CONTENTS

Foreword iii

1. INTRODUCTION 1

1.1 A Simple Economy 1

1.2 Central Problems of an Economy 2

1.3 Organisation of Economic Activities 4

1.3.1 The Centrally Planned Economy 4

1.3.2 The Market Economy 5

1.4 Positive and Normative Economics 6

1.5 Microeconomics and Macroeconomics 6

1.6 Plan of the Book 6

2. THEORY OF CONSUMER BEHAVIOUR 8

2.1 Utility 8

2.1.1 Cardinal Utility Analysis 9

2.1.2 Ordinal Utility Analysis 11

2.2 The Consumer’s Budget 15

2.2.1 Budget Set and Budget Line 15

2.2.2 Changes in the Budget Set 17

2.3 Optimal Choice of the Consumer 19

2.4 Demand 21

2.4.1 Demand Curve and the Law of Demand 21

2.4.2 Deriving a Demand Curve from Indifference Curves and Budget Constraints 23

2.4.3 Normal and Inferior Goods 24

2.4.4 Substitutes and Complements 25

2.4.5 Shifts in the Demand Curve 25

2.4.6 Movements along the Demand Curve and Shifts in the Demand Curve 26

2.5 Market Demand 26

2.6 Elasticity of Demand 27

2.6.1 Elasticity along a Linear Demand Curve 29

2.6.2 Factors Determining Price Elasticity of Demand for a Good 31

2.6.3 Elasticity and Expenditure 31

3. PRODUCTION AND COSTS 36

3.1 Production Function 36

3.2 The Short Run and the Long Run 38

3.3 Total Product, Average Product and Marginal Product 39

3.3.1 Total Product 39

3.3.2 Average Product 39

3.3.3 Marginal Product 39

3.4 The Law of Diminishing Marginal Product and the Law of Variable Proportions 40

3.5 Shapes of Total Product, Marginal Product and Average Product Curves 41

3.6 Returns to Scale 42

3.7 Costs 43

3.7.1 Short Run Costs 43

3.7.2 Long Run Costs 48

4. THE THEORY OF THE FIRM UNDER PERFECT COMPETITION 53

4.1 Perfect Competition: Defining Features 53

4.2 Revenue 54

4.3 Profit Maximisation 56

4.3.1 Condition 1 56

4.3.2 Condition 2 56

4.3.3 Condition 3 57

4.3.4 The Profit Maximisation Problem: Graphical Representation 58

4.4 Supply Curve of a Firm 59

4.4.1 Short Run Supply Curve of a Firm 59

4.4.2 Long Run Supply Curve of a Firm 60

4.4.3 The Shut Down Point 61

4.4.4 The Normal Profit and Break-even Point 61

4.5 Determinants of a Firm’s Supply Curve 62

4.5.1 Technological Progress 62

4.5.2 Input Prices 62

4.6 Market Supply Curve 63

4.7 Price Elasticity of Supply 65

5. MARKET EQUILIBRIUM 71

5.1 Equilibrium, Excess Demand, Excess Supply 71

5.1.1 Market Equilibrium: Fixed Number of Firms 72

5.1.2 Market Equilibrium: Free Entry and Exit 80

5.2 Applications 84

5.2.1 Price Ceiling 84

5.2.2 Price Floor 85

6. NON-COMPETITIVE MARKETS 88

6.1 Simple Monopoly in the Commodity Market 88

6.1.1 Market Demand Curve is the Average Revenue Curve 89

6.1.2 Total, Average and Marginal Revenues 92

6.1.3 Marginal Revenue and Price Elasticity of Demand 93

6.1.4 Short Run Equilibrium of the Monopoly Firm 93

6.2 Other Non-perfectly Competitive Markets 98

6.2.1 Monopolistic Competition 98

6.2.2 How do Firms behave in Oligopoly? 99

Glossary 102

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