Principles ofEconomics

Principles ofEconomics

D N DWIVEDIProfessor in Economics

Maharaja Agrasen Institute of Management Studies, DelhiFormer Reader, Ramjas College

University of Delhi

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Second EditionISBN: 81-259-1651-2Copyright © Author, 1985, 2005

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Printed at Gajendra Printing Press, Delhi-110032

Preface to the Second Edition

Although basic principles of economics remainthe same as delineated in the first edition of thisbook, the need for bringing out its second editionwas felt for three reasons. First, “Principles ofEconomics” is being reintroduced in theeconomics syllabi of various universities. The waythese syllabi were designed it created animpression that there are two kinds ofeconomics—microeconomics and macro-economics—with some specialized branches. Thesystem seems to be returning to the earlier formof first giving students a comprehensive view ofthe basic principles and then initiate them to itstwo major branches with increasing emphasis onmacroeconomics and international economics.This new trend has enhanced the relevance andusefulness of this book. Secondly, there is a greateremphasis on using quantitative method ofelaboration and exposition of economic theoriesin recent years while the use of high-levelmathematics is being underplayed. So, there wasa need for introducing simple quantitativemethods in the presentation of theories. Thirdly,the application of economic concepts and theoriesto real life problems is of late also beingemphasised and this is also finding entry intomanagement, medical and engineering courses.So application content has been brought into focusin this second edition.

The primary objective of writing this test hasbeen to provide a comprehensive text on the basicprinciples of economics for undergraduate andpostgraduate students in a compact volume. Thisbook will also be of immense use to studentspreparing for competitive examinations, like IAS,IES, CA, MBA and BBA degree and diplomacourses, economics paper in engineering and

medical courses. In nutshell, it is an all-purposebook for the students of economics. The studentsof the latter categories who begin with virtuallyno economics background often find it difficult tocomprehend the complex theories of economics.For them this book is a boon. It begins with simpleintroduction to economics as a social science,then moves on to basic economic problems ofindividuals, firms and the society focusing onthe problem of scarcity and choice making finallydiscussing the higher levels of economic theories.Parts II to VI deal with microeconomic theories.

Graphical illustrations and simple algebraicformulations have been used, wherever necessary,for clear exposition of economic theories. Reviewquestions and exercises are given at the end ofeach chapter to help students assess their ownunderstanding of economics.

Thus, substantial changes have been madefor this edition and the subject matter has beenreorganized. While most chapters are rewritten,expanded and updated, some new have beenadded. The new chapters are listed below.Chapter 1. Introduction to Economics: (An

abridgement and updated versionof earlier Ch. 1, 2 and 3).

Chapter 2. The Economy and Its BasicProblems: Scarcity and Choice.

Chapter 3. The Laws of Demand and Supplyand Market Equilibrium:(Constitutes a new part—Part II:Fundamentals of the MarketEconomy).

Chapter 6. Failures of the Market Economy andthe Role of the Government.

Chapter 21. Factor Market: Factor Demand andSupply.

Chapter 22. Theory of Wage Determination (Arevised version of earlier Ch. 24).

Chapter 23. Rent, Quasi Rent and EconomicRent (A rewritten version of earlierCh. 26).

Chapter 26. Product Exhaust Theorem.Chapter 29. Introduction to MacroeconomicsChapter 30. The Circular Flow Model of the

Economy.Chapter 39. Inflation: Meaning, Measure and

EffectsChapter 40. Theories of Inflation and Control

Measures

Most other chapters are rewritten withadditional topics as listed below: Meaning and Measurability of Utility;

Consumer Equilibrium: The General Case;Derivation of Demand Curve has been added(Ch. 7)

The Corner Solution: The Extreme Choice; TheComposite Goods Case; Goods, Bads andNeuters (Ch. 8)

Meaning of Production; Some Basic Concepts(Ch. 11)

Economies of Scale: Why LAC Decreases; CostFunctions and Cost Curves (Ch. 14)

Game Theory Approach to Oligopoly (Ch. 19) Some Early Thoughts of Interest Theory;

Classical Theories of Interest (Ch. 24) Partial Vs. General Equilibrium, Walrasian

General Equilibrium Model; The Process ofAutomatic Adjustment (Ch. 27)

Cardinal Utility Approach: Social Welfare isthe Sum of Individual Utility; Pareto Approach:Social Welfare as Social Optimum; The NewWelfare Economics: Compensation Criteria forWelfare Judgement; The Bergson Criterion: TheSocial Welfare Function (Ch. 28)

Shift in Aggregate Demand Function and theMultiplier (Ch. 32)

Meaning of Economic Growth; Factors inEconomic Growth (Ch. 37)

The book is thus being presented with significantqualitative improvement and with mostcomprehensive coverage.

I am extremely grateful to Shri PiyushChawla, Director Publishing and Marketing ofVikas Publishing House for giving me anopportunity to revise the book.

Comments and suggestions will be gratefullyacknowledged.

D N Dwivedi

vi Preface to the Second Edition

Preface to the First Edition

analysis and their relative merits. In view of thefact that many students from other disciplinestake to economics at a fairly advanced stage, thediscussion on each topic begins at an elementarylevel and proceeds by stages towards the higherlevels. Also, a list of standard texts and importantpapers is given at the end of each chapter tofacilitate advanced study of the subject.

In preparing this book, I have heavily drawnfrom the writings of the reputed economists. Mydebt in this regard is incalculable. I am indebtedto my friend and colleague Mr. R. R. Suresh forgoing through several chapters of the book andmaking valuable suggestions. I gratefullyacknowledge the help I have received fromMr Ramesh Bhatt and Mr Chandra ShekharSharma, both of Sriram College of Commerce(Delhi), in writing the chapters on linearprogramming and profit theory, respectively. I owealso to my wife and son who were deprived oftheir due share in my time during the preparationof this book.

The comments and suggestions to improvethe book shall be gratefully acknowledged.

D N Dwivedi

The aim of this book is to provide a standard andcomprehensive text on a wide range of principlesof economics. It is addressed to the undergraduateand post-graduate students of Indian universitiesand to the candidates for IES and IASexaminations. It would meet the requirement ofalso those who want to possess a textbook ineconomics for general reference.

Writing a textbook, in economics these daysis somewhat similar to producing a commoditywith ‘product differentiation’. The salient featuresof this book that distinguish it from other similarbooks may be briefly mentioned here. Unlike mostadvanced texts, this book provides a non-mathematical treatment of economic concepts andtheories. But, unlike many other texts that relysolely on verbal and imprecise description, thisbook uses the modern tools of economic analysisin the exposition of the subject-matter. It presentsthe complex economic theories in a clear andprecise manner with the help of self-explanatorydiagrams and simple algebra. Besides, an attempthas been made throughout to equip the readerwith classical and modern tools of economic

Contents

Preface to the Second Edition vPreface to the First Edition vii

Part IINTRODUCTION

1. Introduction to Economics 1What is Economics?; The Scope of Economics; IsEconomics a Positive or a Normative Science;Methodology of Economics: What Economists Doand How; How Reliable are the Economic Laws;Why Economic Laws; Review Questions andExercises.

2. The Economy and Its Basic Problems:Scarcity and Choices 16The Economy and its Working; Kinds of EconomicSystems; Production Possibilities of an Economy;The Basic Problems of an Economy; How MarketMechanism Solves the Basic Problems; HowEfficient is the Market System; Reasons for theFailures of the Market System; The Governmentand the Economy; Review Questions and Exercises.

Part IIFUNDAMENTALS OF MARKET ECONOMY

3. The Laws of Demand and Supplyand Market Equilibrium 37Introduction; The Law of Demand: Price-DemandRelationship; The Law of Supply; The SupplyFunction; Equilibrium of Demand and Supply:Determination of Equilibrium Price; ReviewQuestions and Exercises.

4. Elasticities of Demand and Supply 55Price Elasticity of Demand; Determinants of PriceElasticity of Demand; Price Elasticities andMarginal Revenue; Price Elasticity andConsumption Expenditure; Cross-Elasticity ofDemand; Income Elasticity of Demand; TheElasticity of Price Expectations; The Uses of

Elasticity; Price Elasticity of Supply; ReviewQuestions and Exercises.

5. Market Equilibrium and Disequilibrium 71Introduction; Meaning and Uses of Equilibrium;Kinds of Equilibria; Partial and GeneralEquilibrium; Short-term and Long-termEquilibrium; Unique and Multiple Equilibrium;Review Questions and Exercises.

6. Failure of the Market Economy andRole of the Government 86Introduction; Imperfect Market Information andMarket Failure; Growth of Monopolies andMarket Failure; Market Failure in Case of PublicGoods; Public Provision of Public Goods;Externalities and Government Intervention;Review Questions and Exercises.

Part IIITHEORY OF CONSUMER DEMAND

7. Theory of Consumer Demand:Cardinal Utility Approach 97Introduction; Cardinal Utility Theory; The Lawof Diminishing Marginal Utility; Consumer’sEquilibrium, Derivation of Demand Curve;Drawbacks of Cardinal Approach; ReviewQuestions and Exercises.

8. Theory of Consumer Demand:Ordinal Utility Approach 106Introduction; The Meaning and Nature ofIndifference Curve; The Diminishing MarginalRate of Substitution; Properties of IndifferenceCurves; The Budget Constraint and The BudgetLine; Consumer’s Equilibrium; Effects of Changein Consumer’s Income; Effects of Price Change;Income and Substitution Effects on InferiorGoods; Complementarity and Substitutability; TheCorner Solution: The Extreme Choice; TheComposite Goods Case; Goods, Bads andNeuters; Derivation of Individual Demand Curve;

Comparison of Cardinal and Ordinal UtilityApproaches; Critique of Indifference CurveApproach; Applications of Indifference CurveAnalysis; Review Questions and Exercises.

9. Recent Developments inConsumption Theory 146Introduction; Samuelson’s Revealed PreferenceTheory; Neumann-Morgenstern Utility Theory;Friedman-Savage Hypothesis; Hicks’ RevisedDemand Theory; Review Questions and Exercises.

10. Consumer’s Surplus 161Introduction; The Marshallian Consumer ’sSurplus; Hicksian Method of MeasuringConsumer ’s Surplus; Some Uses of theConsumer’s Surplus Concept; Review Questionsand Exercises.

Part IVTHEORY OF PRODUCTION AND

ANALYSIS OF COST

11. Theory of Production-I: Production withOne Variable Input 171Introduction; Meaning of Production; SomeConcepts; Production Function; The Laws ofProduction; Review Questions and Exercises.

12. Theory of Production-II: Production withTwo Variable Inputs 179Introduction; Isoquant Curves; Marginal Rate ofTechnical Substitution; Properties of IsoquantCurves; Isoquant Map and Economic Region;Other Forms of Isoquants; Elasticity ofSubstitution; Laws of Returns to Scale: Long RunAnalysis of Production; Review Questions andExercises.

13. Optimum Combination of Inputs 194Introduction; Budgetary Constraints and Isocosts;Optimising Combination of Inputs; Choice ofOptimal Expansion Path; Change in Input Pricesand Input Combination; Review Questions andExercises.

14. Theory of Production Cost 200Cost Concepts; Short-Run Cost-Output Relations;Long-run Cost-Output Relations; Economies ofScale: Why LAC Decreases; Diseconomies ofScales: Why LAC Increases; Cost Functions andCost Curves; Review Questions and Exercises.

Part VTHEORY OF FIRM: PRICE AND OUTPUT

DETERMINATION

15. Objective of Business Firms andMarket Structure 219Introduction; Objectives of Business Firms; ProfitMaximization; Alternative Objectives of BusinessFirms; The Market Structure; Review Questionsand Exercises.

16. Price and Output Determination UnderPerfect Competition 233A Prelude to the Theory of Firm; The Featuresof Perfect Competition; Perfect Vs. PureCompetition; Equilibrium of the Firm; Derivationof Supply Curve of the Firm; Derivation ofSupply Curve of the Industry; Price and OutputDetermination Under Perfect Competition; Priceand Output Determination in the Long Run; Long-run Supply Curve of a Competitive Industry;Review Questions and Exercises.

17. Price and Output DeterminationUnder Monopoly 247Introduction; Monopoly: Definition and Sources;Demand and Revenue Curves Under Monopoly;Cost and Supply Curves Under Monopoly; ProfitMaximisation Under Monopoly; Why Absence ofSupply Curve Under Monopoly; Monopoly Vs.Perfect Competition: Comparison of Long-runPrice and Output; Equilibrium of the MultiplantMonopoly; Price Discrimination by Monopoly;Measures of Monopoly Power; Review Questionsand Exercises.

18. Price and Output UnderMonopolistic Competition 268Introduction; The Nature of MonopolisticCompetition; Foundations of the MonopolisticCompetition Model; Price and OutputDetermination Under Monopolistic Competition;Analysis of Selling Cost and Firm’s Equilibrium;Critical Appraisal of Chamberlin’s Theory ofMonopolistic Competition; Review Questions andExercises.

19. Price and Output DeterminationUnder Oligopoly 278Oligopoly: Meaning and Characteristics; DuopolyModels; Oligopoly Models; The Game TheoryApproach to Oligopoly; Review Questions andExercises.

20. Some Topics in Pricing Theory 302Introduction; Full-Cost Pricing; Limit Pricing:

x Contents

Bain’s Model; Baumol’s Theory of SalesMaximisation; Review Questions and Exercises.

Part VITHEORY OF FACTOR PRICING

21. The Factor Market: FactorDemand and Supply 311Introduction; Marginal Productivity Theory ofFactor Pricing: An Overview; MarginalProductivity and Factor Demand; The FactorSupply: An Overview; Derivation of IndividualLabour Supply Curve; Derivation of MarketLabour Supply Curve; Review Questions andExercises.

22. Theory of Wage Determination 322Introduction; Wage Determination Under PerfectCompetition in Product and Labour Markets;Monopoly in Commodity Market and PerfectCompetition in Labour Market; WageDetermination Under Monopoly in Product andMonopsony in Labour Market; PerfectCompetition in Commodity Market andMonopoly in Labour Market (Labour Union);Wage Determination Under Bilateral Monopoly:Collective Bargaining; Review Questions andExercises.

23. Rent, Quasi-Rent and Economic Rent 336Introduction; Ricardian Theory of Rent; Quasi-Rent: The Short-Term Rent on Fixed Factors;Factor Price, Transfer Earning and Economic Rent;Review Questions and Exercises.

24. Theories of Interest 342Introduction; Some Early Thoughts on InterestTheory; Classical Theories of Interest; TheLoanable Fund Theory of Interest; ReviewQuestions and Exercises.

25. Theories of Profit 349The Meaning of Pure Profit; Theories of Profit;Does Profit Enter the Cost of Production?; ReviewQuestions and Exercises.

26. Product Exhaustion Theorems 358Introduction; The Adding-up Controversy;Relative Factor Shares and Income Distribution;Review Questions and Exercises.

Part VIIGENERAL EQUILIBRIUM AND

WELFARE ECONOMICS

27. The General Equilibrium 367Partial Vs. General Equilibrium; General

Equilibrium Approach; The Walrasian Approachto General Equilibrium; Existence, Uniqueness andStability of General Equilibrium; Evaluation ofGeneral Equilibrium Approach; Review Questionsand Exercises.

28. Welfare Economics 378Introduction; Definition of Welfare Economics;Nature of Welfare Economics; The Concept andMeasurement of Social Welfare; Classical WelfareEconomics: Smith’s Welfare Criteria; Neo-ClassicalWelfare Economics: Pigou’s Welfare Economics;Pareto’s Welfare Economics; Externalities andPareto Optimality; The New Welfare Economics:Compensation Criteria for Welfare Judgement;The Bergson Criterion: The Social WelfareFunction; Arrow Theorem of Democratic GroupDecision; Grand Utility Possibility Frontier andWelfare Maximisation; The Theory of Second Best;Review Questions and Exercises.

Part VIIIMACROECONOMICS

29. Introduction to Macroeconomics 406What is Macroeconomics?; Major MacroeconomicIssues; Macroeconomics in Perspective; ReviewQuestions and Exercises.

30. The Circular Flow Model ofThe Economy 415Introduction; Circular Flows in a Simple EconomyModel; Circular Flows of Goods and Money in aThree-Sector Economy; Circular Flows in a Four-Sector Model: A Model with Foreign Sector;Review Questions and Exercises.

31. National Income:Concept and Measurement 421Some Basic Concepts; Measures of NationalIncome; Methods of Measuring National Income;Choice of Methods; Measurement of NationalIncome in India; Growth and Composition ofIndia’s National Income; Review Questions andExercises.

32. Theory of National IncomeDetermination 430The Keynesian Theory of National IncomeDetermination; Determination of NationalIncome: Two-Sector Model; The ConsumptionFunction; Derivation of Saving Function; A formalModel of a National Income Determination; Shiftin Aggregate Demand Function and theMultiplier; Shift in Aggregate Demand Functionand the Multiplier; Review Questions and Exercises.

Contents xi

Principles Of Economics

Publisher : Vikas Publishing ISBN : 9788125916512 Author : D N Dwivedi

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