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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.



Application of economic techniques for
evaluating the engineering design and
project alternatives.
Concept of Efficiency
 Economic Efficiency
 Static Efficiency
▪ Allocative efficiency
▪ Productive Efficiency
Demand and Supply
Analysis
 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
 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
 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.
 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.
 Tastes and preferences
Contd…
 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
 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
 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
Demand Schedule and Individual
Demand Curve
Point
on
Demand
Curve
Price (Rs
per cup)
Demand
(‘000
cups)
a
15
50
b
20
40
25
c
25
30
20
d
30
20
e
35
10
e
35
d
30
c
b
a
15
O
10
20
40 50
30
Quantity of coffee
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
 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


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:
 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
Point on
Supply
Curve
a
b
c
d
e
Price (Rs.
Per cup)
15
20
25
30
35
Supply (‘000
cups per
month)
10
20
30
45
60
Supply Curve
35
e
30
25
c
20
b
15
0
d
a
10
20
30 40 50 60
Quantity of Coffee
Change in Supply
Price
S2
S0
S1
P
O
Q2
Q0
Q1
Quantity
 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)
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
Price
S
E
25
D
O
30
Quantity
Demand
(‘000 cups/
month)
Price
(Rs)
Supply
(‘000 cups/
month)
15
10
50
20
15
40
25
30
30
30
45
15
35
70
10
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.
Price
Price
(Rs)
Supply
(‘000 cups/
month)
Demand
(‘000 cups/
month)
15
10
50
20
15
40
25
30
30
30
45
15
35
70
10
S
30
E
25
20
D
O
30
Quantity
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
Price
S0
S1
D1
S2
E0
P0
E
P
P2
S0
E2
S1
S2
O
D1
Q0 Q Q2
Quantity
Changes in Market Equilibrium
(Shifts in Demand Curve)
Price
D2
S1
D1
D0
E
P
P*
E2
D2
S1
O
D0
Q* Q
Q1
▪ 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
E1
P1
 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
D1
Quantity
▪ 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.


Price
D2
D2
D1
S1
S2
P2
P1
E1
S1
O
S2
E0
E2

D1
Q1
Q2
D2
D2
Quantity
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 )


If the market demand curve is given by D=158P 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

There are 1000 identical individuals in the market for
commodity x given by Qd=12000-2000P, 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=140002000P, Find the new equilibrium price and quantity
 Suppose there is improvement in the technology of
producing commodity and the new market function is
Qs=4000+2000P. Derive the new equilibrium price
and quantity.


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.

“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 .

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
 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.

Price Elasticity of Demand

Percentage change in Quantity demanded/Percentage change in Price
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
P
D
O
Q1
Q2
Quantity
D
Price
P1
P2
O
Q1
Quantity
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
Contd
.
D
P1
P2
D
O
Price
Q1
D
Q
2
Quantity
P1
P2
D
O
Q1 Q2
Quantity
Price
D
P1
P2
O
D
Q1Q2
Quantity
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.
Ans:
e= - 0.24, So it is < 1, demand is relatively inelastic.
Don’t consider negative sign as it only shows the
relationship of price and demand. 0.24 is less than 1
that’s why demand is relatively inelastic.
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.
Ans:
e= -2.5, Ignore – sign. So, 2.5 is > 1, so demand
is Highly elastic








Nature of commodity
Availability of substitutes
Number of uses
Proportion of expenditure (Income spent)
Durability of the commodity
Habit
Time
Possibility of postponement
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
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
 ey measures the degree of responsiveness of demand for a good to
a given change in income, ceteris paribus.
ey =
 Types:
Proportion ate change in quantity demanded of commodity X
Proportion ate change in income of consumer
 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


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.
Following pay revision, Mr. Sharma’s monthly
income increases from Rs. 25000 to Rs
60,000. Consequently, his demand for an
item increases from 150 to 180. Find the
income elasticity of demand.

Ans: e= 0.142

ec measures the responsiveness of demand of one
good to changes in the price of a related good
ec =

Proportion ate change in quantity demanded of commodity X
Proportion ate change in price of commodity Y
Degrees
 Negative Cross Elasticity
▪ Complementary goods
 Positive Cross Elasticity
▪ Substitute goods
 Zero Cross Elasticity
▪ Unrelated goods
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.

Ans: e= -7.5, as e is -, so X and Y are
complements

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.
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:

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
Combination
Commodity X
Commodity Y
Utility
a
25
5
U
b
15
7
U
c
10
12
U
d
6
20
U




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.
Y
A
Good Y

B
C
D
IC
1
O
Good X
IC
2
X


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.
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.