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Reading Materials for Basics of Microeconomics

Basics of Microeconomics

• Demand and supply

• Elasticity
• The theory of Consumer behaviour
• Theory of Production
• Perfect and Imperfect Competition
• Factor market and Price of Factor of production

Demand and supply

Supply and demand is perhaps one of the most fundamental concepts of economics and it is the
backbone of a market economy.

Demand

Demand refers to how much (quantity) of a product or service is desired by buyers. The
quantity demands of goods or service is the amount that consumers plan to by during the
a given period of time at a particular price. In economics any one demands something
must he has to have
Want of it
Can afford and
Plan to by it.

The determinants of demand are:

1. price of goods
2. Income
3. Tastes and preferences
4. Prices of related goods and services
5. Consumers' expectations about future prices and incomes that can be checked
6. Number of potential consumers

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Supply

The quantity supplied refers to the amount of a certain good that producers are willing to
supply when receiving a certain price. The correlation between price and how much of a
good or service is supplied to the market is known as the supply relationship. Price,
therefore, is a reflection of supply and demand.

The determinants of supply are:

1. price of goods
2. Supply of alternative goods
3. Production costs
4. Firms' expectations about future prices
5. Number of suppliers

The relationship between demand and supply underlie the forces behind the allocation of
resources. In market economy theories, demand and supply theory will allocate resources in the
most efficient way possible. How? Let us take a closer look at the law of demand and the law of
supply.

The Law of Demand

The law of demand states that, if all other factors remain constant, the higher t price of a
good, the quantity demanded; and the lower the of a good, the greater is the quantity
demanded. The amount of a good that buyers purchase at a higher price is less because as
the price of a good goes up, so does the opportunity cost of buying that good. As a result,
people will naturally avoid buying a product that will force them to forgo the
consumption of something else they value more. The chart below shows that the curve is
a downward slope.

A, B and C are points on the demand curve. Each point on the curve reflects a direct
correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded
will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the
negative relationship between price and quantity demanded. The higher the price of a good the
lower the quantity demanded (A), and the lower the price, the more the good will be in
demand (C).

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The Law of Supply

Other things remaining the same, the higher the price of a good, the higher the price of a
good, the greater is the quantity supplied; and the lower the price of a good, the smaller
is the quantity supplied. This means that the higher the price, the higher the quantity
supplied. Producers supply more at a higher price because selling a higher quantity at a
higher price increases revenue.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation
between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and
the price will be P2, and so on.

Time and Supply

Unlike the demand relationship, however, the supply relationship is a factor of time. Time
is important to supply because suppliers must, but cannot always, react quickly to a
change in demand or price. So it is important to try and determine whether a price
change that is caused by demand will be temporary or permanent.
Let's say there's a sudden increase in the demand and price for umbrellas in an
unexpected rainy season; suppliers may simply accommodate demand by using their
production equipment more intensively. If, however, there is a climate change, and the
population will need umbrellas year-round, the change in demand and price will be
expected to be long term; suppliers will have to change their equipment and production
facilities in order to meet the long-term levels of demand.

Supply and Demand Relationship

let's see an example to show how supply and demand affect price.
Imagine that a special edition CD of your favourite band is released for $20. Because the
record company's previous analysis showed that consumers will not demand CDs at a price
higher than $20, only ten CDs were released because the opportunity cost is too high for
suppliers to produce more. If, however, the ten CDs are demanded by 20 people, the price
will subsequently rise because, according to the demand relationship, as demand increases,
so does the price. Consequently, the rise in price should prompt more CDs to be supplied
as the supply relationship shows that the higher the price, the higher the quantity
supplied.
If, however, there are 30 CDs produced and demand is still at 20, the price will not be

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pushed up because the supply more than accommodates demand. In fact after the 20
consumers have been satisfied with their CD purchases, the price of the leftover CDs may
drop as CD producers attempt to sell the remaining ten CDs. The lower price will then
make the CD more available to people who had previously decided that the opportunity
cost of buying the CD at $20 was too high.

Equilibrium

When supply and demand are equal (i.e. when the supply function and demand function
intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is
at its most efficient because the amount of goods being supplied is exactly the same as the
amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is
satisfied with the current economic condition. At the given price, suppliers are selling all
the goods that they have produced and consumers are getting all the goods that they are
demanding.
As you can see on the chart, equilibrium occurs at the intersection of the demand and
supply curve, which indicates no allocative inefficiency. At this point, the price of the
goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium
price and quantity.
In the real market place equilibrium can only ever be reached in theory, so the prices of
goods and services are constantly changing in relation to fluctuations in demand and
supply.

Disequilibrium

Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.

Consumer's surplus

consume's surplus is the difference between the price that a man would be willing to pay
rather than go without thing over that which he actually does pay

Producer's surplus

Producer's surplus is defined as the amount that producers are paid for a product less the total
variable cost of producing the product

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Excess Supply

If the price is set too high, excess supply will be created within the economy and there
will be allocative inefficiency. At price P1 the quantity of goods that the producers wish to
supply is indicated by Q2. At P1, however, the quantity that the consumers want to
consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much
is being produced and too little is being consumed. The suppliers are trying to produce
more goods, which they hope to sell to increase profits, but those consuming the goods
will find the product less attractive and purchase less because the price is too high

Excess Demand

Excess demand is created when price is set below the equilibrium price. Because the price
is so low, too many consumers want the good while producers are not making enough of
it. In this situation, at price P1, the quantity of goods demanded by consumers at this
price is Q2. Conversely, the quantity of goods that producers are willing to produce at this
price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of
the consumers. However, as consumers have to compete with one other to buy the good
at this price, the demand will push the price up, making suppliers want to supply more
and bringing the price closer to its equilibrium.

Movements

A movement refers to a change along a curve. On the demand curve, a movement denotes
a change in both price and quantity demanded from one point to another on the curve.
The movement implies that the demand relationship remains consistent. Therefore, a
movement along the demand curve will occur when the price of the good changes and the
quantity demanded changes in accordance to the original demand relationship. In other
words, a movement occurs when a change in the quantity demanded is caused only by a
change in price, and vice versa. Like a movement along the demand curve, a movement
along the supply curve means that the supply relationship remains consistent. Therefore, a
movement along the supply curve will occur when the price of the good changes and the
quantity supplied changes in accordance to the original supply relationship. In other
words, a movement occurs when a change in quantity supplied is caused only by a change
in price, and vice versa.

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Shift

A shift in a demand or supply curve occurs when a good's quantity demanded or supplied
changes even though price remains the same. For instance, i f the price for a book was $2
and the quantity of book demanded increased from Q1 to Q2, then there would be a shift
in the demand for book. Shifts in the demand curve imply that the original demand
relationship has changed, meaning that quantity demand is affected by a factor other than
price. A shift in the demand relationship would occur if, for instance, book suddenly
became the only type of book for consumption. Conversely, if the price for a book was $2
and the quantity supplied decreased from Q1 to Q2, then there would be a shift in the
supply of book. Like a shift in the demand curve, a shift in the supply curve implies that
the original supply curve has changed, meaning that the quantity supplied is effected by a
factor other than price. A shift in the supply curve would occur if, for instance, a natural
disaster caused a mass shortage of hops; book manufacturers would be forced to supply
less book for the same price.

Elasticity

Elasticity

Elasticity is one of the most important concepts in neoclassical economic theory. It is

useful in understanding the incidence of indirect taxation, marginal concepts as they
relate to the theory of the firm, and distribution of wealth and different types of goods as
they relate to the theory of consumer choice. Elasticity is also crucially important in any
discussion of welfare distribution, in particular consumer surplus, producer surplus, or
government surplus.

In economics, elasticity is the measurement of how changing one economic variable affects
others.

Specific elasticities

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Price elasticity of demand

Price elasticity of demand measures the percentage change in quantity demanded

caused by a percent change in price. As such, it measures the extent of movement
along the demand curve. This elasticity is almost always negative and is usually
expressed in terms of absolute value (i.e. as positive numbers) since the negative can
be assumed. In these terms, then, if the elasticity is greater than 1 demand is said to
be elastic; between zero and one demand is inelastic and if it equals one, demand is
unit-elastic. A perfectly elastic demand curve is horizontal (with an elasticity of
infinity) whereas a perfectly inelastic demand curve is vertical (with an elasticity of
0).

Cross price elasticity of demand

Cross price elasticity of demand measures the percentage change in demand for a
particular good caused by a percent change in the price of another good. Goods can
be complements, substitutes or unrelated. A change in the price of a related good
causes the demand curve to shift reflecting a change in demand for the original
good. Cross price elasticity is a measurement of how far, and in which direction, the
curve shifts horizontally along the x-axis. A positive cross-price elasticity means that
the goods are substitute goods.

Price elasticity of supply

The price elasticity of supply measures how the amount of a good firms wish to
supply changes in response to a change in price. In a manner analogous to the price
elasticity of demand, it captures the extent of movement along the supply curve. If
the price elasticity of supply is zero the supply of a good supplied is "inelastic" and
the quantity supplied is fixed.

Factors Affecting Demand Elasticity

1. The availability of substitutes

- This is probably the most important factor influencing the elasticity of a good or
service. In general, the more substitutes, the more elastic the demand will be. For
example, if the price of a cup of coffee went up by $0.25, consumers could replace

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their morning caffeine with a cup of tea. This means that coffee is an elastic good
because a raise in price will cause a large decrease in demand as consumers start
buying more tea instead of coffee.
However, if the price of caffeine were to go up as a whole, we would probably see
little change in the consumption of coffee or tea because there are few substitutes
for caffeine. Most people are not willing to give up their morning cup of caffeine no
matter what the price. We would say, therefore, that caffeine is an inelastic product
because of its lack of substitutes. Thus, while a product within an industry is elastic
due to the availability of substitutes, the industry itself tends to be inelastic. Usually,
unique goods such as diamonds are inelastic because they have few if any
substitutes.

2. Amount of income available to spend on the good

- This factor affecting demand elasticity refers to the total a person can spend on a
particular good or service. Thus, if the price of a can of Coke goes up from $0.50 to
$1 and income stays the same, the income that is available to spend on coke, which
is $2, is now enough for only two rather than four cans of Coke. In other words, the
consumer is forced to reduce his or her demand of Coke. Thus if there is an increase
in price and no change in the amount of income available to spend on the good,
there will be an elastic reaction in demand; demand will be sensitive to a change in
price if there is no change in income. br>

3. Time

- The third influential factor is time. If the price of cigarettes goes up $2 per pack, a
smoker with very few available substitutes will most likely continue buying his or
her daily cigarettes. This means that tobacco is inelastic because the change in price
will not have a significant influence on the quantity demanded. However, if that
smoker finds that he or she cannot afford to spend the extra $2 per day and begins
to kick the habit over a period of time, the price elasticity of cigarettes for that
consumer becomes elastic in the long run.

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The Theory of consumer behavior

Utility

Utility is the economist's way of measuring pleasure or happiness and how it relates to
the decisions that people make. Utility measures the benefits (or drawbacks) from
consuming a good or service or from working. Although utility is not directly measurable,
it can be inferred from the decisions that people make.

Different types of utility

Total Utility

Total utility is the aggregate sum of satisfaction or benefit that an individual gains from
consuming a given amount of goods or services in an economy. The amount of a person's
total utility corresponds to the person's level of consumption. Usually, the more the
person consumes, the larger his or her Total Utility will be.

Marginal Utility

marginal utility is the additional satisfaction, or amount of utility, gained from each extra
unit of consumption.

Cardinal Utility

A measure of utility, or satisfaction derived from the consumption of goods and services,
that can be measured using an absolute scale. Cardinal utility exists if the utility derived
from consumption is measurable in the same way that other physical characteristics--
height and weight--are measured using a scale that is comparable between people. There
is little or no evidence to suggest that such measurement is possible and is not even
needed for modern consumer demand theory and indifference curve analysis. Cardinal
utility, however, is often employed as a convenient teaching device for discussing such
concepts as marginal utility and utility maximization

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Ordinal Utility

Ordinal utility theory states that while the utility of a particular good or service cannot be
measured using a numerical scale bearing economic meaning in and of itself, pairs of
alternative bundles (combinations) of goods can be ordered such that one is considered by
an individual to be worse than, equal to, or better than the other.

Law of Diminishing Marginal Utility

The additional benefit which a person derives from a given increase of his stock of
anything diminishes which the growth of the stock that he already has.

Law of equi-marginal utility

"A person can get maximum utility with his given income when it is spent on different
commodities in such a way that the marginal utility of money spent on each item is equal".
It is clear that consumer can get maximum utility from the expenditure of his limited income.
He should purchase such amount of each commodity that the last unit of money spend on each
item provides same marginal utility.

Water diamond paradox

The paradox of value (also known as the diamond-water paradox) is the apparent
contradiction that, although water is on the whole more useful, in terms of survival, than
diamonds, diamonds co mmand a higher price in the market. The philosopher Adam Smith
is often considered to be the classic presenter of this paradox.

Indifference curve

In microeconomic theory, an indifference curve is a graph showing different bundles of

goods between which a consumer is indifferent. That is, at each point on the curve, the
consumer has no preference for one bundle over another. One can equivalently refer to
each point on the indifference curve as rendering the same level of utility (satisfaction)
for the consumer. Utility is then a device to represent preferences rather than something
from which preferences come. The main use of indifference curves is in the representation
of potentially observable demand patterns for individual consumers over commodity
bundles.

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In X axies it show good A and in Y axies Good B. U1,U2,U3 are three indifference curve. Every
curve denotes equal utility to the consumer.

Theory of production

Total Product

Total product (also known as total physical product) is defined as the the total quantity of
output produced by a firm for a given quantity of input necessities. Total product
identifies the specific outputs which are possible using variable levels of input. An
understanding of total product is essential to the short-run analysis of a firm's production.
Changes in total product are taken into account closely when there are changes in
variable costs (labor) of production.

Average Product/Average physical product

Average Product is defined as the product produced per unit of variable input employed
when fixed inputs are held constant. It is commonly thought of as the amount of product
produced by every worker.

(Total Product)/(Variable Inputs Employed)=Average Product

Marginal physical product/Marginal product

Marginal Product is similar to average product but is looked at from another perspective.
Discrete marginal product is defined as the change in total product that comes as a result
of a one unit increase in the variable input/capital level of a firm. Continuous marginal
product is calculated as the derivative of total product with respect to the variable input
employed. This can be represented as:

(dTP)/(dVI)=MP

Law of Diminishing Marginal Return

diminishing returns, also called law of diminishing returns or principle of diminishing

marginal productivity , economic law stating that if one input in the production of a

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commodity is increased while all other inputs are held fixed, a point will eventually be
reached at which additions of the input yield progressively smaller, or diminishing,
increases in output.

In the classic example of the law, a farmer who owns a given acreage of land will find
that a certain number of labourers will yield the maximum output per worker. If he
should hire more workers, the combination of land and labour would be less efficient
because the proportional increase in the overall output would be less than the expansion
of the labour force. The output per worker would therefore fall. This rule holds in any
process of production unless the technique of production also changes.

Early economists, neglecting the possibility of scientific and technical progress that would
improve the means of production, used the law of diminishing returns to predict that as
population expanded in the world, output per head would fall, to the point where the
level of misery would keep the population from increasing further. In stagnant economies,
where techniques of production have not changed for long periods, this effect is clearly
seen. In progressive economies, on the other hand, technical advances have succeeded in
more than offsetting this factor and in raising the standard of living in spite of rising
populations.

Isoquant

economics, an Isoquant (derived from quantity and the Greek word iso which meaning
equal) is a contour line drawn through the set of points at which the same quantity of
output is produced while changing the quantities of two or more inputs. While an
indifference curve mapping helps to solve the utility-maximizing problem of consumers,
the Isoquant mapping deals with the cost-minimization problem of producers. Isoquants
are typically drawn on capital-labor graphs, showing the technological tradeoff between
capital and labor in the production function, and the decreasing marginal returns of both
inputs. Adding one input while holding the other constant eventually leads to decreasing
marginal output, and this is reflected in the shape of the Isoquant. A family of Isoquant
can be represented by an Isoquant map, a graph combining a number of isoquants, each
representing a different quantity of output. Isoquants are also called equal product curves.
An isoquant shows the extent to which the firm in question has the ability to substitute
between the two different inputs at will in order to produce the same level of output. An

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isoquant map can also indicate decreasing or increasing returns to scale based on
increasing or decreasing distances between the isoquant pairs of fixed output increment,
as output increases. If the distance between those isoquants increases as output increases,
the firm's production function is exhibiting decreasing returns to scale; doubling both
inputs will result in placement on an isoquant with less than double the output of the
previous isoquant. Conversely, if the distance is decreasing as output increases, the firm is
experiencing increasing returns to scale; doubling both inputs results in placement on an
isoquant with more than twice the output of the original isoquant.

Marginal Rate of Technical Substitution(MRTS)

The marginal rate of technical substitution (MRTS) can be defined as, keeping constant the
total output, how much input 1 have to decrease if input 2 increases by one extra unit. In
other words, it shows the relation between inputs, and the trade-offs amongst them,
without changing the level of total output. When using common inputs such as capital (K)
and labour (L), the MRTS can be obtained using the following formula: The MRTS is equal
to the slope of isoquants. In the adjacent figure you can see three of the most common
kinds of isoquants. The first one has a MRTS that changes along the curve, and will tend
to zero when diminishing the quantity of L and to infinite when diminishing the quantity
of K.

In the second graph, both inputs are perfect substitutes, since the lines are parallel and
the MRTS = 1, that is the slope has an angle of 45 Degree with each axis. When
considering different substitutes inputs, the slope will be different and the MRTS can be
defined as a fraction, such as 1/2 ,1/3, and so on. For perfect substitutes, the MRTS will
remain constant.

Lastly, the third graph represents complementary inputs. In this case the horizontal
fragment of each indifference curve has a MRTS = 0 and the vertical fractions a MRTS = 8.

Iso-Cost curve

The isocost line is an important component when analysing producer's behaviour. The
isocost line illustrates all the possible combinations of two factors that can be used at
given costs and for a given producer's budget. In simple words, an isocost line represents
a combination of inputs which all cost the same amount.

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Perfect and imperfect competition

Perfect Competitive Market

Perfect competition exists only in case where no farmer, businessman or labourer is a big
enough part of the total market to have any personal influence on market price.

Key characteristics

Perfectly competitive markets exhibit the following characteristics:

1. There is perfect knowledge, with no information failure or time lags. Knowledge is
freely available to all participants, which means that risk-taking is minimal and the
role of the entrepreneur is limited.
2. There are no barriers to entry into or exit out of the market.
3. Firms produce homogeneous, identical, units of output that are not branded.
4. Each unit of input, such as units of labour, are also homogeneous.
5. No single firm can influence the market price, or market conditions. The single
firm is said to be a price taker, taking its price from the whole industry.
6. There are a very large numbers of firms in the market.
7. There is no need for government regulation, except to make markets more
competitive.
8. There are assumed to be no externalities, that is no external costs or benefits.
9. Firms can only make normal profits in the long run, but they can make abnormal
profits in the short run.

In perfect competition The firm as price taker

the single firm takes its price from the industry, and is, consequently, referred to as
a price taker. The industry is composed of all firms in the industry and the market
price is where market demand is equal to market supply. Each single firm must
charge this price and cannot diverge from it. If it increase the price consumer will
not buy his goods the consumers get the same thing at low price from other firm. Or
if the firm decrease the price it will face of loss or will less profit. That's why in
perfect competition firm is price taker.

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Equilibrium in perfect competition

In the short run

Under perfect competition, firms can make super-normal profits or losses.

In the long run

However, in the long run firms are attracted into the industry if the incumbent firms
are making supernormal profits. This is because there are no barriers to entry and
because there is perfect knowledge. The effect of this entry into the industry is to
shift the industry supply curve to the right, which drives down price until the point
where all super-normal profits are exhausted. If firms are making losses, they will
leave the market as there are no exit barriers, and this will shift the industry supply
to the left, which raises price and enables those left in the market to derive normal
profits.
The super-normal profit derived by the firm in the short run acts as an incentive for
new firms to enter the market, which increases industry supply and market price
falls for all firms until only normal profit is made.

The benefits of Perfect competition

It can be argued that perfect competition will yield the following benefits:
1. Because there is perfect knowledge, there is no information failure and
knowledge is shared evenly between all participants.
2. There are no barriers to entry, so existing firms cannot derive any monopoly
power.
3. Only normal profits made, so producers just cover their opportunity cost.
4. There is no need to spend money on advertising, because there is perfect
knowledge and firms can sell all they can produce. In addition, selling
unbranded goods makes it hard to construct an effective advertising
campaign.
5. There is also maximum choice for consumers.
6. There is maximum allocative and productive efficiency:
• Equilibrium will occur where P = MC, hence allocative efficiency.

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• In the long run equilibrium will occur at output where MC = ATC,

which is productive efficiency.

Imperfect Competition

Monopoly

Monopoly is the perfect example of Imperfect competition.A monopoly is a market

structure in which there is only one producer/seller for a product, there are no close
substitutes for the commodity it produces and there are barriers to entry.

Characteristics of Monopoly

Monopoly markets exhibit the following characteristics:

1. Each firm makes independent decisions about price and output, based on its
product, its market, and its costs of production.
2. Monopolies can maintain super-normal profits in the long run. As with all
firms, profits are maximised when MC = MR. In general, the level of profit
depends upon the degree of competition in the market, which for a pure
monopoly is zero. At profit maximisation, MC = MR, and output is Q and price
P. Given that price (AR) is above ATC at Q, supernormal profits are possible
(area PABC).
3. With no close substitutes, the monopolist can derive super-normal profits,area
PABC.
4. A monopolist with no substitutes would be able to derive the greatest
monopoly power.

The advantages of monopolies

Monopoly competition can bring the following advantages:

1. They can benefit from economies of scale, and may be ‘natural’ monopolies,
so it may be argued that it is best for them to remain monopolies to avoid
the wasteful duplication of infrastructure that would happen if new firms
were encouraged to build their own infrastructure.

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2. Domestic monopolies can become dominant in their own territory and then
penetrate overseas markets, earning a country valuable export revenues.
3. According to Austrian economist Joseph Schumpeter, inefficient firms,
including monopolies, would eventually be replaced by more efficient and
effective firms through a process called creative destruction.

The disadvantages of monopoly to the consumer

1. Restricting output onto the market.

2. Charging a higher price than in a more competitive market
3. Reducing consumer surplus and economic welfare.
4. Restricting choice for consumers.
5. Reducing consumer sovereignty.

Higher prices

The traditional view of monopoly stresses the costs to society associated with higher
prices. Because of the lack of competition, the monopolist can charge a higher price
(P1) than in a more competitive market (at P).

The area of economic welfare under perfect competition is E, F, B. The loss of

consumer surplus if the market is taken over by a monopoly is P P1 A B. The new
area of producer surplus, at the higher price P1, is E, P1, A, C. Thus, the overall (net)
loss of economic welfare is area A B C.

The area of dead weight loss for a monopolist can also be shown in a more simple
form, comparing perfect competition with monopoly.

Factor market and Price of Factor of production

Marginal productivity

The term “marginal productivity” refers to the extra output gained by adding one unit of
labour; all other inputs are held constant. So, the technology and efficiency of the factory
stays the same. Marginal productivity is the extra jeans sewn, that is output gained, by
hiring an extra worker, for example.

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marginal revenue product/MRP

The change in revenue that results from the addition of one extra unit when all other
factors are kept equal. The marginal revenue product is used in marginal analysis to
examine the effect of variable inputs, such as labor, and follows the law of diminishing
marginal returns. As the number of units of a variable input increase, the revenue
generated by each addition unit decreases at a certain point. It is calculated by taking the
marginal product of labor and multiplying it by the marginal revenue of a firm.

Marginal revenue product = marginal product x marginal revenue

Marginal productivity Theory of Distribution

The marginal productivity theory of distribution determines the prices of factors of

production. This theory states that a factor of production is paid price equal to its
marginal product. For example a labourer gets his wage according its marginal product. He
is rewarded on the basis of contribution he makes the total output.

Marginal productivity theory of wages

Marginal productivity theory of wage explains that under perfect competition a worker's
wage is equal to marginal as well as average revenue productivity. In other words
marginal revenue productivity and average revenue productivity (ARP) of a worker
determine his wages. According to this theory wage of a laborer is determined by his
marginal productivity. In other words MRP= M.W. Marginal productivity is the addition
made total productivity by employing one more unit of are labours. As the labourers are
given money wage their marginal productivity is calculated in terms of money.

Backward bending labor curve

In economics, a backward-bending supply curve of labour or backward-bending labour

supply curve is a graphical device showing a situation in which, as "real" or inflation-
corrected wages increase beyond a certain level, people will substitute leisure (non-paid
time) for paid work-time and thus higher wages lead to less labor-time being offered for
sale.

The "labour-leisure" tradeoff is the tradeoff faced by wage-earning human beings between

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the amount of time spent engaged in wage-paying work (assumed to be unpleasant) and
satisfaction-generating non-paid time that allows (1) participation in "leisure" activities
and (2) use of time to do necessary self-maintenance, such as sleep. The key to this
tradeoff is a comparison between the wage received from each hour of working and the
amount of satisfaction generated by use of non-paid time. Such a comparison generally
means that a higher wage entices people to spend more time working for pay; this
"substitution effect" implies a positively sloped labour supply curve. However, the
backward-bending labour supply curve results when an even higher wage actually entices
people to work less and to "consume" more leisure or non-paid time

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