Efe Unit 1 Merged

Unit - I
What Economics is all about?
Economics is a study of economic phenomena around individuals, regions,

countries or in the world as a whole.
Many non-economists think that economics is all about how to make or manage
money.
This is not true; economics is much broader in scope.
It is about making choices in the face of scarcity.
S NEHRA EFE UNIT I 2

If things were not scarce, there would not be a subject matter like economics,
because then an individual or a nation could have anything that it wanted.
Unfortunately, that is not the case. If nothing else, time is scarce. Even for the
richest person in the world, Bill Gates, has to make a choice on a particular
morning whether to do yoga for one hour or to have a video conference with a
Microsoft’s top executive who is travelling in India.
Look at yourselves: how hard-pressed for time you are when the final exams
draw near.

The degree of scarcity varies, however, from country to country. For instance, in
a typically developed country, labour is relatively more scarce than technology
and equipment, while in a developing country it is the opposite.
Because things are scarce, one has to make a choice; thus, the problem of
choice arises due to scarcity. The study of such problems of choice at the
individual, social, regional, national and international level is what economics is
all about.

Economics – An Introduction
The word ‘Economics’ was derived from the Greek words ‘Oikos’ (a house) and
‘Nemein’(to manage), which meant managing a household, using the limited
money or resources a household has.
It is important to understand how economics has developed as a discipline.

Origin of Economics/Evolution of
economic thought
Earlier, it used to be called as Political Economy.
The early writers used the term “Political Economy” for the management of the
State.
Indian scholar and philosopher, Chanakya (Kautilya) in his famous book
‘Arth-Shastra’ has examined both kinds of activities, i.e. economics and political.
Greek philosopher Aristotle (384-322 BC) had used the term economics to mean
the management of ‘family and the state’.
Dr. Marshall was the first to use the term ‘economics’ in 1890 in his famous
work “Principles of Economics”.

Development of Economics as a subject
Adam Smith, the Founder of Modern Economics, shaped the form in which we
study economics today.
His famous book “An Enquiry into the Nature and Causes of Wealth of Nations”,
published in 1776, is still acclaimed even today.
Till the end of 18th and the mid of the 19th century (1776 – 1850), several great
Economists like Ricardo, Malthus, J. B. Say, etc., had fully supported the
thoughts of Adam Smith. These economists are known as classical economists.

From the middle of 19th century to the first three decades of the 20th century
(1850-1930) economists like Menger, Walras, Cournot, Marshal, Pigou, etc., had
made significant contributions to the development of the study of Economics.
(Neo-classical economists)
In 1933, Prof. Ragnar Frisch, a famous economist of Oslo University, Norway,
divided the study of economics into two parts:
i) Micro Economics, and
ii) Macro Economics

Scope/Subject matter of
Economics
1. Microeconomics: Concerned with the behavior/economic activities of
individual entities such as markets, firms and households.
◦ Microeconomics is about decision making by individual consumers &
firms, and about how resources are priced and allocated through
markets
◦ When the problems of choice (economic problems) are studied and
addressed at the level of individuals, it is called microeconomics
2. Macroeconomics: Concerned with the overall performance of the economy.
◦ When the problems of choice (economic problems) are studied and
addressed at the level of the country as a whole, it is called
macroeconomics.
◦ This concept came into being after 1935 when General Theory of
Employment, Interest and Money was published by John Maynard Keynes.
Scope of Microeconomics
1. Theory of consumer behaviour
2. Theory of Production and Cost
3. Theory of Factor Pricing
4. Theory of Economic Welfare

Scope of Macroeconomics
1. Theory of income and employment
2. Theory of consumption & investment
3. Theory of business cycles
4. Theory of general price level
5. Theory of economic growth
6. Theory of international trade

Difference
Basis Micro Economics Macro Economics
Unit of Study Individual Aggregate
Method Slicing Complete
Subject Matter Study of product and factor pricing Study of National income, general
level of prices, business cycle
Basis Based on Based on interdependence

independence
Core of study Price Theory Income
Advocated by Alfred Marshall John Maynard Keynes
Vision Worms eye view : Birds eye view: Forest as a whole
study of a tree
Approach Individualistic Aggregative
Objective Allocation of resources Full empt. & growth
Quality of Analysis Simple and easy Difficult and complicated

Complementarity of two approaches
To quote Paul Samuelson; “There is really no opposition between Micro and
Macro-economics. Both are absolutely vital. You are less than half educated if
you understand the one while being ignorant of the other”.

Examples – Micro/Macro Economics
What determines the production of Smart TVs?
What factors determine the price of petrol?
What determines the wage of auto workers at Maruti Suzuki Pvt Ltd.?
Why are people buying more MI company mobile phones?
What causes the retail inflation rate In India to move higher in July 2021?
Why did unemployment in India increased in 2020?
Why did India’s economy slowed down in 2016?
Can the Reserve Bank of India pull the Indian economy from the recession by
keeping interest rates low?

Review question on Micro & Macro
Economics
Consider a big event, such as, Cricket World Cup final match at Eden Garden
stadium of Kolkata in India.
From a micro economic point of view:
1. What are the factors influencing demand and supply of tickets?
2. Is the market for tickets is competitive or monopolistic?
From a macro economic point of view:
1. How might a big event affect tourism, spending and hence inflation rates
and exchange rates?
2. How might a big event be affected by influences such as aggregate
demand or interest rates?

Logic of economics/Nature/ Economic
statements
Economics is a popular, useful and significant social science.
It involves economic activities of man.
Economists use the scientific approach to understand economic activities
• Observation of facts,
• Measurement, (how much change)
• Explanation (cause-effect)
• Verification.
Economics relies upon laws and theories for analysis.

Positive economics / statements
Positive economics (statements) seeks to analyze and explain economic
phenomena as they are or deals with matters of fact (verifiable)
Positive statements are made without obvious value-judgements and
emotions.
Statements are based on economic theory rather than raw emotion.
Positive economics can be described as “what is, what was, and what probably
will be”
Positive economics deals with economic issues (or economic behaviour)
related to past, present or future.

Examples
On the eve of independence, poverty in India affected larger percentage of
population than now (past)
22% of population in India is absolutely poor (below poverty line) (present)
If population in India continues to grow at the existing rate, the percentage of
population below poverty line will exceed 22% in the year 2021 (future)
The Chinese economy now has lower population growth rate than India.
The Indian stock market has boomed in 2020.
India is an over-populated country.

Unscrambling Cause and Effect
Positive economics deals with causes and consequences

Economists are particularly interested in positive statements about cause and
effect. Are computers getting cheaper because people are buying them in
greater quantities? Or are people buying computers in greater quantities
because they are getting cheaper?
To answer such questions, economists create and test economic models.

Descriptive eco. & economic theory
Positive economics is often divided into descriptive economics & economic
theory.
Descriptive economics is simply the compilation of data that describes the facts
Ex – factual data on Indian Economy.
An economic theory (Micro Eco., Macro Eco.) is a model or statement or set of
related statements about cause and effect, action and reaction – Ex – Law of
demand.

Normative economics/statements
Normative economics is the study of how the economy should be. It is also known as Policy
economics.
Normative statements are subjective - based on opinion only (not verifiable) - often without a
basis in fact or theory. They are value-laden, emotional statements that focus on "what ought
to be".
Often, to make normative judgements, one must carry out a positive analysis to find out what
is going to happen.
Examples:
Planning commission should not be replaced.
The national minimum wage rate should be increased to reduce poverty.
Agricultural income should also be taxed.
Food grains should be given at lower price to the poor families.
Old age pensions should be stopped.

Fallacies – Improper conclusion
1. Post hoc fallacy – Assumes because one event occurred before an other
event, the first event caused the second event.
Ex: This fallacy is often apparent when a newly elected government takes credit for
improving the economy. Since the economy improved after the election, the election
result must have been responsible.
Ex: Stock market crash in the late 1929 caused the Great Depression.
2. Fallacy of composition – What is true for the part is also true for a whole, you
are committing the fallacy of composition.
Ex: A farmer who is better off because he has a bumper crop but may not be
better off if every farmer has one.
Ex: Paradox of saving

What is an economy?
People perform different economic activities to earn their living.
Teachers go to school, doctors go to hospital, farmers go to their fields and
industrialists go to their industries.
The nature and level of economic activities performed by the people of an sea
would reveal a system by which people of that area earn their living. This
system is called economy.

Language of Economics
S Economic agents / Economic Activities Economic System
No. Economic units
1 Consumer / Individuals / Consumption Economic activities are governed
Households by the economic system in an
2 Producer / Firms Production/Exchange economy and economic system is
governed by economic policies
3 Government Exchange / Distribution
• Production – An activity designed to satisfy peoples’ want – Done by producers

• Consumption – Using up goods & services to satisfy our wants – Done by consumers
• Distribution/Exchange – Buying & selling of goods & services
• Economic agents faces the problem of scarcity - All the scarce material is called
resources

Question
Watching Toofan movie is an example of “consumption.”
True

Organization of economic activities
Economic activities (activities of production, consumption, investment, and
exchange) are controlled or regulated by the government of a country.
The mechanism to control the economic activities is called as economic system.
The degree of control varies across different nations. In China, Russia and North
Korea, the degree of control is very high.

Types of economies
Such economies where the degree of control is very high are called
'Controlled/Command Economies' or 'Centrally Planned Economies'.
Second, there are economies where the degree of control is notional (very low).
These are called 'Free Economies' or 'Market Economies'.
Third, there are economies where the degree of control is moderate (neither
very high nor very low). These are called ‘Mixed Economies'.

Market, Command and Mixed Economies
1. Command Economy / Planned Economy: Where the Government makes all
important decisions about production & distribution. Ex - Soviet Union. It
may be called as communistic economy as well.
2. Market Economy: Where individuals and private firms make the major
decision about production & consumption. It may also be called
lassiez-faire economy. Ex – USA, UK.
3. Mixed Economy: Where the decision pertaining to production,
consumption & distribution are taken by the Government as well as the
individual such a market is called to have a mixed economy. Ex- India

Economic Interpretation
S. No. Ordinary way Economic way
1 India as a country Indian Economy
2 Geographical size (2.4 % land area) & Economy size (5th rank)
Population (17.7 % of global population)
3 Political system - Democracy Economic system – Mixed economic system

Concept of economics
Economics relates to:
1. Economic activities – Production, Consumption, Exchange (product &
factor pricing)
2. Economic system – Command, Market, Mixed Economy
3. Economic policies – Monetary, Fiscal, Trade

Review Question
Owing to global warming, people are more concerned about environmental
issues. Demand for environmental-friendly vehicles hence increases, leading to
increased price. Some automobile factories put a lot of efforts into the
development of environmental-friendly vehicles in order to increase the market
share.
Identify the type of economic system?

Economic Problem
Human wants are endless whereas resources are scarce
This is true of all kinds of economies – rich and poor, developed, emerging,
under-developed, command, market, mixed.
It is impossible for an economy to produce every thing for each individual
because no economy possesses unlimited resources. It becomes necessary far
ever economy, therefore, to make a choice regarding the efficient use of the
available resources of the economy like land, labour, capital, etc.
The problem concerning the allocation of the resources to different uses is
called economic problem, or the problem of choice.

Scarcity and choice is the essence of economics
Thus:
1. Scarcity causes choice.
2. Choice implies decision making.
3. Decision making relates to usage of limited resources in such a manner that
consumer maximizes his satisfaction, producer maximizes his profits and a
society maximizes its social welfare.

Why does Economic Problem Arise?
Economic problem arises due to the following three causes:
1. Unlimited Wants: Human wants are unlimited. Human wants are multiple and recurring too.
Ex- Laptop, Mobile, Cars. Almost every household is keen to have these items.
2. Limited or Scarce Means: Mast of the goods and services satisfying human wants are limited
or scarce (land, labour, capital equipment's). These goods are called scarce because their
demand is greater than their supply.
3. Alternative Uses: Another cause of economic problem is that the limited resources have
alternative uses. For instance, milk is a scarce commodity. It can be used for preparing
cheese, ice cream, rasgullah, etc. Since resources are limited, all wants cannot be satisfied. It
leads to the problem of choice: which wants should be satisfied and which should not be.
Accordingly, the society has to decide which wants are to be satisfied first and which later.
This is the problem of choice.

Basic or Central Problems of economy
Three Basic or Central Problems of Economy
Allocation Efficient use or Economic Development

of Resources fuller utilization of Or Growth of Resources
Resources
What to How to For whom to

produce? produce? produce?

Basic economic problems
Allocation of resources:
1. What to produce:
◦ Public goods vs private goods
◦ Necessity vs luxury goods
◦ Military vs civilian goods
2. How to produce: Labour intensive vs capital intensive technology
3. Whom to produce: Rich vs poor

Global Inequality Crisis Report 2020:
Oxfam International
The world’s 2,153 billionaires have more wealth than the 4.6 billion people who make up 60
percent of the planet’s population
The world’s richest 1% have more than twice as much wealth as 6.9 billion people.
The 22 richest men in the world have more wealth than all the women in Africa.

Income Inequality in India
India's richest 1 per cent hold more than four-times the wealth held by 953 million people who
make up for the bottom 70 per cent of the country's population
The combined total wealth of 63 Indian billionaires is higher than the total Union Budget of
India for the fiscal year 2018-19 which was at Rs 24,42,200 crore.

Additional economic problems
The economic problems of what, how and for whom are of micro nature. Apart
from microeconomic problems, there are certain macroeconomic problems of
prime importance confronted by under-developed economies. They are:
1. Fuller utilization of resources – Unemployment of resources
Actual output < Potential output
2. Growth of resources – Exploiting untapped resources

Solutions to basic economic problems

Command/Planned economies
• Free markets also fail at times to allocate resources efficiently, so remedies often involve the
allocation of resources by government to compensate for these failures.
• Decisions are taken with a view to maximize welfare.

Market Economies
• Market economies work by allowing the direct interaction of consumers and producers who are
pursuing their own self-interest.
• Decisions are taken on the basis of market forces as well as the social considerations.

Mixed economies
• In reality, all economies are mixed, though there are wide variations in the amount of mix and the
balance between public and private sectors.
• For example, in Cuba the government allocates the vast majority of resources, while in Europe most
economies have an even mix between markets and planning.

Combination of improved technology and
globalization will result in solving the basic
economic problem
The foremost effect of advances in technology is increased productivity and reduced waste of
resources. If fifty years ago, energy for domestic use could only be produced by burning coal,
today’s technology can convert the sun’s and waves’ energy into useful electricity for us to use.
On the other hand, technology can also serve to create new wants like internet, mobile phones
There is increasing demand for such products
This actually feeds more and new wants into the economic problem
Globalisation brings many advantages including the benefits of specialization
Scarcity will continue as new wants will arise and benefits may not be spread equitably. The
position may improve as a result of the changes but the economic problem will continue to
exist.

Mind Map

Production possibility frontier / curve
Production possibility curve is a curve showing alternative production
possibilities of two goods with the given resources and technique of production.
It is also called Production Boundary (or Production Frontier) as it shows the
maximum possible production with the given resources (and the given
technology).
This curve is also called Transformation Line or Transformation Curve because it
indicates that if more of Good-X is to be produced then factors of production
will have to be withdrawn from the production of Good-Y and transferred to the
production of Good-X. In other words, Good-Y is, transformed into Good-X.

Assumptions
1. The amount of productive resources are fixed
2. There is no change in technology.
3. Considering an economy which produces only two economic goods.
4. The resources are fully and efficiently utilized.
5. Resources are not equally efficient in production of all products. So, when resources are
transferred from production of one good to another, the productivity decreases;

Example
Possibilities Guns (in units) Butter (in units) MOC MRT= ∆Guns/∆
Butter
A 21 0 — —
B 20 1 1 1G:1B
C 18 2 2 2G :1B
D 15 3 3 3G:1B
E 11 4 4 4G:1B
F 6 5 5 5G:1B
G 0 6 6 6G: 1B

Production possibility curve
Marginal Opportunity Cost: MOC refers to the number of units of a commodity sacrificed to
gain one additional unit of another commodity. In case of PPF, MOC is always increasing, i.e.
more and more units of a commodity have to be sacrificed to gain an additional unit of
another commodity.
Marginal Rate of Transformation: MRT is the ratio of number of units of a commodity
sacrificed to gain an additional unit of another commodity. MRT = ∆Units Sacrificed/∆ Units
Gained. In the given example of guns and butter, MRT = ∆ Guns/ ∆ Butter
Characteristics of PPF
1. PPF slopes downwards - More of one good can be produced only by taking
resources away from the production of another good. As there exists an
inverse relationship between changes in quantity of one commodity and
change in quantity of the other commodity.
2. PPF is Concave Shaped - PPF is concave shaped because of increasing
marginal opportunity costs, i.e. more and more units of one commodity are
sacrificed to gain an additional unit of another commodity.

PPC and MRT

Whether Economy will always operate
on PPF?
1. Economy will operate on PPF only when resources are fully and efficiently
utilised.
2. Economy will operate at any point inside PPF if resources are not fully and
efficiently utilised.
3. Economy cannot operate at any point outside PPF as it is unattainable with
the available productive capacity.

Efficient, attainable & unattainable
points
All points on the PPC or inside the PPC are attainable combinations of output, with the
given resources and technology.
Any points outside the boundary line of production shows 'unattainable combination’ of
output of two goods.

Shift/Rotation in Production Possibility
Curve
The production possibility curve will shift/rotate under the following conditions:
1. Change in Resources/economic growth: If resources are increased, we can
produce more of both the goods. PPC will shift right side.
2. Change in technology: Efficient technology for the production of good-X
means more production of good-X with the same resources. Accordingly PPC
will rotate in favour of good-X.

Change in Resources

Change in technology

Applying PPF to Society’s choices

1. Poor nation to High Income Nation
• Economic growth shifts the PPF outward

• Before development, the nation is poor and devote almost all its resources for necessities.
Growth of inputs and technological change shift the PPF outside expanding its consumption of
both the goods

2. Backward Society Vs Urban Society
• Economies must choose between Public Goods and Private Goods

• A poor society have little resources for public goods like clean air, health whereas a modern
urbanized society is more prosperous and chooses to spend more of its higher income on public
goods and government services

3.Today’s Choices Vs Future Consequences
• Investment for future consumption requires sacrificing current consumption

• Countries that invest heavily can have both higher investment and consumption in future

Review questions
1. Economic slowdown in some parts of the world adversely affected demand for Indian
exports. How will this affect the Production Possibilities Frontier for India?
2. What will be the impact of large scale outflow of foreign capital on Production Possibilities
curve on the economy?
3. What will be the impact of recently launched ‘Clean India Mission’ (Swach Bharat Mission)
on the Production Possibilities curve of the economy?

Unit I
THEORY OF UTILITY AND CONSUMER'S CHOICE
EFE UNIT I S NEHRA 1

WHO IS A CONSUMER?
A consumer is an economic agent who uses goods and

services for the direct satisfaction of his/her wants.
Consumer can be individuals, households, institutions etc.
Consumer behavior refers to the way in which consumers
spend their income.
The consumer derives utility from his expenditure. The
consumer chooses his expenditures and maximizes his
utility with the given income and given prices of goods and
services.
EFE UNIT I S NEHRA 2

Theory of consumer
behaviour
How does a consumer decide how much of a commodity to
buy at a given price?
How does the consumer respond to change in price of the
commodity, given his income, and prices of the related
goods?
These questions takes us to the theory of consumer
behaviour.
The theory of consumer behaviour is based on the
assumption that a consumer is a utility maximizing entity.
S NEHRA ITE UNIT I 1.1 3

Consumer’s equilibrium with
utility approach
Equilibrium means a state of rest from where there is no tendency to
change.
Consumer’s equilibrium refers to a situation where the consumer has
achieved maximum possible satisfaction from the quantity of the
commodities purchased given his/her income and prices of the
commodities in the market.
There are two main approaches to study consumer’s equilibrium. They
are as follows:
1. Cardinal utility approach (or Marshall’s utility analysis)
2. Ordinal utility approach (or indifference curve analysis)

Concept of Utility
Concept was introduced by social thoughts by Bentham in
1789 and to economic thoughts by Jevons in 1871.
Utility is a measure of the satisfaction, happiness, or benefit
that results from the consumption of a good.
Utility is defined as the power of a commodity to satisfy a
human want.
Economic term referring to the added value or “usefulness”
of a product.

Utility in Money
Util: An artificial construct used to measure utility.
Utility also measured in monetary terms by converting ‘util’
into money by using the following formula:
Utility in Money = Utility in Util/Utility of a rupee.
Utility of rupee can be assumed to be any number such as
1, 2, 3 ... . Let utility of a rupee is assumed to be 2 utils.
Then 10 utils = 10/2 = ₹ 5.

Measurement of utility
Economists hold different views on whether utility is
measurable in absolute terms.
The classical and neo-classical economists held the view
that utility is cardinally or quantitatively measurable.
Modern economists, on the other hand, hold the view that
utility is not cardinally measurable.
It can be measured in ordinal terms.

Cardinal & Ordinal
measurement
There are two views of utility:
◦ Cardinal Utility / Marshallian approach
◦ Cardinal utility is the belief that utility can be measured
and compared on a unit by unit basis.
◦ EX - A utility measure of 200 is twice as big as a utility
measure of 100.
◦ Ordinal Utility / J.R. Hick approach
◦ Ordinal utility is where you rank bundles of goods, but
cannot say how much greater one bundle is to another.
◦ Ranking is the only thing that matters when dealing
with ordinal utility.

Concepts of Total & Marginal utility
Total Utility: Total utility means the total satisfaction
obtained by the consumer from the consumption of all
units at a time.
TU = Sum total of MU
TUn = MU1 + MU2 + .....+ MU
Marginal Utility: The additional utility a person receives

from consuming an additional unit of a good.

Marginal Utility
Marginal utility refers to the additional utility a person
receives from consuming an additional unit of a good.
It refers to the net addition made to the total utility by
consuming one more unit
In mathematical terms,
MU= Δ Total Utility/ Δ in units of consumption of a
commodity
or MU = TU n – TU n-1
◦ Note that Δ means change

Laws of utility analysis
Utility analysis consists of two important laws:
1. Law of Diminishing Marginal Utility.
2. Law of Equi-Marginal Utility.

Law of Diminishing Marginal
Utility
The law of DMU is central to the cardinal utility analysis of the
consumer behaviour
Concept developed by Alfred Marshall
Psychologically, intensity of desire for a commodity tends to
decrease as more and more units (standard) are consumed at a
point of time.
Other things being equal, as the quantity consume increases the
MU of that commodity tends to diminish.
It means more we have of a thing, the less we want to have of it
because the utility of every additional unit appears to go on
diminishing.
The relationship between quantity consumed and utility derived
from each successive unit consumed is called the law of DMU.

Utility Assumptions
1. Homogeneous – Various units are alike in all aspects
2. Continuity – Continuous consumption
3. Standard unit – Standard size of all units
4. No change in taste or habit of the consumer
5. Rationality – Behaviour of consumer is normal and
rational
6. Cardinal measurement – Utility is measurable in
numerical units

Numerical example
Commodity Total Utility Marginal Utility
1 40 40
2 70 30
3 90 20
4 100 10
5 100 00
6 90 -10

Graphical illustration
TU/MU
Units consumed

Relationship between TU & MU
Total utility follows marginal utility. TU = ΣMU
1. When the MU decreases, TU increases at decreasing rate.
2. When MU becomes zero, TU is maximum. It is a
saturation point.
3. When MU becomes negative, TU declines.
4. Decreasing MU implies that the TU increases at a
decreasing rate (MU is the rate of change of TU).

Importance of law of DMU
1. The law explains the Water - Diamond paradox.

Law of equi-marginal utility

Consumer’s equilibrium /
Utility maximization
Consumer's equilibrium refers ta a situation wherein a consumer
gets maximum satisfaction out of his given income and he has no
tendency to make any change in his existing expenditure.
The consumer is in equilibrium if he consumes up to the point
where the MU of the goods equals the market price of the good
MUx = Px
Analyzing consumers equilibrium requires answering the
question how does a consumer allocate his money income
among the various goods and services he consumes to arrive at
his equilibrium?

Assumptions
1. Rationality
2. Limited money income
3. Maximization of satisfaction
4. Utility is cardinally measurable
5. Diminishing marginal utility
6. Constant marginal utility of money - It means that
importance of money remains unchanged. Marginal utility of
money is addition made to utility of the consumer as he
spends one more unit of the money income.

Consumer equilibrium: one
commodity case
Consumer’s equilibrium in case of a single commodity can
be explained on the basis of the law of diminishing marginal
utility.
How does a consumer decide as to how much to buy of a
good? It will depend upon two factors:
1. The price s/he pays for each unit which is given and
2. The utility s/he gets

At the time of purchasing a unit of a commodity, a
consumer compares the price of the given commodity with
its utility. The consumer will be at equilibrium when
marginal utility (in terms of money) equals the price paid
for the commodity say ‘x’ i.e. MUx = Px. (Note that marginal
utility in terms of money is obtained by dividing marginal
utility in utils by marginal utility of one rupee).
This is sometimes loosely called the ‘Marginal Utility = Price’
(MUx=Px) principle. It refers to Marginal utility of X in terms
of money equals price of the good X.

Marginal Utility of a Product / Marginal Utility of a Rupee =
Its Price
We can rewrite the above equation as:
Marginal Utility of a Product / Its Price = Marginal Utility of
a Rupee
The above equations shows consumer’s equilibrium.

One Commodity Case
Units of goods (X) Mux (₹) Price (₹)
1 8 5
2 6 5
3 5 5
4 4 5
5 3 5
Suppose price of good X is 5 per unit.

The equilibrium price is given at OP. The consumer will buy OQ quantity of X in
order to maximize his utility. Total gain falls if more is purchased after
equilibrium.

Two Commodities Case -
Law of equi-marginal utility
In real life, consumer purchases many goods with the help
of their income.
He has to decide how he should spend his limited income
on different goods so as to get maximum possible
satisfaction.

We assume that a consumer consumes only two commodities X
and Y and their prices are Px and Py respectively.
MUx/Px = MUy/Py
This is called the law of equi-marginal utility. The law states that
a consumer will so allocate his expenditure so that the utility
gained from the last rupee spent on each commodity is equal.
MU from last rupee spent on X equals MU from last rupee spent
on of Y. In other words, a consumer buys each commodity up to
the point at which MU per rupee spent on it is the same as the
MU of a rupee spent on another good.

MU schedule of consumer
Good X (Px=1) Good Y (Py=1)
Units of X MUx Units of Y MUy
1 80 (1) 1 60 (4)
2 72 (2) 2 58 (5)
3 64 (3) 3 56 (6)
4 56 (7) 4 54 (8)
5 48 (11) 5 52 (9)
6 40 (13) 6 50 (10)
7 24 7 48 (12)
8 8 8 40 (14)

Criticisms / limitations of
marginal utility analysis
1. Cardinal measurement – Utility cannot measured numerically
2. Unrealistic assumptions – Difficult to satisfy the conditions of
homogeneity, continuity, rationality conditions
simultaneously
3. Inapplicability in case of indivisible goods (goods cannot be
broken into pieces for consumption) – Ex – T.V., Scooter,
House
4. Constant MU of money – MU of money never remains
constant
5. Law is based on observation – Scientific validity has not been
tested
Consumers' equilibrium –
Indifference curve analysis
The IC analysis of consumer's equilibrium discards the
assumption of cardinal measurement of utility. Instead, it is
based on the concept of ordinal measurement of utility.
According to this concept, utility is only ranked as high or
low [more or less). It is never expressed in terms of units
like 10, 20, 30, etc.

ASSUMPTIONS of IC analysis of
Consumer’s equilibrium
1. Money income of the consumer is given and does not
change.
2. The consumer spends his income on such goods which can
be substituted for each other, like laptop/tablet and desktop.
3. The consumer's preference (or scale of preference) for the
two goods is well defined. His intensity of desire for a good
would decrease when he has more of it.
4. More of a good always gives more satisfaction to the
consumer. This is called ‘monotonic preference' for a good.
5. The consumer is rational. He always maximizes his
satisfaction.

Indifference Curve and
Indifference Set/schedule
Indifference curve shows different combinations of two
goods that yield the same level of utility or satisfaction to
the consumer.
Indifference Set/schedule: It is a tabular presentation of
various combinations of two goods that yield the same level
of satisfaction to the consumer.

Different combinations of
Apples & Oranges
Combination No. of Apples No. of Oranges
A 1 10
B 2 7
C 3 5
D 4 4
• Each combination offers the same level of satisfaction to the

consumer.
• As there is no difference among combinations A, B, C and D, we may
say that the consumer is indifferent across these combinations.
Together, these combinations form an ‘Indifference Set’ of the
consumer.

Indifference curve
Indifference Curve shows different combinations of two goods offering the

same level of satisfaction to the consumer.

Indifference Map
A family of indifference curves is called an Indifference Map.
It gives a complete picture of a consumer’s scale of preference for two
goods.
An IC which is to the right and above another IC corresponds to higher
level of income and therefore; represents higher level of satisfaction.

Features of indifference
curves
1. IC Slopes Downward: IC slopes downward from left to
right. It means that IC has a negative slope. It implies
that if the quantity of one good is reduced then the
quantity of the other good is increased.
It is only then that the satisfaction level would remain
constant at different points of the IC.

2. IC is Convex to the origin
An indifference curve is convex to the origin because of
diminishing marginal rate of substitution.
The slope of IC is called Marginal Rate of Substitution (MRS) of X
for Y, symbolically denoted as MRSxy. It is defined as the amount
of Y that a consumer is willing to substitute for an additional unit
of X.
The slope measures the substitution ratio between the two
goods.
The slope of IC tends to decline, as we move along the IC from
left to right. It implies indifference curve is convex to the origin.

Combinations X Y MRSxy
A 1 12 -
B 2 8 1x:4y
C 3 5 1x:3y
D 4 3 1x:2y
E 5 1 1x:1y

MRSxy
MRSxy must be diminishing as consumer moves along the curve to the

right. This is because as the consumer has more and more of X, its
subjective worth or marginal significance to him declines and that of
scarce commodity Y goes up.

Consumers Budget / Budget
Line / Income Line
A budget line is a line which shows all possible combinations of two
goods that a consumer can buy with his given income and prices of the
commodities.
Budget Set: It is the collection or set of all the possible bundles or
combinations of two goods that the consumer can buy with his income
and prevailing prices of the commodities.
Budget Constraint: The budget constraint shows that a consumer can

choose any bundle as long as it costs less or equal to the income
s/he has, given income and prices of goods.

Budget Line
PX = Price of commodity X
X =Quantity of commodity X
PY = Price of commodity Y
Y =Quantity of commodity Y
M = Total income of consumer

Slope of the budget line
Slope of the budget line measures the amount of change in
good Y required per unit change in good X along the budget
line.
In other words, to obtain 1 more units of Good X, how
many units of Good Y is to be sacrificed. Thus the price of
Good X is expressed in terms of the sacrifice of Good Y for
obtaining every additional unit of Good X.
Slope of budget line is also called Marginal rate of exchange
(MRE).

Shifts in Budget Line
A budget line is based on consumer’s income and prices of
the commodities.
Therefore, if any one of these determinants are changed
then budget line will definitely change.

1. Change in income

2. Changes in the price of
commodities
Change in Price of Change in Price of Simultaneous Change in

Commodity X Commodity Y Price of Both
Commodities

Consumer’s Equilibrium
A consumer is in equilibrium when he maximises his utility, given
income and market prices.
In other words, equilibrium is attained when the consumer reaches
the highest possible indifference curve given his budget constraint.
Two conditions that must be fulfilled by the consumer to be in
equilibrium by indifference curve approach are:
1. MRSxy= Px / Py
2. Diminishing MRS - It means, for a stable equilibrium, MRS must be
continuously falling. This condition means that the indifference
curve is strictly convex.

At point E, the consumer’s budget line is tangent to the indifference
curve I2. It is the point of consumer’s equilibrium. At point E,
[Slope of indifference curve] = [slope of budget line]

Income effect on consumer’s
equilibrium
Income effect on consumer’s equilibrium can be defined as the effect
caused by changes in consumer’s income on his/her purchases while
the prices of commodities remain unchanged.
Every increase in the consumer’s income will lead to a higher IC
because the consumer has greater income which will cause the Budget
Line to shift to the right.
Income Consumption Curve: It shows the relationship between
changes in the level of income and corresponding changes in the level
of consumption and the equilibrium level.

Income Consumption Curve

Income effect - Good X is an
inferior good and Good Y is a
normal good

Income effect - Good Y is an
inferior good and Good X is a
normal good

Income effect in case of
necessity goods/neutral
goods

Price effect on consumer
equilibrium
The Price effect explains what will happen to the consumer’s
equilibrium position when the price of one goods changes, while the
price of other factors remain constant.
Every fall in price of Good X will shift the Budget Line outwards to a new
intercept on the X-axis.
Price Consumption Curve: It shows how consumption of a product
changes as price changes.

Price Consumption Curve

Unit - I
THEORY OF DEMAND
Introduction
Demand and supply are the two forces through which market
economy functions.
In a market economy what goods are produced and in what
quantities are determined by demand and supply for various
goods
In a competitive market, prices of goods and services are
determined through interaction of demand and supply of them.
The prices in turn influence demand for and supply of goods and
play an important role in allocation of scarce resources in a
market economy
Demand and supply describes how buyers of goods and sellers of
goods behave in response to changes in process of goods and
other factors
Concept of Demand
The terms desire and demand are used inter-changeably.
Demand = Desire + Ability to pay + Willingness to pay or to
spend
Demand has THREE components:
1. Quantity demanded
2. Price
3. Time
Demand depends upon utility of the commodity.

Demand and Quantity
Demanded
Demand refers to different possible quantities to be
purchased at different possible prices of a commodity.
Quantity demanded refers to a specific quantity to be
purchased against a specific price of the commodity.

Demand function
It shows the functional relationship between demand for a commodity
and its determinants.
It can be expressed as:
DX = f (PX, PZ, Y, T, E, N, Yd )
DX= Demand for commodity X
PX= Price of commodity X
PZ= Prices of related goods
Y = Income of consumer
T = Taste and preferences of consumer
E = Future expectation
N = No. of consumers
Yd= Distribution of income

Determinants Factors affecting
Individual Demand
1. Price of a commodity -
2. Price of related goods – Substitute goods (AC & Cooler)
& Complementary goods (Computer & software)
3. Income of the consumer -
4. Taste and preferences of the consumer – Influenced by
advertisement (mobile phone), change in fashion
(jeans, ethnic wear), climate (cold drinks, umbrella),
new inventions.
5. Consumers expectations – Gold, onions

Factors influencing market
demand
1. Population Size/Number of Buyers - Ex- More aged
population will require more medicines
2. Distribution of Income – Even distribution will create
more demand

Review question - Factors affecting
the demand for healthcare in an
economy
Demand will depend on –
1. Price
2. Income
3. Population size and age distribution
4. Health needs
5. Balance between public and private provision
6. Attitudes to health
7. Awareness of availability of services
8. Government policy etc.
Review questions
1. Nike becomes very unpopular. What will happen to the demand
for Reebok?
2. A firm offers 6 mugs by way of gift with every 500 gm pack of
instant coffee. Name the products the demand for which will
suffer a set back? How?
3. Imagine that you are a new global auto maker planning to enter
the Indian market. List the various demand aspects you think
are important.
4. Explain factors affecting – Mobile phones, TV, Computers.
5. Identify the major factors influencing market demand for – Ice
Cream, Sugar, Jeans.

Law of demand
The law of demand explains the inverse relationship
between the price and quantity demanded of the
commodity.
Other things being equal, price and quantity demanded of a
commodity move in the opposite direction.
DX = f (PX), ceteris paribus

Assumptions of the law
1. No change in price of related goods – Substitute goods (AC and
Cooler) & Complementary goods (Computer and software)
2. No change in Income of the consumer -
3. No change in taste and preferences of the consumer – Jeans
4. No change in consumer expectations – Ex – Cyclone and crude oil
prices
5. No change in population

Demand Schedule – A tabular
representation
Price (per kg) Qty Demanded (Kg per month)
23 6
33 5
40 4
50 3
It is a tabular presentation showing the different quantities of a good

that buyers of the good are willing to buy at different prices during a
given period of time.

Demand Curve – A graphical
representation
The graphical representation of the demand schedule is called a
demand curve.
q = a – bp

Why demand curve slope downwards ?
1. Law of diminishing marginal utility – Consumer will prefer
to buy additional unit only at lower price
2. Income effect – As the price of a commodity decreases,
the real income of the consumer increases
3. Substitution effect – When price of any commodity
increases while prices of other substitute goods remain
unchanged, consumers would prefer any one of these
substitute goods.
4. Entry and exit of new customers –
5. Various uses – Ex- Sugar, Electricity, Milk

Exceptions of the law
1. Giffen goods/ Inferior goods – Demand for inferior goods like
coarse grains will not increase even when their prices fall
2. Articles of distinction – Ex- Jewellery, Luxury goods (Veblen
effect)
3. Necessities of life – Ex- Foodgrains, Medicines
4. Future expectations regarding change in price –Uncertainty in
Afghanistan and price of dry fruits
5. Ignorance / illusion – Stock clearance sale
6. Abnormal conditions – Ex- Wars, Famines, Flood

What will happen to demand for goods
at the time of economy slow down
(Covid-19) ?
1. Real estate
2. Electronics
3. Luxury cars
4. Designers product
5. Travel and tourism
6. Restaurant business
Luxury market do shrink but not hard - hitted by economic
slow down.

Change in quantity demand
Movement along the same demand curve
Other things being equal, when there is a change in the
price of the commodity, the resulting change in
demand is shown along the same demand curve
When the price of commodity falls, its demand
expands it is called as ‘extension of demand’.
When the price rise will result in the reduction of
demand it is called as ‘contraction of demand’.

Change / Shift in the demand
curve
When the demand changes on account of the factors other
than price, there will be a shift in the demand curve. This
situation is termed as change in demand.
When, the demand of the product increases due to any
other factor, it is called increase in demand
(upward/rightward shift).
When, quantity demanded falls due to factor other than
rise in product price, it is called as decrease in demand
(downward/leftward shift).

Increase in demand
The causes of increase in demand are:
1. Increase in the income of the consumers in case of
normal goods.
2. Decrease in the income of the consumers in case of
inferior goods.
3. Increase in the price of substitute goods.
4. Fall in the price of complementary goods.
5. Consumers’ taste becoming stronger in favour of the
good.

Decrease in demand
The causes of decrease in demand are:
1. Fall in the income of the consumers in case of normal
goods.
2. Rise in the income of the consumers in case of inferior
goods.
3. Fall in the price of substitute goods.
4. Rise in the price of complementary goods.
5. Consumers’ taste becoming unfavourable towards the
good.

Change in quantity
demanded vs. change in
demand
Change in quantity demanded Change in demand

Review question – Movement &
shift
1. The Microsoft Xbox 360 gaming console is getting its price
slashed in India, making it all the more affordable for gamers
who’ve been eyeing it for long.
2. When a XYZ Telecom company, offered reduced rates on
weekends, its volumes of weekend calling risen sharply.
3. People buy more long-stem roses in the week of the
Valentine's day.
4. Dell computer’s lowers its prices on all type of laptop models.
5. The government mandates that regular bulbs can no longer
be sold and the consumers make the switch to LED bulbs.

Elasticity – The concept
The responsiveness of one variable to changes in another.
When price rises, what happens to demand?
Demand falls
BUT!
How much does demand fall?

If price rises by 10% - what happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which demand will
change.

Elasticity - Types
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand

Price Elasticity of Demand
Price elasticity of demand is the percentage change in
quantity demanded given a percent change in the price.
It is a measure of how much the quantity demanded of a
good responds to a change in the price of that good.
The responsiveness of demand to change in price

Price Elasticity
Price Elasticity of Demand:
◦ Where % change in demand is greater than % change in
price – elastic
◦ Where % change in demand is less than % change in price
- inelastic

Computing the Price
Elasticity of Demand
The price elasticity of demand is computed as the
percentage change in the quantity demanded divided by
the percentage change in price.
Price Elasticity = Percentage Change in Qd

of Demand Percentage Change in Price

Degrees/coefficients of PEd
There are five coefficients of price elasticity of demand.

Perfectly Inelastic Demand - Elasticity =
0
Price Demand
Life saving medicines,

1. An 5
Essential food item
increase
in price... 4
100 Quantity
2. ...leaves the quantity demanded unchanged.
Inelastic Demand - Elasticity is less than
1
When consumption cannot be postponed or the
Price
expenditure on it is very small or its close substitutes
are not available in the market
1. A 25% 5
increase
in price... 4
Demand
90 100 Quantity
2. ...leads to a 10% decrease in quantity.
Unit Elastic Demand - Elasticity equals 1
Price
1. A 25% 5
increase
in price... 4
Demand
75 100 Quantity
Elastic Demand - Elasticity is greater
than 1
Luxury goods; close substitutes of the
Price
commodity are large; the commodity has
many uses
1. A 25% 5
increase
in price... 4
Demand
50 100 Quantity
Perfectly Elastic Demand -Elasticity
equals infinity
In our real life, we do not have any such
Price
commodity having perfectly elastic demand
1. At any price
above 4, quantity
demanded is zero.
4 Demand
2. At exactly 4,
consumers will
buy any quantity.
3. At a price below 4, Quantity

quantity demanded is infinite.
Determinants of Price
Demand tends to be more elastic :
If the good is a luxury
The longer the time period
The larger the number of close substitutes
Can be postponed
More income is spent on the goods
Price level – Moderate
Not a Joint good
If have more uses
Habits

Determinants of Price
Demand tends to be more inelastic:
If the good is a necessity
If the time period is shorter
The smaller the number of close substitutes
Cannot be postponed
Little income is spent on the goods
Price level – High & low
Joint goods
If have less uses
Habits

Review question
1. Will the demand be – Elastic or inelastic for the
following products and why?
A. Cooking gas
B. Cigarettes
C. T.V.
D. Diamonds
E. Washing Machines

Review question
You are a Ford dealer, and you know that the price elasticity
of demand for Ford cars is 1.5. What will happen to your
total revenue from Ford car sales if you raise your prices?

ANSWER
Because price elasticity of demand for Fords is greater than
1, an increase in price will reduce total revenue.
NOTE: Revenue is NOT profit!

Review question
Suppose you are the manager of a theater. You currently
charge the same admission price to all customers,
regardless of age. You hire an economist to determine the
price elasticity of demand for admissions by age, and he
tells you that at the current price, demand by adults is
inelastic and demand by children is elastic. If you want to
increase your total revenue by adjusting admission prices,
how should they be adjusted?

Answer
The solution is a 2- tier price system, with higher prices for
adults and lower prices for children.

Unit - I
SUPPLY
Supply
The quantity offered for sale at a particular price and during a particular
time by the producer/firm.
THREE elements of supply:
1. Quantity supplied
2. Price
3. Period of time

Supply function
It expresses the functional relationship between the supply
of a commodity and its various determinants.
The supply function can be written as:
SX = f (PX, Pr, G, Pf, T, Ex, N Gp)

SX= Supply of commodity X
f = function of
PX= Price of commodity X
Pr = Price of related good, Z
G= Goal of the firm
T = Technological changes
Pf= Prices of factors of production
N = Natural factors
Gp= Government policy

Factors affecting / Influencing/ Determinants of
Supply
1. Price of the commodity -
2. Price of other commodity – Football Vs volleyball
3. Goal of the firm – Profit / Sales maximization
4. Prices of factors of production
5. State of technology – Picture tube /panel price and LED price
6. Future expectations regarding the price
7. Natural factors – Rainfall, Soil, Climatic conditions
8. Government policies – Taxes (excise duty) and Subsidies – E Vehicle

Review question
Factors affecting the supply of Indian software export
services?

Law of Supply
Other things being equal, the quantity supplied of a
commodity varies directly with its price.
In other words, when price of a commodity rises, supply
increases and vice-versa.
SX= f (PX), ceteris paribus

Assumptions of the law of
supply
1. No change in the price of related goods
2. No change in the state of technology
3. No change in the goals of the firm
4. No change in the price of factors of production
5. No change in the expected price of the commodity by the producer
6. No change in government policy related to tax/subsidies

Supply schedule – A tabular
representation
1. Individual supply schedule – Shows individual quantities
of a commodity that a producer is prepared to sell at
various prices.
2. Market supply schedule – Gives the same information
about the whole market of a given commodity.

Supply schedule
Price (Rs per kg) Qs (Kg per month)
1 5
2 8
3 12

Supply Curve

Why does supply curve slope
upwards?
1. Law of diminishing marginal productivity – Marginal unit increases
cost. So more will be supplied at higher price
2. Change in stock – If price rises, sellers are ready to sell more from
their old stocks
3. Profit and loss – If Price rises, supply will increase and profit will go
up
4. Entry and exit of new firms – If profit, new firms will enter and
supply will increase

Exceptions of the law
1. Future expectations about change in the price
2. In case of agricultural goods
3. In case of perishable goods
4. Goods of auction
5. In case of rare goods – Ex- Poems, Paintings
6. In case of backward countries

Review question
Farmers can plant either corn or soybeans in their fields.
Which of the following would cause the supply of soybeans
to rise?
a) an increase in the price of soybeans
b) a decrease in the price of corn
c) an increase in the demand for corn
d) an increase in the price of soybean seeds

Changes in supply
1. Movements along the same supply curve
2. Shifts in supply curve

Movements along the same supply
curve
When the supply of a commodity changes due to change in its
price. It is reflected by different points on a supply curve which
is called as movement along the same supply curve/change in
quantity supply.
Types:
1. Other things being equal, when supply of a commodity expands due to
rise in its price, it is called extension/expansion of supply.
2. Other things being equal, when the supply of a commodity falls a result
of fall in its price, it is called contraction of supply.

Movement along Supply
Curve

Shifts in supply curve
When the supply of a commodity changes due to the
factors other than the price, it is called change / shift in
supply.
Types:
1. When more quantity is supplies at the same price, the situation is
called as increase in supply.
2. When less quantity is supplied at the same price , the situation is
called as decrease in supply.

Shift in supply

Review question
A company produces steel almirahs of a given type,
dimension and quality. The market price of steel rises by 20
per cent. Illustrate how this would affect the company’s
supply curve of almirahs?

Answer
An increase in the price of steel reflects an input price
increase. This will imply that at the same price for an
almirah, the company will supply less.

Which of the following would shift the supply curve for
energy drinks to the left?
a) a decrease in the expected future price of energy
drinks
b) an increase in consumer income (assuming that
energy drinks are normal goods)
c) a decrease in the number of firms that produce
energy drinks
d) a decrease in the price of an input used to produce
energy drinks

Answer
a decrease in the number of firms that produce energy
drinks

Review question - identify
movement or shift in supply
curve
1. During a real estate boom that causes houses prices to
rise, more homeowners put their houses up for sale.
2. Many watermelon farmers open temporary roadside
stands during harvest season.
3. The Indian government establishes a new regulation that
all seat belts in front as well as in the backseat must
contain airbags.
4. The government offers tax incentives to mobile
manufacturing firms under the Make in India
programme.

Unit I
MARKET EQUILIBRIUM
Market equilibrium: Supply and
demand
How do supply and demand combined together determine the
quantity and price of a good sold in the market?
Supply and demand curves intersect. At this equilibrium price
quantity supplied equals quantity demanded.
Equilibrium is a situation in which supply equals demand.
Equilibrium price is also called as the market clearing price as
quantity supplied equals quantity demanded.

Example
The market for wheat is give as follows. Find the
equilibrium P and Q.
Qs = 1800 + 240P
Qd = 3550 -266P
Market clearing situation: Qs = Qd
Price = 3.46
Qs = 2630

Example
Qd = 66-3P
Qs = -4+2P
Find equilibrium P and Q.

SUPPLY AND DEMAND
What happens when market price is not equal to the equilibrium
price?
Excess supply- surplus in the market
Excess demand- shortage in the market
Free markets reach equilibrium through the interaction of buyers
and sellers and price is the tool through which the market is
cleared.

Market Equilibrium
S NEHRA EFE UNIT I

Analyzing Changes in
Equilibrium: Application
1. Changes in demand- shifts in the demand curve
2. Changes in supply- shifts in the supply curve
3. Changes in both supply and demand- Change in equilibrium
quantity and price

1. Demand shifts to the right
• When Demand increases, Equilibrium Price and Quantity

increases

Demand shifts to the left
• Example: New car market in a recession

• When Demand decreases, Equilibrium Price and Quantity
decrease

2. Supply shifts to the right
• Example: New technology increases amount of corn grown per

acre
• When Supply increases, Equilibrium Price decreases but Quantity
increases

Supply shifts to the left
• Example: Rising cotton prices cause jean manufacturers to

reduce output
• When Supply decreases, Equilibrium Price increases but
Quantity decreases

3. Simultaneous changes in
both supply and demand
Four possible combinations:
1. Supply decreases, demand increases
2. Supply increases, demand decreases
3. Both demand & supply increases
4. Both demand & supply decreases

1. Supply decreases, demand
increases
• Example: Demand for wheat rises but Supply for wheat
decreases
• Equilibrium Price increases but Quantity is same

2. Supply increases, demand
decreases
• Example: Demand for ZEE Music decreases but Supply
increases
• Equilibrium Price decreases but Quantity is same

3. Both demand & supply
increases
• Example: Demand for snowboards increases and Supply
increases
• Equilibrium Price is same but Quantity change increases

4. Both demand & supply
decreases
• Example: Demand for Justin Beiber tickets decreases and
Supply decreases
• Equilibrium Price is same but Quantity change decreases

Applications of Demand and
Supply Analysis
Event: A national newspaper reports that the prices of PC
components are expected to fall by 5-8 percent over the
next six months.
Scenario 1: You manage a small firm that manufactures PCs.
Scenario 2: You manage a small software company.

Both demand and supply
shifts
The computer industry witnessed incredible improvements
in technology, as well as the entry of many new firms into
the industry, have increased supply.
Simultaneously, many people have become very aware of
the benefits of computers, and new software has made
computers more useful for a variety of projects, thereby
increasing demand as well.

Review question
1. A new movie is released after having been heavily
promoted to teenagers. On the first night, the tickets sell
out and there are still teenagers waiting outside
theaters, desperate to see the movie and unable to get a
ticket. Is this market in equilibrium?
2. A Japanese car manufacturer in India has produced a lot
of SUVs, but now is having difficulty selling them at the
price it had intended to sell them for. The cars are sitting
at the warehouse unsold. Is this market in equilibrium?
Explain.

Review question
Suppose the demand curve for petrol shifts to the right, as global
demand from India and China increases. Suppose also that new
discoveries of oil enable an increase in the supply of petrol to be sold on
the market. Assuming that nothing else changes, what is the likely
effect on the equilibrium price of petrol?
1. The equilibrium price rises.
2. The equilibrium price falls.
3. The equilibrium price remains the same.
4. The effect on the equilibrium price is uncertain, as it depends on the
extent of the shifts in supply and demand.

Review question
Which of the following would cause both the equilibrium price and
equilibrium quantity of barley (assume that barley is an inferior good)
to increase?
1. an increase in consumer income
2. a drought that sharply reduces barley output
3. a decrease in consumer income
4. unusually good weather that results in a bumper crop of barley

Answer
A decrease in consumer income

Review question
Prices of commercial airline tickets (assume that this is a normal good)
have fallen in recent months. Over this same period, the price of jet fuel
has risen and consumer incomes have fallen. Which of the following
best explains the falling prices of airline tickets?
1. The supply curve for airline tickets has shifted to the left while the
demand curve for airline tickets has shifted to the right.
2. The demand curve for airline tickets has shifted to the left more
than the supply curve has shifted to the left.
3. The demand curve and the supply curve for airline tickets have both
shifted to the right.
4. The supply curve for airline tickets has shifted to the left more than
the demand curve has shifted to the left.

Price restrictions
In a freely functioning market, equilibrium price is
determined by the intersection of demand and supply
curves. But in a welfare state, government often intervenes
in the market to control prices.
Two ways in which government intervenes in changing the
equilibrium price are:
1. Indirect intervention by imposing taxes and granting
subsidies.
2. Direct intervention by fixing prices.

Price control/ Price Ceiling
The maximum legal price that can be charged. It creates
shortage, black marketing, benefits consumers.
Restrictions on ATM fees
Price of sugar
Rent control act
Life saving medicines

Price Ceiling

Support Price/Price Floor
The minimum legal price that can be charged. It creates
surplus, benefits producers, consumers are at loss.
Minimum wage
Agricultural price support

Price Floor

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Unit - I

What Economics is all about?

Economics is a study of economic phenomena around individuals, regions,

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Basis Based on Based on interdependence

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Economics relies upon laws and theories for analysis.

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Positive economics deals with causes and consequences

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• Production – An activity designed to satisfy peoples’ want – Done by producers

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Allocation Efficient use or Economic Development

What to How to For whom to

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• Economic growth shifts the PPF outward