Five fundamental concepts
- 1. FIVE FUNDAMENTALFIVE FUNDAMENTAL CONCEPTS OF ECONOMICSCONCEPTS OF ECONOMICS Dr Pankaj DixitDr Pankaj Dixit DirectorDirector Lotus Institute of ManagementLotus Institute of Management
- 2. 1. OPPORTUNUITY COST1. OPPORTUNUITY COST PRINCIPLEPRINCIPLE • The opportunity cost principle is usedThe opportunity cost principle is used in making choice from the alternativein making choice from the alternative opportunities available to a person oropportunities available to a person or to a business firm.to a business firm. • Opportunity cost is also calledOpportunity cost is also called alternative cost because it arises duealternative cost because it arises due to the possibility of alternative uses ofto the possibility of alternative uses of the resources.the resources.
- 3. This can best be understood with the helpThis can best be understood with the help of a few illustrations.of a few illustrations. 1.1.The opportunity cost of the funds employedThe opportunity cost of the funds employed in one’s own business is the interest thatin one’s own business is the interest that could be earned on those funds had theycould be earned on those funds had they been employed in other ventures.been employed in other ventures. 2.2.The opportunity cost of the time anThe opportunity cost of the time an entrepreneur devotes to his own.entrepreneur devotes to his own. 3.3.Business is the salary he could earn inBusiness is the salary he could earn in other occupations:other occupations: 4.4.The opportunity cost of using a machine toThe opportunity cost of using a machine to produce is the earnings forgone whichproduce is the earnings forgone which would have been possible from otherwould have been possible from other product.product.
- 4. Points to RememberPoints to Remember • The opportunity cost of a given sum ofThe opportunity cost of a given sum of money can never be zero.money can never be zero. • All decisions involve choice mustAll decisions involve choice must involve opportunity cost calculations.involve opportunity cost calculations. • Opportunity costs may be either real orOpportunity costs may be either real or monetary, either implicit or explicit,monetary, either implicit or explicit, either quantifiable or non-quantifiable.either quantifiable or non-quantifiable. • Accountants never considers,Accountants never considers, opportunity costs, he considers onlyopportunity costs, he considers only the explicit costs.the explicit costs.
- 5. 2. INCREMENTAL PRINCIPLE2. INCREMENTAL PRINCIPLE • The incremental principle is applied toThe incremental principle is applied to business decisions which involve abusiness decisions which involve a large increase in total cost & totallarge increase in total cost & total revenue. Such increase in total cost &revenue. Such increase in total cost & total revenue is called Incrementaltotal revenue is called Incremental Cost & Incremental RevenueCost & Incremental Revenue respectively.respectively.
- 6. 2. INCREMENTAL PRINCIPLE2. INCREMENTAL PRINCIPLE • Incremental Cost can be defined as theIncremental Cost can be defined as the cost that arises due to a businesscost that arises due to a business decision. For instance - a firm decidesdecision. For instance - a firm decides to increase production by using a largeto increase production by using a large quantity of raw materials and using itsquantity of raw materials and using its idle capacity or by adding new plant toidle capacity or by adding new plant to the existing capacity or by setting up athe existing capacity or by setting up a new production unit.new production unit.
- 7. A decision could be made profitable if:A decision could be made profitable if: i.i. it increases revenue more then costit increases revenue more then cost ii.ii.it decreases some cost to a greater extentit decreases some cost to a greater extent then it increases othersthen it increases others iii.iii. it increases some revenues more than itit increases some revenues more than it decreases othersdecreases others iv.iv. it reduces cost more than the revenuesit reduces cost more than the revenues
- 8. 3. PRINCIPLE OF TIME3. PRINCIPLE OF TIME PERSPECTIVEPERSPECTIVE • Principle of time perspective is usefulPrinciple of time perspective is useful in output, prices, advertising andin output, prices, advertising and expansion of business. Economistsexpansion of business. Economists distinguish between short run & longdistinguish between short run & long run in discussing the determination ofrun in discussing the determination of price in a given market because in theprice in a given market because in the long run a firm must cover its full cost.long run a firm must cover its full cost. On the other hand in the short run itOn the other hand in the short run it can afford to ignore to some of itscan afford to ignore to some of its (Fixed) costs.(Fixed) costs.
- 9. 4. DISCOUNTING PRINCIPLE4. DISCOUNTING PRINCIPLE Value of a rupee tomorrow is worthValue of a rupee tomorrow is worth less than a rupee today i.e., value of aless than a rupee today i.e., value of a money keeps on reducing.money keeps on reducing. Formula for calculating this ;Formula for calculating this ; V = AMT/(1+i)^nV = AMT/(1+i)^n Here,Here, V= Present valueV= Present value i= Rate of interesti= Rate of interest n= no. of yearsn= no. of years
- 10. 5. EQUI-MARGINAL PRINCIPLE5. EQUI-MARGINAL PRINCIPLE • This principle deals with theThis principle deals with the allocation of the availableallocation of the available resources among the alternativeresources among the alternative activities. Acc. to this principle anactivities. Acc. to this principle an input should be so allocated thatinput should be so allocated that the value added by the last unit isthe value added by the last unit is same in all cases . Thissame in all cases . This generalization is called EQUIgeneralization is called EQUI MARGINAL PRINCIPLE.MARGINAL PRINCIPLE.