Note: 1.

No diagrams are explained in these notes, but everyone should draw

graphs and prepare them for exams.
2. These notes are only for understanding, not for rote.
Unit 1: Demand and Supply
Demand: definitions, law & determinants
Demand: The quantity of a good that consumers are willing and able to buy at various prices
during a period, ceteris paribus (other things constant).

Law of Demand: Other things constant, as price rises, quantity demanded falls; as price falls,
quantity demanded rises (inverse relationship).

Example: If the price of a cold drink rises from ₹20 to ₹40, many students cut back purchases;
when it drops to ₹15, more buy.

Determinants of Demand (what shifts the curve):

 Income: ↑ income → ↑ demand for normal goods; ↓ for inferior goods (e.g., switch
from local bus to cab).
 Prices of related goods: Substitutes (tea vs coffee), Complements (phone & data
pack).
 Tastes/advertising/fashion: Viral trend → demand up.
 Expectations: Expect higher future prices → buy more today.
 Number of buyers/demographics / season: More students in town → more demand for
hostels.
 Weather/seasonality: Rainy season → more umbrellas.

Movements vs Shifts
 Movement along the demand curve = price change of the same good (other factors
constant).
 Shift of the demand curve = some determinant (income, tastes, etc.) changes at every
price.

Assumptions of Law of Demand: Income, tastes, prices of related goods, and expectations
remain constant; no speculative buying; no conspicuous consumption.
Criticisms / Exceptions (when the law may not hold):
 Giffen goods: Very poor households may buy more of a staple when its price rises
because real income falls and they drop costlier foods.
 Veblen (status) goods: Luxury fashion/jewellery—higher price can increase desirability.
 Speculative/expectations: If people expect prices to rise further (e.g., property), they
may buy even as price rises.
 Necessities with no substitutes: Life-saving medicines have very weak price response.

2) Supply: definitions, law & determinants

Supply: The quantity of a good that producers are willing and able to offer for sale at various
prices during a period, ceteris paribus.

Law of Supply: Other things constant, as price rises, quantity supplied rises; as price falls,
quantity supplied falls (direct relationship).

Example: If tomato prices jump in the mandi, farmers/wholesalers bring more tomatoes to
market next week.
Determinants of Supply (what shifts the curve):
 Input costs: Wages, electricity, raw materials. Input cost ↑ → supply ↓.
 Technology/productivity: Better tech → supply ↑.
 Taxes & subsidies: GST/taxes ↑ → supply ↓; subsidy → supply ↑.
 Number of sellers/industry capacity: More firms → supply ↑.
 Prices of related outputs: If soyabean becomes more profitable than wheat, supply of
wheat may fall.
 Weather/shocks & regulations: Rainfall for crops; compliance rules, etc.
 Expectations: Anticipated higher future price → hold back supply today.
Movement vs Shift (supply):
 Movement along supply curve = own price change.
 Shift = change in any determinant (tech, input cost, taxes, etc.).
Market Equilibrium

Market equilibrium is the situation where quantity demanded (Qd) = quantity supplied (Qs)
at a particular price.

 If price > equilibrium → excess supply (surplus).

 If price < equilibrium → excess demand (shortage).

Example:

 Suppose apples:
o At ₹50/kg → demand = 100 kg, supply = 200 kg → surplus → price falls.
o At ₹30/kg → demand = 200 kg, supply = 100 kg → shortage → price rises.
 Finally at ₹40/kg → demand = 150 kg, supply = 150 kg → equilibrium price.

Elasticity of Demand

Elasticity of demand measures how much the quantity demanded changes when the price or
other factors change.

Types of Elasticity of Demand:

1. Price Elasticity of Demand (PED):

% change in Qd ÷ % change in Price.
o If PED > 1 → Elastic demand (luxury goods).
o If PED < 1 → Inelastic demand (necessities).
Example: Petrol → inelastic (price increase doesn’t reduce demand much).
2. Income Elasticity of Demand (YED):
Change in demand due to change in income.
o Positive YED = Normal goods.
o Negative YED = Inferior goods.
Example: As income rises, demand for premium coffee increases (normal good).
3. Cross Elasticity of Demand (XED):
How demand for one good changes due to price change of another.
o Positive XED → Substitutes (tea & coffee).
o Negative XED → Complements (car & petrol).

Elasticity of Supply

Elasticity of Supply shows how much quantity supplied responds to change in price.

Formula:
Es = % change in Qs ÷ % change in Price

 If Es > 1 → elastic supply (manufactured goods).

  If Es < 1 → inelastic supply (agricultural goods, since crops need time to grow).

Example:

 Wheat supply cannot increase immediately after price hike → inelastic.

 Mobile phone supply can increase quickly in response to demand → elastic.

Determinants of Elasticity of Demand:

1. Availability of substitutes (more substitutes = more elastic).

2. Nature of good (necessity = inelastic, luxury = elastic).
3. Proportion of income spent (costly items more elastic).
4. Time period (demand becomes elastic in long run).

Example:

 Salt → no substitute → inelastic.

 Cold drink → many substitutes → elastic.

Determinants of Elasticity of Supply:

1. Time period (short run = inelastic, long run = elastic).

2. Nature of production (agriculture = less elastic, manufacturing = more elastic).
3. Availability of inputs.
4. Mobility of factors of production.

Example:

 Farmer cannot increase supply of wheat overnight → inelastic.

 Textile factory can increase shirt production quickly → elastic.

Perfectly Elastic Demand (Ed = ∞)

Definition:
A very small change in price leads to an infinite change in quantity demanded.

 Consumers are willing to buy at only one specific price.

 If the price increases even slightly, the demand falls to zero.
 If the price decreases, demand becomes unlimited.
 Demand curve → Horizontal line (parallel to X-axis).

Example:
  In a perfectly competitive market, wheat may be sold at ₹20/kg. Buyers will purchase at
₹20 only. If the seller charges ₹21, nobody buys. If the price drops to ₹19, demand
becomes very high.
 Shares in a stock exchange also show such behavior.

Perfectly Inelastic Demand (Ed = 0)

Definition:
A change in price has no effect on quantity demanded.

 Consumers will buy the same quantity regardless of price changes.

 Demand curve → Vertical line (parallel to Y-axis).

Example:

 Life-saving medicines like insulin: patients must buy them at any price.
 Common salt: most people consume the same quantity whether the price rises or falls.

Unit 2: Consumer Theory

1. Ordinal Utility Theory
 Earlier economists said utility can be measured in numbers (cardinal theory), but in
reality we can only rank preferences (ordinal). Assumes utility can’t be measured in
numbers, only ranked (preferences).
 Example: If you prefer Pizza > Burger > Samosa, you can rank them but cannot say
pizza = 50 utils, burger = 30 utils.

2. Indifference Curve (IC)

 A curve that shows different combinations of two goods giving the same satisfaction.
 Properties: Downward sloping, convex to origin, do not intersect.
 Example:
o Combination A: 1 coffee + 2 tea cups.
o Combination B: 2 coffee + 1 tea cup.
If both give you equal satisfaction, they lie on the same IC.

3. Budget Line
  Shows the maximum possible combinations of goods a consumer can buy with a given
income and prices.
 Formula: PxX + PyY = M.
 Example:
Income = ₹100,
Price of Tea = ₹10,
Price of Coffee = ₹20.
o If you buy only tea → 10 cups.
o If only coffee → 5 cups.
Budget line joins (10 tea, 0 coffee) and (0 tea, 5 coffee).

4. Consumer’s Equilibrium
 Point where consumer gets maximum satisfaction.
 Condition: Slope of IC = Slope of Budget Line → MRSxy = Px/Py.
 Example:
If you are ready to give up 2 coffee for 1 tea (MRS = 2), and market price ratio is also 1
tea = 2 coffee, then you are in equilibrium.

5. Income & Substitution Effect

 Substitution Effect: When tea price falls, you buy more tea instead of coffee.
 Income Effect: Fall in price increases your real income, so you may buy more of both
goods.
 Together → Explain why demand curve slopes downward.
 Example: If tea price falls from ₹10 to ₹5, you can now buy extra cups without extra
income.

6. Price Consumption Curve (PCC)

 Curve joining equilibrium points as price of one good changes.
 Example: As tea price decreases, you buy 2 cups → 4 cups → 6 cups. Plotting these
gives PCC. From PCC, we derive demand curve.

Unit 3: Production and Cost

(A) Production
1. Production Function
 Relation between inputs (like land, labour, capital) and output.
 Example: Wheat = f(Labour, Fertilizer).

2. Law of Variable Proportions (Short Run)

 When one input is increased while others are fixed:
o Stage 1: Increasing Returns – Output rises more than proportion.
o Stage 2: Diminishing Returns – Output rises less than proportion.
o Stage 3: Negative Returns – Output may even fall.
 Example: Farmer has fixed land.
o 1 worker → 10 kg wheat.
o 2 workers → 25 kg (more than double).
o 3 workers → 35 kg (extra but less).
o 5 workers → 36 kg (almost no extra output).

3. Isoquants
An isoquant, also known as an isoproduct curve or equal product curve, is a graphical
representation in economics showing all combinations of two or more factors of production (like
labor and capital) that yield the same level of output. The term comes from the Greek "iso"
(equal) and "quants" (quantity), meaning "equal quantity" or "equal output". Isoquants help
firms to adjust inputs to maintain a specific output level, often at the lowest possible cost.
 Like IC but for production. Shows combinations of inputs giving same output.
 Example: To produce 100 units:
o (2 labour + 5 machines) OR (4 labour + 3 machines).
Both are on the same isoquant.

4. Returns to Scale (Long Run)

 Increasing Returns: Inputs double → Output more than double.
 Constant Returns: Inputs double → Output exactly double.
 Decreasing Returns: Inputs double → Output less than double.
 Example: A bakery doubles workers and ovens.
o If bread output increases from 100 → 250 → Increasing Returns.
 o If output 100 → 200 → Constant.
o If output 100 → 150 → Decreasing.

5. Economies and Diseconomies of Scale

 Economies of Scale: Large firms reduce per-unit cost (bulk buying, specialization).
 Diseconomies of Scale: Too large scale increases cost (coordination issues).
 Example: Big company buys raw material in bulk cheaply (economy). But if it becomes
too big, communication problems raise cost (diseconomy).

(B) Costs
1. Short Run Costs
 Both are available - Fixed Cost (rent), Variable Cost (wages, raw material).
 Example:
Rent = ₹1000 (fixed), Cost per unit = ₹50 (variable).
o For 10 units: TC = 1000 + 500 = 1500.
o For 20 units: TC = 1000 + 1000 = 2000.
 Average and marginal cost curves are U-shaped.

2. Long Run Costs

 In the long run, all costs are variable, no fixed costs.
 Firms can choose plant size.
 Long Run Average Cost (LAC) is an envelope of all short run AC curves.

3. Equilibrium of the Firm

 A firm maximizes profit when MR = MC and MC cuts MR from below.
 Example:
If market price = ₹100, and the firm’s MC = ₹100 at 50 units, then profit max occurs at
50 units.

4. Technological Change (Very Long Run)

 New technology increases efficiency, reduces cost, and shifts production upwards.
  Example: A Farmer using a tractor instead of bullocks produces more wheat on the same
land at a lower cost.

UNIT – 3: PRODUCTION & COST

PART A – PRODUCTION
Meaning of Production
Production refers to the process of converting inputs (such as land, labour, capital, and raw
materials) into output (goods or services).
Example:
3 labour + 2 machines + ₹500 raw materials → 10 chairs

Firm as an Agent of Production

A firm performs the following functions:
 Combining inputs efficiently
 Minimizing cost
 Maximizing output
 Earning profit
Example:
Amul processes milk to produce butter, ghee, and paneer — this is the production activity of the
firm.

Production Function
A production function expresses the technical relationship between the inputs used and the
output produced.
Q=f (L , K)
Example:
If 2 workers produce 20 units and 4 workers produce 50 units, the production function shows the
impact of labour on output.
Short Run vs Long Run
Short Run
At least one input is fixed (usually capital).
Example:
Factory building remains fixed, but the number of labourers can increase.
Long Run
All inputs are variable, meaning the firm can change its scale of operations.
Example:
A firm can expand its building and purchase more machinery.

Law of Variable Proportions (Short Run)

This is a key law in microeconomics. It studies how output changes when only one input varies,
while all others remain fixed.
Here:
 Capital = Fixed
 Labour = Variable
It explains what happens when more and more units of labour are added to a fixed unit of
capital.

Stage 1 – Increasing Returns to a Factor

 Total Product (TP) increases rapidly
 Marginal Product (MP) increases
 Efficiency improves due to specialization
Example:
1 worker → handles 10 customers
2 workers → 25 customers
3 workers → 45 customers
Reasons:
 Specialization
 Better utilization of machinery
 Division of labour
Stage 2 – Diminishing Returns
 TP continues to rise but at a decreasing rate
 MP decreases but remains positive
 This is the most important stage
Example:
4 workers → 55 customers
5 workers → 60 customers
6 workers → 63 customers
Reasons:
 Overuse of fixed machine
 Crowding
 Lower efficiency
👉 Firms always operate in Stage 2 because it is the most productive and profitable.

Stage 3 – Negative Returns

 TP decreases
 MP becomes negative
Example:
7 workers → only 60 customers
(Output falls from 63 to 60)
Reasons:
 Overcrowding
 Lack of space
 Inefficiency and disturbance

Isoquants (Long Run)

An isoquant shows different combinations of inputs that produce the same level of output.
Example:
100 units can be produced using:
 (10 labour, 5 machines)
 (7 labour, 7 machines)
 (5 labour, 10 machines)
All combinations lie on the same isoquant.
Properties:
 Downward sloping
 Convex to origin
 Higher isoquant → higher output
 Isoquants do not intersect

MRTS (Marginal Rate of Technical Substitution)

MRTS measures how many units of capital must be reduced when one extra unit of labour is
added, keeping output constant.
Example:
(10L, 10K) → (11L, 9K)
Meaning:
1 labour can replace 1 machine without changing output.

Returns to Scale (Long Run)

When all inputs are increased in equal proportion, how does output respond?
Increasing Returns to Scale
Input ↑ 10% → Output ↑ 20%
Example:
Labour + Capital ↑ 10%
Output ↑ 25%
Reasons:
 Specialization
 Bulk purchasing
 Better management
Constant Returns to Scale
Input ↑ 10% → Output ↑ 10%
Decreasing Returns to Scale
Input ↑ 10% → Output ↑ 5%
Reasons:
 Managerial inefficiency
  Poor communication

PART B – COST
Short Run Costs
A. Fixed Cost (TFC)
Costs that remain the same even when output is zero.
Example:
Building rent = ₹10,000 per month
B. Variable Cost (TVC)
Costs that change with the level of output.
Example:
Wages, raw materials
C. Total Cost (TC)
TC=TFC +TVC
D. Average Costs
 AFC = TFC / Q → always decreases
 AVC = TVC / Q
 AC = TC / Q
E. Marginal Cost (MC)
Cost of producing one additional unit.
Example:
Cost of 10 units = ₹500
Cost of 11 units = ₹540
MC = 40

Long Run Costs

 No fixed costs
 All costs are variable
LAC (Long-Run Average Cost Curve)
 U-shaped
 Envelope curve
Economies of Scale (Cost Decreases)
Internal Economies:
 Technical
 Managerial
 Marketing
 Financial
 Risk-bearing
Example:
Zara buys fabric in bulk → cost per unit falls.

Diseconomies of Scale (Cost Increases)

Occurs when the size of the firm becomes too large.
Reasons:
 Poor communication
 Management problems
 Over-expansion
Example:
Too many workers cause confusion → cost increases.

Profit Maximization Condition

A firm maximizes profit when:
MC=MR

UNIT – 4 : MARKET STRUCTURE

Market structure refers to the organizational and competitive characteristics of a market.
It tells us:
 how many firms operate,
 how they compete,
 what pricing power they have,
 and how output is determined.
Microeconomics generally studies four major market structures:
1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

PERFECT COMPETITION
A market with many sellers, identical products, and no control over price.
Features (Characteristics)
1. Large Number of Buyers and Sellers
Each firm supplies a very small portion of total output.
2. Homogeneous Product
All firms sell identical products.
3. Free Entry and Exit
Firms can freely enter or leave the market.
4. Perfect Information
Buyers and sellers know all market conditions.
5. Price Taker Firm
The market determines the price; firms accept it.
6. Perfect Mobility of Factors
Labour and capital can move freely.

Demand Curve of a Firm

 Perfectly elastic (horizontal line)
 Because the firm cannot change price
 For the firm:
AR=MR=Price

Short-Run Equilibrium
A firm can earn:
 Supernormal profit
  Normal profit
 Loss
Condition:
MC=MR
and MC curve cuts MR from below.
Example:
If price = ₹10 and MC = MR at 100 units → firm produces 100 units.
Long-Run Equilibrium
 Free entry and exit bring all firms to normal profit.
 Price = Minimum AC
 Market efficiency is maximum.
Outcome:
No firm earns abnormal profit in the long run.

MONOPOLY
A market with one single seller and no close substitutes.
Features
1. Single Seller
2. Unique Product
3. High Barriers to Entry
4. Price Maker
5. Downward Sloping Demand Curve
AR> MR

Monopoly Pricing
Since the monopolist faces a downward demand curve, it must reduce price to sell more.
Equilibrium Condition:
MC=MR

Price Discrimination
Charging different prices to different customers for the same product.
Example:
Movie theatres charge different ticket prices for adults and students.

Necessary Conditions:
 Market separation
 Different elasticity of demand
 Market power

Inefficiency of Monopoly
 Higher price
 Lower output
 Dead-weight loss
Monopolies reduce social welfare.

MONOPOLISTIC COMPETITION
A market with many sellers, but product differentiation.
Features
1. Many small firms
2. Product differentiation (branding, style, quality)
3. Some price control
4. Heavy advertising
5. Free entry and exit
6. Selling cost is important

Short-Run Equilibrium
Firms may earn profit or suffer loss.
Condition:
MR=MC
Long-Run Equilibrium
 Firms earn normal profit
 Because entry of new firms eliminates abnormal profit
  Excess capacity remains

Excess Capacity
Firms do not produce at minimum AC in the long run.
This means capacity is under-utilized.
Example:
A bakery has capacity to make 100 cakes/day but produces only 70.

OLIGOPOLY
A market dominated by a few large firms.
Features
1. Few large firms
2. Mutual interdependence
3. High barriers to entry
4. Non-price competition
5. Products can be homogeneous or differentiated

Types of Oligopoly
 Collusive Oligopoly: Firms cooperate
 Non-collusive Oligopoly: Firms compete

Kinked Demand Curve Theory

Explains price rigidity in oligopoly.
Assumptions:
 If one firm raises price, others do not follow → demand becomes elastic
 If one firm reduces price, others follow → demand becomes inelastic
Result:
The firm faces a kink in its demand curve → price becomes stable.
Game Theory and Strategic Behaviour
Firms make decisions strategically by considering reactions of rivals.
Example:
Coca-Cola vs Pepsi
A change in price or advertisement by one affects the other.

COMPARISON OF MARKET STRUCTURES

Feature Perfect Monopoly Monopolistic Oligopoly
Competition Competition
No. of Firms Many One Many Few
Product Homogeneous Unique Differentiated Both
Price Control None Very high Some High
Entry Free Blocked Free Difficult
Long-run Normal Abnormal Normal Abnormal
Profit
Demand Curve Horizontal Downward Downward Kinked

MARKET EFFICIENCY
 Perfect Competition → Most efficient
 Monopoly → Least efficient
 Monopolistic Competition & Oligopoly → Moderate efficiency

UNIT – 5 : FACTOR PRICING & INCOME DISTRIBUTION

The economy uses four major factors of production to produce goods and services:
1. Land
2. Labour
3. Capital
4. Entrepreneurship
Each factor receives a reward:
Factor Reward

Land Rent

Labour Wages

Capital Interest

Entrepreneur Profit
This unit explains how these factor prices are determined and how national income is
distributed among them.

Meaning of Distribution
Distribution in economics refers to:
How national income is divided among different factors of production.
This is known as functional distribution.
Example:
If national income = ₹100 crore → how much goes to wages, rent, interest, and profit?

Demand for Factors (Derived Demand)

The demand for a factor depends on the demand for the final product; therefore, it is called
derived demand.
Example:
If apple demand increases → farmers hire more labour → labour demand increases.
Factors affecting demand for a factor:
 Productivity
 Price of the factor
 Price of substitute/complementary factors
 Technology

Supply of Factors
Supply of factors depends on:
 Wage/interest levels
 Population
 Education & skill
 Working conditions
  Migration
Backward Bending Labour Supply Curve
At very high wages, workers prefer more leisure → labour supply decreases.

Marginal Productivity Theory of Distribution (Very Important)

This theory says:
A factor is paid according to its Marginal Revenue Product (MRP).
MRP=MP × MR
 MP = extra output from one more unit
 MR = extra revenue from selling it
Example:
If an extra worker produces 5 units and each sells for ₹20 →
MRP = 5 × 20 = ₹100
So, the worker will be paid wage = ₹100.
Assumptions
 Perfect competition
 Profit maximization
 Homogeneous inputs
 Full employment
Criticisms
 Perfect competition is unrealistic
 Difficult to measure MRP
 Labour is not homogeneous

RENT (For Land)

A. Ricardian Theory of Rent
Rent arises because:
 Land supply is fixed
 Land has different fertility levels
Most fertile land earns highest rent, least fertile earns zero rent.
Example:
If land A produces 30 kg wheat and land B produces 20 kg →
Rent of A = extra 10 kg output.

B. Modern Theory – Economic Rent

Economic rent = Payment above the opportunity cost.
It applies to:
 Labour
 Capital
 Entrepreneur
not just land.
Example:
If a worker’s opportunity wage is ₹200 but he earns ₹300 →
Economic rent = ₹100

WAGES (For Labour)

A. Subsistence Theory of Wages
Workers receive just enough wages to maintain a subsistence level of living.
If wages rise → population increases → supply of labour increases → wages fall again.

B. Marginal Productivity Theory of Wages

Wages = Marginal Revenue Product of labour.

C. Modern Wage Theory

Wages depend on:
 Productivity
 Cost of living
 Bargaining power
 Trade unions
 Government laws (Minimum Wage Act)
Example:
If cost of living rises → wages must also rise.
INTEREST (For Capital)
Interest is the price paid for using capital.
Classical Theory of Interest
Determined by:
 Savings (supply of capital)
 Investment (demand for capital)

Loanable Funds Theory

Interest rate depends on supply and demand of loanable funds.
Demand for Loanable Funds comes from:
 Business firms (investment)
 Government borrowing
 Consumers (durables, housing)
Supply of Loanable Funds comes from:
 Savings
 Bank credit
 Dishoarding

PROFIT (For Entrepreneurship)

Profit is the reward for taking decisions, risks, and coordinating production.
Main Theories of Profit
1. Risk Theory (Hawley)
Profit = reward for taking risks.
2. Innovation Theory (Schumpeter)
Profit arises due to innovation, such as:
 new products,
 new technology,
 new production methods.
Example:
Apple introduced the iPhone → huge profits.
3. Dynamic Theory (Clark)
Profit occurs due to dynamic changes:
 population
 technology
 capital
 consumer preferences

4. Uncertainty Theory (Knight)

Profit is reward for uncertainty-bearing.
Uncertainty ≠ risk; uncertainty cannot be measured.

Economic vs Accounting Profit

Type Meaning

Accounting Profit Total Revenue – Explicit costs

Economic Profit Total Revenue – (Explicit + Implicit costs)

Economic profit includes opportunity cost, so it’s more realistic.

Functional vs Personal Distribution

Functional Distribution
How national income is distributed among factors:
 Rent
 Wages
 Interest
 Profit
Personal Distribution
How national income is distributed among individuals:
 rich
 middle class
 poor