Chapter 1

Macro Economics, Micro Economics, Positive Economics, Normative Economics, Economic Profit

Accounting Profit, Opportunity Cost, Present Value

Chapter 2:-

Law of Demand Law of Supply

“If Price Increase Demand Decrease, If price “If Price Decrease Supply Decrease, If Price
decrease Demand Increase” Increase Supply Increase”
Inverse Relation“Movement along the Curve” Direct Relation “ Movement Along the Curve

Other Factors “ Curve Shift” Others Factors “Curve Shift”

Income:- (+) Normal Goods, (-) Inferior Goods Input Prices:- (-)
Related Goods:- (-)Complementary, (+) Substitute Prices of Related Goods In Production:- (+)
Taste:- (+) Complementary, (-) Substitute
Expected Future Prices:- (+) Technology (+)
Number of Consumer:- (+) Expected Future Prices (-)
No of Producers(+)

Chapter 3:- Marginal Cost and Benefits

Maximization problem (An optimization problem that involves maximizing the objective function)

Minimization problem (An optimization problem that involves minimizing the objective function)

Unconstrained optimization (An optimization problem in which the decision maker can choose the level of activity
from an unrestricted set of values)

Constrained optimization(An optimization problem in which the decision maker chooses values for the choice
variables from a restricted set of values)
 Total Benefit = Total Revenue Total Cost = sum of all Cost Net Benefit:-
Total Revenue= Sale Price X Q NB= TB - TC
Marginal Benefits :- MB Marginal Cost:- MC Optimum Level of Output
Change In Benefits Change in Cost (MB=MC)

If MB>MC:-(Activity or Production should Increase) If MB<MC:- (Activity or Production Should Decrease)

Chapter 5:- Consumer Behavior

Completeness:- Transitivity:- Nonsatiation:-
A>B or B>A, or A indifferent If A>B & B>C than A>C (Must) More is always Better
B

Indifference Curves: (IC) “ Same Utility level at all points of One Indifference Curve (IC)”

“Upper IC has higher Utility Level and Lower IC have lower Utility level at all points at IC Map”

Marginal Rate of Substitution and Utility Maximization

 Utility maximization subject to a limited income occurs at the combination of goods for
which the indifference curve is just tangent to the budget line (both have same Slope)
 Consumer allocates income so that the marginal utility per dollar spent on each good is the
same for all commodities purchased.
 Slope of budget constraint indicates the Opportunity cost of an additional unit of good on x
axis in terms of good on y axis.
Budget Line: “In available money howmuch we can afford in how many different combination”

Construction of Budget Line:-Calculate at max what

you canbuy of one product if you spend onlyon that,

locate two extreme point on axis and join them

Change In Budget Line

 Chapter 6: Elasticity
The Elasticity Concept:
Own Price Elasticity:-
Price Elasticity of Demand:- Price Elasticity of Supply:-
“%age change in demand as compare to %age “%Change in Supply as Compare to the
change in Price” %Change in Price”
%Change∈ Demand %Change∈ Supply
Price Elasticity of demand= Price Elasticity of Supply=
%Change∈Price %Change ∈Price
Elastic Demand:- ( ΔQ>ΔP) Elasticity > 1 Elastic Supply:- ΔQ>ΔP
Unitary Elastic Demand:- (ΔQ= ΔP), Elasticity=1 Unitary Elastic Supply:- ΔQ= ΔP
Inelastic Demand:- ( ΔQ< ΔP), Elasticity < 1 Inelastic Supply:- ΔQ< ΔP

Elasticity and Total Revenue:-

If Demand is Elastic. Total revenue increase when price decreases and total revenue
decrease when Prices increases.
If Demand is Unitary No Impact on Revenue when prices increase or decrease.
Elastic.
If Demand is Total revenue Decrease when price decreases and total revenue
Inelastic. Increase when Prices increases.

Point Mid-Point Elasticity

Elasticity:

Slope: Rise/Run (Change In Y/Change in X)

% age Change∈ Demand
Income Elasticity of Demand: (-ive if inferior Goods, +ive If Normal Goods)
% age Change∈Income
%age Change∈ Demand of A
Cross Price Elasticity:- (+ive if Substitute, -ive if Complementary)
% age Change∈Price of B

Factors impacting Demand Elasticity :

Time: Inelastic in Short Run, Elastic In Long Run

Necessity (Inelastic), Luxury (Elastic), More Substitute More Elastic
Price: if less Inelastic, If More Elastic
 Chapter 8 &9:- (Short Run and Long Run Cost of Production)
Technical efficiency occurs when a firm produces maximum output for a given technology;
Economic efficiency is achieved when the firm produces a given output at the lowest total cost
Costs and their behavior in long run and short Run

 Short run refers to the current time span during which one or more inputs are fixed.
 Long run refers to the period far enough in the future that all fixed inputs become variable inputs
 Sunk costs are irrelevant for future decisions and are not part of economic cost of production in
future time periods;
 Avoidable costs are payments a firm can recover or avoid, thus they do matter in decisions
The total product curve gives the economically efficient amount of labor for any output level when
capital is fixed in the short run

 Average product of labor (AP): total product divided by number of workers (labor) AP =
Q/L
 Marginal product of labor: Change in output/ Change in Labor; MP = ∆Q/∆L
 Marginal product of capital: Change in output/ Change in capital; MP = ∆Q/∆k
 Value of the marginal product of labor (VMPL): equal to MPL times output price VMPL = MPL * P
 The law of diminishing marginal product states that as the number of units of the variable
input increases, other inputs held constant, a point will be reached beyond which the
marginal product of the variable input declines.
 Short-run Total Cost, TC, sum of total variable cost, TVC, and total fixed cost, TFC:
STC = TVC + TFC.
 Average fixed cost (AFC), TFC divided by Quantity: AFC = TFC/Q;
 Average variable cost, AVC, is TVC divided by Quantity: AVC = TVC/Q;
 Average total cost (ATC) is TCdivided by Quantity: ATC = TC/Q
 Short-run marginal cost, SMC, is the change in either TVC or TC per unit change in output Q
(SMC = ∆TC/∆Q = ∆TVC / ∆Q)

 When MC < ATC, ATC is falling.

 When MC > ATC, ATC is rising.
 The MC curve crosses the ATC curve at the ATC curve’s minimum.
 The expansion path shows the optimal (or efficient) input combination for every level of
output; long-run cost curves are derived from the expansion path
 The link between product curves and cost curves in the short run when one input is variable
is reflected in the relations, AVC = w/AP and SMC = w/MP, where w is the price of the
variable input

 In the long run, all fixed inputs become variable inputs

 An isoquant (Similar to indifference curve CH5) is a curve showing
all possible input combinations capable of producing a given level
of output
 The marginal rate of technical substitution, MRTS, is the slope of an
isoquant and measures the rate at which the two inputs can be
substituted for one another while maintaining a constant level of
output
 MRTS = - ∆K/∆L = MPL /MPK
 Isocost curves show (right) the various combinations of inputs that may
be purchased for a given level of expenditure at given input prices (The
isocost curve’s slope is the negative of the input price ratio)

 C = LTC = wL + rK (w = labor price, r = capital price).

 The isocost curve’s slope is the negative of the input price ratio
 Minimize total cost of producing a given quantity of output by choosing the input
combination on the isoquant that is just tangent to an isocost curve
 The two slopes are equal in equilibrium
 LMC lies below (above) LAC when LAC is falling (rising).
 LAC = LTC / Q
 LMC = ∆LTC /∆Q
 LMC = LAC at LAC’s minimum value
 When LAC is decreasing, economies of scale.
 when LAC is increasing, diseconomies of scale.
 Long run average total cost curve corresponds to the lowest possible average total cost for
each factory.
 Economies of scope arise when firms produce joint products or when firms employ
common inputs in production
 Because managers possess the greatest flexibility in choosing inputs in the long run, long-
run costs are lower than short-run costs for all output levels except the output level for
which the short-run fixed input is at its optimal level
 Chapter 11:- (Competitive Markets)
Perfect competitors are price-takers, produce homogenous output, and have no barriers to
entry
The demand curve for a perfectly competitive firm is perfectly elastic (or horizontal) at the
market determined equilibrium price or (Demand Curve = Marginal Revenue Curve) (D =MR)
Similarly Supply Curve = Marginal Cost Curve (S = MC)

Managers make two decisions in the short run: (1) produce or shut down, and (2) if produce,
how much to produce
When positive profit is possible, profit is maximized at the output where P = SMC
When market price falls below minimum AVC the firm shuts down and produces nothing,
losing only fix cost

The firm will shut down (in short run) if:

Total revenue cannot cover total avoidable cost (TR < TVC) or, equivalently, P < AVC
MC = MR

 Supply curve equals the MC after the AVC

 The Demand for firm is flatter.
 Equilibrium point for firm is influenced by
industry.
 The quantity for industry is 8000 vs 8 fir firm.
 Firm graph shows short run IF the fixed cost
is represented.
 More company will join the market since
firm is making money, supply curve will shift
to the right and equilibrium price will drop.
In long-run competitive equilibrium
 all firms are in profit-maximizing equilibrium (P = LMC)
 P = MC = MR = ATC

No incentive for firms to enter or exit the industry because economic profit is zero (P = LAC)
Choosing either output or input usage leads to the same optimal output decision and profit
level
Five steps to find the profit-maximizing rate of production and the level of profit for a
competitive firm:
 Forecast the price of the product
 Estimate average variable cost and marginal cost
 Check the shutdown rule
 If P ≥ min AVC find the output level where P = SMC = MR
 Compute profit or loss

Short Run To Long Run Supply Curve:- join the Equilibrium points (how to determine long run
supply curve (impact of taxes andsubsidies)

Profit-Maximizing Input Usage:

 Marginal revenue product (MRP) MRP = ΔTR / ΔL = P x MP
 Average revenue product (ARP) ARP = TR /L = P x AP

Indifferent cost industries:-Constant cost, Reducing Cost, Increasing Cost

Chapter 12 (Monopolistic Competition)

Price-setting firms possess market power

A monopoly exists when a single firm produces and sells a particular good or service for which
there are no good substitutes and new firms are prevented from entering the market

Monopolistic competition arises when the market consists of a large number of relatively small
firms that produce similar, but slightly differentiated, products and have some market power

 A firm can possess a high degree of market power only when strong barriers to the entry of
new firms exist
 Market demand curve is the firm’s demand curve. This was different for pure competition.
 On the lift: D = MR = P = AR
 On the right: D= P but doesn't
equal MR

 In the short run, the manager of

a monopoly firm will choose to
produce where MR = SMC,
rather than shut down, as long as total revenue at least covers the firm’s total variable cost
(TR ≥ TVC),
o TR < TVC or (P < AVC), shutdown.
o P > ATC , Economic profit
o ATC > P > AVC , loss but continue to produce for short run.
 Profit maximization point in monopoly:
 MR >= MC

 In the long run, the monopolist maximizes profit by choosing to produce where MR =
LMC, unless price is less than long-run average cost (P <LAC), in which case the firm exits the
industry
 For firms with market power, marginal revenue product (MRP) is equal to marginal revenue
times marginal product: MRP = MR × MP
 Whether the manager chooses Q or L to maximize profit, the resulting levels of input usage,
output, price, and profit are the same
 Short-run equilibrium under monopolistic competition is exactly the same as for monopoly
 Long-run equilibrium in a monopolistically competitive market is attained
when the demand curve for each producer is tangent to the long-run
average cost curve
 Deadweight loss: Triangle between the demand curve and MC curve.
(figure)
 (a) the long-run equilibrium in a
monopolistically competitive market,
(b) shows the long-run equilibrium in a
perfectly competitive market.
 Two differences.
1. perfectly competitive firm
produces at the efficient scale,
where average total cost is
minimized. By contrast, the
monopolistically competitive
firm produces at less than the efficient scale.
2. Price equals marginal cost under perfect competition, but price is above marginal
cost under monopolistic competition.

 Monopolistic Competition Short-

run equilibrium is identical to
monopoly
 Unrestricted entry/exit leads to
long-run equilibrium, At
equilibrium output, P = LAC
and MR = LMC

 P = A + BQ , after partial derivative -> MR = A + 2BQ

 A firm producing in two plants, Aand B, should allocate production between the two plants
so that MCA = MCB

Chapter 13 (Decision Making In Oligopoly Markets)

Simultaneous decision games occur when managers must make their decisions without
knowing the decisions of their rivals

A dominant strategy is a strategy that always provides the best outcome no matter what
decisions rivals make

A prisoners’ dilemma arises when all rivals possess dominant strategies, and in dominant
strategy equilibrium, they are all worse off than if they cooperated in making their decisions
In Nash equilibrium, no single firm can
unilaterally make a different decision and
do better
Best-response curves are used to analyze
simultaneous decisions when choices are continuous rather than discrete

Sequential decisions occur when one firm makes its decision first, and then a rival firm makes
its decision

Three types of strategic moves: commitments, threats, promises

When decisions are repeated over and over, managers get a chance to punish cheaters, and,
through credible threat of punishment, rivals may be able to achieve the cooperative outcome
in prisoners’ dilemma situations

Strategic entry deterrence occurs when an established firm makes a strategic move designed to
discourage or prevent the entry of a new firm(s)

Two types of strategic moves designed to manipulate the beliefs of potential entrants about the
profitability of entering are limit pricing and capacity expansion