Module – 1: Introduction

Economics is the study of scarcity and its implications for the use of resources, production of goods and services, growth
of production and welfare over time, and a great variety of other complex issues of vital concern to society.

- analyzes human behavior scientifically.

- explores the economic interactions between consumers and producers.
- evolves continuously as current observations and experience provide new evidence about economic behavior and
relationships.
- examines how people choose among the alternatives available to them.
- It is social because it involves people and their behavior.
- It is a science because it uses, as much as possible, a scientific approach in its investigation of choices.

Particulars Microeconomics Macroeconomics

Meaning Microeconomics is the branch of Economics that Macroeconomics is the branch of Economics that
is related to the study of individual, household deals with the study of the behavior and
and firm’s behavior in decision making and performance of the economy in total.
allocation of the resources.
Area of Microeconomics studies the particular market Macroeconomics studies the whole economy, that
study segment of the economy covers several market segments
Deals with Microeconomics deals with various issues like Macroeconomics deals with various issues like
demand, supply, factor pricing, product pricing, national income, distribution, employment, general
economic welfare, production, consumption etc. price level, money etc.
Business It is applied to internal issues. It is applied to environmental and external issues.
Application
It is useful in regulating the prices of a product It perpetuates firmness in the broad price level, and
Significance alongside the prices of factors of production solves the major issues of the economy like
(labor, land, entrepreneur, capital, and more) deflation, inflation, unemployment, and poverty as
within the economy. a whole.
Limitations based on impractical presuppositions, i.e., in It has been scrutinized that the misconception of
microeconomics, it is presumed that there is full composition’ incorporates, which sometimes fails to
employment in the community, which is not at all prove accurate because it is feasible that what is
feasible. true for aggregate (comprehensive) may not be true
for individuals as well.

❖ Positive economics refers to the matter of the presence of the theory along with the proven facts and figures that are
taken into account before developing a theory. Increase in interest rate causes decrease in demand for loans is an
example of positive statement.

❖ Normative economics refers to the beliefs that support the valued judgement which is better for the nation’s
economic future and for social welfare. Having a belief that the income should be distributed evenly in the economy
is an example of normative economics.

❖ Scarcity: The fact that there is a limited number of resources to satisfy unlimited wants. Scarcity is the condition of
having to choose among alternatives. A scarce good is one for which the choice of one alternative use of the good
requires that another be given up. Scarcity confronts people with choices, and the associated fundamental economic
questions. Every economy must determine
o what should be produced,
o how it should be produced, and
o for whom it should be produced.
o What provisions (if any) are to be made for economic growth?
❖ Problem of choice refers to the allocation of various scarce resources which have alternative uses that are utilized for
the production of various commodities and services in the economy for the satisfaction of unlimited human wants.
problem of choice arises due to the following reasons:
o Unlimited Wants: Human wants are unlimited.
o Limited or Scarce Means: Resources are scarce in relation to human wants.
o Alternative Uses: Resources have alternative uses.

❖ A free good is one for which the choice of one use does not require that we give up another.

❖ Opportunity cost is the value of the best alternative forgone in making any choice. Opportunity cost refers to what
one has to give up to buy in terms of other goods or services.
o Example: A farmer chooses to plant wheat; the opportunity cost is planting a different crop, or an alternate use of
the resources (land and farm equipment).

❖ Economic resources: Things that are inputs to production of goods and services. There are 04 economic resources:
land, labor, capital, and technology. Technology is sometimes referred to as entrepreneurship.

o Land: Natural resources that are used in the production of goods and services. Some examples of land are lumber,
raw materials, fish, soil, minerals, and energy resources.
o Labor: Work effort used in the production of goods and services. Some examples are the number of workers and
number of hours worked.
o Capital: Physical goods that are produced and used to produce other goods. Examples of capital would be
machinery, technology, and tools such as computers; hammers; factories; robots; trucks, and trains used to
transport goods.
o Entrepreneurship: The ability to combine the other productive resources into goods and services.
o Technology is playing crucial roles, the knowledge that can be applied to the production of goods and services.
Entrepreneurs put new technologies to work every day, changing the way factors of production are used.

❖ A production possibility curve (PPC)/production possibility frontier (PPF) is made to evaluate the performance of a
manufacturing system when two commodities are manufactured together. The management utilizes this graph to plan
the perfect proportion of goods to produce in order to reduce the wastage and costs while maximizing profits.

The diagram or graph explains the units of goods that a

company can produce if all the resources are utilized
productively. Therefore, a single commodity’s
maximum manufacturing probability is arranged on the
X-axis and that of the other commodity on the Y-axis.
Here, the curve is represented to show the number of
products that can be created with limited resources,
while pausing the use of technology in between.

In the graph, the line sloping down also depicts the

trade-off between producing commodity A and
commodity B. When a firm diverts its resources to
produce commodity B, the production of commodity A
reduces.

A point above the curve indicates the unattainable with

the available resources. A point below the curve means
that the production is not utilizing 100 percent of the
business’ resources
❖ An economic model is a simplified version of reality that allows us to observe, understand, and make predictions
about economic behavior. The purpose of a model is to take a complex, real-world situation and pare it down to the
essentials. Economic models offer a way to get a complete view or picture of an economic situation and understand
how economic factors fit together.

❖ The circular flow model/diagram demonstrates

how money moves through society (households
and firms). Money flows from producers to
workers as wages (labor market) and flows back
to producers as payment for products (goods
and services market). In short, an economy is an
endless circular flow of money.
o Two-factor Model: Households and Firm
o Three-Sectors Model: Households, Firms and Government (Taxes and Expenditures)
o Four-Sectors Model: Foreign Sector (Import and Export, Inflow and Outflow of capital)
o Five Sector Model: Financial Sector. Banks and Other Institutions. (Deposit and advances)

Particulars Market Economy Command Economy

Meaning Economic systems wherein market decisions economic system in which the government
are governed by price fluctuations that occur makes all the economic decisions
when sellers and consumers interact to set regarding the production, distribution, and
the sale of products. consumption of goods and services
Security of the Economy Individuals are responsible for their monetary The government ensures financial security.
security.
Restriction Individuals can unrestrainedly pick their work Individuals can’t unrestrainedly pick their
and utilize their assets and capacities. work or change occupations.
Allocation of Resources Chosen by consumers and factor markets. Chosen by central organizers.
Decision Regarding In light of buyer interest or demand in the The state chooses the manufacturing.
Production market.
Objectives of Goods Benefit objective. Social goal.
Production
Income Inequality Indeed. No.
Rate of Growth The rate of financial development is high. The rate of financial development is low.
Factors of Production Owned by firms and private people. Owned by the public authority.
Price Mechanism Utilized. Not utilized.
Managed by Consumers and manufacturers. Government.

❖ A mixed economic system is a system that combines aspects of both capitalism and socialism. A mixed economic system
protects private property and allows a level of economic freedom in the use of capital, but also allows for governments
to interfere in economic activities in order to achieve social aims.
o government can intervene in key sectors like education, or healthcare while leaving other, less important from
the perspective of a well-being of the society, sectors to private companies.
o The increasing government involvement also ensures that less competitive individuals are looked after. This
eliminates one of the drawbacks of a market economy, which favors only the most successful or inventive.
❖ Traditional Economic System: Traditional economic systems are often found in rural or remote areas where access to
modern technology and infrastructure is limited. These systems tend to be self-sufficient and sustainable, but they may
also be susceptible to external shocks and disruptions. A traditional economy is an economy where historical norms and
habits govern what and how things are created, distributed, and spent. While money can be used in traditional
economies, but it is often limited to certain transactions and may not be the primary medium of exchange. In many
traditional economies, bartering is more common than using money.
 Module – 2: Microeconomics
Supply refers to the market's ability to produce a good or service, whereas demand refers to the market's desire to purchase
the good or service. Supply and demand are often considered to be a fundamental concept within economics and is
primarily used to describe the price and availability of commodities.

Causes of downward sloping of demand curve

❖ Law of diminishing the marginal utility: The law of
diminishing marginal utility states that with each
increasing quantity of the commodity, its marginal
utility declines. For example, when a person is very
hungry the first chapatti that he eats will give him the
most satisfaction. As he will consume more chapattis,
his level of satisfaction will diminish. Thus, when the
quantity of goods is more, the marginal utility of the
commodity is less. Thus, the consumer is not willing
to pay more price for the commodity and its demand
will decline. Also, when the price of the commodity is
low, its demand increases. Hence, the demand curve
slopes downwards from left to right.

❖ Substitution effect: Tea and coffee are substitute goods. If the price of tea rises, consumers will shift to coffee. This will
decrease the demand for tea and increase the demand for coffee. Thus, the demand curve of tea will slope downwards.

❖ Income effect: Income effect refers to the change in the real income or the purchasing power of the consumers. When
the price level falls the purchasing power of the consumer’s increases and they buy more goods. Similarly, when the
price level rises, the purchasing power of the consumer’s decreases and they buy less quantity of goods.

❖ New buyers: Due to the fall in the prices of a commodity new buyers get attracted towards it and buy it. Thus, this
increases the demand for the commodity.

❖ Old buyers: When the prices of the goods fall the old buyers tend to buy more goods than usual thereby increasing its
demand. This causes the downward sloping of demand curve.
Demand Curve shows how much consumer will consume at different prices. Is a function that shows the quanity demanded
at different prices.
Change in Change in
quantity Demand means
demanded shift of main
means demand curve
movement in to left
main demand (decrease) or
curve due right (increase)
changes in price on same price
and quanity. due to income,
Price increase population,
and demand tastes, related
decrease vice goods,
versa expectation
Supply Curve show how much sellers will supply at
different prices. A supply curve is a function that shows
the quantity supplied at different prices.
Example: Oil production cost in Saudi Arabia $2, in
Alaska $10, in Gulf Coast $50. At $2, only Saudi Arabia
will supply, at $10 Alaska (USA) will join, at $50 price,
other costly producer will supply oil. Thus, Supply Curve
is upward slope, higher price, higher supply.
Supply schedule reflects the quantities supplied at each
and every price. Supply curve - is nothing more than a
schedule. There is a positive relation between price and
quantity on a supply curve. Supply Shifters:
❖ Technological innovations, Input Prices, Taxes and Subsidies,
Expectations, Entry or Exit of Producers, Changes in Opportunity Costs
Market equilibrium occurs where supply equals demand (supply curve
intersects demand curve). An equilibrium implies that there is no force that
will cause further changes in price, hence quantity exchanged in the market.
At the equilibrium price, the quantity of the good that buyers are willing and
able to buy exactly balances the quantity that sellers are willing and able to
sell. Given price where quantity demanded is equal to quantity supplied.

An indifference curve is a locus of combinations of goods which

derive the same level of satisfaction, so that the consumer is
indifferent to any of the combination he consumes. If a consumer
equally prefers two product bundles, then the consumer is
indifferent between the two bundles. The consumer gets the
same level of satisfaction (utility) from either bundle. Graphically
speaking, this is known as the indifference curve. An indifference
curve shows combinations of goods between which a person is
indifferent. Advantages of Indifference Curve Technique

• Dispenses with Cardinal Measurement of Utility

• Studies Combinations of Two Goods Instead of One Good
• Provides a Better Classification of Goods into Substitutes and Complements
• Explains the Law of Diminishing Marginal Utility without the Unrealistic Assumptions of the Utility Analysis
• It is Free from the Assumption of Constant Marginal Utility of Money:
• Explains the Proportionality Rule in a Better Way
• Rehabilitates the Concept of Consumer’s Surplus, Explains the Law of Demand more Realistically
Main attributes or properties or characteristics of indifference curves:
1) Indifference Curves are Negatively Sloped: The indifference curves must
slope downward from left to right. As the consumer increases the
consumption of X commodity, he has to give up certain units of Y commodity
in order to maintain the same level of satisfaction. Diagram: 02 combinations
of commodity cooking oil and commodity wheat is shown by the points a and
b on the same indifference curve. The consumer is indifferent towards points
a and b as they represent equal level of satisfaction.

2) Higher Indifference Curve Represents Higher Level of Satisfaction:

Indifference curve that lies above and to the right of another indifference
curve represents a higher level of satisfaction. The combination of goods which lies
on a higher indifference curve will be preferred by a consumer to the combination
which lies on a lower indifference curve. Diagram: 03 indifference curves, IC1,
IC2 and IC3 which represents different levels of satisfaction. The indifference
curve IC3 shows greater amount of satisfaction and it contains more of both
goods than IC2 and IC1. IC3 > IC2> IC1.

3) Indifference Curves are Convex to the Origin: This is an important property of

indifference curves. They are convex to the origin. As the consumer substitutes
commodity X for commodity Y, the marginal rate of substitution diminishes as X for
Y along an indifference curve. The Slope of the curve is referred as the Marginal
Rate of Substitution. The Marginal Rate of Substitution is the rate at which the
consumer must sacrifice units of one commodity to obtain one more unit of
another commodity. Diagram: as the consumer moves from A to B to C to D, the
willingness to substitute good X for good Y diminishes. The slope of IC is negative.
Diminishing MRSxy is depicted as the consumer is giving AF>BQ>CR units of Y for
PB=QC=RD units of X. Thus indifference curve is steeper towards the Y axis and
gradual towards the X axis. It is convex to the origin.

4) Indifference Curves cannot Intersect Each Other: The indifference curves cannot
intersect each other. It is because at the point of tangency, the higher curve will
give as much as of the two commodities as is given by the lower indifference curve.
This is absurd and impossible. In the above diagram, two indifference curves are
showing cutting each other at point B. The combinations represented by points B
and F given equal satisfaction to the consumer because both lie on the same
indifference curve IC2. Similarly, the combinations show by points B and E on
indifference curve IC1 give equal satisfaction top the consumer. If combination F is
equal to combination B in terms of satisfaction and combination E is equal to
combination B in satisfaction. It follows that the combination F will be equivalent
to E in terms of satisfaction. This conclusion looks quite funny because combination
F on IC2 contains more of good Y (wheat) than combination which gives more
satisfaction to the consumer. We, therefore, conclude that indifference curves
cannot cut each other.

5) Indifference Curves do not Touch the Horizontal or Vertical Axis: One of the basic
assumptions of indifference curves is that the consumer purchases combinations
of different commodities. He is not supposed to purchase only one commodity. In
that case indifference curve will touch one axis. This violates the basic assumption
of indifference curves. In the above diagram, it is shown that the in difference IC touches Y axis at point P and X axis at
point S. At point C, the consumer purchase only OP commodity of Y good and no commodity of X good, similarly at point
S, he buys OS quantity of X good and no amount of Y good. Such indifference curves are against our basic assumption.
Our basic assumption is that the consumer buys two goods in combination.
Assumptions about preferences
o Preferences are assumed to be complete: The assumption of completeness implies that consumers have the ability
to rank all their preferences and hence can compare them accordingly.
o Preferences are transitive: The assumption of transitivity implies that if the consumer ranks good A ahead of good
B and good B ahead of good C, then it should be true that good A is ranked ahead of good C.
o More is better than less: The assumption of ‘more is always better signifying that the consumer or the customer
always prefers to have more of all the goods and services he consumes.
o Diminishing marginal rate of substitution: According to this assumption, as the consumers consume more of the
given good or service, he is willing to give up fewer and fewer units of the other good each time the consumption
of the given good is increased by one unit.
Price elasticity of demand is the ratio of the percentage
change in quantity demanded of a product to the percentage
change in price. It is used to understand how supply and
demand change when a product's price changes.
If two linear demand (or supply) curves run through a common
point, then at any given quantity the curve that is flatter is
more elastic.
Determinant: Availability of Substitutes, Time Horizon,
Category of Product (Specific or broad), Necessities vs
Luxuries, Purchase Size.

Price elasticity of supply measures the responsiveness to the

supply of a good or service after a change in its market price.
According to basic economic theory, the supply of a good will
increase when its price rises. Conversely, the supply of a good
will decrease when its price decreases.
Determinant: Change in Per-unit costs with increased
production, Time Horizon, Share of Market for Inputs,
Geographic Scope.
ED/S = Changes in Quantity / Changes in Price
< 1 = Inelastic, > 1 = Elastic, = 1, Unit Elastic
Exceptions to the law of demand:
1) Speculative demand in share market rises
with price.
2) Veblen goods – diamond, rate items to
show capability,
3) Costly items seem more useable,
4) Giffen Goods – inferior goods,
5) Essential goods – drugs
❖ Income elasticity of demand describes the sensitivity to changes in consumer income relative to the amount of a good
that consumers demand. Highly elastic goods will see their quantity demanded change rapidly with income changes,
while inelastic goods will see the same quantity demanded even as income changes. Can Income Elasticity of Demand
Be Negative? Yes, for example with certain "inferior" goods, the more money people have the less likely they are
to buy cheaper products in favor of higher quality ones. What Is Something That Is Inelastic to Changes in Income?
Inelastic goods tend to have the same demand regardless of income. Certain staples and basics such as gasoline or
milk would not change with income—you'll still only need one gallon a week even if your income doubles.

❖ Normal goods (most goods fall into this category) are goods that consumers buy more of when their incomes rise, and
less of when their incomes fall. Normal goods have a positive income elasticity coefficient since increases in incomes
cause increases in the demand for normal goods. Inferior goods are goods like one-ply toilet paper, top ramen, or generic
brand products. When consumers’ incomes rise, consumers buy less of these goods, and when incomes fall, they buy
more. Inferior goods have a negative income elasticity coefficient. This is because increases in incomes cause decrease
in the demand for inferior goods.

❖ In economics, utility is a term used to determine the worth or value of a good or service. More specifically, utility is the
total satisfaction or benefit derived from consuming a good or service. Economic theories based on rational choice
usually assume that consumers will strive to maximize their utility. Ordinal utility assumes that individuals can rank
commodity bundles in accordance with the level of satisfaction associated with each bundle. Cardinal Utility: Ordinal
utility does not indicate by how much one is preferred to another. And when utility is placed using specific number, it is
called cardinal utility. Total Utility: If utility in economics is cardinal and measurable, the total utility (TU) is defined as
the sum of the satisfaction that a person can receive from the consumption of all units of a specific product or service.

❖ Marginal utility is the added satisfaction that a consumer gets from

having one more unit of a good or service. The concept of marginal
utility is used by economists to determine how much of an item
consumer are willing to purchase.
o Positive marginal utility occurs when the consumption of an
additional item increases the total utility.
o negative marginal utility occurs when the consumption of one
more unit decreases the overall utility.
o Zero marginal utility is what happens when consuming more of
an item brings no extra satisfaction.
Marginal Utility = Changes in Total Utility / Changes in Quantity
The law of diminishing marginal utility states that the amount of satisfaction provided by the consumption of every
additional unit of good decreases as we increase that good’s consumption. Marginal utility is the change in the utility derived
from consuming another unit of a good. Exceptions to the law is drugs, alcohol, miser, hobbies, power etc.
❖ Consumer Surplus is the consumer gain from exchange. It is the difference between consumer’s maximum willingness
to pay for a given quantity and the market price, the consumer actually has to pay.
❖ Supplier Surplus is difference between market price and the minimum price supplier will sell a given quantity.
❖ Price Ceiling a maximum price allowed by law: 5 Important effects – Shortages, reductions in product quality, wasteful
lines and other search cost, a loss in gains from trade (deadweight loss), a misallocation of resources.
❖ Price Floor – a minimum price allowed by law. 4 important effects – surpluses, lost gains from trade (deadweight loss),
wasteful increases in quality, misallocation of resources.

Microeconomics studies the study of economics from the view point of an individual unit. Price theory studies how prices
of goods are determined in the commodity market and how process of factors of production are determined in the factor
market. Thus micro economics is also known as price theory. Micro economics analyses how the scare resources are
allocated efficiently to the production of goods and services. It helps in resolving the central economic problems of the
economy at an individual level. Allocation of resource involves what to produce, how to produce and how much to produce.
Efficiency in the allocation of resources is attained when the resources are so allocated that maximizes the satisfaction of
the people.

Macroeconomics connects together the countless policies, resources, and technologies that make economic development
happen. Without proper macro management, poverty reduction and social equity aren't possible. Macroeconomics refers
to the study of an economy - usually a nation’s economy - as a whole. In Concept 10: Economic and Social Goals, we discussed
that nations have economic goals, like equity and efficiency. In macroeconomics three of these goals receive extra focus:
economic growth, price stability and full employment. Economic growth refers to a nation’s ability to produce more goods
and services over time. It is generally measured through some version of gross domestic product. Price stability refers to
minimizing changes in a nation’s prices over time. This is generally measured with a price index. Full employment refers to
the degree to which all willing and able workers can find jobs. This is generally measured through the unemployment rate.
The scope of macroeconomics in management includes understanding how the economy works and how it affects
business operations. This knowledge can help managers make better pricing, production, investment, and other strategic
decisions. Inflation is one of the critical macroeconomic concepts for managers to understand.

Five Macroeconomic Goals: Non-Inflationary Growth, Low Inflation, Low Unemployment or Full Employment, Equilibrium in
Balance of Payments, Fair Distribution of Income.
6 key macroeconomic variables: GDP (Gross Domestic Product), Output, Interest Rates, Production, Income, Expenditure.
Why is economics central to an understanding of the problems of development?
Economics is a social science concerned with the study of proper allocation and efficient utilization of scarce
productive resources to cater the unlimited needs and wants of the people. It central to an understanding of the problems
of development for the reason that these developing countries have limitless needs and wants with only limited resources,
resulting to having complicated options to decide to. Hence, by looking to the economic factors that affects the country’s
development, we can now come up with possible solutions for the development of one’s country and stimulate new
economic opportunities out of these problems. Additionally, with the in-depth comprehension of these economic factors
that define the development problems, individuals can make more-informed decisions when allocating scarce resources
"Economics is the study of mankind in the ordinary business of life.” or Explain- "economics is a science of wealth"
Alfred Marshall provides a still widely-cited definition in his textbook Principles of Economics (1890) that extends analysis
beyond wealth and from the societal to the macroeconomic level. According to Alfred Marshall-
“Economics is a study of man's action in the ordinary business of life it inquires how he gets his income and how he
uses it. It examines that part of individual and social actions which is mostly closely connected with the attainment
and with the use of material requisites of well-being. Thus, economics is on one side a study of wealth and on the
other and important side a part of the study of man ".
From the definition of economics by Alfred Marshall, we see that he lays emphasizes on the below points:
Study of an ordinary man: According to Alfred Marshall, economics is that study of an ordinary man who lives in society. It
is not concerned with the lives of only rich persons or who is cut away from the society. Its subject matter is a particular
aspect of human behavior i.e. earning and spending of incomes for the normal material needs of human beings.
Economics is not a useless study of wealth: Economics does not regard wealth as the be-all and end-all of economics
activities wealth is not of primary importance. It is earned only for promoting human welfare economics is studied to analyze
the causes of material prosperity of individuals and nations.
Economics is a social science: It does not study the behavior of isolated individuals but the actions of persons living in
society. When people live together, they interact and cooperate to work at firms, factories, shop and offices to produce and
exchange goods or services. The problems about these activities are studied in economics.
Study of material welfare: According to Alfred Marshall, economics studies only material requisites of well-being or causes
of material welfare. It is cleared from this definition that it is materialistic aspect and ignores non-material aspects. Alfred
Marshall stressed that the man’s behavior and activities to produce and consume maximum number of goods and services
are the main object of study wealth is not an end or final aim, but only a means to achieve a higher objective of welfare.
Economics is a good major for those interested in investment banking because it provides a strong foundation in financial
and quantitative analysis, as well as an understanding of how businesses and markets operate.
 Module – 3: Production and Cost
Total Product (TP) is the number of units a firm can produce with a given quantity of inputs. According to the given table,
with 2 workers the firm has a total product of 6 units of output. With 3 units of labor, the firm has 9 units of total product.
Average Product (AP) is the total number of units
a firm produced divided by the quantity of inputs
used. At 2 workers, the total product is 6 which
means average product is 3 (6/2).
Marginal Product (MP) is the change in total
product (the number produced by all workers)
from hiring one more worker. If more than one worker is hired, the marginal product is the change in output (Q) divided by
the change in the quantity of labor. With 2 workers, the firm has a total product of 6, and with 3 workers the total product
is 9. The total product increased by 3 units with the addition of 1 worker so the marginal product is 3 (3/1).
The law of diminishing marginal returns: There are
03 parts of a total product curve (Figure C2). Part 1 is
the increasing returns portion where hiring more
workers increases the marginal product because total
product is increasing at an increasing rate. Increasing
returns occur because of division of labor and worker
specialization. Complicated tasks are broken down
and workers get very good their individual roles in the
production process.
Part 2 is the diminishing returns portion where hiring
more workers decreases the marginal product (the Total Product curve is getting less steep) because total product is still
increasing but at a decreasing rate. Part 3 is the negative returns portion where hiring more workers results in a negative
marginal product (the total Product curve is falling). Take a look at Chart B and the graph below for an example.
If different combinations of two factors yielding equal amount of total output
are diagrammatically presented in the form of a curve, then such a curve is
called on Isoquant or Iso-product curve or Equal product or Iso-product or
Production Indifference Curves. Thus, isoquant curve is that curve which shows
the different possible combinations of two factor inputs yielding the same
amount of output. Isoquant curve is called production indifference curve since
it is an extension of indifference curve analysis from the theory of consumption
to the theory of production. An isoquant shows that if the firm have ability to
substitute between the two different inputs (labor and machines) in order to
produce the same level of output
This liner isoquant is drawn if there is a perfect substitutability in the inputs of
production. For example, Power plant equipped to burn either oil or gas, various
amounts of electric power can be produced by burning gas only or oil only. Gas
and oil are perfect substitutes here. Hence isoquants are straight lines.
Returns to scale in economics refers to a term that states that the degree of
change in input factors changes the output proportionally and concurrently
during the production process. It reflects the quantitative change that applies in
the long-term using similar technology.
Increasing Returns to Scale If output more than doubles when inputs are
doubled, there are increasing returns to scale. This might arise because the larger
scale of operation allows managers and workers to specialize in their tasks and
to make use of more sophisticated, large-scale factories and equipment. The
automobile assembly line is a famous example of increasing returns.
Constant Returns to Scale A second possibility with respect to the scale of production is that output may double when inputs
are doubled. Decreasing Returns to Scale Output may be less than double when all inputs double.
Total cost is the price of input. It is calculated by multiplication of Price (per unit) and Quantity produced.
Fixed Costs: Rent, loan payments, insurance, etc. On a graph, FC is a horizontal line. A firm operates as long as losses are less
than fixed costs. Otherwise, the firm temporarily shuts down. Because fixed costs are 'sunk costs’ meaning already lost.
Variable Costs: Labor, electricity, and raw materials. If total revenue is greater than total variable costs, the firm will operate
and their losses will be less than fixed costs, vice-versa.
Marginal Cost: Marginal cost is the change in total cost divided by the change in quantity (MC = ΔTC/ΔQ). Usually, the change
in quantity is just 1 so MC is the cost associated with producing just one more unit of output. The marginal cost curve
intersects the ATC and AVC at their minimum points. That relationship is because as long as the cost of producing one more
unit of output (MC) is less than the current average the average will fall. Also, as long as the cost of producing one more unit
of output is higher than the current average, the average will rise.
At low quantities, the marginal cost curve is downward sloping. That is due to specialization that causes increasing marginal
returns. The quantity where the marginal cost curve is at its minimum is where diminishing marginal returns sets in.
Diminishing marginal returns causes marginal costs to rise at higher quantities.
Average Fixed Costs: Add up all of the fixed costs for a firm and divide by the quantity produced (AFC = FC/Q). Continually
decreases. Rarely drawn because the distance between the ATC and AVC will be equal to the AFC at that quantity. Average
fixed costs continually decrease as output increases.
Average Variable Costs: Add up all of the variable costs for a firm and divide by the quantity produced (AVC = VC/Q).
Decreases until it intersects the MC then increases. Looks like a smirk. Firms shut down (temporarily) when price falls below
the minimum point on the AVC.
Relationship between Marginal Product and Total Product
The law of variable proportions is used to explain the relationship between Total Product and Marginal Product. It states
that when only one variable factor input is allowed to increase and all other inputs are kept constant, the following can be
observed:
• When the Marginal Product (MP) increases, the Total Product is also increasing at an increasing rate. This gives the
Total product curve a convex shape in the beginning as variable factor inputs increase. This continues to the point
where the MP curve reaches its maximum.
• When the MP declines but remains positive, the Total Product is increasing but at a decreasing rate. This give ends
the Total product curve a concave shape after the point of inflexion. This continues until the Total product curve
reaches its maximum.
• When the MP is declining and negative, the Total Product declines.
• When the MP becomes zero, Total Product reaches its maximum.
Relationship between Average Product and Marginal Product
There exists an interesting relationship between Average Product and Marginal Product. We can summarize it as under:
• When Average Product is rising, Marginal Product lies above Average Product.
• When Average Product is declining, Marginal Product lies below Average Product.
• At the maximum of Average Product, Marginal and Average Product equal each other.

Explicit costs are the out-of-pocket costs paid by the business owner. Explicit costs for website: hosting fees, software, etc.
Implicit costs are the implied costs, or the value of opportunities lost (aside from out-of-pocket money costs). The implicit
costs associated with producing this website include the value of my evening leisure time.
Shifts in the Cost Curves: Cost curves shift in response to changes in two factors:
1. Technology: A technological change that increases productivity shifts the product curves upward and the cost curves
downward. If a technological change results in the firm using more capital, the average fixed cost curve shifts upward and
at low levels of output, the average total cost curve may shift upward. At large output levels, average total cost decreases.
2. Prices of factors of production: An increase in the price of a factor of production increases costs and shifts the cost curves
upward. An increase in fixed cost does not affect the variable cost or marginal cost curves (TVC, AVC, and MC curves). An
increase in variable cost does not affect the fixed cost curves (TFC and AFC). The total cost curves (TC and ATC curves) are
affected by a price change for any factor of production.
Short-run Average Total Cost (SRATC) vs Long-run Average Total Cost (LRATC): When a business first opens, it will have a
short-run average total cost curve for various quantities it can produce. In the short run, only variable costs can be changed;
fixed costs cannot. The firm can only change the rate of production by changing the number of raw materials, labor, etc. it
utilizes in the production process. In the long run, all costs (fixed and variable) can change. The firm can expand capacity, by
purchasing more machinery or building a new factory. That change gives the firm a new short-run average total cost curve
at greater quantities. As the firm continues to grow, each new capacity creates a new short-run average total cost curve at
a higher quantity. Each possible SRATC gives way to a long-run average total cost curve which shows average costs for all
quantities the firm can produce in the long run at every possible capacity. LRATC is an economics metric that is used to
determine the minimum (or lowest) average total cost at which a firm can produce any given level of output in the long run
(when all inputs are variable).

The concept of "diminishing returns" states that as more and more of a certain factor is added to a production process, the
resultant output will eventually decrease. However, there are a few exceptions to this concept:
• Increasing returns to scale: In some cases, as more and more of a certain factor is added to a production process,
the output will actually increase. This is known as increasing returns to scale.
• Network effects: In some cases, the value of a product or service increases as more and more people use it. This is
known as a network effect.
• Learning by doing: In some cases, as more and more of a certain factor is added to a production process, the workers
become more efficient and the output increases. This is known as learning by doing.
It's worth noting that these exceptions are relatively rare and the concept of diminishing returns is a general rule that applies
to most production processes.
The Three stages of production are defined by the slopes,
shapes, and interrelationships of the total, marginal and
average product curves.
1) The First Stage of production is depicted by a positive
slope of the average product curve, ceasing at the
intersection between the average product and
marginal product curves. In stage one, the average
product is positive and continues to increase.
2) The Second Stage of production continues up to the
point where the marginal product will become
negative, at the peak of the total product curve. In
stage two, the marginal product is positive but keeps
on diminishing
3) The Third Stage of production prevails over the range
where the total product curve is negatively sloped
and in Stage three total product is diminishing.
 Module – 4: Market Structure

Monopolistic competition: Monopolistic competition exists when many companies offer competing products or services
that are similar, but not perfect, substitutes. The barriers to entry in a monopolistic competitive industry are low, and the
decisions of any one firm do not directly affect its competitors. Restaurants, hair salons, household items, and clothing
Oligopoly: Oligopoly is a form of imperfect competition and the competition among a few. Hence, Oligopoly exists when
there are two to ten sellers in a market selling homogeneous or differentiated products. Cold Drinks industry. characteristics
include high barriers to new entry, price-setting ability, the interdependence of firms, maximized revenues, product
differentiation and non-price competition (rewarding customers for their loyalty, differentiating product offerings, providing
sales promotion schemes, acting as sponsors etc.)
Monopoly: Natural gas, electricity companies, and
other utility companies. They exist as monopolies
because the cost to enter the industry is high and new
entrants are unable to provide the same services at
lower prices and in quantities comparable to the
existing firm.
Perfect competition is a hypothetical market
structure in which there are very many firms, each of
which represents an infinitesimal share of the market.
In a perfectly competitive market, if any firm is able to
earn an economic profit, other firms will immediately
enter the market, driving economic profit to zero. Perfectly competitive firms earn zero economic profits in the long run
because they maximize revenues. firms can only experience profits or losses in the short run. Normal profit occurs when
economic profit is zero or alternatively when revenues equal explicit and implicit costs (opportunity costs), are costs that
will influence economic and normal profit.
Economic Profit vs Accounting Profit: Suzie owns a bagel shop called Suzie’s Bagels, which generates an average of $150,000
revenue each year. Salary cost $20,000, Withdrawal $40,000, rent $20,000 and input cost $30,000. Estimated opportunity
cost of operating Suzie’s Bagels full time is $20,000 each year. Explicit costs = $20,000 + $20,000 + $40,000 + $20,000 +
$30,000 = $130,000. So, accounting profit before taxes of $20,000. Implicit costs are $20,000, So Economic Profit = 150,000
– ($130,000 + $20,000) = 0.
Long Run Equilibrium under Monopolistic Competition
The market will be at equilibrium in the long run only if there is no exit or
entry in the market anymore. The firms will not exit or enter the market only
if every firm makes zero profit. This is the reason why we name this market
structure monopolistic competition. In the long run, all firms make zero
profit just as we see in perfect competition. At their profit-maximizing
output quantities, the firms just manage to cover their costs.
Graphical representation of monopolistic competition in the long run
If the market price is above the average total cost at the equilibrium output
level, then the firm will make a profit. If the average total cost is above the
market price, then the firm incurs losses. At the zero-profit equilibrium, we
should have a situation between both cases, namely, the demand curve and
the average total cost curve should touch. This is only the case where the
demand curve and the average total cost curve are tangent to each other at
the equilibrium output level.
In Figure 3, we can see a firm in monopolistic competition and is making zero profit in the long-run equilibrium. As we see,
the equilibrium quantity is defined by the intersection point of the MR and MC curve, namely at A.
We can also read the corresponding quantity (Q) and the price (P) at the equilibrium output level. At point B, the
corresponding point at the equilibrium output level, the demand curve is tangent to the average total cost curve.
If we want to calculate the profit, normally we take the difference between the demand curve and the average total cost
and multiply the difference with the equilibrium output. However, the difference is 0 since the curves are tangent. As we
expect, the firm is making zero profit in the equilibrium.
Price Leadership: Price leadership occurs when a leading firm in a given industry is able to exert enough influence in the
sector that it can effectively determine the price of goods or services for the entire market. This type of firm is sometimes
referred to as the price leader. Common in industries that have oligopolistic market conditions, such as the airline industry.
Price leadership more likely to occur within an industry: the number of companies involved is small; entry to the industry
is restricted; products are homogeneous; demand is inelastic, or less elastic; organizations have a similar long-run average
total cost (LRATC).
Barometric: The barometric price leadership model occurs when a particular firm is more adept than others at identifying
shifts in applicable market forces, such as a change in production costs. This allows the firm to respond to market forces
more efficiently. For instance, the firm may initiate a price change.
Collusive: The collusive price leadership model may emerge within markets that have oligopolistic conditions. Collusive
price leadership occurs as a result of an explicit or implicit agreement among a handful of dominant firms to keep their
prices in mutual alignment. Smaller firms within the market are effectively forced into following the price change initiated
by the dominant firms. This practice is most common in industries where the cost of entry is high, and the costs of production
are known.
Dominant: The dominant price leadership model occurs when one firm controls the vast majority of the market share in its
industry. Within the industry, there are other, smaller firms that provide the same products or services as the leading firm.
However, in this model, these smaller firms cannot influence prices.
Advantages of Price Leadership
• if companies in a particular market follow a price leader by setting higher prices, then all producers in that market
stand to profit, as long as demand remains steady.
• Price leadership also has the potential to eliminate (or reduce) price wars. If a market is completely comprised of
companies of a similar size, in the absence of price leadership, price wars could follow as each competitor tries to
increase its share of the market.
• One side effect of price leadership may be better-quality products as a result of an increase in profits. Increased
profits often mean more revenue for companies to invest in research and development (R&D), and thus, an increase
in their ability to design new products and deliver more value to customers.
• The dynamics of price leadership may also create a system of interdependence rather than rivalry. When firms in
the same market choose a parallel pricing structure–instead of undercutting each other–it fosters a positive
environment conducive to growth for all companies.
Disadvantages:
• Price leadership where prices are increased does not convey any material advantages to consumers.
• the price leader lowers prices consumers may benefit with less expensive goods and services.
• Price leadership can also be unfair to smaller firms because small firms who attempt to match a leader's prices may
not have the same economies of scale as the leaders.
• Price leadership can also result in malpractices on the part of competing firms that make the decision not to follow
the leader's prices. Instead, they may engage in aggressive promotion strategies, such as rebates, money-back
guarantees, free delivery services, and installment payment plans.
• Finally, in a price leadership model, there is an inevitable discrepancy between the benefits conferred to the price
leader versus the benefit conferred to other firms operating in the same industry. For example, if it costs the price
leader less capital to produce the same product than it costs another firm, then the leader will set lower prices. This
will result in a loss for any firm that has higher costs than the price leader.
A cartel is defined as a group of firms that gets together to make output and price decisions. The conditions that give rise to
an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where
there are few firms and each firm has a significant share of the market. In the U.S., cartels are illegal; however, internationally,
there are no restrictions on cartel formation. The organization of petroleum-exporting countries (OPEC) is perhaps the best-
known example of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel
will be allowed to produce.
 Module – 5: Market Failure and Market Intervention
Market failure which generally means failure of the price of demand-supply system may be caused by: market power,
incomplete information, externalities, and public goods. We will discuss each in turn.

• Market Power Inefficiency arises when a producer or supplier of a factor input has market power. the producer of food
has monopoly power, sells less output at a price higher than it would charge in a competitive market. The lower output
will mean a lower marginal cost of food production.
• Incomplete or Asymmetric Information If consumers do not have accurate information about market prices or product
quality, the market system will not operate efficiently. This lack of information may give producers an incentive to supply
too much of some products and too little of others. In other cases, while some consumers may not buy a product even
though they would benefit from doing so, others buy products that leave them worse off. For example, consumers may
buy pills that guarantee weight loss, only to find that they have no medical value.
• Externalities: An externality is a cost or benefit to someone other than the producer or consumer. Negative externalities
are costs and positive externalities are benefits. Some examples of negative externalities include second hand smoke
(from cigarettes), air pollution (from gasoline), and noise pollution (from concerts). These are all costs that fall on people
other than the producer and consumer of that product. Some examples of positive externalities include nice smell (from
a neighborhood cookie factory), herd immunity (from immunizations), and fruit and vegetable production (from bees in
the production of honey).
• Public Goods Market failure arises when the market fails to supply goods that many consumers value. A public good can
be made available cheaply to many consumers, but once it is provided to some consumers, it is very difficult to prevent
others from consuming it. Research without a patent. Once the invention is made public, others can duplicate it. As
long as it is difficult to exclude other firms from selling the product, the research will be unprofitable. Markets, therefore,
undersupply public goods. Government can sometimes resolve this problem either by supplying a good itself or by
altering the incentives for private firms to produce it.
When there are no externalities, MB (Marginal Benefit), MPB (Marginal Private Benefit), MSB (Marginal Social Benefit) and
Demand are all equal, MC (Marginal Cost), MPC (Marginal Private Cost), MSC (Marginal Social Cost) and Supply are all equal.
Externalities in production are external costs or benefits created
by the suppliers of a product. When a factory pollutes the
environment, the pollution is a negative externality in production.
When bees owned by honey producers pollinate a nearby orchard,
the fruit that comes from the pollination is a positive externality
in production.
Externalities in consumption, external costs or benefits created
by the consumers of a product. Second smoke is a negative
externality in consumption from cigarette smokers, while herd
immunity is a positive externality in consumption for vaccines.
Negative Eternities in Productions can be removed by imposing
Pigouvian tax, which equal to the external cost makes private cost +
tax = social. Thus, Supply curve will shift upward and make efficient
equilibrium.
Negative Externalities in Consumption When a good produces a
negative externality in consumption, that spillover cost will be
subtracted from the marginal private benefit curve to create a lower
marginal social benefit curve (or net marginal social benefit).
Positive Externality in Consumption In a market with positive externalities in consumption, the external benefit to society
must be added to the marginal private benefit to get the marginal social benefit. As a result, the MSB is higher than the MPB
and Demand. The allocative efficient quantity (what is best for society) is where the Marginal Social Benefit equals the
Marginal Social Cost (MSB=MSC).
Positive Externality in Production When a good produces a positive externality in production, that spillover benefit will be
subtracted from the marginal private cost curve to create a lower marginal social cost curve (or net marginal social cost).

Correcting for a positive externality When it comes to correcting for a positive externality market failure, there are two
common ways to do it; a per-unit (not lump sum) subsidy to the consumer, or a per-unit subsidy to the producer. A per-unit
subsidy to the consumer has the effect of shifting the demand curve to the right. If the subsidy is equal to the external
benefit, the demand curve will shift right until it equals the MSB curve.

An outcome of asymmetric information is adverse selection. Adverse selection arises when products of different qualities
are sold at a single price because buyers or sellers are not sufficiently informed to determine the true quality at the time of
purchase. As a result, too much of the low-quality products and too little of the high-quality product are sold in the
marketplace. Adverse selection challenges may create serious difficulty in the insurance and credit market.

Public goods have two characteristics: non-rival and nonexclusive. A good is non-rival if for any given level of production,
the marginal cost of providing it to an additional consume is zero. Highways, Lighthouse, public television.
A good is nonexclusive if people cannot be excluded from consuming it. As a consequence, it is difficult or impossible to
charge people for using nonexclusive goods; the goods can be enjoyed without direct payment. Example: national defense.

Market Intervention
Taxes When the government imposes a tax on a good or service, the supply curve will shift to the left by the vertical distance
of the tax. The new equilibrium quantity will decrease, the price consumers pay will increase, and the after-tax price sellers
receive will decrease. If the product has no externalities, the tax will create deadweight loss. If the product produces a
negative externality, a per-unit tax will reduce deadweight loss. If the product produces a positive externality, a per-unit tax
will increase deadweight loss.

Subsidies When the government grants a subsidy to the producers of a good or service, the supply curve will shift to the
right by the vertical distance of the subsidy. The new equilibrium quantity will increase, the price consumers pay will
decrease and the after-subsidy price sellers receive will increase. If the product has no externalities, the subsidy will create
deadweight loss. If the product produces a positive externality, a per-unit subsidy will reduce deadweight loss. If the product
produces a negative externality, a per-unit subsidy will increase deadweight loss.

Price Ceilings on a Natural Monopoly A natural monopoly is an industry which captures economies of scale at the allocative
efficient quantity resulting in much lower average costs when there is a large single provider. These businesses usually have
extremely high start-up costs but have a very low marginal cost of production. Electricity. Governments will often regulate
natural monopolies by imposing price ceilings which may be more efficient than the unregulated price. The socially optimal
price is allocative efficient and creates no deadweight loss where price equals marginal cost, but the firm may suffer
economic losses at this price. If forced to earn economic losses, the firm will eventually exit the market so the government
must provide the firm with a lump sum subsidy (equal to its loss) to eliminate deadweight loss.

A fair return price is one which enforces a price ceiling where economic profits are zero (P=ATC). At the fair return price,
there is less deadweight loss than an unregulated monopoly and the firm breaks even.

Anti-trust legislation Oligopolies are prone to collusion or the formation of cartels which set production quantities low and
prices high. When cartels are successful oligopolies function as monopolies. Governments often regulate oligopolies and
attempt to prevent collusion and cartels while encouraging competition through anti-trust laws. These anti-trust policies
reduce monopoly power among firms. Fortunately, since there is an incentive to cheat, collusive agreements often break
down even without anti-trust laws.

The Lorenz curve is one way to measure income distribution. This curve
is a graph with cumulative percentages of income on the Y axis and
cumulative percentages of households on the X axis. If each group
earns their share of the national income (bottom 20% earn 20% of
national income, bottom 60% earn 60%, etc.), the Lorenz curve will be
a straight line at a 45° angle. This is called the line of equality. An
economy with an unequal distribution of income (bottom 20% earn 2%
of national income, bottom 60% earn 15%, etc.), will create a Lorenz
curve that is bowed out from the line of equality.

The Gini ratio (sometimes called Gini coefficient or Gini Index) is a numerical value derived from the Lorenz curve to measure
income distribution. Using the areas from the Lorenz curve, the formula for the Gini ratio is: Gini Ratio = A/(A+B)

There are 3 different types of taxes. Each is based on the percentage of a person’s income and will have differential impact
on the income of the population.
• Progressive Taxes: are taxes where marginal tax rates increase as a person makes more income. A progressive tax
system may charge a citizen 10% on the first BDT10,000 of income, 20% on the next BDT30,000 (BDT10,001–
BDT40,000) and 30% on marginal income above BDT40,000. That would mean a person earning BDT 5,000 a year
would pay BDT500 in taxes while a person earning BDT100,000 a year would pay BDT25,000 in taxes. Progressive
income taxes shift the Lorenz curve inward toward the line of equality and lower the Gini ratio.

• Regressive Taxes: are taxes where tax rates are higher for those earning less. If a person earning BDT10,000 pays
10% of their income (BDT1000) to the regressive tax, a person earning BDT1,000,000 might pay 5% of their income
(BDT50,000). The higher income earner might pay a higher amount, but the person with less income pays a higher
percentage. Sales taxes are considered regressive because low-income earners pay higher percentages of their
income toward those taxes than high income earners. Regressive taxes shift the Lorenz curve outward away from
the line of equality and increase the Gini ratio.

• Proportional Taxes: are taxes where the marginal tax rate does not change based on income earned. If someone
earning BDT10,000 pays 10% of their income, then someone earning BDT1,000,000 would also pay 10% of their
income. Proportional taxes do not change the Lorenz curve or Gini ratio.

Transfer Payments: are social programs for people with low income that provide subsidies or direct aid. Social security
payments, unemployment compensation, food stamp programs, etc. are all examples of transfer payments. Transfer
payments reduce income inequality and shift the Lorenz curve inward toward the line of equality and reduce the Gini ratio.
Market Failure in the Context of the Financial Sector
Financial market failure occurs when banking, equity and bond markets failure to achieve an efficient and/or equitable
outcome. This can lead to economic and social costs including macro instability and loss of trust and confidence in financial
institutions. Market failure is a persistent problem in financial markets, which is why it is necessary to have strict regulation
of banks and other financial institutions. Reckless lending, mis-selling of financial services and outright fraud are all common
problems. The main reasons why market failure occurs in financial markets are as follows:
• Asymmetric information where one party to the transaction (usually, but not always the seller) has much better
knowledge of the product than the other party. Persuasive and misleading advertising can add to this problem. it
can lead to market failure and misallocation of resources.
• Moral Hazard If an economic agent, whether an individual or a business is able to transfer the risk of their actions
onto others moral hazard is said to exist. Moral hazard may cause serious difficulty in insurance and credit market.
• Negative Externalities Sometimes the behavior of banks can result in serious consequences for third parties, such
as bank customers, the government and the wider business community and their employees. The financial crisis of
2007/8 led to a massive bailout of the banks, costing many billions of taxpayers’ money in many countries.
• Speculation and Market Bubble Much of the buying and selling in financial markets is by speculators, who trade
primarily to make a profit (or avoid a loss). This can often result in ‘herding’ behavior.

A cost-benefit analysis is a systematic process that businesses use to analyze which decisions to make and which to forgo.
The cost-benefit analyst sums the potential rewards expected from a situation or action and then subtracts the total costs
associated with taking that action. Advantages/Importance:
1) Focuses on data-driven decision-making
2) Discovers hidden costs
3) Makes some decisions easier
4) Provides a competitive advantage

Cost-benefit analysis disadvantages

1) Unpredictable variables
2) Not as effective for long-term projects
3) Requires extensive data

Process:
1) Identify Project Scope
2) Determine the Costs: Direct Cost, Indirect Cost, Intangible Cost, Opportunity Cost, Potentials risk.
3) Determine the benefits
4) Compute Analysis Calculations
5) Make Recommendation and Implement
 Module – 6: Basic Macroeconomics
Aggregate demand is the amount of total spending on domestic goods and services in an economy. The aggregate demand
curve represents the total of consumption, investment, government purchases, and net exports at each price level in any
period. It slopes downward because of the wealth effect on consumption, the interest rate effect on investment, and the
international trade effect on net exports. The downward-sloping aggregate demand curve shows the relationship between
the price level for outputs and the quantity of total spending in the economy.

Aggregate supply, or AS, refers to the total quantity of

output; in other words, real GDP that the firms produce
and sell. The aggregate supply curve shows the total
quantity of output i.e. real GDP that firms produce and
sell at each price level. For most products and services,
as the price increases, so will the supply; this illustrates
a positive correlation. Short-run aggregate supply
curves illustrate supply in the near future or over a
period in which capital is fixed. Long-run aggregate
supply curves show supply in the long-term in which all
inputs are variable. Aggregate supply is a function of
total production within an economy and the price level.

The short-run aggregate supply curve, or SRAS, is an upward-sloping curve. In the short-run, aggregate supply changes in
response to changes in demand by increasing or decreasing the amount produced. In the short-run, the company's capital
is fixed, meaning that in order to increase the amount of supply, they must use their existing infrastructure, technology, and
equipment. It is not possible for a company to quickly construct another factory to meet the demand of this month; that is
why the capital is fixed and the curve slopes upward.

The long-run aggregate supply curve, or LRAS, is vertically graphed with real GDP on the x-axis and price level on the y-axis.
In the long-run view of supply, it is not affected by demand and prices. Instead, it is affected by the variability of all business
inputs. This includes human capital, equipment, technology, and other large expenditures. The LRAS curve is vertical in
contrast to the upward-sloping SRAS curve because the real GDP of an economy is not related to the price level; additionally,
prices have time to fully adjust to changes in the economy whereas they do not in the short-run. The curve for long-run
aggregate supply is also vertical at the level of full employment because since prices have had time to adjust, the economy
will be able to produce at its full potential.

Types of Unemployment:
Seasonal Unemployment: Seasonal unemployment occurs when workers lose their jobs due to the time of year. Lifeguards
getting laid off in the winter and temporary store retail clerks getting laid off after the holiday shopping season are two
examples. Seasonal unemployment is a natural part of a healthy economy.
Frictional Unemployment: This type of unemployment is characterized by movement between jobs. When a college
graduate is looking for her first job, a cook quits his restaurant job, or a brick mason is fired from construction company, all
three of these people are now frictionally unemployed. Frictional unemployment is a natural part of a healthy economy.

Structural Unemployment: This type of unemployment is most often characterized by a skills mismatch; meaning the skills
unemployed workers have do not match the skills needed for the jobs available. These workers must go back to school or
be retrained to get the skills they need. Caused by technological changes, economy changes etc. Structural unemployment
is also a natural part of a healthy economy as well. As the economy changes, some structural unemployment is inevitable.

Cyclical Unemployment: This is unemployment caused by the business cycle. People unemployed as a result of the great
depression of the 1930’s and the recent great recession were cyclically unemployed. Cyclical unemployment is characterized
by an overall downturn in the economy.

Full Employment: Full Employment is defined as zero cyclical unemployment; or when the unemployment rate equals
frictional unemployment plus structural unemployment. When the economy is at full employment the unemployment rate
will equal what is called the natural rate of unemployment (NRU).
Inflation is a situation in an economy where prices of goods and services increase and the purchasing power of people
decreases. Inflation leads to a reduction in the purchasing power of money. Inflation results in unequal distribution of money.
However, certain minimum rate of inflation is desirable in an economy. Inflation refers to a sustained and broad-based
increase in the overall price level.

Deflation is the downward movement of the general price level of goods and services. Deflation occurs when the Inflation
rate falls below 0% leading to a negative inflation rate. Deflation leads to an increase in the purchasing power of money. In
several instances, deflation is caused by the economic recession when the low-income people are sufferers.

Disinflation refers to a decline in inflation rates that are still positive. Disinflation has been widespread since the mid-1970s,
whereas outright deflation has been rare.

Relative prices, which measure the price of one good or service relative to the price of another (or a weighted average of
all other goods and services) and signal information about relative surpluses or shortages in different product markets. A
rising relative price of a certain good or service indicates that the demand for it outstrips supply and encourages production
while discouraging consumption. Hence, in contrast to inflation, relative price movements are critical for the efficient
allocation of resources. If goods, services, and factor markets were fully flexible, inflation (which in principle involves no
change in relative prices) would not affect the allocation of resources and relative price changes would occur without
inflation.

Headline inflation usually refers to changes in the prices of all goods and services in a basket of goods and services that is
representative of consumer expenditures. Core inflation measures are intended to capture the underlying, common trend
in all prices, regardless of relative price changes. For example, swings in food and energy prices tend to be changes in relative
prices that shift consumption and production patterns.

The most common measure of inflation is the percentage change in the headline consumer price index (CPI), which captures
the cost of living of the average consumer. The CPI includes domestically produced and imported consumer goods. The
producer price index (PPI) reflects the prices charged by domestic producers of goods and services.

The GDP deflator measures the average price of the economy’s output, broadly defined. It differs from the CPI by excluding
import prices but including prices of exports, investment, and government consumption. It differs from the PPI by including
taxes net of subsidies.

Particulars REAL INTEREST RATES NOMINAL INTEREST RATES

Meaning The real rates are accustomed to considering the The nominal interest rate is the least difficult rate
monetary waves or the financial ripples brought that doesn’t take into consideration economic
about by economic inflation. inflation.
Also Known The real interest rate is additionally called an actual The other name for the nominal interest rate is the
as interest rate. coupon rate.
Formula Real Rate = Nominal Rate – Inflation Nominal Rate = Real Rate + Inflation
Economic The rate of real interest is fixed in view of levels of The nominal interest rate is fixed without the impact
Inflation economic inflation. of economic inflation.
Stability Adaptability and flexibility are the components of Strength and stability are the elements of the
the real interest rate. nominal interest rate.
Adjustment The real interest rate can be a negative measure The nominal interest rate can never be a negative
assuming that specific circumstances prevail. measure.
Amount Typically, the interest is low in the real interest rate. Generally, the interest is high in nominal interest rate.
Example The deposit rate is 2% p.a. on an Rs.1,000 and A deposit rate is 2% p.a. on an Rs. 1,000 speculation
inflation rate is 3%. The real rate returns the or investment. The financial backer figures, he will
financial backer will acquire is 2% – 3% = – 1%. The get Rs. 200 as interest in nominal terms.
return in the wake of considering the rate of
economic inflation is negative.
Fiscal policy refers to the governmental use of taxation and spending to influence the conditions of the economy. A budget
deficit is when the government’s expenditure is higher than its revenue. A budget surplus occurs when government revenue
is greater than government expenditure. A balanced budget, which occurs less frequently, is when government expenditure
and revenue are equal. A government may deliberately alter its expenditure or tax revenue to influence economic activity.
Typically, fiscal policy comes into play during a recession or a period of inflation, where conditions are escalating quickly
enough to warrant government intervention.
• Expansionary Fiscal Policy aims to increase aggregate demand and shift the AD curve outwards by reducing taxes and
raising government spending. With lower taxes, individuals and households have more income at their disposal to spend
on goods and services. This increases production and creates new job opportunities. The increased government
spending will also boost economic activities which require workers to be hired, contributing to lower employment levels.
• Contractionary Fiscal Policy tries to reduce aggregate demand and shift the AD curve inwards by increasing taxes and
decreasing public spending. By increasing taxes, the government can reduce the budget deficit, fight inflation, and
resolve other balance of payment issues.

Monetary policy is the policy of the monetary authority (generally central banks) that deals with money supply, rate of
interest, exchange rate, and price level. If the money supply is increased by printing more money, buying back government
bonds or encouraging commercial banks to lend more, the aggregate demand increases. On the other hand, a decrease in
the money supply reduces aggregate demand.
• Expansionary Monetary Policy aims to boost economic activities by lowering interest rates or increasing the money
supply. When the interest rates decrease, the cost of borrowing money is lower. More individuals and firms will be
inclined to borrow more money and spend it. This improves the overall production and economic growth.
• Contractionary Monetary Policy tries to reduce inflation and reduce the size of the budget deficit by increasing interest
rates. With higher interest rates, the cost of borrowing money will increase. This discourages individuals and firms from
borrowing from the central bank and spending it on goods and services.

Fiscal and monetary policies are basically demand side policies. Supply-side policies aim to remove market imperfections to
make production more efficient, which can help reduce inflationary pressures. They also aim to encourage the free flow of
labor and capital by reducing restrictions in the economy. Supply-side policies include interventionist supply-side policies
such as government provision for private sector firms, training, education, and infrastructure. This policy emphasizes the
role of the government more than the role of the market. Non-interventionist supply-side policies - tax cuts, welfare benefit
cuts, privatization, marketization, and deregulation. In this policy, market plays more important role than government.

Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced in a
specific time period within a nation’s border. Gross National Product (GNP) is Gross Domestic Product (GDP) plus net factor
income from abroad. GNP measures the monetary value of all the finished goods and services produced by the country's
factors of production (citizens) irrespective of their location.

GDP GNP
Definition The value of goods and services produced The value of goods and services produced by the
within the geographical boundaries of a nation citizens of a nation irrespective of the geographical
in a financial year is termed as GDP. limits in a financial year is known as GNP.
What Measure? It measures only the domestic production. It measures only the national production.
Emphasis It emphasizes on the production that is It emphasizes on the production that is achieved by
obtained domestically. the citizens living in different nations.
Scope Local scale International scale
Excludes The goods and services that are being The goods and services that are produced by the
produced outside the economy are excluded. foreigners living in the country are excluded.
Balance of trade is the account that details the value of exported goods and the value of imported goods. To calculate the
balance of trade, the national accounts service evaluates imports and exports of goods based on customs statistics on goods.

Balance of payments summarizes the economic transactions of an economy with the rest of the world. These transactions
include exports and imports of goods, services and financial assets, along with transfer payments (like foreign aid).
Macroeconomic Accounts
• National Income and Product
Accounts attempt to measure the
overall level of economic activity
undertaken by domestic residents
during a given period; thus, these
accounts record flows.
• Balance of Payment Accounts
reflects transactions only between
residents of the reporting country
and foreigners.
• Fiscal Accounts
• Monetary Accounts

All four macroeconomic accounts are

interrelated. The figure shows the three
supporting accounts (balance of
payments, fiscal, and monetary) and
their relationship with both the national
income and product accounts and
intersectoral linkages. Transactions
appearing in more than one sector are
highlighted. Bank financing of the
government, for example, while a source
of financing for budgetary expenditures,
is also a banking sector asset and
external financing for the budget enters
the balance of payments as a capital
account transaction.

Banking Industry and Macroeconomic Growth The

contribution of the banking and financial sector is
considered one of the key economic sectors while
computing GDP or GNP. In addition to that, the banking
and financial industry plays role by creating employment
opportunities, and several other economic activities are
linked with banking and financial services. However, the
true contribution of a banking industry is measured by its
role in facilitating payment, deposit, and credit services
to other economic sectors of an economy. The banking
industry contributes to economic growth by promoting
business and trade activities through payment services,
mobilizing resources (savings), and allocating
resources(investments).