Elasticity of Demand- Price Elasticity and Arc Elasticity Methods

Elasticity of Demand

The term 'elasticity of demand' refers to the responsiveness of demand to changes in the price of a given commodity, assuming all other factors remain constant.

To be more specific, the Price Elasticity, or "Elasticity of Demand," is a measure used to determine the percentage change in the quantity demanded of a good or service in response to a one percent change in the price of that good or service.

We are all aware that whenever the price of a commodity increases, we tend to curtail our demand for that commodity. So, the tool of the elasticity of demand tries to measure the magnitude of those changes in demand with reference to the changes in the price of that commodity.

The Elasticity of Demand is also known as the price elasticity of demand.

These terms are expressed in abbreviated form, either as "Ed" or "PED", respectively.

The elasticity of demand is mostly negative in almost all cases except in cases of "status goods" (Veblen goods) or "goods that have no substitutes" (Giffen goods).

Veblen goods are luxurious items that are the status symbols of extremely wealthy people.

Giffen goods are basic, non-luxury goods that have no substitutes. They are necessary for survival when the prices of other staple items rise. Bread, potatoes, and rice are essential for a common man to survive. So, he has to buy them when no food is available, even at higher prices.

How to Measure Elasticity of Demand?

The Elasticity of Demand is measured with the help of formulas just like Elasticity of Supply.

The general equation for Price Elasticity of Demand is expressed as follows:

Price Elasticity of Demand = Percentage change in quantity demanded divided by Percentage change in Price

So, if the original quantity is Q and the price is P, then Ed = (dQ/Q)/ (dP/P)

In the above equation, Ed denotes the elasticity of demand (price elasticity).

DQ refers to the change in quantity, and Q refers to the original quantity demanded.
DP points to the change in price, and P to the original price.

You can express the above equation as (Qd1/Qd) / (P1/P), where Qd1 denotes the changed quantity, and Qd denotes the original quantity. P1 is the new price, and P is the original price.

But we know that when prices increase, demand for those items decreases, and demand increases whenever prices fall. 

So, there is always an inverse relationship in the equation, except in the cases mentioned above. Hence, the equation always gives a negative value.

Two more precise, result-yielding formulas are being used by economists nowadays to measure the elasticity of demand. 

These formulas are as follows:

1) The Arc Elasticity of Demand formula
This method is used when there is no exact equation for demand available or when we are not accustomed to taking derivatives.

2) The Point-Price (or Price-Point) Elasticity of Demand formula
This method is used when we have the exact equation available, or when we are capable of calculating the derivatives of equations.

Now, let us study these two methods of calculation, one by one:

Arc Elasticity of Demand Method

The arc elasticity method gives us the average elasticity of demand between two end points of an arc on a demand curve. So, it gives us the average elasticity of demand for that curve. 

It solves the problem faced by analysts in choosing one point as the original point and the other point as the new point and, thereby, provides great relief from the dilemma faced by economists in calculating the elasticity. 

But it may not provide accurate figures, as you are taking the average of two points on a curve.

The mathematical equation for arc elasticity of demand is as follows:

{(P1+P2)/2} / {(Qd1+Qd2)/2} x (change in quantity demanded/change in price)

So, Elasticity of Demand according to this formula = (the average of prices divided by the average of quantities demanded at each price) x (change in quantity divided by change in price)

You are taking the average of multiple prices on an arc and dividing it by the average of new quantities demanded by consumers at those changed prices. Thereafter, you are multiplying the same by the derivative of (change in quantity divided by the change in price) at any point to decide the elasticity at that point.

Suppose there are two price levels for a commodity, sugar, at Rs. 40 per kg and Rs. 50 per kg.
Let us assume that at price 40, quantity demanded is 10 kg, and at 50, quantity demanded is 8kg.

Now, according to above formula, Ed = {(40 + 50)/2 divided by (10 + 8)/2} x {(10 - 8) divided by (40 - 50)} = (90/2 divided by 18/2) X (2/10) = (45 divided by 9) X (2/10) = 5 X 0.2 = 1
So Ed = 1

1% change in original price is 40 x 1/100 = 0.40 = 40 paise.

According to this formula, for every 40 paise, the quantity is assumed to change by 1%.

Point-price Elasticity of Demand Method

The point-price method is used to determine the elasticity of demand at very small changes in prices. 

It is useful in determining the price elasticity of demand at a specific point on the demand curve. 

It studies the changes in demand at price points very close to each other on a demand curve.

It also uses the same formula: the percentage change in demand divided by the percentage change in price. 

But instead of calculating each equation, we take information from the demand equation to calculate the price elasticity of demand.

Ed = percentage change in demand / percentage change in price = (Qd1/Qd) / (P1/P) = (P/Qd) x (Qd1/P1)

Now, as I mentioned above, this method is applied when we have the exact equation for the demand curve and the derivatives with respect to price.

Let us take an example:

The equation for the elasticity of demand for a demand curve Q = 5000 - 50P

So, in this equation, Qd1/P1 = 50 (per one unit of price, the change in quantity demanded is 50).

Now, suppose we have to find the point-price elasticity of demand at prices of 40 and 25.

The quantity demanded at 40 will be 5000-2000=3000. (multiplying 40 by 50)
The quantity demanded at 25 will be 5000-1250=3750. (multiplying 25 by 50)

So, Ed at 40 is -50 (40/3000) = -2000/3000= -2/3= -0.666
Ed at 25 is -50 (25/3750) = -1250/3750= -1/3= -0.333

Saving, Insurance and All About their Business

Saving and Insurance are two major economic activities, just like capital formation and other activities. These two are becoming a part of the daily lives of our modern economy. 

People have become somewhat aware of the insecurity of their lives and have begun to realize the need to secure their future by saving a little from their current consumption habits and by adopting insurance policies.

Saving

Need for Saving
If people go on consuming and spending all their income, and producers go on producing and thereby utilising all the resources of the economy, a day will come when there will be nothing more left to produce or to consume. So, people should curtail their consumption and spending habits and save some money and resources for future and emergency needs.

Meaning and Definition of Saving
"Saving is that portion of income or the excess value of the resources that has been left unused or unspent in a given period of time."

Saving is different from 'Savings'. 

Saving is an economic activity, whereas 'savings' is an accounting term. 

• Savings is only a part of the total act of Saving.

In Keynesian economics, "Saving" has been defined as the excess of the amount or value left out of the available resources after consumption. 

So, saving is an economic term that points to the "total pool of savings" accumulated during a period of study.

• The total saving of an economy can be considered as the total income or value of the resources less the total expenditure or value of the resources consumed by that economy in a given period.

Suppose a person 'X' received an income of Rs.6,00,000 during a year and spent a total of Rs.5,00,000 during that period; then, the balance of Rs.1,00,000 is his savings during that year.

So, when we add all the amounts of similar savings created by each and every member of that economy, it is the total Saving of that economy.

• Saving not only constitutes the money saved but also includes the value of all the resources saved.

How to Save?

You can start with a very simple method. Try to be conscious of saving at every step. You can save even a few coins or rupees from your purchases and collect that money in a safe place. 

You will experience the wonderful results of that habit. After a month, you may find that you have saved as much as Rs.500 or even Rs.5,000 depending upon your saving habits and income. Now, you can deposit the money in a Bank. Maintain this practice continuously and make it a habit. This is the simplest thing to do if you are conscious of it.

Besides the above, you can save lump sums at periodic intervals, whenever you receive some extra income such as Overtime payments or Bonus, etc. 

Invest the saved amount in FD's or other Investment schemes.

Similarly, Producers and Manufacturers can also save much of their resources utilised by following some simple economic methods of production. 

• Experiment with different ingredient ratios in production to minimize input quantities and costs.
• Implement techniques such as identifying waste during material handling and/or leaks, and managing labor efficiency, etc.

The above are some ideas for saving resources.

Benefits of Saving to the Economy

Whenever people save some amount of their income, they generally deposit it in Banks or invest in some investments like FDs, stocks, or Debentures, etc.

Bank deposits lead to the availability of ample funds with Banks. 

As they are not going to be immediately withdrawn by all of them at the same time, Banks are naturally left with idle funds for a certain period. 

So, they can utilise these funds by lending to needy customers who are willing to take loans to meet their urgent requirements and then return the money along with some interest at a later time, either in instalments or in one lump sum.

In that way, Banks earn income from idle funds, and thereby, they can pay some "interest income" to their depositors in return for keeping funds in the bank.

• So, you can see that the money saved by people not only creates extra income for themselves as well as for banks, in the form of interest, but it also helps other people meet their urgent and unforeseen expenses because of this saving habit of people.

Besides this, the money saved and deposited in banks or invested in shares, debentures, or government bonds helps businesses and industries further augment their production and add to the growth of the economy. 

• The money saved results in increased production and in increased capital formation. 

• The money invested in Government Bonds helps governments to utilise the money for public welfare programmes like constructing roads and dams, irrigation canals, parks, schools, and for many other purposes like providing subsidised schemes, midday meals to school children, etc., which all result in the welfare of the public and the growth of the economy as a whole.

Insurance

Importance of Insurance
Life is always uncertain. It is more so in this present-day world. People often get sick due to polluted water, air, and atmosphere that are causing or spreading so many viral infections. 

Impoverished roads and surging vehicular traffic are also a cause for concern, as they can result in accidents. Even the habits of people are deteriorating their health and resulting in premature deaths.

 

Natural calamities, accidents, thefts, and burglaries all cause huge loss to property. 

So, everything needs to be protected with a suitable insurance cover. Insurance provides great relief to people as it reimburses them an ample portion of the losses suffered by them.

Meaning and Definition of Insurance

Insurance is a helpful tool available for the security of the people. It is a kind of assurance from an undertaker to provide compensation for a certain loss suffered by the victim, like death, accident, fire, etc., in consideration of a nominal premium paid by him at the time of purchasing that assurance.

Insurance can be defined as "an arrangement or contract whereby a party or company facilitates its customers by providing financial compensation for the loss or damage incurred by them". 

It is generally represented by a policy that guarantees to indemnify against loss in consideration of a one-time or periodic premium paid by the victim.

Insurance Business and Income to Insurance Companies

An insurer bears the risk and assumes the responsibility of reimbursing the insured person a certain percentage or amount of loss, in the event of loss or damage as covered in the agreement.

As a return for their services, they collect monthly or periodic insurance premiums from their customers as their charges. 

Since people are always insecure about their lives, properties, and health, they look to these insurance coverages as their refuge. 

Many people opt to purchase these insurance policies. As a result, the insurance business generates a large pool of funds for the insurance company, from which reimbursements are made to customers who incur losses.

But the actual losses incurred by customers may not occur during the same period. Furthermore, not all customers suffer losses in reality. Only a portion of them will claim reimbursements at any given period. 

So, the companies can invest most of the money collected in profit-yielding investments or in real estate businesses and thus earn good profits from their insurance business.

The premiums are calculated to include all expenses of the company so that they can withstand any claims of huge losses and still sustain their business. 

By managing the risk in an intelligent and smart way and by evaluating the weak points minutely in all respects, the insurance companies can make ample profits and minimise their incumbent reimbursement occasions.

Different Types of Insurance Policies

There are many types of insurance policies to cover different types of losses.

a) Life Insurance
The life of a person is insured under this cover. 

Insurance companies examine the individual's health history and determine the amount to be reimbursed under the policy. Normally, younger people can opt for higher coverage with lower premiums, whereas older people are covered only for lower amounts, and even then at higher monthly premiums. This is because older people's life expectancy cannot be predicted as accurately, and it is riskier for insurance companies to underwrite their policies.

b) Health Insurance 
Health insurance policies cover hospitalization and medical expenses. 

These policies also require periodic premium payments to cover these expenses. The policies are issued annually.

The health of the person concerned is thoroughly examined before determining the amount to be reimbursed. You can renew policies annually. Most MNCs provide their employees with this health insurance coverage nowadays. Medical expenses are reimbursed by insurance companies after verifying the bills and expenses. Some expenses are not reimbursed during the process because they are deemed unnecessary by the insurers.

c) Personal Accident Insurance
Personal accident policies cover injury or death resulting from accidents. They cover only accident-related cases. 

The sum assured is generally limited to 5 or 6 years of the person's job earnings. It does not take into account other income. If the insured dies or suffers a serious, irrecoverable loss of limbs, the insurer will reimburse the full sum assured. Otherwise, only a portion of the sum assured is paid based on its norms. The insured needs to pay a premium to activate the policy.

d) Auto Insurance
Auto insurance covers the damages incurred by vehicles due to accidents or other calamities. The insurance amount is calculated based on the value of the vehicle according to its ageing factor also. A new vehicle can be insured for its whole cost with a higher premium payment. Old vehicles are insured for their residual value only with lower premium payments.

5) Other Insurance Policies
There are many other insurance options available for almost all kinds of damages or losses suffered by people. 

Some of them are Fire Insurance, Theft or Burglary Insurance, Marine Insurance (for losses suffered during shipwrecks, etc.), Fidelity Insurance (losses due to dishonesty, etc. during employment), Travel Insurance, Credit Insurance (loss due to bad debts), Crop Insurance (for farmers due to natural calamities), Workmen Compensation Insurance (loss incurred during employment due to negligence of employer resulting in accidents).

Meaning and Definition of Bank | Functions of Banks

A Bank is an organization that is licensed by the government or law to receive and safeguard deposits from the public, sanction loans, and to act as an intermediary in their financial transactions.

Banking institutions have been in operation since ancient history, when funds were pooled and loans were sanctioned to farmers and small traders for the overall development of economic conditions in their respective areas or kingdoms.

The modern banking system had its roots in the aftermath of the Renaissance in Europe. 

Thereafter, gradually, the modern banking concepts and practices developed from the 18th century onwards, resulting in the present banking system and practices.

Definition of Bank

A Bank can be defined as follows:

"An establishment authorized or licensed by a government to accept/ receive deposits, pay interest on those deposits, issue loans, act as an intermediary in all financial transactions, and provide other related financial services to its customers."

Functions of Banks

From the above-cited definition, it is evident that Banks perform all types of financial transactions like receiving deposits from their customers, maintaining their accounts, safeguarding those deposits and allow withdrawals or payments from those deposits, pay interest on those deposits, collection or payment of cheques and bills on their behalf, provide debit or credit cards based on those accounts to enable easy transactions of funds from any corner of the world, etc.

Now, these functions of banks can be grouped into two distinct sub-groups. 

They are primary functions and secondary functions. Let us discuss both these types of functions in detail.

Primary Functions of Banks

The primary functions are also known as the main banking functions. Banks (mainly commercial banks) perform many banking functions, such as accepting deposits and lending loans and advances in various forms.

A) Accepting Deposits

i) Current Account Deposits:
These accounts are mainly suitable for business people who need to make daily transactions, including depositing cash or checks and withdrawing cash or making bill payments by check or draft. 

These accounts are also known as Demand Accounts, as banks should pay these amounts immediately on demand by the depositors, without any limits or restrictions. 

No interest is paid on these accounts. Some service charges are debited to the account depending on the nature and volume of transactions.

ii) Savings Deposits:
Savings deposits are aimed at creating a habit of savings among people. 

These deposits provide an incentive of interest to the customers (it used to be 4% to 5%, but nowadays it is only 2 or 3 per cent). The interest gets credited to their accounts quarterly. There is a ceiling on withdrawals, presently 3 times per month. Any extra withdrawal is charged with some fees.

iii) Fixed Deposits or Term Deposits:
Fixed Deposits are also known as Term Deposits because they are deposited for a particular period or term. These deposits carry higher interest rates depending upon the period of deposit and as per the prevailing interest rates of those banks.

Deposits made for shorter periods will be paid lower interest rates, and longer periods will be paid higher rates. The current applicable rates are approximately 4% to 8%, varying according to the period.

The minimum period of deposit is 7 days and the maximum period is 10 years.
If you withdraw money before the maturity period, penalty charges are imposed, and the amount is deducted from your maturity balance, calculated as of the day of withdrawal.

iv) Recurring Term Deposits:
These are known as Recurring Deposits and are generally treated as Term Deposits and carry the same interest rates and rules as governed under Fixed Deposits.
The only difference between Recurring Deposits and Fixed Term Deposits is that in Recurring Deposits, you enjoy the facility of depositing monthly denominations of the deposits instead of a lump sum deposit.
These deposits are suitable for those who want to save money but can not afford a one-time deposit.

The interest provided ranges between 4% and 7%.

The minimum deposit accepted is Rs. 1,000, and thereafter, you can deposit in denominations of Rs.100 and above every month till maturity.
The tenure of deposits ranges from 12 months to 10 years. The interest is calculated monthly or quarterly according to the denominations deposited, and the amount will be paid on maturity of the entire period.

If you are unable to deposit an installment on time, you will be charged penalty charges from the due date to the next deposit date.

v) Money-Multiplier Deposits:

This is a new scheme launched in recent years, as far as I know.

It resembles the Term Deposits. But these schemes are launched to boost fund-pooling for Government schemes, etc.

They offer higher interest rates.

The minimum deposit is 1,000, and further amounts are in denominations of thousands. It is a one-time deposit for a fixed period. 

Premature closures attract penalties and charges similar to FDs and Other Deposit Schemes.

B) Lending of Loans and Advances

Banks lend various types of loans and advances to facilitate their customers. 

The main types of these loans and advances are classified into three categories.

i) Cash Credit:
Cash Credit is similar to a loan sanctioned generally to business people against their stocks, shares, bonds, and other securities. 

It is allowed upon opening a dedicated loan account, irrespective of their other accounts. A fixed amount of credit limit is sanctioned after evaluating the security provided.

Interest is charged on the amounts withdrawn, calculated by the number of days those particular balances are outstanding. 

Customers can enhance their credit limits by providing further securities.

ii) Overdraft:
Overdraft facilities are provided to existing account holders on request up to a certain fixed limit, based on their creditworthiness.

Whereas Cash Credit applies to business entities and traders, overdraft facilities can be obtained by salaried people, professionals, and even businesses also. 

It is generally provided after verification of his/their creditworthiness and repayment capacity. 

It can be availed for personal accounts and business accounts. 

Interest is charged on the overdraft amounts.

iii) Loans and Term Loans:
Term loans, or simply loans, are sanctioned by banks to customers either for a short-term or comparatively longer periods to facilitate their various needs upon providing some security or lien.

Some of these loans are as follows, to list a few.

a) Home Loans
b) Car Loan or Vehicle Loan
c) Educational Loan
d) Personal Loan (for short-term needs of customers like meeting marriage expenses, hospital, or medical expenses, etc.)

These loans and advances are credited to their account after approval, and the customers can withdraw the money according to their needs. 

Interest is calculated on the whole amount of the loan credited, and the loan amount is repayable in equal EMIs (including the interest amount), which is calculated according to the rates of interest prevailing at the time of the sanctioning of the loan.

Secondary Functions of Banks

Secondary functions of Banks are, generally, not performed by all banks. These may not be considered as essential functions of most commercial banks. So, they are known as Secondary Functions. These functions include many services provided by banks to facilitate customers and keep them around their banks.

The secondary functions of banks are classified into two types:

Agency Functions and Utility Functions.

The Banks charge a commission or bank charges for providing each one of these secondary functions.

1) Agency Functions of Banks

a) Discounting of Bills
Banks allow advances to their customers to facilitate their need for funds against bills of exchange drawn by them or of which they are the beneficiaries. 

The payments are made after deducting some charges. The bank will later collect the payment from the drawee of the bill or from the party that accepted the bill, by presenting it after the due date.

b) Transfer of Funds
Banks transfer funds of their customers from one account to another, from one branch to another, or to other banks both within the country and abroad at the request of customers in the form of demand drafts or mail transfers for which they charge some commission and/or bank charges.

c) Collection or Payment of Bills, etc.
Banks can also collect or pay your bills according to your instructions. 

This includes collection and payment of salaries, pensions, utility bills, interest amounts, insurance premiums, taxes, dividends, etc.

Banks charge fees for this service.

d) Portfolio Services
The banks can also provide the services of acting as your agent in the sale and purchase of stocks, bonds, and debentures, etc.

e) Other Agency Functions
Banks can also act as trustees, executors, and income-tax consultants for your deposits, deeds, wills, and funds.

2) General Utility Functions

The banks also offer other public services to facilitate and woo their customers, which are known as general utility functions.

a) Locker Facilities
Lockers are available to customers for safekeeping of their valuable possessions, like gold ornaments, title deeds, or documents.

Banks may charge some nominal fees for keeping them in the bank lockers.

b) Issue of Letter of Credit
Banks provide their customers with a letter of credit, certifying their creditworthiness, to facilitate their needs.

c) Issue of Traveller's cheques
Traveller cheques are also issued by banks to facilitate people on their journeys so that they need not carry huge cash balances with them while on a journey.

d) Underwriting of Securities
Banks undertake the function of underwriting or certifying the securities of their customers to facilitate the sales of those securities.

e) Purchase and Sale of Foreign Exchange
Banks are authorised to deal in foreign exchange transactions by RBI. 

So, they provide the services of handling the purchases and sales of foreign exchange transactions on behalf of their customers.

f) Collection of Statistics and Preparation of Project Reports
Banks collect statistics from markets on trade and commerce and can thereby provide the required information to their clients. 

They also prepare project reports for their clients.

g) Social Welfare Programmes
Banks may also indulge in the activities of public awareness, public welfare, and literacy programmes as a service to the nation.

Note:

Please collect the latest information regarding the services provided and/or the interest rates from your banks.

A Study of the Role of Money in Economy

By the role of money, I mean the part it plays in our modern economy.

Money is regarded as the pulse of our life. Without money, there is no life or activity in this modern economy. 

Everything is related to money here. From morning to evening, from birth to death, you need money for this or that.

Money plays an important role in our economy. It motivates and influences all our economic activities; consumption, production, supply, demand, and distribution are all influenced by the supply and power of money in any economy.

• As a consumer, you can purchase goods and services and make payments in money, which is universally accepted. 
• As a unit of exchange and as a measure of value, money guarantees the real value of all your goods and services.
• Thus, money gets generated and circulated through our activities.
• To be able to pay in money, you need to earn money. So, you will be earning money by doing some business or other, working as an employee in a company, or doing some labor. Money is earned through our occupations.
• Money facilitates economic activity, creating businesses in the manufacturing and services sectors and thereby creating more jobs for more people across different fields. This, in turn, boosts the economy. 
• Money further facilitates and ensures that goods and services are produced to meet the demands of consumers. Consumers can opt for better products by choosing from multiple options, as they are free to buy as and when they desire to do so. This is possible because of the storage value of money.
• Money facilitates the easy transfer and distribution of goods and services to any corner of the world, as you can make payments through money.
• Money plays another important role in equalizing the marginal utilities of consumers. Consumers are able to shift toward higher-utility goods by discarding lower-marginal-utility products, as they can distinguish differences in utility with the help of money as a standard of value, which sets the prices of goods in terms of money.
• So, money facilitates rational distribution of income earned by consumers among different needs and necessities. The buyer can draw a picture of his income and expenses and match them with utmost utility levels within the given income.
• Money, as a standard of value, makes the maintenance of accounts very easy, as everything is accounted for in terms of money. This facilitates accurate calculation of expenses and income for any business and aids in the fixation of the prices of their products.
• Money helps governments to calculate and collect their taxes and plan their projects, estimate their revenue, and prepare Budgets accordingly, thereby enabling them to boost their economy.
• Further, money enables a continuous flow of funds from one person to another and from one corner of the world to the other.

To sum up, money has different roles in our economy. 

It acts as the power of purchase. 

It serves as a store of value. 

It facilitates a continuous flow of economic activities.

It boosts businesses and trade internationally. 

It helps in the distribution of wealth. 

It aids in the progress of the economy as a whole.

Money: Different Types of Money and Forms of Money

Do you realise that money is used nowadays in various types and forms?

Gold and Silver, Tokens, Coins, etc. are some of the types of money that we use in our daily transactions. Similarly, Currency notes, Credit Cards, Bitcoins, etc. are examples of Money.

So, money is classified into different types and forms according to its nature. 

Difference Between Type and Form of Money

• "Type" of money refers to the underlying nature, status, and qualities that define its value.
• "Form" refers to the physical material or technological mechanism used to store and use the money.

Types of Money

Money can be broadly classified into four major types. This classification describes the abstract nature of money, as opposed to its physical forms.

1. Commodity money.
2. Representative money.
3. Fiat money.
4. Fiduciary money.

Commodity Money:

Commodity money consists of commodities with intrinsic value. 

Gold and silver are examples of commodity money in our present economy. Their face value is equal to their real value. 

In earlier times, important commodities such as rice, wheat, tobacco, seashells, pearls, and valuable stones were also treated as commodity money. 

This kind of money is characterized by the scarcity of the commodity and the value attached to it by the parties to the transaction. 

But in the present-day economy, this kind of money is not significant, even though gold and silver are used as a store of value.

Representative Money: 

Representative money is that which can be exchanged for a real commodity or for money. 

For example, tokens, documents, or certificates issued to a person can be exchanged by the holder for real items, such as gold, silver, or any goods and services. 

Coins and paper currency can be treated as representative money. It represents the quantum or degree of value borne by it. 

Gold certificates and silver certificates are also examples of representative money.

Fiat Money:
Fiat money is any money declared by governments to be legal tender. 

This money by itself has no intrinsic value. It is not backed by any physical commodity, but is declared legal tender. 

For example, paper currency. You can not reject it. You are bound to accept it as money.

Fiduciary money
Fiduciary money is a form of money based on the trust and reputation of the issuer. 

The issuer of the instrument of money, whether a government, a company, or any trustee, promises to pay a certain amount of money or value as stated on the instrument, and the beneficiary places faith and trust in it. 

Most transactions in the present-day economy are conducted through these fiduciary instruments.

Forms of Money

Some of the more popular and common forms of physical/digital money are discussed here.

Coin Money

Different forms of coins are used, such as gold, silver, copper, bronze, and nickel, each representing a value printed on them.

Paper Money or Paper Currency

This form of money constitutes the currency notes printed and issued by the government or central bank, and financial documents such as bills of exchange, promissory notes, checks, bank drafts, etc.

Bank Money or Demand Deposits Money

Bank money is the money created through deposits made by the public into their bank accounts.

Demand deposits are funds deposited into banks by customers that can be withdrawn on demand without any prior notice to the bank. 

This money is characterized by the fact that the original physical money available with the banks is multiplied into larger volumes due to the facility of the minimum reserve ratio that banks must maintain against their actual deposits. 

So, the actual money available with the bank at any time will be much less than their account book balances, as they have lent it to the public and/or businesses as short-term loans. 

The total money created in this way can be known only by calculating the money in circulation with the public and then adding to it the actual money with banks and the value of checks or drafts in hand with the public and at the bank.  

Token Money
Token money is a form of money in which the tokens, such as coins or paper currency, have no intrinsic value but represent and guarantee the value stated on them, which is reimbursable.

Full-bodied Money
Full-bodied money is the form of money where its real value equals its commodity or physical value.

Gold coins and Silver coins are examples of full-bodied money or real money. They have the same physical value as their face value depicts. 

Standard Money
Standard money refers to the form of money used by different countries or economies for their accounting purpose. 

For example, the countries mentioned below use the corresponding standard units for their circulation and accounting purposes in their economies.
U.S.     Dollar ($)
U.K.     Pound (L)
India    Rupee (Rs.)
Europe  Euro  (E )
China    Yuan or Renminbi
Japan    Yen   (Y )

Legal Tender Money  
Legal tender is the form of money that is legally acceptable. 

You cannot reject any payment made with legal tender. 

Paper currency is fully legal tender, and you should accept all payments in that form. 

Coins are not fully legal tender. Only small payments can be made with coins, and you have the right to refuse payments made using large quantities of coins.
       

Electronic Currency or Digital Money
Electronic money, also known as e-money, is a form of money that is transacted through the internet or other digital channels. 

Funds are transferred, and payments or receipts are made through internet transactions using computers and mobile phones. 

Examples of e-money include bank deposits made using e-services of banks on the internet, fund transfers made online, claims against banks and agencies resulting from e-transfers or payments, and account settlements. 

PayPal, Google Wallet, Apple Pay, RuPay, Bitcoin, etc., are among the most popular forms of this kind of money.

Money: Meaning and Definition | Four Functions of Money

Definition and Meaning of Money

Money is a medium of exchange that is generally acceptable to people as a unit of exchange and as a store of value. 

Generally, currency notes and coins are considered money by the public. 

But money can be any instrument with some purchasing power and can be stored for future use.

The great economist Geoffrey Crowther, who was the editor of a newspaper, "The Economist" during the 1930s and 1940s and later became the Managing Director and Chairman of The Economist Newspaper Ltd., defined money in his book "An Outline of Money" as follows:

"Anything that is generally acceptable as a means of exchange and which at the same time acts as a measure and store of value".

So, money is anything that is legally and socially acceptable for buying and selling goods and services or for making payments, or for the repayment of debts.

The Importance of Money

Money plays a crucial role in economics. 

It serves as a medium of exchange for goods and acts as a unit and store of value for executing transactions. 

Without money, obtaining goods and services would be much more difficult. 

In the ancient barter system, individuals had to find someone who was willing to exchange their goods for what they needed. This meant that both parties in the barter system had to have products that the other desired, creating a challenge in matching needs and offers. 

However, in today’s money economy, there is no need to search for someone who wants your product in exchange for what you need. You can sell your product directly in the market and receive money in return. With that money, you can purchase whatever you require. 

Using money simplifies transactions. 

You can buy goods or services whenever it's convenient for you, pay your bills, deposit money in banks for future use, transfer it anywhere in the world, and access it as needed. This illustrates the significance and benefits of money in our lives.

Four Functions of Money in the Economy

Money performs four major functions:
1) Money is the medium of exchange.
2) Money is a unit of account and measure of value.
3) Money functions as a store of value.
4) Money is a standard of deferred payments.

Among the four functions of money, the medium of exchange and measure of value are considered the primary functions. 

The store of value and standard of deferred payment are viewed as secondary functions, as they are derived from the primary functions.

Primary Functions of Money:

1) As a Medium of Exchange:
Money is a medium of exchange in the sense that it is used to exchange for goods and services. The buyer purchases goods and services and pays money for them. The seller sells goods, and the service provider provides services, and in both cases, they receive money from the buyer. Thus, money is an important medium for their transactions.

For example, you buy a chocolate and pay money for it. The seller of chocolates receives money in exchange for his chocolate. 

Similarly, you get the services of a barber to shave your beard, and in exchange, you pay money. The barber provides the service and receives money. 

Thus, money serves as an important medium of exchange in all transactions.

2) A Measure of Value or Unit of Account:
Money acts as a unit of account or measure of value. You value goods and services in terms of their monetary value. You are fixing monetary value per one unit of a good or service. 

So, any goods or services that we buy or sell are quoted in their value/ per unit.

For example, a chocolate is quoted at Rs 5, a loaf of bread at Rs 50, and a computer at Rs 20,000. Similarly, one shave is quoted at Rs 50, one haircut at Rs 100, and one car wash at Rs 200. 

When you give a value to a unit of a good or service, it becomes very easy to identify those goods and services and compare them with other similar products or services offered by different sellers or providers.

Secondary Functions of Money:

1) Money as A Store of Value:
Money can be stored and used subsequently without losing its value for a certain period. Money can be used only when you need to buy or procure something. Till then, you can keep your money in your purse or wallet, or deposit it in your bank account. 

Money gets stored for your future needs. 

With that, you can buy anything like rice, bread, chocolate, wheat flour, a car, a computer, and so on in the future, whenever you need them. 

Thus, you are storing the purchasing power of money for a certain period, until you actually need those goods or services. 

You are much more relaxed as you know that you can purchase anything with the stored value of money. This is one wonderful function performed by money.

This function of money is the result of its primary functions as a unit of account and as a medium of exchange. It is because of those two functions that you are capable of storing money. 

It is because money is generally accepted as a medium of exchange that you are keeping it in store. 

It is because of the fact that it is a unit of transaction that you are procuring different denominations of money and using them for your purchases.

2) Standard of Deferred Payments
Money functions as a standard for deferred payments. When someone borrows money from you and agrees to return it after a certain period, he will pay it back in the form of money on that stipulated date, along with interest, if any, charged by you for lending him the money instead of using it for other useful purposes by you. Millions of transactions are taking place now, which are not paid immediately.

Payments get deferred till a certain period of time or till the happening of a certain event or till the actual goods or services reach you. So, till such period, the payment gets postponed or deferred, and nobody worries as money will not lose its value even if paid later under normal circumstances. 

You defer the payment because of the standard value of money and its general acceptability. 

This function of money has given rise to various financial institutions and lending businesses and thereby advanced economic development.

Definition and Explanation of Producer Equilibrium - Different Approaches to Producer Equilibrium

Just as consumers seek to maximize their satisfaction and utility by reaching consumer equilibrium, producers strive to reach a point that maximizes their profits, known as "producer equilibrium."

What is Producer's Equilibrium?

Producer's equilibrium is the point on the scale of production at which the level of production of any particular commodity yields the maximum profit for the producer of that commodity. At that point, the production cost of that commodity will be much less than the total revenue obtained through the sale of that commodity. It is the maximum possible profit that any producer can obtain at that equilibrium point.

In other words, producer equilibrium refers either to the level of profit maximisation or, otherwise, to the level of cost minimisation. 

Cost minimisation also results in profit maximisation.

Definition of Producer Equilibrium in Economics

• Producer's equilibrium can be defined as a state of economic condition that leads to the achievement of that level of output, after which no further maximization of profit is possible.
• It is the stage where there is no further inclination towards expansion or contraction of the output.
• It is a point at which there is either maximum profitability and/or minimal loss.

Different Approaches in Studying Producer's Equilibrium

There are two approaches for reaching out to producer's equilibrium:

1) the TR - TC approach and

2) the MR = MC approach.

There can be Two Types of Markets for studying producer equilibrium

a) Perfect competition market where prices remain constant and

b) Imperfect competition market where prices are either rising or falling constantly.

We need to study the equilibrium under both these market conditions.

Now, let us study the producer's equilibrium under all these different conditions, one by one.

I) Total Revenue - Total Cost (TR - TC) Approach

Under the TR - TC approach, the producer tries to attain the equilibrium point by maximising his profits to the utmost possible level. So, this implies that the TR-TC approach should satisfy the following two conditions.

• The difference between Total Revenue and Total Cost has been maximised.
• Any further effort to increase output after that point will result in a fall in total profit.

Let me explain this approach under both Perfect Competition and Imperfect Competition.

i) The producer equilibrium under perfect competition (When prices remain constant)

When prices are constant in perfect competition, the producer goes on increasing his output or sales and is able to enjoy maximum profit till a certain point, after which he may not be able to produce more without adding extra machinery or extra expenses and capital. 

The addition of capital and machinery may increase the product's costs and force him to raise the sale price or face a loss. Alternatively, he may not be able to sell more unless he lowers the price, which may also reduce profits.

So, he is forced to maintain the status quo at the equilibrium level.

Let us study the same point through the table below:

Price per unit       Output (units)      Total Revenue     Total Cost     Profit

      6                        1                          6                      5                  1

      6                        2                        12                     10                 2

      6                        4                        24                     19                 5

      6                        6                        36                     28                 8

      6                        7                        42                     34                 8

      6                        8                        48                     41                 7

From the illustration above, we can see that producer equilibrium has been achieved at the output level of 7 units, at which point you are enjoying a maximum profit of 8 dollars by producing 7 units. When you tried to increase the output by another unit, the profit decreased to 7 dollars.

The same thing can be illustrated in the form of a graph also. But I am not doing the graph.

ii) Now, watch producer equilibrium under imperfect competition (when prices are falling upon increased output )

There is no control over the prices, and each producer has his own price norms and sells products accordingly. 

But, after a certain level of output, he is forced to lower the prices as his stocks are accumulating. 

The example below illustrates this position.

Price per unit       Output (units)      Total Revenue     Total Cost      Profit

       8                       2                          16                    10                   6

       7                       3                          21                    14                   7

       6                       5                          30                    21                   9              

       5                       6                          30                    23                   7

The producer equilibrium in the above example is attained at an output level of 5 units. He was making profits at production levels of 2, 3, and 5 units.

But after the output level of 5 units, an additional unit resulted in a fall in total profit.

II) Marginal Revenue = Marginal Cost Approach (MR = MC approach)

According to this approach, producer equilibrium is attained where the marginal revenue from an additional unit of output equals its marginal cost.

This approach should satisfy the following two conditions or assumptions:

1) MC = MR

2) Marginal cost becomes higher than Marginal Revenue if one more unit of output is produced after reaching the output level of MR = MC

Let us study this approach also under both the perfect and imperfect competition conditions of the market.

i) Producer equilibrium under perfect competition (when price is constant)

When price is constant, each unit of output is sold at the same price. 

So, the average price (AR) of any particular unit is the same for every unit. 

The marginal revenue (MR) will be the same, as the prices are constant for each unit. 

So, you will enjoy producer equilibrium until there is a rise in MC or a fall in MR.

Let me illustrate this with a table as below:

Let us assume that the price is constant at Rs 6, but the cost of producing additional units differs. The MC figure shows the additional value per each additional unit.

Price (Rs.)    No.of units         TR            TC              MR            MC          Profit (TR-TC)

6                    1                     6                8                6                 8                -2

6                    2                    12              15                6                 7                -3

6                    3                    18              20                6                 5                -2

6                    4                    24              24                6                 4                 0

6                    5                    30              28                6                 4                 2

6                    6                    36              34                6                 6                 2

6                    7                    42              41                6                 7                 1

From the above, we can see that the producer was initially incurring losses, and he increased his output to eliminate them and make profits. 

When he produced 4 units, there were no losses. 

At levels of 5 and 6 units of production, he was able to make profits of 2 points. 

At 6 units of production, MR is equal to MC. When he tried to increase output by one more unit, the profit decreased again. 

So, the producer's equilibrium output is 6 units in this case.

ii) Producer equilibrium under imperfect competition (when price falls with increase in output)

When there is no perfect competition among sellers, producers and sellers try to maximize their profits by engaging in unhealthy practices. They take advantage of monopolistic opportunities and charge very high prices to gain maximum profits. 

This is workable up to a point. But when the produced quantity is much larger and identical alternative products enter the market, demand gets distributed among identical products, and each brand naturally loses demand in the long run. 

The effect will be a fall in product prices. So, too much increase in production will result in a fall in prices. In such circumstances, the producer has to decide on his maximum level of production based on producer equilibrium. He will try to match Marginal Cost with Marginal Revenue in deciding his level of production.

Let us consider an example to arrive at this producer equilibrium under fluctuating market prices.

Qty. produced   Price per unit           Total              Total       MR      MC      Profit 

                                                     Revenue           Cost                             (TR-TC)

           1                    8                        8                   6           8        6            2

           2                    7                       14                 11           6        5            3

           3                    6                       18                 15           4        4            3

           4                    5                       20                 18           2        3            2

In the illustration above, MR and MC are equal at the production level of 3 units. Beyond that level, when production increases to 4 units, profit begins to decrease because MC is higher than MR at that point. (The profit dropped from 3 to 2.)

So, the producer's equilibrium level of output is 3 units in this case.   

From the above study of producer equilibrium, we noticed two salient features:

1) Under perfect competition (where prices remain constant), Price = MR = MC, ie., the product price, marginal revenue, and marginal cost are equal to one another at the equilibrium point.

2) Under imperfect competition (where prices fall with every increase in supply or production), Price is always greater than MC or MR, as equilibrium is attained at a point where MC = MR, and marginal revenue will always be decreasing with additions of supply.                  

Consumer Equilibrium, Indifference Curve, and Consumer Behaviour

Meaning of Consumer Equilibrium

Consumer equilibrium means that you are completely satisfied with the way you are spending your money. It happens when you are enjoying the utmost happiness from goods and services within your limited budget.

• You feel no regrets for the way you have spent your money.
• You are utterly confident that you cannot get more satisfaction by spending the money in some other way.
• You do not want to switch to another combination of goods and services.

For example, you have Rs 100 in your pocket.

You want to purchase chocolates and ice cream with that money.

The price of ice cream is 20, and that of a chocolate is 10.

You will buy 3 cups of ice cream and 4 chocolates. But you are unable to enjoy the 3rd cup of ice cream, and it goes to waste. With the chocolates, you feel very happy and content. You feel that you could have enjoyed two more chocolates instead. 

So, the next time, you will buy 2 cups of ice cream and 6 chocolates. You feel completely satisfied and happy with your choice. This level of satisfaction is known as "Consumer Equilibrium" in economics.

Consumer Equilibrium Definition

Consumer equilibrium is the point of maximum satisfaction where a consumer attains the highest possible utility within their limited income. It represents the situation where the consumer can purchase the optimal quantity of goods and services available at current prices, given their income level.

Conditions for a Single Product:

The consumer has a fixed amount of money to spend, and the extra satisfaction (marginal utility) from the last rupee spent equals the price of the good.

Formula: Marginal Utility (MU) = Price (P).

Conditions for Multiple Products: 

All products have equal per-rupee utility, and the satisfaction gained per rupee spent is the same across all purchased items.

If there are two goods X and Y, and the Price of each is P, then the marginal utility of good X divided by the Price of good X will be equal to the marginal utility of good Y divided by the Price of good Y

So, the Formula for Multiple Products is MUX/PX = MUY/PY

It means that the marginal utility derived from good X equals the marginal utility from good Y. 

This applies to any number of products(goods) under Consumer Equilibrium.   

Assumptions underlying Consumer's Equilibrium

The following are some of the assumptions implicit in consumer equilibrium.

• The consumer's income is given, and He has to spend within that income.
• The prices are set and stable for the time being under study.
• It is assumed that he has to choose only from various combinations of products available in the market during that particular time.
• The availability of goods and the time gap play an important role along with his income levels.

Marginal Utility is measured in units, and these units are called Utils. So, you can say that you enjoyed a marginal utility of 60 Utils from your ice cream if you ate two ice creams and their utilities were 100 utils for the first ice cream and 60 for the second one.

There are two ways of viewing marginal utility:

1. The Cardinal View (Numbers): 

You give numbers to the utility derived: 100 utils, 60 utils, 30 utils, etc. 

But many economists argue that you can not actually visualise and count the satisfaction derived using numbers. They are only assumptions.

2. The Ordinal View (Rankings):

This is the modern, realistic approach. It assumes you can not measure utility in numbers, but you can rank them.

Indifference Curve

An indifference curve is a curve formed on a graph by connecting the points of different combinations of two commodities that a consumer regards as of equal value and are giving him equal satisfaction. The consumer regards any combination on that curve as of equal value, and so he is indifferent to each of those combinations.

With a given income and the present ranges of prices, the consumer has to choose among various alternative combinations of goods and services to derive utmost satisfaction and enjoy most of those goods and services. 

The manner in which he responds and the solution that he finds at a particular level with a given combination is his equilibrium.

Indifference Curve Example

Now, let us take an example. Suppose your income is $100 and you have to purchase two goods within that income. 

Let us assume that the price of product X is $10, and that of product Y is $20. 

Now, if you want to purchase only one commodity, then you can purchase either 10 units of X or 5 units of Y. 

But you can't have only one item. You have to buy both items to maximise your satisfaction levels. So, you will try different combinations of those goods, and the results are depicted through the indifference curves in the indifference map below.

In the figure above, the X-axis represents product X and the Y-axis represents product Y. At the right-hand tip of each curve, IC stands for the indifference curve. We have drawn four indifference curves, labeled IC1, IC2, IC3, and IC4. You will notice that points on IC1, IC2, and IC3 fall within your income range. However, IC4 is completely outside your income range, as it lies beyond the price line. The price line AB is tangent to the indifference curve IC3 at point E. Therefore, point E can be considered the consumer equilibrium point, at which the consumer maximizes satisfaction by purchasing Q1 units of product X and Q2 units of product Y. Any other points on lower levels that touch the price line will yield less satisfaction. Furthermore, at those points, the consumer is not spending his full income. Points at higher levels do not touch the price line AB and so are not within his income range.

To Sum-Up,

Consumer equilibrium is the point at which the consumer maximizes satisfaction by spending his full income on those products in the most effective way. In real life, there are so many products that the buyer purchases, and it is a more complicated problem. The decision-making ability of the consumer shows his smartness and prudence in attaining consumer equilibrium.

Pricing Process: Ever Wondered How Businesses Set Their Prices?

How Do They Set Their Prices?

 
While sitting in a Cafe and drinking a cup of Coffee, have you ever wondered why that cup of coffee costs so much?

Businesses just won't come up with a figure by magic to set their prices.

It is not a simple job for the producers or sellers to set a particular price for their products. It involves a lot of calculations that involve science, math, and customer feelings.

Businessmen have to consider many factors before arriving at a price. They are doing business to earn their living. They have to earn some extra income beyond what they are spending on their business. 

So, how do they arrive at their price tags?

Let us take a peek into the process of setting the prices. For this purpose, I am taking the example of a recipe, say, idli and its side dish, chutney.

Determining the Cost of Idli

Ingredients required for preparing this breakfast recipe (for 10 idlis) are as follows:

• Black gram (split lentil) 100 grams = Rs 40
• Idli Rawa                        200 grams = Rs 20
• Coconut pieces (for chutney) 50 grams = Rs 30
• Green chili & ginger (for chutney) approx. = Rs 10
• Roasted chana dal 20 grams             = Rs 10
• Salt & spices used for topping chutney = Rs 10

Total Cost of Ingredients (Raw Materials)    = Rs 120

Now, add your time and labour invested, say   Rs  50

Add the fuel cost and rent for utensils, say       Rs  30

                          

                  Total cost of preparing 10 idlis   = Rs 200

                                                                       ________

                  So, cost of one idli is  200/10     = Rs 10

This is how businesses determine prices for products.

The above is a single example for your understanding. In actual practice, the process can be more complex. 

1. The cost of raw materials is the primary input.
2. Thereafter, add other costs like power and fuel consumed during production.
3. Add the labour cost involved.
4. Add the rent/depreciation for machinery and equipment used.
5. Calculate other expenses incurred in producing the output and include them also in the total cost.
6. Total up the expenses cited above and divide by the quantity produced. 
7. The average cost is the basic price for your product.
8. But you are doing the business to earn your livelihood. Your income/profit is the main objective.
9. Increase the sale price by the minimum average amount of that profit margin. This is the Price at which you should sell your product.

From the above example, I hope it is clear to you in understanding the pricing process of goods and services.

Many external factors also need to be considered while determining the prices. Let us look into them.

Factors Influencing Price Determination

The following are some of the most important factors affecting price determination:

1) Cost of production
Cost of production is the basic element of price, as discussed above.

But there should be a periodic review of the cost. The prices of the ingredients are ever-fluctuating. Salaries and wages keep changing. Other overhead expenses also keep fluctuating. A continuous moniteering should be done to ascertain that you are recovering the costs from the sales.

2) Competition in Market

You are not the only businessman for your products. The same products are produced and sold by many others. 

If there are many sellers of the same commodity, each one of them will be trying to maximise his sales by giving incentives to buyers. 

Buyers generally buy from a dealer who offers the products at comparatively lower prices. Even a small fraction of a rupee charged less can allure the buyers. 

So, the producer or seller needs to pay attention to this factor of market competition while setting his prices.

3) Value of Product to the Buyer
This is another important element in fixing the price. 

The value that buyers attach to the product is a very sensitive element of price. 

Necessities like food grains, salt, and sugar are more important for consumers. So, they cannot live without these products. 

Similarly, bridal wear, birthday gift items, and children's toys can be important items for the customers. They would like to pay a little more than foregoing such items. 

The producer or supplier can set the prices of such goods with ample margins without losing market share.

4) The Forces of Supply and Demand

The forces of demand and supply play a major role in price determination. 

Buyers normally tend to purchase products at reasonably lower prices to get maximum satisfaction.

Similarly, sellers try to maximise their profits by selling things at higher prices. 

So, when both these forces clash, buyers try to restrict their purchases whenever prices rise, or try to increase their purchases when prices fall. 

Naturally, when there are no buyers at increased prices, the supplier is forced to reduce their price a little to attract buyers. 

Similarly, when prices fall too much, there will be excessive demand for products, but the supplier may not have enough supply to meet that demand. The markets may become out of stock. Under such circumstances, buyers will be ready to pay a slightly higher price. Thereby, the prices will increase. 

In this way, the price level settles at a point of equilibrium where quantity demanded and quantity supplied match up.

Thus, the forces of supply and demand have an effect on the price structures of markets.

5) Government Policies

The government can always try to regulate prices through its policies and laws to safeguard the interests of consumers. So, producers and sellers have to set their prices in accordance with those policies and guidelines, or else they may face legal proceedings and bans.