GANDHI INSTITUTE OF TECHNOLOGY

AND MANAGEMENT

An ISO 9001 Institute

NBA Accredited

LECTURE NOTE

Name of the Subject: Engineering Economics

Module No: I
Name of the faculty: Bhakta Charan Jena
 ENGINEERING ECONOMICS

Engineering economy is the discipline concerned with the economic aspects of engineering, it involves the
systematic evaluation of the costs and benefits of proposed technical projects.
Engineering economics deals with the methods that enable one to take economic decisions towards
minimizing costs and / or maximizing benefits to business organizations.

Scope

1.Product policy, sales promotion and market strategy

The scope of managerial economics extends to some of the core managerial aspects of the firm
because the decision in this regard play a very significant role in the success of the firm. If the economics
aspects of these decision are not taken care of, it may prove to be disastrous. Some of these are, the
product policy which explains how and what quality a product should be. The expenditure on sales
promotion and its benefits also required to be studied. Market strategy has also to be planned keeping in
view the economics aspects.

2. Demand Analysis and Forecasting

A business firm is the economic unit which operates to transform productive resources into goods
and services for sales in a market. Thus, the first task in the managerial decision-making is to get accurate
estimates of demand for the product of the firm. Until the firm has clear idea of the demand for its product
it is not possible to prepare production schedules and employ resources for management, as it highlights
the factor on which demand for their product depends.

3. Cost Analysis
The study of the data about costs made available from the firm accounting record yield significant
cost estimation for the management’s decision-making. The managerial economics identifies the factors
causing cost uncertainty exists because all the factors determine costs are not clearly known.

4.Production analysis
It is concerned with quantitative aspects of physical inputs. Given the technology and the nature of
the product, the managerial economist studies the production function of the firm-the economies and
diseconomies of scale, the minimum efficient scale of the plant etc. The behaviour of costs of a firm
depends directly on the nature of its production function.

5.Pricing decisions, policies and practices

Pricing of a product is an important element of the marketing mix of a firm. Besides the knowledge
of fixed and variable costs of inputs, a scientific decision about price needs the knowledge of various
elasticity of demand and the potential rivals who may enter the market. The price policy of a firm is based
on such analysis. The area of study deals with the analysis of market structures, pricing methods,
differential pricing, product pricing and pricing forecasting.

6.Profit Management
Business firms not only want to make profits but also want to make more profits. They want profit
maximization or sales revenue maximization.

According to Drucker, profit is the measure of business success in the long run. However, an important
point worth considering is the element of uncertainty existing about profits because the variations in costs
and revenues. If knowledge about future were perfect, profit analysis would have been a very easy task.
Break-even analysis and profit elasticity calculations are of great use in pricing and profit management.

7.Capital management
Decision about investment are most crucial for a firm because the funds involved are often huge
and the behaviour of the capital market is least predictable. A firm can raise funds by issuing shares or
debentures and debt instruments. It can also choose to employ its own cash reserves. But the most difficult
part is the choice of the investment projects. This is the choice of the top-management because the
committed expenditures cannot be recalled.

BASIC PROBLEM OF AN ECONOMY

All countries face the problem of scarcity as their resources are limited and resources have
alternative uses. Every economy be it capitalist, socialist or mixed has to deal with this central problem of
scarcity of resources relative to the wants for them. This is generally called ‘The Central
Economic Problem’.
The Central Economic problem is further divided into four basic economic problems.
These are:
 What to produce?
 How to produce?
 For whom to produce?
 What provisions (if any) are to be made for economic growth?
1. WHAT TO PRODUCE –
Society has to decide whether to produce guns or butter, machines (capital goods) or cell phone (consumer
goods). It also has to decide in what quantity each of the good would be produced. In nutshell, society
must decide how much wheat, how many schools, how many meters of cloths etc. have to be produced.
2. HOW TO PRODUCE –
Society has to decide whether the goods and services are to be produced using labour intensive techniques
or capital-intensive techniques. This choice would depend on the availability of different factors of
production (i.e. labour and capital) and their relative prices. For eg. Cotton can be produced using
handloom, power looms or automatic looms. Production with handlooms involves use of labour and
production with automatic loom involves use of more machines and capital. It is in the society’s interest to
use those techniques of production that make the best use of available resources.
3. FOR WHOM TO PRODUCE –
A society cannot satisfy wants of all and thus it has to take an important decision ‘for whom’ it should
produce. It has to decide on who should get how much of the total output of goods and services i.e. How to
distribute goods and services among members of society.
4. WHAT PROVISION SHOULD BE MADE FOR ECONOMIC GROWTH –
A society has to decide how much saving and investment has to be made for future progress. A society
would not like to use all its scarce resources for current consumption only, as if it uses all resources for
current consumption and no provision is made for future production, the society’s production capacity
would not increase.

Micro Economics
Microeconomics is the study of decisions made by people and businesses regarding the allocation of
resources and prices of goods and services. The government decides the regulation for taxes.
Microeconomics focuses on the supply that determines the price level of the economy.
It uses the bottom-up strategy to analyse the economy. In other words, microeconomics tries to understand
human’s choices and allocation of resources. It does not decide what are the changes taking place in the
market, instead, it explains why there are changes happening in the market.
The key role of microeconomics is to examine how a company could maximise its production and
capacity, so that it could lower the prices and compete in its industry. A lot of microeconomics information
can be obtained from the financial statements.

The key factors of microeconomics are as follows:

  Demand, supply, and equilibrium
 Production theory
 Costs of production
 Labour economics
Examples: Individual demand, and price of a product.

Macro Economics
Macroeconomics is a branch of economics that depicts a substantial picture. It scrutinizes itself with the
economy at a massive scale, and several issues of an economy are considered. The issues confronted by an
economy and the headway that it makes are measured and apprehended as a part and parcel of
macroeconomics.

Macroeconomics studies the association between various countries regarding how the policies of one
nation have an upshot on the other. It circumscribes within its scope, analysing the success and failure of
the government strategies.

In macroeconomics, we normally survey the association of the nation’s total manufacture and the degree of
employment with certain features like cost prices, wage rates, rates of interest, profits, etc., by
concentrating on a single imaginary good and what happens to it.

The important concepts covered under macroeconomics are as follows:

 Capitalist nation
 Investment expenditure
 Revenue
Examples: Aggregate demand, and national income.
S.
Microeconomics Macroeconomics Examples
No
Micro: A family
budgeting its monthly
Macroeconomics studies a
Microeconomics studies individual expenses.
1. economic units
nation’s economy, as well as its
Macro: A government
various aggregates.
analyzing the entire
country's GDP growth.

Micro: A business
Macroeconomics focuses on the setting the price of a
Microeconomics primarily deals study of economic aggregates, product based on its
2. with individual income, output, including national output, cost.
price of goods, etc. income, and overall price levels. Macro: The national
inflation rate affecting
all goods and services.

Micro: A company
trying to reduce waste
Microeconomics focuses on Macroeconomics focuses to cut costs.
overcoming issues concerning the on upholding issues like Macro: The
3. allocation of resources and price employment and national government
discrimination. household income. implementing policies
to reduce
unemployment.

Micro: The supply of

cars in a local market
based on consumer
Microeconomics accounts for
Macroeconomics considers the demand.
4. factors like the demand and supply
total demand and supply within Macro: The total
of a particular commodity.
a nation's economy. national demand and
supply of goods and
services affecting GDP.

Micro: An analysis
Microeconomics provides an showing that electric
overview of the goods and services cars may see increased
Macroeconomics helps ensure
essential for an efficient economy demand in the future.
5. and identifies those that may see
optimum utilization of the
Macro: A nation
resources available to a country.
increased demand in the future. utilizing its resources
efficiently to avoid
economic recession.

6. Microeconomics helps to point out Macroeconomics help Micro: A business

how equilibrium can be achieved at determine the equilibrium levels finding the balance
a small scale. of employment and income of between supply and
the nation. demand for a product.
Macro: A government
setting policies to reach
a national employment
 rate goal.

Micro: A customer
deciding whether to
buy a product based on
Microeconomics also focuses on The primary component of
price changes.
7. issues arising due to price variation macroeconomic problems is
Macro: National
and income levels. income.
policies focusing on
increasing the average
household income.

DEMAND
Demand is when a customer desires for a particular commodity at the given price in which they are ready
to buy in one market at different prices during a certain period of time. Hence, there can be two aspects of
demand:
Willingness to buy: Customer’s desire for the product
Ability to pay: Customer’s purchasing power to pay the price for the desired commodity
The demand of the customers depends upon their needs and preferences. Hence, to create demand in the
market, the following are essential:
Desire for the commodity
Means to purchase the commodity
Willingness to use those means for purchasing the commodity.

Demand Function
A demand function is a mathematical function describing the relationship between a variable, like the
demand of quantity, and various factors determining the demand. The purpose of this function is to analyze
the behavior of consumers in a market and to help firms make pricing decisions.

Individual Demand Function

The Individual function of demand means the functional relationship between a particular need for a
product and all the factors that affect it. Moreover, it also explains the relationship between the market's
direction and its aspects. In addition, companies can calculate this function by using data on consumer
buying behavior, such as surveys, market research, or sales data. Therefore, this function is derived from
individual consumers' preferences, income, and other characteristics of individual consumers.
Consequently, it helps understand consumer behavior in response to changes in price.
Algebraically, the individual function of demand is described as follows:
Dx = f (Px, I, Pr, E, T)
  The Demand of Commodity x (Dx)
 The function of product x (f)
 Price of good or service (Px)
 Incomes of buyers (I)
 Prices of related goods & services (Pr)
 The future expectation of the product (E)
 Taste patterns of buyers (T)

Market Demand Function

The market function of demand means the existing functional relationship between the need of the market
and the factors affecting the market demand. Besides those factors affecting the individual demand
process, the magnitude, and structure of climatic conditions and income distribution also affect the
demand's market function.
Subsequently, evaluating this function involves using data on the prices and quantities demanded by all
buyers in the market. Therefore, this data can be obtained from market research, surveys of buyer
behavior, and sales records. Hence, this function evaluates the market stability price and quantity, which is
the point where demand meets supply.
Algebraically, the market function of demand is described as follows:

Dx = f (Px, Y, Py, Ep, T, Pp, A, U)

 The demand of Commodity x (Dx)
 The function of commodity x (f)
 Price of good or service (Px)
 Incomes of buyers (Y)
 Prices of related goods & services (Py)
 The Expected future price of the product (Ep)
 Taste patterns of users (T)
 Number of buyers in the market (Pp)
 Distribution of Income (A)
 Government Policy (U)

Law of Demand
The law of demand states that the quantity demanded of a good show an inverse relationship with the price
of a good when other factors are held constant (cetris peribus). It means that as the price increases, demand
decreases.
The law of demand is a fundamental principle in macroeconomics. It is used together with the law of
supply to determine the efficient allocation of resources in an economy and find the optimal price and
quantity of goods.

Exceptions to the Law of Demand:

While the law of demand holds true in most cases, there are certain situations where it may not
apply. These exceptions are important to understand as they can alter consumer behavior in
unique ways.

1. Giffen Goods:
o Named after the economist Sir Robert Giffen, Giffen goods are inferior goods for
which an increase in price leads to an increase in demand.
o This phenomenon occurs because the income effect outweighs the substitution
effect. When the price of a Giffen good rises, consumers feel poorer and buy more
of the good because they can no longer afford better substitutes.
o Example: Basic staple foods like bread or rice in low-income areas where they
form a major part of a household’s consumption.
2. Veblen Goods:
o Veblen goods are luxury goods whose demand increases as their price increases
because they are perceived as more desirable when they are expensive.
o Consumers buy these goods as a status symbol to showcase their wealth or social
standing.
o Example: High-end designer clothing, luxury cars, expensive watches, etc.
3. Speculative Bubbles:
o In certain market conditions, such as in the case of financial markets, demand for
assets like stocks, real estate, or cryptocurrency may increase as prices rise.
o Investors might anticipate further price increases and rush to buy the asset,
disregarding the basic principles of the law of demand. This is often observed
during speculative bubbles.
 o Example: The housing market in the mid-2000s or the cryptocurrency market
during its surges.
4. Necessities:
o Some goods, particularly basic necessities, may not follow the law of demand
strictly. If a good is essential for survival or basic function (like insulin for diabetic
patients), a price increase may not significantly decrease demand.
o Example: Life-saving medicines, utilities (water, electricity), etc.
5. Habitual Goods:
o Products that consumers are addicted to or have developed a strong habit for (like
tobacco, alcohol, or caffeine) may not follow the law of demand.
o Even if prices increase, consumers may continue to buy them out of addiction or
established habits, showing a relatively inelastic demand curve.
6. Income-Effect Dominance in Certain Low-Income Scenarios:
o For certain essential goods, particularly in low-income economies, the income
effect can dominate. When prices rise, people may buy more of the good, as they
cannot afford alternatives, even though the good has become more expensive.
o Example: In poverty-stricken regions, people may buy more of a basic staple food
(even if it becomes more expensive) due to lack of choice.

Determinants of Demand
Determinants of demand are factors that influence how much of a product or service people
want to buy. In simpler terms, they are the things that make people decide whether to buy more
or less of something.
1. Price: The most obvious one is the price of a product. When prices go down, people
tend to buy more. For example, when Indian smartphone companies like Xiaomi offer
lower-priced phones with good features, more people buy them.
2. Income: People's income levels affect their buying decisions. When people in India
have higher incomes, they may choose to buy more expensive cars like those from Tata
Motors or Mahindra & Mahindra, as opposed to lower-priced alternatives.
3. Taste and Preferences: Different people like different things. For instance, some might
prefer traditional Indian clothing from companies like FabIndia, while others might
prefer Western-style clothing from brands like Zara.
4. Population and Demographics: The size and characteristics of the population matter.
With a growing population of tech-savvy youth in India, IT companies like Infosys and
TCS have a larger market for their services.
5. Advertising and Promotion: How much a company advertises and promotes its
products can influence demand. If a company like Amul promotes its dairy products
heavily, more people may buy them.
6. Substitute Goods: If there are similar products available, people might switch between
them based on price and quality. For example, consumers may choose between different
brands of tea like Tata Tea and Brooke Bond based on taste and price.
7. Complementary Goods: Some products go well together. If you buy a mobile phone,
you might also need a charger. So, if phone companies offer bundles with chargers, it
can boost demand for both products.
8. Expectations of Future Prices: If people expect prices to go up in the future, they
might buy more now. This can be seen in the gold market, where consumers in India
often buy more gold when they anticipate higher future prices.
9. Government Policies and Regulations: Government decisions, like taxes or subsidies,
can impact demand. For example, when the Indian government reduced the Goods and
Services Tax (GST) on certain products, it made those products more affordable and
boosted demand.
10. Cultural and Social Factors: Sometimes, cultural or social trends can influence
demand. For instance, the popularity of yoga in India has led to increased demand for
yoga mats and clothing.

ELASTICITY OF DEMAND
Elasticity of demand refers to the degree to which the quantity demanded of a good or service changes in
response to a change in its price. It is a key concept in economics, helping to understand how sensitive
consumers are to price changes. Here's a detailed explanation:
Elasticity of Demand: The percentage change in the quantity demanded of a good or service divided by
the percentage change in its price.

 Formula:

Ed =% Change in Quantity Demanded / % Change in Price

Types of Elasticity of Demand

Based on the variable that affects the demand, the elasticity of demand is of the following types. One point
to note is that unless otherwise mentioned, whenever the elasticity of demand is mentioned, it implies price
elasticity.

Price Elasticity
The price elasticity of demand is the response of the quantity demanded to change in the price of a
commodity. It is assumed that the consumer’s income, tastes, and prices of all other goods are steady. It is
measured as a percentage change in the quantity demanded divided by the percentage change in price.

E Original Price
p =¿
Change∈Quantity
¿ ×
Original Quantity Change∈Price

Income Elasticity
Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a
change in the real income of consumers who buy this good.
The formula for calculating income elasticity of demand is the percent change in quantity demanded
divided by the percent change in income. With income elasticity of demand, you can tell if a particular
good represents a necessity or a luxury.

Percentage change ∈Quantity demanded

E I=
Percentage change∈ Income

Cross Elasticity
The cross elasticity of demand is an economic concept that measures the responsiveness in the quantity
demanded of one good when the price for another good changes. It's also referred to as cross price
elasticity of demand.
This measurement is calculated by taking the percentage change in the quantity demanded of one good and
dividing it by the percentage change in the price of the other good.

Percentage change ∈Quantity of X

E xy =
Percentage change ∈Price of Y

Degrees of Price Elasticity

Different commodities have different price elasticity’s. Some commodities have more elastic demand
while others have relative elastic demand. Basically, the price elasticity of demand ranges from zero to
infinity. It can be equal to zero, less than one, greater than one and equal to unity.
“The elasticity or responsiveness of demand in a market is great or small according as the amount
demanded increases much or little for a given fall in price and diminishes much or little for a given rise in
price”.
However, some particular values of elasticity of demand have been explained as under:
1. Perfectly Elastic Demand:
Perfectly elastic demand is said to happen when a little change in price leads to an infinite change in
quantity demanded. A small rise in price on the part of the seller reduces the demand to zero. In such a
case the shape of the demand curve will be horizontal straight line as shown in figure 1.

Perfectly Elastic Demand

The figure 1 shows that at the ruling price OP, the demand is infinite. A slight rise in price will contract the
demand to zero. A slight fall in price will attract more consumers but the elasticity of demand will remain
infinite (ed=∞). But in real world, the cases of perfectly elastic demand are exceedingly rare and are not of
any practical interest.
2. Perfectly Inelastic Demand:
Perfectly inelastic demand is opposite to perfectly elastic demand. Under the perfectly inelastic demand,
irrespective of any rise or fall in price of a commodity, the quantity demanded remains the same. The
elasticity of demand in this case will be equal to zero (ed = 0).

Perfectly Inelastic Demand

In diagram 2 DD shows the perfectly inelastic demand. At price OP, the quantity demanded is OQ. Now,
the price falls to OP1, from OP, the demand remains the same. Similarly, if the price rises to OP2 the
demand still remains the same. But just as we do not see the example of perfectly elastic demand in the
real world, in the same fashion, it is difficult to come across the cases of perfectly inelastic demand
because even the demand for, bare essentials of life does show some degree of responsiveness to change in
price.
3. Unitary Elastic Demand:
The demand is said to be unitary elastic when a given proportionate change in the price level brings about
an equal proportionate change in quantity demanded. The numerical value of unitary elastic demand is
exactly one i.e. Marshall calls it unit elastic.

Unitary Elastic Demand

In figure 3, DD demand curve represents unitary elastic demand. This demand curve is called rectangular
hyperbola. When price is OP, the quantity demanded is OQ\. Now price falls to OP1 the quantity
demanded increases to OQ2. The area OQ\RP = area OP\SQ2 in the fig. denotes that in all cases price
elasticity of demand is equal to one.

4. Relatively Elastic Demand:

Relatively elastic demand refers to a situation in which a small change in price leads to a big change in
quantity demanded. In such a case elasticity of demand is said to be more than one (ed > 1). This has been
shown in figure 4.

Relatively Elastic Demand

In fig. 4, DD is the demand curve which indicates that when price is OP the quantity demanded is OQ1.
Now the price falls from OP to OP1, the quantity demanded increases from OQ1 to OQ2 i.e. quantity
demanded changes more than change in price.’

5. Relatively Inelastic Demand:

Under the relatively inelastic demand, a given percentage change in price produces a relatively less
percentage change in quantity demanded. In such a case elasticity of demand is said to be less than one (ed
< 1). It has been shown in figure 5.

Relatively Inelastic Demand

All the five degrees of elasticity of demand have been shown in figure 6. On OX axis, quantity demanded
and on OY axis price is given.

It shows:

1. AB — Perfectly Inelastic Demand

2. CD — Perfectly Elastic Demand

3. EG — Less than Unitary Elastic Demand

4. EF — Greater Than Unitary Elastic Demand

5. MN — Unitary Elastic Demand

NUMERICALS FOR PRACTICE: ELASTICITY OF DEMAND

Q1) For a particulate product, price was reduced from Rs 50 per unit to Rs 48 in order to attract more
customers. It was observed that demand for the product subsequently increased from 100 to 110 units.
Calculate the price elasticity of demand.

Q2) The price of a product falls from Rs 10 to Rs 8. As a result, the quantity demanded increases from 50
units to 60 units. Calculate the price elasticity of demand (PED).

Q3) A price increase from Rs 5 to Rs 6 leads to a decrease in the quantity demanded from 200 units to 150
units. Find the price elasticity of demand (PED).

Q4) A company increases the price of a product from Rs 25 to Rs 30. The quantity demanded decreases
from 100 units to 80 units. Find the price elasticity of demand (PED).

Q5) The price of a product decreases from Rs 15 to Rs 10, and as a result, the quantity demanded increases
from 50 units to 75 units. Calculate the price elasticity of demand (PED).

Demand Forecasting

Demand forecasting seeks to investigate and measure the forces that determine sales for existing
and new products. Generally, companies plan their business – production or sales in anticipation
of future demand. Hence forecasting future demand becomes important. In fact, it is the very soul
of good business because every business decision is based on some assumptions about the future
whether right or wrong, implicit or explicit. The art of successful business lies in avoiding or
minimizing the risks involved as far as possible and face the uncertainties in a most befitting
manner. Thus, Demand Forecasting refers to an estimation of most likely future demand for
a product under given conditions.

Levels of Demand Forecasting

Demand forecasting may be undertaken at three different levels, viz., micro level or firm level,
industry level and macro level.
Micro level or firm level
This refers to the demand forecasting by the firm for its product. The management of a firm is
really interested in such forecasting. Generally speaking, demand forecasting refers to the
forecasting of demand of a firm.
Industry level
Demand forecasting for the product of an industry as a whole is generally undertaken by the
trade associations and the results are made available to the members. A member firm by using
such data and information may determine its market share.
Macro-level
Estimating industry demand for the economy as a whole will be based on macro-economic
variables like national income, national expenditure, consumption function, index of industrial
production, aggregate demand, aggregate supply etc, Generally, it is undertaken by national
institutes, govt. agencies etc. Such forecasts are helpful to the Government in determining the
volume of exports and imports, control of prices etc.

Methods or Techniques of Forecasting

Demand forecasting is a highly complicated process as it deals with the estimation of future
demand. It requires the assistance and opinion of experts in the field of sales management. While
estimating future demand, one should not give too much of importance to either statistical
information, past data or experience, intelligence and judgment of the experts. Demand
forecasting, to become more realistic should consider the two aspects in a balanced manner.
Application of commonsense is needed to follow a pragmatic approach in demand forecasting.
Broadly speaking, there are two methods of demand forecasting. They are:
1.Survey methods and
2. Statistical methods.
 SUPPLY
Supply of a commodity is the quantity of the commodity that a seller offers
for sale at a given price at a given time.
The definition of supply includes the following three things:
1. The quantity of a commodity offered for sale by a seller.
2. The price of the commodity given in the market at which the seller is willing to
sell that quantity of the commodity.
3. The time period during which the seller is willing to sell that quantity of the
commodity.

Examples of Supply
Ganga Singh sold 120 litres of milk at a price of Rs.25 per litre during last week
from his dairy farm.
The fruit seller sold 600 Kg of apples during past 15 days at Rs. 50 per Kg
of apple.

SUPPLY FUNCTION
When the relationship between quantity supplied and the determinants of supplied is expressed
mathematically in an equation, it is called a supply function. So, a supply function can be expressed as:
Sn = f (Pn, Pr, Pf, T, Tr, G)
where Sn = Supply of commodity
Pn = Price of the commodity
Pr = Price of other related goods
Pf = Price of inputs/factors
T = Technology of production
Tr = Government policy or tax rate
G = Goal or objective of the producer.
Typically supply function shows the relationship between price and quantity supplied, keeping all other
determinants of supply as constant. It shows the amount of a good that a seller supplies at different
levels of price. For example, a supply function can be
qs = –15 + 3P
FACTORS AFFECTING INDIVIDUAL SUPPLY

The most important factors are the following: Price of the commodity Technology of production Price of
inputs Price of other related goods Objective of the firm Government policy.
(i) Price of the commodity: Price of the commodity is an important determinant of supply of a
commodity. When a producer produces a commodity, he incurs a lot of expenditure on factors of
production and raw materials etc. which we call cost of production. He can recover these costs by selling
the product at certain price in the market. Since price is also the average revenue, higher the price higher
will be the average revenue and accordingly higher will be total revenue. So, price is a very important
determinant of supply.
(ii) Technology of production: An improvement in technology of production reduces the cost of
production per unit of the commodity which increases the margin of profit of the firm. This induces the
firm to supply more of the commodity with the use of improved technology on the other hand if a firm
uses old and inferior technology; it increases the cost of production per unit of the commodity and
reduces the margin of profit which leads to decrease in supply of the commodity.
(iii) Price of inputs: Suppose a firm is producing ice cream. If the price of milk falls, the cost of
production per unit of ice creams will fall. It will lead to increase in margin of profit per unit. So, the firm
will increase the supply of ice cream. On the other hand, if the price of milk increases, cost of production
per unit of ice cream will increase. It will lead to decrease in margin of profit and firm will decrease the
supply of ice cream. Thus, if price of any input used in production of a commodity falls, it leads to
decrease in cost of the production per unit and as a result supply of the commodity will increase. On the
other hand, an increase in price of any input used in production of a commodity increases cost of
production per unit and decreases supply of the commodity.
(iv) Price of other related goods: Supply of a commodity is also influenced by the price of other related
goods. Let us suppose that a farmer produces two goods wheat and rice with the help of given resources. If
the price of rice increases, it will be more profitable for the farmer to produce more of rice. The farmer will
divert his resources from production of wheat to production of rice. As a result, the supply of rice will
increase and that of wheat will decrease. On the other hand, a fall in price of rice will result in decrease in
supply of rice and an increase in supply of wheat.
(v) Objective of the firm: Different firms have different objectives. Some firms have an objective to
maximize their profits whereas some may have an objective of maximizing sales. Some other firms may
have an objective to increase their goodwill/prestige and some may have an objective of increasing
employment opportunities. A firm having an objective of increasing sales may supply more of a
commodity even at a lower price. Thus, supply of a commodity is influenced by the priority given to the
objective by the firm and readiness to sacrifice the one for the other.
(vi) Government policy: Government policy also influences the supply of a commodity. For example, if
the government increases the rate of value added tax or sales tax on a commodity, it will increase the cost
of production per unit which will decrease the supply of the commodity. On the other hand, a reduction in
the tax on a commodity will decrease cost of production per unit and increase the supply of the
commodity.

LAW OF SUPPLY
The law of supply depicts the relationship between price and quantity supplied of a commodity when all
other determinants of supply remain constant. This law states that there is a direct relationship between
price and quantity supplied of a commodity, other factors determining supply remaining constant. It
means quantity supplied of a commodity increases with increase in price and decreases with decrease in
price.

Assumptions of the law of supply

(i) Price of other related goods should remain the same
(ii) There should be no change in the price of inputs (factors)
(iii) Technology of production should not change.
(iv) There is no change in the taxation policy of the government.
(v) Objective of the firm should not change.
The law of supply is based on the assumptions that the supply of commodity changes only due to change
in price when all other determinant of supply remains constant.

Individual and Market Supply

Individual Supply
Individual supply refers to the quantity of a commodity which an individual firm is willing to sell at a given
price during a given period of time. It is related with the supply of an individual firm.
Market Supply
Market supply is the collective supply of all the firms in the market of a commodity at a given price
during a given period of time. Market supply tells us the told availability of a commodity which can be
used to meet the total element of the commodity. Market supply can be desired by summing up the
supply of all the individual firms in the market.
Supply Schedule
Supply schedule is a table showing different quantities of a commodity that a firm is willing to sell at
different prices during a given period of time. Supply schedule can be of two types.
(i) Individual supply schedule: When we represent a single firm, willingness to sell different quantities of
a commodity at different prices during a given time period, we get individual supply schedule.
(ii) Market supply schedule: Market supply schedule is constructed by summing up the supplies of all
the individual firm at different prices during a given period of time. A market supply schedule is a table
showing the total supply of a good by all the firms at different price during a given time period. Market
supply schedule can be explained with the help of the following table.

Supply Curve
Supply curve is the graphical presentation of a supply schedule. It shows the quantity that all the firms in
the market are willing to supply at a given price during a given time period when all other factors
influencing supply remain constant. Supply curve is also of two types.
(i) Individual supply curve: Graphical presentation of individual supply schedule is called individual supply
curve. It shows the different quantities of a commodity; an individual firm is willing to sell at different
prices during a given time period.
(ii) Market supply curve: Market supply can be derived by horizontal summation of all individual supply
curve: It show the different quantities of a commodity that all the firms are willing to sell at different
prices during a given time period.