Microeconomics

Lecture 01
Md. Tuhin Ahmed
Lecturer
Department of Economics
Mawlana Bhashani Science and Technology University, Santosh, Tangail-1902

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What is Economics?
• The word “Economics” comes from the ancient Greek word “Oikonomia” based
on ‘Oikos’ (house) and ‘Nemein’ (manage). Oikonomia literally means household
management.
• Economics as a subject came into being with the publication of the very popular
book in 1776, “An Enquiry into the Nature and Causes of Wealth of Nations”,
written by Prof. Adam Smith.
• Adam Smith was a Scottish political economist and moral philosopher. He is
called the father of economics.
• Wealth Definition of Economics: Economics is the science of wealth.
• In Adam Smith’s view, "wealth" means the overall economic prosperity of a
nation, including the goods and services it produces, the accumulation of capital,
etc.
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What is Economics?
• Adam Smith, who is also regarded as the father of economics, stated that
economics is a science concerned with the nature and causes of wealth of
nations.
• Welfare Definition of Economics: Economics is the science of welfare.
• According to Alfred Marshall, economics is not a science of wealth but a science
of man primarily.
• Economics is not only the study of wealth but also the study of human beings.
Wealth is required for promoting human welfare.
• Scarcity Definition of Economics: Economics is the science of scarcity.
• According to Lionel Robbins, ‘Economics is the science which studies human
behaviour as a relationship between ends and scarce means which have
alternative uses’.
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What is Economics?
• ‘Ends’ are the wants, which every human being desires to satisfy.
• ‘Means’ or resources are limited. Means are money, time, land, labour, capital,
natural resources etc.
• The scarce means have ‘alternative uses’. A piece of land can be used for farming,
building a house, or setting up a factory.
• Example of Robin’s Definition: Ends: Suppose you want to buy an iPhone and a
laptop computer. Scarce means: Your money income is limited (for example 1
lakh taka). Alternative uses: The money can be used for buying an iPhone or
laptop to satisfy your different wants.
• Human behaviour: Your decision-making process involves choosing between
purchasing the iPhone or the laptop, based on which one you prioritize or
consider more important at the moment.
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What is Economics?
• Scarcity is the condition in which our wants (for goods) are greater than
the limited resources (land, labor, capital, and entrepreneurship) available
to satisfy those wants.
• Our wants (for goods) are infinite, but our resources (which we need to
produce the goods) are finite.
• Economics is the study of how societies use scarce resources to produce
valuable goods and services and distribute them among different
individuals to satisfy unlimited wants.
• Economics is the social science that studies the choices that individuals,
businesses, governments, and entire societies make as they cope with
scarcity and the incentives that influence and reconcile those choices.

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Microeconomics versus macroeconomics
• The subject matter of economics is divided into two categories–
microeconomics and macroeconomics.
• Adam Smith is usually considered the founder of microeconomics, the
branch of economics which today is concerned with the behaviour of
individual entities such as markets, firms, and households.
• Microeconomics is the study of how households and firms make decisions
and how they interact in the markets.
• The other major branch of our subject is macroeconomics, which is
concerned with the overall performance of the economy. Macroeconomics
did not even exist in its modern form until 1936, when John Maynard
Keynes published his revolutionary ‘General Theory of Employment,
Interest and Money’.
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Microeconomics versus macroeconomics
• At the time, England and the United States were still stuck in the Great
Depression of the 1930s, with over one-quarter of the American labour
force unemployed.
• Macroeconomics is the study of a economy as a whole.
• Micro means small and macro means large.
• Microeconomics, which deals with individual agents, such as households
and firms, and macroeconomics, which considers the economy as a whole.
• Microeconomics deals with the price and quantity of a particular
commodity, utility of a consumer, cost, revenue, profit of a firm etc.,
whereas macroeconomics deals with national income, GDP, inflation,
unemployment, etc.

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Three Fundamental Questions!
• Every human society must confront and resolve three fundamental economic
problems!
• What to produce?
• How to produce?
• For whom to produce?
• What to produce?: What commodities are produced and in what quantities? A
society must determine whether they will produce more consumption goods (like
RMG) or fewer investment goods (like RMG-making machines) using scarce
resources. A society also must determine how much of each goods and services
they will produce.
• This question addresses the issue of resource allocation. Given the limited
resources (land, labor, capital), society must decide which goods and services to
produce and in what quantities. The decision depends on factors such as
consumer preferences, production costs, and the availability of resources.
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Three Fundamental Questions!
• How are goods produced?: This question focuses on the methods and
techniques of production. It asks how goods and services should be
produced, considering factors like the technology to be used, the
combination of resources (labor and capital), and the cost-effectiveness of
different production methods. For example, should goods be produced
using more labor-intensive or capital-intensive methods?
• For whom are goods produced?: This question addresses the distribution
of goods and services. It asks who will receive the products and in what
quantities. Who consumes the goods and services that are produced
depends on the incomes that people earn. People with large incomes can
buy a wide range of goods and services. People with small incomes have
fewer options and can afford a smaller range of goods and services

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Production Possibilities Frontier
• A production possibilities frontier (PPF) is the combination of two
goods that an economy can produce, given its available resources and
technology.

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Production Possibilities Frontier
• The x-axis shows the quantity of pizzas produced, and the y-axis shows the
quantity of cola produced.
• The PPF illustrates scarcity because the points outside the frontier are
unattainable. These points describe wants that can’t be satisfied.
• We can produce at any point inside the PPF or on the PPF. These points are
attainable. For example, we can produce 4 million pizzas and 5 million cans of
cola. Figure 2.1 shows this combination as point E on the graph and as possibility
E in the table.
• Moving along the PPF from point E to point D (possibility D in the table) we
produce more cola and less pizza: 9 million cans of cola and 3 million pizzas.
• Or moving in the opposite direction from point E to point F (possibility F in the
table), we produce more pizza and less cola: 5 million pizzas and no cola.

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Production Possibilities Frontier
• The PPF separates the attainable from the unattainable.
• Production is possible at any point inside the orange area or on the
frontier.
• Points outside the frontier are unattainable.
• Points inside the frontier, such as point Z, are inefficient because
resources are wasted or misallocated. At such points, it is possible to
use the available resources to produce more of either or both goods.
• Opportunity cost: Opportunity cost is the value of the next best
alternative that must be given up to obtain something.

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Opportunity Cost
• To produce more pizzas we must produce less cola. The opportunity
cost of producing an additional pizza is the cola we must forgo.
• Similarly, the opportunity cost of producing an additional can of cola
is the quantity of pizza we must forgo.
• In Fig. 2.1, if we move from point C to point D, we produce an
additional 1 million pizzas but 3 million fewer cans of cola. The
additional 1 million pizzas cost 3 million cans of cola. Or 1 pizza costs
3 cans of cola.
• Similarly, if we move from D to C, we produce an additional 3 million
cans of cola but 1 million fewer pizzas. The additional 3 million cans of
cola cost 1 million pizzas. Or 1 can of cola costs 1/3 of a pizza.
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 Introduction to Economic Systems
Economic System Capitalism Command Economy Mixed Economy
An economic system based on A system where the government
A combination of capitalism and command
private ownership, free markets, controls all economic activities,
Definition economy, where both private enterprise and
and minimal government including production, distribution, and
government intervention coexist.
intervention. pricing.
Private individuals and businesses The government owns and controls Both private and public ownership of industries
Ownership
own resources and industries. most industries and resources. exist.
The government makes all economic Markets operate freely, but the government
Market Market forces (supply and demand)
decisions, including pricing and regulates to prevent market failures and ensure
Regulation determine prices and production.
production. social welfare.
Minimal intervention; government Complete control over economic
Role of Balances free markets with government oversight
primarily enforces laws and protects activities to ensure equal distribution
Government and social policies.
property rights. of wealth.
High; consumers decide what to buy Limited; the government determines Moderate; a mix of free choice and government-
Consumer Choice
based on their preferences. available goods and services. provided services.
Economic High due to competition and Low due to lack of competition and Moderate; competition exists but is regulated by
Efficiency innovation. bureaucracy. the government.
North Korea, Cuba, former Soviet
Examples United States, Canada, Australia Germany, France, India
Union 14
Microeconomics
Lecture 02
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

15
Theory of Demand
▪ Demand: Demand refers to the quantity of a good or service that
consumers are willing and able to purchase at various prices over a
specific period of time.
▪ Quantity Demanded: Quantity demanded refers to the specific amount of
a good or service that consumers are willing and able to purchase at a
particular price. It is a single point on the demand curve.
▪ Law of Demand: Other things remaining constant (ceteris paribus), if price
of a good rises, the quantity demanded of it will fall and if price of the good
falls, the quantity demanded will rise. The inverse relationship between
price and quantity demanded is called the law of demand.

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Demand Schedule and Demand Curve
▪ Demand schedule is a tabular statement that shows the different quantities of a
good that would be demanded at different prices.
▪ A demand curve is the graphical representation of the demand schedule.

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Individual vs Market Demand
▪ Individual Demand: Individual demand is the quantity of a good or service that a single
consumer is willing and able to purchase at various prices over a specific period of time.
▪ Market Demand: Market demand is the total quantity of a good or service that all
consumers in a market are willing and able to purchase at various prices over a specific
period of time.

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Deriving a Market Demand Curve

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Determinants of Demand
▪ Determinants of Demand: Demand for a good (𝑄𝑥 ) depends on
several factors:
1. Price of the good 𝑷𝒙 : If 𝑃𝑥 rises, 𝑄𝑥 will fall and if 𝑃𝑥 falls, 𝑄𝑥 will
rise.
2. Income of consumer 𝑰 : If 𝐼 rises, 𝑄𝑥 will rise and if 𝐼 falls, 𝑄𝑥 will
fall.
3. Price of substitute goods 𝑷𝒚 : If 𝑃𝑦 rises, 𝑄𝑥 will rise and if 𝑃𝑦 falls,
𝑄𝑥 will fall. For example: Tea (x) and Coffee (y).
4. Price of complementary goods 𝑷𝒛 : If 𝑃𝑧 rises, 𝑄𝑥 will fall and if 𝑃𝑧
falls, 𝑄𝑥 will rise. For example: Tea (x) and Sugar (z).

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Determinants of Demand
5. Taste and preference of consumer 𝑻 : If 𝑇 rises, 𝑄𝑥 will rise and if 𝑇 falls,
𝑄𝑥 will fall.
6. Number of buyers (N): More buyers means higher demand; fewer buyers
means lower demand.
𝑄𝑥 = 𝑃𝑥 , 𝐼, 𝑃𝑦 , 𝑃𝑧 , 𝑇, 𝑁 … … …
▪ Demand for a good mainly depends on the price of the good.
𝑄𝑥 = 𝑓 𝑃𝑥
▪ Let a demand function for a good is as follows:
𝑄 = 50 − 5𝑃
▪ Draw the demand function and check whether the function satisfies the
law of demand?
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Change in Demand vs Change in Quantity
Demanded (Shift vs movement)

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Theory of Supply
▪ Supply: Supply refers to the total amount of a good or service that
producers/sellers are willing and able to offer for sale at various prices
over a certain period of time.
▪ Quantity Supplied: refers to the specific amount of a good or service
that producers are willing and able to offer for sale at a specific price
over a certain period of time.
▪ Law of Supply: Other things remaining constant (ceteris paribus), if
price of a good rises, the quantity supplied of the good rises and if
price of a good falls, the quantity supplied of the good falls. The
positive relationship between price and quantity supplied is called the
law of supply.

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Supply Schedule and Supply Curve

Supply Schedule
Points Price Quantity
Supplied
A 1 10
B 2 20
C 3 30
D 4 40

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Deriving a Market Supply Curve

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Determinants of Supply
▪ Determinants of Supply: Supply of a good (𝑄𝑥 ) depends on several factors:
1. Price of the good 𝑷𝒙 : If 𝑃𝑥 rises, 𝑄𝑥 rises and if 𝑃𝑥 falls, 𝑄𝑥 falls.
2. Technology 𝑻 : If 𝑇 advances, 𝑄𝑥 rises and if 𝑇 demotes, 𝑄𝑥 falls.
3. Price of substitute goods 𝑷𝒚 : If 𝑃𝑦 rises, 𝑄𝑥 falls and if 𝑃𝑦 falls, 𝑄𝑥
rises. For example: Tea (x) and Coffee (y).
4. Price of complementary goods 𝑷𝒛 : If 𝑃𝑧 rises, 𝑄𝑥 rises and if 𝑃𝑧 falls,
𝑄𝑥 falls. For example: Tea (x) and Sugar (z).
5. Price of factors/resources (𝑷𝑭 ): If 𝑃𝐹 rises, 𝑄𝑥 falls, and if 𝑃𝐹 falls, 𝑄𝑥
rises.
6. 6. Future price expectation 𝑷𝒆 : If 𝑃𝑒 rises, 𝑄𝑥 falls now and if 𝑃𝑒 falls,
𝑄𝑥 rises now.

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Determinants of Supply
7. Number of sellers (N): More sellers means higher supply; fewer sellers means
lower supply.
8. Taxes and Subsidies: Higher tax, lower supply (tax increases per unit costs).
Higher subsidy, higher supply.
9. Government Restrictions: Government acts to reduce supply. Impose import
quota on imports. The quota reduces the supply of BD RMG in the US market.
𝑄𝑥 = 𝑃𝑥 , 𝑇, 𝑃𝑦 , 𝑃𝑧 , 𝑃𝐹 , 𝑃𝑒 , 𝑁, 𝑇, 𝑆, 𝐺 … … …
▪ Supply of a good mainly depends on the price of the good.
𝑄𝑥 = 𝑓 𝑃𝑥
▪ Let a supply function for a good is as follows:
𝑄 = 10 + 3𝑃
▪ Draw the supply function and check whether the function satisfies the law of
supply?
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Change in Supply vs Change in Quantity
Supplied (Shift vs movement)

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Microeconomics
Lecture 03
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

29
Market Equilibrium
▪ The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
▪ The equilibrium quantity is the quantity bought and sold at the equilibrium price.

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Math Practice on Market Equilibrium
1.The demand and supply function of a good market are given
by 𝑄 𝑑 = 50 − 5𝑃 and 𝑄 𝑠 = 10 + 3𝑃, respectively.
a. Define equilibrium price and equilibrium quantity. (4 Points)
b.Derive the equilibrium price and quantity of the good
market. (4 Points)
c. Draw the market equilibrium and show your findings you
derived in part (b) into the equilibrium. (2 Points)

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Effects of a Change in Demand
1. When demand increases,
the price rises and the
quantity increases.
2. When demand decreases,
the price falls and the
quantity decreases.

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Effects of a Change in Supply
1. When supply increases,
the price falls and the
quantity increases.
2. When supply decreases,
the price rises and the
quantity decreases.

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Effects of Change in both Demand and Supply

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Consumer Surplus and Producer Surplus
• Consumers’ Surplus (CS ) is the difference between the maximum price a buyer is willing and able
to pay for a good or service and the price actually paid.
• Consumers’ surplus = Maximum buying price - Price paid
• For example, if the highest price you would pay to see a movie is $10 and you pay $7 to see it,
then you have received a $3 consumers’ surplus.
• Producers’ (Sellers’) Surplus (PS ) is the difference between the price sellers receive for a good
and the minimum or lowest price for which they would have sold the good.
• Producers’ (sellers’) surplus = Price received - Minimum selling price
• Suppose the minimum price the owner of the movie theater would have accepted for admission
is $5. But she sells admission for $7, not $5. Her producers’ or sellers’ surplus is therefore $2.
• Total surplus (TS ) is the sum of consumers’ surplus and producers’ surplus:
• Total surplus = Consumers’ surplus + Producers’ surplus

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Consumer Surplus and Producer Surplus

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 Consumer Surplus and Producer Surplus

• For example, at 25 units, consumers’ surplus is equal to area A and producers’ surplus is equal to area E. At 50 units,
consumers’ surplus is equal to areas A + B and producers’ surplus is equal to areas E + F.
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Microeconomics
Lecture 04
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

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Price Elasticity of Demand
• Price elasticity of demand measures the responsiveness of quantity
demanded to changes in price. It is the percentage change in quantity
demanded divided by the percentage change in price.

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Graphical Representation of Price Elasticity of
Demand

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Cross elasticity of demand
• Cross elasticity of demand measures the responsiveness in the
quantity demanded of one good to changes in the price of another
good. It is calculated by dividing the percentage change in the
quantity demanded of one good by the percentage change in the
price of another. That is,

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Income elasticity of demand
• Income elasticity of demand measures the responsiveness of
quantity demanded to changes in income. It is calculated by dividing
the percentage change in quantity demanded of a good by the
percentage change in income. That is,

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Price Elasticity of Supply
• Price elasticity of supply measures the responsiveness of quantity
supplied to changes in price. It is calculated by dividing the
percentage change in the quantity supplied of a good by the
percentage change in the price of the good. Mathematically,

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Graphical Representation of Price Elasticity of
Supply

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Microeconomics
Lecture 05
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

45
Consumer Behavior
• Theory of Utility: Utility denotes satisfaction. The utility that implies the satisfying power
of a good or service is a psychological phenomenon. It varies from person to person and
measurement of it is a matter of concern.
• In the theory of demand, we assume that people maximize their utility, which means
that they choose the bundle of consumption goods that they most prefer.
• Total Utility The total satisfaction a person receives from consuming a particular quantity
of a good.
• Marginal utility denotes the additional utility you get from the consumption of an
additional unit of a commodity. Marginal utility (MU ) is the change in total utility (ΔTU )
divided by the change in the quantity (ΔQ) consumed of a good:

• The law of diminishing marginal utility states that, as the amount of a good consumed increases,
the marginal utility of that good tends to decline.

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Graphical Representation of Total and
Marginal Utility

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Difference between Cardinal and Ordinal
Utility
Cardinal Utility Ordinal Utility
1. It can be measured numerically. [1, 2, 3, 4 etc.,] 1. It can’t be measured numerically. [A>B>C]
2. It measures the utility objectively. 2. It measures the utility subjectively.
3. It is less realistic. 3. It is more realistic.
4. It is based on marginal utility analysis. 4. It is based on indifference curve analysis.
5. It is measured in terms of utils (units of utility). 5. It is measured in terms of ranking of preferences of
a commodity when compared to each other.
6. This approach was pronounced by Alfred Marshall 6. This approach was pioneered by Hicks and Allen.
and his followers.

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Consumer Equilibrium
• Consumer equilibrium is the equilibrium that occurs when the
consumer has spent all of his or her income and the marginal utilities
per dollar spent on each good purchased are equal.

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Consumer Equilibrium

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Consumer Equilibrium
• Budget Line/constraint: A budget line, also known as a budget
constraint, represents all the possible combinations of two goods that
a consumer can purchase given their income and the prices of the
goods.

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Consumer Equilibrium
• Indifference curve: An indifference curve is a graph that shows
different combinations of two goods that provide the same level of
satisfaction or utility to a consumer.
• Characteristics of IC:
-Indifference curves are downward sloping.
-Indifference curves are convex to the origin.
-Higher curves reflect higher utility.
-Indifference curves do not cross (intersect).

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Slope of Indifference Curve
• Marginal Rate of Substitution: The amount of one good that an
individual is willing to give up to obtain an additional unit of another
good and maintain equal total utility.

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Consumer Equilibrium

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Microeconomics
Lecture 06
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

55
Theory of Production
• In this chapter, our goal is to predict the behavior of firm.
• Firm: A firm is an institution that hires factors of production and organizes
those factors to produce and sell goods and services.
• Goal of Firm: A firm’s goal is to maximize profit.
• Factors of Production or Inputs: The resources used to produce goods and
services are called factors of production or inputs, which are grouped into
four categories: (i) Land, (ii) Labor, (iii) Capital, and (iv) Entrepreneurship.
• Land: The “gifts of nature” that we use to produce goods and services are
called land.
• Labor: The work time and work effort that people devote to producing
goods and services is called labor.

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Theory of Production
• Capital: The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and services are called
capital.
• Entrepreneurship: The human resource that organizes labor, land, and
capital is called entrepreneurship.
• The goods and services are called output.
• Production: Production is a transformation of resources or inputs into
goods and services (output).
• In technical terms, production means the creation of utility or creation of
want-satisfying goods and services.
• Output=f(inputs)

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Theory of Production
• Production function: Production function shows the relationship between
the quantity of inputs used to make a good and the quantity of output of
that good.
• Production function can be expressed as follows:
• 𝑄 = 𝑓 𝐿𝑎𝑛𝑑, 𝐿𝑎𝑏𝑜𝑟, 𝐶𝑎𝑝𝑖𝑡𝑎𝑙, 𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑒𝑛𝑒𝑢𝑟𝑠ℎ𝑖𝑝 .
• For analysis, we often use two inputs such as labor and capital.
• In this sense, 𝑄 = 𝑓(𝐿, 𝐾) is production function, where Q is output, L is
labor and K is capital.
• There are generally two types of production functions mostly used in
economics.
-The short-run production function, 𝑄 = 𝑓(𝐿, 𝐾)ഥ
-The long-run production function, 𝑄 = 𝑓(𝐿, 𝐾)
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 Theory of Production
• Difference between short run and long-run
Short Run Long Run
1. The short run is a period during which some inputs 1. The long run is a period during which all inputs
are fixed. can be varied. (No inputs are fixed.)
2. In the short run, a firm’s plant (capital) is fixed but 2. In the long run, both plant (capital) and labor are
labor is variable. variable.
3. To increase output in the short run, a firm must 3. To increase output in the long run, a firm can change
increase variable factor such as the quantity of labor. its plant as well as the quantity of labor it hires.
4. Short run decisions are easily reversed. 4. Long-run decisions are not easily reversed. Because
sunk cost is relevant in the long run.
• Short-run production function is a production function where at least one input is fixed, and the firm can only
vary some inputs (such as labor or raw materials) to increase output.
• Long-run production function is a production function where all inputs are variable, allowing the firm to
adjust all factors of production, including both labor and capital, to increase output.
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Production in the short run
• Total product is the maximum output that a given quantity of input
(such as labor) can produce.
• The marginal product of an input is the increase in total product from
a one-unit increase of that input while other inputs are held constant.
• The final concept is the average product, which equals total product
divided by total units of input.
• The Law of Diminishing Returns: The marginal product of each unit of
input will decline as the amount of that input increases, holding all
other inputs constant.

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Total Product, Marginal Product and Average
Product
Labor (workers Total Product Marginal Product Average Product Points in
per day) (sweaters per day) (sweaters per (sweaters per Graph
additional worker) worker)
0 0 A
1 4 4 4.00 B
2 10 6 5.00 C
3 13 3 4.33 D
4 15 2 3.75 E
5 16 1 3.20 F
• Most production processes experience increasing marginal returns initially, but all
production processes eventually reach a point of diminishing marginal returns.
• Diminishing marginal returns arise from the fact that more and more workers are using the
same capital and working in the same space. As more workers are added, there is less and
less for the additional workers to do that is productive.
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Total Product, Marginal Product and Average
Product

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Production in the long run
• Returns to Scale refers to the change in output resulting from a proportional change in all
inputs in the long run.
• Constant returns to scale denote a case where a change in all inputs leads to a proportional
change in output. For example, if labor, land, capital, and other inputs are doubled, then
under constant returns to scale output would also double.
• Increasing returns to scale (also called economies of scale ) arise when an increase in all
inputs leads to a more-than-proportional increase in the level of output. For example, an
engineer planning a small-scale chemical plant will generally find that increasing the inputs of
labor, capital, and materials by 10 percent will increase the total output by more than 10
percent.
• Decreasing returns to scale occur when a balanced increase of all inputs leads to a less-than
proportional increase in total output.

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Microeconomics
Lecture 07
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

64
Costs of production: Total, Average and
Marginal
• A firm’s total cost (TC ) is the cost of all the factors of production it uses.
• We separate total cost into total fixed cost and total variable cost.
• Total fixed cost (TFC ) is the cost of the firm’s fixed factors. Total fixed cost
represents expenses that do not vary with the level of output. For a
Sweater firm, total fixed cost includes the cost of renting knitting machines.
• Total variable cost (TVC ) is the cost of the firm’s variable factors. Total
variable cost represents expenses that vary with the level of output—such
as raw materials, wages, and fuel—and includes all costs that are not fixed.
• TC=TFC+TVC

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Costs and Cost Curves

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Marginal Costs
• That total variable cost and total cost increase at a decreasing rate at small outputs but
eventually, as output increases, total variable cost and total cost increase at an increasing rate. To
understand this pattern, we need to understand the marginal costs.
• A firm’s marginal cost (MC) is the increase in total cost that results from a one-unit increase in
output. We calculate marginal cost as the increase in total cost divided by the increase in output.
∆𝑇𝐶
• 𝑀𝐶 =
∆𝑄
• MC curve is U-shaped. At initial stage, when the number of inputs is low, each additional input
can lead to a significant increase in output because there’s more room for specialization and
better utilization of resources. Due to increasing returns in the first phase, at small outputs,
marginal cost decreases as output increases. This means it becomes cheaper to produce
additional units. This leads to the downward-sloping portion of the MC curve. Decreasing
Marginal Returns (Second Phase): As production increases, the firm faces diminishing returns due
to constraints like limited equipment or space. So the firm faces higher costs to produce each
additional unit of output. As a result, marginal cost rises. This leads to the upward-sloping portion
of the MC curve.
67
Average Costs
• There are three average costs of production:
• 1. Average fixed cost: Average fixed cost (AFC ) is total fixed cost divided by number of outputs.
• 2. Average variable cost: Average variable cost (AVC ) is total variable cost divided by number of
outputs
• 3. Average total cost: Average total cost (ATC ) is total cost divided by number of outputs.
• 𝑻𝑪 = 𝑻𝑭𝑪 + 𝑻𝑽𝑪
𝑻𝑪 𝑻𝑭𝑪 𝑻𝑽𝑪
• 𝑸
= 𝑸
+ 𝑸
• 𝑨𝑪 = 𝑨𝑭𝑪 + 𝑨𝑽𝑪
• The green average fixed cost curve (AFC ) slopes downward. As output increases, the same constant
total fixed cost is spread over a larger output.
• The blue average total cost curve (ATC ) and the purple average variable cost curve (AVC ) are U-
shaped. The vertical distance between the average total cost and average variable cost curves is equal
to average fixed cost—as indicated by the two arrows. That distance shrinks as output increases
because average fixed cost declines with increasing output.

68
Total, Average and Marginal Costs

69
Marginal and Average Costs
• The marginal cost curve (MC) intersects
the average variable cost curve and the
average total cost curve at their
minimum points.
• When marginal cost is less than average
cost, average cost is decreasing, and
when marginal cost exceeds average
cost, average cost is increasing.
• When marginal cost just equals average
cost, average cost is constant.
• This relationship holds for both the ATC
curve and the AVC curve.
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Why the Average Total Cost Curve
Is U-Shaped
• Average total cost is the sum of average fixed cost and average variable cost, so
the shape of the ATC curve combines the shapes of the AFC and AVC curves.
• The U shape of the ATC curve arises from the influence of two opposing forces:
• 1. Spreading total fixed cost over a larger output
• 2. Eventually diminishing returns
• When output increases, the firm spreads its total fixed cost over a larger output
and so its average fixed cost decreases—its AFC curve slopes downward.
• Diminishing returns means that as output increases, ever-larger amounts of labor
are needed to produce an additional unit of output.

71
Why the Average Total Cost Curve
Is U-Shaped
• So as output increases, average variable cost decreases initially but eventually
increases, and the AVC curve slopes upward. The AVC curve is U-shaped. The
shape of the ATC curve combines these two effects. Initially, as output increases,
both average fixed cost and average variable cost decrease, so average total cost
decreases. The ATC curve slopes downward.
• But as output increases further and diminishing returns set in, average variable
cost starts to increase. With average fixed cost decreasing more quickly than
average variable cost is increasing, the ATC curve continues to slope downward.
Eventually, average variable cost starts to increase more quickly than average
fixed cost decreases, so average total cost starts to increase. The ATC curve slopes
upward.

72
Microeconomics
Lecture 08
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

73
Market and Market Structure
• In economics, a market is a system where buyers and sellers interact to
exchange goods, services or resources.
• Key Features: (i) Buyers and Sellers, (ii) Goods and Services, (iii) Price
Determination, (iv) Competition
• Market structure is the environment whose characteristics influence a
firm’s pricing and output decisions.
• Economists identify four market structure:
✓Perfect competition
✓Monopolistic competition
✓Oligopoly
✓Monopoly

74
Market Structure

75
Perfect Competition
• Perfect Competition is a theory of market structure in which
(i) There are many sellers and many buyers
(ii) Each firm produces and sells a homogeneous product.
(iii) Buyers and sellers have all relevant information about prices, product quality, sources of supply, and so
forth.
(iv) Firms have easy entry and exit into the market.
• A Perfectly Competitive Firm Is a Price Taker
• Firms in perfect competition are price takers. A price taker is a firm that cannot influence the market price
because its production is an insignificant part of the total market.
• For example, if Farmer Stone is a price taker, he can increase or decrease his output without significantly
affecting the price of his product.
• In other words, such a firm “takes” the price determined in the market.

76
The Demand Curve for a Perfectly
Competitive Firm Is Horizontal
• The perfectly competitive setting has many sellers and many buyers. Together, all buyers make up the
market demand curve; together, all sellers make up the market supply curve.
• An equilibrium price is established at the intersection of the market demand and market supply curves.
• When the equilibrium price has been established, a single perfectly competitive firm faces a horizontal (flat,
perfectly elastic) demand curve at the equilibrium price.
• In short, the firm takes the equilibrium price as given—hence the firm is a price taker—and sells all
quantities of output at this price.

77
Why Does a Perfectly Competitive Firm Sell at
the Equilibrium Price?
• If a perfectly competitive firm tries to charge a price higher than the market-
established equilibrium price, it won’t sell any of its product. The reasons are that
the firm sells a homogeneous product, its supply is small relative to the total
market supply.
• If the firm wants to maximize profits, it does not offer to sell its good at a lower
price than the equilibrium price. Why should it? It can sell all it wants at the
market-established equilibrium price. The equilibrium price is the only relevant
price for the perfectly competitive firm.

78
The Marginal Revenue Curve of a Perfectly
Competitive Firm Is the Same as Its Demand Curve
• Total revenue (TR) is equal to the price (P) multiplied by the quantity sold (Q).
𝑻𝑹
• Average revenue (AR) is the total revenue divided by the quantity sold. 𝑨𝑹 =
𝑸
• Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in
quantity sold. Marginal revenue is calculated by dividing the change in total revenue by the
∆𝑻𝑹
change in the quantity sold. M𝑹 =
∆𝑸
• Since the firm in perfect competition is a price taker, the change in total revenue that results from
a one-unit increase in the quantity sold equals the market price.
• In perfect competition, the firm’s marginal revenue equals the market price.
• If price is equal to marginal revenue, then the marginal revenue curve for the perfectly
competitive firm is the same as its demand curve.

79
Profit maximizing output level of a
competitive firm
Quantity (Q) Price (P) TR=P*Q 𝑨𝑹=𝑻𝑹/𝑸 ∆𝑻𝑹 TC MC Profit=TR-TC
M𝑹 =
(Sweaters per day) ∆𝑸
7 25 175 25 140 35
8 25 200 25 25 160 20 40
9 25 225 25 25 185 25 40
10 25 250 25 25 215 30 35
11 25 275 25 25 250 35 30
12 25 300 25 25 300 50 0

• The break-even point occurs where the Total Revenue (TR)

line intersects the Total Cost (TC) line. This is the point
where the firm’s total revenue is equal to its total costs, and
thus, the firm’s profit is zero.

80
What Level of Output Does the Profit-
Maximizing Firm Produce?
• The graph compares marginal revenue, MR, with marginal cost, MC.
• As output increases, the firm’s marginal revenue is constant but its marginal
cost eventually increases.
• If marginal revenue exceeds marginal cost MR>MC, then the revenue from
selling one more unit exceeds the cost of producing it and an increase in
output increases economic profit.
• If marginal revenue is less than marginal cost, MR<MC, then the revenue
from selling one more unit is less than the cost of producing that unit and a
decrease in output increases economic profit.
• If marginal revenue equals marginal cost MR = MC, then the revenue from
selling one more unit equals the cost incurred to produce that unit.
• Economic profit is maximized and either an increase or a decrease in output
decreases economic profit

81
Three short run outcomes for the firm

82
Short run supply decision of a perfectly
competitive firm

83
The Perfectly Competitive Firm’s Short-Run
Supply Curve
• The perfectly competitive firm produces (supplies output) in
the short run if price is above average variable cost.
• It shuts down (does not supply output) if price is below
average variable cost.
• Therefore, the short-run (firm) supply curve is the portion of
the firm’s marginal cost curve that lies above the average
variable cost curve.

84
Microeconomics
Lecture 09
Md. Tuhin Ahmed
Lecturer
Department of Economics, MBSTU

85
Monopoly
• A monopoly is a market with a single firm that produces a good or
service with no close substitutes and that is protected by a barrier
that prevents other firms from entering that market.
• Examples: WASA in Dhaka City, DESCO etc.
• Characteristics of monopoly:
• There is one seller.
• The single seller sells a product that has no close substitutes.
• The barriers to entry are extremely high.

86
Why monopoly arises?
• Monopoly arises for two key reasons:
(i) No close substitutes: A monopoly sells a good or service that has
no good substitutes. For example: a local public utility that supplies
tap water is a monopoly.
(ii) Barrier to entry: A constraint that protects a firm from potential
competitors is called a barrier to entry. There are three types of
barrier to entry:
✓Natural
✓Ownership
✓Legal

87
Why monopoly arises?
• Natural Barrier to Entry: A natural barrier to entry creates a natural
monopoly: a market in which economies of scale enable one firm to supply
the entire market at the lowest possible cost. The firms that deliver gas, water,
and electricity to our homes are examples of natural monopoly.
• Ownership Barrier to Entry: An ownership barrier to entry occurs if one firm
owns a significant portion of a key resource. For example: Grameenphone’s
Telecom Network.
• Legal Barrier to Entry: A legal barrier to entry creates a legal monopoly: a
market in which competition and entry are restricted by the granting of a
public franchise, government license, patent, or copyright. For example:
Bangladesh Railway for railway services.

88
Monopoly’s output and price decisions

89
Monopoly’s demand and marginal revenue
curve
• In a monopoly, there is only one firm. Thus, the demand curve for the
monopoly firm is the market demand curve, which is downward sloping.
• Since a downward-sloping demand curve shows an inverse relationship
between price and quantity demanded, more is sold at lower prices than
at higher prices, ceteris paribus.
• Unlike the perfectly competitive firm, the monopolist can raise its price
and still sell its product (though not as much)
• Since it faces a downward-sloping demand curve, to sell an additional
unit of its product, the monopolist must necessarily lower its price for
the product on all previous units.

90
Monopoly’s demand and marginal revenue
curve
• The demand curve (D) plots price and
quantity; the marginal revenue curve
(MR ) plots marginal revenue and
quantity.
• Because price is greater than marginal
revenue for a monopolist, its demand
curve necessarily lies above its marginal
revenue curve.

91
Monopolist’s output and price decisions

• The monopolist that seeks to maximize profit produces the

quantity of output at which MR=MC and charges the highest
price per unit at which this quantity of output can be sold.
• The monopolist produces the quantity of output (Q1) at
which MR = MC and charges the highest price per unit P1 at
which this quantity of output can be sold.
• Notice that, at the profit-maximizing quantity of output,
price is greater than marginal cost (P>MC).

92
Comparison between perfect competition
and monopoly
• 1. For the perfectly competitive firm, P=MR; for the monopolist, P>MR. The perfectly competitive firm’s
demand curve is its marginal revenue curve; the monopolist’s demand curve lies above its marginal revenue
curve.
• 2. The perfectly competitive firm charges a price equal to its marginal cost; the monopolist charges a price
greater than its marginal cost. For a perfectly competitive firm, P=MC, and for the monopolist, P>MC.

• A competitive market produces the quantity QPC at price Ppc.

• A monopoly produces the quantity QM at which
marginal revenue equals marginal cost and sells that quan -
tity for the price PM.
• Compared to perfect competition, a monopoly produces a
smaller output and charges a higher price.

93
Deadweight loss of monopoly
• The monopolist produces QM, and the
perfectly competitive firm produces the
higher output level QPC. The deadweight
loss of monopoly is the triangle (DCB).
• The greater output is produced under
perfect competition than under monopoly.
The net value of the difference in these two
output levels is said to be the deadweight
loss of monopoly.
• The loss due to not producing the
competitive quantity of output.

94