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Micro Economics Meaning Nature And Scope

Economics is the study of those activities of human beings, which areconcerned, with the satisfaction of unlimited wants by using the limitedresources. Micro means the millionth part. The term micro has been takenfrom the Greek word mikros meaning small. Under microeconomics westudy the individual units like a consumer, a rm, an industry, price

determination of a particular commodity etc. n short the microeconomicsdeals with the study of the economic problems of a single unit like a rm orsmall economic units or resource owners. The main ob!ective ofmicroeconomics is to study the principles, policies and the problemsrelating to the optimum allocation of resources. "rom the theoretical pointof view it tells us the functioning of a free enterprise economy. t e#plainsus how through the market mechanism goods and services produced in theeconomy are distributed.

Nature and scope of Micro Economics

n the nature of economics we may consider whether it is a science oran art. $cience not only means the collection of facts but it also means thatthe facts are arranged in such a manner that they speak for themselves. tmeans that some laws are discovered through these facts. Thus science is asystematic body of knowledge concerning the relationship between causesand e%ects of a particular phenomenon.

Characteristics of a science

& "irst of all the facts are observed. E.g. when price rise the demandcontracts.

' The facts in this step are properly classied. (ike if price falls howmuch the demand has fallen.

) *fter the compilation of facts and having knowledge about themagnitude of a problem a law is framed keeping onto considerationthe cause and e%ect of a fact. E.g. (aw of demand

+ The nal feature of science is by applying the scientic laws to reallife. t is veried whether they are valid or not.

Thus from the above discussion it could be concluded that economics isa science. ut some economists believe that it is not an e#act science.

-hether its a social science or a natural science

Arguments in favour of social science

&. Economics is a systematic study . t is the study of the interrelatedactivities like production consumption and e#change of wealth.

'. (aws of economics show a cause and efect relationship betweenthem



). (aws of economics are based on real experiences of life.

*rguments against economics as a natural law

& The laws of economics are not the exact laws. (ike law of economicsdoes not operate if there is a change in the income of the person or achange in price of substitute goods.

' Economics laws are ar rom universal applicability . These lawscannot be applied in all situations and at all the times.

) The laws of economics cannot be veried in the laboratories. nthe e#ceptional cases even the information or the results obtainedthrough the application can prove to be futile.

Thus economics is not a natural science. t is a social science.

Economics As A Positive Or A Normative Science

/ositive science is that science which studies an accurate and true

description of events as they happen. Thus it deals with what, how andwhy. 0ormative science is suggestive in nature. 0ormative science tells uswhat ought to be.

Economics as a positive science

& /ositive science is logical whereas normative science is emotional.Therefore it is more e#acts it is based on the logic.

' f economics studies only the realities of the real world then thechances of the disagreement are less, as the case would be if itstudies both.

) The economists cannot make the rational !udgments if they try toanaly1e both what is and what ought to be.

Economics as a normative science

&. Economics would o%er more meaningful conclusions if it givessuggestions too long with the facts.

'. Economics will be more useful if it is fruit bearing too along with thelight bearing. Most of the people study economics for the fruits and notfor the light merely.

) if the economist synchroni1es the analysis of economic problems withconcrete economic policies he would save time. Else it would be di%icultif one person nds the solutions and the other tries to !ustify thosesolutions.

Thus the argument can be put to an end only by saying that it is both thepositive as well as a normative science

*rguments in favour of economics as an art



Many economists like Marshall, /igou etc. believe that economics is an artalso besides being a science

Economics as an art

&. Economics o%er a solution to the problems of human beings. t tells ushow we can make the !udicious use of our resources.

'. t is through the art that we can verify the economic laws. "ore#ample the law of demand

). The doubts can be removed by dividing the economics into science aswell as an art.

*rguments against art

& $cience and art are di%erent. f economics is science it cannot beart and if it is an art it cannot be a science.

' Economic problems are in2uenced by social and political nature.

Therefore economics cannot be considered from the economicpoint of view only.

UTILIT

ts the want satisfying power of a commodity.

&. Utility is sub!ective. t depends upon the human wants.

'. Utility keeps on changing with time and place.

). t need not be always useful.

+. Utility has nothing to do with the morality.

Measurement of utility

t can be measured both in terms of money as well as in terms ofunits. f two persons pay di%erent sum of money for the same amount ofcommodity then it is the measurement in terms of money.

Marshall, 3evons and Menger etc have tried to measure it in terms ofcardinal numbers. /areto, *llen, 4icks etc. measured it in ordinal an termthat is ndi%erence curve approach.

Utility has three concepts5

&. nitial utility

'. Marginal utility

). Total utility

Marginal utility can further be divided into Positive Marginal Utility or Zero Marginal Utility or Negative Marginal Utility



6uantity Total utility Marginal utility

7 7 8

& 9 9

' &+ :

) &9 +

+ '7 '

; '7 7

: &9 8'

<pportunity costs

<pportunity costs may be dened as the e#pected returns from the secondbest use of the resources which are foregone due to the scarcity of

resources. E.g. if with a sum of =s. & lakhs one can purchase two machines.<ne yields a prot of =s.'7777 and the other a prot of =s. &7777. 0owthe buyer will forego the use which is less productive. t can also betermed as economic rent

>=s. '7777 ? =s &7777 @ =s. &7777A

E#plicit and mplicit costs

Marginal and ncremental costs

t is the change in Total costs due to the production of one more or one less

unit of a factor of production.MB @ TBn ? TBn8&

Incremental costs refer to the total additional costs associated with thedecisions to e#pand output or to add a new variety of product etc. n thelong run when rms e#pand their production they hire more of men,machinery and eCuipments. These e#penditures are included in theincremental costs. These costs also arise due to change in the productlines, addition or introduction of a new product, replacement of worn outplant and machinery, replacement of old techniCues of production with anew one etc.

$unk costs are those costs, which cannot be increased or decreased by varying the rate of output. E#ample once it is decided to make incrementalinvestment e#penditure and the funds are allocated, all the preceding costsare considered to be the sunk costs as these costs cannot be recoveredwhen there is a change in the market decisions.

!U"#"$%"UM



ECuilibrium is a state of balance. n fact sometimes the moderneconomics is also called as an eCuilibrium analysis. -hen the forces actin the opposite direction is in the state of rest they are called as to be inthe eCuilibrium. ECuilibrium can be a stable eCuilibrium, unstableeCuilibrium or a neutral eCuilibrium.

&A $table eCuilibrium is that eCuilibrium in which the ob!ectconcerned after having been disturbed reverts back to the originalstate.

'A n an unstable eCuilibrium a slight disturbance further evokesdisturbance.

)A n the neutral eCuilibrium the disturbing forces neither bring it backnor they

can take it away from the eCuilibrium position.

$hort term or the long8term eCuilibrium

n the short run demand plays an important role in the determinationof price and in the long run both demand and supply plays an importantrole.

Partial and general e!uili"rium

/artial eCuilibrium e#cludes certain variable and studies a fewselected items at a time. This method takes into consideration the

impact of one or two variables and keeps all others constant. E.g.demand and supply depends upon many variables but for the sake ofsimplicity we study only a few aspects.

In case of general e!uili"rium anal#sis

*n analysis that treats various individual units and markets asinterrelated and attempts to trace the conseCuence of an economicevent is called the general eCuilibrium. n the process of making thedecisions the consumers as well as the rms a%ect the prices of the

commodities. The changes in the prices serve as signals to variousconsumers and rms that a%ect their decisions accordingly. n this waythe changes in the prices will go on bringing the changes in theCuantities supplied and demanded until eCuilibrium in all the markets isnot achieved simultaneously.

Static and d#namic approaches

The word static generally means a position of rest but in economics itmeans a state in which there is a continuous, regular, certain andconstant movement without any change. *ccording to Blark there is an



absence of the following ve types of changes &A si1e of population 'Asupply of capital )A methods of production +A forms of businessorgani1ation and ;A the wants of the people.

4arrod is of the view that static analysis is concerned with the lack ofinvestment in the economy. n static economics we do not study aboutthe seCuences, lags etc. its like ordinary demand and supply theory.

E#ample people continue to be born and die but births eCual deaths sothere is no change in the numbers but the composition of population ischanging. The ma!or drawback is that it takes us far from the actualpicture assuming the variables constant.

MICRO ECONOMICS AND BUSINESS

Microeconomics e#plains how an individual business rm decides to # theprice and output of their product and what factor combination do they useto produce them. Microeconomics is concerned with the choosing of anappropriate course of action from the number of alternatives present for a

business. Microeconomics tells us how to make a rational choice inallocating the scarce resources of the rm while making the decisionsregarding price, output, technology, advertising e#penditure etc. *business has to make the following decisions with the use ofmicroeconomics

Price output decisions that is how much Cty. is to be produced and atwhat prices it is to be sold.

Demand Decisions that is to estimate the correct demand so that there isneither the shortage of the product not there is any surplus.

Choice of a technique of production that is what type of techniCue is tobe used whether the capital8intensive techniCue or the labour intensivetechniCue.

Even the adertisement decisions of the rm are pro!ected with the helpof microeconomics. * rm will spend on that mode of advertising which hasthe ma#imum reach and which has the least costs.

n the long run the rm has to decide about the location of the plant, si1eof the plant or the choice of the production techniCue etc.

t also tells a business about the investment decisions that is what is therate of investment over the years or is it protable to takeover the otherrms of not.

!"EOR# O$ DEMAND

The demand in economics means both the desire to purchase as wellas the ability to pay for the good.

Demand is di%erent from the Cuantity demanded. Demand is theCuantities that the buyers are willing and able to buy at alternative prices



during the given period of time whereas Cuantity demanded is a specicamount that buyers are willing and able to buy at on price.

Nature o demand or a product

-ith the normal goods the demand has a negative relationship. tmeans as the price of a commodity falls the Cuantity demanded for theproduct goes up.

#D

/rice /&

/

D 6& 66ty y

The law of demand operates due to the following reasons& (aw of diminishing marginal utility

' ncome e%ect

) $ubstitution e%ect

+ Di%erent uses

; $i1e of consumer group

E#ceptions to the law of demand

& Goods having the prestige value or the articles of distinction

' Gi%en goods

) n case of emergencies

+ gnorance

0DDU*( DEM*0D *0D T4E M*=FET DEM*0D

ndividual demand is the Cuantity demanded by an individual person atdi%erent possible prices at a given point of time.



Market demand is the Cuantity demanded by all the persons in themarket at di%erent possible prices at a point of time.

*s demand s demand Market demand

d

/rice /rice d& /rice D

d d&D

6uantity 6uantity 6uantity

Determinants of demand

The demand for commodity is a%ected by the following factors

& /rice of the commodity

' /rices of related goods

) ncome of the consumer

+ Tastes and preferences of the consumer

; E#pectation of a price change of the commodity

: /opulation

H ncome distribution



h. andwagon E%ect5 it is also calledcromo e%ect. t means that peopleundertake certain tasks as other asalso doing like that. /eople try tofollow the crowd withoute#amining the merits of aparticular thing.

i. $nob E%ect5 preference for thegoods because they are di%erentfrom the good the communitypreferred. t is the demand for thee#clusive goods.

Elasticit# of demand and its determinants

Elasticity is a measure of the responsiveness of one variable to the changein other.

Ed can be

&. /rice Elasticity of demand

'. ncome elasticity of demand

). t can be cross elasticity of demand

Methods to measure the price elasticity of demand

& Total e#penditure method as given by Marshall

T E I &

/rice E @ &

E E J &

Total e#penditure

' /roportionate method

Ed @ >8A / × ∆6



6 ∆ /

) /oint elasticity method

n case of a linear demand curve

M E @ α

/rice . * E I&

. / E @&

. E J&

< 06ty

+ *rc elasticity method

*

B

Determinants of elasticity of demand

&. 0ature of the commodity

'. *vailability of substitutes

). /ostponement of the use

+. ncome of the consumer

;. 4abit of the consumer

:. Time period

H. 3oint demand

9. Goods with the di%erent uses

Demand as a multivariate function or a dynamic demand function



The demand in the long run is not only in2uenced by the price rather it isin2uences by all other factors that we have assumed constant in the shortrun. The long run demand for the product depends on the compositeimpact of all its determinants operating simultaneously. To estimate thelong run demand we have to take into consideration all the relevantfactors. * demand function, which describes the relationship betweendemand and all its variables, is known as the multivariate demand function.

D# @ > /#, M, / y, T, * A

Theory of consumer behaviour

Di%erent theories have been developed time to time to e#plain theconsumer behaviour. The ma!or breakthrough was achieved in the form ofcardinal utility analysis. Marshall gave this theory.

*ccording to this theory as a consumer goes on consuming more and more

units of a commodity the utility derived from each successive unit goes ondiminishing.

*ssumptionsK

& Utility is measurable in cardinal numbers.

' Marginal utility of money remains constant

) Marginal utility of every commodity is independent

+ There is a continuous consumption f the commodity.

; Every unit of the commodity consumed is same in si1e.: 0o change in the price of the commodity and its substitutes.

H 0o change in the tastes character, fashion and habits of the consumer.

Bups of co%eeconsumed everyday

Total utilty >utilsA Marginal utility

& &' &'

' '' &7

) )7 9

+ ): :

; +7 +

: +& &



H )L 8'

9 )+ 8;

E#ceptions

& Good book or poem

' Misers

) Drunkards

+ nitial units

mportance

asis of laws of consumption

arity in consumption

Di%erence in value in use and value in e#change

asis of progressive ta#ation.

Briticism

Bardinal measurement of utility is not possible.

Marginal utility of money is not constant.

Every commodity is not an independent commodity



Unrealistic assumptions.

(aw of eCui marginal utility or law of substitution

This law was again developed by Marshall. t is also known as the Gossenssecond

law. *ccording to this law, a consumer allocates his limited income in sucha way that the last unit of money spent on di%erent commodities gives theconsumer the same level of satisfaction.

*ssumptions

$ame as above N consumer is a rational person

=upees spent MU of Mangoes MU of Milk

&' &7

&7 9

9 :

: +

+ '

MU of mangoes MU of milk

8888888888888888888888888888888888888888888888888

mportance

n the eld of consumption

n the eld of production

n the eld of e#change

Distribution of income between saving and consumption.



Briticism

Bonsumers are not fully rational

Minute calculations are not possible

gnorance of the consumer

n2uence of fashions, customs and habits.

Bardinal measurement of utility is not possible

Bonstancy of marginal utility of money is not possible

ndi%erence curve analysis

4icks and *llen gave this approach. *n B is a locus of all such pointslocated on an indi%erence curve, which gives the consumer the same levelof satisfaction. The di%erent points on the depicted B show the same levelof satisfaction.

ut we must bear in mind the concepts of the Marginal =ate <f$ubstitution and the Diminishing Marginal =ate <f $ubstitution. The M=$is the rate at which the consumer is willing to sacrice the number of units

of another commodity, so that his over8all level of satisfaction may remainunchanged.

The marginal rate of substitution is the amount of one good >i.e. workA thathas to be given up if the consumer is to obtain one e#tra unit of the othergood >leisureA.

The eCuation is below.



The marginal rate of su"stitution $M%S& ' change in good ()change in good

The DM=$ states that the M=$ of good for good O will go on diminishingwhile the level of the satisfaction of the consumer remains the same.

Bombination Mangoes Milk M=$

* & &7

' H ) 5 &

B ) ; ' 5 &

D + + & 5 &

ndi%erence Map

*$$UM/T<0$

& =ational consumer

' <rdinal utility

) DM=$

+ Bonsistency in selection

; Transitivity.

/roperties of B

*n B has a negative slope or that it slopes downwards



B are conve# to the point of origin

Two B cannot intersect each other

4igher B represents the

higher level of satisfaction

B need not be parallel to each other



$traight line ndi%erence curve

/rice (ine or the udget (ine

t may be dened as a set of combinations of two commodities thatcan be purchased if whole of the given income is spent on them.

f there is an increase in the income of the consumer, the budget lineshifts

t can also increase due to the change in the price



Bonsumer eCuilibrium through the ndi%erence curves

There are t*o conditions of the consumer e!uili"rium+

&A /rice line should be tangent to the ndi%erence curve

'A ndi%erence curve must be conve# to the point of origin.

ncome e%ect $ubstitution e%ect and /rice e%ect



0B<ME E""EBT

*nother important item that can change is the income of the consumer. *slong as the prices remain constant, changing the income will create aparallel shift of the budget constraint. ncreasing the income will shift thebudget constraint right since more of both can be bought, and decreasing

income will shift it left.

Depending on the indi%erence curves the amount of a good boughtcan either increase, decrease or stay the same when income increases. nthe diagram below, good O is a normal good since the amount purchasedincreased as the budget constraint shifted from B& to the higher incomeB'. Good is an inferior good since the amount bought decreased as theincome increases.

/rice e%ect

These curves can be used to predict the e%ect of changes to the budgetconstraint. The graphic below shows the e%ect of a price shift for good y. fthe price of O increases, the budget constraint will shift from B' to B&.

http://en.wikipedia.org/wiki/Parallel_(geometry)

http://en.wikipedia.org/wiki/Inferior_good

http://en.wikipedia.org/wiki/Image:Inferior_good.png

http://en.wikipedia.org/wiki/Parallel_(geometry)

http://en.wikipedia.org/wiki/Inferior_good



Su"stitution e,ect

Every price change can be decomposed into an income e%ect and asubstitution e%ect. The substitution e%ect is a price change that changesthe slope of the budget constraint, but leaves the consumer on the sameindi%erence curve. This e%ect will always cause the consumer to substituteaway from the good that is becoming comparatively more e#pensive. f thegood in Cuestion is a normal good, then the income e%ect will re8enforcethe substitution e%ect. f the good is inferior, then the income e%ect willlessen the substitution e%ect. f the income e%ect is opposite and strongerthan the substitution e%ect, the consumer will buy more of the good whenit becomes more e#pensive. *n e#ample of this might be a -i,en good.

http://en.wikipedia.org/wiki/Giffen_good

http://en.wikipedia.org/wiki/Image:Substitution_effect.png

http://en.wikipedia.org/wiki/Image:Found_demand.png

http://en.wikipedia.org/wiki/Giffen_good



*pplications of ndi%erence curves

& n the eld of consumption.

-ith the help of consumer eCuilibrium one can nd out the positionof consumer eCuilibrium.

' Bonsumer surplus

Money ncome

0o. of ce creams

) t has helped us to solve the problems of price e%ect, income e%ectand substitution e%ect.

+ n the eld of e#change

; n the eld of /ublic "inance

: E%ects of rationing

H n the eld of production.

T4E<=O <" /=<DUBT<0 *0D B<$T$

/roduction function refers to the functional relationship between thephysical output and the physical inputs. Thus it is the relationship betweenthe Cuantity of output and the Cuantities of inputs used in the process ofproduction.

E#ample # @ > a, b, c, dP.A



/roduction function can be of both the #ed proportions type and the variable proportions type.

n the #ed proportions type the labour as well as the capital are used inthe #ed proportions. E#ample if the technical coe%icient of production is&Q;, i.e. to produce '77 units of a commodity +7 labourers are employedthen it continues to be the same for all the units.

Bapital )77

'77

&77

; &7 &;

(abour

ariable proportions type production function

n this type of the production function di%erent factors of production canbe used to produce a given level of output.

<ne variable input

(aw of increasing returns to a factor or diminishing costs5 it occurs whenmore and more units are employed and the marginal production goes on

increasing or the average costs start diminishing.

t could be due to the indivisibility of factors or the increase in e%iciencyarising out of the division of labour.

*B

M/



(abour labour

(aw of Diminishing returns or the increasing returns5 t occurs when

as a result of increase in the factors of production cost of production perunit of the commodity goes on increasing.

M/ *B

(abour labour

t could be due to the #ed factors of production or more than the optimumproduction or imperfect factor substitutability between the factors.

La* of constant costs or the constant returns to the factor+ t takesplace when the additional application of the variable factor increases the

output only at a constant rate.

M/ *B

(abour (abour

(aw of variable proportions



=eturns to scale

-hen all the factors of production are increased in the same proportionand as a result output increases more than proportionately then it is knownas constant returns to scale. E#ample / @ f >(, FA

f both the labour and capital are increased in the same proportionand a result there is a change in the output it will be termed as returns toscale.

/& @ >m(, mFA

Two variable input



Meaning of the eCual product curves5

*n iso product curve shows all the combinations of the two inputsphysically capable of producing a given level of output. n the able givenbelow we can have an estimate regarding the eCual product combinations.

Bombinations "actor R& "actor R'

* & &'

' 9

B ) ;

D + )

E ; '

Consumer side Producer side

Indi,erence Curve Iso!uant

Bs are level sets of consumers utility function.

soCuants are level sets of production function.

Every point on an Brepresents a combination of consumption goods that

yields the same level of utility.

Every point on an isoCuantrepresents a combination of inputs that yields the sameoutput.

Iso . Product Map



Marginal %ate of Technical Su"stitution Marginal =ate <fTechnical $ubstitution >M=T$A is the increase in productivity a companye#periences when it substitutes on unit of labour input 8 ie, an hour workedby a factory worker 8 for one unit of capital 8 ie, a machine on the factory2oor.

* positive M=T$ indicates that it is advantageous for a company tomake this substitution, and a negative M=T$ implies that the company

would drop in productivity if it did this.

*n iso cost line is that line which shows the various combinations oftwo factors that can be purchased with the given amount of money.

Bhange in the iso cost curves

http://www.answers.com/topic/isoquant-map-png



/roducers eCuilibrium with the eCual product curves

Cost Minimisation

05

10

15

20

25

30

35

40

45

0 5 10 15 20

Labour per wee k

C a p i t a l p e r w

e e k

50

£1000

Cost minimising

point

The e#pansion path



Deriving Long Run Total Cost

0

5

10

15

20

2530

35

40

45

0 5 10 15 20

Labour per wee k

C a p i t a l p e r w

e e k

50

£1000

100

£1600

Expansion path

INC%EASIN-/ CONSTANT AN0 0IMINIS1IN- %ETU%NS TO SCALE

0ecreasing returns to scale

f an increase in all inputs in the same proportion k leads to anincrease of output of a proportion less than k, we have decreasing

returns to scale.

Constant returns to scale

f an increase in all inputs in the same proportion k leads to anincrease of output in the same proportion k, we have constant returnsto scale. E#ample5 f we increase the number of machinists andmachine tools each by ;7S, and the number of standard piecesproduced increases also by ;7S, then we have constant returns inmachinery production.

Increasing returns to scale



f an increase in all inputs in the same proportion k leads to anincrease of output of a proportion greater than k, we have increasingreturns to scale.

%I0-E LINES O% T1E ECONOMIC %E-ION O2 P%O0UCTION

etween the shaded area the factors of production can be substitutedfor each other. 0o producer will operate at the points outside the ridgelines, as it is an ine%icient 1one. The production outside the ridgelinesinvolves an increase in both the labour as well as capital to produce thesame amount of output. 4ence this area is called the region of economicnonsense. * rational producer will operate in the region bounded by thetwo ridgelines where the iso Cuants are negatively sloping and marginalproducts of factors are diminishing but positive.

Cost anal#sis

"i#ed costs5 These are the costs that do not change with the change in thelevel of output. These costs remain #ed at all the levels of output. Even ifthe output is 1ero these costs are to be borne by the producer.

ariable costs these are the costs, which change with the change in the

level of output. These costs rise as the level of output also goes high.Total cost5 These costs are the summation of the #ed costs and the

variable costs.

TB @ "B N B



Marginal cost

Marginal cost is the change in the total costs due to the production of onemore or one less unit of output.

Marginal cost @ the change in total costs

the change in output

Using mathematical notation where the Greek letter delta is used to signify8 change in.

MB @ ∆TB ∆6

*verage #ed costs5 these are aobtained by dividing the #ed costs withoutput

http://en.wikipedia.org/wiki/Image:Marginalcost.gif

http://en.wikipedia.org/wiki/Image:Marginalcost.gif



*verage variable costs5 these are obtained by dividing the variable costswith the output

*verage total costs5 these are obtained by dividing the total costs with theoutput.

=elationship between short run variable costs.



=elationship between *B and MB

(ong run average cost curve

(ong run average cost curve is the summation of the short runaverage cost curves. Therfore it is also called the envelope curve.

http://en.wikipedia.org/wiki/Image:Costcurve_-_Long-Run_Av_Cost.PNG



The Saucer-Shaped LRAC curve

q

$/q

q0 q1

Between 0 and q0: Economies of Scale

Between q0 & q1: Constant returns to scale

Between q1 and∞

: Diseconomies of Scale

LRAC

%evenue function

A% and M% curves

*= is the revenue per unit of the output sold. t is obtained by dividingthe Total =evenue with 6. /recisely it is the demand curve of the rm.

M= is the change in the T= due to the sale of one more or one lessunit of the output.

M= @ T= n 8 T= n8&



http://www.bized.ac.uk

Copyright 2005 – Biz/ed

Total and Marginal ValuesPrice

Sales

D = AR

MR

Under normal conditions,the demand curve facing

the firm is downwardsloping from left to right.

This implies that to sellincreasing items of aproduct a firm mustaccept a lower price for

each successive unit.

A ! T"#. The areaunder the curverepresents T

$arginal evenue %$& isthe addition to T as a result

of selling one e'tra unit ofoutput. (f the ) curve is

downward sloping, each unitis sold at a progressivel*lower price. The $ curvelies under the )%A& curve.

At the point where the $ cutsthe hori+ontal a'is, $ ! .

That means that the addition toT from selling one e'tra unit

was 0. This is the definition forunit price elasticit* of demand.

Therefore the e-uivalent pointon the ) curve is where ed !

/ 1

ed ! /1



Total ValuesCost/Revenue

Output/Sales

TR

Total evenue is price '

-uantit* sold. %T ! ' #&

A firm facing a downward

sloping demand curve

must lower price to sell

successive units of its

product. T therefore rises

at first ut the rate at which

it rises egins to slowdown and will eventuall*

fall.

The slope of the T curve

varies at each point. This is

ecause the amount added

to T from each sale is

slightl* less than efore. A

positive slope suggests T

is rising, a negative slope

that T is falling.





TR

Cost / Revenue

Output/Sales

Output/Sales

D = AR

MR

TC

MC

Q1 Q2

Putting te t!o togeter"

(f we put the two diagramstogether we can see that profit

ma'imisation occurs where thedifference etween T and T

is greatest %where $ ! $&

(f a firm was to target revenue

ma'imisation as an oective,this would not necessaril*

correlate with the profitma'imising output revenuema'imisation occurs where Tis at a ma'imum %$ ! 0&

. r i c e

% 4 &

A R ,

M R % 4 &

P e

S

D

D = AR

= MR

Q %millions& Q %hundreds&

(a) The maret (b) The firm

Deriving a firm’s AR and MR: pricetaking firmDeriving a firm’s AR and MR: pricetaking firm



*= and M= curves for monopoly and monopolistic competition

=evenue =evenue

*= *=

M= M=

Monopoly monopolistic

=E*F EE0 *0*(O$$



/=B0G U0DE= /E="EBT B<M/ETT<0

/erfect competition is a market situation characteri1ed by thefollowing features5

(arge number of buyers and sellers

4omogeneous products

0o selling costs

$ame *= and M= curves

/erfect mobility

/erfect knowledge

0o e#tra transportation costs

n the pure competition the conditions of /erfect mobility and /erfectknowledge are missing.

$4<=T =U0 E6U(=UM 0 /E="EBT B<M/ETT<0

n the short run in perfect competition the rms may get normalprots, super normal prots of it may incur the loss. "irst of all the rmearning the super normal prots is shown in the diagram.



£

(b) !irm

Q %thousands&

(a) "ndustr#

P

Q %millions&

S

D

P e

MC

AR

D = AR

= MR

Qe

AC

AC

$%ortrun e&uilibrium of industr# and firm underperfect competition

$%ortrun e&uilibrium of industr# and firm underperfect competition

n the diagram the rm incurring the loss is shown but the e#tent ofloss should not e#ceed the average variable costs.

Qe

P 1

D1 = AR 1

= MR 1 AR 1

(a) "ndustr#

P £

Q %millions&

S

D

(b) !irm

MC AC

AC

Q %thousands&

Loss minimising under perfect competitionLoss minimising under perfect competition

The shut down point of the rm is given below



$%ortrun s%utdown point$%ortrun s%utdown point

(a)(a) (ndustr*(ndustr*

P £

P 2

Q %millions&

S

D2

(b)(b) 6irm6irm

AR 2

D2 = AR 2

= MR 2

MC AC

AVC

Q %thousands&

(ong run eCuilibrium of the rm

(a)(a) (ndustr*(ndustr*

P £

Q %millions&

S1

D

(b)(b) 6irm6irm

LRAC

P 7

P 1

Q7

Se

AR 1 D1

AR 7 D7

Q %thousands&

Longrun e&uilibrium under perfect competitionLongrun e&uilibrium under perfect competition

New firms enterSupernormal profitsProfits return

to normal

(ong run eCuilibrium of the rm



£

Q

(SR)AC

(SR)MC

LRAC

AR = MR

D7

LRAC = (SR)AC = (SR)MC = MR = AR

Longrun e&uilibrium of t%e firm under perfect competitionLongrun e&uilibrium of t%e firm under perfect competition

Bonstant cost industry

P

Q

'arious longrun industr# suppl# curves under perfect competition'arious longrun industr# suppl# curves under perfect competition

7ong/run S

S1

D1

S2

D2

a

(a) Constant industr# costs(a) Constant industr# costs

c

ncreaing cost industry



7ong/run S

P

Q

S1

D1

S2

D2

a


(b) "ncreasing industr# costs: eternal diseconomies of scale(b) "ncreasing industr# costs: eternal diseconomies of scale

c

Decreasing cost industry



7ong/run S

P

Q

S1

D1

S2

D2

a


(c) Decreasing industr# costs: eternal economies of scale(c) Decreasing industr# costs: eternal economies of scale

c

/rice and output determination under monopoly

* monopoly is a market situation in which there is

&. <ne seller

'. (arge number of buyers

). 0o entry or e#it of rms+. 0o distinction between rm and industry

;. /rice discrimination

:. *= and M= curves downward sloping

H. 0o close substitutes

Bauses of monopoly

&. Government policy

'. Entry lag). Unfair competition

+. usiness mergers

Determination of price and eCuilibrium under monopoly



losses under monopoly

n the long run also the monopoly rm continues to earn the super normalprots.

Discriminating monopoly



-hen a monopolist charges di%erent prices from di%erent people for thesame product, he is said to be a discriminating monopolist.

http://en.wikipedia.org/wiki/Image:Pricediscrimination2small.png



Degrees of price discrimination

"irst8degree price discrimination5 here the monopolist charges a di%erentprice for each unit of the commodity sold. 4e charges what theconsumer is willing and able to pay. Thus there is the ma#imume#ploitation of the consumers in this case.

$econd degree price discrimination5 here the buyers are divided intodi%erent groups and from each group the monopolist charges adi%erent price.

Third degree price discrimination5 here the monopolist splits the entiremarket into a few sub markets and thus charge a di%erent price ineach sub market

M<0</<($TB B<M/ETT<0

t is a market situation in which there are a large number of small sellers,selling di%erentiated but close substitute products.

*ssumptions

(arge number of rms and buyers

/roduct di%erentiation

"reedom of entry and e#it of rms

$elling costs

mperfect knowledge

0on8price competition

$hort and long run eCuilibrium in monopolistic competition



!")*R+ ,: $%ortRun +&uilibrium*nder Monopolistic Competition

!")*R+ ,: $%ortRun +&uilibrium*nder Monopolistic Competition

D

AC

P

,-./

0 r i c e p e r ) a l l o n

)allons of )asoline per 1eek

,23///

4,-5/

MR

MC

E

C

Copyright© 2006 South-Western/Thomson Learning. A r ights reser!e".

4,-6/

4,-//

2#-$Copyright 2002 %y The &'(ra)-*i Companies+ ,n'. A rights reser!e".

&onopoisti' Competitor Taing a Loss in the

Short un

Output

24

22

20

18

16

14

12

10

8

6

4

2

0

C

A!C

"

R

0 10 20 #0 40 0 60 %0 80 0 100 120 140 160

utput is #2

ri'e is 11ATC is 12.0

Tota ro3it4ri'e-ATC 7 utput

411-12.0 7 #2

4-1.0 7 #2

4 -$5.60



!")*R+ 2: LongRun +&uilibrium*nder Monopolistic Competition

!")*R+ 2: LongRun +&uilibrium*nder Monopolistic Competition

,53///

4,-75

0 r i c e p e r ) a l l o n

)allons of )asoline per 1eek

,/3///

4,-.5

MR

MC

AC

D

E

P

Copyright© 2006 South-Western/Thomson Learning. A rights reser!e".

M

Under utili1ation in the long run

*nderutilisation of capacit# in t%e long run*nderutilisation of capacit# in t%e long run

#

LRAC

D7 under monopolistic

competition

Q1 Q2



Group eCuilibrium

product di%erentiation in the long run

$elling costs

The costs incurred on advertising, publicity and salesmanship areknown as selling costs. The need for the advertising arises if thebuyers are not available about the product or there are many rivalsfor the rm. n this case the selling cost is assumed to be a #ed cost.y adding selling costs to the original curve the new curve soobtained will be above the original curve. The area "/ indicates thema#imum net return in this case.

MB



"

E

*=

M=

/ricing under oligopoly

Finked demand curve

/rice leadership under monopoly

Under this system one rm becomes a leader and set the price whichis to be followed by all the rms. t often happens that priceleadership is established as a result of price war between the rmsand as a result one rm comes out as a leader.

/rice leadership is mainly of the following types

y a dominant rm >which produces a bulk of ots productsA



;Q&:. 0ow * may react by producing >& ? ;Q&:A @ &&Q)'.This process will continue till eCuilibrium utput and price

are reached.

bba -notes

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