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ECONOMICS NOTES
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WHAT IS ECONOMICS?
Economics is the study of how we the people engage ourselves in production, distribution and Consumption of goods and services in a society.
Law of Demand
Other things remaining the same when price of a good increase its demand Decreases and
vice-versa. Other factors are income, population, tastes, prices of all other goods etc.
Price
Demand
10
20
12
18
14
16
Demand curve:
A demand curve is a graph that obtains when price (one of the determinants of demand) is
plotted against quantity demanded.
Price (P)
14
12
10
Demand Curve (inverse Relation with Demand and Price)
16 18 20 Quantity Demanded (Q)
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Law of Supply
When Price of a good increases its supply also increase and vice versa..
Price
Supply
10
50
12
55
14
60
Supply curve:
A supply schedule is a table which shows various combinations of quantity supplied and
price.
Graphical illustration of this table gives us the supply curve.
Price (P) 14
12
Supply Curve
10
50 55 60 Supply
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Other Things also Called Assumption.
Assumption Demand
(I) No Change in income
(II) No Change in people or population
(III) No change in season / Weather
(IV) No change in Prices of selected goods
Assumption of Supply
(I) No change in technology
(II) No Change in Supply related Goods
(III) No change in Season/weather
Related Goods
(I) Substitute (Exp Pepsi & Cock)
(II)
Compliment
(These are Also Called Jointly Use)
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Market Equilibrium
Its a Point where Quantities, Demand and Supply are equal at one price or point called Equilibrium.
Price
Demand
Supply
10
10
20
12
80
40
14
60
60
16
40
80
18
20
100
Choose in Demand Supply
1 Extension and Contraction / Movement along the Curve ( Due to change in price)
2 Rise and Fall / Shifts in Curve (Due to Change in Other Factors)
Price (P)
P2
b
Edition
a P1 Contraction
Qs1 Qs2 QS
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S
S1
Price (P)
Fall
Rise
QS
Price (P)
Fall Rise
D1
D
Qd
Extension means: When increase due to change in price.
Rise: when increase due to changes in other Factors
ELASTICITY
It is responsiveness of one variable to changes in another. In proper words, it is the relative
response of one variable to changes in another variable.
The price elasticity of Demand is measure of degree of Responsiveness of changes in
quantity of demand to change in price of product in other word it is the Ratio of
Proportionate or percentage change in quantity of Demand to proportionate or percentage
change in the price of the product.
Ep= Proportionate / Percentage changes in Demand
Proportionate / Percentage changes in price
A B
Price Qd Price Qd
2 10 20 5 2 10 20 2
12 15 12 18
Product A has High Elasticity of Demand as compared to the product B
A B
Price Qd Price Qd
3 10 60 17 2 15 78 26
13 43 17 52
Ep = 1 Where Price and Quantity percentage are change equal.
Ep
Ep
=
=
> 1
< 1
Where Price increase and quantity Decrease.
Where price decrease and Quantity increase.
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Method of Measurement
1- Total Revenue / Total Expenditure
2- Formula / Mathematical
3- Geometrical
Total Revenue / Total Expenditure
According to this method the price Elasticity of Demand is observed by changes in price &
total Expenditure according to this method there three categories of Elasticity.
(I) Price Elasticity Demand = 1
(ii) Price Elasticity Demand > 1
(iii) Price Elasticity Demand < 1
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THREE CORE RULES OF ELASTICTY
RULE #Ol
Less than gieater than
Price elasticity Inerastic 1 Elastic
RULE #02
Income elasticity
RULE #03
onnal good
Inferior good
+
Cross elasticity
Substih1tes
Cornpletnents
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Price Elasticity Demand = > 1
If Price and Total Expenditure/ Revenue make in Opposite Direction.
Price Elasticity Demand = 1
If due to change in price total expenditure remain the same.
For Exp.
Price Qd TR/TE = P x Qd
10 20 200
20 10 200
For Exp.
Price Qd TR/TE = PxQd
10 20 200
20 8 160
Price Elasticity Demand = < 1
If Price and Total Expenditure make in same direction.
For Exp.
P Qd TR/TE = PxQd
10 20 200
20 12 240
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Formula / Mathematical Method
(I) Point Elasticity
(II) Arc Elasticity
Point Elasticity
Point elasticity is used when the change in price is very small, i.e. the two points between
which Elasticity is being measured essentially collapse on each other.
Formula point Elasticity
Ep = Qd x P1
P Qd1
Arc Elasticity
Arc elasticity measures the average elasticity between two points on the demand curve.
Formula of Arc Elasticity
Ep = Qd x P2 + P1
P Qd2 + Qd1
Where
Qd1 = Initial Quantity of Demand
Qd2 = New Quantity of Demand
P1 = initial Period
P2 = New Period
Qd = Qd2 Qd1
P = P2 P1
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Example: Calculate Ep by Point and Arc Formula to Following Data.
Price Qd
20 40
23 32
3 -8
Point Formula
Ep = Qd x P1
P Qd1
= -8 x 20
3 40
= -8
6
Ep = -1.33
Arc Formula
Ep = Qd x P
P2 + P1
Qd2 + Qd1
= -8 x
3
23+20
32+40
= -8 x 43
3 72
Ep = -1.59
Relationship between Price & Demand is Always Negative. Due to Negative Relationship
between Price & Quantity of Demand
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Example No 2
Price Qd
23 32
20 40
-3 8
Point Formula
Ep = Qd x P1 P Qd1
= 8 x 23
- 3 32
= 23
-12
Ep = -1.92
Arc Formula
Ep = Qd x P2 + P1
P Qd2 + Qd1
= 8 x 20 + 23 - 3 40 + 32
=
8
x
43 - 3 72
= 43 -27
Ep
=
-1.59
The Point Formula is preferable when changes price and Demand are minor otherwise Arc
Formula give better result. Moreover Arc formula in general preferable because it gives
constant result if the value are inverse.
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Geometrical Method
According to this method price Elasticity of Demand is calculated in two cases.
(I) When Demand Curve is Linear
(II) When Demand Curve is Non Linear
When Demand Curve is Linear
In this case price Elasticity of Demand on the certain point of the linear Demand curve is
calculated by lower distance of Demand curve with upper distance of Demand curve.
P A Ep = infinity
Ep = >1
C Ep = 1
Ep = < 1
B Ep = 0
Qd
Example AB = 8 cm
AC
cb
=
=
4cm
4cm
When Demand Curve is Non Linear.
In this Price Elasticity of Demand on a certainty point of Non Linear Demand curve is
calculated by 1st making a tangent point and the dividing the lower distance of tangent with
upper distance.
BC +?
P B
F
A Ep = AC
BA
E Ep = AC
FE
c G
Qd
Kind / Types of Elasticity of Demand
1 Price Elasticity of Demand (Ep)
2 Income Elasticity of Demand (Ei)
3 Cross Elasticity of Demand (Ec)
Income Elasticity of Demand
Price Elasticity is a measure of Degree of Responsiveness of change in quantity of demand
to change in income of consumer in other words it is a ratio of proportionate of of
percentage change in Demand in income.
Ey = Proportionate / Percentage change in Demand
Proportionate / Percentage change in Income
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Measurement
Point Formula
Ey = Qd2 qd1
y2 y1 = Qd x y1
y1 y Qd1
Arc Formula
Ey = Qd2 Qd1
Qd2 + Qd1 = Qd x y2 + y1
y2 - y1 y Qd2 + Qd1
y2 + y1
Where
Qd1 = Initial Demand
Qd2 = New Demand
P1 = initial Income
P2 = New Income
Qd = Qd2 Qd1
P = Y2 Y1
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Y Qd
5000 10
55000 12
5000 2
Point Formula
Ey = Qd x Y1 y Qd1
= 2 x
50,000 5000
10
= 100,000
50000
Ey = 2
Arc Formula
Ey = Qd x y2 + y1 y Qd2 + Qd1
= 2 x
50
55000 + 50000
12 10
=
2
x 105,000 5000 22
Ey
=
1.91
For normal goods income Elasticity of demand is positive where as for inferior goods
income elasticity of Demand is negative.
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3- Cross Elasticity of Demand (Ec)
Cross Elasticity of Demand is a measure of Degree of Responsiveness of Change in
quantity of Demand of one goods to change in price of an other goods. In other word its is a
ration of to proportionate / percentage change in demand one goods to proportionate /
percentage change price another goods.
Ec = Proportionate\ Percentage change in Demand of X
Proportionate \ Percentage change in Price of Y
Measurement
(i) Point Formula
Ey = Qdx2 Qdx1
Qdx1
Py2 Py1 = Qdx x Py1
Py1 Py Qdx1
(ii) Arc Formula
Ey = Qdx2 Qdx1
Qdx2 + Qdx1 = Qdx x Py2 + Py1
Py2 - Py1 P y Qdx2 + Qdx1
Py2 + Py1
Where
Qdx1 = Initial Demand of Goods x
Qdx2 = New Demand of Goods x
Py1 = initial Price of Goods y
Py2 = New Income price of goods y
Qdx= Qdx2 Qdx1
Py = Py2 Py1
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Example No 1
Py Qdx
15 20
17 25
2 5
Point Formula
Ey = Qdx x Py1
Py Qdx1
= 5 x 15 2 20
= 15
8
Ey = 1.87
Arc Formula
Ey = Qdx x Py2 + Py1
Py Qdx2 + Qdx1
= 5 x 15 + 17
2 25 + 20
= 5 x 32
2 45
= 160
90
Ey = 1.77
The cross Elasticity between substitute is positive where as cross Elasticity between
compliment is negative.
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Example.
Y = Petrol
x = KM driven
Factor or Determinant of Elasticity of Demand.
(I) Nature of Goods
(II) Availability of Substitute
(III) No of uses of a product
(IV) Time period
(V) level of income
(VI) Level of Price
Example
Example of Nature of Goods (Necessity, comfort, luxury)
In case of Availability Substitute Elasticity Demand is high
In case of Non Availability Substitute Elasticity Demand is Low
In Case of level of income Low + High (Elasticity Low) in case of Middle Elasticity High
In short time period Elasticity Demand is (Inelastic)
In long time period Elasticity Demand is (Elastic)
Elasticity of Supply:
Price Elasticity of Supply is a measure of Degree of Responsiveness of change in quantity
of supply to change in price of a product in other word it is a ratio of proportionate/
percentage change in supply to proportionate / percentage change in price.
Es = Proportionate/ percentage change in supply
Proportionate/ percentage change in price
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Measurement
(i) Point Formula
Es = Qs2 Qs1
Qs1
P2 P1 = Qs x P1
P1 P Ps1
(ii) Arc Formula
Ey = Qs2 Qs1
Qs2 + Qs1 = Qs x P2 + P1
P2 - P1 Py Qs2 + Qs1
P2 + P1
Where
Qs1
Qs2
=
=
Initial Supply of Goods
New Supply of Goods
P1
P2
=
=
Initial Price of Goods
New price of goods
Qs
=
Qs2 Qs1
P
=
P2 P1
Example No 1
P Qs
55 100
60 120
5 20
Elasticity of Supply is + ve
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D (Ep = 0)
D
P S S(Es = 0)
S
Demand Qd Supply Qs
P S
Qd Qs
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Determinants / Factors of Elasticity of Supply
1 Level of Technology (Advance technology High Elasticity)
2 Nature of goods (Agricultural Low Elasticity + Industrial High Elasticity)
3 Productive Capacity of Firms
4 Mean of Transportation and Communication
5 Time Period (Short time period low and long high elasticity)
Market Equilibrium and Govt Policy
1- Price Floors and Price Ceilings
2- Taxes and Subsidies
P s
S1
S Excess
Pc
Pc E
Pe E pe
pf Shortage
D
Qe Qe1 Q Q
S S
E
E
D
D
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Incidents of a Tax
Incident of tax denote the incident of a tax of producer & consumers its depend upon
relative Elasticity of Demand and Supply. Incident of tax is more on consumer if Demand is
less elastic than supply where as its more on producer if supply is less elastic than Demand.
Analysis of Cost
1- In Short Run
2- In Long Run
Deference in Short Run and Long Run
The Distinguish between short run and long run is that in the short run atleast one factor of
production is constant where as in long run all the four factor of production become
variable.
In Short Run
1- Fixed Cost (FC)
2-
Variable Cost
(VC)
3-
Total Cost
(TC)
=
FC + VC
4-
Average Fixed Cost
(AFC)
=
FC/Q
5-
Average Variable Cost
(AVC)
=
VC/Q
6-
Average Fixed Total Cost
(ATC)
=
TC/Q
=
AFC + AVC
7-
Marginal Cost
(MC)
=
TC/ Q
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Fixed Cost
Fixed Cost is that cost which Does not change with change in level of output. Fixed
cost consists of expenditure on Rent infrastructure supply of Administrative staff etc.
Variable Cost
Variable Cost is that cost which change with the level of output it consist of
expenditure on raw material Wages of Direct Labor Fuel and Electricity Maintenance etc.
Analysis of Cost
Q FC VC TC AFC AVC ATC MC
0 300 0 300 0 0 0 0
1 300 300 600 300 300 600 300
2 300 400 700 150 200 350 100
3 300 440 740 100 146.67 246.67 40
4 300 450 750 75 112.50 187.50 10
5 300 500 800 60 100 160 50
6 300 600 900 50 100 150 100
7 300 780 1080 42.86 111.43 154.29 180
8 300 990 1290 37.50 123.75 161.25 210
9 300 1300 1600 33.33 144.44 177.78 310
10 300 1700 2000 30 170 200 400
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-Q
- Fe
- vc
-TC
1 2 3 4 5 6 7 8 9 10 11
700
600
500
400
300
200
100
0
1 2 3 4 5 6 7 8 9 10
- AFC
- AVC
- ATC
-MC
The three curves AVC, AVC & MC are U shave meaning that initially they fall and after
reacting a minimum point they rise again. The margin cost curve fall speedily and also rise
speedily and while rising it intersect the minimum point of AVC & ATC AFC curve is not
U shade but is L shave meaning that it fall continuously will rise in level of output.
In Long Run
Cost
LMC
LAC
Q
TC
LTC
Q
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Maximize
Profit = TR TC Loss = TC TR
Main Object of Firm maximizes profit and minimize loss
A Revenue under Perfect competition
B Revenue under Imperfect competition
Market Structure
Perfect competition Imperfect competition
Imperfect Competition
1- Monopoly
2- Duopoly
3- Oligopoly
4- Monopolistic competition
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Under perfect Competition
Q p TR AR MR
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
Revenue
50 TR
40
30
20
10 AR =MR=P
0
1 2 3 4 5
Revenue
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Under imperfect competition
Q
P
TR
AR
MR
1
10
10
10
10
2
9
18
9
8
3
8
24
8
6
4
7
28
7
4
5
6
30
6
2
6
5
30
5
0
7
4
28
4
-2
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Relationship Note
Where the total revenue is maximum minor revenue will be zero when total revenue start
falling margin revenue will become negative.
The MR Curve fall at the double speed than average revenue curve.
Speed Point
AR
MR
Perfect Competition
Perfect Competition is a market structure in which there is large number of firms
producing a homogenous product and there are no barriers in the market.
Characteristics / Futures
Many sellers and Buyers
Homogenous products
Free entry to exit of firms
Complete knowledge market condition
Free mobility of factor of production
Equilibrium of firm under perfect competition
A- In short Run B- In Long Run
In Short Run
1- Firm Earning Abnormal Profit
2- Firm Earning Normal Profit
3- Firm Facing Normal Loss
4- Firm Facing Abnormal Loss
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1- Firm Earning Abnormal Profit
Revenue cost MC
ATC
Pe E AR=MR
A
B
0 Qe Q
Firm as in Equilibrium at point E, Where MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Profit= TR TC
= AR x Q AC x Q
= OPe x OQe OA x OQe
= OQeEPe
= OQeEPe OQeBA
= ABEPe (Abnormal Profit)
(AR=MR=P)
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2- Firm Earning normal Profit
Revenue cost MC
ATC
Pe E AR=MR
0 Qe Q
Firm as in Equilibrium at point E, Where MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OPe x OQe
= OQeEPe
= OQeEPe OQeEPe
= 0
TC= (Rent + Wages + Interest + Normal Profit)
Firm earns normal profit which is including in its cost.
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3- Firm Facing Normal Loss
Revenue cost MC
ATC
AVC
A B
Pe E AR=MR
0 Qe Q
Firm as in Equilibrium at point E, Where MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Loss = TC TR
= AC x Q - AR x Q
= OA x OQe - OPe x OQe
= OQeBA - OQeEPe
= PeEBA
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4- Firm Facing Abnormal Loss
Revenue cost MC
ATC
AVC
A B
Pe E AR=MR
AFC
0 Qe Q
Firm as in Equilibrium at point E, Where MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Loss = TC TR
= AC x Q - AR x Q
= OA x OQe - OPe x OQe
= OQeBA - OQeEPe
= PeEBA = FC
The distance Between ATC & AVC will be Reduce
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In Long Run
Revenue cost LMC (Long Run Marginal Cost)
LAC (Long Run Average Cost)
Pe E AR=MR
0 Qe Q
Firm as in Equilibrium at point E, Where MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OPe x OQe
= OQeEPe
= OQeEPe OQeEPe
= 0
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Monopoly
Monopoly is a Market Structure in which there is only one firm producing or selling the
product and there are barriers in the market.
Characteristic of Monopoly
1- Only one firm
2- Product may be homogenous or differentiated
3- Barriers in the market
4- Complete information about the market
Equilibrium of firm (In Short Run/ Time of start business)
1- Firm Earning Abnormal Profit
2- Firm Earning Normal Profit
3- Firm Facing Normal Loss
4- Firm Facing Abnormal Loss
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Firm Earning Abnormal Profit
RC
MC
c AC
Pe
A B
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OA x OQe
= OQecPe OQeBA
= ABCPe
In Monopoly price and quantity decided according to own wish and take help
equilibrium point.
Under Perfect Competition
Under Perfect competition a firm is called price taker.
Under Monopoly
Under monopoly a firm is called price setter.
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Firm Earning Normal Profit
RC
MC
A AC
Pe
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OPe x OQe
= OQeAPe OQeAPe
= 0
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Firm Facing Normal Loss
RC
MC
B AC
A AVC
Pe C
D F
E
MR AR = P
Q
0 Qe
Firm is in equilibrium at a point E Where MR = MC
Loss =
=
=
=
=
TC = OQeBA
= FC + VC
= DFBA + OQeFD
Loss < FC
PeCBA < DFBA
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Loss Portion should must be less than F.C.
Firm Facing Abnormal Loss (Shut down position)
RC
MC
A B AC
AVC
Pe C
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Loss = TC TR
= AC x Q AR x Q
= OA x OQe OPe x OQe
= OQeBA OQeCPe
= PeCBA
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Monopolistic Competition
Monopolistic Competition is a market structure in which there are large number of firms
producing or selling differentiated product and there are no barriers in the market.
Characteristic of Monopolistic competition
1- Large number of buyer & seller
2- Differentiated Product
3- Free entry and exit of firms.
4- Complete market information
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It is a mixture of Perfect Competition & Monopoly.
Example of monopolistic Competition Curve
Price & Demand Curve also called AR
Pe AR = MR
Monopoly
Perfect Competition
Monopolistic Competition
Oligopoly
Duopoly
In monopolistic all Four cases are same like monopoly just the AR & MR Curve more
flat.
Monopolistic Competition Curve
AR
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Firm Earning Abnormal Profit
RC
MC
C AC
Pe
A B
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OA x OQe
= OQecPe OQeBA
= ABCPe
Under Perfect Competition
Under Perfect competition a firm is called price taker.
Under Monopoly
Under monopoly a firm is called price setter.
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Firm Earning Normal Profit
RC
MC
A AC
Pe
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OPe x OQe
= OQeAPe OQeAPe
= 0
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Firm Facing Normal Loss
RC
MC
A B AC
C AVC
Pe
D F
E
MR AR = P
0 Qe Q
Firm is in equilibrium at a point E Where MR = MC
Loss = TC TR
= AC x Q AR x Q
= OA x OQe OPe x OQe
= OQeBA OQeCPe
= PeCBA
TC = OQeBA
= FC + VC
= DFBA + OQeFD
Loss < FC
PeCBA < DFBA
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Firm Facing Abnormal Loss
RC MC
AC
A B
C AVC
Pe
E
MR AR = P
0 Qe Q
Firm is in equilibrium at point E Where MR = MC
Loss = TC TR
= AC x Q AR x Q
= OA x OQe OPe x OQe
OQeBA OQeCPe
= PeCBA
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Monopoly
Equilibrium of Firm in Long Run
Firm Earning Abnormal Profit
RC LMC
LAC
Pe C
A
E
MR AR
0 Qe Q
Firm is in equilibrium at point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OA x OQe
= OQeCPe OQeBA
= ABCPe
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Monopolistic competition
Equilibrium of Firm in Long Run
Firm Earning Normal Profit:
RC LMC
LAC
Pe A
E
MR AR
0 Qe Q
Firm is in equilibrium at point E Where MR = MC
Profit = TR TC
= AR x Q AC x Q
= OPe x OQe OPe x OQe
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= OQeAPe OQeAPe
= 0
Macro Economics
National Income and Its Concepts
National income is the aggregate of market value of all final goods and services produce
by the country during one year.
Concept of National Income
1- Gross Domestic Product (GDP)
2- Net Domestic Product (NDP)
3- Gross National Product (GNP)
4- Net National Product (NNP)
5- Personal Income (PI)
6- Disposable Personal Income (DPI)
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1- Gross Domestic Product (GDP)
Gross domestic Product is the aggregate of market value of all final goods &
Services produce inside the country during one year.
2- Net Domestic Product (NDP)
Net domestic product (NDP) is obtained by subtracting depreciation from GDP.
Depreciation is the reduction in the value of a capital good due to the wear and
tear caused during production. The total market value of all final goods and
services produced within the political boundaries of an economy during a given
period of time, usually a year, after adjusting for the depreciation of capital.
NDP = GDP Depreciation allowance
3- Gross National Product (GNP)
Gross National Product is the Aggregate of Market Value of all Final goods &
Services produced by the Nationals of the country.
4- Net National Product (NNP)
NNP = GNP Depreciation allowance
5- Personal Income (PI)
Personal Income is the aggregate of all incomes actually received by all
individuals of a country during one years
Personal income is equal to = National income social security Contribution
Corporate Taxes Undistributed Corporate Profit + Transfer Payments
(Gifts, Pension, Grants)
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6- Disposable Personal Income (DPI)
DPI= Personal Income Direct Tax
Relationship between GDP and GNP
GNP = GDP + Net Foreign Income
Net Foreign Income = Income of Home Factors engaged abroad Income of
Foreign factors engaged at home
Method of Measurement of National Income
1- Product or Output Method
2- Income Method
3- Expenditure Method
1 Product or Output Method
According to Product Method National Income is the aggregate of Market value of
all final goods and services produced in various sector of the economy. The major
sector of the economy includes agriculture, Manufacturing, transport and
communication, services, Mining, Fishery, Forestry etc.
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2- Income Method
According to income method national income is the aggregate of the following items.
1- Wages & Salaries
2- Rents of Houses, Land, Buildings
3- Interest on capital
4- Profits of unincorporated enterprises
5- Profits of incorporated enterprises (like dividend)
6- Undistributed corporate profit
7- Corporate Taxes
8- Indirect taxes
9- Depreciation
10- Net income from abroad
3- Expenditure Method
According to expenditure Method National income is the aggregate of following
four items.
(i) Conception Expenditure ( C )
(ii) Investment Expenditure ( I )
(iii) Government Expenditure ( G ) ( Development + Non Development)
(iv) Net Expenditure (X M)(X = Export Earning, M = Import Payment)
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Y = National Income
Y = C + I + G + (X M)
Difficulties in Measurement of National Income
1- Barter Transaction
2- Services Without Reward
3- Self Consumed Production
4- Income Earned Through illegal activities
5- Part time Jobs
6- Non Co-Operation of Public
7- Non Maintenance of accounts
8- Price changes
Circular Flow of National Income
The circular flow of National income shows how National income moves between
household sector and Business sector in the economy. This circular flow also includes
some leakages and injections which effect National income in a positive and negative
way.
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There are three types of Leakages and Injections.
Leakages Injections
1- Savings Investments
2- Taxes Government Expenditures
3- Imports Exports
Leakages: leakages cause reduction in national income
Injections: injections cause increase in national income
Inflationary and Deflationary Gaps
1- Aggregate Supply Curve
2- Aggregate Demand Curve
Aggregate Supply Curve
Aggregate supply curve shows aggregate of goods and services produced and supplied at
various price levels. Aggregate supply curve can be shown with the following diagram.
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Price Level (P) AS
Where Yf National income
At full employment level.
0 Yf AS
Aggregate supply curve has + ve relation with price.
Aggregate Demand Curves
Aggregate demand curve shows the aggregate of goods and services consumed or
demand at different price levels. Aggregate Demand shown with following diagram.
Price Level (P) ADC has inverse relation with price.
AD
0 AD
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Ideal Situations
Price Level (P) AS
Pi E Means equality of
Pi (ideal price level) ASC &ADC.
AD
0 Yf AS,AD
Note:
In this situation aggregate Demand curve intersects aggregate supply curve at full
employment level and the price level determined by this situation is called ideal price level.
Inflationary Gape
Inflationary gaps occur when aggregate demand curve intersects aggregate supply curve
at a higher point than full employment level of income. It can be shown with following
diagram.
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P AS
E
Pe
Inflationary
Gap Pi
AD
0 Yf AS,AD
Note:
In the diagram the difference between equilibrium price and ideal price is inflationary
gap because equilibrium price is higher than ideal price.
Deflationary Gap
Deflationary gap occurs when aggregate demand curve intersects aggregate supply at
less than full employment level of income .It shown with following diagram.
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P AS
Deflationary Pi
Gap Pe E
AD
0 Y1 Yf AS, AD
Price are less than received level
In this diagram equilibrium price is less than ideal price and the difference is called
deflationary gap.
Measure to Remove inflationary and Deflationary gaps
There are two methods.
1- Fiscal Policy
2- Monitory Policy
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Measure to Remove Inflationary Gap
In case of inflationary gap contractionary Fiscal and monitory policy are
required which means that government expenditure should be reduced and
government earning should be increased through taxes and other measures and
in case of monitory policy the circulation of money and credit should be
reduced to reduced inflation in the economy.
Measure to Remove Deflationary Gap
In case of deflationary gap expansionary Fiscal and monitory policies are
required In Case of Fiscal policy government expenditure should be increased
and taxes should be decreased. In case of monitory policy circulation of money
and credit should be increased in ordered to increase prices and economic
activity in the economy.
Fiscal Policy
Fiscal policy is the policy of regulating and controlling revenue and expenditure of the
government to achieve macro economics objective.
Budget: Budgeting is the picture of Fiscal policy
Budget Deficit : Difference Between Revenue and Expenditures is Called Budget Deficit.
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Budget Deficit is also called deficit Financing.
Budget
Revenue Expenditures Deficit Financing
Current Exp. Development Exp.
Tax Revenue Non Tax Revenue Internal External
Direct Taxes Indirect Taxes Bank Borrowing Public Debt / Borrowing
Objectives of Fiscal Policy/ Macro Economics Objectives
1- High growth of national income
2- Fair Distribution of national income
3- High Employment
4- Price Stability
5- Reduction in regional disparities
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6- Discouraging Production and Consumption of unnecessary goods
7- Reduction in deficit in balance of payment
Instruments/ Tools of Fiscal Policy
A- Automatic / Built in Stabilizers (Non Discretionary Tools)
B- Discretionary Tools
Automatic /Non Discretionary Tools
1- Progressive taxation
2- Unemployment allowance
3- Support price policy
4- Corporate and Family saving
Discretionary Tools
1- Changes in tax rates
2- Changing public works expenditure
3- Changing in transfer payment
4- Credit aids
Business Cycles
The fluctuation in economic activities comprising National income and employment is
called business cycle or trade cycle.
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Phases
1- Recovery
2- Boom / peek
3- Recession
4- Depression
Economic
Activities
Recovery Boom
Recession
Depression
0 Time
Boom
Recovery Recession
Depression
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Features
1- One business cycle is said to be completed when it passes through all the four phases.
2- There is no hard and Fast rule regarding time period for the completion of a trade
cycle whoever the research has shown that it takes from two to ten years for its
completion.
3- The recovery phase is said to be longer than the recession phase.
4- Every next Boom or Depression will be at higher level of economic activity than
previous one.
Business Cycle and Fiscal Policy
The role of government in controlling fluctuations comes in the form of changes in
Fiscal policy in the period of boom government operates a contractionary Fiscal policy
in which it increases the tax rates and revenue and decreases its expenditure. Where as in
the time of depression government operate expansionary Fiscal policy in which it
decreases tax rates and its revenue and increases its expenditure to move out the
economy from depression.
Monitory Policy
Monitory policy is the policy of controlling supply and demand for money and credit in
the economy.
Monitory policy is the policy of central Bank and Fiscal policy is the policy of government.
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Features of Monitory Policy
1- Creation and expansion of financial institutions.
2- A suitable interest rate policy.
3- Debt management (Public Debt)
4- Proper adjustment between supply and demand for money.
5- Credit control
(I) Quantitative Measures
(II) Qualitative Measures
Quantitative Measures
1- Open Market operation
2- Bank Rate policy
3- Variable reserve rate
1- Open Market Operation
Open Market operations are the sale and purchase of government securities through
financial institutions in order to increase the money supply. These securities are
purchased back from the public while to decrease money supply more securities are sold
to the public through financial institutions.
2- Bank Rate Policy
The Bank rate is that rate of interest at which central bank provides loan to
reduced. Where as to decreased the supply of credit the bank rate is increased.
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3- Variable Reserve Ratio
Commercial Banks are directed to keep a certain portion of their demand and time
deposits to meet their daily cash requirements. If the purpose is to increase credit supply
their reserve ratio is decreased where as to decreased credit supply this reserve ratio is
increased.
Qualitative Measures
1- Selective Credit Control.
1- Selective Credit Control
Selective credit control means different interest rates for different sectors or public
requirements for loans on preference basis. For Example A low rate of interest may be
charged for the a farmers to purchase seeds, Fertilizers, Pesticides machinery etc.
Similarly a low interest rate may be charged for public on loans for Houses, Car
Financing, Foreign Development.
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Unemployment And its kinds
1- Employed
2- Unemployed
3- Not in Labour Forces
4- Labour Force
1- Employed
The employed are those persons who perform any paid work and those who
have jobs but are absent from work due to illness strike or vocations.
2- Unemployed
Unemployed are those persons who are not employed but are actively
looking for work not labour force.
3- Not in Labour Force
The persons who are not in labour force include retired, aged and not looking
for work.
4- Labour Force
The labour force include those persons who are either employed or
unemployed.
Labour Force = Employed + Unemployed
Unemployment Rate
The unemployment rate is equal to the number of unemployed people / labour force
Unemployment Rate = Number of unemployed people
Labour Forces
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Okun's Law
For every two persons that GDP falls relative to potential GDP the
unemployment rate rises about one percentage point
For example it mean that if GDP begins at 100% of its potential level and falls to 98%
of its potential the unemployment rate rises by 1% point. For example 6 % to 7 %.
Kind of unemployment
1- Frictional Unemployment
2- Structural Unemployment
3- Cyclical Unemployment
4- Disguised Unemployment
5- Voluntary Unemployment
6- Involuntary Unemployment
1- Frictional Unemployment
Frictional unemployment arises because of movement of people between
regions and jobs. It is possible that in a full employed country there is a
frictional unemployment at a moderate level.
2- Structural Unemployment
Structural unemployment arises due to a mismatch between supply and
demand for workers when structure and technology of the economy changes.
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3- Cyclical Unemployment
Cyclical Unemployment arises when demand for labour decreases in recession
due to a fall in aggregate demand.
4- Disguised Unemployment
Disguised unemployment arises when people seem to work but their work do not
contribute to the productivity.
For example: In rural area if five worker are needed but that works is done by ten
workers then five workers are called disguised unemployed.
5- Voluntary Unemployment
Voluntary unemployment arises when people do not want to work at existing
wage rates and they considered that the wage rate is lower than their education
skill or experience.
6- Involuntary Unemployment
Involuntary unemployment arises when people are willing to work at existing
wage rates but they do not find work due to low demand for labour. In this
situation markets existing rate is higher than market clearing wage rate due to
minimum wage laws or labour unions.
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Voluntary Unemployment
Wage Rate SL
Equilibrium Wage Rate
E
We --------------------- ------------ Voluntary Unemployment
DL
LT Labour Force
Involuntary Unemployment
Wage Rate SL
Involuntary
Unemployment
Minimum Wage Rate
Wm
We ---------------------
DL
LT Labour Force
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