Overview of Economics Example
Economics is a science that studies human behaviour in different situations and derives various inference that will be useful for the business. Economics is also considered as the science of choice making which will help the person in choosing the various factors based on their requirement. The basic assumption in all the economic theorems or rule is that human being is rational and will be thinking in terms of civilised society.
There is a various concept in Economics, however, we have tried to describe the below mentioned most important concept of economics.
Examples of Economics
Using some general or real-world examples, economics can be better understood:-
Economics Example #1 – Consumer Surplus
Consumer Surplus is the ability of the consumer to pay a price for any commodity as compared to the actual price prevailing in the market.
As per Prof. Alfred Marshall,
“the surplus price which a person is willing to pay rather than stay without the thing, over that what he actually pays, is the measurement of a surplus of utility– known as consumer’s surplus.”
- Consumer’s surplus = Price ready to pay (-) Price Actually Paid
- Consumer’s surplus = Total utility – ( P * Q)
- Consumer’s surplus = Total utility – Total expenditure.
Let’s understand this concept with the help of an example:
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Illustration
There is a Product A, whose marginal utility and prices per unit are as given below:
From this calculate Consumer’s surplus and plot the same on a curve with proper description.
Solution:
From the table, it is clear that for 6 units the consumer was willing to pay 210 but he had to pay 60. Therefore consumer’s surplus = 210 – 60 = 150
Consumer Surplus Curve
In the figure, we have the shaded zone exhibiting consumer’s surplus.
The Usefulness of Consumer’s Surplus
(i) It helps to make economic comparisons about the people’s welfare between two places or countries.
(ii) The concept is useful in understanding the pricing policies of a discriminating monopolist & wiping out the surplus by different degrees of discrimination.
(iii) It helps in evaluating the economic effect of a tax on a commodity.
(iv) It helps to measure the benefits of international trade.
Economics Example #2 – Short-Run Costs
In the short run, many factors of production will not varied, and therefore, remain fixed. The cost that a firm incurs to irrespective of production is termed total fixed cost (TFC). Fixed cost will remain the same and it will not change at any level of output. In the short run only output can be controlled, hence cost that changes based on the output are termed as Variable cost. (TVC). Adding the fixed and the variable costs, we get the total cost (TC) of a firm
Formula
- TC = TVC + TFC
- SAC = TC/q
- AVC = TVC/q
- AFC= TFC/q
- SMC= Change in total cost/ change in output = ΔTC/ Δq
In order to increase the production of output, the firm needs to employ more of the variable inputs. As a result, the total variable cost and the total cost will increase. Thus, With an increase in output, the variable cost will increase however fixed cost will remain the same.
Illustration:
ABC Ltd is planning to set up the factory. It is planning to manufacture the commodity. The detailed schedule of cost based on output is as given below:
Calculate Average fixed cost (AFC), Average Variable cost (AVC), Short term average cost(SAC) and short term marginal cost (SMC)
Solution :
The above calculation is made based on below formulae:
- Total cost= Total Fixed Cost + Total Variable Cost
- Average Fixed Cost = Total Fixed Cost / Output
- Average Variable cost = Total Variable cost / Output
- Short-run Average cost = Total Cost / Output
- Short-run marginal cost = Total cost at the output at Q1 – Total cost at the output at Q0
Diagram:
In the above diagram we can observe that:
- Fixed cost remains the same irrespective of output.
- Variable cost increases at a reduced rate.
- The total cost will start with Fixed cost and will increase in parallel to variable cost.
- AFC curve is, in fact, a rectangular hyperbola. AFC is the ratio of TFC to q. TFC is constant. Therefore, as q increases, AFC decreases. When the output is very close to zero, AFC is arbitrarily large, and as output moves towards infinity, AFC moves towards zero.
Inference:
- Marginal cost is the increase in TVC due to increase in production of one extra unit of output
- For any level of output, the sum of marginal costs up to that level gives us the total variable cost at that level.
- Average variable cost at some level of output is, therefore, the average of all marginal costs up to that level
Economics Example 3 – Law of Diminishing Marginal Utility
The main aim of all the customers is to attain maximum satisfaction from all the commodities they are owning. Utility means the benefit that can be obtained from the product.
Terms that are mainly used in this, law is total utility and marginal utility. Total utility means utility derived from different commodities used by the consumer. Marginal utility means utility derived from the consumption of an additional commodity.
Law:
- “The additional satisfaction which a person drives with a given increase in consumption of a commodity reduces with every increase in the commodity that he already has. “
Formula
- Marginal Utility = Utility from Q2 -Utility from Q1
- Thus, Total Utility = Sum of all marginal Utility
Illustration:
Let us understand the said law with an example:
Alex is a fan of chocolates. By consuming 1 chocolate, he gets the utility of 30 Utils (a measurement of satisfaction). With the consumption of 2nd chocolate, he gets the satisfaction of 50 Utils and further satisfaction is given in the below table:
From the above table calculate the Marginal Utility.
Solution :
Marginal Utility = Total Utility at Q2 – Total Utility at Q1
Thus, Marginal utility is derived in the below table:
We can see that, with an increase in consumption, Total utility is increasing; however, it is increased with a decreasing rate. This is clearly visible in the Marginal utility figures, which is constantly reducing and even goes negative because, after the consumption beyond one point of time, it can lead to sickness. Therefore, Alex has to stop the consumption and his utility from the chocolate will keep on reducing.
The same is evident from the below graph:
Inference:
- When Total Utility Rises, the Marginal Utility diminishes.
- When total utility is maximum, the Marginal utility is Zero.
- When total utility is diminishing, the marginal utility is negative.
This law helps us in understanding how consumer reaches equilibrium in any commodity and how their taste and preference will get affected. Marginal Utility curve is downward sloping, that shows consumer will go on buying a good until the marginal utility of good becomes equal to the market price. Here his satisfaction will be maximum.
Economics Example 4 – Law of Demand
The law of demand is one of the most important laws of economic theory
This law states that
Other things remain static, With the reduction in prices, the quantity demanded of it will increase and with an increase in the price of the commodity, the quantity demanded of it will decrease. Thus, there is an opposite relationship exists between price and quantity demanded, other things being static.
Demand means the Number of goods or services that consumers are willing to buy a given set of price and point of time.
This can be understood with the help of the demand schedule and demand curve:
Let’s take the example of Commodity X, having different sets of price and the quantity demanded in the market as given below:
When the price of the commodity is $ 5, the demand of the product is 10 units, as the price falls to $4, there is a demand of 15 units, similarly, with further reduction up till $ 1, the demand of the commodity reaches till 60 units. This shows the inverse relationship between the price of the commodity and the quantity demanded of the commodity.
Let’s plot the above data in the demand curve,
On Y-axis, we have plotted price, and on X-axis, we have plotted quantity demanded. We have mapped all prices with respective demand of the commodity at point A, B, C, D & E. Then we have drawn curve passing through all the points, this curve is termed as the demand curve.
Inference:
- People will buy more quantity at a lower price because they want to equalize the marginal utility of the commodity and its price. This is termed as the law of diminishing the marginal utility
- When the price of a commodity falls, it becomes relatively cheaper than other commodities. It forces consumers to replace the commodity whose price has reduced for other commodities, which has become relatively expensive. This is termed as substitute effect
- When the price of the product falls, the same consumer can buy more commodity at lesser money. In other words, with a reduction in price consumer’s purchasing power increases, i.e., real income increases. This is termed as income effect.
- With a reduction in price, more consumer will start buying it as consumers, in past, who cannot afford to buy it, may now afford it
- Few commodities have a variety of use. If their price falls, people will start using the same for a variety of purposes and will try to satisfy their utility with the same commodity.
Conclusion
Thus, economics helps in understanding human tendency is different in the situation of the business. It helps in analyzing human behavior based on their need, taste, preference, etc. Moreover, it also helps in estimating the behavior of consumers based on the industrial cycle and demand & Supply of commodities.
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