Introductory Microeconomics

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  • 15 Feb 2015
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    Contents Foreword iii 1. I 1. I 1. I 1. I 1. I NTRODUCTIONNTRODUCTIONNTRODUCTIONNTRODUCTIONNTRODUCTION 11111 1 .1 A Simple Economy 1 1 .2 Central Problems of an Economy 2 1 .3 Organisation of Economic Activities 4 1.3.1 The Centrally Planned Economy 4 1.3.2 The Market Economy 5 1 .4 Positive and Normative Economics 6 1 .5 Microeconomics and Macroeconomics 6 1 .6 Plan of the Book 6 2. T 2. T 2. read more..

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    3 .3 Total Product, Average Product and Marginal Product 3 8 3.3.1 Total Product 3 8 3.3.2 Average Product 3 9 3.3.3 Marginal Product 3 9 3 .4 The Law of Diminishing Marginal Product and the Law of 4 0 Variable Proportions 3 .5 Shapes of Total Product, Marginal Product and Average Product Curves 4 1 3 .6 Returns to Scale 4 2 3 .7 Costs 42 3.7.1 Short Run Costs 4 3 3.7.2 Long Run Costs read more..

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    Chapter 1 IntroductionIntroductionIntroductionIntroductionIntroduction 1.1 A S IMPLE E CONOMY Think of any society. People in the society need many goods and services 1 in their everyday life including food, clothing, shelter , transport facilities like roads and railways, postal services and various other services like that of teachers and doctors. In fact, the list of goods and services read more..

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    2 Introductory Microeconomics and services that it can procure in exchange of corn is also limited. As a result, the family is forced to make a choice between the different goods and services that are available. It can have more of a good or service only by giving up some amounts of other goods or services. For example, if the family wants to have a bigger house, it read more..

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    3 Introduction What is produced and in what quantities? Every society must decide on how much of each of the many possible goods and services it will produce. Whether to produce more of food, clothing, housing or to have more of luxury goods. Whether to have more agricultural goods or to have industrial products and services. Whether to use more resources in education and read more..

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    4 Introductory Microeconomics If all the resources are used in the production of corn, the maximum amount of corn that can be produced is 4 units and if all resources are used in the production of cotton, at the most, 10 units of cotton can be produced. The economy can also produce1 unit of corn and 9 units of cotton or 2 units of corn and 7 units of cotton or read more..

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    5 Introduction well-being of the economy as a whole, e.g. education or health service, is not produced in adequate amount by the individuals on their own, the government might try to induce the individuals to produce adequate amount of such a good or service or , alter natively, the gover nment may itself decide to pr oduce the good or service in question. In a different read more..

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    6 Introductory Microeconomics the role of the government in the Indian economy has been reduced considerably in the last couple of decades. 1.4 P OSITIVE AND N ORMATIVE E CONOMICS It was mentioned earlier that in princip le there are more than one ways of solving the central problems of an economy. These different mechanisms in general are likely to give rise to read more..

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    7 Introduction K K K K Key Concepts ey Concepts ey Concepts ey Concepts ey Concepts Consumption Production Exchange Scarcity Production possibilities Opportunity cost Market Market economy Centrally planned economy Mixed economy Positive analysis Normative analysis Microeconomics Macroeconomics ? ?1 . Discuss the central problems of an economy. 2 . What do you mean by the production possibilities of an read more..

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    Chapter 2 TheorTheorTheorTheorTheor y ofy ofy ofy ofy of Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour In this chapter , we will study the behaviour of an individual consumer in a market for final goods 1 . The consumer has to decide on how much of each of the different goods she would like to consume. Our objective here is to study read more..

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    income and the prices of the two goods , the consumer can a fford to buy only those bundles which cost her less than or equal to her income. 2.1.1 Budget Set Suppose the income of the consumer is M and the prices of the two goods are p 1 and p 2 respectively. 3 If the consumer wants to buy x 1 units of good 1, she will have to spend p 1 x 1 amount read more..

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    10 Introductory Microeconomics 2.1.2 Budget Line If both the goods are perfectly divisible 4 , the consumer’s budget set would consist of all bundles ( x 1 , x 2 ) such that x 1 and x 2 are any numbers greater than or equal to 0 and p 1 x 1 + p 2 x 2 ≤ M . The budget set can be represented in a diagram as in Figure 2.1. All bundles in the positive read more..

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    11 Theory of Consumer Behaviour Price Ratio and the Slope of the Budget Line Think of any point on the budget line. Such a point represents a bundle which costs the consumer her entire budget. Now suppose the consumer wants to have one more unit of good 1. She can do it only if she gives up some amount of the other good. How much of good 2 does she have to read more..

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    12 Introductory Microeconomics Changes in the Set of Available Bundles of Goods Resulting from Changes in the Consumer’s Income . A decrease in income causes a parallel inward shift of the budget line as in panel (a). An increase in income causes a parallel outward shift of the budget line as in panel (b). 1 as compared to point C. Point B contains more of good 1 and read more..

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    13 Theory of Consumer Behaviour Changes in the Set of Available Bundles of Goods Resulting from Changes in the Price of Good 1 . An increase in the price of good 1 makes the budget line steeper as in panel (a). A decrease in the price of good 1 makes the budget line flatter as in panel (b). Equation (2.10) can also be written as 2 1 1 22 – p' M xx pp (2.11) read more..

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    14 Introductory Microeconomics 2.2.1 Monotonic Preferences Consumer’s preferences are assumed to be such that between any two bundles (x 1 , x 2 ) and ( y 1 , y 2 ), if ( x 1 , x 2 ) has more of at least one of the goods and no less of the other good as compared to ( y 1 , y 2 ), the consumer prefers ( x 1 , x 2 ) to ( y 1 , y 2 ). Preferences of this read more..

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    15 Theory of Consumer Behaviour consumer is indiff erent between two bundles ( x 1 , x 2 ) and ( x 1 + Δ x 1 , x 2 + Δ x 2 ). Monotonicity of preferences implies that if Δ x 1 > 0 then Δ x 2 < 0, and if Δ x 1 < 0 then Δ x 2 > 0; the consumer can move from ( x 1 , x 2 ) to ( x 1 + Δ x 1 , x 2 + Δ x 2 ) by read more..

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    16 Introductory Microeconomics Points Above and Points Below the Indifference Curve . Points above the indifference curve represent bundles which are preferred to bundles represented by points on the indifference curve. Bundles represented by points on the indifference curve are preferred to the bundles represented by points below the indifference curve. on the segment AB , and hence , read more..

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    17 Theory of Consumer Behaviour 2.2.6 Indifference Map The consumer’s preferences over all the bundles can be represented by a family of indifference curves as shown in Figure 2.9. This is called an indifference map of the consumer . All points on an indif ference curve repr esent bundles which a re considered indif ferent by the consumer . Monotonicity of prefer ences imply read more..

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    18 Introductory Microeconomics Equality of the Marginal Rate of Substitution and the Ratio of the Prices The optimum bundle of the consumer is located at the point where the budget line is tangent to one of the indifference curves. If the budget line is tangent to an indifference curve at a point, the absolute value of the slope of the indifference curve (MRS) and that of read more..

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    19 Theory of Consumer Behaviour Where on the budget line will the optimum bundle be located? The point at which the budget line just touches (is tangent to) , one of the indifference curves would be the optimum. 8 To see why this is so, note that any point on the budget line other than the point at which it touches the indiff erence curve lies on a lower indif read more..

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    20 Introductory Microeconomics 2.4 D EMAND In the previous section, we studied the choice problem of the consumer and derived the consumer’s optimum bundle given the prices of the goods, the consumer’s income and her preferences. It was observed that the amount of a good that the consumer chooses optimally, depends on the price of the good itself, the prices of other goods, read more..

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    21 Theory of Consumer Behaviour Graphical Representation of a Function A graph of a function y = f (x ) is a diagrammatic representation of the function. Following are the graphs of the functions in the examples given above. Usually, in a graph, the independent variable is measured along the horizontal axis and the dependent variable is measured along the vertical axis. However , read more..

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    22 Introductory Microeconomics 9 Consider , for example, a consumer whose income is Rs 30. Suppose the price of good 1 is Rs 4 and that of good 2 is Rs 5, and at these prices, the consumer’s optimum bundle is (5,2). Now suppose price of good 1 falls to Rs 3. After the fall in price, if the consumer’s income is reduced by Rs 5, she can just buy the bundle read more..

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    23 Theory of Consumer Behaviour on or below the budget line ar e available to the consumer . As the consumer’s preferences are monotonic, the optimum bundle ** 12 (, ) xx lies on the budget line. The blue line represents the budget line after the fall in the price of G ood 1. If the consumer’s income is reduced by an amount * 11p x , there would be a parallel read more..

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    24 Introductory Microeconomics 10 As we shall shortly discuss, a rise in the purchasing power (income) of the consumer can sometimes induce the consumer to reduce the consumption of a good. In such a case, the substitution effect and the income effect will work in opposite directions. The demand for such a good can be inversely or positively related to its price depending read more..

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    25 Theory of Consumer Behaviour consumer’s income decreases. Such goods are called normal goods . Thus, a consumer’s demand for a normal good moves in the same direction as the income of the consumer . However , ther e are some goods the demands for which move in the opposite direction of the income of the consumer . Such goods are called inferior goods . As the read more..

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    26 Introductory Microeconomics Movement along a Demand Curve and Shift of a Demand Curve . Panel (a) depicts a movement along the demand curve and panel (b) depicts a shift of the demand curve. curve shifts leftward due to an unfavourable change in the preferences of the consumer . The demand curve for ice-creams, for example, is likely to shift rightward in the summer because read more..

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    27 Theory of Consumer Behaviour 2.5 M ARKET D EMAND In the last section, we studied the choice problem of the individual consumer and derived the demand curve of the consumer . However , in the market for a good, there are many consumers. It is important to find out the market demand for the good. The market demand for a good at a particular price is the total demand read more..

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    28 Introductory Microeconomics good changes considerably even for small price changes. On the other hand, there are some goods for which the demand is not affected much by price changes. Demands for some goods are very responsive to price changes while demands for certain others are not so responsive to price changes. Price-elasticity of demand is a measure of the responsiveness read more..

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    29 Theory of Consumer Behaviour = 10 0 (– ) p p rup e e s p e r k il o g ram p ru p ees p e r k il og ra m × 100 = 10 0 (– ) p p p × 100. Change in quantity of the good = q 1 kilograms – q 0 kilograms = ( q 1 – q 0 ) kilograms. Percentage change in quantity of the good = 10 0 (– ) qq k il o g ra m qk il o g ra m × 100 = 10 0 qq q read more..

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    30 Introductory Microeconomics From (2.17), it is clear that the elasticity of demand is different at different points on a linear demand curve. At p = 0, the elasticity is 0, at q = 0, elasticity is ∞ . At p = 2 a b , the elasticity is 1, at any price greater than 0 and less than 2 a b , elasticity is less than 1, and at any price greater than 2 a b , read more..

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    31 Theory of Consumer Behaviour Since Bp 0 D and BOA are similar triangles, 0 0 qD p B = DA DB Thus, e D = DA DB . The elasticity of demand at different points on a straight line demand curve can be derived by this method. Elasticity is 0 at the point where the demand curve meets the horizontal axis and it is ∝ at the point where the demand curve meets the read more..

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    32 Introductory Microeconomics close substitutes are easily available. On the other hand, if close substitutes are not available easily, the demand for a good is likely to be inelastic. 2.6.3 Elasticity and Expenditure The expenditure on a good is equal to the demand for the good times its price. Often it is important to know how the expenditure on a good changes as a read more..

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    33 Theory of Consumer Behaviour Rectangular Hyperbola An equation of the form xy = c where x and y are two variables and c is a constant, giving us a curve called rectangular hyperbola. It is a downward sloping curve in the x -y plane as shown in the diagram. For any two points p and q on the curve, the areas of the two rectangles Oy 1 px 1 and Oy 2 qx 2 are same read more..

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    34 Introductory Microeconomics K K K K Key Concepts ey Concepts ey Concepts ey Concepts ey Concepts Budget set Budget line Preference Indifference Indifference curve Rate of substitution Monotonic preferences Diminishing rate of substitution Indifference map,Utility function Consumer’s optimum Demand Law of demand Demand curve Substitution effect Income effect Normal good Inferior good Substitute Complement read more..

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    35 Theory of Consumer Behaviour 12. Suppose a consumer’s preferences are monotonic. What can you say about her preference ranking over the bundles (10, 10), (10, 9) and (9, 9)? 13. Suppose your friend is indifferent to the bundles (5, 6) and (6, 6). Are the preferences of your friend monotonic? 14. Suppose there are two consumers in the market for a good and their demand read more..

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    Chapter 3 PPPPP roduction and Costs roduction and Costs roduction and Costs roduction and Costs roduction and Costs A Firm Effort In the previous chapter , we have discussed the behaviour of the consumers. In this chapter as well as in the next, we shall examine the behaviour of a pr oducer . A pr oducer or a fir m acquir es dif fe rent inputs like labour , machines, land, read more..

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    of 8 pairs of shoes. Production function considers only the efficient use of inputs. It says that worker 1, worker 2, machine 1, machine 2 and 10 kilograms of raw materials together can produce 10 pairs of shoes which is the maximum possible output for this input combination. A production function is defined for a given technology. It is the technological knowledge that read more..

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    38 Introductory Microeconomics In our example, both the inputs are necessary for the production. If any of the inputs becomes zero, there will be no production. With both inputs positive, output will be positive. As we increase the amount of any input, output increases. 3.2 T HE S HORT R UN AND THE L ONG R UN Before we begin with any further analysis, it is read more..

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    39 Production and Costs In our production function, if we keep factor 2 constant, say, at the value 2 x and vary factor 1, then for each value of x 1 , we get a value of q for that particular 2 x . W e write it in the following way q = f ( x 1 ; 2 x ) (3.2) This is the total product function of factor 1. Let us again look at Table 3.1. Suppose read more..

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    40 Introductory Microeconomics 3.4 T HE L AW OF D IMINISHING M ARGINAL P RODUCT AND THE L AW OF V ARIABLE P ROPORTIONS The law of diminishing marginal product says that if we keep increasing the employment of an input, with other inputs fixed, eventually a point will be reached after which the resulting addition to output (i.e., marginal product of that input) read more..

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    41 Production and Costs Total Product . This is a total product curve for factor 1. When all other inputs are held constant, it shows the different output levels obtainable from different amounts of factor 1. Fig. 3.1 Output Factor 1 q 1 TP x 1 O 3.5 S HAPES OF T OT A L P RODUCT , M ARGINAL P RODUCT AND A VERAGE P RODUCT C URVES An increase in the amount of read more..

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    42 Introductory Microeconomics Returns to Scale Consider a production function q = f (x 1 , x 2 ) where the firm produces q amount of output using x 1 amount of factor 1 and x 2 amount of factor 2. Now suppose the firm decides to increase the employment level of both the factors t (t > 1) times. Mathematically, we can say that the production function exhibits read more..

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    43 Production and Costs 3.7.1 Short Run Costs W e have pr eviously discussed the short run and the long run. In the short run, some of the factors of production cannot be varied , and therefore , remain fixed. The cost that a firm incurs to employ these fixed inputs is called the total fixed cost (TFC). Whatever amount of output the firm produces, this cost remains read more..

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    44 Introductory Microeconomics Similarly, the average variable cost ( AV C ) is defined as the total variable cost per unit of output. W e calculate it as A VC = TV C q (3.8) Also, average fixed cost (AFC) is AFC = TFC q (3.9) Clearly, SAC = A VC + AFC (3.10) In Table 3.3, we get the AFC-column by dividing the values of the second column by the corresponding values read more..

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    45 Production and Costs run, margi nal cost is the increase in TVC due to increase in production of one extra unit of output. For any level of output, the sum of marginal costs up to that level gives us the total variable cost at that level. One may wish to check this from the example represented through Table 3.3. Average variable cost at some level of output is read more..

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    46 Introductory Microeconomics W e can also calculate AFC fr om TFC curve. In Figure 3.5, the horizontal straight line cutting the vertical axis at F is the TFC curve. At q 0 level of output, total fixed cost is equal to OF . At q 0 , the corresponding point on the TFC curve is A . Let the angle ∠ AOq 0 be θ. The AFC at q 0 is AFC = TFC q u a n ti ty = read more..

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    47 Production and Costs In Figure 3.7, we measure output along the horizontal axis and TVC along the vertical axis. At q 0 level of output, OV is the total variable cost. Let the angle ∠ E0 q 0 be equal to . Then, at q 0 , the A VC can be calculated as AV C = TV C ou tp u t = 0 0 Eq Oq = tan θ Let us now look at SAC. SAC is the sum of A VC read more..

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    48 Introductory Microeconomics Long run marginal cost (LRMC) is the change in total cost per unit of change in output. When output changes in discrete units, then, if we increase production from q 1 –1 to q 1 units of output, the marginal cost of producing q 1 th unit will be measured as LRMC = (TC at q 1 units) – (TC at q 1 – 1 units) (3.14) Just like read more..

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    49 Production and Costs K K K K Key Concepts ey Concepts ey Concepts ey Concepts ey Concepts Production function Short run Long run Total product Marginal product Average product Law of diminishing marginal product Law of variable proportions Returns to scale Cost function Marginal cost, Average cost 1. Explain the concept of a production function. 2. What is the total product of an read more..

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    50 Introductory Microeconomics 11. When does a production function satisfy decreasing returns to scale? 12. Briefly explain the concept of the cost function. 13. What are the total fixed cost, total variable cost and total cost of a firm? How are they related? 14. What are the average fixed cost, average variable cost and average cost of a firm? How are they related? 15. Can read more..

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    51 Production and Costs Q TC 15 0 26 5 37 5 49 5 5 130 6 185 26. The following table gives the total cost schedule of a firm. It is also given that the average fixed cost at 4 units of output is Rs 5. Find the TVC, TFC, A VC, AFC, SAC and SMC schedules of the firm for the corresponding values of output. 27. A firm’s SMC schedule is shown in the following table. read more..

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    Chapter 4 The Theor The Theor The Theor The Theor The Theor y of the F y of the F y of the F y of the F y of the F irmirmirmirmirm under P under P under P under P under P ererererer fect Competition fect Competition fect Competition fect Competition fect Competition In the pr evious chapter , we studied concepts r elated to a fir m’s production function and cost curves. The read more..

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    will be willing to sell to her . On the other hand, should the price asked be greater than or equal to the market price, the buyer can obtain as many units of the good as she desires to buy. Since this chapter deals exclusively with firms, we probe no further into buyer behaviour . Instead, we identify conditions under which price-taking is a reasonable assumption for read more..

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    54 Introductory Microeconomics straight line. This means that the TR curve is an upward rising straight line. Third, consider the slope of this straight line. When the output is one unit (horizontal distance Oq 1 in F igure 4.1), the total revenue (vertical height Aq 1 in F igure 4.1) is p × 1 = p. Therefore, the slope of the straight line is Aq 1 /Oq 1 = p . Now read more..

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    55 The Theory of the Firm under Perfect Competition 4.3 P ROFIT M AXIMISATION A firm produces and sells a certain amount of a good. The firm’s profit, denoted by π, is defined to be the difference between its total revenue (TR) and its total cost of production (TC ). 1 In other words π = TR – TC Clearly, the gap between TR and TC is the firm’s earnings read more..

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    56 Introductory Microeconomics price multiplied by the change in quantity; that is, the area of the rectangle q 4 q 5 EF . On the other hand, the decrease in total cost br ought about by this output contraction is the area under the marginal cost curve between output levels q 4 and q 5 ; that is, the area of the region q 4 q 5 ZY . But, a comparison of the two read more..

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    57 The Theory of the Firm under Perfect Competition Let us turn to F igure 4.4. Observe that at the output level q 1 , the market price p is lower than the A VC. W e claim that q 1 cannot be a pr ofit-maximising output level. Why? Notice that the firm’s total revenue at q 1 is as follows T R = Price × Quantity = V ertical height Op × width Oq 1 = The read more..

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    58 Introductory Microeconomics that the market price is p . Equating the market price with the (short run) marginal cost, we obtain the output level q 0 . At q 0 , observe that SMC slopes upwards and p exceeds A VC. Since the thr e e conditions discussed in sections 3.1-3.3 are satisfied at q 0 , we maintain that the profit- maximi s ing output level of the firm is q 0 . read more..

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    59 The Theory of the Firm under Perfect Competition does not exceed the market price, p 1 . Thus, all three conditions highlighted in section 3 are satisfied at q 1 . Hence, when the market price is p 1 , the firm’s output level in the short run is equal to q 1 . Case 2: Price is less than the minimum AVC Suppose the market price is p 2 , which is less than read more..

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    60 Introductory Microeconomics Hence, when the market price is p 1 , the firm’s supplies in the long run become an output equal to q 1 . Case 2: Price less than the minimum LRAC Suppose the market price is p 2 , which is less than the minimum LRAC. We have argued (see condition 3 in section 3) that if a profit-maximising firm produces a positive output in the long read more..

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    61 The Theory of the Firm under Perfect Competition revenue equals total cost, i.e., the zero level of profit. Profit that a firm earns over and above the normal profit is called the super-normal profit . In the long run, a firm does not produce if it earns anything less than the normal profit. In the short run, however , it may produce even if the pr ofit is less read more..

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    62 Introductory Microeconomics 4.5.3 Unit Tax A unit tax is a tax that the government imposes per unit sale of output. For example, suppose that the unit tax imposed by the government is Rs 2. Then, if the firm produces and sells 10 units of the good, the total tax that the firm must pay to the government is 10 × Rs 2 = Rs 20. How does the long run supply curve read more..

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    63 The Theory of the Firm under Perfect Competition the output produced by the n firms in aggregate is [supply of firm 1 at price p ] + [supply of firm 2 at price p ] + ... + [supply of firm n at price p ]. In other words, the market supply at price p is the summation of the supplies of individual firms at that price. Let us now construct the market supply read more..

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    64 Introductory Microeconomics Notice that S 1 (p ) indicates that (1) firm 1 produces an output of 0 if the market price, p , is strictly less than 10, and (2) firm 1 produces an output of ( p – 10) if the market price, p , is greater than or equal to 10. Let the supply curve of firm 2 be as follows S 2 (p ) = 0: 1 5 –1 5 : 1 5 p pp The interpretation read more..

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    65 The Theory of the Firm under Perfect Competition When the supply curve is vertical, supply is completely insensitive to price and the elasticity of supply is zero. In other cases, when supply curve is positively sloped, with a rise in price , supply rises and hence, the elasticity of supply is positive. Like the price elasticity of demand, the price elasticity of supply read more..

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    66 Introductory Microeconomics • If there is a positive level of output at which a firm’s profit is maximised in the short run, three conditions must hold at that output level (i) p = SMC (ii) SMC is non-decreasing (iii) p ≥ AV C . • If there is a positive level of output at which a firm’s profit is maximised in the long run, three conditions must hold at read more..

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    67 The Theory of the Firm under Perfect Competition 9. Will a profit-maximising firm in a competitive market ever produce a positive level of output in the range where the marginal cost is falling? Give an explanation. 10. Will a profit-maximising firm in a competitive market produce a positive level of output in the short run if the market price is less than the minimum of read more..

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    68 Introductory Microeconomics 22. Consider a market with two firms. The following table shows the supply schedules of the two firms: the SS 1 column gives the supply schedule of firm 1 and the SS 2 column gives the supply schedule of firm 2. Compute the market supply schedule. 23. Consider a market with two firms. In the following table, columns labelled as SS 1 and SS 2 read more..

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    Chapter 5 Price O Quantity SS DD p * p f q' 1 q * q 2 p 1 q 1 q' 1 MarkMarkMarkMarkMark et Equilibrium et Equilibriumet Equilibrium et Equilibrium et Equilibrium This chapter will be built on the foundation laid down in Chapters 2 and 4 where we studied the consumer and firm behaviour when they are price takers. In Chapter 2, we have seen that an individual’s demand curve for a read more..

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    70 Introductory Microeconomics where p ∗ denotes the equilibrium price and q D (p ∗ ) and q S (p ∗ ) denote the market demand and market supply of the commodity respectively at price p ∗ . If at a price, market supply is greater than market demand, we say that there is an excess supply in the market at that price and if market demand exceeds market supply at read more..

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    71 Market Equilibrium there is excess demand. To see what happens when market demand does not equal market supply, let us look, in Figure 5.1, at any price at which the equality does not hold. In Figure 5.1, if the prevailing price is p 1 , the market demand is q 1 whereas the market supply is 1q' . Therefore, there is excess demand in the market equal to 1q' q read more..

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    72 Introductory Microeconomics q D = q * = 200 – 40 = 160 Alternatively, q S = q * = 120 + 40 = 160 Thus, the equilibrium quantity is 160 kg. At a price less than p * , say p 1 = 25 q D = 200 – 25 = 175 q S = 120 + 25 = 145 Therefore, at p 1 = 25, q D > q S which implies that there is excess demand at this price. Algebraically, read more..

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    73 Market Equilibrium nature and carries out pr oduction with the goal of profit maximisation. W e also assume that given the technology of the firm, the law of diminishing marginal product holds. The firm being a profit maximiser will always employ labour upto the point where the extra cost she incurs for employing the last unit of labour is equal to the additional benefit read more..

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    74 Introductory Microeconomics Shifts in Demand and Supply In the above section, we studied market equilibrium under the assumption that tastes and preferences of the consumers, prices of the related commodities, incomes of the consumers, technology, size of the market, prices of the inputs used in pr oduction , etc r emain constant. However , with changes in one or more of these read more..

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    75 Market Equilibrium Now suppose the market demand curve shifts rightward to DD 2 with supply curve remaining unchanged at SS 0 , as shown in panel (a). This shift indicates that at any price the quantity demanded is more than before. Therefore, at price p 0 now there is excess demand in the market equal to 00qq '' . In response to this excess demand some individuals read more..

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    76 Introductory Microeconomics Now, suppose due to some reason, the market supply curve shifts leftward to SS 2 with the demand curve remaining unchanged, as shown in panel (a ). Because of the shift , at the prevailing price, p 0 , there will be excess demand equal to 0q' 'q o in the market. Some consumers who are unable to obtain the good will be willing to pay read more..

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    77 Market Equilibrium goods equal to q 0 0 q' . In response to this excess supply, some firms will reduce their price and the new equilibrium will be attained at F where the supply curve SS 1 intersects the demand curve DD 0 such that the new market prices is p 1 at which q 1 quantity is bought and sold. Notice the directions of change in price and quantity are read more..

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    78 Introductory Microeconomics Here we give diagrammatic representations for case (ii) and case (iii) in Figure 5.4 and leave the rest as exercises for the readers. Shift in Demand Shift in Supply Quantity Price Leftward Leftward Decreases May increase, decrease or remain unchanged Rightward Rightward Increases May increase, decrease or remain unchanged Leftward Rightward May increase, Decreases decrease read more..

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    79 Market Equilibrium To see why it is so, suppose, at the prevailing market price, each firm is earning supernormal profit. The possibility of earning supernormal profit will attract some new firms which will lead to a reduction in the supernormal profit and eventually supernormal profit will be wiped out when there is a sufficient number of firms. At this point, with all firms read more..

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    80 Introductory Microeconomics number of firms in the market is equal to the number of firms required to supply q 0 output at p 0 , each in turn supplying q 0 f amount at that price. If we denote the equilibrium number of firms by n 0 , then n 0 = 0 0 f q q To understand the equilibrium price and quantity determination more clearly, let us look at the following read more..

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    81 Market Equilibrium the price which is equal to the minimum average cost of the firms. The initial equilibrium is at point E where the demand curve DD 0 cuts the p 0 = min AC line and the total quantity demanded and supplied is q 0 . The equilibrium number of firms is n 0 in this situation. Now suppose the demand curve shifts to the right for some reason. At read more..

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    82 Introductory Microeconomics 5.2 A PPLICATIONS In this section, we try to understand how the supply-demand analysis can be applied. In particular , we look at two examples of gover nment intervention in the form of price control. Often, it becomes necessary for the government to regulate the prices of certain goods and services when their prices are either too high or too low read more..

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    83 Market Equilibrium Effect of Price Floor on the Market for Goods . The market equilibrium is at (p *, q *). Imposition of price floor at p f gives rise to an excess supply. Fig. 5.8 Price O Quantity SS DD p * p f q f q * q' f Summary Summary Summary Summary Summary • Equilibrium is a situation where there is no tendency for any change. • In a perfectly competitive read more..

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    84 Introductory Microeconomics K K K K Key Concepts ey Concepts ey Concepts ey Concepts ey Concepts Equilibrium Excess demand Excess supply Marginal revenue product of labour V alue of marginal pr oduct of labour Price ceiling, Price floor 1. Explain market equilibrium. 2. When do we say there is excess demand for a commodity in the market? 3. When do we say there is excess supply read more..

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    85 Market Equilibrium 11. How will a change in price of coffee affect the equilibrium price of tea? Explain the effect on equilibrium quantity also through a diagram. 12. How do the equilibrium price and quantity of a commodity change when price of input used in its production changes? 13. If the price of a substitute(Y) of good X increases, what impact does it have on the read more..

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    Chapter 6 Non-competitive Mark Non-competitive Mark Non-competitive Mark Non-competitive Mark Non-competitive Mark etsetsetsetsets W e r ecall that per fect competition was theorised as a market structure where both consumers and firms were price takers. The behaviour of the firm in such circumstances was described in the Chapter 4. W e discussed that the per fect competition market structure read more..

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    In order to examine the difference in the equilibrium resulting from a monopoly in the commodity market as compared to other market structures, we also need to assume that all other markets remain per fectly competitive. In particular , we need (i) that the market of the particular commodity is perfectly competitive from the demand side ie all the consumers are price takers; read more..

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    88 Introductory Microeconomics For the monopoly firm, the above argument expresses itself from the reverse direction. The monopoly firm’s decision to sell a larger quantity is possible only at a lower price. Conversely, if the monopoly firm brings a smaller quantity of the commodity into the market for sale it will be able to sell at a higher price. Thus, for the monopoly read more..

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    89 Non-competitive Markets This is not the equation of a straight line. It is a quadratic equation in which the squared term has a negative cofficient. Such an equation represents an inverted vertical parabola. In Table 6.1, the TR column represents the product of the p and q columns. It can be noticed that as the quantity increases, TR increases to Rs 50 when output becomes read more..

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    90 Introductory Microeconomics 6.1.2 Total, Average and Marginal Revenues A more careful glance at Table 6.1 reveals that TR does not increase by the same amount for every unit increase in quantity. Sale of the first unit leads to a change in TR from Rs 0 when quantity is of 0 unit to Rs 9.5 0 when quantity is 1 unit, i.e., a rise of Rs 9.50 . As the quantity read more..

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    91 Non-competitive Markets Relation between Average Revenue and Marginal Revenue curves . If the AR curve is steeper , then the MR curve is far below the AR curve. Fig. 6.5 (a) Output AR MR O AR, MR AR MR Output AR, MR O (b) 6.1.3 Marginal Revenue and Price Elasticity of Demand The MR values also have a relation with the price elasticity of demand. The detailed relation is not read more..

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    92 Introductory Microeconomics requirements on this well. The well is owned by one person who is able to prevent others fr om drawing water fr om it except thr ough pur chase of water . The person who purchases the water has to draw the water out of the well. The well owner is thus a monopolist firm which bears zero cost in producing the good. W e shall analyse this read more..

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    93 Non-competitive Markets produced, the total revenue is TR 1 and total cost is TC 1 . The difference, TR 1 – TC 1 , is the profit received. The same is depicted by the length of the line segment AB, i.e., the vertical distance between the TR and TC curves at q 1 level of output. It should be clear that this vertical distance changes for diferent levels of read more..

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    94 Introductory Microeconomics Therefore, if the firm is producing a level of output less than q 0 , it would desire to increase its output since that would add to its profits. As long as the MR curve lies above the MC curve, the reasoning provided above would apply and thus the firm would increase its output. This process comes to a halt when the firm reaches an read more..

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    95 Non-competitive Markets The diagram shows that at this level of output, the quantity produced q c is greater than q 0 . Also, the price paid by the consumers is lower at p c . From this we conclude that the perfectly competitive market provides a production and sale of a larger quantity of the commodity compared to a monopoly firm. Further t h e price of the read more..

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    96 Introductory Microeconomics This kind of a structure is more commonly visible. There is a very large number of biscuit producing firms, for example. But many of the biscuits being produced are associated with some brand name and are distinguishable from one another by these brand names and packaging and are slightly different in taste. The consumer develops a taste for a read more..

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    97 Non-competitive Markets fresh decisions about the quantity and price of their own output. There are various ways in which this can be theorised. W e briefly explain two of them. Firstly duopoly firms may collude together and decide not to compete with each other and maximise total profits of the two fir ms together . In such a case the two firms would behave like a read more..

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    98 Introductory Microeconomics which is greater than the quantity supplied under a monopoly market structure and less than the quantity supplied under a perfectly competitive structure. Since price depends on the quantity supplied by the formula p = 10 – 0.5 q, for q = 40 3 , price is 10 – 20 3 = Rs 3.33. This is lower than the price under monopoly and higher than read more..

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    99 Non-competitive Markets K K K K Key Concepts ey Concepts ey Concepts ey Concepts ey Concepts Monopoly Monopolistic Competition Oligopoly. Exercises Exercises Exercises Exercises Exercises 1. What would be the shape of the demand curve so that the total revenue curve is (a ) a positively sloped straight line passing through the origin? (b ) a horizontal line? 2. From the schedule provided read more..

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    100 Introductory Microeconomics 5. If the monopolist firm of Exercise 3, was a public sector firm. The government set a rule for its manager to accept the goverment fixed price as given (i.e. to be a price taker and therefore behave as a firm in a perfectly competitive market), and the government decide to set the price so that demand and supply in the market are equal. read more..

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    Average cost Total cost per unit of output. Average fixed cost Total fixed cost per unit of output. Average product Output per unit of the variable input. Average revenue Total revenue per unit of output. Average variable cost Total variable cost per unit of output. Break-even point is the point on the supply curve at which a firm earns normal profit. Budget line read more..

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    102 Introductory Microeconomics Income effect The change in the optimal quantity of a good when the purchasing power changes consequent upon a change in the price of the good is called the income effect. Increasing returns to scale is a property of production function that holds when a proportional increase in all inputs results in an increase in output by more than the read more..

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    103 Glossary Price elasticity of supply is the percentage change in quantity supplied due to a one per cent change in the market price of the good. Price floor The government-imposed lower limit on the price that may be charged for a particular good or service is called price floor . Price line is a horizontal straight line that shows the relationship between market read more..

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