📘 Economics Tutorial Notes
Exam-Ready Answers with Diagrams
1. Demand
Definition
Demand refers to the quantity of a commodity that consumers are willing and able to purchase at various prices
during a given period of time, other things remaining constant (ceteris paribus).
Law of Demand
The Law of Demand states that, other things being equal, as the price of a commodity falls, the quantity
demanded rises, and as the price rises, the quantity demanded falls. Thus, there is an inverse relationship
between price and quantity demanded.
Assumptions of Law of Demand
• Income of the consumer remains constant.
• Prices of related goods remain constant.
• Tastes and preferences of the consumer remain unchanged.
• No expectation of future price changes.
• No change in fashion, custom, or habits.
Demand Function
Qd = f(P, Y, Ps, Pc, T, ...)
Where: Qd = Quantity Demanded, P = Price of the good
Y = Income, Ps = Price of substitute goods
Pc = Price of complementary goods, T = Tastes
Demand Curve Diagram
The demand curve is a graphical representation of the relationship between price and quantity demanded. It
slopes downward from left to right (negative slope).
Fig 1.1 – Downward Sloping Demand Curve
Shifts in Demand Curve
• Increase in Demand: Curve shifts rightward — caused by rise in income, rise in price of substitutes, fall in
price of complements.
• Decrease in Demand: Curve shifts leftward — caused by fall in income, fall in price of substitutes, rise in
price of complements.
Exceptions to Law of Demand (Giffen Goods)
In certain cases the demand curve slopes upward (positive slope). These exceptions include:
• Giffen Goods: Inferior goods where income effect dominates substitution effect (e.g., bread for poor
consumers).
• Veblen / Prestige Goods: Luxury goods demanded more at higher prices due to their status symbol.
• Speculative Demand: When consumers expect price to rise further, they buy more at current high prices.
📝 Exam Tip: Always mention: (1) definition, (2) law, (3) assumptions, (4) diagram with
explanation. Mention exceptions for extra marks.
2. Elasticity of Demand
Definition
Elasticity of Demand measures the degree of responsiveness of quantity demanded of a commodity to a change
in its determinants such as price, income, and price of related goods.
(a) Price Elasticity of Demand (PED)
Price Elasticity of Demand (Ed) measures the percentage change in quantity demanded in response to a
percentage change in price.
Ed = % Change in Quantity Demanded / % Change in Price
= (ΔQ/Q) ÷ (ΔP/P)
= (ΔQ/ΔP) × (P/Q)
Types of Price Elasticity:
• Perfectly Elastic (Ed = ∞): Demand curve is horizontal. A slight change in price causes infinite change in
quantity demanded.
• Highly Elastic (Ed > 1): Percentage change in Qd > Percentage change in price. (Luxury goods, substitutes
available)
• Unit Elastic (Ed = 1): Percentage change in Qd = Percentage change in price. TR remains constant.
• Inelastic (Ed < 1): Percentage change in Qd < Percentage change in price. (Necessities, no substitutes)
• Perfectly Inelastic (Ed = 0): Demand curve is vertical. Quantity demanded does not change at all with price
change.
Fig 2.1 – Types of Price Elasticity of Demand
(b) Income Elasticity of Demand (YED)
Ey = % Change in Quantity Demanded / % Change in Income
= (ΔQ/Q) ÷ (ΔY/Y)
• Positive (Ey > 0): Normal goods — demand rises with income.
• Negative (Ey < 0): Inferior goods — demand falls as income rises.
• Zero (Ey = 0): Neutral goods — demand unaffected by income changes.
(c) Cross Elasticity of Demand (XED)
Exy = % Change in Qd of Good X / % Change in Price of Good Y
= (ΔQx/Qx) ÷ (ΔPy/Py)
• Positive Cross Elasticity: Substitute goods (e.g., tea and coffee).
• Negative Cross Elasticity: Complementary goods (e.g., car and petrol).
• Zero Cross Elasticity: Unrelated goods.
Factors Determining Elasticity of Demand
• Nature of the commodity: Necessities are inelastic; luxuries are elastic.
• Availability of substitutes: More substitutes → more elastic.
• Proportion of income spent: Higher proportion → more elastic.
• Time period: Longer period → more elastic.
• Number of uses: More uses → more elastic.
📝 Exam Tip: Formula for PED must be written with units. Always state whether Ed > 1, < 1, or =
1, and link to shape of TR. Diagrams of all 5 types are highly examinable.
3. Indifference Curve Analysis
Definition
An Indifference Curve is a locus of points representing different combinations of two goods that give the consumer
the same level of satisfaction (utility). The consumer is indifferent between any two points on the same curve.
Properties of Indifference Curves
• Downward Sloping: To maintain the same utility, if one good is reduced, the other must increase. Hence
slopes negatively.
• Convex to the Origin: Due to the principle of Diminishing Marginal Rate of Substitution (MRS). As consumer
has more of X, they give up less and less of Y.
• Higher Curve = Higher Satisfaction: A curve farther from the origin represents a higher level of utility.
• Two ICs Never Intersect: Intersection would be a logical contradiction (same bundle cannot give two
different utility levels).
• ICs Cannot Be Thick: A thick curve would include two different utility levels on the same curve.
Marginal Rate of Substitution (MRS)
MRS is the rate at which a consumer is willing to give up units of Good Y to obtain one more unit of Good X, while
maintaining the same utility level.
MRS(xy) = ΔY / ΔX (along the IC)
MRS = MUx / MUy
MRS diminishes as consumer moves down the IC → IC is convex.
Consumer Equilibrium (Optimal Choice)
The consumer reaches equilibrium where the Budget Line is tangent to the highest possible Indifference Curve.
Condition: MRS(xy) = Px / Py
i.e., MUx/MUy = Px/Py
i.e., MUx/Px = MUy/Py
Fig 3.1 – Indifference Curves & Consumer Equilibrium at Point E
Budget Line
The Budget Line (also called Price Line or Budget Constraint) shows all combinations of two goods a consumer
can purchase given their income and the prices of both goods.
Budget Constraint: Px·X + Py·Y = M
Where M = Money Income, Px and Py = Prices of X and Y
Slope of Budget Line = − Px/Py
Types of Goods on IC Map
• Perfect Substitutes: ICs are straight lines (constant MRS).
• Perfect Complements: ICs are L-shaped (right angles). No substitution possible.
• Normal Goods: Convex ICs (standard case, diminishing MRS).
📝 Exam Tip: Always draw IC curving from top-left to bottom-right. Show at least 3 ICs (IC1, IC2,
IC3) and the budget line tangent to the highest attainable IC. Mark equilibrium point E and write
tangency condition.
4. Isoquant
Definition
An Isoquant (Equal Product Curve or Production Indifference Curve) is a locus of all combinations of two factors
of production (Labour and Capital) that yield the same level of output. It is the production equivalent of an
Indifference Curve.
Properties of Isoquants
• Downward Sloping: More of one input requires less of the other to maintain output — negative slope.
• Convex to the Origin: Due to Diminishing Marginal Rate of Technical Substitution (MRTS).
• Higher Isoquant = Higher Output: IQ₂ > IQ₁ → more output.
• Two Isoquants Never Intersect: Same logic as ICs — a logical contradiction.
• Cannot be Thick: A thin curve represents a single output level.
Marginal Rate of Technical Substitution (MRTS)
MRTS measures the rate at which Labour can be substituted for Capital while keeping output constant.
MRTS(LK) = ΔK / ΔL (along the isoquant)
MRTS = MPL / MPK
MRTS diminishes along the isoquant → isoquant is convex.
Producer Equilibrium
The producer reaches equilibrium where the Isocost Line is tangent to the highest possible Isoquant. At this point,
output is maximized for a given cost.
Condition: MRTS(LK) = w/r
i.e., MPL/MPK = PL/PK (w = wage rate, r = rental rate)
Fig 4.1 – Isoquants & Producer Equilibrium at Point E
Difference: Isoquant vs Indifference Curve
Isoquant Indifference Curve
Used in Production Theory Used in Consumer Theory
Axes: Labour (L) & Capital (K) Axes: Good X & Good Y
Shows equal output combinations Shows equal satisfaction combinations
Measurable (units of output) Not measurable (ordinal utility)
Equilibrium via Isocost Equilibrium via Budget Line
📝 Exam Tip: Examiners often ask to compare IC and Isoquant. Use the table above — it scores
full marks. Always draw the isocost line tangent to the isoquant and state MRTS = w/r.
5. Relationship between TR, AR and MR
Definitions
• Total Revenue (TR): The total amount a firm earns from selling a given quantity of output. TR = P × Q
• Average Revenue (AR): Revenue per unit of output sold. AR = TR / Q = P (AR always equals Price).
• Marginal Revenue (MR): Additional revenue from selling one more unit of output. MR = ΔTR / ΔQ
TR = P × Q
AR = TR / Q = P → AR Curve = Demand Curve
MR = ΔTR / ΔQ (or dTR/dQ in calculus)
Relationship: TR = ΣMR (TR is sum of all MRs)
Under Perfect Competition
Price is constant (firm is a price-taker). Therefore:
• AR = MR = P = Constant
• TR increases at a constant rate (straight line through origin).
• Both AR and MR curves are horizontal (perfectly elastic) and coincide.
Under Monopoly / Imperfect Competition
To sell more, the firm must lower its price. Therefore:
• AR = Demand Curve — slopes downward.
• MR < AR at all output levels (MR falls faster than AR).
• TR first rises, reaches maximum when MR = 0, then falls.
• MR can be negative; AR (price) is always positive.
Fig 5.1 – TR, AR and MR under Imperfect Competition
Important Relationships (Must Memorise)
Condition TR MR Elasticity
Ed > 1 Rising MR > 0 Elastic
Ed = 1 Maximum MR = 0 Unit Elastic
Ed < 1 Falling MR < 0 Inelastic
Key Formula: MR = AR (1 − 1/Ed)
Or: MR = P (1 − 1/Ed)
When Ed = 1 → MR = 0 → TR is maximum
When Ed > 1 → MR > 0 → TR is rising
When Ed < 1 → MR < 0 → TR is falling
📝 Exam Tip: This relationship between MR and elasticity is very frequently asked. The diagram
must clearly show: TR reaching maximum when MR=0, MR curve bisecting the horizontal axis
at exactly half the quantity where AR hits zero.
6. Returns to Scale
Definition
Returns to Scale refers to the change in output when all inputs (Labour and Capital) are increased proportionately
in the long run. It is a long-run concept since all factors are variable.
(a) Increasing Returns to Scale (IRS)
When a proportionate increase in all inputs leads to a more than proportionate increase in output.
Example: Inputs doubled → Output more than doubles
If L and K increase by 10% → Output increases by >10%
• Causes: Specialisation & division of labour, better use of technology, technical indivisibilities, economies of
scale.
• Isoquant Shape: Isoquants move closer together as output increases.
(b) Constant Returns to Scale (CRS)
When a proportionate increase in all inputs leads to an exactly proportionate increase in output.
Example: Inputs doubled → Output exactly doubles
If L and K increase by 10% → Output increases by exactly 10%
• Causes: Economies and diseconomies of scale exactly offset each other.
• Isoquant Shape: Isoquants are equally spaced.
(c) Decreasing Returns to Scale (DRS)
When a proportionate increase in all inputs leads to a less than proportionate increase in output.
Example: Inputs doubled → Output less than doubles
If L and K increase by 10% → Output increases by <10%
• Causes: Managerial inefficiencies, diseconomies of scale, limited natural resources.
• Isoquant Shape: Isoquants move farther apart as output increases.
Diagram – Returns to Scale
Fig 6.1 – Isoquant Map showing Increasing Returns to Scale (IRS)
In the diagram above: Along the expansion path O→A→B→C, to produce equal increments of output (Q=10, 20,
30), the distances OA > AB > BC, indicating that proportionally less input is needed for each additional unit of
output — this characterises Increasing Returns to Scale.
Summary Table
Type Input Change Output Change Isoquant Spacing
IRS +10% +15% (more) Gets closer
CRS +10% +10% (same) Stays equal
DRS +10% +5% (less) Gets farther
Difference: Returns to Scale vs Returns to Factor
• Returns to Scale: Long-run concept. ALL inputs vary proportionately.
• Returns to Factor (Law of Variable Proportions): Short-run concept. ONLY one input is variable; others
are fixed.
📝 Exam Tip: Always state whether it is a long-run or short-run concept. Numerical examples in
the formula box are excellent for exams. Draw isoquant map showing all three types if the
question asks for "explain" or "illustrate."
⚡ Quick Revision Cheat Sheet
Topic Key Formula / Condition to Remember
Demand P↑ → Qd↓ (Inverse relationship). Shift right = Increase. Shift left = Decrease.
PED Ed = %ΔQd / %ΔP. Ed>1 Elastic, Ed<1 Inelastic, Ed=1 Unit elastic, Ed=0
Perfectly inelastic, Ed=∞ Perfectly elastic
Income Elasticity Ey>0 Normal good, Ey<0 Inferior good
Cross Elasticity Exy>0 Substitutes, Exy<0 Complements
Indifference Curve Equilibrium: MRS = Px/Py. IC is convex; never intersect; higher IC = higher
utility.
Isoquant Equilibrium: MRTS = w/r = PL/PK. Same properties as IC but for production.
TR, AR, MR AR = P always. MR = ΔTR/ΔQ. MR = AR(1−1/Ed). TR max when MR=0.
Returns to Scale IRS: Output rises >proportionately. CRS: =proportionately. DRS:
<proportionately. Long-run concept.