Introductor y

Microeconomics
Textbook in Economics for Class XII
 ISBN 81-7450-678-0

First Edition ALL RIGHTS RESERVED

February 2007 Phalguna 1928
q No part of this publication may be reproduced, stored in a retrieval system
Reprinted or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise without the prior permission of the
December 2007 Agrahayana 1929 publisher.
December 2008 Pausa 1930 q This book is sold subject to the condition that it shall not, by way of trade,
January 2010 Magha 1931 be lent, re-sold, hired out or otherwise disposed of without the publishers
March 2013 Phalguna 1934 consent, in any form of binding or cover other than that in which it is
November 2013 Kartik 1935 published.
q The correct price of this publication is the price printed on this page, Any
December 2014 Pausa 1936
revised price indicated by a rubber stamp or by a sticker or by any other
December 2015 Pausa 1937 means is incorrect and should be unacceptable.
February 2017 Magha 1938

PD 130T HK
OFFICES OF THE PUBLICATION
DIVISION, NCERT
National Council of Educational NCERT Campus
Research and Training, 2007 Sri Aurobindo Marg
New Delhi 110 016 Phone : 011-26562708

108, 100 Feet Road

Hosdakere Halli Extension
Banashankari III Stage
Bengaluru 560 085 Phone : 080-26725740

Navjivan Trust Building

P.O.Navjivan
Ahmedabad 380 014 Phone : 079-27541446

CWC Campus
Opp. Dhankal Bus Stop
Panihati
Kolkata 700 114 Phone : 033-25530454

CWC Complex
Maligaon
Guwahati 781 021 Phone : 0361-2674869

` 65.00

Publication Team
Head, Publication : M. Siraj Anwar
Division
Chief Editor : Shveta Uppal
Chief Business : Gautam Ganguly
Manager
Chief Production : Arun Chitkara
Officer (Incharge)
Printed on 80 GSM paper with NCERT Assistant Editor : R. N. Bhardwaj
watermark
Production Assistant : Sunil Kumar
Published at the Publication Division by the
Secretary, National Council of Educational
Research and Training, Sri Aurobindo Cover, Layout and Illustrations
Marg, New Delhi 110 016 and printed at Nidhi Wadhwa
Bengal Offset Works, G-181, Sector-63,
Noida 201 301.
 Foreword
THE National Curriculum Framework (NCF), 2005, recommends that
childrens life at school must be linked to their life outside the school.
This principle marks a departure from the legacy of bookish learning
which continues to shape our system and causes a gap between the
school, home and community. The syllabi and textbooks developed
on the basis of NCF signify an attempt to implement this basic idea.
They also attempt to discourage rote learning and the maintenance
of sharp boundaries between different subject areas. We hope these
measures will take us significantly further in the direction of a child-
centered system of education outlined in the National Policy of
Education (1986).
The success of this effort depends on the steps that school
principals and teachers will take to encourage children to reflect on
their own learning and to pursue imaginative activities and
questions. We must recognise that, given space, time and freedom,
children generate new knowledge by engaging with the information
passed on to them by adults. Treating the prescribed textbook as the
sole basis of examination is one of the key reasons why other resources
and sites of learning are ignored. Inculcating creativity and initiative
is possible if we perceive and treat children as participants in
learning, not as receivers of a fixed body of knowledge.
These aims imply considerable change in school routines and
mode of functioning. Flexibility in the daily time-table is as necessary
as rigour in implementing the annual calendar so that the required
number of teaching days are actually devoted to teaching. The
methods used for teaching and evaluation will also determine how
effective this textbook proves for making childrens life at school a
happy experience, rather than a source of stress or boredom. Syllabus
designers have tried to address the problem of curricular burden by
restructuring and reorienting knowledge at different stages with
greater consideration for child psychology and the time available
for teaching. The textbook attempts to enhance this endeavour by
giving higher priority and space to opportunities for contemplation
and wondering, discussion in small groups, and activities requiring
hands-on experience.
The National Council of Educational Research and Training
(NCERT) appreciates the hard work done by the textbook development
committee responsible for this book. We wish to thank the
Chairperson of the advisory group in Social Sciences, at the higher
secondary level, Professor Hari Vasudevan and the Chief Advisor for
this book, Professor Tapas Majumdar, for guiding the work of this
committee. Several teachers contributed to the development of this textbook; we are
grateful to their principals for making this possible. We are indebted to the
institutions and organisations which have generously permitted us to draw upon
their resources, materials and personnel. We are especially grateful to the members
of the National Monitoring Committee, appointed by the Department of Secondary
and Higher Education, Ministry of Human Resource Development under the
Chairpersonship of Professor Mrinal Miri and Professor G.P. Deshpande for their
valuable time and contribution. As an organisation committed to systemic reform
and continuous improvement in the quality of its products, NCERT welcomes
comments and suggestions which will enable us to undertake further revision and
refinements.

Director
New Delhi National Council of Educational
20 November 2006 Research and Training

iv
CHAIRPERSON, ADVISORY COMMITTEE FOR SOCIAL SCIENCE TEXTBOOKS
AT THE H IGHER SECONDARY LEVEL
Hari Vasudevan, Professor, Department of History, University of
Calcutta, Kolkata

CHIEF ADVISOR
Tapas Majumdar, Professor Emeritus of Economics,
Jawaharlal Nehru University, New Delhi

ADVISOR
Satish Jain, Professor, Centre for Economics Studies and Planning,
School of Social Sciences, Jawaharlal Nehru University, New Delhi

MEMBERS
Harish Dhawan, Lecturer, Ramlal Anand College (Evening) New Delhi
Papiya Ghosh, Research Associate, Delhi School of Economics, New Delhi
Rajendra Prasad Kundu, Lecturer, Economics Department,
Jadavpur University, Kolkata
Sugato Das Gupta, Associate Professor, CESP, Jawaharlal Nehru
University, New Delhi
Tapasik Bannerjee, Research Fellow, Centre for Economics studies
and Planning, Jawaharlal Nehru University, New Delhi

MEMBER-COORDINATOR
Jaya Singh, Lecturer, Economics, Department of Education in Social
Sciences and Humanities, NCERT, New Delhi
The National Council of Educational Research and Training (NCERT)
acknowledges the invaluable contribution of academicians and
practising school teachers for bringing out this textbook. We are grateful
to Anjan Mukherjee, Professor, JNU, for going through the manuscript
and suggesting relevant changes. We thank Jhaljit Singh, Reader,
Department of Economics, University of Manipur for his contribution.
We also thank our colleagues Neeraja Rashmi, Reader, Curriculum
Group; M.V. Srinivasan, Ashita Raveendran, Lecturers, Department
of Education in Social Sciences and Humanities (DESSH) for their
feedback and suggestions.

We would like to place on record the precious advise of (Late) Dipak

Banerjee, Professor (Retd.), Presidency College, Kolkata. We could have
benefited much more of his expertise, had his health permitted.

The practising school teachers have helped in many ways. The Council
expresses its gratitude to A.K.Singh, PGT (Economics), Kendriya
Vidyalaya, Varanasi, Uttar Pradesh; Ambika Gulati, Head, Department
of Economics, Sanskriti School; B.C. Thakur, PGT (Economics),
Government Pratibha Vikas Vidyalaya, Surajmal Vihar; Ritu Gupta,
Principal, Sneh International School, Shoban Nair, PGT (Economics),
Mothers International School, Rashmi Sharma, PGT (Economics),
Kendriya Vidalaya, JNU Campus, New Delhi.

We thank Savita Sinha, Professor and Head, DESSH for her support.

Special thanks are due to Vandana R. Singh, Consultant Editor, NCERT

for going through the manuscript.

The council also gratefully acknowledges the contributions of Dinesh

Kumar, Incharge, Computer Station; Amar Kumar Prusty and Neena
Chandra, Copy Editors in shaping this book. The contribution of the
Publication Department in bringing out this book is duly acknowledged.
 Contents
Foreword iii
1. INTRODUCTION 1
1.1 A Simple Economy 1
1.2 Central Problems of an Economy 2
1.3 Organisation of Economic Activities 4
1.3.1 The Centrally Planned Economy 4
1.3.2 The Market Economy 5
1.4 Positive and Normative Economics 6
1.5 Microeconomics and Macroeconomics 6
1.6 Plan of the Book 6
2. THEORY OF CONSUMER BEHAVIOUR 8
2.1 The Consumers Budget 8
2.1.1 Budget Set 9
2.1.2 Budget Line 10
2.1.3 Changes in the Budget Set 12
2.2 Preferences of the Consumer 13
2.2.1 Monotonic Preferences 14
2.2.2 Substitution between Goods 14
2.2.3 Diminishing Rate of Substitution 15
2.2.4 Indifference Curve 15
2.2.5 Shape of the Indifference Curve 16
2.2.6 Indifference Map 17
2.2.7 Utility 17
2.3 Optimal Choice of the Consumer 18
2.4 Demand 20
2.4.1 Demand Curve and the Law of Demand 21
2.4.2 Normal and Inferior Goods 24
2.4.3 Substitutes and Complements 25
2.4.4 Shifts in the Demand Curve 25
2.4.5 Movements along the Demand Curve and Shifts 26
in the Demand Curve
2.5 Market Demand 27
2.6 Elasticity of Demand 27
2.6.1 Elasticity along a Linear Demand Curve 29
2.6.2 Factors Determining Price Elasticity of Demand for a Good 31
2.6.3 Elasticity and Expenditure 32
3. PRODUCTION AND COSTS 36
3.1 Production Function 36
3.2 The Short Run and the Long Run 38
 3.3 Total Product, Average Product and Marginal Product 38
3.3.1 Total Product 38
3.3.2 Average Product 39
3.3.3 Marginal Product 39
3.4 The Law of Diminishing Marginal Product and the Law of 40
Variable Proportions
3.5 Shapes of Total Product, Marginal Product and Average Product Curves 41
3.6 Returns to Scale 42
3.7 Costs 42
3.7.1 Short Run Costs 43
3.7.2 Long Run Costs 47
4. THE THEORY OF THE FIRM UNDER PERFECT COMPETITION 52
4.1 Perfect competition: Defining Features 52
4.2 Revenue 53
4.3 Profit Maximisation 55
4.3.1 Condition 1 55
4.3.2 Condition 2 56
4.3.3 Condition 3 56
4.3.4 The Profit Maximisation Problem: Graphical Representation 57
4.4 Supply Curve of a Firm 58
4.4.1 Short Run Supply Curve of a Firm 58
4.4.2 Long Run Supply Curve of a Firm 59
4.4.3 The Shut Down Point 60
4.4.4 The Normal Profit and Break-even Point 60
4.5 Determinants of a Firms Supply Curve 61
4.5.1 Technological Progress 61
4.5.2 Input Prices 61
4.5.3 Unit Tax 62
4.6 Market Supply Curve 62
4.7 Price Elasticity of Supply 64
4.7.1 The Geometric Method 65
5. MARKET EQUILIBRIUM 69
5.1 Equilibrium, Excess Demand, Excess Supply 69
5.1.1 Market Equilibrium: Fixed Number of Firms 70
5.1.2 Market Equilibrium: Free Entry and Exit 78
5.2 Applications 82
5.2.1 Price Ceiling 82
5.2.2 Price Floor 83
6. NON-COMPETITIVE MARKETS 86
6.1 Simple Monopoly in the Commodity Market 86
6.1.1 Market Demand Curve is the Average Revenue Curve 87
6.1.2 Total, Average and Marginal Revenues 90
6.1.3 Marginal Revenue and Price Elasticity of Demand 91
6.1.4 Short Run Equilibrium of the Monopoly Firm 91
6.2 Other Non-perfectly Competitive Markets 95
6.2.1 Monopolistic Competition 95
6.2.2 How do Firms behave in Oligopoly? 96

Glossary 101

viii