1micro Economics (Page 1 68) Book 1

Vidyamandir Classes Micro-Economics
(a) Introduction :
Economy, Central Problems and Production Possibility Curve
Economy : An economy is a system that provides people with the means to work and to earn a living in a process of
production.
How do Economic Problem Arise : Human limits are unlimited, resources to satisfy them are limited. These resources
have alternative uses. The problem of choice which arises because of scaricity called economic problem.
Economising of Resources : It means making use of available resources. Scarcity of resources have alternative uses in
relation to unlimited wants which gives rise to an economic problem. Economy has to make a choice among its available
resources.
Central Problems : The central problem is allocation of resources.

(a) What to produce ?
As the resources are limited and wants are unlimited, the economy has to choose what commodity has to produce and
in how much quantity.
The main principle is to allocate resources in such a way that generates maximum aggregate utility.
(b) How to Produce ?

It is concerned with technique of production. A good can be produced either by capital or labour intensive technique.
The principle is the production should be done in such a manner which gives maximum profit and the per unit cost of
production should be least.
(c) Whom to Produce ?

Relating to allocation of resources is of functional distribution. Goods and services are produced for the people who
can purchase them. Purchasing power depends upon distribution of income.
The principle is to fulfill the urgent wants of each productive factor to the maximum possible extent.
Production Possibility Curve : PPC is defined as a two good economy showing various combinations that can be produced
with available technologies and with given resources which are fully and efficiently used.
Opportunity Cost : Opportunity cost of any commodity is the value of next best alternative i.e. forgone.
Board Notes/Micro-Economics 2 Class XII

Micro-Economics Vidyamandir Classes
Marginal Opportunity Cost : It is the rate of scarifise to produce a good.

Increasing Marginal opportunity cost: As more and more of a good is produced, factors producing it becomes marginally less
and less productive. Therefore ,more and more of other good has to be scarifised to increase the production of the former
good.
PPC Schedule and Curve :
Features :
(i) If an economy makes full use of its available resources with given technologies, it will be producing on PPC i.e. a, b,
c, d, e, f.
(ii) If the economy produces any combination of goods that lies below the PPC, it is under utilisation of resources i.e. G.
(iii)Economy cannot choose any combination above the PPC with the given resources and technology. This shows the
problem of scarcity.
(iv) Economys PPC may shift upward to the right if technological advancement. This will lead to growth i.e. H.
(v) The concativity of PPC is due to law of diminishing returns.

MC/MOC Schedule and Curve (Same as PPC)
Market Economy : It is a political economic system based on private property and private benefit.
Planned Economy : It is based on government control and social welfare motive.
Positive Economics : It deals with what is or how economic problems facing an economy is actually solved.
Normative Economics : It deals with ought to be or how economic problem should be solved.
Practice Questions :
1. Why is PPC downward slopping ?
2. What is the slope of PPC ?
3. Why is PPC called opportunity cost curve ?
4. Explain the effect on PPC when there is earthquake and floods in the economy ?
5. Explain the effect on PPC if there is massive unemployment in the society ?
6. Give two examples each of underutilisation and growth of resources ?
7. Explain the shape of PPC or frontier.

(b) Consumers Equilibrium : Utility Analysis

Utility : It is the amount of satisfaction which a consumer gets from consumption of a good. The unit of utility is util.
For example : 1 util = 1 Rupee assumption, means if a consumer gets 5 utils of satisfaction from consumption of a
good, the utility is taken as Rs.5 worth.
Concepts of Utility :
(a) Marginal Utility : Marginal utility means addition made to total utility by consuming an additional unit of a com-
modity
MUn = TUn TUn 1 where n = number of units
n 1 = value of the previous unit
in total utility
Also, MU =
Q (no. of units consuming)
(b) Total Utility : Total utility is the total satisfaction a consumers options from a given amount of a particular commodity.
MU
TU =
(MU1 MU 2 . . . MU n )
Relationship between total Utility and Marginal Utility :

Analysis :
(a) If total utility increases at increasing rate, marginal utility rises.
(b) If total utility increases at diminishing rate, marginal utility falls.
(c) When total utility reaches maximum and is constant, marginal utility is zero.
(d) When total utility falls, marginal utility is negative.
Law of Diminishing Marginal Utility :

As more and more units are consumed, the utility derived from successive units goes on declining, it is known as
fundamental psychological law. (Refer previous schedule)
Consumer Equilibrium for a Single Commodity Approach :

It is a situation when consumer spends his given income on purchase of goods in such a way that gives him maximum
satisfaction and he feels no urge to change.
As more and more units are consume the utility derived from successive units goes on declining.
Conditions :
(a) Marginal utility in terms of money is equal to price.
(b) The gain decreases as more of a commodity is consumed after the equilibrium.
To Express the Marginal Utility in terms of Money following Formula is used :
MU p
MU m (in terms of money)
MU r
where MUp = MU of a product
MUr = MU of a rupee
Numerical Example :
Assume : Price = Rs.2, MUr = Rs.2
Consumer equilibrium (Gain falls beyond this unit) and hence the consumer equilibrium conditions are satisfied.

Marginal Utility of a Rupee : It is worth of a rupee to a consumer is terms of other goods.
Consumer Equilibrium for a Two-Commodity Approach :

Consumer attains equilibrium when the ratio of marginal utility of a commodity to its price becomes equal to the
marginal utility of other commodity to its price.
Conditions :
(a) Marginal utulity of last rupee of expenditure on each good is the same. (Law of equi marginal utility)
(b) Marginal utility of a good falls as more of it is consumed (Law of diminishing marginal utility)
MU X MU y
MUm = Price = Cardinal approach :
Px Py
Where MUX = MU of X Px = Price of X
MUY = MU of Y Py = Price of Y
Px 4
Numerical Example : Assume : Income = Rs.30
Py 2
Income = PXQx + PY Qy
Analysis :
Therefore the consumer will obtain equilibrium where he consumers four units of x and seven units of y commodity.

Consumer Equilibrium : Indifference Curve Analysis :

Consumers Budget :
Budget Line
Budget Set
Budget Line : A budget line is a graphical representation of the combination of two goods which cost the consumer
exactly his income. It is a narrow concept as it is a concept of budget set.
Equation of Budget Line

Px Q x + Py Q y = M
Budget Set : It refers to a set of possible combinations of the two goods which the consumers consumes which
he can afford from his income and given prices. It is a broader concept.
Equation of Budget Line
Px Qx + Py Qy M
where P x = Price of commodity x

Qx = Quantity of commodity x
P y = Price of commodity y
Qy = Quantity of commodity y
M = Income
Note : (a) All bundles of budget set lies below the budget line or on it.
(b) All bundles of budget set lies on budget line.
Px Price of good obtain

(c) Slope of budget =
Py Price of good sacrified

Various causes of Shifts of Budget Line :

(a) If income changes :
It income increases the price line will shift If income decreases the price line will shift
rightwards leftwards
(b) If price of X changes

If price of X increases, price line on x-axis shift If price of X falls, price line on x-axis shift
leftrwards rightwards.
(c) If price of y changes

If price of y increases price line on y-axis shift If price of y falls price line on y-axis shift
leftwards rightwards.

(d) If price of x and price of y increases or (g) If Px increases and Py decreases : Price line
decreases by same percentage - The budget of x-axis shift left wards and y-axis
line will shift rightwards or leftward or will rightwards respectively.
remain parallel to each other. Price line will
shift leftwards when there is price rise and
will shift rightwards when price falls.
(e) If income and price x and price y changes

by same percentage
No change in Budget and price line.
(f) If Px falls and Py increases : The price line

on x-axis shift rightwards and price line on
y-axis shift leftwards respectively.

Monotomic References :
It means that a rational consumer always prefer more of a commodity as it offers him a higher level of satisfaction.
For example : A consumer prefer the bundle (2, 3) to (2, 2) (1, 3) (1, 2) and so on.
Indifference Schedule (IC) :

A tabular presentation of different combination of goods that gives the same level of utility to the consumer.
Marginal Rate of Substitution (MRS) :

This is defined as the rate at which the consumer is willing to scarifise a good to obtain one more unit of the other good.
Change in Y (Quantity of good scarifise)

MRS and IC =
Change in X (Quantity of good obtained)
Indifference Curve :
It is a diagramatic presentation of indifference schedule. It shows different combinations of good that gives the same
level of satisfaction to the consumer.
Assumptions :
(a) Consumer buys only two goods (b) Rational consumer
(c) Ordinal utility compressed in terms of ranking (1, 2, 3 . . . . . so on)
Analysis :
(a) A, B, C, D combinations are the locus following indifference curve.

(b) IC is a downward slopping curve is a negatively slopped. As consumption of X increases, the consumption of Y
decreases keeping utility level unchanged.
(c) IC can never touch X or Y axis, because he is consuming only one good.
(d) IC is convex to origin because marginal rate of substitution does on decreasing.

Indifference Map :
The set of all possible indifference curve, the consumer has is called indifference map.
The features are :

(a) Consumer would like to have more and more of consumption as utility is a increasing function of consumption.
(b) In the given diagram the level of satisfaction is lowest in IC1, then a little higher in IC2 and the highest in IC3.
Indifference Curve According to Consumer Equilibrium :

Conditions :
(a) Where budget line is tangent to indifference curve.
(b) Indifference curve is convex to origin and hence marginal rate of substitution goes on falling.
Equilibrium is attained when the consumer reaches the highest possible indifference curve given his budget constraint.
Features :
1. IC1, IC2, IC3 shows the scale of preferences of consumer between two goods x and y shown by an indifference
map.
2. Points E is the consumers budget line tangent to IC2. Therefore, it is a position of consumer equilibrium.
3. If a consumer operates on point F, consumer MRS is less than the price ratio. Therefore, consumer will move
back to point E.
4. Points to the rights of E are desirable but not attainable.
5. Therefore ,consumer can achieve equilibrium when he consumer m units of y and n units of x, that is point E.

Analysis :
1. Slope of IC is equal to slope of budget line
Px
MRSxy
Py
What the consumer is willing to buy (IC) is equal what the consumer can buy (budget line)
2. Marginal rate of substitution of two commodities X and Y goes on falling.
Utility Approach :
(i) It is an cardinal concept
i.e. measured in money terms.
(ii) Diminishing marginal utility is applicable i.e. as more and more units a consumer consumes, the marginal
utility goes on falling.
(iii) Diminishing marginal utility is shown by MU curve which is falling throughout.
(iv) Consumer equilibrium condition
MU X MU y
(a) MUm = Price (b)
PX Py
(v) The approach assumes constant MUm or constant income.
Indifference Approach :
(i) It is an ordinal concept i.e. that can be ranked and not measured.
(ii) Diminishing MRS is observed i.e. as the consumer has more unit of good x, its subjective worth declines. So,
the consumer is willing to give up less units of good y for an additional of good X.
(iii) MRS is the slope of IC which is convex to the origin due to it.
(iv) Consumer equilibrium condition.

P
(a) MRS X (b) Convexticity of IC
PY
(v) The approach slits price effect into substitution effect and income effect.

Demand
Meaning : Demand is a willingness of a consumer to purchase a commodity at a particular price and time.
Factors Affecting Demand :
Dx = f (Px , Py , T , y)
where Dx = Demand for a particular good
f = Function of (effected by)
Px = Price of particular good
P y = Price of related good
y = Income of the consumer
T = Taste and preferences
(a) Price of Particular Good : The price of particular good and demand for that particular good are inversely related to
each other i.e. if the price of commodity increases then the demand for that particular good will decrease and
vise-versa.
(b) Price of Related Good : There are two types of related good :
(i) Substitute good (ii) Complementary good
(i) Substitute Goods : These are those goods which are used in place of each other.
For eg. : Tea, Coffee, Pepsi and Coke etc.
If the price of substitute good increases then the demand for particular good increases and vice versa.
(ii) Complementary Good : These are these goods which are used together.
For eg. Tea, Sugar ; Car, Petrol and Ink, Pen.
If the price of complementary good increases then the demand for particular good decreases and vice-versa.
(c) Taste and Preferences : If the taste is favourable then the demand for particular good will increases, if unfavourable
the demand will decreases.
(d) Income of the Consumers : (Money Income)

There are two types of goods : Normal Good (Superior Quality) If income increases demand for normal good
increases and vice-versa.
Inferior Good (Low Quality) If income increases the demand for imperior good decreases and vice-versa.
Law of Demand :
Other things being constant : Price of a commodity and quantity demanded for that particular good are inversely related
to each other.
Demand Schedule : It is a tabular presentation of various quantity demanded at different prices and at a particular period
of time.

Demand Curve : It is a graphical representation of demand

schedule showing various quantity demanded at different
prices at a particular period of time :
Assmptions of Demand :
Other things being constant means :
(i) Price of related good remain constant (ii) Income of the consumers remain constant
(iii) There is no change in taste and preferences.
Note : The law of demand is based on (utility = price) law of diminishing marginal utility.
Reasons for Demand Curve as Downward Slopping Curve :

(i) Law of Diminishing Marginal Utility : As more and more units, a consumer consumes the marginal utility from
successive units goes on declining. The consumer pays according to the utility. Therefore as the quantity demanded
increases the price falls. For eg. A hungry man is maximum satisfied with the first chapatti as compared to second and
third.
(ii) Price Effect : It is summation of income effect and substitution effect.

Income Effect : It is the change in demand caused due to change in price due to the change in real income.
For eg. If the price increases from Rs.25 to Rs.50 per unit, the demand for that particular good falls from 4 units to
2 units. The purchasing power or the real income has fallen down.
Substitution Effect : It is the substitution of one commodity to another when it becomes relatively cheaper.
For eg : If the price of tea increases the demand for tea decreases because now the coffee is more cheaper and price
of coffee remains constant.

Factors which affect the demand are called determinants of demand. Determinants of demand are categorised
into two categories :
(i) Price of the commodity itself [Dx = f (Px)]
(ii) Other factors [Dx = f (Py, T, y)]
Change in price of commodity itself affecting the demand is known as movement along the same demand curve
leading to expansion and contraction.
Change in other factors affecting the demand is known as shift in demand curve leading to increase and decrease in
downward.
Important Differences :

Increase and Decrease in Demand :

Market Demand : It is defined as the summation of all individual households willingness to purchase commodities at
different prices and at a particular period of time.
Market Demand Schedule : It is a tabular presentation of the quantities purchased by all individual households at
different price and particular period of time.
Market Demand Curve : It is graphical presentation of market demand schedule showing various quantities demanded by
various individuals at different prices and at a particular period of time.
Schedule :
(units)
Factors affecting market demand :

(i) Price of commodity itself
(ii) Price of related goods
Discussed before
(iii) Income of consumer
(iv) Taste and preference
(v) Number of consumers are more, the demand will increase and vice versa.
(vi) Distribution of Income : If it is equal or uneven then the demand for commodity will increase, if inequal then the
demand will decrease
(vii) Age sex compsotion of Population : If the population constitutes more students then the demand for the stationary
items will increase, if more children then the demand for toys will increase.

Price Elasticity of Demand :

Meaning : It is the degree of responsiveness of change in quantity demanded due to change in price.
(Law of demand : Other things being constant is applicable)
Degree of Elasticity of Demand :
Demand for different commodities respond differently to change in price. It is broadly classified into five categories :
(i) When percentage change in quantity demanded is equal to percentage change in price. The demand for the
commodity is known as unit elastic demand. For eg. comfort goods.
(ii) More than Unit Elastic Demand : (Ed > 1)
When percentage change in quantity demanded is greater than percentage change in price, the demand for the
commodity is known as more than unit elastic demand. For eg. Luxury goods.
(iii) Less than Unit elastic Demand (Ed < 1)
When percentage change in quantity demanded is less than percentage change in price, the demand for the
commodity is known as less than unit elastic demand. Eg: necessary goods
(iv) Perfectly Inelastic Demand (Ed = 0)
When with the change in price, demand does not reponds at all, it is known as perfectly inelastic demand.
Eg., life saving drungs

(v) Perfectly Elastic Demand (Ed = (Infinity))
When demand goes on expanding or contracting without any change in price, it is known as perfectly elastic
demand. It is seen in perfect competition situation
Methods of Measuring Elasticity of Demand
(i) Percentage Method : According to this method price elasticity of demand is measured by taking the ratio of
percentage change in quantity demanded to the percentage change in price. As price and quantity demanded are
inversely related, the price elasticity of demand. Therefore Ed is always negative in number. To understand we take
an absolute value only otherwise our Ed will be less than 1
Change in Q.D.
100
% in Q.D. Original Q.D.
Ep
% in Price Change in P
100
Original P
Q
100
Q Q P

P P Q
100
P
(ii) Expenditure Method : It measures the relationship between the expenditure and its effect on elasticity of
demand. It indicates the direction in which the total expenditure on a product changes as a result of change in
price of the commodity there are three cases:

Factors Affecting Elasticity of Demand :

(i) Availability of Substitutes : If there are many substitutes of a commodity then the demand for that particular good is
elastic in demand. If a commodity has no substitute, then the demand for particular good is inelastic.
(ii) Nature of Commodity : If the commodity is a luxury good, then the demand for a commodity is elastic while as if the
commodity is a necessity, then the demand is inelastic.
(iii) Share in total expenditure : If the share is large of the expenditure undertaken, then the demand for commodity is
elastic. If the share is small of the expenditure, then the demand for commodity is inelastic.
(iv) Habitual Commodity : If the commodity is a habit of the consumer, the demand for the commodity is elastic and
vice-versa.
(v) Time Period : If the time period is short, the demand for commodity is inelastic while if the time period is long, then
the demand for commodity is elastic.
(vi) Price Level : If the commodity is very high leveled or low leveled price then the demand for the commodity is
inelastic.
Concept of Rectangular Hyperbola :

A rectangular hyperbola (Ed = 1 throughout) has a special property that the areas of all rectangles formed on the demand
curve is the same. For eg., At point A, rectangle POQA is equal to point B, the rectangle P0 O Q, B is formed.
(iii) Geometric Method :

It is used when elasticity is to be measured at different points on a straight line demand curve.
Here, AE is a straight line demand curve which is extended both sides touching X and Y axis. Elasticity of demand
at any point is measured by dividing the line segment below the point with the line segment above the point.
line segment below the point
Ep
line segment above the point
CE
At point C = , Ep 1
CA

DE
At point D = , Ep 1
DA
BE
At point B = , Ep 1
BA
EE
At point E = , Ep 1
EA
AE
At point A = , Ep
AA
PRACTICE QUESTIONS
Consumes Equilibrium and Demand :
1. Explain why does MRS goes on declining as consumer moves along the curve to the right ?
2. Where is consumer equilibrium achieved according to indifference curve analysis ?
3. Why does a consumer buy more at less price or vice versa? / Why is demand curve has a negatively slopped curve ?
4.(a) What is the relation between good x and good y in each case if with the fall in price of X, demand for good y increases
and fall ? Give reason :
(b) In a particular city, the people are employed due to a industry was established. How will it effect the demand for black
and white and coloured television.try Making shifts in demand curve ?
(c) The govt. of India has encouraged the tourism by reducing the airfare to four metro cities. How will it effect the demand
for air travel ?
5. A consumer consumes only two goods. What are the conditions of consumers equilibrium in the utility approach ?
Explain the changes that will take place if the consumer is not in equilibrium ?
6. Explain why MRS must equal MRE when a consumer is in equilibrium ?
7. What is the relation between good X and Y in each case, if with the fall in price of X demand for good Y (i) rises (ii)
falls?
8.(a) What is the measure of Ep

when demand and price change by same %
when demand falls to zero if price is ?
9. How does the nature of a commodity influence its price elasticity of demand ?
10. The diagram shows PQ is the demand curve of a commodity.

On the basis of this diagram, state whether the following
statements are true or false along with the reasons :
(a) demand at points S is price inelastic
(b) demand at point R is price inelastic
(c) demand at point S is more price elastic than at point R
(d) price elasticity of demand at point S is greater than the
price elasticity of demand at point T

Numericals :
1. The quantity demanded of a commodity at a price of Rs.8 per unit is 600 units. Its price falls by 25% and quantity
demanded rises by 120 units. Calculate its price elasticity of demand ?
2. A consumer buys 100 units of good at price of Rs.5 per unit. When price changes then he buys 140 units. What is the
new price if Ed is 2 ?
3. As a result of fall in price from Rs.7 to Rs.5, the total expenditure increases from 3500 to 6250. Calculate price
elasticity.
4. Kanav buys Rs.10 unit of good of X at a price of Rs.5 per unit. The price elasticity of demand for this good is 2.
Price falls to Rs.4 unit. How many unit of good X will Kanav now buy at this price ?
5. Price elasticity of demand of a good is 1. 60 units of this good are bought at a price of Rs.8 per unit. At what price will
45 units be bought ?
6. Find out price elasticity of demand ?
7. If value of price elasticity of demand of a commodity is 3, what will be percentage change in demand as a result of 10%
change in price ?
8. 2% fall in price leads to same percentage change in quantity demanded ? If elasticity of demand is 2.5, find the percentage
change in demand ?
9. Complete the table :
10. A consumer wants to consume two good X and Y. The price of X and Y goods are Rs.4 and Rs.5 respectively. The
consumers income is Rs.20.
(i) Write down the equation of budget line.
(ii) What is the slope of budget line ?
(iii) How much of good y can she consume if she spends her entire income on that good ?

(c) Production
Production Functions : It refers to technological relationship between physical inputs and physical output.
Output = f (Input)
Example : Wheat = f (land, labour capital seeds, fertilisers)
Types of Production Function :
Short Run : It is the time period in which the output can be increased only by increasing variable factors, fixed factors
remain constant. The economist have made a law named is Return to a factor or law of variable proportion.
Long Run : It is the time period in which all factors of production can change in the same proportion. The economists
have named the law as Returns to scale.
Total Physical Product (TPP) : It refers to the total volume of goods and services produced by a firm with the given
inputs in a given period of time.
TPP = EMPP, TPP = APP Q

Marginal Physical Product (MPP) : It is an addition to the total production when an additional unit of a variable factor is
employed.
TPP
MPPn = TPPn TPPn 1, MPP
Q
Average Physical Product (APP) : It is the per unit production of a variable factor in a given period of time.
TPP
APP
Q
Board Notes 24 Class XII

Relationship between TPP, MPP, APP

Schedule :
Production Curve :

Law of Variable Proportion :

As more and more variable inputs are employed with fixed factors, TPP increases at increasing rate, TPP increases at
diminishing rate, reaches to the maximum and finally falls.
If more and more variable factors are employed with fixed factors, MPP rises, falls, becomes zero and finally negative.
Production Schedule :

Assumptions :
(i) Technique of production does not change.
(ii) All units of a variable factor are equally efficient.
(iii) Factors of production are not perfect substitutes.
(iv) This process is undertaken in short run.
Ist Phase : Increasing Returns to a Factor : TPP increases at increasing rate, MPP rises. Therefore, when more and more
units of a variable factors is employed with fixed factors i.e. variable factors are less in proportion to fixed factors.
There is underutilisation of resources.
IInd Phase : Diminishing returns to a factor

TPP increases at diminishing rate and reaches to maximum, MPP falls and becomes zero but remains positive. With the
increase in variable factor along with fixed factor i.e. variable factor and fixed factor are in equal proportion. This is
optimum utilisation of resources. A rational firm tries to operate in this phase.
IIIrd Phase : Negative returns to a factor

TPP falls, MPP becomes negative. Therefore with the increase in variable factors along with fixed factors i.e. variable
factors are more in proportion to fixed factors. There is over utilisation of resources. It is an economy absurdity.
Analysis : Law of variable proportion is extention to law of diminishing returns.
Reasons for Increases in Returns to a factor :
(i) Optimum utilisation of factors : The under utilised fixed factors like machines, buildings are better and fully used.
Therefore factor proportions become more suitable for production.
(ii) Specilisation : It results to division of labour which help in getting increasing returns.
(iii) Volume Discounts : It is the discount on price when large quantity is purchased which gives increasing returns to a
factor (producer)
Diminishing Returns to a Factor :
(i) Use beyond Optimum Capacity : After achieving optimum combination of variable and fixed factors efficiency
starts declining when more units of variable factors are employed.
(ii) Scarcity of Resources : It is due to limited resources and unlimited wants which brings diminishing returns.
(iii) Lack of perfect substitutes between factors : Upto a certain limit of factors production can be substituted for one
another but beyond a certain stage, this is not possible. The factors of production becomes imperfect substitutes
leading to diminishing returns.

PRACTICE QUESTIONS
1. Show with the help of a table that changes in the TPP, MPP and APP as we apply more and more units of a variable
factors on some fixed factors ?
2. What will you say about MPP when TPP is falling ?
3. TPP will increase only when MPP increases. It is true or false ?
4. Explain meaning of increasing return to a factor with the help of TPP schedule and curve ?
5. Explain effects on TPP when all inputs are increased in the same proportion.
6. Explain reasons behind law of variable proportion.
7. (a) How does TPP change with change in MPP of an input ?

(b) What happens to TP when MP becomes negative ?
(c) Describe the stage of a firms operation is returns to a variable factor ?
8. Give reason whether the following are true or false :

(i) When there are diminishing returns to a factor, total product always decreases.
(ii) Total product will increase only when marginal product increases.
Numericals :
1. Complete the table assuming that there are increasing returns to a factor :

3. Identify the different phases of law of variable proportion from the schedule :
4. Calculate TP and MP :

Producers Equilibrium
Meaning : It is position where producer attains maximum profit and has no incentive/urge to increase or decrease the
output.
Two Approaches of Producer Equilibrium :

(i) Total Revenue and Total cost approach (TR and TC)
(ii) Marginal Revenue and Marginal cost approach (MR and MC)
Total Revenue and Total Cost Approach : A producer is in equilibrium at the level of output where the difference
between TR and TC is maximum. The profit falls as more output is produced.
Schedule :
In Perfect Competition :
Firm is only a price taken and cannot influence the price.
Price (AR) remains the same at all levels of output.
TR of the firm is an upward sloping straight line curve increasing at
increasing rate.
TC curve rises as output increasing initially at a diminishing and
finally at a increasing rate.
Explanation:
Upto ON level of putput the firm is suffering losses as TC curve lies above the TR curve. Point B is the break even point
i.e. no profit no loss (normal profit). Here TR = TC. Beyond ON level of output the firm starts earning profit as TR > TC.
The total profits are maximum at OQ level of output. The vertical difference between TR and TC is maximum i.e. PM.
Beyond this point the difference between TR and TC reduces i.e. profit falls.

Marginal Revenue and Marginal Cost Approach :

Generally, a firms profit maximising condition is MR = MC and MC is rising. But in perfect competion, this condition
is P = MC. As P = AR = MR
Therefore the conditions of profit maximising are :
(i) P = MC (ii) MC should be rising
PP is a price line. MC curve is a smooth curve (all units are
percectly divisible). The firms will maximise the profit at OQ level
of output where P = MC i.e. price line intersects MC curve.
We know that area under price line is TR, Area under MC curve is
TVC and profit = total revenue total cost
At output OQ At output OQ1 At output OQ2

TR = OPAQ TR = OPAQ1 TR = OPAQ2
TVC = OMAQ TVC = OMOQ1 TVC = OMLQ2
Profit = TR TVC Profit = TR TVC Profit = TR TVC
= PAM = PA DM < PAM = PAM ALA(Loss)
= P < MC (Loss)
Here the firms scarifise (Q1 A AQ) is > than savings of the firm (Q1DAQ)
Question : Why does produces does not opt for producing when the MC is falling ?
At point A, MC is decreasing. Therefore it cannot be profit
maximising level of output because of the firm increases its output
beyond OQ0, MC falls and remains below MR or price. Firm can
add to its total profit by expanding output upto Q level of output.

Rising MC curve is a supply curve :
We know that industry is a particular and firm is a price taker. If the
industry fixes the price higher, than the equilirbium point will
move upwards from E to E . The firm will increase the output i.e.
from OQ to OQ1. Therefore, higher the price more is the quantity
sold (P to P). Hence proved that rising MC curve is a supply curve.
Numerical Based on Approach :

(i) TR and TC Approach :
Analysis : At 3 unit he earns maximum profit because beyond the 3 unit he will incurr losses i.e. profit falls.
(ii) MR and MC Approach :
Analysis : At 4unit the producer will attain maximum profit because price MR = MC, MC is rising.

Revenue
Meaning : The revenue of a firm is the money receipt that a firm gets from selling its output.
Concept of Revenue :
Total Revenue : It is the total amount of money receipt by the firm from the sale of total output. It is same thing as total
expenditure by the buyers on purchase of the product of the firm. Example : If a firm sells 100 units at the rate Rs.150
per unit then the total revenue is equal to Rs.15000
Total Revenue = Price Quantity Sold
Marginal Revenue : It is the addition to the total revenue from the sale of an additional unit of a commodity.
Example : A firm gets TR of Rs.15000 by selling 100 units and Rs.15500 by selling 101 units then MR is Rs.500.
MRn = TRn TRn 1
Average Revenue : It is the per unit revenue of the product sold. AR is something as price because price paid by the
consumer is the per unit revenue of the firm. Example : TR of a firm from sale of 100 units is Rs.15000. Then AR is
TR
Rs.150. Therefore AR = Q
TR P Q
Important AR P
Q Q
AR is demand curve because it indicates quantity demanded by the buyers at different prices. AR is also known as price
line or price curve.
Relationship Between TR and MR in Imperfect Market Condition :

(When a firm sells more quantity by lowering the prices)
Schedule :

Relationship Between TR and MR :

(i) TR increases at diminishing rate, MR falls but remains positive.
(ii) TR reaches maximum, MR is zero.
(iii) TR falls, MR becomes negative.
Relationship Between AR and MR [Refer schedule and graph as above]

(i) At first unit AR = MR.
(ii) AR and MR downward sloping curve i.e. a firm can sell more only by lowering the price.
(iii) MR falls twice the rate than AR i.e. MR falls at a faster rate than AR.
Relationship Between TR, MR and AR in Perfect Market Competition :

When a firm sells more quantity at the same price.
Schedule:
(i) TR increases but at a constant rate because price is constant. Graphically, TR curves is upward sloping straight
line curve throughout starting from the origin.
(ii) AR is unchanged as output changes because price remains constant. Graphically, AR curve is parallel to x-axis.
AR (demand curve or price line) is perfectly elastic demand curve (Ed = )
(iii) AR or price is constant. Therefore AR = MR. Graphically, MR is parallel to x-axis.
Relationship Between Price Line And TR

To prove area under price line is TR :

(i) In perfect competition firm is a price taker and industry is a price maker.
(ii) TR = P Q. If a firm sells 4 units at rate Rs.10 per unit then TR = 40.
(iii) Graphically if the price is OP and PA is the price lines, firm sells OQ units of output. Therefore TR = OP OQ.
(iv) ARea of a rectangle OQAP i.e. under PL is equal.
Relationship Between AR, MR and TR (General Relationship)

It is the marginals which purchase average up and pulls average down.

PRACTICE QUESTIONS
1. The MR schedule of a monopoly firm is given below. Derive TR and AR.
5. Explain why MR = MC is the profit maximisation principle of a firm ?

6. What will be the effect on MR when TR increases at decreasing/increasing constant rate ?
7. A producer will increase his profit by reducing production when his MC is greater than his MR. Explain.

9. Explain showing TR, AR and MR of a firm who can sell any quantity at a given price. Take at least five output levels.
10. What change should take place in total revenue so that :

(a) MR is positive
(b) MR is falling
11. Calculate AR, MR and TR from the following :

6 10
7 9
8 8
9 7
10 6
12. Complete the following table :
13. What will be the effect of the following changes in total revenue on marginal revenue ?
(i) TR decreasing rate but increases
(ii) TR increases at a constant rate
14. What change in total revenue will result in :

(i) Decrease in marginal revenue
(ii) An increase in marginal revenue

Supply
Meaning : It is the quantity offered for sale at a particular price and time by a firm.
Determinants of Supply :
Sx = f (Px, Py, Tech., Ip, Ed)
Whereas Sx = Supply of a particular good
f = function of
Px = Price of a particular good
Py = Price of other good
Tech. = Technology
Ip = Input Price
Ed = Excise Duty
Price of Commodity Itself :

Price of the commodity itself and supply for that particular good are directly related to each other i.e. higher the price
of the good more is the supply of that particular good and vice versa.
Price of other Good :

Price of other good and the supply of the particular good are inversely related to each other. For e.g., If the price of
wheat increases the supply of pulses will fall and vice versa.
Technology :
If the technology is advanced then the cost of production will decline which will increase the supply.
If the technology is backward or outdated then the cost of production will increase which will reduce the supply.
Input Price : Input price means payment made to the factors of production i.e. rent, wages, interest, profit. If the input
price increases, then cost of production increases which will lead to fall in supply.
If the input price falls, cost of production also falls which will increase the supply.
Excise Duty : It is the tarrif tax imposed by the government on a firm on producing a commodity.
If excise duty increases, cost of production increases which will reduce the supply.
If excise duty falls, cost of production also fall which will increase the supply.
Law of Supply : Other things being constant

Price of the commodity itself and supply of that particular good are directly related to each other.

Schedule : It is a tabular presentation of different quantity supplied at a given price and time.
Price Q.S.
1 10
2 20
3 30
Curve : It is a graphical presentation showing the various quantity supplied at a given and time :
Assumptions : Other things being constant means other than price of that commodity itself :
(a) Technology remains constant (b) Price of other good does not change
(c) Input price remains constant (d) Excise duty remains constant
Changes in Supply : Changes in supply means change in supply due to :

(i) Price of commodity itself (ii) Other factors
Change in supply due to price of the commodity itself is known as movement along the same supply curve leading to
expansion and contraction.
Change in supply due to other factors is known as shift in supply curve leading to increase and decrease in supply curve.



Market Supply :
Meaning : It is defined as the quantity supplied by all the individual firms at a given price and time :
Meaning of Supply Schedule :

It is a tabular presentation of the quantity supplied by all the firms at a given price and time.
Market Supply Curve :

Determinants of Market Supply :

Sx = f (Px, Py, Tech., Tp, Ed, O, NF, NC, IS)
Where O = Objective
NF = Number of firms
NC = Natural condition
From I to V (Same as supply)
(vi) Objective Firm : The firm takes into consideration the social prestige issue ignoring the profit maximisation
motive.
(vii) Number of Firms : If number of firms are more in number then the supply is more and vice versa.
(viii) Natural Condition : If the natural condition is favourable for the producer then supply is more and vice versa.
(ix) Infrastructure : If the transportation, communication, banking, post and telegraph, availability is the for a
producer then the supply will be more and vice versa.
Price Elasticity of Supply :

It is degree of responsiveness of change in quantity supplied due to change in price. (Application of law of supply)
Degrees of Elasticity :
(i) Perfectly Inelastic Supply (Es = 0)
When the supply for a commodity does not responds with changes in price. The supply is known as prefectly
inelastic.
(ii) Less than unit elastic supply (Es < 1)

When percentage change in quantity supplied is less than percentage change in price then the supply is less than
unit elastic.

(iii) Unit Elastic Supply : (Es = 1)

When percentage change in quantity supply is equal to percentage change in price the supply is unit elastic.
(iv) More than unit Elastic Supply : (Es > 1)

When percentage change in quantity supplied is more than percentage change in price.
(v) Perfectly Elastic : (Es = )

When supply goes on expanding and contracting without change in price.
Methods of Measuring Price Elasticity :

(i) Percentage Method (ii) Geometric Method
Percentage Method : Price elasticity of supply is measured by the following formula :

% in Q.S.

% in Price
Change in Q.S.
100
Original Q.S. Q.S. P Q.S. P

Change in P Q P P Q
100
Original P

Q.S. P 10 2
Example : Es 1 i.e. unit elastic
P Q 1 20
Elasticity of supply is positive in number because price and quantity supplied are directly related to each other.
Geometry Method : According to this elasticity of supply is measured at a particular point by the following formula :
Supply curve int ercept on X-axis
Es
Quantity supplied at point P
There are three cases under this method :

(i) Es > 1 : To calculate elasticity at point P on a supply curve SS. The following formula has to be used.
Es = supply curve intercept on x-axis
Q.s. at point P
Draw a perpendicular intersecting x-axis at point Q. This gives us output OQ supplied at price P.
Extend the supply curve leftward intersecting x-axis at point T which gives us intercept TQ on axis.
TQ
TQ > OQ
OQ
Es > 1
Analysis : Any straight line supply curve starting from y-axis has price elasticity greater than one on all points.
(ii) Es < 1 :
To measure elasticity of supply at point P, following formula is used.
Supply curve intersect on x-axis

Es
Q.S. at point P

Draw a perpendicular intersecting x-axis at point Q. This gives output OQ supplied at price P.
Extend the supply curve leftward intersecting x-axis at point T which gives us intercept TQ on x-axis.
TQ
TQ < OQ
OQ
Es < 1
Analysis : Any straight line supply curve starting from x-axis has price elasticity less than on all points.
(iii) Es = 1 : To measure elasticity at P following formula is used :

Supply curve intersect on x-axis
Es
Q.S. at point P
Draw a perpendicular intersecting x-axis at point Q. This gives output OQ supplied at price P.
Extend the supply curve leftward touching the origin at point T gives intercept TQ on x-axis.
TQ
Es TQ = OQ
OQ
Es = 1
Analysis : Any straight line supply curve starting from the origin has price elasticity equal on all points.
Factors Affecting Price Elasticity of Supply :

(i) Cost of Production : If cost of production increases at decreasing rate, then the supply for the commodity
will be elastic.
If the cost of production increases at increasing rate, then the supply for the commodity will be inelastic.
(ii) Nature of commodity : If the commodity is durable then the supply of commodity will be elastic and if it is
perishable then the supply of commodity will be inelastic.
(iii) If the time period is short then the supply of commodity will be inelastic and if the time period is long then the
supply of the commodity will be elastic.
Market Period : If refers to very short period which means the

producer cannot increase the supply even by increasing the
number of variable factors and therefore it is perfectly
inelastic.

PRACTICE QUESTIONS
1. Draw supply curve with Es = 0, Es = 1, Es > 1, Es < 1 throughout.
2. Draw supply curves out of which one is elastic and the other is inelastic.
3. Explain the concept of shift and meaning of movement along the same supply cureve.
4. What effect does an increase in input price have on supply curve ?
5. A firms supply curve consists of raising portion of its MC. Explain.
6. Show that the rising portion of MC curve is the supply curve of a competitive firm.
7. How is supply of a product-affected by decrease in tax?
8. Why do technological progress and increase in number of firms shift the supply curve to the right ?
9. What will be the effect on the supply curve of stainless steel utensils if a new technique of production has reduced the
marginal cost of producing stainless steel ?
10. If a farmer grows rice and wheat, how will an increase in price of wheat effect the supply curve of rice.
11. How will an increase in number of firms shift the market supply curve ?
12. How is supply of a particular good affected by the decrease in excise duty ?
Numericals :
1. The Eds of a commodity g is half the price elasticity of supply of commodity x. 16% rise in price of x results in a 10%
rise in supply. If price of x falls by 8%, calculate % fall in its supply. (ans: 10%)
2. The price of a commodity is Rs.5 per unit and its quantity supplied is 600 units. If its price rises to Rs.6 per unit,
its quantity supplied rises by 25%. Calculate Eds. (ans: 1.25)
3. At a price of 8 per unit, the quantity supplied of a commodity is 200 units. Its Eds is 1.5. If its price rises to Rs.10 per
unit, calculate its quantity supplied at new price.(ans: 275)
4. There are three firms A, B and C in the market. The supply schedule for the market and that for firms A and B is given
below. Prepare supply schedule for firm C.
5. When price of a good rises by 10%, the supply remains the same what is Es ?(ans: 0)
6. The price of a good falls from Rs.6 to Rs.5. As a result, supply by a firm falls by 600 units. If Es = 2, find the quantity
supplied at Rs.6. (ans: 1800units)

7. Es of a good is 2. A producer sells 60 units of a good at a price of Rs.6 per unit. At what price will he sell 40 units?
(ans: Rs.5)
8. A seller of onions sells 80 quintals a day when price of onions is Rs.4 per kg. The Es of onions is 2. How much quantity
will this seller supply when the price rises to Rs.5 kg ? (ans: 40)
9. Commodities X and Y have equal 5. The supply of x rises from 400 units to 500 units due to a 20% rise in price.
Calculate the % fall in supply of y if its price falls by 8%. (ans: 10%)
10. At a price of Rs.8 per unit, the quantity supplied of a commodity is 200. Its price Es Rs.1.5. If its price rises to Rs.10
per unit, calculate its quantity supplied at new price. (ans: 275units)

Cost :
Meaning : It is the money expenditure increased by a firm on account of factor inputs and non-factor inputs.
Economic Cost : The summation of explicit and implicit cost is economic cost.
Emplicit cost = These are money payments which is actually made by firms for hiring the services of factors of produc-
tion.
Implicit cost = These are the cost of self owned and self-employed factors of production by a firm.
Real Cost : If refers to scarifise, discomfort and pain involved in supplying factors of production by their owners.
Short Run Cost :

In short run some factors are variable. For e.g., labour, raw material and the cost incurred on it is known as variable cost
some factors are fixed. For e.g., land, building, cost incurred on it as fixed cost.
Short run constitutes fixed cost and variable cost. There are three types of short run cost :
(i) Total cost (TC) (ii) Average cost (AC) (iii) Marginal cost (MC)
Total Cost : It is the sum of total variable cost and total fixed cost.
TC = TFC + TVC
Total Fixed Cost : It is the cost of production which do not change with the change in level of output. It is also called
indirect cost or supplementary cost. For e.g., Rent of land and factor building, property tax, insurance charges, interest
on debentures.
Schedule : TFC
Total Variable Cost : It is the cost which change directly with the change in level of output. It is also known as direct cost,
prime cost. For e.g., cost incurred on raw material, labour, wear and tear of machines.
Schedule :

Relationship between TC, TVC, TFC :

(i) At O level of output total fixed cost is equal to TC because TVC is O.
(ii) an increase in TC indicates increase in TVC only because TFC remains
constant.
(iii) TC and TVC curves have similar shape. The two curves remains parallel
to each other.
(iv) The distance between TC and TVC is TFC. Therefore RT = RT
Schedule :
Average and Average Total Cost : It is the per unit cost of production of a commodity produced.
TC
ATC
Q
Why ATC Curve U-Shaped : ATC curve is U-shaped because of law of variable proportion.
ATC falls in the beginning as TC increases at diminishing rate and rises as TC increases at increasing rate.
Average Fixed Cost : It is per unit fixed cost of producing a commodity.

TFC
AFC
Q

Why AFC downward Sloping Curve :

(i) AFC curve is a rectangle hyperbola shaped curve because fixed cost remains constant.
(ii) AFC cannot touch X or Y axis because fixed cost is constant.
Average Variable Cost : It is per unit variable of producing a commodity.

TVC
AVC
Q
Why AVC Curve A U-shaped Curve : AVC a u-shaped curve due to law of variable proportion.
In the beginning AVC falls because TVC increases at diminishing rate, finally AVC rises because TVC increases at
increasing rate.
ATC = AFC + AVC
Also TC = TFC + TVC dividing both sides by Q.
TC TFC TVC
i.e.
Q Q Q
ATC = AFC + AVC
Relationship Between ATC, AFC and AVC :
Schedule :

(i) ATC and AVC are U-shaped curve.

(ii) AFC is a rectangular hyperbola shaped curve.
(iii) As ATC = AFC + AVC. Therefore the gap between ATC and AVC is AFC.
(iv) ATC and AVC narrows down (come closer to each other) because AFC does on declining with the increases in
level of output.
(v) ATC and AVC cannot meet each other because AFC cannot be zero or does not touch x-axis.
ATC = AFC + AVC
20 = 0.2 + 19.8
Marginal Cost : It is the addition to total cost when an additional unit of a commodity is produced in a given period of
time.
MCn = TCn TCn 1
or MCn = TVCn TVCn 1

ATC
MC
Q
MC = TCn TCn 1 . . . .(i)
As we know TC = TFC + TVC
From (i) MC = (TFCn + TVCn) (TFCn 1 + TVCn 1)
As fixed cost remains constant, MCn=TVCn-TVCn-1
Schedule :
Why MC curve A U-shaped Curve :

MC curve is a U-shaped curve due to law of variable proportion.
MC falls in the beginning as TVC increases at diminishing rate, MC rise because TV increases at increasing rate.
Relationship Between Average and Marginal Cost :

(i) When MC < AC, AC falls.
(ii) When MC = AC, MC is minimum and constant.
(iii) When MC > AC, AC rises.
Analysis : It is marginals which pulls average down and pushes average up.

MC and AVC :
(i) MC < AVC, AVC falls (ii) MC = AVC, AVC is minimum and constant
(iii) MC > AVC, AVC rises
Analysis : It is the marginals which pulls average up and pushes average up.
PRACTICE QUESTIONS
1. Give reasons :
(a) When MC is less than AC, what happens to AC ?
(b) When AC is falling, what is the relation between MC and AC ?
(c) What happens to AVC, AFC and ATC as output increases ?
2. Why does the difference between average total cost and average variable cost decrease with increase in the level of
output ? Explain.
3. Do AVC curve and ATC curve intersect ? State reasons for your answer.
4. Does a firm get supernormal profit at break even point ? Give reasons in support of your answer.
5. Show the behaviour of AC when AVC per unit of output is constant.
6. Describe the nature of TC at zero level of production.
7. AC is the sum of AFC and AVC. Explain with the help of a schedule.
8. Give the reasons for U-shape of AC curve.
Numericals :
1. Calculate TC and AVC of a firm at each given level of output output.
2. Calculate MC and TC from the folllwing cost schedule of a firm whose total fixed costs are Rs.15.
3. Complete the following table if AFC of one unit of a production is Rs.60.
Find TVC, TFC, AVC, AFC, ATC, MC.

4. A firm is producing 20 units. At this level of output, ATC and AVC are respectively equal to Rs.40 and Rs.37. Find out
TFC of this firm.

5. Calculate TFC, TVC, AFC, AVC and ATC from the following :
6. Calculate TVC and MC at given level of output :
7. A firms average fixed cost, when it produces 2 units is Rs.30. its average total cost schedule is given below. Calculate
its MC and AVC at each level of output
10. Calculate MC and AVC at each level of output :

(d) Main Market Forms :
Market : It refers to the region in which buyers and sellers of a commodity are in close contact to sell and purchase of
a commodity.
Determinants of Market :
(i) No. of buyers and sellers
(ii) Nature of Commodity
(iii) Mobility of goods and factors
(iv) Perfect Knowledge
Perfect Competition : It is a market situation in which buyers and sellers operate freely and a commodity is sold at a
uniform price.
Features :
1. Very large number of buyers and sellers :
The price of a commodity is determined by aggregate demand and aggregate supply in the whole industry.
Once the price is determined each firm and buyers has to accept it.
Effect/Importance :
It means that the share of each seller in the
total market supply is so small that no single
seller can influence the price. Therefore, the
firm is said to be price taker.

2. Homogeneous Product :
Product sold in the perfect market are homogeneous. That is why they are identical in all respects
i.e. in quality, colour, size, weight, design etc. They are perfect substitute of one another.
Effect : All firms have to charge the same price for the product.
3. Free entry and exist of firms :

New firms induce by large profits can enter the industry whereas losses makes the inefficient firms to leave the
industry.
In case of abnormal profits new firms will be attracted to the industry, this will lead to increases in supply,
leading to fall in price and profit. Therefore the entry process of firms will continue till there are abnormal
profits.
In case of losses some firms quit leading to decrease in supply leading to increase in price. Exit process of firms
will continue till there are no losses.
Effect : Each firm earns just normal profit i.e. minimum profit which is necessary to run the business.
P = LMC = LAC
P = Long run
LMC = Long run marginal cost
LAC = Long run average cost
4. Perfect Knowlwdge :
The buyers and sellers have perfect knowledge which leads to emergence uniformity is price.
5. There is perfect mobility of goods and factors of production (land, labour, rent. . . . .)
6. Absence of transportation cost leads to uniformity in the price of the product.
7. Demand curve (AR) is perfectly elastic (Ed = ).

Imperfect Competition
Monopoly Market : It is a market situation where there is a single firm selling the commodity and there is no close
substitute of the commodity sold by the monopolist.
Features :
(i) Single Seller of a Commodity : The monopoly firm has has full control over the supply of the commodity. He may be
a individual, a firm or a group of firms or a government itself or a government corporation.
Effect : The monopolist is a price maker.
(ii) Absence of close Substitutes of a Product : The consumer will buy the commodity from the monopolist or go
without it altogether. This is due to the monopolist having a patent right, forming a cartel, government monopoly or
the government corporation permission.
(iii) Difficult entry and exit of firms : The monopolist tries his utmost to block the entry of new firm.
Effect : A monopoly firm earns abnormal profits in the long run.
(iv) Negatively slopped Demand curve : The monopolist is the only seller in the market. Therefore the demand curve
facing is market demand curve. A monopoly firm decides he output in price itself. There is no supply curve.
The monopolist can sell more only by lowering the price makes AR downward sloping.
(v) Price maker with constraint : A monoplist has no competitor. Therefore he can fix the price partially. In monopoly
market as output increases price decreases. As output decreases output increases price decreases. As output decreases
price increases price decreases. As output decreases price increases. In accordance with what consumer are willing
to pay along the demand curve. The demand curve is inelastic because there are no close substitutes. A monopolist
firm can charge any price but it cannot sell any quantity at that price.
(vi) Price Discrimination : A monopolist can charge different price for his product from different persons and different
market areas.
For e.g. electricity charge is different for commercial and residential purpose, a surgean charging prices from rich
and poor.
2. Absence of close Substitutes of a Product :

The consumer will buy the commodity from the monopolist or go without it altogether. This is due to the
monopolist having a patent right, forming a cartel, government monopoly or the government corporation
permission.
Effect : A monopolist has full control over price and therefore does not face competition.
3. Difficult entry and exit of firms :

The monopolist tries his utmost to block the entry of new firm.
Effect : A monopoly firm earns abnormal profits in the long run.
4. Negatively Slopped Demand Curve :

The monopolist is the only seller in the market. Therefore the demand curve facing is market demand curve.
A monopoly firm decides the output in price itself. There is no supply curve. The monopolist can sell more only
by lowering the price which makes AR downward sloping.

5. Price maker with constraint :

A monopolist has no competitor. Therefore he can fix the price partially. In monopoly market as output increases
price decreases. As output decreases price increases. In accordance with what consumers are willing to pay along
the demand curve. The demand curve is inelastic because there are no close substitutes. A monopolist firm can
charge any price but it cannot sell any quantity at that price.
6. Price Discrimination : A monopolist can charge different prices for his product from different persons and different
market areas for e.g., electricity charges is different for commercial and residential purpose, a surgean charging
prices from rich and poor.
Monopolistic Market : It refers to a market situation in which there are many firms which sell closely related but
differential products.
Features :
(a) A large number of firms :
The number of firms selling similar product is large, each supplying a small percentage of total supply of the
product. The firm influence marginally the price of their product due to their brandnames.
For e.g., Among soaps of different brands, pears sells at a comparatively higher price.
Effect : A monopolistic is a price maker.
(b) Product Differentiation :

There are variants of a given commodity. Each firm sells product which has a unique brand of the same product
which can be differentiated from brands of other firms. The commodity are close substitutes for one another.
Each firm enjoys a monopoly power over the brand of its product.
Effect : A monopolist has some control over price.
(c) Free entry and Exit of Firms :

Theory = same as perfect competition.
Effect: In long run, a monopolistic firm gets normal profit
i.e. MR = LMC (equilibrium condition) and P = LAC (normal profit)
4. Selling Cost :
These are the expenses which are incurred for promoting sales and persuing customers to buy the commodity of
a particular brand. It is also known as advertisement cost. These are persuasive advertisement whose aim is to
lure away the customers from other brands.
5. Demand Curve :
AR curve is negatively slopped because the firm can sell more only by lowering the price of its product.
The demand curve is elastic due to availability of close substitutes.

Oligopoly Market : It refers to market situation in which there are few big firms competing for their homogeneous
and differentiated products. They are interdependent in making decision regarding price and output.
Features :
1. A few firms :
There are a few firms controlling the market where each firm produces a big part of total output of the industry.
The no. of firms is no small that each firm can incluence the price and provoke the rival firms to react.
2. Homogeneous Product :
A product may be homogeneous or differentiated like steel, cement and automobilles respectively.
3. Entry of new firms is difficult :

Due to difficult entry in long run a firm continuous to earn abnormal profits.
4. Price Rigidity :
The firm generally keep the prices at similar level to avoid price war. There is a fear of competitors reaction.
5. Indeterminate Demand Curve :

No form can be certain of demand for its product due to unsure reaction of rival firm. They can influence the
market price because of substantial share in output and can sell more only by lowering the price and therefore AR
is downward slopping.
6. Interdependency among Firms :

There is interdependence of firms in deciding price and output. One firms action affect the other firm action.
The mutual interdependence helps to develop alternatives to price competition to earn abnormal profits.
7. Non Price Competition :

When there are only few firm they are normally afraid of competing each other by lowering the price war.
Avoiding the price war the firms use other ways of competition like advertising, customer care, free gifts known
as non-price competition.
Short Terms
Perfect Oligopoly :
If the firms producing homogeneous products.
Example : Cement, Steel Industry
Imperfect Oligopoly :
If the firms produce differentiated products.
Example : Automobiles
Non-Collusive Oligopoly :
If the firm competing with each other.

Price Determination Under Perfect Competition

Market Equilibrium : It is defined as equality between quantity demanded and quantity supplied.
Equilibrium Price : It is the price at which quantity demands is equal to quantity supplied.
Equilibrium Quantity : It is the quantity at which quantity demanded is equal to quantity supplied.
In a competitive market price is determined by interaction of market forces of demand and supply in the industry.
The market equilibrium is achieved at OP price and OQ quantity. If the price is OP1 i.e. above the market equilibrium then
quantity supplied is greater than QD.
OS1 > OD1
This creates excess supply equal to AB or D1S1. There is a competition among sellers. The sellers will reduce the price
which will increase the demand and reduce the supply leading to downward movement along the same demand and supply
curve. The price will finally settle when there is no excess supply.
If the price is OP0 i.e. below market equilibrium quantity demanded is greater than quantity supplied.
OD2 > OS2
There will be excess demand equal to CD or S2D2. There is competition among the buyers. The price will increase which
will decrease the demand and increase the supply. It will lead to upward movement along the same demand and supply
curve. The price will finally settles when there is no excess demand.
Analysis : The situation of zero excess demand and zero excess supply defines market equilibrium i.e. point E. The price
P is equilibrium price. The quantity Q is equilibrium quantity.

Effect of Shift in Demand and Supply on Equilibrium Price and Quantity :

1. When demand curve shifts rightward/when income increases for normal good/price of substitute good increases/
income decreases for inferior good/decrease of complementary good
At point E there is zero excess demand and zero excess supply. If the demand curve shifts rightward there creates a
excess demand i.e. EA. Excess demand will lead to rise in price. Rise in price will lead to increase in quantity
supplied. There is an upward movement along the same supply curve.
Analysis : Therefore with the rightward shift in the demand curve which will lead to increase in equilibrium price and
increase in equilibrium quantity.
2. When demand curve shift leftwards/income decreases for normal good/price rise for complementary good/income
increases for inferior goods/price decrease for substitute good.

At point E there is zero excess demand and zero excess supply. If the demand curve shifts leftwards there creates a
excess supply i.e. EA. Excess supply will lead to fall in price. Fall in price will lead to decrease inquantity supplied.
There is a downward movement along the same supply curve.
Analysis : Therefore a leftward shift in the demand curve will lead to decrease in equilibrium price and decrease in
equilibrium quantity.
3. If tech. is upgraded, excise duty reduces, input price reduces, by reduces/supply shifts rightward.
At point E there is zero excess demand and zero excess supply. If supply curve shifts rightward then there creates
excess supply i.e. EA. It will lead to fall in price. Fall in price leads to increase in quantity demanded (not increase in
demand). It leads to downward movement along the same demand curve.
Analysis : A rightward shifts in supply curve will lead to fall in equilibrium price and increase in equilibrium quantity.

4. Supply curve shifts leftward/and all other courses
At point E there is zero excess demand and zero excess supply. If supply curve shifts leftward then there creates a
problem of excess demand i.e. EA. It will lead to rise in price. Rise in price will lead to fall in quantity demanded (not
fall in downward). It will lead to upward movement along the same demand curve.
Analysis : A leftward shift in supply curve will lead to increase in equilibrium price and decrease in equilibrium
quantity.
Note : (a) With the increase in demand the equilibrium price and quantity increase, with the decrease in demand equilibrium
price and quantity decrease in price and quantity behaves directly with the change in demand.
(b) If supply increases equilibrium price falls but equilibrium quantity increases. If supply decreases equilibrium price
increase, equilibrium quantity falls i.e. with the change in supply equilibrium price behaves inversely while quantity
behaves directly.
Simultaneous Shifts in Demand and Supply
1. Effect on equilibrium price and quantity if both demand and supply increases. There are three possibilities :
(a) If demand increases equal to increase in supply then there will be no change in equilibrium price but equilibrium
quantity will increase.

(b) If increase in demand is greater than increase in supply then the equilibrium price will rise and quantity will also rise.
(c) If demand increases lesser than increase in supply then equilibrium price will fall and equilibrium quantity will
increase.
2. Effect on equilibrium price if both demand and supply decreases. There are three possibilities :
(a) If demand decreases equal to decrease in supply then there will be no effect on equilibrium price and equilibrium
quantity will decrease.

(b) If demand decreases greater than decrease in supply then the equilibrium price will fall and quantity will decrease.
(c) If demand decreases lesser than decrease in supply then the equilibrium price will rise and equilibrium quantity will
decrease.
3. If demand increases and supply decreases - effect on equilibrium price.

If demand increases and supply decreases equilibrium price willrise and quantity is indefinite.

4. If supply increases and demand decreases.

If supply decreases and demand decreases the equilibrium price will fall and quantity is indefinite.
5. Effect on the equilibrium price and quantity :

(a) If demand curve is perfectly elastic and supply curve shifts out and in.
If demand curve is perfectly elastic and supply curve shifts out (rightward) then the equilibrium price does not
change but equilibrium quantity increases.
If demand curve is perfectly elastic and supply curve shifts in (leftward) then the equilibrium price does not
change in but equilibrium quantity decreases.
(b) If demand curve is perfectly inelastic and supply curve shifts in and out.
If demand curve is perfectly inelastic and supply shifts out (rightward) then the equilibrium quantity does not
change but equilibrium price decreases.
If demand curve is perfectly inelastic and supply shifts in (leftward) then equilibrium quantity does not change
but equilibrium price will increase.

(c) If supply curve is perfectly elastic and demand curve shifts out and in.
If supply curve is perfectly elastic and demand
curve shifts out (rightward) then equilibrium price
does not change and quantity increases.
If supply curve is perfectly elastic and demand
curve shifts in (leftward) then equilibrium price
does not change and quantity decreases.
(d) If supply curve is perfectly inelastic and demand curve shifts in and out.
If supply curve is perfectly inelastic and demand curve shifts out (rightward) then equilibrium quantity does not
change and price increases.
If supply curve is perfectly inelastic and demand curve shifts in (leftward) then equilibrium quantity does not
change, price decreases.
Price Mechanism : It is a mechanism in which price is determined by the forces of demand and supply.
Merits : It is a self adjusting and self-correcting mechanism.
Demerits :
(a) It lacks social welfare as producer produces luxury goods whereas the poor was unable to get necessities of life.
(b) It does not change or bring about equal distribution of income.
(c) It favours large producers and the small producers are unable to complete them.
Types of Intervene :
(a) Indirect Intervention Taxes and Subsidies
(b) Direct Intervention Support and control price

Control Price (Maximum Price Ceiling)

It means the maximum price the producers are allowed to charge. The government imposes when it finds that the equilibrium
price is high. It leads to rationing and blacak marketing.
Support Price (Minimum Price Ceiling)
It means a guranteed minimum price at which the government purchases the specified goods from the supplier.
For e.g. In case of agricultural products, the government agency, FCI purchases wheat from farmers at its fixed price.
PRACTICE QUESTIONS
1. Why is demand curve of a firm under monopolistic competition more elastic than under monopoly ?
2. Define oligopoly. Explain one feature which is exclusive to the oligopoly market.
3. Why is AR curve of a firm under perfect competition parallel to x-axis and negatively sloped under monopoly ?
4. What happens when demand curve of a produce does not intersect its supply curve at any positive quantity ?
5. State the conditions of long run equilibrium in a perfectly competitive industry.
6. Explain with a diagram :
(a) Increase in output price affect the equilibrium quantity exchanged in the produce market ?
(b) Increase in the price of a substitute good in consumption affect the equilibrium price ?
7. Explain the changes that will take place if market price is higher than equilibrium price.
8. Why is AR curve of a firm under perfect competitive parallel to x-axis.
9. How is equilibrium price and quantity of a normal commodity affected by an increase in the income of its buyers ?
Explain.
10. Explain the feature a large number of buyers and sellers of a perfectly competitive market.
11. How will an increase in the income of the buyers of an inferior good affects its equilibrium price and quantity ? Explain.
12. Explain the effects on demand, supply and price of a commodity caused by a leftward shift of its demand curve.
Indirect Questions :
1. Equilibrium price may or may not change with the shift in both, demand and supply curves. Comment.
2. There is a simultaneous decrease in demand and supply of a commodity. When will it result in :
(a) no change in equilibrium price (b) a fall in equilibrium price
3. There is a change in demand and supply of a commodity, when will it result in :
(a) no change in equilibrium price (b) a rise in equilibrium price
(c) a fall in equilibrium price

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Vidyamandir Classes Micro-Economics

Central Problems : The central problem is allocation of resources.

(b) How to Produce ?

(c) Whom to Produce ?

Board Notes/Micro-Economics 2 Class XII

Marginal Opportunity Cost : It is the rate of scarifise to produce a good.

PPC Schedule and Curve :

Board Notes/Micro-Economics 3 Class XII

MC/MOC Schedule and Curve (Same as PPC)

Planned Economy : It is based on government control and social welfare motive.

7. Explain the shape of PPC or frontier.

Board Notes/Micro-Economics 4 Class XII

(b) Consumers Equilibrium : Utility Analysis

Relationship between total Utility and Marginal Utility :

Board Notes/Micro-Economics 5 Class XII

Law of Diminishing Marginal Utility :

Consumer Equilibrium for a Single Commodity Approach :

To Express the Marginal Utility in terms of Money following Formula is used :

where MUp = MU of a product

Board Notes/Micro-Economics 6 Class XII

Marginal Utility of a Rupee : It is worth of a rupee to a consumer is terms of other goods.

Consumer Equilibrium for a Two-Commodity Approach :

Where MUX = MU of X Px = Price of X

Board Notes/Micro-Economics 7 Class XII

Consumer Equilibrium : Indifference Curve Analysis :

Equation of Budget Line

where P x = Price of commodity x

(b) All bundles of budget set lies on budget line.

Px Price of good obtain

Board Notes/Micro-Economics 8 Class XII

Various causes of Shifts of Budget Line :

(b) If price of X changes

(c) If price of y changes

Board Notes/Micro-Economics 9 Class XII

(e) If income and price x and price y changes

(f) If Px falls and Py increases : The price line

Board Notes/Micro-Economics 10 Class XII

Indifference Schedule (IC) :

Marginal Rate of Substitution (MRS) :

Change in Y (Quantity of good scarifise)

(a) A, B, C, D combinations are the locus following indifference curve.

Board Notes/Micro-Economics 11 Class XII

The features are :

Indifference Curve According to Consumer Equilibrium :

Board Notes/Micro-Economics 12 Class XII

(v) The approach assumes constant MUm or constant income.

(iv) Consumer equilibrium condition.

Board Notes/Micro-Economics 13 Class XII

(d) Income of the Consumers : (Money Income)

Board Notes/Micro-Economics 14 Class XII

Demand Curve : It is a graphical representation of demand

prices at a particular period of time :

Reasons for Demand Curve as Downward Slopping Curve :

(ii) Price Effect : It is summation of income effect and substitution effect.

Board Notes/Micro-Economics 15 Class XII

Board Notes/Micro-Economics 16 Class XII

Increase and Decrease in Demand :

Board Notes/Micro-Economics 17 Class XII

Factors affecting market demand :

Board Notes/Micro-Economics 18 Class XII

Price Elasticity of Demand :

Degree of Elasticity of Demand :

(ii) More than Unit Elastic Demand : (Ed > 1)