th

Class - 12
Subject - Micro
Economics

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 UNIT - 1

Economics: An Introduction

Meaning of Economics: Economics is generally concerned with

the study of economics issues or problems which arises due to scarity of
resources.

Economics is broadly divided into two parts:

1. Micro Economics
2. Macro Economics

(1) Micro Economics: The word 'micro' is word 'Mikros' which means
small. Thus micro economics is that branch of economics which studies
individual units.

Characteristics of Micro Economics are:

1. Study of Individual units : The first characteristics of micro

economics is that it studies individual units, e.g. Individual
production individual consumption etc.
2. Study of Small variables : Micro economics studies small variables
in an economy which have very little impact on the whole economy.
3. Price theory : Micro economics is also called price theory as it
determines individual price of different products by analyzing the
demand and supply.
4. Microscopic approach : Tools used under micro economics helps in
micro scope study in an economy.

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 Importance of Micro Economics

Study of Micro economics helps to derive various economics

conclusions. The importance can be studied as under:

1. Helps to understand economy - Micro economics studies individual

units so it gives a comprehensive picture of the whole economy.
2. Helps government in formulation of policies - The economic
policies of government are based upon the microscopic study. Thus it
helps in formulation of economic policies.
3. Helps in taking individual decisions - Micro economics helps
individual consumers and producers to take decisions in their
respective areas.
4. Helpful in preparation of economic laws - Micro helps in
formulation of laws like "law of diminishing marginal utility", law of
equi-marginal utility etc.

Limitations of Micro Economics

1. Not Complete knowledge of whole economy - As Microeconomics
studies only individual units. Thus full knowledge about the whole
economy cannot be known.
2. Not applicable on group -In micro economics decisions are derived
on the basis of study of single units, it cannot be applied on group.
3. Unrealistic assumptions -Some assumptions of Micro economics
are unrealistic which are not found in real world.
4. Not possible to study all economic problems-Micro economics
cannot study few economic problems like monetary issues etc.

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(2) Macro Economics: The word 'Macro' is derived from Greek word
'Makros' which means large. Thus, Macro economics is that branch of
economics which studies aggregate variables in an economy.

For example - Aggregate demand, Aggregate Supply etc.

Characteristics of Macro economy

1. Study of Aggregates - Macro economics studies aggregate variables

in an economy like National income, Total employment.
2. Broader Perspective - Macro economics is a broader concept than
Micro economics as it studies economy as a whole.
3. Analysis of general problems - Macro economics focuses on
general problems of national level like general price level, general
employment etc.
4. Interdependence on Micro economics - Both macro economics and
micro economics are interdependent and interrelated to each other.
Importance of Macro economics

1. Helps in study of complex problems - Modern economics is very

complex because many economic elements are dependent on each
other. Thus macro economics helps in the study of such complex
problems.
2. Helps in execution of economic policies - Macro economics helps in
successful execution of economics of economic policies in an
economy.
3. Helpful in measuring economic growth - The government can
measure economic growth with the help of studies done under macro
economics.

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4. Helpful in allocation of resources - With the help of National
income data, resources of an economy can be allocated among
various sections of the society
Limitations of Macro economics
1. Misleading Conclusion - Sometimes conclusions drawn under the
study of macro economics may prove wrong.
2. Difficult to measure - Sometimes it becomes very difficult to
measure some variables in an economy.
3. Lack of uniformity - Under macro economics analysis all units are
assumed to be same, but in reality there exist few differences
amongst them.
4. Neglects parts of a group - As it studies the group as a whole, so
many times the parts of a group are neglected which results in
misleading or wrong conclusions.

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 Economy
An economy can be defined as a system that provides the people
the means to earn their livelihood. It includes activities like Production,
exchange, investment etc.
On the basis of above definitions it can be said that economy
means that system, in which all natural, physical and human resources
are used to produce different goods and services, So that people can get
their livelihood and satisfy their wants and needs.
Type of Economy
Broadly three types of economies exist in the world
1. Capitalist or Market economy - Capitalist economy is that
economic system in which factors of production are owned managed
and controlled by the private sector to get maximum profit.
2. Socialist economy - A Socialist economy is an economic system in
which factors of production are not under private Control but are
owned and controlled by the society as a whole. All the decisions
related to factors of production are taken by the government to
maximize benefits of the society.
3. Mixed economy - Mixed economy is a compromise between two
opposite economic systems, Capitalism and Socialism. The draw-
backs of both the system have encouraged the growth of this form of
economic system.
Central Problems of an Economy
Every economy of the world has to face some basic problems, there
are also called central problems of an economy.

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1. What to Produce - This problem is basically the problem of
selection of commodities & their quantities to be produced. It has two
dimensions.
a) Kind of goods to be produced
i.e. Capital or Consumer goods
b) Quantity of goods to be produced.
2. How to produce - This problem is basically related to the technique
of production. We generally consider two type of techniques of
production.
a) Labour intensive techniques
b) Capital intensive techniques
Thus, every economy has to choose most efficient technique of
producing a commodity.
3. For whom to produce - This problem is basically related to the
distribution. Distribution of Goods & Services produced in an
economy should be made among various section of the society in
such a way that every section must get a fair share in Nations wealth.
Production Possibility Curve
A production possibility curve is that curve, which represents
various combinations of two goods or services that can be produced in
an economy with the given resources and technology in the given time.
It is also called "Production Possibility froutier" or "Transformation
Curve" or "Transformation line"

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 Production Possibility Schedule
Production Possibility Good X Good Y
A 0 21
B 1 20
C 2 18
D 3 15
E 4 11
F 5 6
G 6 0

21 A B

18 C

15 D

12 E Inefficient or under
utilisation of resources
O
Good Y

6 F

G
0 1 2 3 4 5 6
Good X

Assumptions of Production Possibility Curve

1. Economy produces only two goods X and Y.
2. Amount of resources available in the economy are given and fixed.
3. Resources are not specific i.e. they can be shifted from production of
one good to another.
4. Resources are fully employed i.e. there is no wastage of resources.
5. State of technology in an economy is given and unchanged.
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 Features of Production Possibility Curve

1. Slopes downward - A PPC always slope downward from left to

right, because under full employment of resources, production of one
good can only be increased by sacrificing production of another
good.
2. Concave to origin - It is also concave to origin because to produce
each additional unit of Good X more and more unit of Good Y have
to be sacrificed.
Opportunity Cost
In economic analysis, the Concept of opportunity Cost is widely
used.
"Opportunity Cost is defined as the cost of alternative opportunity
given up or surrendered"
For example - on a place of land both wheat and sugarcane can be
grown with same resources. If wheat is grown then opportunity cost of
producing wheat is the quantity of sugarcane given up.
Marginal Opportunity Cost
For the production of extra unit of one commodity, we have to
make a sacrifice of another commodity. This rate of sacrifice is called
marginal opportunity cost.

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 Difference between controlled economy,
free economy and mixed economy
S.No. Basis of Controlled Free Mixed
difference Economy Economy Economy
1. Control of Economics Economic Economic
economic activities are activities areactivities are
activities firmly controlled by governed by
controlled by the market the free play
the forces of market but
Government or regulated by
some Central the
Authority Government
2. Economic The decisions The decision The decisions
Decisions are driven by are driven by are driven by
the motive of the motive of both motive
social welfare. profit of profit and
maximization. motive of
social
welfare.
3. Position of the The consumer The consumer The consumer
consumer is not is sovereign. is sovereign.
sovereign.
4. Dominance of The public The private Both the
economic sector sector public sector
activities dominated the dominates the dominate the
economic economic economic
activities. activities. activities.

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 UNIT - 2
Consumer's Equilibrium & Demand
Introduction - A Consumer is one who buys goods and services for
satisfaction of wants. The objective of a consumer is to get maximum
satisfaction from spending his income on various goods and services
Meaning of Utility
The term utility refers to the want satisfying power of a
commodity. It means realized satisfaction to a consumer when he is
willing to spend money on a stock of commodity which has the capacity
to satisfy his wants.
Characteristics of Utility
The main characteristics of utility are
1. Utility is personal - Utility is a personal concept, because utility to
one person may not be same to another person.
2. Utility is Psychological - Utility is a psychological phenomenon
because it is felt internally. It can only be felt and cannot be seen or
touched.
3. Utility Can be positive or negative - As long as person gets
satisfaction by using a thing, we say that utility is positive. When no
satisfaction is derived we say that utility is nil or zero.
4. Utility is not always beneficial - It is not necessary that the
consumption is always useful to the person.
For example- milk and liqour both satisfy human wants.

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 Approaches to Utility
The two main approaches to measure utility are
1. Cardinal Approach - This approach is given by Prof. Marshall.
According to him it can be measured in numbers.
2. Ordinal Approach - Few economists are not in favour of the
concept given by Marshall. They think that utility cannot be
measured as it is a psychological concept.
Difference between Cardinal utility and Ordinal Utility
S.No. Basis Cardinal Utility Ordinal Utility
1. Meaning Cardinal utility is the Ordinal utility states
utility wherein the that the satisfaction
satisfaction derived by which a consumer
the consumers from derives from the
the consumption of consumption of good
goods or services can or service cannot be
be expressed expressed numerical
numerically. units.
2. Approach Quantitative Qualitative
3. Realistic Less More
4. Measurement Utils Ranks
5. Analysis Marginal utility Indiffernce Curve
Analysis Analysis
6. Promoted by Classical and Neo- Modern Economists
classical Economists.

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 Types of Utility
1. Total utility - It is the sum total of all the utilities that a consumer
derives from the consumption of certain amount of a commodity.
2. Marginal utility - It is the change in total utility by consuming one
more unit of a commodity by the consumer.
3. Average utility - It is the per unit utility of a commodity.
It is calculated as under

 
Average utility =
  
.

Units of Total Marginal Average

Chapati Utility Utility
0 0
1 10
2 18
3 24
4 28
5 30
6 30
7 28
Y
Utility
- -
10 10
8 9
6 8
4 7
2 6
0 5
-2 4

30

27
TU

24

21

18

15

12

3
AU

0 X
1 2 3 4 5 6 7
MU
-3

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 Law of diminishing Marginal Utility
Law of diminishing marginal utility is an important law of
consumption. The law states that as a consumer consumes more and
more units of a commodity, marginal utility derived from each
successive unit goes on diminishing
Y

Falling MU
Curve

X
O

Assumption of the law of Diminishing Marginal Utility

The law is based on certain assumptions which are stated below:
1. Utility can be measured.
2. The period on consumption must be the same.
3. Commodities should be homogeneous.
4. Mental state of consumer should remain unchanged.
5. Price of the commodity should remain the same.
Consumer's Equilibrium
It is that situation in which a consumer yet maximum satisfaction
by consumption of units of commodity with his given income and price.

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In Case of one Commodity
A consumer purchasing a single commodity will meet equilibrium
at a point where he is buying such a quantity of that commodity which
gives him maximum satisfaction.
Thus, a Consumer is in equilibrium when he satisfies the following
conditions.
MUx = Px

Marginal utility of Price

commodity x commodity x
It can be explained with the help of following table:
Consumer's Equilibrium
Units of
MUx Price
good (x)
1 8 5
2 6 5
3 5 5
4 4 5
5 3 5

In case of two commodities

In Case of consumer's equilibrium under two commodities, a
consumer wants to spend his money income between two commodities
in such a way that he gets maximum satisfaction.
Consumer will be in equilibrium When

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 =
 =

  

Here,
MUx and MUy = Marginal utility of good x and y
Px and Py = Prices of goods x and y
MUm = Marginal utility of money
Law of Equi-Marginal Utility

According to this law, one consumer spends his income on

different commodities in such a manner that the marginal utility
received from last unit of money in all uses is same. This way he is able
to maximize the total utility.
Number of MU of x MU of y
Units
1 100 80
2 80 40
3 60 30
4 40 20
5 20 10

Suppose Consumer's income = 12 Rs.

Price of Good x = 2 Rs.
Price of Good y = 2 Rs.
Condition is satisfied when
40 40
2 = 2 = 20
4 units of x and 2 units of y will be purchased

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 Indifference Curve
An indifference curve shows various combinations of two goods
that yield equal satisfaction to consumer on all points.
Indifference Schedule

Combination of
Apples (A) Mangoes (B)
Apples & Mangoes
A 1 15
B 2 11
C 3 8
D 4 6
E 5 5

16
A

14 Indifference
B
Curve
12
Units of Mangoes

10

8 C

D
6
E
4

1 2 3 4 5

Units of Apples

In the above table a consumer is having five different

combinations of Apples and Mangoes. When these combinations are
shown graphically and are joined together we get an Indifference Curve.
Assumptions of Indifference Curve
Indifference Curve approach is based on certain assumptions.
These assumptions are:

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1. Two Commodities - There must be two commodities & prices of
which should be constant.
2. Rationality - The consumer is assumed to be rational. He aims at
maximizing his benefits from consumption, given his income and
prices of the goods.
3. Ordinal utility - The consumer can rank his preferences on the basis
of satisfaction derived from each bundle of Commodities
4. Monotonic preference - Modern economists hold that the
indifference curve analysis is based on the assumption of monotonic
preference.
Characteristics of Indifference Curve
1. Downward sloping to right - An indifference curve always slopes
downward to right because, if the consumer wants to have more unit
of one good, he will have to reduce the number of unit of another
good.
2. Convex to origin - An indifference curve is always convex to origin,
due to the application of diminishing marginal rate of substitution.
3. Higher the Indifference Curve, Higher will be the Satisfaction - A
higher indifference curve will always represent higher level of
satisfaction because of monotonic preferences.
4. Indifference Curve never intersect each other - Two indifference
curves never intersect each other because two indifference curves
cannot represent same level of satisfaction.
5. An indifference curve never touches X-axis or Y-axis - An
indifference curve never touches x-axis or y-axis because there must
be two commodities consumed at the same time.

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 Indifference Map
Indifference map refers to a group or set of indifference curves.
Each of them shows a given level of satisfaction. In fact, it is the family
of indifference curves which represent consumer's preference over all
a
the bundles of two commodities. It is interesting to note that a consumer
is indifferent along an indifference curve but he is not indifferent among
various indifference curves. A higher indifference curve always shows a
higher level of satisfaction.
It will be more clean by the following diagram

Here, these are four indifference

indiffere curves - IC1 IC2, IC3, and IC4.
Each indifference curve shows different level of satisfaction
i. IC2, shows more satisfaction in comparison to that of IC1.
ii. IC3 shows more satisfaction in comparison to that of IC2.
iii. IC4 shows more satisfaction in comparison to that of IC3.
Thus, IC4 > IC3 > IC2 > IC1
Monotonic Preferences
Monotonic preferences refer to the situation that consumption of
more commodities means more satisfaction. In other words, with the

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increase of consumption, the total utility also increases. Modern
economists hold that the indifference curve analysis is based on the
assumption that the consumer's preferences are monotonic. According to
Monotonic preferences, a consumer always given preference to that
combination which has either more of both the commodities or more of
atleast one commodity and no less of the other in comparison to another
bundle.
Example - Suppose there are two commodities Apple (A) and
Mangoes (B)
Suppose, two different bundles are
First: 10A, 10B
Second: 7A, 7B
Here, consumer's preference to first Bundle in comparison to
second Bundle will be called monotonic preference simply because the
first Bundle has more of both Apples and Mangoes.
Suppose, two different bundles are -
First: 10A, 10B
Second: 9A, 7B
Here, consumer's preference to First Bundle in comparison to
Second Bundle will be called monotonic preference as First Bundle has
more of Apples and although mangoes are the same.
Marginal Rate of Substitution
a) Meaning - Marginal rate of Substitution means the rate at which the
commodities can be substituted with each other in such a way that the
total satisfaction of the consumer remains unchanged.

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Example - There are two commodities (1) Apple and (2) Mango which
are termed respectively commodity A and Commodity B. The marginal
rate of substitution of A and B will be the number of units of B which
the consumer wants to sacrifice for an additional unit of A in order to
maintain the same level of satisfaction. The formula will be
Marginal rate of substitution of A        
=
for B or MRSAB        

or
∆ 
MRSAB =
∆ 

It indicates that MRS measures the slope of indifference curve

b) Explanation with the help of example and diagram - The
following shows the combinations of Apples (A) and Mangoes (B)
on different levels
Levels of Combination Apples (A) Mangoes (B)
P 1 15
Q 2 10
R 3 6
S 4 3
T 5 1

Find out the Marginal Rate of Substitution and draw up the

diagram.
Solution - Marginal Rate of Substitution between Apples and
Mangoes
Combination Apple (A) Mangoes B Marginal Rate of

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Substitution between Apple and Mango
Marginal Rate of
Combination Apples (A) Mangoes (B) Substitution between
Apple and Mango
P 1 15 -
Q 2 10 5B:1A
R 3 6 4B:1A
S 4 3 3B:1A
T 5 1 2B:1A
(Hint : 15 - 10 = 5B, 10 - 6 = 4B, 6 - 3 = 3B, 3-1 = 2B, 2-1
2 = 1A, 3-2 =
1A 4-3 = 1A, 5 - 4 = 1A)
1A
Diagrammatic repre
epresentation
sentation of rate of marginal substitution
between A and B.

Here, when the consumer

sumer proceeds from P to Q, he sacrifices 5 mangoes
for 1 apple. Hence MRSAB is 5:1, from Q to R. MRSAB is 4:1,
4: from R to
S, MRSAB is 3:1, from S to T, MRSAB is 2:1. Thus MRS of Apples for
Mangoes
goes is diminishing.
c) Reason for diminishing of Marginal Rate of Substitution - Due to
the application of the law of diminishing marginal utility, the marginal
rate of substitution is diminishing here. At point 'P', the consumer has
only 1 apple and so it is relatively more important than mangoes. This is
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why, the consumer is willing to sacrifice more mangoes for an
additional apple. But as he consumes more and more apples, his
marginal utility from apples goes on falling down. Consequently, he is
willing to sacrifice less and less mangoes for each additional apple.
Budget Set and Budget Line
Budget Set - It is the collection or set of all the possible bundles or
combinations of two goods that consumer can buy with his given
income and prevailing prices of commodities
Suppose a consumer has income of Rs. 200 and price of
Commodity X = 40 per unit
Price of Commodity y = 20 per unit
Different possible Combinations are
Consumption Possibility Schedule
or
Budget Set
Combinations Commodity (X) Commodity (Y)
A 0 10
B 1 8
C 2 6
D 3 4
E 4 2
F 5 0

Budget line - A budget line is a graphical representation of budget set.

It is also known as price line which shows all possible combinations of
two goods that a consumer can buy with his given income.
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 Y

10 A

8 B
Budget Line
6 C

4 D

2 E

F
X
1 2 3 4 5
Commodity

Shift in Budget line

A budget line is based on consumer's income and prices of
commodities. Therefore if any of these determinants are changed budget
line will also definitely change.
1. When there is a change in Income of consumer
Commodity Y

30
0
20
0
10
0

Commodity X

2. When there is a change in price of commodities

Mangoes (B)

A
A2
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A1
Apples (A)

Budget line Shifts from AB to A1B due to decrease in price of
Apple

Budget line Shifts from AB to A2B due to increase in price of
Apple
Consumer's Equilibrium by Indifference Curves
By indifference curve approach, equilibrium is attained when the
consumer reaches the highest possible indifference curve given his
budget constraint
It is very important to fulfill the following two conditions
ೣ
1. MRSxy =
೤
The first equilibrium condition is necessary but it is not sufficient.
Y

B
F

H
N E
IC3
IC2
G IC1

X
O M A

2. MRS Continuously falls - The second condition underlines that for

equilibrium, MRS must be diminishing at the point of equilibrium i.e.
indifference curve must be convex to origin at the point of
equilibrium.
In the above diagram -
Suppose IC1 , IC2 and IC3 are three indifference curves and AB is
the budget line with constrainst of budget line, the highest indifference
curve which a consumer can meet is IC2 at point E. This is the point of
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consumer equilibrium where consumer purchases OM quantity of
commodity X and ON quantity of Commodity Y.
Theory of Demand
Meaning and features of Demand
In normal language, by demand we mean the desire of having a
Commodity, but
In economics
Demand is defined as the quantity of that commodity which a consumer
is willing to buy at a particular price during a particular period of time.
There are four essential of demand
1. DESIRE
2. ENOUGH RESOURCES
3. WILLINGNESS
4. AVAILABILITY
The main features of demand are
a) Demand depends upon the utility of the commodity.
b) Demand always means "Effective demand" i.e. desire should be
backed by Purchasing Power.
c) Demand is a flow Concept.
d) Demand means demand for final goods.
Demand Function
Demand function shows the relationship between demand for a
commodity and its various determinants.
(A) Individual Demand Function
Individual demand function is the functional relationship between
individual demand and factors which affect individual demand.

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It can be expressed with the help of a formula as under
Dx = F(Px , Pr, Y, T, F)
Here - Dx = Demand for Commodity x
Px = Price of commodity x , Pr = Price of related goods
F = Future expectations
Y = Income of consumer , T = Taste & preference
(B) Market Demand Function
Market demand function is the functional relationship between
market demand and the factors which affect market demand.
It can be expressed with the help of a formula as under
Dx = F(Px , Pr, Y, T, F, N, D)
Here in addition to individual demand function are
N = No. of Consumers
D = Distribution of Income
Determinants of Individual Demand
The determinants of individual demand are as under
1. Price of Commodity - There is an inverse relationship between price
and quantity demanded. It means, when there is an increase in a
commodity's price, the demand for it falls and vice versa.
2. Change in price of substitute goods - Substitute goods are those
goods which can be used in place one-another for satisfying a
particular want. For example tea and coffee. If there is an increase in
price of one (Tea) substitute, there will be an increase in demand for
another (coffee) and vice-versa.
3. Price of Complementary Goods - If the price of a complementary
commodity rises, it will result in fall of demand for given

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 commodity. In other words, there is an inverse relationship between
the change in the price of complementary goods and demand for
goods to be used together.
4. Income of consumer - (a) When a commodity is a normal good, an
increase in the income of consumer will also increase in the demand
for such commodity. If there is fall in the income of consumer, there
will be a reciprocal fall in the demand for such commodity. (b) When
a commodity is inferior good, the increase in consumer's income
reduces the demand for such commodity and decrease in consumer's
income increases the demand for such commodity.
5. Consumer's tastes and preferences - The consumer's tastes and
preferences directly affect the demand for a commodity.
For example - A commodity which is very much in fashion in
preferred by consumers and so the demand for such articles rises. On
the other side, if a consumer has no taste or preference for a
commodity, the demand for it tends to decrease.
6. Hope of change in price in future - If the price of a commodity is
expected to rise in future, people will buy more of such commodity
than they usually buy. For example, if the price of sugar is expected
to rise in future, people will buy more of it in present.

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 Difference between Individual demand and Market demand
S.No. Basis Individual Demand Market Demand
1. Involvement Demand is created by Demand is created by
of consumer Individual consumers. all the consumers.
2. Law of May or May not be Law of demand is
Demand followed. always followed.
3. Factors Not affected by all the Affected by all the
factors. factors.

Demand Schedule
Demand schedule refers to a tabular statement which shows
different quantities of a commodity to be demanded at different levels of
price during a particular period of time.
(A) Individual Demand Schedule
Individual demand schedule is a tabular statement which shows
different quantities of a commodity which a consumer is willing to
purchase at different levels of price during a particular period of time.
Price (in Rs.) Quantity demanded (for Good x)
10 2
8 4
6 6
4 8
2 10

(B) Market Demand Schedule

It is a tabular statement which shows different quantities of a
commodity which all consumers are willing to buy at different level of
price during a particular period of time.

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 It can be expressed as under
Dm = DA + DB
Here
DM = Market demand
DA + DB + . . . . . = Individual demands of household A,
household B etc.
Price Individual Demand (in units) Market Demand
(Rs) Household A (DA) Household B (DB) (in units) (DA + DB)
10 2 4 2+4=6
8 4 6 4+6=10
6 6 8 6+8=14
4 8 10 8+10=18
2 10 12 10+12=22
Difference between Substitute Goods and Complementary Goods
S.No. Basis Substitute Goods Complementary Goods
1. Meaning Those goods are called Those goods are called
substitute which can be complementary goods
used in place of one- which are used together
another for satisfying a for satisfying a
particular want. particular want.
2. Nature of Such goods have Such goods have joint
Demand competitive. demand.
3. Relationship Price of one substitute Price of complementary
commodity has positive commodity has negative
relationship with relationship with
quantity demanded for quantity demanded for
another substitute another complementary
goods. commodity
4. Examples (1) Tea and Coffee. (1) Tea and Sugar
(2) Coke and Peps. (2) Car and Petroleum
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Demand Curve
Demand Curve is a graphical representation of a demand schedule.
It shows the relationship between price of the commodity and its
demand.
Slope of Demand Curve
As there is an inverse relationship between price and demand, the
demand curve always slopes downward to the right
Reasons behind downward slope of demand Curve
1. Law of diminishing marginal utility: According to this law as
consumer purchases more and more units of a commodity, the
marginal utility goes on diminishing. Thus a consumer is willing to
pay a lesser price for more units of a good. This implies that demand
curve is downward sloping.
2. Substitution effect - Substitution effect means with full in the price
of a good, consumer's feels a rise in relative price of other goods,
which in turn leads to more demand for the good.
3. Income effect - Income effect means with fall in price of a good,
consumer's real income or purchasing power rises and he demands
more units of the good (normal good).
Law of Demand
This law is also called "First law of Purchase". According to this
law "There is a definite inverse relationship between the price of a
commodity and its demand, if other things remain constant.
Assumptions
The law of demand comprises an important clause "other things
being Constant" which expresses its assumptions or limitations.

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1. Income of the consumer should remain unchanged.
2. The price of the related good remains the same.
3. All the units of the good are homogeneous.
4. Tastes and preferences of consumer should remain the same.
5. Commodity should be a normal good.
Exception to the Law of Demand
Following are the exceptions to the law of demand
1. Necessities - Law of demand does not work for necessities of life. No
matter how costly the life saving medicines are, there demand do not
change.
2. Giffen Goods - The 'Giffen goods' (inferior good) is often considered
an exception to the law of demand. The demand for this good rises
with an increase in price and falls with decrease in price. This
phenomenon is popularly known as "Giffen Paradox".
3. Future expectations - If there is a strong possibility of rise in price
of a commodity in future, people presently will purchase it in more
quantity in spite of increase in prices.
4. Prestigious goods - In some cases goods are purchased at higher
prices to maintain status in the society. Thus law of demand does not
operate in such case.
5. War fear - In the near future there is a possibility of war, then also
demand is high even if prices are higher.

Page | 32
 Change in Quantity Demanded
VS
Changee in Demand (Shift in Demand)
(1) Change in quantity demanded
When quantity demanded of a commodity
c changes due to change
c
in its price, keeping other factors
factors unchanged (constant), it is called
change
hange in quantity demanded.
In graphicall language, it is known as movement along the same
demand curve.
It can be of two types
a) Extension of Demand (Downward
(Down movement) - Other things
remaining the same, if the demand for a commodity
commodity increases due to
fall in its price, it is known as extension of demand.
Price Demand of Goods (in Units)
5 10
4 15
3 20
2 25
1 30

Page | 33
b) Contraction of Demand (Upward movement) - Other things
remainingg the same, if the demand of a commodity
commodity decreases due to
increase
se in its price it is known as contraction of demand
demand.
Price (in `) Demand (in Units)
1 30
2 25
3 20
4 15
5 10

(2) Change in Demand (Shift in Demand)

When demand for a commodity changes
changes due to any other factor
than its price,, it is called change in demand.
It can be of two types
a) Increase in demand (Upward
(U Shift of demand curve)
ve)
If demand for a commodity increases due
due to any other factor
f than its
price, it is called increase in demand.
Income of Price of X Demand for
Consumer (`) (`) X (units)
2000 10 15
5000 10 20

Page | 34
 Y

30

25
D
20 D1

15

10

5
D
D1
X
5 10 15 20 25

b) Decrease in demand
If demand for a commodity decreases due to any other factor than
its price, it is called decrease in demand.
Income of Price of X Demand for
Consumer (`) (`) X (units)
8000 10 20
5000 10 15

30
D1
25 D

20

15

10

5 D1

D
5 10 15 20 25

Elasticity of Demand
Price elasticity of demand is the rate of responsiveness of demand
due to change in price of the commodity.
It refers to proportionate change in demand due to change in price
of the commodity.
It is calculated as -

     
Ed =

     
Page | 35
 Degrees or Types of Price Elasticity
Following are various types of price elasticity of demand
1. Unit or Unitary elasticity of demand - When demand for
commodity changes in same proportion in which the price changes,
it is called Unit elasticity of demand.

2. Relatively elastic demand or more than unit elastic - When

proportionate change in demand is more than proportionate change
in price it is called relatively elastic demand.

3. Relatively Inelastic demand or less than unit elastic demand -

When proportionate change in demand is less than proportionate
change in price, it is called relatively inelastic demand.

Page | 36
4. Perfectly Inelastic demand - When there is no change in demand
for a commodity in response to a change in its price, it is called
perfectly elastic demand.
demand

5. Perfectly elastic demand -When demand for a commodity rises or

falls to any extent without change in its price, it is called Perfectly
Elastic Demand.

Factors affecting Price elasticity of Demand

Price elasticity of demand is affected by the following factors:
1. Nature of Commodities - Nature of the commodity affects the price
elasticity of demand. Necessities
Necessities have inelastic demand, goods of
comfort
omfort have elastic demand and luxury goods
goods have highly elastic
demand.

Page | 37
2. Availability of Substitutes - Those commodities which have close
substitutes have highly elastic demand. Whereas commodities with
no substitutes have inelastic demand.
3. Consumer's habit - If the consumer is in the habit of using a
commodity then any increase in the price of such commodity will not
reduce demand, hence it will be inelastic demand. For example -
liquor.
4. Number of use of the commodity - If the commodity has more use
the demand will be elastic, on their other hand if commodity has
lesser use, the demand will be less elastic.
5. Economic position of the Consumer - Normally demand of rich
people is inelastic because some changes in price does not affect
them so much. On the contrary demand is more elastic for middle &
poor section of the society.

Page | 38
 UNIT-3
Production function, Cost, Revenue and producer's
Equilibrium
Meaning of production
Production is defined as the transformation of inputs into output.
For example - inputs of sugarcane, capital and labour are used to
produce sugar.
However production includes not only production of physical
goods like cloth, rice etc. but also production of services.
Factors of Production
Things that help in the production of goods and Services are called
factors of production. These are also called means of production.
Earlier there have been differences about the number of factors of
production. But now there is almost consensus among the economists
that factors of production are five.
1. Land - Land is the first important factor of production. Land not
only includes surface of the earth but also includes all natural
resources.
2. Labour - Labour is the second important factor of production. It
includes any sort of physical and mental work which is done for
earning money.
3. Capital - Capital is that part of wealth which leads to further
production and increase in wealth.
4. Organization - Organization means to arrange and control the
different factors of production. A person who does this task is called
entrepreneur.
Page | 39
5. Enterprise - Enterprise means to bear the uncertainty and risk of
business planning is done by entrepreneur to minimize risk.
Production Function
The relationship between inputs (factors of production) and output
(return) is called production function.
It can also be defined as technological relation between physical
inputs and output of the commodity.
It can be expressed as -
Qx = f (i1, i2, i3 ....... in)
Here,
Qx = Output of Commodity X
f = functional relationship
i1, i2...... in = inputs required for Qx
Short run and Long run Production Function
Meaning of Short run
It refers to production in the Short-run where there is at least one
fixed factor and other factors are variable factors.
Fixed factors - Fixed factors are those factors of production which
cannot be changed in Short-run.
Examples - Building, Machinery etc.
Variable factors - Variable factors are those factors of production
which can be changed in short-run.
Examples - Raw material, labour etc.

Page | 40
hMeaning of Long-run
Long run production function refers to a period in which output
can be changed by changing all factors of production.
Distinguish between Short run and Long run
S.No. Basis of Short-run Long-run
difference
1. Meaning It refers to a period in It refers to a period in
which output can be which output can be
changing by changing changing all factors.
variable factors.
2. Classification Factors are classified All factors are variable.
of factors as fixed and variable.
3. Price Demand force is more Supply force is more
determination active. active.
4. Application Law of variable Law of returns to scale.
of law proportion.

Distinguish between Fixed factors and Variable factors

S.No. Basis of Variable Factors Fixed Factors
difference
1. Meaning The factors of These are the factors of
production which can production which
be changed in short cannot be changed in
run. short run.
2. Relation with They vary with output They do not vary with
output output.
3. Examples Raw material, casual Building, Machinery,
labour, fuel etc. plant, permanent staff
etc.

Page | 41
 Concept of Production
Meaning
The volume of goods produced by a firm or an industry during a
particular period of time is called product or output.
A product has three important concepts.
1. Total Product or Total Physical Product
It refers to the total quantity of goods produced by a firm with the
given inputs during a specified period of time.
In other words, it is the sum total of marginal products.
Tp = ΣMP x N
Here,
TP = Total Product
ΣMP = Sum of marginal products
N = units of a factor
2. Average Product or Average Physical product
When we divide the Total output by the quantities of a variable
factor, we get average product.
Symbolically

 
 
Average Product =
 
3. Marginal Product or Marginal physical Product
It refers to the change in total product due to employment of one
more unit of variable product.
Symbolically
   
 
Marginal Product =
    


MP =

Page | 42
 Relationship between TP, AP and MP
The relationship between TP, AP and MP can be understood with
the help of following schedule and graph.
Production Schedule
Variable factor (labour) Total Product Average Product MP
0 0 0 -
1 4 4 4
2 10 5 6
3 18 6 8
4 24 6 6
5 28 5.6 4
6 30 5 2
7 30 4.3 0
8 28 3.3 -2

Graph showing Relationship between TP, AP & MP

Y

30

TP
27
Total Product / Average Product /

24

21
Marginal Product

18

15

12

3 AP

0 X
1 2 3 4 5 6 7 8
MP
Units of Variable factor (labour)

Page | 43

MP curve rises initially, reaches a maximum and then declines.

When TP increases at increasing rate, MP increases.

When TP increases at decreasing rate, MP decreases but remains
positive.

When TP is maximum, MP is zero.

When TP starts falling, MP becomes negative.
Law of Variable Proportions
or
Returns to a factor
The law of variable proportion is basically related to Short-run.
According to this law, as more and more units of variable factors
are employed, keeping other factors fixed, the TP first increases at
increasing rate, then increases at diminishing rate and finally starts
falling
Assumptions of the law
1. It operates in Short-run.
2. There must be some inputs whose quantity is kept fixed.
3. All units of variable factors are homogeneous.
4. The state of technology is assumed to be given and unchanged.
5. This law is applicable to the field of production only.

Page | 44
 Three Stages or Phases of Production
Explanation of the law is divided into two parts Tabular
presentation and Graphical presentation.
Fixed input Variable input TP MP Phases or
(land in Acre) (labour) stages
1 0 0 -
1 1 4 4
Phase I
1 2 14 10
1 3 34 20
1 4 50 16
1 5 62 12
Phase II
1 6 70 8
1 7 74 4
1 8 74 0
1 9 70 -4 Phase III
1 10 62 -8

Phase - I Increasing returns to a factor

In the first stage, if more and more units of variable factors are
applied, than the output will increase proportionately greater than
increase in variable factors.
In this stage total product increases at increasing rate and MP is
maximum.

Page | 45
 Phase - II Diminishing returns of a factor
In the second stage TP increases at decreasing rate and MP
becomes zero.

Phase - III

In this stage TP, starts falling and MP becomes negative.

80

70

60 TP
Total Product / Marginal Product

50

40

Phase I Phase II Phase III

30

20

10

0 X
1 2 3 4 5 6 7 8 9 10

Units of Variable factor MP

Page | 46
 Returns to Scale
Return to scale means the behaviour of production when all the
factors (fixed & variable) are increased.
Stages of Returns to Scale
A. Increasing returns to scale - In this stage increase in output is in
greater proportion than increase in input.
For examples- If the inputs are increased by 20% then output
increases by 25%.
Causes of Increasing returns to Scale
1. Indivisibilities - Certain inputs such as machines are indivisible.
Therefore as scale of production increases, there indivisible factors
are utilized more efficiently.
2. Specialization - As the scale of production increases, the efficiency
of labour increases due to division and specialization of labour.
3. Internal and external economies - Increase in the scale of
production results in many types of internal and external economies,
which in result further leads to increase in production.
4. Financial economies - A larger firm is in a position to mobilize
funds from public than smaller firms, because they enjoy more
goodwill. Thus it helps in reduction of costs.
B. Constant returns to scale - If the output increases in the same
proportion as increase in all factors of production then it is called
constant returns to scale. For example: If inputs are increased by 20%
and output also increases by 20%.

Page | 47
C. Diminishing returns to Scale - If the output increases in less
proportion than the increase in all factors of production, then this
stage is known as diminishing returns to scale.
Causes of Diminishing returns to scale
1. Diseconomies in Scale - After a limit any further increase in the
production brings many diseconomies. Due to this law diminishing
returns starts operating.
2. Delay in decision making - Sometimes delay in decision making
may be a result of diminishing returns to scale.
3. Labour problems - For increasing the production, number of
worker's also have to be increased. Thus it may result in more labour
related problems and affects the level of production.
4. Entrepreneurship is fixed - Entrepreneurship is always fixed and
cannot be increased easily. Due to this reason also output ultimately
falls and stage of diminishing returns starts operating.
Difference between Returns to a factor and Returns to Scale
S.No. Basis of Returns to a factor Returns to Scale
difference
1. Meaning It refers to increase in It refers to increase in
total production by total production by
increasing only variable increasing all factors of
factors. production.
2. Time Period Applicable in Short run Applicable in long-run

Page | 48
 Concepts of Cost
Cost of producing a commodity is the payment made to the factors
of production which are used in the production of that commodity.
Short run costs - Short run costs are the costs over a period during
some factors are fixed like plant, machinery etc.
Long run cost - Long run costs are the costs over a period during which
all factors can be changed.
Explicit Cost and Implicit Cost
Explicit costs refer to all those expenses made by a firm to buy
goods directly. They include payments for raw material taxes and
depreciation.
It is also called money cost.
Implicit cost or imputed cost is the estimated cost of inputs owned
& used by the firm in the production process.
For example - Rent of self owned building, wages of self labour
etc.
Difference between Explicit cost and Implicit cost
S.No. Basis Explicit Cost Implicit Cost
1. Meaning It is the money It is the imputed cost of
expenditure incurred factor's owned by the
by the firm on factor firm
purchase
2. Shown It is shown in the It is not shown in the
books of accounts books of accounts
3. Concept It is a payment It is a receipt concept
determinatio concept i.e. payments received
n by produces himself
4. Examples Wages to labourer, Wages of self labour,
Interest on loan. rent of self premises.
Page | 49
 Analysis of Cost in Short- Run
Short run is a period in which output can be changed by changing
variable factors only.
These are the three costs in short run.
1. Total Cost
2. Average Cost
3. Marginal Cost
(1) Total Cost

Fixed or Variable or
Supplementary cost Prime Cost

Total cost refers to the total expenditure incurred by a firm for the
production of a specific quantity of a commodity.
Total cost is always the aggregate of fixed cost and Variable cost
Total Cost = Fixed cost + Variable cost
A. Fixed Cost or Supplementary Cost
Fixed Costs are the sum total of expenditure incurred by the
producer on the purchase or hiring of fixed factors of production.
It is also known as "Total fixed cost" or "General Cost" or
"Indirect Cost"
Examples - Overhead expenses, wages of permanent workers, rent of
building & depreciation, Interest on Capital.
B. Variable Cost
Variable Cost are the sum total of expenditure incurred by the
producer on the purchase of variable factors of production.
Page | 50
 It is also known as "Prime cost" or "Direct Cost" or "Total
Variable Cost"
Examples - Salary of labourers, price of raw material, fuel and
electricity expenses.
Difference between Fixed Cost and Variable Cost
S.No. Basis Explicit Cost Implicit Cost
1. Meaning It refers to expenditure It refers to expenditure
incurred by the firm incurred by the firm on
on purchase of fixed purchase of variable
factors of production. factors of production

2. Variation It does not change It changes with the

with the quantity of quantity of output
output.
3. Factors It is related to fixed It is related to variable
factor factors
4. Period It is a long-run It is a short-run concept
concept
5. Zero It can never be zero It can be zero

Page | 51
 (2) Average Cost

Average Fixed cost Average Variable cost

Average Total cost

A. Average Total Cost
It is arrived by dividing total fixed cost by units.

AFC =
 (   )
Here,
AFC = Average fixed cost
TFC = Total fixed cost
Q = Quantity produced

Page | 52
 Cost Schedule
Unit of TFC TVC TC AFC AVC AC MC
output (`) (`) (`) (`) (`) (`) (`)
0 200 - 200 - - - -
1 200 50 250 200 50 250 50
2 200 80 280 100 40 140 30
3 200 100 300 66.6 33.3 100 20
4 200 110 310 50 27.5 77.5 10
5 200 115 315 40 23 63 5
6 200 125 325 33.3 21 54.3 10
7 200 140 340 28.5 20 48.5 15
8 200 184 384 25 23 48 44
B. Average Variable Cost
It is arrived by dividing total variable cost by units.

AVC =

Here, AVC= Average variable cost
TVC= Total variable cost
Q= Quantity produced

Page | 53
 C. Average Total Cost or Average Cost
It is arrived by dividing total cost by units. It is the sum total of
average fixed cost (AFC) and Average variable cost (AVC)

AVC =

Here,
AC= Average cost
TC= Total cost
Q= Quantity produced

(3) Marginal Cost

Marginal cost may be defined as change in total cost sue to
increase in output by one unit.
It is interesting to note that marginal cost depends upon variable
cost, not and fixed cost. In short run marginal cost is just an addition to
the total variable cost.
  
 

MC =
     
= ∆

∆ 

Page | 54
 Y

MC
AC

Cost

X
O Q
Quantity of Production

Relationship between Average cost and Marginal cost

The relation between average cost and marginal cost is very
important for price theory.
1. Both are calculated on the basis of total cost -

 
Average Cost =

   
  
 
Marginal Cost =
     
2. Marginal cost curve always leads - When both AC curve and MC
curve are falling, MC curve falls faster.
3. When average cost is minimum, marginal cost is equal to
average Cost - When a average cost is lowest, the marginal cost
curve cuts average cost curve downward. Here both are equal.
4. Both curves are of U-shape - Both AC and MC lines are U-shaped,
reflecting law of variable proportions.
Concepts of Revenue
The term "revenue" refers to the total money payment received by
a firm from the sale of a commodity.

Page | 55
 The main motive of a firm or producer is maximize the profit.
Profit is the excess of revenue over cost. Thus more revenue means
more profit for the firm.
Types of Revenue

Total Revenue (TR) Marginal revenue (MR)

Average revenue (AR)

Revenue has been classified into three types

1. Total Revenue - It refers to the total money received by a firm from
sale of its products.
It can be expressed as -
TR = P x Q
Here, TR= Total revenue
P = Price per unit
Q= Quantity (units sold)
2. Average Revenue - Average revenue is the revenue per unit of the
commodity sold.
It can be expressed as

AR =

Here,
AR= Average revenue
TR= Total revenue
Q = Quantity (units sold)

Page | 56
3. Marginal Revenue - Marginal revenue is the addition made to an
additional unit of a product.
It can be expressed as
∆

MR =

∆

Here,
MR= Marginal revenue
∆TR= Change in total revenue
Q = Quantity (units sold)

Revenue Schedule (Under Perfect Competition)

Units Sold Price TR AR MR
Q P (Q×P) (TR÷Q) (∆ ÷∆ )  
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
6 10 60 10 10
Y
Total revenue/ Marginal revenue

60 TP
/ Average revenue (rs)

50

40

30

20

AR=TP=P
10

0
X
1 2 3 4 5 6

Page | 57
 Revenue Schedule (Under Imperfect Competition)
Units Sold Price TR AR MR
Q P (Q×P) (TR÷Q) (∆ ÷∆ )  
1 20 20 20 20
2 18 36 18 16
3 16 48 16 12
4 14 56 14 8
5 12 60 12 4
6 10 60 10 0
Y
Here TR is
Maximum
60
TR

50

40

30

20

10

X
0
1 2 3 4 5 6 7
Y

60

50

40

30

20

AR
10
MR=0
X
0
1 2 3 4 5 6 7

Relationship between TR, MR and AR in Perfect Competition

TR and MR

MR Curve is a horizontal straight line parallel to X-axis.

TR Cure is a positively slope straight line.

TR increases at same rate.
Page | 58

TR starts from Zero as no revenue is received by firm when sales
is Zero
MR and AR

Since price of all the units are same therefore MR = AR

Both AR and MR are parallel to X-axis
Producer's Equilibrium
Producer's equilibrium refers to that price and output combination
which brings maximum profit to the producer
These are two methods to decide firm's equilibrium position.
1. Marginal revenue and marginal Cost Approach
2. Total revenue and Total Cost Approach
(1) Marginal revenue and marginal cost approach
Marginal revenue is the revenue or income of an additional unit
sold whereas marginal cost is the cost of producing an additional unit of
output.
A firm is said to be in equilibrium where on a particular quantity
of output MC is equal to MR. If the production is increased or decreased
beyond this output, there will be a situation of loss or fall in the profit
(2) Total Revenue - Total Cost Approach
According to TR-TC approach, producer's equilibrium refers to
stage of that output level at which the difference between Total Cost and
Total Revenue are maximum.

Page | 59
 Output TR (`) TC(`) Profit(`)
0 0 3 -3
1 10 6 4
2 18 8 10
3 24 11 13
4 28 15 13
5 30 20 10
6 30 26 4
7 28 33 -5

The equilibrium level of output in the above schedule is 4th unit as

difference between TC and TR is maximum on that level.

In the above diagram the distance between TR and TC is largest at

points F4, hence here profits are maximum.

Page | 60
 Supply and Elasticity of Supply

Meaning of Supply - Supply refers to that quantity of a commodity

which a firm is willing to sell at a given price during a particular period
of time.
It has three essential elements
a. Quantity of a commodity that a producer is willing to sale.
b. Price of the commodity.
c. Time during which the quantity is offered for sale.
Difference between Stock and Supply
S.No. Basis Stock Supply
1. Meaning Stock is total quantity Supply is that part of
of a commodity with a stock which a firm is
willing to sale.
firm at a particular
time.

2. Quantity Stock can never be Supply can never be

less than supply. more than stock
3. Effect of Stock is not affected Supply is always
price change by price change. affected by price
change.
4. Time Stock is concerned Supply is concerned
with a particular point with a period of time.
of time.

Page | 61
 Supply function
Supply function shows the relationship between supply of a
commodity and its various determinants
Individual Supply function
Individual Supply function is a functional relationship between
individual supply and factors affecting it.
It can be expressed as
Here
Sx = f(Px,Pr,P1,S1,T,G)
Sx2 =Supply of the given Commodity
Px2 =Price of the given Commodity
Pr = Price of related goods
P1 = Prices of factors of production
T= Taxation policy
G = Goals of firm.
S1 = State of technology
Market Supply function
Market Supply function is a functional relationships between
market supply and factors affecting it.
It can be expressed as
Sx = f(Px,Pr,P1,S1,T,G,N,F,M)
Here in addition to individual supply function are
N = Number of firms
F = future expectations
M = Means of transport and Communication

Page | 62
 Supply Schedule
Supply schedule refers to a tabular statement which shows
different quantities of a commodity supplied at different levels of prices
during a particular period of time.
Individual Supply Schedule
It is a tabular Statement which shows various quantities of a
commodity which an individual producer is willing to sell at Various
Price level during particular period of time
Price Quantity Supplied (X)
1 10
2 20
3 30
4 40
5 50

Market Supply Schedule

It is a tabular Statement which shows varions quantities of a

commodity which all producers are willing to sell at various price level
during a particular period of time.

Market in the supply schedule can be expressed language of formula as

under.
Sm = SA +SB+............Sn
Here,
Sm = Market supply
SA+ SB +.............................Sn (individual suppliers in the economy)

Page | 63
 Individual supply Market Supply
Price ` Px
units units
SA SB (SA+SB)
1 10 20 30
2 20 40 60
3 3 50 80
4 40 70 110
5 50 80 130

Determinants of Market Supply

Those factors which lead to a change in the supply of a commodity
are called determinants of supply. It means change in a factor brings
change in the supply of a commodity.
1. Price of commodity - Usually, the price of a commodity and supply
of a commodity have a direct correlation between them. If price
increases, the supply will also increase and if price decreases, the
supply will also decrease.
2. Prices of other commodities - Increase in prices of other goods
make the sellers more profitable than the sellers of a given
commodity. Consequently, the firm shifts its scarce resources from
production of given commodity to production of other goods.
3. Prices of inputs (factors of production) - If the price of inputs
increases, the cost of production also increases. It leads to decrease of
profitability. Consequently, a seller reduces the supply of commodity
and vice versa.

Page | 64
4. Technological changes - Technological changes affect the supply of
a commodity. Advancement of technology helps reduce-the cost of
production which in turn increase the supply.
5. Number of firm in the industry - If the number of firms in the
industry increases, the market supply also increases because large
number of producers produce the goods. On the other, if the number
of firms in the industry reduces, the market supply will tend to
decrease.
6. Expectation of rise or fall in price in future - When the market
sellers hope a rise in price in future, the current market supply will
decrease for increasing the supply in future at lucrative prices. When
the sellers are afraid of fall in price in future, they will increase the
present supply to avoid losses in future.
Supply Curve
Supply curve is a graphical presentation of supply schedule. It is a
positive curve that moves upward from left to right.
Individual Supply Curve
It is a graphical & presentation of individual supply schedule

Page | 65
 Market Supply Curve
It is a graphical representation of market supply schedule. It is the
summation of individual supply curves.

Law of Supply
According to this there is a direct relationship between the price of
a commodity and its supply if other factors remain constant.
In other words other things remaining the supply, when price of a
commodity rises supply increases and when price falls supply decreases
Symbolically, it can be expressed as
Sx = f(Px), (eteris paribus)
Assumptions of the law of supply
1. Price of related goods should remain unchanged.
2. Price of factors of production (i.e. Price of inputs) should remain
unchanged.
3. Level of technology should remain unchanged.
4. Government policy regarding taxation should remain unchanged.
5. Goals of the firm should remain unchanged.

Page | 66
 Limitations or exceptions to law of Supply
Visually there is a positive relationship between supply and price.
But in the following cases it does not happen. These are
1. Perishable goods - Seller cannot hold perishable goods like milk,
vegetables etc. as their life is short. So it may be possible that a
seller may sell more goods at low prices.
2. Agricultural Goods - To certain agricultural goods law of supply
does not apply because their production mostly depends on
favourable climate.
3. Rare Commodities - Rare and precious stones are also an
exception to the law of supply.
For examples Painting of Mona Lisa
4. Future expectations- When a seller expects a decrease in price in
future, the law of supply will not apply.
5. Backward Countries :- In economically backward countries
production and supply cannot be increased even if price rises, due to
shortage of resources.

Page | 67
 Change in Quantity Supplied
or
Movement along the same Supply Curve
VS
Change in Supply
1. Change in Quantity Supplied
Supply of a commodity changes due to change in its own price,
keeping other factor unchanged (constant), it is called Change in
quantity Supplied.
In graphical language, it is known as movement along the same
Supply Curve.
It can be of two types
a) Expansion in Supply (upward movement)
Other things remaining the same, if supply for a commodity
increases due to rise in its price, it is known as expansion in supply.
It leads to an upward movement along supply curve.gg
Price (`) Supply (units)
2 1
8 4

10

b
8
Price (Rs.)

a
2

0 X
1 2 3 4 5
Page | 68
Quantity (units)
b) Contraction in Supply (Downward movement)
Other things remaining the same, if supply for a commodity
decreases due to fall in its price it is known as Contraction in Supply.
It leads to a downward movement in Supply Curve.

Price (`) Supply (units)

6 5
2 2

a
6

4
Price (Rs.)

b
2

0 X
1 2 3 4 5
Quantity (units)

Change in Supply
or
Shift in Supply Curve
When Supply for a commodity changes due to any other factor
than its price, it is called Change in Supply.
It can be of two types
a) Increase in Supply
If supply of a commodity increases due to any other factor than its
price, it is called increase in supply.

Page | 69
 Price (`) Supply (units)
10 20
10 30
Y

30

S S1
20
Price (Rs.)

10

S S1

0 X
10 20 40
Quantity (units)

b) Decrease in Supply
If supply of a commodity decreases due to any other factor than its
price, it is called decrease in supply.
Price (`) Supply (units)
10 30
10 20

30

S1 S
20
Price (Rs.)

10

S1 S

0 X
10 20 40
Quantity (units)

Page | 70
 Difference between Change in quantity
Supplied and Change in Supply
S.No. Basis Change in quantity supplied Change in supply
1. Meaning It is a situation in which It is situation in which
supply if a commodity supply of a
commodity changes
change due to change in its
due to factors other
price. than price

2. Effect It leads to movement among It leads to shift in the

on curve same supply curve. supply curve.
3. Cause Price is the main cause Factors other than
price are the main
cause.

Difference between Expansion in supply and Increase in supply

S.No. Basis Expansion in Supply
1. Meaning It is a situation in which
supply increases due to
increase in price of
commodity
Increase in Supply
It is a situation in which
supply increases due to
factors other than price
commodity.

2. Tabular Price (`) Supply (units) Price (`) Supply (units)

presenta 20 100 20 100
tion 24 150 20 150
3. Effect Upward movement Rightward shift in the
on curve among the same supply supply curve
curve
4. Cause Its cause is increase in Its cause is other factor
the price of commodity for ex- decrease in tax

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 Difference between contraction in supply
and decrease in supply
S.No. Basis Contraction in supply Decrease in supply
1. Meaning It is a situation in which It is a situation in which
supply decreases due to supply decreases due to
decreases in the price of factors other than price
commodity. commodity.
2. Tabular Price (`) Supply (units) Price (`) Supply (units)
presenta 24 150 24 150
tion 20 100 24 100
3. Effect Downward movement in Leftward shift in the
on curve the same supply curve supply curve.
4. Cause Its cause is decreases in Its is cause is change in
the price of commodity other factor
for ex- increase in tax

Price Elasticity of Supply

Price elasticity of supply is the rate of responsiveness of supply
due to change in price of the commodity.
It refers to proportionate change in supply due to change in price
of the commodity.
It is calculated as

        
Es = -

     

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 Degrees or Types of Elasticity of Supply
Following
owing are the various
variou types of elasticity of Supply
1. Unit or Unitary
nitary elastic Supply - When Supply of a commodity
c
changes in the same proportion in which price Changes,
Chang it is called
unit elasticity of supply.
supply

it elastic Supply -When

2. More than unit hen proportionate change in
supply is more than proportionate
proportio change in price,
rice, it is called
relatively elastic or more than unit
u elastic supply.

3. Relatively inelastic or less than unit elastic Supply - When

proportionate change
hange in supply is less than proportionate change in
price, it is called relatively in elastic
ela or less than unitt elastic supply.
s

Page | 73
4. Perfectly
erfectly inelastic supply
s - When there is no change in supply of
commodity in response
esponse to a change
c inn its price, it is called perfectly
inelastic supply.

5. Perfectly
erfectly elastic Supply - When supply for a commodity rises or
falls to any extent without change in its price it is called perfectly
elastic supply.

Page | 74
 Factors affecting elasticity of Supply
1. Nature of the Commodity - Perishable goods have inelastic supply
because their supply cannot be increased or decreased with the
change in price.
2. Time Period - During short period supply is less elastic as supply
cannot be adjusted according to demand, but in long period supply is
more elastic.
3. Technique of Production - Goods having simple technique of
production have elastic supply. On the other hand goods having
complex technique of production mile have inelastic supply.
4. Nature of Inputs - A commodity will have elastic supply if inputs
are easily available, but if inputs are not easily available then supply
will be inelastic.
5. Cost of Production - If marginal cost is increasing than supply will
be inelastic on the other hand if marginal cost is decreasing than
supply will be more elastic.

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 Unit - 4
Forms of Market &
Price Determination
Meaning of market -
In ordinary language market refers to a particular place where
goods are bought and sold. In economics market has a wider meaning
"Market is an arrangement in which buyers and sellers can come
into contact and exchange goods and services."
A market can be regional national international. A market must
have features or following features
Essential constituents of market (characteristics)
1. Place or region - A market should have wider region in which
arrangement between buyer and seller is done.
2. Commodity :- there must be a commodity which is bought and sold
in the market.
3. Buyer and Sellers - There must be existence of buyers and sellers in
the market.
4. Communication - There must be exchange of information i.e.
communication between buyers and sellers.

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 Classification of Market
Market

(1) On the
basis of
Place
(2) On the
basis of
time
(3) On the basis
of type of
sales
(4) On the
basis of
legality
(5) On the
basis of
competition

Page | 77
 (1) On the basis of Place

(1) Local (2) Statement (3) National (4) International

Market or provincial Market market
market

1. Local market - The extent of local market is very small. It is related

to a particular town or village.
2. State or Provincial market - Provincial market has wider area than
local market, it covers a number of district in the state.
For ex- jute market of West Bengal.
3. National market - When buyers and sellers are spread all over the
country it is called national market.
For ex- wheat, cloth, sugar.
4. International market - In the international market buyers and sellers
are spread all over the world.
For ex- Market of Gold and Silver
(2) On the basis of Time

(1) Very short (2) Short period (3) Long period (4) Very Long
period market market market period market

1. Very short period market - These are also known as daily markets.
These markets are generally for 2 to 4 hrs.
For ex. Vegetable market
2. Short period market - In these type of market exists for a few days.
They are also known as weekly markets.
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 For ex- Trade fairs, festive sales etc.
3. Long period market - These are also known as permanent markets.
This market deal with durable goods like cloth and electric items.
4. Very long period- These are also known as secular market. Goods
like machines, gold and silver fall under this category.
(3) On the basis types of Sale

(1) Mixed or (2) Specialized (3) Sample (4) Wholesale (5) Retail
simple market market market market
market

1. Mixed or simple market - In mixed market all types of commodities

are sold. These are found in all cities.
2. Specialized markets - Such markets deal in specific commodities
like grain, jwellery etc.
3. Sample markets - In such type of market goods are sold by showing
the sample of goods. Stock are kept in godown by the sellers.
4. Whole sale markets - The market in which goods are sold in bulk
quantities are called whole sale market.
5. Retail market - The market in which goods are sold in small
quantities directly to consumers are called retail market.
(4) On the basis of legality

(1) Legal market (2) Illegal market

or or
Fair market Black market
Page | 79
1. Fair market - The market in which sale and purchase takes place on
legal basis is called legal or fair market.
2. Black market - The market in which sale and purchase take place on
illegal basis is called illegal or black market
(5) On the basis of legality

(1) Perfect Competition (2) Imperfect competition

(a) Monopoly (b) Monopolistic (c) Oligopoly

competition

1) Perfect Competition
Meaning - It refers to a situation of market, where there are large
number of buyers and sellers and commodities are homogeneous.
Characteristics of perfect competition
Following are the characteristics of perfect competition market
1. Large number of buyers and sellers - In this type of market, there
are a large number of buyers and sellers.
2. Homogeneous product - Perfect competition market has
homogeneous goods which are same in size, colour, price etc.
3. Perfect knowledge - In perfect market both buyers and seller have
full knowledge about the goods which are being bought and sold.
4. Freedom of entry and exit - There is no barrier to entry & exit of
firm in perfect competition. If industry is gaining new firms may
enter & if industry is losing new firms may exit.

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5. Uniform price - Firm is price taker in the perfect market price is
fixed by the industry and goods are sold at same price.
6. Perfect mobility of factors of production - In perfect competition
market, the factors of production (land, labour etc) are perfectly
mobile and free to move from one place to another.\
2) Imperfect Competition
Imperfect market represents practical situation which we observe
in daily life. It is that condition of market in buyers and sellers do not
have full knowledge about the goods.
Characteristics of Imperfect Competition
Following are the characteristics of Imperfect competition.
1. Less number of buyers and sellers - In an imperfect market the
number of buyers and sellers are comparatively less.
2. Products differentiation - There is a product differentiation in an
imperfect market. It means products are not homogeneous.
3. Lack of mobility of factors of production - Unlike perfect market,
there is a lack of mobility of the factors of production (land, labour,
capital etc)
4. Unorganized market - This market is not property organized
because of various social, political and physical barriers.
5. No fixed price - The price differs from place to place in imperfect
market. Generally price is controlled in an imperfect market.
Forms of Imperfect Market
The scope of imperfect market is very wide. The market in this
competition can be studied in three forms.

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 a) Monopoly
'Mono' means one and 'poly' means seller. Monopoly is a market
structure in which there is a single seller who has a complete control
over the market. Main aim of monopolist is to earn maximum profit.
For ex - Government has monopoly in supplying water and
railway services in India.
Characteristics of monopoly market
Following are the characteristics of a monopoly market
1. Single firm - In a monopoly market there is a single firm (producing)
the good. That firm is known as monopolist
2. Lack of Competition - As there is only a single seller in the
monopoly market, hence there is not competition at all.
3. No close substitutes - In a monopoly market, the product sold by a
monopolist has no close substitutes.
4. Price maker - In a monopoly market, the firm is a price-maker rather
than price-taker. Monopolist fixes the price in this type of market.
5. Price discriminations - Price discrimination refers to the practice of
charging different prices from different buyers. A monopolist may
opt this practice.
6. Restrictions or barriers to entry - There are strong barriers to the
entry of the new firm. These barriers may be economic, institutional
or artificial.
b) Monopolistic Competition
Monopolistic competition is a market structure which comprises
the features of both perfect competition and monopoly.

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 In a monopolistic market there are a large number of firms which
sells closely related but differentiated products.
Characteristics of monopolistic competition
Following are the features of monopolistic competition
1. Large number of sellers - In a monopolistic market, a large number
of firms exist which are selling closely related but homogeneous
products.
2. Product differentiation - In a monopolistic market, there is product
differentiation it may be due to difference of brand, size, colour etc.
3. Freedom of entry and exit - There is no barrier to entry and exit of
the firms in a monopolistic competition.
4. Lack of perfect knowledge - The buyers and sellers do not have
perfect knowledge about the market in this type of competition.
5. Selling costs - Due to lack of knowledge in such type of market,
firms make advertisement to attract buyers. Thus it includes selling
costs.
c) Oligopoly
Oligopoly is a market structure in which there are few big firms
and a large number of buyers of a commodity.
In our country markets of automobile, cement, telecom are the
examples of oligopoly.
Characteristics of oligopoly
Following are the characteristics of an oligopoly market
1. Existence of few firms - There are only a few firms in an oligopoly
market, each firm produces a significant portion of total output.

Page | 83
2. Mutual Interdependence - Under this type of market, a firm
considers action and reaction of its rival firm before determining its
price and volume of output.
3. Nature of products - The firms under oligopoly may produce same
products like cement, steel etc which is called perfect oligopoly.
Firms may also produce differentiated products like automobiles
which is called imperfect oligopoly.
4. Restrictions of entry of new firm - Under such type of market, there
are barriers to the entry of new firms into the market.
5. Non-price competition - Under oligopoly, the firms do not prefer
price competition for fear of price war. Instead they adopt other
devices like advertisement.
6. Indeterminate demand curve - The demand curve under oligopoly
cannot be determined due to steps taken by the rivals.
Difference between perfect competition
and imperfect competition
S.No. Basis Perfect Competition Imperfect Competition
1. No. of It consists large number It consists of small
sellers of sellers. number of seller than
perfect competition.
2. Price Same price exists. Difference in price exists.
3. Mobility Factors of production are Factors of production are
of factors perfectly mobile. not mobile
4. Existence Perfect competition is This competition is
imaginary. found in practical life.
5. Nature of Commodities are Commodities are
goods homogeneous differentiated on the
basis of colour, size etc.

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 Difference between perfect competition
and monopolistic competition
S.No. Basis Perfect Competition Monopolistic Competition
1. Type of Products are Products are differentiated
product homogeneous as brand, size
2. Selling No selling cost incurs. Selling costs incurs.
cost
3. Knowle- Buyer and sellers have Buyers and sellers do not
dge of perfect knowledge. have perfect knowledge.
buyers
and
sellers
4. Price Firm is a price taker.
Firm is neither price taker
nor maker.
5. Producti Goods are produced on Goods are produced below
on level optimum scale. optimum level.

Difference between Monopoly

and Monopolistic Competition
S.No. Basis Monopoly Monopolistic Competition
1. No. of There is only a single There are large number of
sellers seller. sellers
2. Control The monopolistic A firm does not enjoy much
over the enjoys full control control over the market.
market over the market.
3. Entry and There is restriction to Only a competitive firm can
exit enter in the market. enter into market.
4. Abnormal A firm can earn A firm cannot earn
profit abnormal profit in the abnormal profit.
long-run
5. Selling Selling cost are very Selling cost are heavy.
costs less
Page | 85
 Difference between Perfect Competition,
Monopoly, Monopolistic Competition and Oligopoly
S. Basis of Perfect Monopoly Monopolistic Oligopoly
No. difference competition competition
1. Number of Very large Single. Large number of Few big
sellers number. sellers. sellers.
2. Nature of Homogeneous No close Closely related Under pure
product products substitutes but differentiat- oligopoly
ed products. homogeneous
products.
Under
differential
oligopoly
differentiated
products.
3. Entry and Full freedom of Restricted Freedom of Restrictions on
Exit entry and exit. entry of new entry and exit. entry of new
firm and firms.
restricted
exit of old
firms.
4. Price Each firm is Firm is price Firm gas partial Price rigidity
price taker so maker, so control over due to fear of
price is price price due to price war.
uniform. discriminatio product
n is possible differentiation.
5. Selling No selling Only High selling High selling
Costs costs incurred informative costs are costs are
selling costs incurred. incurred.
are incurred.
6. Knowledge Perfect Imperfect Imperfect Imperfect
about knowledge knowledge. knowledge. knowledge.
market
conditions

Page | 86
 Equilibrium Price
Equilibrium price is that price when quantity demanded for a
commodity equals its quantity supplied.
Equilibrium Price

Quantity demanded = Quantity supplied

We can easily understand the equilibrium concept with the help of
a schedule and diagram.
Price of (x) Quantity Quantity
Situation
commodity supplied of X demanded of X
10 2 10
Excess demand
20 4 8
30 6 6 Equilibrium
40 8 4
Excess supply
50 10 2

Here,
Equilibrium price = `30 OP
Equilibrium quantity = 6 units OQ
On the X axis, we have quantity demanded / supplied, and on the
Y axis we have price. The demand curve DD and supply curve SS
intersects each other at point e which is the equilibrium point.
When market is below the equilibrium price, it is a situation of
excess demand,
And when market is above equilibrium price it is the situation of
excess supply

Page | 87
 Effects of changes in demand
and in supply curve on equilibrium price
As we know that equilibrium price is derived by that point where
quantity demanded is equal to quantity supplied.
Therefore, if either demand changes or supply changes or both
change, equilibrium price and output will change.
This change can take place in following three ways
1) When supply is fixed but demand is changed
If the supply does not change but there is a change in demand, the
increase in demand will result in rise in price and the decrease in
demand will result in fall in price.

It is clear from the above diagram.

Here, the DD curve is shifted to D'D', the price will rise from QP
to Q'P' and the quantity sold will be increased from OQ to OQ'
conversely if D'D' curve is shifted to DD the price will fall from Q'P' to
QP and quantity sold will fall from OQ' to OQ.

Page | 88
 2) When demand is fixed but supply is changed
If the demand does not change and supply changes, the increase in
supply will result in fall in price and decrease in supply will result in
rise in price.

It is cleared from the above diagram

Here, SS is shifted to S'S', the price will fall from QP to Q'P' and
quantity sold increases from OQ to OQ'. Conversely

Page | 89