1. Economics for Engineers ECO310

2. LEARNING OBJECTIVES
To understand the relevance of economics for engineers
To understand the concept of demand, suply and the market equilibrium.
To discuss various types of elasticities of demand.
To learn how to measure elasticity by various methods.
To understand the relevance and application of elasticities of demand.

3. Engineering Economics
Application of economic techniques for evaluating the engineering design and project alternatives.
Concept of Efficiency
Economic Efficiency
Static Efficiency
Allocative efficiency
Productive Efficiency

4. Demand and Supply Analysis

5. Demand Demand: effective desire
Demand is that desire which backed by willingness and ability to buy a particular commodity.
Amount of the commodity which consumers are willing to buy per unit of time, at that price.
Things necessary for demand:
Time
Price of the commodity
Amount (or quantity) of the commodity consumers are willing to purchase at the price

6. Types of Demand
Direct and Derived Demand
Direct demand is for the goods as they are such as Consumer goods
Derived demand is for the goods which are demanded to produce some other commodities; e.g. Capital goods
Recurring and Replacement Demand
Recurring demand is for goods which are consumed at frequent intervals such as food items, clothes.
Durables are purchased to be used for a long period of time
Wear and tear over time needs replacement

7. Complementary and Competing Demand
Some goods are jointly demanded hence are complementary in nature, e.g. software and hardware, car and petrol.
Some goods compete with each other for demand because they are substitutes to each other, e.g. soft drinks and juices.

8. Determinants of Demand
Price of the product
Single most important determinant
Negative effect on demand
Higher the price-lower the demand
Income of the consumer
Normal goods: demand increases with increase in consumer’s income
Inferior goods: demand falls as income rises
Price of related goods
Substitutes
If the price of a commodity increases, demand for its substitute rises.
Complements
If the price of a commodity increases, quantity demanded of its complement falls.
an inferior good is a good that decreases in demand when consumer income rises 

9. Determinants of Demand
Contd…
Tastes and preferences
Very significant in case of consumer goods
Expectation of future price changes
Gives rise to tendency of hoarding of durable goods
Population
Size, composition and distribution of population will influence demand
Advertising
Very important in case of competitive markets

10. Demand Function
Interdependence between demand for a product and its determinants can be shown in a mathematical functional form
Dx = f(Px, Y, Py, T, A, N)
Independent variables: Px, Y, Py, T, A, N
Dependent variable: Dx
Px: Price of x
Y: Income of consumer
Py: Price of other commodity
T: Taste and preference of consumer
A: Advertisement
N: Macro variable like inflation, population growth, economic growth

11. Law of Demand
A special case of demand function which shows relation between price and demand of the commodity
Dx = f(Px)
Other things remaining constant, when the price of a commodity rises, the demand for that commodity falls or when the price of a commodity falls, the demand for that commodity rises.
Price bears a negative relationship with demand

12. Demand Schedule and Individual Demand Curve10 20 30 15 35 50 40 25
Quantity of coffee
Price of Coffee O
Point on Demand Curve
Price (Rs per cup)
Demand (‘000 cups) a 15 50 b 20 40 c 25 30 d e 35 10 e d c b a

13. Exceptions to the Law of Demand
Law of demand may not operate due to the following reasons:
Giffen Goods
Snob Appeal /Prestigious goods
Demonstration Effect
Future Expectation of Prices(Panic buying)
Addiction
Neutral goods
Life saving drugs
Salt
Amount of income spent
Match box

14. Market Demand
Market: interaction between sellers and buyers of a good (or service) at a mutually agreed upon price.
Market demand
Aggregate of individual demands for a commodity at a particular price per unit of time.
Sum total of the quantities of a commodity that all buyers in the market are willing to buy at a given price and at a particular point of time (ceteris paribus)
Market demand curve: horizontal summation of individual demand curves

15. Supply Price of the product (Px)
Indicates the quantities of a good or service that the seller is willing and able to provide at a price, at a given point of time, other things remaining the same.
Supply of a product X (Sx) depends upon:
Price of the product (Px)
Cost of production (C) [Price of Factors of Production]
State of technology (T)
Government policy regarding taxes and subsidies (G)
Number of firms (N)
Hence the supply function is given as:
Sx = (Px, C, T, G, N)

16. Supply (‘000 cups per month)
Law of Supply
Law of Supply states that other things remaining the same, the higher the price of a commodity the greater is the quantity supplied.
Price of the product is revenue to the supplier; therefore higher price means greater revenue to the supplier and hence greater is the incentive to supply.
Supply bears a positive relation to the price of the commodity.
Supply Schedule
Supply Curve 30 10 20 60 50 40 15 35 25
Price of Coffee
Quantity of Coffee
Point on Supply Curve
Price (Rs. Per cup)
Supply (‘000 cups per month) a 15 10 b 20 c 25 30 d 45 e 35 60 e d c b a

17. Change in Supply Shift in the supply curve from S0 to S1
More is supplied at each price (Q1>Q0)
Increase in supply caused by:
Improvements in the technology
Fall in the price of inputs
Shift in the supply curve from S0 to S2
Less is supplied at each price (Q2<Q0)
Decrease in supply caused by:
A rise in the price of inputs
Change in government policy (VAT) S0
Price
Quantity O S2 S1 P Q0 Q2 Q1

18. Market Equilibrium
Equilibrium occurs at the price where the quantity demanded and the quantity supplied are equal to each other.
At point E demand is equal to supply hence 25 is equilibrium price
Quantity
Price O
Price
(Rs)
Supply
(‘000 cups/ month)
Demand (‘000 cups/ month) 15 10 50 20 40 25 30 45 35 70 D S 25 E 30

19. Market Equilibrium
For prices below the equilibrium, Quantity demanded exceeds quantity supplied (D>S) (Shortage).
Price pulled upward
For prices above the equilibrium, Quantity demanded is less than quantity supplied (D<S) (Excess).
Price pulled downward.
At point E demand is equal to supply hence 25 is equilibrium price. D S
Quantity
Price O
Price
(Rs)
Supply
(‘000 cups/ month)
Demand (‘000 cups/ month) 15 10 50 20 40 25 30 45 35 70 30 25 E 30 20

20. Changes in Market Equilibrium
(Shifts in Supply Curve)
The original point of equilibrium is at E, the point of intersection of curves D1 and S1, at price P and quantity Q
An increase in supply shifts the supply curve to S2
Price falls to P2 and quantity rises to Q2, taking the new equilibrium to E2
A decrease in supply shifts the supply curve to S0. Price rises to P0 and quantity falls to Q0 taking the new equilibrium to E0
Thus an increase in supply raises quantity but lowers price, while a decrease in supply lowers quantity but raises price; demand being unchanged Q P E D1 S1
Price
Quantity O E0 P0 Q0 S0 S2 Q2 P2 E2

21. Changes in Market Equilibrium
(Shifts in Demand Curve)
The original point of equilibrium is at E, the point of intersection of curves D1 and S1, at price P and quantity Q
An increase in demand shifts the demand curve to D2
Price rises to P1 and quantity rises to Q1 taking the new equilibrium to E1
A decrease in demand shifts the demand curve to D0
Price falls to P* and quantity falls to Q* taking the new equilibrium to E2.
Thus, an increase in demand raises both price and quantity, while a decrease in demand lowers both price and quantity; when supply remains same. D1 S1
Price
Quantity O E P Q D2 D0 Q1 P1 E1 Q* P* E2

22. Change in Both Demand and Supply
Initial equilibrium is at E1, with price quantity combination (P1, Q1).
An increase in both demand and supply takes place;
demand curve shifts to the right from D1 D1 to D2 D2
supply curve also shifts to the right from S1 S1 to S2 S2.
The new equilibrium is at E2, and price quantity is (P2, Q2).
An increase in both supply and demand will cause the sales to rise, but
the price will increase if increase in D>S (as at E2 )
No change in price if increase in D=increase in S (as at E0 ) D2
Quantity
Price O D2 D1 S1 S2 P2 Q2 E2 P1 E1 E0 Q1

23. l

24. If the market demand curve is given by D=15-8P and the market supply S=2P, find the equilibrium price and quantity mathematically.
Given the following demand and supply functions, find the equilibrium price and quantity in the market. Demand=100-P & S=10+2P

25. There are 1000 identical individuals in the market for commodity x given by Qd= P, ceteris paribus and 100 identical producers of commodity X with a function given by Qs=2000P
Find the equilibrium price and quantity
If there is increase in consumer’s income, Qd= P, Find the new equilibrium price and quantity
Suppose there is improvement in the technology of producing commodity and the new market function is Qs= P. Derive the new equilibrium price and quantity.

26. Consumer Surplus – When Price that the consumer actually pays is less than the Price that the consumer is ready to pay.
Producer Surplus – When the price that the producer receives in the market is more than the minimum they would be prepared to supply for.

27. Elasticity of Demand
“Elasticity” is a standard measure of the degree of responsiveness (or sensitivity) of one variable to changes in another variable.
Elasticity of Demand measures the degree of responsiveness of demand for a commodity to a given change in any of the independent variables that influence demand for that commodity, such as price of the commodity, price of the other commodities, income, taste, preferences of the consumer and other factors.
Responsiveness implies the proportion by which the quantity demanded of a commodity changes, in response to a given change in any of its determinants .

28. Elasticity of Demand
Mathematically, it is the percentage change in quantity demanded of a commodity to a percentage change in any of the (independent) variables that determine demand for the commodity.
Three major types of elasticity:
Price elasticity,
Income elasticity,
Cross elasticity
In order to assess the impact of one variable on demand, we assume other variables as constant

29. Price Elasticity of Demand
Price is most important among all the independent variables that affect the demand for any commodity
Hence price elasticity of demand ( “ep” or “e”) is considered to be the most important of all types of elasticity of demand.
Price elasticity of demand means the sensitivity of quantity demanded of a commodity to a given change in its own price.

30. Formula Price Elasticity of Demand
Percentage change in Quantity demanded/Percentage change in Price

31. Degrees of Price Elasticity
Slope of demand curve is used to display price elasticity of demand
Perfectly elastic demand
ep=∞ (in absolute terms).
Horizontal demand curve
Unlimited quantities of the commodity can be sold at the prevailing price
Perfectly inelastic demand
ep=0 (in absolute terms)
Vertical demand curve
Quantity demanded of a commodity remains the same, irrespective of any change in the price
Such goods are termed neutral.
Price
Quantity O P D Q1 Q2 D Q1
Price
Quantity O
Perfectly Inelastic – Insulin fir a diabetic person, Food for a starving man. P1 P2

32. Degrees of Price Elasticity
Contd.
Highly elastic demand (Or Elastic)
Proportionate change in quantity demanded is more than a given change in price
ep >1 (in absolute terms)
Demand curve is flatter
Unitary elastic demand
Proportionate change in price brings about an equal proportionate change in quantity demanded
ep =1 (in absolute terms).
Demand curves are shaped like a rectangular hyperbola, asymptotic to the axes
Relatively inelastic demand (Or Inelastic)
Proportionate change in quantity demanded is less than a proportionate change in price
ep <1 (in absolute terms)
Demand curve is steep
Price
Quantity O D Q1 P1 Q2 P2
Price
Quantity O D Q1 P1 Q2 P2
Price
Quantity O D Q1 P1 Q2 P2

33. Numerical
In india, when the petrol price increases from Rs 54 per litre to Rs.63 per litre, Rahul decreases petrol consumption from 25 litre to 24 litre per month. Find the price elasticity of demand of petrol.

34. Ans:
e= , So it is < 1, demand is relatively inelastic.
Don’t consider negative sign as it only shows the relationship of price and demand is less than 1 that’s why demand is relatively inelastic.

35. The demand for apples in a small town was 200 kg when the price was Rs
The demand for apples in a small town was 200 kg when the price was Rs. 20 per Kg. It expanded to 250 Kg when the price was reduced to Rs. 18 Per kg. What is the elasticity of demand for apples in the town.

36. Ans:
e= -2.5, Ignore – sign. So, 2.5 is > 1, so demand is Highly elastic

37. Factors Influencing Elasticity of Demand
Nature of commodity
Availability of substitutes
Number of uses
Proportion of expenditure (Income spent)
Durability of the commodity
Habit
Time
Possibility of postponement

38. Determinants of Price Elasticity of Demand
Nature of commodity
Necessities are relatively price inelastic, while luxuries are relatively price elastic
Availability and proximity of substitutes
Price elasticity of demand of a brand of a product would be quite high, given availability of other substitute brands
Alternative uses of the commodity
If a commodity can be put to more than one use, it would be relatively price elastic

39. Proportion of income spent on the commodity
Contd…
Proportion of income spent on the commodity
The greater the proportion of income spent on a commodity, the more sensitive would the commodity be to price
Reason is income effect
Time
Demand for any commodity is more price elastic in the long run
Durability of the commodity
Perishable commodities like eatables are relatively price inelastic in comparison to durable items
Items of addiction
Items of intoxication and addiction are relatively price inelastic

40. Income Elasticity of Demand (ey)
ey measures the degree of responsiveness of demand for a good to a given change in income, ceteris paribus.
Types:
Positive income elasticity
Demand rises as income rises and vice versa
Normal good
Negative income elasticity
Demand falls as income rises and vice versa
Inferior good
Zero Income Elasticity
Neutral goods

41. Positive Income Elasticity
Income Elasticity >1 then Good is luxury Good and Income Elastic.
Income Elasticity<1 (Between 0 and 1), then Good is normal Good and Income-inelastic.

42. Numerical
Following pay revision, Mr. Sharma’s monthly income increases from Rs to Rs 60,000. Consequently, his demand for an item increases from 150 to 180. Find the income elasticity of demand.

43. Ans: e= 0.142

44. Cross Elasticity of Demand
ec measures the responsiveness of demand of one good to changes in the price of a related good
Degrees
Negative Cross Elasticity
Complementary goods
Positive Cross Elasticity
Substitute goods
Zero Cross Elasticity
Unrelated goods

45. Consider two goods X and Y
Consider two goods X and Y. There was no change in price of X but its demand decreased from 6000 units to 5500 units. On analysis, it was found that price of another commodity Y has increased from 225to 250. Find out the cross elasticity between X and Y and the relationship between the two goods.

46. Ans: e= -7.5, as e is -, so X and Y are complements

47. Importance of Elasticity
Determination of price
Elasticity is the basis of determining the price of a product keeping its possible effects on the demand of the product in perspective
Basis of price discrimination
Products having elastic demand may be sold at lower price, while those having inelastic demand may be sold at high prices
Determination of rewards of factors of production
Factors having inelastic demand are rewarded more than factors that have relatively elastic demand.
Government policies of taxation
Goods having relatively elastic demand are taxed less than those having relatively inelastic demand.
This slide also has an automatic response with ten second gaps in between each point. At this stage we have tried to keep things as simple as possible but to introduce issues that will be dealt with later in the course.

48. Consumer's Equilibrium Through Indifference Curve Analysis:
Definition:
"The term consumer’s equilibrium refers to the amount of goods and services which the consumer may buy in the market given his income and given prices of goods in the market".
The aim of the consumer is to get maximum satisfaction from his money income. Given the price line or budget line and the indifference map:

49. Indifference Curve
Indifference Curve Analysis (J.R. Hicks and R.G.D. Allen )
Indifference curve: Locus of points which show the different combinations of two commodities among which the consumer is indifferent, i.e. derives same utility.
Since all these points render equal utility to the consumer, an indifference curve is also known as an isoutility (“iso” meaning equal) curve.
Indifference map: group of indifference curves

50. Combination
Commodity X
Commodity Y
Utility a 25 5 U b 15 7 c 10 12 d 6 20

51. Properties of Indifference Curves
Indifference curves are downward sloping. (negatively sloped)
Higher indifference curve represents higher utility.
Indifference curves can never intersect.
Indifference curves are convex to the origin.
Indifference curve do not touch the horizontal or vertical axis. X Y O
Good X
Good Y
IC2
IC1 A B C D

52. BUDGET LINE
The budget line is the locus of combinations of two goods that an individual can afford to buy with his/her income.
Sifts in Budget Line
When prices of both products are constant but there is change in the income of the customer.
When income of the customer and price of one product is constant.

53. Revision
1. If the price of milk increases, what do you think will happen to the demand for cornflakes? 2. Suppose the technology to manufacture computers improves but due to some recession in the economy, the income of the consumers falls. Assuming the computers to be normal goods, what will be the equilibrium quantity and price for computers in this case.