FOCUS AREA

MICRO ECONOMICS

Chapter- 1 INTRODUCTION

Definitions of Economics:-
The word ‘Economics’ originated from a Greek word ‘ Oikonomia’ which means
household management. There are various definitions of Economics.
Definitions Economists Year Books
Wealth definition Adam Smith 1776 Nature and causes
of wealth of nations
Welfare definition Alfred Marshal 1890 Principles of
Economics
Scarcity definition Lionel Robbins 1932 An Essay on the
nature and
significance of
economic science
Growth definition P A Samuelson 1948 Economics

Central or basic economic problems of an economy:-

The central economic problems of an economy arise due to unlimited
human wants and limited resources which have alternative uses. Such problems can
be classified in to three.

1. What to produce?
2. How to produce?
3. For whom to produce?

1. What to produce:-
Human wants are unlimited. When one want is satisfied, another one
grows up in that place. But the resources to satisfy the wants are scarce in nature.
More over, the resources have alternative uses. So the economy wants to take a
decision regarding what type of goods in what quantities to be produced. This is the
problem of ‘what to produce.’

2. How to produce:-
This is the second basic economic problem of an economy. This is the
problem related to the choice of technology of production. The production technology

Downloaded from www.hssreporter.com

may be labour intensive or capital intensive. The labour intensive technique uses
more labour power and less capital in the production. But capital intensive technique
uses more capital and less labourers in the production. The economy chooses that
technique of production which is the least cost one.

3. For whom to produce:-

The third basic economic problem of an economy is ‘for whom to
produce’. This problem deals with the distribution of national income. The national
income is distributed in to four forms of rewards of factors of production. They are
rent, wage, interest and profit. The problem for whom to produce explains the
distribution of national income as rent, wage, interest and profit.
In shortly, these basic economic problems are the ‘problems of choices’.

How do different economies solve these problems?

Different economies solve the basic economic problems in different ways. There
are mainly three different economies in the world related to their organisation. They
are;
1. Market economy.
2. Centrally planned economy.
3. Mixed economy.
1. Market economy:-
The main features of a market economy are given.
* Capitalist economy.
* Private ownership exists.
* Inequality.
* Profit motivated economy
* Example – U S A, U K, News land, Australia etc....
In a market economy, all central problems are solved by ‘price mechanism’.

2. Centrally planned economy:-

A centrally planned economy has the following characteristics.
* Socialist economy.
* Government ownership exists.
* Equality.
* Welfare motivated economy.
* Example – Cuba, China etc....
In a centrally planned economy, all basic economic problems are solved by’
planning’

3. Mixed economy:-
Mixed economy has the given features.
* Mixing of market economy and centrally planned economy.
* Both private and public sectors exist.
* Joint sector.
* Example – India.

Downloaded from www.hssreporter.com

In a mixed economy, the central problems are solved by price mechanism and
planning. In the private sector, the problems are solved by price mechanism. But the
problems of public sector are solved by planning authority.

Micro Economics & Macro Economics:-

Micro Economics Macro Economics

Study about individual part of an Study about the economy as a whole
economy
Individualistic study Aggregate study
Example – study about a consumer, a Example – study about G D P, National
market, a firm etc... income, Policy of R B I etc...
Price theory Income and employment theory
Partial equilibrium analysis General equilibrium analysis
A worm’s eye view of the economy A bird’s eye view of the economy

MICRO – Chapter 2
THEORY OF CONSUMER BEHAVIOUR
UTILITY
Want-satisfying power of a commodity is called Utility. The more the need of a
commodity, the greater is the utility derived from the commodity.

Cardinal Utility Analysis

Cardinal utility analysis assumes that level of utility can be measured in numbers.
Eg: utility of consumption of 5 units of orange is 20 utils. The unit of utility is termed
as utils.

Total Utility:

Total satisfaction derived from consuming the given amount of a commodity is called
total utility. More units of a commodity provides more satisfaction to the consumer.
TU depends on the quantity of the commodity consumed.

Marginal Utility:

Marginal utility (MU) is the Change in total utility due to consumption of one
additional unit of a commodity.
Eg: suppose 4 oranges give us 28 utils of total utility and 5 oranges give us 30 utils of
total utility. Therefore, marginal utility of the 5 th orange is 2 utils (30 utils-28 utils).

Downloaded from www.hssreporter.com

 MU n = TU n – TU n-1

where, n refers to the n th unit of the commodity.

The law of diminishing Marginal utility:-

Law of Diminishing Marginal Utility states that Marginal utility from consuming
each additional unit of a commodity declines as its consumption increases.

Units Total Utility Marginal Utility

1 12 12
2 18 6
3 22 4
4 24 2
5 24 0
6 22 -2

Relationship between TU and MU:-

* MU is falling when TU increases at a decreasing rate.

* MU = 0, when TU is maximum and constant.
* MU is negative when TU falls.

Derivation of Demand Curve in the Case of a Single Commodity (Law

of Diminishing Marginal Utility):-

Downloaded from www.hssreporter.com

Cardinal utility analysis can be used to derive demand curve for a commodity. The
law of DMU explains why demand curves have a negative slope. While a person is
consuming additional units of a commodity continuously MU from it diminishes.
Therefore the individual will be willing to pay less and less amounts of money for
each additional unit. This results in negatively sloping demand curve.

2.Ordinal Utility Analysis:-

It says that the consumer can not measure utility in numbers, but he can ranks various
alternative combinations in terms of various consumption bundles. This is ordinal
utility analysis.

Indifference Curve
IC is a curve which shows the locus points of combinations of two
commodities which give same level of utility (satisfaction) to the consumer. The
points representing bundles which give equal level of utility can be joined to obtain
an Indifference Curve.

Indifference Map:-
A collection of indifference curves is known as indifference map.

Downloaded from www.hssreporter.com

Features of indifference curves:-
1. Indifference curve has negative slope:-

An indifference curve slopes downwards from left to right, which means

that in order to have more of one good, the consumer has to forego some of other
good.
2. Indifference curve is convex to the origin:-

IC generally is convex to the origin due to the Diminishing Marginal

Rate of Substitution (D MRS).The rate at which one commodity is sacrificed to
substituting another commodity is termed as Marginal Rate of Substitution (MRS).
In IC analysis the rate of sacrificing one commodity for each additional unit of
another commodity, goes diminishing. This is termed as Diminishing Marginal Rate
of Substitution (DMRS).

MRS=∆Y/∆X

Combinations Good 1 Good 2 MRS=∆Y/∆X

A 1 15 ----
B 2 12 3/1 =3
C 3 10 2/1 = 2
D 4 9 1/1 = 1

3. Higher indifference curve gives greater level of utility:

As long as marginal utility of a commodity is positive, an individual will always
prefer more of that commodity, as more of the commodity will increase the level of
satisfaction. So higher indifference curve gives greater level of utility and vice versa.

4.Two indifference curves never intersect each other:-

Downloaded from www.hssreporter.com

 Two indifference curves intersecting each other will lead to conflicting
results.
Indifference Curve of Perfect Substitute Goods:-
Normally I Cs are Convex to the origin. In the case of Perfect Substitutes (eg:
5 Rupees Currency & 5 Rupees Coin) IC will be a straight line, sloping from left to
right. Here MRS remains same.

Budget set and Budget constraint:-

Budget set consists of all bundles of two goods available to the consumer with
his income at given prices. The bundles in the budget set can be selected with the
help of budget constraint. The general form of budget constraint is;
P1X1 + P2 X2 ≤ M
P1 = price of good1; P2 = price of good2 ; X1 = quantity of good1 purchased ; X2 =
quantity of good2 purchased; M = income of the consumer.
Budget line:-
The line representing the quantities of bundles of two goods which cost
exactly equal to the income of consumer. The budget line can be drawn with the help
of a budget line equation. The budget line equation is;
P1 X1 + P2 X2 = M
good 2
M/P2

P1 X1 + P2 X2 = M

good 1 M/P1
* Budget line has negative slope.
* slope of budget line = - P1/ P2
* Horizontal intercept of budget line = M/P1
* vertical intercept of budget line = M/P2
Changes in budget line:-

The budget line of the consumer changes when income and prices of
goods change. The important changes are;

1. income increases 2. income decreases

good2 horizontal & vertical good2 horizontal & vertical

intercepts rise intercepts decrease

good1 good1

Downloaded from www.hssreporter.com

3. price of good1 increases 4. price of good 1 falls

good2 horizontal intercept falls good2 horizontal intercept rises

good1 good1

5. price of good 2 increases 6. price of good2 falls

good2 vertical intercept falls good2 vertical intercept rises

good1 good2
ASSIGNMENT
Q: Sita purchases two goods, good X& good Y at rupees 5/- and 10/- respectively
with her income rupees 30. Then;
(a) Write the budget constraint of her budget set.
(b) Select the bundles in her budget set
(c) Select the bundles which cost exactly equal to her income
(d) Write the equation of her budget line
(e) Draw her budget line
(f) Show the change in her budget line when her income increases to rupees 40.
(g) Show the change in her budget line when the price of good X increases to rupees
15 .

Monotonic Preferences:-
A consumer’s preferences are monotonic if and only if between any two bundles, the
consumer prefers the bundle which has more of at least one of the goods and no less
of the other good as compared to the other bundle.
Eg: Bundle 1 of X and Y = (3,2) Bundle 2 of X and Y=(3,3) .Then, Consumer Prefer
Bundle 2.

Consumer’s optimal choice ( Consumer’s Equilibrium )

The budget set consists of all bundles that are available to the
consumer. The consumer can select her consumption bundle from the budget set. It is
assumed that the consumer is a rational individual. So she always tries to choose the
best bundle from her budget set. The best bundle is one which gives her maximum
satisfaction. The choice of the bundle which gives maximum satisfaction to the
consumer is known as optimal choice of the consumer. This situation of the consumer
is also called as consumer’s equilibrium.

Downloaded from www.hssreporter.com

 The optimal choice of the consumer is decided by her budget line and indifference
curves. This optimal choice can be explained in the following figure.

In the figure, the quantities of good X are measured along X axis and the quantities of
good Y are measured along Y axis. The line AB represents the budget line of the
consumer. The curves IC1 IC2and IC3 represent indifference curves available to the
consumer. The consumer wants to choose the bundle on IC3 because it gives her the
higher level of satisfaction. But this is not possible because her budget line is below
IC3. She does not choose the bundles on IC1 because the bundles on IC1 are
providing less satisfaction.So she chooses the bundles on IC2 curve. The optimal
choice of the consumer is decided by her budget line. It is possible at point E in the
figure. At point E, the consumer selects the bundle (Qx,Qy) .
The point E represents the point of consumer’s optimal choice. At this point three
conditions are necessary for the optimal choice.
1. Indifference curve should be tangent to the budget line.

2. The slope of indifference curve is equal to the slope of budget line.

3. M R Sxy = - p1/p2

Demand:-

Demand means desire. Demand may be defined as desire, ability to pay and
willingness of a consumer to purchase a given quantity of the goods at a given price.
Factors affecting on demand (Determinants of demand )

1. Price of the goods:-

Price of the goods is the most important determinants of demand for that
goods. Generally the quantity demanded of the goods is negatively related to it’s
price.

2. Income of the consumer:-

Downloaded from www.hssreporter.com

 When income of the consumer increases the demand for the goods also
increases. That is the demand is positively related to the income of the consumer.

3. Prices of other goods:-

(a) substitute goods:- When two goods are substituted for each other such
goods are called as substitute goods. For example- Tea & Coffee, Milk & Milk
powder, Shoe & Chappals etc…. Consider the case of tea and coffee. Suppose the
price of tea increases. Then the tea will be dearer goods. As a result the demand for
coffee rises. On the other hand, if the price of tea falls the tea will be cheaper goods.
As a result the demand for coffee falls. That means, in the case of substitute goods the
price and demand are positively related.
(b) complementary goods:- The goods which are jointly demanded for a
particular use are called as complementary goods. Example- car & petrol, pen & ink,
bread & jam etc… consider the case of car and petrol. Suppose the price of car falls.
Then the demand for cars increases. As a result the demand for petrol also increases.
But the demand for petrol is falling when the price of car increases. That means, in
the case of complementary goods the price and demand for the goods are negatively
related.
4. Tastes & preferences of the consumer:-
Tastes and preferences of the consumer to a particular goods raise the
demand for that goods.
5. Climate:-
The demand for some type of goods depends on climate. For example the demand for
umbrella increases during rainy season. But in summer season it’s demand is low.
6. Number of consumers (population):-
When the number of consumers in the market increases the quantity
demanded of the goods also increases.
7. Tax rate:-
The quantity demanded of the commodity is negatively related to the tax rate on
commodities . That means, the demand for the goods is falling when the tax rate on
that goods increases.

Law of demand:-

Law of demand explains the negative relationship between price of the

good and it’s demand. The law states that when other things remaining the same the
quantity demanded of the good is negatively related to it’s price.
The law of demand can be explained with the help of demand schedule
and demand curve.

Demand schedule:-

Downloaded from www.hssreporter.com

 The table which shows the relationship between various prices and
quantities demanded of the good.

Prices Quantity
of the demande
good d of the
good(Kg
)
5 50
10 40
15 25
20 10
25 5
The table explains that when the prices of the goods are increasing it’s quantities
demanded are falling.

Demand curve:-

The graph representing the demand schedule is known as demand curve.

Generally the demand curve has negative slope due to the negative relation between
price and quantity demanded of the good.

Normal goods:-
In the case of normal goods the price-demand relationship is negative.
The consumer demands more quantities of that good when his income increases.
Example , fruits.

Downloaded from www.hssreporter.com

Inferior goods:-
In the case of certain goods, the consumer demands less quantity of such
goods when his income is increasing. Such goods are known as inferior goods. In
India, food articles like bajra, jowar, ragi etc...are inferior to rice and wheat.
Market demand, market demand schedule and market demand
curve:-

The sum of individual demands is called as market demand.

For example; suppose there are three consumers in the market who
purchase 3kg, 4kg and 2kg of the good X at the price 50/kg respectively.
Then market demand for the good X is 3+4+2 = 9kg.

Suppose the demand functions of two consumers in the market are

d1(p) = 20 – 2p and d2(p) = 25 – p . Then market demand is;
(20 – 2p ) + (25 – p) = 45 – 3p .

The horizontal summation of individual demand schedules is

called as market demand schedule.

The graph obtained from market demand schedule is called market demand curve.
This is the horizontal summation of individual demand curves .

Downloaded from www.hssreporter.com

Changes in Demand:-

CHANGES IN DEMAND

Movement along the demand curve Movement of the demand curve

Expansion of demand Contraction of demand Increase in demand Decrease in demand

1. Movement along the demand curve:-

This change in demand arises due to the change in price of the goods.
Such changes are two types.
a) Expansion of demand ( downward movement along the demand curve):-
Increase in quantity demanded of the good due to a fall in price of the
good is called expansion of demand. This is explained in the following figure.

When the price is falling from P to P1 price D

the quantity demanded increases from P
Q to Q1.
P1

Q Q1 demand
b) Contraction of demand (upward movement along the demand curve):-
Decrease in quantity demanded of the good due to a rise in price of the
good is called contraction of demand. This is explained in the following figure.

When the price is increasing from P to P1 price D

the quantity demanded decreases from P1
Q to Q1.
P

Q1 Q demand
2. Movement of the demand curve (Shifts in demand):-
This type of change in demand arises due to the changes in non-price
determinants of demand. That means shifts in demand arise due to the changes in;
* income of the consumer
* tastes & preferences of the consumer
* price of substitutes
* price of complementary goods
* climate
* number of consumers
* tax rate etc…..
Such changes may be in two forms.
a) increase in demand
b) decrease in demand
.

Downloaded from www.hssreporter.com

a) increase in demand:- This is rightward shift of the demand curve

Price D D1

demand
causes of increase in demand
* income of consumer increases
* tastes & preferences of the consumer increases
* price of substitute good increases
* price of complementary good falls
* tax rate falls
* number of consumers increases. Etc….

b) decrease in demand:- This is leftward shift of the demand curve.

Price D1 D

demand
causes of decrease in demand
* income of consumer decreases
* tastes & preferences of the consumer decreases
* price of substitute good decreases
* price of complementary good increases
* tax rate increases
* number of consumers decreases. Etc….

Chapter – 3
PRODUCTION & COSTS

Meaning of production:- Production is the transformation of inputs into output.

Inputs:- Inputs are factors of production. Example, land, labour, capital, organisation etc…
Fixed inputs:- The inputs those quantities are fixed in the production.
Variable inputs:- The inputs those quantities are changed in the production.
Firm:- A production unit.
Production function:- The functional relationship between inputs and output in the production is
known as production function. A production function can be represented as;
Q = f (X1,X2)

Downloaded from www.hssreporter.com

Q = quantity of output
f=function
X1= input 1 ie, labour
X2 = input 2 ie, capital
There are two types of production function in the production process.
a) Short run production function:- In this type of production function, one input is variable
keeping all other inputs as fixed to produce more units of output.
Q = f(X1,X2)
X1 = variable input, labour
X2 = fixed input, capital
b) Long run production function:- In this type of production function, all inputs are variable to
produce more units of output.
Q = f (X1,X2)
X1= variable input , labour
X2= variable input, capital

Concepts of production:-
1. Total product (TP) 2. Average product (AP) 3. Marginal product (MP)
1. Total product:- TP is the total quantity of output produced at a given variable inputs. It is the
relationship between total output and total units of variable inputs.
2. Average product:- AP is the total product per unit of variable input.
AP = TP/L where, L= units of labour, variable input.
3. Marginal product:- MP is the change in total product per unit change in variable input.
MP = ΔTP/ΔL where ,
ΔTP = change in total product; ΔL = unit change in labour
or, MP = TP n – TP n-1
Example,
L TP AP=TP/L MP=ΔTP/ΔL
1 10 10/1=10 10
2 22 22/2=11 22-10=12
3 36 36/3=12 36-22=14
4 48 48/4=12 48-36=12
5 55 55/5=11 55-48=7

ASSIGNMENTS:-

1. Calculate AP & MP
Labour 1 2 3 4 5 6
Total product 15 25 33 37 40 35

2. Complete the table

L TP AP MP
1 10
2 8
3 6
4 4
5 -2

Downloaded from www.hssreporter.com

3. Calculate TP & MP. Write down the equations to calculate them.
L AP
1 12
2 14
3 16
4 18
5 20

Law of variable proportions:-

Law of variable proportions states that when more and more units of
variable input (L) are combined with fixed input (K), initially marginal product increases. But
after a certain level the marginal product falls. This is a short run production function. The law is
also known as law of diminishing marginal product.
The law of variable proportions can be explained with the help of a production
function schedule which is given below.

The law explains three stages of production. They are

1. Increasing returns
2. Diminishing returns
3. Negative returns
The changes in T P, A P and M P under these three stages can be summarized as follows.
1. Increasing returns:- 2. Diminishing returns 3. Negative returns

The three stages of production under variable proportions can be illustrated in the
following diagram.

Downloaded from www.hssreporter.com

Relations between Total product, Average product & Marginal product:-
In the law of variable proportions T P, A P and M P are related as follows.
Relations between T P & M P
* When M P is increasing T P increases at an increasing rate.
* When M P is decreasing T P increases at a decreasing rate.
* When M P is zero T P is at maximum.
* When M P is negative T P is falling.
Relations between M P & A P
* A P is increasing when M P is above A P.
* A P is decreasing when M P is below A P.
* A P is maximum when M P = A P.

Cost function:-
The functional relationship between costs and output of a firm is called as cost function.
C = f(q); where, C = costs, f = function and q = quantity of output.
The cost function is in two types.
1. Short run costs
2. Long run costs.
1. Short run costs:-
In the short run a firm has both fixed and variable costs due to fixed and variable
inputs in the production.
Fixed costs Variable costs
Costs not depended on the output Costs depended on the output
Short run costs Short run and long run costs
Firm has fixed costs when it’s output is zero Variable cost is zero when output is zero
E g- salary of M D, insurance charges, rent for E g – wages of workers, electricity charge, cost
buildings etc... for fuel etc...
The major short run costs of a firm are;
a) Total fixed cost (T F C)
b) Total variable cost (T V C)
c) Total cost (T C)
d) Average fixed cost (A F C)

Downloaded from www.hssreporter.com

e) Average variable cost (A V C)
f) Short run average cost (S A C)
g) Short run marginal cost (S M C)

Total fixed cost(T F C), Total variable cost(T V C), Total cost(T C):-
T F C is the sum of costs of all fixed inputs of a firm. T V C is the sum of costs
of all variable inputs. T C is the sum of total fixed cost and total variable cost.
TC = T F C + T V C
TFC=TC–TVC
TVC=TC–TFC
q TFC TVC TFC+TVC
0 20 0 20 + 0 =20
1 20 10 20 + 10 = 30
2 20 18 38
3 20 24 44
4 20 29 49
5 20 33 53
6 20 39 59
7 20 47 67
8 20 60 80
9 20 75 95
10 20 96 116

From the above schedule and graph the relationship T F C , T V C and T C can be explained as
follows.

1) T C = T F C + T V C

2) When output is zero T C = T F C because T V C is zero.

3) When output increases T C and T V C increase. T C increases as T V C increases.

Average fixed cost (AFC):- AFC is fixed cost per unit of output of a firm.
AFC = T F C / q

Average variable cost (A V C):- A V C is variable cost per unit of output of a firm.
AV C = TV C / q

Short run average cost (S A C):- SAC is total cost per unit of output of a firm. It is also known as
average total cost.(A T C)
S AC = T C / q
SAC =AFC +AV C

Short run marginal cost( S M C):- S M C is change in total cost divided by a unit change in
output of a firm.
SMC=ΔTC/Δq

Downloaded from www.hssreporter.com

 S M C = TC n – TC n-1

From the above schedule, we can draw A F C, A V C, S A C and S M C curves.

CURVES SHAPE
AF C Rectangular hyperbola
AVC ‘U’ shape
SAC ‘U’ shape
SMC ‘U’ shape

Relationship between S AC & S M C curves:-

1. S A C falls when S M C is below S A C.
2. S A C is minimum when S M C = S A C.
3. S A C increases when S M C is above S A C.

Downloaded from www.hssreporter.com

Relationship between A V C & S M C:- SMC
1. A V C falls when S M C is below A V C. cost AV C
2. A V C is minimum when S M C = A V C.
3. A V C increases when S M C is above A V C.
q output

Relationship between A F C, A V C & S A C:- cost

1. S A C = A F C + A V C
2. When output increases A F C is falling. A V C and
S A C initially fall. After a level of output, both curves
increase.
3. S A C is always above A V C.
4. When output increases the gap between S A C and
A V C is falling due to the fall of A F C.

output
ASSIGNMENTS:-
1. A cost schedule of a firm is given.

q 0 1 2 3 4 5 6
TC 10 30 45 55 70 90 120
a) What is the value of total fixed cost?
b) Calculate T V C, A F C, A V C, S A C and S M C.
c) Draw T F C, T V C and T C on the same set of axis.
d) Explain the relationship between the curves.
2. It I given that the average fixed cost at 4 units of output is Rs 5.

q 1 2 3 4 5 6
TC 50 65 75 95 130 185

a) FindT F C, T V C, A F C, A V C, S A C and S M C.
b) Draw S A C and S M C on the same set of axis.
c) Explain the relationship between S A C & S M C.
3. A firm’ cost function is given. Firm’s T F C is 100.
a) Find T V C, A F C, A V C, S A C and S M C.
b) Write the equations to calculate them.
c) Draw A F C , A V C, S A C and S M C curves on the same set of axis.
d) Identify the shapes of each curve.
q SMC
0 ----
1 500
2 300
3 200
4 300
5 500
6 800

Downloaded from www.hssreporter.com

 Chapter – 4
Theory of Firm under Perfect Competition
Features of perfect competition:-
* Large number of buyers and sellers.
* Homogeneous products.
* Uniform price.
* Firm is ‘price taker’. Under perfect competition the price of output of the firm is decided by the
market forces, demand and supply. An individual firm can not decide the price of output. The price
is decided when demand for the output is equal to it’s supply.
* Perfect knowledge of buyers and sellers about market conditions.
* Freedom of entry and exit of firms.
* TR (Total revenue), AR (Average revenue) and MR (Marginal revenue) of the firm.

TR = Price X quantity = Pq
AR = TR / q
MR = ΔTR / Δq

q P TR=Pq AR=TR/q MR=ΔTR / Δq

1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10

* Demand curve or price line of a competitive firm is a horizontal straight line parallel to X axis.

Downloaded from www.hssreporter.com

Short run equilibrium of a competitive firm:-
A competitive firm is in equilibrium when it gets maximum profit. For the
maximisation of profit, the following conditions are necessary.
1) The market price, p = MC, marginal cost.(p = M R = MC)
2) MC is non decreasing.
3) p ≥ A V C (Average variable cost).
The following figure explains the short run profit maximisation of a competitive firm.

In the figure, the firm is in equilibrium at point A. At this point,

1) p = MC.
2) MC is non decreasing.
3) p ≥ A V C.
At point A, market price of output is p and quantity of output is q1.
In equilibrium, the firm gets maximum profit of the area of recangle A B E P in the figure. The
profit of the firm can be calculated as;
Profit,π = T R – T C
TR= pq
= OP X Oq1.
= area of rectangle O P A q1.
TC= AC X q
= Bq1 X Oq1
= area of rectangle O E B q1.
Profit = area of rectangle O P A q1 - area of rectangle O E B q1
= area of A B E P.

Long run equilibrium of a competitive firm:-

The following conditions are necessary for profit maximisation of a competitive firm in the
long run.
1) Market price, p = MC.
2) MC is non decreasing.
3) p ≥ AC.

Downloaded from www.hssreporter.com

Short run supply curve of a firm:-

The rising portion of S M C curve from the minimum point of A V C curve.

Long run supply curve of the firm:-

The rising portion of L R M C curve from the minimum point of L R A C curve.

Normal profit:-
* Minimum profit of the firm to sustain in the business.
* The profit when p=AC

Ab – normal profit:-
* The profit excess over normal profit of the firm.
* Super normal profit.
* The profit when p>AC
Shut down point of the firm:-

* Production stopping point.

* Below the minimum point of A V C of the firm. (Short run)
* Below the minimum point of L R A C of the firm. (Long run)
Break-even point:-

*Normal profit earning point of the firm.

* T R = T C point of the firm.
* The firm has no neither profit nor loss.
* p=SAC (short run).
* p=L R A C (Long run).

Downloaded from www.hssreporter.com

 Chapter - 5

MARKET EQUILIBRIUM

The market equilibrium is determined by two forces , demand for and supply of goods.
The demand for the good means the quantity purchased of the goods by the consumer at a given
price. The quantity demanded of the goods is negatively related to it’s price. The supply of the good
means the quantity of the good sold by a seller at a given price. The quantity supplied of the good is
positively related to it’s price.
* The market is in equilibrium when the quantity demanded of the good is equal to it’s
quantity supplied.
Qd=Qs
* The price at which the quantity demanded equal to the quantity supplied is known as
equilibrium price. This is market clearing price.
* The quantity demanded and supplied of the good at equilibrium price is called as
equilibrium quantity.
The following schedule and figure explains the determination of market equilibrium.

* At prices 5 & 4, quantity supplied is greater than the quantity demanded. The situation is
called as excess supply.
* At prices 2 & 1, the quantity demanded is greater than the quantity supplied. The situation is
called as excess demand.
Suppose Q d= 100 – 5P and Q s = 15P – 60. Find equilibrium price and quantity.

Qd=Qs

100 – 5P = 15P + 60

100 – 60 = 15P + 5P

40 = 20P

40/20 = P

Downloaded from www.hssreporter.com

 2 =P
Equilibrium price = 2

Equilibrium quantity = 100 – 5X2 = 100 – 10 = 90.

APPLICATIONS OF MARKET EQUILIBRIUM

1. Price ceiling
2. Price floor ( support price policy)

1. Price ceiling:-

Government imposed upper limit on the price of a good is called as price ceiling.
This policy is also called as ‘Maximum price fixation’. In this policy price fixes below
market equilibrium price. This policy protects consumers. Government applies price
ceiling for the products like rice, sugar, kerosene wheat etc… When the government
fixes the price below equilibrium price, it leads to excess demand ( demand >
supply ).

The price ceiling policy of government can be explained with the help of a
figure.

In the figure, curve D represents demand for and the curve S represents supply of goods in the
market. The market equilibrium price is P* and equilibrium quantity is q*. Government imposes the
price below the equilibrium price. Then the quantity demanded (qD) is greater than the quantity
supplied (q S). This is the situation of excess demand for the good in the market. This policy of
government has two important impacts in the market.
(a)Long queues of consumers to buy the goods from the ration shops.(b) Black
market:-Goods are sold in the open market at a price higher than the government
fixed price.

2.Price floor:-

Downloaded from www.hssreporter.com

Government imposed lower limit on the price of a good is called as price floor. This
is the policy of ‘Minimum price fixation’. In this policy, the price fixes above market
equilibrium price. Government applies this pricing policy in the case of products
like coconut, pepper, rubber etc.… This is the ‘support price policy’ for producers.

The price floor policy can be explained with the help of a figure

In the figure, market equilibrium price is P* and the equilibrium quantity is q* when quantity
demanded is equal to the quantity supplied of the good ( demand curve intersects supply curve) The
government fixes the price above the equilibrium price to protect producers. This is the price floor.
This policy is resulted to excess supply because quantity supplied (qs) is greater than the quantity
demanded (qD). As a result the market faces the following impacts.
Impacts of price floor
To prevent price from falling because of excess supply, the government purchases
the surplus goods at the predetermined price. The government increases their
buffer stocks.

Differences between price ceiling & price floor:-

Price ceiling Price floor
Government imposed upper limit on the Government imposed lower limit on the
price of a good price of a good

Maximum price fixation Minimum price fixation

Price fixes below market equilibrium price Price fixes above market equilibrium
price

Protects consumers Support price policy for producers

Products like rice, sugar, kerosene wheat Products like coconut, pepper, rubber
etc... etc....

Downloaded from www.hssreporter.com

Leads to excess demand ( demand > Leads to excess supply (supply >
supply ) demand )

Model question:-

Suppose two cases in the market.

Case 1: Price of sugar per kilogram is rupees 50. Government fixes it’s price at
35/Kg.

Case 2: The market price of rubber R S S 4 per quintal is rupees 15500. But the
government fixes it’s price at 16500/quital.

a) Identify the pricing policies of government in these two cases.

b) Describe the impacts of these policies in the market with suitable diagrams.

Chapter – 6

Non Competitive Market Forms

Types:-

1. Monopoly.

2. Monopolistic Competition

3. Oligopoly

Downloaded from www.hssreporter.com

TR, AR & MR under monopoly

Prepared by TEAM DETA KOZHIKODE.....

Downloaded from www.hssreporter.com