Contents Chapter 1 Introduction Introduction to Economics... 1 Meaning of Economics... 1 Definitions of Economics... 2 Introduction to Economic Theory... 3 The Structure of Theories... 5 Importance of Assumptions... 7 Problem of Scarcity... 9 Scarce Resources of Production... 10 Thinking in Terms of Scarcity s Effects... 12 Three Fundamental Economic Questions... 13 Opportunity Cost... 14 The Production Possibilities Curve... 16 Marginal Rate of Transformation (MRT)... 19 The Law of Increasing Opportunity Costs... 19 Constant Opportunity Cost... 20 Shift in Production Possibility Curve (PPC) and Economic Growth.. 21 Introduction to Microeconomics and Macroeconomics... 23 Microeconomics... 23 Macroeconomics... 25 Function of Microeconomic Theory... 27 Importance of Microeconomics... 28 Interdependence between Microeconomics and Macroeconomics... 29 Dependence of Macroeconomics on Microeconomics... 29 Dependence of Microeconomics on Macroeconomics... 30 Comparative Statics and Dynamics... 31 Static and Comparative Statistics... 33 Comparative Statics... 38 Dynamic Equilibrium... 41 Positive and Normative Economics... 44 Positive and Normative Statements... 45 The Relation between Positive and Normative Economics... 48 Fundamental Principles of Economics... 49 Chapter Questions... 52
Chapter 2 Theory of Consumer Behavior Part A: Demand, Supply and Equilibrium Meaning and Concept of Demand... 55 Law of Demand... 59 Exceptions of the Law of Demand... 61 Determinants of Demand... 62 Individual Demand Schedule and Derivation of Individual Demand Curve... 63 Movement along and Shift of a Demand Curve... 68 Theory of Supply... 72 Law of Supply... 73 Derivation of Single Producer's Supply Curve... 76 Movement along and Shift of a Supply Curve... 79 Market Equilibrium and Determination of Equilibrium Price... 82 Sample Numerical Problems and Solution... 89 Chapter Questions... 96 Part B: Measurement of Elasticity of Demand and Supply Concept of Elasticity... 98 Types of Elasticity of Demand... 98 Methods of Measurement of Price Elasticity of Demand... 107 Total Outlay or Expenditure Method... 107 Point Method of Measuring Elasticity of Demand... 110 Arc Elasticity of Demand... 117 Determinants of Price Elasticity of Demand... 118 Uses of the Concept of Elasticity of Demand... 119 Price Elasticity of Supply... 124 Measurement of Elasticity of Supply (Geometry of Elasticity of Supply) 126 Factors that Determine Elasticity of Supply... 131 Sample Numerical Problems and Solution... 133 Chapter Questions... 140 Part C: Theory of Consumer Behaviour Concept of Utility... 143 Consumer s Utility Analysis... 143 Cardinal Approach... 143 Basic Assumptions of Cardinal Utility Analysis... 145 Law of Diminishing Marginal Utility... 146
Derivation of Demand Curve from the Law of Diminishing Marginal Utility... 148 Law of Equi-Marginal Utility: Consumer s Equilibrium... 150 Derivation of Demand Curve from Equi-marginal Utility Approach. 152 Ordinal Approach to Utility Analysis... 154 Assumptions of Ordinal (Indifference Curve) Approach... 155 The Indifference Curve (IC) Approach to Utility Analysis... 155 Marginal Rate of Substitution (MRS)... 157 Indifference Map... 160 Properties of Indifference Curves of Two Goods... 160 Budget Constraint or Budget Line... 166 Budget Line Gymnastics (Change in the Budget Line)... 169 Consumer s Equilibrium under Ordinal Utility: Consumer s Equilibrium under Indifference Curve Approach... 171 Income Effect and the Income Consumption Curve... 174 The Case of Normal Goods... 175 Income Effect in the Case of an Inferior Good... 176 The Case of Neutral Goods... 177 Income Effect and Derivation of Engle Curve... 178 Price Effect and Price Consumption Curve (PCC)... 179 Price Effect in Case of Giffen Good... 180 Separation of Price Effect into Substitution and Income Effects... 181 Hicks and Slutsky Decomposition of Income and Substitution Effects... 183 Income and Substitution Effect for Inferior Goods... 189 Income and Substitution Effect for Giffen Goods... 190 Price Effect and Derivation of Demand Curve: Normal Good... 192 Engel Curve vs. Demand Curve... 193 Comparison of Cardinal Utility Analysis with Ordinal Utility Analysis... 193 Superiority of Ordinal Utility Approach... 194 Criticisms of Indifference Curve... 195 Sample Numerical Problems and Solution... 197 Chapter Questions... 203
Chapter 3 Production and Cost Part A: Theory of Production Meaning of Production... 205 Fixed and Variable Factors of Production... 206 Production Function... 206 Total Product, Average Product and Marginal Product... 207 Short Run and the Long Run in Production Activities... 209 Laws of Production Function... 210 Law of Variable Proportion... 210 Importance of the Law of Diminishing Returns... 216 Production with Two Variable Inputs: The Concept of Isoquant... 217 Isoquant Map... 218 Marginal Rate of Technical Substitution (MRTS)... 218 Diminishing Marginal Rate of Technical Substitution... 220 Properties of Isoquant... 221 Exceptions to the General Properties... 223 Isocost Line... 225 Shift in Iso Cost Line... 226 Least Cost Combination of Factors... 228 Expansion Path or Scale Line of the Firm... 229 Laws of Returns to Scale: Long Run Production Behaviour... 233 Increasing Returns to Scale (IRS)... 233 Constant Returns to Scale (CRS)... 234 Decreasing Returns to Scale (DRS)... 235 Sample Numerical Questions and Solution... 239 Chapter Questions... 242 Part B: Cost and Cost Curves... 244 Concept of Cost of Production... 244 Explicit Cost... 244 Implicit Cost... 244 Opportunity Cost... 245 Accounting Cost... 245 Economic Cost... 246 Sunk Cost... 246 Short Run Cost... 248 Short-run Total Costs... 249 Geometry of Short-run Total Costs... 251
Short-run Per-Unit Costs... 252 Geometry of short-run Per-Unit costs... 255 Relationship between AC and MC... 258 Derivation of Short-run Per-Unit Cost Curves from Total Costs... 258 Long Run Cost Curves... 263 Long-run Total Cost (LTC)... 264 Long-run Average Cost (LAC)... 264 Long-run Marginal Cost (LMC)... 267 Economies of Scale... 269 Types of Economies of Scale... 270 Optimum Firm... 273 Factors Affecting the Optimum Size of the Firm... 277 Sample Numerical Questions and Solution... 280 Chapter Questions... 283 Part C: Revenue Curves... 284 Concept of Revenue... 284 Concepts of Total, Average and Marginal Revenues... 284 Relation between AR and MR... 285 Relation under Perfect Competition... 285 Relation under Imperfect Competition... 287 Relation between AR and MR Curves in Imperfect Competition Market... 290 Chapter Question... 292 Chapter 4 Market Structures and Pricing Introduction to the Concept of Product Pricing... 293 Market Structure and Product Pricing... 294 Product Pricing in a Market of Perfect Competition... 294 Price and Output Determination under Perfect Competition... 295 Marginal Revenue-Marginal Cost (MR-MC) Approach... 296 Short Run Equilibrium of the Industry... 297 Short-Run Equilibrium of the Firm... 297 Long Run Equilibrium of Firm... 299 Product Pricing in Monopoly Market... 301 Reasons for Monopoly... 302 Price and Output Determination under Monopoly... 302 Short-Run Equilibrium of the Monopoly... 302
Long Run Equilibrium of Firm under Monopoly... 305 Price Discrimination under Monopoly... 306 Dumping... 311 Product Pricing in Monopolistic Competition... 312 Characteristics of Monopolistic Competition... 312 Equilibrium Output and Price Determination of a Firm under Monopolistic Competition... 314 The Short Run Equilibrium... 314 The Long Run Equilibrium... 316 Difference between Perfect Competition and Monopolistic Competition... 317 Introduction to Oligopoly Business Market... 318 Characteristics of Oligopoly... 318 Main Attributes of Market Structure... 319 Price and Non-price Competition... 320 Price Competition... 321 Non-price Competition... 321 Market Structure and Degree of Firm s Market Power... 326 The Lerner Index (LI)... 327 The Herfindahl- Hirschman Index (HHI) and Market Power... 329 Sample Numerical Questions and Solution... 330 Chapter Questions... 338 Chapter 5 Theory of Distribution Meaning of Factor Pricing... 339 Factor Market Structures... 340 Factor Pricing In Perfectly Competitive Markets... 340 The Demand Curve of a Firm for a Single Variable Input... 341 Shape of MRP and VMP Curves... 344 Optimum Condition for Hiring a Factor (Labour) by a Firm... 345 Demand for a Factor Input when Several Inputs are Variable... 351 The Market/Industry Demand for a Factor... 353 The Supply of Labour (a Variable Factor) in Perfectly Competitive Markets... 355 The Work-Leisure Trade Off: Backward-Bending Labour Supply Curve... 356 Market Supply Curve for an Input (Labour)... 359
The Determination of the Factor Price in Perfectly Competitive Market... 360 Factor Pricing in Imperfect Competition Market... 361 Demand for a Variable Factor by a Monopolistic Firm when Many Factors are Used... 364 The Market Demand for and Supply of Labour... 365 Bilateral Monopoly... 367 Theories of Rent... 371 Modern Theory of Rent... 371 The Concept of Quasi Rent... 374 Theories of Interest Rate... 374 Loanable Funds Theory of Interest... 374 Liquidity Preference Theory of Interest... 378 Theories of Profit... 383 Dynamic Theory of Profit... 385 Innovation Theory of Profit... 387 Concept of Wage Differential... 389 Wage Differentials Due to Heterogeneity of Labour... 389 The Nature and Causes of Persisting Wage Differentials... 390 Minimum Wages and Brain Drain... 391 Effects of Minimum Wage... 391 Brain Drain... 392 Chapter Questions... 393 Pokhara University Board Exam Questions... 394 Bibiliography... 401