COURSE CONTENT

COURSE TITLE: INTRODUCTION TO MICROECONOMICS

CODE: ECO 1101

Introduction to concepts and definitions

 Meaning of microeconomics

 Purpose and principles of Economic theory

 Positive and normative economics

 Scarcity choice and opportunity cost

 Market functions and equilibrium

 Economic systems and economic questions

 Price mechanism and resource allocation

Price theory (Demand and Supply)

 The law of demand

 Change in demand and change in quantity demanded

 Factors that affect market demand

 Market functions and Equilibrium

 Types of Equilibrium

 Price ceiling and price floor

 Consumer surplus and producer surplus

 The law of supply

 Factors that affect market supply

Elasticity

 Meaning of Elasticity

 Types of elasticity and their determinants

 Measurement of elasticity
Theory of consumer behavior
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Cardinal utility Approach

 Assumptions
 Total and marginal utility analysis
 Consumer’s equilibrium
 Derivation of an individual demand curve
 Critiques of the cardinal utility approach
Ordinal utility Approach

 Assumptions
 Properties of indifference curve
 Critique of the indifference curve approach
 Marginal rate of substitution
 Budget line
 Consumer’s equilibrium
 Income consumption curve, price consumption curve and the Angel curve
Theory of Production

 Assumptions
 Basic concepts of the theory
 Shapes of AP and MP curves
 Stages of production
 Production with two variable inputs
 Isoquants – their properties and characteristics
 Marginal rate of technical substitution
 Isocosts and their characteristics
 Production Equilibrium
Theory of Costs

 Meaning of cost function, implicit and explicit costs

 Short run and long-run average cost curve
 Tabulation and derivation of different costs of production

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  Production function and cost curve i.e. total production and marginal production
Market Structures

Perfect Competition

 Factors for classifying markets

 Price and output under perfect competition

 Characteristics of perfect competition

 Price determination

 Short run equilibrium of a firm

 Short run profit and loss

 Long run equilibrium of a firm

 Firm and industry analysis

 Constant, increasing and decreasing cost industries

Monopoly

 Price and operation under pure monopoly

 Basis of monopoly powers

 MR curve and elasticity

 Short run equilibrium

 Regulation of monopoly (price control, lamp sum and per unit taxes)

 Price discrimination
Monopolistic competition

 Understanding monopolistic competition

 Conditions necessary for monopolistic competition to succeed

 Short run and long run equilibrium

 Excess capacity analysis

Oligopoly

 Understanding oligopoly
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  Characteristics of oligopoly

 Equilibrium position

 Kinked demand curve

THE CONCEPT OF MICROECONOMICS

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Definition of Economics: is the science that studies how people choose to use scarce productive
resources to produce various goods and to distribute these goods to various members of society
for their consumption. Now lets’ we look into the field of economics.

Economics still can be defined as the study of how scarce resources are and can be used to
satisfy wants or needs. Scarce resources are such things like raw materials, energy, and labour
that can be used to produce goods and services to satisfy human wants and needs

 That is, Economics tells how a man utilizes his limited resources for the satisfaction of
unlimited wants.
 Man has limited amount of time and money.
 He should spend time and money in such a way that they derive maximum satisfaction.
 A man wants food, clothing and shelter.
 To get these things they must have money.
 For getting money they must make an effort. Effort leads to satisfaction.
Thus, it is called “Queen of Social Sciences”.

Economics attempts to answer the following questions

1. What to produce; is it the consumer durables or non-consumer durables

2. How to produce; it tries to identify those cost minimizing, hence efficient techniques
of production
3. For whom to produce; whether it is for the low income or high income groups, for the
young or the old people.
4. When to produce; society is always faced with the problem of choosing between
producing now for consumption or delaying production and having it later.
5. Where to produce; whether near the sources of raw materials or near the sources of
energy, near transport system or near market.
Solutions to the above questions are answered differently depending on the type of
the economic system; whether capitalist, socialist or mixed economy.

Economics is divided into two major parts; Micro-economics and Macro-economics

Meaning of Microeconomics:microeconomics studies a limited, smaller area of economics,

including the actions of individual consumers and businesses, and the process by which both
make their economic decisions that is, buying, selling, the prices businesses charge for their
goods and services and how much of these goods and services they produce and or offer

Microeconomic study reveals howstart-up businesses have determined the competitively

successful or unsuccessful pricing of their goods and services based on consumer needs and
choices, market competition and other financial and economic formulas.

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Microeconomics also studies supply-demand ratios and its effect on consumer spending and
business decision-making.

Microeconomics still can be defined as the study of individual economic decisions of small
groups and the allocation of these units’ e.g. a consumer, producer, etc.

It is got from a Greek word known as mikros meaning small it is divided into the price theory
and the theory of production.

Macro Economics

Macroeconomics looks at the economy as a whole. It aggregates all the economic agents; the
consumers and producers or business firms. It addresses the four major problems of an economy
which are; economic growth, unemployment, inflation and balance of payment problem.

Still macroeconomics is the study of the whole economic system mainly using general
economic magnitudes. E.g. the total number of people who are employed in a country, national
income, inflation, etc. it deals with aggregates.

It is derived from a Greek word called macros –meaning large.

PURPOSE AND PRINCIPLES OF ECONOMIC THEORY:

The purpose of economic theory is to explain and predict the consequences of human choice in
economizing, that is, where the resources being used are not sufficient to satisfy all possible uses,
so some must be given priority over others.

Economic Theory provides an outlet for research in all areas of economics based on rigorous
theoretical reasoning and on topics in mathematics that are supported by the analysis of
economic problems.

POSITIVE AND NORMATIVE ECONOMICS:two (2) approaches in the study of economics

Normative approach: Economists explain how the world should be or what should have been
the case. It involves moral judgments e.g distributions of income should be equitable. Normative
economics deals heavily in value judgments and theoretical scenarios. It is the opposite of
positive economics.
Positive economic: Positive economics (as opposed to normative economics) is the branch of
economics that concerns the description and explanation of economic phenomena. It focuses on
facts and cause-and-effect behavioral relationships and includes the development and testing of
economics theories. It looks at how the world is and not what it should be. It takes account of the
fact that the world has limited resources and insatiable wants.

So, it is the study of economic conditions which can at least in principle be verified by the
observation of events in the world.
 GDP (C+I+G)
 GNP (C+I+G+X-M)

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GDP (gross domestic product): it is the total value of goods produced and services provided
within a country during one year.
GNP (gross national product): it is the total value of goods produced and services provided by a
country during one year, equal to the gross domestic product plus the net income from foreign
investments.)
C = Consumption, I = Investment, G = Government expenditure, X = Exports, M = Imports

BASIC PRINCIPLES OF ECONOMICS

Basic principles of economics explain fundamental economic problems which include;

1. Scarcity: Scarcity means limited in supply. It indicates that commodities are relatively
less than people desires for them. The available resources do not satisfy all our ends.
Scarce goods are called economic goods whereas those which exist in abundant are called
free goods.
Scarcity is a relative term e.g. Gold is more scarce than Sand.
2. Choice: choice refers to the taking of the right decision. It arises because of scarcity.
Choice is made often looking at the scale of preference where wants are organized in
order of priority.
3. Opportunity cost: this is the alternative foregone when choice is made. It also arises
because of scarcity. E.g. by having a lecture you can forego a video show.

ILLUSTRATION OF OPPORTUNITY COST/PRODUCTION POSSIBILITY

FRONTIER (PPF)
This is a practical representation of the maximum of one good or service that economically can
produce by reducing the production of second good or service and transferring the resources to
the production of the first good.

ASSUMPTIONS OF PPF
 Only two goods X and Y are produced in different proportions in the economy.
 There is full employment of resources
 The supply of F.O.P is fixed but they can be reallocated to the production of the two
goods within limits.
 The production technique is given and constant
 The time period is short.

PPF SCHEDULE

Guts Rice
0 10
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 1 9
2 7
3 4
4 0

Rice T

10A B

PPF curve

9 W D

0 1 2 3 4 G.nuts

By producing at A and E it would be violating the assumption of the two combinations of

commodities. B, C and D are well positioned and can bring maximum outcome because the
resources are fully employed. Point W is not good because it implies resources are not fully
employed or exploited. Point T would be good but it is unattainable because resources are scarce
to enable somebody to produce at T.

THE USES OF PPF CURVE

1. Economic growth
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Capital goods p2

C
P1
S
A

0 P1P2 Consumer goods

The PPF curve shows a shift from P1 to P2, this implies that resources have been
increased and are fully utilized or resources have been discovered.

2. It shows efficiency in the production

The points shown along the PPF curve shows fully utilization of resources. Points shown
inside the PPF curve shows underutilization of resources hence inefficiency and points
beyond the PPF curve shows that resources are not available to produce the commodities.

3. Unemployment aspects

Cloth p2 B

C
P1

A D

0 P1P2Books
Comparing P1,P1 and P2,P2, P1,P1 which is haring point A shows inefficient use of
resources within the economy. BDC on P2P2 curve shows full employment of resources.
Therefore, P1P1 shows the level of unemployment.

4. Technological progress
Basing on the assumptions of given and constant production technique, progress is
indicated by the outward shift of the PPF Curve.

A BIASED SHIFT IN THE PPF CURVE

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 Diagram I Capital goods Diagram II

Capital goods T2

P T1

Consumer goodsConsumer goods

From diagram I, the implication is that, more of consumer goods have been produced than
capital goods (Capital goods are those goods that are used in producing other goods, rather than
being bought by consumer). Resources have been fully employed in the production on the
consumer goods.

From diagram II, resources have been diverted to the production of capital goods than consumer
goods.

MARKET FUNCTIONS AND EQUILIBRIUM:

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EconomicSystems: An economic system refers to the organization of owner shop, allocation
and distribution of resources in the economy.

Or it refers to the mode of production and distribution of goods and services within which an
economic activity takes place. They include capitalist, socialism and mixed economy.

 CAPITALIST

Here an individual as a consumer capacity, producer and resource owner is engaged in an

economic activity with large measures of freedom.

It is also called a free market economy, unplanned economy or a laissez faire economy. (Leave
us alone i.e. no government intervention).

Features of capitalism economy

1. There is private ownership of property (there is freedom to own property).
2. There is profit motive. The decisions of businessmen, farmers, producers, including that
of wage corners based on the profit motive.
3. There is price mechanism. This operates automatically without any direction and control
by the central authorities.
4. The role of the sate in only confined to keep law and order, protection from external
aggression and provision of health and education facilities.
5. Freedom of enterprise ie free choice of acceptation of an entrepreneur, this freedom is
subject to the ability, training, legal restrictions and existing market condition.
6. There is competition. This is the most characteristic of capitalism. It implies large
numbers of sellers and buyers in the market who are motivated by self market decisions
by their individual actions. Societies associated with such economic systems include
USA.
Note: there is no single country in the world which is purely capitalistic in nature except trade,
the highest percentage of the features constitute those of capitalism.

Advantages of capitalism
i. The presence of competition leads to increase in efficiency
ii. Decisions are made quickly because of individual decision making and limited
bureaucracy of the state.
iii. The twin freedoms of consumers and producers lead to the production of quality products
and lowering of costs and prices.
iv. The automatic working of the price mechanism leads to profit maximization hence
welfare of the community.
v. The individual ownership of the property brings improvement in production and
increases productivity.
vi. Since there is limited role of the government, government expenditure is reduced and
directed to productive state ventures e.g. roads, schools, hospitals, etc.

Disadvantages of capitalism

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a) Competition breads a tendency to destroy competition hence leading to monopoly. It is
profit motive under capitalism which leads to cut-throat competition, cartels and other
combinations. This might have an effect of breeding unemployment.
b) The institution of private property creates inequalities of income and wealth.
c) Consumer sovereignty is a myth under capitalism. Customers have to buy only those
commodities which are manufactured and supplied by the producers in the market.
Consumers are not rational buyers because of ignorance in the utility and equality of the
products available.
d) Capitalism cannot achieve a light degree of productivity because of its unplanned nature.
Excessive competition leads to over production leading to commodities failing to get market
hence depression and mass unemployment.
e) The price mechanist under capitalism can fail to employ the country’s resources fully. This
is because of inequalities in income distribution, over production and depression. These lead
to wastage of productive resources.

SOCIALISM ECONOMIC SYSTEM (CENTRALLY PLANNED/COMMAND

ECONOMY)
This refers to all economic systems where the allocation of resources is under the state through a
central planning authority. Or

Socialism is an economic organization of the society in which the internal means of production
are owned by the whole community according to the general economic plan, all members being
entitled to benefit from the results on the basis of equal rights.

Features of Socialism Economic system

1. There is public ownership of property
2. There is central planning authority or board which formulates the plan for the entire
economy.
3. There are definite objectives i.e. socio-economic objectives, these objective may concern
aggregate demand, fully employment, satisfaction of communal development, allocation of
inputs, income (national income), the amount of capital accumulation etc. these objectives
are achieved according to priority.
4. Freedom of consumption, under socialism consumers’ sovereignty implies that production in
state owned industries is generally governed by preferences of consumers and the available
commodities are distributed to the consumers at fixed prices without restrictions.
5. Equality of income distribution is achieved here than in capitalism.
6. Planning and pricing process under socialism does not operate freely but works under the
control and regulations of the central planning authority.
7. The state is therefore the sole producer
8. The state owners and operates the means of production e.g. land, labour, capital and
entrepreneurship.

Advantages of Socialism Economic System

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  There is greater economic efficiency, (means of production are owned by the state)
 There is greater welfare due to less inequality of income
 Absence of monopolistic practices
 Absence of business fluctuations

Disadvantages of Socialism Economic System

 It is full of bureaucracy. (which can delay allocation of resources and decision making)
 There is a complete centralization of economic power in the central planning authority.
The authority fixes the plan objectives, priorities and targets.
 There is no freedom of occupation so, consumers have to buy those goods and services
which are decided to be supplied to them in stipulated quantities and at prices fixed by
the central authority
 There is an impossibility of economic calculation. It is the planning authority which
calculates all the economic activities in the country. So, there can be no competitive
pricing of the means of production.
 Un-utilization of the means of production. This is because the government would want to
embark on priority ones leaving out the rest, this is unfair.
 Consumers can easily be imposed to inferior goods, etc

MIXED ECONOMIES
This refer to economic systems where both private and government/public (state) sectors
participate in taking economic decisions. A mixed economy is comprise between two opposite
economic systems i.e. capitalism and socialism.

Features of a mixed economy

1. Existence the private sector. Individuals are allowed to own some enterprises especially
where small investment capital is required. E.g. colleges, shops etc.
2. Existence of public sector. This is the most important sector of the economy and at the
same time the biggest in which the entire production and distribution is done by the state.
3. There is existence of joint sector. Mixed sector in this economic system especially in
developing countries. The state invests more than 50% while the rest of the amount is
invested by the private sector.
4. There is the co-operative sector. This is the sector based on principles of co-operation
existing in a mixed economy. It is usually to be found in farming, dairying, consuror
purchasing and in small scale manufacturing.
5. Public welfare. A mixed economy is organized for public welfare and rewinding the bad
evil of capitalism. It protect workers from capitalist exploitation, the state passes labor
laws and fixes minimum wages, working hours and provides social security in form of

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 insurance, unemployment insurance, pension, maternity benefits, free education etc. the
aim is also to lessen inequalities between the rich and the poor.
6. Economic freedom and control. The mixed economy enjoys all the freedom of capitalism
e.g. freedom of consumption, freedom of production and freedom of occupation and
freedom to own property but these freedoms cannot be enjoyed absolutely and at the exit
of public welfare.
7. Economic planning. One of the vital features of a mixed economy is economic planning.
It is through planning that the advantages of planned economy are imported to a mixed
economy.
Developing countries like Uganda, Kenya etc have opted to operate along the line of mixed
economies.

Advantages of a mixed economy

1. General balance. This is between the public and private sector because there is a
competition and cooperation between the two sectors to achieve a higher rate of capital
accumulation.
2. Best allocation of resources. Since a mixed economy cooperate the best advantages of
both capitalism and socialism, the resource of the economy are utilized in the best
possible manner.
3. Welfare state. A mixed economy contains all the features of a welfare state. There is no
exploitation either by capitalism as under a free enterprise economy or by the state as
socialist economy.

Disadvantages of a mixed economy

A mixed economy also has certain defects, they include;

1. Inefficient public sector, the public sector in a mixed economy is a bit burdened because
it works inefficiently. i.e. bureaucratic control brings in inefficiency. There is over
staffing of personnel, corruption and nepotism and as a result product falls.
2. Economic fluctuations. There is improper mixture of capitalism and socialism. The
private sector is allowed to operate and loose systems of government regulations and
controls, the public sector does not work under the rigid conditions which are laid down
under a centrally planned economy, if in the market prices of inputs are increasing due
to the shortages the public sector will be equally be experiencing the shortages and price
hence economic fluctuations.

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 3. Narrow cooperation between these two sectors
The private sector is treated like a stapes child because of various restrictions imposed by the
state yet in public sector the government puts in work inputs to resource costs of production.

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EQUILIBRIUM PRICE

This is the price attained when quantity supplied equals to quantity demanded. It is determined
by the interaction of demand and supply curves
When supply and demand are equal (i.e. when the supply function and demand function
intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its
most efficient because the amount of goods being supplied is exactly the same as the amount of
goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the
current economic condition. At the given price, suppliers are selling all the goods that they have
produced and consumers are getting all the goods that they are demanding.
A graph showing determination of prices by the forces of demand and supply

As you can see on the chart, equilibrium occurs at the intersection of the demand and supply
curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P*
and the quantity will be Q*. These figures are referred to as equilibrium price and quantity.

In the real market place equilibrium can only ever be reached in theory, so the prices of goods
and services are constantly changing in relation to fluctuations in demand and supply.

Disequilibrium: Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.

Price legislation
1. Excess Supply /minimum price: This is a price set above the equilibrium price. And it’s
illegal to sell below the equilibrium price. If the price is set too high, excess supply will be
created within the economy and there will be allocative inefficiency.

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At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1,
however, the quantity that the consumers want to consume is at Q1, a quantity much less than
Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed.
The suppliers are trying to produce more goods, which they hope to sell to increase profits, but
those consuming the goods will find the product less attractive and purchase less because the
price is too high.
2. Excess Demand/maximum price: This is a price set below the equilibrium price and its
illegal to sell above that price. Excess demand is created when price is set below the equilibrium
price. Because the price is so low, too many consumers want the good while producers are not
making enough of it.

In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2.
Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus,
there are too few goods being produced to satisfy the wants (demand) of the consumers.

However, as consumers have to compete with one other to buy the good at this price, the demand
will push the price up, making suppliers want to supply more and bringing the price closer to its
equilibrium.

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PRICE MECHANISM AND RESOURCE ALLOCATION:

Price mechanism refers to the system where the forces of demand and supply determine the
prices of commodities and the changes therein. It is the buyers and sellers who actually
determine the price of a commodity.

Price mechanism is the outcome of the free play of market forces of demand and supply.
However, sometimes the government controls the price mechanism to make commodities
affordable for the poor people too.

Price Mechanism is perhaps the most basic feature of the market economy for allocating
resources to various uses. It is the system in a market economy whereby the decisions of
producers determine the supply of commodity and the decisions of buyers determine the demand.
The interaction between the consumers’ demand for a good and the supply of that good by a
producer determine the price.

The price mechanism describes the means by which millions of decisions taken by consumers
and businesses interact to determine the allocation of scarce resources between competing uses

The price mechanism plays three important functionsin a market:

(1) Signaling function
 Prices perform a signaling function – they adjust to demonstrate where resources are
required, and where they are not
 Prices rise and fall to reflect scarcities and surpluses
 If prices are rising because of high demand from consumers, this is a signal to suppliers
to expand production to meet the higher demand
 If there is excess supply in the market the price mechanism will help to eliminate a
surplus of a good by allowing the market price to fall.
(2) Transmission of preferences
 Through their choices consumers send information to producers about the changing
nature of needs and wants
 Higher prices act as an incentive to raise output because the supplier stands to make a
better profit.
 When demand is weaker in a recession then supply contracts as producers cut back on
output.
One of the features of a market economy system is that decision-making is decentralized i.e.
there is no single body responsible for deciding what is to be produced and in what quantities.
This is a remarkable feature of an organic market system.
(3) Rationing function
 Prices serve to ration scarce resources when demand in a market outstrips supply.
 When there is a shortage, the price is bid up – leaving only those with the willingness
and ability to pay to purchase the product. Be it the demand for tickets among England

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 supporters for an Ashes cricket series or the demand for a rare antique, the market price
acts a rationing device to equate demand with supply.
 The popularity of auctions as a means of allocating resources is worth considering as a
means of allocating resources and clearing a market.

Government intervention in the market mechanism

 Often the incentives that consumers and producers have can be changed by government
intervention in markets
 For example a change in relative prices brought about by the introduction of government
subsidies and taxation.
Agents may not always respond to incentives in the manner in which textbook economics
suggests.

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 DEMAND AND SUPPLY

DEMAND
Demand in economics means a desire to possess a good supported by willingness and ability to
pay for it. If you have a desire to buy a certain commodity, say, a tractor, but do not have the
adequate means to pay for it, it will simply be a wish, a desire or a want and not demand.
Demand is an effective desire, i.e., a desire which is backed by willingness and ability to pay for
a commodity in order to obtain it. In other words, "Demand means the various quantities of
goods that would be purchased per unit of time at different prices in a given market.

There are thus three main characteristics of demand in economics.

1. Willingness and ability to pay. Demand is the amount of a commodity for which a
consumer has the willingness and also the ability to buy.
2. Demand is always at a price. If we talk of demand without reference to price, it will be
meaningless. The consumer must know both the price and the commodity. He will then
be able to tell the quantity demanded by him.
3. Demand is always per unit of time. The time may be a day, a week, a month, or a year.

INDIVIDUAL AND MARKET DEMAND FOR A COMMODITY: Demand can either be

Individual demand for a commodity or Market demand for a commodity.
Individual's Demand for a commodity:is the amount of a commodity which the consumer is
willing to purchase at any given price over a specified period of time. The individual's demand
for a commodity varies inversely with price ceteris paribus (all other things being equal).
 As the price of a good rises, other things remaining the same, the quantity demanded
decreases and
 As the price falls, the quantity demanded increases. Price (p) is here an independent
variable and quantity (q) dependent variable.

PD PD
P 500
500
500

D D
D 14 Qtydd
12 Qtydd
10 Qtydd

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The Market Demand for a Commodity: The market demand for a commodity is obtained by
 Adding up the total quantity demanded at various prices by all the individuals over a
specified period of time in the market.
 It is described as the horizontal summation of the individuals‟ demand for a commodity
at various possible prices in market.
 In a market, there are a number of buyers for a commodity at each price.
 In order to avoid a lengthy addition process, we assume here that there are only four
buyers for a commodity who purchase different amounts of the commodity at each price.
The horizontal summation of individuals‟ demand for a commodity will be the market

PD
500

D
36 Qty DD

THE LAW OF DEMAND:

It states that the higher the price, the lower the quality demanded and vice varsa.
Therefore, a normal demand curve slopes down wards from left to right implying that price and
quantity demand change in opposite direction.

There is an inverse relationship between the price of a good and demand.

 As prices fall, we see an expansion of demand.
 If price rises, there will be a contraction of demand.

DEMAND SCHEDULE
This is a table which shows quantity of particular commodity demanded at various prices over a
given period of time.

Price (shs) Quantity demanded (kg)

500 10
1000 8
1500 6

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The Demand Curve

It is a graph that represents quantity demand at various prices over a given time.
Basing on the demand schedule, a demand curve is shown below

A demand curve shows the relationship between the price of an item and the quantity demanded
over a period of time. There are two reasons why more is demanded as price falls:

The Income Effect: There is an income effect when the price of a good falls because the
consumer can maintain the same consumption for less expenditure.  Provided that the good is
normal, some of the resulting increase in real income is used to buy more of this product. 

The Substitution Effect: There is a substitution effect when the price of a good falls because the
product is now relatively cheaper than an alternative item and some consumers switch their
spending from the alternative good or service.

 As price falls, a person switches away from rival products towards the product
 As price falls, a person’s willingness and ability to buy the product increases
 As price falls, a person’s opportunity cost of purchasing the product falls
 Note: Many demand curves are drawn as straight lines to make the diagrams easier to
interpret.

Tastes and preferences:a preference for a particular good may affect the consumers’ choice and
he / she may continue to demand the same even in rising prices scenario

CHANGE IN QTY DEMANDED AND CHANGE IN DEMAND

A change in qty demanded refers to an increase or a decrease in qty demand of a commodity due
to a change in price while other factors which affect demand remain constant.

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 This is shown by the movement along the same demand curve either upwards or down wards.

D
ses
Price
P2

ses
P1

D
Q2 Q1 Qty

A change in demand is an increase or decrease qty demand of a commodity at a constant price

due to other factors which influence demand.

D
D1
D3
Price
P1

D
D1
D2
Q2 Q1 Q2 Qty

REASONS WHYA DEMAND CURVE SLOPES DOWN WARDS FROM LEFT TO

RIGHT.

Price effect. An increase in price of a commodity reduces its demand but a fall in its price
increases qty demand hence consumers tend to buy more of the commodity because its price is
low.

The law of diminishing marginal utility

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According to this low of diminishing marginal utility as more and more units of a commodity are
consumed, additional satisfaction derived from each additional unit consumed diminishes.
Therefore, when marginal utility is high, price is high and the consumer buys less of the
commodity.
When marginal utility falls, price reduces and the consumer buys more of the commodity.

Income effect
It refers to a change in qty demand resulting from a change in real income due to change in price
of a commodity. When the price of a commodity falls, the real income of a consumer falls i.eThe
consumer becomes a little bit richer because he can buy a lot of a commodity at a lower price.
Real income refers to the purchasing power of money income ie the amount of a commodity a
consumer can buy using his total money income.

Substitution effect
It is the change in qty demanded resulting from a changing price of another commodity. If the
price of a commodity increases, consumers lend to buy cheaper substitutes. Therefore, more of a
commodity is demand at a lower price than at a higher price e.g when the price of Colgate falls
while the price of close-up remain relatively high , more of Colgate is demand.

Income distribution
When income is evenly distributed in a given society, demand will always be high but if income
is concentrated in the hands of the few, demand will be low.

Size of the population

The higher the size of the population, the higher the demand and the reverse is true other factors
remaining constant.

Fashion
Commodities which are considered to be fashionable have a higher demand than those that are
unfashionable

Different uses of a certain commodity

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When the price of a commodity with many uses increases, its demand reduces and it is used for
only important purposes. When price falls, demand increases because consumers can now use a
such good for luxurious purposes eg. When electricity charges increases, consumers only use it
for lighting and when charges fall, it can them be used for other purposes like ironing, cooking.

Tastes and preferences.

Consumers will demand more goods which are in time with their tastes. Subsequently, those
goods whose tastes don’t favour the consumer will have less demand.

Taxation
The higher the level of taxes, the lower the demand and the reverse is true. Taxation lend to high
the prices.

Speculation
When a consumer expects unfavourable condition affecting the price in future, he will demand
more of that commodity presently, and if he expects favourable conditions in future, he will buy
less of the commodity other factors remaining constant.

Quality of the commodity

A good of a high quality has got a relatively high demand, while a good with poor quality has got
every low demand.

Advertisement
Favorable persuasive advertising increases demand but a dull advertising has less effect on
demand.

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Consumer surplus
It refers to the difference between what a consumer willing to pay and what he actually pays for
a commodity e.g. A student goes to the market to buy a trouser at 2500= but on reaching there ,
he buys it at 2300=, then the difference is 200= is the consumer surplus.

Consumer surplus =planned expenditure = actual expenditure

P2
Consumer surplus

P1 A

DD
Q1 Qtydd

A consumer is willing to pay price OP 2 for qty or Q1 but actuary pays OP1 for the same quantity.
Therefore, his total exp. Is OP1, AQ1 and his total utility is OP2, AQ1. This means that the shaded
area P1 P2 A is the consumer surplus.

This means that;

Consumer surplus =Planned expenditure –Actual expenditure

Or total utility– Marginal utility

i.e OP2 AQ1-OP1 AQ1
Study the table below of price and quantity
Price Qty
300 1
250 2
200 3
150 4
100 5
50 6

Using shs 150 as the market fixed price, find the consumers surplus.

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Solution
Consumer surplus = ∑ (PE-AE)
300-150=150
250-150=100
200-150=50
150-150=0
100-150=-50
50-150=-100
∑PE=150/=

Method 2
Total price -(mrktpxq)
=(300+250+150+100+50)-(150x6)
=1050-900
150/=
Producers’ surplus
It refers to the difference between what a producer is willing to get from a given amount of
commodity produced and what he actually gets after production.

This is shown or illustrated as;

Surplus curve =MC
Price

P0 E

DD
0
Q0 Qtydd

Surplus curve

A producer has to be paid a minimum amount shown by the area below MC curve
Since he receives OPo, EQ0, when OQ0 is sold at OP0, then the area between the marginal cost
curve price PO is the producers surplus (shaded area).

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SUPPLY
Meaning of supply:It is the amount of a commodity that sellers are able and willing to offer for
sale at different prices per unit of time. In the words of Meyer “Supply is a schedule of the
amount of a good that would be offered for sale at all possible prices at any period of time; e.g., a
day, a week, and so on”.

Supply schedule
It is a table which shows qty supplied at various prices in a given period of time
We assume that the qty supplied depends on price

Price Qty supplied

500 5
1000 10
1500 15
2000 20

SUPPLY CURVE
It is a graph which represents the supply schedule and shows qty supplied to the market at
various prices in a given time.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation
between quantities supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and
the price will be P2, and so on.

Law of Supply
It states that the higher the price the higher the qty supplied and the lower the price, the lower the
quantity supplied.

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Like the law of demand, the law of supply demonstrates the quantities that will be sold at a
certain price. But unlike the law of demand, the supply relationship shows an upward slope. This
means that the higher the price, the higher the quantity supplied. Producers supply more at a
higher price because selling a higher quantity at higher price increases revenue.
Determinants of supply
Quantity supplied of a good/ service is affected by various factors. Several key factors affecting
supply are discussed as below:
 Price of the product: Since the producer always aims for maximizing his returns/profit, so
the quantity supplied changes with increase or decrease in the price of the good.
 Technological changes: Advanced technology can yield more quantity and at lesser costs.
This may result in the producer to be willing to supply more quantity of the goods.
 Resource supplies and production costs: Changes in production costs like wage costs, raw
material cost and energy costs might impact the producers‟ production and eventually the
supply. An increase in such cost might result in lesser quantities produced and thus lesser
quantities supplied and vice versa.
 Tax or subsidy: Since the producer aims to minimize costs and expand profit, an increase
in tax will increase the total cost, thereby decreasing the supply. Similarly a subsidy
might incentivize the producer to supply more of those goods in order to maximize his
profits. Tax and subsidy are two important tools used by central government to control
supplies of certain goods. For example an increase in tax can be used to reduce the supply
of cigarettes, while increase in subsidy can be used to increase the supply of fertilizers.
 Expectations of prices in future: An expectation that the prices of goods will fall in future
might lead to lessen the production by the producer and thereby decrease the supply and
vice-versa.
 Price of other goods: A producer might have several options to produce. Since the money
to invest is limited with the producer he would decide to produce the good which offers
him the maximum profit. Thus if the producer is currently producing good A and the
price of good B increases than he might switch to producing good B as this would result
in better returns for him.
 Number of producers in the market: This is a very important factor or determinant of
supply. If there is large number of producers or sellers in the market willing to sell goods
then the supply of good will increase and vice versa.

 Demand. A high demand for a commodity encourages more production and this
increases supply but low demand reduces supply.

 Availability of inputs. Increased availability of input increases supply but scarcity of

inputs decreases supply

 Objective of a firm. A firm that aims at maximizing sales leads to an increase in supply
and whereas a firm that aims at maximizing profits , supply is low.

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  Natural factors. Favourable natural factors increase supply while unfavourable natural
factors reduce supply. This mainly affects agricultural products which depends on nature.

 Gestation period (maturity period). A short gestation period increases supply but along
gestation period reduce supply.

 Government policy. Favourable government policy e.g low taxation, tax holiday,
subcidisation increase supply but unfavourable government policy e.g high taxation
reduces supply.

 Better conditions of work like free medical supply while poor conditions of work tend
to reduce supply.

 Political instability in some parts. The places which are political secure, production will
be high which will increase supply while places which are political insecure production
will tend to be low hence reducing supply.

 Degree of freedom of entry of firms. Free entry of firms leads to an increase in supply
e.g. in case reduces supply e.g.incase of monopoly.

CHANGE IN QTY SUPPLIED AND CHANGE IN SUPPLY (shifts vs movement)

A change in qty supplied refers to an increase or decrease in qty supplied due to a change in
price of a commodity other factors which influence supply remains constant.
1.Movements: A movement refers to a change along a curve .Like a movement along the
demand curve, a movement along the supply curve means that the supply relationship remains
consistent. Therefore, a movement along the supply curve will occur when the price of the good
changes and the quantity supplied changes in accordance to the original supply relationship. In
other words, a movement occurs when a change in quantity supplied is caused only by a change
in price, and vice versa.

Change in supply refers to a decrease or increase in qty supplied at a constant price

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In this case, the supply curve shifts to the right or left due to other factors which influence supply
apart from price.
2. Shifts: A shift in a supply curve occurs when a good's supplied changes even though price
remains the same.
Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1
to Q2, then there would be a shift in the supply of beer. Like a shift in the demand curve, a shift
in the supply curve implies that the original supply curve has changed, meaning that the quantity
supplied is affected by a factor other than price. A shift in the supply curve would occur if, for
instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced
to supply less beer for the same price.

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ELASTICITY

Meaning of Elasticity: The degree to which a demand or supply curve reacts to a change in
price is the curve's elasticity. Elasticity varies among products because some products may be
more essential to the consumer. Products that are necessities are more insensitive to price
changes because consumers would continue buying these products despite price increases.
Conversely, a price increase of a good or service that is considered less of a necessity will deter
more consumers because the opportunity cost of buying the product will become too high.

A good or service is considered to be highly elastic if a slight change in price leads to a sharp
change in the quantity demanded or supplied. Usually these kinds of products are readily
available in the market and a person may not necessarily need them in his or her daily life. On
the other hand, an inelastic good or service is one in which changes in price witness only modest
changes in the quantity demanded or supplied, if any at all. These goods tend to be things that are
more of a necessity to the consumer in his or her daily life.

ELASTICITY OF DEMAND
It refers to the degree of responsiveness of qty demanded of a commodity due to change in any
of the factors which influence demand eg price, income of the consumer , price of other goods
etc.
Elasticity of demand is therefore categorized into;
 Price elasticity of demand
 Income elasticity of demand
 Cross elasticity of demand
(1) Price Elasticity of Demand: The concept of price elasticity of demand is commonly used in
economic literature. Price elasticity of demand is the degree of responsiveness of quantity
demanded of a good to a change in its price.

Precisely, it is defined as: The ratio of proportionate change in the quantity demanded of a good
caused by a given proportionate change in price.

Formula: The formula for measuring price elasticity of demand is:

Price Elasticity of Demand = Percentage in Quantity Demand
                                       Percentage Change in Price
 
                                                         Ed = Δq X P
                                                               Δp    Q

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Example
Given that the price of a commodity falls from shs2000 to 1000 resulting in an increase in qty
demanded from 60kg -80kg calculate price elasticity of demand.

Price elasticity of demand = -∆Q x P

∆P Q
∆P = P1-P0 = 1000-2000 = -1000
∆Q =Q1-Q0 = 80-60=20
∆P = -1000
∆Q=20

PED = -20 x 2000

-1000 60

= -2 x2 = +4
-6 +6

=2/3
INTERPRETATION OF PRICE ELASTICITY
Perfectly inelastic demand
This is where price elasticity of demand is zero. It means a given percentage change in price
doesn’t change qty demanded.

Price D
P3

P2

P1

Q1 Qtyddd

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Inelastic demand
This is where price elasticity of demand is less than one but greater than zero
O<PED<1
When the percent change in quantity of a good demanded is less than the percentage change in
its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a
fall in price decreases total revenue and a rise in its price increases total revenue.
This means, a bigger percentage ∆ in price causes a smaller percentage ∆ in quantity demanded
as it is illustrated below
D

Price

P3

P1

D
Q3 Q1 Qtyddd

Unitary elastic demand

This is where price elasticity of demand is one (1) .
When the percentage change in the quantity of a good demanded equals percentage in its price
the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is
equal to one or unitary, a rise or fall in price leaves total revenue unchanged.
It means a given percentage ∆ in price causes equal percentage ∆ in quantity demanded.

Price

P3

P1

D
Q3 Q1 Qtyddd

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Elastic demand
Price elasticity of demand is greater than one and less than infinity.
When the percent change in quantity of a good is greater than the percent change in its price, the
demand is said to be elastic. When elasticity of demand is greater than one, a fall in price
increases the total revenue (expenditure) and a rise in price lowers the total revenue
(expenditure).
It means a small percentage ∆ in price causes a bigger percentage ∆ in quantity demanded.
1<PED<∞ D

Price

P3

P1

Q3 Q1 Qtyddd
Perfectly elastic demand
This is where price elasticity of demand is equal to infinity. It means that at a given constant
price any qty is demanded.

Price

P DD

Q1 Q2 Q3
Qtyddd
Question .
Supposing that the price of commodity y falls from 1000 to 800 and qty demanded increases
from 5kg-8kg.
(i). Calculate price elasticity of demand for commodity y
(ii). What type of elasticity of demand does it have
(iii). Give reasons for your answer.

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(i). PED=-∆Q x P
∆P Q
∆P=100-800=200=
∆Q=5-8 =3kg
PED=- 300x1000
-200 5
=+30
+10
=3

(ii). Elasticity demand

(iii). It is greater than 1 but less than infinity.

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

Degree of necessity
Necessities have inelastic demand but luxiary goods have elastic demand e.g consumers may
hardly respond to an increase in price of salt but neglect aluxiary good like blue band , jarm etc.

Availability of substitutes
Goods which have many substitutes have elastic demand and goods without substitutes have
inelastic demand e.g if the price of colgateincreases , consumers cut down its demand by bigger
percentage.

Consumers level of income

Consumers with low level of income have elastic demand and those with high level of income i.e
the rich have in elastic demand egevenif price increases , rich consumers still buy more of the
commodity but the poor try to look for cheaper substitutes.
Degree of habbit in using a commodity
Consumers with high degree of habbit in using a commodity tend to have inelastic demand eg
hard core smokers cant greatly cut down smoking evenif price for tobacco increases.
Consumers with low degree of habbit have elastic demand .if the price increase the poor people
will shift to cheap substitute

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Nature of the good
Durable goods have elastic demand eg bicycles. This is because they canot be replaced until they
were out while perishable goods have inelastic demand e.g fish
Degree of complementality
Goods which arenot used together have elastic demand but goods which are used together have
inelastic demand eg as long as people continue using cars , the demand for petrol remains
inelastic
Convenience of having a good. A good that is easy to get has inelastic demand but a good
which is difficult to get has elastic demand
No of uses of a good
Demand is elastic for a good with many uses eg electricity but it is unelastic for a good with
limited uses.
Proportion of income spent on a particular good
A good that takes a large propotion f income lends to have elastic demand but goods that take a
small proportion of consumers income has inelastic demand eg a match box
Degree for which the use of a good can be post ponned
Demand for a good which use can be post ponned tend to be elastic while a good with an
immediate use has inelastic demand.
Time factor
Demand for a good is inelastic if the consumer takes a short time to buy it but elastic if the
consumer takes a long time.

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IMPORTANCE OF PRICE ELASTICITY OF DEMAND
To the producer
It helps the producer in fixing prices and determining revenue.

If his products has elastic demand, the producer earns more revenue by reducing the price as
shown below;

Price

P2 A

P1 B

0 Q2 Q1 Qtyddd

A decrease in price from P2 to p1 increases total revenue from Op2 AQ2 –OP1 BQ1
If the product has inelastic demand , the producer gets a small revenue by increasing the price

Price

P2 B

P1 A

D
0 Q2 Q1 Qtyddd

An increase in price from p1 –p2 increases total revenue from OP1 AQ1-OP2 BQ2
For unitary elastic demand, the producer should maintain the existing price. This is because total
revenue doesn’t change even if price increases or decreases.

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It helps a discriminating monopolist where giving prices for his commodity in different market.
He charges a lower price in the market where demand is elastic and higher price in market where
demand is inelastic.

It helps the producer in determining wages. Higher wages. Are paid to labour which produces
goods with inelastic demand. A low wage is paid to labour which produces goods with elastic
demand.

It is useful to the producer in determining how much to supply to the market

He supplies less if demand for his product is inelastic but supplies more if the product had elastic
demand.

It helps the producer in determining incidence of the tax ie how much of the tax he is to share
with the consumer.
If demand is inelastic, the producer pays less tax than the consumer who is charged highly and
where demand is elastic , the producer pays more of a tax.

To the government
It helps the government in taxation policy. The government gets high revenue by taxing highly,
commodities with inelastic demand and tax less commodities with elastic demand.

It helps the government in determining wages for labour. Higher wages are paid for labour that
has inelastic demand and low wages for labour with elastic demand.

It is useful to the government when nationalizing industries. The state should take over industries
which produce goods with inelastic demand to be treated as public utilities.

It helps the government in determining the incidence of the tax ie how much of the tax is to be
paid by the producer and the consumer.

The consumer pays more of a tax if the product has inelastic demand and the producer pays more
of a tax if demand is elastic.
For unitary elastic, a tax is shared equally between the consumer and a producer.

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It guides the government when giving subsides to un industries. Only industries whose product
have elastic demand are given a subcidy.
This reduces the cost of production, increases supply, reduces prices leading to higher demand.
It helps the government in devaluation policy devaluation succeeds where demand for exports
and imports is elastic.
Devaluation refers to legal lowering of the exchange value of a country’s currency in relation to
other currencies.

To the consumer
It helps the consumer in planning for expenditure. If demand is elastic, a fall in price increase
consumers expenditure but an increase in price reduces expenditure.

It helps in determining how much of a tax the consumer pays. A lower tax is paid if demand is
elastic and a higher tax is paid if demand is inelastic.

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(2) Income Elasticity of Demand: Income is an important variable affecting the demand for a
good. When there is a change in the level of income of a consumer, there is a change in the
quantity demanded of a good, other factors remaining the same. The degree of change or
responsiveness of quantity demanded of a good to a change in the income of a consumer is called
income elasticity of demand.

Income elasticity of demand can be defined as: The ratio of percentage change in the quantity of
a good purchased, per unit of time to a percentage change in the income of a consumer".

Formula: The formula for measuring the income elasticity of demand is the percentage change
in demand for a good divided by the percentage change in income. Putting this in symbol gives.
                             
Ey = Percentage Change in Demand
       Percentage Change in Income
 
Simplified formula:
 
Ey= Δq X P
        Δp    Q
 
Example: A simple example will show how income elasticity of demand can be calculated. Let
us assume that the income of a person is $4000 per month and he purchases six CD's per month.
Let us assume that the monthly income of the consumer increase to $6000 and the quantity
demanded of CD's per month rises to eight. The elasticity of demand for CD's will be calculated
as under:
Δq  =  8 - 6 = 2                                   
Δp = $6000 - $4000 = $2000
Original quantity demanded = 6
Original income = $4000
Ey = Δq / Δp x P / Q = 2 / 200 x 4000 / 6 = 0.66
 
The income elasticity is 0.66 which is less than one.

If income elasticity of demand is positive, it means a normal good ie demand of such good
increases as income of consumer increases.

If income elasticity of demand is negative, it means an inferior good ieqty of a such good falls as
income of a consumer increases

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If income elasticity of demand is zero, it means that good is necessity eg salt ie an increase in
income doesn’t change qty demanded.

QUESTION
Study the table below and answer the questions which follow.

Income shs qtyddd of X (kg)

10,000 50
3000 20
(a). Calculate income elasticity of dd for good x
(b). what type of a good is X
(c). Give reasons for your answer
IED = ∆Q xy
∆y Q
= 30 X 10000
7000 50
= 6/7
=0.86

(b). A normal good

(c). Income elasticity of demand is a positive

 Quantity demanded of such good increases as income of a consumer increases.

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 Necessity

Income

Normal good

Inferior good

qty

(3) Cross Elasticity of Demand: The concept of cross elasticity of demand is used for
measuring the responsiveness of quantity demanded of a good to changes in the price of related
goods.

Cross elasticity of demand is defined as: The percentage change in the demand of one good as a
result of the percentage change in the price of another good".

Formula:The formula for measuring, cross, elasticity of demand is:

 
Exy = % Change in Quantity Demanded of Good X
          % Change in Price of Good Y
       
    Cross elasticity of demand = ∆Qx x Py
∆PyQx

    
The numerical value of cross elasticity depends on whether the two goods in question are
substitutes, complements or unrelated.
 

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Types:
(i) Substitute Goods. When two goods are substitute of each other, such as coke and Pepsi, an
increase in the price of one good will lead to an increase in demand for the other good. The
numerical value of goods is positive.
 
For example: there are two goods Coke and Pepsi which are close substitutes. If there is
increase in the price of Pepsi called good y by 10% and it increases the demand for Coke called
good X by 5%, the cross elasticity of demand would be:
Exy= %Δqx / %Δpy =  0.2

Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.

(ii) Complementary Goods. However, in case of complementary goods such as car and petrol,
cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the
demand for the balls (say by 6%). The cross elasticity of demand which are complementary to
each other is, therefore, 6% / 7% = 0.85 (negative).
(iii) Unrelated Goods. The two goods which are unrelated to each other, say apples and pens, if
the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of
pens. The elasticity is zero of unrelated goods.
Note:
i If CED is a negative, the goods are complements this means that, an increase in price of one
good reduces demand for another good and vice versa.
(ii). If CED is positive, goods are substitutes .ie an increase in price of one good increases
demand for another good and vice varsa.
(iii). If CED is zero, then goods are not related at all (independent)
If the price of commodity H increases from 1000 to 1100 and as a result, demand for commodity
K increases from 150kg -195kg.
Calculate C.E.D from commodity K
What type of commodities are KH
Give reasons for your answer.

C.E.D =∆QH X PK
∆PK QH
= 45X 100
100 150
=3

(b), Substitutes

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(c). C.E.D is positive

ELASTICITY OF SUPPLY
It refers to the degree of responsiveness of quantity supplied of a commodity due to changes in
any of the factor that influence supply.

Price elasticity of supply

This refers to the degree of responsiveness of quantity supplied due to a change in price of a
commodity.
Price elasticity of supply
= ∆Qs X Qs
∆P P

Example
Supposing the price of commodity X increases from 8000 to 12000 shs per kg leading to an
increase in supply from 2000kg -5000kg . Calculate PED
PED =∆Qs XQs
∆P P
=3000 X 2000
4000 8000
PES =3/16
PES=0.1875

INTERPRETATION OF PRICE ELASTICITY OF SUPPLY.

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Perfectly inelastic supply
This is where PES is equal to zero .It means that a given percentage in price doesn’t change qty
supplied e.g. supply of agricultural products.

SS
Price

P2
Fixed land
Consumer benefit
P1

0
Q1 Qtyss

Inelastic supply
Inelastic supply is greater than zero but less than one. This means that a bigger percentage
change in price causes a smaller percentage in quantity ssed.
S

Price
P2

P1

0S
Q1 Q2 Qtyss

Unitary elastic supply

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PES is equal to one. This implies that a given percentage in price causes equal percentage change
in quantity supplied

Price S

P2

P1

0S
Q1 Q2 Qtyss

Elastic supply
This is where PES is greater than one but less than infinity 1<PES<∞
It means that, a small percentage in price causes a bigger percentage change in quantity supplied.

Price

P2

P1

0S
Q1 Q2 Qtyssd

Perfectly elastic supply

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This is where PES is equal to infinity PES=∞
It means that at any given constant price , any qty is supplied

Price

P1 SS

Consumer benefit

0
Q1 Q2 Q3 Qtyssd

DETERMINANTS OF PES
Cost of production
High costs of production leads to inelastic supply while a low costs of production lead to elastic
supply.

Nature of the good

Durable goods have elastic supply. This is because they can be stored for a long time to be
supplied as price increases while perishable goods have inelastic supply.

Method of production (technology)

Goods which are produced by simple methods of production have elastic supply and goods
which need complicated method of production have inelastic supply.

Gestation period
Supply of goods with along gestation have inelastic supply e.g. agricultural products but goods
with short gestation period have elastic supply e.g. mfd goods.

No. of producers

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A good which is supplied by few producers tend to have inelastic supply while a good with many
producers had elastic supply.

Availability of factors of production

Scarcity of production factors leads to inelastic supply while increased availability of factors of
production leads elastic supply.

Degree of entry of new firms into an industry.

Restricted entry tend to make supply inelastic while free entry makes supply elastic.

Government policy
Supply of good whose production is encouraged by the government tend to be elastic but poor
government support leads to inelastic supply.

Availability of excess capacity

Supply is elastic for a firm that is producing at excess capacity but inelastic for a firm that is
producing full capacity.

Time
Supply is elastic in the long run because all factors of production can be changed but inelastic in
a short run where it is not possible to change all factors of production.

Price expectation
Supply is inelastic where prices are expected to rise or fall eg industries may not quickly increase
supply for a good until they are sure that the increase is permanent

IMPORTANCE OF PRICE ELASTICITY OF SUPPLY

 It helps in taxation policy. The government gets more revenue by taxing commodity with
inelastic supply.

 It helps in explaining price fluctuations of agricultural products. Prices tend to increase if

supply is inelastic and fall if supply is elastic.

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 It helps the producers in estimating price and revenue. He gets more revenue if he sells
goods with inelastic supply at a higher price.

 It is useful to the government in devaluation policy. Devaluation succeeds in solving BOP

problems where the supply of exports and imports is elastic.

 It is useful in determining wages for labour. Higher wages are payed to labour with inelastic
supply compared to elastic supply.

 It helps in determining the incidence of a tax. The producer bears a greater tax budden than
a consumer if a commodity has inelastic supply.
 It helps the government in determining the type of goods to export and earn more foreign
exchange.
 More foreign exchange is earned from products with elastic supply.
 It helps in minimum price registration aimed at increasing supply. This increases output if
the good has elastic supply.

THEORY OF CONSUMER BEHAVIOR

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A consumer is any person who uses goods and services to get satisfaction. He’s the final user of
a good or service. The satisfaction he gets is measured in imaginary units called utils and the
satisfaction got is known as utility which must be understood in the different ways.

The theory of consumer behavior describes how consumers buy different goods and services.
Furthermore, consumer behavior also explains how a consumer allocates its income in relation to
the purchase of different commodities and how price affects his or her decision.

CARDINAL UTILITY APPROACH

 ASSUMPTIONS:
Utility refers specifically to the consumer’s feeling of satisfaction, not the product’s usefulness.

The marginal analysis, also known as neo - classical utility theory, is the oldest (traditional)
theory of demand (consumer behavior). It not only provides an explanation for the consumer's
demand for a commodity, but also derives law of demand from it. This theory of consumer
behavior makes use of the concept of utility.
Utility theorists assume that consumers have full information and can make rational decisions
about which products will grant them the most utility. It is necessary to assume complete
information on behalf of the consumer to demonstrate that markets serve the consumer (not just
the producer). 
Another assumption of utility theory is that consumers are both self-interested and rational.
Consumers rationally make choices that move them toward their highest level of satisfaction. It
is also assumed that they have taste and preferences that are stable and innate
ASSUMPTIONS OF CARDINAL UTILITY ANALYSIS:
The main assumption or premises on which the cardinal utility analysis rests are as under.
1. Rationality. The consumer is rational. He seeks to maximize satisfaction from the
limited income which is at his disposal.
2. Utility is cardinally measurable. The utility can be measured in cardinal numbers such
as 1, 3, 10, 15, etc. The utility is expressed in imaginary cardinal numbers tells us a great
deal about the preference of the consumer for a good.
3. Marginal utility of money remains constant. Another important premise of cardinal
utility of money spent on the purchase of a good or service should remain constant.
4. Diminishing marginal utility. It is also assumed that the marginal utility obtained from
the consumption of a good diminishes continuously as its consumption is increased.
5. Independent utilities. According to the Cardinalist school, the utility which is derived
from the consumption of a good is a function of the quantity of that good alone. If does
not depend at all upon the quantity consumed of other goods. The goods, we can say,
possess independent utilities and are additive.
6. Introspection method. The Cardinalist school assumes that the behavior of marginal
utility in the mind of another person can be judged with the help of self observation. For
example, I know that as I purchase more and more of a good, the less utility I derived
from the additional units of it. By applying the same principle, I can read other people

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 mind and say with confidence that marginal utility of a good diminishes as they have
more units of it.

 TOTAL AND MARGINAL UTILITY ANALYSIS:

Utility refers to the amount of satisfaction derived from consuming the given commodity at a
particular time.
Utility is measured in units called utils .
The concept of utility helps to explain consumer behavior i.e manner in which the consumer
responds to changes in the market. e.gprice , change in fashion etc.
Total utility is the total satisfaction a consumer derives from the consumption of a given
commodity in a given unit of time. As a consumer consumes more units of a commodity, total
utility increases up to a certain point beyond which the total utility starts declining. That point is
called the point of satiety.

Marginal utility is technically referred to as the additional satisfaction a consumer derives from
the consumption of an additional unit of a commodity.

Change in total utility

Change in qty demanded

∆Tu = dTu
∆Q dQ
A relationship between total utility and marginal utility can be explained by the help of the
scheduled and the graph.

Units of a commodity Total utility Marginal utility(∆Tu)

∆Q
1 6 6
2 9 3
3 11 2
4 12 1
5 12 0
6 10 -2
7 7 -3

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Disutility is refers to the dissatisfaction delivered from the consumption of the commodity. It is
sometimes referred to as negative utility arising from consumers taking of more units of a
commodity.

Utility principal is referred to as a cardinal approach to understanding consumer behavior. This

approach tries to give the relationship between total utility, marginal and disutility.

From the above table, when the consumer reach it total satisfaction (0), the consumer start
having dissatisfaction in any additional commodity until the consumer gets to zero.

 CONSUMER EQUILIBRIUM THROUGH UTILITY:

A consumer is one who buys goods and services for his/her personal satisfaction. In theoretical
terms, consumer’s equilibrium is achieved at a point when he/she reaches to the maximum level
of his/her satisfaction, given resources and other conditions. On the other hand, in technical
terms, a consumer reaches his maximum satisfaction level when the last unit of money spent on
each good yield’s the same utility.
It can be seen from above curves that when total utility is increasing, marginal utility is
decreasing and price is increasing.

When total utility reaches maximum ie at the 5 th unit, marginal utility is zero. This is called
appoint of satiety (circulation point /bliss pt). Bliss pt is the pt where total utility received by the
consumer is maximum and marginal utility is zero.

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When total utility starts falling, marginal utility becomes –ve . This means change in utility or
negative utility.

The term disutility means satisfaction lost by a consumer after consuming much of the
commodity. It is shown by the falling portion of the total utility curve and the –ve portion of
marginal utility curve.

RELATIONSHIP BETWEEN TOTAL UTILITY, MARGINAL UTILITY AND PRICE

OF A COMMODITY

Total utility
Total utility

Unity of
a commodity

D
MU1 P1
Marginal utility

MU2 P2
D

Q1 Q2Unity of a commodity
Marginal utility curve

It can be seen from above that when total utility is increasing, marginal utility is decreasing and
price is decreasing.

When total utility is maximum, marginal utility is zero and are is no price.

When total utility is decreasing, marginal utility become negative hence no price.

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The law of diminishing marginal utility
It states that, as more and more units of a commodity are consumed, additional satisfaction
derived from each additional unit consumed diminishes.

It should be noted that, marginal utility curve is related to the demand curve and they both more
downward from left to right.

Therefore, marginal utility is related to the price of the commodity because as marginal utility
diminishes by consuming extra units of the commodity, the consumer will be prepared to pay a
lower price.

ASSUMPTIONS / LIMITATIONS OF THE LAW OF DIMINISHING MARGINAL

UTILITY
Uniform units of a single commodityi.e all units should be of the same weight and quality other
wise the law doesn’t apply.

Continueity in consumptioni.e no break in the commodity consumption e.g pieces of bread

taken at random may increase utility.

No change in income and tastes of the consumer. A change in any of them will increase utility
instead of reducing it.

Constant prices should be ensured. This enables the consumer to maximize utility.

The commodity should be divisiblei.e divided into smaller units otherwise the law doesn’t
apply for durable consumer goods like TV.

Goods should be of ordinallytype . If they are commodities or diamond, the low doesn’t apply.

Unity of a commodity should be of a suitable sizeeg giving H2O to athursty person with
spoons will increase marginal utility

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IMPORTANCE OF THE LAW OF DIMINISHING MARGINAL UTILITY
 It helps to explain the law of demand
 It helps to explain progressive taxation ie as income of a person increase, the rate of the tax
increases because marginal utility of money doesn’t reduce.
 It helps to explain the relationship between marginal utility and the demand curve.
 It helps to explain the diamond water paradox. Due to its relative scarcity , diamond has a
high marginal utility hence high price
 Since H2O is relatively abundant, it has a low marginal utility hence low price.

 CONSUMER EQUILIBRIUM THROUGH UTILITY:

A consumer is one who buys goods and services for his/her personal satisfaction. In theoretical
terms, consumer’s equilibrium is achieved at a point when he/she reaches to the maximum level
of his/her satisfaction, given resources and other conditions. On the other hand, in technical
terms, a consumer reaches his maximum satisfaction level when the last unit of money spent on
each good yield’s the same utility.

Let us take an example of one good to explain how a consumer reaches equilibrium.

Suppose a consumer consumes only one good X with a given income. He has two options either
to spend income to purchase good X or retain it in the form of an asset. If the MU of good X
(MUx) is greater than MU of money (MUm), the consumer would purchase the good.

Therefore, the consumer would spend his income on good X as long as utility of a good is
greater than the price of a good, which implies MUx>Px (MUm). Here, the assumption is that
MU of a good diminishes as more and more unit of the good is consumed and MU of money
remains constant that is MUm=1.

Thus, consumer reaches equilibrium when:

MUx = Px(MUm) Or Mux/Px (MUm) = 1

The consumer’s equilibrium is shown graphically in below:

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As shown in above graph, the horizontal line Px shows the constant utility of money and MUx
curve represents the diminishing marginal utility of a good. The intersection of MUx and Px
curve takes place at E that is when quantity consumed is OQx, then MUx=Px(MUm).

Thus, consumer achieves equilibrium at E. Above point E, MUx>Px(MUm) implying that a

consumer increase the consumption of good as utility achieved is more. At point R, consumer
gains MU as RC where cost incurred is TC. Thus, marginal gain is RT and this situation exists
till a consumer reaches point E.

If we look at the point below point E, where MUx<Px (MUm), a consumer would consume more
than OQx and loses utility. Thus, satisfaction is increased by reducing the consumption.
Therefore, point E is the equilibrium point.

Let us now take the numerical example to learn consumer’s equilibrium with the help of
Table-2:
Total
Expenditure
Consumption Total Utility Marginal (Market price= Gain To
Units (Rs) Utility (Rs) Rs 3) Consumer
0 0 0 -  - 
1 4 4 3 1
2 7 3 6 1
3 9 2 9 0
4 10 1 12 -2
5 10 0 15 -5

From Table-2, it can be seen when a consumer buys one unit of a good at the market price of Rs.
3, he/she gains utility worth Rs. 4 In such a case, the consumer gains Re. 1. When he/she buys
two units, the utility gained is Rs. 7 and total price paid is Rs 6. Again, he/she gains Re 1. Next,
when he/she purchases three units, the utility gained is Rs. 9 and price paid is Rs. 9.

In such a case’ he/she does not gain anything. If he buys further, the total gain would become
negative. From Table-2, it can be seen that MU is equal to price two units of consumption.
Consumer equilibrium is achieved when the consumer buys two units because at this point
quantity and utility gained is maximum and MU (Rs. 3) is equal to price (Rs. 3).

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  DERIVATION OF AN INDIVIDUAL DEMAND CURVE:
The derivation of demand curve was done on the basis of the law of demand. It should be noted
that the demand curve and law of demand are based on the utility maximizing behavior of
consumers. The analysis of consumer equilibrium helps in deriving an individual demand curve
for a good. As discussed earlier, consumer equilibrium takes place when MUx= Px (MUm).

Figure-5 shows the derivation of demand curve from MUx:

Figure-5 shows the derivation of demand curve for good X. The price quantity combination
corresponding to equilibrium points E1 E2 and E3 are shown at point J, K, and L, respectively
which gives a demand curve for good X. Suppose E1 is the point of equilibrium at price P3 and
quantity OQ1. If price falls to P2, the equilibrium would be disturbed and shift to E2 with
quantity OQ2.

Similarly, when the price becomes P1, equilibrium shifts to E3 with quantity OQ3. Thus, when
price increases, quantity demanded decreases. This inverse relationship between price and
quantity gives the demand curve. Explaining with the help of utility, if P3 falls to P2, MUx> P3
(MUm) at OQ1. Thus, for maintaining equilibrium, the quantity demanded by a consumer should
increase to OQ2, which would reduce MUx. Thus, equilibrium is achieved at MUx =P2 (MUm).

 CRITIQUE OF THE CARDINAL UTILITY APPROACH:

Pareto, an Italian Economist, severely criticized the concept of cardinal utility. He stated that
utility is neither quantifiable nor addible. It can, however be compared. He suggested that the
concept of utility should be replaced by the scale of preference. Hicks and Allen, following the

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footsteps of Pareto, introduced the technique of indifference curves. The cardinal utility approach
is thus replaced by ordinal utility function.

ORDINAL UTILITY APPROACH

 ASSUMPTIONS:
The ordinal utility theory or the indifference curve analysis is based on four main assumptions.
1. Rational behavior of the consumer: It is assumed that individuals are rational in
making decisions from their expenditures on consumer goods. 
2. Utility is ordinal: Utility cannot be measured cardinally. It can be, however, expressed
ordinally. In other words, the consumer can rank the basket of goods according to the
satisfaction or utility of each basket.
3. Diminishing marginal rate of substitution: In the indifference curve analysis, the
principle of diminishing marginal rate of substitution is assumed.
4. Consistency in choice: The consumer, it is assumed, is consistent in his behavior during
a period of time. For insistence, if the consumer prefers combinations of A of good to the
combinations B of goods, he then remains consistent in his choice. His preference, during
another period of time does not change. Symbolically, it can be expressed as:
a. If A > B, then B > A
5. Consumer’s preference not self contradictory: The consumer’s preferences are not self
contradictory. It means that if combinations A is preferred over combination B is
preferred over C, then combination A is preferred over combination A is preferred over
C. Symbolically it can be expressed:
a. If A > B and B > C, then A > C
6. Goods consumed are substitutable: The goods consumed by the consumer are
substitutable. The utility can be maintained at the same level by consuming more of some
goods and less of the other. There are many combinations of the two commodities which
are equally preferred by a consumer and he is indifferent as to which of the two he
receives.

 PROPERTIES OF INDIFFERENCE CURVE:

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Anindifference curve shows combination of goods between which a person is indifferent. The
main attributes or properties or characteristics of indifference curves are as follows: 

1. Indifference curves are negatively sloped:  

The indifference curves must slope down from left to right. This means that an indifference
curve is negatively sloped. It slopes downward because as the consumer increases the
consumption of X commodity, he has to give up certain units of Y commodity in order to
maintain the same level of satisfaction. 

In fig. 3.4 the two combinations of commodity cooking oil and commodity wheat is shown by
the points a and b on the same indifference curve. The consumer is indifferent towards points a
and b as they represent equal level of satisfaction. 

At point (a) on the indifference curve, the consumer is satisfied with OE units of ghee and OD
units of wheat. He is equally satisfied with OF units of ghee and OK units of wheat shown by
point b on the indifference curve. It is only on the negatively sloped curve that different points
representing different combinations of goods X and Y give the same level of satisfaction to make
the consumer indifferent. 

2. Higher Indifference Curve Represents Higher Level: 

A higher indifference curve that lies above and to the right of another indifference curve
represents a higher level of satisfaction and combination on a lower indifference curve yields a
lower satisfaction.

In other words, we can say that the combination of goods which lies on a higher indifference
curve will be preferred by a consumer to the combination which lies on a lower indifference
curve. 
 

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In this diagram (3.5) there are three indifference curves, IC 1, IC2 and IC3 which represents
different levels of satisfaction. The indifference curve IC 3 shows greater amount of satisfaction
and it contains more of both goods than IC2 and IC1 (IC3> IC2> IC1).

3. Indifference Curve are Convex to the Origin:  

This is an important property of indifference curves. They are convex to the origin (bowed
inward). This is equivalent to saying that as the consumer substitute’s commodity X for
commodity Y, the marginal rate of substitution diminishes of X for Y along an indifference
curve. 

In this figure (3.6) as the consumer moves from A to B to C to D, the willingness to substitute
good X for good Y diminishes. This means that as the amount of good X is increased by equal
amounts, that of good Y diminishes by smaller amounts. The marginal rate of substitution of X
for Y is the quantity of Y good that the consumer is willing to give up to gain a marginal unit of
good X. The slope of IC is negative. It is convex to the origin. 

4. Indifference Curve Cannot Intersect Each Other:

Given the definition of indifference curve and the assumptions behind it, the indifference curves
cannot intersect each other. It is because at the point of tangency, the higher curve will give as
much as of the two commodities as is given by the lower indifference curve. This is absurd and
impossible. 

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In fig 3.7, two indifference curves are showing cutting each other at point B. The combinations
represented by points B and F given equal satisfaction to the consumer because both lie on the
same indifference curve IC2. Similarly the combinations shows by points B and E on indifference
curve IC1 give equal satisfaction top the consumer. 

If combination F is equal to combination B in terms of satisfaction and combination E is equal to

combination B in satisfaction. It follows that the combination F will be equivalent to E in terms
of satisfaction. This conclusion looks quite funny because combination F on IC2 contains more of
good Y (wheat) than combination which gives more satisfaction to the consumer. We, therefore,
conclude that indifference curves cannot cut each other.

5. Indifference Curves do not Touch the Horizontal or Vertical Axis: 

One of the basic assumptions of indifference curves is that the consumer purchases
combinations of different commodities. He is not supposed to purchase only one commodity. In
that case indifference curve will touch one axis. This violates the basic assumption of
indifference curves. 

6.

In fig. 3.8, it is shown that the indifference IC touches Y axis at point C and X axis at point E.
At point C, the consumer purchase only OC commodity of rice and no commodity of wheat,
similarly at point E, he buys OE quantity of wheat and no amount of rice. Such indifference
curves are against our basic assumption. Our basic assumption is that the consumer buys two
goods in combination.

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  MARGINAL RATE OF SUBSTITUTION AND ITS APPLICATION:
The concept of marginal rate substitution (MRS) was introduced by Dr. J.R. Hicks and Prof.
R.G.D. Allen to take the place of the concept of diminishing marginal utility. Allen and Hicks
are of the opinion that it is unnecessary to measure the utility of a commodity. The necessity is to
study the behavior of the consumer as to how he prefers one commodity to another and maintains
the same level of satisfaction.

For example, there are two goods X and Y which are not perfect substitute of each other. The
consumer is prepared to exchange goods X for Y. How many units of Y should be given for one
unit of X to the consumer so that his level of satisfaction remains the same?

The rate or ratio at which goods X and Y are to be exchanged is known as the marginal rate of
substitution (MRS). In the words of Hicks:The marginal rate of substitution of X for Y
measures the number of units of Y that must be scarified for unit of X gained so as to maintain a
constant level of satisfaction”. 

Marginal rate of substitution (MRS) can also be defined as:The ratio of exchange between small
units of two commodities, which are equally valued or preferred by a consumer”. 

Formula:
MRSxy =∆Y                                                                               
∆X

It may here be noted that the marginal rate of substitution (MRS) is the personal exchange rate of
the consumer in contrast to the market exchange rate.

Schedule: The concept of MRS can be easily explained with the help of schedule given below:
Marginal Rate of Substitution

Combination Good X Good Y MRS of X for Y

1 1 13 --
2 2 9 4:1
3 3 6 3:1
4 4 4 2:1
5 5 3 1:1
In the table given above, all the five combinations of good X and good Y give the same
satisfaction to the consumer. If he chooses first combination, he gets 1 unit of good X and 13
units of good Y. 

In the second combination, he gets one more unit of good X and is prepared to give 4 units of
good Y for it to maintain the same level of satisfaction. The MRS is therefore, 4:1.

In the third combination, the consumer is willing to sacrifice only 3 units of good Y for getting
another unit of good X. The MRS is 3:1. 

Likewise, when the consumer moves from 4th to 5th combination, the MRS of good X for good Y
falls to one (1:1). This illustrates the diminishing marginal rate of substitution.
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Diminishing Marginal Rate of Substitution:
In the above schedule, we have seen that as the consumer moves from combination first to fifth,
the rate of substitution of good X for good Y goes, down. In other words, as the consumer has
more and more units of good X, he is prepared to forego less and less of good Y.

For instance, in the 2nd combination, the consumer is willing to give 4 units of good Y in
exchange for one unit of good X, in the fifth combination only one unit of Y is offered for
obtaining one unit of X.

This behavior showing falling MRS of good X for good Y and yet to remain at the same level of
satisfaction is known as diminishing marginal rate of substitution.

Diagram/Figure:The concept of marginal rate of substitution (MRS) can also be illustrated with
the help of the diagram. 

In the fig. 3.3 above as the consumer moves down from combination 1 to combination 2, the
consumer is willing to give up 4 units of good Y (∆Y) to get an additional unit of good X (∆X).

When the consumer slides down from combinations 2, 3 and 4, the length of ∆Y becomes
smaller and smaller, while the length of ∆X is remain the same. This shows that as the stock of
the consumer for good X increases, his stock of good Y decreases.

He, therefore, is willing to give less units of Y to obtain an additional unit of good X. In other
words, the MRS of good X for good Y falls as the consumer has more of good X and less of
good Y. The indifference curve IC slopes downward from left to the right. This means a negative
and diminishing rate of substitution of one commodity for the other.

Importance of Marginal Rate of Substitution (MRS): 

1. Measures utility ordinally: The concept of MRS is superior to that of utility concept
because it is more realistic and scientific than the theory of utility. It does not measure the
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 utility of a commodity in isolation without reference to other commodities but takes into
consideration the combination of related goods to which a consumer is interested to
purchase.
2. A relative concept: The concept of marginal rate of substitution has the advantage that it
is relative and not absolute like the utility concept given by Marshall. It is free from any
assumptions concerning the possibility of a quantitative measurement of utility.

 CONSUMER EQUILIBRIUM:
The term consumer’s equilibrium refers to the amount of goods and services which the
consumer may buy in the market given his income and given prices of goods in the market.

The aim of the consumer is to get maximum satisfaction from his money income. Given the price
line or budget line and the indifference map:

A consumer is said to be in equilibriumat a point where the price line is touching the highest
attainable indifference curve from below.

Conditions:Thus the consumer’s equilibrium under the indifference curve theory must meet the
following two conditions:

First: A given price line should be tangent to an indifference curve or marginal rate of
satisfaction of good X for good Y (MRSxy) must be equal to the price ratio of the two goods. i.e.
MRSxy = Px / Py 

Second: The second order condition is that indifference curve must be convex to the origin at the
point of tangency.

Assumptions:
The following assumptions are made to determine the consumer’s equilibrium position.
1. Rationality: The consumer is rational. He wants to obtain maximum satisfaction given
his income and prices.
2. Utility is ordinal: It is assumed that the consumer can rank his preference according to
the satisfaction of each combination of goods.
3. Consistency of choice: It is also assumed that the consumer is consistent in the choice of
goods.
4. Perfect competition: There is perfect competition in the market from where the
consumer is purchasing the goods.
5. Total utility: The total utility of the consumer depends on the quantities of the good
consumed.

Explanation:The consumer’s consumption decision is explained by combining the budget line

and the indifference map. The consumer’s equilibrium position is only at a point where the price
line is tangent to the highest attainable indifference curve from below.
1. Budget Line should be tangent to the Indifference Curve:
The consumer’s equilibrium in explained by combining the budget line and the indifference map.

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In the diagram 3.11, there are three indifference curves IC1, IC2 and IC3. The price line PT is
tangent to the indifference curve IC2 at point C. The consumer gets the maximum satisfaction or
is in equilibrium at point C by purchasing OE units of good Y and OH units of good X with the
given money income.

The consumer cannot be in equilibrium at any other point on indifference curves. For instance,
point R and S lie on lower indifference curve IC1 but yield less satisfaction. As regards point U
on indifference curve IC3, the consumer no doubt gets higher satisfaction but that is outside the
budget line and hence not achievable to the consumer. The consumer’s equilibrium position is
only at point C where the price line is tangent to the highest attainable indifference curve IC 2
from below.

2. Slope of the Price Line to be Equal to the Slope of Indifference Curve:

The second condition for the consumer to be in equilibrium and get the maximum possible
satisfaction is only at a point where the price line is a tangent to the highest possible indifference
curve from below. In fig. 3.11, the price line PT is touching the highest possible indifferent curve
IC2 at point C. The point C shows the combination of the two commodities which the consumer
is maximized when he buys OH units of good X and OE units of good Y.

Geometrically, at tangency point C, the consumer’s substitution ratio is equal to price ratio Px /
Py. It implies that at point C, what the consumer is willing to pay i.e., his personal exchange rate
between X and Y (MRSxy) is equal to what he actually pays i.e., the market exchange rate. So the
equilibrium condition being Px / Py being satisfied at the point C is:

Price of X / Price of Y = MRS of X for Y

The equilibrium conditions given above states that the rate at which the individual is willing to
substitute commodity X for commodity Y must equal the ratio at which he can substitute X for Y
in the market at a given price.

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 3. Indifference curve should be convex to the origin:
The third condition for the stable consumer equilibrium is that the indifference curve must be
convex to the origin at the point of equilibrium. In other words, we can say that the MRS of X
for Y must be diminishing at the point of equilibrium. It may be noticed that in fig. 3.11, the
indifference curve IC2 is convex to the origin at point C. So at point C, all three conditions for the
stable-consumer’s equilibrium are satisfied.

 INCOME CONSUMPTION CURVE:

If the prices of goods, tastes and preferences of the consumer remains constant and there a
change in his income, it will directly affect consumer’s demand. This effect on the purchase due
to change in income is called the income effect.

A rise in consumer’s income will shift the price line or budget line upward to the right and he
goes on to higher point of equilibrium. A fall in the income will shift the price line downward to
the left and the consumer attains lower (tangency) points of equilibrium. The shift of the price
line is parallel as the prices of the goods are assumed to remain the same. The income effect is
explained with the help of following diagram.

In the diagram (3.12) wheat is measured along OX and rise along OY. When the price line or
budget line is BB/, the consumer gets maximum satisfaction or is in equilibrium position at point
K where it touches the indifference curve IC 1. The consumer buys OS quantity of wheat and ON
quantity of rice. Suppose now that the income of the consumer has increased and the price line is
now CC1. This shifts in a parallel fashion to the right.

The consumer is in equilibrium at a level at point L which is its equilibrium point. If there is
further increase in income: shift of the price line now will be DD 1, and the consumer is in
equilibrium at point T and will be purchasing OZ quantity of wheat and OE quantity of rice. If
these, equilibrium points K, L, T are joined together by a dotted line passing through the origin,
we get income consumption curve ICC.

This shows that with the rise in income, the consumer generally buys more quantities of the two
commodities rice and wheat. The income consumer is now better off at T on indifference curve

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IC3 as compared to L at a lower indifference curve IC 2. The income effect is positive in case of
both the goods rice and wheat as these are normal goods. The income consumption curve ICC
which is derived by joining the successive equilibrium positions has a positive slope.

 PRICE CONSUMPTION CURVE:

Price Effect on the Consumption of a Normal Good:When there is change in the price of a good
shown on the two axes of an indifference map, there takes place a change in demand in response
to a change in price of a commodity, other things remaining the same, is called price effect.

For example in fig. 3.15, AB is the initial budget line. It is assumed that the price of wheat has
fallen and the price of rice and the income of the consumer remain unchanged. The price line
takes a new position AC and the equilibrium point shifts from P to U.

The consumer buys now OT quantity of wheat (the amount demanded rises from OE to OT and
OZ quantity of rice. With further fall in the price of wheat, the consumer is in equilibrium at
point S, where the budget line AD is tangent to a higher indifference curve AC3. He buys now
OF quantity of wheat and OR quantity of rice.

The rise in amount purchased of wheat (OE to OF) as a result of a fall in its price is called price
effect. The price effect on the consumption of a normal good is negative. If we join the
equilibrium points PUS, we get price consumption curve (PCC) of the consumer for the
commodity wheat.

 CRITIQUE OF THE INDIFFERENCE CURVE APPROACH:

Indifference curve technique is definitely an improvement over utility analysis and it has a
number of uses and merits. In spite of merits, indifference curve analysis suffers from
shortcomings and these are followings:

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1.Unrealistic assumptions:
It is based on unrealistic assumptions of rationality, perfect competition, divisibility of goods and
perfect knowledge of scale or preference.

The purchases of a consumer are very much affected by habits, customs and fashion. Therefore,
a consumer does not act always rationally. We cannot expect a consumer to know his
indifference map. Goods Visible and perfect completion is a myth.

2.No novelty:
Prof. D.H. Robertson remarked that the indifference curve technique is merely “An old wine in
new bottle.”

This technique is similar to the utility analysis because it merely gave new names to old terms.
The concept of utility is replaced by scale of preference, tendency of diminishing marginal utility
is replaced by diminishing marginal rate of substitution and ordinal numbers such as 1, 2, 3 etc.,
were labelled as ordinal numbers I, II, III, etc.

The conditions of equilibrium in both analyses are similar. According to utility analysis the
consumer is in equilibrium when:
MUX / MUy =Px/Py
According to QC, equilibrium is given by:
MRSxy= Px/ Py
Where MRS xy = MUX / MUy
By substituting for MUx/ MUyMRSxy, we get
MUx/ MUy = Px / Py
Therefore, conditions of equilibrium are similar in both the techniques.

But this criticism is untenable. Prof. Hicks claims, “The replacement of diminishing marginal
rate of substitution is not mere translation.

It is a positive change in the theory of consumer demand.” We need not measure utility in fact to
know the marginal rate of substitution. The consumer is simply asked to tell how much of if he
gives to take an additional unit of X.

3.Indifference curve is non-transitive:

 Prof. W.E. Armstrong has argued that a consumer is indifferent between close alternative
combinations only because he is not able to perceive the difference between the two.

 But as the difference of combinations increases, the difference in the satisfaction of

different combinations becomes evident and so the different combinations on the same
indifference curve do not yield equal satisfaction.

 Thus, if Armstrong argument is accepted different points on an indifference curve give

different satisfaction. The indifference curve will become non-transitive.

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4.Fails to explain risky choice:
 Indifference curve analysis is criticized on the ground that it cannot explain consumer
behavior when he has to choose among alternatives involving risk or uncertainty of
expectation.

 To make a choice among uncertain alternatives quantitative measurement of utility is

needed to decide whether the risk is worth taking. In such situations ordinal system of
utility can explain consumer behavior.

5.Absurd and unrealistic combinations:

Indifference curve analysis is based on hypothetical combinations. When we consider different
combinations of two goods, then there may be some combinations that are meaningless and
cannot be possible in real life.

6.Does not provide behavioristexplanation of consumer behavior:

 The indifference map is hypothetical in nature and is not based on observed market
behavior. It is subjective in nature instead of objective.

 The reason is that it does not set up functions and curves in purely objective terms. Purely
objective indifference curves can be possible only if it is possible to obtain quantitative
data.

 The logical structure of indifference curve theory is such that it is difficult to quantity
indifference curves. Though attempts have been made to quantity indifference curve but
success is very limited.

7.Based on weak ordering:

 Indifference curve analysis is based on the weak ordering hypothesis i.e., a consumer can
be indifferent between a large number of combinations.

 But, according to Prof. Samulson, it is not possible to find many situations of indifference
in real world. The weak ordering makes it subjective in nature.

 But ordinal analysis is certainly better than coordinal analysis as it is based on fewer
assumptions.

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 THEORY OF PRODUCTION

Production is the process of transforming resources into output of goods and services to satisfy
human wants. It is an economic activity that makes goods available for consumption. Production
at times is also defined as all economic activities minus consumption. It is the process of creating
goods or services using various available resources.

Production theory is the study of production, or the economic process of converting inputs into
outputs. Production uses resources to create a good or service that is suitable for use, gift-giving
in a gift economy, or exchange in a market economy. This can include manufacturing, storing,
shipping, and packaging.

THE LAW OF DIMINISHING RETURNS

(Law of variable proportions /factor proportions)

The law of variable proportions states that as more and more units of a variable factor are applied
to a given quantity of a fixed factor the marginal product/marginal output first rises , reaches a
maximum point and then diminishes.

Assumptions of the Law

 It assumes the existence of a variable factor e.g. fertilizers,labour units etc.
 It assumes the existence of a fixed factor which is land
 It assumes that technology employed is constant
 It assumes that the unit of a variable factor are homogeneous e.g. equally divisible into
small units and equally efficient
 It assumes constant factor rewards/prices e.g constant wages,rent,profits etc.
 It assumes a short run period of time.

An illustration of the law of variable proportions

Land Labour(L) Total pdt Average pdt Marginal pdt
(T.P) (A.P=TP/L (M.P)=∆TP
∆L
1 1 10 10 _
1 2 24 12 14
1 3 39 13 15
1 4 52 13 13
1 5 61 12.2 9
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 1 6 66 11 5
1 7 66 9.4 0
1 8 64 8 -2

 Production with one variable input:

Total product (T.P)
It refers to the total output resulting from employing all factors of production (variable & fixed).
Total product (also known as total physical product) can also be defined as the total quantity of
output produced by a firm for a given quantity of input necessities. Total product identifies the
specific outputs which are possible using variable levels of counts. An understanding of total
product is essential to the short-run analysis of a firm's production. Changes in total product are
taken into account closely when there are changes in variable costs (labor) of production.

It is illustrated by a T.P curve which is based on the assumption of adding avariable factor to a
fixed factor (land).

TP

T.P

VF(labour)

From the above curve, it can be noted that as more units of a variable factor (L) are applied to
affixed factor, output first increase , reaches the maximum and …….falls due to the law of
variable.

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Average product (A.P)

It is the total product of the firm i.e. output divided by the number of inputs (labour). It is the
product produced per unit of variable input employed when fixed inputs are held constant. It is
commonly thought of as the amount of product produced by every worker.

AP=T.P
L

A.P

0 MP V.f(L)

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Marginal Product (MP)

It is the change in total output per unit change in the units of the variable factor (labour)
Is the extra product or output produced when 1 extra unit of that input is added while other inputs
are held constant at any given set of inputs.

I.e. MP= ∆T.P

∆L

MP

MP VF(L)

The relationship between TP, AP and MP

TP I II III

AP
MP vf(labour)

When the total product (TP) is its maximum, MP is equal to zero

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As MP becomes negative TP begins to fall
MP cuts the AP at its maximum PT

 STAGES OF PRODUCTION:
Pre-Production (Primary Production): This is a stage which involves extraction extraction of
natural resources from nature. This is the stage in which all the planning for the project takes
place.

That is, Primary production involves the extraction of raw materials (e.g. farming, forestry,
lumbering, fishing, and mining). There is little value added in primary production. The aim is
usually to produce the highest quantity at lowest cost to a satisfactory standard.

Production (Secondary Production):This is the level of production which involves the

processing of raw materials to make them more useful products. E.g. cement manufacturing,
food processing, fish processing making tiles etc. This is where the strength of the pre-
production work is put to the test.

That is, it is also known as manufacturing industries.Secondary production involves transforming

raw materials into goods.

 There are two main kinds of goods: -Consumer goods e.g. washing machines, DVD
players. As the name implies, these are used by consumers
 Industrial / capital goods e.g. plant and machinery, complex information systems.
Industrial and capital goods are used by businesses themselves during the production
process.

In the secondary production sector, value is “added” to the raw material inputs e.g. foodstuffs are
transformed into ready meals for sale in supermarkets; metals, fabrics, and plastics are
transformed into motor vehicles.

There are many different industry sectors in secondary production. For example:Electronic
instruments, House-building, Car building.

Post-Production (Tertiary Production): This is the level of production which involves the
provision of services. E.g. personal services like teaching or commercial like banking, insurance
etc.

That is, it is also known as the service industries. Tertiary production is associated with the
provision of services (an intangible product). As with the secondary sector, there are many

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tertiary production markets. Good examples include:Hotels, Private healthcare and education,
Accountants, Tourism.

Types of production

1. Direct/Subsistence production
This is the production of goods and services to satisfy one’s own needs or needs of the
house hold
2. Indirect production
It refers to the production of goods and services for commercial purpose or for sale.

 PRODUCTION WITH TWO VARIABLE INPUTS:

For the analysis of production function with two variable factors we make use of the concept
called isoquants or iso- product curves which are similar to indifference curves of the theory of
demand. Therefore, before we explain the production function with two variable factors and
returns to scale, we shall explain the concept of isoquants (that is, equal product curves) and their
properties.

Isoquants: Isoquants, which are also called equal product curves, are similar to the indifference
curves of the theory of consumer’s behavior. An isoquant represents all those factor
combinations which are capable of producing the same level of output.

The isoquants are thus contour lines which trace the loci of equal outputs. Since an isoquant
represents those combinations of inputs which will be capable of producing an equal quantity of
output, the producer would be indifferent between them. Therefore, isoquants are also often
called equal product curves production-indifference curves.

Table of Factor Combinations to Produce a given or Level of output

Factor Combinations Labour Capital
A 1 12
B 2 8
C 3 5
D 4 3
E 5 2

The concept of isoquant can be easily understood from Table above. It is presumed that two
factors labour and capital are being employed to produce a product. Each of the factor
combinations A. B, C, D and E produces the same level of output, say 100 units. To start with,
factor combination A consisting of 1 unit of labour and 12 units of capital produces the given
100 units of output.

Similarly, combination B consisting of 2 units of labour and 8 units of capital, combination C

consisting of 3 units of labour and 5 units of capital, combination D consisting of 4 units of
labour and 3 units of capital, combination E consisting of 5 units of labour and 2 units of capital
are capable of producing the same amount of output, i.e., 100 units. In Fig. 17.1 we have plotted
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all these combinations and by joining them we obtain an isoquant showing that every
combination represented on it can produce 100 units of output.

Though isoquants are similar to be indifference curves of the theory of consumer’s behaviour,
there is one important difference between the two. An indifference curve represents all those
combinations of two goods which provide the same satisfaction or utility to a consumer but no
attempt is made to specify the level of utility in exact quantitative terms it stands for.

This is so because the cardinal measurement of satisfaction or utility in unambiguous thermos is

not possible. That is why we usually label indifference curves by ordinal numbers as I, II, III etc.
indicating that a higher indifference curve represents a higher level of satisfaction than a lower
one, but the information as to how much one level of satisfaction is greater than another is not
provided.

On the other hand, we can label isoquants in the physical units of output without any difficulty.
Production of a good being a physical phenomenon lends itself easily to absolute measurement in
physical units. Since each isoquant represents a specified level of production, it is possible to say
by how much one isoquant indicates greater or less production than another.

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In Fig. 17.2 shows an isoquant-map or equal- product map with a set of four isoquants which
represent 100 units, 120 units, 140 units and 160 units of output respectively. Then, from this set
of isoquants it is very easy to judge by how much production level on one isoquant curve is
greater or less than on another.

 Isoquants:
Isoquants are those combination of inputs or factors of production which provides an equal or
same quantity of output. Isoquant curves are also called Equal product or isoproduct curve. For a
production function which denotes isoquant:
Q=F(L,K),
Q is fixed level of production
L = labour and K = Capital are variable

The table below shows different combinations of labour and capital required to produce 100
shirts
Labour Capital Output
(L) (K) (Shirts)
10 90 100
20 60 100
30 40 100
40 30 100
50 20 100
Different resources/ inputs are required for production of goods. Same number of outputs can be
produced using different input combinations. Isoquant is the combination of all such
combination of inputs which produces same output. Thus we have an isoquant curve for every
level of output. Since the quantity produced will remain unchanged on an isoquant, the producer
is indifferent for different input combinations.

Properties of an Isoquant
1. An isoquant has a negative slope and the curve is convex to the point of origin.

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 2. An isoquant curve does not intersect with each other.
3. An isoquant curve that lies farther to the right of the point of origin corresponds to higher
level of output.

 MARGINAL RATE OF TECHNICAL SUBSTITUTION:

Prof. R.G.D. Alien and J.R. Hicks introduced the concept of MRS (marginal rate of substitution)
in the theory of demand. The similar concept is used in the explanation of producers’ equilibrium
and is named as marginal rate of technical substitution (MRTS).
 
Marginal rate of technical substitution (MRTS)is: The rate at which one factor can be substituted
for another while holding the level of output constant.
 
The slope of an isoquant shows the ability of a firm to replace one factor with another while
holding the output constant. For example, if 2 units of factor capital (K) can be replaced by 1 unit
of labor (L), marginal rate of technical substitution will be thus:
 
MRS = ΔK  = 2 = 2
                                                                                    ΔL     1    
 ISOCOSTS AND THEIR CHARACTERISTICS:
An isocost line shows the different combination of factor input that can be bought for a given
amount of budget. In our previous example, we assumed two factor inputs: labor and capital
production of furniture units. As applied to this example, isocost line, therefore shows the
various combination of capital and labor that can be brought with a given amount of money.

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 THEORY OF COSTS

Costs Are Expenses incurred by the firm in order to produce a given amount of output

The firm’s costs determine the supply of output while the demand for the output determines the
price.

Cost function" is a financial term used by economists and mangers within businesses as a way
of expressing how different costs behave under a variety of circumstances.

TYPES OF COSTS

(i). Implicit costs

These are costs of production incurred during the production process but are not always included
in the balancing of accounts when calculating costs of the firm e.g. labour provided by one’s own
household, interest on personal capital , rent on one’s own buildings etc.

(ii). Explicit costs

These are costs of production incurred by the firm on buying and processing of resources
e.g. costs of raw materials, hiring labour, power costs , transport etc.

These costs increase as the level of output increase whether in the short run or long run
Explicit costs are in two forms.

a) Total fixed costs (TFC)

These are costs of production that remain the same at whatever level of output produced
by the firm. They include initial costs of land, electric installation, initial rent etc.

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 They are also known as; overhead/supplementary /unavoidable/indispensable costs.

b) Total variable costs (TVC)

These are costs of production that change as the level of output of the firm changes
They increase when output increases and decrease when it increases
They are also known as; dispensable /avoidable /prime costs

c) Total costs (TC)

These are costs of production that are incurred by the firm when producing a given level
of output
They are a summation of variable and fixed costs of the firm i.e. TC=TFC + TVC

d) Average costs (Average total costs) AC/ATC)

These refer to total costs of production per unit output produced by the firm i.e.
AC = TC where Q-output
Q

AC

Co

0 Q Q/P

e) Average fixed costs (AFC)

These are fixed costs of a firm per unit output produced
AFC=TFC where Q –output
Q

Since total fixed costs are constant, it means that as output increases, AFC decreases.

Costs

AFC
0 Q/P

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f) Average variable costs (AVC)
These are total variable costs incurred by the firm per unit output produced ie
AVC = TVC where Q=output
AVC

Costs
C1

0 Q1 Q/P

g) Marginal costs (MC)

This refers to the additional costs incurred by the firm in producing an additional unit of
output or a change in total costs of the firm brought about by a change in its output.
MC=∆TC
∆Q
MC

Costs
C0

0 Q Q/P

THE RELATIONSHIP BETWEEN SHORT RUN COSTS OF A FIRM

I.E. (SAC, SAFC, SAVC, MC)

CostsMCSAC/ATC
(SAC, SAVC
SAVC,
SAFC,
MC )

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SAFC
 Q1Q2 Q/P

O Q1 Q2 Q/P

From the above graph, the relationship among the short run curves is that;
1. All the curves except (SAFC) are U-shaped
2. The (SAC) lies above (MC) and (SAVC) when it is falling
3. The (MC) lies above the (SAC) after is minimum /optimum, point of the (SAC) i.e. when
the (SAC) is rising, it lies below the (MC) curve.
4. The (MC) curve intersects both the (SAC) and (SAVC) curve at their minimum points.
5. The (MC) reaches the minimum point of the (SAC) (b) before it reaches the minimum
Point of the (SAVC) (a) i.e. Minimum point of the SAC is up and to the right of the
minimum point over the entire range of output OQ1 and OQ2, the
6. SAC lies above SAVC but at output beyond OQ 2, the SAVC runs asymptotically to the
SAC.
7. The SAC starts to fall faster than the MC and when both are falling, the MC is below the
SAC .
8. The SAFC is convex to the origin and it neither approaches nor intersect either axis
9. At output beyond OQ2, the SAFC runs parallel to the X-axis
10.
 WHY THE AC IS U-SHAPED IN THE SHORT RUN:
In the short run, the shape of the average total cost curve (ATC) is U-shaped due to the law of
diminishing returns. The, short run average cost curve falls in the beginning, reaches a
minimum and then begins to rise. The reasons for the average cost to fall in the beginning of
production are that the fixed factors of a firm remain the same. The change only takes place in
the variable factors such as raw material, labor, etc.

As the fixed cost gets distributed over the output as production is expanded, the average cost,
therefore, begins to fall. When a firm fully utilizes its scale of operation (plant size), the average
cost is then at its minimum. The firm is then operating to its optimum capacity. If a firm in the
short-run increases its level of output with the same fixed plant; the economies of that scale of
production change into diseconomies and the average cost then begins to rise sharply.

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The shape of the average total cost curve (ATC) is U-shaped due to the law of diminishing
returns.

Costs SAC
sing return
sing return

X
Co

O Qo O/P
The AC is U-shaped in the longrun due to economies and dis economies of scale

Costs LAC
EOS
DOS

M
Co

O Qo O/P

 DERIVATION OF THE LONGRUN AVERAGE COST CURVE (L.AC)

In the long run, all costs of a firm are variable. The factors of production can be used in varying
proportions to deal with an increased output. The firm having time-period long enough can build
larger scale or type of plant to produce the anticipated output. The shape of the long run average
cost curve is also U-shaped but is flatter that the short run curve as is illustrated in the following
diagram: 

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In the diagram 13.7 given above, there are five alternative scales of plant SAC 1 SAC2, SAC3,
SAC4 and, SAC5. In the long run, the firm will operate the scale of plant which is most profitable
to it.
 
For example, if the anticipated rate of output is 200 units per unit of time, the firm will choose
the smallest plant it will build the scale of plant given by SAC 1 and operate it at point A. This is
because of the fact that at the output of 200 units, the cost per unit is lowest with the plant size 1
which is the smallest of all the four plants. In case, the volume of sales expands to 400, units, the
size of the plant will be increased and the desired output will be attained by the scale of plant
represented by SAC2 at point B, If the anticipated output rate is 600 units, the firm will build the
size of plant given by SAC3 and operate it at point C where the average cost is $26 and also the
lowest The optimum output of the firm is obtained at point C on the medium size plant SAC3.
 
If the anticipated output rate is 1000 per unit of time the firm would build the scale of plant given
by SAC5 and operate it at point E. If we draw a tangent to each of the short run cost curves, we
get the long average cost (LAC) curve. The LAC is U-shaped but is flatter than tile short run cost
curves. Mathematically expressed, the long-run average cost curve is the envelope of the SAC
curves.
 
In this figure 13.7, the long-run average cost curve of the firm is lowest at point C. CM is the
minimum cost at which optimum output OM can be, obtained.

 SHAPE OF LAC AND ITS LINK WITH ECONOMIES AND DISECONOMIES

OF SCALE AND EXTERNALITIES:
Economies of scale occur when an equal percentage increase in all factors of production results
in a greater percent increase in output eg. 10% more workers and a 10% bigger factory results in
15% more tacos being made.

Economies of scale can occur because firms are taking advantage of their size and
specialization.  Being bigger allows for cheaper training, less overhead, need for managers,
people working more efficiently together, etc

Diseconomies of scale occur when an equal percentage increase in all factors of production
results in a lower percent increase in output eg. 10% more workers and a 10% bigger factory
results in 5% more tacos being made.

Diseconomies of scale can occur when firms become too big and confusing.  While history has
shown relatively few examples, there are some companies that tried to make industrial towns. 
These firms ended up having to finance their own police and fire fighters, take medical care into
consideration, and other things the firm wasn't really good at doing.  This raised costs
tremendously, and the firms suffered from diseconomies of scale.

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  LONG RUN MARGINAL COSTS:
After too many workers have been added, however, employees may find themselves wasting
time waiting to use tools and equipment, or simply crowding one another out, resulting in a
higher marginalcost. Due to the inverse relationship between marginalcost and product,
marginal product will always be at its maximum level just as marginalcost reaches its
minimum point.

For example, manufacturing one metal soda can in a factory requires only a few cents' worth of
metal, so if a can factory is already operational and is not constantly running at maximum
capacity, the marginalcost of an additional can is very small. The marginalcost of the factory's
first can was enormous, however, because increasing the number of cans produced from zero to
one required a large fixed cost that had to be paid to make any can production possible.

 LONG RUN TOTAL COST:

A company can determine its profitability by subtracting totalcosts from total revenue, leaving
total economic profit. The totalcost function provides charts that come from various formulas,
providing pictorial references for assessing a company’s increasing or decreasing returns.

The change in totalcosts is totalcosts for higher production output less totalcosts for the
previous production level.

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 REFERENCES
1. Baumol W.J. (1999) Economic theory and operation analysis 3rd Ed. Prentice Hall.
2. Bade, Robin; Michael Parkin (2001). Foundations of Microeconomics. Addison Wesley
Paperback 1st Edition
3. Colander, David. (2008). Microeconomics. McGraw-Hill Paperback, 7th Edition
4. Dunne, Timothy, J. Bradford Jensen, and Mark J. Roberts (2009). Producer Dynamics:
New Evidence from Micro Data. University of Chicago Press.
5. Dwived D.N. 2000, Principles of economic, Karyan Publishes, New Delhi.
6. Left Richard (1986), The price system and resource allocation 5th Ed. Dry Den press.
7. Mansfield Edwin (2000) Micro economics, Theory and Application, New York.
8. Eaton, B. Curtis; Eaton, Diane F.; and Douglas W. Allen. Microeconomics. Prentice Hall,
5th Edition: 2002.
9. Jhingan ML (2000). Advanced Economic Theory, 8th Ed., McGraw-Hill
10. Keppler, J. H. and J. Lallement (2006), ‘The Origins of the U-Shaped Average Cost
Curve: Understanding the Complexities of the Modern Theory’, History of Political
Economy, 38 (4), 733-774.

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