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ECONOMICS

NOTES

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
Demand Curve

(inverse Relation with Demand and Price)

12
10

16

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18

20

Quantity Demanded (Q)

Page 1

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

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55

60

Supply

Page 2

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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Page 3

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

Extension and Contraction / Movement along the Curve ( Due to change in price)

Rise and Fall / Shifts in Curve (Due to Change in Other Factors)

Price (P)

b
P2
Edition

a
P1

Contraction

Qs1

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Qs2

QS

Page 4

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

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Page 5

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

Price

Qd

10

20

12

15

Price

Qd

10

20

12

18

Product A has High Elasticity of Demand as compared to the product B


A

Price

Qd

10

60

13

43

17

Price

Qd

15

78

17

52

Ep

Ep

> 1 Where Price increase and quantity Decrease.

Ep

< 1 Where price decrease and Quantity increase.

26

Where Price and Quantity percentage are change equal.

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Page 6

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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Page 7

THREE CORE RULES OF ELASTICTY


RULE #Ol

Less than

gieater than

Price elasticity Inerastic

Elastic

RULE #02

onnal good
Income elasticity
Inferior good
RULE #03

Substih1tes

Cross elasticity
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

Price

Qd

TR/TE = PxQd

10

20

200

20

160

For Exp.

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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Page 9

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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Page 10

Example:

Calculate Ep by Point and Arc Formula to Following Data.

Price

Qd

20

40

23

32

-8

Point Formula
=

Qd x P1
P
Qd1

-8
3

-8
6

Ep

-1.33

Ep

Qd x
P

-8
3

x 23+20
32+40

-8
3

x 43
72

-1.59

Ep

x 20
40

Arc Formula

Ep

P2 + P1
Qd2 + Qd1

Relationship between Price & Demand is Always Negative. Due to Negative Relationship
between Price & Quantity of Demand
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Page 11

Example No 2
Price

Qd

23

32

20

40

-3

Point Formula
=

Qd x P1
P
Qd1

23
-12

Ep

-1.92

Ep

Qd x P2 + P1
P
Qd2 + Qd1

8 x
-3

8 x 43
-3
72

Ep

23
- 3 32

Arc Formula

Ep

43
-27

-1.59

20 + 23
40 + 32

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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Page 12

Geometrical Method
According to this method price Elasticity of Demand is calculated in two cases.
(I)
(II)

When Demand Curve is Linear


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.

infinity

Ep =

Ep = >1
C

Ep = 1

Ep = < 1
B

Ep = 0
Qd

Example

AB

8 cm

AC

4cm

cb

4cm

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Page 13

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

G
Qd

Kind / Types of Elasticity of Demand


1

Price Elasticity of Demand

(Ep)

Income Elasticity of Demand (E i)

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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Page 14

Measurement

Point Formula
Ey

Qd2 qd1
y2 y1
y1

= Qd x y1
y
Qd1

Arc Formula
Ey

Qd2 Qd1
Qd2 + Qd1
y2 - y1
y2 + y1

= Qd x y2 + y1
y
Qd2 + Qd1

Where
Qd1 =

Initial Demand

Qd2 =

New Demand

P1

initial Income

P2

New Income

Qd =

Qd2 Qd1

P =

Y2 Y1

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Page 15

Qd

5000

10

55000

12

5000

Point Formula
Ey

Qd x Y1
y
Qd1

2 x
50,000 5000
10
100,000
50000

Ey

Ey

Qd x
y

Arc Formula

Ey

y2 + y1
Qd2 + Qd1

x 55000 + 50000
50
12
10

2
x 105,000
5000
22

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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Page 16

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
P y2 P y1

P y1

= Qdx x P y1
Py
Qdx1

(ii) Arc Formula


Ey

Qdx2 Qdx1
Qdx2 + Qdx1
Py2 - Py1
Py2 + Py1

= Qdx x Py2 + Py1


P y
Qdx2 + Qdx1

Where
Qdx1 =

Initial Demand of Goods x

Qdx2 =

New Demand of Goods x

Py1

initial Price of Goods y

P y2

New Income price of goods y

Qdx =

Qdx2 Qdx1

Py =

P y2 Py1

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Page 17

Example No 1

Py

Qdx

15

20

17

25

Point Formula
=

Qdx x P y1
Py
Qdx1

5 x
2

15
8

Ey

1.87

Ey

Qdx x
Py

Ey

15
20

Arc Formula

5 x
2

15 + 17
25 + 20

5 x
2

32
45

Ey

Py2 + Py1
Qdx2 + Qdx1

160
90
1.77

The cross Elasticity between substitute is positive where as cross Elasticity between
compliment is negative.
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Page 18

Example.
Y

Petrol

KM driven

Factor or Determinant of Elasticity of Demand.


(I)
(II)
(III)
(IV)
(V)
(VI)

Nature of Goods
Availability of Substitute
No of uses of a product
Time period
level of income
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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Page 19

Measurement
(i)

Point Formula
Es

Qs2 Qs1
Qs1

P2 P1
P1

= Qs x P1
P
Ps1

(ii) Arc Formula


Ey

Where
Qs1 =

Qs2 Qs1
Qs2 + Qs1
P2 - P1
P2 + P1

= Qs x P2 + P1
P y
Qs2 + Qs1

Initial Supply of Goods

Qs2 =

New Supply of Goods

P1

Initial Price of Goods

P2

New price of goods

Qs =

Qs2 Qs1

P =

P2 P1

Example No 1

Qs

55

100

60

120

20

Elasticity of Supply is + ve
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Page 20

D (Ep = 0)

S(Es = 0)

Qd

Demand

Supply

Qs

Qd

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Qs

Page 21

Determinants / Factors of Elasticity of Supply


1

Level of Technology

(Advance technology High Elasticity)

Nature of goods

(Agricultural Low Elasticity + Industrial High Elasticity)

Productive Capacity of Firms

Mean of Transportation and Communication

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
Pe

E
E

pe
pf

Shortage
D

Qe Qe1

Q
S

Q
S
E

E
D

D
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Page 22

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

7-

Marginal Cost

(MC)

TC/ Q

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AFC + AVC

Page 23

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

300

300

300

300

600

300

300

600

300

300

400

700

150

200

350

100

300

440

740

100

146.67

246.67

40

300

450

750

75

112.50

187.50

10

300

500

800

60

100

160

50

300

600

900

50

100

150

100

300

780

1080

42.86

111.43

154.29

180

300

990

1290

37.50

123.75

161.25

210

300

1300

1600

33.33

144.44

177.78

310

10

300

1700

2000

30

170

200

400

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Page 24

-Q

- Fe
- vc
-TC

10

11

700
600
500
400
300
200

AFC

AVC

ATC

-MC

100
0
1

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10

Page 25

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

TC
LTC

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Page 26

Maximize
Profit =

TR TC

Loss =

TC TR

Main Object of Firm maximizes profit and minimize loss

Revenue under Perfect competition

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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Page 27

Under perfect Competition

TR

AR

MR

10

10

10

10

10

20

10

10

10

30

10

10

10

40

10

10

10

50

10

10

Revenue
50

TR

40

30

20

10

AR =MR=P
0
1

Revenue

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Page 28

Under imperfect competition

TR

AR

MR

10

10

10

10

18

24

28

30

30

28

-2

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Page 29

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
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Page 30

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

AR=MR

A
B

Qe

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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Page 32

2-

Firm Earning normal Profit

Revenue cost

MC

ATC

Pe

Qe

AR=MR

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

TC= (Rent + Wages + Interest + Normal Profit)


Firm earns normal profit which is including in its cost.

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Page 33

3-

Firm Facing Normal Loss

Revenue cost

MC
ATC
AVC

Pe

Qe

AR=MR

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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Page 34

4-

Firm Facing Abnormal Loss

Revenue cost

MC
ATC
AVC

Pe

AR=MR

AFC

Qe

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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Page 35

In Long Run

Revenue cost

LMC

(Long Run Marginal Cost)

LAC

Pe

Qe

(Long Run Average Cost)

AR=MR

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

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Page 36

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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Page 37

Firm Earning Abnormal Profit

RC

MC

AC

Pe
A

MR
0

AR = P

Qe

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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Page 38

Firm Earning Normal Profit

RC
MC

AC

Pe

MR

AR = P

Qe

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

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Page 39

Firm Facing Normal Loss

RC
MC
B

AC

AVC

Pe

MR

AR = P
Q

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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Page 40

Loss Portion should must be less than F.C.


Firm Facing Abnormal Loss

(Shut down position)

RC
MC
A

AC
AVC

Pe

MR
0

AR = P

Qe

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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Page 41

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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Page 42

It is a mixture of Perfect Competition & Monopoly.


Example of monopolistic Competition Curve
Price & Demand Curve also called AR

Pe

AR = MR

Perfect Competition
Monopolistic Competition
Oligopoly
Duopoly
Monopoly

In monopolistic all Four cases are same like monopoly just the AR & MR Curve more
flat.
Monopolistic Competition Curve

AR
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Page 43

Firm Earning Abnormal Profit

RC

MC
C

AC

Pe
A

MR
0

Qe

AR = P
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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Page 44

Firm Earning Normal Profit

RC
MC

AC

Pe

MR
0

Qe

AR = P
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

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Page 45

Firm Facing Normal Loss

RC
MC
A

AC

AVC

Pe
D

MR
0

AR = P

Qe

Firm is in equilibrium at a point E Where MR = MC


Loss =

TC

TC TR

AC x Q AR x Q

OA x OQe OPe x OQe

OQeBA OQeCPe

PeCBA

OQeBA

FC + VC

DFBA + OQeFD

Loss

<

FC

PeCBA < DFBA


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Page 46

Firm Facing Abnormal Loss

RC

MC
AC

B
C

AVC

Pe

MR
0

Qe

AR = P
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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Page 47

Monopoly

Equilibrium of Firm in Long Run

Firm Earning Abnormal Profit

RC

LMC
LAC

Pe

A
E

MR
0

Qe

AR
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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Page 48

Monopolistic competition
Equilibrium of Firm in Long Run

Firm Earning Normal Profit:

RC

LMC
LAC

Pe

MR
0

Qe

AR
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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Page 49

OQeAPe OQeAPe

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-

3-

Net income from abroad

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)

(iv)

Net Expenditure

(X M)(X = Export Earning, M = Import Payment)

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( Development + Non Development)


Page 53

National Income

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

123-

Investments
Government Expenditures
Exports

Savings
Taxes
Imports

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.

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

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AD

Page 56

Ideal Situations

Price Level

(P)

AS

Pi
Pi (ideal price level)

Means equality of
ASC &ADC.
AD

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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Page 57

AS

E
Pe
Inflationary
Gap

Pi
AD

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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Page 58

Deflationary
Gap

AS

Pi
Pe

AD

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

Current Exp.

Tax Revenue

Direct Taxes

Development Exp.

Non Tax Revenue

Indirect Taxes

Deficit Financing

Internal

Bank Borrowing

External

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
Depression
Recession

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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Page 64

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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Page 66

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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Page 67

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-

1-

Frictional Unemployment

2-

Structural Unemployment

3-

Cyclical Unemployment

4-

Disguised Unemployment

5-

Voluntary Unemployment

6-

Involuntary Unemployment

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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Page 68

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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Page 69

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

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Labour Force

Page 70