- Economics is the study of allocating scarce resources to meet unlimited human wants. Opportunity cost is the value of the best alternative forgone when making a choice between mutually exclusive alternatives. - The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from each additional unit decreases. Total utility initially increases at an increasing rate, reaches a maximum, then decreases. - Demand is the quantity of a good consumers are willing and able to purchase at various prices. The law of demand states that, all else equal, as price increases, demand decreases. The demand curve slopes downward due to substitution, income, and future expectations effects. - Supply is the quantity of a

1. Economics
Economics is the study of allocation of
scarce resources to meet unlimited
human wants.

2. Opportunity Cost
In microeconomic theory, the opportunity cost of a
choice is the value of the best alternative forgone, in a
situation in which a choice needs to be made between
several mutually exclusive alternatives given limited
resources.
Total cost of factors of production includes both explicit
and implicit cost where implicit costs are the opportunity
cost of those factors.

3. Law of diminishing marginal utility
A law of economics stating that as a
person increases consumption of a
product - while keeping consumption of
other products constant - there is a
decline in the marginal utility that
person derives from consuming each
additional unit of that product.

4. TU
MU
MU
TU
Q
QQm
TU is maximum

5. d(TU)
d(Q)
MU =
When TU is increasing, MU > 0
When TU is maximum, MU = 0
When TU is decreasing, MU < 0
d(MU)
d(Q)
=
d(Q)
d (TU)
2
2 < 0

6. Demand
Demand may be defined as the amount of the commodity an
individual is willing to buy at a particular price and at a particular
time.
Q = f(P). It means quantity demanded is a function of price.
Law of Demand
Law of demand states that all other factors being equal, as the price
of a good or service increases, consumer demand for the good or
service will decrease and vice versa.

7. P
Q
D
There is an inverse relationship between
the price and quantity of a product.

8. The demand curve slopes downwards due to the following reasons:
(1) Substitution effect: When the price of a commodity falls, it becomes relatively
cheaper than other substitute commodities. Thus, the quantity demanded of the
commodity, whose price has fallen, rises.
(2) Income effect: With the fall in the price of a commodity, the consumer can buy
more quantity of the commodity with his given income because as a result of a fall in
the price of the commodity, consumer’s real income increases and so, the demand for
the commodity.
(3) Number of consumers: When price of a commodity is high, only few consumers can
afford to buy it, And when its price falls, more numbers of consumers would start
buying it. So, the total demand increases.
(4) future expectations - When a consumer expects the prices of commodities to rise
in near future, he starts making more demand and vice versa. E.g. when we expect that
the prices of gas cylinder is going to rise after few days, we start making more
demand at low prices.
(5)Several uses of the commodity- When the price of a commodity falls, people start
demanding more to put it into different uses Eg. Milk. When the price of milk falls,
we start demanding more of it so as to make butter, sweets and curd etc.

9. Q
P
D
P
Q
D
P
Q
D
P
Q
D2
D1
Elasticity of Demand

10. Price Elasticity of a Demand Curve
PED =
dP
P
Q
dQ
When PED < 0, a good is price inelastic.
When PED > 0, a good is price elastic.
When PED = 0, a good is perfectly
inelastic
When PED = 1, a good is unitary elastic
When PED = ∞, a good is perfectly
elastic

11. Market demand curve
Q QQ
P P P
P1
P2
D1 D2 Dm
Q1Q1Q2 Q3 (Q2+Q3)
Market demand curve is the horizontal
summation of individual demand curves
for private goods.

12. Total Product, Average Product and
Marginal Product
Total product (TP) is the maximum
output that a given quantity of labour
can produce when working with a given
quantity of capital units.
TP = Q

13. Average product (AP) equals total
product of labor divided by the quantity
of labour units employed.
AP =
Q
L

14. Marginal product (MP) is the increase in
total product brought about by hiring
one more unit of labour, while holding
quantities of all other factors of
production constant.
MP =
d(Q)
d(L)
and
d(MP)
d(L)
=
d (Q)
d(L)
2
2

15. TP
L
Q

16. Q
L
AP
MP

17. L
L
Q
Q
TP
AP
MP
a
b
c

18. TP increases at an increasing rate until
point (a). Point (a) represents the ‘Point
of Inflection’.
At point (a), MP is maximum.
At point (b), AP is maximum, where
AP = MP
MP > AP, when AP is increasing
MP < AP, when AP is decreasing
At point (c), MP = 0, where TP is Maximum

19. Total Product increases at a decreasing
rate from point (a) to (b), therefore,
Marginal Product is decreasing but
positive during that period. After point
(c), Total product start to decrease, as
a result, MP is negative from point (c).

20. Law of Diminishing Returns
A law of economics stating that, as the number of new
employees increases, the marginal product of an
additional employee will at some point be less than the
marginal product of the previous employee.
Initially MP increases from origin to point (a), but at a
decreasing rate. At point (a), MP is maximum. From point
(a), MP is decreases at a decreasing rate.

21. MP
Q
Q
L
L
a
At point (a),
d(MP)
d(L)
= 0

22. From origin to point (a)
d(MP)
d(L)
> 0 and
d(L)
d (MP)
2
2 < 0
∴ MP is increasing at a decreasing rate.
d(MP)
d(L)
< 0 and
d(L)
d (MP)
2
2 < 0
From point (a) onwards
MP is decreasing at a decreasing rate.∴

23. Cost Analysis
Total Cost =
Total Fixed Cost
+
Total Variable Cost
TAC =
TFC
Q
+
TVC
Q
= AVCAFC +
Total cost includes opportunity cost.

24. Marginal Cost
MC =
d(TC)
d(Q)
=
d(TVC)
d(Q)
We know
TVC = (W.L)
&
W is Fixed
=
W.d(L)
d(Q)
=
W
MP
There is an inverse
relationship between
MC and MP.

25. Average Variable Cost and Average
Product
AVC =
Q
TVC
We know
TVC = (W.L)
&
W is Fixed
=
Q
W.L
=
W
AP
There is an inverse
relationship between
AVC and AP.

26. Q
Cost
TFC
TC
Cost
Q
AFC
AVC
TAC
MC
TVCa

27. Initially Total Cost increases at a
decreasing rate, then it reaches at ‘point
of inflection’ at (a), and after point (a)
it starts to increase at an increasing
rate.
Marginal Cost is positive but decreasing
until it reaches point (a). At point (a),
marginal cost is minimum, and after that
point MC is positive and increasing.

28. Relationship between TC, AVC and MC
When TFC = 0, TC = TVC
When AVC is minimum, AVC = MC
When AC is minimum, AC = MC
MC < AVC & AC, when AVC & AC is decreasing
MC > AVC & AC, when AVC & AC is increasing

29. Revenue Analysis
Total Revenue = (Price * Quantity)
Average Revenue =
TR
Q
= Price
Marginal Revenue =
d(TR)
d(Q)
Since Price is
Constant=
[P * d(Q)]
d(Q)
= Price
Therefore, Price = AR = MR

30. Profit Analysis
Economic Profit (∏) = TR - TC
d(∏)
d(Q)
= -
d(TC)d(TR)
= MR - MC
d(Q) d(Q)
P - MC=Marginal Profit∴
Profit is maximum or minimum where Marginal Profit = 0,
i.e. P = MR = MC
A normal profit is achieved when TR = TC, since TC includes
opportunity cost.

31. Q
Price and
Cost
TC TR
∏
a
b
c
d

32. Q
∏
Marginal Profit
c
a
Q
∏
b

33. d(∏)
d(Q)
= MR - MC
From Origin to point (a)
MC > MR
∴ d(∏)
d(Q)
< 0
d(∏)
d(Q) 2
2
= -
d(MC)
d(Q)
and
d(MC)
d(Q)
< 0
and
d (∏)
2
d(Q)
2 > 0
TC > TR ,
∏ < 0 ,
Total Profit is decreasing at an increasing rate and
is negative
1)

34. From Point (a) to Point (c)
TC > TR , MR > MC and
d(MC)
d(Q)
< 0
∴ ∏ < 0 ,
d(∏)
d(Q)
> 0 and
d (∏)
d(Q)
> 0
2
2
Total Profit is increasing at an increasing rate but is
still negative
2)

35. From Point (c) to (b)
TR > TC , MR > MC and
d(MC)
d(Q)
> 0
∴ ∏ > 0 ,
d(∏)
d(Q)
> 0 and
d (∏)
d(Q)
2
2
< 0
Total Profit is increasing at a decreasing rate but is
positive
3)

36. From Point (b) onwards4)
d(∏)
MC > MR and
d(MC)
d(Q)
> 0
∴
d(Q)
< 0 and
d (∏)
d(Q)
2
2
< 0
Total Profit is decreasing at a decreasing rate

37. AT POINT (a)
d(∏)
d(Q)
= 0
From (1) & (2), we can conclude that ∏ is minimum
at point (a).
AT POINT (b)
d(∏)
d(Q)
= 0
From (3) & (4), we can conclude that ∏ is maximum
at point (b).
AT POINT (c) ∏ = 0
d(∏)
d(Q)
is Maximum and
d (∏)
d(Q)
2
2 = 0

38. Supply Curve Analysis
A firm maximises it’s profit, when MR = MC and MC is
increasing
Q
P
MC
ATC
AVC
Q1 Q2 Q3 Q4 Q5
P1
P2
P3
P4
P5
AR1 = MR1
AR2 = MR2
AR3 = MR3
AR4 = MR4
AR5 = MR5
P6 AR6 = MR6
Q6

39. At Q1 level of output, AR < AVC, therefore, the firm will not be able
to cover it’s variable cost in producing output. Therefore, the firm
will not produce any output at this stage.
At Q2 level of output, AR = AVC, the firm covers it’s variable cost, so
it is indifferent at this point.
At Q3 level of Output, AR > AVC, the firm covers variable cost and a
part of it’s fixed cost, so it will benefit by producing output at this
level.
At Q4 level of output, AR = ATC, it is break-even at this stage.
From the above analysis, it can be concluded that a firm’s short run
supply curve is MC curve above minimum point on AVC curve.

40. Benefit analysis
Total Benefit = (W*Q)
W = willingness to pay by the consumer
Q = Quantity demanded
Marginal benefit =
d(TB)
d(Q)
=
d(W*Q)
d(Q)

41. Consumer surplus
Consumer surplus is defined as the difference
between the consumers' willingness to pay for a
commodity and the actual price paid by them.
CS = TB - (P*Q)
A consumer will demand quantity of goods at any
fixed price, where consumer surplus is maximum.
= MB.d(Q)∫ - (P*Q)

42. consumer surplus is maximum when
d(CS)
d(Q)
= 0
i.e.
d(TB)
d(Q)
= 0-
d(Q)
d(P*Q)
or, MB - P = 0 Since, P is constant
or, MB = P
Therefore, demand curve is same as the marginal benefit
curve.

43. Producer surplus is defined as the difference
between the amount the producer is willing to
supply goods for and the actual amount
received by him when he makes the trade.
Producer surplus
Producer surplus = (P - MC)*Q
A producer surplus is maximum when P = MC.

44. D
S
P
QQe
e
P
e
Market Equilibrium
Consumer Surplus
Producer Surplus
Pe = Equilibrium Price
Qe = Equilibrium Quantity
Equilibrium point

45. When demand and supply curves
intersect, i.e. MR = MC, the market is in
equilibrium. That is where quantity
demanded and quantity supplied are
equal. The corresponding price is the
equilibrium price or market-clearing
price, the quantity is the equilibrium
quantity.

46. Difference between changes in demand and changes
in quantity demanded
Changes in quantity demanded occurs when there is
a change in demand due to a change in price, and
all other factors remaining unchanged and that is
represented by a movement along a demand curve.
Changes in demand occurs when there is a change in
demand caused by change in a factor other than
price of the good in question and that is represented
by a shift in the position of the whole curve.

47. Market or aggregate demand is the summation of individual demand curves. In
addition to the factors which can affect individual demand there are three factors
that can affect market demand (cause the market demand curve to shift):
a change in the number of consumers,
a change in the distribution of tastes among consumers,
a change in the distribution of income among consumers with
different tastes.
Some circumstances which can cause the demand curve to shift in include:
Decrease in price of a substitute
Increase in price of a complement
Decrease in income if good is normal good
Increase in income if good is inferior good
Factors affecting market demand

48. Changes in Market Equilibrium
1) Changes in Demand with Supply conditions constant
Q
P
S
D’
D’’ D
When demand changes from D to D’, price rises for the same amount
of quantity. As price rises, supply increases. Therefore, both the
equilibrium price and quantity will rise.
When demand changes from D to D’’, price falls for the same
amount of quantity. As price falls, supply decreases. Therefore, both
the equilibrium price and quantity will fall.

49. Changes in Supply with Demand conditions constant2)
S’’
S’
S
D
Q
P
When supply changes from S to S’, price falls for the same amount
of quantity. As price falls, demand increases. Therefore, equilibrium
price falls but equilibrium quantity rises.
When supply changes from S to S’’, price rises for the same amount
of quantity. As price rises, demand decreases. Therefore, equilibrium
price rises but equilibrium quantity falls.

50. P
Q
P
D
s
P
Q
D
s
P
Q
D
s
P
Q
D
s
s’
D’
s’’
3)
D’
s’
4)
D’
s’
5)
s’’
6)
D’
s’
s’’
s’’

51. An increase in Demand and an increase in Supply simultaneously3)
When increase in demand is equal to increase in supply for a good,
then the equilibrium price will be the same as before, however, there
will be an increase in equilibrium quantity.
When increase in demand is more than increase in supply for a
good, then the equilibrium price will rise, and there will be an
increase in equilibrium quantity as well.
When increase in demand is less than increase in supply for a good,
then the equilibrium price will fall, however, there will be an
increase in equilibrium quantity.

52. An increase in Demand and a decrease in Supply simultaneously4)
When increase in demand is equal to decrease in supply for a good,
then the equilibrium price will rise, however, there will be no change
in equilibrium quantity.
When increase in demand is more than decrease in supply for a
good, then the equilibrium price will rise, and there will be an
increase in equilibrium quantity as well.
When increase in demand is less than decrease in supply for a
good, then the equilibrium price will rise, however, equilibrium
quantity will fall.

53. A decrease in Demand and an increase in Supply simultaneously5)
When decrease in demand is equal to increase in supply for a good,
then the equilibrium price will fall, however, there will be no change
in equilibrium quantity.
When decrease in demand is more than increase in supply for a
good, then the equilibrium price will fall, and equilibrium quantity
will fall as well.
When decrease in demand is less than increase in supply for a
good, then the equilibrium price will fall, however, equilibrium
quantity will rise.

54. A decrease in Demand and a decrease in Supply simultaneously6)
When decrease in demand is equal to decrease in supply for a
good, then there will be no change in equilibrium price, however,
equilibrium quantity will fall.
When decrease in demand is more than decrease in supply for a
good, then equilibrium price will fall, and equilibrium quantity will
fall as well.
When decrease in demand is less than decrease in supply for a
good, then equilibrium price will rise, however, equilibrium quantity
will fall.

55. Price ceiling
P
Q
Supply
Demand
Pc
Pe
Qe
A B
Excess Demand/Supply shortage = From point A to point B
Qs Qd

56. A price ceiling is a maximum price set by the government
in order to protect customers from higher prices charged
by the suppliers of particular goods and services. When
the regulated price is lower than equilibrium price, the
producers will reduce the supply of the product. However,
the demand at a lower price will rise, i.e. quantity
demanded is higher that the quantity supplied. So, there
will be an excess demand or supply shortage in the
market. If this price ceiling continues for some time, it
can lead to black marketing. As long as excess demand/
supply shortage is on the lower side, price ceiling can be
successful. This can be achieved only when both demand
and supply of the product is relatively price inelastic.

57. Price floor
P
Q
Supply
Demand
Pf
Pe
Qe
A B
QsQd
Excess Supply/Demand shortage = From point A to point B

58. A price floor is a minimum price set by the authority in
order to protect producers from very low price of
particular goods and services. When the regulated price
is higher than the equilibrium price, suppliers will be
encouraged to increase production. But as price rises, the
demand for the goods will start to fall. As a result, there
will be a excess supply of goods in the market for which
there is no demand i.e. quantity demanded is lower than
the quantity supplied. In order to minimise the loss of
producers, the authority can buy all the surplus goods, so
that producers are not affected due to price rise. Also, if
both demand and supply of the goods are price inelastic,
then the amount of surplus product will be less, and
price floor will be successful.

59. Tax on equilibrium
P
Q
D
S
S’

60. Imposition of tax will increase the cost of the
product, as a result, the supply curve will shift to
the left. Tax will increase the price and reduce
the quantity demanded due to higher price.
Therefore, both consumers and suppliers will have
the burden of tax. The more inelastic the
demand curve, the burden of tax will be greater
on consumers. Similarly, if the supply is more
inelastic and demand is elastic, then the burden
of tax will be greater on suppliers.

61. Subsidy on equilibrium
The effect of subsidy on equilibrium price and
quantity depends on who gets the subsidy. If the
customer receives subsidy, then there will be
increase in demand, which will shift the demand
curve to the right, as a result, both the
equilibrium price and equilibrium quantity will
rise. When supplier receives the subsidy, it will
shift the supply curve to the right, as a result,
equilibrium price will fall and the quantity
demanded will increase. As a result, the
equilibrium quantity will rise.

62. Dynamics adjustments in the market
P P
Q Q
S
S
D
D’
D’’
D’’
D
D’
Short run Long run

63. The supply curve in the short run is relatively inelastic
due to the fact that only variable factors of production
can be adjusted if there is a sudden change in demand.
Therefore, the equilibrium price will have a greater effect
than equilibrium quantity, as it will be difficult to meet
the required demand in the short run. However, in the
long run, all factors of production can be varied, so if
there is a change in the demand, it is possible to meet
the change in demand. As a result, the equilibrium
quantity will have a greater effect than equilibrium price.

64. Economic Efficiency
Efficiency is concerned with optimal production and
distribution of scarce resources. Economic efficiency is a
combination of allocative and productive efficiency. An
allocative efficiency occurs when there is an optimal
distribution of goods and services, taking into account
consumer’s preferences i.e. when marginal benefit or price
is equal to marginal cost. A productive efficiency occurs
when the maximum number of goods and services are
produced with a given amount of inputs. This will occur
on the production possibilities frontier. On the curve it is
impossible to produce more goods without producing less
services. Productive efficiency will also occur at the
lowest point on the firms average cost curve.

65. Organisation of Industries
Industry
Characteristics
Number
of firms
Type
of product
Barriers to
entry
Control over
price
Degree of
concentration
Example
Perfect
Competition
Very
Large
Homogeneous None None Zero
Many
agricultural
products
Monopolistic/
Imperfect
Competetion
Large Differentiated None/Few Some Low
Restaurants,
Clothing
stores
Oligopoly Small Homogeneous Scale Substantial High
Cars,
Chemicals,
Oil
Monopoly One Unique Scale/Legal Complete 100%
Public
Utilities

66. Perfect Competition
In a perfectly competitive market, a firm’s demand curve is perfectly
elastic. It is determined by the intersection of market demand and
supply curve. Therefore, the price is constant for every firm in this
industry. When price is constant, P = AR = MR = D.
Q
P P
Q
Sm
Dm
Df
= AR = MR
Qm
Pm
1)

67. A firm can earn economic profit in the short run, however, in the long run, the
entrance of new firms and expansion of existing firms will bring more resources into
the industry, which will force the equilibrium price to fall and as a result, there will
be no economic profit for a firm in the long run.
MC
D = AR = MR
P
Q
AC
Economic Profit
Short Run Analysis
Cost of Production
(including normal profit)

68. Q
P
Sm
Dm
P
Q
Sm’
MC
AC
D = AR = MR
D = AR = MR
Long Run Analysis
P
P1
Q1Q

69. Monopoly
In monopoly market, there is only one supplier in the industry.
Therefore, the market demand curve is the demand curve for the
monopolist.
TR = (P*Q)
AR =
TR
Q
=
(P*Q)
Q
= P = Demand Curve
MR =
d(TR)
d(Q)
=
d(P*Q)
d(Q)
= Q*
d(P)
d(Q)
+ P
∴ MR < AR and When Q = 0, MR = AR
2)

70. Profit maximisation
P
Q
AR
MR
MC
ATC
Economic Profit
Cost of
Production
(including
normal profit)
Profit is maximum where MR = MC

71. P
Q
AR/Demand
MR
MC/Supply
ATC
A
B
C
D
E
F
G
H
QeQm

72. In monopoly market, a producer is a price maker, and the objective
is to maximise profit. Profit is maximum at point (f), where MR = MC.
At point (f), only Qm quantity of output is produced, which is less
than the equilibrium output at point (e). Therefore, under monopoly,
market equilibrium will not be reached. A monopolist will sacrifice
revenue in order to achieve maximum profit.
Consumer Surplus = Area under ABC
Producer Surplus = Area under BHFC
Under monopoly, the producer can make economic profit or super
normal profit under area BGDC. This is possible because of lack of
competition in the market.

73. Monopoly vs Perfect competition
Point (e) is the equilibrium point. Under perfect competition, the
equilibrium quantity will be produced at Qe.
Under perfect competition,
Consumer Surplus = Area under AGE.
Producer Surplus = Area under GHE.
As under monopoly market, a producer charges higher prices from
his customer, he will take away a part of consumer surplus which is
equal to the area under BGDC, which is equal to the economic profit.
Area under CDE and DFE is known as deadweight loss, it means
there is a portion of the surplus that will be lost by both consumer
and producer due to monopoly pricing.

74. Economies of scale
The cost advantage that arises with increased output of a product.
Economies of scale arise because of the inverse relationship between
the quantity produced and per-unit fixed costs; i.e. the greater the
quantity of a good produced, the lower the per-unit fixed cost
because these costs are shared over a larger number of goods.
Economies of scale may also reduce variable costs per unit because
of operational efficiencies and synergies. Economies of scale can be
classified into two main types: Internal – arising from within the
company; and External – arising from extraneous factors such as
industry size.

75. The fixed-plant period. Only labour can be added or
subtracted from the production of a good.
The variable plant period. Land and capital can be
added to or taken out of production of a firm’s good.
Short Run:
Long Run:
As a firm grows larger, it’s average total cost tend to decline,
because of the following reasons:
- Better bargaining power with labour unions
- Better prices from raw material providers
- Better productivity due to higher quality and more capital
- Lower transportation cost
- More favourable interest rate from banks
- Better specialisation

76. Cost
Q
ATC
ATC
ATC
ATC
ATC
ATC
ATC
ATC
1
2
3
4 5
6
7
8
Q Q Q Q Q Q Q Q1 2 3 4 5 6 7 8
c
c
c
c
c
1
2
3
4
5
LRAC Curve

77. When the demand for a product is Q1 or less, a firm can minimise
its cost at ATC1, but if the demand increases then average cost will
increase at the present AVC curve unless the firm opens another
factory with additional capital. By doing that, total average cost will
fall by opening a new factory whenever the average cost is about to
rise at the existing ATC curve, and it will continue to fall till 5th
factory at Q5 level of output. Therefore, the firm can achieve
economies of scale or increasing returns to scale till Q5 amount of
output. At Q5, Minimum efficiency scale(MES) is achieved. After Q5,
there will be a period where average cost is not going to fall despite
opening new factories to meet the increased demand, the firm will
have constant returns to scale. From Q6 level of output, a firm’s
average cost will start to grow again with increasing number of
factories, then there will be diseconomies of scale or decreasing
returns to scale. Diseconomies of scale can occur due to reasons like
duplication of efforts, mismanagement, principal-agent problems etc.

78. Monopoly in the long run
P
Q
AR
MR
LRMC
LRAC
Economic Profit
Cost of
Production
(including
normal profit)
ATC
Since a monopolist has the advantage of economies of scale, there is
a barriers to entry for new firms. As a result, a monopolist can
maximise it’s profit even in the long run. New firms do not have the
resources in the beginning to compete with a monopoly business, they
simply cannot reach the minimum average cost maintained by the
monopolist.
MC

79. Monopolistic/Imperfect competition3)
Monopolistic competition is a type of imperfect
competition such that many producers sell products that
are differentiated from one another (e.g. by branding or
quality) and hence are not perfect substitutes. In
monopolistic competition, a firm takes the prices
charged by its rivals as given and ignores the impact of
its own prices on the prices of other firms. In the
presence of coercive government, monopolistic
competition will fall into government-granted monopoly.
Unlike perfect competition, the firm maintains spare
capacity. Since, the firms have a degree of control over
price, they face a downward sloping demand curve. The
demand curve is highly elastic but not “flat”.

80. Short run profit
P
Q
AR
MR
MC
ATC
Economic Profit
Cost of
Production
(including
normal profit)
In the short run, the objective of a firm under
monopolistic competition is to maximise profit.
Profit is maximum where MR = MC

81. Long run profits
P
Q
AR
MR
LRMC
LRAC

82. In the long run, as there is no barriers to entry, more firms will
enter the market as they try to take part in the economic profit
available in the market. As a result, there will be increase in
resources in the market, market supply curve will shift to the right
and each firm’s demand curve will shift to the left. However, the firm
will continue to maximise their profit and produce output where MR
= MC. Therefore, in the long run, there will be no economic profit.
The demand curve will become the tangent to the LRAC curve for
every firm in the industry, where everyone can only claim normal
profit.
In monopolistic competition, the producers will not be able to reach
full capacity in the long run as they will not reach the minimum
LRAC because of downward sloping demand curve. The gap between
the actual output and output at minimum efficient scale is called
excess capacity.

83. Oligopoly4)
A situation in which a particular market is controlled by a small
group of firms.
An oligopoly is much like a monopoly, in which only one company
exerts control over most of a market. In an oligopoly, there are at
least two firms controlling the market.
In oligopoly, the objective of every firm is to maximise profit.
Therefore, they will produce that level of output where MR = MC.
Every firm in this type of market faces a kinked shaped demand
curve.

84. P
Q
MR
AR = D
MC1
MC2
o q
p
Kinked demand curve

85. In oligopoly market, each firm faces a demand curve
kinked at the existing price, that is if the firm raises its
price above the current existing price, competitors will
not follow and the acting firm will lose market share
and second if a firm lowers prices below the existing
price then their competitors will follow to retain their
market share and the firm's output will increase only
marginally. The firm's marginal revenue curve is
discontinuous (or rather, not differentiable), and has a
gap at the kink. For prices above the prevailing price the
curve is relatively elastic. For prices below the point the
curve is relatively inelastic. The gap in the marginal
revenue curve means that marginal costs can fluctuate
without changing equilibrium price and quantity. Thus
prices tend to be rigid.

86. Public goods
A public good is a good that is both non-excludable and
non-rivalrous in that individuals cannot be effectively
excluded from the use and where use by one individual
does not reduce the availability to others. Examples of
public goods are National defence, fresh air etc. Because
of the special two characteristics of public goods
mentioned above, it is not possible to achieve an
efficient allocation of resources like private goods
through market mechanism. This is a case of “market
failure’. This situation arrives due to ‘free rider’ problem.
A free rider is someone who consumes a good without
having to pay for it.

87. P
Q
D1
D2
(D1 + D2)
The market demand for private goods are derived through the
horizontal summation of the individual demand curves. However, the
market demand curve for public goods are derived through the
vertical summation of the individual demand curves. The difference
is due to the characteristics of the public goods being non-
excludable and non-rivalrous. Any extra quantity of public goods
produced will be consumed by everyone at the same time, so the
extra benefit of the public good is the addition of everyone’s
marginal benefit or willingness to pay for it.

88. Externalities
Every economic activity involves costs and benefits. When
a firm or an individual makes an economic decision,
they consider private cost and private benefits. However,
for some economic activities, individuals not directly
involved receive benefits from those activities. Such
benefits are known as external benefits or positive
externalities, for they accrue to the individuals who are
external to the activity. Public goods are one of the
examples of positive externalities. Similarly, for some
activities, individuals not directly involved bear some of
the costs of those activities. Such costs are known as
external costs or negative externalities, for they are
borne by individuals who are external to the activity.