NCERT NOTES

FOR ECONOMICS
12th Standard
Introductory Microeconomics
CONTENTS
Introduction ...................................................................................................................................... 1 - 2

Theory of Consumer Behaviour ................................................................................................ 3 - 6

Production and Costs .................................................................................................................... 7 - 9

The Theory of the Firm under Perfect Competition ........................................................ 10 - 11

Market Equilibrium .................................................................................................................... 12 - 14

Non-Competitive Markets ....................................................................................................... 15 - 16

 1 INTRODUCTION
Resources within the society are scarce, when compared to the needs of various goods and services.
Because of the scarcity of resources, it is crucial to allocate resources efficiently.

Central Problems of an Economy:

Production, exchange and consumption of goods and services are among the basic economic activities of
life. In the course of these activities, every society face scarcity of resources which gives rise to the various
economic problems. The central economic problems of an economy are very often summarised as follows:
● Every society must decide on how much of each of the many possible goods and services it will
produce. For example, whether to produce more of food, clothing, housing or to have more of luxury
goods.
● Every society has to decide on how much of which of the resources to use in the
production of each of the different goods and services. For example, whether to use more
labour or more machines.
● The society has to decide who gets how much of the goods that are produced in the economy.
● How should the produce of the economy be distributed among the individuals in the economy.
● In addition, the choice between public and private goods.

The collection of all possible combinations of the goods and services that can be produced from a given
number of resources and a given stock of technological knowledge is called the production possibility set of
the economy.

Production Possibility Frontier:

● It is a point in the curve that shows the maximum amount of a good that can be produced in the
economy for any given amount of another good and vice-versa.
● The production possibility frontier gives the combinations of goods that can be produced when the
resources of the economy are fully utilised.
INTRODUCTION

Fig 1.1: Production possibility frontier (for cotton and corn)

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 ● In this above figure, AE represents the production possibility curve which shows the various
combinations of the two goods (e.g., Cotton and Corn) which the economy can produce with a given
number of resources.
● A point lying strictly below the production possibility frontier represents a combination of goods
that will be produced when all or some of the resources are either underemployed or are utilised in a
wasteful fashion.

Opportunity Cost:
● It is also called economic cost.
● It is the cost of having a little more of one good in terms of the amount of the other good that has to be
forgone.
● Simply, the opportunity costs of a product are only the best alternative forgone and not any other
alternative.

Organization of Economic Activities

Centrally Planned Economy:
● In a centrally planned economy, the government or the central authority plans all the important
activities in the economy.
● All important decisions regarding production, exchange and consumption of goods and services are
made by the government.
● The central authority decides allocation of resources and a consequent distribution of the final
combination of goods and services.
● The government is also responsible for the equitable distribution of the final mix of goods and
services.

Market Economy:
● In a market economy, all economic activities are organised through the market.
● All goods or services come with a price which is mutually agreed upon by the buyers and sellers and at
which the exchanges take place.
● In a market economy, the price reflects society's valuation of the good or service. Therefore, if the
buyers demand more of a certain good, the price of that good will rise and vice versa.
● Moreover, the price and consumer demand for goods or services are the important determinant of
production in a market economy.
Today, most of the economies are mixed economies where some important decisions are taken by the
INTRODUCTION

government and the economic activities are by and large conducted through the market.
Since Independence, the Government of India has played a major role in planning economic activities.
However, the role of the government in the Indian economy has been reduced considerably in the last
couple of decades.

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 THEORY OF CONSUMER
2 BEHAVIOUR
Theory of Consumer Behaviour
Consumer behaviour is referred to the study which analyses how consumers make decisions when
obtaining various goods and services. It also studies various factors that influence consumers decisions.
Therefore, understanding the behaviour of consumers is crucial to analyse the potential consumers towards
a new product or service.

Important terms related to Consumer Behaviour

Utility:
● Utility of a commodity is its want satisfying capacity. A consumer usually decides his demand for a
commodity on the basis of utility (or satisfaction) that he derives from it.
● The more the need of a commodity or the stronger the desire to have it, the greater is the utility derived
from the commodity.
● Utility is subjective. Different individuals can get different levels of utility from the same commodity.
● Total Utility: Total satisfaction derived from consuming the given amount of some commodity.

Marginal Utility:
● It is the change in total utility due to consumption of one additional unit of a commodity.
● Total utility can be derived from marginal utility. Total utility is the sum of marginal utility of number of
commodities consumed.
● The marginal utility diminishes with increase in consumption of the commodity. This happens
because having obtained some amount of the commodity, the desire of the consumer to have still more
of it becomes weaker.

Law of Diminishing Marginal Utility:

● It states that marginal utility from consuming each additional unit of a commodity declines as its
consumption increases, while keeping consumption of other commodities constant.
● Marginal utility (MU) becomes zero at a level when total utility (TU) remains constant. In the
example, TU does not change at 5th unit of consumption and therefore MU5 = 0. Thereafter, TU starts
THEORY OF CONSUMER BEHAVIOUR

falling and MU becomes negative.

Fig 2.1: Diminishing marginal utility curve

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Indifference Curve:
● An indifference curve is a graph which shows combination of two goods that give the consumer
equal satisfaction and utility.
● Quantitative measure of utility is difficult. At the most, it can be ranked in terms of having more or less
utility in various alternative combinations of goods consumed.
● The indifference curve joins all points representing the different bundles of goods, in which the
consumer is indifferent that is the total Utility derived from each combination is the same.
● Indifference curve slopes downward.
● Higher indifference curve gives greater level of utility.
● Two indifference curves never intersect each other.

Fig 2.2: Indifference curve

Marginal rate of Substitution:

● It is defined as the rate at which a consumer is ready to exchange one good for another at the same
level of utility.
● It is used to analyse the indifference curve.

THEORY OF CONSUMER BEHAVIOUR

Demand:
The quantity of a commodity that a consumer is willing to buy and is able to afford, given prices of goods and
consumer's tastes and preferences is called demand for the commodity.
Whenever one or more of these variables change, the quantity of the good chosen by the consumer is likely
to change as well.

Demand Curve and the Law of Demand:

● The demand curve is a relation between the quantity of good chosen by a consumer and the price of
the good. It shows the quantity demanded by the consumer at each price.

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 ● The amount of a good that the consumer optimally chooses, becomes entirely dependent on its price, if
the prices of other goods, the consumer's income and her tastes and preferences remain unchanged.
● The relation between the consumer's optimal choice of the quantity of a good and its price is very
important, and this relation is called the demand function.

Fig 2.3: Demand Curve

● The Law of Demand states that when price of the commodity increases, demand for it falls and when
price of the commodity decreases, demand for it rises, other factors such as consumer taste and
preferences, income, etc remaining the same. The law of demand signifies that there is a negative
relationship between the demand for a commodity and its price.

The quantity of a good that the consumer demands can increase or decrease with the rise in income
depending on the nature of the good. Goods can be further classified into:

● Normal Goods: For most of the goods, the quantity that a consumer chooses to consume increases as
the consumer's income increases and decreases as the consumer's income decreases. Such goods
are called normal goods. The demand for a normal good, moves in the same direction as the
THEORY OF CONSUMER BEHAVIOUR

consumer's income.
● Inferior Goods: For Items like low quality food, coarse cereals etc. the demand for them decreases as
the income of the consumer increases, due to now attained better affordability. Demand for an
Inferior Good moves in the opposite direction of the income of the consumer.
● Giffen Goods: It refers to a good that people consume more of as the price rises. The demand for such
a good can be inversely or positively related to its price. If the good can easily be substituted then the
demand would remain inversely related, however in a scenario where substitution cannot work in line
with income change, the demand of such a good would be positively related to its price.
● Complementary Goods: These are those goods which are used together, in compliment to each
other like Tea and Sugar. Here, the demand for a good move in the opposite direction of the price of its
complementary goods. The increase in price of tea may reduce the demand for sugar as well.

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 Subs tutes: The goods which are not consumed with each other like tea and coffee. Here, the
demand for a good moves in the same direc on of the price of its subs tute good. Put simply, an
increase in the price of coffee may drive consumers to consumer more tea instead of coffee.

Elasticity of Demand:
● Price elasticity of demand is a measure of the responsiveness of the demand for a good to changes in
its price. It is defined as the percentage change in demand for the good divided by the percentage
change in its price.
● When the percentage change in quantity demanded is less than the percentage change in market
price, the demand for the good is said to be inelastic at that price. Demand for essential goods is often
found to be inelastic.
● When the percentage change in quantity demanded is more than the percentage change in market
price, the demand is said to be highly responsive to changes in market price. The demand for the good
is said to be elastic at that price. Demand for luxury goods is often found to be elastic.
● When the percentage change in quantity demanded equals the percentage change in its market
price, the demand for the good is said to be Unitary-elastic at that price.

THEORY OF CONSUMER BEHAVIOUR

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 PRODUCTION AND COSTS
3
Production is the process by which inputs are transformed into 'output'. Production is carried out by
producers or firms. A firm uses different factors of production (inputs) such as land, labour, machines, raw
materials etc. to produce output. This output can be consumed by consumers or used by other firms for
further production.
However, to acquire inputs a firm has to pay for them. This is called the cost of production. Once output has
been produced, the firm sell it in the market and earns revenue. The difference between the revenue and
cost is called the firm's profit.

Production Function:
● It is a relationship between inputs used and output produced by the firm.
● It gives an idea about the maximum quantity of output that can be produced for various quantities of
inputs used.
● It is defined for a given technology. If the technology improves, the maximum levels of output
obtainable for different input combinations increase. We then have a new production function.

Time concepts in Production:

● Short Run: In short run, at least one of the factors: labour or capital – cannot be varied, and therefore,
remains fixed. Therefore, to vary the output level, the firm can vary only the other factor. The factor that
remains fixed is called the fixed factor whereas the other factor which the firm can vary is called the
variable factor.
● Long Run: All factors of production can be varied, due to the long time frame being considered. There is
no fixed factor in this concept.

Other Important Terms related to Production:

● Total Product (TP): It is a relationship between the variable input and output. Total product is the
output received at a particular level of the Variable Input, keeping all other factors constant.
● Average product (AP): It is defined as the output per unit of variable input.
● Marginal product of an input (MP): It is defined as the change in output per unit of change in the
input when all other inputs are held constant. For any level of an input, the sum of marginal products of
PRODUCTION AND COSTS

every preceding unit of that input gives the total product.

● Law of Variable Proportions: It is defined as Marginal Product of a variable factor input initially rises
with its input level but after reaching a certain level of employment, it starts falling.

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 Fig 3.1: Curve (TP, AP and MP)

Beyond a certain point, the production process becomes too crowded with the variable input and further
effectiveness can only be attained by enhancing the fixed input. However, this is a Short Run concept as in
the Long Run all the factors are Variable.

Returns to Scale:
● It is the quantitative change in output of a firm resulting from a proportionate increase in all inputs.
● When a proportional increase in all inputs results in an increase in output by the same proportion, the
production function shows a Constant Return to Scale (CRS).
● When a proportional increase in all inputs results in an increase in output by a larger proportion, the
production function is said to display Increasing Returns to Scale (IRS).
● Decreasing Returns to Scale (DRS) holds when a proportional increase in all inputs results in an
increase in output by a smaller proportion.

Costs:
Cost is the monetary value of all the expenditures for raw materials, equipment, labours, etc. required to
produce goods and services. For every level of output, the firm chooses the least cost input combination in
order to achieve price competitiveness and to maximise profit.
PRODUCTION AND COSTS

Thus, the cost function describes the least cost of producing each level of output given prices of factors of
production and technology.
● Total Fixed Cost: In the short run, some of the factors of production cannot be varied, and therefore,
remain fixed. The cost that a firm incurs to employ fixed inputs is called the total fixed cost.
● Total Variable Cost: To produce any required level of output, the firm, in the short run, can adjust only
variable inputs. Accordingly, the cost that a firm incurs to employ these variable inputs is called the total
variable cost (TVC).

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 Key points:
Total cost of a firm is the sum of fixed and variable cost.
In order to increase the production or output, the firm must employ more of the variable
inputs. As a result, total variable cost and total cost will increase. Therefore, as output
increases, total variable cost, and total cost increase.

● Short Run Average Cost: It is defined as the total cost per unit of output. At zero output, short run
average cost is undefined.
● Short Run Marginal Cost: It is defined as the change in total cost per unit of change in output.
● Average Variable Cost: It is defined as the total variable cost per unit of output in short term production.
If the price of a good is higher than the average variable cost of the good, the firm is covering all the variable
costs and a percentage of the fixed costs. In this case, firms continue production.
PRODUCTION AND COSTS

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 THE THEORY OF THE FIRM
4 UNDER PERFECT COMPETITION
Every firm works in varied kinds of environments. One such environment is that of perfect competition.
Perfect competition describes a market structure where competition is at its greatest possible level.
Features of Perfect Competition:
● The market consists of a large number of buyers and sellers.
● No individual buyer or seller can influence the market by their size.
● Each firm selling a homogeneous product (i.e., the products cannot be differentiated).
● Entry and exit into the market are free for the firms.
● Perfect flow of information, which means both buyers and sellers are perfectly informed about prices,
quality, and other market aspects.

Price Taking Behaviour of the Perfect Competitive Market:

● A price taker is an individual buyer or seller who buy and sell products at prevailing market price.
● A price-taking firm believes that if it sets a price above the market price, it will be unable to sell any
quantity of the good that it produces. However, if it set price which is less than or equal to market price;
the firm can sell as many units of the good as it wants to sell.
● From a buyer end, a buyer will not purchase any products from the seller if it sells at a price higher than
the prevailing market price.

Supply Curve of a Firm:

● A firm's 'supply' is the quantity that it chooses to sell at a given price, given technology, and given the
prices of factors of production.

THE THEORY OF THE FIRM UNDER PERFECT COMPETITION

● The supply curve of a firm shows the levels of output (plotted on the X-axis) that the firm chooses to
produce corresponding to different values of the market price (plotted on the Y-axis), again keeping
technology and prices of factors of production unchanged.

Fig 4.1: Supply Curve

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 ● When the supply curve is vertical, supply is completely insensitive to price and the elasticity of supply
is zero. In other cases, when supply curve is positively sloped, with a rise in price, supply rises and
hence, the elasticity of supply is positive.
● The quantity that the firms supply at the given price level, can change without any corresponding
change in the market price, due to the change in other factors, such as:

⮚ Technological Progress: Improvement in technology allows the firm to produce more output, from
the same amount of input allowing to sell more at the same market price. This causes the curve to
shift to the right due to increase in supply.
⮚ Input Prices: Due to an increase the input prices, the firm now sells less at the same Market Price,
causing the supply curve to shift to the left and vice-versa in case of reduced input prices.

Price Elasticity of Supply:

● It is the ratio of the percentage change in quantity supplied to percentage change in price.
● It measures the responsiveness of the quantity of goods supplied in the market with the changes in
prices.
● If the supply of goods ceases completely when the price of the goods drops slightly, and the supply of
the goods become infinite when there is even a little increase in the price of the goods, the supply is
said to be perfectly elastic.
● If supply does not get affected due to change in price, the supply is said to be perfectly inelastic.
● If price of goods exactly equal to the supply of goods in the market, the supply is said to unitary elastic.
THE THEORY OF THE FIRM UNDER PERFECT COMPETITION

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 MARKET EQUILIBRIUM
5
Market equilibrium is a condition where the demand and supply curve intersect to set the market price and
amount of goods sold.

Market Equilibrium, Excess Demand and Excess Supply

Equilibrium:
● In equilibrium, the aggregate quantity that all firms wish to sell equals the quantity that all the
consumers in the market wish to buy.
● If at a price, market supply is greater than market demand, then there is an excess supply in the market
at that price. On the contrary, if market demand exceeds market supply at a price, it is said that excess
demand exists in the market at that price.
● Equilibrium in a perfectly competitive market can be defined alternatively as zero excess demand-
zero excess supply situation.
● Whenever market supply is not equal to market demand, and hence the market is not in equilibrium,
there will be a tendency for the price to change.
● In the below graph, SS represents the market supply, DD represents the market demand and
equilibrium point is the point of intersection of DD and SS.

Fig 5.1: Market equilibrium with fixed number of firms

MARKET EQUILIBRIUM

Shift in Demand and Supply:

● The equilibrium points may shift if there is shift in the demand and supply curve.
● The demand and supply curve may shift upward or downward due to any change in the factors like
technology, consumer Preferences etc.
● Due to such shifts in demand or supply, the existing market equilibrium get disturbed and reaches to
new equilibrium point.

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 Fig 5.2: Shifts in demand from the equilibrium point

● In the above graph, original Market Demand (DD0) shifts to the new market demand (DD1). Due to
which the original equilibrium point E gets disturbed, and a new equilibrium Point (Point F) is derived
where the new and changed market demand now meets the market supply.

Market Equilibrium: Free Entry and Exit

Under perfect competition, an important feature being the free entry and exit firms, also has certain other
implications.
● In equilibrium, no firm earns supernormal profit or incurs loss by remaining in production (i.e., in other
words, the equilibrium price will be equal to the minimum average cost of the firms).
● If firms at the prevailing prices are able to earn Super Normal Profits, this case will attract new firms
into the market, and due to free entry, they would be able to do so easily and quickly.
● Due to new firms entering, the Market Supply will increase, but the demand remains constant due to
which the Market Price to fall, eventually wiping out the super normal profits. Similarly, in the scenario
of Losses, certain firms will exit the market reducing the supply and hence driving the Market Price
up.
● Thus, with free entry and exit, each firm will always earn normal profit at the prevailing market price.

Applications of Demand-Supply Analysis

MARKET EQUILIBRIUM

Price Ceiling:
● The upper limit imposed by the Government on the price of a good or service is called Price Ceiling.
● It is generally imposed on necessary items like wheat, rice etc. as a large section of population may not
be able to afford these items at the market determined prices.
● However, due to the price ceiling the suppliers get discouraged to supply at a price lower than the
market determined equilibrium price. Moreover, the quantity they are willing to supply is lower than
quantity that the consumers want to consume.

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 ● To tackle such situations, government uses policies like rationing so that no individual can buy more
than a certain amount. This stipulated amount, is the distributed through ration shops also called Fair
Price Shops.

Price Floor:
● The lower limit imposed by the Government on the price that may be charged for a particular good or
service is called price floor.
● This is used in areas like purchase price for agricultural Produce.
● Government sets up an agricultural price support programme, to fix prices of the produce above the
market determined price.
● Similarly, it also used to set a floor wage rate which is above the market determined wage rate.
● This leads to excess supply situation in the market, and to prevent the prices from falling as a result, the
government needs to purchase the excess supply and produce available in the market.
MARKET EQUILIBRIUM

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 NON-COMPETITIVE MARKETS
6
Under perfect competition, both the buyers and sellers are price takers. However, there exists other forms of
market structures which may not satisfy one or more conditions of the perfect competitive market. A market
is non-competitive when the firms acting in such a market have the power to influence the price, directly or
indirectly.

Monopoly:
● It is market structure in which there is a single seller or producer of a particular commodity.
● In monopoly, no other commodity works as a substitute for this commodity.
● To maintain the monopolistic nature of the market sufficient restrictions are required to be in place to
prevent any other firm from entering the market and to start selling the commodity.
● For a monopolistic firm, the price depends on the quantity of the commodity sold as firm can sell a
larger quantity of the commodity only at a lower price and vice versa.
● The firm can also decide the price at which it wishes to sell its commodity, and therefore, determines
the quantity to be sold.

Differences between Perfect Competition and Monopoly:

● Perfectly competitive market provides production and sale of a larger quantity of the commodity
compared to a monopoly firm.
● Price of the commodity under perfect competition is lower compared to monopoly.
● The profit earned by the perfectly competitive firm is also smaller compared to monopoly.
● The profits earned by the monopolistic firms, do not go away in the long run, unlike in perfect
competition.
● In general sense, monopolies are considered to be exploitative and charge the consumers
comparatively a higher price.

However, it is very difficult for such a monopoly to exist in the real word as substitutes for all commodities
exist. New firms are taking up new technologies and coming up with newer products in an ever-changing
economy.

Oligopoly:
NON-COMPETITIVE MARKETS

● It is a market structure, where for a particular commodity there exist only a few sellers (more than one).
● In oligopoly market, the product sold by the firms is homogenous.
● The special case of oligopoly where there are exactly two sellers is termed duopoly.
● In the oligopoly market each firm is relatively large as compared to the size of the market.
● Each firm can affect the total supply in the market, and thus influence the market price.
● Any change in supply or price by one firm can significantly impact all the other firms as well.
● In oligopoly, firms can also act as a “cartel” and create monopolistic conditions. On the other hand, they
can keep on undercutting each other's prices to attract more consumers.

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Cartel: A cartel is an associa on of manufacturers or suppliers formed to manipulate price of a par cular
product in order to maximise their profits and dominate the market.

NON-COMPETITIVE MARKETS

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