Introductory Microeconomics

This is the introduction to the Microeconomics book (Class 12), covering scarcity, the three central economic problems (what, how, and for whom to produce), the Production Possibility Frontier, opportunity cost, and how economies are organised — through central planning, markets, or a mix of both. It is distinct from the Macroeconomics introduction, which focuses on economy-wide aggregates.

• 1Every individual and society faces scarcity of resources relative to needs, making choice unavoidable.
• 2The three central economic problems are: what to produce and in what quantities, how to produce it, and for whom the goods are produced.
• 3The Production Possibility Frontier (PPF) shows all combinations of two goods an economy can produce when all resources are fully and efficiently utilised.
• 4A point strictly below the PPF indicates that all or some resources are underemployed or used wastefully.
• 5Opportunity cost is the amount of one good forgone to obtain an additional unit of another; it is also called economic cost.

Chapter 2 explains how a rational consumer decides how to spend a fixed income on goods to maximise satisfaction, covering Cardinal and Ordinal Utility Analysis, the budget constraint, consumer's optimal choice at the tangency of the budget line and an indifference curve, the demand curve and its shifts, and price elasticity of demand.

• 1Two approaches to consumer behaviour: Cardinal Utility Analysis (utility measured in numbers) and Ordinal Utility Analysis (utility ranked through indifference curves).
• 2Law of Diminishing Marginal Utility: marginal utility from each additional unit of a commodity declines as consumption increases, keeping other goods constant.
• 3An indifference curve is downward sloping and convex to the origin; two indifference curves never intersect; a higher indifference curve gives greater utility.
• 4The Marginal Rate of Substitution (MRS) is the rate at which a consumer substitutes one good for another while remaining on the same indifference curve; MRS diminishes as the quantity of the substituted good increases.
• 5The budget line (p1x1 + p2x2 = M) has slope –p1/p2; income changes cause parallel shifts, while price changes rotate the line around the opposite-axis intercept.

This chapter explains how firms use labour and capital to produce output, covering the production function, short-run and long-run distinctions, the law of variable proportions, returns to scale, and the full structure of a firm's costs (fixed, variable, average, and marginal).

• 1The production function q = f(L,K) gives the maximum output a firm can produce for each combination of labour (L) and capital (K), and is defined for a given technology.
• 2In the short run at least one factor is fixed; in the long run all factors can be varied — the distinction is not defined by calendar time but by whether inputs can change.
• 3Total product (TP) is output from a variable input with all others held constant; average product (AP) = TP ÷ L; marginal product (MP) = change in TP ÷ change in input.
• 4The law of variable proportions (law of diminishing marginal product) states that MP initially rises as employment increases, then falls after a certain level; both MP and AP curves are inverse U-shaped, and MP cuts AP at AP's maximum.
• 5Returns to scale describe long-run output responses: constant returns to scale (CRS) when output rises proportionally, increasing returns to scale (IRS) when output rises more than proportionally, and decreasing returns to scale (DRS) when output rises less than proportionally.

This chapter explains how a profit-maximising firm in a perfectly competitive market decides how much to produce, derives the firm's short run and long run supply curves, and shows how individual supply curves are aggregated into a market supply curve.

• 1Perfect competition has four defining features: a large number of buyers and sellers, homogeneous products, free entry and exit, and perfect information — these together produce price-taking behaviour.
• 2For a price-taking firm, TR = p × q; the TR curve is an upward-sloping straight line through the origin with slope equal to the market price.
• 3For a price-taking firm, AR = MR = market price; the demand curve facing the firm is perfectly elastic (a horizontal price line).
• 4Three conditions must hold for profit maximisation in the short run: (i) P = SMC, (ii) SMC is non-decreasing, and (iii) P ≥ AVC.
• 5Three conditions must hold for profit maximisation in the long run: (i) P = LRMC, (ii) LRMC is non-decreasing, and (iii) P ≥ LRAC.

Chapter 5 explains how equilibrium price and quantity are determined in a perfectly competitive market through demand-supply analysis, covering fixed-firm and free-entry scenarios, shifts in demand and supply, wage determination in the labour market, and government price controls (price ceiling and price floor).

• 1Equilibrium is a situation where market supply equals market demand (qD(p*) = qS(p*)); the price is called the equilibrium price (p*) and the corresponding quantity is the equilibrium quantity (q*).
• 2Excess demand exists when market demand exceeds market supply at a price; excess supply exists when market supply exceeds market demand. The 'Invisible Hand' (Adam Smith, 1723–1790) raises prices under excess demand and lowers them under excess supply to restore equilibrium.
• 3With a fixed number of firms, a rightward (leftward) demand shift raises (lowers) both equilibrium price and quantity; supply shifts move price and quantity in opposite directions.
• 4When both demand and supply shift in the same direction, the change in equilibrium quantity is unambiguous but the change in price depends on the magnitude of the shifts; when they shift in opposite directions, the price change is unambiguous but the quantity change depends on magnitudes.
• 5With free entry and exit of identical firms, the equilibrium price always equals the minimum average cost (p = min AC); a demand shift changes equilibrium quantity and number of firms in the same direction but leaves price unchanged.