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3 3 # #Edited by:Dr.Tanima Dutta

MICRO ECONOMICSEdited ByDr. Tanima Dutta

Printed byEXCEL BOOKS PRIVATE LIMITEDA-45, Naraina, Phase-I,New Delhi-110028forLovely Professional UniversityPhagwara

SYLLABUSMicro EconomicsObjectives: To expand the students' knowledge in the field of microeconomics and to make them ready to analyze realeconomic situations.Sr. No.Topics1.Basic concepts and principles: Definitions and scope; types of economic analysis;managerial economics; economic principles relevant to managerial decision.2.Demand and Supply Analysis: Introduction; Demand: Law of demand; shift and movement;exceptions of the law of demand, Law of supply: shift and movements. Market Equilibrium,Elasticity of demand: introduction; price, income and cross elasticity.3.Consumer preference and choice: Utility Analysis; Indifference curve analysis; consumer’sequilibrium: Cardinal & Ordinal; consumer surplus, income, Price & Substitution effect.4.Production Theory: Types of input; production function; Isocost lines; producer’sequilibrium; expansion path.5.Cost concepts: Introduction, kinds of cost, short & long run cost; Linkage between cost,revenue and output through optimization, Economies of Scale; internal and external6.Market structure: Perfect competition: Introduction, features, short run & long runequilibrium. Perfect competition: Existence in Real World7.Monopoly: Introduction, types; price and output determination in short run & long run.Economic inefficiency of monopoly.8.Monopolist Competition: Introduction, features, short run & long run equilibrium,monopolistic competition and advertising.9.Oligopoly: Features, Types, Kinked demand curve.10.Pricing Decisions: Cost based pricing; pricing based on firm’s objective; competition basedpricing.

CONTENTUnit 1:Basic Concepts of Economics1Dilfraz Singh, Lovely Professional UniversityUnit 2:Demand Analysis13Tanima Dutta, Lovely Professional UniversityUnit 3:Supply and Market Equilibrium27Dilfraz Singh, Lovely Professional UniversityUnit 4:Elasticity of Demand44Tanima Dutta, Lovely Professional UniversityUnit 5:Consumer Behaviour: Cardinal Approach57Dilfraz Singh, Lovely Professional UniversityUnit 6:Consumer Behaviour: Ordinal Approach67Tanima Dutta, Lovely Professional UniversityUnit 7:Production Theory84Dilfraz Singh, Lovely Professional UniversityUnit 8;Laws of Production102Tanima Dutta, Lovely Professional UniversityUnit 9:Cost Concepts116Ashwani Panesar, Lovely Professional UniversityUnit 10:Market Structure – Perfect Competition141Pavitar Parkash Singh, Lovely Professional UniversityUnit 11:Monopoly162Ashwani Panesar, Lovely Professional UniversityUnit 12:Monopolistic Competition177Pavitar Parkash Singh, Lovely Professional UniversityUnit 13:Oligopoly193Ashwani Panesar, Lovely Professional UniversityUnit 14:Pricing DecisionsPavitar Parkash Singh, Lovely Professional University220

Dilfraz Singh, Lovely Professional UniversityUnit 1: Basic Concepts of EconomicsUnit 1: Basic Concepts of inition of Economics1.2Scope of Economics1.3Types of Economics and its use in Managerial Decisions1.3.1 Economics and Managerial Decision-making1.3.2 Central Problems of an Economy1.4Summary1.5Keywords1.6Self Assessment1.7Review Questions1.8Further ReadingsObjectivesAfter studying this unit, you will be able to:Define economicsDiscuss the scope of economicsDescribe the types of economics and use in managerial decisionState the three central problems of an economyIntroductionWe all use economics in our day-to-day life. For example, all of us have to make certain choiceswith the limited money at our disposal. You may spend your money on things like food, houserent, electricity bills and medicines, and somebody else may spend the same amount of moneyon buying clothes, watching movies and other allied activities. Both spend the same amount ofmoney, but in a different manner. Making such choices is just one activity related to Economics.Then what is Economics? Different people may define economics in varied manners, but in alllikeliness they all would only be partly right. In this unit, you will get introduced to Economics asa field of study and its fundamentals. The fundamental nature of economics is trying to understandhow both individuals and nations behave in response to certain material constraints.1.1 Definition of EconomicsNow let’s go through the various definitions of economics as given by various economists andother sources.Simply defined, “Economics is the social science that examines how people make a choice forusing their limited or scarce resources in order to satisfy their unlimited wants.”LOVELY PROFESSIONAL UNIVERSITY1

Micro EconomicsNotesDid u know? One of the earliest and most famous definitions of Economics was that ofThomas Carlyle, who in the early 19th century termed it the “dismal science.” Carlylebelieved that population would always grow faster than food and due to this, peoplewill have to face severe poverty and hardship. Carlyle argued that slavery was actuallymorally superior to the market forces of supply and demand promoted by economists,since, in his view, the freeing up of the labor market by the liberation of slaves had actuallyled to a moral and economic decline in the lives of the former slaves themselves.Another early definition, one which is perhaps more useful, is that of English economistW. Stanley Jevons who, in the late 19th century, wrote that economics was “the mechanics ofutility and self interest.” One can think of economics as the social science that explores the resultsof people acting on the basis of self-interest. Psychology, Sociology, Anthropology, and PoliticalScience – attempt to tell us about those other dimensions of man. The assumption of self-interest,that a person tries to do the best for himself with what he has, underlies virtually all of economictheory.At the turn of the century, Alfred Marshall’s Principles of Economics was the most influentialtextbook in Economics. Marshall defined Economics as “a study of mankind in the ordinarybusiness of life; it examines that part of individual and social action which is most closelyconnected with the attainment and with the use of the material requisites of wellbeing. Thus itis on one side a study of wealth; and on the other, and more important side, a part of the studyof man.”Many other books of the period included in their definitions something about the “studyof exchange and production.” Definitions of this sort emphasize that the topics with whicheconomics is most closely identified concern those processes involved in meeting man’s materialneeds. Economists today do not use these definitions because the boundaries of economics haveexpanded since Marshall. Economists do more than study exchange and production, thoughexchange remains at the heart of economics.Most contemporary definitions of economics involve the notions of choice and scarcity. Perhapsthe earliest of these is by Lionell Robbins in 1935: “Economics is a science which studies humanbehavior as a relationship between ends and scarce means which have alternative uses.”Virtually all textbooks have definitions that are derived from this definition. Though the exactwording differs from author to author, the standard definition is something like this: “Economicsis the social science that examines how people choose to use limited or scarce resources inattempting to satisfy their unlimited wants.”The above definition has the following characteristics:21.Economics is Social Science: A social science is a systematic body of knowledge thatseeks solutions to the problems of the society, in general. Economics also does this. So it isconsidered a social science.2.Economics examines how people choose to use scare resources: We all know that theresources on this earth are not in abundance. In simpler words, they are only limited. Theywill get over after some time. So, people have to use them very carefully.3.Human wants are unlimited: one want gets satisfied, another one comes up. There is nolimit to our wants.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Basic Concepts of EconomicsNotesNoteScarcity and ChoiceScarcity occurs because people want more than what is available. Scarcity limits us both asindividuals and as a society. As individuals, limited income (and time and ability) keepsus from doing and having all that we might like. As a society, limited resources (suchas manpower, machinery, and natural resources) fixes a maximum amount of goods andservices that can be produced.Scarcity requires choice. People must choose which of their desires they will satisfy andwhich they will leave unsatisfied. When we, either as individuals or as a society, choosemore of something, scarcity forces us to take less of something else. Economics is sometimescalled the study of scarcity because economic activity would not exist if scarcity did notforce people to make choices.When there is scarcity and choice, there are costs. The cost of any choice is the option oroptions that a person gives up. For example, if you gave up the option of playing a computergame to read this text, the cost of reading this text is the enjoyment you would have receivedplaying the game. Most of economics is based on the simple idea that people make choicesby comparing the benefits of option A with the benefits of option B (and all other optionsthat are available) and choosing the one with the highest benefit. Alternatively, one canview the cost of choosing option A as the sacrifice involved in rejecting option B, and thensay that one chooses option A when the benefits of A outweigh the costs of choosing A(which are the benefits one loses when one rejects option B).The widespread use of definitions emphasizing choice and scarcity shows that economistsbelieve that these definitions focus on a central and basic part of the subject. This emphasison choice represents a relatively recent insight into what economics is all about; the notionof choice is not stressed in older definitions of economics. Sometimes, this insight yieldsrather clever definitions, as in James Buchanan’s observation that an economist is onewho disagrees with the statement that whatever is worth doing is worth doing well. WhatBuchanan is noting is that time is scarce because it is limited and there are many things onecan do with one’s time. If one wants to do all things well, one must devote considerabletime to each, and thus must sacrifice other things one could do. Sometimes, it is wise tochoose to do some things poorly so that one has more time for other things.1.2 Scope of EconomicsEconomics is concerned with the application of economic concepts and analysis to the problem offormulating rational individual and national decisions. There are four groups of problem in bothdecision making and forward planning.1.Resource allocation: Scarce resources have to be used with utmost efficiency to get optimalresults. These include production planning, problem of transportation, etc.2.Inventory and queuing problem: Inventory problems involve decisions about holding ofoptimal levels of stocks of raw materials and finished goods over a period. These decisionsare taken by considering demand and supply conditions. Queuing problems involvedecisions about installation of additional machines or hiring of extra labour in order tobalance the business lost by not undertaking these activities.3.Pricing problems: Fixing prices for the products of the firm is an important part of thedecision making process. Pricing problems involve decisions regarding various methodsof pricing to be adopted.LOVELY PROFESSIONAL UNIVERSITY3

Micro EconomicsNotes4.Investment problems: Forward planning involves investment problems. These are problemsof allocating scarce resources over time. For example, investing in new plants, how muchto invest, sources of funds, etc.Study of economics essentially involves the analysis of certain major subjects like:1.Demand analysis and methods of forecasting2.Cost analysis3.Pricing theory and policies4.Profit analysis with special reference to break-even point5.Capital budgeting for investment decisions6.The business firm and objectives7.Competition.Demand analysis and forecasting help a manager in the earliest stage in choosing the productand in planning output levels. A study of demand elasticity goes a long way in helping thefirm to fix prices for its products. The theory of cost also forms an essential part of this subject.Estimation is necessary for making output variations with fixed plants or for the purpose of newinvestments in the same line of production or in a different venture. The firm works for profitsand optimal or near maximum profits depend upon accurate price decisions. Theories regardingprice determination under various market conditions enable the firm to solve the price fixationproblems. Control of costs, proper pricing policies, break-even point analysis, alternative profitpolicies are some of the important techniques in profit planning for the firm which has to workunder conditions of uncertainty. Thus managerial economics tries to find out which course islikely to be the best for the firm under a given set of conditions.Economics and other DisciplinesEconomics is linked with various other fields of study like:41.Operation Research: This field is used in economics to find out the best of all possibilities.Operation Research is a great aid in decision making in business and industry as it can helpin solving problems like determination of facilities on machine scheduling, distribution ofcommodities, optimum product mix, etc.2.Theory of Decision-making: Decision theory has been developed to deal with problems ofchoice or decision making under uncertainty, where the applicability of figures requiredfor the utility calculus are not available. Economic theory is based on assumptions of asingle goal whereas decision theory breaks new grounds by recognising multiplicity ofgoals and persuasiveness of uncertainty in the real world of management.3.Statistics: Statistics helps in empirical testing of theory. With its help better decisionsrelating to demand and cost functions, production, sales or distribution are taken.Economics is heavily dependent on statistical methods.4.Management Theory and Accounting: Maximisation of profit has been regarded as acentral concept in the theory of the firm in microeconomics. In recent years, organisationtheorists have talked about “satisficing” (a decision-making strategy that attempts to meetcriteria for adequacy, rather than to identify an optimal solution) instead of “maximising”as an objective of an enterprise. Accounting data and statements constitute the languageof business. In fact, the link is so close that “managerial accounting” has developed as aseparate and specialised field in itself.LOVELY PROFESSIONAL UNIVERSITY

Unit 1: Basic Concepts of EconomicsNotesCaseletBirla Yamaha – Shriram Honda and Ensuing CompetitionWith Honda acquiring a majority in Shriram Honda, arch rival Birla Yamaha nowhas a strong opponent to tackle. As the two companies enjoy a virtual duopolyin the potable generator set market, Honda’s move to acquire managementcontrol in its Indian venture was enough to rush Birla’s executives back into a huddle.RS Sharma, MD, Birla Yamaha points out, “Our competitors are now witnessing a changeof management. As fresh funds are infused in the company, we will be up against strongercompetition.”It is obvious that it will be difficult to understand and tackle this problem withoutthe knowledge of concepts like duopoly, competition, etc., which are a part of microeconomics.Tasklinkage.Name other fields that economics is linked to. Give examples to show their1.3 Types of Economics and its use in Managerial DecisionsThere are two major branches of economics – microeconomics and macroeconomics.Microeconomics is the study of decisions that people and businesses make regarding the allocationof resources and prices of goods and services. This means also taking into account taxes andregulations created by governments. Microeconomics focuses on supply and demand and otherforces that determine the price levels seen in the economy. For example, microeconomics wouldlook at how a specific company could maximize it’s production and capacity so it could lowerprices and better compete in its industry.Macroeconomics, on the other hand, is the field of economics that studies the behavior of, not juston specific companies, but entire industry and economy. It looks at economy-wide phenomena,such as Gross National Product (GNP) and how it is affected by changes in unemployment,national income, rate of growth, and price levels. For example, macroeconomics would look athow an increase/decrease in net exports would affect a nation’s capital account or how GDPwould be affected by unemployment rate.While these two studies of economics appear to be different, they are actually interdependentand complement one another since there are many overlapping issues between the two fields.Example: Increased inflation would cause the price of raw materials to increase forcompanies and in turn affect the end product’s price charged to the public. So in times of inflation,if you go to buy a t-shirt, it might cost you more than usual (micro effect) due to an increase in theprice of cotton and other raw materials.The bottom line is that Microeconomics takes a bottoms-up approach to analyzing the economywhile Macroeconomics takes a top-down approach.!Caution Regardless, both Micro and Macro economics provide fundamental tools for anyfinance professional and should be studied together in order to fully understand howcompanies operate and earn revenues and thus, how an entire economy is managed andsustained.LOVELY PROFESSIONAL UNIVERSITY5

Micro EconomicsNotes1.3.1 Economics and Managerial Decision-makingAs you have already learnt, economic activity is the constant effort to match ends to meansbecause of scarcity of resources. The optimal economic activity is to maximise the attainment ofends, given the means and their scarcities or to minimise the use of resources, given the ends andtheir priorities.Decision making by management is truly economic in nature because it involves choices amonga set of alternatives – alternative courses of action. For example, a company may have to make achoice in cases like:1.Setting up a plant at location A or setting up a plant at location B.or2.Producing more of product X or product Y.The optimal decision making is an act of optimal economic choice, considering objectives andconstraints. This justifies an evaluation of managerial decisions through concepts, precepts, toolsand techniques of economic analysis of the following types:1.Micro and Macro Analysis: In micro analysis the problem of choice is focused on singleindividual entities like a consumer, a producer, a market, etc. Macro analysis deals with theproblem in totality like national income, general price level, etc.2.Partial and General Equilibrium Analysis: To attain the state of stable equilibrium, theeconomic problem may be analysed part by part – one at a time – assuming “other thingsremaining the same.” This is partial equilibrium analysis. In general, in equilibriumanalysis the assumption of “given” or “other things remaining equal” may be relaxed andinterdependence or interactions among variables may be allowed.3.Static, Comparative Static and Dynamic Analysis: This is in reference to time dimension.A problem may be analysed:4.(a)Allowing no change at a point of time (static)(b)Allowing once for all change at a point of time (comparative static)(c)Allowing successive changes over a period of time (dynamic).Positive and Normative Analysis: In positive economic analysis, the problem is analysedin objective terms based on principles and theories. In normative economic analysis, theproblem is analysed base

Notes LOVELY PROFESSIONAL UNIVERSITY 1 Unit 1: Basic Concepts of Economics CONTENTS Objectives Introduction 1.1 Defi nition of Economics 1.2 Scope of Economics 1.3 Types of Economics and its use in Managerial Decisions 1.3.1 Economics and Managerial Decision-making 1.3.2 Central Problems o

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