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Overview of Economics Example

Economics is a science that studies human behavior in different situations and derives various inferences that will be useful for the business. Economics is also considered the science of choice-making, which will help people choose the various factors based on their requirement. The basic assumption in all the economic theorems or rules is that humans are rational and will think in terms of civilized society.

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There is a various concepts 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:

There is a Product A, whose marginal utility and prices per unit are as given below:

From this, calculate the 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 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 evaluate a tax’s economic effect 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 be varied and, therefore, remain fixed. A firm’s cost, irrespective of production, is termed total fixed cost (TFC). Fixed costs will remain the same and will not change at any output level. In the short run, only output can be controlled; hence, changes based on the output are termed 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 and total costs will increase. Thus, With an increase in output, the variable cost will increase however the 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 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 the 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

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 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 an increase in the 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 customers’ main aim is to attain maximum satisfaction from all the commodities they own. Utility means the benefit that can be obtained from the product.

Terms that are mainly used in this law are 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 satisfaction measurement). 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:

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 understand how consumers reach equilibrium in any commodity and how their taste and preference will be affected. The marginal Utility curve is downward sloping, showing that consumers will go on buying a good until the marginal utility of the 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 will increase, and with an increase in the commodity’s price, the quantity demanded will decrease. Thus, 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 at a given price and point in 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 prices and the quantity demanded in the market as given below:

When the commodity price is $ 5, the demand for the product is 10 units. As the price falls to $4, there is a demand for 15 units. Similarly, with further reduction up to $ 1, the demand for the commodity reaches 60 units. This shows the inverse relationship between the commodity’s price and the quantity demanded of the commodity.

Let’s plot the above data in the demand curve,

On Y-axis, we have plotted the price; on X-axis, we have plotted the quantity demanded. We have mapped all prices with the respective demand of the commodity at points A, B, C, D & E. Then we have drawn a curve passing through all the points. This curve is termed 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 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 a substitute effect

When the price of the product falls, the same consumer can buy more commodities for 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 consumers will start buying it as consumers, in the 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 business situation. It helps analyze human behavior based on need, taste, preference, etc. Moreover, it also helps in estimating the behavior of consumers based on the industrial cycle and the demand & Supply of commodities.