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§ LECTURE 1 - INTRODUCTION
• OPTIMIZATION
• MARGINAL ANALYSIS
• EQUILIBRIUM
§ It will deal with the choices these economic agents make, the context in which
they make these choices, and the implications of these on society
§ The Course will also introduce you to the interventions that the
Regulator/Government can make in the markets when they ‘fail’
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§ What is the opportunity cost of you attending a two year PGP course in IIM
Nagpur?
§ If you start a manufacturing firm after your MBA, spend Rs. 1 crore on inputs and
earn Rs. 1.08 crores in Revenues, what is your accounting profit? What is your
economic profit?
§ Do you think there were more entrepreneurs from the past batches of older
IIMs(A,B,C) than the present batch? Why?
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20
• Scarcity is reflected by the fact that the points beyond
the production possibility frontier (for the firm) and the
Apple iPods
15
budget line (for the consumer) are unattainable
10
OPTIMIZATION
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Marginal Analysis
Control
§ As a manager, what is the value of the
Variabl Gross Total Net Marginal Marginal Net Marginal control variable you will finalize upon?
e Revenue Costs Revenue Revenue Costs Benefits
EQUILIBRIUM
Source: David Acemoglu, David Laibson and John A. List. (2016). Microeconomics. Pearson Education
Limited Global Edition
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SUMMARY
Consumers
maximize
their levels
of
Opportunity satisfaction
• Time, Money, and other Costs Markets allow
resources are scarce
• While we do so, we interaction of
• We make choices in
presence of this scarcity account for opportunity the two and
costs (cost of the best
foregone alternative)
we obtain an
equilibrium
Scarcity
Producers
maximize
their profits
• DEMAND
• SUPPLY
• EQUILIBRIUM
• EFFICIENCY
Mantri Cards
• GOVERNMENT INTERVENTIONS
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DEMAND - Example
§ Example:
PRICE § Consider the demand for coffee (in Tonnes):
!"&# $ $ %% =12000 - 3'" # $ $ %% +4'( %) -1*+ %) , +2- . %) ,
Where !"#$$%%
& is the amount of Coffee (in
Tonnes) demanded in a year, '"#$$%% is the
Price of Coffee (in Rs./Kg), '(%) is the Price of
Tea (in Rs./Kg), *+%), is the average annual
income of the individuals in the country, and
D0 -.%), is the number of minutes of Coffee
Advertisements shown in the TV in a year
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S0 § Input Prices
S1
§ Number of Firms
§ Producer Expectations
§ Other Factors
QUANTITY
SUPPLY - Example
§ Example:
PRICE § Consider the supply of Burgers in a month
(in lakhs):
'
!"#$%&$ =2000 + 4("#$%&$ -2()*&+,
'
Where !"#$%&$ is the amount of Burgers (in
lakhs) supplied in a month, ("#$%&$ is the
S0 Price of Burger (in Rs.),()*&+, is the Price of
Wheat Flour (in Rs./Kg)
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S
§ Consumer surplus is the excess of
PRICE consumers willingness to pay over the
A market valuation
§ Producer Surplus is the excess of
P E
market price over the reservation
price of the suppliers
§ In Equilibrium (E), the Consumer
D Surplus is given by A(APE) while
producer surplus is given by A(FPE).
F
The sum of these two is the total
Q
surplus.
QUANTITY
§ An Efficient market is the one that
maximizes the total surplus
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SUMMARY
P E
E
loss
QUANTITY
EQUILIBRIUM
DEADWEIGHT LOSS
S
PRICE
S
PRICE
Externalities
QA QE QC
QUANTITY
QB QE QD
QUANTITY
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• ELASTICITY
• TAX INCIDENCE
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ELASTICITY
§ The concept of elasticity allows you to answer questions like the following:
§ If as a chair manufacturing small firm, would a Rs. 200 price cut in chairs increase my
revenue?
§ If we do cut prices by Rs. 100, do we have inventories to meet the increased demand? If we
do not, how do we have to increase production?
§ If the incomes of the households increases by 5%, what is the expected increase in our
demand?
§ If own price elasticity of demand for a product is -2.12, it would mean that a
percentage increase (decrease) in price from the current one will decrease
(increase) demand by 2.12%
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6
l as 0 10 0 ---
tic
4
1 9 9 -9
2
0 2 8 16 -4
0 2 4 6 8 10 12
Quantity 3 7 21 -2.33
4 6 24 -1.5
30
5 5 25 -1
25
20 6 4 24 -0.67
Revenue
15 7 3 21 -0.43
10
8 2 16 -0.25
5
9 1 9 -0.11
0
0 2 4 6
Quantity
8 10 12
10 0 0 ¥
12
§ In extreme cases, demand is perfectly
10
inelastic (top graph) or perfectly
8 elastic (bottom graph)
Price
$%
§ The !"## value for a perfectly
2
0
0 1 2 3 4 5 6 elastic demand
¥ is , while that of
Quantity
a perfectly inelastic curve is 0.
6
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10 0 27 ¥ -0.06
3 14 6 -3.50 -5.00
8 4 21 -0.29 -0.38
9 2 24 -0.13 -0.20
10 0 27 ¥ -0.06
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§ Available Substitutes
§ More the substitutes available for the good, more elastic will be the demand
§ Implication à Elasticity of a broadly defined commodity group will be less than the narrowly
defined commodity group. Example: Demand for pulses will be less elastic than that of
demand for red gram (tur dal). Demand for food will be less elastic than the demand for
pulses.
§ Time
§ Demand tends to be more inelastic in the short term than in the long term
§ Expenditure Share
§ Good that comprise a relatively small share of expenditure tend to be more inelastic than
goods for which consumers spend a sizeable share of their incomes
§ Example: Demand for salt
§ The cross price elasticities for substitutes will be positive, the same for
complements will be negative, and it will be 0 for unrelated commodities
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% DQxd dQxd M
eM
d
Q
= x
=
% DM dM Qx
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TAX INCIDENCE
TAX INCIDENCE
S1
§ Consider an initial equilibrium point E
with initial supply curve S0 and a
PRICE
S0
demand curve D0
A
§ An increase in tax will decrease the
supply and the prices will increase.
P1
P E § In a case where the supply curve
P1-T moves to S1, the consumer bears an
increase in price of P1-P and the
D0
supplier bears the remaining brunt of
P-P1-T
D1
F
§ Which of the curves D0 or D1
Q
QUANTITY represent the demand for
petrol/diesel better?
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SUMMARY
OWN PRICE ELASTICITY INCOME ELASTICITY
% DQxd dQxd Px % DQxd dQxd M
eP Qxd
eM
d
= = Q
=x
=
x
% DPx dPx Qx % DM dM Qx
Qxd æ Q2 - Q1 ö æ P2 - P1 ö x
=
eP =ç ÷ ç ÷
x
% DAx dAx Qx
è (Q2 + Q1 ) / 2 ø è ( P2 + P1 ) / 2 ø
x
S1
S0
TAX
% DQxd dQxd Py
P1
e PQ =
d P
INCIDENCE
E
x
= P1-T
y
% DPy dPy Qx D0
D1
F
QL
QUANTITY
ELASTICITY OF SUPPLY
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• THE APPROACH
• CONSUMER PREFERENCES
• INDIFFERENCE MAPS
• UTILITY
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APPROACH
Consum ers
m axim ize
their levels
Opportunity of
satisfaction
• Time, Money, and other Costs Markets
resources are scarce
• While we do so, we allow
• We make choices in
presence of this account for opportunity interaction
scarcity costs of the two
and we
obtain an
Scarcity equilibrium
Producers
m axim ize
their
profits
CONSUMER PREFERENCES
§ Assumption 4: Transitivity. If you prefer a blue pen to a red pen and prefer
red pen to a green pen, you will prefer blue pen to a green pen
2nd chocolate
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INDIFFERENCE MAPS
B(2,1) I2
§ In our example, the consumer will
I1 prefer any point on I2 to a point on
I1 and any point on curve I3 to a
point in I1 or I2. The consumer will
choose C over A/B and D over
APPLES
A/B/C
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6
3
5 B(2,4) § It is the rate at which the consumer is
willing to substitute one good for other
maintaining the same level of
4
3 2
C(3,2)
satisfaction
2
1 C(4,1)
1
§ The indifference curves exhibit a
diminishing marginal rate of
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5
substitution. The amount of good X
APPLES
that a consumer is willing to give up to
obtain another unit of Y reduces as
amount of Y increases
3
§ Transitivity implies that the
2 indifference curves do not intersect
1
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5
§ The intersection point is common to
APPLES
both curves which means all the
points should lie on a single curve
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6
§ Consider an example where the
consumer perceives coca cola and
5
1
§ The consumer’s indifference map
shows that the consumer derives
0
0 1 2 3 4 5 6 7 8
4
§ Consider an example of satisfaction
3 from a right glove and a left glove
2
1
§ The consumer’s indifference map
0
0 1 2 3 4 5 6
shows that the consumer derives
satisfaction from a pair of gloves, 2
RIGHT GLOVE pairs and 3 pairs of gloves. The
consumer’s satisfaction will not
increase with a glove for a single
hand
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UTILITY
B(2,1) I2
§ Instead of talking in terms of
I1 preferences, we could state in terms of
utility as follows: The consumer derives
the same utility from consuming 2
apples and 1 chocolates or 1 apple
and 2 chocolates. Also, the consumer
APPLES will derive more utility from consuming
2 apples and 2 chocolates
UTILITY
A(1,2)
C(2,2)
§ The utility of a consumer is same for
an indifference curve
B(2,1) I2
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4 8 22.63 1.46
9.00
4 9 24.00 1.37 MARGINAL UTILITY
8.00
4.00
4 13 28.84 1.13
3.00
4 14 29.93 1.09
2.00
4 15 30.98 1.05 1.00
§ Marginal rate of substitution can also § The utility in any of the indifference
be expressed as the ratio of marginal curve is given by
utility of two commodities
U = U ( A, C )
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SUMMARY
CHOCOLATES
35.00
TOTAL UTILITY
30.00
25.00
20.00
A(1,
2) C(2,2) 15.00
10.00
B(2,1) I2 5.00
I1 0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
%& !)'
APPLES !"# = =−
%' !)& 9.00
MARGINAL UTILITY
8.00
CHOCOLATES 8
7.00
A(1,7)
7
6.00
6
3 5.00
5 B(2,4)
4.00
4
3.00
3 2
C(3,2) 2.00
2
1 C(4,1) 1.00
1
0.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5
APPLES
• BUDGET CONSTRAINTS
• UTILITY MAXIMIZATION
• INCOME EFFECT
• GIFFEN GOOD
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BUDGET CONSTRAINTS
50 A + 25C = 3000
120
C = 120 - 2 A
100 BUDGET LINE
40
20
0
0 10 20 30 40 50 60 70
BUDGET CONSTRAINTS
40
the whole income on commodity Y
20
0
0 10 20 30 40 50 60 70
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UTILITY MAXIMIZATION
UTILITY MAXIMIZATION
C
60
40
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UTILITY MAXIMIZATION
U ( A, C ) = 20 AC
50 A + 25C = 3000
MU A = 10 C / A
X Y MUX MUY MUX/PX MUY/PY
§ At the optimal point for the
MU C = 10 A / C
consumer, the slope of the budget
5 110 46.90 2.13 0.94 0.09 line and the slope of the indifference
10 100 31.62 3.16 0.63 0.13 curve are the same
15 90 24.49 4.08 0.49 0.16
INCOME EFFECT
50 A + 25C = 2000
C = 80 - 2 A
§ For normal goods, a change in income
will result in change in amount
180 50 A + 25C = 3000 consumed in the same direction
160
C = 120 - 2 A
140
50 A + 25C = 4000
C = 60 - 2 A
§ A reduction in income will shift the
120
100
D budget line towards left
80
C
60
40
B
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70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0
0 20 40 60 80 100 120 140 0 20 40 60 80 100 120 140
80
§ Income effect is found as the change
E (60, 60);U (60, 60) = 60*60 = 60
in consumption due to reduction in
60 this compensatory income. It is also
40
G (30, 60);U (30, 60) = 30*60 = 42.4 negative for normal goods. For Giffen
50 X + 25Y = 3000
good, the income effect is large and
20 25 A + 25C = 3000 significantly positive to overcome the
0
substitution effect and reverse its
0 20 40 60 80 100 120 140 impact.
Both Substitution and Income Effect
Negative for Price Rise
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SUMMARY
140
120
MU A PA
100 MRS = =
MU C PC
80
or
60 MU A MU C
=
40 PA PC
20
0
0 10 20 30 40 50 60 70
140 80
70
120
60
100
50
80
40
60 30
40 20
20 10
0
0
0 20 40 60 80 100 120 140
0 20 40 60 80 100 120 140
MANAGERIAL ECONOMICS
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§ Liconsa which was under Conasupo now under Ministry of Social Development
§ Opportunidades
§ Liconsa – Buy milk and only milk at a subsidized prices (3.5 peso per litre)
LICONSA
Advantages Disadvantages
§ Coverage Problems
§ Assistance to the poor § Four liters of milk may not be that
valuable to some participants
§ For a worthwhile use : Milk
§ Does it impose no cost to the
§ Milk à Nutrition à Health à School à Government? – If free why is Liconsa
Jobs limited to 5 million participants?
§ For an average rural family. Is Liconsa
like a cash transfer?
§ No Longer Corrupt
§ Financially self-supporting
§ Support from the dairy industry
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In-Kind Assistance
§ Assumptions
Original Budget Line With Licons a Original Budget Line With Licons a With Income Transfer
311 331
321
301
311
291
301
281 291
281
271
271
261
261
251 251
0 2 4 6 8 10 12 0 2 4 6 8 10 12
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Tarriffs
§ World Price = 1517 million pesos/105 million kilos = $14.5 per kilo
Tarriffs
§ Welfare Costs??
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Price
Demand Curve Price
Demand Curve
Supply
Supply
w/o
C w/o
A subsidy
A subsidy
B
Supply
Supply
with
with
subsidy
subsidy
Quantity
Quantity
You are lying on the beach on a hot day. All § In both versions the ultimate consumption
you have to drink is ice water. For the last act is the same - drinking one beer on the
hour you have been thinking about how much beach. The beer is the same in each case.
you Would enjoy a nice cold bottle of your
favorite brand of beer. A companion gets up § No "atmosphere" is consumed by the
to go make a phone call and offers to bring respondent.
back a beer from the only nearby place where
beer is sold (a fancy resort hotel) [a small,
run-down grocery store]. He says that the beer
might be expensive and so asks how much
you are willing to pay for the beer. He says
that he will buy the beer if it costs as much
or less than the price you state. But if it costs
more than the price you state he will not buy
it. You trust your friend, and there is no
possibility of bargaining with (the bartender)
[store owner]. What price do you tell him?
36
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APPROACH
Consum ers
m axim ize
their levels
Opportunity of
satisfaction
• Time, Money, and other Costs Markets
resources are scarce
• While we do so, we allow
• We make choices in
presence of this account for opportunity interaction
scarcity costs of the two
and we
obtain an
Scarcity equilibrium
Producers
m axim ize
their
profits
PRODCUTION FUNCTION
§ Capital (K): Land, Buildings (factories, stores), and equipment (machines, trucks)
§ Labour (L): labourers (construction workers, assembly-line workers) , skilled workers (architects,
engineers, plumbers, economists), and managers
§ Materials (M): Raw goods (oil, water, wheat), and processed goods (aluminium, paper, plastic,
steel)
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INPUTS
§ Fixed input is an input whose input does not vary with the production for
some time. The costs for the input do not vary with the level of production
§ Short run is the time in which at least one factor of production cannot be
varied practically
§ Long run is a lengthy enough period of time that all inputs can be varied
Total Average
K L Product Marginal Product Product
3 0 0
3 1 5 5 5
3 2 16 11 8
3 3 31 15 10
3 4 48 17 12
3 5 63 15 13
3 6 75 12 13
3 7 83 8 12
3 8 88 5 11
3 9 90 2 10
3 10 90 0 9
3 11 88 -2 8
3 12 84 -4 7
3 13 78 -6 6
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q
10
5 APL =
0 L
0 2 4 6 8 10 12 14
-5
-10
LABOUR
1 10 14 17 20 22 24
4 20 28 35 40 45 49
§ A lumberyard can produce 200 planks
5 22 32 39 45 50 55 with 10 workers using handsaws, 4
workers using handheld power saws, or
6 24 35 42 49 55 60 with 2 workers using bench power saws
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ISOQUANTS
§ Isoquant
ISOQUANTS
7
q = f ( K , L)
§ Farther the Isoquant is from the origin,
6
CAPITAL
§ Slope of the isoquant is the marginal
rate of technical substitution (MRTS)
ΔK MPL
MRTS = =-
ΔL MPK
ISOCOSTS
40
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New cost-minimizing
point due to higher wage
F
B
%& Initial point of cost minimization
A
%$
!"
H J
0 #& #$ G Labor Input (L)
SUMMARY
100
90
ISOQUANTS
7
80 TOTAL PRODUCT
70 6
60 5
50 4
40
3
30
2
20
10 1
0 0
0 2 4 6 8 10 12 14
MPL MPK 0 1 2 3 4 5 6 7
LABOUR =
w r
20
25
MARGINAL PRODUCT
15
20
AVERAGE PRODUCT
10
15
5
10
0
0 2 4 6 8 10 12 14 5
-5
0
0 5 10 15 20 25 30 35 40 45
-10
LABOUR
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RETURNS TO SCALE
§ Constant Returns to Scale – When all the inputs are increased by a certain
percentage the output increases by same percentage
f (αK , αL) = αf ( K , L)
q = ALα K β
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§ Fixed Costs (FC) are the costs that do not change with changes in output
§ Variable Costs (VC) are the costs that change with the changes in output
§ Total Costs (TC) are the sum of fixed and variable costs
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(5)=20000*(2
(1) (2) (3) (4)=50000*(1) ) (6)=(4)+(5)
44
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PERFECT COMPETITION
§ Identical Products
§ Full Information
PROFIT MAXIMIZATION
§ Two Decisions
§ Output Decision : What is the optimal level q* which maximizes the firms profits?
§ Shutdown Decision: Is it more profitable to produce q* or to shut down and produce no
output?
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p
Profit
Rs.
Loss
0 q
46
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Fixed Cost
Loss if produce
0 q
Rs
Short-run supply
curve for individual firm
!"#
0 q
47
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P
Individual firm’s
supply curve
Market supply
curve
S
$12
$10
LRAC (Rs.)
!"#&
!"#$ '(!#
!"#%
0 )∗ Output
48
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Price
Price
Exit
Entry
D
0 Market 0 Firm’s
Output Q Output q
Rs
Long-run competitive
equilibrium
0 Firm’s output q
49
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ECONOMIES OF SCALE
§ Economies of scale
§ Portion of the long-run average cost curve where long-run average costs
decline as output increases
§ Diseconomies of scale
§ Portion of the long-run average cost curve where long-run average costs
increase as output increases
ECONOMIES OF SCOPE
§ Economies of scope
§ Exist when the total cost of producing !" and !# together is less than the total cost of
producing each of the type of output separately.
$ !", 0 + $ 0, !# > $ !", !#
§ Cost complementarity
§ Exist when the marginal cost of producing one type of output decreases when the output of
another good is increased.
∆*$" !", !#
<0
∆!#
# #
§ $ = 100 − 0.5!" !# + !" + !#
50