Chapter 1: Introduction (Weightage: 6 Marks)
Chapter Overview
This chapter sets the foundation for all economic study. Remember, Economics exists
because of the fundamental problem of scarcity: unlimited wants meet limited resources.
This scarcity forces every society to make crucial choices.
List of Topics & Subtopics
● Central Problems of an Economy (What, How, For Whom)
● Microeconomics vs. Macroeconomics
● Positive vs. Normative Economics
● Centrally Planned Economy vs. Market Economy
Concept-wise Notes
1. Central Problems of an Economy (Most Expected 4 or 6 Marks)
The universal problem of scarcity leads to three central questions every economy must
answer:
1. What to Produce?
○ Focus: Choice of Goods. Should the economy produce more consumer goods
(like food and clothes) or more capital goods (like machines and tools)?
○ Example: 1. Choosing between producing more defence goods (guns) or more
civilian goods (butter). 2. More consumer goods or more capital goods?
2. How to Produce?
○ Focus: Choice of Technique. Should production use Labour-Intensive
Technique (more workers, less machinery) or Capital-Intensive Technique
(more machinery, less workers)?
○ Goal: To produce goods at the minimum cost possible.
○ Example: Labour-intensive technique (more jobs) or capital-intensive
technique (more machinery)?
3. For Whom to Produce?
○ Focus: Distribution of Output. How should the national product be
distributed among the population? This relates to issues of equity and
equality.
○ Example: 1. Should goods be distributed based on need or based on the
ability to pay (purchasing power)? 2. More for the rich or more for the poor?
💡 Memory Tip W-H-W (What, How, Whom)
2. Production Possibility Curve (PPC) Short Notes
The PPC (or PPF) is a curve showing the maximum possible combinations of two goods that
an economy can produce, given its fixed resources and technology. It illustrates the core
economic problems of Scarcity and Choice.
Key Assumptions
1. Only two goods are produced.
2. Resources are fixed in quantity.
3. Technology is constant.
4. Resources are fully and efficiently utilized.
PPC Diagram
● Y-axis: Capital Goods (Good A)
● X-axis: Consumer Goods (Good B)
● A, B (On the curve): Full & Efficient use of resources.
● C (Inside): Underutilization / Inefficient production (Unemployment).
● F (Outside): Unattainable given current resources (Scarcity).
● Slope: Represents Marginal Opportunity Cost (MOC).
Characteristics of the Curve
● Slopes Downwards : Scarcity and Trade-off - To produce more of one good, the
economy must sacrifice some production of the other good.
● Concave to the Origin : Law of Increasing MOC - As we transfer resources from
producing Good A to Good B, the efficiency decreases, meaning we must give up
increasing amounts of Good A to gain constant amounts of Good B.
● Shifts : Outward Shift - Occurs due to an increase in resources (e.g., population
growth) or technological advancement (Economic Growth).
3. Microeconomics vs. Macroeconomics (Expected 4 Marks)
3. Positive vs. Normative Economics (Expected 4 or 6 Marks)
4. Market Economy vs. Centrally Planned Economy
Key Terms / Formulas / Relationships
● Microeconomics: Study of individual economic units.
● Scarcity: Limited resources vs. unlimited wants.
● Production Possibility Frontier (PPF): Curve showing maximum combinations of two
goods that can be produced.
● Positive Economics: Deals with facts ("What is").
● Normative Economics: Deals with opinions ("What ought to be").
Quick Revision Table (1-Minute Recap)
W-H-W Central Problems (What, How,
Whom)
Micro Individual unit (Firm/Consumer)
Macro Aggregate level (Nation/Inflation)
Positive Fact-based (What is)
Normative Opinion-based (What ought to be)
Chapter 2: Theory of Consumer Behaviour (Weightage: 20 Marks)
Chapter Overview
This is a high-weightage chapter. We analyze how a rational consumer makes choices to
maximize utility (satisfaction), given their income and market prices. The focus is on the
Indifference Curve Approach.
List of Topics & Subtopics
● Budget Set and Budget Line
● Indifference Curves and Map
● Properties of Indifference Curves (Most Important)
● Consumer's Equilibrium (Optimal Choice)
● Demand Curve (Derivation)
● Price Elasticity of Demand
Concept-wise Notes
1. Utility
Utility is the want-satisfying power or the expected satisfaction that a consumer derives
from consuming a commodity or service.
● It is subjective: It varies from person to person (a vegetarian gets zero utility from
meat, but an omnivore gets high utility).
● Expected vs. Realised: Utility is the satisfaction anticipated before consumption. The
actual satisfaction derived after consumption is simply called satisfaction.
Types (Approaches to Measuring) of Utility
Economists classify the measurement of utility into two main types:
a. Cardinal Utility Approach
● Meaning: It assumes that utility can be measured and expressed numerically, using
units called 'Utils'.
● Example: A consumer can say, "I got 10 utils of satisfaction from eating this apple."
● Concepts Used: This approach is historically associated with the Law of Diminishing
Marginal Utility (the satisfaction from each successive unit decreases).
b. Ordinal Utility Approach (Modern Approach)
● Meaning: It assumes that utility cannot be measured numerically, but the consumer
can rank or order their preferences.
● Example: A consumer can say, "Good A gives me more satisfaction (Rank 1) than
Good B (Rank 2)."
● Core Tool: This approach uses Indifference Curves (IC) and Budget Lines and is the
basis for the modern theory of consumer behavior.
2. Budget Set and Budget Line (Expected 4 Marks)
● Budget Set: The collection of all bundles (combinations of 2 goods) that a consumer
can afford with their given income (M) and prices (P1,P2)
● Budget Line (or Price Line): A line showing all combinations of two goods that a
consumer can buy when spending their entire income.
○ Formula: P1x1+P2x2=M (for Budget Set)
○ Slope: The slope of the Budget Line is P2−P1. This is the market rate of
exchange (It represents the rate at which the consumer can trade one good
for the other in the market at the particular price)
3. Indifference Curve (IC) and Properties (Most Expected 6 Marks)
● Indifference Curve (IC): A curve that shows all combinations of two goods that give
the consumer the same level of satisfaction (utility). The consumer is indifferent
between any points on the curve.
● Indifference Map: A family of Indifference Curves. Curves further from the origin
represent higher levels of utility. Higher IC ⟹ Higher Utility.
● Monotonic Preferences: A consumer always prefers more of a good to less of it. A
consumer's preferences are monotonic if they prefer a bundle having more of at
least one good and no less of the other good, compared to any other bundle. (More
is better).
Properties of Indifference Curves:
1. IC slopes downward from left to right: To maintain the same utility, if a consumer
increases the consumption of one good, they must decrease the consumption of the
other.
2. IC is convex to the origin: This is due to the Law of Diminishing Marginal Rate of
Substitution (MRS). As a consumer consumes more of good X, they are willing to
give up less and less of good Y for for each extra unit of Good 1.
3. Higher IC represents a higher level of utility: Since the consumer has monotonic
preferences, a higher curve (more goods) means more satisfaction. Combinations on
a higher curve contain more of at least one good, offering greater satisfaction.
4. Two ICs never intersect: If they intersected, it would mean the same level of
satisfaction could be achieved on both a lower and a higher curve, which violates the
assumption of monotonic preferences.
4. Marginal Rate of Substitution (MRS)
● Definition: The rate at which the consumer is willing to substitute Good 2 for Good 1
while keeping the total satisfaction constant.
● Relationship: MRS is the slope of the Indifference Curve.
5. Consumer's Optimal Choice (Equilibrium) (Expected 6 Marks)
The consumer achieves maximum satisfaction (equilibrium) at the point where the Budget
Line is tangent to the highest possible Indifference Curve.
● Equilibrium Condition: The slope of the IC equals the slope of the Budget Line:
● Diagram Hint: Draw three ICs and one straight Budget Line. The equilibrium point E is
where the Budget Line just touches the highest attainable IC.
6. The Law of Demand and Demand Curve
• Demand Curve: A graph showing the relationship between the price of a good and the
quantity demanded by the consumer.
• Law of Demand: Other things remaining constant (ceteris paribus), there is an inverse
relationship between the price of a commodity and its quantity demanded.
i.e. When price increases, quantity demanded decreases, and vice versa.
● Change in Demand Curve: a. Movement and b. Shift
- Movement are of 2 types : Extension = Increase in demand ; Contraction =
Decrease in Demand
- Movement occurs due to a change in price, increase in price due to added
tax will contract. Vice-versa - decrease in price will extend the curve.
- Shift are of 2 types : Forward/Increasing shift - Increase in quantity
demanded; Backward/Decreasing shift - decrease in quantity demanded
- Shift happens dues to other factors(not price) like change in trend, style,
weather etc. basically any other reason othe than price of the good causes
shift.
7. Price Elasticity of Demand (PED)
● Definition: The responsiveness (degree of change) of the quantity demanded (%ΔQ)
to a change in the price (%ΔP). In other words, the degree of change that occurs in
the quantity demanded due to the change in price.
● Formula: Ep = % Change in Price / % Change in Quantity Demanded
● Types:
○ Ep>1: Elastic (change in the demand is more than the change in price. Eg-
Luxuries, people will buy more if price decreases).
○ Ep<1: Inelastic (change in the demand is less than the change in price., e.g.,
Necessity good, even if the price changes we will still buy it).
○ Ep=1: Unitary Elastic. (change in the demand is equal the change in price
Key Terms / Formulas / Relationships
● Budget Line Slope: P2−P1
● MRS: Slope of IC.
● Equilibrium: MRS=P2P1
● Elasticity (Ep):
Chapter 3: Production and Costs (Weightage: 10 Marks)
Chapter Overview
This chapter explores how a firm chooses inputs to produce output (Production) and the
expenditure incurred in this process (Costs) in the short run and long run.
List of Topics & Subtopics
● TP, AP, MP and their relationship
● Law of Variable Proportions (LVP)
● Law of Return to Scale
● Short-Run Costs (TFC, TVC, TC, AFC, AVC, AC, MC)
● Relationship between AC, AVC, and MC
● Long-Run Costs (LRC)
Concept-wise Notes
1. Total Product (TP), Average Product (AP), and Marginal Product (MP)
• Total Product (TP): The total quantity of output produced by a firm using a given amount
of factors of production.
• Average Product (AP): Output per unit of the variable input (Labour). How much quantity
is being produced by a single labour.
• Marginal Product (MP): The change in TP when one more unit of the variable input is
used. MP refers to the increase or decrease in the total product (TP) when there is an
increase in the variable factor of production like adding more labourer or increasing the raw
materials.
[Link] Run Production: Law of Variable Proportions (LVP) (Most Expected 6 Marks)
The LVP explains how output changes when only one input is varied/changed/increased
(e.g., Labour, L) while other inputs (Capital, K) remain fixed (Short Run). The law states that
as we increase the variable factor, the TP curve passes through three phases:
Stage TP Trend MP Trend Rationale
I: Increasing Increases at an Increases and Better utilization of resources.
Returns Increasing Rate reaches its
maximum.
II: Diminishing Increases at a Decreases
Returns Diminishing Rate (and becomes
(till its maximum zero at the
point) maximum TP
point)
III: Negative Decreases Becomes Over-crowding/over-utilization
Returns Negative of fixed factor.
(falling
below the
x-axis)
● Diagram Hint: TP curve is S-shaped. The MP curve rises, falls to zero (when TP is
max), and then becomes negative. MP cuts AP at AP's maximum.
3. Returns to Scale (Long Run Production)
Returns to Scale refer to the change in output when all inputs are increased in the same
proportion (a long-run concept).
Increasing Returns to Scale (IRS): Output increases by more than the proportional
increase in inputs.
Constant Returns to Scale (CRS): Output increases by the same proportion as the
increase in inputs.
Decreasing Returns to Scale (DRS): Output increases by less than the proportional
increase in inputs.
4. Short-Run Costs (TC, TFC, TVC, AC, AVC, MC) (Expected 4 or 6 Marks)
The Short Run has both Fixed and Variable costs.
● Total Cost (TC): TC=TFC+TVC
● Total Fixed Cost (TFC): Cost that does not change with level of output (e.g., Rent,
Insurance). TFC is a horizontal line.
● Total Variable Cost (TVC): Cost that changes with the level of output (e.g., Raw
materials, labour wages).
● Average Cost (AC) - Cost per unit of output. Cost of the input used to produce a
single product in the total output. Eg. - If 100 total goods were produced at a cost of
1000/- then what is the cost of 1 good. AC = TC/Total quantity of output(Q) Eg. -
1000/100 or AC - TVC + TFC
● Average Variable Cost (AVC): Variable cost per unit of the variable input used.
AVC=TVC/Q
● Marginal Cost (MC): The change in total cost when one more unit of output is
produced. MC = Change in TC/Change in Quantity or ΔTC/ΔQ
5. Relationship between AC, AVC, and MC (Expected 4 Marks)
1. AC, AVC, and MC curves are all U-shaped due to the Law of Variable Proportions
2. The MC curve cuts the AC curve and the AVC curve at their respective minimum
points.
3. When MC<AC, AC falls (MC pulls AC down).
4. When MC>AC, AC rises (MC pulls AC up).
5. The gap between AC and AVC (which is AFC) continuously decreases as output
increases.
6. Diagram Hint: Draw U-shaped AC and AVC. Draw a sharper U-shaped MC that
intersects both AC and AVC at their minimums.
6. Long Run Cost Curve
- Long Run cost curve is a collection of all the short run cost curves.
- In the diagram - LAC - Long Run Average Cost and SAC - Short Run Average Cost Curve.
Sharing the same properties as the short run curves.
Key Terms / Formulas / Relationships
● Short Run: K is fixed.
● Long Run: All factors are variable.
● LVP Stage II: MP is positive but falling.
● Total Cost: TC=TFC+TVC
● MC = Slope of TC (or TVC).
● AFC Shape: Continually declines (Rectangular Hyperbola).
Chapter 4: The Theory of the Firm under Perfect Competition (Weightage: 11 Marks)
Chapter Overview
This chapter studies the behavior of a firm operating in a Perfectly Competitive
Market—the structure where many small firms sell identical products.
List of Topics & Subtopics
● Features of Perfect Competition (PC)
● Revenue under PC
● Profit Maximisation conditions
● Short-Run Supply Curve (Shut-down point, Break-even point)
Concept-wise Notes
1. Features of Perfect Competition (PC) (Most Expected 4 or 6 Marks)
1. Large Number of Buyers and Sellers:The number is so large that no single firm can
influence the market price. The firm is a Price Taker.
2. Homogeneous Product: All products are identical/same.
3. Free Entry and Exit of Firms: There are no barriers to joining or leaving the industry.
4. Perfect Knowledge: Both buyers and sellers have complete information about the
market.
2. Revenue under Perfect Competition (P = AR = MR)
● In a perfectly competitive market, the price is constant for all output levels. Since the
price (P) is constant (determined by the market), the revenue curves are horizontal:
P=AR=MR.
● Price (P) = Average Revenue (AR)
● Average Revenue (AR) = Marginal Revenue (MR)
● The AR and MR curves are a single, horizontal line parallel to the X-axis at the
market price.
● The demand curve for a PC firm is perfectly elastic (horizontal).
3. Profit Maximisation (Expected 4 Marks) (Same Diagram as above)
A perfectly competitive firm maximizes profit when the following two conditions are met:
1. Marginal Revenue (MR) must equal Marginal Cost (MC): MR=MC.
2. Marginal Cost (MC) must be rising (or MC must cut MR from below): This ensures
the f irm continues to produce after the intersection point.
● Diagram Hint: Draw a horizontal MR=AR line. Draw the U-shaped MC curve
intersecting MR at two points. The profit-maximizing point is the second intersection,
where MC is rising. (Above diagram)
4. Shut-Down Point
● The Shut-down Point is the point where a firm is indifferent between producing and
● shutting down. It is the point where the price equals the minimum of the Average
Variable Cost (AVC). P=minAVC (where P is the market price)
● In the short run, the firm will produce only if the market price is greater than or
equal to the minimum AVC, because, at least, it should be able to cover its variable
costs.
5. The Normal Profit and Break-even Point (Refer to the same diagram as above)
• Normal Profit: The minimum level of profit needed to keep a firm in the business. It is
included in the cost of production. i.e the cost of production is equal to the revenue.
• Break-even Point: The point where the firm earns zero economic profit (Normal Profit
only). It occurs when Price (P) equals the minimum of the Average Cost (AC). P1=minAC AC
or ATC(Average Total Cost are the same thing different name.
6. Derivation of the Short-Run Supply Curve of a Firm (Important)
The short-run supply curve of a perfectly competitive firm is the portion of its Marginal Cost
(MC) curve that lies above the minimum point of the Average Variable Cost (AVC) curve.
• Reason: Below the minimum AVC, the firm can't even cover its variable costs, so it will
shut down and supply zero output. Short-Run Supply Curve
Key Terms / Formulas / Relationships
● PC Firm Status: Price Taker.
● Revenue Rule: P=AR=MR (Horizontal).
● Profit Max Rule: MR=MC and MC is rising.
● Shut-down: P=minAVC.
Chapter 5: Market Equilibrium (Weightage: 10 Marks)
Chapter Overview
This chapter brings Demand and Supply together to determine the market price (P∗) and
quantity (Q∗). It also studies government intervention through price controls.
List of Topics & Subtopics
● Market Equilibrium (Fixed Number of Firms)
● Excess Demand and Excess Supply
● Shifts in Demand and Supply
● Price Ceiling (Most Important)
● Price Floor (Most Important)
Concept-wise Notes
1. Market Equilibrium
● Definition: Market Equilibrium: The state where the Quantity Demanded (QD)
equals the Quantity Supplied (QS). The corresponding price is the Equilibrium Price
(Pe) and the quantity is the Equilibrium Quantity (Qe).
● Equilibrium Price (Pe): The price at which QD=QS.
● Equilibrium Quantity (Qe): The quantity at which QD=QS
2. Market Dis-Equilibrium
● Excess Demand: Occurs when the prevailing market price is below the equilibrium
price. At this price, QD>QS. (The price will tend to rise).
● Excess Supply: Occurs when the prevailing market price is above the equilibrium
price. At this price, QS>QD. (The price will tend to fall).
3. Price Ceiling (Maximum Price) (Most Expected 6 Marks)
Both Price Ceiling and Price floor are government-imposed restrictions on the equilibrium
price.
● Definition: Maximum price for a good, set below the equilibrium price. It is fixed by
the government.
● Reason: To protect consumers and ensure necessities are affordable (e.g., essential
drugs, rent control).
● Condition: Price Ceiling is always set below the market equilibrium price
(PCeiling<P).
● Consequence: Creates a Shortage (Excess Demand). The quantity demanded is
greater than the quantity supplied.
● This leads to the government start Rationing by fixing the quantity that should be
sold to a single person. This therefore becomes the reason for the emergence of
Black Marketing where supplies hoard the goods and sell it outside the formal
market at a higher price and greater quantity.
4. Price Floor (Minimum Price) (Most Expected 6 Marks)
● Definition: The minimum price that must be paid to the producers for their goods or
services, fixed by the government.
● Reason: To protect producers (farmers) and ensure a minimum return on investment
(e.g., Minimum Support Price (MSP) for crops).
● Condition: Price Floor is always set above the market equilibrium price (PFloor>P).
● Consequence: Creates a Surplus (Excess Supply). The quantity supplied is greater
than the quantity demanded.
5. Effects of Shifts in Demand and Supply
The equilibrium price and quantity change when there is a shift in either the demand curve
or
the supply curve.
• Note: A simultaneous shift in both curves leads to an ambiguous change in either price
or quantity, depending on the magnitude of the shifts.
Key Terms / Formulas / Relationships
● Equilibrium: QD=QS.
● Ceiling Rule: Pset<P∗⟹ Shortage.
● Floor Rule: Pset>P∗⟹ Surplus.
💡 Final Exam Preparation: 10 Most Expected Questions
Practice drawing and writing answers for these ten questions immediately. They cover the
most repeated and high-weightage topics.
1. Explain the three central problems of an economy. (Ch 1)
2. Explain the difference between Positive and Normative Economics. (Ch 1)
3. Explain the properties of Indifference Curves with a diagram. (Ch 2)
4. Explain the consumer's optimal choice (equilibrium) using Indifference Curve
analysis. (Ch 2)
5. Explain the factors determining the Price Elasticity of Demand. (Ch 2)
6. Explain the Law of Variable Proportions with the help of a diagram and table (three
stages). (Ch 3)
7. Explain the relationship between AC, AVC, and MC with a diagram. (Ch 3)
8. Explain the characteristics/features of a perfectly competitive market. (Ch 4)
9. Explain the consequences of a Price Ceiling with a diagram. (Ch 5)
10.Explain the consequences of a Price Floor with a diagram. (Ch 5)
