example is the jobless recovery. There are many growth opportunities available after a recession, but it takes time for employers to react, leading to high unemployment. High unemployment decreases wages, which makes hiring more attractive, but it takes time for new jobs to be created Oligopoly An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). A general lack of competition can lead to higher costs for consumers.Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence and are influenced by the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants. Monopolistic competition Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. Perfect competition In economic theory, perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the

concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets. THREE TYPES OF BUSINESS FIRM ORGANIZATION To start a business, you would have to operate as one of three legal organizations: Proprietorship, Partnership and Corporation. PROPRIETORSHIP - 74% of all firms in U.S. are sole proprietorships. Self- employed workers: piano tuners, small business owners, small family business, plumbers, attorneys, accountants, consultants, farms, barbershops, etc. Advantage: easy to set up a business this way. Disadvantage: Unlimited liability, Hard to raise large amounts of capital to expand. Many firms start this way, and eventually become partnerships or corporations to expand. PARTNERSHIP - Two or more partners acting as co-owners. Partners have unlimited liability for business debts, lawsuits, etc. 7% of firms are organized as partnerships. Common for physicians, accounts, lawyers, consultants, etc. CORPORATION - Less than 20% of the number of firms, but corporations have 90% of Sales Revenue. Advantages of corporations: 1. Limited liability, makes it easy to raise large amts of capital. Example: you own 100 shares of GM, and GM gets sued. You could lose your entire investment, but your personal assets are not at stake. 2. Easy to transfer ownership, just sell shares of stock if you are unhappy with company. 3. Unlimited Life of a corporation. DIFFERENCE BETWEEN GOODS AND SERVICES. 1. Goods are tangible but services are intangible. 2. The ownership rights of goods are transferable, but there is no ownership involved in services. 3. Once goods are produced, their quality remains uniform, but the quality of service varies step to step (with the change in environmental conditions) 4. Goods may be perishable or non-perishable, but they can be stored for a long time. Services cant be stored for a long time and they are only perishable. 5. Goods are produced using raw material, but services are not produced using raw material. They are automatically formed with the change in environment. 6. Services have ultimate and strong impact on demand for goods. But services have not ultimate effect on demand for goods, and if there is an impact, it will be negligible. Examples: 7

Goods : tooth paste ,soap, cofee ,tea, presitge pressure pans etc. Service :,Education, Banking, Insurance, Postal serive, Couier service, Transportation, etc. Free Products: Air, sunshine are and other items so plentiful no one could own them. Economists are interested in "economic products" - goods and services that are useful, relatively scarce and transferable. Good: tangible commodity. These are bought, sold, traded and produced. Types of Goods Consumer Goods: Goods that are intended for final use by the consumer. Capital Goods: Items used in the creation of other goods. factory machinary, trucks, etc. Durable Goods: Any good that lasts more than three years when used on a regular basis. Non Durable Goods: Any item that lasts less than 3 years when used on a regular basis. Services: Work that is performed for someone. Service cannot be touched or felt. Consumers: people who use these goods and services. Conspicuous Consumption: Use of a good or service to impress others. Value: An assignment of worth. The assignment is usually based upon the utility (usefulness) or scarcity of the item (supply and demand). Utility: capacity to be useful.

OPPORTUNITY COST: Every time scarce resources are used in one way we must give up the opportunity to use them in other ways. To produce more weapons, you must sacrifice the opportunity of producing more civilian goods. The sacrificed or foregone civilian goods represent the opportunity cost of producing more weapons. The opportunity cost of producing more of good X is the most desired goods or services foregone in order to transfer resources to this good.

BASIC DECISIONS What to Produce? That is, the country should pick only one point on the PPC. This determines the output mix, more guns or butter? How to produce? Should we generate electricity from oil, coal, nuclear power, solar power? Here someone should make a decision about which production methods to use. This is a question of not just efficiency but of social values as well. For whom to produce? Who is going to get the output produced? How should the goods and services an economy produces be distributed? (income distribution) MARKET PARTICIPANTS: There are four participants in a market: consumers, business firms, government and the international sector. There are two types of markets: the factors of production markets and the product markets. International participants Goods and services demanded Product markets Goods and services supplied

Consumers

Governments

Business Firms

Factors of production supplied International participants Factor markets

Factors of production demanded

A market includes buyers and sellers and it exists whenever any exchange takes place. The buyers are on the demand side of the market, and the sellers are on the supply side of the market. DEMAND:

Let us focus first on a single consumer or a buyer. Law of Demand: the quantity of a good demanded increases as its price falls during a given time period, Ceteris Paribus. Demand Curve: A curve that describes the quantities the consumer is willing and able to buy at alternative prices in a given time period, Ceteris Paribus.

Individual Demand: Tom is willing and able to pay for a tutor in web-design.

Tom is willing to buy 1 hour of tutoring per semester if he must pay $50 an hour. If the price drops to $45/hr, Tom would be able and willing to buy 2 hours per semester. Thus, Tom would purchase more tutoring services if the price per hour drops. Demand is an expression of consumer buying intention, of willingness to buy not a statement of actual purchases. The demand curve is a summary of buying intentions. Common feature of demand is that it has a downward slope(QD/P < 0) PCurrent QD PCurrent QD This inverse relationship between the current price and quantity is called the law of demand. Graphically, this is a movement along the demand curve. In the graph above, if the price drops from say $50 to $30 the quantity demanded increases from 1 to 7 tutoring hours. Compaq used this law to increase computer sales in 2001. In the holiday season people snapped a Compaq Presario computer priced at $1099 for $699. 10

Other Determinants of Market Demand: The simple demand schedule or curve has only one determinant which is the current price. Other determinants of the standard demand include: Tastes (desire) Income (purchasing power) Price of related goods Expectations of future income, price and taste Number of buyers in the market.

Related goods: Include substitute goods (consumed instead of, say, tutoring in web design), complementary goods (consumed with tutoring in web design). If the price of a substitute (e.g.,: Math tutoring and Scuba diving) for webdesign tutoring falls, the entire demand for web-design falls (or shifts down). This is because other goods or services have become cheaper and they can be substituted for web design tutoring. Then the entire demand for web design tutoring shifts down. If the price of a complement (books, software etc) to web design increases, then the entire demand for web design declines. If the expected future price (Pe) for web-design, expected future income or expected taste increases the entire demand increases. If the number of buyers increases, the market demand which is an aggregate of individual demands in the market will increase. Ceteris Paribus Assumption: The simple demand schedule or curve, which depends only on the current price and quantity, has a big assumption. This assumption is called ceteris paribus. It means nothing else other than the current price changed. It is used to isolate the effects of the other determinants on demand when the current price changes. Shifts in Market Demand: If any of the so-called other determinants of demand changes then the entire demand curve will shift up or down.

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Suppose Toms income increases by $1,000 after he won the lottery. This means his entire demand schedule will shift up if income increases (for a normal good). QD (hours / semester) Price Initial Demand ($/hour) (in hours) $50 1 45 2 40 3 35 5 30 7 25 9 20 12 New Demand (in hours) 8 9 10 12 14 16 19

A B C D E F G

The increase in income shifted market demand to the right; which is an increase in demand. This increase or the right shift in demand can also happen if: Taste increases. The prices of the substitutes for the web design increase If the prices of complements decrease. Movements vs Shifts: A movement along the demand curve is a change in the quantity demanded in response to changes in the current price (slope). A shift in the demand curve is a shift in the entire demand curve in response to changes in other determinants of demand. Market Demand:

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Market demand is the sum of individual demands. It is the total quantity of a good or service consumers are willing to purchase at different prices in a given period. Suppose there are three consumers in the market. The market demand is the sum of the three quantities purchased by these consumers at each possible price. Quantity Demanded by: Price Tom George ($) (hours) (hours) 50 1 4 45 2 6 40 3 8 30 5 11 30 7 14 25 9 18 20 12 22 15 15 26 Lisa (hours) 0 0 0 0 1 3 5 6 Market Demand 5 8 11 16 22 30 39 47

One of the determinants of demand is taste or desire. We measure desires by the pleasure, satisfaction or utility obtained from a good or a service. The more we desire a good or the more utility we obtain from it, the more we are willing to pay for it.

SUPPLY: This is the other side of the market and it deals with producers or sellers of, say, the webdesign services. Market Supply: the total quantities (QS) of a good that sellers are willing and able to sell at alternative prices (P) in a given time period, ceteris paribus. The relationship is positive. Or QS/P > 0. Slope is positive. PCurrent QS, ceteris paribus. (That is, if current price goes down producers supply less) PCurrent QS This means that slope of the market supply is positive. In other words, there is a law of supply that parallels the law of demand. This law says that larger quantities will be offered for sale at higher prices and vise versa. Other Determinants of Market Supply: These determinants change the entire supply curve:

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 Technology: Improvement in technology enables sellers or producers to supply the good or service easier and quicker. Then the market supply curve increases. Costs of factors of production: If labor, capital or materials cost of production decreases the supply curve increases and shifts to the right because of increased profitability. Prices of related goods: If other jobs or business offer better prices than webdesign, sellers of web-design will offer less web design services. The entire supply curve for web-design services decreases. Taxes: An increase in taxes decreases the supply curve which shifts to the left. Expectation of a price change: The supply curve may increase or decrease if the price is expected to increase in the future. It depends on storability of the good. Storable: (e.g., Oil) an expected increase in price of oil decreases the supply curve because oil is storable and extraction can be reduced. Non-Storable: (e.g., Milk) an expected increase in price, increases the supply curve. Here the producers can increase output easily and they want to maintain market share. This is the standard case. Number of individual suppliers: The market supply is also an aggregate supply in the sense that it is the sum of individual quantities supplied at each price during a given time period, Ceteris Paribus. If this number increases then the aggregate will increase, which means an increase in the aggregate supply.

Price Elasticity (% / %):

This elasticity measures by how much the quantity demanded would fall if the price were raised or vice versa. Suppose the price increases by 10%, would the quantity change by more or less than 10%? The elasticity answers this question. Price elasticity of demand: Elasticity = %Q / %P

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= {(Q2 Q1 )/Average Q)} / {(P2 P1)/Average P)} where Average Q = (Q1+Q2 )/ 2 , Average P = (P2+P1) / 2 Example: (calculate the midpoint price elasticity of demand) P $9 (P1 ) 7 (P 2 ) QD 15 Units Q1 25 Q2

EPD = (Q2 - Q1) / (Q1 + Q2) = (Q2 - Q1) / average Q (P2 - P1) / (P1 + P2) (P2 - P1) / average P EPD = (25 - 15)/ (15 + 25) (7 - 9) / (7 + 9)

= -2 (if the price increases by 10% percent, then the quantity decreases by 20%). The price elasticity of demand is expressed as a positive number for convenience (not compare negative numbers) but it is always negative. Types of Elasticities: We use the absolute value of the elasticity (coefficient of Elasticity) If EDP > 1 in absolute value (e.g., -1.5, -2.3, -3.4etc) then the demand is price elastic (the consumer is responsive to the price change). If EDP < 1 in absolute value (e.g., -0.33, -0.50, -0.76 etc) then the demand is price inelastic (the consumer is not very sensitive to the price change). If EDP = 1 in absolute value then the demand is price unitary elastic (%Q = %P in absolute value).

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Fig. 20.3: Elasticity Estimates (remember: the demand elasticity is always negative) There are positive elasticties which mean coefficient of price elasticity of demand. Example: Price elasticity of demand for the airline industry is -2.4 (p-elastic). How much will the quantity drop %Q if the price increases on average by 10% (i.e., %P = 10%)? Elasticity = EDP = %Q / %P = %Q / +10% = -2.4. Then %Q =elasticity* %P= -2.4* %P = -2.4* 10%= -24%. Demand for Popcorn: Price (Per Ounce) A B C D E F G $0.50 0.45 0.40 0.35 0.30 0.25 0.20

Quantity Demanded (Ounces Per Show) 1 2 4 6 9 12 16

Example: Let the price drop from $0.50 to $0.45 and quantity increases from 1 to 2 ounces. P1 = $0.50 Q1 = 1 ounces P2 = $0.45 Q2 = 2 ounces Average P = (0.5 + 0.45)/2 = $ 0.475 Average Q = 1.5 units

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Calculate: EDP = (Q2 Q1)/[( Q1 + Q2)/2] / (P2 P1)/[( P1 + P2)/2] In this definition, the two 2s cancel out. Then EDP = [(2 -1) / *(1+2)] / [(0.45 0.50) / *(0.50 + 0.45)] or EDP = (1/1.5) / (-0.05/0.475) EDP = -0.6667 / 0.1053 = -6.331 (Price-elastic) Next, suppose %P = +10%. Then solve for %Q by using the calculated elasticity: %Q = EDP * %P Then %Q = -6.331*10% = -63.31% (quantity drops by more than 63 percent). The consumer is highly responsive or sensitive to the change in the price.

If EDP = 0 (that is, %Q / %P = 0/%P), then the demand is perfectly price inelastic. The demand curve would be a vertical line and the consumer is not at all responsive to the change in price. An example of this case is the demand for heart transplants. Demand for illegal drugs is almost perfectly inelastic.

Determinants of Price Elasticity of Demand Why consumers are more sensitive, in terms of changing quantity demanded, to the same percentage change in price of airlines travel than to changes in price of gasoline. We must look at the determinants of the price elasticity demand. Four determinants are particularly important. Necessities Vs. Luxuries: Necessities are goods to which we have a strong taste to have (e.g.; tooth paste, shaving cream, salt etc). Demand for necessities is relatively price inelastic. Luxuries: are the goods we like to have, but can get by without them. Ex: vacation travel, new cars. The demand for luxuries is relatively price elastic. Availability of substitutes: The greater the availability of substitutes for a certain good, the more price elastic is the demand (compare Pepsi and gasoline).

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Relative price of a good to consumer income: The greater the ratio (price/income), the more elastic the demand is. The ratio is high for vacation travel and for new cars but low for salt. Price increase TR Decreases TR Increase TR Unchanged Price reduction TR Increases Decrease Unchanged

Demand is Elastic(E>1) Inelastic(E<1) Unitary Elastic(E=1)

(E- Elasticity, TR- Total Revenue)

Other Elasticities: The price elasticity of demand changes not only when the price changes along the demand curve but also when there is a shift in demand. Income Elasticities of Demand: Suppose there is an increase in income. Given the same price, the demand curve shifts out to the right as a result of the income increase. An increase in income does not always shift the demand curve out or to the right. If the good is normal, an increase in income shifts demand out. In this case, EID>0 or demand is income elastic (example: designer clothes). This means if income increases quantity demanded also increases. If the good is inferior (EID < 0), demand shifts to the left. Inferior goods include discount clothes, used books, used cars, cheap beer, and generic brands. Cross Price Elasticity of demand Demand and quantity demanded for good X can also change when prices of related goods Y or Z change. There are two related goods: substitutes and complements. The Case of Substitutes: Coke and Pepsi The cross Elasticity of demand for coke when the price of Pepsi changes is: Ep(Pepsi)Q(Coke) = (QCoke /Average quantity of coke) / (PPepsi /Average price of Pepsi)> 0 This means if the price of Pepsi increases, the quantity demanded of coke also increases because the entire demand for Coke below shifts from R to F. The cross price elasticity of demand for substitutes is positive.

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

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Land: Includes the ground and natural resources such as crude oil, water and minerals. Labor: Includes skilled and unskilled labor. Both the quantity and the quality of human resources are included in the labor factor (e.g., skilled, unskilled etc). Capital: Final goods produced to be used as inputs in further production. It includes machines, equipment, buildings. Example: residents of a fishing village in southern Thailand braided huge fishing nets to catch more fish. The fishing nets are regarded as capital. Entrepreneurship: This factor of production is related to how well a given quantity of resources can be used in production. Entrepreneur is the person who sees the opportunity of new or better products and brings together the resources needed for producing them. The entrepreneur is an organizer and a risk taker.

Payments to Resources (returns to factors of production): Land is paid rent Labor is paid wages Capital is paid interest or the rental price of capital. Entrepreneur is rewarded profit.

Land Unlimited Wants Production of goods and services Scarce Resources Labor Capital Entrepreneur

Choic es

Cost of Production
Total revenue: Amount a firm receives for the sale of its output

Total cost: Market value of the inputs a firm uses in production

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Profit: Total revenue minus total cost

Explicit costs: Input costs that require an outlay of money by the firm Implicit costs:Input costs that do not require an outlay of money by the firm
Economic profit: Total revenue minus total cost (including both explicit and implicit
costs)

Accounting profit: Total revenue minus total explicit cost

Accounting cost Actual expenses plus depreciation charges for capital equipment Economic cost Cost to a firm of utilizing economic resources in production, including opportunity cost. Sunk cost Expenditure that has been made and cannot be recovered Because a sunk cost cannot be recovered, it should not influence the firms decisions.Because it has no alternative use, its opportunity cost is zero. Total cost (TC or C) variable costs. Total economic cost of production, consisting of fixed and

Fixed cost (FC) Cost that does not vary with the level of output and that can be eliminated only by shutting down. Variable cost (VC) Cost that varies as output varies.

The only way that a firm can eliminate its fixed costs is by shutting down. Shutting down doesnt necessarily mean going out of business.By reducing the output of a factory to zero, the company could eliminate the costs of raw materials and much of the labor. The only way to eliminate fixed costs would be to close the doors, turn off the electricity, and perhaps even sell off or scrap the machinery.

Average Costs in the short run

These are costs per unit. Average fixed cost (AFC) AFC = Fixed cost / Total output Fixed cost (FC) does not change with the level of total output. But the average fixed cost (AFC) means dividing the fixed cost over more output units, which reduces the fixed cost per unit. Examples, maintenance cost, property taxetc AFC declines all the way as output increases.

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Average variable cost (AVC) AVC = Variable cost / Total output AVC declines initially then it increases as output increases. The rise in AVC is due to diminishing returns in production which happens because of facility constraints. This happens at point k where output is 20 units in the figure below. Average total cost (ATC) ATC = Total cost / Total output or ATC = AFC + AVC. ATC is Ushaped because of the battle between the declining AFC and the declining and rising AVC. Initially, both AFC and AVC decline, so does the ATC. Still the decline in AFC dominates the rise in AVC, so ATC declines. Then later the rise in AVC dominates the small decline in AFC, and ATC rises. AVERAGE COSTS IN THE SHORT_RUN Output (Q) 0 Pairs 10 15 20 30 40 50 51 Fixed Cost (FC) $120 120 120 120 120 120 120 120 AFC = FC/Q $120/0 120/10=12 120/15=8 120/20= 6 120/30=4 120/4 = 3 Variable Cost (VC) $0 $85 125 150 240 350 AVC = VC/Q $0/0 $85/10= 8.5 125/15=8.33 150/20= 7.5=min AVC 240/30= 8.0 8.75 Total cost ATC = TC/Q (TC) $120=FC 120/0 205 245 270 360 470 670 753 205/10=20.50 245/15=16.33 270/20=13.50 360/30=12.00 11.75 =min ATC 13.40 ?

120/50 = 2.4 ? = TC- FC 550/50=11.00 120/51=2.35 753-120=633 ? = VC/Q

FC does not change with output but its AFC declines all the way. VC increases with output, but AVC goes down for a while reaching a minimum at $7.5 per pair then it goes up and thus is U-shaped because the initial decline has to do with increase in productivity due to specialization and then the later increase in AVC has to do with downtime. ATC is also U-shaped. It reaches it minimum at $11.75 per pair

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AVC reaches its minimum at an output level less than that corresponding to the min ATC. Marginal Cost This is the cost of additional increases in the amounts of resources as output increases by one extra unit. There are a marginal resource cost and a marginal dollar cost. We can move from the marginal resource cost to the marginal dollar cost by multiplying the amounts of the resources by their corresponding prices. Marginal resource cost:

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Recall an increase in output of jeans from 15 pairs to 16 pairs (an additional pair) requires an increase in labor cost by 1 / 19 = 0.053 workers day and an increase in denim cost by 1 / 10 = 0.1 bolt of one denim ( recall one bolt produces 10 pairs of jeans). There is no change in fixed cost. Resources used per an additional pair 0.053 (worker/ day) 0.1 bolt of denim Market value of MC resources $80 / worker a day 0.053*80 = $4.24 $30 / bolt 0.1*30 = $3.00

Marginal dollar cost in the short-run: MC = change in total cost / change in total output. Or MC = VC/Q you get the same marginal cost in the short run because FC will cancel out.

Output 0 P Q R S 10 15 20 30

TC $12 0 205 245 270 360

TC/Q = MC $85 /10 =$8.5 40 / 5 = $8.0 25 / 5 = $5.0 90 / 10 = $9.0

Output 0 10 15 20 30

VC
$0 $85 125 150 240

MC = VC/Q $8.5 = $85 /10 $8.0 = 40 / 5 $5.0 = 25 / 5 $9.0 = 90 /10

Marginal cost decreases then starts rising. It crosses AVC and ATC at their respective minimums.

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Economic Vs Accounting Costs

The distinction between economic costs and accounting costs is one between resource cost and dollar cost. Dollar cost refers to actual dollar payments and thus are accounting costs, while resource costs reflect the economic costs to the society whether it has cash payments or not. Part of economic cost is imputed and the other part is actual payments. In this case economic costs include accounting costs. Examples of costs without cash payments include: self-employed labor, self owned capital.

Accounting cost = explicit dollar costs Economic cost = explicit dollar costs + implicit costs. Economic cost = Accounting cost + implicit costs
Implicit costs are the costs of the self-employed labor, self-owned capital etc.

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Economic Cost versus Accounting Cost

Accountants: Take a retrospective view of a firms finances Their purpose is to evaluate past performance Equate cost with actual expenses and depreciation expenses Depreciation expenses are calculated according to tax rules Economists: Take a forward-looking view of the firms finances. Purpose to evaluate future profitability Equate costs with opportunity costs because the firm rearranges resources to minimize cost and increase expected profitability. The cost = actual expenses + opportunity costs of own time, money, materials and buildings. Depreciation expenses = actual wear or tear. Example : Owner/manager of a pizza restaurant in his/her own building Accounting costs Owners/managers salary = 0 Own building rent = 0 Workers wages > 0 Cheese > 0 Flour > 0 Other expenses > 0 Total accounting cost Economic costs Owners / managers salary = opportunity cost > 0 Own building rent = opportunity cost > 0 Workers wages > 0 Cheese > 0 Flour > 0 other expenses > 0 < Total economic cost

Total economic Cost = Explicit $ cost + Implicit cost Explicit $ cost = accounting cost (out of pocket expenses). Implicit cost = forgone own salary + forgone interest on own money + forgone own rent In this case, the implicit cost is the sum of opportunity costs.

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Long Run Cost The long run is a planning period during which the firm attempts to figure out the future demand for its product. Capacity or size is not fixed in the long-run. Once a firm chooses a fixed size, then there is a fixed capital, and hence there is a fixed cost and the firm is operating in the short-run. Suppose the firm is considering three sizes: Small Size with shortrun ATC = ATC1 Mid Size with short run ATC = ATC2 Large Size with short run ATC = ATC3

If the anticipated demand is between 0 and point a, the firm should consider building a small plant (size 1) because this is the size that gives the lowest possible cost per unit. If the demand is between a and b it should consider the medium size with ATC2. If the demand is expected to exceed b, then the firm should build the large size. In the long-run the firm should consider building sizes with lowest possible cost per unit. The long run ATC is the three solid portions of the three short run ATCs. Since the firm can build any size, then it is faced by infinitely many sizes with infinitely many short run ATCs. These ATCs can smooth out the long run ATC, which includes only one point on each short run ATC. This point corresponds to the minimum ATC. A Cost Summary MC equals AVC when the latter is at its minimum. MC also equals ATC when the latter is at its minimum.

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MC

ATC AVC

Min ATC

Min AVC MC goes through min AVC and min ATC.

Output

Scale Economies
Scale economies include three types: economies of scale; no economies of scale (constant returns to scale) and diseconomies of scale. This concept summarizes the relationship between changes in output and changes in costs, and it is characterized by the shape of the long-run ATC (LATC). Suppose the desired output is a relatively large one such as level QM in the graph below. This output level can be produced using several small plants or one large one. Let ATCS represent the ATC for a typical small plant and ATCL be the ATC for the large plant. How would the choice of plant size or scale affect costs? This has to do with scale economies. Fixed versus Sunk Costs Sunk costs are costs that have been incurred and cannot be recovered. An example is the cost of R&D to a pharmaceutical company to develop and test a new drug and then, if the drug has been proven to be safe and effective, the cost of marketing it. Whether the drug is a success or a failure, these costs cannot be recovered and thus are sunk. Example : SUNK Vs. FIXED Vs. VARIABLE It is important to understand the characteristics of production costs and to be able to identify which costs are fixed, which are variable, and which are sunk. Good examples include the personal computer industry (where most costs are variable), the computer software industry (where most costs are sunk), and the pizzeria business (where most costs are fixed). Because computers are very similar, competition is intense, and profitability depends on the ability to keep costs down. Most important are the variable cost of components and labor. A software firm will spend a large amount of money to develop a new application. The company can try to recoup its investment by selling as many copies of the program as possible. For the pizzeria, sunk costs are fairly low because equipment can be resold if the pizzeria goes out of business. Variable costs are lowmainly the ingredients for pizza and perhaps wages for a couple of workers to help produce, serve, and deliver pizzas. 28

Marginal Cost (MC): Increase in cost resulting from the production of one extra unit of output. Because fixed cost does not change as the firms level of output changes, marginal cost is equal to the increase in variable cost or the increase in total cost that results from an extra unit of output. We can therefore write marginal cost as

Average Total Cost (ATC) Average total cost (ATC) Firms total cost divided by its level of output. Average fixed cost (AFC) Fixed cost divided by the level of output. Average variable cost (AVC) Variable cost divided by the level of output. The Determinants of Short-Run Cost The change in variable cost is the per-unit cost of the extra labor w times the amount of extra labor needed to produce the extra output L. Because VC = wL, it follows that

The extra labor needed to obtain an extra unit of output is L/q = 1/MPL. As a result,

Diminishing Marginal Returns and Marginal Cost Diminishing marginal returns means that the marginal product of labor declines as the quantity of labor employed increases. As a result, when there are diminishing marginal returns, marginal cost will increase as output increases.

COST IN THE LONG RUN User cost of capital Annual cost of owning and using a capital asset, equal to economic depreciation plus forgone interest

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The user cost of capital is given by the sum of the economic depreciation and the interest (i.e., the financial return) that could have been earned had the money been invested elsewhere. Formally,

We can also express the user cost of capital as a rate per dollar of capital:

The Cost-Minimizing Input Choice We now turn to a fundamental problem that all firms face: how to select inputs to produce a given output at minimum cost. For simplicity, we will work with two variable inputs: labor (measured in hours of work per year) and capital (measured in hours of use of machinery per year). The Price of Capital :The price of capital is its user cost, given by r = Depreciation rate + Interest rate. The Rental Rate of Capital: Cost per year of renting one unit of capital.

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Diminishing marginal product

Marginal product of an input declines as the quantity of the input increases

Total-cost curve
Relationship between quantity produced and total costs Gets steeper as the amount produced rises The various measures of cost: Conrads coffee shop

Quantit y of coffee (cups per hour)

Total Cost

Fixed Variable Average Average Average Marginal Cost Cost Fixed Variable Total Cost Cost Cost Cost

0 1 2 3 4 5 6 7 8 9 10

$3.00 $3.00 3.30 3.00 3.80 3.00 4.50 3.00 5.40 3.00 6.50 3.00 7.80 3.00 9.30 3.00 11.00 3.00 12.90 3.00 15.00 3.00

$0.00 0.30 $3.00 0.80 1.50 1.50 1.00 2.40 0.75 3.50 0.60 4.80 0.50 6.30 0.43 8.00 0.38 9.90 0.33 12.00 0.30

$0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20

$3.30 1.90 1.50 1.35 1.30 1.30 1.33 1.38 1.43 1.50

$0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10

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Average total cost (ATC) Total cost divided by the quantity of output Average total cost = Total cost / Quantity ATC = TC / Q Marginal cost (MC) Increase in total cost Arising from an extra unit of production Marginal cost = Change in total cost / Change in quantity MC = TC / Q Average total cost Cost of a typical unit of output If total cost is divided evenly over all the units produced Marginal cost Increase in total cost From producing an additional unit of output

Cost curves and their shapes Rising marginal cost Because of diminishing marginal product U-shaped average total cost: ATC = AVC + AFC AFC always declines as output rises AVC typically rises as output increases Diminishing marginal product The bottom of the U-shape At quantity that minimizes average total cost 32

Efficient scale Quantity of output that minimizes average total cost Relationship between MC and ATC When MC < ATC: average total cost is falling When MC > ATC: average total cost is rising The marginal-cost curve crosses the average-total-cost curve at its minimum

Typical cost curves Marginal cost eventually rises with the quantity of output Average-total-cost curve is U-shaped Marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost

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Costs in Short Run and in Long Run Many decisions Fixed in the short run Variable in the long run, Firms greater flexibility in the long-run Long-run cost curves Differ from short-run cost curves Much flatter than short-run cost curves Short-run cost curves Lie on or above the long-run cost curves

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Diseconomies of scale Long-run average total cost rises as the quantity of output increases Increasing coordination problems

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Market Structures
Objectives of Firms
Traditional theory Profit maximisation 1. MC = MR Alternative theories Managerial theories 1. Managerial utility maximisation 2. Sales revenue maximisation 3. Growth maximisation Behaviourial theories 1. A variety of goals, eg. production, sales, market share, profit 2. Aim to achieve a satisfactory performance for each goal

Types of Market Structure

Different types of market structure include: 1. Pure competition 2. Pure monopoly 3. Monopsony 4. Monopolostic competition 5. Oligopoly 6. Oligopsony 7. Price discrimination These market structures are discussed below.

1.Pure competition:
The market consist of buyers and sellers trading in a uniform commodity such as wheat, copper, or financial securities. No single buyer or seller has much effect on the going market price. A seller can not change more than the going price, because buyer can obtain as much they need at the going price. In a purely competitive market, marketing research, product development, pricing, advertising, and sales promotion play little or no role. Thus, sellers in these markets do not spend much time on marketing strategy.

2.Pure monopoly:
In economics, an industry with a single firm that produce a product, for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profit is called pure monopoly.

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Example: When the City Cell mobile service company first started their business in Bangladesh, they were the only mobile service provider then. Before the Grameen Phone came into the market, they enjoyed pure monopoly. There are two types of pure monopoly: 1. Regulated monopoly 2. Nonregulated monopoly Regulated monopoly: The government permits the company to set rates that will yield a fair return. Example: Power Company. Nonregulated monopoly: Company is free to price at what the market will bear. Example: City Cell ( When it first introduced mobile service in Bangladesh).

3.Monopsony:
This is the market situation where there is only one buyer in the market. When City Cell first introduced mobile service network in Bangladesh, they were the only mobile phone and its accessories buyer from Nokia and Motorolla in Bangladesh.

4.Monopolistic competition:
In economics, the market consist of many buyers and sellers who trade over a range of prices rather than a single market price is called monopolistic competition. A range of price occurs because sellers can differentiate their offers to buyers. Sellers try to develop difference by using customer segments, and in addition to price, freely uses branding, advertising, and personal selling to set their offers apart.

5.Oligopoly:
In economics, the market consist of few sellers who are highly sensitive to each others pricing and marketing strategies. There are few sellers because it is difficult for new sellers to enter the market. Each seller is alert to competitors strategies and move.

6.Oligopsony:
In economics, oligopsony is a market where there is a small number of buyers for a product or a service. In this market structure, buyers have power over the seller. Because as there are small number of buyers, if they are united and pressure the seller to sell the product or service in a reasonable and affordable price, the seller must have to consider that.

7.Price discrimination:
In economics, if one product or service has different price for different buyers which is provided by the same provider, then we call that price discrimination market strategy. A good example of this strategy could be the airlines company-Emirates. It has offered different prices for different category of passengers for the same destination. Such as, it has Student package for the students, Honeymoon package for the couples which are of lower price than their regular one.

Perfect markets 1. Firms are price takers 2. No market power for firms Imperfect markets 1. Firms are price setters 2. Varying extent of market power of firms 37

Market structures differ in terms of 1. Nature of product 2. Ease of entry 3. Concentration of firms 4. Competition between firms Equilibrium output for all market structures at MC = MR Profits Normal profit 1. TR = TC 2. Zero economic profit 3. No incentive for firms to leave or new ones to enter Supernormal profits 1. TR > TC 2. Firms earns more than opportunity costs 3. Entry of firms will depend on ease of entry a. If barriers exist, profit level remains high b. If no entry barriers, profit level goes down to normal profit Subnormal profits 4. TR < TC 5. Firms makes less than opportunity cost 6. Firms will cease production when a. Revenue < Variable Cost, firm leaves in short run b. Revenue > Variable Cost, firm continues in short run but leaves in long run Perfect Competition Characteristics 1. Homogeneous products 2. No barriers to entry, hence a large number of small firms 3. Firms have no market power, price takers Revenue Curves Average Revenue (AR) 1. Same as demand curve of product 38

2. Perfectly elastic Marginal Revenue (MR) 1. MR = AR

Total Revenue (TR) 1. Straight line from origin

Equilibrium Output Marginal approach

1. MC = MR 39

2. Since P = MR, P = MC. Firm is allocative efficient. Total approach 1. Point where vertical difference between TR and TC is the greatest

Short Run Profits Supernormal Profits

New firms will enter Industrys supply increases Price falls until normal profit Normal Profits

Subnormal Profits

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Firms objective shifts to loss minimisation.

Long Run Profits 1. Normal profit 2. Price = Minimum of AC (minimum efficient scale)

From supernormal profits to long run equilibrium, AR/MR moves down

Evaluation of Perfection Competition 41

Pros 1. Allocative efficient, sum of consumer surplus and producer surplus is maximum

2. Production at least cost output, minimum efficient scale 3. Normal profit 4. Ease of movement of resources Cons 1. Social efficiency is not attainable without government intervention when externalities are present 2. Little incentive to innovate 3. Absence of product variety Monopoly Characteristics 1. No close substitutes 2. Strong barriers to entry 3. Only firm 4. Strong market power Barriers to Entry 1. Cost condition a. Highly capital-intensive b. Minimum efficient scale occurs at high output 2. Legal barriers 3. Contrived barriers a. Control of input supplies b. Brand loyalty 42

Revenue Curves

Equilibrium Supernormal profits due to: 1. P > MC 2. Price discrimination 3. Lower costs from economies of scale 4. Incentive to innovate

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Shaded area = Supernormal profits Price Discrimination A practice of firms charging different prices for the same products, unsupported by cost reasons Conditions Necessary 1. Markets are separable 2. Differing price elasticities of demand between markets 3. Resale of product not possible 1st Degree Price Discrimination 1. Different price for every customer 2. No consumer surplus left 3. Allocatively efficient (P = MC) 2nd Degree Price Discrimination 1. Charging differently according to blocks of consumption

3rd Degree Price Discrimination 1. Different types of consumers (with different price elasticity of demand) charged differently 2. Less elastic market charged higher

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Two effects: 1. Absorption of consumer surplus by firm 2. Allocatively efficient as in 1st degree Pros 1. Higher consumption level made possible 2. Extra revenue is reinvested 3. Enables firms to supply otherwise unprofitable goods Evaluation of Monopoly Pros 1. Cost advantage a. Economies of scale and R&D will lead to lower MC b. Price can be lower and output (MC = MR) can be higher than allocative efficient level of PC (P = MC) c. Lower MC Larger consumer surplus 2. Research and development 3. Lower cost despite not producing at minimum efficient scale as MC is lower Cons 1. Allocatively inefficient 2. Higher price, lower output a. Production at MC = MR and not P = MC b. Loss of consumer surplus

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3. Income inequality Theory of Contestable Markets 1. Price, output and behaviour in an industry is determined by the threat of competition 2. Monopolies forced to be more efficient and lower price to prevent new entrants 3. Factors favouring contestability: a. Free trade policy b. Deregulation trend Controlling Monopolies 1. Regulation on pricing and output 2. Transferring monopoly to government (nationalisation) 3. Taxes 4. Legislations and anti-trust policies Monopolistic Competition Characteristics 1. Slightly differentiated products 2. Entry of firms is relatively easy 3. Many small firms 4. Mild market power due to slight product differentiation Revenue Curve 1. Same as monopoly, with lower price elasticity

Short Run Profit 1. Supernormal profits

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2. Normal profits

47

3. Subnormal profits a. AC above AR Long Run Profit 1. Supernormal profits entry of new firms a. Decrease in demand for firms MR and AR shifts to the left and become more elastic 2. Normal profits 3. Output falls short of MES Evaluation of Monopolistic Competition Pros 1. Small margin of P > MC 2. Economies of scale lower LRAC, lower MC, higher output 3. Product varieties Cons 1. Allocative inefficient (P > MC) 2. Excess capacity between LR output ant MES output 3. Lack of R&D

Comparison between Monopolistic Competition and Perfect Competition

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Monopolistic Competition leads to: 1. Higher price 2. Lower output 3. Higher AC Comparison between Monopolistic Competition and Monopoly 1. Lack of R&D due to normal profits 2. Monopolistic competitions smaller scale leads to higher costs Oligopoly Characteristics 1. Differentiated products 2. Restricted entry of new firms 3. Few large firms a. Two firms - Duopoly 4. Interdependence among firms Alternative Theories of Oligopolys Price-Output Non-collusive 1. Price rigidity with kinked demand a. Drop in price others follow revenue falls demand is inelastic b. Rise in price others do not follow revenue falls demand is elastic Collusive 1. Cartel 2. Dominant firm price leadership 3. Barometric firm price leadership 4. Rule of thumb pricing 49

 Collusion best when: I. II. III. IV. Few firms Identical products Awareness of methods and common costs No new competition

Evaluation of Oligopoly Pros 1. R&D 2. Product differentiation Cons 1. Allocatively inefficient (P > MC) 2. Wastage of resources 3. Smaller scale of production compared to monopoly 4. Firms may collude and behave as a monopoly Non-Price Competition 1. Product development and innovation 2. Marketing

National Income
The study of National Income is important because of the following reasons: To see the economic development of the country. To assess the developmental objectives. To know the contribution of the various sectors to National Income. Internationally some countries are wealthy, some countries are not wealthy and some countries are in-between. Under such circumstances, it would be difficult to evaluate the performance of an economy. Performance of an economy is directly proportionate to the amount of goods and services produced in an economy. Measuring national income is also important to chalk out the future course of the economy. It also broadly indicates peoples standard of living. Income can be measured by Gross National Product (GNP), Gross Domestic Product (GDP), Gross National Income (GNI), Net National Product (NNP) and Net National Income (NNI). In India the Central Statistical Organization has been formulating national income. 50

However some economists have felt that GNP has a measure of national income has limitation, since they exclude poverty, literacy, public health, gender equity and other measures of human prosperity. Instead they formulated other measures of welfare like Human Development Index (HDI) Calculating National Income There are various methods for calculating the national income such as production method, income method, expenditure method etc. Production Method The production method gives us national income or national product based on the final value of the produce and the origin of the produce in terms of the industry. All producing units are classified sector wise. Primary sector is divided into agriculture, fisheries, animal husbandry. Secondary sector consists of manufacturing. Tertiary sector is divided into trade, transport, communication, banking, insurance etc. Income Method: Different factors of production are paid for their productive services rendered to an organization. The various incomes that includes in these methods are wages, income of self employed, interest, profit, dividend, rents, and surplus of public sector and net flow of income from abroad. Expenditure Method: The various sectors the household sector, the government sector, the business sector, either spend their income on consumer goods and services or they save a part of their income. These can be categorized as private consumption expenditure, private investment, public consumption, public investment etc.

Per Capita Income

Meaning and Significance Per capita Income means how much an individual earns, of the yearly income that is generated in the country through productive activities. It means the share of each individual when the income from the productive activities is divided equally among the citizens. Per capita income is reported in units of currency. Per capita income reflects the gross national product of a country. Per capita income is also a measure of the wealth of a population of a nation when compared with other countries. It is expressed in terms of commonly used international currency such as Euro, Dollars because these currencies are widely known.

NATIONAL INCOME
This can be considered from two sides: receipt of income and its expenditure. PART I: RECEIPTS SIDE

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National income is a stock concept. It is taken as the total income over a period of one year. This is an accounting procedure for national income. I. CONCEPTS TAKEN AT MARKET PRICE/ MARKET VALUE GDP/ GNP/ NDP/ NNP are always taken at market price, i.e., the market value, unless stated otherwise. 1. Domestic income = Wages and salaries+rents+interest+dividends+undistributed profits(including depreciation or CCA) + mixed incomes +direct taxes Domestic income is known as GDP. Nothing is counted twice. Therefore, only goods and services bought for final use are considered; i.e., no unfinished goods are considered.

2.

National Income or GNP/ GNE/ GNI/ Y: National Income = Domestic Income + net asset income earned from abroad

GNP = GNI = GNE =

Unduplicated (final) value of the flow of goods and services produced by a nation annually. Gross national income Gross national expenditure

Note: GNP = GNI = GNE = Y GNP is usually denoted by Y, the national income, and is used in Keynesian economics GNP = GDP + net property income from abroad (X-M) => GNP = GDP + (E - M) NOTE: GNP > GDP We do a detailed breakup of Y later on. 3. Net increase in capital stock: = GDP + X where E = exports, M = imports where X is net exports

Depreciation goes towards replacing old stock. Therefore, by removing depreciation from GDP/NDP, we get the new buildup of new capital stock. Of course, to this is added the total output of consumer goods in the year, etc. Therefore, NDP is GDP less depreciation. NNP is GNP less the depreciation. Further, NNP = NDP + (E - M) 4. Net Disposable income NDI

If net income paid overseas is subtracted from GNP, then that gives the net income available to the nation, including depreciation, i.e., 52

NDI = GNP - net disposable income. 5. National income NI

Out of the NNP, the amount of income received by the country's residents is the national income. This is calculated by removing net income paid overseas from NNP. NI = NNP - net income paid overseas. 6. Personal income PI, or Household income HI:

If we subtract undistributed profits from NI, then we are left with the income which normal residents receive. 7. PDI Personal disposable income: or HDI: If we subtract the personal taxes from PI, we are left with PDI. I. B. CONCEPTS TAKEN AT FACTOR COST Not all the market value of goods and services is received by factors of production. Some is paid to government in indirect taxes. At the same time, some subsidies are received from government. E.g., out of our personal income, we pay sales tax, and receive the benefits of subsidised public transportation system. Hence we have actually received Wages - indirect taxes + subsidies. This is what a factor receives, leading to a series of concepts "at factor cost". 1. 2. 3. 4. GDP at factor cost GNP at factor cost NDP at factor cost NNP at factor cost = = = = GDP at market prices - indirect taxes + subsidies GNP at market prices - indirect taxes + subsidies GDP at factor cost - depreciation GNP at factor cost - depreciation

PART II: EXPENDITURE SIDE Here we consider how the money which is received is spent. The money spent/ saved must be equal to the money received. Therefore, from either side, national income must be the same. Let C= consumption, I= investment. 1. Two sector economy: Here, there is no government. Only the producers and consumers. Therefore, consumers consume C (and save S), and this goes towards new investment. Simultaneously, producers (use the savings S to) invest I. Y=C+I Further, if S is savings, then, I = S 53 - (1)

This is obvious, since producers can only invest what all the consumers save. However, there is a simple proof: Now, Income = expenditure on goods and services + savings (in all three sectors: government, business and household) Therefore, Y = C + S Equating, (1) and (2) C+I = C+S or, I=S -(2)

2.

Three sector economy: Here there is government, in addition to producers and consumers. Let G = government spending. Therefore, Y=C+I+G Let T be the taxes. Then, I+G=S+T i.e., the total money available in economy for investment purposes, plus government spending, comes from savings and taxes. Usually, I = S and G = T.

3.

Four sector economy: Here, there is interaction with the rest of the world in addition. Let E= exports, M= imports, then: Y = C + I + G + (E-M) or, Y = C + I + G + X Further, (think a bit) I+C+E=S+T+M

NOTE: many books use X instead of E to represent exports.

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