Unit -1

Introduction
Meaning of Economics:- Economics is a branch of knowledge which deals with economic activities of
human being.
Definitions
Adam smith (1776):- “Economics is an inquiry into the nature and causes of the wealth of the nations”.
Alfred Marshal (1890):- “Economics is the study of mankind in the ordinary business of life; it examines
that part of individual and social action which is most closely connected with the attainment, with the use of
material requisites of wellbeing”
Lionel Robbins (1932):- “Economics is the science which studies human behavior as a relationship
between ends (wants) and scare means which have alternative uses”.
 Father of Economics:- Adam smith (1776)
 Father of modern macroeconomics:- John Maynard Keynes (1936)
 Economist who split economics in to two branches:- Regner Frisch (1936)
Branches of Economics
Microeconomics:- Microeconomics is a branch of economics which deals economics activities at individual
level.
Macroeconomics:- Macroeconomics is that branch of economics which study economic activities at
aggregate level or economy as a whole.
Difference between micro and macroeconomics
Basis Microeconomics Macroeconomics
1. Focus Study of individuals Study of aggregate
2. Tools Market demand and market Aggregate demand and Aggregate
supply supply
3. Objective It aims to determine price of a It aims to determine income and
commodity or factors price employment level of the economy
4. Other name Price theory Income and employment theory
5. Subjects matter Individual income and National income and National
Individual output price of a output price level
good
6. Degree of aggregates Limited degree of aggregates High degree of aggregates

Interdependence between micro and macro

Micro and macroeconomics are not opposite to each other. In fact the study of one depends upon the study
of other. As the macro variables are the sum of micro variables like; Aggregate demand which is macro
variable is a sum of demand by all individuals for all goods and services which is studied under micro
economics.
Examples:-
1. National income (macro variables) is the sum total of income of all the residents of the economy (micro
variables)
2. Wages in particular industry (micro variable) is affected by overall wage rate in the economy (macro
variables)
Meaning of Economy
An economy is a system or framework in which all the economics activities are take place.
Types of Economy
1. Centrally planned economy:- Centrally planned economy is an economy system in which all the
decision regarding economic problems are taken by central authority or government for maximization
of social welfare.
2. Market economy:- Market economy is an economic system in which decision regarding central
economics problems are taken by market forces for maximization of profit
3. Mixed economy:- Mixed economy is that economic system in which both public and private sector
work together for full filling their motive by using resources own by them
Positive economics vs normative economics

Positive economics Normative economics

1. Positive economics deals
with economics issue (or
economic behavior) related
to past present and future.
2. It relates to what was, what
is and what would be.
3. These may be true and
false.
4. Facts can be verified.
5. It doesn’t include value
judgment.
1. Normative economics deals with
opinions of the economists related
to economic issue or economic
problem.
2. Statement of normative
economics relate to “what ought
to be”.
3. It can’t be termed as true and
false, it requires opinion.
4. It can’t be verified.
5. It requires value judgment.

Economic Problem
Economics problem are the problem of making choices in the use of scare resources those have alternative
use for the satisfaction of unlimited human wants
Why does the Economic problem arises?
The reasons of Economic problem are:
1. Unlimited human wants:- Human wants are unlimited. As one want is satisfied many other wants
arises. Wants also differ in urgency. Some wants are more urgent than others. Hence resources always
remains scare in relation to wants.
2. Scarcity of the resources:- Scarcity is a situation in which supply of anything fall less than its demand
even at zero price. Resources always remain scare in relation to wants this the reason problem of
choices arises.
3. Alternative use of the resources:- Alternative use of resources means that the resources can be put to
more than one use. Hence choice has to be made for different alternative uses.
Economizing of the resources
Making best use of the available resources is known as the economizing of the resources.
Central Problems of an Economy
Every economy has to face problem of choices those are called central problems of an economy.
1. What to produce and in what quantities:- This problem involve selection of goods and services to
produce and the quantity to be produced of each selected commodity. Every economy has limited
resources and thus cannot produce all the goods. An economy has to make sacrifice of one good for
choosing the other one.
Alternative use of the resources

Captial goods Consumer goods

For producens use For Consumer use

Help in making profit Help in welfare

Generally market economy choose Centrally planned economy choose

2. How to produce:- How to produce problem refers to selection of technique to be used for production
of goods and services. A good or service can be produce by using different technique of production like
capital intensive or labor intensive.
Technique of production

Capital intensive techinque Labour intensive techinque

More use of captial More use of labour

More quantity at less cost Less quantity but more empolyment

More profit More welfare

Choose by market economy Choose by centrally planned economy

3. For whom to produce:- Goods and services are only produced for those who have purchasing power to
buy them. Purchasing power in fact depends upon the distribution of income. Therefore this problem
for whom to produce is studied in reference to distribution of income.
Distribution of factor income

Personal Distribution Functional Distribution

Guided by self interest Guided by collective interest

Some people become rich All factors get according to contribution

Create inequality Create equitability

Production Possibility Curve
Production possibility curve shows different combination of two goods which can be produced with the
given resources on the assumption that (i) resources are fully and efficiently utilized (ii) technique of
production does not change and (iii) no resources are equally efficient in the production of all goods.
Other names of PPC:-
 Production possibility frontier
 Production possibility boundary
 Transformation line
 Transformation curve.
Explination:- Productions Possibility Schedule

Combinations Cloth ‘x’ Wheat ‘y’ MOC/MRT

(‘000’ mts) (‘000 qnt.) ∆Y/∆X
A 0 15 -
B 1 14 1Y : 1X
C 2 12 2Y : 1X
D 3 9 3Y : 1X
E 4 5 4Y : 1X
F 5 0 5Y : 1X
If all the given resources are employed for production of wheat it is supposed that 15 thousands quantities
of wheat can be produced on the other hand if all the resources are devoted to production of cloth 5
thousand meters of cloth can be produce. In between there will be many other production possibilities such
as B, C, D and E
 15

Fuller and efficient

utilization of the
resources

 Point ‘A, B, C, D, E, F’ are on the PPC hence they show fuller and efficient utilization of resources.
 Point ‘H’ lie below the PPC hence it shows inefficient and underutilization of the resources.
 Point ‘G’ Lie beyond the PPC hence it shows that this combination is unattainable at the given
resources.
Or
This combination shows Economic growth for future.
Marginal opportunity cost (MOC):- MOC is defined as the amount of one good that needs to be
sacrificed per unit increase in production of the other good.
Marginal rate of transformation (MRT):- MRT can be defined as the ratio of number of units for a good
scarified to produce one more unit of other good in a two goods economy.
Loss of output
MOC =
Gain of output
Sacrifice of good 2
MRT =
Gain of good 1
MOC = MRT  Both express the slope of „PPC‟.
Slope of PPC:-
Slope from a to c
Y Loss
MOC/MRT  
X Gain
Owo  Ow WWo ab
 
Oc1  Oc CC1 bc
Hence MOC or MRT is consider as a slope of a PPC
Y

A
a
W

Wheat
loss y
Wo c
b

Gain
x
O
C C1 B X
Cloth
Opportunity cost:- Opportunity cost is the cost of availing one opportunity in terms of the loss of the other
opportunity.
Properties of the PPC
1. Sloping down ward from left to right:- It is so because to produce one good an economy has to
sacrifice some quantity of the other good. As the resources are scare production of both the good cannot
increase together.
2. A PPC is a concave to the origin:- Because a PPC is based on Law of increasing MOC/MRT. The law
of increasing MOC/MRT state that every economy has to sacrifice more and more unit of good 2 for
producing an additional unit of good 1.As we known that all the resources are not equally efficient for
the production of all the goods.
Changes in PCC
A PPC rotate and shifted due to two reasons.
1. Change in the resources
(a) Increase in the resources (b) Decrease in the resources
2. Improvement in the production technology.
(a) Improvement in production technology for „x‟
(b) Improvement in production technology for „y‟
(c) Improvement tin production technology for both.
1. Change in PPC due to resources:- If the resources for an economy or a producer increase and
decreases a PPC shifted right ward and left ward.
(A) Increase (B) Decrease
(Rightward shifting) (Left ward shifting)
Y
Y
2y PP
C y
af
te In
ri
Good 'y'

nc iti
al
Good 'y'

re P
y sa PC
se
y
In

2
iti

PP
al

C
P
PC

af
te
rd
ec
re
as
e

O x O x
2x X x/2 X
Good x Good x
2. Change in PPC due to improvement in technology:- If the production technology improve over the
time than a PPC rotate and shifted.
(a) Tech. improve for „x‟ (b) Tech. improve for „y‟
Y Y

y 2y

y
Good 'y'

Good 'y'
O x O x
2x X X
Good x Good x
(c) Tech improve for both „x‟ and „y‟. Right ward shifting

2y

y
Good 'y'

O x 2x X
Good x
Economic agent:- Economic agent are the person or organization who take economic decision about scare
means for fulfilling their motive of economic activity.
Example:- Consumer, producer, Government

*****
 Unit -2
Consumer’s Equilibrium
Who is a consumer:- Consumer is a person who destroy the utility of the goods and services for the
satisfaction of his own wants.
What is Equilibrium:- An Equilibrium is a point of state which every economics agent want to attain for
maximization of his motive of economic activity by the use of scare resources. But after attaining this level
he has no tendency to change this point.
What is consumer’s Equilibrium:- It is a situation in which a consumer utilise his income in such a
manner that he maximize his total satisfaction at the given income at constant prices. The consumer have
urge to reach at this point but do not want to go beyond this point of state.
Approaches of Consumer’s Equilibrium
1. Cardinal approach:- Cardinal approach is propounded by prof. Alfred Marshal in 1890. This approach
also known marginal utility analysis.
According to cardinal approach utility of the goods and services are measurable in cardinal numbers
(i.e., 1, 2, 3 ……….) and express in terms of utile.
2. Ordinal approach:- Ordinal approach is given by R.G. D. Allen and J.R hicks in 1934. This approach
is well known as indifference curve analysis.
According to ordinal approach satisfaction derive from goods and services cannot be measure but
preference can be given to consumption like 1st , 2nd 3rd ………… ect.
Cardinal Utility Approach
The cardinal utility theory was developed by classical economics like
 H.H. Gossen (1854) of Germany
 William Stanley Jevons (1871) of England
 Leon walrus (1874) of France
 Karl Menninger (1840 – 1921) of Austria
Neo-classical economists particularly Alfred Marshal (1890) refine the coordinal utility theory. This led the
cardinal utility theory to be known as Marshalian utility theory.
Before we proceed to describe the cardinal utility theory, we will first understand the basic concepts
used in this theory.
 Utility:- utility is the want satisfactory power of goods and services
 Utils:- Util is the measuring unit for utility.
One util is equal to the money units those a consumer is willing to sacrifice for a commodity.
 Measurement of utility:-
1. Marginal Utility (MU):- Marginal utility is the additional utility derived from the consumption of
one additional unit of a commodity.
Or
Marginal utility is the addition to the total utility.
TU
MU  or MU  TUn  TUn 1
Q
2. Total Utility (TU):- Total utility refers to the entire amount of satisfaction obtained from consuming
various quantities of a commodity.
Or
Total utility is the sum total of marginal utility.
TU   MU
TU  MU1  MU 2  MU 3  MU 4 .......MU n
The Law of Diminishing Marginal Utility:- The law of diminishing marginal utility state that as a
consumer consumes standard unit (consumable unit) of a commodity in continuous manner satisfaction
derived from every additional unit will diminish continuously.
Example:- Suppose you are very hungry and you are offered sandwiches to eat. The satisfaction which you
derive from the first piece of sandwich would be maximum because intensity of your hunger was the
highest. When you eat the second piece you derive a lower satisfaction because maximum hungriness was
satisfied by first piece of sandwich. As you go on eating more and more pieces of sandwich the intensity of
your hunger goes of consumption is known as law of diminishing marginal utility.
Assumption of the Law of DMU:-
1. Unit of the commodity should be standard unit in term of size or volume.
2. There should be no time gap in the consumption period.
3. Purpose of the consumption should be satisfaction not for demonstration or show off.
4. Mental status during the consumption time should be the same.
5. Price of the good, income of the buyer, taste, preference and fashion should not change.
6. Commodity should be independent only ect.
Relationship between TU and MU:-
Units MU TU
1 6 6
2 4 10
3 2 12
4 0 12
5 -2 10
TU and MU
1. TU increases till MU diminishes but positive (unit 1 to 3)
2. TU is at maximum as MU reached at zero (unit to 4)
3. TU start declining as MU goes negative (unit to 5 on ward)
Y

12

10 TU

TU 8
& 6
MU 4

2
0 X
1 2 3 4 5
2
MU
4 units
Point of Saturation
Point of Satiety
Point of full satisfaction
(MU = Zero)
Point of saturation:- It is a point where a consumer fully satisfy after the consumption of certain units of a
commodity. This point have no concern with the price of the commodity. At this point MU = zero, TU =
Maximum.
Consumer’s Equilibrium
Consumer equilibrium refers to a situation under which the consumers spend his given income on the
purchase of a commodity or combination of goods in such a way that gives him maximum satisfaction (or
total utility). If consumers choose less to consume than the equilibrium unit will have less satisfaction and
if he consume more than equilibrium unit than the total satisfaction will reduce. Hence a consumer do not
have tendency to change the equilibrium.
Two case of consumer‟s equilibrium under marginal utility analysis.
(a) One commodity approach (b) Two (multi) commodity approach
(A) One commodity case
When a consumer buys a single commodity he will try to consume the commodity upto a point where price
of a commodity become equal to ratio of marginal utility of good and marginal utility of the money.
MU of commodity
 price of commodity
MU of money
Assumptions:
1. Marginal utility of the good is measurable in terms of cardinal numbers.
2. Price of a commodity is constant.
3. Marginal utility of the money is also constant.
4. Consumer is a rational person.
MU x
 Px MU x
MU m Or  MU m
Px

Satisfaction derived Sacrifice for an

Actual satisfaction Estimated satisfaction
from an additional additional unit
from an addition from an addition
unit of a good of a good
unit unit
Marginal Utility of money:- MUm refers to worth of a rupee to consumer. The consumer is expected to
define it himself.
Note:- MUm = 1 Assume in our example to make our analysis is simple.
Explanation of Consumers equilibrium:-
Suppose Px  10
MU m  1 Util
MU x
So,  Px  MU x  Px  MU m  1
MU m
Units MUx Price Status of consumption
1 20 10 MUx > Px
2 15 10
3 10 10 MUx = Px
4 5 10
5 0 10 MUx < Px
6 -5 10
Consumer surplus:- Consumer is in surplus situation at unit 1 and 2 because he is gaining more
satisfaction than what he is expecting or sacrifing (price) for the good. So consumer will choose these units
for consumption.
Consumer equilibrium:- Consumer is in equilibrium situation at unit 3. Because he is obtain equal
satisfaction to what he is expecting or sacrificing for the good. This equilibrium point is also known as
point of rest, point of state. Because consumer have urge to react this point but do not have tendency to
cross the point.
Consumer loss:- A consumer would not like to consume any unit after the equilibrium point. Because
marginal satisfaction fall less than marginal sacrifices (price) for the unit (unit 4 onwards)
Y
MU x
 Px
20 MU m

MU x
15  Px
MU m
10 ........ Price
MU m ........ MU x
......  Px
MU m ...
5
MU m

0 X
1 2 3 4 5 6
-5 units MU x
MU m
-Y
 Condition of consumer‟s equilibrium in single commodity case:-
Ratio of MUx and MUm should be equal to price of the commodity.
MUx MUx
 price or  MUm
MUm Px
(B) Two (Multi) commodity case
When a consumer choose two (or more than two) commodity for consumption than the maximum
satisfaction will be at a point where ratio of marginal utility of both (or more) the commodities become
equal to price ratio of both (or more) the commodities. This is according to law of Equi marginal utility.
Law of Equi marginal utility:- According to the law of equi marginal utility a consumer gets maximum
satisfaction when the ratio of marginal utilities of all commodities and their prices are equal.
This law is also known as law of substitution or second law of consumption. It is given by H. H. Gossen.
 If Px  Py
MUx MUy MUx Px
Than  or 
Px Py MUy Py
 If Px  Py
Than MUx  MUy
 Condition of consumer’s equilibrium in two commodity case:-
MUx MUy
1. MU of last unit of money spent on each good is same 
Px Py
 What happens when equality condition is not satisfied:-
MUx MUy
Suppose  this means that MU from the last rupee spent on „x‟ is greater than the MU
Px Py
of last rupee spent „y‟. The consumer will transfer his expenditure from „y‟ to „x‟. This transfer of
MUx MUy
expenditure will continue till the ratio of  again.
Px Py
2. The money income should be equal or less to the sum of expenditure done on „x‟ and „y‟
commodity.
M   Px  Qx    Py  Qy 
Explination:-
 Suppose Px  Py  Rupee 1
Income = Rupees 7
Units MUx MUy
1 14 12
2 12 10
3 10 8
4 8 6
5 6 4
6 4 2
A consumer spend first rupee on x good because here MUx  MUy (14 > 12) and then second and third on
x and y here MUx  MUy (12 = 12) (10 = 10) but second condition is not operating some money will
remain unused with the consumer and we know that a consumer is guided by monotonic preference so he
spend more to satisfied more because he has no tendency to save.
Than the consumer buy 4th unit both the condition of consumer‟s equilibrium satisfy
1. MUx  MUy 8 utils = 8 utils
2. M   Px  Qx    Py  Qy 
7  1 4   1 3
7   4  3
77
Y Y1

14 14
Point of
12 Equilibrium 12
Mu x  Mu y
10 10
Mu x Mu y
8 8
6 6
4 Mu y 4
Mu x
2 2
0 01
x 1 2 3 4 5 6
6 5 4 3 2 1 y

Consumer’s reaction in different situation:- We know that in the case of two commodities a consumer
will be in equilibrium when the ratio of marginal utility to price in regard to both the commodities are
equal.
MUx MUy

Px Py
Let discuss some conditions when the situation is disturbed.
1. When ratio of marginal utility to price in case of x is higher than in case of ‘y’
MUx MUy

Px Py
It indicates that the per rupee MUx is greater than the per rupee MUy. It means that by transferring one
rupee from y to x the consumer gets more utility than he losses. Hence the consumer would like to
transfer some expenditure from y to x, this behavior will continue till again the ratio between marginal
utilities and price ratio of both the commodities become equal.
 MUx MUy
Vice versa in case of 
Px Py
2. In case of two commodities consumer’s equilibrium when the price of x falls.
MUx MUy  MUx MUy 
In this situation will become greater then    . Hence, here per rupee MUx
Px Py  Px Py 
becomes greater than per rupee MUy. Therefore consumer would start buying more units of x and this
MUx MUy
process will continue till again becomes equal to .
Px Py
Note:- vice versa in case price of y falls and mold the answer accordingly when price of x or y rises.

******
 Unit -3
Indifference Curve (Ordinal Approach) For Consumer Equilibrium
Ordinal approach:- This approach given by R.G.D Allen and J.R. Hicks in 1934. Ordinal approach is
strongly oppose the marshal‟s concept that the marginal utility of goods and services are measurable. Hicks
and Allen said that a rational consumer can only give prefential order to his consumption but no cardinal
number use by him to show satisfaction level.
Ordinal approach use indifference curve and budget line to show consumer‟s Equilibrium condition.
Consumer’s equilibrium (ordinal approach):- According ordinal approach a consumer attain equilibrium
where the slope of budget line. (MRExy) and slope of indifference curve become equal or tangent.
MRSxy  Px
Py

Slope of Slope of
indifference curve budget line

Shows willingness Shows buying capicity of

of the buyer the buyer at the market price
Let understand the slope separately for indifference curve and budget line.
Indifference curve:- Indifference curve is a curve which shows different combination of two goods those
gives equal level of satisfaction and the consumer become indifferent between two combination of two
goods when it comes to make choice between them.
Indifference set:- It is a set of those combinations of two goods which offer the consumer same level of
satisfaction.
Combination Apple Orange Satisfaction
A 1 10 2500 calories
B 2 7 2500 calories
C 3 5 2500 calories
D 4 4 2500 calories
Y

10 A
Points A B C D on IC
shown equal satisfaction
O
R
A B
N 7
G C
E 5
D Ic
4

0 1 2 3 4 X
APPLE
Properties/ Features / Characteristics of an IC
1. ICs have negative slop:- It implies two facts
(a) That the two commodities can be substituted with each other.
(b) If quantity of one commodity increases quantity of the other commodity must decrease to
stay on equal level of satisfaction.
2. ICs are convex to the origin:- The convexity of IC implies that the two commodities are imperfect
substitutes for each other and the marginal rate of substitution (MRSxy) between two commodities
diminishes as a consumer moves along the same IC.
3. Higher IC means higher the level of satisfaction:- Higher IC have more quantity of two goods in a
bundle as compare to lower IC and we know more quantity consume more satisfaction.
4. Two ICs never intersect each other:- The two ICs never intersect each other. If they intersect, at
some point both the ICs shows same satisfaction and at some point lower IC gives more satisfaction
than the higher one which is not possible. Because it discard the third properties
5. An Ic never touches x and y axis:- An IC is draw for two commodities not for one hence it never
touch any axis. If an IC touches any axis means it is for only one good.
What is marginal Rate of substitution:- It is rate at which a consumer is willing to substitute good 1 for
good 2. It is estimated as
Sacrifice of good-2
MRSxy 
Gain of good- 1
Slope of IC from point A to B
AC Good 2 Y ST
  
CB Good 1 X RP
MRSxy

Slope of I C

Willingness of consumer
Why MRSxy diminishes always:- The negative slope of IC implies that two commodities are not perfect
substitutes for each other. If a consumer having more and more of Good-1 his intensity of desire to have it
reduces and its willingness to sacrifice less and less of Good -2 for every additional unit of Good-1.
Indifference Map:- When more than one ICs are drawn on the same diagram then it is said indifference
map.
Note:- On an indifference map higher IC shows higher level of satisfaction.
Combination of good in different ICs
Y

A A1 A2
Y
Good - 2

IC3

IC 2

IC1

O x 2x 3x X
Good-1
Curve No. of Goods Hence
IC1  x  y IC3  IC2  IC1
IC2  2x  y  Higher the IC higher the
IC3  3x  y  Satisfaction level
Monotonic preference:- It means that a rational consumer always prefers more of a commodity as it offers
him a higher level of satisfaction. This behavior motivates him to more at higher indifference curve.

Budget line or Price line:- Budget line is a diagrammatic line showing different possible combination of
two goods those a consumer can purchase with his given income and at the constant prices. Budget line is
also known as price line.
Budget set:- It is a table which shows different bundle of two goods those a consumer can purchase with
the given income at constant prices.
Explination:- Suppose you have Rate 80 and Px  Rate 2/- Py  Rate 4/-
Combination of No. of Goods Marginal rate
Bundle of
Good (x) Good (y) exchange
A 0 20 -
B 10 15 5 y /10 x  .5
C 20 10 5 y /10 x  .5
D 30 5 5 y /10 x  .5
E 40 0 5 y /10 x  .5
Point A, B, C, D, E on budget line shows the bundle of goods those can be purchase.
Y

20 A
Non-Fessible
B or
15 Non-attainable
area
Good - 'Y'

C
10

D
5

E
O 10 20 40 X
30
Good 'x'
Slope of budget line:- Slope of budget line is term as marginal rate of exchange or the price ratio of both
Px Py
the goods or
Py Px
Price of good sacrificed
MRExy 
Price of good obtained
Slope of budget line from point A to B
AC price of 'Y'

CB price of 'X'
y ST Py
 
x RP Px
MRExy

Slope of budget line

Buying capacity of consumer
Market rate of exchange:- Market rate of exchange is a rate at which two goods can be exchange in regard
of the price.
 Or
Px Py
MRE between the x and y goods is the price ratio of the goods. e.g. or
Py Px
Budget constraint:- The consumer can afford to buy all those bundles of two goods that lie on or below the
budget line. He cannot buy any bundle of goods that lie above the budget line because line shows the budget
constraint.
It can be express M   Px  Qx    Py  Qy 
Properties of budget line
1. Budget line is left to right down ward Sloping:- It is because a consumer can buy extra units of one
commodity only by sacrificing some units of the other commodity as the income is constant.
2. Budget line is a straight line:- Slope of budget line is straight because it is based on two assumptions
(a) Consumer has a fixed income (b) Prices of two goods are given
Changes in budget line
1. Due to change in price:-
(A) If price of x good increases or decrease (B) If price of y good increases or decreases
Y

y1
Y

y
Px 
Good 'y'

y
Good 'y'

y0 Px 

Px  Px 
O x0 x x1 X
O x X
Good 'x' Good 'x'
(A) Price of x rises so a budget line rotate to left OX to OXo price of x falls than budget line rotate to right
OX to OX1
(B) Price of y rises than budget line rotate downward from OY to OYo. Price of y falls than budget line
rotate upward from OY to OY1
2. Due to change in income:-
(C) If income of the buyer increases (D) If income of the buyer decreases
Y

y1

y
Good 'y'

Y
=
R
at

y0
e
16
0
Y
=
R
at
Y
=

e
80
R
at
e
40

O x0 x x1 X
Good 'x'
 (C) and (D) If income of the buyer increases than budget line shifted right ward from OX OY to OX1
OY1
If income of the buyer decreases than budget line shifted left ward from OX OY to OXo OYo
 Now combine both indifference curve and budget line consumer equilibrium through ordinal approach.
Consumer’s equilibrium (Ordinal approach)
According to ordinal approach a consumer is in equilibrium situation where a budget line becomes tangent
to indifference curve.
Or
Slope of IC = Slope of budget line
 
Px
MRSxy =  MRExy 
Py
 
Willingness of = Buying capability
consumer of consumer
 Px 
 MRSxy   MRExy  
Y
 Py 
 Px 
 MRSxy   MRExy  
K
 Py 
E
 Px 
 MRSxy   MRExy  
 Py 
Good - 2

C A B IC2
P

IC1

D
IC0

X
O S T M
Good-1
Explination of Different situation on diagram
1. At ‘A’ Point:- Point „A‟ is point of consumer equilibrium because an IC become tangent to budget line
Px
here MRSxy = or MRSxy = MRExy . Bundle combination „A‟ a consumer is willing and able to
Py
buy also hence he attain maximum satisfaction on this point.
Px
2. At ‘C’ Point:- At this point MRSxy  or MRSxy  MRExy. A consumer can buy more goods than
Py
this combination. Point C is lie on IC0 which gives less satisfaction than IC1 hence monotonic
preference motivate him to go on higher IC.
Px
3. At ‘B’ Point:- Point „B‟ shows that MRSxy  or MRSxy  MRExy means willingness of buyer is
Py
more than his buying capacity. Hence a consumer cannot obtain combination „B‟ the given income.
4. At ‘E’ & ‘D’ Point:- At point E & D both lie on IC0 monotonic preference motivate a consumer to
move on higher IC hence these combination will not be prefer by the consumer.
Condition of Consumer’s equilibrium for ordinal approach
1. Budget line should be tangent to the indifference curve.
2. Indifference curve should be convex to the origin or Diminishing MRS between two goods.
*****
 Unit -4
Concept of Demand
Desire:- Willingness to have a commodity for the satisfaction of wants.
Element required to Desire to become Demand: - A desire become demand only when the following
element attached.
1. Desire for a commodity
2. Sufficient means to purchase
3. Willingness to spent the means on the commodity
4. Commodity must be available in the market at some prices.
5. The desire must be fulfilled within a particular time period.
Demand:- Demand for a commodity refers various quantities of a commodity those a consumer is willing
and able to buy at various prices in particular time period.
Quantity demanded:- Quantity demanded refers to specific quantity of a commodity which a consumer is
willing and able to buy at specific price and at a point of time.
Level of Demand

Individual demand Market demand

Individual Demand:- Individual demand means willingness for a commodity by a consumer which is able
to buy at various prices.
Market Demand:- Market demand refers to sum total of demand for a commodity by all the buyers in the
market at various prices.
Demand Schedule
Demand Schedule is a table showing the relationship between different quantities of a commodity to be
purchased at different prices.
(A) Individual demand schedule:- A table showing different quantities of a commodity that one particular
buyer in the market is willing and able to buy at different prices.
Example:- Demand for Pizza by „A‟
Price Q.D. for
Pizza
5 5
10 4
15 3
20 2
25 1
(B) Market demand schedule:- A table showing different quantities of a commodity that all the buyers in
the market are willing and able to buy at different prices.
Example:- Suppose there are two buyers A and B for the Pizza in the market
Market Demand = Demand by „A‟ + Demand by „B‟

Price ‘A’ s Demand ‘B’s Demand Market Demand

5 5 6 11
10 4 5 9
15 3 4 7
20 2 3 5
25 1 2 3
Demand Curve
Demand curve is a graphical presentation showing relationship between different quantities of a commodity
those demanded at different prices.
(A) Individual demand curve:- A curve showing relationship between different quantities of a
commodity those a buyer is willing and able to buy at different prices.
(B) Market demand curve:- A curve showing relationship between different quantities of a commodity
those all the buyers in the market are willing and able to buy at different prices.
Y
Individual Demand curve
(By 'A' &'B')

DA DB D mkt
25

P 20
R Market Demand curve
I
C 15
E
10

5
DA DB D mkt

X
0 1 2 3 4 5 6 7 8 9 10 11
QUANTITY DEMANDED
Demand Function
Demand function is a functional relationship between demand for a commodity and various factors affecting
it.
Demand function can be express in the following way.
Dx  F  Px, Pr, Y , T & P, Pfut , N , Gp, Cr , Advt 
  
Demand for Depends Determinants of
x good on demand
Note:- When we study effect of one determinant on the demand of the good we assume other factor to be
constant.
1. Own price of the goods (Px):- Own price of the goods affect the demand negatively when other things
assume to be constant.
 Px  Dx  
  Inverse relationship
 Px  D x  
2. Prices of related goods (Pr):- The good can be relate to each other only by two ways either they can be
substitute to each other or complimentary to each other.
(A) Substitute goods:- Substitute goods are the goods those can replace each other‟s demand in the
market. Substitute goods also known as competitive goods. Substitute goods have positive price
effect.
Example:- Tea and coffee, Juice and Cold drink, Nokia and Samsung
 P  DCold drink  
Example:-  Juice  Positive effect. (Assuming price of cold drink constant).
 PJuice  Dcold drink  
Why substitute goods have positive effect:- It is because when price of a good rises the goods
becomes costlier in relation to its substitute goods. So buyers shifted there demand from costlier
good to cheaper goods.
 When price of a good fall the good becomes cheaper in relation to its substitute goods hence buyer
prefer cheaper goods than the other costly good.
(B) Complimentary goods:- Complimentary goods are the pair of goods those jointly demanded for
the satisfaction of the wants.
Complimentary goods also known as dependent goods and they have negative price effect.
Example:- Car and Petrol
Pen and Ink
Electricity and AC ect.
 PPetrol  DCar  
  Negative effect . (assuming price of car do not change)
 PPetrol  DCar  
Why complimentary goods have negative effect:- If price of any good out of pair rises this lead to
rise in total expenditure on the pair and a consumer have limited income to fulfill the wants hence
increase in price of a complimentary goods leads to fall of its pair goods demand.
3. Income of the consumer (Y):- On the basis of income consumer good can be classify into two types.
(A) Normal goods:- All such goods those have positive income effect are known as normal good for
the consumer. Means demand for the good rises and fall with the rises and fall in income of the
consumer.
Y  Dx 
Positive income effect
Y  Dx 
(B) Inferior goods:- Inferior goods are those goods the demand for which falls as income of the
consumer increases and rises as income falls. Such goods have negative income effect.
Y  Dy 
Negative income effect
Y  Dy 
Note:- No goods specifically term as normal or inferior goods it depends on consumer to consumers
one good may be normal good for consumer „A‟ but it may be inferior to consumer „B‟ at the same
level of income.
4. Taste and Preference (T and P):- If taste and preference of the buyer improve for a good demand for
that good rises and if taste and preferences de improve demand for good falls.
T & P improve Dx 
T & P de-improve D x 
5. Future expectation about price (Pfut.):- If future price is expected to rise for the good consumer would
like to buy more at the present prices and if further price is expected to fall he like to buy less at the
present price.
Price expected  D x  (Prepond demand) at the present prices
Price expected  D x  (Postpand demand) at the present prices
6. No. of people(N):- If no of people in the market increase demand also increases and demand fall with
the fall in no. of people.
more people 
 more demand
less people 
 less demand
7. Government policy (Gp):- If government make a favorable policy for the good demand for the good
rises and demand falls with the unfavorable policy.
Govt. favorable policy   Dx 
Govt. unfavorable policy 
 Dx 
8. Credit policy (Cr):- If cheap and affordable credit policy is there for good than demand for the good
will be more and if no credit is avaible or credit is costly then demand for the good will be less.
9. Advertisement (Advt):- A good advertisement leads to rise in demand while a poor presentation may
decline the demand for a good.
10. Distribution of income:- Equal distribution means more demand and unequal distribution of income
means less demand.
Law of demand:- Law of demand state that there invere relationship found between price of a commodity
and its demand when other things assume to be constant.
Explanation:- Demand for a good rises when price of the good fall and fall when its price rises and it is
assume that factors other than price remains constant.
Y

D
P
 Px  Dx   R P1
  I
 Px  Dx   C
E P
D
X
O D0 D
DEMAND
Assumption of the law:-
1. Price for substitute goods remain same
2. Price of complimentary goods do not change
3. Income of the buyer assume constant
4. Taste and preferences constant
5. No future expectation about the price
6. Quality, Season, Economic condition, Climate population all remains same.
Why other factors are assume constant:- The demand of a good depends on many factors besides price
of the given commodity. If we want to study the separate influence of one factor. It is necessary that all
other factors assume to be constant. Therefore while discussing the law of demand. It is assumed that there
is no change in the other factors.
Important facts about the law of demand
1. Inverse relationship between price and demand of a good.
2. Law of demand is a qualitative statement not a quantities statement. Because it indicate the
directional of changes in demand not the quantity changes.
3. Price and demand do not have proportional relationship.
4. One sided law tells only about changes in demand due to change in price, it does not tells about
what happens when demand changes and its effect on the price.
Why does law of demand operate:- Law of demand operate due to the following reasons.
1. Law of diminishing marginal utility:- The law of demand is based upon law of DMU. As a consumer
gets diminishing satisfaction from every additional unit hence be will be willing to buy next unit only
when its price falls.
2. Substitute Effect:- When price of the given goods falls it become relatively cheaper compared to its
substitute good as a result consumer substitute his demand in favour of the cheaper goods this leads to
fall in demand of the good which have more price and vice versa when price of the given goods rises.
3. Real income effect:- If price of a particular goods falls a consumer become able to buy more of that
good at the same level of income because his purchasing power of monetary income rises and vice
versa when price rises.
4. No. of buyers:- No. of buyers increases with the fall in prices this leads to rise in demand and no. of
buyers decreases with the rise in price of the good and demand fall.
5. Different uses:- If price falls for a good people find some other uses of it hence demand for that good
rises and if price rises people cut some uses of the good to control expenditure and thus demand fall.
Exceptions of the law of demand:- First ever sir Robert Geffen gives some cases in 1904 where law of
demand become fail.
1. Giffin Paradox: - These are highly inferior goods in case of which price effect is positive.
Or
These are special kind of inferior goods for which an increase in price leads to an increase in the
demand and decrease in price result in a decrease in demand. This is also known as Giffen paradox
Px  Dx 
Px  Dx 
2. Status symbol goods: - Diamond, Gold, antique paintings are such status symbol goods those demand
even when their price rises. These goods also known as „Articles of distinction explain by prof. Veblen.
3. Ignorance of the buyers: - Due to many other reason consumer ignore increase and decrease in the
prices and increase demand at increase prices and decrease demand at decrease prices in that case law
of demand do not operate.
4. Expenditure on good is less in proportion to income: - When consumer spent very less on a good in
proportion to his monetary income than increase in prices does not affect his begets largely hence
consumer do not response according to the law of demand.
5. Necessities: - There are some goods which are necessities of life like food grains, salt, medicine ect. A
minimum quantity has to be purchased by consumers irrespective of their price. Hence law of demand
does not operate in such cases.
6. Other exceptional cases.
 Fear of shortage
 Change in weather
 Fashion related goods ect.
Changes in demand and quantity demanded
Basis Change in Q.D Change in Demand
1. Meaning When Q.D of a commodity changes due When demand of a commodity
to change in price keeping other factors changes due to change in other factors
constant is term as change in quantity at the same price is term as change in
demanded demand
2. Cause Change in price Change in other factors
3. Assumption Other factor remain constant Price of the good remain constant
4. Types (A) Extension of demand:- When (A) Increase in demand: - When
demand of a good rises due to fall demand of a commodity rises due
in price of the good other things to favorable change in other
being equal. factor at the same price.
Example:- Example:-
Price Demand Price Demand
20 100 50 100
15 150 50 125
(B) Contraction of demand:- When Reasons
demand falls due to rise in price of (i) Income of the buyer rises.
a commodity other things being (Normal goods)
equal (ii) Price of substitute good rises
Example:- (iii)Price of complimentary good fall
Price Demand (iv) Taste improve
20 100 (v) Future expectation about price to
25 70 rise
(B) Decrease in demand:- When
demand of a commodity falls due
 to unfavorable change in other
factors at the same price.
Example:-
Price Demand
50 100
50 75
Reasons
(i) Income falls (Normal goods)
(ii) Price of substitute good falls.
(iii)Price of complimentary good
rises.
(iv) Taste de improve
(v) Future price about to fall.
5. Change on (A) Extension:-Downward movement (A) Increase:- Rightward shifting
Diagram Y Y
D1
D D
P
P A R
R 20 I A B Price
I C 50
E
C B D1
D
E 15 0 X
D 100 125
0 X (B) Decrease:- Left ward shifting
100 150
Q.D Y
D
(B) Contraction:-upward movement 0
D
Y P
R
I B A
D C 50 Price
P B E
R 25 D
I D0
0 X
C A 75 D 100
E 20
D
0 X
70 100
Q.D

Distinction between substitute goods and complimentary goods

Basis Substitute goods Complimentary goods
Meaning These are the goods which can be used These are the goods which are
in place of one another consumed in pair to obtain
Example: Tea and Coffee satisfaction.
Coke and Pepsi Example: Car and Petrol ect.
Types of demand The demand of substitute goods is The demand of complimentary
competitive demand goods is jointly demanded.
Relation with The demand for a good have direct The demand for a good have inverse
price relation to price of its substitute goods. relation to price of its
complimentary goods.
Distinction between Normal goods and Inferior goods
Basis Normal goods Inferior goods
Meaning All goods those have positive income All goods those have negative
effect. income effect
Demand curve Demand curve shifted right/ left with Demand curve shifted left / right
rise/fall in income. with rise/fall in income
 Unit -4
Concept of Demand
Desire:- Willingness to have a commodity for the satisfaction of wants.
Element required to Desire to become Demand:- A desire become demand only when the following
element attached.
6. Desire for a commodity
7. Sufficient means to purchase
8. Willingness to spent the means on the commodity
9. Commodity must be available in the market at some prices.
10. The desire must be fulfilled within a particular time period.
Demand:- Demand for a commodity refers various quantities of a commodity those a consumer is willing
and able to buy at various prices in particular time period.
Quantity demanded:- Quantity demanded refers to specific quantity of a commodity which a consumer is
willing and able to buy at specific price and at a point of time.
Level of Demand

Individual demand Market demand

Individual Demand:- Individual demand means willingness for a commodity by a consumer which is able
to buy at various prices.
Market Demand:- Market demand refers to sum total of demand for a commodity by all the buyers in the
market at various prices.
Demand Schedule
Demand Schedule is a table showing the relationship between different quantities of a commodity to be
purchased at different prices.
(A) Individual demand schedule:- A table showing different quantities of a commodity that one particular
buyer in the market is willing and able to buy at different prices.
Example:- Demand for Pizza by „A‟
Price Q.D. for
Pizza
5 5
10 4
15 3
20 2
25 1
(B) Market demand schedule:- A table showing different quantities of a commodity that all the buyers in
the market are willing and able to buy at different prices.
Example:- Suppose there are two buyers A and B for the Pizza in the market
Market Demand = Demand by „A‟ + Demand by „B‟

Price ‘A’ s Demand ‘B’s Demand Market Demand

5 5 6 11
10 4 5 9
15 3 4 7
20 2 3 5
25 1 2 3
Demand Curve
Demand curve is a graphical presentation showing relationship between different quantities of a commodity
those demanded at different prices.
(C) Individual demand curve:- A curve showing relationship between different quantities of a
commodity those a buyer is willing and able to buy at different prices.
(D) Market demand curve:- A curve showing relationship between different quantities of a commodity
those all the buyers in the market are willing and able to buy at different prices.
Y
Individual Demand curve
(By 'A' &'B')

DA DB D mkt
25

P 20
R Market Demand curve
I
C 15
E
10

5
DA DB D mkt

X
0 1 2 3 4 5 6 7 8 9 10 11
QUANTITY DEMANDED
Demand Function
Demand function is a functional relationship between demand for a commodity and various factors affecting
it.
Demand function can be express in the following way.
Dx  F  Px, Pr, Y , T & P, Pfut , N , Gp, Cr , Advt 
  
Demand for Depends Determinants of
x good on demand
Note:- When we study effect of one determinant on the demand of the good we assume other factor to be
constant.
7. Own price of the goods (Px):- Own price of the goods affect the demand negatively when other things
assume to be constant.
 Px  Dx  
  Inverse relationship
 Px  D x  
8. Prices of related goods (Pr):- The good can be relate to each other only by two ways either they can be
substitute to each other or complimentary to each other.
(C) Substitute goods:- Substitute goods are the goods those can replace each other‟s demand in the
market. Substitute goods also known as competitive goods. Substitute goods have positive price
effect.
Example:- Tea and coffee, Juice and Cold drink, Nokia and Samsung
 P  DCold drink  
Example:-  Juice  Positive effect. (Assuming price of cold drink constant).
 PJuice  Dcold drink  
Why substitute goods have positive effect:- It is because when price of a good rises the goods
becomes costlier in relation to its substitute goods. So buyers shifted there demand from costlier
good to cheaper goods.
 When price of a good fall the good becomes cheaper in relation to its substitute goods hence buyer
prefer cheaper goods than the other costly good.
(D) Complimentary goods:- Complimentary goods are the pair of goods those jointly demanded for
the satisfaction of the wants.
Complimentary goods also known as dependent goods and they have negative price effect.
Example:- Car and Petrol
Pen and Ink
Electricity and AC ect.
 PPetrol  DCar  
  Negative effect . (ssuming price of car do not change)
 PPetrol  DCar  
Why complimentary goods have negative effect:- If price of any good out of pair rises this lead to
rise in total expenditure on the pair and a consumer have limited income to fulfill the wants hence
increase in price of a complimentary goods leads to fall of its pair goods demand.
9. Income of the consumer (Y):- On the basis of income consumer good can be classify into two types.
(C) Normal goods:- All such goods those have positive income effect are known as normal good for
the consumer. Means demand for the good rises and fall with the rises and fall in income of the
consumer.
Y  Dx 
Positive income effect
Y  Dx 
(D) Inferior goods:- Inferior goods are those goods the demand for which falls as income of the
consumer increases and rises as income falls. Such goods have negative income effect.
Y  Dy 
Negative income effect
Y  Dy 
Note:- No goods specifically term as normal or inferior goods it depends on consumer to consumers
one good may be normal good for consumer „A‟ but it may be inferior to consumer „B‟ at the same
level of income.
10. Taste and Preference (T and P):- If taste and preference of the buyer improve for a good demand for
that good rises and if taste and preferences de improve demand for good falls.
T & P improve Dx 
T & P de-improve D x 
11. Future expectation about price (Pfut.):- If future price is expected to rise for the good consumer would
like to buy more at the present prices and if further price is expected to fall he like to buy less at the
present price.
Price expected  D x  (Prepond demand) at the present prices
Price expected  D x  (Postpand demand) at the present prices
12. No. of people (N):- If no of people in the market increase demand also increases and demand fall with
the fall in no. of people.
more people 
 more demand
less people 
 less demand
11. Government policy (Gp):- If government make a favorable policy for the good demand for the good
rises and demand falls with the unfavorable policy.
Govt. favorable policy   Dx 
Govt. unfavorable policy 
 Dx 
12. Credit policy (Cr):- If cheap and affordable credit policy is there for good than demand for the good
will be more and if no credit is avaible or credit is costly then demand for the good will be less.
13. Advertisement (Advt):- A good advertisement leads to rise in demand while a poor presentation may
decline the demand for a good.
14. Distribution of income:- Equal distribution means more demand and unequal distribution of income
means less demand.
Law of demand:- Law of demand state that there invere relationship found between price of a commodity
and its demand when other things assume to be constant.
Explanation:- Demand for a good rises when price of the good fall and fall when its price rises and it is
assume that factors other than price remains constant.
Y

D
P
 Px  Dx   R P1
  I
 Px  Dx   C
E P
D
X
O D0 D
DEMAND
Assumption of the law:-
7. Price for substitute goods remain same
8. Price of complimentary goods do not change
9. Income of the buyer assume constant
10. Taste and preferences constant
11. No future expectation about the price
12. Quality, Season, Economic condition, Climate population all remains same.
Why other factors are assume constant:- The demand of a good depends on many factors besides price
of the given commodity. If we want to study the separate influence of one factor. It is necessary that all
other factors assume to be constant. Therefore while discussing the law of demand. It is assumed that there
is no change in the other factors.
Important facts about the law of demand
5. Inverse relationship between price and demand of a good.
6. Law of demand is a qualitative statement not a quantities statement. Because it indicate the
directional of changes in demand not the quantity changes.
7. Price and demand do not have proportional relationship.
8. One sided law tells only about changes in demand due to change in price, it does not tells about
what happens when demand changes and its effect on the price.
Why does law of demand operate:- Law of demand operate due to the following reasons.
6. Law of diminishing marginal utility:- The law of demand is based upon law of DMU. As a consumer
gets diminishing satisfaction from every additional unit hence be will be willing to buy next unit only
when its price falls.
7. Substitute Effect:- When price of the given goods falls it become relatively cheaper compared to its
substitute good as a result consumer substitute his demand in favour of the cheaper goods this leads to
fall in demand of the good which have more price and vice versa when price of the given goods rises.
8. Real income effect:- If price of a particular goods falls a consumer become able to buy more of that
good at the same level of income because his purchasing power of monetary income rises and vice
versa when price rises.
9. No. of buyers:- No. of buyers increases with the fall in prices this leads to rise in demand and no. of
buyers decreases with the rise in price of the good and demand fall.
10. Different uses:- If price falls for a good people find some other uses of it hence demand for that good
rises and if price rises people cut some uses of the good to control expenditure and thus demand fall.
Exceptions of the law of demand:- First ever sir Robert Geffen gives some cases in 1904 where law of
demand become fail.
7. Giffin Paradox:- These are highly inferior goods in case of which price effect is positive.
Or
These are special kind of inferior goods for which an increase in price leads to an increase in the
demand and decrease in price result in a decrease in demand. This is also known as Giffen paradox
Px  Dx 
Px  Dx 
8. Status symbol goods:- Diamond, Gold, antique paintings are such status symbol goods those demand
even when their price rises. These goods also known as „Articles of distinction explain by prof. Veblen.
9. Ignorance of the buyers:- Due to many other reason consumer ignore increase and decrease in the
prices and increase demand at increase prices and decrease demand at decrease prices in that case law
of demand do not operate.
10. Expenditure on good is less in proportion to income:- When consumer spent very less on a good in
proportion to his monetary income than increase in prices does not affect his begets largely hence
consumer do not response according to the law of demand.
11. Necessities:- There are some goods which are necessities of life like food grains, salt, medicine ect. A
minimum quantity has to be purchased by consumers irrespective of their price. Hence law of demand
does not operate in such cases.
12. Other exceptional cases.
 Fear of shortage
 Change in weather
 Fashion related goods ect.
Changes in demand and quantity demanded
Basis Change in Q.D Change in Demand
6. Meaning When Q.D of a commodity changes due When demand of a commodity
to change in price keeping other factors changes due to change in other factors
constant is term as change in quantity at the same price is term as change in
demanded demand
7. Cause Change in price Change in other factors
8. Assumption Other factor remain constant Price of the good remain constant
9. Types (C) Extension of demand:- When (B) Increase in demand: - When
demand of a good rises due to fall demand of a commodity rises due
in price of the good other things to favorable change in other
being equal. factor at the same price.
Example:- Example:-
Price Demand Price Demand
20 100 50 100
15 150 50 125
(D) Contraction of demand:- When Reasons
demand falls due to rise in price of (vi) Income of the buyer rises.
a commodity other things being (Normal goods)
equal (vii) Price of substitute good rises
Example:- (viii) Price of complimentary good
Price Demand fall
20 100 (ix) Taste improve
25 70 (x) Future expectation about price to
rise
(C) Decrease in demand:- When
 demand of a commodity falls due
to unfavorable change in other
factors at the same price.
Example:-
Price Demand
50 100
50 75
Reasons
(vi) Income falls (Normal goods)
(vii) Price of substitute good falls.
(viii) Price of complimentary good
rises.
(ix) Taste de improve
(x) Future price about to fall.
10. Change on (C) Extension:-Downward movement (C) Increase:- Rightward shifting
Diagram Y Y
D1
D D
P
P A R
R 20 I A B Price
I C 50
E
C B D1
D
E 15 0 X
D 100 125
0 X (D) Decrease:- Left ward shifting
100 150
Q.D Y
D
(D) Contraction:-upward movement 0
D
Y P
R
I B A
D C 50 Price
P B E
R 25 D
I D0
0 X
C A 75 D 100
E 20
D
0 X
70 100
Q.D

Distinction between substitute goods and complimentary goods

Basis Substitute goods Complimentary goods
Meaning These are the goods which can be used These are the goods which are
in place of one another consumed in pair to obtain
Example: Tea and Coffee satisfaction.
Coke and Pepsi Example: Car and Petrol ect.
Types of demand The demand of substitute goods is The demand of complimentary
competitive demand goods is jointly demanded.
Relation with The demand for a good has direct The demand for a good has inverse
price relation to price of its substitute goods. relation to price of its
complimentary goods.
Distinction between Normal goods and Inferior goods
Basis Normal goods Inferior goods
Meaning All goods those have positive income All goods those have negative
effect. income effect
Demand curve Demand curve shifted right/ left with Demand curve shifted left / right
rise/fall in income. with rise/fall in income
 Unit -5
Elasticity of Demand
The law of demand is a qualitative statement because it does not tells anything about the degree of change
in quantity demanded due to change in price it tells only directional changes in Q.D. So to measure the
quantitive change in Q.D. due to various factors affecting it, we use elasticity of demand.
Meaning of Elasticity of demand:- Elasticity of demand is measuring method to measure percentage
change in demand due to percentage change in any of the factors affecting demand for that commodity.
Types of Elasticity of Demand

Price elasticity Income elasticity Cross elasticity

of demand of demand of demand
Price Elasticity of demand:- It is measure of degree of responsiveness of demand for a commodity to
change in its price.
Methods for measuring price elasticity of demand:-
1. Percentage / Proportionate method
2. Geometric method
3. Total expenditure method.
1. Percentage method:- Alfred marshal was the first economist to formulate the concept of price
elasticity of demand as the ratio of a relative (percentage) change in quantity demanded of a commodity
to a relative (percentage) change in its price.
%change in Q.D.
Ed 
%change in Price
Where
Q  Q0
%change in Q.D.  1 100
Q0
Q1  New quantity
Q0  Initial quantity
P1  P0
%change in Price  100
P0
P1  New Price
P0  Initial quantity
Q1  Q0
100  Q1  Q0  Q 
Q0
Ed 
P1  P0
100  P1  P0  P 
P0
Q P Q P
  
Q0 P Q P
Q P
 
P Q
( - ) sign should be put before the formula because there is inverse relationship between price and
demand of a commodity
 Q P
Ed     
P Q
Example:- Calculate price elasticity of demand if demand increases from 4 units to 5 units due to fall in
price from Rate 10 to Rate 8.
Solution: Price quantity
10 4   Initial
8 5   New
Q P
Ed     
P Q
5  4 10
  
8  10 4
1 10
  
2 4
10
 1.25
8
Ed  1.25 Greater than unitrary (Ed > 1)
2. Geometric method:- According to geometric method elasticity of demand on any point on a straight
demand line is measured by dividing the lower part of the demand line by the upper part of the demand
line.
Lower segment of demand line
Ed =
Upper segment of demand line
Y
Upper segment (PN)
P
Price

N
NQ
Lower segment (NQ) Ed =
PN

O Q X
Q.D

Example:- Suppose PQ is a demand line equal to 10 cm long

PQ = 10 cm
PT = TN = NS = SQ = 2.5 cm
Lower part
Ed =
Upper part
 Y

P Ed = 

Ed > 1
T
Ed = 1

Price
N
Ed < 1
S
Ed = 0
O Q X
Q.D
Explination:-
NQ 5 cm
(i) Elasticity at point ' N '   NQ  PN  ,  1 Ed = 1
PN 5 cm
Lower segment = upper segment
If both the segment of a demand line are equal than elasticity will be unitary elastic
SQ 2.5 cm
(ii) Elasticity at point ' S '   SQ  PS  ,  .3 Ed  1
PS 7.5 cm
Lower segment < upper segment
If lower segment of a demand line is shorter than upper segment than elasticity will be less than unitary
TQ 7.5 cm
(iii) Elasticity at a point ' T '  TQ  PT   3 Ed  1
PT 2.5 cm
Lower segment > upper segment
If lower segment of a demand line is bigger than upper segment than elasticity will be greater than
unitary.
PQ 10 cm
(iv) Elasticity at a point ' P '  ,   Ed  
O 0
At any point on the y-axis (like point „P‟) elasticity is equal to infinity because at this point there is no
upper segment of demand line.
O 0
(v) Elasticity at a point ' Q '   0 Ed  0
PQ 10 cm
At any point on the x-axis (like point Q) elasticity is equal to zero because at this point there is no lower
segment of demand line.
3. Total expenditure /Total outlay method:- The total expenditure done by a consumer of a particular
commodity is greatly affected by price of that commodity so this method helps to know price elasticity
of demand by observing the changes in total expenditure due to change in price of the commodity.
Total expenditure = Price × Quantity
(i) Unitary elastic demand (Ed = 1):- The elasticity of demand will be unitary when total expenditure do
not response despite of change in price of that commodity.
Price  Demand 
TE unchanged.
Price  Deamnd 

Price Quantity Total exp.

5 10 50
2.5 20 50
10 5 50
(ii) Greater than unitary elastic (Ed > 1):- Elasticity of demand will be greater than unitary. If total
expenditure response in opposite direction to change in price of the commodity.
Price  Demand  T. Exp.  opposite
Price  Deamnd  T. Exp.  direction

Price Quantity Total exp.

5 10 50
2.5 21 52.50
10 4 40

(iii) Less than unitary elastic (Ed < 1):- Elasticity of demand
will be less than unitary. If total expenditure response in the same direction to change in price of the
commodity.
Price  Demand  T. Exp.  same
Price  Deamnd  T. Exp.  direction

Price Quantity Total exp.

5 10 50
2.5 19 47.5
10 6 60

Limitation of T.E. Method

1. Do not measure degree of elasticity gives only rough idea about elasticity
2. Based on law of demand. Cannot used when law is not operating.
Combined diagram for total expenditure

A
Y
Ed > 1

B
Price

Ed = 1

Ed < 1
D
O X
Total expenditure
Degrees of elasticity of demand
Price elasticity of demand can be expressed in terms of numerical value which range from zero to infinity.
1. Perfectly elastic demand (Ed = ∞):- If demand for any commodity extend upto any level with without
any change in its price the elasticity said to be perfectly elastic demand Ed = ∞.
Q P
Note:- since P  O it make the value of  
P Q
Y

Ed = 
P D

Price O Q0 Q Q1 X
2. Perfectly inelastic demand (Ed = 0):- When there is no change in demand for a commodity with
change in price of it then elasticity said to be perfectly inelastic Ed = 0
Q P
Note:- Since Q  0 it makes the value of  0
P Q
Y D

P1
Price

P Ed = 0

P0
O Q X
3. Unitary elastic demand (Ed = 1) :- When percentage change in Q.D. is equal to percentage change in
price elasticity said to be unitary elastic Ed = 1
Y
D
P1
Price

P0
D
O Q0 Q Q1 X
Q.D.
4. Highly elastic demand (Ed > 1):- When percentage change in Q.D. is more than percentage change in
price elasticizing said to be highly elastic demand Ed > 1
 Y

D
P1 Ed > 1

P
D

O Q Q1 X
5. Less elastic demand (Ed < 1):- When percentage change in Q.D. is less than percentage change in
price then demand for such a commodity is said to be less elastic demand Ed < 1
Y
D

P1
Ed < 1
Price

O Q Q1 X
Q.D.

Combined diagram of elasticity of demand

Y

Ed = 
Price

Ed > 1
Ed = 1
Ed < 1
O Ed = 0 X
Q.D.
Factors affecting price elasticity of demand:- A charge in price does not always lead to same
proportionate change in demand. There are many other factors those effect elasticity of demand.
To answer such questions note the following points.

Don’t use Use

1. Perfectly elastic 1. Elastic when Ed > 1
2. Perfectly inelastic 2. Inelastic when Ed < 1
3. Unitary elastic 3. Highly elastic
4. Less elastic
1. Nature of commodity:-
 Necessity goods   Inelastic demand
Comfort goods   Elastic demand
Luxury goods   Highly elastic demand
2. Availability of substitutes:-
Substitutes available for the good   Elastic demand
No substitutes available for the good   Inelastic
3. Income level:-
High income   Inelastic
Medium income   Elastic
Low income   Highly elastic
4. Price level:-
High price level   Elastic
Low price level   Inelastic
5. Postpondness of consumption:-
Consumption can be postponed   Elastic
Consumption cannot be postponed   Inelastic
6. Number of uses:-
Single use commodity   Inelastic
Different use commodity   Elastic
7. Share in total expenditure:-
Large part of income spend on a good   Elastic demand
Small part of income spend on a good   Inelastic demand
8. Time period:-
Short time to fulfill demand   Inelastic
Long time to ful fill demand   Elastic
9. Habit of good:-
Consumer is habitual to good   Inelastic
Consumer is not habitual to good   Elastic
Some Important Questions
Que.1 Prove that elasticity demand will be more on a curve which have more flatterness.
Ans. Draw two demand curves on a same diagram with different flatterness.
Y DA DB
P
Price

P0 DB

DA

O DA D1A D B D1B X

Q.D.
DA, DA (steeper curve) DB DB (Flatter curve) same price fall for both the demand curve P to Po but
the change in quantity demanded is more for demand curve DB DB which is more flatter than DA DA
which is steeper.
Que.2 A unitary elastic demand curve shows elasticity equal to unitary at all point.
Or
Why a unitary elastic demand curve is rectangular hyperbola in shape.
Ans. It is a mathematical property of a rectangular hyperbola that area of all rectangular formed under it
(from any point on the curve) are the same.
Y D
Ed = 1 Throughout the curve

R S

Price T
P
D

O Q U X
Q.D.
Diagram of rectangular hyperbola curve
We know
Total experience = OP × OU
 OPTU (at OP price)
Total experience = OR × OQ
 ORSQ (at OR price)
Here = OPTU = ORSQ (area wise)
So when expenditure total remains same in response to increase and decrease in price of the
commodity elasticity measured equal to one.
*****
 Unit -6
Production Function
Production function:
Production function is a functional or technical relationship between physical output and physical inputs.
Q x  f  Land, Labour, Capital 
 
Physical output Physsical inputs
Production function in different time period
1. Short run production function:- Short run is that time period in which only one factor can be change
to increase in output all other remains fixed.
Q x  f  Labour,Land,Capital 

Variable Fixed factors
factor
2. Long run production function:- Long run is that time period in which all the factor can be change to
increase in output and they increase in same proportion
 Labour,Land,Capital 
Qx  f
All are variable
Concepts of production
Product or output refers to the volume of goods produced by a firm during a given period of time. The
volume of goods produced can be measure in three different level
(1) Total product (2) Marginal product (3) Average product
1. Total product (TP):- Total product refers to the total volume of goods and services produced during a
specified period of time.
TP   MP
TP  AP  Labour (units)
2. Marginal product (M.P.):- Marginal production is the addition to total product by the employment of
an additional unit of a variable factor
MP  TPn  TPn 1
TP
MP 
L
3. Average product (A.P):- It is the average per unit production of the variable factor.
TP
AP 
L
Short Run Production Function
Under short time period by a firm want to increase its production than the firm can increase output with the
use of variable factor only other factor remain fixed because in short period of time, it is not possible to
increase all the factor at once so with this condition a firm faces three stage of production.
1st : Increasing returns to a factor
nd
2 : Diminishing returns to a factor
rd
3 : Negative returns to a factors
These three stages communally known as law of variable proportion or Law of Return to a factor.
Law of variable proportion or Law of return to a factor
The law states that as a producer increase more and more variable factor over the fixed factor of production
in short period of time initially. Total product increase at increasing rate than increases at diminishing rate
and ultimately start falling
Or
The law state that as a producer increase more and more variable factor over the fixed factor of production
in short period of time initially MP increases than diminishes and then goes negative.
Assumption of the Law
1. There is one variable input and the other inputs are fixed.
2. Units of variable factor are homogeneous
3. The technology assume to be constant
4. There is a possibility to increase in variable factor.
5. This law is applicable only in short period in production of goods.
6. It assume that factors of production are imperfect substitutes of each other.
Explination of the Law
Suppose a farmer has 1 acre of land (fixed factor) on which he wants to increase the production of wheat
with the help of labour (variable factor). When he employed more and more units of labour, initially output
increased at an increasing rate than at a decreasing rate and finally at a negative rate.
Fixed factor Variable factor TP (units) MP (units) AP (units) Stages
(Land) (Labour) (000) (000) (000)
1 Acre 1 1 1 1 1st stage
1 Acre 2 3 2 1.5 increasing
1 Acre 3 6 3 2
1 Acre 4 10 4 2.5 2nd Stage
1 Acre 5 13 3 2.6 diminishing
1 Acre 6 15 2 2.5
1 Acre 7 16 1 2.3
1 Acre 8 16 0 2 3rd Stage
1 Acre 9 15 -1 1.67 negative
st
Stage 1 Law of increasing returns:- From labour 1 to labour 4 marginal production of every variable
factor increases.
MPincreasing 
 TP increasing at increasing rate
nd
Stage 2 Law of diminishing returns :- From labour 4 to 8 MP of every variable factor diminishes as
compared to previous variable factor.
MP diminishes   TP increases at diminishing rate
rd
Stage 3 Law of negative returns :- Beyond 8 labour MP goes negative TP start falling.
 Y TP maximum (Point of saturation)
Point of inflexion
16
14 TP
12
TP 1st stage Q 2nd stage 3rd stage
10
8
6
4
2
X
O 1 2 3 4 5 6 7 8 9

1st stage 2nd stage 3rd stage

4
MP 3
2
MP = zero
1

O 1 2 3 4 5 6 7 8 9
 1 MP
Units of variable factor
 Y 
Causes of increasing return to a factor
1. Fuller and Efficient utilization of fixed factor starts as more variable factor combined.
2. Efficiency of the variable factor improve as the work divided in the variable factors.
3. Co-ordination between fixed and variable factor improve which resulted in increase of TP.
Causes of diminishing returns to a factor
1. Fixity of the factors:- The fixed factor in the production unit become insufficient for more and more
variable factor which result as at decreasing rate.
2. Imperfect factor substitutability:- Only labour cannot increase TP as required fixed factor also need
to be change because labour is not perfect substitute of fixed factor like building machine ect.
3. Poor co-ordination between the fixed and variable factor. Which cause fall in MP.
Relationship between AP and MP
1. As long as MP is more than AP, AP rises (MP > AP)
2. When MP is equal to AP is at its maximum (MP = AP)
3. When MP is less than AP, AP falls
4. Thereafter both AP and MP fall but MP becomes negative whereas AP remains positive
 Y

 MP > AP  Both rising

AP &  AP = MP  AP maximum
MP

 MP<AP  Both falling

AP
O
Labour
-Y MP

Relationship between TP and MP

1. TP increases as increasing rate till MP rises (1st stage)
2. TP increases at diminishing rate, when MP fall but positive (2nd stage)
3. TP is at maximum when MP becomes zero end point of 2nd stage
4. TP start falling as MP goes negative (3rd stage)
Y TP maximum (Point of saturation)
Point of inflexion
16
14 TP
12
TP 1st stage Q 2nd stage 3rd stage
10
8
6
4
2
X
O 1 2 3 4 5 6 7 8 9

1st stage 2nd stage 3rd stage

4
MP 3
2
MP = zero
1

O 1 2 3 4 5 6 7 8 9
 1 MP
Units of variable factor
 Y 
Postponement of the law
1. It Technology of production improved.
2. It substitute of fixed factor discovered
3. If additional variable factor is more efficient than the previous factors.
Significance of the stages
Stage 1st:- A producer will continue to produce goods in first stage because employment of every
additional unit of variable factor is giving more and more marginal output and fixed factor
started utilizing fully and efficiency.
nd
Stage 2 :- A producer also continues in this stage because in the short run only variable factor can
increase TP (all other factor fixed) so produces. Continue to employ every additional factor till
they bring any change in TP and in this stage fixed factor are optimally utilized. (stage of
producer‟s Equilibrium)
rd
Stage 3 :- A producer would not like to entire in this stage because now and onward hiring every
additional labour bring down the TP from the previous level (MP negative) and fixed factor are
over burdened.
******
 Unit -7
Concepts of cost
Cost
Cost refers to all types of monetary expenditures incurred in the productions of the commodity by prouder.
Cost function
A cost function is a functional relationship between cost and output. If shows least combinations of output
corresponding to different level of output
Cost = f (Quantity)
Types of cost
1. Explicit cost:- Explicit cost refers to the actual payment made to outsiders for hiring services of the
factors of production. For example, wages paid to the employees, rent paid for hired premises cost of
raw materials, interest on loan ect.
Explicit cost is also known as accounting cost because this only entered into the account book.
2. Implicit cost:- Implicit cost refers to the all such cost those do not take the form of cash outlay nor do
they appear in the accounting system or it is the cost of self-supplied factors.
For example:- Rent of his own land interest on his own capital salary for his own services ect.
While calculating
Accounting profit = Total Revenue – Explicit cost
Economic profit = TR – (Explicit + Implicit cost)
3. Opportunity cost:- opportunity cost is the cost of the next best alternative use of the factors. Eg.
suppose a farmer can produce either 50 quintals of rice or 40 quintals of wheat on his land with the
given resources. If he chooses to produce rice then he will have forgone (left out) the opportunity of
producing 40 quintals of wheat.
4. Social cost:- Social cost includes the disadvantages suffered by the society due to the production of a
commodity. This cost does not take into account book.
Eg. By cutting down of trees by a contractor society incurs social cost in the form of health hazards like
increase in pollution.
5. Short Run cost:- In the short run some of the factor in a production unit remain fixed and some are
variable so in short run the are two types of cost
(i) Fixed cost (ii) variable cost
(i) Fixed cost:- Fixed cost is the payment to fixed factor of production unit in short run.
(ii) Variable cost:- Variable cost is the payment to variable factors of production unit.
6. Production cost:- Production cost refers to the expenditure incurred on the production of a commodity
eg. Payment for raw material, wages to labour, interest on capital ect.
7. Selling cost:- Selling cost refers to the expenditure incurred by the producer in order to produce sale of
the commodity. Eg. Advertisement Expenditure, Transportation cast, Warehouse cost ect.
Production costs

Short run Long run

Fixed cost + variable cost variable cost

TFC, TVC,TC, AFC, AVC, AC, MC

1. Total fixed cost:- Total fixed cost are the sum total of expenditure incurred by producer on the
purchase of fixed factors of production.
 Example: Suppose you start a furniture business of making chairs you hire a shop at a monthly rent of
Rate 5000 and take a loan of Rs. 1 lac from ICICI Bank @12% interest PA. Now your monthly total
fixed cost will be Rs. 6000 (Rs. 5000 Rent + Rs 1000 per month interest @12% PA). You will have to
pay Rs. 6000 no matter how much you produces.
TFC also known as supplementary cost, overhead cost, Indirect cost, General cost, Unavoidable cost.
Some examples of TFC:- Rent, Interest, wages to permanent labour, minimum electricity charges,
License fees ect. TFC = TC – TVC
TFC = AFC × Q
Output TFC (Rate)
(units)
0 100
1 100
2 100
3 100
4 100
5 100

Why TFC does not vary with output?

Because payment to fixed factor are indivisible even if the firm is producing zero or small level of
output. If means a firm cannot have half the rent, interest, license fees ect.
2. Total variable cost:- TVC is the payment to variable factor of a production unit variable cost vary with
the quantity of output. Eg. Payment to raw material, wages to casual labour, Electricity consumption
charges, Transportation ect.
TVC is also known as Prime cost, Specific cost, Direct cost, Avoidable cost.
Reason for TVC curve shape: Law of variable proportion
TVC = TC – TFC
TVC = AVC × Q
TVC = MC

Output TFC (Rate)

(units)
0 0
1 100
2 190
3 270
4 360
5 480
6 600
7 800

Difference between FC and VC

Basis Variable cost Fixed cost
1. Meaning Paid to variable factors Paid to fixed factors.
 2. Time period Can be change in short run Cannot be change in short run
3. Cost at zero output zero Never be zero
4. Shape of the curve VC is inversely „S‟ shaped Horizontal to OX axis
Wagers to casual labor, payment Wagers to permanent labor,
5. Example
to raw material Rent, Interest ect
3. Total cost:- TC is the total expenditure incurred by a firm on the factors of production required for the
production of a commodity.
TC = TFC + TVC or TC = AC × Q.
Output TFC TVC TC
(units) (Rate) (Rate) (Rate)
0 100 0 100
1 100 100 200
2 100 190 290
3 100 270 370
4 100 360 460
5 100 480 580
6 100 600 700
7 100 800 900

 The change in TC is entirely due to TVC as TFC is constant at all level of output.
 TC = TFC at zero level of output as TVC is zero.
 TC and TVC curves are parallel to each other because the gap between them equal to TFC and TFC
is constant
 Shape of TC and TVC are the same because of law of variable proportion.

Stages TC and TVC

st
1 stage: law of increasing returns TC and TVC increases but at diminishing rate
2nd stage: Law of decreasing returns TC and TVC increases but at increasing rate.
3rd stage: Law of negative returns TV and TVC increases at rapid rate
4. Average fixed cost:- AFC refers to the per unit fixed cost of production.
TFC
AFC 
Q
Output TFC (Rate) AFC (Rate)
(units)
0 100 ∞
1 100 100
2 100 50
3 100 33.3
4 100 25
5 100 20

 AFC falls with increase in output as TFC remains same at all levels of output
 AFC curve never touches the x-axis as TFC can never be zero
 AFC curve never touches the Y-axis because at zero output AFC is infinite value.
Q. Why does AFC curve is rectangular hyperbola in shape?
Ans. Rectangular hyperbola is a geometrical shape in which the curve area under remains same at all point
here on the diagram
TFC = AFC × Q
At OA output AFC is OE where TFC will be OAFE
At OB output AFC is OD where TFC will be OBCD
So at two different output level TFC is equal thus area of rectangular OAFC is equal to area of
another rectangular OBCD.
OAFC  OBCD
 
TFC  TFC
5. Average variable cost:- AVC refers to the per unit variable cost of production.
TVC
AVC  AVC  AC  AFC
Q
Output TVC AVC
(units) (Rate) (Rate)
0 0 -
1 100 100
2 190 95
3 270 90
4 360 90
5 480 96
6 600 100
7 800 114.28

 AVC curve is widen „U‟ shaped curve

 Reason of AVC curve shape is law of variable proportion
6. Average cost:- AC is per unit total cost or production
TC
AC  or AC  AFC  AVC
Q
Output TC (Rate) AFC (Rate) AVC (Rate) AC (Rate)
(units)
0 100 ∞ - -
1 200 100 100 200
2 290 50 95 145
3 370 33.3 90 123.33
4 460 25 90 115
5 580 20 96 116
6 700 16.67 100 116.67
7 900 14.28 114.28 128.57
  AC curve is „U‟ shaped curve.
 Reason for its shape is three stages of law of variable proportion.
7. Marginal cost:- MC is the addition to the total variable cost on account to produce an additional unit of
a commodity.
TC TC
MC  or MC  TCn  TCn 1 TVCn  TVCn 1
Q Q
Output TC MC
(units)
0 100 -
1 200 100
2 290 90
3 370 80
4 460 90
5 580 120

 MC curve is „U‟ shaped because it is based on law of variable production.

Relationship between the following
1. AC and MC or AVC and MC 2. TVC and MC or TC and MC
1. Relationship between AC/AVC and MC
Y
AC Y
MC

MC
AVC
AC & AVC &
MC MC

O Quantity X O Quantity X

AC & MC AVC & MC

1. When AC fall MC is also fall and remain
below from AC (MC < AC)
2. MC cuts AC at its lowest point (MC = AC)
3. When AC rises MC also rises and remain
above from it (MC > AC)
1. MC and AVC equal at first unit of output
2. Both fall but MC remain below from AVC
3. MC cuts AVC from below at its lowest
point
4. Both rises but MC remain above from it
Relationship between TC/TVC and MC
TC

Y TVC

TC &
TVC

X
O
Y MC

MC

O X
Quantity
-Y
 TC/TVC increases at decreasing rate till MC decreases.
 TC/TVC increases at increasing rate when MC increases.
 TC/TVC increases at the rapid rate when MC rises at rapidly.
Some hot questions
Q.1 Prove that MC is variable cost only.
Ans. MC is an additional cost. Additional cost by definition cannot be fixed cost; it can only be variable
cost as explain by following way.
MC = TCn – TCn-1 as we know TC = TFC + TVC
So, MC = (TFCn + TVCn) – (TFCn-1 + TVCn-1)
TFCn = TFCn-1 TFCn - TFCn-1 = 0
Than MC = TVCn - TVCn-1
Conclusion TVC =  MC (MC is variable cost only no fixed cost in it)
Area ABCD is equal to TVC
This is because TVC =  MC
Y

MC
C
D

MC

TVC

B X
O A
Quantity
Q.2 Why the gap between AC and AVC reduces as output increases in short period of time.
Ans. As we know that AC is the sum of AFC and AVC and AFC reduces as the level of output increase
so contribution of AFC decreases in AC and contribution of AVC increases thus AC and AVC curve
come closer as the output increases. But they never touches each other.
Y

AC
AVC

AC &
AVC
AFC AFC

X
O Quantity
Q.3 Diagrammatically explains how AC is the summation of AFC and AVC. (AC = AFC + AVC)
Ans. I line:- AFC = SQ, AVC = SR
AC = SQ + SR  AC = SN

II line:- AFC = TZ; AVC = TZ

AC = TZ + TZ  AC = TY

III line:- AFC = UV; AVC = UW

AC = UV + UW  AC = UX
Y I II III

N
AC
AVC
AC X
Q Y
AFC
AVC W
R Z
V
AFC

X
O S T U
Quantity
Calculation method of Different costs.
1. TC = TFC + TVC
2. TFC = TC – TVC
3. TVC = TC – TFC
= AC × Q = AFC × Q = AVC × Q
=  MC
4. AC = AFC + AVC
5. AFC = AC – AVC
6. AVC = AC – AFC
TC TFC TVC
= = =
Q Q Q

TC
7. MC =
Q
= TCn  TCn-1
= TVCn  TVCn-1
 TVC

Q
*****
 Unit -8
Concepts of Revenue
Meaning of Revenue
The revenue of a firm is its sales receipts or money receipts from the sale of a product.
Revenue and Profit are different
Profit = Revenue - costs
Or
Revenue = costs + Profit
Different Measurement of Revenue of a firm
1. Total Revenue (TR):- TR is total money receipts of a producer on account of the sale of his total output.
TR = Price × Quantity or  MR
2. Marginal Revenue (MR):- Marginal revenue is the addition to total revenue by the sale of an additional
unit of the commodity.
MR  TRn  TRn 1
or
TR
MR 
Q
3. Average Revenue (AR):- Average revenue is the price per unit. It can be obtained by dividing total
revenue by the quantity sold.
TR
AR 
Q
TR, MR, AR in different Market condition
(A) Perfect competition:- Price under perfect competition is determined by market forces market demand
and market supply and it is accepted by every firm.
So price for every firm remain constant. Every firm is free to sale any quantity at the given price.

Units Price TR MR AR
Offered for sale (Rate) (Rate) (Rate) (Rate)
0 0 0 - 0
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
INDUSTRY
AR MR of a firm TR of a firm

S Y TR
D

E P AR
Price

P
MR

S D 45o
O Q X O X O X
Quantity Quantity Quantity

Observations
 1. In perfect competition a firm is a price taker while industry is a price maker
2. In perfect competition
Price = AR = MR
o
3. TR will be 45 at origin shows constant increase. Because every additional unit sold at same price
thus TR increase at constant rate
4. AR curve is also known as demand curve thus price elasticity of demand under perfect competition is
perfectly elastic (Ed = ∞)
(B) Imperfect competition:- In a monopolistic market because close substitute is available in the market
thus a firm has to reduce its product price to increase sale.
Units Price TR MR AR
Offered for sale (Rate) (Rate) (Rate) (Rate)
1 10 10 10 10
2 9.5 19 9 9.5
3 9 27 8 9
4 8.5 34 7 8.5
5 8 40 6 8
6

AR, MR in monopolistic market TR in monopolistic market

Y Y

TR

AR & TR
MR

AR
MR
O X O X
Quantity Quantity

Observations
1. A firm has to reduce its product price because firm faces tuff competition from close substitute
available in the market.
2. Price = AR
But AR > MR
3. TR increases but at decreasing rate because price at every additional unit offered for sale is reducing.
4. AR curve which is demand curve also is falling thus price elasticity of the product is highly elastic
(Ed > 1)
5. AR, MR under monopolistic competition both fall but MR remain below from AR and MR at double
rate than AR fall.
(C) Monopoly:- Monopoly producer is producing unique product which have no substitute in the market.
despite of full control over the supply a monopoly firm also have to reduce its product price to increase
sale. Because if monopoly firm choose a high fixed price than product sale will be determine by the
market and at the high price people prefer to buy less quantity (according to law of demand) which
further put negative effect on firms profit. Thus monopoly firm reduce price to increase product sale but
more than what reduces by monopolistic firms.
 Units Price TR MR AR
Offered for sale (Rate) (Rate) (Rate) (Rate)
1 10 10 10 10
2 9 18 8 9
3 8 24 6 8
4 7 28 4 7
5 6 30 2 6
6 5 30 0 5

AR, MR in monopoly market TR in monopoly market

Y Y

AR & TR
TR
MR

AR

O X O X
Quantity
MR
Quantity

Observations
1. Monopoly firm reduce the products price to increase the sale
2. Price = AR
But AR > MR
3. AR curve is demand curve and less flatter than AR cure under monopolistic thus is less elastic (Ed
< 1)
4. TR is increases but at decreasing rate.
Prove that AR = Price
TR
We know AR 
Q
We know also TR = Price × Quantity
Price  Quantity
So, AR 
Quantity
Thus AR = Price
Explain how AR curve is demand curve also
A demand curve is a graphically representation. Which shows various quantity demanded by consumer at
various price so as a AR curve shows various quantity at different prices. Therefore in economics AR curve
showing the same relationship between quantity demand and price which shown by demand curve.
Hence AR curve is demand curve also.
Relationship between AR and TR in Monopoly and Monopolistic
1. TR increases at decreasing rate till MR is falling but positive
2. TR become maximum as MR reached at zero
3. TR start declining as MR goes negative.
Elasticity of demand under different market
Competition Monopolistic Monopoly
Y Y

Ed AR (P)
Ed =  AR (P) >

Ed
AR (P) 1
D (AR)

<1
D (AR) D (AR)
O X O X
Quantity Quantity Quantity
1. Perfect competition – Perfectly elastic Ed = ∞
2. Monopolistic - Highly elastic Ed > 1
3. Monopoly - less elastic Ed < 1
Note: - Price of product become zero only in government sector where government providing various
services and good as free. Thus AR only becomes zero in welfare work.

*****
 Unit -9
Form of Market
Definition of Market
Market is that geographical area where potential buyers and sellers contact each other for the purpose of
exchange of goods and services at some prices.
Essential Constituents of Market
1. Geographical area 2. Buyers 3. Sellers
4. Contact (Through any medium) 5. Exchange purpose 6. Commodity
7. Prices
Classification of market on the basis of competition
Market

Perfect competition Imperfect competition Monopoly

Monopolistic Duopoly Oligopoly

Perfect competition
Perfect competition refers to a market situation where there are very large number of buyers and sellers
dealing in homogeneous product at a fixed price determined by the market
Features of perfect competition
1. Large number of buyers:- In perfect competition there are large number of buyer thus individual
buyer do not have any control over market demand so he cannot effect market price of the commodity.
2. Large number of seller:- There are large number of sellers in the market for a product thus individual
seller do not effect market supply in any manner and so he cannot influence the price also.
3. Homogenous product:- The products offered for sale in the market are homogeneous i.e. the product is
identical in all respects like size, shape, quality, colour packing, after sale service ect.
Homogeneous product is that buyers do not ready to pay a different price for the identical product so
any attempt by a firm to sale its product at a higher price will fail. So all sellers have to charge the
same price from all the buyers
4. Freedom of entry and exit:- A firm can enter and can take exit from the market. There are no barriers
for entry of new firms and exit of old firm thus all the firms earn normal profit in long run.
5. Perfect knowledge:- Buyers and sellers both have perfect knowledge about market thus if any firm
charge more price than market price will faces loss due to short of sale.
6. Absence of selling and transport cost:- No firm can charge any other cost like selling cost ect.
Because any other cost will increase marginal cost of the product and in perfect competition no form
can charge his own price thus they do not spend any selling cost which will further reduce their profit.
7. Perfect mobility of factors of production:- Factors of production like Labour, Capital can move in the
industry as all the firms are using same technology to produce homogenios product so they can move
without facing fractional unemployment.
8. Independent decision:- Every firm working under perfect competition is free to decide its quantity for
sale at given prices and want to continue in the market or take exit from the market. Even buyers also
have free to decide their quantity demand for a good at given prices no firm form cartel no consumers
associations exists.
9. No government interference:- Government does not interfere in any way with the functioning of the
market. There are no taxes or subsidies, no licensing system. Government follow free enterprise policy.
Monopoly Market
The word monopoly has been derived from two Greek words „monos‟ and „Polus‟.
Monos   single
Polus   seller
So word monopoly means single seller.
Meaning
Monopoly is that market situation in which a firm has the sole right over production or sale of the product
and it has no competitor in the market and no substitute for its product.
Features of Monopoly
1. Single seller / firm:- There is only one seller for a commodity in the market he has full control over the
market supply for the product thus firm enjoy the power of price discrimination.
2. No substitute for the product:- Buyers do not have choice of another product in place of monopoly
product thus the demand under monopoly is less elastic.
3. Price discrimination:- A monopolist follow the price discrimination policy when he charge different
prices for the same (or slightly differentiated) product is sold to different buyer, group or nation.
4. Restrictions on entry of new firm:- This enable the monopoly firm to earn supernormal profit in long
run because as market demand rises it leads to increase in price but supply do not affected by rising
prices because new firm cannot enter into the market and monopolist firm earn all the profit but do not
increase the supply.
5. Price maker:- Single firm determined the price of its product because it enjoy full control over supply.
How does monopoly market arises
1. Government Licensing:- when government give license for production of particular commodity only
to one producer.
2. Patent Right:- Patent right is the legal recognition of innovator of a new product or technology which
gives him monopoly power.
3. Cartel:- When group of firm behave like monopolist their collective decision control the market as
monopoly do.
4. Natural occurrence:- A monopoly may arises due to the reason that nature grant sole power over a
product which no other region have.

Merits and Demerits of Monopoly

Merits
1. High level of skill and efficiency in the work.
2. High level of research and development

Demerits
1. Less output:- For earning more profit a firm produce less quantity which result in high prices.
2. High price:- A monopolist always charge high prices for its unique produce because he has full control
over a product which do not have substitute.
3. Consumer’s exploitation:- A consumer is always exploited by a private monopolist by different ways.
4. Economic concentrations:- A monopolist capture the whole profit of the market due to unique product
which have less elastic demand.
Monopolistic competition
It is a market form where large no of buyers and sellers exchange differentiated product which have close
substitute in the market at different prices.
Features of Monopolistic Market
1. Large no of sellers:- Large no of sellers selling differentiated product having partial control over the
market supply.
2. Product differentiation:- Under the monopolistic market all the producers producing differentiated
product which is differ in any form of production like size, packing, color, quantity, design etc.
Because of product differentiation each firm can decide its price policy independently so that each firm
has a partial control over price of its product.
3. Freedom of entry and exit:- A firm under monopolistic market earn normal profit in long run because
Demand  Price  Supernormal profit  New firm entre  Supply  Price  Normal profit

Demand  Price  Loss  Old firm exit  Supply  Price  Normal profit
4. Selling cost:- Each firm has to incur selling cost like advertisement, after, wholesalers retailer
commission ect to promote its sales. This is because there is a large number of close substitutes in the
market.
5. Less mobility:- Factors of production are less or imperfectly mobile in the industry because of product
differentiation technology for production also differ.
6. No perfect knowledge:- Because of large no of producer with product differentiation no one in the
market having perfect knowledge about the market and product.
7. Non price competition:- Because product is differentiated. So there production cost also differs thus
every producer determines its own price for the product. They are not competing for price there
competition is for quantity sale.
8. More quantity can be sold only by lowering the price:- Every firm facing competition from the
substitute product available in the market so more quantity of their product can be sold by them if they
lower the price. This effort attracts the buyers of their substitute product thus a demand curve is highly
elastic in this market.

Oligopoly Market
It is a form of imperfect competition where few sellers (normally more than 2 less than 15)exchange
differentiated product with Large no of buyers and entry of new firm faces some barriers.
Examples: Car market: Maruti, Tata, Fiat, Ford, GM etc.
Tooth pest: Pepsodent, Colgate, close-up vico etc.
Features of Oligopoly
1. Few firms:- In oligopoly market firms are few in numbers normally they are more than two but less
then fifteen. Thus each firm commands a significant share of the market it can impact market price of
the product
2. Large no. of buyers:- Buyers are large thus the individual buyer do not hold any control on market
price.
3. High degree of Interdependence:- Decision of every firm about price and output affected from its
rival firm they have close substitute thus whatever policy adopted by a firm regarding price and output
also affect the decision of other firm. Thus a demand curve (AR curve) cannot determine under this
market.
4. Formation of cartels:- With a view to avoiding competition firm may form a cartel. It is a formal
agreement among the firms to avoid competition. It is a situation of collusive oligopoly under it output
quotas and prices are fixed.
5. Not possible to determine firms demand curve:- It is not possible to predict changes in price because
if a firm lower the price the demand for its product may not increase because the competitor firm also
reduce the price and if a firm increase the price competitor firm may not increase the price.
6. Barriers on entry:- Entry at new firm is difficult in this market, New firm faces barriers like
technological barriers, Huge investment, control over the raw material ect.

Collusive and Non- Collusive Oligopoly

Collusive Oligopoly
It is a form oligopoy market in which there are few firms in the market and all decide to avoid competition
through a formal agreement. They make a cartel and fix output, quotas and market price.
Why Collusion?
1. Collusion reduces the degree of competition between the firms and help them to earn good profit as
monopoly do.
2. Collusion reduces the uncertainly of the market which affect the firms profit.
3. Collusion forms a kind of barrier to the entry of new firms.
Non-Collusive Oligopoly
It is a form of oligopoly in which there are few firms in the market and each firm pursues its price and
output policy independent of the rival firms. Each firm tries to increase its market share through
competition.
Difference between Pure and Perfect competition
Pure competition Perfect competition
1. The pure term use by British economies 1. The term perfect use by USA economists
2. Features of pure competition are 2. Features of perfect competition are
(a) Large no of buyers and sellers (a)Large no of buyers and sellers
(b) Homogeneous product (b)Homogeneous product
(c) Free entry and exit of the firms (c)Free entry and exit of the firms
(d)Independent decision
(d) Independent decision
(e)Perfect knowledge
(f)No selling cost
(h)perfect immovability of the factor
(i)No government interference
3. More real term for market 3. Imaginary market form

Perfect Competition, Monopolistic Competition and Monopoly – Some Differences

S. Reference Perfect Monopolistic Monopoly
No. Competition Competition
1. Number of Sellers Large Large One seller, but large
and Buyers number of buyers
2. Product Homogeneous Product Homogeneous or
differentiation differentiated
3. Price Uniform Not uniform because Not uniform because
of product of price discrimination
differentiation
4. Entry of Firms Free entry Not absolute Not possible
freedom
5. Knowledge of Perfect knowledge Imperfect Imperfect knowledge
Market knowledge
Conditions
6. Mobility Perfect mobility Imperfect mobility Imperfect mobility
7. Firm‟s Demand Perfectly elastic Relatively more Relatively less elastic
Curve elastic
8. Slope of Firm‟s Horizontal straight Slopes downward Slopes downward with
Demand Curve line (AR = MR) with high elasticity low elasticity (AR >
(AR > MR) MR)
 9. Selling Costs Not required Very significant Not required
10. Degree of Price No control over Partial control over Full control over price
Control price price
11. Level of Profit in AR = AC ⟹ AR = AC AR > AC
the long run normal profits ⟹ normal profits ⟹ extra normal
profits

******
 Unit -10
Producer’s Equilibrium
Meaning
Producer‟s Equilibrium refers to a state of rest when no change is required. A firm (producer) is said to be
in equilibrium when it has no inclination to expand or to contract its output. This state either reflects
maximum profit or minimum losses.
There are two methods for determination of producer‟s Equilibrium:-
1. Total revenue and Total cost approach 2. Marginal revenue and Marginal cost approach
1. Total revenue and Total cost approach:- According to TR and TC approach a producer is in
equilibrium situation where the TR is greater than TC and Gap between them is maximum.

(i) Producer‟s Equilibrium (when price is constant)

Q Price TR TC Profit Situation

units (Rate) (Rate) (Rate) (Rate)
0 10 0 5 5 TR < TC (Loss)
1 10 10 10 0 TR = TC (BEP)
2 10 20 15 5 TR > TC (Profit)
3 10 30 24 6 TR > TC (Profit)
4 10 40 30 10 TR > TC (Max. Profit
5 10 50 45 5 TR > TC (Profit)
6 10 60 60 0 TR = TC (BEP)
7 10 70 78 8 TR < TC (Loss)

Explination:- In the given case firm can sell any level of output at the prevailing market price of Rs 10.
However a rational firm will aim to produce that level of output at which profit are maximum.
The producer will be at equilibrium at 4th unit of output because at this level both the condition of
producer‟s equilibrium are satisfied.
1. Producer earning maximum profit of rate 10
2. Total profit fall to 5 after 4th unit of output.
 TC
BEP Loss
Y
TR
e
 TR = TC 
TR>TC d
TR & TC Profit
BEP

a c
Loss b

O X
Qo Q Q1
Y

Total profit Maximum profit

O X
Qo Q Q1
Profit

Diagram Explination:- Diagram shows the TR and TC curve at different output level. In the (starting TC is
higher than TR thus diagram shows negative profit) (At OQo output level TR and TC both equal means no
profit no loss situation (Break even point) as the output level increases and a producer offer to sale OQ level
he will get maximum profit which is „dc‟ in diagram) but (no producer would like to go beyond this level
because as he offer more quality for sale the total profit will decrease) thus (the OQ quantity is the point
where a producer earn maximum profit)

(i) Producer‟s Equilibrium (When price fall with rise in output):-

Output Price TR TC Profit Situation
units (Rate) (Rate) (Rate) (Rate)
0 10 0 2 -2
1 9 9 5 4
2 8 16 9 7 Profit rises with
3 7 21 11 10 increase in output
4 6 24 14 10 Producer‟s Equilibrium
5 5 25 20 5 Profit falls with
6 4 24 27 -3 increase in output
Explination:- Producer has to reduce the price to increase the volume at sales. In order to maximum the
profit, the producer will keep on increasing the output. The maximum profit of Rs 10 can be achieved
by producing either 3 units or 4 units. But the producer will be at equilibrium at 4 units of output
because at this level both the condition of producer‟s equilibrium is satisfied.
1. Producer earning maximum profit of Rs 10
2. Total profits fall to Rs 5 after 4th units of output
 Y
TC Loss
b c
TR
TR & TC
S
d
a

Loss

O X
Qo Q Q1
Y

P Maximum profit
Total profit

O X
Qo Q Q1
Profit

2. Marginal revenue and Marginal cost approach:- According to MR – MC approach a producer will be
in equilibrium situation where the two essential conditions fulfilled.
(a) MR = MC (b) MC should cut the MR curve from below.

(i) Producer‟s Equilibrium (when price is constant):-

Q Price TR TC MR MC Profit
1 12 12 13 12 13 -1 -
2 12 24 25 12 12 -1 -
3 12 36 34 12 9 2 -
4 12 48 42 12 8 6
5 12 60 54 12 12 6 Producer‟s
Equilibrium
6 12 72 68 12 14 4 -
MC
P
Y

R K
MR
MC
MR

O Qo Q Q1 X
Explination:- A producer is in equilibrium at „k‟ where he produce OQ quantity of the product. he is
not in equilibrium at point R where MR-MC equal but MC will decline if he produces more unit of the
product. Means as the producer increase the output level every additional unit would be at less cost
implying less addition to TVC   MR  thus the gap between the TR and TC tending to widen. At point
 „P‟ or after every point of „R‟ a producer will face loss because additional unit become more and more
costly while less addition to TR as Compared TC.
(ii) Producer‟s Equilibrium (when price falls with rise in output):-
Q Price TR TC MR MC Profit
1 8 8 6 8 6 2
2 7 14 11 6 5 3
3 6 18 15 4 4 3
4 5 20 20 2 5 0
5 4 20 26 0 5 -6

MC
Y S

MC & MR R

O Qo X
Q Q1
Out put MR

Explinition:- As two conditions of producer‟s equilibrium are satisfying at point where

(a) MR=MC and (b) MC rising
So OQ quantity will be produced by the producer any efforts beyond this will gives less profit.

Producer’s Equilibrium in Short period and Long period Analysis

Short Run
New firm cannot join the industry and existing firms cannot leave the industry during the short period
means there will be very less or negligible change in supply.
So three situations can arise in the market
1. Normal Profit:- TR = TC
TR TC
=
Q Q
 P  AR = AC
In this situation the prices determine by the industry on the basis of market forces are just covering all
the total cost for a firm implying. Total revenue equals to Total cost or (AR = AC)
 INDUSTRY FIRM
Y Y MC
D S
AC

E P K AR
Price

MR

S D

O Q X O Q X
AR = AC OP = OP
TR = TC = OPKQ = OPKQ
 AR× Q  =  AC× Q  =  OP× OQ  =  OP× OQ 
2. Super normal Profit:- TR  TC
TR TC

Q Q
 P  AR  AC
In this situation if the demand increase and supply cannot charge because short time period all the profit
due to rise in the price distributed among the existing producer thus the firm earn super normal profit
INDUSTRY FIRM
Y Y
D S
Super MC
Normal AC
Profit

E P K AR
Price

MR
T
S

S D

O Q X O Q X

Q Q
AR  AC 'OP'  'OP'
TR  TC 'OPKQ'  'OTSQ'  Profit = 'TPKS' 
 AR× Q    AC× Q 
 OP× OQ    OT× OQ 
3. Loss:- TR  TC
TR TC

Q Q
 P  AR < TC
In this situation if demand decrease and old firm cannot leave the market they have to face all the loss
due to fall in the prices.
 INDUSTRY FIRM
Y Loss AC
Y MC
D S
K
T

E P AR
Price

S MR

S D

O Q X O Q X

Q Q
AR  AC 'OP'  'O T '
TR  TC  Loss = 'PTKS'
'OPSQ' < 'OTKQ'
 AR×Q    AC×Q    OP×OQ    OT×OQ 
Long Period
New firms can join the industry and existing firms can leave the industry in the long period implying both
market demand and supply can change and the firm earns only normal profit in long run. Because both
market demand and market supply equally effect the situation for all the firms working under perfect
competition
INDUSTRY FIRM
1
D
Y Y MC
D S
S1 AC

E E1 K AR
Price

MR

D1
S D
1
S
O Q Q1 X O Q X

Q Q
Break-even point
„BEP‟ is a situation where a firm just covering its cost of production as market price
 P = AC 
 AR = AC   Break even point
 
 TR = TC 
Shout down point
„SDP‟ is a situation where a firm just covering its variable cost as a price. Here a firm losing fixed cost
which is the same as losing at zero output thus the firm will suspend the production till the price increases.
SHOUT  P = AVC  loss of AFC  
 
DOWN  AR = AVC (loss of AFC 
POINT TR = TVC (loss of TFC) 
 
 INDUSTRY FIRM
Y AC
Y
D S AC

Do
E AFC K AR
Price

P MR
T
Po
o
E
S D
Do
O Q X O Q X

Q Q Point „k‟ =
BREAK EVEN POINT
Point „T‟ = SHOUT DOWN POINT

*****
 Unit -11
Market Equilibrium Under Perfect Competition

Market Equilibrium
Consumers and producers have opposite interests as far as the market price of the good is concerned.
Consumers would like to pay the price as low as possible. Producers would like to charge price as high as
possible. The both agreed to exchange specific quantity at specific price. Thus agreed price is term as
equilibrium price and agreed quantity is called equilibrium quantity or this position is known as market
equilibrium in economics.
Definitions

Market equilibrium:- Market equilibrium is a situation in which market demand and market supply
become equal
Or when all the sellers of a commodity are able to find buyers and all the buyers of the commodity are able
to find sellers. There is neither excess demand nor excess supply in the market of a product.

Equilibrium price:- It is that market price where both buyers and sellers are agreed to buy or sale specific
quantity of a product in the market.

Equilibrium Quantity:- It is that specific quantity of a product which all the buyers and sellers are agreed
to buy or sale at specific prices in the market.

Determination of Equilibrium:- Under perfect competition, equilibrium in the market is determined by

the market forces of market demand and market supply. Market forces operate according to law of demand
and law of supply.
Market equilibrium struck where all the buyers and sellers agreed to buy and sale specific quantity at
specific price.
Market equilibrium through schedule
Price (Rate) Demand (in kg) Supply (in kg) Situation
10 500 100 Excess
20 400 200 Demand
30 300 300 Market
Equilibrium
40 200 400 Excess
50 100 500 Supply
Y Supply
50 D
S
P1 H
40 K

E
Price (Ruppes)

P
30 Market equilibrium
P0 R T
20

Exess Demand
10 S D

0 100 200 300 400 500 X

Quantity (kg)
Explination:- Table and diagram explain the market equilibrium situation. Market demand and market
supply both are equal at price Rs. 30 where 300kg quantity will be buy or sold thus the market equilibrium
is at point „E‟
Excess demand is at price Rs. 10 and 20 where buyers demand 500 and 400 kg but sellers are willing to
sale only 100 and 200 kg respectively. Excess supply is at price Rs. 40 and 50 where sellers are willing to
sale 400 and 500 kg but buyers are willing to buy only 200 and 100 kg only.

What happens when there is excess supply?

Suppose the price rises to OP1 (Rs. 40). The demand will reduce to „H‟ (200 kg) Supply on the other hand,
will increase to „k‟ (400 kg). The excess supply „HK‟ over demand will force to sellers to reduce their
prices in order to clear their surplus stock. This increase in supply leads to fall in prices consequence
demand rises and again market reach in equilibrium situation.

What happens when there is excess demand?

Suppose the price fall to OPo (Rs. 20). The supply reduces to „R‟ (200 kg) demand on the other hand will
increase to „T‟ (400 kg). The excess demand „RT‟ over supply will push the prices upward to „OP‟. This
process leads to increase in supply and fall in demand and again market demand and supply become equal.

Shifting in the equilibrium

(A) Change in demand
(i) Increase (Rightward Shifting) (ii) Decrease (leftward Shifting)
(B) Change in supply
(i) Increase (Rightward Shifting) (ii) Decrease (leftward Shifting)

(A) Shift in demand:- Shift in demand means increase or decrease in demand due to factors other than
price. In case increase in demand curve shifted rightward and in case of decrease in demand, demand
curve shifted leftward.

(i) Increase / Rightward Shifting (ii) Decrease / Leftward Shifting

D1
Y Y
D S D
S
E1 Do
P1
E P E
P
Price
Price

Po
D1 Eo
D
S D
S Do
X O Qo Q X
O Q Q1
Quantity Quantity

Chain effects of increase in demand:-

(a) When demand rises from DD to D1D1 buyers are now prepared to offer a higher price. This leads to
increase in price.
(b) As a result of rise in price producer offer more to sale from the stock the market move upward
from E to E1 along the supply curve.
 (c) Rise in price on the other hand puts pressure on demand. The buyers now start demanding less
(contraction in demand)
(d) The trend of rising supply and falling demand continues till the excess demand reduced to zero.
(e) Market demand and market supply become equal at point E1. But this new price OP1 is higher than
what it was before increase in demand.

Chain effects of decreases in demand:-

(a) When demand decreases from DD to DoDo buyers are now prepared to offer a lower price. This
leads to fall in price.
(b) As a result of fall in price producer are willing to supply less. The market move downward from E
to Eo along the supply curve.
(c) Fall in price motivate buyers to buy more of the product which leads extension in demand.
(d) The trend of falling supply and rising demand continue till market again settles a new equilibrium
point Eo where OPo new price and OQo new equilibrium quantity
Shift in supply
A change in supply means increase or decrease in supply due to factors other than price. When supply
increases the supply curve shifted rightward and when supply decreases the curve shifted leftward side.

(i) Increase / Rightward Shifting (ii) Decrease / leftward Shifting

Y S Y So
D D
S1 S

E Eo
P L P1
Price
Price

R
Po 1 P E
E

S
D So D
S 1 S
O Q Q1 X O X
Qo Q
Quantity Quantity

Chain effects of increasing in supply:-

(a) Rightward shifting of supply curve when demand remaining unchanged creates a situation of excess
supply in the market.
(b) Excess supply puts a downward pressure on price.
(c) The lower price puts an upward pressure on demand and downward movement on supply.
(d) This rising demand an falling supply would clear the excess supply from the market.
(e) Market demand and supply become equal at E` which is new equilibrium for the market an new
equilibrium price OPo for short run only.

Chain effects of decrease in supply:-

(a) Decrease in supply, leads to excess demand. (Equal to RE) at prevailing market price.
(b) Competition among buyers create excess demand situation which puts an upward pressure on price
(c) Higher price puts a down ward pressure on demand and upward pressure on supply.
(d) Finally fall in demand and rise in supply would lead to reduction in excess demand.
Simultaneous change in Demand and Supply

(A) Simultaneous increase in Demand and Supply

(i) D↑ = S ↑ (ii) D↑ > S↑ (iii) D↑ < S↓
(B) Simultaneous decrease in Demand and Supply
(i) D↓ = S ↓ (ii) D↓ > S↓ (iii) D↓ < S↓
(A) Increase in Demand and Supply
(i) D↑ = S ↑ (ii) D↑ > S↑
1
Y D S D1
Y S
1
D S D S1

E
Price

P1 E1

Price
P E1
E
P

D1 D1
S S
S1 D S1 D
O Q X O Q X
Quantity Quantity
(iii) D↑ < S↓
Y D1 S
D
S1

E
Price

P
Po E1

D1
S D
S1
O Q X
Quantity
(i) D↑ = S ↑:- If market demand and market supply both increases in same proportion than equilibrium
price will remain the same but due to change in quantity new equilibrium will be at E‟
(ii) D↑ > S↑:- If market demand increase more than market supply this excess demand leads to rise in
prices and equilibrium will be at E1 with new prices OP1.
(iii) D↑ < S↓:- If market supply increases at faster rate than market demand this put down the prices and
new equilibrium will be at E1 with less prices OPo.
B) Decrease in Demand and Supply
(i) D↓ = S ↓ (ii) D↓ > S↓
Y So
So
Y S D S
D
o Do
D

Eo E

Price
E P
Price

P
Po Eo

So So
S D D
S
Do Do
O Q X O Q X
Quantity Quantity
(iii) D↓ < S↓
Y So
D S
Do

P1
Price

Eo
P E

So
S D
Do
O Q X
Quantity
(i) D↓ = S ↓ :- If market supply and market demand both fall in the same proportion than equilibrium
price will not affect but due to change in quantity new equilibrium will be at Eo
(ii) D↓ > S↓:- If market demand fall at faster rate than fall in supply equilibrium price also decrease due to
excess supply and new price will be OPo with new equilibrium Eo.
(iii) D↓ < S↓:- If market supply fall more than market demand this shortage of supply leads to increase in
prices and new equilibrium will be at Eo with new price OP1.
Market Equilibrium when Demand and Supply are perfectly elastic and perfectly inelastic
(A) Perfectly elastic demand (B) Perfectly inelastic demand
Y So
Y D So
S
S
S1
E1 S1
E o
E E1
P D
Price
Price

E
o
S S o

S Eo
S
S1 S1
O Qo Q1 X O X
Q Q
Quantity Quantity

(A) Perfectly elastic demand:- When marked demand can adjust up to any level. Any increase and
decrease in supply will not affect market equilibrium price only due to quantity change market
equilibrium reached at new levels like E1 or Eo
(B) Perfectly inelastic demand:- If market demand of a product is perfectly inelastic means demand will
not change no matter, What are the prices previous in the market so prices fall with the increase in
supply (excess supply) and prices rise with the decrease in supply (excess demand) new equilibrium
will be at E1 and Eo.
(C) Perfectly elastic supply (D) Perfectly inelastic supply
Y D1 S
Y 1
D D
D
Do
Do
E1
Price

Eo E E 1
S P1
P

Price
P E
1
D
D Po Eo D1
Do D
O X Do
Qo Q Q1 O X
Q
Quantity Quantity
(C) Perfectly elastic supply:- When supply is perfectly elastic any change in demand will not bring
change in equilibrium price. But the equilibrium quantity change new equilibrium will adjust at E 1 or
Eo levels.
(D) Perfectly inelastic supply:- When supply do not change with the change in price any increase in
demand pull up the prices due to excess demand and any decrease in demand leads to fall in prices due
to shortage of demand and accordingly market equilibrium adjust at E1 or Eo levels.

*****
 Unit -12
Concept of Supply
Supply
Supply refers to different quantities of a product those a firm is willing and able to offer for sale at different
prices during a period of time.
Stock
Stock refers to total quantity of a product that is available with the firm at a particular point of time. Supply
is that part of stock which is actually brought into the market for sale. Stock can never be less than the
supply.
For example:- A seller has a stock of 50 tones of sugar in the go down . if the seller is willing to sell 30
tones at a price of Rs. 40 per kg then supply of 30 ones is a part of total stock of 50 tones.
Quantity supplied:-Quantity supplied is that specific quantity of a product which a producer is willing
and able to sale at specific price at a point of time.
Types of Supply
1. Individual Supply of Firm’s supply:- Supply of a particular commodity by an individual firm at given
price in the market is termed as individual supply.
2. Market Supply:- Quantities of a particular commodity offered for sale by all the firms at given price in
the market is known as market supply.
Supply Schedule
Supply schedule is a tabular presentation for showing different quantities of a commodity which offered for
sale at various prices. It is of two types.
1. Firm’s (Individual) Supply schedule:- Individual supply schedule is a table shows different quantities
of a commodity those a firm is willing and able to sale various prices.
Price Ice Cream
Supply by firm ‘A’

5 100
10 200
15 300
20 400
2. Market supply Schedule:- Market supply schedule is a table shows different quantities of a
commodity those all the sellers are willing and able to in the market at various prices.
Prices Ice cream Supply
Firm A Firm B Market
5 100 200 300 units
10 200 400 600units
15 300 600 900 units
20 400 800 1200 units
Supply curve
Supply curve is a graphical presentation of different quantities of a commodity at a various prices.
 Firms supply curve
Supply curve  
 Market supply curve

Firm’s Supply curve

It is a diagram which shows quantities of a commodity which a seller willing and able to sale at different
prices.
Market Supply Curve
It is a diagram which shows different quantities of a commodity those all the sellers are willing and able to
sale in the market at different prices.
Y

P SA SB SMKt
20
R
I 15
C
10
E
5

O 100 200 300 400 500 600 700 800 900 1000 1100 1200 X
Supply Function
Supply function is a functional relationship between quantity supplied of a commodity and various factor
affecting it.
Sx = f (Px, Psub, Pf, T, Gf, Gp , Ex, No, C)
Factor affecting Q. S of a commodity
 Price of the commodity (Px):- Own price of a commodity affect its quantity supplied positively
Px  S x 
Px  S x 
 Price of substitute goods:- Price of substitute goods affect the supply of a commodity inversely.
Eg. The supply of wheat will fall with the rise in the price of rice. This is due to the fact that rise in
the price of rice will encourage producers to produce more rice consequently area under wheat
cultivation will be lesser and the supply will decline
 Pwheat  SRice  
 
 Pwheat  SRice  
 Price of inputs (Pf):- with the rise in the price of inputs like wages, interest, rent ect. The cost of
production also raises which results in decrease in supply because producer have scare resources
which become unable to hire sufficient factors and thus supply fall and vice versa.
 Pf  Sx  
 
 Pf  Sx  
 Technology of production (T):-
 Lastest technology Sx  
 
Out dated technology Sx  
 Goal of the firm (Gf):-
Price maximisation Goal- Sx 
Sales maximisation Goal- Sx 

 Government Policy (GP):-

Favorable policy (or provide subsidy) → Sx 
Unfavorable policy (or impose tax)→ Sx 
 Future price expectation (Ex):-
Future price about to rise - Sx 
Future price about to fall - Sx 
  No of firms:-
More firms – more supply
Less firms – less supply
 Mean of transport and communication (c):-
Developed means of transport and communication result in increase in supply and vice versa.
Law of supply
It state that there is a positive relationship between price of a commodity and quantity supplied of that
commodity when other things assume to be constant
 Px  Sx  
  other things assume to be constant
 x
P  S x  
Explanation of the law
Price Supply
5 500
6 600
7 700
8 800
9 900
10 1000
Assumption of the law
 There should be no change in price of related goods
 There should be no change in production technology
 There should be no change in price of inputs
 The goal of the firm remains the same
 No future expectation about the price
 No change in government policy.
Exceptions of the law
 The law does not apply in case of agricultural products whose supply is affected by natural factors.
 The law may not apply in case of perishable goods.
 The law may not apply in case of goods having social distinction.
Change in Supply and Change in quantity Supplied
1. Change in supply:- When the supply of a commodity changes due to change in other factors at the
same price it is known as change in supply.
2. Change in quantity supplied:- When the Q.S of a commodity changes due to change in its price
keeping other factor constant known change in Q.S.
 Change in Supply

(1) (2)
Change in Q.S. Change in Supply
 
Happen due to Happen due to change
change in price in other factor
 
Assuning that other Assuming that price of the
factor do not change commodity do not change
 
Leads to movement Leads shifting in the supply
along the same supply curve
curve

(A) (B) (A) (B)

Upward Downward Rightward Leftward
(movement) (movement) shifting shifting
   
Expension Contraction Increase Decrease
   
Due to increase Due to decrease ferverable change Unfevarable change
in price in price in other factor in other factors
1. Change in quantity supplied:-
(A) Extension in supplied:- When the Q.S. increase with the rise in price and other things do not
change an upwards movement happen in the same supply curve.
(B) Contraction in supplied:- When the Q.S. decreases with the fall in price and other things do not
change an downward movement happen on the same supply curve.
Extension
Px Q.Sx
25 1000x Y Px  QSx 
30 2000x
S
P B
30
R
I A
25
C
E S
O 1000 2000 X
Q.S.
Contraction

Y
Px  QSx 
Px Q.Sx S
P A
25 1000
R 25
20 500x
I
B
C 20
E
S
O 500 1000 X
Q.S.
Change in Supply:-
(A) Increase in supply:- When due to change in factor other then price, more units are supplied it is
known as increase in supply. It leads to rightward shifting in supply curve.
Causes of increase in supply:
 Improvement in technology
 Reduction in price of inputs
 Fall in the price of substitute goods
 Sales maximization is the goal of the firm
 Government policy become fever able
 Future price about to fall
 No of firm increases.

Y S
S1
Px Sx Right
P ward
25 1000 R shifting
25 1500 A B
I 25
C
E
S S1
O 1000 1500 X
Q.S.
(B) Decrease in supply:- When due to change in factor other than prices more quantity is supplied. It is
known as decrease in supply. It leads leftward shifting in supply curve.
Causes of decrease in supply:
 Out dated production technology taken into use
 Rise in price of inputs
 Rise in price of substitute goods
 Price maximization become inferable
 Future price about to rise.
 O of firms reduces.

So S
Y
Left
P ward
R shifting
Px Sx B A
I 25
25 1000
25 750 C
E So S
O 750 1000 X
Q.S.
Time period and Supply
1. Market period (very short time):- Market period is the period of time during which production cannot
be changed at all.
2. Short period:- It is a time when output can be increase through the application of variable factor only.
3. Long period:- It is a period of time in which supply of a commodity can be changed by the application
of all factors of production.
SS Short Period
Market Period
P S P SL
R R
I I Long Period
C C
E E SS
SL
S
SUPPLY SUPPLY

Elasticity of Supply
Price elasticity of supply
Price elasticity of supply refers to degree of changes in the quantity of supply in relation to change in price.
Measurement of the Elasticity of Supply
1. Percentage method 2. Geometric method
1. Percentage method:-
Percentage change in Q.S.
Es 
Percentage change in price
Where
Q  Q0
(i) % change in Q.S.= 1  100
Q0
Q1 = New Q.S. Q0 = Initial Q.S.
P P
(ii) % change in price = 1 0  100
P0
P1 = New price P0 = Initial price
Q1  Q0
 100  Q1  Q0  Q 
Q0
Es 
P1  P0
P0
 100  P1  P0  P 
Q
Q0 Q P Q P
   
P Q0 P0 Q P
P0

Q P
Es  
P Q
Example:- If the market price of a commodity is Rs. 4 a seller is willing to sell 600 unit of the commodity
when the price rises to Rs. 5 he is willing to sell 750 unit what is the sellers elasticity of supply?
Solution: P0 = 4 Q0 = 600
P1 = 5 Q1 = 750
Q P
Es  
P Q
750  600 4
Es  
54 600
150
Es   1 (unit elastic supply)
150
2. Geometric method:- Geometrically elasticity of supply depends on the origin of the supply curve.
Horizontal distance
Es =
Origin distance
Y A B Y C
Y
Po E Po E Po E

-X B O C X O C XO B C X
Q.S. Q.S. Q.S.

-Y
Figure (A):-Supply curve is extended towards x-axis it intersects the x-axis in its negative range at
point B. The price elasticity is greater than one as (BC > OC).Horizontal distance is greater
than origin distance
Figure (B):-The point of intersection is the origin i.e. the straight line supply curve passes
through origin. The price elasticity is unitary as (OC = OC) Horizontal distance is equal to
origin distance
Figure (C):- The supply curve intersects the x-axis in its positive range the price elasticity of
supply is less than one as (BC < OC) Horizontal distance is shorter than origin distance

Two Extreme situation of elasticity of supply

D E
Y S Y

P P
S
S

S
O X O
Q.S. X
Q.S.
Figure (D):- Perfectly elastic supply. It refers to a vertical straight line. Supply curve showing constant
supply no matter what the prices are
Figure (E):- Perfectly inelastic supply: It refers to a horizontal straight line supply curve supply can be
any quantity no matter price changes or not.
 Supply is elastic when Es > 1
Supply is inelastic when Es < 1

Factors affecting elasticity of supply

1. Nature of commodity:-
Commodity can be stock   Elastic supply
Commodity cannot stock   Inelastic supply.
2. Cost of production:-
Cost of output more   Inelastic
Cost of output less  Elastic
3. Time period:-
Short time period   Inelastic
Long time period   Elastic
4. Technique of production:-
Simple technique   Elastic
Complex technique   Inelastic
5. Risk taking capacity:-
More risk taking capacity   Elastic
Low risk taking capacity   Inelastic
6. Natural constraints:-
Production depends on nature   Inelastic
Production do not depends on nature   Elastic
*****