Basics of micro economics

1. DEMAND
● Demand in Economics is the desire for something plus willingness and ability to pay certain price in order to posses it.
● Demand function for a commodity is the relation between various amount of commodity that the consumer demands and the
determinants of those amount.
Qd=f(p)
● The law of demand states that other factors being constant (cetris peribus), price and quantity demand of any good and
service are inversely related to each other. When the price of a product increases, the demand for the same product will
fall.
● Inverse demand function is P=f(Qd)

2. Why does demand curve slope downward?
● Income effect
● Substitution effect
● Diminishing marginal utility
● Increase in the number of consumers
● Increase in the number of uses
Extension and Contraction of demand
● Extension and contraction are due to own price of the commodity
● A movement along the demand curve in downward direction is called extension of demand
● A movement along the demand curve in upward direction is called contraction of demand

4. Shift in demand
● Factors other than own price of the commodity cause shift of demand curve
● Rightward and upward shift of demand curve represent increase in demand
● Leftward and downward shift of demand curve represent decrease in demand
Exceptions of law of demand
● Conspicuous consumption or veblen effect
● Giffen goods
● Goods with uncertain product quality
● Price expectations
● Snob effect
● Bandwagon effect

5. SUPPLY
● All other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers
offer will increase, and vice versa
● Supply is a flow concept
S=f(P)
P=price of the product
● Supply is a direct function of price of the commodity, when other determining factors are held constant

6. Causes of shift in supply curve
● Cost of production
● Price of other goods
● Technology
● Number of sellers
● Goal of the firms
Exceptions of law of supply
● Constant cost of supply: The long run
supply curve of constant cost industry
is perfectly elastic.

7. ● Decreasing cost of supply: The long run supply curve of decreasing cost industry is downward sloping curve (due to
economies of scale of large scale production)
● Some goods or productive factors are of completely fixed amount regardless of its price. In such cases supply curve
is vertical straight line.
Eg: perishable goods
Paintings

8. ● Labour supply curve or backward bending supply curve: An increase in the wage rate beyond a certain level reduces
the supply of labour. Thus the labour supply curve bends backward
● Up to a wage rate W increase in the wage rate will
Increase the supply of labour. Above the wage rate
W the labour will work for few hours. Here higher
wage rate work as a disincentive for longer hours of
work
● Above the wage rate W, income effect becomes
stronger than substitution effect.

9. Equilibrium
● Market is in equilibrium when quantity demanded is equal to quantity supplied.
● The price at which Qd=Qs is called equilibrium price
● When the market price is below equilibrium price there would be excess demand for the commodity or shortage of
the commodity. When market price is above the equilibrium price there would be excess supply or surplus of the
commodity.

10. ● Given the market supply curve of a commodity, the rightwaed shift of demand curve results an increase in both
equilibrium quantity and equilibrium price of the commodity.
● Given the market supply curve of a commodity, the leftward shift of demand curve results a decrease in both
equilibrium quantity and equilibrium price of the commodity

11. ● Given the market demand curve of a commodity, a rightward shift in market supply curve results an increase in
equilibrium quantity and a decrease in equilibrium price.
● Given the market demand curve of a commodity, a leftward shift in market supply curve results a decrease in
equilibrium quantity and an increase in equilibrium price.

12. Price elasticity of demand
● It is the ratio of percentage change in demand to percentage change in price of the commodity.
● It is the measure of degree of responsiveness in the quantity demanded of a commodity to change in its price.

13. ● Demand is said to be elastic when, price elasticity coefficient is greater than one. That is, a specific percentage
change in price results larger percentage change in quantity demanded
● Demand is said to be inelastic when, the price elasticity coefficient is less than one but more than zero. That is, a
specific percentage change in the price results a lesser percentage change in the quantity demanded.

14. ● If price elasticity coefficient is equal to one, then the demand is said to be unitary elastic. That is, a specific
percentage change in the price and resulting percentage change in quantity demanded are equal. Then the shape of
the demand curve is rectangular hyperbola.

15. ● If price elasticity coefficient is equal to zero, then demand is said to be perfectly inelastic

16. ● If price elasticity coefficient is equal to infinity, demand is said to be perfectly elastic. When the coefficient is
infinity, a small price reduction results a infinitely large increase in quantity demand.

17. Methods to measure price elasticity of demand
● Percentage method
● Expenditure method
● Graphic method
Percentage method: In percentage method, price elasticity of demand is the percentage change in the quantity demanded
devided by the percentage change in price
Expenditure method: A change in the price of a commodity will affect total expenditure on the commodity.
TE=P×Qd
On the basis of affect of price change on expenditure, we can classify elasticity in to three types- elastic, inelastic and
unitary elastic

18. Price elasticity and total revenue
Price elasticity and total revenue of a firm are closely related. When price of a commodity is reduced by a specific
percentage, if elasticity is equal to one, then, change in price will cause quantity demanded to rise by exactly that specific
percentage it self. Then total revenue will remain unchanged since increase in TR due to increase in Qd will be offset by
decrease in TR due to fall in price.
If elasticity coefficient is less than one, TR will fall with a price reduction. That is, increase in TR due to increase in Qd is less
than decrease in TR due to decrease in price
If elasticity coefficient is greater than one, TR will rise with a price reduction. That is, increase in TR due to increase in Qd is
greater than decrease in TR due to decrease in price.

19. GRAPHIC METHOD
Straight line method or point elasticity method : elasticity of demand on a straight line is different at each point on the line.
If a demand curve is linear, point elasticity of
demand at any point on the line can be
measured by dividing the length of lower
segment by the length of upper segment.

20. Arc elasticity of demand: In arc elasticity, we measure elasticity between two points. Elasticity is measured at the midpoint
of the arc.

21. Cross elasticity of demand: It is the responsiveness of demand for one commodity to change in the price of related
commodity

22. Substitute goods: Goods that can easily replace one another in consumption. They are the goods that serve the same
purpose. Eg: Butter and jam
Substitute goods have positive cross elasticity of demand.
Complimentary goods: Goods that are consumed together are called complementary goods. Eg: tea and sugar, Bread and
jam
In case of complementary goods consumption of both tend to rise or fall simultaneously.
For complementary goods, cross elasticity of demand is negative.

23. Income elasticity of demand: The responsiveness of commodity consumption to change in income is termed as income
elasticity of demand.

24. Normal good: Goods for which consumption increases in response to an increase in income. That is goods having positive
income elasticity.
Superior or luxury good: Normal goods with an income elasticity of demand greater than one.
Necessary good: Normal good with income elasticity of demand less than one is called necessary goods.
Inferior good: Goods for which consumption decreases as income increases. That is goods having income elasticity
negative.