ECONOMICS HARBOUR

UGC NET ECONOMICS STUDY MATERIAL

(NINTH EDITION)

UNIT 1
MICRO-ECONOMICS

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 Unit 1: Micro-Economics 1

CONCEPT OF DEMAND
The concept of demand was given by Alfred Marshall in 1890s in his book “Principles of
Economics”.

Five characteristics of demand

Desire Willingness Ability to Pay

(to consume the (to purchase the
(for the commodity)
commodity) commodity)

Price Time
(to consume the
(of the commodity)
commodity)

Demand is a flow concept

Why?
Because it is seen with reference to a continuous flow of purchases over a period of time.

Demand Function

Functional relationship between demand and factors affecting the demand such as
income, price of related goods, etc.

Quantity demanded is a function of:

1. Price of own good: There is an inverse

relationship between price of the goods and its
quantity demanded. Higher the price, less will
be the quantity demanded of it and vice-versa.

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 Unit 1: Micro-Economics 2

2. Income of the consumer: The

goods can be classified as:
Types of goods

Normal goods Inferior goods

(Positive relation (Negative relation
between demand between demand
and income.) and income)

3. Price of related goods (Substitutes/Complements): In case of substitute goods

(goods consumed in place of), there is a positive relationship between price of related
goods and quantity demanded. Higher the price of related good say Y, more will be the
quantity demanded of X. In case of complementary good (goods consumed together),
there is a negative relationship between price of related good say Y and quantity
demanded of X.
4. Tastes and preferences: In case of favourable tastes, there is a positive relationship
with the demand and in case of unfavourable tastes, there is a negative relationship with
demand.
5. Advertisement outlay: Higher the advertisement outlay, more will be the demand, thus
hinting on a positive relationship.
6. Future expectations of price: If prices are expected to rise in future, the demand at
present will increase. Alternatively, if prices are expected to fall in future, the demand
at present will fall.
7. Number of customers in the market: More are the consumers in a market, more will
be the quantity demanded of a good and vice-versa.

Identify the relationship between following factors and demand. Tick the
correct column.
Factor Positive Negative
relationship relationship
1. Price
2. Normal Goods
3. Inferior Goods
4. Substitute Goods
5. Complementary Goods
6. Favourable Tastes
7. Unfavourable Tastes
8. Advertisement Outlay
9. Price to increase in future
10. Price to decrease in future
11. Number of consumers in the market.

Check your answers:

Score: 10-11: Excellent, 8-9: Good, 6-7: Satisfactory, 5 or below: Please study!

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 Unit 1: Micro-Economics 3

LAW OF DEMAND

The law of demand was given by Alfred Marshall. It

For your information!
is a partial equilibrium analysis and states that there
Partial Equilibrium models
is an inverse relationship between price of the consider only one market at a
commodity and the quantity demanded of it. time, ignoring potential
interactions across markets.

REPRESENTATION OF LAW OF DEMAND

Demand Curve Demand Schedule

Graphical presentation of the law of demand. Tabular presentation of the law of

demand.
Price of the Quantity
commodity demanded

5 2

4 4

3 6

2 8

1 10

Demand curve and demand schedule do not tell us what the price is, they only tell us how
much quantity of the good would be purchased by the consumer at various possible prices.

Market Demand

 Horizontal summation of individual demands.

 Affected by the population level, that is, larger the population, more will be the market
demand.
 Market demand curve is flatter as to the individual demand.

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 Unit 1: Micro-Economics 4

Reasons for downward sloping demand curve

1. Law of Diminishing Marginal Utility: The law was given by Alfred Marshall and it
states that “as the consumer consumes more and more of a good, the marginal utility
derived from each successive unit keeps on decreasing.” As a result, a consumer would
purchase subsequent units of a commodity only if its price decreases and vice-versa.
Therefore, the demand curve slopes downwards.

2. Income effect:

Increase in Real
Decrease in price
Income

Increase in Increase in
demand Purchasing power

What is Real Income?

Real income is an economic measure that provides an

estimation of an individual’s actual purchasing power.

Real Income = Nominal Income Price of the commodity

3. Substitution effect: Marshall explained the downward sloping demand curve with the
aid of substitution effect alone; and he ignored the income effect on price change.

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 Unit 1: Micro-Economics 154

2. Walras Approach :- Quantity dependent approach depends on price movement.

Shape of Shape of supply Particular Walras Marshall

Demand curve
Curve Feature Stability Stability

Downward Upward Intersecting Stable Stable

Upward Downward Intersecting Unstable Unstable

Downward Downward Supply curve cuts demand Stable Unstable

curve from above

Downward Downward Supply curve cuts demand Unstable Stable

curve from below

Upward Upward Supply curve cuts demand Stable Unstable

curve from above

Upward Upward Supply curve cuts demand Unstable Stable

curve from below

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 Unit 1: Micro-Economics 155

Government Intervention in terms of fixing maximum and minimum prices

Floor means the lowest limit. Floor price means

the minimum price fixed by the government for
a commodity in the market. It seems
paradoxical, but is true that the government in
most countries fixes floor price for most
agricultural products, food grains in particular.

Ceiling means maximum limit. Price ceiling

means maximum price of a commodity that the
sellers can charge from the buyers. Often, the
government fixes this price much below the
equilibrium market price of a commodity so that
it becomes within the reach of the poorer sections of the society.

How demand and supply curves change when government intervenes?

Rationing Demand curve shifts upward to the right

Subsidies to producers Supply curve shifts to the right

Taxes on producers Supply curve shifts to the left

2-Minute Quiz
1. Giffen paradox occurs when income effect is:
a. negative and is more than substitution effect.
b. equal to substitution effect.
c. greater than substitution effect.
d. less than the substitution effect.

2. In the consumer behavior theory, the following

theories consider risk and uncertainty factors are:
a. Hicks-Allen Indifference curve
b. revealed preference approach
c. Theory by Neumann-Morgenstein
d. Marshallian cardinalist approach.

3. Slutsky equation deals with the decomposition of:

a. Goods into necessaries and luxuries.
b. goods into superior and inferior goods.
c. goods into high priced and low priced.
d. price effect into substitution and income effects.

Correct Answers: 1) A, 2) C, 3) D

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 Unit 1: Micro-Economics 156

BAUMOL’S SALES MAXIMISATION MODEL

The main aim of the model is to maximise the sales or maximising revenue from sales, subject
to some minimum level of profits.

L is the minimum profit line which should be earned to satisfy the shareholders.

The managers aim to maximise revenues instead of maximising the profits. As a result, the firm
does not operate at A level of output. Rather it works at B output level, so as to maximise the
sales and hence revenue. If the firm produced more than B, then profits would become less
than the minimum profit level, hence causing disequilibrium to the shareholders. Therefore,
the management prefers to produce output till B.

It should be noted that profit maximisation leads to lesser output as compared to revenue
maximisation.

The reasons behind managers working towards maximising sales instead of profits are as
follows:

1. Sales is considered to be the main criteria for the index of performance of the firm by
various financial institutions.
2. The managers are more satisfied by maximising revenue instead of maximising profits
in which they get no share.
3. Salaries and perks of the managers are dependent on the sales earning.
4. The day to day problems can more easily be solved by growing the sales of the firm,
hence increasing revenue.
5. Increasing sales implies more share of the firm in the market and hence increasing the
bargaining power of the firm.

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 Unit 1: Micro-Economics 157

MARRIS MODEL OF MAXIMISATION OF GROWTH RATE

According to R. Marris, the managers do not aim to maximise profits. Rather they aim to
maximise the balanced growth rate of the firm. It can be expressed as

Maximise: G = Gd = Gc

Where: Gd is the growth of product market, Gc is the growth of supply of capital.

It should be noted that utility of managers is a function of,

Umanagers = F ( Gd, Job Security)

And Utility of owners is a function of

Uowner = F( Gc)

Marris also talked about two types of constraints

1. Managerial constraints: These are related to the skills of manager and research &
Development.
2. Financial constraints: He talked about a few ratios:
𝑫𝒆𝒃𝒕
a. Debt Ratio/Leverage ratio = 𝑮𝒓𝒐𝒔𝒔 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒂𝒔𝒔𝒆𝒕𝒔
Higher the ratio, lesser the security.

𝑳𝒊𝒒𝒖𝒊𝒅 𝒂𝒔𝒔𝒆𝒕𝒔
b. Liquidity Ratio = 𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Higher the ratio, higher is the security.

𝒓𝒆𝒕𝒂𝒊𝒏𝒆𝒅 𝒑𝒓𝒐𝒇𝒊𝒕𝒔
c. Retention Ratio =
𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Higher the ratio, higher the security.

Financial Constraint is a combination of debt ratio, liquidity ratio and retention

ratio.

Rationale for Maximizing Growth Rate

Managers do not maximize the absolute size of the firm but the rate of growth.
Utility function of managers:
Um = f (Gd, S)
Where Gd = Growth rate of product market or demand (+), S = Measure of job security (+)

Utility of owners:
Uowner = F( Gc)
Where: GC = Growth rate of capital supply
GC depends on debt ratio, liquidity ratio, retention ratio

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 Unit 2: Macro-Economics 20

Increase in government expenditure

Full employment of resources; resources will

not increase (DemandFactor > SupplyFactor)

Increase in factor prices

Inflationary pressures

Inflationary gap only generates money income without creating matching real output because
economy is in full employment equilibrium.

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 Unit 2: Macro-Economics 24

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