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What is Micro Economics?

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Micro Economics

A.K.A Price Theory/Partial Analysis

MIKRO means Small

Study of individual units of the economy

Explains price determination in both commodity andfactor market

Based on price mechanism which depends on demandand supply

Important questions studied in microeconomics…

1. What is the level of total output in the economy?

2. How is the total output determined? 3. How does the total output grow over time? 4. Are the resources of the economy (eg labour)

fully employed? 5. What are the reasons behind the

unemployment of resources? 6. Why do prices rise?

Table of Contents

W.R.T NCERT-XII

TOPICS

1. INTRODUCTION2. THEORY OF CONSUMER BEHAVIOUR3. PRODUCTION AND COSTS4. THEORY OF FIRM UNDER PERFECT COMPETITION5. MARKET EQUILIBRIUM6. NON-COMPETITIVE MARKETS

1. INTRODUCTION

1.1 A Simple Economy 1.2 Central Problems of an Economy 1.3 Organisation of Economic Activities

1.3.1 The Centrally Planned Economy 1.3.2 The Market Economy

1.4 Positive and Normative Economics1.5 Microeconomics and Macroeconomics

2. THEORY OF CONSUMER BEHAVIOUR

2.1 The Consumer’s Budget2.1.1 Budget Set 2.1.2 Budget Line 2.1.3 Changes in the Budget Set

2.2 Preferences of the Consumer 2.2.1 Monotonic Preferences 2.2.2 Substitution between Goods 2.2.3 Diminishing Rate of Substitution 2.2.4 Indifference Curve 2.2.5 Shape of the Indifference Curve 2.2.6 Indifference Map 2.2.7 Utility

2.3 Optimal Choice of the Consumer 2.4 Demand

2.4.1 Demand Curve and the Law of Demand 2.4.2 Normal and Inferior Goods 2.4.3 Substitutes and Complements 2.4.4 Shifts in the Demand Curve 2.4.5 Movements along the Demand Curve and Shifts in the Demand Curve

2.5 Market Demand 2.6 Elasticity of Demand

2.6.1 Elasticity along a Linear Demand Curve 2.6.2 Factors Determining Price Elasticity of Demand for a Good 2.6.3 Elasticity and Expenditure

3. PRODUCTION AND COSTS

3.1 Production Function 3.2 The Short Run and the Long Run 3.3 Total Product, Average Product and Marginal Product

3.3.1 Total Product 3.3.2 Average Product 3.3.3 Marginal Product

3.4 The Law of Diminishing Marginal Product and the Law of Variable Proportions3.5 Shapes of Total Product, Marginal Product and Average Product Curves 3.6 Returns to Scale 3.7 Costs

3.7.1 Short Run Costs 3.7.2 Long Run Costs

4. THE THEORY OF THE FIRM UNDER PERFECT COMPETITION

4.1 Perfect competition: Defining Features 4.2 Revenue 4.3 Profit Maximisation

4.3.1 Condition 1 4.3.2 Condition 2 4.3.3 Condition 3 4.3.4 The Profit Maximisation Problem: Graphical Representation

4.4 Supply Curve of a Firm 4.4.1 Short Run Supply Curve of a Firm 4.4.2 Long Run Supply Curve of a Firm 4.4.3 The Shut Down Point 4.4.4 The Normal Profit and Break-even Point

4.5 Determinants of a Firm’s Supply Curve 4.5.1 Technological Progress 4.5.2 Input Prices 4.5.3 Unit Tax

4.6 Market Supply Curve 4.7 Price Elasticity of Supply

4.7.1 The Geometric Method

5. MARKET EQUILIBRIUM

5.1 Equilibrium, Excess Demand, Excess Supply 5.1.1 Market Equilibrium-Fixed Number Firms5.1.2 Market Equilibrium: Free Entry & Exit

5.2 Applications 5.2.1 Price Ceiling 5.2.2 Price Floor

6. NON-COMPETITIVE MARKETS

6.1 Simple Monopoly in the Commodity Market 6.1.1 Market Demand Curve is the A.R Curve 6.1.2 Total, Average and Marginal Revenues 6.1.3 Marginal Revenue and Price Elasticity of Demand6.1.4 Short Run Equilibrium of the Monopoly Firm

6.2 Other Non-perfectly Competitive Markets6.2.1 Monopolistic Competition6.2.2 How do Firms behave in Oligopoly

PRODUCTION

Production

ProductGoods

Free Goods

Economic Goods

Services

Economic goods

Consumer Goods

Capital Goods

Intermediary Goods

Consumer Goods

Perishable Goods

Durable Goods

Single Use C.G

Durable Use C.G

•The Output of an economy is called PRODUCT

Raw Materials

Intermediate goods Final Goods

• Rent + Wages + Interest + Profit = Factor Cost (10)• Factor Cost (10)+ Taxes(2) = MRP(12)• Anything sold below the factor cost is ‘Subsidy’• Factor Cost (10) = Actual Cost (8)+ Subsidy(2) • Net Taxes = Taxes – Subsidy (Taxes > Subsidy)• Factor Cost + Net Taxes = MRP• Value = price × quantity

Factors of Production• Land• Labour• Capital• Entrepreneur

Factor Payments• Rent• Wages• Interest• Profit

Based on Ownership of F.O.P

(A) Capitalist Economy• The capitalist or free enterprise economy is the oldest form of

economy. Earlier economists supported the policy of ‘laissez fair’ meaning leave free.

• They advocated minimum government intervention in the economic activities. The following are the main features of a capitalist economy;

Free enterprise Private property Freedom of Contract Profit Motive Competition Consumer’s Sovereignty

Capitalist Economy

Capitalist Economy

Pros• Production of cheap and

better products• Reward• Innovation• Competition• Efficiency

Cons• Inequalities of Income• Labour Exploitation• Inefficient distribution of

fruits

(B) Socialist Economy

• In the socialist or centrally planned economies all the productive resources are owned and controlled by the government in the overall interest of the society.

• The socialist economy has the following main features

Collective Ownership of means of ProductionSocial Welfare ObjectiveCentral PlanningReduction in InequalitiesNo class conflict

(C) Mixed Economy• A mixed economy combines the best features of capitalism

and socialism. Thus mixed economy has some elements of both free enterprise or capitalist economy as well as a government controlled socialist economy. The public and private sectors co-exist in mixed economies.

• The main characteristics of a mixed economy are as follows:

Co-existence of public and private sectors. Individual Freedom Economic Planning Price Mechanism

Market

• Place where buyer & Seller meets.• Edwards defined ‘Market as a mechanism by

which buyer and sellers are brought together.’

Cost & Price?

Cost & Price

• The cost is the amount spent by a business making the product.

• The price is the amount customers pay for a product.

• What is Profit/Gain?(Revenue – Cost)

• What is Loss?(Cost- Revenue)

P.P.C ?

Production Possibilities Curve (PPC):

The Production Possibilities Curve (PPC) or “transformative curve” is a graph that shows the different rates of production of two goods that an individual of group can efficiently produce with limited resources.

BENEFITS OF P.P.C

• SCARCITY• TRADE-OFFS• OPPORTUNITY COST• EFFICIENCY

HEROOF

MARKET ECONOMY

HERO OF TOLLYWOOD

DEMAND AND SUPPLY

• DEMAND– LAW OF DEMAND– REASONS FOR CHANGES IN DEMAND– DECREASE IN DEMAND– INCREASE IN DEMAND– DETERMINERS OF DEMAND SHIFT– DEMAND vs DEMAND QUANTITY

REASONS

• SUBSTITUTION EFFECT• INCOME EFFECT• LAW OF DIMINISHING MARGINAL UTILITY

DECREASE IN DEMAND

INCREASE IN DEMAND

DETERMINERS OF DEMAND SHIFT

• TASTE OR PREFERENCES• NUMBER OF CONSUMERS• PRICE OF RELATED GOODS

– SUBSTITUE GOODS– COMPLIMENT GOODS

• INCOME– NORMAL GOODS– INFERIOR GOODS

• EXPECTATIONS

• SUPPLY– LAW OF SUPPLY– DECREASE IN SUPPLY– INCREASE IN SUPPLY– DETERMINERS OF SUPPLY SHIFT

SUPPLY GRAPH

INCREASE IN SUPPLY

DECREASE IN SUPPLY

DETERMINERS OF SUPPLY SHIFT

• PRICE OF RESOURCES• NUMBER OF PRODUCERS• CHANGE IN TECHNOLOGY• TAXES AND SUBSIDIES• EXPECTATIONS

Equilibrium Price

Elasticity and the Total Revenue

• Elasticity is used to determine how changes in product demand and supply relate to changes in consumer income or the producer's price.

• The elastic product means that any change in price can result in changes in supply or demand.

• The inelastic product means that changes in price do not affect to a noticeable degree the supply or demand.

What is Contract Theory?Oliver Hart from Harvard and MIT professor Bengt Holmstrom won this year's Nobel Memorial Prize inEconomics for their study of contracts and human behaviour in business.

What is Contract Theory?How contracts are designed defines our incentives in various situations in the real world. Contracts can be

o formal or informal, depending on whether they are enforced by law or social normso complete or incomplete, which is based on whether they take into account all possibilities that lay in the future

Contract theory is, partly at least, an attempt to understand the nuances in our contracts and how thosecontracts could be better constructed.

The two economists provided "a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities.“

It has become especially relevant in the years after the 2008 financial crisis, which was blamed on the short-term risk encouraged by huge cash bonuses paid to investment bankers.

It also touches on themes of moral hazard, which arises where those that take the risks don't share in thecosts of failure.

QUIZ

1. In Duopoly, there is/are

A. Many firmsB. Two firms controlling the MarketC. Large corporationsD. None of the above

2. Model of Monopolistic Competition (i.eImperfect competition) is characterized by

A. Homogeneous goodsB. Differentiated goodsC. Substitute GoodsD. All of the above

3. Price discrimination is a situation when a producer

A. charges different prices in different marketsB. charges same priceC. Charges many pricesD. All of the above.

4. Monopoly is a form of market where there is

A. large number of buyerB. Small number of buyerC. A single firm controlling the marketD. Any of the above

5. Shape of Total Fixed Cost(TFC) Curve is

A. VerticleB. HorizontalC. 45 degree lineD. None of the above

6. Production Functions Shows

A. Prices of input and outputB. Relationship between output and inputC. various combinations of inputsD. All of the above

7. Law of Demand states that

A. with the increase in price, Quantity increasesB. with the increase in price, quantity decreases other things remaining the same.C. quantity does not change with any increase in price.D. All of the above.

• 8. What Microeconomics is about?

A. Study of Business EnvironmentB. Study of financial position of the economyC. Study of the Economy at Micro LevelD. None of the above

•9. While in Perfect Competition

A. Firms are price takerB. Buyers are independentC. Input prices are givenD. None of the above

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