Microeconomics PDF

# Microeconomics Microeconomics starts with **scarcity**, which means that resources are limited and human needs are more. This leads to economic agents making choices. **Microeconomic** agents like Consumer and business influences market prices and quantity of any product. **Macroeconomic** age...

# Microeconomics Microeconomics starts with **scarcity**, which means that resources are limited and human needs are more. This leads to economic agents making choices. **Microeconomic** agents like Consumer and business influences market prices and quantity of any product. **Macroeconomic** agents like banks and governments provide financial service and regulate the market. ### Demand and Supply - **Demand** is the quantity a customer is willing to purchase at various prices during a specific period. - **Supply** refers to the quantity producers are willing to offer at various prices during a specific period. **Both curves are U shaped.** - Demand curve is downward, convex to origin and cannot be negative. - Supply curve is upward and cannot be negative, but can start from zero. ## General Demand & Supply Factors | Factor | Demand | Supply | |---------------|------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------| | **Price** | Price increases, demand decreases | Supply is more when the product is at a higher price to earn more profit | | **Income** | Income increases, demand increases (but demand decreases for inferior goods as with more salary consumer wants good quality) | Production cost refers to raw material, labor, technology. Increase in production cost can reduce willingness to produce more. | | **Related Goods** | When the price of one product increases, the demand for other related goods increases (e.g., coke and pepsi) | Price changes for complementary goods impact demand for other goods. | | **Customer taste** | Market, influence can impact demand. | Government policies, regulation can impact supply. | | **Population** | Population increase can increase demand | Producer adjusts supply based on the expectation of future prices. | ## Demand-Income Relation | TERM | MEANING | |----------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | **Normal Goods** | When a person's income increases, their demand for these products also increases. Examples include milk and soft drinks. | | **Inferior Goods** | When a person's income increases, their demand for these products tends to decrease. Examples include bread and lower-quality snacks. | | **Giffen Goods** | Giffen goods are a type of inferior good, but their demand increases when their price rises due to unique circumstances. An example is often cited as bread during a famine. | | **Cross-Price Effect** | This term refers to the change in demand for one commodity when the price of another commodity changes. | | **Substitute Goods** | These are goods that can be used in place of one another. For example, if the price of tea rises, people may buy more coffee. | | **Complementary Goods** | These are goods often consumed together. If the price of one complementary good, like gasoline, increases, it can lead to a decrease in demand for the other good, such as petrol cars. | | **Elasticity** | Elasticity is the percentage change in quantity divided by the percentage change in its price. | ## Elasticity | ELASTICITY | ABOUT | EXAMPLES | |---------------------------|------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | **When elasticity = 0** | Perfect Inelastic Demand | Life-saving medication (demand is essential, regardless of price) | | **When elasticity < 1** | Inelastic Demand | Gasoline (demand is relatively insensitive to price changes) | | **When elasticity > 1** | Elastic Demand | Luxury watches (demand is highly responsive to price changes) | | **When elasticity = ∞** | Perfectly Elastic Demand | Identical agricultural products from multiple suppliers (consumers will buy from the cheapest source) | | **When elasticity = 1** | Unit Elastic Demand (percentage change in price matches the percentage change in quantity demanded) | Bread (percentage change in price matches the percentage change in quantity demanded) | ## Budget Line It gives combination of goods and services that can be purchased at a certain budget. It is always a straight line concave to origin # Utility ## Utility Concept | CONCEPT | DEFINITION | EXAMPLE | |-----------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------| | **Total Utility** | Overall satisfaction from consuming a quantity of a good or service. | Eating slices of pizza: Total utility increases as you eat more slices, with diminishing additional satisfaction. | | **Marginal Utility** | Additional satisfaction gained from consuming one more unit of a good. | Eating ice cream: Marginal utility decreases with each additional scoop, representing diminishing satisfaction. | | **Diminishing Marginal Utility** | Principle is as you consume more, additional satisfaction from each unit diminishes. | Consuming chocolate: The first few pieces are highly satisfying but as you eat more, the satisfaction decreases. | | **Rational Choice** | Consumers aim to allocate resources to maximize total utility while considering marginal utility and budget constraints. | Budget allocation between chips & chocolate: Consumers allocate their budget to maximize overall satisfaction, considering diminishing marginal utility of each snack. | ## Indifference Curves Indifference curves are a tool in consumer theory that allow economists to analyze consumer preferences, understand how consumers can make choices given their budget constraints, and predict how changes in prices or income will impact their consumption decisions. # Production Theory - Four production factors are Land, Labour, Capital and Market - **Production Possibility Curve or Boundary** is a graphical representation in economics that shows the maximum potential output of two goods or services an economy can produce with its given resources and technology, while efficiently using all available resources. - **Curve "A" shows underutilization of resources.**/ - **Curve "X" represents economic growth.** - **Curve "BDC" represents optimum utilisation of resources.** - Production possibility frontier curve is always concave to origin. ## Production Cost Types | TYPE | MEANING | |----------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | **Implicit Cost** | Costs that represent opportunity cost of using self-owned resources, e.g., not renting out a car when it could have been rented to earn money | | **Explicit Cost** | Direct, out-of-pocket expenses incurred for a specific activity or transaction, such as the cost of renting a car. | | **Opportunity Cost** | The cost associated with forgoing the next best alternative when making a decision, e.g., choosing a more expensive car over a cheaper one results in an opportunity cost. This means you are giving up the opportunity to save by choosing more expensive option | | **Break Even Point** | When revenue is equal to total cost, resulting in neither profit nor loss. It's the point where a business covers all its costs. | | **Equilibrium Point** | The point at which the quantity demanded equals the quantity supplied in a market, resulting in a state of balance or stability and there is no shortage or surplus of goods or services. | | **Economy of Scale** | When increasing production leads to a reduction in average costs. | # Law of Diminishing Marginal Returns The **Law of Diminishing Marginal Returns** is a fundamental concept in economics demonstrating how the combination of inputs in the production process can affect output. - **TP** (Total Production) - e.g., total number of cookies baked in a day. - **MP** (Marginal Productivity) - e.g., extra cookies you get by adding one more worker. - **AP** (Average Productivity) - e.g., Average cookies made by each worker **Stages of Production** - **Stage 1:** When TP increases, AP is also increasing. MP reaches constant. - **Stage 2:** When TP increases but slowly, AP reaches constant and MP declines. - **Stage 3:** When TP is constant, AP declines but never touches zero. MP declines to negative. ## Marginal Cost, Marginal Revenue & Average Total Cost The relationship between **Marginal Cost (MC), Marginal Revenue (MR), and Average Total Cost (ATC)** is vital for understanding a firm’s production decisions. 1. When MC declines, ATC declines 2. When MC reaches constant, ATC declines 3. When MC increases, ATC is constant 4. When MC increases, ATC increases ## Total Cost, Total Fixed Cost & Total Variable Cost - **TVC + TFC = Total Cost** - **AVC + AFC = Average Cost** - **MVC + MFC = Marginal Cost** # General Microeconomics Points - **Marginal Productivity Theory** explains why some earn more than others and how factors of production affect income inequality. - **Game theory** in economics explains how individuals or organizations make decisions in situations where the outcome of each participant's depends on the choices of others. - **Nash Equilibrium** is a concept of game theory where no player can improve outcome by changing their strategy alone when others don't make a change (e.g., international relations). - **The Prisoner's Dilemma** illustrates how individuals might not cooperate, even when it appears that it is in their best interest to do so because they fear the other will cheat. - **Pareto Efficiency** is a state where no individual can be made better off without making someone else worse off. - **Gini Coefficient** is a measure of income inequality within a country, with 0 representing perfect equality and 1 indicating perfect inequality. - **The Free Rider Problem** is when individuals benefit from a public good without directly paying for it (e.g., every citizen gets protection benefits by military regardless of contributing to tax). - **Veblen Goods** are Luxury goods for which the demand increases as the price rises, often due to their conspicuous consumption, luxury status (e.g., Gucci, Prada). # Market Types | MARKET STRUCTURE | KEY FEATURES | EXAMPLE | |-----------------------------|-----------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------| | **Perfect Competition** | Many buyers and sellers. Homogeneous goods with free entry and exit. | Local vegetable markets | | **Monopoly** | One seller with a unique product and high barriers to new entry. | Regional utilities like a sole electricity provider | | **Monopolistic Competition** | Many sellers with differentiated products with free entry and exit. | Restaurants differentiating with menu and ambiance | | **Oligopoly** | Few dominant sellers; Interdependent firms. | Airline industry or mobile phone manufacturers | | **Duopoly** | Only two sellers. | Two companies providing a particular service in a region | # Macroeconomics ## Macroeconomics Key Terms - **Gross Domestic Product (GDP)** is the total value of all the goods and services produced within a country's borders in a specific time, usually a year. - **Gross National Product (GNP)** is like GDP, but it also includes the money earned by people and businesses working or investing outside the country. - **NNP** is like GNP, but it takes away the cost of the stuff that wore out or got used up while making all those goods and services. - **National Income** is the money people and businesses earned from making and selling stuff. It includes wages, rents, and profits before taxes. - **Personal Income** is the money people get to keep from various sources, such as your job, investments, and rental properties. - **Disposable Income** is the amount of money a person has left after paying income taxes and other mandatory deductions and contributions. - **Real Income** is the income an individual or household receives after adjusting for inflation. ## How to Measure GDP GDP can be measured using three different approaches: 1. **Production approach**: represents GDP by summing the value-added at each stage of production. This is called **Gross Value Added (GVA)**. 2. **Income approach**: calculates GDP by summing all the incomes earned within the country. 3. **Expenditure approach**: calculates GDP by summing all the spending within an economy. # Fiscal and Monetary Policy ## Fiscal Policy Fiscal policy is like a tool that the government uses to manage the economy. It's all about how the government collects money (taxes) and spends money. - When the economy needs a boost, the government can spend more money on things like building roads, schools, and hospitals. - When inflation is rising, the government might cut back on spending and increase taxes to cool things down. ## Monetary Policy Monetary policy is a tool that the central bank uses to control money and interest rates. - When the economy needs a boost, the central bank can lower interest rates so that it is cheaper to borrow money, and businesses might spend more. - When the economy is getting too hot, the central bank can raise interest rates. Higher interest rates make it more expensive to borrow money, and businesses might spend less. # Unemployment Unemployment refers to the number of people who are willing and able to work but do not have a job. Economists typically classify unemployment into three main types: - **Cyclical Unemployment**: This occurs due to economic downturns or recessions when demand for labor decreases. - **Structural Unemployment**: This arises when the skills and qualifications of job seekers do not match the requirements of available jobs. - **Frictional Unemployment**: This represents the temporary period during which people are transitioning between jobs. # Sectors of the Economy - **Primary sectors** are agriculture, forestry and fishing, mining, etc. They make direct use of natural resources to get the produce. - **Secondary sectors** are industrial sectors like clothing. They use the produce of the primary sector as raw materials and thereafter continue with manufacturing. - **Tertiary sectors** are retail sectors, tourism, banking, medical, etc., that do not produce any good but aid and support the production and promote the primary and secondary sectors through services. # Types of Economy - **Traditional economy**: Ancient civilisations used barter systems and had no concept of currency or money. Produce was only made for living. - **Market economy**: has limited interference from controlling power like government (e.g., India). - **Free economy**: is completely free from government regulations. - **Command economy**: is completely under one controlling power, which is the government (e.g. China). - **Mixed economy**: typical federation between government and free market. # Money and Banking - **Money** is a **medium of exchange** that simplifies transactions, eliminates the need for barter and makes it easier to buy and sell goods and services. - It is a **unit of account** that provides a common measure for the value of goods and services, allowing for easy comparison of prices and facilitating economic calculations. - It is a **store of value** as it can be saved and used in the future, preserving value over time and serving as a store of wealth. - It also enables **deferred payments** as it allows for deferred payments, such as loans and credit transactions. ### Functions of Reserve Bank of India (RBI) - Established in 1934, started as a private owned bank and later converted into a wholly government owned bank - *Monetary Policy:* RBI formulates and implements monetary policy to control inflation, support economic growth, and ensure financial stability -* Banker to banks and lender of last resorts:* provide financial aid to the banking system -* Sole authority to issue currency notes in India:* maintain money supply -* Regulates foreign exchange:* Manage foreign reserves and regulates foreign exchange transactions -* Regulates and supervises the banking and financial system* -* Banker and debt manager for the Indian government* ### RBI Monetary Tools | Tool | Meaning | |-----------------|---------------------------------------------------------------------------------------------------------------------------------| | **SLR** | Statutory liquidity ratio is minimum liquid cash that a bank must deposit in government-approved securities. | | **CRR** | Cash Reserve ratio is the minimum cash reserves that a bank must deposit with RBI. | | **OMO** | Open Market Operations is buying and selling governmental securities to control the money supply | | **Repo Rate** | Repurchase Rate is the rate at which the Reserve Bank of India or RBI lends money to commercial banks for a short-term period. | ### National Payments Corporation of India (NPCI) - Provides the regulatory oversight and ensures efficiently secure ecosystem for digital payments like UPI. - It operates UPI and several other retail payment systems in India. ### Functions of Commercial Banks - Accepting deposits: savings, current, and fixed deposits. - Lending loans and credit: to individuals, businesses, and governments to support economic activities - Providing payment services: cheques, electronic funds transfer, and digital wallets. - Acting as intermediaries between savers and borrowers. ### Non-Performing assets (NPA) - These are bad loans. - Occurs when borrower defaults in repayment of interest or principal payments for 90 days or more. - When the borrower defaults for 12 months, it's called loss of asset to the bank. - It can affect financial health of the bank. ### Time Deposits - A type of savings account offered by banks where the depositor agrees to keep their money locked in account for a specified period to earn interest. ### Demand Deposits - Allow depositors to withdraw money on demand without any notice or penalty. - Often used for daily transactions and does not earn interest ### Credit Rating - An assessment of the creditworthiness of a borrower. - Indicates the level of credit risk associated with a borrower. - **Liquidity**: Ease with which an asset can be converted into cash easily. - **Collateral**: Asset or property that a borrower offers to a lender as security for loan. - **Default**: When a borrower fails to make loan or debt payments as agreed. - **Overdraft**: A facility provided by a bank that allows an account holder to withdraw more money than is available in their account. - **SWIFT (Society for Worldwide Interbank Financial Telecommunication)** is a global network used by financial institutions for international financial transactions. # Stock Exchanges in India - **Bombay Stock Exchange (BSE)**: Located in Mumbai and also known as "BSE Sensex" or simply "Sensex." It uses an electronic trading system called BOLT and has a diverse investor base, including retail investors, institutional investors, and foreign institutional investors. - **National Stock Exchange (NSE)**: Headquartered in Mumbai, the NSE uses an electronic trading platform called NEAT. ## International Trade ### Balance of Trade - Measures the difference between a country's exports and imports of goods and services. - **Trade surplus:** When the value of exports exceeds imports. - **Trade deficit:** When imports exceed exports. ### Balance of Payments - Compares record of all economic transactions between a country and the rest of the world. - Three main components - Current Account: - Exports of Goods and Services - Net Income from Abroad - Net Current Transfers - Capital Account - Capital transfers - Acquisition or disposal of non-produced, non-financial assets - Financial Account: - Foreign Direct Investment (FDI) - Portfolio Investment - Other financial derivatives ### Exchange Rates - **Foreign Exchange (Forex or FX):** Refers to the global marketplace for buying and selling currency. - **Fixed Exchange Rate:** Currency's value is fixed to a specific reference currency or a basket of currencies. - **Floating Exchange Rate:** Determined by market forces of supply and demand. ### Factors affecting exchange rates: - Interest rates - Inflation rates - Political stability - Market sentiment ### FDI and FII - **Foreign Direct Investment (FDI)**: A foreign entity makes a significant and lasting investment in a business or project in another country. - **Foreign Institutional Investment (FII)**: Involve purchase of financial assets (e.g., stocks and bonds) in another country's financial markets. # Public Finances - Governments raise revenue through various sources, including taxation: - *Income tax* - *Goods and services tax* - *Property tax* - Governments also issue bonds and borrow money from financial markets. ## Types of Taxes | TERM | MEANING | |------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | **Direct Taxes** | It is directly paid to government. Burden of tax cannot be transferred to other e.g income tax, wealth tax. Your income tax has to be paid by you. | | **Indirect Taxes** | These are indirectly paid while consuming products and services. Burden can be shifted e.g paying the tax on final product while consuming commodity like GST. (It is to note that GST was first introduced in France). | ## Progressive Tax vs. Regressive Tax Taxes can be classified as **progressive** (where tax is increased with income) or **regressive** (where tax is reduced with increase in income). ## Types of Indirect Tax | TAX | MEANING | |---------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------| | Customs Duty | Levied on goods imported into India and certain goods exported from India, including basic customs duty, Countervailing Duty (CVD), and Special Additional Duty (SAD). | | Excise Duty | A tax on the production and manufacture of goods in India, typically paid by the manufacturer of goods and included in the product's price. | | Entertainment Tax | Imposed by states on activities such as cinema shows, amusement parks, and cultural events. | | Luxury Tax | Levied by some states on the usage of luxury goods, e.g., high-end hotels. | | Professional Tax | A comprehensive tax on the income earned by professionals, such as lawyers, doctors, and chartered accountants, in some states. | | Goods and Services Tax (GST) | A comprehensive tax on the supply of goods and services at each stage of the supply chain where the burden of tax falls on the ultimate consumer. VAT & central sales tax now come under GST. GST has multiple rates for each type of goods and service. | | State GST (SGST) | State GST is part of the GST system, levied by state governments on the supply of goods and services within a state. | | Integrated Goods and Services Tax (IGST) | When an inter-state transaction occurs, IGST is collected by the central government. The rate of IGST is typically equal to the total of the CGST and SGST rates applicable to the transaction. | | Anti-Dumping Duty | It is imposed on imported goods that are being sold at prices lower than their fair market value. The purpose of anti-dumping duties is to protect domestic industries from unfair competition by foreign producers engaging in dumping practices. | # Budgets - Budgeting involves estimating revenues and planning expenditures for various government functions. - **Capital Budget**: Allocation for capital receipts and capital expenditure. - **Revenue Budget**: Allocation for revenue receipts and revenue expenditure. - **Budget Deficit**: Total expenditure - total receipts. - **Fiscal deficit**: Total Expenditure - Total receipts (excluding borrowings). - **Revenue deficit**: Revenue Expenditure - Revenue Receipts - **Primary deficit**: Fiscal Deficit - Interest Payments ## Components - Capital Expenditure: Infrastructure development, education, healthcare, investment in public sector. - Revenue Expenditure: Salaries, pensions, subsidies, operational costs - Capital Receipts: Borrowing, privatization of PSU, sale of government land, assets - Revenue Receipts: Taxes, fines, fees, grants ## Nationalisation, Privatisation, and Disinvestments - **Nationalisation**: Transfer of ownership and control of a business or industry from the private sector to the public sector, typically the government. - **Privatisation**: Transfer of ownership and control of a business or industry from the public sector (government) to the private sector (private individuals or companies). - **Disinvestment**: Process of reducing the government's ownership or stake in a public sector enterprise by selling shares to the private sector, public sector or the public # Economic Planning | TERM | MEANING | |-----|---------------------------------------------------------------------------------------------------------------------------------------------------------| | Imperative planning | By central authorities plan on what should be produced, how it should be produced, and for whom it should be produced. | | Indicative planning | Government provides guidelines, suggestions but private sector has more flexibility and autonomy in making economic decisions. | | Perspective planning | Long-term planning that typically spans several years or decades. | | Rolling plan | Long-term plan that are continuously updated and revised, typically on an annual or semi-annual basis. | # Indian Economic Facts | POINT | ANSWER | |------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------| | Imperial Bank | Imperial Bank of India, later renamed as State Bank of India (SBI) after Independence. | | PNB | Punjab National Bank | | Central Bank | Central Bank of India | | Bank of India | Bank of India | | RBI governor | Osborne Smith | | RBI governor | Chintaman D Deshmukh | | RBI governor | BR Rau | | PRI governor | Amitav Ghosh | | Union Budget | Department of Economic Affairs | | Indian Agricultural Lending | NABARD | | Indian Industrial Lending | SIDBI | | Plant Bengal | Set up with help of Britain | | Chhattisgarh | Set up with help of Russia | | Odisha | Set up with help of Russia | | Odisha Budget after independence | R.K. Shanmukham Chetty | # Economic Terms - **Deprecation**: decrease in the value of assets such as machinery, buildings, and equipment over time. - **Fixed Assets**: Long-term holdings like machinery, land, and buildings, used in a business, not intended for daily sale or quick cash conversion. It also includes intangible assets like copyrights and patents. - **Capital**: Money or financial assets used to invest in a business. # Environmental Reforms - **Cost Benefit Analysis**: Best approach to achieve benefits while preserving associated benefits such as environmental damage, job creation etc. - **Environmental Valuation**: Placing monetary value on environmental goods and services. - **Green GDP**: Measures a nation's economic growth while accounting for environmental damages and depletion of natural resources. - **Carbon Trading**: Allows countries and companies to buy and sell units of greenhouse gas emissions with actual money in an effort to reduce global carbon emissions. ### Important Environmental Agreements - **United Nations Framework Convention on Climate Change (UNFCCC)**: An international treaty to address climate change and its impacts. Holds Annual Conference of Parties meetings to discuss and negotiate climate-related decisions. - **Kyoto Protocol**: An international agreement linked to the UNFCCC that sets binding targets for the reduction of greenhouse gas emissions. # Sustainable Development Goals (SDGs) - Adopted by the UN General Assembly in 2015. - There are 17 goals to achieve by 2030. This includes eliminating poverty, reducing inequality, and promoting sustainable development. # Economic Laws and Theories - **Say's Law**: "Supply creates its own demand." Argues that production leads to the creation of demand. - **Phillips Curve**: Represents the relationship between inflation and unemployment in an economy. Suggests that when unemployment is low, inflation is high. - **Laffer Curve**: Shows the relationship between tax rates and tax revenue collected by the government. There is an optimal tax rate that maximizes government revenue. - **Trickle-down economics**: Suggests that benefits provided to the wealthy or businesses will eventually "trickle down" to everyone else in the form of increased investment, job creation, and economic growth. - **Multiplier Effect**: Increase in final income arising from any new injection of spending into the economy (government spending or investment). The initial spending can lead to a chain reaction of consumption.