ECONOMICS-1

Course outline
introduction to economics

 micro economics

 Economics macro economics


 public finance

 international trade
 Essential readings-
  Economics, Paul A. Samuelson & William D. Nordhaus, Tata McGraw Hill
 Principles of Economics, Gregory N. Mankiw, South-Western College Pub
 Public Finance in Theory and Practice, R. A. Musgrave and P. B. Musgrave, McGraw-Hill College
 International Economics, Bo Sodersten and Geoffrey Read, London: Macmillan
 Economic Times
 Economic & political weekly (magazine)
 Additional Readings-
 Positive Economics, Richard G. Lipsey & K. Alec Chrystal, Oxford University Press
 A Text Book of Economic Theory, 5th.edition, W. Stonier and D.C. Hague, Longman Higher Education
 Modern Micro Economics, A. Koutsoyiannis, Princeton University Press
 Macro Economics, E. Shapiro, Harcourt Brace Jovanovich
 Macroeconomics, Rangarajan, C, Tata-McGraw Hill
Unit UNIT 1 No. of Hours
Topic: Introduction to Economics

1.1 Introduction, Nature and Scope of Economics: Basic Concepts of Economics, Micro and 4
Macro Economics, Static and Dynamic and Comparative Analysis, Positive and Normative
Economics, Opportunity Cost

1.2 Demand-Supply analysis and its applications 2

1.3 Economics and Law 1
  UNIT 2  
Topic: Micro Economics
2.1 Theory of Demand: Cardinal and Ordinal Utility; Law of Diminishing Marginal Utility, Law 5
of Equi-marginal principle, Indifference Curve analysis and its applications, Elasticity-
demand and supply. Consumer’s Surplus,

2.2 Theory of Production: Production Function and Factors of Production, Law of Variable 3
Proportions, Returns to Scale

2.3 Theory of cost: Cost curves and function, Revenue, and Profit Functions, and Profit 3
Maximization.
2.4 Markets and Price Determination in different markets: 10
Perfect and Imperfect Competition, Monopoly and its regulation, Monopolistic
competition, and Oligopoly
  UNIT 3  
Topic: Macro Economics
3.1 National Income— Concepts and Measurement, Uses 1
3.2 Theories of Consumption, Theories of Investment, Theories of Employment 5

3.3 Meaning and Value of Money- Fisher’s Quantity theory of Money 2

3.4 Monetary Policy, Role of Reserve Bank of India (RBI) 2

  UNIT 4  
Topic: Public Finance
4.1 Taxation: Cannons and its Objectives, Direct and Indirect Taxes 3
4.2 Taxation in Developed Countries and Developing Countries 3
4.3 Public Expenditure: Nature and Importance 2
4.4 Public Debt: Nature, Objective and Management 2
4.5 Fiscal policy 1
  UNIT 5  
Topic: International Economics
5.1 Classical and Modern Theories of International Trade 3
5.2 Balance of Payments: Meaning and Its Importance, Equilibrium and Disequilibrium in The 2
BOP
5.3 Exchange Rate Regimes- Fixed Vs Flexible 1
5.4 International Financial Institutions-IMF,IBRD, and WTO 3
5.5 Foreign Direct Investment (FDI), Foreign Debt Burden, Foreign Trade Policy 2
Top 10 Reasons for studying Economics
1. Economic Forecaster

2. You can always give advice

3. Diminishing Returns

4. Rational Behaviour

5. Economics is a very humorous subject

6. Economics gets you a high paid job

7. Economies of Scale

8. However - On the Other Hand contradicting yourself

9. You will Know Why you are Unemployed

10. You can apply it to understand issues related to economics as well as other issues related to other fields of
knowledge
 WHY STUDY ECONOMICS?
 Economics is the study of how societies, governments, businesses, households, and individuals
allocate their scarce resources.
 Economics has two important features–
 1. Develops conceptual models of behavior to predict responses to changes in policy and
market conditions.
 2. Uses rigorous statistical analysis to investigate the changes.
 Economists are well known for advising the government on economic issues, formulating
policies at the Federal Reserve Bank, and analyzing economic conditions for investment banks,
brokerage houses, real estate companies, and other private sector businesses.
 They also contribute to the development of many other public policies including health care,
welfare, and school reform and efforts to reduce inequality, pollution and crime.
 Contd…
 The study of economics can also provide valuable knowledge for making decisions in everyday life.
 It offers a tool with which to approach questions about the desirability of a particular financial investment
opportunity, whether or not to attend college or graduate school, the benefits and costs of alternative careers, and
the likely impacts of public policies including universal health care and a higher minimum wage.
 The complementary study of econometrics, the primary quantitative method used in the discipline, enables
students to become critical consumers of statistically based arguments about numerous public and private issues
rather than passive recipients unable to sift through the statistics.
 Such knowledge enables us to ask whether the evidence on the desirability of a particular policy, medical
procedure, claims about the likely future path of the economy, or many other issues is really compelling or
whether it simply sounds good but falls apart upon closer inspection.
 Economics in study of Law
 Interest has grown recently in the combined study often known as “law and economics”, for which
the economic analysis of law is really a better description.
 Anyone with an interest in the institutional framework, i.e., the “rules of the game”, governing economic
activity, will find the economics of law useful in understanding how laws affect human incentives.
 The economics of law may be defined as the application of economic principles to legal instruments,
questions, and procedures.
 It has many practical applications, such as helping with the drafting of laws, or in assessing the amount of
damages required to return a person to the level of welfare enjoyed before an accident occurred.
 Legal instruments are devices like damages for breach of contract that feature regularly in the legal system and
have implications for economic incentives.
 Legal questions, such as whether it would be appropriate to award damages for the interruption to production
following an oil spill from a tanker, are also amenable to economic analysis.
 Legal procedures may also interact with economic incentives: for example when lawyers work for contingent
fees on a “no-win, no-fee” basis.
 Questions to be answered set-1
 What is Economics?
 What is the definition of Economics?
 What is the meaning of Economics?
 Why to study Economics? Or what is the importance of Economics?
 What is/are the methodology to study Economics?
 What are the branches of Economics?
 What is the nature of Economics?
 What is the scope of economics?
 What is/are the economic problem/s?
 What is the relationship/role of other field of knowledge/Subjects in Economics?
 What is the relationship/role of Economics in other field of knowledge/Subjects in general and
Law in particular?
Questions to be answered, set-2
 What is rationality?
 How rationality effects the system/economic system?
 What is rational choice?
 What is the difference between economics and economy?
 what are the basic problems of economics?
 What is resource?
 What is scarcity? What is trade-off?
 What is want/s and need/s?
 What is/are economic forces?
 What is economic analysis?
 What is opportunity cost? Its applications?
 Questions set-3
 What/ Who is/are economic agent/s?
 Why the economic agents?
 What is the need/role/importance of economic agent?
 Do the economic agents make decisions?
 How they make decision?
 Do the decision making depends on rationality? How?
 Dothe decisions are based on any- of the following?
basis/criteria/principles/parameters/standards etc.? What are these?
 What is cost-benefit analysis? Its applications?
 Do the decisions are also based on law?
 How law effects the decision making and vice-versa?
 Questions, set-4
 What is demand?
 What is the definition of demand?
 What is the meaning of demand?
 What are the factors effecting the demand “or” demand depends on which factors “or” determinants of
demand?
 What is demand function (general and specific), equation?
 What is demand schedule?
 What is demand curve?
 What is the law of demand?
 What is the need/role/importance of demand?
 What is role of law/s(statutory) in relation to demand?
 Do the demand of any good or service has/ve effect on the law/s(statutory)?
 Can the demand be created or generated?
 Can the demand be suppressed?
 Questions, set-5
 What is supply?
 What is the definition of supply?
 What is the meaning of supply?
 What are the factors effecting the supply “or” supply depends on which factors “or” determinants of
supply?
 What is supply function (general and specific), equation?
 What is supply schedule?
 What is supply curve?
 What is the law of supply?
 What is the need/role/importance of supply?
 What is role of law/s(statutory) in relation to supply?
 Do the supply of any good or service has/ve effect on the law/s(statutory)?
 Can the supply be created or generated?
 Can the supply be suppressed?
 Questions, set-6
 What is demand-supply analysis?
 Why to study demand-supply analysis?
 Who do the demand-supply analysis?
 Where to apply demand-supply analysis?
 When to do demand-supply analysis?
 How to do demand-supply analysis?
 Can the demand-supply analysis help us to understand the law(statutory)?
 What is the role of demand-supply analysis in real life?
 What is the methodology of demand-supply analysis?
 What are the applications of demand-supply analysis in economics and in law(statutory)?
 Questions, set-7
 What is elasticity?
 What is the definition of elasticity?
 What is the meaning of elasticity?
 What are the types of elasticity?
 What are the advantages and disadvantages of elasticity?
 What are the applications of elasticity in economics?
 Can the elasticity be applied in the study of law(statutory)?
 What is the role of elasticity in making policy by the government or a private entity?
 How elasticity helps in understanding different activities in economics and in the
law(statutory)?
 Economics DEMAND AND SUPPLY

 Goods and Services, Consumer/ Consumer behavior, Producer/Producer

 behavior, Market and types of Market, Welfare, National Income,
 Consumption, Savings, Investment, Multiplier, Accelerator,
 Trade/Business cycles, Money, Taxation, Expenditure/Subsidies, Debt,
 Public Good and Private Good, Budget, Finances, Export, Import, Trade
 Surplus/Deficit, Balance of Payments, Foreign Exchange, National and
International Economic Institutions/Organizations like WTO, IBRD, IMF


 Policies related to all matters/ECONOMIC POLICIES

 Economics Subject
 Social Science
 study of social behavior in general
 study of economic behavior in particular
 way of thinking
 ways and means ,end
 tool/s, methods
 Basis of social welfare
 Concepts
 Micro and Macro Economics/analysis
 Static and Dynamic and Comparative Analysis
 Positive and Normative Economics/analysis
 Opportunity Cost
 Equilibrium, example- market, consumer, producer
 Optimization, example- consumption, production
 Production possibility curve
 Efficiency
 Equity
Definition of Economics A) Wealth Definition
 B) Welfare Definition
 C) Scarcity Definition
 D) Growth Definition
A) Wealth Definition
 1.) Adam Smith- Father of Economics. “An enquiry into the nature and causes of wealth
of Nations”- Book, 1776
 “a science which enquires into the nature and causes of wealth of nations”
 2.) J. B. Say- “Economics is the science which treats of wealth.”
 3.) J.S. Mill- “ Economics investigates the nature of wealth and the laws of its production and
distribution.”
 4.) Walker- “Economics is the body of knowledge that relates to wealth.”
 5.) Senior- “The subject of political economy is not happiness but wealth.”
 B) Welfare Definition
 1) Dr. Alfred Marshall, “Principles of Economics”, 1890
 “Political economy or economics is a study of mankind in the ordinary business of life; it examines that part of
individual and social action which is most closely connected with the attainment and with the use of material
requisites of well being. Thus, it is, on the one side, a study of wealth and on the other, and more important side, a
part of the study of man.”
 2.) Prof. Pigou- the range of our enquiry becomes restricted to that part of social welfare that can be brought
directly or indirectly into relation with measuring rod of money.”
 3.) Prof. Cannon- “The aim of political economy is the exploration of the general causes on which the material
welfare of human beings depends.”
 4.) William Beveridge- “Economics is the study of general methods by which men cooperate to meet their
material needs.”
 5.) Penson- “Economics is the science of material welfare.”
 C) Scarcity Definition
 1.)Prof. Lionel Robbins, “An essay on the Nature and significance of
Economic Science”, 1931
 “Economics is the science which studies human behavior as a
relationship between ends and scarce means which have alternative
uses.”
 2.)Stonier and Hague- “Economics is fundamentally a study of
scarcity and the problems which scarcity gives rise to.”
 3.)
Scitovsky- “Economics is a science concerned with the
administration of scarce resources.”
 D) Growth Definition
 1.)Prof. P.A. Samuelson- “Economics is the study of how people and
society choose, with or without use of money, to employ scarce
productive resources, which could have alternative uses, to produce
various commodities over time and distribute them for consumption
now and in the future among various people and groups of society.”
 2.)J.M. Keynes, “Economics is the study of the administration of
scarce resources and of the determinants of income and employment.”
 The importance of economics?
 Economics is concerned with the optimal distribution of resources in society. The subject involves-
 1.) Understanding what happens in markets and the macro-economy.
 2.) Examining statistics about the state of economy and explaining their significance
 3.) Understanding different policy options and evaluating their likely outcomes.
 Examples of the importance of economics
 1.) Dealing with a shortage of raw materials
 2.) To what extent should the government intervene in the economy 
 3.) The principle of opportunity cost 
 4.) Social efficiency
 5.) Knowledge and understanding 
 6.) Forecasts
 7.) Evaluation
 8.) Behavioural economics 
 9.) Applying economics in everyday life
 the methodology

INDUCTIVE AND DEDUCTIVE METHOD

MICRO ANALYSIS AND MACRO ANALYSIS
POSITIVE ANALYSIS AND NORMATIVE ANALYSIS
Static, dynamic and comparative analysis
 Branches of economics-
 ECONOMICS 1.) MICRO ECONOMICS
2.) MACRO ECONOMICS
3.) PUBLIC FINANCE
4.) INTERNATIONAL ECONOMICS
5.) AGRICULTURAL ECONOMICS
6.) INDUSTRIAL ECONOMICS
7.) MANAGERIAL ECONOMICS
8.) LABOUR ECONOMICS
9.) FINANCIAL ECONOMICS
10.) Environmental Economics
11.) ECONOMETRICS
ETC.
 MICRO ECONOMICS CONSUMER BEHAVIOR

 PRODUCER BEHAVIOR

 MARKET AND ITS TYPES

 PRICE AND OUTPUT DETERMINATION



 WELFARE
 DEMAND SIDE
 CONSUMER BEHAVIOR A) UTILITY ANALYSIS BY ALFRED MARSHALL
 B) INDIFFERENCE CURVE ANALYSIS BY HICKS
 C) REVEALED PREFERENCE ANALYSIS BY P. A.
 SAMUELSON
 D) OTHER ANALYSIS/ MODERN APPROACHES
 GREEN’S THEORY, LANCASTER ETC.
 SUPPLY SIDE
 PRODUCER’S BEHAVIOR 1.) COST OF PRODUCTION
 A.) LAND AND RENT,
 B.)LABOUR AND WAGES,
 C.) CAPITAL AND INTEREST,
 D.) ORGANIZATION/
 ENTREPRENEURSHIP AND
 PROFIT AND
 E.) OTHER COST
 2.) REVENUE
 3.) PROFIT
 Basic Economic problem/s
1. What to produce?
2. How to produce?
3. For whom to produce?
 Economic Problems
 1. The economizing problem involves the allocation of resources among competing wants.
 There is an economizing problem because there are:
 A. unlimited wants B. limited resources
 2. Resources and factor payments:
 A. land - includes space (i.e., location), natural resources, and what is commonly thought
of as land land is paid rent
 B. capital - are the physical assets used in production - i.e., plant and equipment
capital is paid interest
 C. labor - is the skills, abilities, knowledge (called human capital) and the effort exerted
by people in production labor is paid wages
 D. entrepreneur or entrepreneurial talent - (risk taker) the economic agent who creates
the enterprise entrepreneurial talent is paid profits
 Micro vs Macro Economics
 Key Difference-
Microeconomics focuses on individual markets, while
macroeconomics focuses on whole economy
 Microeconomics
 Microeconomics deals with-
 the economic interactions of a specific person
 a single entity or a company
 it is the study of markets
 Macroeconomics
 Macroeconomics is the study of-
 the performance
 Structure of an economy as a whole
 behavior and decision-making
 Contd…
 Microeconomics and macroeconomics both focus on the allocation of scarce resources. Both
disciplines study how the demand for certain resources interacts with the ability to supply that
good to determine how to best distribute and allocate that resource among many consumers.
 Microeconomics studies the behavior of individual households and firms in making decisions
on the allocation of limited resources. Another way to phrase this is to say that
microeconomics is the study of markets.
 Macroeconomics is generally focused on countrywide or global economics. It studies involves
the sum total of economic activity, dealing with the issues such as growth, inflation, and
unemployment.
 There are some economic events that are of great interest to both micro-economists and macro-
economists, but they will differ in how and why they analyze the events.
 Contd…
 Stemming from Adam Smith’s seminal book, The Wealth of Nations, microeconomic and macroeconomics both focus on the allocation of
scarce resources. Both disciplines study how the demand for certain resources interacts with the ability to supply that good to determine
how to best distribute and allocate that resource among many consumers. Both disciplines are about maximization: microeconomics is
about maximizing profit for firms, and surplus for consumers and producers, while macroeconomics is about maximizing national income
and growth.
 The main difference between microeconomics and macroeconomics is scale. Microeconomics studies the behavior of individual
households and firms in making decisions on the allocation of limited resources. Another way to phrase this is to say that microeconomics
is the study of markets.
 In contrast macroeconomics involves the sum total of economic activity, dealing with the issues such as growth, inflation, and
unemployment. Macroeconomics is the study of economies on the national, regional or global scale.
 This key difference alters how the two approach economic situations. Microeconomics does consider how macroeconomic forces impact
the world, but it focuses on how those forces impact individual firms and industries. While macroeconomists study the economy as a
whole, micro-economists are concerned with specific firms or industries.
 Many economic events that are of great interest to both micro-economist and macroeconomists, though they differ in how they analyze
those events. A shift in tax policy would interest economists in both disciplines. A micro-economist might focus on how the tax might shift
supply in a specific market or influence a firm’s decision making, while the macroeconomist will consider whether the tax will translate
into an improved standard of living for all of the economy’s participants.
 microeconomics
 The two key elements of this economic science are-
 the interaction between supply and demand, and
 scarcity of goods.
 One of the major goals of microeconomics is-
 to analyze the market and determine the price for goods and services that best allocates limited resources among the
different alternative uses.
 This study is especially important for producers as they decide what to manufacture and the appropriate selling price.
Microeconomics assumes businesses are rational and produce goods that maximizes their profit.
 If each firm takes the most profitable path, the principles of microeconomics state that the market’s limited resources will
be allocated efficiently.
 The science of microeconomics covers a variety of specialized areas of study including:
 Industrial Organization: the entry and exit of firms, innovation, and the role of trademarks.
 Labor Economics: wages, employment, and labor market dynamics.
 Financial Economics: topics such as optimal portfolios, the rate of return to capital, and corporate financial
behavior.
 Public Economics: the design of government tax and expenditure policies.
 Political Economics: the role of political institutions in policy.
 Health Economics: the organization of health care system.
 Urban Economics: challenges faced by cities, such as sprawl, traffic congestion, and poverty.
 Law and Economics: applies economic principles to the selection and enforcement of legal regimes.
 Economic History: the history and evolution of the economy.
Macroeconomics
 Macroeconomics is the study of the performance, structure, behavior and decision-making of
an economy as a whole.
 Macroeconomics is the study of the performance, structure, behavior and decision-making of
an economy as a whole.
 Macroeconomists focus on the national, regional, and global scales.
 For most macroeconomists, the purpose of this discipline is to maximize national income and
provide national economic growth.
 Economists hope that this growth translates to increased utility and an improved standard of
living for the economy’s participants.
 While there are variations between the objectives of different national and international
entities, most follow the ones detailed below:
 macroeconomics
 Sustainability occurs when an economy achieves a rate of growth which allows an increase in living standards without undue structural and environmental
difficulties.
 Full employment occurs when those who are able and willing to have a job can get one. Most economists believe that there will always be a certain amount of
frictional, seasonal and structural unemployment (referred to as the natural rate of unemployment). As a result, full employment does not mean zero
unemployment.
 Price stability occurs when prices remain largely stable and there is not rapid inflation or deflation. Price stability is not necessarily zero inflation; steady levels
of low-to-moderate inflation is often regarded as ideal.
 External balance occurs when exports roughly equal imports over the long run.
 Equitable distribution of income and wealth among the economy’s participants. This does not, however, mean that income and wealth are the same for
everyone.
 Increasing Productivity over time throughout the national economy.

 To achieve these goals, macroeconomists develop models that explain the relationship between factors such as
national income, output, consumption, unemployment, inflation, savings, investment and international trade.
These models rely on aggregated economic indicators such as GDP, unemployment, and price indices.
 On the national level, macroeconomists hope that their models help address two key areas of research:
 the causes and consequences of short-run fluctuations in national income, otherwise known as the business cycle, and
 what determines long-run economic growth.
Interdependence between Micro Economics and Macro Economics
 Micro Economic analysis and Macro Economic analysis are complementary to each other;
 They do not complement but supplement each other.
 The basic goal of both the theories is same: the maximization of the material welfare of the
nation.
 From the micro economic point of view, the nation’s material welfare will be maximized by
achieving optimal allocation of resources.
 From the macro economic point of view, the nation’s material welfare will be maximized by
achieving full utilisation of productive resources of the economy.
 The study of both is equally vital so as to have full knowledge of the subject-matter of
economics.
 The contemporary economists are concerned with both micro economics and macro
economics.
 Opportunity Cost
 The concept of opportunity cost occupies a very important place in modern economic analysis.
 Factors of production are scarce in relation to wants.
 When a factor is used in the production of a particular commodity, the society has to forgo other goods which this factor could
have produced.
 This gave birth to the notion of opportunity cost in economics.
 Suppose a particular kind of steel is used in manufacturing war-goods, it clearly implies that the society has to give up the
amount of utensils that could have been produced with the help of this steel.
 Hence we can say that the opportunity cost of producing war-goods is the amount of utensils forgone.
 Opportunity cost is the cost of the next-best alternative that has been forgone.
 From the meaning of opportunity cost two important points emerge:
 (i) The opportunity cost of anything is only the next-best alternative foregone and not any other alternative.
 (ii) The opportunity cost of a good should be viewed as the next-best alternative good that could be produced with the same
value of the factors which are more or less the same.
 The Formula for Opportunity Cost is:
 Opportunity Cost = Total Revenue – Economic Profit
The concept of opportunity cost can better be explained with the help of an illustration.
 Suppose a piece of land can be used for growing wheat or steel. If the land is used for growing steel, it is not
available for growing wheat.
 Therefore the opportunity cost for steel is the wheat crop foregone.
 This is illustrated with the help of the following diagram:
 Suppose the farmer, using a piece of land can produce either 50 quintals (ON) of rice or 40 quintals (OM)
of wheat.
 If the farmer produces 50 quintals of rice (ON), he cannot produce wheat.
 Therefore the opportunity cost of 50 quintals (ON) of rice is 40 quintals (OM) of wheat.
 The farmer can also produce any combination of the two crops on the production possibility curve MN.
 Let us assume that the farmer is operating at point A on the production possibility curve where he produces OD
amount of rice and OC amount of wheat.
 Now he decides to operate at point B on the production possibility curve.
 Here he has to reduce the production of wheat from OC to OE in order to increase the production of rice from OD
to OF.
 It means the opportunity cost of DF amount of rice is the CE amount of wheat.
 Thus, opportunity cost for a commodity is the amount of other next-best goods which have to be given up in order
to produce additional amount of that commodity.
 Applications of Opportunity Cost
 The concept of opportunity cost has been widely used by modern economists in various fields. The main applications of the concept of
opportunity cost are as follows –
 (i) Determination of factor prices - The factors of production need to be paid a price that is at least equal to what they command for
alternative uses. If the factor price is less than factor’s opportunity cost, the factor will quit and get employed in the better-paying alternative.
 (ii) Determination of economic rent - The concept of opportunity cost is widely used by modern economists in the determination of
economic rent. According to them economic rent is equal to the factor’s actual earning minus its opportunity cost (or transfer earnings).
 (iii) Decisions regarding consumption pattern - The concept of opportunity cost suggests that with given money income, if a consumer
chooses to have more of one thing, he has to have more of one thing, he has to have less of the other. He cannot increase the consumption of
all the goods simultaneously. Hence with the help of opportunity cost he decides the consumption pattern, that is, which goods should be
consumed and in what quantities.
 (iv) Decisions regarding production plan - With given resources and given technology if a producer decides to produce greater amount of
one commodity, he has to sacrifice some amount of another commodity. Thus on the basis of opportunity costs a firm makes decisions
regarding its production plan.
 (v) Decisions regarding national priorities - With given resources at its command a country has to plan the production of various
commodities. The decision will depend on national priorities based on opportunity costs. If a country decides that more resources must be
devoted to arms production then less will be available to produce civilian goods. In this situation a choice will have to be made between arms
production and civilian goods. The concept of opportunity cost helps in making such choices.
 Opportunity Cost Formula –Example #1
A Furniture manufacturer who manufactures and sells furniture was given
two orders and in which he can only take one order only.
 Now it’s up to the Furniture manufacturer to decide between the two orders
as he has time and labor limitations. The manufacturer has to pay wages @
INR 100/hour to the labor.
 1storder: One table Selling Price INR 7500, the time required- 16Hours, Raw
material costs- INR 1800
 2nd Order: Two Chairs Selling Price INR 4000 each, Time required – 11 hours
each, Raw material costs – INR 800 each.
 Find out the better option and the opportunity costs he misses?
 Solution:
 As the manufacturer has two different orders with diversified characteristics, so we have to calculate the profit
from both of the orders individually
 Profit from the First Order
 Opportunity Cost = Total Revenue – Economic Profit
 First Order = INR 7500 – [(16 * 100) + 1800]
 First Order = INR (7500 – 3400)
 First Order = INR 4100
 Profit from the Second Order
 Second Order = INR (4000 * 2) – [(11 * 2 * 100)+ (800 * 2)]
 Second Order = INR 8000 – 3800
 Second Order = INR 4200
 Conclusion – The manufacturer will take order no. 2 as it will give him much more earnings (INR 4200 vs
INR 4100). Thus the Opportunity cost is INR 4100 which the manufacturer misses during his course of business.
As the manufacturer has time limitations and he can take only one order at a time, so he would opt for the second
order.
 Opportunity Cost Formula – Example #2
 Tata Motors have three bulk orders and it can take the most profitable one first as to
strengthen its Cash Flow so has to enhance its working capital to process the rest of the
two orders. Find out the most profitable and the least profitable in a descending manner
in order to protect its Cash balance. (Assume that all the Sales are made on a Cash basis).
 Order 1: 100 Cars of Selling Price of INR 4.5 lakh each, RM costs – INR 80 lakhs, Total
Labor expenses – INR 22 lakhs
 Order 2: 50 Cars of Selling Price of INR 8 lakh each, RM costs – INR 95 lakhs, Total Labor
expenses – INR 45 lakhs
 Order 3: 20 Trucks of Selling Price of INR 22 lakh each, RM costs – INR 1.12 Cr, Total Labor
expenses – INR 38 lakhs
 Solution:
 From the above problem, we should calculate the profitability in each case. As we all know the
Sales are done in a Cash basis, so more earnings would help the business to generate higher
cash flow and there would not be pressure on the Working capital as the company will borrow
less short term borrowings.
 Profitability from First Order
 First Order = INR [(4, 50,000 * 100) – (80,00,000 + 22,00,000)]
 First Order = INR 4,50,00,000 – 1,02,00,000
 First Order = INR 3,48,00,000
 Profitability from Second Order
 Second Order = INR [(8,00,000 * 50) – (95,00,000 + 45,00,000)]
 Second Order = INR (4,00,00,000 – 1,40,00,000)
 Second Order= INR 2,60,00,000
 Profitability from Third Order
 Third Order = INR [(22,00,000 * 20) – (1,12,00,000 + 38,00,000)]
 Third Order = INR 4,40,00,000 – 1,50,00,000
 Third Order = INR 2, 90,00,000
 Thus Tata Motors will undertake the First order First , then it will take the
Third order and lastly it will take the second order in order of profitability so
as to strengthen its working capital.
 Thus the opportunity costs after the First order is done would be = INR (2.9
+2.6) Cr or INR 5.5 Cr (as the company has not executed the other orders and
it might choose not to execute) and after the second order the opportunity costs
would be INR 2.6 cr.
 Opportunity Cost Formula – Example #3
 Larsen and Toubro Ltd has two order for execution, But it can undertake only one. Based on the following
data choose which one to operate and the opportunity costs.
 Order one will derive a Revenue of INR 10,00,000 and Costs 4,00,000.
 Order two will derive a Revenue worth INR 12,00,000 and will cost INR 8,00,000.
 Solution:
 Profitability from First Order
 First Order = INR 10,00,000 – 4,00,000
 First Order = INR 6,00,000
 Profitability from Second Order
 Second Order = INR 12,00,000 – 8,00,000
 Second Order = INR 4,00,000
 Thus L&T will take order one and the Opportunity costs of not taking second order would be INR 400000.