Microeconomic Concepts PDF

Co11tent Unitl ~ Ik.l\)t:X---O.Uc.m1i~ 11 - 77 Unitl 78 - 111 Unit3 St-.Uisti~ tmd L.--ooo.metrks 112 -141 Unit4.\ fathcrnati~~ E~'tmon1i-...-s 142 -161 Unit5 Intcrnatiomtl E""'Ollonli~...

Co11tent Unitl ~ Ik.l\)t:X---O.Uc.m1i~ 11 - 77 Unitl 78 - 111 Unit3 St-.Uisti~ tmd L.--ooo.metrks 112 -141 Unit4.\ fathcrnati~~ E~'tmon1i-...-s 142 -161 Unit5 Intcrnatiomtl E""'Ollonli~ 162- 184 Unit6 Public f (onom.ics 185 - 197 Unit7 ~ foney and Banking 198 - 204 Unit8 Gro,"th and Development Economks 205- 230 Unit9 En,ironment-.tl Economics 231- 238. Unit 10 Indian Economr 239- 251 (ix) I i I Microeco ,nomic~ I Concept Of Demand The concept of demand was given by Alfred Marshall in ~'s in I his book» Principles of Eco ~cs" Demand is a flow concept Demand Changes Due to any factor other than price i.e.- income, tastes, prices of other goods etc. Quantity Demanded Changes Due to change in price only Law of demand:- It was given by Alfred Marshall: It states that there is an in- verse relationship between price of the commodity and the quantity demanded of it, other things remaining constant.  s1MRANJ'' ,u ·- 12 NTA UGC NET JRF SET ECON OM ICS 1ndjvi dual 13 (2l Substitution cffcc1:- Marke t Price decrease N nnal Good. curve for o oernan d Good becomes cheaper as compared to other s Increase in Dema nd D (3) Law ofdimioisbing marginal utility ~ B Cons umer buy more ifhe has to pay less. IJ 6 u ·.:: C. 4 D 2 Units 0 Exceptions to the law of dema nd : - R asons fir dem and slo in I. Veblen effect :- Veblen propo unde d the conce pt of Cons pic uous consu mp- ti on. Unde r this case, the prestige va lue of a comm odity is linke d with its price. (I) Income effect : - Highe r the price more will be the prestige and vice versa. Price decreaSC 2. Giffen Good s :- Acco rding to Robe rt ! tive relation betwe en price and quan tity Giffen, for Giffen good s there is a posi- dema nded. Real income increase ! Purchasing power increase ! Increase in demand 1-1 NTA UGC NET )RF \ i:.T ~...CO IIO MI1 Income Elasticity of Demand: -It is the responsiveness of change inquantity demanded due to change in income levels. N Ed =1.. !J.Q y O Edd Income e1ashc1ty = - x - Q !J.Y p Ed= 0 For Normal Good Ey>O D For Inferior Good Ey< 1 For Luxurious Ey> 1 For Necessity O "C 0 0 \!) X 0 Good X 0 B Good X B1 ~ Budget Constraint/ Budget Line/Price Line :- Shows the combinations of goods that can be purchased if the entire money income is spent. ► As a result of decrease in price of 'X', budget line moves from pxQx + PvOv = Money Income AB to AB 1 y As a result of decrease in A A1 price of 'Y', budget line shifts AB is Budget line from BA to BA 1 > "C g A \!l )-. "'O 0 0 X ~ 0 Good X 8 B Good X 0  SIMRANJ\T KAUR 28 NTA UGC NET JRF SET ECONOM ICS Consumer Equilibrium:- 29 y B ► Comer solution in case of -0 0 convex IC: only commodity Y 0 ~ >- is bought. ,:, IC 0 0 C, 0 0 X L Good X ► 'E' is equilibrium where budget line 'AB' and Indi fference Curve 'IC' Diamond Water Paradox By Adam touches. Smith :- First order condition:- Water is available in abundant quan tities so that it's relatively Marginal is low.Thus, its price is low. Diamond Utility s are scarce, their relative Marginal Utility is quite high and thus , its price is high. MRSxv = ~ Income Effect means change in cons YY Slope of IC Slope of budget line change in his money income. umer's purchases of a good as ares. ult of A" Slope of IC must be equal to slope of budget line ► Both goods are normal X Second order condition: - At the poin 0 B B' t of tangency, IC should be convex B" to the origin. Good.X. In other words, MRSXY must be fallin g at the point of equilibrium. Income Consumption Curve{ICC) Corner Solution:- In case of corner shows the changes in consumer equilibrium for convex IC's,consum equilibrium with changes in income. only one commodity. er buy  NT/\ UGC NET JRF SET ECONO MICS 31 y I JC( · ► Backward bending ICC, in of 'x' A' case commodity is inferior. A >- ,:, 0 0 l!) X B B' B" B Bl B2 0 Good X GoodX ubstitution Effect: -Substitution effect traces the ~hang es in consumption of e remain S,i. odities when the relative prices change, real mcom comm constant SE is always nega t·1ve 1.. e - fall in the relativeprice, increase the Goods PE IE SE demand for the commodity. Nor- Neg. Positive Nega- Price effect : - It is the change in demand due to change in. the pnce of the com- mal tive modity, other things remaining the same. Inferi- Neg. Nega- Nega-. Engel ~urve : - Engel Curve describes how household expe~d or (IESE) tive tive y E Compensated Demand Curve: - Engel Curve in case of QJ E ► necessities l)Real income remains constant. 0 u 2)Considers only substitution effect. E 3) Compensated demand curve is better while studyi ng consumer surplus. L-- --- --- --.x Compensating Variation in Income: - 0 Good X Compensation variation, or CV, is the adjustment in income that brings the consumer back to the original utility after an econo mic change has occurred. This concept is given by Hicks. Consumer remains on the same Indifference Price Consumption Curve:- curve. ► Slopes upwards to the right  NT /\ UGC N E.T JRr s n ECONOM ICS 33 Ql _ Price Effect ~::QI _ Substitution Effect 2) Transitivity (If A>B and B>C, then A>C). QI to Q2 _ Income Effect 3) Strong ordering (Relation of indifference between variow alternative combi- ► E.1 nations is ruled out). "C 0 0 fund amental Theorem of Consumption:- 0 The theorem was given by Samuelson. X Hicks Logical Ordering Theory of demand:- Hicks brought a book in 1956 A O Q Ch Qi revision of demand theory in which he revised his demand theory which he GoodX presented in his earlier work value and capital. ,...; \ iethod. - Given by Slutsky. Consumer moves on higher Indif- Consumer behaviour under uncertainty:-Theory was propounded by. Cost Du,erence. · 'Neumann and Morgenstern' Risk: - Outcome of a decision is uncertain but probability of each y possible outcome is known. Uncertainty: - More than one possible outcome but probability of each out- come is not known. For a Risk Averse: -, Marginal utility of Money diminishes as he has more money. For a Risk seeker, MUM increases as money increases with him. For a risk neutral, MUM remains constant as money increases. Friedman Savage Hypothesis :-For most people MUM diminishes up to acer- GoodX tain level of money income, it increases from middle level to a certain higher Benefits of Ordinal Theory of Demand:- level of money and at very high levels of income, it again diminishes. !) Decomposes price effect into substitution and income effect. 2) Explains Giffen Paradox. Revealed preference theory:-It was given by Samuelson in 1938. The theory is based on the behaviour that choice of the consumer reveals the pref- erence. Assumptions:- !) Consistency (If A is preferred to B in one particular instance then he cannot choose B rather than A in any other instance when both are available to the consumer.  ~IMHAN )ff l\ ,\ UH.H eroducrton IbeoCY ~I/\ UCC NET )RF SET ECONOM ICS. is. · 11 rd:,t1ons. tcxh mu ' between the inputs and the out.. h ,p 35 Production fun1..-t1on ~ puts. Increasing returns to a factor i::;, Q=ftL, K) Under this stage the MP increases, reaches maximum and starts decreasing. This stage ends where the AP reaches maximum. TP ATP AP =L MP=-;;;; ~- l ) Indivisibility of factors. - Production Function r- t.aw oi Variable Proportion -"7 Law of Returns to scale 2) Specialisation increases....,.. 3) Fixed factor is effectively utilised. Stage2:- {Short Run Law] (Long Run Law] Diminishing returns to a factor ( 1 factor Variable, others fixed] (All factors Variable] Under the stage, MP and AP decrease. Law oi ,-ariable proportions/ Returns to a factor:- Stage ends where MP becomes zero. It is short run theory in which there is at least one factor which is fixed. Beyond Reasons: - a certain point, the MP of the factor would diminish. 1) Scarcity and indivisibility of a fixed factor. Assumptions 2) Imperfect substitutability of factors. 1) Technology is fixed. Stage3:- 2) One factor is variable others are fixed. Negative returns to a factor MP becomes negative TP starts falling. DIAGRAM Reason :-Variable factor is in excess of fixed factor. Most optimal stage of production is stage 2 where Total product is Maximum. - 11D STAGE Returns to scale:- It is long run law in which all factors are variable. PROOUCT Stages of Returns to scale:- r, 1) Constant returns to scale:-Change in proportion of inputs is equal to the ,., change in proportion of outputs. R NOOf 1A10W1D1s w, Isoquonts are equi-distant X Labour 36 SIMRAN)IT KAUR 2) Decmsifii Return s to ~. _The change in proportion of inputs is greater NTA UGC NET JRF SET ECO than the proportionate chasc.· nge m outputs. NOMlCS 37 R Properties : -Down ward sloping and y Con vex to origin. Two isoquants never intersec IClJ t. Higher isoquant means higher ► The distance between the level of production. IQi isoquants keeps increasing. 0 Labour X 0 labour Slope of isoq,uants: - Margin al rate of Technical substitution (No. of units of capital gives lMRTS1 3) Increasing returns to scale up to get one unit of labour). :-The change in proportion of the change in proportion in out inputs is less than It is Diminishing in nature. puts. y MRTSLK = MPL/ MPK The distance between the isoquants keeps decreasing... Output elastlc1 ty of an mp. ut= -MPL APL Elasticity of substitution of perf ect substitutes is infinity. ~ 0 Labour X Reason of Increasing Return s to scale is economies of scale and Decreasing Returns to scale of are diseconomies of scale. Economies of scale:- Advanta g due to expansion of output Es of perfect complements is zero. Diseconomies of scale:-Disadv antage due to expansion of output. Isoquants /Equal produc t curves/Iso- Product cur locus of var ious combinatio ves :-I so quant are the ns of inputs producing the output. same level of  SIMR,\Nl11 KAUR 38 NTA UGC NET JRF SET ECONOMICS 39 6. E5 is unity ~ Homoi(Ilous Prodm:tion fum;tlo14-: 7. Linear homogeneous production function passes through origin. Q = f{x. y)Q = f (m X. Ill)' ) ~+P=l CRS Q = mlfl.x, y) If K = 1-> CRS ~ + P> 1 IRS i\n,"thinl! r:uses tu P'-"wer ·m · If K> 1-> IRS If ~,~us ilie degree of homogeneity DRS K < 1-> ORS Euler Theorem/Product Exhaustion Theorem: - If the factors are paid accord- teRS _ Constant Returns to scale ing to their Marginal productivity, then total output will be exhausted. It holds true in linearly homogenous production function. ~ IRS - Increasing Returns to scale ~ DRS-Decreasing Returns to scale. I MPL*L + MPK*K = Q Linearl_y Homogenous Production function:- CES Production Function: - ~ Arrow, Minhas, Cbenery, All factors increase in same proportion. Solow ~ 1 i.e. Constant Returns to Scale. Q = y[aL-fJ +(1- a)K-fJ]"'1 Cobb Douglas Production Function: - ~ y = Coeff. OfTechnical Efficiency. l. Linearly Homogenous Production Function. a = Distribution Parameter. 2. Constant Returns to Scale. Q = Output {J = Substitution Parameter. 3. E5 = 1 A = Technology ,--Q-=_A_t_cc_KfJ-- L = Labour ~ K = Capital ~ cc = tells output elasticity of labour. ex: = Share of labour in production Endogenous Technological Change:- ~ = tells output elasticity of capital. Neutral Technical Chanie:- Some properties of Cobb Douglas production function: - y 1. Linear homogeneous production function with constant returnsto scale. 2. Diminishing returns to each factor. 'iij 3. Coefficients of it represent output elasticity of input. -~ Q. n, 4. ~l~~~icity of output in relation to labour is 'oc' and in relation to capital u IS t-'· O "-----L-a_b_ou_r_ _...,.X 5. Share of labour in National Income = ex: share of ca 'ta!. N. 11 come= p ' PI m at1ona n-  :--I MH ,\ Nll 1 1\ 1\\ lH 40 NTA IJ(;C: tlltr JRP SEi ECONOMICS 41 - ilil ical Chanie :- Due to technical The region of economic production. l1lxlur S:l\lni Q-ugittl Bla~ \O °i!ss labour per unit of capital, then ch~~- tht' nrm t'f\'>\i11,'t·~ \\\ll)'\l l by uslllg A tt-cllnKAI.:hat~' Combination of two goods which can be prod~ced given the technology. ] Q ·a. ISO - Revenue Line: - It is the locus of points of Combination of two tO u goods produced which generate equal revenue B Producer Equilibrium:- 0 Labour A Ri4&e Lines : - Aie the locus of points where Marginal productivity of at least C one factor is zero. > The optimum stage of production is the region between The two ridge lines and hence is called ISO -Revenue Line ---· r 0 ----------------.PPC,-----------, D B MRPT - Ratio of number of units of a good is sacrificed to produce one more unit of another good.  SIMRANJIT KAUR 42 NTA UGC NET )RF SET ECONOMICS 43. duct transformation (MRPT) whichis Slope of PPC is Marginal mte ot pro increasing. Technical Efficiency: - Maximizing the output with given inputs. MRPT =M.Cx C-- Economic Efficiency: - Minimizing the cost to produce a given level of input. :1., M~- Px Equilibrium: - MRPT-:,..'"Y = Py If the production function is Q = 5.L213 K113 then what is the value of MP of capital , If 64 units of labout and 27 units of capital are used. d more of one good is produced, factors Q = 5.L2/3Kll3 PPC is concan~ m shape as more an.fi d.. - I d l ss productive. Hence more units are sacn ce. MPK= 5. L2/3(1/3)K2/3 producmg 1t become ess ~ e Therefore, MRPT is increasmg.. = 5/3(L/K) 213 For a firm producing single output, equilibrium will occur at the pomt of tan- = 5/3( 64/27) 213 gency of isoquant and the iso cost line. = 5/3[(64/27) 113 ] 2 = 5/3(4/3)2 = 5/3xl6/9 A = 80/27 E - Producer Equilibrium Q Iso Cost Line : - An Iso Cost Line is defined as the laws of various combinations of factors which a firm can buy with a constant outlay. O Labour B IQ = Isoquant AB = Iso Cost Line Expansion Path:- Locus of points of revenue maximisation. It is also known as A C=W.l+rK scale line because it tells how firms change their scale of product W = wages to labour W P1 Slope=-=- R PK r = Rate of interest on Expansion Pat k capital 0 Labour B Ch 0 B- B' B" X Labour  T ,11\\lli\Nll r 1(/\llH NTA UGC NET )RF SET ECONOMICS 45 ·..., the payments that necessary to -H. consists o1 111 · d Th.. Cost of prvJu.:tion. · d 111 anagement require to produce Cost _ e:on;· ·. d 1 bour capital an 4TC obtain the t:Kt0rs 01 htn ' a ' Marginal Cost:-TCn - TCn-1 or ~ a commodit)·· Cost = f (Output) fi r cost of having a Factor of pro. e out of the rm o f..wli.;it Co~: -These cost ar duction.. f d goods and services and are in. MC t;.. -. These are the pnces o owne lmrhat COfil. - t Also called imputed cost. 8 eluded in average cos... Ex licit Cost + Implicit Cost Economic Cost. - ~ - - -. Al called transferred Qpportunit:Y Cost: - Cost of next best alternative. so Quantity earnings. b h · the past Historical Cost: - Original price of FOP when oug t m. Sunk Cost:- It is a kind of historical cost which cannot be recovered. D When AC is falling, MC is falling more than the AC. Traditional theory of costs D When AC is minimumAC = MC Total cost = Total fixed costs + Total variable costs D When AC is rising, MC rises more Minimum l l Payments to Quantity than AC. Administrati- labor Long Run Costs: - They are flatter as compared to short run costs. 1----====------ TFC -on employed i.e. Expensives prices of the actors i.e. raw material 0 Quantity Manager's Salary (LRAC) Long Run Average Cost Curve is also known as planning curve. Plants are used at less than full capacity at point left to the minimum point and are Average Cost: - Average Fixed Cost + Average Variable Cost used more than full capacity at point's right to the minimum point. The opti- o/ AVC mum plant size is when it operates at minimum LAC. ~ ~ AFC is rectangular Hyperbola Modern theory of costs:- Cost curves are not U shaped due to reserve capacity. 8 (decreases but never touch any axis) There are Saucer shaped short run cost curves. AFC Quantity  ~l~IH,\ NII r KA\ 1H NTA UGC NET JRF SET ECONOMICS (2) When TR 1' MR'1, Ed> 1 (3) When TR '1, MR=Neg. Ed< 1 0 a. ~ Slope of a MR L _ Shaped Long Run Average Cost Curve curve is twice that of the AR curve Reasons:- u 1. Economies of Scale 5 LAC 2. Learning Effect 0 Quantity 3. Technological Progress Leaming Curve: - Kenneth Arrow It states that the increase in cumulative output leads to decline in per unit cost due to learning by doing. Economies of Scope: - Joint production of a good is more efficient than the separate production. Diseconomies of Scope: -Joint production is less efficient than the individual production. Relation between TR, MR and AR:- (1) TR= Max. MR=O Ed= 1  Sl~\IV\ N] IT K_Al IR NTA UGC NET JRF SET ECONOMICS 49 Market l (a) Super Normal Profits:- Monopolistic Oligopoly Pt.~"t Monopoly Competition MC C~tion Collusive Non-Collusive Revenue MR=AR Oligopoly Costs Nature of Price Price Ease of Form of No. of Firms product elastic- Con- Entry marl-et ity trol. _ _ _ ~ : - - - - - - - - - Output 0 Super Normal Profit Perfect Large Homoge- Infinity Zero Free nous (b) Nonnal Profits:- Monopolis- Large Differenti- Large Some Free Price MC 'Supply curve under perfect compe- tic ated AC tition is Upward Sloping Part of MC PureOli- Few Homoge- Small Some Limit- above the minimum point of AVC gopoly nous ed Reenue r------'""",f,-====---- MR= AR Differentiat- Few Differenti- Small Large Limit- Costs ed Oligopoly ated ed Monopoly One Unique Very Very Strong Small Large Barri- 0 Q Quantity ers to entry (c).. Short Run Equilibrium of Perfect Competition : - MC AC Conditions (1) MC= MR p Minimum Loss (2) MC should cut MR from below P=MR :->Supernormal profit when AR> AC Normal profits when AR = AC Minimum Loss AR < AC Shut Down Point (P$ AVC) 0  Sl~\RANJIT KAUR NTA UGC NET JRF SET ECONOMICS 49 Market (a) Super Normal Profits:- Monopolistic Oligopoly ~ Monopoly Competition MC Comretition f t Collusive Non-Collusive Revenue MR=AR Oligopoly Costs No. of Nature of Price Price Ease of Form of Firms product elastic- Con- Entry market ity trol " - - ~ - - ----____. Output 0 Free Super Normal Profit Perfect Large Homoge- Infinity Zero nous (b) Normal Profits:- Monopolis- Large Differenti- Large Some Free Price MC 'Supply curve under perfect compe- tic ated AC tition is Upward Sloping Part of MC Pure Oli- Few Homoge- Small Some Limit- above the minimum point of AVC gopoly nous ed Reenue r------.::"'-,(..-::::::~-- - MR= AR Di.fferentiat- Few Differenti- Small Large Limit- Costs ed Oligopoly ated ed Monopoly One Unique Very Very Strong Small Large Barri- 0 Q Quantity ers to entry (c).. Short Run Equilibnum of Perfect Competition : - AC Conditions (1) MC= MR (2) MC should cut MR from below p Minimum Loss P=MR :->Supernormal profit when AR> AC Normal profits when AR = AC Minimum Loss AR < AC Shut Down Point (Ps AVC) 0  NTA l lGC NeT /RF SET ECONOMICS 51 L0n~ Run Eswhl'.miJ11 L\IC (1) Price = MC I LAC (2) New firms enter or exit the industry. Price P=AR=MR=MC=AC Demand "--------1.----~--Quantity 0 Output Criticism of perfect Competition : - Maximizing total economic surplus is not a Economi( E.m.:ienc:y fPerfect competitive Market) good measure of equity. It may not be fair/equitable. Resources efficiently used and Maximum possible satisfaction. Monopoly: - Causes/Sources: - Patents or copy rights controls our essential raw materials. Points of Remember: - Natural Monopoly :- Experiences economies of scale and the AC is diminishing (I) _.\ perfectly competitive firm does not quit the industry even if it incurs in nature. losses in the short run because they can't alter the fixed capital equipment in the short run. Therefore, they will have to incur the losses equal to fixed cost even Legal /Statutory Monopoly: - The Government provides the legal status through when they shut down. Thus they continue production in the short run even patents or copy rights. when they incur losses. Monopolist will never been eP < 1. (2) A perfectly competitive firm is in business even when economic profits are When ep < 1, MR becomes negative, TR will decline. So it will not be rational zero because economic profit includes the opportunity costs. So at zero eco- for the monopolist to operate a point where MR is negative. nomic profits, firms still earn a return on capital invested. So at zero economic □ Monopoly is in equilibrium where zero Marginal Cost. Because here TR profits, firms still earn a return on the capital invested. is maximum and elasticity is 1. Consumer Sur:plus: - Price consumers are willing to pay - what they actual pay. '□ There is no supply curve in monopoly. Prod ucer's_ S~r:plus : - Market price at which sellers sell -(minus) minimum price they are willing to sell □ No unique price - quantity relationship. Conditions of Equilibrium:- ► MR=MC ► MC should cut MR curve from below.  s1MRANJ I TKAUR 52 NTA UGC NET JRF SET ECONOMICS 53 ( 1) Surc;r l\orn1Jl pro.fu:- Long Run : - The monopolist earns only super normal profit because there are MC barriers to entry Conditions:- SAC = LAC Cost MR= LRMC = SRMC p AC < AR Price> LAC AR Difference between perfect Competition and Monopoly. PC Monopoly Q Output 0 Price Lower Higher (2) Nonna! Profit:- Quantity Higher Lower MC Monopolist does not have a unique supply curve. AC In Monopoly there is no economic efficiency. Dead weight loss occur. Cost Q) :::::, Under monopoly, C producer surplus AR ~Q) increases due to Q 0:: 0 vi higher price iii 0 MR () Consumer surplus decreases due to (3) Losses :- hi her rice Pmon Cost Loss of consumer AC surplus larger than s gain in producer Losse SU lus Dead-Weight Loss to Output societ 0 Output  ~IMR/\NJIT KAUR NTA UGC NET JRF SET ECONOMICS 55 Dead weight loss A B E = Consumer Surplus 1hird degree price Discrimination-Different prices are charged in different F C BG = Monopoly Gain markets depending on the elasticities. dnd s C G E= dead Weight Loss Ex.. Dumping [electric company sells electric power at a lower price to the Weigh1 Lo.