Microeconomics PDF

Microeconomics WWW.ECOHOLICS.IN Table of Contents Microeconomics................................................................................................................................ 4 Microeconomics..............................................................

Microeconomics WWW.ECOHOLICS.IN Table of Contents Microeconomics................................................................................................................................ 4 Microeconomics............................................................................................................................ 4 Central Problems of an Economy................................................................................................... 5 Circular Flow of Income................................................................................................................. 7 Positive v/s Normative Analysis..................................................................................................... 8 PPC (Production Possibility Curve)................................................................................................. 8 Theory of Consumer Behaviour....................................................................................................... 10 Consumer Behaviour................................................................................................................... 10 Utility.......................................................................................................................................... 10 Measures of Utility...................................................................................................................... 11 Consumer’s Equilibrium............................................................................................................... 13 Law of Equi-marginal Utility......................................................................................................... 13 What is Mux/Px > Muy/py not equal Mux/px < Muy/py ?............................................................ 15 Microeconomics Consumer surplus............................................................................................................................ 17 Revealed Preference Theory........................................................................................................ 18 Indifference curve analysis.............................................................................................................. 20 Indifference Curve....................................................................................................................... 20 Indifference Map......................................................................................................................... 20 Budget Line................................................................................................................................. 21 Consumer’s Equilibrium............................................................................................................... 21 Theory of Demand........................................................................................................................... 24 Demand....................................................................................................................................... 24 Individual Demand Function........................................................................................................ 24 Market demand function............................................................................................................. 24 Demand Schedule........................................................................................................................ 25 Demand Curve............................................................................................................................. 25 Exceptions to Law of Demand...................................................................................................... 27 Movement v/s Shift in Demand................................................................................................... 27 Elasticity of Demand.................................................................................................................... 28 Relationship between Price Elasticity and Total Revenue............................................................. 29 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. 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Page | 1 Microeconomics Microeconomics WWW.ECOHOLICS.IN Methods of Measuring Elasticity of Demand................................................................................ 30 Impact of Price Change................................................................................................................ 31 Price Consumption Curve............................................................................................................ 33 Supply............................................................................................................................................. 35 What is Supply?........................................................................................................................... 35 Supply Curve............................................................................................................................... 35 Law of Supply.............................................................................................................................. 35 Movement v/s Shift in Supply...................................................................................................... 37 Elasticity of Supply....................................................................................................................... 37 Theory of Production and Costs....................................................................................................... 40 Production Function:................................................................................................................... 40 Short run v/s Long run Production Function................................................................................. 40 Cobb-Douglas production function:............................................................................................. 41 Leontief Production Function:...................................................................................................... 41 Microeconomics CES Production Function:............................................................................................................. 42 Elasticity of Substitution.............................................................................................................. 42 Reasons for the Law of Variable Proportions................................................................................ 45 Law of Diminishing Marginal Product........................................................................................... 46 Long-run Average Cost Curve....................................................................................................... 50 Decision Making Under Risk and Uncertainty................................................................................... 53 Risk Return Tradeoff.................................................................................................................... 54 Game theory............................................................................................................................... 55 Cooperative v/s Non-Cooperative Games.................................................................................... 57 Market Structure, competitive and non-competitive equilibria and their Efficiency Properties........ 61 Market Structure......................................................................................................................... 61 Perfect competition..................................................................................................................... 61 Determination of Market Price.................................................................................................... 62 Conditions of equilibrium under Perfect Competition:................................................................. 62 Monopoly market........................................................................................................................ 65 Price Discrimination..................................................................................................................... 66 Monopolistic competition............................................................................................................ 67 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. 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Page | 2 Microeconomics Microeconomics WWW.ECOHOLICS.IN Oligopoly market......................................................................................................................... 68 DUOPOLY.................................................................................................................................... 70 Factor pricing.................................................................................................................................. 74 Factor Pricing............................................................................................................................... 74 Wage Determination in competitive Labour Market..................................................................... 74 Bilateral Monopoly...................................................................................................................... 76 Predatory Pricing......................................................................................................................... 77 General Equilibrium Analysis........................................................................................................... 78 General Equilibrium..................................................................................................................... 78 Walras Law.................................................................................................................................. 78 Welfare Economics...................................................................................................................... 79 Product Market v/s Factor Market............................................................................................... 80 Efficiency Criterion- Pareto Optimality......................................................................................... 80 Compensation Principle............................................................................................................... 82 Microeconomics Kaldor-Hicks Welfare Criterion..................................................................................................... 83 Scitovsky Double Crtiterion.......................................................................................................... 83 Bergson Criterion......................................................................................................................... 84 Little Criterion............................................................................................................................. 84 Social Welfare Function............................................................................................................... 85 Asymmteric Information.................................................................................................................. 87 Asymmetric Information.............................................................................................................. 87 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 3 Microeconomics Microeconomics WWW.ECOHOLICS.IN Microeconomics Microeconomics Microeconomics is based on models of consumers or firms (which economists call agents) that make decisions about what to buy, sell, or produce-with the assumption that those decisions result in perfect market clearing (demand equals supply) and other ideal conditions. Scope and Method of Economics Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. Economics is regarded as a social science; it studies how people in an economy employ the already scarce resources with or without using money. Hence, they use these scarce resources with alternative uses for manufacturing, buying, and the consumption of goods and services. Microeconomics Types of Economic Problems SCARCITY CHOICE Scarcity Scarcity is one of the key concepts of economics. It means that the demand for a good or service is greater than the availability of the good or service. Therefore, scarcity can limit the choices available to the consumers who ultimately make up the economy. Choice Economic choice can be defined as the behaviour observed when individuals make choices solely based on subjective preferences. The problem of scarcity and choice lies at the very heart of economics, which is the study of how individuals and society choose to allocate scarce resources. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 4 Microeconomics Microeconomics WWW.ECOHOLICS.IN Reason for scarcity Resources have alternative uses Human wants are unlimited Human wants Re-occur Resources such as land, labour, and capital are limited in relation to their demand and the economy cannot produce all that people required to satisfy themselves. This is why economic problems exist in an economy. Scarcity is universal which is applicable to all individuals, institutions, and the economy as a whole. If there are abundant or sufficient resources then there will not be any problem in an economy. Hence, scarcity leads to economic problems. Opportunity Cost Opportunity cost is the cost of that alternative which is given up or surrendered. Microeconomics Example! Let us understand! John has to give up 2 episodes of his favourite cartoon for studying an hour. Therefore, the opportunity cost of studying 1 hour is 2 episodes of the cartoon. Central Problems of an Economy What to Produce? How to Produce? For Whom to Produce? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 5 Microeconomics Microeconomics WWW.ECOHOLICS.IN What to Produce? "What to produce" refers to the choice of the product to be produced by the society for that good which is in actual need of the society. The goods may be classified as: Consumer Goods Microeconomics Capital Goods Defence Goods Civil Goods How to Produce? The problem of how to produce related to the production is a technique related to employ in the production of the decided goods and services. The choice is mainly between: Labor-Intensive Technique Capital- Intensive Technique How to distribute Output? The systematic attempt to account for the sharing of the national income among the owners of the factors of production-land, labor, and capital. This problem deals with the issue of deciding the category of people who will consume the goods. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 6 Microeconomics Microeconomics WWW.ECOHOLICS.IN Economics as a Science Economics is a science that studies human behavior which aims at allocation of scarce resources in such a way that consumer can maximize their satisfaction, producers can maximize their profits and society can maximize its social welfare. It is about making choice in the presence of scarcity. Economics is a science because it deals with cause-and-effect relationships and also with various predictions. We use various mathematical models to make certain predictions. These predictions and decision- analysis lead to economics is a science. Circular Flow of Income The circular flow of income model is a graphical representation of the cyclical movement of money between households and businesses in an economy, depicting the exchange of labour Microeconomics and resources for income and the subsequent spending of that income on goods and services produced by businesses. In the basic model, the circular flow of income consists of two components: Firms: companies that produce goods and pay wages to employees. Households: individuals who receive wages from firms while simultaneously purchasing the goods and services from the firms. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 7 Microeconomics Microeconomics WWW.ECOHOLICS.IN Positive v/s Normative Analysis Positive economics and normative economics are two standard branches of modern economics. Positive Economics describes and explains various economic phenomena, while normative economics focuses on the value of economic fairness or what the economy should be. Positive economics is a stream of economics that focuses on the description, quantification, and explanation of economic developments, expectations, and associated phenomena. Microeconomics Normative economics focuses on value- based judgments aimed at improving economic development, investment projects, and the distribution of wealth. PPC (Production Possibility Curve) The production possibilities curve (PPC) is a graph that shows all of the different combinations of output that can be produced given current resources and technology. Sometimes called the production possibilities frontier (PPF), the PPC illustrates scarcity and trade-offs. For example, If the production of butter is to be increased the production of guns is to be reduced. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 8 Microeconomics Microeconomics WWW.ECOHOLICS.IN Question Bank 1. How does microeconomics differ from macroeconomics, and what specific aspects of economic analysis does it focus on? 2. Can you explain the concept of opportunity cost and its significance in decision-making for individuals and businesses? 3. What is the production possibility curve, and how does it illustrate the concept of opportunity cost in the context of an economy's production choices? 4. Can you explain the factors that can cause a shift in the production possibility curve, and how technological advancements or changes in resource availability impact the trade-offs faced by an economy? 5. How does the shape of the production possibility curve reflect the concept of increasing opportunity cost, and what implications does this have for decision-making in resource allocation within an economy? Microeconomics 6. What are the fundamental economic questions that every society must address, and how do the concepts of scarcity, choice, and opportunity cost play a crucial role in resolving these central economic problems? 7. Can you elaborate on how the allocation of resources is determined in an economy, considering the challenges of balancing production between goods and services, deciding on the appropriate mix of factors of production, and addressing the distribution of output among members of society? 8. What distinguishes positive economics from normative economics, and how does the objective analysis of economic facts and relationships differ from the subjective judgments involved in normative statements? 9. How does the problem of scarcity permeate all economic decisions, and what role does it play in shaping the fundamental choices individuals, businesses, and societies must make in allocating limited resources? 10. Can you discuss the impact of scarcity on the production possibilities of an economy, and how the concept of opportunity cost arises as a direct consequence of the fundamental economic problem of scarcity? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 9 Microeconomics Microeconomics WWW.ECOHOLICS.IN Theory of Consumer Behaviour Consumer Behaviour Consumer behaviour studies the behaviour of individual or a group of consumers regarding how to allocate their given limited income resources in such a way that it maximises their level of satisfaction. All the desires and aspirations and motives of humans are known as human wants in economics. Utility It is the amount of satisfaction which a consumer derives from the consumption of a commodity. In other words, want satisfying power of a commodity is called utility. Unit of measurement of utility is termed as utils. Microeconomics Utility Cardinal Approach Ordinal Approach Cardinal Utility Approach This approach was propounded by a group of Economists led by Alfred Marshall. According to this analysis, utility can be measured in cardinal numbers such as 1, 2, 3, 4 etc. Cardinal numbers either can be added or subtracted. Fisher has used this term “Util” as measure of utility. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 10 Microeconomics Microeconomics WWW.ECOHOLICS.IN Ordinal Utility Approach This approach is different from cardinal approach in the sense that it propounds that utility can't be measured, but preference between two commodities can be expressed. Therefore, what a consumer needs to do is to reveal his preferences in case of two or more than two commodities. He should be able to rank different commodities on the basis of satisfaction he derives from different commodities. This approach was propounded by economists such as Hicks, Pareto, Allen, etc. Measures of Utility Measures of Utility Total Utility Marginal Utility Microeconomics Total Utility It is the sum total of utility derived from the consumption of all units of a commodity. 𝑻𝑼𝒏 = ∑𝑴𝑼 Marginal Utility Marginal utility is the additional utility derived from the additional commodity consumed. 𝑴𝑼𝒏 = 𝑻𝑼𝒏 − 𝑻𝑼𝒏 − 𝟏 ∆𝑻𝑼 𝑴𝑼 = ∆𝑸 Relationship between TU and MU Relationship between TU and MU can be understood with the help of given schedule and graph: Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 11 Microeconomics Microeconomics WWW.ECOHOLICS.IN Output Total utility Marginal utility 0 0 0 1 8 8 2 14 6 3 18 4 4 20 2 5 20 0 6 18 -2 When MU is diminishing but remains positive (+𝑣𝑒), TU tends to increase at a diminishing rate. When MU becomes zero, TU reaches at its maximum point. Microeconomics When MU becomes negative (−𝑣𝑒), TU starts to fall. Law of Diminishing Marginal Utility The law of DMU states that as more and more units of a commodity are consumed, marginal utility derived from every additional utility must decline. This law was first put forward by Gossen in the year 1854. Therefore, Jevons referred to as 'Gossen's First Law'. The law of diminishing marginal utility is a psychological law, therefore, it is called as a 'fundamental law of satisfaction' or 'fundamental psychological law.’ Did You know? Adam Smith was greatly surprised to observe that water which is essential for life has such a low price (or is free), while diamonds which are quite unnecessary, have such a high price. Modern economists solved this paradox with the help of the concept of marginal utility. According to them, water is available in abundant quantity, therefore its relative marginal utility is low or even zero. Therefore, its price is also low or zero. On the other hand, diamonds are scarce and their relative marginal utility is quite high and therefore their price is also high. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 12 Microeconomics Microeconomics WWW.ECOHOLICS.IN Consumer’s Equilibrium Consumer is the one who takes decision about what to buy for satisfaction of wants. Thus, Consumer Equilibrium is a situation where the consumer secures maximum satisfaction out of his expenditure given the prices of the goods. Law of Equi-marginal Utility Single Commodity case: Consumer Equilibrium in case of single commodity is obtained at a point where marginal utility of a commodity is equal to the price of the commodity. 𝑴𝑼𝑿 𝑷𝑿 = 𝑴𝑼𝑴 𝑴𝑼𝑿 = Marginal utility of good x 𝑴𝑼𝑴 = Marginal utility of money 𝑷𝑿 = Price of good x Microeconomics Assumptions: Utility is measured cardinally. consumer’s income is given Price of the commodity is given MU of money (worth of rupee to a consumer) remains constant. Law of DMU holds good. Consumer behaves rationally i.e. aims at maximum satisfaction Explanation: Units MUx Px MUx/MUm 1 6 2 6 2 4 2 4 3 2 2 2 4 0 2 0 5 -2 2 -2 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 13 Microeconomics Microeconomics WWW.ECOHOLICS.IN Suppose a consumer purchases a good-x with Price = Rs. 2 and 𝑴𝑼𝑴 = 1: The consumer will buy 3 units of X to maximize his satisfaction because here, 𝑴𝑼𝑿 𝑷𝑿 = 𝑴𝑼𝑴 Here, the price is fixed at Rs.2 and the price line are parallel to the x-axis as price is fixed. MU keeps on diminishing, MU is a downward sloping curve because of Lw of DMU. Here, the equilibrium is attained at 3 units of commodity at point E in diagram. Where, 𝑴𝑼𝑿 𝑷𝑿 = 𝑴𝑼𝑴 Microeconomics Double commodity case Consumer Equilibrium in case of double commodity is obtained at a point where he spends his limited income in such a way that the ratio of MU of goods and their respective prices are equal. 𝑴𝑼𝑿 𝑴𝑼𝒀 𝑴𝑼𝑴 = 𝑷𝑿 𝑷𝒀 𝑴 = 𝑷𝑿 𝑸𝑿 + 𝑷𝒀 𝑸𝒀 𝑴𝒖𝒙 = Marginal utility of good x 𝑴𝒖𝒎 = Marginal utility of money 𝑷𝒙 = Price of good x 𝑷𝒚 = Price of good y 𝑸𝒙 = Quantity of good x 𝑸𝒚 = Quantity of good y 𝑴 = Money income Assumptions: Utility is measured cardinally. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 14 Microeconomics Microeconomics WWW.ECOHOLICS.IN consumer’s income is given Prices of the commodities are given MU of money (worth of rupee to a consumer) remains constant. Law of DMU holds good. Consumer behaves rationally i.e. aims at maximum satisfaction Explanation 𝑴𝑼𝒙 𝑴𝑼𝒚 UNITS 𝑴𝑼𝒙 𝑴𝑼𝒚 𝑷𝒙 𝑷𝒚 1 12 10 12 10 2 10 8 10 8 3 8 6 8 6 4 6 4 6 4 5 4 2 4 2 Microeconomics What is Mux/Px > Muy/py not equal Mux/px < Muy/py ? 𝑴𝑼𝒙 𝑴𝑼𝒚 𝑴𝑼𝒙 𝑴𝑼𝒚 > < 𝑷𝒙 𝑷𝒚 𝑷𝒙 𝑷𝒚 𝑴𝑼𝒙 𝑴𝑼𝒚 𝑴𝑼𝒙 𝑴𝑼𝒙 𝑴𝑼𝒚 𝑴𝑼𝒙 If and are not equal and is If and are not equal and is less 𝑷𝒙 𝑷𝒚 𝑷𝒙 𝑷𝒙 𝑷𝒚 𝑷𝒙 𝑴𝑼𝒚 𝑴𝑼𝒚 greater than , then consumer will than , then the consumer will substitute 𝑷𝒚 𝑷𝒚 substitute good ‘x’ for good ‘y’. As a result, good ‘y’ for good ‘x’. As a result, the marginal the marginal utility of good ‘x’ will fall. The utility of good ‘y’ will fall. The consumer will consumer will continue substituting good ‘x’ continue substituting good ‘x’ till 𝑴𝑼𝒙 = 𝑴𝑼𝒚 𝑴𝑼 𝑴𝑼 𝑷𝒙 𝑷𝒚 for good ‘y’ till 𝑷 𝒙 = 𝑷 𝒚 where the 𝒙 𝒚 where the consumer will be equilibrium. consumer will be in equilibrium. Question Bank 1. How do economists quantify and measure utility? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 15 Microeconomics Microeconomics WWW.ECOHOLICS.IN 2. What role does the concept of marginal utility play in understanding the satisfaction or pleasure individuals derive from consuming additional units of a good or service? 3. Can you discuss the relationship between total utility and marginal utility? 4. What is the concept of diminishing marginal utility, influencing consumer choices and preferences in the allocation of resources? 5. What is the Law of Equi-Marginal Utility, and how does it explain the optimal allocation of resources among different goods to maximize total satisfaction or utility for a consumer? 6. Can you provide practical examples or scenarios where the Law of Equi-Marginal Utility can be applied, and how does this economic principle guide rational decision-making in consumption patterns? 7. How is consumer equilibrium achieved in a two-commodity scenario? Microeconomics 8. What role do the concepts of marginal utility and budget constraint play in determining the optimal combination of goods that maximizes a consumer's satisfaction? 9. Can you illustrate the concept of consumer equilibrium graphically for a two-commodity case? 10. Discuss the significance of the consumer's indifference curve intersecting with the budget line in representing the most preferred consumption point? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 16 Microeconomics Microeconomics WWW.ECOHOLICS.IN Consumer surplus Consumer’s Surplus is basically defined as the difference between what the consumer wants to pay and what he actually pays. The difference between the amount of satisfaction which a consumer obtains from purchasing things over that which he actually pays for them is the economic measure of consumer's surplus. CONSUMER SURPLUS Marshallian Consumer Surplus Hicks Consumer Surplus Microeconomics Marshallian Consumer Surplus "The price which a person pays for a thing can never exceed and seldom comes up to that which he would be willing to pay rather than go without it - so that the satisfaction which he gets from its purchase generally exceeds that which he gives up in paying away its price: and he thus derives from the purchase a surplus of satisfaction". Difficulty in Measurement Constant Marginal utility of Money Lack of Precise Measurement Hicks Consumer Surplus According to Hicks, "the best way of looking at consumer surplus is to regard it as a means of expressing, in terms of money income, the gain which accrues to the consumer as a result of a fall in price". Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 17 Microeconomics Microeconomics WWW.ECOHOLICS.IN Revealed Preference Theory Revealed Preference Revealed preference is an economic theory regarding an individual's consumption patterns, which asserts that the best way to measure consumer preferences is to observe their purchasing behaviour. Three Axioms of Revealed Preference Weak Axiom of Revealed Preference (WARP) Strong Axiom of Revealed Preference (SARP) Generalized Axiom of Revealed Preference (GARP) Microeconomics Weak Axiom of Revealed Preference (WARP) The weak axiom also states that if we buy one particular product, then we will never buy a different product or brand unless it is cheaper, offers increased convenience, or is of better quality (i.e. unless it provides more benefits). As consumers, we will buy what we prefer and our choices will be consistent, so suggests the weak axiom. Strong Axiom of Revealed Preference (SARP) Strong Axiom of Revealed Preference (SARP): This axiom states that in a world where there are only two goods from which to choose, a two-dimensional world, the strong and weak actions are shown to be equivalent. Generalized Axiom of Revealed Preference (GARP) Generalized Axiom of Revealed Preference (GARP): This axiom covers the case when, for a given level of income and or price, we get the same level of benefit from more than one consumption bundle. In other words, this axiom accounts for when no unique bundle that maximizes utility exists. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 18 Microeconomics Microeconomics WWW.ECOHOLICS.IN Question Bank 1. What is consumer surplus? 2. How does the consumer surplus represent the economic benefit or gain that consumers experience when the market price of a good is lower than the maximum price they are willing to pay? 3. Can you explain how consumer surplus is calculated? 4. Discuss the factors that influence the magnitude of consumer surplus? 5. What is the Revealed Preference theory? 6. How does the revealed preference theory provide insights into consumer behavior by analyzing the choices individuals make in the marketplace as indicators of their true preferences? Microeconomics 7. Can you discuss the key assumptions underlying the Revealed Preference theory? 8. How economists use this theory to infer and understand consumer preferences based on observed market choices and decisions? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 19 Microeconomics Microeconomics WWW.ECOHOLICS.IN Indifference curve analysis Indifference Curve An Indifference Curve (IC) is the curve of all those points which represents different bundle of two goods, which yields same level of satisfaction to the concerned consumer. This curve shows the different combinations of Good A and Good B which yields the same level of satisfaction. Another name for this curve is the iso-utility curve. Indifference Map An Indifference Map is a set of Indifference Curves. It depicts the complete picture of a consumer’s preferences. The following diagram showing an indifference map consisting of three curves: Microeconomics Properties of Indifference Curve: An IC is downward sloping from left to right, i.e. it has a negative slope. This is because in order to maintain the same level of satisfaction along a particular IC, we need to sacrifice some amount of commodity Y in order to get more of commodity X. Two different IC can never intersect. IC is convex to the point of origin, due to diminishing marginal rate of substitution. IC does not touch either axis. Marginal Rate of Substitution The slope of indifference curve is called marginal rate of substitution of two commodities. This represents the mutual exchange rate between alternate units of two commodities. It can be computed by using the given formula 𝐍𝐨 𝐨𝐟 𝐮𝐧𝐢𝐭𝐬 𝐬𝐚𝐜𝐫𝐢𝐟𝐢𝐜𝐞𝐝 𝐨𝐟 𝐠𝐨𝐨𝐝 − 𝐱 (𝚫𝐗) 𝑴𝑹𝑺𝒙𝒚 = 𝐍𝐨 𝐨𝐟 𝐮𝐧𝐢𝐭𝐬 𝐠𝐚𝐢𝐧𝐞𝐝 𝐨𝐟 𝐆𝐨𝐨𝐝 − 𝐲 (𝚫𝐘) Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 20 Microeconomics Microeconomics WWW.ECOHOLICS.IN Budget Line A budget line is a straight line, representing different combinations of two goods a consumer can buy, given his money income and price level. Budget line is also called as price line. Budget Set Budget set is defined as set of all those bundles having combination of two goods which are affordable to consumer, given his money income and market prices. Equation of budget set: 𝑷𝒙 𝑸𝒙 + 𝑷𝒚 + 𝑸𝒚 ≤ 𝑴 Shifts in Budget Line Microeconomics Shifts in Budget Line Due to change in Price of Due to change in Price of Due to change in Income Good-X Good-Y Due to Change in Income When income increases, BL shifts to the right. When income decreases, BL shifts to the left. Due to change in Price of Good-X When Px falls, BL shifts right on the x-axis. When Px rises, BL shifts left on the x-axis. Due to change in Price of Good-Y When Py falls, BL shifts right on the y-axis When Py rises, BL shifts left on the y-axis. Consumer’s Equilibrium Consumer’s Equilibrium Consumer’s equilibrium is a situation in which a consumer attains maximum satisfaction and he has no tendency to change his/her expenditure plan. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 21 Microeconomics Microeconomics WWW.ECOHOLICS.IN Assumptions: Utility is measured ordinally. Consumers are rational Consumer preferences are monotonic i.e. more of at least 1 good and no less of the other. Consumers income is given Prices of the goods remain constant. Diminishing MRS applies. Conditions 𝑷𝒙 𝑴𝑹𝑺𝒙𝒚 = = 𝑴𝑹𝑬 𝑷𝒚 IC should be convex AB is a budget line. Microeconomics There are 3 indifference curves, IC1, IC2, and IC3. Consumer equilibrium is attained at a point where, Slope of IC = Slope of Budget line. This happens at 3 points i.e. C, D and E, where C and D are on IC1 and E on IC2. The consumer will choose IC2 i.e. point E, where MRS= MRE as it is on the higher IC. 𝑷 Let us assume the equilibrium point at where 𝑴𝑹𝑺 = 𝑷𝒙 𝒚 But IC1 is concave not convex. This is not a stable equilibrium because points b and c on IC2 and IC3 offer higher level of satisfaction as compared to IC1. So, IC should be convex or MRS must be diminishing to attain equilibrium. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 22 Microeconomics Microeconomics WWW.ECOHOLICS.IN Question Bank 1. What is the foundation of ordinal utility analysis, and how does it differ from cardinal utility in examining consumer preferences? 2. Can you explain how the concept of indifference curves is central to ordinal utility analysis, and how these curves represent combinations of goods that yield equal satisfaction to consumers? 3. What is a budget set explain graphically? 4. What are the properties of an Indifference curve? 5. How does the concept of diminishing marginal rate of substitution manifest on an indifference curve, and what implications does it have for consumer behavior? Microeconomics 6. In ordinal utility analysis, how is consumer equilibrium determined, and what role do budget constraints play in shaping the optimal consumption bundle? 7. What are the limitations of ordinal utility analysis, and how do these limitations impact its applicability in certain economic contexts? 8. How do changes in income impact the position and slope of a consumer's budget line? 9. Can you discuss the effect of a change in the price of one good on the budget line, and how this alteration influences the trade-off between the two goods in the consumer's budget constraint? 10. What role do shifts in the prices of both goods play in reshaping the budget line? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 23 Microeconomics Microeconomics WWW.ECOHOLICS.IN Theory of Demand Demand Demand is the quantity of a commodity consumer is willing and able to buy at each possible price during a given period of time. Individual Demand Function Individual demand function refers to the functional relationship between individual demand and the factors affecting individual demand. It is expressed as: 𝑫𝒙 = 𝒇(𝑷𝒙, 𝑷𝒓, 𝒀, 𝑻, 𝑭) where, 𝐷𝑥 = Demand for Commodity 𝐹 = Expectation of Change in Price in future 𝑇 = Tastes and Preferences 𝑌= Income of the Consumer Microeconomics 𝑌𝑟 = Price of Related Goods 𝑃𝑥 = Price of the given Commodity X Market demand function Market demand function refers to the functional relationship between market demand and the factors affecting market demand. Market demand function can be expressed as: 𝑫𝒙 = 𝒇(𝑷𝒙, 𝑷𝒓, 𝒀, 𝑻, 𝑭, 𝑷𝒐, 𝑺, 𝑫) Where, 𝐷𝑥 = Market demand of commodity X 𝑃𝑥 = Price of given commodity X 𝑃𝑟 = Price of related good 𝑌 = Income of the consumers 𝑇 = Taste and preferences 𝐹= Expectation of change in price in future 𝑃𝑜 = Size and composition of population 𝑆 = Season and weather 𝐷 = Distribution of income Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 24 Microeconomics Microeconomics WWW.ECOHOLICS.IN Demand Schedule Demand schedule is a tabular statement showing various quantities of a commodity landed at various levels of price, during a given period of time. PRICE QUANTITY DEMANDED Rs. 4 20 kg Rs. 3 30 kg Rs. 2 50 kg Demand Curve Demand curve is a graphical representation of demand schedule. It is the locus of all the points showing various quantities of a commodity that a consumer is willing to buy Microeconomics at various levels of price, during a given period of time, assuming no change in other factors. Law of Demand Law of demand States the inverse relationship between price and quantity demanded, keeping other factors constant (ceteris paribus). It is also known as the 'First law of purchase'. Reasons for Law of Demand Law of Diminishing Marginal Utility: Law of diminishing marginal utility states that as we consume more and more units of a commodity, the utility derived from each successive unit goes on decreasing. So, demand for a commodity on its utility. Substitution Effect: Substitution effect refers to substituting one commodity in place of other when it becomes relatively cheaper. Income Effect: Income effect refers to effect on demand when real income of the consumer changes due to change in price of the given commodity. Different Uses: Some commodities milk, electricity, etc have several uses, some of which are more important than the others. When price of such a good increase, its uses get restricted to the most important purpose. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 25 Microeconomics Microeconomics WWW.ECOHOLICS.IN Determinants of Demand Price of the commodity: Generally, there exists an inverse relationship between price and quantity demanded. It means as price increases quantity demanded falls due to decrease in the satisfaction level of consumers. Price of related goods: Demand for the given commodity is also affected by change in prices of the related goods. Related goods are of two types: Related Goods Substitute Goods Complementary Goods o Substitute goods: Substitute goods are those goods which can be used in place of one Microeconomics another for satisfaction of a particular want, like tea and coffee, pen and pencil, CD and DVD, etc. o Complementary goods: Complementary goods are those goods which are used together to satisfy a particular want, like tea and sugar, pen and ink, etc. Income of the consumer: A greater income means a greater purchasing power. Therefore, when incomes of people rise, they can afford to buy more. It is because of this reason that the increase in demand has a positive effect on the demand for a good. Nature of Commodity Normal Goods Inferior Goods o Normal Good: If the given commodity is a normal good, then an increase in income leads to a rise in its demand, while a decrease in income reduces the demand. Inferior Good: If the commodity is an inferior good, then an increase in income reduces the demand while a decrease in income leads to rise in demand. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 26 Microeconomics Microeconomics WWW.ECOHOLICS.IN Tastes & Preferences: Taste and preferences of the consumer directly influence the demand for a commodity. They include changes in fashion, customs, habits, pressure of advertisements by the of different manufacturers and sellers of products, etc. Expectation of Price change: If the price of a certain commodity to increase in near future, then people will buy more of that commodity than what they normally buy. There exists a direct relationship between expectation of change in the prices in future and change in demand in the current period. Exceptions to Law of Demand Veblen Effect: Some consumers measure the Utility of a commodity entirely by its price i.e., for them, the greater the price of a commodity, the greater its utility. Example, Diamond. Giffen Goods: Giffen goods are special kind of inferior goods on which consumer spends a large part of his income and their demand rises with an increase in price and demand falls with decrease in price. In these goods negative income effect is stronger than positive Microeconomics substitution effect. Fear of Shortage: If the consumers expect a shortage or scarcity of a particular commodity in future, then they would start buying more and more of that commodity in the current period even if their prices are rising. Necessities: Another exception occurs in the use of such commodities which become necessities of life due to their constant use. The demand for them does not change even with an increase in price of such necessities. Movement v/s Shift in Demand Shift in the demand curve A shift in the demand curve is when the price stays the same, but some other unusual occurrence happens that pushes the demand schedule to either increase or decrease at each price point. Reasons for Shift in Demand Income levels Taste and preference Price of related goods Expectations of future prices Population size and composition. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 27 Microeconomics Microeconomics WWW.ECOHOLICS.IN Leftward shift → Rightward shift→ Decrease in Increase in Demand Demand Movement along the demand curve Movement, or a change in quantity demanded, occurs when the price of the product changes, and hence, consumers adjust the quantity they are willing to buy. This change is depicted as a movement along the curve, either up or down. Reasons for Movement: Change in own price of the commodity. Microeconomics Leftward Movement →Contraction of Demand Rightward Movement →Extension of Demand Elasticity of Demand The price elasticity of demand is the percentage change in the quantity demanded of a good or service divided by the percentage change in the price. Types of Elasticity of Demand Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 28 Microeconomics Microeconomics WWW.ECOHOLICS.IN Price Elasticity of Demand— The price elasticity of demand measures the responsiveness of quantity demanded of a commodity to change in its price. % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 Ed = % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐩𝐫𝐢𝐜𝐞 Income Elasticity of Demand—The income elasticity of demand measures the responsiveness of quantity demanded of a commodity to change in consumer’s income. % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 Ed = % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐩𝐫𝐢𝐜𝐞 Cross Elasticity of Demand—The cross elasticity of demand measures the responsiveness of quantity demanded of a commodity to change in price of the related commodity. % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐨𝐟 𝐆𝐨𝐨𝐝−𝐱 Ed = % 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐩𝐫𝐢𝐜𝐞 𝐨𝐟 𝐆𝐨𝐨𝐝−𝐲 Microeconomics Degrees of Price Elasticity of Demand S no. Categories of Elasticity Coefficient of Elasticity 1 Perfectly Elastic Ep = ∞ 2 Relatively Elastic Ep >1 3 Unitary Elastic Ep = 1 4 Relatively Inelastic Ep 1) Rise Decrease Inelastic Demand Fall Decrease (𝑒𝑝 < 1) Rise Increase Unitary elastic Demand Fall Unchanged (𝑒𝑝 = 1) Rise Unchanged Income Elasticity of Demand Types Classification of goods 𝑒𝑦 < 0 Inferior goods 𝑒𝑦 > 0 Normal Goods 𝑒𝑦 < 1 Necessities 𝑒𝑦 = 1 Comforts 𝑒𝑦 > 1 Luxuries Microeconomics (𝑒𝑦 = 0) Neutral goods Cross Elasticity of Demand Nature of Commodity Cross Elasticity Substitutes Positive Complements Negative Unrelated Zero Methods of Measuring Elasticity of Demand Proportionate Method 1 Point or Geometric Method 2 Arc Elasticity Method 3 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 30 Microeconomics Microeconomics WWW.ECOHOLICS.IN 1. Proportionate Method: According to this method, elasticity is measured as the ratio of percentage change in the quantity demanded to percentage change in the price. % 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 𝑬𝒅 = %𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 2. Point or Geometric Method The point elasticity of demand measures the elasticity at a point on demand curve. Mainly it’s the ratio of percentage change in quantity demanded of a good to the percentage change in its price calculated at a specific point on the demand curve. 𝑳𝒐𝒘𝒆𝒓 𝒔𝒆𝒈𝒎𝒆𝒏𝒕 𝒐𝒇 𝒕𝒉𝒆 𝒅𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆 𝑬𝒅 = 𝒖𝒑𝒑𝒆𝒓 𝒔𝒆𝒈𝒎𝒆𝒏𝒕 𝒐𝒇 𝒕𝒉𝒆 𝒅𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆 3. Arc Elasticity Method Microeconomics The arc price elasticity of demand measures the responsiveness of quantity demanded to a price. It takes the elasticity of demand at a particular point on the demand curve, or between two points on the curve. In the concept of arc elasticity, elasticity is measured over the arc of the demand curve. on a graph. 𝑸𝟐 − 𝑸 𝟏 𝑷𝒓𝒊𝒄𝒆 𝑬𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝑫𝒆𝒎𝒂𝒏𝒅 = (𝑸 𝟐 + 𝑸 𝟏 ) / 𝟐 𝑷𝟐 − 𝑷𝟏 (𝑷𝟐 + 𝑷𝟏 ) / 𝟐 𝑸𝟐 − 𝑸𝟏 𝑷𝟐 + 𝑷𝟏 𝑷𝒓𝒊𝒄𝒆 𝑬𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝑫𝒆𝒎𝒂𝒏𝒅 = × 𝑸𝟐 + 𝑸𝟏 𝑷𝟐 − 𝑷𝟏 Impact of Price Change Income Effect The income effect means the change in consumer’s purchases of the goods as a result of a change in his money income. Here, the change in demand due to having more purchasing power or a change in real income of the consumer. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 31 Microeconomics Microeconomics WWW.ECOHOLICS.IN Substitution Effect Substitution effect means the change in the quantity purchased of a good as a consequence of a change in its relative price alone, real income or level of satisfaction remaining constant. Here, the consumer is brought to the original level of satisfaction. Income Consumption Curve ICC (Income Consumption Curve) is defined as the locus of all the points of consumer’s equilibrium reflecting the changes in money income when the prices of the two commodities are held constant. Microeconomics Engel Curve Engel curve shows the amount of commodity the consumer will purchase per unit of time at various level of income. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 32 Microeconomics Microeconomics WWW.ECOHOLICS.IN Price Consumption Curve Price Consumption Curve or PCC can be defined as the locus of all the points of consumer equilibrium where price of only one commodity (say X) changes when price of other commodity (say Y), his tastes and preferences and money income are held constant. Derivation of Demand curve There are three cases: Normal Good Inferior Good Giffin Good Microeconomics Normal Good case Income Effect for a good is said to be positive, when with an increase in income of the consumer, his/her consumption of the good also increases. 𝑺. 𝑬 = 𝑰. 𝑬 Inferior Good case Income Effect for a good is said to be negative, when with an increase in income of the consumer, his/her consumption of the good decreases. 𝑺. 𝑬 > 𝑰. 𝑬 Giffin Good case Giffen good is typically an inferior good that does not have easily available substitutes. There are certain strange goods that people buy more of when they get more expensive. These goods do not follow the law of demand that most other goods do. As a result of which, 𝑰. 𝑬 > 𝑺. 𝑬 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 33 Microeconomics Microeconomics WWW.ECOHOLICS.IN Are Giffen goods also inferior goods? Yes, All the Giffen goods are always inferior goods. However, not all the inferior goods shall be considered as the Giffen. Question Bank 1. Can you discuss how the income effect is triggered by a change in the price of a good, and how it affects the consumer's purchasing power and overall consumption patterns? 2. What is the income consumption curve, and how does it illustrate the relationship between a consumer's income and the quantity of a good or service consumed? 3. How does the concept of Engel curves relate to the income consumption curve? 4. A product has an elasticity coefficient of 1.2. If the price increases by 5%, what is the expected percentage change in quantity demanded? Microeconomics 5. The quantity demanded for a luxury good increases by 8% when consumer incomes increase by 12%. Calculate the income elasticity of demand for this good. 6. Can you provide examples or scenarios where external factors such as demographic changes, government policies, or cultural shifts act as determinants of demand, and how do these factors impact the market dynamics for various goods and services? 7. Can you discuss the concept of the law of demand and how it relates to the inverse relationship between price and quantity demanded? 8. Can you explain how an increase in consumer income influences the demand curve? 9. What is the difference between a normal good and an inferior good? 10. In the context of movements along the demand curve, how does the concept of elasticity impact the degree of responsiveness of quantity demanded to changes in price? Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 34 Microeconomics Microeconomics WWW.ECOHOLICS.IN Supply What is Supply? Supply refers to the quantity of a commodity that a seller is willing to sell at different prices during a given period of time. Supply Schedule A supply schedule is a table that shows the quantity supplied at each price. A supply curve is a graph that shows the quantity supplied at each price. PRICE QUANTITY DEMANDED Rs. 4 20 kg Rs. 6 30 kg Rs. 8 50 kg Microeconomics Supply Curve A supply curve is a graph that shows the relationship between price and supply. As prices rise, quantity supplied also typically rises. Law of Supply “It states that keeping other determinants of supply constant, the quantity supplied decreases with the fall in price and increases with the rise in price.” Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 35 Microeconomics Microeconomics WWW.ECOHOLICS.IN Determinants of Supply Price of the Commodity: There is a direct relationship between own price of a commodity and its quantity supplied. Higher the price, higher the quantity supplied and vice-versa. Goal of the firm: If goal of the firm is to maximise profits, more quantity of the commodity will be offered only at a higher price. On the other hand, if goal of the firm is to maximise sales, more will be supplied even at the same price or same will be supplied even at a reduced price. Price of the related goods: Supply for the given commodity is also affected by change in prices of the related goods. Related goods are of two types: o Substitute goods: Substitute goods are those goods which can be used in place of one Microeconomics another for satisfaction of a particular want, like tea and coffee, pen and pencil, etc. The supply of a particular commodity is inversely relating with the price of its substitute commodities, such as the supply of wheat will fall with rise in the price of rice, i.e. supply decreases and vice-versa. o Complementary goods: Complementary goods are those goods which are used together to satisfy a particular want, like tea and sugar, pen and ink, etc. In case of complementary goods, supply is directly related with the price of complementary goods. With rise in price of petrol, supply of cars will rise, i.e. supply increases and vice-versa. Number of firms: Increase in the number of firms in the market implies increase in market supply and decrease in the number of firms implies decrease in market supply of a commodity. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 36 Microeconomics Microeconomics WWW.ECOHOLICS.IN Exceptions to Law of Supply Agricultural Goods: Law of supply does not apply for agricultural goods, as their supply depends on climatic conditions and not on price. Perishable Goods: Perishable goods like fruits, vegetables, milk and milk products cannot be held for long. Therefore, suppliers are willing to supply these products, even when prices are less, for fear that they would become totally useless. Future Expectations Regarding Prices: If prices are rising, but sellers anticipate that they would rise further in future, then they would not increase their supply now. Lack of Resources: In underdeveloped or backward economies, supply cannot be increased due to lack of resources. Movement v/s Shift in Supply Shift in the supply curve: A shift in the supply curve is when the price stays the Microeconomics same, but some other unusual occurrence happens that pushes the supply schedule to either increase or decrease at each price point. Rightward shift → Increase in Supply Leftward shift → Decrease in Supply Movement along the supply curve: When the supply of a product either increases or decreases due to an increase or decrease in its price (all the other factors remain constant), that change in the quantity of the product supplied is depicted as the movement in Supply Curve. Rightward Movement →Extension of Supply Leftward Movement →Contraction of Supply Elasticity of Supply The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 37 Microeconomics Microeconomics WWW.ECOHOLICS.IN Degrees of Elasticity of Supply Categories of Elasticity Coefficient of Elasticity Perfectly Elastic Es = ∞ Relatively Elastic Es >1 Unitary Elastic Es = 1 Relatively Inelastic Es BC or BC < AB ↑ 𝑂𝑢𝑡𝑝𝑢𝑡 > ↑ 𝑖𝑛 𝐼𝑛𝑝𝑢𝑡 Decreasing Returns to Scale AB = BC ↑ 𝑖𝑛 𝑂𝑢𝑡𝑝𝑢𝑡 = ↑ 𝑖𝑛 𝐼𝑛𝑝𝑢𝑡 Negative Returns to Scale AB < BC or BC > AB ↑ 𝑖𝑛 𝑂𝑢𝑡𝑝𝑢𝑡 < ↑ 𝑖𝑛 𝐼𝑛𝑝𝑢𝑡 Download the Ecoholics app for full courses on UGC-NET (Paper-1 and Economics), Economics optional for UPSC, Indian Economic Service, Econometrics, Mathematical Economics, RBI Grade-B DEPR etc. Contact Sanat sir +91-7223946092 or Ecoholics Team +91-7880107880. Website - www.ecoholics.in Ecoholics is committed to help you. Page | 46 Microeconomics Microeconomics WWW.ECOHOLICS.IN Increasing Returns to Scale In this stage, the output increases more than proportionally with the increase in the quantity of inputs. In this stage, the distance between multiple isoquants decreases. In the graph, AB > BC or BC < AB Constant Returns to Scale In this stage, the output increases in the same proportion as the increase in the quantity of inputs. In this stage, the distance between multiple isoquants remains the same. In the graph, AB = BC Decreasing Returns to Scale In this stage, the output increases less than Microeconomics proportionally with the increase in the quantity of inputs. In this stage, the distance between multiple isoquants increases. In the graph, AB < BC or BC > AB Cost Function The relation between the cost incurred and output is known as the 'Cost Function. It can be expressed as, C = f(q)𝑪 = 𝒇(𝒒) Where, C = Cost of production q = Quantity of Output f = Functional Relationship