CHAPTER 1 ECONOMICS: It is the study of how individuals and societies choose to use the scare resources that nature

and previous generations have provided Opportunity cost: The best alternative which we forgo or give up while taking a decision or a choice is called opportunity cost Microeconomics: It deals with the functioning of individual markets and industries and with the behavior of individual decision making units: business firms and house holds. Macroeconomics: looks at the economy as a whole. It deals with the economic behavior of aggregatesnational output, national income, the overall price level, and the general rate of inflation. The Methods of Economics: 1) Positive Economics: It attempts to understand the behavior and operation of economies without making any judgments about whether the outcomes are good or bad. i) Descriptive economics: It involves the compilation of the data accurately describe economic facts and events. ii) Economic Theory: It attempts to generalize and explain what is observed. It involves the statements of cause and effect- of action and reaction. 2) Normative Economics: It looks the results of economic behavior and asks whether they are good or bad and whether they can be improved. Economic Model: It is the formal statement of an economic theory. Models simplify and abstract from reality. Ceteris Paribus: It is the tool which gives the relation between the two variables where the other variables are kept constant. Post Hoc, Ergo propter hoc: Event A happens before event B, event A is not the cause of event B. Fallacy of Composition: the erroneous belief that what is true for a part is necessarily true for the whole. Empirical Economics: Collection and usage of data for various economic theories. Four specific criteria used most often in economics: efficiency, equity, growth, and stability. CHAPTER 2 1) ECONOMIC PROBLEM: All societies must ask three basic questions: what gets produced? How is it produced? Who gets what is produced? 2) Even if one individual or nation is absolutely more efficient at producing goods than another, all parties will gain if they specialize in producing goods in which they have a comparative advantage.

3) A production possibility frontier (ppf) is a graph that shows all the combinations of goods and services that can be produced if all societys resources are used efficiently. The ppf illustrates a number of important economic concepts: Scarcity, unemployment, inefficiency, increasing opportunity cost and economic growth. 4) Economic growth occurs when society produces more, either by acquiring more resources or by learning to produce more with existing resources. Improved productivity may come from additional capital or from the discovery and application of new, more efficient techniques of production. 5) The ppf can be used to illustrate the gains from trade and the theory of competitive advantage. Trade and specialization enable people and countries to move out beyond their own productive possibilities. CHAPTER 3 FIRMS AND HOUSHOLDS: THE BASIC DECISION MAKING UNITS 1) A firm exists when a person or a group of people decides to produce a product or products by transforming resources, or inputs, into outputs- the products are sold in the market. Firms are the primary producing units in the market economy. We assume firms making decisions to try to maximize profits 2) Households are the primary consuming units in an economy. All households incomes are subjected to constraints. INPUT MARKET AND OUTPUT MARKET THE CIRCULAR FLOW: 1) The households and firms interact in two basic kinds of markets: product or output markets and input or factor markets. Goods and services intended for use by households are exchanged in output markets. In output markets, competing firms supply and competing households demand. In input markets, competing firms demand and competing households supply. 2) Ultimately, firms choose the quantities and character of outputs produced, the types and quantities of inputs demanded, and the technologies used in production. Households choose the types and quantities of products demanded and the types of inputs supplied. DEMAND IN PRODUCT/ OUTPUT MARKETS 1) The quantity demanded of an individual product by an individual household depends on 1) price 2) income, 3) wealth, 4) prices of other products, 5) tastes and preferences, and 6) expectations about the future. 2) Quantity demanded is the amount of a product that an individual household would buy at a given period if it could buy all it wanted at the current price. 3) A demand schedule shows the quantities of a product that a household would buy at different prices. The same information can be presented graphically in a demand curve 4) The law of demand states that there is a negative relation ship between price and quantity demanded: As price rises, quantity demanded decreases, and vice versa. Demand curve slope downwards. 5) All demand curves eventually intersect the price axis because there is always a price above which a household cannot, or will not, pay. All demand curves also eventually intersect the quantity axis because demand for most goods is limited, if only by time, even at a zero price.

6) When an increase in income happens demand for a good rise, the good is normal good. When an increase in income causes decrease in demand then it is an inferior good. 7) If a rise in a good X causes demand for good Y to increase then the both goods are substitutes. If a rise in price of good X causes the demand of good Y fall, then they are compliment goods. 8) Market demand is simply the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. It is the sum of all the individual quantities demanded at each price. SUPPLY IN PRODUCT/ OUTPUT MARKETS 1) Quantity supplied by a firm depends on 1) the price of good and services, 2) the cost of producing the product, which includes the prices of required inputs and the technologies that can be used to produce the product; and 3) the prices of related goods. 2) Market supply is the sum of all that is supplied in each period by all producers of a single product. It is the sum of all individual quantities supplied at each price. 3) It is very important to distinguish between movements along demand and supply curves and shift of demand and supply curves. The demand curve shows the relationship between the price and quantity demanded. The supply curve shows the relationship between the price and quantity supplied. Changes in tastes, income, wealth, expectations, or prices of other goods and services cause demand curves to shift; changes in cost, input prices, technology, or prices of related goods and services cause supply curve to shift.

MARKET EQUILIBRIUM 1) When quantity demanded exceeds quantity supplied at the current price, excess demand (or a shortage) exists and the price tends to rise. When prices in a market rise until equilibrium is reached at which quantity supplied and demanded are equal. At equilibrium, there is no further tendency for price to change. 2) When quantity supplied exceeds quantity demanded at the current prices, excess supply exists and the price tends to fall. When price falls, quantity supplied decreases and quantity demanded increases until an equilibrium price is reached where quantity supplied and quantity demanded are equal.

CHAPTER 4 THE PRICE SYSTEM: RATIONING AND ALLOCATING RESOURCES: 1) In a market economy, the market system (or price system) serves two functions. It determines the allocation of resources among the producers and the final mix of outputs. It also distributes goods and services on the basis of willingness and ability to pay. In this sense, it serves as a price rationing device. 2) Governments, as well as private firms, some times decide not to use market system to ration an item for which there is excess demand. Examples of nonprice rationing systems include queuing, favored customers, and retain coupons. The common rationale for such policies is fairness.

SUPPLY DEMAND ANALYSIS The basic logic of supply and demand is a powerful tool for analysis. For example, supply and demand analysis show that an oil import tax will reduce quantity of oil demanded, increase the domestic production, and generate revenues for the government. SUPPLY AND DEMAND AT MARKET EFFICIENCY Supply demand curves can also be used to illustrate the idea of market efficiency, an important aspect of normative economics CUSTOMER SURPLUS: It is the difference between the maximum amounts of a person is willing to pay for a good and current market price. PRODUCER SURPLUS: It is the difference between the current market price and the full cost of production for the firm. At free market equilibrium with competitive markets, the sum of customer surplus and producer surplus is maximized. The net loss of producer and customer surplus from underproduction or over production is referred to as a deadweight loss.

CHAPTER 5 1) Elasticity is a general measure of responsiveness that can be used to quantify many different relationships. If one variable A changes in response to changes in another variable B, the elasticity of A wrt B is equal to %ge change in A/%ge change in B 2) Price elasticity of demand: % change in quantity demanded/ % change in price. 3) Perfectly inelastic demand: It is the demand whose quantity demanded does not respond at all to changes in price; its numerical value is zero. 4) Inelastic demand: 0 to -1 5) Elastic demand: <-1 6) Unitary elasticity:=1 7) Perfectly Elastic demand: small change in price of a product causes the quantity demanded to zero. 8) If demand is elastic, a price increase will reduce the quantity demanded by a large percentage than the % increase in price, and total revenue (P*Q) will fall. If demand is inelastic, price increase will increase TR. 9) If demand is elastic, a price cut will cause quantity demanded to increase by a greater percentage than the % decrease in price and TR will rise. If demand is in elastic, a price cut will cause Qd to increase by a smaller % than the % decrease in price, and TR revenue will fall. 10) The elasticity of demand depends on: 1) The availability of substitutes 2) the importance of the item in individual budgets, and 3) the time frame in question.

11) Income elasticity of demand measures the responsiveness of the quantity demanded wrt changes in income. 12) Cross price elasticity of demand measures the response of the quantity of one quantity demanded to the change in price of another good. %change in Qy/ % change in Px 13) Elasticity of supply measures the response of the quantity of good supplied to a change in the price of that good. 14) The elasticity labour supply measures the response of the quantity of labour supplied to a change in the price of labour. CHAPTER 6 1) An indifference curve is a set of points, each point representing a combination of goods X and Y, all of which yield the same total utility. A particular customers set of indifferent curves is a preference map. 2) The slope of indifference curve is the ratio of the marginal utility of X to the marginal utility of Y, and it is negative. 3) As along as indifferent curves are convex to the origin, utility maximization will take place at that point at which the indifference curve is just tangent to- that is, just touches- the budget constraint. The utility maximizing rule can also be written as MUx/Px=MUy/Py. CHAPTER 7 1) The demand curve facing a competitive firm is perfectly elastic. If a single firm raises its price above the market price, it will sell nothing. Because it can sell all it produces at the market price, a firm has no incentive to reduce price. BEHAVIOUR OF PROFIT MAXIMIZING FIRMS 1) Profit maximizing firms in all industries must make three choices: 1) How much output to supply? 2) How to produce that output, 3) How much of each input to demand. 2) Profits= TR-TC (costs). TC (economic costs) includes 1) out-of-pocket costs and 2) the opportunity cost of each factor of production, including a normal rate of return (NRR) on capital 3) NRR to capital is included in TC because tying up resources in a firms capital stock has an opportunity cost. If you start a business or buy a share of stock in a corporation, u do so because u expect to make a NRR. Investors will not invest their money in a business unless they expect to make a NRR. 4) Positive profit, when > NRR of capital achieved. 5) Two assumptions define the short run: 1) a fixed scale or fixed factor of production and 2) no entry to or exit from the industry. In the long run, firms can choose any scale of operations they want, and new firms can enter and leave the industry. 6) To make decisions, firms need to know three things: 1) the market price of their output 2) the production techniques that are available, and 3) the prices of inputs. THE PRODUCTION PROCESS

1) Production function/ product function: relationship of inputs and outputs expressed mathematically. 2) Marginal product of a variable input is the additional output that an added unit of that input will produce if all other inputs are held constant. According to law of diminishing returns, when additional inputs are added to fixed inputs after a certain point, the marginal product of the variable input will decline. 3) Average product is the average amount of product produced by each unit of variable factor of production. If marginal product is above average product, the average product rises; if marginal product is below average product, the average product falls. Average product of labour= total product/ total units of labour. 4) Capital and labour are complimentary and substitutes to each other. Capital can enhance the labour. CHAPTER 8 COSTS IN SHORT RUN 1) Fixed Costs (FC): costs that do not change firms output. In short run, firms can not avoid them or change them, even if production is zero. 2) Variable costs (VC): costs that depend on the level of output produced. TC=TFC+TVC 3) Average Fixed costs (AFC): As output raises, AFC declines steadily because the same total is being spread over a larger and larger quantity of output. This phenomenon is called spreading overhead. AVC= TFC/q 4) Total Variable Costs (TVC): it is the sum of all costs that vary with output in the short run. Slope of TVC= MC Marginal cost (MC): It is the increase in total cost that results from the production of one more unit of output. In a short run, as firm increases output, it will eventually find itself trapped by that scale. Because of the fixed scale, marginal cost eventually rises with output. MC is the slope of the TVC curve. The TVC curve slope is always positive, because TC always rises with output. Increasing MC means increasing TC ultimately rise at an increased cost. AVC= TVC/q MC above AVC, AVC is increasing. If MC below AVC cost is declining. Mc intersects AVC at minimum point. ATC= TC/q=AVC+AFC MC below ATC, ATC declines towards MC. If MC is above ATC, ATC will increase. MC intersects ATC at minimum point.

5) 6) 7) 8) 9) 10) 11)

OUTPUT DECISIONS: REVENUES, COSTS, AND PROFIT MAXIMIZATION 1) A perfect competition firm faces a demand curve that is horizontal. Perfectly elastic demand. 2) TR is simply price times the quantity of output that a firm decides to produce and sell. Marginal revenue (MR) is the additional revenue that a firm takes in when it increases output by one unit.

3) Perfect competitive firm, MR= current market price of its products. 4) Profit maximizing firm in a perfectly competitive industry, P=MC, MR=MC=> P=MR. MC curve of a perfectly competitive industry is the firms short-run supply curve. CHAPTER- 9 EXTERNAL ECONOMIES AND DISECONOMIES: When long- run AC decreases as a result of industry growth, we say that the industry exhibits external economies. When long-run AC increases as a result of industry growth, we say that the industry exhibits external diseconomies. THE LONG RUN INDUSTRY SUPPLY CURVE (LRIS): LRIS is a graph that traces out price and total output over time as an industry expands. A decreasing-cost industry is one which ACs fall as the industry expands. It exhibits external economies, and its long-run industry supply curve slopes downward. An increasing- cost industry is one which ACs rise as the industry expands. It exhibits external diseconomies, and its long-run industry supply curve slopes upward. A constant- cost industry is one that shows no economies and diseconomies as the industry grows. Its long-run industry supply curve is horizontal, or flat. CHAPTER 12 A general equilibrium exists when all markets in an economy are in simultaneous equilibrium. Partial equilibrium analysis can be misleading, because it looks only at adjustments in one isolated market. ALLOCATIVE EFFICIENCY AND COMPETITIVE EQUILIBRIUM: a) An efficient economy is one that produces goods and services that people want at least possible cost. Pareto optimal, system is one in which no such changes are possible. b) If all assumptions of perfect competition hold, the result is inefficient, allocation of resources. The assumptions that factor markets are competitive and open, that all firms pay the same prices for inputs, and that all firms maximizes profits lead to the conclusion that the allocation of resources among firms is efficient. c) Perfectly competitive firms will produce as long as the price of their product is greater than the MC of production, they will continue to produce as long as a gain for society is possible. THE SOURCES OF MARKET FAILURE 1) When the assumptions of perfect competition do not hold, the conclusion breaks down that free, unregulated market will produce an efficient allocation of resources. 2) An imperfect competitive industry is one in which single firms have some control over price and competition. Forms of imperfect competition include monopoly, monopolistic and oligopoly. In all imperfect competitive industries, output is lower and price is higher than they would be in perfect competition. Imperfect competition is the main source of market efficiency.

3) An externality is the cost or benefit that is imposed or bestowed on an individual or group that is outside, or external to, the transaction. If such social costs or benefits are overlooked, the decisions of households or firms are likely to be wrong or inefficient. CHAPTER-13 Assumptions underlie the logic of perfect competition. 1) A large number of firms and households are interacting in each market; 2) firms in a given market produce undifferentiated, or homogeneous;, product; 3) new firms are free to enter industries and to compete for profits. The first two imply that firms have no control over input prices or output prices; the third implies that opportunities for positive profit are eliminated in the long run. IMPERFECT COMPETITION AND MARKET POWER 1) A market in which individual firms have some control over price is imperfectly competitive. Such firms exercise market power. The three forms of imperfect competition are monopoly, oligopoly, and monopolistic competition. 2) A pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes and in which there are significant barriers to entry. 3) There are many barriers to entry, including govt franchises and licenses, economies of scale, and ownership of scare factors of production. 4) Firms have to take 4 decisions: 1) how much to produce 2) how to produce it, 3) how much to demand in each input market, and 4) what price to change for their output. PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS 1) Only one firm in a monopoly market, however, there is no distinction between firm and the industry- The firm is the industry. The market demand curve is thus the firms demand curve, and the total quantity supplied in the market is what the monopoly firm decides to produce. 2) For a monopolist, an increase in output is not just increasing the production and selling it but also reducing the price of its output to sell it. MR to monopolist is not equal to product price, as it is in competition. Instead, MR < price because to raise output one unit they have to sell that one unit, the firm must lower the price it charges to all buyers. 3) For profit maximizing monopolist, MR=MC. 4) In short run, monopolists are limited by a fixed factor of production, just as comparative firms are. Monopolies that do not generate enough revenue to cover costs will go out of business in the long run. 5) Compared with competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits. Because MR always lies below the demand curve for a monopoly, monopolists will always charge price higher than MC. THE SOCIAL COSTS OF MONOPOLY

1) When P above MC, the result is inefficient mix of output. The decrease in consumer surplus > then the monopolists profit, thus causing a net loss in social welfare. 2) Actions that firms take to preserve the positive profits, such as lobbying for restrictions on competition, are called rent seeking. Rent-seeking behavior consumes resources and adds to social costs, thus reducing social welfare even further. PRICE DISCRIMINATION 1) Charging different prices at different buyers is called price discrimination. The motivation for price discrimination is fairly obvious: if a firm can identify those who are willing to pay a higher price for a good, it can earn more profit from them by charging a higher price. 2) A firm that charges the maximum amount that buyers are willing to pay for each unit is practicing perfect price discrimination. REMEDIES FOR MONOPOLY: ANTITRUST POLICY 1) Governments have assumed two roles wrt imperfectly competitive industries: 1) They promote and restrict market power, primarily through antitrust laws and other congressional acts; 2) they restrict competition by regulating industries. 2) Congress created Interstate Commerce Commission in 1887 for railroads, 1890 passed Sherman Act, which declared monopoly and trade restrains illegal. 3) 1914, Clayton Act, which was designed to strengthen the Sherman Act. A NATURAL MONOPOLY When a firm exhibits economies of scale so large that average costs continuously decline with output, it may be efficient to have only one firm in an industry. CHAPTER 14 MONOPOLISTIC COMPETITION 1) A monopolistically competitive industry has following structural characteristics: 1) a large number of firms 2) no barrels to entry 3) product differentiation. Relatively good substitutes for a monopolistic competitors products are available. Monopolistic competitors try to achieve a degree of market power by differentiating the product. 2) Advocates of free and open competition believe that differentiated products and advertising give the market system its vitality and other basis of its power. Critics argue that product differentiation and advertising are wasteful and inefficient. 3) A demand curve facing monopolistic competitor is less elastic than the demand curve faced by perfectly competitive firm but more elastic than the demand curve faced by monopoly. 4) To maximize profit in short run, a monopolistically competitive firm will produce as long as the MR from increasing output and selling it exceeds the MC of producing it. This occurs at pt. MR=MC 5) When firms enter monopolistically competitive industry, they introduce close substitutes for the goods being produced. This attracts demand away from the firms already in the industry. Demand faced by firm shifts left, and profits ultimately eliminated in the long run. This long run

equilibrium occurs at that point where the demand curve is just tangent to the average total cost curve. 6) Monopolistically Competitive firms end up pricing above marginal cost. This is inefficient, as is the fact that monopolistically competitive firms will not realize all economies if scale available. OLIGOPOLY 1) An Oligopoly is an industry dominated by few firms that, by virtue of their individual sizes, are largely enough to influence market price. The behavior of a single oligopolistic firm depends on the reactions it expects of all the other firms in the industry. Industrial strategies usually are very complicated and difficult to generalize about. 2) When firms collude, either explicitly or tacitly, they jointly maximize profits by charging an agreed- to price or by setting output limits and splitting profits. The result is exactly as a monopolized industry. The firm will produce output till MC=MR, P above MR 3) Cournot Model of oligopoly is based on three assumptions 1) that there are just two firms in an industry- a situation called duopoly; 2) that each firm takes the output of the other as a given; 3) both firms maximize profits. The model holds that a series of output adjustment decisions in the duopoly leads to a final level of output between that which would prevail under perfect competition and that which would be set by a monopoly. 4) A firm faces kinked demand curve if competitors follow price cuts but fail to respond to price increase. The Kinked demand curve model predicts that in oligopolistic industries price is likely to be more stable than costs. 5) The price leadership model of oligopoly leads to a result similar but not identical to the collusion model. An oligopoly with a dominant price leader will produce a level of output between what would prevail under competition and what a monopolist would choose in the same industry. CHAPTER-19 Gross Domestic Product (GDP) is the key concept in national income accounting. GDP is the total market value of all final goods and services produced within the country. GDP excludes intermediate goods. To include goods both when they are purchased as inputs and when they are sold as final products would be double counting and an overstatement of the value of production. GDP excludes all transactions in which money or goods change hands but in which no new goods and services are produced. GDP includes the income of foreigners working in the US and the profits that the foreign companies earn in US. GDP excludes the income of US citizens working abroad and profits earned by US companies in foreign companies. Gross National Product (GNP) is the total market value of all final goods and services produced during a period of time by the factors of production owned by countys citizens. CALCULATING GDP: EXPENDITURE APPROACH METHOD: Adds up the amount spent on all final goods and services during a given period. C- Personal Consumption- durable goods, non durable goods and services, I- Gross private domestic Investment- residential, nonresidential and changes in business inventories, G- Government Consumption and gross investment- Federal, state, local. Net Exports- (EX-IM)

GDP= C+I+G+(EX-IM) I dont take depreciation- the decrease in assets. Gross Investment- Depreciation= Net Investment INCOME APPROACH: Because every payment to the buyer is a receipt (income) for seller, GDP can be computed in terms of who receives it as an income- the income approach is calculating gross domestic product. NATIONAL INCOME (Total income earned by the factors of production) 1) Compensation to labour 2) Proprietor Income 3) Rental Income 4) Company profit 5) Indirect taxes- subsidies 6) Net interest 7) Net business transfer payments 8) Surplus of Government Enterprises INCOME APPROACH GDP +RECEIPTS OF FACTORS FROM OTHER COUNTRIES -RECEIPTS OF FACTORS TO OTHER COUNTIES GNP -DEPRECIATION NET NATIONAL PRODUCT (NNP) -STATISTICAL DISCREPENCY NATIONAL INCOME NATIONAL INCOME -AMOUNT OF NATIONAL INCOME NOT GOING TO HOUSEHOLD PERSONAL INCOME -PERSONAL INCOME TAXES DISPOSABLE PERSONAL INCOME -PERSONAL CONSUMPTION EXPENDITURE -PERSONAL INTEREST PAYMENTS -TRANFER PAYMENTS MADE BY HOUSEHOLDS PERSONAL SAVING Personal saving rate is the % of disposable personal income saved instead of spent. NOMINAL VERSUS REAL GDP: GDP measured in current dollars is nominal GDP. If we use nominal GDP to measure growth, we can be misled into thinking that production has grown when all that has happened is a rise in the price level, or inflation. A better measure of production is real GDP, which is nominal GDP adjusted for price changes. The GDP deflator is the measure of over all price level.

LIMITATIONS OF GDP: 1) The peculiarities of GDP accounting mean that institutional changes can change the value of GDP even if real production has not changed. GDP ignores most social ills, such as pollution GDP does not tell what kind of goods are been produced or how income is distributed across the population. It ignores many transactions of underground economy. The concept of GNI (Gross national Income) is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation.

GDP= FINAL SALES- CHANGE IN BUSINESS INVENTORIES NET INVESTMENT = CAPITAL END OF PERIOD- CAPITAL BEGINNING OF PERIOD

CHECK THE NOTES CHAPTER-20 CHAPTER-21 CHAPTER-22 CHAPTER-23 CHAPTER-24