EXAMINATION QUESTIONS

1. Microeconomics as a science, its methodology and methods.
2. Basic problem of the organization of economic activity.
3. Production possibilities curve and rational economic choice. Opportunity cost.
4. Positive and normative analysis.
5. The nature of the demand. Demand function. The determinants of demand.
6. Market demand versus Individual demand.
7. The nature of the supply. Supply function. The determinants of supply.
8. Market supply versus individual supply.
9. Market equilibrium establishment and price of equilibrium.
10. Applied aspects of the model of demand and supply. Consequences of the government
intervention in the market mechanism (by fixing the prices, taxation, subsidies).
11. Preferences, prices and income as general determinants of consumer behavior. Assumptions
of consumer’s preferences.
12. Utility as the economic category. Utility functions.
13. Total and marginal utility. The law of the diminishing of marginal utility.
14. The marginal rate of substitution of goods and the slope of indifference curves.
15. Indifference curve analysis.
16. Budget constraint of a consumer
17. Consumer equilibrium.

Interior and corner solutions.

Consumer equilibrium means that condition, which gives him/her maximum utility from full
use of income.
The consumption decision of a rational consumer is motivated by the desire to maximise
utility or satisfaction. But this decision is constrained by his limited purchasing power. Given
the assumptions about consumer's preferences, we can draw the indifference curves showing
different levels of satisfaction. Three such indifference curves, I0, I1, I2 are drawn in Figure
3.27. The budget line AB contains commodity bundles which are purchasable. The
consumption bundles like a, b, c lying on the budget line AB are purchasable. The consumer
will choose that commodity bundle which lie on the highest indifference curve. The
consumption bundle b on indifference curve I1 is the obvious choice because the alternative
commodity bundles such as a and c are located on lower indifference curve I0. The
indifference curve lying above I1, such as I2. consists of commodity bundles which are not
attainable with the given budget line AB.
The consumption choice of b from among alternative consumption bundles maximises the
utility subject to purchasing power limitations specified by the budget line. The consumer is
in equilibrium at point b because he has no incentive to choose any other commodity bundle.
Note that consumption choice at b contains OX0 amount of good X and 0Y0 amount of good

We now. the condition for equilibrium consumption choice is given by the equation written below : MUX/MUY= PX/PY 18.consumption curves. both MIPX and MIPY rises.X (iv) X rises but Y remains constant (v) X remains constant but Y rises.y and the negative of the slope of the budget line is (Px/Py). There can be five possible changes in consumption pattern: (i) both X and Y rise (ii) X rises but Y falls in such a way that the rise in P. and P. the consumer can purchase more of both X and Y if M rises at fixed prices. The division of higher purchasing power among various items of consumption depends on consumer's preferences. However. Income . We give below a graphical analysis of each situation . We have earlier stated that the purchasing power of money income in terms of good X is (MIPX) and the purchasing power in the units of good Y is (MIPY). When M rises. Since the negative of the slope of the indifference curve is called MRSx. budget line AB is tangent to the indifference curve I. At the equilibrium consumption point b. consider the effect of a change in M on equilibrium consumption demand. this does not mean that the consumer will actually increase the consumption of both X and Y. In other words. Consider a rise in M at fixed prices. are held constant.X is higher than the fall in PO' (iii) X falls and Y rises such that the rise in P.Y is higher than the fall in P. if P.Y.

31. The initial budget line as well as income level is indicated by M0 and the corresponding consumption choice by commodity bundle a. income rise leads to a rise in the equilibrium consumption of both X and Y. . The upward-sloping line OE is the income-consumption curve (ICC). Therefore. we have a complete picture of how equilibrium consumption plan changes with the change in the level of income. b starting from the origin and lying on an upward-sloping curve OE. If we imagine many equilibrium consumption choices like a. The diagram shows that bundle b contains more of both X and Y than bundle a.In Figure 3. the budget line has a constant slope. the budget line have a parallel rightward shift to M1 and the new consumption choice is shown by the commodity bundle b. If income rises to M1.

A necessity is defined as a good for which (EXIM) falls as income rises. when income rises. I. the proportion of income spent on food decreases (i. the proportion of income spent on nonfood items increases) with the increase in income. Price . implying that X/M rises as M rises. A luxury is defined as a good for which the proportion of income spent (EXIM) rises with the rise in income. we draw the Engel curve as a straight line through the origin in Figure 3. The real life Engel curve need not always be straight line. In general.39. 21.19. If we denote the amount of 'all. By plotting M on the horizontal axis and X on the vertical axis. Price elasticity of demand. If we take drawn in Figure 3. On average. the consumption of a good may rise by a proportion greater than or less than the rise in income. The Engel curve shows the equilibrium consumption of one of the two goods as a function of income.e. is convex from below. we see that the consumption of X rises by the same proportion as the rise in income. The budget equation can be written as M = PxX + Z or Z= -PxX + M . prices remaining unchanged. 20.38. expenditure on all other goods equals Rs. Z. The Engel curve in Figure 3..consumption curves and derivation of demand curve. other goods' by Z and price per unit of Z by Re.31. Engel curves.

Income elasticity of demand. Price elasticity of supply measures the degree of responsiveness of quantity supplied of a commodity to change in its own price. 24. The value of elasticity of supply can be calculated by the formula: Ex= Percentage change in the quantity supplied / Percentage change in price This may be expressed as: Ex=(ΔQ/Q) / (ΔP/P) = (ΔQ/ ΔP) x (P/ Q) Elasticity of supply is positive since the supply curve slopes upwards from left to right. Cross –price elasticity of demand. 23.22. However. Supply elasticity. in case of backward bending supply curve the supply curve will have a segment on which Ex is negative. Types: Periods of Supply Elasticity .

44. Constant returns to scale. 32. Production with two variable inputs. Marginal revenue – marginal cost approach: profit maximization. Thus E. 30. A perfectly competitive firm and market supply curve in the short-run. Applied aspects of the theory of elasticity. etc. 25. The production function. (c) Long run: In the long run all factors may be varied and firms may enter or leave the industry. Long-run equilibrium in perfectly competitive firm. 43. Total revenue – total cost approach. 40. machines. The cost function. . 39. 35. Isoquants and their characteristics. 42. economic and normal profit. The Nature of production costs.). Isocost lines and their characteristics. 26. Accounting. 29. 28. in the short run is generally low. Short . 31. Total. Total Revenue and profit of the firm. Long . Returns to scale. Production with one variable input. average and marginal product of a variable input and the interdependence between them. 36.run cost. 37.run cost.(a) Momentary: In the momentary period or the very short run supply is fixed and E. 41. Accounting and Economic costs. 38. is zero. 27. The competitive firm’s demand curve. The nature and features of perfectly competitive markets. Determinants of increasing and decreasing returns to scale. Economies and diseconomies of scale. 33. (b) Short run: In the short run supply can be varied with the limit of the present fixed assets (buildings. 34. losses minimization and shut-down decisions. Optimal combination of input factors for a firm. MRTS. Explicit and implicit costs.

modifying the supply quantity. and thus transform the consumer surplus into revenues. Perfect price discrimination can be only if the monopoly firm knows the consumer demand curve and sell each unit of good at the demand price (at the higher price which the consumer is able to buy a certain quantity of goods). So the price is higher than marginal revenue and higher than marginal cost. The demand for a monopolist product. Another coefficient used to calculate the monopoly power is the elasticity coefficient of the demand in relation with the price. the seller is able to sell the good or service to each consumer at the maximum price he is willing to pay. which means that there is no deadweight loss. The monopoly power consist in the capacity of the firm to set the price of its products at a higher level as marginal cost. The difference between selling price and marginal cost can be used to evaluate the monopoly power. the monopoly firm has to modify the production volume or the selling price. but differ in relation with the quantity purchased. Marginal revenue curve for a monopolist. Larger quantities are . So the profit is equal to the sum of consumer surplus and producer surplus. Price discrimination under monopoly. and when he decide to modify the quantity supplied. Social price of monopoly. 51. 49. When trying to maximize the profit. though. There are 3 types of price discrimination: - Perfect price discrimination (1st degree) – suppose that for each particular buyer it will set a particular price. the practice of collusive tendering could reduce the market efficiency.45. Price discrimination consists in firm application of different prices for different unities of the same product. Examples of where this might be observed are in markets where consumers bid for tenders. Price discrimination in possible only if the monopoly firm can divide buyers in dependence with their demand elasticity and if the reselling of its goods are impossible. 47. it has to minimize the price. Monopoly power. The marginal consumer is the one whose reservation price equals to the marginal cost of the product. The power of the monopoly firm depends on the available substituents of this good and on the market quota of the firm. Monopoly total revenue and its maximization. The seller produces more of his product than he would to achieve monopoly profits with no price discrimination. Pure monopoly and its properties. in this case. 46. and this action hasn’t any link with the cost differences. 48. Short-run profit maximization and losses minimization by monopoly firm. 50. Monopoly demand. - 2nd degree price discrimination – consist in the setting of the same price for all consumers. By knowing the reservation price.

and each of them has a small share on the market and a limited control over the price. This is particularly widespread in sales to industrial customers. On the market there isn’t an interdependence between firms and when one of them decide something about the price and production volume. no sunk costs and no exit costs. 53.Firms don’t take care on the competitors’ reactions. Additionally to second degree price discrimination. In the long run there are no entry and exit costs. There are numerous firms waiting to enter the market. placement. price varies by attributes such as location or by customer segment. who own the monopoly in a narrow specialized field. where bulk buyers enjoy higher discounts. or in the most extreme case. each with their own "unique" product or in pursuit of positive profits. Monopolistically competitive markets have the following characteristics: .available at a lower unit price. 52. This allows the supplier to set different prices to the different groups and capture a larger portion of the total market surplus. . by the individual customer's identity. and others. package. services. furniture. food production and others.There are few barriers to entry and exit. shoes production.There are many producers. Short-run equilibrium under monopolistic competition. Each firm has a unique role as a seller of a certain quantity of goods. is a means by which suppliers use consumer preference to distinguish classes of consumers. it doesn’t mind about the competitors’ reactions. . The short-run. Any firm unable to cover its costs can leave the market without incurring liquidation costs. Thus. This type of market is distinctive for clothes. the suppliers will provide incentives for the consumers to differentiate themselves according to preference. sellers are not able to differentiate between different types of consumers.There are different products which don’t represent perfect substituents of goods offered by other firms. is a time period . Monopolistic competition is an intermediary type of market which combines elements of monopoly market and those of the market with perfect competition as high competition and an insignificant part of monopoly power. Monopolistic competition and its properties. As above. Monopolistic Competition is a market structure featuring few large and many small firms. . This assumption implies that there are low start up costs. or non-linear pricing. - In third degree price discrimination. quantity "discounts". The differentiation of the goods can appear through its quality. possessing a certain market power. where the attribute in question is used as a proxy for ability/willingness to pay. fairly low entry barriers similar goods and relatively high competition.

The firm will produce quantity Qs at price Ps. the goods are similar enough to ensure that competition will always remain high. . The firm produces where marginal cost (MC) and marginal revenue (MR) curves meet. ACs (average cost of producing one good at this quantity) and the AR curve (average revenue curve) is the abnormal profit the firm makes. Monopolistic Competition is a market structure featuring few large and many small firms. In the long run. 54. fairly low entry barriers similar goods and relatively high competition. Thus. This means that the shaded area between Ps. Finally. Producing at this point ensures the highest amount of profit. because MC is the cost of producing an one more of the good and MR is the revenue of selling one more good and their meeting point is the most efficient production. there are no abnormal profits because of the features of Monopolistic competition. but many small firms that will compete for profit and thus drive the price down. Long-run equilibrium under monopolistic competition. equilibrium is created in the short run. Also. The long-run period is when all factors of production are variable. low entry barriers mean new firms will enter the market and further add competition.in which at least one factor of production is fixed and firms can usually gain some abnormal profit. There are a few large firms. AR is equivalent to the demand curve and is the average revenue the firm makes per item sold.

meaning they get to unilaterally charge whatever they want for their goods without being influenced by market forces. It also means that producers will supply goods below their manufacturing capacity. or long run marginal cost curve. as the average cost of the good equals the average revenue of the good. there is no abnormal profit.This price exceeds the firm's marginal costs and is higher than what the firm would charge if the market was perfectly competitive. The LRMC describes the cost of producing one more of the good when no factors of production are fixed over the long run. Both types of firms' profit maximizing production levels occur when their marginal revenues equals their marginal costs. or long run average cost curve. in the long run. the price that will maximize their profit is set where the profit maximizing production level falls on the demand curve. the loss in consumer surplus due to monopolistic competition guarantees deadweight loss and an overall loss in economic surplus. Thus. Because the LRAC curve is above the AR curve. That point is. 55. Firms in a monopolistically competitive market are price setters. Monopolistically competitive markets are less efficient than perfectly competitive markets. the firm produces where the LRMC. The difference between the quantity of products which correspond with the minimum level of long-run average cost and the quantity of products offered by the firm in conditions of long-run equilibrium is called excess capacity of firm production . Excess capacity. and the marginal revenue curve meets. which shows them average cost of producing one good at this quantity over the long run. equilibrium is acquired.In this diagram. Excess capacity. This quantity is less than what would be produced in a perfectly competitive market. Regardless of whether there is a decline in producer surplus. firms that are in monopolistically competitive markets behave similarly as monopolistic firms. Monopolistic competition and economic efficiency. In terms of economic efficiency. equivalent to the LRAC. In these types of markets. in the long run.

the price in long-run can be higher than average costs. . firms offer differentiable goods. The profit gained by firms attract in this field other firms and maintain the prices at a lower level than in case of existence of a monopoly firm.advertising increases sales and permits economies of scale. The role of advertizing in the monopolistic competition Some of the arguments in favor of advertising are . Because the price is always bigger than marginal revenue. in contradiction to homogeneous ones offered by firms from perfect competition market. 57.56. doesn’t permit the existence of economic profit for a long period of time. in conditions of equilibrium the price will be higher than marginal cost. but the price level is higher as in case the products are offered by firms from perfect competition. In conditions of monopolistic competition. In conditions of monopolistic competition. The equilibrium of the firm from monopolistic competition resembles (se aseamana) with the equilibrium in the monopoly situation through the idea that prices are higher than marginal costs. and unique goods offered by pure monopoly firms. In perfect competition market. economic profit become equal with 0 (zero) when the price is equal with minimum total average costs for long period (P=LRACmin). Monopolistic competition. P=LRMC=LRACmin. consumers are imposed to pay higher prices for differentiate goods. Because here exist barriers to enter the market. pure monopoly and perfect competition: comparative analysis. So in case of equilibrium for long-run activity of perfect competition. free entrance on the market. in conditions of monopolistic competition. Consumers buy goods at the minimum possible level of price. The firm modify the price until MR=MC. The prices reflect minimum average costs for one unit of production and marginal cost. in case of monopoly market. . prices are lower as in case the products are offered by a monopoly firm. In monopolistic competition industry. So.advertising is informative.

product or advertising. . or five firms occupy the market Homogenous or differentiated products. Some oligopolistic industries offer homogenous.advertising increases competition and lowers prices. those of steel. 58. . ownership and control of the raw materials is a factor. Other industries. Some of the arguments against advertising are . those of automobiles. offer different products and place an emphasis on nonprice competition. The main characteristics of oligopoly are: A few large producers.the economies of scale are illusory. Oligopoly and its properties.. . and . to some extent. Any new firms would have too small a market share and would have to produce at too high a price.advertising increases sales and contributes to economic growth. output. Entry barriers exist that allow a handful of firms to achieve economies of scales. products. Usually three. breakfast cereal. oligopolies must take note at how they react to its change in price. . -Strategic Behavior: self-interested behavior that takes into account the reactions of others -Mutual interdependence: profit doesn't depend entirely on its own price and strategies Relatively high entry barriers.advertisers may use their influence to bias the media. four. electronics. because there are rival firms. but still mutually interdependent. but no more beyond that.advertising supports the media.advertising is used as an entry barrier. lead. Oligopoly is a situation on the market where exist a limited number of producers (more than one) and a big number of consumers. tires. or standardized. . e. Patents and brand loyalty are also barriers of entry into an oligopolistic market. The small number of firms let oligopolies to set prices and output levels.g. industrial alcohol. Sometimes the cost of capital is too high and other times.advertising raises the cost curve.g. such as advertising. Price maker. copper. zinc. .advertising is not a productive activity. However. . e.advertising is not informative but competitive.