Micro Economics

SUGGESTIVE STUDY MATERIAL FOR
BCOM 2ND SEMESTER
Unit1
Micro Econo
mics
Uma kant
(JRF, ResearchScholar, JNPG College Lko. Affiliatedto
UniversityofLu
cknow,Lko)
F A C U L T Y O F C O M M E R C E , J N P G C O L L E G E , C H A R B A G H L U C K N O W , U P

Suggestive Study Material (Micro Economics) for BCom 2nd
Semester Unit - 1
2 | Page Prepared by Dr A.K. Mishra (Associate Professor) & Uma kant (JRF, Research Scholar)
Unit – I
Market;- Concept, Classification of Market. Supply: Meaning and Change in
Supply. Factors Affecting the Supply; Supply Elasticity. Perfect Competition;-
Firm and Industry, Assumptions, Equilibrium and Price Determination.
Practical Problems.
Concept of Market
In simple terms, market refers to a physical place where goods and services are
exchanged between buyers and sellers at a particular price.
However, in economic sense, market does not require a physical location or
personal contact between buyers and sellers for the transaction of a product.
In economics, market is defined as a set of buyers and sellers who are
geographically separated from each other, but are still able to communicate to
finalize the transaction of a product. The market for a product can be local,
regional, national, or international.
According to Cournot, “Economists understand the term market not any
particular marketplace in which things are bought and sold but the whole of any
region in which buyers and sellers are in such free intercourse with one another
that the price of the same goods tends to equality easily and quickly.”
As per the definition given by Cournot, following are the essentials of a market:
1) Products which are dealt with
2) Presence of buyers and sellers
3) A place, whether a certain region, country, or the whole world
4) A type of interaction between buyers and sellers, so that the same price
prevails for same products at the same time
Classification of Markets
v On the Basis of Geographic Location
· Local Markets: In such a market the buyers and sellers are limited to the
local region or area. They usually sell perishable goods of daily use since
the transport of such goods can be expensive.
· Regional Markets: These markets cover a wider are than local markets
like a district, or a cluster of few smaller states

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· National Market: This is when the demand for the goods is limited to one
specific country. Or the government may not allow the trade of such
goods outside national boundaries.
· International Market: When the demand for the product is international
and the goods are also traded internationally in bulk quantities, we call it
an international market.
v On the Basis of Time
· Very Short Period Market: This is when the supply of the goods is fixed,
and so it cannot be changed instantaneously. Say for example the market
for flowers, vegetables. Fruits etc. The price of goods will depend on
demand.
· Short Period Market: The market is slightly longer than the previous one.
Here the supply can be slightly adjusted.
· Long Period Market: Here the supply can be changed easily by scaling
production. So it can change according to the demand of the market. So
the market will determine its equilibrium price in time.
v On the Basis of Nature of Transaction
· Spot Market: This is where spot transactions occur, that is the money is
paid immediately. There is no system of credit
· Future Market: This is where the transactions are credit transactions.
There is a promise to pay the consideration sometime in the future.
v On the Basis of Regulation
· Regulated Market: In such a market there is some oversight by
appropriate government authorities. This is to ensure there are no unfair
trade practices in the market. Such markets may refer to a product or
even a group of products. For example, the stock market is a highly
regulated market.
· Unregulated Market: This is an absolutely free market. There is no
oversight or regulation, the market forces decide everything
Concept of Supply
Meaning of Supply
Supply refers to the amount of a good or service that the producers/providers
are willing and able to offer to the market at various prices during a period of
time. There are two important aspects of supply:

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· Supply refers to what is offered for sale and not what is finally sold.
· Supply is a flow. Hence, it is a certain quantity per day or week or month,
etc.
Determinants of Supply
1) Price of the Good/ Service:- The most obvious one of the determinants of
supply is the price of the product/service. With all other parameters being
equal, the supply of a product increases if its relative price is higher.
2) Price of Related Goods:- Let’s say that the price of wheat rises. Hence, it
becomes more profitable for firms to supply wheat as compared to corn
or soya bean. Hence, the supply of wheat will rise, whereas the supply of
corn and soya bean will experience a fall
3) Price of the Factors of Production:- Production of a good involves many
costs. If there is a rise in the price of a particular factor of production,
then the cost of making goods that use a great deal of
that factors experiences a huge increase.
4) State of Technology:-Technological innovations and inventions tend to
make it possible to produce better quality and/or quantity of goods using
the same resources. Therefore, the state of technology can increase or
decrease the supply of certain goods.
5) Government Policy:- Commodity taxes like excise duty, import duties,
GST, etc. have a huge impact on the cost of production. These taxes can
raise overall costs. Hence, the supply of goods that are impacted by these
taxes increases only when the price increases. On the other hand,
subsidies reduce the cost of production and usually lead to an increase in
supply.
6) Other Factors:- There are many other factors affecting the supply of goods
or services like the government’s industrial and foreign policies, the goals
of the firm, infrastructural facilities, market structure, natural factors etc.
Changes in Supply
Change in supply includes an increase or decrease in supply. It may be due to
the change in the price of related goods, income, taste, and preference of
consumers, etc. So there are two possible changes in supply:
· Increase (shift to the right) in supply;
· Decrease (shift to the left) in supply;
(i) Increase in Supply:
When there is an increase in supply, demand remaining unchanged, the supply
curve shifts towards right from SS to S1S1 (Fig. 11.8).

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(ii) Decrease in Supply:
When the supply decreases, demand remaining unchanged, then supply curve
shifts to the left from SS to S2S2 as seen in Fig. 11.9.
.
Law of Supply
The law of supply reflects the general tendency of the sellers in offering their
stock of a commodity for sale in relation to the varying prices.
“Other things remaining unchanged, the supply of a commodity rises i.e.,
expands with a rise in its price and falls i.e., contracts with a fall in its price.
In other-words, it can be said that—”Higher the price higher the supply and
lower the price lower the supply.
Explanation of the Law:

Semester Unit - 1
This law can be explained with the help of a supply schedule as well as by a
supply curve based on an imaginary figures and data.
This can be shown by diagram as follows:
Assumptions Underlying the Law of Supply:
1) No change in the income:- There should not be any change in the
income of the purchaser or the seller.
2) No change in technique of production:- There should not be any change
in the technique of production. This is essential for the cost to remain
unchanged. With the improvement in technique if the cost of
production is reduced, the seller would supply more even at falling
prices.
3) There should be no change in transport cost:- It is assumed that
transport facilities and transport costs are unchanged. Otherwise, a
reduction in transport cost implies lowering the cost of production, so
that more would be supplied even at a lower price.

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4) Cost of production be unchanged:- It is assumed that the price of the
product changes, but there is no change in the cost of production. If the
cost of production increases along with the rise in the price of product,
the sellers will not find it worthwhile to produce more and supply more
5) There should be fixed scale of production:- During a given period of
time, it is assumed that the scale of production is held constant. If there
is a changing scale of production the level of supply will change,
irrespective of changes in the price of the product.
6) There should not be any speculation:- The law also assumes that the
sellers do not speculate about the future changes in the price of the
product. If, however, sellers expect prices to rise further in future, they
may not expand supply with the present price rise.
7) The prices of other goods should remain constant:- Further, the law
assumes that there are no changes in the prices of other products. If the
price of some other product rises faster than that of the product in
consideration, producers might transfer their resources to the other
product—which is more profit yielding due to rising prices.
8) There should not be any change in the government policies:-
Government policy is also important and vital for the law of supply.
Government policies like—taxation policy, trade policy etc., should
remain constant.
Such exceptional cases may be described as follows
1) Exceptions about Future Price:- In this connection if the seller expects a
rise in the price in future, he may withhold his stock of the commodity. He
will therefore reduce his supply in the market at the present price.
Similarly, if he expects a further fall in price in future, he will try to dispose
of the commodity and will supply more even at a lower price.
2) Supply of Labour:- Supply of labour after a certain point, when the wage
rate rises, its supply will tend to diminish. Why such situation because
workers normally prefer leisure to work after receiving a certain amount of
wage.
3) Rate of Interest and Savings Position:- When there is rise in the interest rate,
more savings are induced. But after a certain point of rise in the rate of

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interest households may tend to save less than before due to high income
from the interest. In that case savings tend to decline even with a rise in the
rate of interest.
Elasticity of Supply
The elasticity of supply establishes a quantitative relationship between the
supply of a commodity and it’s price. Hence, we can express the numeral
change in supply with the change in the price of a commodity using the concept
of elasticity. Note that elasticity can also be calculated with respect to the other
determinants of supply.
Es= [(Δq/q)×100] ÷ [(Δp/p)×100] = (Δq/q) ÷ (Δp/p)
Δq= The change in quantity supplied
q= The quantity supplied
Δp= The change in price
p= The price
(a) Elastic Supply (ES>1):
Supply is said to be elastic when a given percentage change in price leads to a
larger change in quantity supplied. Under this situation, the numerical value of
Es will be greater than one but less than infinity.
(b) Inelastic Supply (ES< 1):
Supply is said to be inelastic when a given percentage change in price causes a
smaller change in quantity supplied. Here the numerical value of elasticity of
supply is greater than zero but less than one.

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(c) Unit Elasticity of Supply (ES = 1):
If price and quantity supplied change by the same magnitude, then we have unit
elasticity of supply. Any straight line supply Curve passing through the origin.
(d) Perfectly Elastic Supply (ES = ∞):
The numerical value of elasticity of supply, in exceptional cases, may reach up
to infinity. The supply curve has been drawn parallel to the horizontal axis. The
economic interpretation of this supply curve is that an unlimited quantity will
be offered for sale at the given price OS. If price slightly drops down below OS,
nothing will be supplied.
(e) Perfectly Inelastic Supply (ES = 0):
Another extreme is the completely or perfectly inelastic supply or zero elasticity.
SS1 curve drawn in Fig. 4.21 illustrates the case of zero elasticity. This curve

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describes that whatever the price of the commodity, it may even be zero,
quantity supplied remains unchanged at OQ. This sort of supply curve is
conceived when we consider the supply curve of land from the viewpoint of a
country, or the world as a whole.
One important point to note here. Any straight line supply curve that intersects
the vertical axis above the origin has an elasticity of supply greater than one (Fig.
4.17). Elasticity of supply will be less than one if the straight line supply curve
cuts the horizontal axis on any point to the right of the origin, i.e. the quantity
axis (Fig. 4.18).
Perfect competition
A perfectly competitive market is a hypothetical market where competition is at
its greatest possible level. Neo-classical economists argued that perfect
competition would produce the best possible outcomes for consumers, and
society.
1) A Large Number of Buyers and Sellers:- Under perfect competition there
are a large number of buyers and sellers of a commodity.
2) An Identical or a Homogeneous Product:- All the sellers in a perfectly
competitive market supply an identical product. In other words, the
products of all the competitive firms are the same.
3) No Individual Control Over the Market Supply and Price:- As many sellers
are selling an identical product, a single firm supplies a negligible or an
insignificant portion of the industry. For this reason, it has no control over
market supply and market price.
4) No Buyers’ Preferences:- In a perfectly competitive market there is no
preference of buyers for the product of any particular seller. As the

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products of all the sellers are identical, buyers can buy the product from
any of them.
5) Perfect Knowledge:- Again, both buyers and sellers have a perfect or full
knowledge relating to the price prevailing in the market. For this reason,
there can exist only one price in a perfectly competitive product market.
6) Perfect Mobility of Factors:- The factors of production like labour or capital
can freely move into the industry or freely go out of the industry. This is
necessary to keep a proper balance between demand and supply of a
commodity.
7) Free Entry and Free Exit of Firms:- In this type of market new firm can
freely enter the industry or an existing firm can freely leave the industry in
the long run.
8) Absence of Transport Cost and a Close Contact between Buyers and Sellers:
- A market becomes perfectly competitive when both buyers and sellers
stay at the same place so that there is a close contact between them.
Because of this, neither buyers nor sellers have to bear any transport cost.
Benefits of Perfect Competition
It can be argued that perfect competition will yield the following benefits:
1) Because there is perfect knowledge, there is no information failure and
knowledge is shared evenly between all participants.
2) There are no barriers to entry, so existing firms cannot derive any
monopoly power.
3) Only normal profits made, so producers just cover their opportunity cost.
4) There is no need to spend money on advertising, because there is perfect
knowledge and firms can sell all they can produce. In addition, selling
unbranded goods makes it hard to construct an effective advertising
campaign.
5) There is maximum possible:
· Consumer surplus
· Economic welfare
6) There is maximum allocative and productive efficiency:
7) Equilibrium will occur where P = MC, hence allocative efficiency.

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8) In the long run equilibrium will occur at output where MC = ATC, which
is productive efficiency.
9) There is also maximum choice for consumers.
Price determination under Perfect Competition
Price determination under perfect competition is analyzed under three different
time periods:
a) Market Period
b) Short Run
c) Long Run
a) Market Period:
In a market period, the time span is so short that no firm can increase its output.
The total stock of the commodity in the market is limited. The market period
may be an hour, a day or a few days or even a few weeks depending upon the
nature of the product.
In case of Perishable Goods
Fig 4.1 shows that the supply curve of perishable commodities like fish is
perfectly inelastic and assumes the form of a vertical straight line SS. Let us
suppose that the demand curve for fish is given by dd. Demand curve and
supply curve intersect each other at point R, determining the price OP. If the
demand for fish increases suddenly, shifting the demand curve upwards to d’d’.
Ø Price is determined solely by the demand condition that is an active agent.

Semester Unit - 1
Similarly, if the demand for a product is given, as shown in demand curve SS in
figure 4.2. If the supply of the product decreases suddenly from SS to S’S’, the
price increases from P to P’.
Ø In this case price is determined by supply, the supply being an active
agent.
Ø The supply curve of non-perishable but reproducible goods will not be a
vertical straight line throughout its length.
Ø The price below which the seller declines to offer for any amount of his
product is known as ‘reserve price’.
b) Pricing in the Short Run- Equilibrium of the Firm:
Short period is the span of time so short that existing plants cannot be extended
and new plants cannot be erected to meet increased demand. However, the time
is adequate enough for producers to adjust to some extent their output to the
increase in demand by overworking their fixed capacity plants.
Ø In the short run, therefore, supply curve is elastic.
The firm is in equilibrium at the point B where the marginal cost curve
intersects the marginal revenue curve from below:

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The firm supplies OQ output. The QC is the average cost and the firm earns total
profit equal to the area shown by ABCD. The firm maximizes its profit. Earlier to
the point of equilibrium, the firm does not attain the maximum profit as each
additional unit of output brings more revenue that its cost. Any level of output
greater than OQ brings less marginal revenue than marginal cost.
For the equilibrium of a firm the two conditions must be fulfilled:
1. The marginal cost must be equal to the marginal revenue
2. The second and necessary condition for equilibrium requires that the
marginal cost curve cuts the marginal revenue curve from below
The fact that a firm is in equilibrium does not imply that it necessarily earns
supernormal profits. In the short-run equilibrium firms may earn supernormal
profits, normal profits or may incur losses.
Ø If the average cost is below the average revenue, the firm earns
supernormal profits.
Figure 4.5 illustrates that the average cost QC is less than average revenue QB,
and the firm earns profits equal to the area ABCD.
Ø If the average cost is above the average revenue the firm makes a loss.
Figure 4.6 shows that the Average cost QF is higher than QG average revenue
and the firm is incurring loss equal to the shaded area EFGH.

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· In this case the firm will continue to produce only if it is able to cover its
variable costs. Otherwise it will close down, since by discontinuing its
operations the firm is better off; it minimizes its losses.
· The point at which the firm covers its variable costs is called ‘the closing-
down point’
Figure 4.7 explains shut- down point.
Equilibrium of the Industry:
An industry is in equilibrium at that price at which the quantity demand is equal
to the quantity supplied.
Figure 4.8 explains that DD is the industry demand and SS the industry supply.
The point E at which industry demand and industry supply equalizes, the price
OP is determined. OQ is the quantity demanded and quantity supplied. This,
however, is a short run equilibrium where at the market-determined price some
firms may be making supernormal profits, normal profits or making losses. In
the long run the firms may not continue incurring losses. Loss making firms
that cannot adjust their plant will close down.

Semester Unit - 1
Firms that are making supernormal profits will expand their capacity.
Simultaneously new firms will be attracted into the industry. Free movement of
firms in and outside the industry and readjustment of the existing firms in the
industry will establish a long run equilibrium in which firms will just be earning
normal profits and there will be no tendency of entry or exit from the industry.
c) Pricing in the Long Run:
The long run is a period of time long enough to permit changes in the variable
as well as in the fixed factors. In the long run, accordingly, all factors are
variable and non- fixed. Thus, in the long run, firms can change their output by
increasing their fixed equipment. They can enlarge the old plants or replace
them by new plants or add new plants.
Moreover, in the long run, new firms can also enter the industry. On the
contrary, if the situation so demands, in the long run, firms can diminish their
fixed equipments by allowing them to wear out without replacement and the
existing firm can leave the industry.
Thus, the conditions for long run equilibrium of perfectly competitive firm can
be written as:
Price = Marginal Cost = Minimum Average Cost.
The conditions for the long run equilibrium of the firm under perfect
competition can be easily understood from the Fig. 4.9, where LAC is the long
run average cost curve and LMC in the long run marginal cost curve. The firm
under perfect competition cannot be in long run equilibrium at price OP’,
because though the price OP’ equals MC at G (i.e., at output OQ) but it is greater
than the average cost at this output and, therefore, the firm will be earning
supernormal profits.

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Since all the firms are assumed to be identical, all would be earning
supernormal profits. Hence, there will be attraction for the new firms to enter
the industry. As a result, the price will be forced down to the level Op at which
price, the firm is in equilibrium at F and is producing OQ” output.
At point F or equilibrium output OQ”, the price is equal to average cost, and
hence the firm will be earning only normal profits. Therefore, at price OP, there
will be no tendency for the outside firms to enter the industry. Hence, the firm
will be in equilibrium at OP price and OQ output.
On the contrary, a firm under perfect competition cannot be in the long run
equilibrium at price OP”. Though price OP” is equal to marginal cost at point E,
or at output OQ” but price OP” is lower than the average cost at this point and
thus the firm will be incurring losses.
Since all the firms in the industry are identical in respect of cost curves, all
would be incurring losses. To avoid these losses, some of the firm will leave the
industry. As a result, the price will rise to OP, where again all firms are making
normal profits. When the price OP is reached, the firms would have no further
tendency to quit
Thus, to conclude that at price OP, the firm under perfect competition is in
equilibrium in the long run when:
Price = MC = Minimum AC
Now, at price OP, besides all firms being in equilibrium at output OQ, the
industry will also be in equilibrium, since there will be no tendency for new
firms to enter or the existing firms to leave the industry, because all will be
earning normal profits. Thus, at OP price, full equilibrium, i.e. equilibrium of
all the individual firms and also of the industry, as a whole, is achieved in the
long run under perfect competition.

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