Vedanta High School Economics Book 9 Final (2077)

GLANCING THE UNIT

Meaning of Utility Assumptions of the Law of Substitution
1. The consumer is rational and tries to maximize
The word ‘utility’, means, the want satisfying power
of a commodity. satisfaction.
2. Utility can be measured in cardinal numbers i,e
Total Utility: It is the total satisfaction obtained
from the consumption of a specific quantity of in terms of money.
commodity in a specific period of time. It is a 3. The marginal utilities of different commodities
function of the quantity consumed of a commodity.
are independent of each other.
i.e. TU=f(X). 4. The marginal utility of money remains

Marginal Utility: Marginal utility is also defined as constant.
the additional utility obtained from the consumption 5. The income of the consumer is given.
of an additional unit of the given commodity. 6. The prices of the commodities are given.
7. Diminishing marginal utility operates in

consumption.

Law of Diminishing Marginal Utility Limitations of the Law of Substitution
The law of diminishing marginal utility states 1. MU of money doesn’t remain unchanged
that additional satisfaction a person derives by 2. Utility not measurable quantitatively
consuming a commodity goes on declining as he 3. Not applicable if prices are unstable
consumes more and more of that commodity. 4. Not applicable if consumers are ignorant
5. Not applicable if resources are unlimited
Assumptions of law of diminishing marginal utility 6. Not applicable in case of shortage of goods
a. The consumer is rational 7. Not applicable in case of addiction
b. The MU of money remains unchanged.
c. Utility is additive and independent. Importance of the law of substitution
d. There is no gap in consumption. 1. It applies to consumption
e. Habits, fashion, taste remain unchanged. 2. Distribution of earnings
3. It applies in distribution
Exceptions or limitations of the law 4. It applies in public finance
1. Not applicable for dissimilar units 5. Expenditure of time
2. Requires units to be of suitable size
3. No gap in consumption Consumer surplus
4. No change in taste It may be defined as the difference between
5. Not applicable in rare collection willingness to pay for a commodity and the actual
6. Not applicable in case of abnormal persons payment.
7. Requires goods to be divisible
Criticisms of Consumers’ Surplus
Importance of law of diminishing marginal utility 1. Utility not Measurable:
1. Basis of the law of demand 2. MU of Money not Constant:
2. Basis of economic laws
3. Basis of the theory of taxation 3. Neglects Complementary Goods:
4. Basis of price determination
5. Redistribution of income and wealth 4. Neglects Substitutes

Law of substitution 5. Neglects Tastes and Sensibilities:
This law explains how the consumer makes
substitution between goods and spends his limited 6. Consumer’s Surplus from Necessaries
income on various commodities to get maximum Indefinite
satisfaction.
7. Not measurable for Luxury Goods

8. Hypothetical, Unreal and Imaginary:

51 Vedanta High School Economics - Book 9

QUESTIONS FOR REVIEW
Very Short Answer Type Questions
1. Define utility
2. How is utility subjective?
3. What is total utility?
4. Define marginal utility.
5. What is the change in total utility called?
6. State the law of diminishing marginal utility.
7. What is meant by point of satiety?
8. Define consumer surplus
9. What is the difference between willingness to pay and actual payment called?

Short Answer Type Questions
1. Explain the types of utility
2. What are the assumptions of the law of diminishing marginal utility?
3. Explain the limitations of the law of diminishing marginal utility.
4. Explain the importance of the law of diminishing marginal utility.
5. Explain the limitations of the law of substitution
6. Explain the importance of the law of substitution.
7. Write the importance of consumer surplus.
8. What are the criticisms of the consumer surplus.

Long Answer Type Questions
1. Explain the law of diminishing marginal utility. What are its limitations?
2. Explain the law of substitution. Write its importance.
3. Illustrate and explain the concept of consumer surplus. What are its exceptions?

Vedanta High School Economics - Book 9 52

3UNIT DEMAND AND SUPPLY EQUILIBRIUM

Learning Objectives Weight: 15 Lecture Hours

On Completion of this unit the student will

be able to:

• Understand the meaning of deamnd

• Understand the law of demand

• Explain the limitations of the law of demand

• Understand and explain the concept of

supply

• Explain the law of supply

• Explain the concept of market equilibrium

• BeforeExplain the elasticity of demand and its types you begin
• Understand the measurement of varioMusarket equilibrium is a market state where
types of elasticity of demand
the supply in the market is equal to the de-

mand in the market. The equilibrium price

is the price of a good or service when the

supply of it is equal to the demand for it

Very Short Type Short Type Long Answer Type Total Marks
1 2 0 11

53 Vedanta High School Economics - Book 9

3.0 CONCEPT OF DEMAND

In the ordinary sense demand means desire. A child may demand a doll. It means that he
desires it. But, in Economics, demand does not mean mere desire. Demand in Economics
means both the willingness as well as the ability to purchase a commodity by paying a
price and also its actual purchase.
According to Benham, “The demand for anything at a given price is the amount of it, which
will be bought per unit for time at that price.”

The demand for any commodity is the desire for that commodity backed by ability to pay

as well as willingness to pay for it, and is always defined with reference to a particular

time and price on which it depends. following attributes: Demand is effective desire as
In economics, demand connotes the the desire has to be backed by

a. Desire for a commodity the willingness and ability to

b. Willingness of consumer to pay for the good pay for a commodity

c. Ability to pay for the commodity

Demand for a commodity is in fact consumer's reaction or attitude towards that commodity.

Hence, a mere desire is not demand; it has to be backed by ability and willingness to

pay for it. It is effective desire. An effective desire is a desire which is fully backed by

willingness and ability to pay so as to make the desire a reality.
3.1 DEMAND SCHEDULE AND DEMAND CURVE

A demand schedule is a tabular statement that shows the different quantities of a commodity

that would be demanded at different prices. In other words, a demand schedule is a list of

the quantities of a good or service the consumer(s) will buy at different possible prices.

There are two types of demand schedule: A demand schedule lists the
various quantity demanded
a. Individual demand schedule of a commodity at different
b. Market demand schedule prices of the commodity
A. Individual Demand Schedule And Demand Curve

Individual demand refers to the various quantities demanded of a good (or service) by an
individual buyer at various prices of the good (or service). An individual demand schedule
is, therefore, a list of various prices and the corresponding quantities demanded of a good
or a service by an individual buyer say, Ram.

Individual demand schedule of Ram

Price of good X (Rs) Quantity demanded of X

10 5

8 10

6 15

4 20

2 25

The table shows a list of various prices and the
corresponding quantities demanded of good X by
Ram. At price Rs.10,Rs.8, Rs.6, Rs.4 and Rs.2; the
quantity demanded are 5 units, 10 units,15 units, 20 units and 25 units respectively.
The data from demand schedule are plotted graphically to derive the demand curve. An
individual demand curve is a graphical of an individual demand schedule.

Vedanta High School Economics - Book 9 54

Y

D A demand curve shows the re-
10 lationship between the quantity
8 a Individual Demand Curve demanded of a good and its price
b when all other influences on
Price of good X 6 consumers’ planned purchases-
4 c remain the same.

d

2e
D

O 5 10 15 20 25 X
Quantity of good X

The various quantities demanded by Ram are plotted as (a,b,c,d,e) in the figure and joined

together to derive the individual demand curve DD.

B . Market Demand Schedule And Market Demand Curve

Market demand refers to the total quantities demanded of a good (or service) at
particular prices by all the buyers in the market. Suppose there are two buyers (Ram
and Shyam) of good X in the market on a particular day. At price Rs.10, the quantity
demanded by Ram and Shyam is 5 units and 10 units respectively. The total quantity
demanded by them is 5+10=15 units.

A market demand schedule is the sum of all individual demand schedules. Considering
that there are only two buyers in the market for good X, we can calculate the market
demand schedule for good X as follows:

Price of X Ram's Shyam’s Market Market demand schedule:
demand demand demand for X a table that lists the various
10 quantity of a good demn-
8 5 10 5+10=15 ded in a market at different
6 10 15 10+15=25 prices
4 15 20 15+20=35
2 20 25 20+25=45
25 30 25+30=55

The table shows that the market demand schedule is the sum of all individual demand
schedules. At each price, market demand for X = Ram's demand + Shyam's demand.

A market demand curve is the graphical Y
DS
representation of the market demand
DR
schedule. In other words, it is the horizontal DM Ram’s Demand Curve
10
summation of all individual demand Shyam’s Demand Curve
8 Market Demand Curve
curves. When we plot the market demand Price of good X

schedule and join the various points, we get 6
4
the market demand curve DM as shown in
the figure.

sMuamrkmeat tdioenmaonfdincudrivveid(uDaMl) is the horizontal 2 DM
demand curves,
O DR DS X

i.e. market demand curve Ram's demand 5 10 15 20 25 30 35 40 45 50 55

curve + Shyam's demand curve. i, e DM= Fig B Quantity of good X
DR+DS

55 Vedanta High School Economics - Book 9

3.2 LAW OF DEMAND

Demand is the desire, willingness and ability to pay for a commodity. A relationship
can be established between the price of the commodity and the quantity demanded of
it. The statement of this functional relationship between the price of the commodity and
the quantity demanded of it is called the law of demand.

Statement of the Law
The law of demand expresses the functional relationship between price and quantity

demanded of a good. According to this law, other things remaining constant (ceteris
paribus), if the price of a commodity falls the quantity demanded of it increases and vice
versa. Thus, there is an inverse relationship between price and quantity demanded of it.

In the words of Marshall, “Other things remaining the same, the amount demanded
increases with the fall in price and diminishes with a rise in price”

Explanation of the Law

The law of demand can be explained with the help of a demand schedule and a demand
curve. A demand schedule is shown as under.

Price of good X (Rs) Quantity demanded of X Economists use the term
10 5 quantity demanded to de-
8 10 KEY scribe how much of a good is
6 15 IDEA demanded at a specific price
4 20

2 25
It is seen in the table that when the price of the commodity is Rs.10 per unit, a consumer

buys 5 units only and at Rs. 2/- per unit, he buys 25 units of the commodity. Thus, as price
goes down, the consumer buys more of a commodity and vice versa. The demand curve
drawn from this schedule is shown in the figure below.


Y

D a Demand Curve
10
Price of good X b
8

6c

4d
2e

D
O 5 10 15 20 25 X

Quantity of good X

In the figure quantity is measured along X-axis, and along Y-axis price of the commodity
is measured. By joining various points or combinations of price and quantity demanded,
we get a demand curve ‘DD’ sloping downwards from left to right. The downward sloping
demand curve clearly indicates that price is inversely related to quantity demanded of the
commodity. As price falls, the quantity demanded rises and it shrinks when price rises.

Vedanta High School Economics - Book 9 56

Reasons for Downward Sloping Demand Curve

The demand curve slopes downward to the right due to the following reasons:

1. Income Effect: When price of a commodity falls, real income of the consumer increases.
In other words, the consumer is able to buy more goods and services now with the
same amount of money. This is called income effect.

2. Substitution Effect: When the commodity is cheaper, it tends to be substituted for
other commodities, which are dearer. This is called substitution effect.

3. Increase in Use of a Commodity: Another reason for downward sloping demand curve
is that when a commodity becomes cheaper, it can be put to more uses or not so urgent
uses. This also makes demand to be greater when price falls.

4. Law of Diminishing MU: A rational consumer equates the marginal utility of a
commodity with the price of the commodity. The MU falls with increase in consumption
of a commodity. As price of the commodity falls, the equality between MU and price
is disturbed. To equalize MU with the reduced price, consumption of the commodity
has to be increased. As a result, the quantity demanded increases with the fall in price
of the commodity.

5. New Consumers: When price of the commodity falls, new consumers who could
not afford to consume it before are attracted towards the commodity. This cause the
quantity demanded to increase at a lower price.

Assumptions of the Law

The law of demand applies only when certain conditions are met, which have been

mentioned as under: Income effect: The effect of a change
Glossary
in price on quantity demanded arising
Key Definitions
1. Incomes of consumers do not change. from the consumer becoming better or
worse off as a result of the price change.
2. People’s tastes and preferences remain Substitution effect: The effect of a
unchanged. change in price on quantity demanded
arising from the consumer switching to
3. Prices of substitutes and complements do or from alternative (substitute) products.
not change.

4. No change in fashion.
5. No change in consumer’s expectation

6. A normal economic environment with no abnormalities like war, famine etc

Ceteris paribus : Latin for ‘other things being equal’
Opposite
Inverse: Become smaller
Goods having the same uses
Shrink: ` Goods which are used jointly

Substitutes:

Complementaries:

LIMITATIONS OR EXCEPTIONS TO THE LAW DEMAND

There are certain situations where the law does not hold good. These are called the

exceptions or limitations of the law of demand. They are:

1. Giffen Goods: Sir Francis Giffen observed that when Irish Giffen good is a type

potato prices increased in bad years, people curtailed of inferior good which

spending on other commodities and increased their KEY doesn’t have easily
spending on potatoes. Because with high potato prices and IDEA available substitutes
no increase in their money incomes, they were now too poor

to afford meat and other foodstuffs. So they had to sustain themselves by eating more

potatoes. In case of Giffen goods, the quantity demanded varies positively with price.

This is called Giffen Paradox. 57 Vedanta High School Economics - Book 9

2. Conspicuous Consumption: This exception is associated with the economist, Thorstein
Veblen. Goods like diamond can be purchased only by rich people. The prices of these
goods are so high that they are beyond the capacity of common people. The higher the
price of the diamond the higher the prestige value of it. When price of diamonds increase,
the prestige value goes up and therefore, the quantity demanded of it will increase.

3. High Priced Goods: The law of demand doesn't not applies to a commodity whose quality
is judged by its high price. At high prices, some people buy more of such commodity than
at lower price thinking that high priced are better than those priced lower.

4. Speculation: Speculation is another exception to the law Pause for Thought
of demand. If the price of commodity is increasing and
people expect a further rise in the price, they will tend to The price of Millet rises
buy more of the commodity at higher price than they did and yet it is observed that its
at the lower price in the expectation that future prices quantity demanded increas-
will be even more. es among the poor. Why?

5. Emergencies: During emergency like war, famine, floods, cyclone etc., people buy certain
articles even though the prices are quite high. In such situations, the inverse relation
between price of the commodity and quantity demanded of it doesn’t follow.

6. Change in Income: If the consumers’ income increases, they will demand more goods or
services even at a higher price. On the other hand, they will demand less quantity of goods
or services even at lower price if there is decrease in their income. It is against the law of
demand.

7. Ignorance: A consumer’s ignorance is another factor that at times induces him to purchase more
of the commodity at a higher price. This is especially so when the consumer is haunted by the
phobia that a high-priced commodity is better in quality than a low-priced one.

8. Fear of shortage: When people feel that a commodity is going to be scarce in the near
future, (e.g. during the war period) they buy more of it even if there is a current rise in
price. They buy more to avoid paying higher price in future.

9. Basic Necessities: In case of basic necessities of life such as salt, rice, medicine, etc. the
law of demand is not applicable as the demand for such necessary goods does not change
with the rise or fall in price.

10. Change in Fashion: If the commodity goes out of fashion, people do not buy more even
if the price falls. For example: People do not purchase old fashioned shirts and pants
nowadays even though they’ve become cheap. Similarly, people buy fashionable goods in
spite of price rise.

DID YOU KNOW? GIFFEN PARADOX

Giffen goods named after Sir Robert Giffen are inferior goods that are tied

in the mind of individuals to hard times. Marshall introduced the Giffen’s

paradox as an exception to the law of demand. Mr Giffen has pointed out,

a rise in the price of bread makes so large a drain on the resources of the

poor that they are forced to curtail their consumption of more expensive

foods and, bread being still the cheapest food which they can get and they

consume more, and not less of it.

Vedanta High School Economics - Book 9 58

3.3 SUPPLY ANALYSIS

Supply is defined as a quantity of a commodity offered for sale by the produces at a
particular price and at a certain time. Like demand, supply is also influenced by price
as higher price positively impacts the seller’s willingness to sell, and often, the ability to

bring the goods and services to the market as well. As such, supply refers to the quantity

of a commodity firms or producers are willing to sell at a given price over a period of time

under given conditions.

R.C. Lipsey -”The amount of a commodity that firms are able and willing to offer for

sale is called the quality supplied of that commodity.”

Watson and Getz-”In economics, the word supply always means a schedule-a schedule of

possible prices and of amount that would be sold at each price.”

The quantity supplied of a good, service, or resource is the amount that people are willing
and able to sell during a specified period at a specified price.

Four things must be carefully noted regarding the meaning of supply:
1. Supply is the desired quantity offered for sale, not how much they actually sell.
2. Supply is only a part of the stock, not the stock.
3. Supply is always expressed in relation to price of the commodity.
4. Supply is expressed with respect to specific period of time.

Thus, a statement of supply without reference to price and time conveys no economic
sense.

3.4 SUPPLY SCHEDULE AND SUPPLY CURVE

A Supply schedule is a tabular statement showing various quantities of a commodity being

supplied at various levels of price, during a given period of time. The supply schedule is

usually represented in a tabular form where it shows the price of the product and the

corresponding quantity supplied by a seller at a given period of time.

Like demand schedule, supply schedule is also of Supply schedule is a table show-

two types: ing the different quantities of a

a. Individual Supply schedule KEY good that producers are willing and
IDEA able to supply at various prices over
b. Market Supply schedule a given time period.

A. Individual Supply Schedule and Supply Curve

Individual supply schedule refers to a tabular statement showing various quantities of
a commodity that a producer is willing to sell at various levels of price, during a given
period of time. It is, therefore, a list of various prices and the corresponding quantities
supplied of a commodity by an individual seller.

Price of X (Rs.) Quantity Supplied
of X
25

4 10

6 15

8 20

10 25

The table shows that as price of the commodity rises from Rs.2 to Rs.4, Rs.6, Rs.8 and
Rs.10; the quantity supplied of a commodity increases from 5 units to 10 units,15 units,
20 units and 25 units respectively.

59 Vedanta High School Economics - Book 9

An individual supply curve is a graphical representation Y S
of an individual supply schedule. The various quantities
supplied by a seller are plotted in the figure and joined 10
together to derive the individual supply curve SS. The 8
upward sloping supply curve SS indicates that as price 6
of the commodity rises, the quantity demanded of a 4
commodity also increases and vice versa. 2S
O5
• The supply schedule can be represent-
ed graphically as a supply curve

• A supply curve may be an individual
firm’s supply curve or a market curve
Keynote 10 15 20 25 X
Price of good Quantity of good X
X

B. Market Supply Schedule and Market Supply Curve

Market supply refers to the total quantities of a product supplied by all the firms or sellers
at each possible price in the market. It is the total of individual supplies made by all the
sellers in a market. Suppose there are three sellers of good X in the market: Seller A, seller
B and seller C. If the supply of X by firm A is 5, by firm B is 10 and by firm C is 15 units
when the price of X is Rs.2, then the market supply at this price is 30 .

A market supply schedule is a chart or table of various prices and the corresponding
quantities of a product supplied by all firms in the market. It is the sum of individual
supply schedules. In line with our assumption of three sellers in the market, we can
calculate the market supply schedule of good X as follows:

Price of Quantity Quantity Quantity Market supply Market supply schedule is

good X by A by B by C (unit) a chart that lists how much
KEY of a good all suppliers will
2 5 10 15 30(=5+10+15)

4 10 15 20 45 (=10+15+20) IDEA offer at different prices

6 15 20 25 60 (=15+20+25)

8 20 25 30 75 (=20+25+30)

10 25 30 35 90 (=25+30+35)

The table shows market supply schedule as the list of various prices and the corresponding
total quantities supplied by all three individual firms in the market. It is the horizontal
summation of all individual schedules. At each price, market supply of good X = supply
by firm A+supply by firm B + supply by firm C.

Y Individual supply of firm A Individual supply of firm B
SA SB SC
Individual supply of firm C SM Pause for Thought
Market Supply

10 Curve A market supply curve is

Price of good X 8 a graphical representation of
the market supply schedule.

6 How is a market supply curve

4 derived from the individual

2 supply curve?

SA SB SC SM

O 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 X

Quantity of goo9d0X

Vedanta High School Economics - Book 9 60

The market supply curve is the graphical representation of the market supply schedule. It
is the horizontal summation of all individual supply curves. If we plot the market supply
schedule in the table on a graph we get the market supply curve as above.

ciTnuhdrevivefii,dgwuurahelicsshhuopiswpdlsyetrhcivueerddveebrsiyvoahftoiforiirnzmoosnf tAtahl,elyBmsauanrmkdmetCisnurgepsupppleycthtcieuvretvhlyer..eeSSAMiSnSAdM,ivSisiBdStuBhaealnmsduapSrpkCSleyCt are the
supply
curves,

i.e. SMSM = SASA+ SBSB + SCSC.

• Supply curve is a graph showing the relationship between the price of a
good and the quantity of the good supplied over a specified period of time
Keynote
• When the price of a good rises, the quantity supplied per period of time

will usually also rise. This applies both to individual producers’ supply

and to the whole market supply.

3.5 LAW OF SUPPLY

Supply is the quantity of a commodity offered for sale by the produces at a particular
price and at a certain time. A positive relationship exists between the price and the
supplied quantity when other factors are held constant. This positive relationship between
price and supplied quantity is called the law of supply.

According to Marshall, “As the prices rise, other things remaining same, the supply rises and
as the price falls the supply decreases”.

The law states ‘Other things remaining the same, as the price of a commodity rises
its supply is extended’. The quantity offered for sale varies positively with price, i.e. the
higher the price the larger is the quantity supplied of a commodity and vice versa.

Assumptions of the Law of Supply

The law of supply assumes certain things to remain unchanged. The following are the

main assumptions of the law Did you Know?
1. No change in the cost of production
2. Prices of inputs remain unchanged Supply and Stock
3. No change in technology Supply means the quantity actu-
4. No change in taxes and subsidies ally offered for sale at a certain
5. No change in price of substitutes price, but stock means the total
quantity which can be offered for

6. The goal of the producer remains unchanged. sale if the conditions are favora-
7. A normal social, political environment is assumed. ble. Stock constitutes potential
8. No change in natural factors and resources. supply. The quantity that actually
comes out is the supply.

Explanation of the Law of Supply

The law of supply can be explained with the help of a supply schedule and a supply
curve. A supply schedule is a tabular presentation of the various quantities supplied of a
commodity at different level of prices.

In the table as price of the commodity rises from Rs.2 to Rs.4, Rs.6, Rs.8 and Rs.10; the
quantity supplied of a commodity increases from 5 units to 10 units,15 units, 20 units and
25 units respectively.

61 Vedanta High School Economics - Book 9

Price of X (Rs.) Quantity Supplied of X Economists use the term
2 5 quantity supplied to describe
4 10 KEY how much of a good is offered
6 15 IDEA for sale at a specific price
8 20

10 25
The direct and positive relationship between price of the commodity and the quantity
supplied of a commodity is illustrated in the figure below. The supply curve SS in the
figure is obtained by plotting the supply schedule and joining the various points.

Y S Pause for Thought

10 • How is the law of
supply different from the
8 law of demand?
Price of good
X 6 • How does expectatation
about price change af-
4 fect the quantity sup-
plied of a commodity?
2S 10 15 20 25 X
O5 Quantity of good X

The upward sloping supply curve SS indicates that as price of the commodity rises, the
quantity supplied of a commodity also increases and vice versa. It indicates that price and
quantity supplied are positively related.

Reasons for the Upward Sloping Supply Curve

The reasons behind the positive relationship between the price and the quantity supplied

of a product are explained as under: Diminishing returns indi-
cates falling marginal prod-
1. Profit Consideration: The basic aim of producers is to uct with increase in employ-
secure maximum profits. When the price of a commodity ment of variable factor
increases, the profit margin increases. As a result, the KEY
seller increases the quantity supplied of the commodity. IDEA

2. Law of Diminishing Returns: Law of diminishing returns implies that the cost of production
increases as the level of production rises due to declining factor productivity. It implies
that producers would be prepared to produce and supply a larger quantity of a commodity
only at a higher price so as to cover higher costs of production.

3. Shift of Resources: The rise in the price of a product motivates producers to divert
resources towards the production of the commodity whose price have increased. This
would give incentive not only to the existing producers of the product but also motivate
other prospective producers to produce this commodity so as to earn higher profits.

4. Change in Number of Firms: A rise in price induces prospective producers to enter into
the market to produce the given commodity so as to earn higher profits. Increase in number
of firms increases the market supply. However, as price starts falling, some firms which do
not expect to earn any profits at a low price either stop production or reduce it.

5. Future Expectations: If there is a tendency of increasing prices at present period, the
sellers increase quantity supplied for the lust of profit. They want to maximize their profit
due to good present circumstances as they may expect decline in price in the near future.

Vedanta High School Economics - Book 9 62

LIMITATIONS OR EXCEPTIONS TO THE LAW OF SUPPLY

There are certain cases in which the law of supply fails to operate. These cases are called
the exceptions to the law of supply.

1. Future Expectations: If sellers expect a fall in price in the future, then the law of supply
may not hold true. In this situation, the sellers will be willing to sell more even at a lower
price. However, if they expect the price to rise in the future, they would reduce the supply
of the commodity, in order to supply the commodity later at a high price.

2. Agricultural Goods: In agricultural production, natural and seasonal factors play a
dominant role. Due to the influence of these constraints supply may not be responsive to
price changes. In times of bad harvest, the quantity supplied of agricultural goods cannot
be increased even at higher prices.

3. Perishable Goods: Those goods which have very short life-time and they become useless
after that are all perishable goods. Those goods must be made available in the market at
its right time whatever be its price. So the seller becomes ready to sell his goods at any
offered price. It is also against the law of supply.

4. Rare Articles: Rare, artistic and precious articles are also outside the scope of law of
supply. For example, supply of rare articles like painting of Mona Lisa cannot be increased,
even if their prices are increased.

5. Backward Countries: In underdeveloped countries, producers face shortage of inputs
and resources to produce goods and services in large scale. Due to shortage of inputs the
producers cannot increase the supply of goods even if the prices are rising.

6. Fear of Fashion Out: The latest goods that are in fashion have high prices. But, the out of
fashion goods have low prices. If the seller thinks that the goods are going to be outdated
in the near future, he sells more at a lower price which is also against the law of supply.

7. Stock Clearances: When a seller wants to clear its old stock in order to store new goods,
he may sell large quantity of goods at heavily discounted price. It is also against the law of
supply.

8. Auction Sale: The law of supply states that quantity supplied increases with increase in
price and vice-versa. But this law doesn’t hold true in case of auction sale. An auction sale
takes place at that time when the seller is in financial crisis and needs money at any cost.

9. Closure of Business: When a business is on the verge of closure, the seller may sell the
goods even at low prices in order to clear the stock. Thus, in this case, the law of supply
shall not hold true.

10. Competition: When there is a cut-throat competition in the market the sellers may sell
more quantity of goods even at low prices. This is a situation where the law of supply will
not apply.

Incentive: Inducement, motivation

Glossary Perishable: Likely to decay or go bad quickly

Inputs: ` Resources used in production activity

Constraints: Limitations or restrictions

Auction: public sale of goods or property

63 Vedanta High School Economics - Book 9

3.5 MARKET EQUILIBRIUM

The term equilibrium is used in economics to explain a condition when all variables
have reached an established position with no tendency to change any further. In a
market, demand and supply are the opposing forces. Demand for a commodity varies
inversely with its price and supply of a commodity varies positively with price.

Market equilibrium is a state of perfect balance in the market brought about by the equality
of market demand and market supply. The functioning of market economy lies on the
interaction between demand and supply forces which move in opposite direction. In the
course of interaction between these two forces, the equality between them occurs. This
equality between these two forces is known as the market equilibrium.

At the point of market equilibrium, the need of buyers is equal to the need of sellers i,e the
quantity demanded is equal to quantity supplied at a certain price level. The particular
quantity and price are known as equilibrium quantity and equilibrium price. The concept
of market equilibrium can be explained with the help of a schedule and diagram as in
perfect competition.

Price of X (in Rs) MarketDemand Market Supply Market Tendency Market clearing
(Kg) (Kg)
10 5 25 D>S price: The equilib-
8 10 20 Price tends to rise
6 rium price is the
4 15 15 D=S
2 20 10 D<S one that clears the
25 5 Price tends to fall
market: the price

where demand

equals supply.

The table shows that as price of the commodity falls from Rs. 10 to Rs.8, Rs.6, Rs.4 and
Rs.2; the quantity demanded of a commodity in the market increases from 5 units to
10 units, 15 units, 20 units and 25 units respectively. While the quantity supplied of a
commodity in the market decreases correspondingly from 25 units to 20 units, 15 units,
10 units and 5 units. At price Rs. 6 per unit both the market demand and market supply
are equal at 15 units. This defines market equilibrium at which the equilibrium price so
determined is Rs. 6.

The process of determination of the equilibrium price is further explained below.

Y

D S POINTS TO NOTE
10
Price (in Rs.) Excess Supply • If the demand for a good
8 cd exceeds the supply, there
will be a shortage. This will

6E lead to a rise in the price of

a b the good.
4
Excess Demand • If the supply of a good ex-

2 ceeds the demand, there will
S
D X be a surplus. This will lead
O5 10 15 20 25 to a fall in the price.

Fig:2.16 Quantity



Vedanta High School Economics - Book 9 64

In the figure X-axis represents quantity and Y-axis represents price per unit of the
commodity. DD is market demand curve and SS is market supply curve. The market
demand curve intersects the market demand curve at point E, which defines market
equilibrium. This determines equilibrium price Rs. 6 and equilibrium quantity 15 units.

If price rises higher than Rs.6, there is excess supply (surplus) equal to ab and this
situation leads to fall in price back to equilibrium price Rs. 6. If price falls below Rs.6,
there is excess demand (shortage) equal to cd and this results into the rise in price back to
Rs. 6.

CHETChKuPsO, iInNTpe1r.f ecEtxlyplacionmthpeetlaitwivoef mdeamrkaentd,.tWhehafot racresthoefedxecempatinondsatnodthseulapwployf, dinemtearancdt?ing with
each other,2d. etEerxmplainine tehqeulailwiborfiusumppplryi.cWehaantdaroeutthpeuetxacenpdtiaonsytdo itsheeqluaiwliobfrisupmplsyi?tuation will
generate fo3r.c esHothwadt oreesstaoGreiffeeqnugioliobdriduifmfe.r Wfrohmeninfeeqruioirligboroiud?m is disturbed, market forces
sTh45h..o ertleHWaasgwohteawa,botltifihsismsehthemapedrrakliiracnekwetethtfrooeiefsrqmescuusea.ipslripksbeltryatiutdemisff?-eWrHeohnwtenfriosthmeeqrtuheieliislbaarwiusmuofrpdpleruimcse,atnahdne?dpreiqcueilfiablrlisu;manqduwanhteitny
restore it.
there is a

3.6 ELASTICITY OF DEMAND

Elasticity can be defined as the sensitivity measurement of a particular variable
towards change its determinants. In economics, elasticity is the measurement of the
proportional change of an economic variable in response to a change in another.

Elasticity of demand is the responsiveness of the quantity demanded of a commodity
to changes in one of the variables on which demand depends. In other words, it is the
percentage change in quantity demanded divided by the percentage in one of the variables
on which demand depends. It measures the responsiveness of one variable to the changes
in another variable.

Boulding:“Elasticity of demand measures the responsiveness of demand to changes in

price”.

Marshall: “The elasticity of demand in a market is great or small according to the
amount demanded increases much or little for a given fall in price, and diminishes much or

little for a given rise in price”

There are three main variables on which the demand for a commodity depends. They are

price of the commodity, price of some related goods and consumer income. As such, three

types of elasticity of demand may be noted: Elasticity in the Kitchen: In No-

1. Price elasticity of demand. vember 1998 angry citizens voted
2. Income elasticity of demand. the ruling party out of power in
several Indian states because of

3. Cross elasticity of demand. the high price of onions

Though there are three types of demand elasticity, it is the price elasticity which is referredKeynote
as the elasticity of demand.


• Equilibrium is the point where conflicting interests are balanced.
• A market clears when supply matches demand, leaving no shortage or
surplus.
• Elasticity allows comparisons to be made towards the change for two
subjects measured in different units

65 Vedanta High School Economics - Book 9

A PRICE ELASTICITY OF DEMAND

Price elasticity of demand is the measure of the degree of responsiveness of quantity
demanded of a commodity due to change in its price when other factor remaining
constant. It may be defined as the ratio of proportionate change in the quantity demanded
of a commodity to a given proportionate change in price of the commodity. The formula for
price elasticity of demand is:


The more substitutes there
are for a product, the more

elastic the demand
for that product will be.

Where, P = Original price

Q = Original quantity demanded

∆P = Change in price (New price -Old price)

∆Q = Change in quantity ( New quantity – Old quantity)

Example: As price of the commodity falls from Rs. 10 to Rs. 5, the quantity demanded

of good X increases from 100 units to 150 units. The coefficient of price elasticity is

calculated as:

Given, Initial price (P) = Rs. 10 Initial quantity (Q) = 100 units

New price (P1) = Rs. 5 New quantity(Q1) = 150 units

Change in price (ΔP) = P1 - P = 5 -10 = -2

Change inquantity (ΔQ) = Q1 - Q = 150 -100 = 50
∆Q = 1 ( Negative sign is ignored)
eP = ∆P × P = - 50 × 10
Q 5 100

Price elasticity of demand is always negative, indicating inverse relationship between

quantity demanded of a commodity and price. However as a convention, the negative sign

is ignored and only the absolute value is considered.

TYPES OR DEGREE OF PRICE ELASTICITY OF DEMAND

Depending upon the value of the coefficient of price elasticity, there are five types of price

elasticity. They are explained below:

1. Perfectly Eolaf saticcoDmemmoadnitdy:ePc=ha∞n:geIsf the quantity Y
demanded to any extent
Price of good X(in
even without any change in price of the commodity Rs) Demand Curve
or a very small change in price that can be ignored,

then the demand is said to be perfectly elastic. The P 10 D

horizontal demand curve in the figure indicates such

price elasticity. In such a case, the coefficient of price

elasticity is infinity. i,e, eP=∞. This is however, an
imaginary concept.
O 5 10 X

Quantity of good X

Vedanta High School Economics - Book 9 66

2. Perfectly Inelastic Demand: If the quantity demanded Price of good X(in Rs) Y D
of a commodity remains constant whatever may be 20 Demand Curve
the change in price, the demand is said to be perfectly
inelastic. The vertical straight line demand curve 10
parallel to Y- axis shows such perfectly inelastic
demand. In such a case, the coefficient of price 5
elasticity is equal to zero. This is however an imaginary
concept. O Qu1a0ntity of good X X

3. Unitary Elastic Demand: If the quantity demanded of Y

a commodity changes in exact proportion to change Price of good X (in Rs.)

in price of the commodity, then the demand is said D Demand Curve

to be unitary elastic. The demand curve in the figure 15
50%
shows such a demand. For e.g., 50 % rise in price leads
10
to exactly 50 % decrease in quantity demanded. In
D
such a case, the coefficient of price elasticity is equal 50% X
O
to one. di,eme eanP=d1b.uItt is possible to come across unitary 10 20
elastic it is rare phenomenon. Quantity of good X

4. Relatively Elastic Demand: If the quantity demanded Y
of a commodity changes more than proportionately to
change in price of the commodity, then the demand Price of good X (in Rs) D Demand Curve
is said to be relatively elastic. The relatively flatter
demand curve in the figure shows such a demand. 20
For e.g., 50 % fall in price leads to 200 % increase in 50%
quantity demanded of a commodity. In such a case,
the coefficient of price elasticity is greater than one. i, 10 D X
e eP>1 200%

5. Relatively inelastic Demand: If the quantity demanded O
of a commodity changes less than proportionately to 10 30
change in price then the demand is said to be relatively Quantity of good X
inelastic. The relatively steeper downward sloping
demand curve in the figure shows such a demand. For YD Demand Curve
e.g.,100 % rise in price leads to 50% fall in quantity 20
demanded. In such a case, the coefficient of price Price of good X
elasticity is less than one. i, e eP<1 100%
10

50% D
OX

15 30
Quantity of good X

POINTS TO NOTE

When the price of a good rises,
your demand for that good is
• Elastic if your expenditure

on it decreases.
• Unit elastic if your expendi-

ture on it remains constant.
• Inelastic if your expenditure

on it increases.

67 Vedanta High School Economics - Book 9

B INCOME ELASTICITY OF DEMAND

Income elasticity of demand is the measure of the degree of responsiveness of quantity
demanded of a commodity due to change in consumer’s money income when other
factor remaining constant. It may be defined as the ratio of percentage change in the

quantity demanded of a commodity to a given percentage change in income. While

measuring income elasticity of demand, all influences on demand other than income are

held constant.
′
Income elasticity =

Or,eY ∆Q ×100
Q
= ∆Y The income elasticity for
Y ×100 normal good is positive while

∴ep= ∆Q x Y for inferior good or Giffen
∆Y Q good, the income elasticity is
negative
Where,

Y= original Income

Q= original quantity demanded

∆Y = small change in income (New income – Old income)

∆Q = change in quantity demanded.( New quantity – Old quantity)

Example: As consumer's money income increases from Rs. 1000 to Rs.3000, the quantity
demanded of good X increases from 100 units to 200 units. The coefficient of income
elasticity is calculated as:

Given, Initial Income (Y) = Rs. 1000 Initial quantity (Q1) = 100 units

New Income (Y1) = Rs. 3000 New quantity(Q1) = 150 units

Change in income (ΔY) = Y1 - Y = 3000 -1000= - 2000 Key Term

Change inquantity (ΔQ) = Q1 - Q = 150 -100 = 50 Neutral goods: goods whose
∆Q quantity demanded doesn’t
eY = ∆Y × Y = 50 × 1000 = 0.5 change with the change in
Q 2000
100

money income

Income elasticity may be either positive or negative or zero. It is positive for normal
goods, negative for inferior goods and zero for neutral goods like salt, matches.

C CROSS ELASTICITY OF DEMAND

Cross elasticity of demand is a measure of the degree KEY Related goods may be ei-
of responsiveness on quantity demanded of a IDEA ther substitutes or comple-
commodity due to change in price of related good when mentaries. If the two goods
other factors remaining constant. It may be defined as are not related, cross elastic-
the proportionate change in the quantity demanded ity beween them is zero.
of a particular commodity in response to a change in

the price of another related commodity. While measuring cross elasticity of demand, all

influences on demand other than price of related good are held constant. The formula for

cross elasticity of demand is:

Vedanta High School Economics - Book 9 68

Cross elasticity =

∆
×100 The cross elasticity for
substitutes is positive
Or, ec = ∆ ×100 while for complementa-
ries the cross elasticity
∆ x is negative
∴ ec = ∆


Where,

Qx= original quantity of good X
PY= original price of good Y
∆QX = small change in quantity (New quantity – Old quantity)
∆PY = small change in price of good Y ( New price – Old price)

Example: As price of coffee rises from Rs. 100 to Rs. 150, the gg demanded of tea increases
from 100 units to 150 units. The coefficient of cross elasticity is calculated as:

Given, Initial price of coffee (PY) = Rs. 100 Initial quantity of tea (QX) = 100 units

New price of coffee (PY1) = Rs. 150 New quantity of tea (Q1) = 150 units

Change in price of coffee (ΔPY) = PY1 - PY = 150 -100 = 50

Change inquantity (ΔQX) = QX - QX1 = 200 -100 = 100

SinecCe=th∆∆QPeYXc×roQPssYX = 100 × 100 =2
50 100
elasticity between two goods is positive, they are substitutes.

For substitutes like tea and coffee, the cross elasticity is positive; while for complementaryKeynote
goods like car and petrol, the cross elasticity is negative. If goods are not related at all, the
cross elasticity between them is zero.

• When the percentage change in the quantity demanded exceeds the
percentage change in price, demand is elastic.

• When the percentage change in the quantity demanded equals the
percentage change in price, demand is unit elastic.
• When the percentage change in the quantity demanded is less than the

percentage change in price, demand is inelastic.

FACTORS DETERMINING THE ELASTICITY OF DEMAND

The elasticity of demand depends upon the following factors:

1. Nature of the Commodity: If a commodity is of necessary nature, the price elasticity is very
low. For instance, the elasticity of demand for products such as medicine, cooking gas,
petroleum products, salt, etc. The opposite is true in the case of luxurious goods.

2. Availability of Substitutes: Commodities with no or few substitutes have low elasticity
of demand. On the contrary, commodities with a large number of substitutes have high
elasticity of demand.

3. Multiple Uses of a Commodity: If a commodity is has multiple uses, the quantity demanded
of it increases with the fall in its price as it is put into several uses. As such, its elasticity
of demand will be higher.

4. Habits of Buyers: Habit goods such as cigarettes, liquor, etc. have very low elasticity of

69 Vedanta High School Economics - Book 9

demand. The demand for such goods is not affected much by price change.

5. Income of the Buyers: For buyers belonging to higher income group, the elasticity of
demand for commodities will be lower. It is because high income group consumption
is not constrained by lack of purchasing power. The opposite is true in case of buyers
belonging to lower income group.

6. Time Factor: In the short run adjustment in consumption cannot be made. So the elasticity
of demand will be low. The opposite is true in case of consumption in long run.

7. Deferred Consumption: If consumption of goods can be postponed, then these goods have
high elastic demand.

8. Joint demand: Some goods are jointly demanded. For example, a car is jointly demanded
with petrol. If the demand for cars is less elastic, so is the demand for petrol and vice-
versa.

9. Proportion of Income Spent: If consumers spend only a small proportion of their income
on the purchase of a commodity, its demand is generally inelastic. For example, the
elasticity of demand for matchboxes, needles, salt, etc. is inelastic.

10. Price Range: Demand for a product is generally inelastic at very high and very low prices.
At a very high price of the product, its demand comes from the rich only for whom any
change in price does not make much difference. Similarly, at a very low price, any further
fall in the price does not cause much change in the quantity demanded. However, demand
is elastic within the moderate range of prices.

CHECKPOINT 1. Define elasticity of demand. What are the different types of elasticity of demand?
2. Define price elasticity of demand. What are the different types of price elasticity of
demand?
3. Make a list of elastic and inelastic demand.
4. What are the factors influencing the elasticity of demand?
5. How does the availability of substitutes affect the elasticity of demand? Explain.

3.7 ELASTICITY OF SUPPLY

Elasticity of supply refers to the degree of relationship between price of the commodity
and quantity supplied of it. It measures the degree of responsiveness of quantity
supplied of a commodity to a change in its price. More precisely, elasticity of supply is the

quantitative value resulting from a certain percentage change on quantity supplied due to

a certain percentage change in price. It can be calculated as follows:

Proportionate change in quantity supplied of a commodity
Elasticity of Supply = Proportionate change in price of the commodity

es = ∆Q ×100 = ∆Q x P Pause for Thought
Q ∆P Q
i.e. ∆P How does the elasticity of
P ×100 supply differ from elasticity
of demand?

Where,

P= original Price

Q= original quantity supplied

∆P = small change in price (New price – Old price)

∆Q = small change in quantity demanded.( New quantity – Old quantity

Vedanta High School Economics - Book 9 70

TYPES OF ELASTICITY OF SUPPLY

There are five types of elasticity of supply which may be Y
pointed out:

1. Perfectly Elastic Supply (teoS=an∞y):eIxftethnet quantity supplied Price of good X
of a commodity changes even without any
es=∞.
change in price of the commodity othen the supply is said
S S'

to be perfectly elastic. The horizontal supply curve in the

figure indicates such elasticity of supply. In such a case, O Quantity of good X X
Y S'
the coefficient of elasticity of supply is infinity. i,e, eS=∞.

2. oPferafeccotlmy mInoedlaitsyticreSmuapipnlsy(ceoSn=st0a)n:tIfwthheatqeuvaenrtimtyasyubpepltihede Price of good X

change in price of the commodity, the supply is said to be

perfectly inelastic. The vertical straight line supply curve

parallel to Y- axis shows such perfectly inelastic supply. In

such a case, the coefficient of elasticity of supply is equal

to zero. i,e, es = 0. O S X
Quantity of good X

3. Unitary Elastic Scuhpapnlgyes(eisn=1e)x:aIcft the quantity supplied Price of good X Y S'
of a commodity proportion to change
P2 •

in price of the commodity, then the supply is said to be (20)

unitary elastic. The supply curve in the figure shows such P1 •

a supply. In such a case, the coefficient of elasticity of (10) 1Q001
)S
supply is equal to one. i,e es=1. O 2Q002 X
Quantity

Y

4. oRfelaactiovmelmy oEdlaitsyticchSaunpgpeslym(eosre>t1h)a: nIf the quantity supplied S'
proportionately to the
Price of good X P2 •
change in price of the commodity, the supply is said to be (12) •

greater than one. The supply curve in the figure indicates P1
(10)

such a supply. In such a case, the coefficient of elasticity S

of supply is greater than one. i,e, es >1 O Q1 Q2 X
(100 (175 Quantity
of

)) X

5. Relatively Inelastic Supply (leess<s1 ): If the quantity supplied Y S'
of a commodity changes than proportionately to P •
Price of good X (2
change in price of the commodity, then the supply is said 02)

to be relatively inelastic. The relatively steeper upward P •

sloping supply curve in the figure shows such a supply. (1
In such a case, the coefficient of elasticity of supply is less 01)
S
than one. i,e, eS <1
Equilibrium: O baQ(01l1)0anQ(012c)3 eQduanXtity of X

Glossary A state in which opposing forces or influences are

Deffered: Postponed

Substitutes: Goods having the same uses

Complementaries: Goods which are used jointly

71 Vedanta High School Economics - Book 9

FACTORS DETERMINING THE ELASTICITY OF SUPPLY
The extent to which supply is elastic or inelastic depends upon a variety of factors which
are explained below:

1. The price of the commodity: It is the main determinant of supply. The quantity supplied
of a commodity varies positively with the price of the commmodity. For instance, a rise in
the price of good X will lead to a rise in quantity supplied of good X. This is because good
X is now more profitable and producers supply more of it.

2. Technical Progress: Technical progress means improvements in the performance of
machines and production methods. It increases efficiency in production and allows more
to be produced and supplied.

3. Prices of Related Goods: If prices of related goods fall, the Goods may be related ei-
seller of a given commodity offer more units in the market ther as substitutes or com-
even though the price of his product has not gone up. Opposite plementaries
will be the case when the price of related goods rises.

4. Perishable Nature of the Commodity: In case of perishable goods, the supply is inelastic
as they cannot be stored. Such products are not sensitive to price change due to their
perishable nature.Hence, an increase in price will not bring about a distinctive rise in the
quantity supplied.

5. Changes in Input Prices and Costs of Production: Movement in wages, prices of raw
materials, fuel and power, rents, interest rates and other factor prices affects the cost
of production. For instance, increase in wages paid to workers increases the cost of
production and reduces the profits of firms. Hence, firms will produce and supply less
goods.

6. Time Period: The elasticity of supply tends to be greater in the long run than in the short
run because it is easier to increase the amount produced when the firm has more time. It
may be difficult to change quantities supplied in response to a price increase in the short
run.

7. Price Expectations: When sellers anticipate a further rise in price, the current supply
tends to fall. If producers expect that there will be a rise in the prices of products in future,
they will cut down the present supply of their products. Opposite will be the case when
the sellers expect a fall in price.

8. Taxes and Subsidies: If tax is imposed by the government on the inputs of a commodity,
cost of production will go up. Supply will be reduced. When subsidy is given to the
producer, it will encourage them to produce and supply more. Subsidy means a part of
the cost of a commodity will be borne by the government.

CONCEPTS FOR REVIEW

Desire Effective Desire Demand
Demand schedule Demand curve Supply
Supply schedule Supply curve Law of Demand
Law of Supply Equilibrium Market
Demand Elasticity Perfectly elastic demand Perfectly inelastic demand
Price elasticity Income elasticity Cross elasticity

Vedanta High School Economics - Book 9 72

A COMPACT GLOSSARY OF ELASTICITY OF DEMAND

A relationship is When its Which means that
described as magnitude is

Perfectly elastic Infinity The smallest possible increase in price
causes an infinitely elastic large decrease
in the quantity demanded

Elastic Less than infinity The percentage decrease in the quantity
but demanded exceeds the percentage increase
Price Elasticity greater than 1 in price

Unit elastic 1 The percentage decrease in the quantity
demanded equals the percentage increase
in price

Inelastic Greater than zero The percentage decrease in the quantity
but less demanded is less than the percentage
than 1 increase in price

Perfectly inelastic Zero The quantity demanded is the same at all
prices

Income elastic Greater than 1 The percentage increase in the quantity
(normal good) demanded is greater than the percentage
Income Elasticity increase in income

Income inelastic Less than 1 The percentage increase in the quantity
(normal good) but greater than demanded is less than the percentage
zero increase in income

Negative income Less than zero When income increases, quantity
elastic (inferior demanded decreases
good)

Perfect substitutes Infinity The smallest possible increase in the price
of one good causes an infinitely large
increase in quantity demanded of the other

Cross Elasticity Substitutes Positive, less than If the price of one good increases the
infinity quantity demanded of the other good also
increases

Independent Zero The quantity demanded of one good
remains constant regardless of the price of
the other good

Complements Less than zero The quantity demanded of one good
decreases when the price of the other good
increases

MARKET MECHANISM - The doctrine of invisible hand

The concept of the “invisible hand” was coined by the Scottish Enlight-
enment thinker, Adam Smith. It refers to the invisible market force that
brings a free market Market Economy Market economy is defined as a
system where the production of goods and services are set according to
the changing desires and abilities of the market players.

73 Vedanta High School Economics - Book 9

WORKED OUT NUMERICAL PROBLEMS

Example 1. As price of the commodity falls from Rs. 10 to Rs. 5, the quantity demanded of good X
increases from 100 units to 150 units. Find the coefficient of price elasticity.

Solution:

Given, Initial price (P) = Rs. 10 Initial quantity (Q) = 100 units

New price (P1) = Rs. 5 New quantity(Q1) = 150 units

Change in price (ΔP) = P1 - P = 5 -10 = -2

Change inquantity (ΔQ) = Q1 - Q = 150 -100 = 50

eP = ∆Q × P = - 50 × 10 = 1 ( Negative sign is ignored)
∆P Q 5 100

Example 2. As consumer's money income increases from Rs. 1000 to Rs.3000, the quantity demanded

of good X increases from 100 units to 200 units. Find the coefficient of income elasticity.

Solution:

Given, Initial Income (Y) = Rs. 1000 Initial quantity (Q1) = 100 units

New Income (Y1) = Rs. 3000 New quantity(Q1) = 150 units

Change in income (ΔY) = Y1 - Y = 3000 -1000= - 2000

Change inquantity (ΔQ) = Q1 - Q = 150 -100 = 50

eY = ∆Q × Y = 50 × 1000 = 0.5
∆Y Q 2000 100

Example 3. As price of coffee rises from Rs. 100 to Rs. 150, the quantity demanded of tea increases from

100 units to 150 units. Find the coefficient of cross elasticity. How are the two goods related?

Solution:

Given, Initial price of coffee (PY) = Rs. 100 Initial quantity of tea (QX) = 100 units

New price of coffee (PY1) = Rs. 150 New quantity of tea (Q1) = 150 units

Change in price of coffee (ΔPY) = PY1 - PY = 150 -100 = 50

Change inquantity (ΔQX) = QX - QX1 = 200 -100 = 100

eC = ∆Q X × PY = 100 × 100 =2
∆P Y
QX 50 100

Since the cross elasticity between two goods is positive, they are substitutes.

KNOW YOUR ECONOMIST
Muhammad Yunus 1940–Present
Muhammad Yunus has done much for the economies of the
world’s poorer areas. Early in his career, Yunus discovered
that very small loans had a disproportionately positive impact
on a poor person. Loaning to poor people was a practice banks
were reluctant to subscribe to before Yunus’ work. The micro-
credit was born, now widely used in developing countries and
with the potential to alleviate poverty. Critics of microcredit
argue that the practice leaves the world’s poor in a debt trap.

Vedanta High School Economics - Book 9 74

GLANCING THE UNIT

Demand: Demand is the desire,willingness and Elasticity of Demand: Elasticity of demand is the
ability to pay for a commodity measure of the degree of change in the amount
demanded of the commodity in response to a given
Law of demand: The law of demand states that change in price of the commodity (or change in
other things remaining unchanged; the quantity consumer income or price of related goods)
demanded of a commodity varies inversely with
price of the commodity. There are three types of elasticity of demand:
1. Price elasticity of demand.
Why the law of demand operates? 2. Income elasticity of demand.
1. Income effect
2. Substitution effect 3. Cross elasticity of demand.
3. Increase use of a commodity
4. Law of diminishing marginal utility Price Elasticity of Demand : Price elasticity of
5. New consumers demand may be defined as the ratio of proportionate
change in the quantity demanded of a commodity
Main assumptions of the law of demand to a given proportionate change in price of the
1. No change in consumer’s money income commodity.
2. No change in taste and preference
3. No change in fashion Types or Degree of Price Elasticity
4. No change in consumer’s expectation
Depending upon the value of the coefficient of price
Supply: Supply is the quantity offered for sale by a elasticity, there are five types of price elasticity.
seller at a given price over aperiod of time They are explained below:
1. Perfectly Elastic Demand (eP=∞)
Law of supply: The law states that other things 2. Perfectly Inelastic Demand (eP=0
remaining the same, the quantity offered for sale 3. Relatively Elastic Demand (eP>1)
varies directly with price, i.e. the higher the price 4. Relatively Inelastic Demand (eP<1)
the larger is the supply, and vice versa.
5. Unitary elastic demand (eP=1)
Why the supply curve slopes upward? Income Elasticity of Demand: Income elasticity of
1. Profit consideration demand measures the degree of responsiveness of
2. Law of diminishing marginal returns quantity demanded of a commodity to change in
3. Shift of resources the consumer’s money income.
4. Change in the number of firms
Cross Elasticity of Demand: Cross elasticity of
Limitations of the law of supply demand measures the degree of responsiveness of
1. In applicable for agricultural goods quantity demanded of a commodity to change in
2. Not applicable for perishable goods price of related goods.
3. In case of future expectations
4. Fear of fashion out Elasticity of Supply: Elasticity of supply measures
5. Not applicable in rare items the degree of responsiveness of quantity supplied
6. Not applicable in stock clearance of a commodity to a change in its price.

Market Equilibrium Types of Elasticity of Supply
Market equilibrium is a state of perfect balance in 1. Perfectly Elastic Supply (es=∞)
the market brought about by the equality of 2. Perfectly Inelastic Supply (es = 0)
demand and supply 3. Unitary Elastic Supply (es=1)
4. Relatively Elastic Supply (es >1)
5. Relatively Inelastic Supply (es <1)

75 Vedanta High School Economics - Book 9

QUESTIONS FOR REVIEW

Very Short Answer Type Questions

1. Define demand.
2. What is meant by demand schedule?
3. State the law of demand.
4. What does the downward sloping demand curve indicates?
5. Define supply.
6. What is meant by market supply schedule?
7. State the law of supply.
8. Why does the supply curve slope upward to the right?
9. What is meant by market equilibrium?
10. what is meant by demand elasticity?
11. What is meant by price elasticity of demand?
12. What is meant by income elasticity of demand?
13. Define cross elasticity of demand.

Short Answer Type Questions
1. Distinguish between Price Elasticity of Demand and Cross Elasticity of Demand?
2. Explain the types of price elasticity of demand.
3. What are the reasons for the downward sloping demand curve?
4. What are the limitations of the law of demand?
5. What are the assumptions of the law of demand?
6. What are the exceptions to the law of supply?
7. Explain the types of elasticity of supply.
8. What are the reasons for the upward sloping supply curve.
9. Explain the concept of market equilibrium.
10. Explain the various degree of price elasticity of demand.
11. Explain the types of elasticity of supply.
12. What are the main assumptions of the law of supply?

Long Answer Type Questions

1. Explain and illustrate the law of demand. What are its exceptions?
2. Explain and illustrate the law of supply. What are its exceptions?
3. Define price elasticity of demand. Explain the types of elasticity of demand.
4. Define elasticity of supply. Explain the types of elasticity of supply.
5. Define market equilibrium. Explain the process of determination of market equilibrium.
6. What is meant by elasticity of demand? Explain the types of elasticity of demand.

Vedanta High School Economics - Book 9 76

4UNIT FACTORS OF PRODUCTION

Learning Objectives Weight: 28 Lecture Hours

On Completion of this unit the student will be

able to:

• Understand the meaning of production

• Explain the various factors of production and

their characteristics

• Understand division of labour; its merits and

demerits

• Define efficiency of labour and explain the

factors affecting it

• Explain the Malthusian and the Optimum Before you begin

theory of population

• Understand and explain the concept of Factors of production is an economic

capital formation term that describes the inputs used in

• Understand and explain the various forms of the production of goods or services The
factors of production are classified into
• business organization formation of joint four groups: land, labour, capital and
Explain the features and organization.
stock company

Very Short Type Short Type Long Answer Type Total Marks
1 1 1 16

77 Vedanta High School Economics - Book 9

4.0 FACTORS OF PRODUCTION

Production is a combined effort of various inputs like land, laboure, raw materials,
capital, machines etc. These inputs or resources called the factors of production
are the means by which goods and services are produced. These inputs are collectively

called factors of production. In traditional economic theory, the factors of production

are grouped into four headings: Land, labour, capital and

a. Land organization are the in-

b. Labour puts which are used in
c. Capital the production of all types
d. Enterprises or Organization of goods and services

4.1 LAND

In the general sense, land means the soil or the outer surface of the earth. But in
economics land refers to the free gift of nature which aids in production. It is not
simply the surface of the earth on which houses and factories can be built but is also

the natural resources which can be found on or below the surface. So land not only

includes earth surface but also hills, mountainous, rivers, minerals, air, light etc. Land

as a factor of production refers to all those natural resources or gifts of nature which

are provided free to man.

According to David Ricardo, “The concept of land applies to all those gifts of nature which man

uses in providing the things that satisfy his wants.” According

to Marshall, “By land it is meant not merely land in strict sense of the world, but whole of

materials and forces which nature gives freely for man’s aid in land and water, in air, light

and heat”.

In the light of above definitions land includes soil, mineral wealth fishes, air, sunlight,

oceans, streams, fertility of soil, rainfall etc. In short, whatever free gifts of nature we

find on earth surface, below and above it are within the category of land.

The following free gifts of nature are included under land:

• Natural things available on earth surface: forest, mountains, hills, rivers etc.

• Things available under the surface: minerals. Land refers to the natural re-

• Things available above the surface of the earth: air, sources that are on earth sur-

sunlight, heat etc. KEY face, above it and below it. It

Characteristics of Land IDEA comprises both renewable and
The following are the major characteristics of land. nonrenewable resources

1. Free gift of Nature: Land is a free gift of nature. Land is not the outcome of human

labour. Rather, it existed even long before the evolution of man.

2. Fixed Supply: The total quantity of land does not undergo any change. It is limited and
cannot be increased or decreased with human efforts. However, the supply of land for
a particular use can be increased or decreased.

3. Immobile: Land is immobile in nature. It cannot be transferred from one place to
another. But the products produced on land such as vegetable food grains etc can be
taken from one place to another.

Vedanta High School Economics - Book 9 78

4. Indestructible Power: There are some original and indestructible powers of land, which
a man cannot destroy. Its fertility may be varied but it cannot be destroyed completely.

5. Possibility of Improvement: The quality of land can be improved by human efforts.
Man can significantly increase the productivity of soil by applying fertilizers, irrigation,
advanced inputs etc

6. Passive Factor: Land is passive factors of production. This is because it cannot produce
anything by itself. For example, wheat cannot grow on a piece of land automatically.
To grow wheat, man has to cultivate land. Land should be mobilized by active agent of
production such as labour.

7. Primary Factor of Production: In any kind of production process, we have to start with
land. For example, in industries, it helps to provide raw materials, and in agriculture,
crops are produced on land.

8. Land Differs in Quality: All lands differ from each other in terms of their fertility. They
all are not equally alike. The difference in the qualities of land is due to various natural
factors such as soil composition, frequency of rainfall, climate, etc.

9. Land has Multiple Uses: Land can be used in various uses according to its situation and
form. It can be used to grow different types of crops, to make buildings, etc. on the same
Key Term
plot of land. Diminishing returns: a rate
of yield that beyond a certain
10. Subject to Diminishing Returns: Land is subject to

diminishing returns. As more and more units of labour point fails to increase in pro-
and capital are used on a same piece of the land, the portion to additional invest-
additional return from it decline gradually.
ments of labour or capital

4.2 LABOUR

Labour as a factor of production refers to the human effort that is used in the
production of goods and services. It includes all physical and mental efforts that are
made by employees during the production process. In economics, any activity carried
by a person with the motive of earning money is known as labour. Such activities can
be physical or mental.

According to Marshall, “By labour is meant the economic work of man, whether by the hand

or the head.”
The work done out of pleasure or hobby is not labour unless a reward is attached to it.
For example, teaching a child by a mother is not labour, but the same work done by a
tutor is labour. Labour is thus the work done by a person. It has the following elements:

a Labour is the work done by a person.Keynote

b The work or effort may be physical or mental.

c The work is done with a view of earning income.

• Land can be separated into renewable and non-renewable resources.
• Labour is the human resource providing time, effort and expertise which
individuals allocate to producing goodsand services.
• The supply of labour is all important and it is determined by the size of

the population
• Land is passive factor of production

79 Vedanta High School Economics - Book 9

Characteristics of Labour

Labour possesses certain characteristics which are as follows:
1. Active Factor of Production: All other factors of production like land, capital and

enterprise are passive factors of production and cannot be active on their own. Only
labour can make these factors active in the production process.

2. A Man’s Labour is a Part of Himself:: Labour cannot be separated from labourer. When
the labourer sells his labour he has to deliver it in person and he cannot sell his labour
like land and capital.

3. Most Perishable Factor: Labor is the most perishable factor of production because it
cannot be stored as other goods. The labour power withheld once is lost forever and
cannot be stored. It cannot be regained. As there is no stock, the labourer has to sell his
labour immediately irrespective of the price. Labour is a flow of service of labourer.

4. Less Mobility of Labour: As compared to capital and other goods, labour is less mobile.
Capital can be easily transported from one place to other, but labour cannot be transported
easily from its present place to other places. A labourer is not ready to go too far off
places leaving his native place. Therefore, labour has less mobility.

5. Weak Bargaining Power: Since labour is perishable in nature, Labor is the work done
the bargaining power of labourer is weak. If the labourer starts by a person with the
view of earning an in-
bargaining then there is a chance of waste of labour if he is come
thrown out of work or denied work.

6. Labour Ends with the Death of the Labourer: Other factor of production such as capital
and land can be used after the death of owners. But labour cannot be used after the
death of labourer. Labour dies along with labourer.

7. Labour is a Means as well as an End: Labour is not only meant for producing. The
labourers are fully entitled to use whatever they have produced. Being human the
labourers works for the satisfaction of their wants and their labour acts as the means to
achieve their ends i.e. their satisfaction.

8. Man not a Machine: Labourer is a living being. Every labourer has his own tastes, habits
and feelings. Therefore, labourers cannot be made to work like machines. Labourers
cannot work round the clock like machines. After continuous work for a few hours,
leisure is essential for them.

9. Inelastic Supply of Labour: The supply of labour is inelastic in a country at a particular
time. The supply of labour depends upon the size of population. Population cannot be
increased or decreased in the short run. So, the supply of labour is inelastic to a great
extent in the short run. However, the supply of labour for a particular use is elastic.

1o. Labour creates Capital: Capital, which is considered as a separate factor of production
is, in fact, the result of the reward for labour. Labour earns wealth by way of production.
We know that capital is that portion of wealth which is used to earn income. Therefore,
capital is formulated and accumulated by labour.

Glossary Immobile: Which cannot be moved from one place to another
Passive: Idle
Perishable: Likely to decay or go bad quickly
Inelastic supply: Which cannot be incresed or decreased

Vedanta High School Economics - Book 9 80

4.3 CAPITAL

Capital is a human-made resource which can be used in the production of goods and
services. It includes plant, machinery and factory buildings. It refers to that part of
man-made wealth which is used for the further production of wealth.

Capital can be divided into fixed and circulating capital. Fixed capital includes such

items as machinery and factories and can be used over a period of time. Circulating

capital, which is sometimes called working capital, includes the stock of raw materials,

partly finished products and all the finished products in the factory waiting to be sold.

An important point to remember when considering capital is that it does not refer to

money, for capital consists of real assets.

According to Marshall, “Capital consists of those kinds of wealth other than free gift of

nature which yield income”.
As such, capital may be defined as that part of a person’s wealth, other than land, which
yields an income or which aids in the production
of further wealth. Capital is a part of wealth.
However, if wealth is left un-

Characteristics of Capital KEY used or is hoarded, it cannot be
The major characteristics of capital are as follows. IDEA considered capital

1. Capital is Man made Factor: Capital is the result of human labour. Thus, every type of

capital such as roads, machines, buildings and factories etc. are produced by man. It is

a produced factor of production.

2. Passive Factor: Capital cannot produce without the help of the active services of labour.
To produce with machines, labour is required. Capital on its own cannot produce
anything until labour works on it.

3. Result of Saving: Capital is stored-up labour. By putting in his labour man earns wealth.
A part of this wealth is spent on consumption goods and the rest of it is saved. When
saving is invested, it becomes capital.
Pause for Thought
Can money, shares and
4. Capital is a Mobile Factor: Capital is a fully mobile securities be called capital?
factor of production. It can be easily transferred from Give reasons.
one place to another.

5. Capital Depreciates: The value of capital goes on depreciating. When machines are
used continuously for some time, these depreciate and their value falls.

6. A Part of Wealth: Since capital has all features of wealth viz. utility, scarcity,
transferability and externality, capital is a wealth but wealth doesn’t necessarily become
capital. All capital is wealth but all wealth is not capital.

7. Roundabout Production: Capital goods don’t satisfy our wants directly. But resources
should be diverted towards production of capital goods first. And thereafter such produced
means can be used to produce consumer goods having direct demand.

Keynote8. Supply of Capital is Elastic: Since capital is man made object and it can be increased
as required. So supply of capital is elastic in the long run.

• Capital is a produced means of production and is a man made factor
• Capital is a part of man’s wealth used in further production of goods
• Capital has been produced by man working with nature.
• Capital is stored up labour and is the result of saving

81 Vedanta High School Economics - Book 9

4.4 CAPITAL FORMATION

Capital formation refers to the increase in the amount of capital stock over time. It
is the increase in the amount of capital goods by investing in machine-equipment,
instruments, human services etc.

Capital formation is the process of building up the capital stock of a country through
investing in productive plants and equipments. It involves the increasing of capital assets
by efficient utilization of the available material and human resources of the country. It
refers to the increase in productive capacity of the economy over a period of time.

For a nation, capital refers to a wide range of fixed assets Key Term
such as ports, roads, railways, electricity, dams and so on. Human resources: the skill
Therefore, money spend on these projects in a particular knowledge and efficiency
inherent in the population
year is known as capital formation.
of a country
Process of Capital Formation

Capital formation involves three crucial steps. The three stages involved are discussed
below:

1. Creation of Savings: Savings are done by individuals and households. Business
enterprises save by retaining a part of them in the form of undistributed profits.
Individuals and households save by cutting down consumption.

2. Mobilization of Savings: Savings are mobilized by individual investors, banks,
investment trusts, insurance companies, finance corporations, governments, etc. A
well- developed capital market will ensure that the savings of the society are mobilized
and transferred to the entrepreneurs or businessmen who require them.

3. Investment of Savings: For savings to result in capital formation, they must be invested.

In order that the investment of savings should take place, there must be a good number

of honest and dynamic entrepreneurs in the country who are able to take risks and bear

uncertainty of production. Key Term
SOURCES OF CAPITAL FORMATION
There are two sources of capital formation. They are: Entrepreneur: one who
a. Internal Sources organizes, manages, and
b. External Sources assumes the risks of a busi-

A Internal Sources ness or enterprise

Internal sources of capital formation refer to accumulation of capital using internal
sources available within the country. The following are the methods of capital formation
from internal source.

1. Domestic Savings: In developing countries saving rate is low. Increase in voluntary savings
is to restrict domestic consumption. Rigorous enforcement of existing taxes allows the
government to force savings and reduce disposable income. But this method may increase
involuntary savings and diminish voluntary savings.

2. Optimum Utilization of Resources: In the developing countries there are many
resources which remain unutilized and underutilized. If they are properly tapped and
diverted to productive purposes, the rate of capital formation can increase rapidly.

3. Taxation: Taxation is the compulsory payment made by public to the government
without any expectation of direct benefit. Payment of tax, on one hand, discourages

Vedanta High School Economics - Book 9 82

unnecessary consumption and on the other hand, government collects more revenue
which can be utilized in various productive works.

4. Public Borrowing: Government borrows from the individuals, by selling them its
securities through central bank. The government issues long and short term bonds of
various denominations and mobilizes saving from the general public as well as from the
financial institutions.

5. Economy in Administrative Expenditure: Deficit financing is done by

Economies in administrative expenditure means the government to fill up deficit

reduction in expenditure. This helps to increase KEY in a budget. It helps in financ-
saving. More saving implies more capital formation. IDEA ing development projects

6. Deficit Financing: Deficit financing is regarded an important source of capital formation.
It refers to the issue of currency notes by the central bank. In the less developed countries,
it is used for generating savings by activating unemployed or underemployed resources.
But this process is not free from danger because it creates inflation.

7. Use of Hoardings:  A large proportion of rural population is literate and due to limited
banking facilities people keep their savings in the shape of hoardings. They also keep gold
and silver in the shape of ornaments for the sake of their dignity, pride and social status.
Such hoardings can be utilized for capital formation.

8. Removal of Disguised Unemployment: Removal of disguised unemployment in agriculture
is another way to increase capital formation. These unproductive workers can be employed
on projects like roads, irrigation and construction with Key Term
nominal amount of capital. A shift of labour from agricultural Disguised unemployment:
sector to industrial sector would result in capital formation. a situation where more peo-
ple are engaged tthan what
B External Sources is actually required

Capital accumulation from outside the country is known as external sources. The
methods of capital formation from external sources are:

1. Foreign Loans: Generally developed countries and international financial institutions
provide aid to developing countries for developmental works and for other long term
projects. If utilized properly foreign aid can be a major source of capital formation.

2. Foreign Grants: Foreign Grants are economic aid which carries no obligation to pay
back. Developing countries receive such grants from donor countries or other agencies
for developments works.

3. Foreign Investment: Investment of citizens of foreign countries is called foreign
investment. More foreign investment means capital inflow in the country. This helps
to increase capital formation inside the country.

4. Decreasing Consumer Goods Imports: Foreign exchange can be saved by decreasing
import of consumer goods and the saved foreign exchange can be used for the import of
industrial raw material, machinery and modern technology.

Disposable income: Income left after tax

Glossary Capital formation: Increase in productive capacity of the economy over time

Inflation: A sustained rise in the general levelof prices

Bond: Interest yielding financial asset

Foreign Grants: Foreign assistance with no obligation to pay back

83 Vedanta High School Economics - Book 9

IMPORTANCE OF CAPITAL FORMATION

The importance or significance of capital formation in the process of economic

development of a country is briefly given below. Vicious circle of poverty is

1. Breaking the Vicious Circle of Poverty: Developing KEY a situation of low level equi-
librium in which there is
countries are stuck in a low level equilibrium trap IDEA perpetuation of poverty
which leads to poverty perpetuation. Increase in rate

of capital formation helps to raise investment activity, fosters development thereby

increasing employment and income. This helps in breaking the vicious circle of poverty.

2. Building up of Sound Infrastructures: The foremost significance of capital accumulation
specially in its initial stages is that it promotes the establishment of social overheads in
developing countries as these countries need these infrastructures at a priority level. It
goes a long way in the development of basic capital goods in developing countries.

3. Use of Round-about Methods of Production: The process of capital formation makes

possible the use of roundabout or complex methods of production. It initiates the division

in different stages on the basis of modern techniques which leads to specialization.

This further leads to rapid growth in production. Key Term

4. Import Substitution: Capital formation helps in building Balance of trade: the
and expansion of import substitution industries. The difference between export

reduced demand of foreign goods helps in solving the earnings and import pay-
ments over a period of time
problem of adverse balance of trade.

4. Human Resource Development: Human capital formation depends on the people’s
education, training, health, social and economic security, for which sufficient capital
in needed. The expenditure incurred on human resource development contributes to
better health of the people and in increasing productivity of the country.

5. Proper Utilization of Natural Resources: Adequate volume of capital formation makes
it possible to utilize the natural resources of a country to the maximum extent and thus
increase the rate of economic growth.

6. Improvement in Technology: Capital formation creates overhead capital and necessary
environment for economic development. This helps to initiate technical progress. The
technological improvements help in getting more output from the given resources.

7. Agricultural and Industrial Development: Modern agricultural and industrial
development needs adequate funds for adoption of latest mechanised techniques,
input, and setting of different heavy or light industries. Without sufficient capital at
their disposal, leads to lower rate of development thus, capital formation.

8. Growth in National Income: Capital formation improves the conditions and methods
for the production of a country. Hence, there is much increase in national income and
per capital income. This leads to increase in volume of production which leads to again
rise in national income.

• Capital formation involves the conversion of savings into capital assetsKeynote
• Disguised unemployment is generally found in agriculture
• Capital formation serves as the base for development. Higher the rate of

capital formation, higher the level of economic development



Vedanta High School Economics - Book 9 84

4.5 ORGANIZATION OR ENTERPRISE

Organization or enterprise may thus be defined as a factor which brings together the
required factors of production, manage them in right proportion, make them work
harmoniously, determine remuneration and undertake risk and uncertainty in production
process. The person who takes the leadership of business activities is known as organizer
or entrepreneur.

Entrepreneur is the human resource that organizes land, labour, and capital to produce
goods and services. Entrepreneurs are creative and imaginative. They come up with
new ideas about what and how to produce, make business decisions,and bear the risks
that arise from these decisions. As such, entrepreneur is a unique factor of production
with no guaranteed reward. Its reward is profit which may be positive or negative. If their
ideas work out, they earn a profit. If their ideas turn out to be wrong, they bear the loss.

Characteristics of an Entrepreneur

A successful and ideal entrepreneur, should have certain qualities or skills as given

below: POINTS TO NOTE

a Risk taker • Organization, organizer

b Far sightedness and entrepreneur refer to the

c Quick decision capacity same factor of production

d Capable or intelligent • The person who takes the

e Patience leadership of business activi-

f Knowledge of human nature ties is known as organizer or

g Leadership quality entrepreneur.
h Laborious • Entrepreneurship is a hu-
i Honest
j Knowledge of the market man resource that organizes
labour, land, and capital to
Functions of an Entrepreneur
produce goods and services

The main functions of an entrepreneur are explained below:

1. Initiating Business Activity: He has to start the business activity by preparing a proper
plan. The plan should be detailed one covering all the aspects of the business.

2. Organizing the Factors of Production: The entrepreneur has to collect all the other factors
of production and combine them in the right proportion.

3. Decision Making: Business involves variety of decisions to be taken. The entrepreneur
has to decide about the nature of product, technology, price policy, advertisement strategy,
etc. A proper strategy has to be adopted by him to take the right decision.

4. Co-ordination: A business firm consists of a number of departments. He has to co-ordinate
various units effectively by having proper communication channels and supervision.

5. Innovations: According to Prof. Schumpeter, the true function of an entrepreneur is
introducing innovations. Innovations imply introduction of a new product, discovering
a new product, introduction of a new technology or new method of production etc.
Innovation involves risk.

6. Budgetting the business: The entire budgeting process is the responsibility of the
entrepreneur. He has to mobilize resources for the implementation of the business plan.

7. Risk and Uncertainty Bearing: Risk and uncertainty bearing is one of the unique functions
of an entrepreneur. While risks are insurable, uncertainties cannot be insured. While
facing these uncertainties entrepreneur may get profit or may incur loss.

85 Vedanta High School Economics - Book 9

4.6 FORMS OF BUSINESS ORGANIZATION

Forms of the business organization depend on the criteria like the nature of the
business, size of operations and on many more things. The main forms of business
organization are:
1. Sole Proprietorship or Individual Enterprise Key Term

2. Partnership, and Unlimited liability: a lia-

3. Joint Stock Company bility of a business tied up
4. Cooperative Organization to personal property of the
5. Public Enterprises entrepreneur

6. Multinational Company

4.6 SOLE PROPRIETORSHIP OR INDIVIDUAL ENTERPRISE

As the name suggests, ‘sole’ means ‘only one’ and ‘proprietorship’ implies ‘ownership’.
Hence, a sole proprietorship is a form of business organisation, wherein a single
person owns, manages and controls, all the business activities and the individual who

operates the business is called as a sole proprietor or, a sole trader. This type of business

is owned by a single person so it is also known as sole trading concern.
According to L.J. Gilman – “Partnership is a business owned by two or more than two
persons and operated for profit”.


In individual enterprise, all profits and losses are borne by the owner. There is unlimited

liability in this type of business. This type of business is usually run with the help of

family members. All decisions related to production, distribution and use of profit are

carried out by the owner himself.

Features of an Sole Proprietorship

The important features of a sole-proprietary organization include the following:

1. Single Ownership: It is a type of business unit, in which a single person owns the entire
business, i.e. all the assets and property belongs to the proprietor. Accordingly, he bears
all the risk associated with the enterprise.

2. Risk Bearing: The proprietor is the sole beneficiary of profits in this form organization. If
there is a loss he alone has to bear it. The risks are not distributed.

3. Management and Control: Management and control of this type of organization is the
responsibility of the sole proprietor. He may, however, employ a manager or other people
for the purpose.

4. Minimum Government Regulations: The government does not interfere with the working
of the sole proprietorship organization. However, they have to comply with the general
laws and rules laid down by government.

5. Unlimited Liability: The sole proprietor has to bear the losses and is responsible for the
liabilities of the business. If the business assets are not sufficient to meet the liabilities, he
may also have to sell his personal property for that purpose.

6. Secrecy: All important decision are taken by the owner himself. He keeps all the business

secrets only to himself.

Glossary Innovation: A new idea, creative thoughts, new imaginations in form of method

Enterprise: A business organization

Proprietor: Owner

Liabilities: An obligation to, or something that you owe somebody else

Vedanta High School Economics - Book 9 86

ADVANTAGES OF INDIVIDUAL PROPRIETORSHIP
The advantages of sole proprietorship are discussed below:

1. Easy to Establish: The formation of sole proprietorship business is very easy and
simple. No legal formalities are involved for setting up the business excepting a license
or permission in certain cases. The entrepreneur with initiative and certain amount of
capital can set up such form of business.

2. Sole Authority. The owner of the business has complete authority to deal with the

affairs of business. He prepares the plain, invest his money, supervise the business and

enjoy the profit. There is incentive for hard

3. Encouragement to Hard Work: The owner has sole right in work as profits don’t have to
all profit as well as full responsibility in loss. So he works be shared
hard in the business.

4. Low Cost to Operate: Establishment cost of this type of business is low. The sole
proprietor does not appoint any specialists for various functions. He personally
supervises various activities and can avoid wastage in the business.

5. Direct Relationship with Customers. A sole trader has close relation with his customers.
Therefore, he offers everything according to the taste of the customers. This creates his
goodwill in the market.

6. Business Secrecy: A sole trader being the owner of the business has high standard of
secrecy due to their own managing of the affairs of the business. It is easy to maintain
secrecy as there is no need to share decisions with others.

7. Easy Dissolution: In proprietorship business, the entrepreneur is all in all. As there
are no co-owners or partners, therefore, there is no scope for the difference of opinion
in the case the proprietor/entrepreneur-wants to dissolve the business. It is due to the
easy formation and dissolution, proprietorship is often used to test the business ideas.

8. Flexible Management: The sole proprietor make prompt decision, in carrying out
policies, changes the methods of production, reducing or increasing the prices, of the
commodities, delegating responsibilities etc.

ADVANTAGES OF INDIVIDUAL PROPRIETORSHIP
The disadvantages of sole proprietorship are discussed below:

1. Unlimited Liability: Proprietorship is characterised by unlimited liability also. It
means that in case of loss, the private property of the proprietor will also be used to
clear the business obligations. Hence, the proprietor avoids taking risk.

2. Limited Resources: A proprietor has limited resources at his command. The proprietor
mainly relies on his funds and savings and, to a limited extent, borrowings from
relatives and friends. His own capital may be limited and his personal assets may
also be insufficient for raising loans against their security. This reduces the scope of
business growth.

3. Low Bargaining Power: The sole trader is the in the receiving Because of unlimited li-
end in terms of loans or supply of raw materials. He may ability the personal prop-
have to compromise many times regarding the terms and erty of the proprietor is tied
conditions of purchase of materials or borrowing loans from up to the debt of the firm
the finance houses or banks.

87 Vedanta High School Economics - Book 9

4. Jack-of-all Trade: In single handed business, owner is a jack-of-all trade. He has to
make all types of decisions by himself. Sometimes the decision may not be fruitful to
the organization.

5. More Competition: Because it is easy to set up a small business, there is a high degree
of competition among the small businessmen and a few who are good in taking care of
customer requirements alone can survive.
Pause for Thought
6. Limited Managerial Ability: In this type of business,
the proprietor has to rely their own skill and A sole proprietorship is a
great incentive to work hard
managerial experience. Due to lack of adequate and yet it has its own limita-
relevant knowledge, the decisions taken by him can be tions. Give reasons.
imbalanced. This limits the size of the business.

7. Lack of Specialization: The services of specialists such as accountants, market
researchers, consultants and so on, are not within the reach of most of the sole
traders.

8. Limited Life of Enterprise Form: The life of a proprietary enterprise depends solely
upon the life of the proprietor. When he dies or becomes insolvent or insane or
permanently incapacitated, there is very likelihood of closure of enterprise.

4.7 PARTNERSHIP

Partnership is an association of persons who agree to combine their financial resources
and managerial abilities to run a business and share profits in an agreed ratio. It
may well be defined as an association of persons who agree to combine their financial
resources and managerial abilities to run a business and share profits in an agreed
ratio. The minimum number of partners in a partnership is two.

According to L.H. Haney, “Partnership is the relation between persons competent to make
contract who agree to carry on a lawful business in common with a view to private gain”
Partnership is a business organization where like-minded persons with resources come
together to do the business and share the profits/losses of the business in an agreed ratio.
Persons who have entered into such an agreement are individually called ‘partners’ and
collectively called ‘firm’. The relationship among partners is called a partnership.

LIMITED PARTNERSHIP AND UNLIMITED PARTNERSHIP

A. LIMITED PARTNERSHIP:

It is a partnership in which two or more partners agree to conduct a business jointly,
and in which one or more partner is liable only to the extent of the amount of capital
he has invested. Such partner has limited liability. A limited partnership allows each
partner to restrict his or her personal liability to the amount of his or her business
investment.

At least one partner must accept general partnership status, exposing himself or herself

to full personal liability for the business’s debts and obligations. The general partner

retains the right to control the business, while the limited partner does not participate

in management decisions. A limited partner has no A general partner has un-

role in business management and decision making limited liability and is an ac-

and is called ‘dormant partner’ KEY tive partner while a dormant
IDEA partner has limited liability

Vedanta High School Economics - Book 9 88

B UNLIMITED PARTNERSHIP:

It is an arrangement by which partners conducting a business jointly have unlimited
liability, which means their personal assets are liable to the partnership’s obligations.
It is also called General Partnership.

Each partner represents the organization and has equal right to participate in the

management, decision making and control of the business. In terms of risks and returns,

the assumption is that profits are distributed equally and liability is shared equally.

If the business is unable to meet any financial obligations or settle any outstanding

liabilities, the owner’s personal assets can be seized to Key Term

settle the debts. Partnership deed: a doc-

Features of Partnership ument which contains the
terms and conditions of a
partnership
The features of partnership are as follows:

1. Two or More Persons: There must be at least two persons to form a partnership. A
person cannot enter into partnership with himself.

2. Existence of an Agreement: Partnership is the outcome of an agreement between
persons. The terms and conditions of partnership are laid down in a document known
as Partnership Deed.

2. Engagement in Business: A partnership can be formed only for the purpose of carrying
on a business. An association of persons who jointly own a house without carrying on
a business is not partnership.

3. Sharing of Profits and Losses: There can be no partnership without the intention of
mutual gain. The profits must be distributed among the partners in an agreed ratio.
Similarly, losses should be shared among the partners.

4. Unlimited Liability: Every partner is liable to an unlimited extent for the debts of the
partnership firm. In case the assets of the firm are insufficient to pay the debts in full,
the personal property of each partner can be attached to pay the creditors of the firm.

5. Agency Relationship: Every partner is an implied agent of the other partners and of the
firm. Each partner is an agent of other partners. The business is carried on by all or any
one of them acting on behalf of all other partners. Every partner can bind the firm by
his acts.

6. Common Management: Every partner has a right to take part in the running of the
business. It is not necessary for all partners to participate in the day-to-day activities of
the business but they are entitled to participate.

7. Restriction on Transferability of Share: A partner cannot transfer his share in business
to an outsider without the consent of all other partners. This is because the partnership
agreement is based on contract among individuals.

8. Duration: The existence of the partnership firm continues at the pleasure of the partners.

Legally of partnership comes to an end, if any partner dies or becomes insolvent or

retries.The remaining partners may agree to continue the business under the original

firm’s name after settling the claims of the outgoing partner.

Glossary Dormant partner: Idle partner or sleeping partner with no active role in management

Deffered: Postponed

Substitutes: Goods having the same uses

Complementaries: Goods which are used jointly

89 Vedanta High School Economics - Book 9

ADVANTAGES OF PARTNERSHIP

The following are the major advantages of partnership business.
1. Easy Formation and Dissolution: This business can be established at any time by presenting

the paper of agreements to register it. Not many legal and bureaucratic formalities are
involved.

2. Pooling of Financial Resources: Partnership commands more financial resources compared
to sole proprietorship. This helps in expanding business and earning more profits. As
and when a firm requires more money, more partners can be admitted.

3. Large Scale Production: Large amount of capital investment will be possible in the
partnership, which is used in production process. So, large scale production is possible in
this business.

4. Pooling of Managerial Skills: As there are more than one owners in partnership, all the

partners are involved in decision making. Usually, partners are pooled from different

specialised areas to complement each other. This leads to greater efficiency in business

operations. With risks being spread bold

5. Diffusion of Risk: The losses of the firm are shared by all decisions can be taken for
the partners as per their agreed profit-sharing ratios. There business expnsion
is division of risk. So risky ventures can also be taken up.

6. Flexibility: Like proprietorship, the partnership business is also flexible. The partners
can easily appreciate and quickly react to the changing conditions. Changes in the
business can be adopted easily.

7. Better Management: Due to more number of partners in this business there will be better
management because partners will work properly and with mutual understanding.
Views of all partners and their presence helps for better management.

8. Loan facility: Due to unlimited liabilities with the partners any individual or institutions

will not hesitate in providing loan to partnership business. Such business is trusted by

banks and financial institutions. Key Term

9. Application of Division of Labour: Different partners have Division of labour: the act
different abilities in different sector. Different partners of splitting a work into sever-
can take up different responsibility. They handle different al specialized processes

departments according to their skill and efficiency.

10. Personal Contact with Customers: There is scope to keep close monitoring with customers
requirements by keeping one of the partners in charge of sales and marketing. Necessary
changes can be initiated based on the merits of the proposals from the customers.

DISADVANTAGES OF PARTNERSHIP
The disadvantages of partnership business are as follows.
1. Unlimited Liability: Due to unlimited liability of this business partners hesitate to

invest sufficient capital. The creditors of a firm can recover their loan amounts from the
personal properties of the partners when the firm’s sources are not enough. Therefore
the personal properties of the partners are not safe.

2. Lack of Secrecy: In partnership business all decisions should be made known to all
the partners. It may not be possible to maintain secrecy in partnership because of the

Vedanta High School Economics - Book 9 90

number of partners. So, there will be possibility of leakages of secrets of the business.

3. Uncertainty of Existence: The existence of a partnership firm is very uncertain. The
retirement, death, bankruptcy or lunacy of any partner can put an end to the partnership.
Further, the partnership business can come to a close if any partner demands it.

4. Delay in Decisions: Quick and prompt decisions may not Key Term

be possible in a partnership. As opinions of all partners Bankruptcy: being unable to

are required before making a decision there will be delay pay off debts or become in-
in making decisions. As a result, there will be lack of quick solvent

decisions.

5. Risks of Disharmony: In partnership, there may arise situations when some partners may
adopt rigid attitudes and make it impossible to arrive at a commonly agreed decision. Lack
of harmony may paralyze the business and cause conflict and misunderstanding.

6. Difficult to Close Down: Partnership business is very difficult to close down because
all partners should give consent to close down. If all partners do not agree to close the
business partnership business will not be dissolved.

7. Lack of Institutional Confidence: A partnership business does not enjoy much confidence
of banks and financial institutions. As a result large financial resources cannot be raised
by partnership and growth of business cannot be ensured.

8. Frozen Investment: Since a partner cannot sell or transfer In a partnership ownership-
his stake to any other person without the agreement of all cannot be transferred with-
other partners, his investment is almost frozen. If only one out the consent of other exist-
partner opposes transfer of ownership then transferring of ing partners
ownership is not possible.

9. Lack of Capital: More partners mean more capital. However, if any partner oppose to
add additional capital or take loan then it will not be possible to increase capital. So,
there will be lack of capital in this business.

10. Possibility of Misunderstanding: As people are motivated by selfish feelings there
will be high possibility of misunderstanding between the partners. Misunderstanding
between partners may lead the business to close down.

Ceteris Paribus Pause for Thought
This Latin term is widely used by econo-
mists to refer to a situation where ‘other • How does a limited
things remain equal’. The idea behind this partnership differ from
is to be able to simplify an actual situa- unlimited partnership?
tion by assuming that apart from a single
change of circumstances, everything else • What is a partnership
is unchanged. In this way, economists can deed? What are usually
model one change at a time. included in a partner-
ship deed?

CHECKPOINT 1. What are the factors influencing the efficiency of labour?
2. Why is an entrepreneur a unique factor of production? What are the essential
qualities of an entrepreneur?
3. Explain the process of capital formation. How does capital formation help in the
economic development of a developing country like Nepal?

91 Vedanta High School Economics - Book 9

4.8 JOINT STOCK COMPANY

Ajoint stock company is defined as a voluntary association of persons having
separate legal existence, perpetual succession, a common seal and capital divided
into transferable shares. It is a modern form of business organization established
by registering according to Company Act with the objective of earning profit.

Prof. L.H. Haney - “A Joint Stock Company is a voluntary association of individuals for
profit, having a capital divided into transferable shares, the ownership of which is the condi-
tion of membership.”
James Stephenson - “An association of many persons who contribute money or money’s
worth to a common stock and employ it in some trade or business, and who share the profit
and loss (as the case may be) arising therefrom.”

As per the definition, there must be a group of persons who voluntarily agree to form a
company. Once formed, the company becomes a separate legal entity with a distinct name
of its own. Its existence is not affected by change of members. It must have a common seal
to be imprinted on documents whenever required. The capital of a company consists of
transferable shares, and members have limited liability.

TYPES OF JOINT STOCK COMPANY

On the basis of number of members a joint stock company is of two types:

1. PRIVATE LIMITED COMPANY: A private limited company is a voluntary association of

not less than one and not more than fifty members. Its liability is limited and the transfer

of shares is limited to its members. POINTS TO NOTE

Features of Private Limited Company • In Private Limited Compa-
a. It has an independent legal existence.  ny shares cannot be advertised
and offered for sale to
b. The liability of its members is limited.
the general public.

c. The number of shareholders should be minimum 1 and • In Public Limited Company
maximum 50. shares can be advertised and
sold to the general public

d. Shares are not marketable in the stock exchange. • In both Private Limited Co-
e. The shares are also not freely transferable mapny and Public Limited
Company shareholders have

f. The shares and debentures are not open to the general limited liability

public.

2. PUBLIC LIMITED COMPANY: A public limited company is a vountary association of

members which is incorporated and, therefore has a separate legal existence and the

liability is limited. There should be a minimum of seven members and maximum is not

specified. The earliest records of joint
Features of Public Limited Company stock company can be found in

a. The company has a separate legal existence China during the Song Dynasty
(960–1279)
b. Its formation, operation and dissolution, are

strictly governed by laws, rules and regulations. 

c. A company must have a minimum of 7 members but there is no limit as regards the
maximum number.

d. The company collects its share capital by the sale of its shares.

e. The shares of a company are freely transferable.

f. The liability of a shareholder is limited to the face value of his shares

Vedanta High School Economics - Book 9 92

Characteristics of a Joint Stock Company

The following are the characteristics of a joint stock of company

1. Artificial Person: A joint stock company is a legal entity created by the statutes of law.

Like a natural person, it can do certain things, like own property in its name, enter into

a contract, borrow and lend money, sue or be sued, etc. It is also granted certain rights

by the law which it enjoys through its board of directors.

2. Incorporation: For a company to be recognized as a separate legal As an artificial person,
entity and for it to come into existence, it has to be incorporated. all transactions can be
Not registering a joint stock company is not an option. Without done on the name of
the company
incorporation, a company simply does not exist.

3. Voluntary Association: It is completely a voluntarily established association. Members
who are interested can be involved and who are not interested need not apply.

4. Separate Legal Entity: As soon as the joint stock company is incorporated it has its
own distinct legal identity. It is established and operated according to the Company Act
of the country.

5. Limited Liability: The share-holders of the company have limited liability. The liability

of a sharehoder is limited only to the extent of his share capital. The personal assets of

a member cannot be liquidated to repay the debts of a company.
Key Term
6. Transferability of Shares In a joint stock company, the
ownership is divided into transferable units known as Limited liability: liability of
shares. In case of a public company the shares can be a shareholder limited only to
the face value of his shares
transferred freely, there are almost no restrictions.

vi. Perpetual existence: The joint stock company is born out of the law, so the only way for
the company to end is by the functioning of law. The retirement or death of a director
or any other shareholder will not lead to the closure of the company. The company
continues its existence.

vii. Common Seal: The company has its own seal which is legal. Its day-to-day functions
are conducted by the board of directors. When a company enters any contract or signs
an agreement, the approval is indicated via a common seal.

Formation of a Joint Stock Company The promoters of a JSC are

The process of formulation of a joint stock company KEY the founders of the company,
are explained below: IDEA they concieve the business plan
and initially sit as the board of

1. Stage of Promotion directors

In this stage, individuals who are eager to form the company meet to have a discussion
on it. They plan about the company and estimate the required capital. They are called
promoters of the company.

2. Stage of Incorporation

In this stage, Memorandum of Association and Article of Association are prepared.
Memorandum of Association contains the name of the company, its head office, aims
and objectives, amount of authorized capital and a declaration of limited liability.
Articles of Association furnishes the bye laws or internal rules governing the internal
conduct of the company. They are submitted in the company registrar office with
application. After proper investigation, the concerned office gives the certificate of
incorporation of the company.

93 Vedanta High School Economics - Book 9

A private company need not obtain the certificate of commencement of business.

It can start its commercial operations immediately after obtaining the certificate of

incorporation. Certificate of incorporation is a
legal document issued by the com-
3. Stage of Arranging Capital

After obtaining the certificate of incorporation, a KEY pany registrar which certifies that the
joint stock company mobilizes capital by floating IDEA company is registered to trade

the following types of shares:

a Ordinary Share: Ordinary share holders receive the share of profit of the company
only after the profit has been distributed to preference share holders. This type of
share holders will not get any profit if the company fails to earn profit.

b. Preference Share: The share that receives dividend from the profit earned prior
to ordinary share is known as the preference share. If the company is closed
down then the preference share holder will have the first right than ordinary
shareholders. Preference shares are of two types: Cumulative preference shares and
non - cumulative preference shares. The rate of profit for cumulative preference
shareholders is fixed. While non- cumulative preference shareholders will receive
profit only if the company earns profits.

c Deferred Share: This type of share holders will get the share of profit only after the
profit has been distributed to preference share holders and ordinary share holders.
Such shares are usually retained by the promoters.

4. Stage of Starting Business

When all the above conditions are fulfilled, the concerned office gives the certificate of
commencement of business to run the company.

Glossary Dividend: Distributed profit
Promoters: Founders of the company
A long-term security yielding a fixed rate of interest
Debenture Obligation to pay
Liability:

ADVANTAGES OF A JOINT STOCK COMPANY
The main advantages of a Joint Stock Company are as follows:
1. Large Capital: A joint stock company has the ability to collect large amounts of capital by

issuing shares to the public. In a public limited company there is no limit of shareholders.
This advantage helps the company to collect huge amount of capital from large number of
shareholders. Furthermore, the company can raise capital to a large extent through issue
debenture to public.
2. Limited Liability: The liability of shareholders is limited to the amount they have invested
in the business. It means their personal property remains safe in case of bankruptcy. This
advantage encourages large number of investors to invest in the business.

Limited liability implies that the liability of a shareholder’s to company debts is limited only to the
amount of his share capital invested
3. Transferability of Shares: The shares of the company are easily transferable. A
shareholder can convert his holding into cash by selling his shares at any time in the
stock exchange. This brings liquidation of investment.
4. Durability and Stability: A joint stock company enjoys continuous existence and
stability. The funds invested in a company by shareholders are generally not withdrawal

Vedanta High School Economics - Book 9 94

until it is wound up. As a result of this, a company can undertake projects of long
duration and attract people to invest in the business of the company.

5. Growth and Expansion: With the large resources at its command a joint stock company
can organize business on a large scale. Once the
business is started on a large scale, it gives the company Pause for Thought
strength to grow and expand. This is because of high How is a Joint Stock Com-
profits, which accrue from the economies of large-scale pany formed in Nepal? Point
organization and production. out its merits and demerits.

6. Efficient Management: Since a joint stock company
undertakes large-scale activities, it requires the services of expert professional managers.
Competent managers can be easily hired by a company because it commands large
financial resources. Thus, efficient management is ensured in a company organization.

7. Public Confidence: A joint stock company enjoys great confidence and trust of the
general people. Companies have to disclose the results of their activities and financial
position in the annual reports. The reports are available to the public. It is on the basis
of the annual reports and other information that investment is made in companies.

8. Democratization of Management: In a joint stock company, management of the
business is entrusted to the board of directors which are the elected representative of
shareholders. As a result of democratic management the business of company is run in
the best interest of the majority shareholders.

9. Dispersal of Ownership: Since a large number of persons are associated with a company
as members, its ownership is widely held. Thus the benefits of the company’s
operations are distributed among a large section of people.

10. Assumption of Social Responsibilities: Large companies often undertake and
contribute to social welfare activities by making donations to schools and colleges,
developing rural areas, running health-care institutions, and so on.

Keynote • A Private Limited Company needs not obtain the Certificate of Com-
mencement of Business

• Preference shareholders have first priority in company profits

• Deferred shares are usually retained by the promoters.

DISADVANTAGES OF A JOINT STOCK COMPANY

The main disadvantages of a Joint Stock Company are as follows:
1. Lengthy and Expensive Legal Procedure: The registration of a company is a long-drawn

process. A number of documents are to be prepared and filled. For preparing documents
experts are to be hired who charge heavy fees. Besides, registration fees have also to be
paid to the Registrar of Companies.
2. ExcessiveGovernmentRegulations:Acompanyissubject to government regulations at every
stage of its working. A company has to file regular returns and statements of its activities
with the Registrar. There is a penalty for non- compliance of the legal requirements. All
this reduces flexibility in operations.
3. Lack of Incentive: The Company is not managed by shareholders but by directors and
other paid officials. Officials do not have investment in the company and also do not bear
the risks. As such, they may not be as much motivated to safeguard the interests of the
company as the shareholders.

95 Vedanta High School Economics - Book 9

4. DelayinDecision-makingandAction:Inlarge companies the individual managers have to
consult others which may take a lot of time. Similarly, after decisions are taken, they have
to be communicated to people working at various levels.It also delays the implementation
of the decision.

5. Conflict of Interest: The Directors are responsible for decision making in a joint stock
company. The decision taken by the board of directors may not suit the general interests
of the shareholders. In such a situation, the business is bound to suffer in course of time
unless there is a reconciliation of interests of the directors and general shareholders.

6. Undemocratic Management: The company management may seem to be fully democratic,
but in actual practice, it is the worst form of oligarchy i.e. control by a small group of
persons. Initially the promoters are elected as directors of the company. They adopt
various means to get themselves re-elected over and again.

7. Lack of Secrecy: A Joint Stock Company has to publish its account in yearly meeting of
shareholders and audit its account. Thus, several statements like legal process, management
situations etc. become known to other persons. So, there is lack of secrecy in a joint stock
company.

8. Speculation: A joint stock company provides scope for speculation in shares by the
directors. Because directors have knowledge of all information about the functioning of
Company, they can use it to their personal advantage. For example, directors may sell or
buy shares knowing that prices will decline or go up because of low or high profits. As a
result of this, innocent shareholders may suffer loss.

9. Growth of Monopolistic Tendencies: Because of its large size a joint stock company has
the tendency to grow into a monopoly so as to eliminate competition, control the market
and charge unreasonable prices to maximize profits.

10. Influencing Government Decisions: Big companies are generally in a position to
influence government officials to make decision in their favour. This is because such
companies have large financial resources and are in a position to bribe even high officials.

CHECKPOINT 1. Write the process of formation of a Joint Stock Company.
2. Distinguish between Private Limited Company and Public Limited Company.
3. What are the main features of a Joint Stock Company?
4. What are the main advantages of a Joint Stock Company?

4.9 PUBLIC ENTERPRISES

The term public enterprise, as a business entity, refers to any industrial or commercial
undertaking which is owned and managed by the central, state or local government
and of which the output is marketed i.e. not supplied free. Public enterprises include
manufacturing, trading as well as service organisations which are essentially business
undertakings.

According to L.H. Hansen, “ A public enterprise means state ownership and operations of
industrial, agricultural and commercial undertakings (enterprises).”

Therefore, the enterprises owned, managed and operated by the government with definite
objectives are called public enterprises.

Nepal accorded high priority to PEs since the Second Plan. They were seen as a vehicle
for development. They were envisaged as an instrument for production and for execution
of socio-economic policies in the country.

Vedanta High School Economics - Book 9 96

Features of Public Enterprises

1. State Ownership: Public enterprises are owned and managed by the government or

agencies set up by the government. Pause for Thought

2. Government Financing: The whole or major part of the How would you rate the
capital required for the public enterprises is provided by performance of public enter-
prises in Nepal?
government.

3. Government Body: A public enterprise can be organised as a departmental undertaking or
as a statutory corporation or as a government company.

4. Service Motive: Public enterprises are governed by public policies laid down by the
government in the public interest and are not entirely guided by profit motive.

5. Public Accountability: Their objectives are laid down in conformity with the development
plans. They are accountable to the government for their performance and fulfillment of
objectives.

6. Autonomous Bodies: Public enterprises are autonomous or semi autonomous government
bodies working under the control of government departments or government bodies.

Differences between Private Enterprises and Public Enterprises.

Headings Private Enterprises Public Enterprises
Formation
Membership Formed by private individuals Formed by the government

Control Private members are shareholders Publicc enterprises have no
shareholders
Share of Profit
Controlled by board of directors Controlled by board of directors
Financing
elected by the shareholders approved by the government

Dividends are shared among All profits go to the state
shareholders

Financed by members contribution, Financed through capital provided by

ploughback or borrowings taxation, borrowings

IMPORTANCE OF PUBLIC ENTERPRISES

The importance of public enterprises in Nepal may be explained as:
1. Planned Development: The main aim of public enterprises is to promote economic and

social development. It helps to run all developmental works in an efficient manner. It
follows government plans and policies and provides planned development by setting up
industries too.

2. Balanced Development: Development works are done in a planned and balanced way.
Public enterprise provides decentralization of industries. It tries to develop all regions in
harmonious ways. Balanced development is the main aim of public enterprise.

3. Accelerating the Rate of Economic Growth: Developing countries strive to accelerate the
rate of economic growth. Public enterprises provide infrastructural facilities for economic
development. It provides employment opportunities. Amount of capital, technical
empowerment and other facilities can be easily arranged by the government.

97 Vedanta High School Economics - Book 9

4. Public Utilities: Public enterprises provide the utility of transportation, water supply, ,
electricity, communication, education, health facilities and so on to the general public.

5. Supply Essential Goods and Services: Public enterprise provides goods and services to
the public at reasonable price. The government helps in manufacture and distribution of
goods. These types of services are not done for earning profit.

6. Provide Job Opportunities: Public enterprises help to create the employment opportunities
in the society and work as the model employer. They help in uplifting the living standard
of the people.

7. Reducing Economic Inequality: Public enterprises help to develop different regions of
the country. This helps to remove economic inequality and therefore, maintains living
standard of the general public.

8. Promotion of Social Welfare: Public enterprises help in planned and balanced development
of the country. They are established for the supply of essential goods and services. They
help in providing job opportunities to people and thus help in reducing economic
inequality thereby promoting social welfare.

PROBLEMS OF PUBLIC ENTERPRISES IN NEPAL

The major problems faced by public enterprises in Nepal are as follows:
1. Interference: Intereference is a main problem of management in Nepal. Government

and political leaders interfere in the management of public enterprises in Nepal. Such
interference is found in managerial functions like planning, organizing and controlling.

2. Small Market: Nepal’s market is small and limited. As small quantity of goods is to be
produced for small market, the production cost is high. As a result public enterprises
cannot compete with cheap imported goods.

3. Lack of Efficient Manpower: Efficient and skilled manpower cannot be found in Nepal’s
labour market. Labour is supplied from the crowd of unskilled and inefficient people.This
creates problems in management.

4. Lack of Technical Knowledge: The manager working in organization should have
technical knowledge. Because of the absence of technical knowledge in other employees,
organizational performance cannot be effective. So the lack of technical knowledge in
employees is also a problem for management.

5. Labour Problems: Labour organization gives pressure on management to fulfil their
interest by holding demonstration, calling for strike, lockouts etc. As the leaders of labour
organization are affiliated to political parties and leaders, labour organization becomes
strong.

EYE ON THE PAST

Biratnagar Jute Mills

Biratnagar Jute Mills Limited is the biggest and oldest jute mill
in Nepal. The Biratnagar Jute Mills was established under Prime
Minister Juddha Shamsher in 1936. This was the first registered
industry in the country and is an impressive example of an
industrial complex, even by today’s standards. It was privatized in
2002 A.D. It is the first registered company in the country.

Vedanta High School Economics - Book 9 98

4.10 DIVISION OF LABOUR

Division of labour is the act of splitting a work into several specialized process and
assigning each process of the work to different workers on the basis of their skill,
efficiency and capability. In other words, the splitting of the production process on to its
components process is known as division of labour. For example, in a large readymade
garment factory, some workers cut the cloth, some stitch the clothes with machines, some
put the buttons and some put the clothes into packets.

According to Watson, “ Production by Division of Labour consists of splitting up the
productive process into its component parts, concentrating specialised factor on ereaqcuhirseudb”-
division and combining their output into particular forms of consumption output

Thus, division of labour is the result of specialization. POINT TO NOTE
Different workers who are assigned specific operation are
specialized and skilled in their work. Division of labour The main focus of Adam
Smith's The Wealth of
increases the efficiency of labour. It helps in producing cheap Nations lies in the con-
and quality goods. So division of labour is the backbone of cept of economic growth
the modern economy.
which is rooted in the

Types of Division of Labour increasing division of la-
bour.
Following are the types of the division of labour

1. Simple Division Of Labour: It means the division of society into major sections, each
specialized in occupations e.g. carpenter ,weavers, blacksmith etc.

2. Occupational Division of Labour: It refers to professional division of labour i.e. each and
every person be engaged in different occupations. For example someone works as a clerk,
other as a manager, a lecturer in a college etc.

3. Complex Division of Labour: In this case no groups of workers make a complete article.
Instead, the making of the article is split up into number of process and sub-process and
each is carried out by a separate group of people. Such division of labour is found in a
modern factory system.

4. Territorial or Geographical Division of Labour: This form refers to certain localities
cities or towns specializing in the production of a particular commodity. It is also called
localization of industries or regional division.

ADVANTAGES OF DIVISION OF LABOUR

The advantages of division of labour can be explained as follows:
1. Right Person in the Right Job: Every worker is assigned the task for which he is best
suited. This helps to provide, opportunities for the best utilization of natural talents as a
person performs the job for which he has best talent, skill and experience. The work will
be done better.
Division of labour leads
to speciaization which
2. Improvement in Skill: Practice makes a man perfect. When a in turn improves the
man does a certain work over and over again, he is bound to skill of a worker
improve. He will be able to turn out better goods.

3. Saving of Time: Division of labour helps to avoid waste of time and effort caused by
changes from one type of work to another. A worker does not have to shift from one
process to another. He is employed on the same process. He therefore goes on working
without loss of time.

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4. Less Strain: Division of labour makes it possible for heavy work to be passed on to
machinery. Only light work is done by men so that there is less strain on workers.

5. Less Training Required: As the worker has to do only a part of the job, he need learn
only that much. Long and costly training is rendered unnecessary. The shortening of the
period of training for a worker is a great gain.

6. Economies of Large Scale Production: Division of labour facilitates mass production.
Large scale production provides economies in the use of resources, such as raw materials,
labour, tools etc. Optimum use of means of production helps to reduce cost of production.

7. Introduction of Machinery: With division of labour, the work is reduced to a few simple
movements. Sooner or later, some machinery is brought in to take over these mechanical
movements.

8. Inventions: When a person does the same work over and Key Terms
over again, some new ideas are bound to occur. This leads to Innovation: a new method,
inventions. These inventions make for economic progress. idea, product, etc.
Thus, division of labour increases scope for inventions and Economies: advantages or
innovations. benefits

9. Cheaper Output at Lower Cost: Division of labour increases the efficiency and productivity
of workers. With division of labour, the work is reduced to a few simple movements.

10. Economy in the Use of Tools: It is not necessary to provide each worker with a complete
set of tools. He needs a few tools only for the job he has to do. These tools are kept
continuously employed. This proves very economical.

ADVANTAGES OF DIVISION OF LABOUR

Despite various advantages of division of labour, there are some disadvantages also.
Some of the disadvantages are as follows:

1. Monotony: Doing the same work over and again without any change cause mental
fatigue. Work becomes monotonous. There is no pleasure in the job. The worker cannot
be expected to take any interest. As such, the quality of work suffers.

2. Kills Creative Instinct: Since many men contribute to the making of an article, none can
say that he has made it. His creative instinct is not satisfied. The work gives no pride and
no pleasure, since no worker can claim the product as his own creation.

3. Loss of Skill: A worker under division of labour makes Pause for Thought
a part of the article not the whole. This deteriorates his As a worker makes only a part
technical skill of making the whole article. The skill of the article, he loses his skill of
gradually dies out. making a complete article

4. Check Mobility: The mobility of labour is reduced on account of division of labour. The
worker performs only a part of the whole task. He is trained to do that much part only. So,
it may not be easy for him to trace out exactly the same job somewhere else, if he wants
to change the place.

5. Risk of Unemployment: If the worker is dismissed from one factory he may have to search
far and wide before he secures a job in which he has specialized. There is always the risk
of remaining unemployed as the worker is semi skilled.

6. Checks Development of Personality: Under division of labour, a person performs only a part
of the work. If a man has been making an eighteenth part of a pin he becomes an eighteenth
part of a man. A narrow sphere of work checks proper physical and mental development of

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