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Organization and Market
Economics
Session 1-3
Introduction to Market
SUPPLY AND DEMAND
The Demand Curve
Figure 2.2
The Demand Curve
The demand curve,

labeled D, shows how the
quantity of a good
demanded by consumers
depends on its price.
The quantity demanded
may also depend on other
variables, such as
income, the weather, and
the prices of other goods.
A higher income level
shifts the demand curve
to the right (from D to D’).
IEA sees surge in oil demand from India,
emerging nations
PTI May 12, 2016
As dollar values are Y

falling, oil prices are Price
falling in India.
Before oil
Surge in oil demand in demand
India and other emerging Surge
nations will lead to
reduction in global oil
surplus in the first half of After oil
2016, the International demand
Energy Agency (IEA) said Surge X
Before Oil After Oil
today. Surge Surge Oil Demand
Monsoon to wash away diesel demand surge
Reuters Jun 16, 2016
The monsoon is expected to Shift In Demand Curve
dump above-average rainfall
Price
on the South Asian nation
after two years of drought,
cutting its use of diesel for
Failed
irrigation pumps and
monsoon
generators over the third
quarter and potentially
rejuvenating exports of the oil
product.
Good
Monsoon
Demand For Diesel

Relationship Between Consumption
Goods
When Price of X Increases,
Quantity Demanded Quantity Demanded

of Y Decreases of Y Increases
Complements Substitutes
Two goods for which an Two goods for which an
increase in the price of one increase in the price of one
leads to a decrease in the leads to an increase in the
quantity demanded of the quantity demanded of the
other other.
More under cross price elasticity

SUPPLY AND DEMAND
The Supply Curve
● supply curve Relationship between the quantity of a good that
producers are willing to sell and the price of the good.
Figure 2.1
The Supply Curve
The supply curve, labeled S in

the figure, shows how the
quantity of a good offered for
sale changes as the price of the
good changes. The supply
curve is upward sloping: The
higher the price, the more firms
are able and willing to produce
and sell.
If production costs fall, firms

can produce the same quantity
at a lower price or a larger
quantity at the same price. The
supply curve then shifts to the
right (from S to S’).
THE MARKET MECHANISM
Figure 2.3
Supply and Demand
The market clears at price P0

and quantity Q0.
At the higher price P1, a surplus

develops, so price falls.
At the lower price P2, there is a

shortage, so price is bid up.
Mini Case: North Korean
Currency Reform 2009
• Kim Jong-il increased everybody’s salary
a hundredfold along with keeping
the same prices.
• North Korea is a non-market

economy country with the Govt. being the
producer.
• What will happen to consumption?
What Babur knew but Kim Jong-
il did not
• Babur was born in Central Asia. He

came to India in 1526 AD.
• His commanders wanted to go back to
Central Asia with all the gold acquired
from India.
• Babur understood the issue of
inflation.
CHANGES IN MARKET
EQUILIBRIUM
Figure 2.6
New Equilibrium Following
Shifts in Supply and Demand
Supply and demand curves
shift over time as market
conditions change.
In this example, rightward
shifts of the supply and
demand curves lead to a
slightly higher price and a
much larger quantity.
In general, changes in price
and quantity depend on the
amount by which each
curve shifts and the shape
of each curve.
CHANGES IN MARKET
EQUILIBRIUM
Figure 2.6
New Equilibrium Following Price
Shifts in Supply and Demand
S1
Supply and demand curves
shift over time as market
conditions change.
In this example, rightward
shifts of the supply and S2
demand curves lead to a
slightly lower price and a
much larger quantity.
In general, changes in price P1
and quantity depend on the
amount by which each P2
curve shifts and the shape
of each curve. D2
D1
Q1 Q2 Quantity
CHANGES IN MARKET EQUILIBRIUM
Demand Supply Quantity Price
Increases Increases Increases Ambiguous
Decreases Decreases Decreases Ambiguous
Increases Decreases Ambiguous Increases
Decreases Increases Ambiguous Decreases

A change in demand for a
change in price
P
P=p(Q)
700
680
Q
4990
5000
Price Elasticity of Demand: Definition
Percentage change in
quantity demanded of a
good resulting from a 1-
percent increase in its
price.
Elasticity for Linear Demand Curve
The price elasticity of

demand depends not
only on the slope of the
demand curve but also
on the price and
quantity.
Slope is constant for
this linear demand
curve. But the
elasticity, therefore,
varies along the curve
as price and quantity
change..
Infinitely Elastic Demand
Linear Demand Curve
For a horizontal demand

curve, ΔQ/ΔP is infinite.
Because a tiny change
in price leads to an
enormous change in
demand, the elasticity of
demand is infinite.
Goods that are perfectly

substitutable have very
highly elastic demand.
Completely Inelastic Demand
Linear Demand Curve
For a vertical demand

curve, ΔQ/ΔP is zero.
Because the quantity
demanded is the same
no matter what the
price, the elasticity of
demand is zero.
Commodities that has

no substitute will be
completely inelastic.
Price Elasticity of Demand
Elastic Inelastic
Tomato Hyundai Car Car Salt
-∞ -4.6 -4.3 -1.3 E = -1 -0.1 0

Infinitely Unitary Completely
Elastic Elastic Inelastic
A change in quantity (algebra)
 Total Revenue ≡ TR(Q) = p(Q) · Q
 Marginal Revenue ≡ MR(Q) = TR’(Q)
 TR’(Q) = p(Q) + p’(Q) · Q
= p(Q) [ 1 + p’(Q) · Q / p(Q)]
= p(Q) [ 1 + 1/e]
where
 e = p / (p’(Q) · Q)
Price elasticity of demand
 e = p · Q’(p) / Q(p)
 TR’(Q) = MR(Q) = p(Q) [ 1 + 1/e]
 Abs(e) > 1 ; demand is elastic; TR’(Q) > 0

 Abs(e) < 1 ; demand is inelastic; TR’(Q) < 0
Other Demand Elasticities
● income elasticity of demand Percentage change in

the quantity demanded resulting from a 1-percent
increase in income.
● cross-price elasticity of demand Percentage change

in the quantity demanded of one good resulting from a
1-percent increase in the price of another.
Capital Punishment and Murder
No Capital Punishment
Capital Punishment
For each inmate put to death, the studies

say, 3 to 18 murders are prevented.
Policy Perspective: Fat Tax
• Context: Obesity Epidemic
• What is Fat tax?
• And, when will it work?
– A 20% Sugar Tax would reduce sugar
consumption by 16%, fat by 12% and salt by 10%
and calorie intake by 19%.
• Can fat tax be the government policy?
– Denmark is the first country to introduce fat
tax.
– Kerala has imposed fat tax in 2016 budget.
SHORT-RUN VERSUS LONG-RUN : CONSUMPTION GOODS
(a) In the short run, an GASOLINE

increase in price has only
a small effect on the
quantity of gasoline
demanded. Motorists may
drive less, but they will
not change the kinds of
cars they are driving
overnight.
In the longer run,

because they will shift to
smaller and more fuel-
efficient cars, the effect of
the price increase will be
larger.
SHORT-RUN VERSUS LONG-RUN: DURABLE GOODS
(b) The opposite is true for

automobile demand. If
AUTOMOBILES
price increases, consumers
initially defer buying new
cars; thus annual quantity
demanded falls sharply.
In the longer run, however,

old cars wear out and must
be replaced; thus annual
quantity demanded picks
up. Demand, therefore, is
less elastic in the long run
than in the short run.
Income Elasticities:
SHORT-RUN VERSUS LONG-RUN
Income elasticities also differ from the short run to the

long run.
For most goods and services—foods, beverages, fuel,

entertainment, etc.— the income elasticity of demand
is larger in the long run than in the short run.
For a durable good, the opposite is true. The short-run

income elasticity of demand will be much larger than
the long-run elasticity.
MARKET DEMAND
From Individual to Market Demand
Market Demand
Curve relating the
quantity of a good
that all consumers
in a market will buy
to its price.
CONSUMER SURPLUS and DEMAND
● consumer surplus Difference between what a consumer is willing to

pay for a good and the amount actually paid.
Consumer surplus is the total

benefit from the consumption
of a product, less the total
cost of purchasing it.
Individual consumer surplus

is the difference between the
maximum amount that a
consumer is willing to pay for
a good and the amount that
the consumer actually pays.
Consumer and Producer Surplus
Producer surplus for a

particular unit of output is
the difference between the
price at which it is sold
and the marginal cost of
producing it. Total
producer surplus is the
sum of producer surplus
over all units sold. It
equals the difference
between revenue and
variable costs.
Homework 2 (Page 86, exercise 5)
• Much of the demand for U.S. agricultural output has come
from other countries. In 1998, the total demand for wheat
was Q = 3244 – 283P. Of this, total domestic demand was
QD = 1700 – 107P, and domestic supply was QS = 1944
+ 207P. Suppose the export demand for wheat falls by 40
percent.
a) U.S. farmers are concerned about this drop in export
demand. What happens to the free-market price of wheat
in the United States? Do the farmers have much reason
to worry?
b) Now suppose the U.S. government wants to buy enough
wheat to raise the price to $3.50 per bushel. With the drop
in export demand, how much wheat would the
government have to buy? How much would this cost the
government?
Economics
Session 3-5
Scarcity and Choice
Can Money buy you
happiness?
Buddha said, No. The path to
happiness is through “the middle
path”.
Modern Researchers
Consumer Behavior for Homo
Economicus
1. Consumer preferences: Survey
2. Budget constraints: publicly
available.
Consumer choices: Observed
purchases.
CONSUMER PREFERENCES
1.Completeness: For any two market baskets A and B, a

consumer either prefers A to B, or prefers B to A, or is
indifferent between the two. By indifferent we mean that
a person will be equally satisfied with either basket.
Note that these preferences ignore costs. A consumer

might prefer steak to hamburger but buy hamburger
because it is cheaper.
A B
Indifferent
2.Transitivity: Preferences are transitive. Transitivity
means that if a consumer prefers basket A to basket B
and basket B to basket C, then the consumer also prefers
A to C. Transitivity is normally regarded as necessary for
consumer consistency.
A B C
A C
3.More is better than less, consumers always prefer more of
any good to less. In addition, consumers are never satisfied
or satiated; more is always better, even if just a little better.
Of course, some goods, such as air pollution, may be
undesirable, and consumers will always prefer less. We
ignore these “bads” in the context of our immediate
discussion.
A B
C D
CONSUMER PREFERENCES: Market Baskets
● market basket (or bundle) List with

specific quantities of one or more goods.
TABLE 3.1 Alternative Market Baskets
Market Basket Units of Food Units of Clothing
A 20 30
B 10 50
D 40 20
E 30 40
G 10 20
H 10 40
To explain the theory of consumer behavior,
we will ask whether consumers prefer one
market basket to another.
Because more of each

good is preferred to
less, we can compare
market baskets in the
shaded areas. Basket A
is clearly preferred to
basket G, while E is
clearly preferred to A.
However, A cannot be
compared with B, D, or
H without additional
information.
INDIFFERENCE CURVE
The indifference
curve U1 that passes
through market
basket A shows all
baskets that give the
consumer the same
level of satisfaction
as does market
basket A; these
include baskets B
and D.
INDIFFERENCE MAPS
An indifference
map is a set of
indifference
curves that
describes a
person's
preferences.
CAN INDIFFERENCE CURVES
CROSS EACH OTHER?
If indifference
curves U1 and U2
intersect, one of
the assumptions
of consumer
theory is violated.
Who is a Foodie?
(A) (B)
Clothing Clothing
C
a
A D
a B b
b
a b Food a b Food
Utility and Utility Functions
● utility Numerical score representing the satisfaction
that a consumer gets from a given market basket.
● utility function Formula that assigns a level of utility

to individual market baskets.
A utility function can be

represented by a set of
indifference curves, each with
a numerical indicator.
This figure shows three
indifference curves (with utility
levels of 25, 50, and 100,
respectively) associated with
the utility function FC.
Marginal Utility
● marginal utility (MU) Additional

satisfaction obtained from consuming
one additional unit of a good.
• MUX = Δ U/ ΔX
● Law of diminishing marginal utility

Principle that as more of a good is
consumed, the consumption of additional
amounts will yield smaller additions to
utility.
MARGINAL RATE OF SUBSTITUTION
• Maximum amount of a good (MRS)
that a consumer is willing to
give up in order to obtain one
additional unit of another good.
• The magnitude of the slope of

an indifference curve
measures the consumer’s
marginal rate of substitution
(MRS) between two goods.
• MRS = MUF/MUC
• The decline in the MRS

reflects a diminishing
marginal rate of substitution
Two Special Cases of
Indifference Curves
● Perfect Substitutes Two goods for

which the marginal rate of substitution
of one for the other is a constant.
● Perfect Complements Two goods

for which the MRS is zero or infinite;
the indifference curves are shaped as
right angles.
Perfect Substitutes and
Perfect Complements
In (a), Bob views orange juice

In (b), Jane views left shoes and
and apple juice as perfect
right shoes as perfect complements:
substitutes: He is always
An additional left shoe gives her no
indifferent between a glass of
extra satisfaction unless she also
one and a glass of the other.
obtains the matching right shoe.
3.2
BUDGET CONSTRAINTS
● budget line All combinations of goods for
which the total amount of money spent is
equal to income.
TABLE 3.2 Market Baskets and the Budget Line

Market Basket Food (F) Clothing (C) Total Spending
A 0 40 $80
Clothing (C)
B 20 30 $80
D 40 20 $80
E 60 10 $80
G 80 0 $80
Income = $80, Price of Food = $1, Price

of clothing = $2.
THE BUDGET LINE
PF F  PC C  I
C  ( I / PC )  ( PF / PC ) F
I = 80
PC = 2
PF = 1
Slope = PF/ PC = 1/2

EFFECT OF INCOME CHANGE
EFFECT OF PRICE CHANGE
CONSUMER CHOICE
The maximizing market basket must satisfy two conditions:
1. It must be located on the budget line.
2. It must give the consumer the most preferred
combination
of goods and services.
At the optimal point

A,
Slope of the
Indifference Curve
(MRS)
= Slope of the
Budget line = PF/ PC
EQUAL MARGINAL PRINCIPLE
• Principle that utility is maximized when the

consumer has equalized the marginal
utility per dollar of expenditure across all
goods.
• and MRS  P / P
F C
Imply that
MU / P  MU / P
F F C C
In-class Problem Solving
• Sonakshi lives in a dormitory that offers soft
drinks and chips for sale in vending machines.
Her utility function is U(S, C) = 3SC (where S is
the number of soft drinks per week and C the
number of bags of chips per week). Soft drinks
are priced at Rupees 50 each, chips Rupees 25
per bag.
• What are Sonakshi’s marginal utilities of soft
drink and chips?
• If Sonakshi has Rupees 500 per week to spend
on chips and soft drinks, how many of each
should she purchase per week?
Homework
• Chapter 3, Page 131, Exercise 2
• Chapter 3, page 132, Exercise 13
• Shai buys only pomegranates and mangos. In

July, pomegranates sell for rupees 20 each and
mangos sell for rupees 10 each. In January,
pomegranates sell for rupees 10 each and
mangos sell for rupees 20 each. Shai’s income is
rupees 200, both in July and January. If Shai
buys exactly eight pomegranates in July, then
she is________.
– certainly happier in July
– certainly happier in January
– equally happy in July and January
– There is not enough information to answer this
question
Do we obtain the demand curve
from this Theory of Consumer
Choice?
• Yes. We do by changing the prices
keeping income fixed.
• How?
– An excel demonstration
DEMAND vs. INCOME: ENGEL CURVE
Engel curves relate the

quantity of a good consumed
to income.
In (a), food is a normal good
and the Engel curve is
upward sloping.
In (b), however, hamburger is
a normal good for income
less than $20 per month and
an inferior good for income
greater than $20 per month.
How A Good Becomes An Inferior Good
An increase in a
person’s income can
lead to less
consumption of one
of the two goods
being purchased.
Here, hamburger,
though a normal
good between A and
B, becomes an
inferior good when
the income-
consumption curve
bends backward
between B and C.
What are the inferior goods?
• Any good can be an inferior good at some
level of income when a superior substitute
exists.
• is a normal good for a

middle-class family but becomes an
inferior good for a family who buys
which, again in turn, becomes an inferior
good for someone who buys
INCOME AND SUBSTITUTION EFFECTS
The consumer is initially at A, on

budget line RS.
When the price of food falls,
consumption increases by F1F2
as the consumer moves to B.
The income effect EF2
(associated with a move from D
to B) keeps relative prices
constant but increases
purchasing power.
Food is a normal good because
the income effect EF2 is positive.
The substitution effect F1E
(associated with a move from A
to D) changes the relative prices
of food and clothing but keeps
real income (satisfaction)
constant.
INCOME AND SUBSTITUTION EFFECTS: INFERIOR
GOOD
The consumer is initially at A
on budget line RS.
With a decrease in the price of
food, the consumer moves to
B.
The resulting change in food
purchased can be broken
down into a substitution effect,
F1E
In this case, food is an inferior
good because the income
effect is negative.
However, because the
substitution effect exceeds the
income effect, the decrease in
the price of food leads to an
increase in the quantity of food
demanded.
GIFFEN GOOD: A SPECIAL CASE OF INFERIOR GOOD
When food is an inferior good,

and when the income effect is
large enough to dominate the
substitution effect, the demand
curve will be upward-sloping.
The consumer is initially at
point A, but, after the price of
food falls, moves to B and
consumes less food.
Because the income effect EF2
is larger than the substitution
effect F1E, the decrease in the
price of food leads to a lower
quantity of food demanded.
● The Demand Curve for a

Giffen Good is upward sloping.
GIFFEN GOOD EXAMPLE
• Income = Rs 500 • Income = Rs 500
• Chicken = Rs. 200/kg • Chicken = Rs. 200

• Rice = Rs. 20/kg • Rice = Rs. 50/kg
Consumption Consumption
• Chicken = 2 Kg • Chicken = 1 Kg
• Rice = 5 Kg • Rice = 6 Kg
Labour Leisure Choice
• This is a choice everyone faces:
Consumption and Leisure.
What says Cross-country data?
What happens over time?
Labour-Leisure Choice
• In the present times, with more wage comes a
diminish in working hours.
• Did we see the working hours rise with rising
wage?
Economics
Session 06
Choice and Uncertainty
DESCRIBING RISK
• Probability Likelihood that a

given outcome will occur.
• expected value Probability-

weighted average of the payoffs
associated with all possible
outcomes.
• payoff Value associated with a

possible outcome.
MAKE A CHOICE
• 1> Rupees 10,000 (Ten Thousand)
• 2> A lottery ticket to fetch Rupees
1,000,000 (Ten Lakh) with probability
1/100.
• Do you prefer
– 1 over 2
– 2 over 1
– Indifferent between 1 and 2
Expected Value of a Lottery
• The lottery has two outcomes
– Rs 0 with probability 0.99
– Rs 10,00,000 with probability 0.01
• Expected value = x1 ·P(x1) + x2 ·P(x2)

= 0 × 0.99 + 10,00,000 × 0.01
= Rs 10,000
• The value of the sure outcome = Rs 10,000

The Scale of Risk
Aversion:
Hey Risk-averse!
Where do thou stand?

The Scale for Risk-
lovers:
Hey Risk-lover! How

much risk can thou
take?

Where to invest your money?
Invest in a/c
company
You have
some money
and two
choices to
invest upon.
Invest in
Heater
Company
With probability of 50% High Profit
of $30,000
With probability of 50% Low Profit of

$12,000
Investment Problem
With probability of 50% Low Profit of
$12,000
With probability of 50% High Profit

of $30,000
Investment Problem
Where to invest your money?
Invest in a/c
company
You have a
third Invest in both half
and half
alternative.
Invest in Heater
Company
Invest in both
half and half
With probability of 50% Profit from a/c
$15,000 +
Profit from
heater $6,000
= $21,000
With probability of 50%

Profit from a/c
$6,000 +
Profit from heater
$15,000
= $21,000
Investment Problem
The Key to Diversification is …
• Negatively correlated stocks
Your House and the burglars
• Is your house safe from the burglars?
• Your original wealth is $50,000. But

burglars await…
• The insurance company provides
compensation in lieu of an actuarially fair
premium of $1,000.
Your wealth is
$50,000

Your wealth is
$40,000
Burglar problem
$1,000

Your wealth is
$49,000
In-Class Problem Solving
• Suppose that utility of a person is given by
U(x) = √x
• Find certainty equivalent for this person.
Describe this person’s preference towards
risk.
• Utility of Option 1 = √10,000 = 100
• Utility of Option 2 = 0.99* √0 + 0.01*
√1,000,000 = 10
• Since utility is more, she prefers Option 1.
She is Risk-averse.
Certainty Equivalent Calculation
• Let CE be the certainty equivalent amount
for this person.
• Utility of the certainty equivalent is equal to
utility of the lottery.
• U(CE) = √CE
• Utility of the lottery = 10
• √CE = 10, thereby CE = 100
• The certainty equivalent is 100.
Utility function and the
attitude towards risk
• U(x) = √x is a concave
utility function which denotes
Risk-aversion.
• U(x) = x2 is a concave
utility function which denotes
Risk-loving attitude.
• U(x) = x is a linear utility
Function which denotes
risk neutral attitude.
Homework
• Page 212, Chapter 5, Exercise 3
Economics
Session 7-9
Production and Optimal Choice of
Inputs
“Production…is the basis of all social structure.”
Production Function
• Production function shows the highest output

that a firm can produce for every specified
combination of inputs.
• Above equation applies to a given technology.

• The Short Run versus the Long Run
● Short run Period of time in which quantities of

one or more production factors cannot be changed.
● fixed input Production factor that cannot

be varied.
● long run Amount of time needed to make all

production inputs variable.
cf: Fixed cost and variable cost

Widget Production: A
Laboratory Experiment
• To study production
function, our approach
will be a laboratory
driven one.
• We will manufacture
widget to know about
the nature of production
process.
The Slopes of the Product Curve
Division of
Labour Congestion
The Malthusian Trap
What Malthus
observed
What Malthus
theorised
Was Malthus Right?
Population of the World
Definitely Yes...till
Malthus wrote his
theory in 1798.
Was Malthus Right?
But not after 1798

The Law of Diminishing Marginal Returns
● As the use of an input increases with other inputs fixed, the resulting
additions to output will eventually decrease.
The Effect of Technological

2015
Improvement
Labor productivity (output 1955
per unit of labor) can
increase if there are
improvements in technology,
1900
even though any given
production process exhibits
diminishing returns to labor.
As we move from point A on
curve O1 to B on curve O2 to
C on curve O3 over time,
labor productivity increases.
Homework
Lexicon
Consumers
Producers
• Utility function U(C, F) • Production Function F(K, L)
• Marginal Utility MUC • Marginal Product MPL
• Law of Diminishing • Law of Diminishing Marginal
Marginal Utility Returns
• Indifference Curve (map) • Isoquant (map)
• Marginal Rate of • Marginal Rate of Technical
Substitution (MRS) Substitution (MRTS)
• MRS = MUC/MUF • MRTS = MPK/MPL
Isoquant Map
More
Automation
Less use of
machines
Illustration of an Isoquant
• Production function: Q = K1/2 L1/2
• A standard Cobb-Douglas production
function
• If K = 40 and L = 10, Q = 20
• If K = 10 and L = 40, Q = 20
• Both points are in the same isoquant.
Calculation of MRTS from the
functional form
MPL = ½ K1/2 L-1/2 = ½ (K/L)1/2.
Clearly, MPL declines as L increases.
MPK = ½ K-1/2 L1/2 = ½ (L/K)1/2.

MPK declines as K increases.
MRTS Falls as we move from left to right.

Marginal Productivity
• What is MPL at (K = 40, L=10)?
• Q(40, 10) = 20 and Q(40, 10+1) = 20.98
• The marginal contribution of last unit of
labor is 0.98 – It is the value of is MPL at
(K = 40, L=10).
• Similarly, MPK at (K = 40, L=10)
= Q(40 + 1, 10) – Q(40, 10)
= 0.25
MRTS calculation from the first
principle
• Both (K = 40, L=10)
and (K = 36.36 and L
= 11) are in the
isoquant.
• MRTS = - DK/DL
= -(36.36-40)/(11-10)
= 3.64
It is Close to MPL/ MPK
= 0.98/0.25 = 3.92
Numeric Calculation of MRTS as
ratio of marginal productivities
• MPL at (K = 10, L=40)
= Q(10, 40+1) - Q(10, 40) = 0.25
• MPK at (K = 10, L=40)
= Q(10 + 1, 40) – Q(10, 40) = 0.98
• MRTS - DK/DL = -(9.76-10)/(41-40)= 0.24
• MPL/ MPK = 0.25
Returns to Scale
RETURNS TO SCALE
● increasing returns to scale Situation in
which output increases more than
proportionately when all inputs are
increased in a certain proportion.
● constant returns to scale Situation in

which output changes in the same
proportion as the change in inputs.
● decreasing returns to scale Situation in

which output increases less than
proportionately when all inputs are
increased in a certain proportion.
Homework
• Firms Maximize Profit.
• That firms minimize cost given production
OR
• That firms maximise revenue given costs
• The conditions are exactly the same!

Fixed Cost versus Variable Cost
● total cost (TC) = fixed cost (FC) + variable cost (VC)
● Fixed Cost is associated with the fixed input.
● The only way that a firm can eliminate its fixed costs is
by shutting down the operations.
● Fixed cost is zero in the long run.
● average fixed cost (AFC) = FC / Q;

average variable cost (AVC) = VC / Q;
average cost (AC) = TC / Q;
Marginal Cost
• Marginal Cost is the change in cost for a
unit change in output produced.
• MC = DVC/ Dq
• What is the structure of Marginal Cost

curve based on Law of Diminishing
Returns?
Labourers Production Wage Cost
Marginal Cost of a container = w
Marginal Cost of a container = w/2
Marginal Cost of a container = 2w
Marginal Cost first falls, then rises.

So do Average Cost.
Marginal Product of Labour and
Marginal Cost
35
30
25
20 Marginal Product of
Labour
15 Marginal Cost
10
0
1 2 3 4 5 6 7
COST CURVES IN THE SHORT RUN
In (a) total cost TC is
the vertical sum of fixed
cost FC and variable
cost VC.
In (b) average total cost
ATC is the sum of
average variable cost
AVC and average fixed
cost AFC.
Marginal cost MC
crosses the average
variable cost and
average total cost
curves at their minimum
points.
Calculation of Costs
• C(q) = q2 + 30q + 50
• Find FC, VC, MC, AFC, AVC and AC.
• Total cost is C(q)
• FC = C(0) = 50
• VC = C(q) – FC = q2 + 30q
• MC = VC’(q) = 2q + 30
• AFC = FC/q = 50/q
• AVC = VC/q = q + 30
• AC = C(q) /q = 2q + 30 +50/q
Opportunity
Cost: costs
associated with
opportunities
that are
forgone when
a firms'
resources are
not put to their
best alternative
use.
Sunk Cost
• Defined as a cost for which there is no
alternative use. (Zero
opportunity cost)
• Not a fixed cost
Singur abandoned site
The Chunnel –
A Really Sunk Cost
• Chunnel is a tunnel under the
English channel connecting
England and France.
• The Initial (1987) estimate:

– Cost £3 Billion
– Revenue £4 Billion
• The Revised (1990) estimate:

– Cost £4.5 Billion
– Already spend £2.5 Billion
– Revenue £4 Billion
Sunk Cost Fallacy
Long Run Costs
• In the long run, there is no fixed cost as there are
no fixed input.
• In the long run flexibility lowers the cost.
• The opportunity cost of labour is considered w,
the wage rate.
• The opportunity cost of capital is considered r,
the interest earned in bank thanks to capital
market.
• Total cost is w L + r K
Lexicon
Consumers Producers
• Utility function U(C, F) • Production Function F(K, L)
• Marginal Utility MUC • Marginal Product MPL
• Law of Diminishing • Law of Diminishing
Marginal Utility Marginal Returns
• Indifference Curve (map) • Isoquant (map)
• Marginal Rate of • Marginal Rate of Technical
Substitution (MRS) Substitution (MRTS)
• MRS = MUC/MUF • MRTS = MPK/MPL
• MUC/MUF = PC/ PF • MPK/MPL = r/w

A profit maximizing firm produces output Q using
two inputs L and K. The firm purchases L (labour) and
K (capital) in competitive markets at price w = 20 and
r = 10 per unit respectively and sells Q in a
competitive market at some price p.
Calculate the long run cost of the firm as a function of

the quantity of output for the following cases:
• The production function of the firm is a Cobb-
Douglas function, given by Q =L2/3K1/3.
• The inputs are perfect complements by nature

and the production function is given by:
Q =min (K, L).
Some implications
• MPL/MPK = w/r means more the wage,
less the labour!
• In developed countries more
mechanization is observed.
• In sectors with higher labour output,
productivity of capital is high and
less labourers are
employed.
Homework
Economics
Session 10-12
The Competitive Markets
PERFECTLY COMPETITIVE MARKETS
The model of perfect competition rests on three basic assumptions:
Price Taking
Product
Homogeneity
Free Entry &

Exit
When Is a Market Highly Competitive?
Because firms can implicitly or explicitly collude in setting prices, the presence
of many firms is not sufficient for an industry to approximate perfect
competition.
Conversely, the presence of only a few firms in a market does not rule out
competitive behavior.
PROFIT MAXIMIZATION
Do Firms Maximize Profit?
• Survival of the Fittest
Alternative Forms of
Organization
● cooperative Association of businesses or people jointly
owned and operated by members for mutual benefit.
Kibbutz
MARGINAL REVENUE, MARGINAL COST, AND PROFIT MAXIMIZATION
● profit Difference between total revenue and total

cost.
π(q) = R(q) − C(q)
A firm chooses output
q*, so that profit, the
difference AB between
revenue R and cost C,
is maximized.
At that output, marginal
revenue (the slope of
the revenue curve) is
equal to marginal cost
(the slope of the cost
curve).
MR(q) = MC(q)
FIRM DEMAND and MARKET DEMAND
Figure 8.2
In (a) the demand curve facing the firm is perfectly elastic, even
though the market demand curve in (b) is downward sloping.
CHOOSING OUTPUT IN THE SHORT RUN
Demand and Marginal Revenue for a Competitive Firm
The demand d curve facing an individual firm in a competitive market

is both its average revenue curve and its marginal revenue curve.
Along this demand curve, marginal revenue, average revenue, and
price are all equal.
Profit Infinitely
Maximization Elastic Firm
Condition Demand
MC(q) = MR = P
Output Rule: If a firm is producing any output, it

should produce at the level at which marginal
revenue equals marginal cost.
ILLUSTRATION OF OPTIMAL OUTPUT
In the short run, the

competitive firm maximizes
its profit by choosing an 6
output q* at which its
marginal cost MC is equal 5
to the price P (or marginal
revenue MR). 4
3
The profit of the firm is
measured by the rectangle 2
ABCD.
1
Any change in output, 0

whether lower at q1 or
higher at q2, will lead to
lower profit.
What if no economic profit in the short run?
Shut-Down Rule: The

firm should shut down if
the price of the product
is less than the average
variable cost of
production at the profit-
maximizing output.
Newspaper Industry is not
shutting down
The oil industry in the U.S.
• In 1985. when the price of crude oil
was $27 a barrel. there were about
35,000 oil wells United States.
• But by the next year, the number of
wells being drilled had fallen by half to
under 19,000.
• Had the oil fields run dry? Not at all!
• Duction was discouraged because the
price of oil fell to only $14 a barrel. It
is the profits, not the wells that dried
up. As a result, companies just shut
down.
FIRM’S SHORT-RUN SUPPLY CURVE
The firm’s supply curve is the portion of the marginal cost

curve for which marginal cost is greater than average
variable cost.
In the short run, the firm

chooses its output so that
marginal cost MC is equal to
price as long as the firm
covers its average variable
cost.
The short-run supply curve

is given by the crosshatched
portion of the marginal cost
curve.
A Problem
• A competitive firm has the following cost
function:
C(q) = q2 + 30q + 50
• Derive the supply curve for the firm.
• If the industry consists of 100 such firms,
derive the supply curve of the industry.
Solution to the Problem
• AVC = q+ 30
• AVCmin = 30
• So price below 30, no supply exists.
• If Price is above 30, P = MC
• MC = 2q + 30 = P
• q = 0.5P – 15
• Market supply = 100q = 50P - 1500
Homeworks
Long-Run Profit Maximization
WHAT DOES ZERO ECONOMIC PROFIT MEAN?
• Zero (no supernormal profit) Economic

Profit does not mean zero accounting
profit but
accounting profit = opportunity cost
for all economic resources of the
owner
Maximization of Consumer
Surplus and Producer Surplus
from Perfect Competition
Communism and Capitalism
Fairness Efficiency
• Communism fails to
• Communism means motivate people to make
equal opportunity and efficient economic
fairness. system.
• Perfect competition
• Companies make zero means all companies run
profit in the long run. systems efficiency
inspired by the zeal to
maximise profit.
• Consumers pay the
technologically best
available price.
Securing Free Entry and Exit:
Anti-Trust Laws in the US
• Discussion of prices is not permitted by
the law, among competitors.
– The Sherman Act
– The Federal Trade Commission Act
– The Clayton Act
Bumble Bee Foods and StarKist have

also both pleaded guilty to fixing canned
tuna prices between 2011 and 2013.
Bumble Bee was fined USD 25 million
(EUR 22.8 million), while StarKist’s
fine is expected to range between USD
50 million and USD 100 million. Chris Lischewski, Bumble Bee
CEO
• The Competition Act, 2002,
as amended by the
Competition (Amendment)
Act, 2007, follows the
philosophy of modern
competition laws. The Act
prohibits anti-competitive
agreements.
Who faced the irk of CCI?
• fine of ₹ 74 crore on pharma firms, Himalaya
Drug Company and Intas Pharmaceuticals,
along with its senior officials f (June 2019)
• ₹ 136-crore fine on Google for “search bias”
and abusing its “dominant position”. (Feb 2018)
• ₹ 6,300 crore in penalties on 11 cement
companies, including UltraTech Cement Ltd,
ACC Ltd, Ambuja Cement Ltd,
Ramco Cements Ltd and JK
Cement Ltd. (Aug 2016)
Crony Capitalism?
• Between 1989 and 2017 (Unlike 1952-88),

majority of wealth accruing to equity
holders did not come from compensation
for bearing risk, but from reallocation of
workers’ share towards shareholders.
• Is free entry being jeopardised by elite
capture of the institutions?
In-Class Problem
• The market demand for watermelon,
• P = 10.5 – 0.1Q, where P is price (in
rupees), and Q is the output.
• The short run market supply is expressed
as P = 2.5 + 0.1Q.
• A typical farmer that grows watermelons
has a cost of production, C(q) = 1 + 2.5q +
q2, where q is the output of the farmer and
the cost in rupees.
• This cost of production is valid for both long
run and short run.
• Determine the market equilibrium price for
watermelons. Also determine the
production in the market.
• Demand = Supply
Therefore, 10.5 – 0.1Q = 2.5 + 0.1Q
• Solving we get, Q = 40, P = 6.5.
• Determine how much a typical farmer will
grow at the equilibrium price.
• P = MC
• MC = C’(q) = 2.5 + 2q
• Equating MC to the market price of 6.5,
q = 2.
• Profit for a firm in the short run = P*q –
C(q) = 6.5*2 - (1 + 2.5*2 +22) = 3
• If all farmers had the same cost structure,

how many farmers would compete at the
equilibrium price?
• Number of firms = Market quantity/ firm
output = Q/q = 40/2 = 20.
• Profit in the short run implies more firms in

the long run.
• What is long run price for this market if the
cost structure stays the same as stated
above?
• Average Cost = 1/q + 2.5 + q
• For minimising AC, AC = MC.
• Therefore, 1/q + 2.5 + q = 2.5 +2q. Solving
q = 1.
• P = MC = 2.5 + 2*1 = 4.5
• Determine the production level of the
market in the long run.
• From the market demand curve, Q = 60.
• How many farmers in the Long run?

• Total number of firms = Q/q = 60.
• Since profit is positive, number of firms
have gone up.
• It has 164 members and 23 observer
governments.
.
• Why Trade is good?
• And, who dislikes trade?
WHY FREE TRADE IS GOOD FOR THE NATION?
Without free trade, the market

price is P0.
In a free market, the domestic
price equals the world price Pw.
A total Qd is consumed, of which
Qs is supplied domestically and
the rest imported.
The loss to producers is
trapezoid A.
The gain to consumers is A + B
+ C, so the net gain is B + C.
Tax Rate and Competitive Market
THE IMPACT OF A VALUE-ADDED TAX
Pb is the price (including
the tax) paid by buyers. Ps
is the price that sellers
receive, less the tax. CS
Buyers lose A + B.
Sellers lose D + C.
The government earns A +
D in revenue.
PS
The deadweight loss is B +
C.
Impact of a Tax Depends on
Elasticities of Supply and Demand
(a) If demand is very inelastic relative (b) If demand is very elastic relative to
to supply, the burden of the tax falls supply, it falls mostly on sellers.
mostly on buyers.
In-Class Problem
• The demand and supply curves for globes
are given by PB = 700 − 5QD and PS =
2QS, where PB is the price the buyers pay
and PS is the price the suppliers receive.
• QD and QS are quantity demanded and
supplied, respectively. The government
has imposed a tax of rupees 35 per unit of
soap.
• Find the pre-tax equilibrium price of soap.
• During pre-tax times, demand is equal to
supply at the same price.
• PB = 700 − 5Q and PS = 2Q. Equating
them, we obtain, Q = 100, P = 200.
• Find the equilibrium price of soap to the
buyers as a result of taxation.
• After taxation, PB – PS = 20 (tax)
• 700 − 5Q − 2Q = 35, So Q = 95.
• PB = 700 – 5*95 = 225, PS = 2*95 = 190
• Find the deadweight loss due to
taxation.
• Area of the black
triangle marked
as deadweight
loss =
½* base*height
= 0.5*(100-95)
*(225-190)
= 87.5
Homework
Economics
Session 13-14
Market Failure
Is Market a Just
entity?
• The story so far is that market
maximizes social welfare.
• However, there are limitations in that
story.
• If we consider the market economy,
there are many examples in which it
ignores the human welfare.
Why does a big mac cost
less than salad/ Apple?
• Growing 1 kg of
beef needs more
than 15,000 litres
of water along with
hundreds of
kilograms of
cereals.
• Growing 1 kg of vegetables needs not even
1,500 litres of water.
Why is it iniquity?
• Society loses a lot when a

person takes a big mac.
• But the person taking it, is

paying much less.
• Who bears the cost?

• Someone else!
Why does this happen?
• Farmlands are owned by • Cattle pastures are not

farmers and they pay the owned by any person but
price for their decisions. they are collective properties.
Therefore, all the costs
are incurred based on the • Cattle ranching is the
benefits. greatest cause of Amazon
rainforest destruction.
OVER EXPLOITATION OF GRASSLANDS AND
COMMON PROPERTY RESOURCES
• Social Cost consists of

private cost as well as
cost to others in
society.
• For example, the
production of meat
impacts the amazon
rain forest and
consequently changes
climate. The society
pays for them.
• The price does not take
care of this cost.
Why are there a rise in the
superbugs?
• Anti-biotics are too cheap and overused.
• The efficiency of
the anti-biotics
are on the wane.
– Colistin (2015-16)
• The anti-biotics
come with the price
for all future users
which is not considered by the manufacturer.
Why price is not always “right”?
• Marginal benefit is the potential price for

the demand curve.
• Marginal Cost is the

potential price for the supply curve.
• Benefit = Cost from a private point of view

but not from a social point of view.
EXTERNALITIES
● externality Action by either a

producer or a consumer which
affects other producers or
consumers, typically
unaccounted for in the market
price.
● external cost cost imposed

externally by firms
● social cost Sum of the l cost

of production and the external
cost.
NEGATIVE EXTERNALITIES AND TAX
Negative
externality means
loss of social
welfare. The
government can
increase social
welfare by
imposing a tax of
P1 – P2.
POSITIVE EXTERNALITY
and SUBSIDY
• Can there be external benefits?
• In these case, the private benefit is less

than social benefit and so individual’s tend
to consume it less than optimal.
A dialogue between
Economic Left and Economic Right
Market is
socially
Have you efficient.
forgot about
EXTERNALITY!
Have you ever

heard about
Ronald Coase?
Coase Theorem (1943)
• What a benevolent dictatorial
• government may do, a
government may ensure the same
– amount of welfare by suitable
allocation of property rights.
• property rights Legal rules stating what

people or firms may do with their property.
The Factory and the Fishermen
- Baseline Scenario
Factory makes $500 and Fisherman makes $100.

- Filter Scenario

- Treatment Plant Scenario

- Blue Water Scenario

What is the efficient solution?
Cynic Capitalist
Green Labourer
Depends on the point of view
Cynic Capitalist
Do Factory
Nothing! earns more!
Green Labourer
Blue Fisherman
water! earns more!
From a Social Welfare
Maximization point of view
• Combined social welfare ($800) is
maximum in Filter Scenario.
• A economically left government can
implement this solution by ordering the
factory to build the plant.
• Can the economically right government
make the society reach the same solution?
What kind of laws are required?
Any law will do?
• Coase says, any law will do as long as it
is well-defined!
• Law says, Right to Clean Water.
– It is obvious that the factory has to build the
filter.
• Law says, Right to Dump.
– So shall we reach
Treatment Plant Scenario?
Costless bargaining
• Coase says, When parties can bargain

without cost and to their mutual advantage,
the resulting outcome will be efficient
regardless of how property rights are
specified.
Bargaining Outcome
• In Treatment Plant scenario, factory
receives $500 and fisherman gets $200.
• The factory will build the plant if it gets
more than the cost of the plant ($200).
• The fisherman will receive a net gain of
$300. They can spend anything less than
$300.
An Illustrative Outcome
• Say, the fisherman transfers $250 to
factory to build a filter (instead of building
a treatment plant themselves).
• The factory makes $300 + $250 = $550 >
$500
• The Fisherman makes $500 - $250 = $250
> $200
Formation of Legal Institutions
• The idea of written
Constitution and independent
Judiciary for property rights
– Till 1979, China had no formal legal system
• Law must facilitate bargaining between parties.
– Principle of least surprise
– 99% of civil suits are settled outside court
– Prompt judgment delivery
– Law is objective and precedence based
Judicial Reform in
Market Economy oriented India
• Long neglected in India
– Judgments are late
– Unanticipated Issues
– Long constitution
• Govt. moves SC to make
NCLT judges stick to deadline
for resolving cases
• Reforms in lower judiciary can further
improve India's ease of doing business,
says Economic Survey
Public Goods and Tax
• In spite of the Coase
theorem, governments
tax at a high rate.
• When a good is non-
rival and non-exclusive,
there is no alternative
but government to
provide it. These are
called public good.
What is non-rivalry?
What is non-excludability?
Public Goods:
How? How Much?
• Taxes fund public goods.
• Manifesto dictates spending for public
goods.
• The median voter
effectively decides
the democratic outcome.
• Is it efficient?
• No!
A Numerical Example
• A country is considering whether to have
national defence or not. The country has
three citizens. Kyle, Stan and Cartman who
utilities from national defence are 0.1, 0.7 and
2.5, respectively (In rupee terms).
• If national defence is opted, it needs to be
funded by equally taxing all the citizens. Total
cost is Rs. 3 and each pays a tax of Rs. 1.
• For a citizen the net utility is equal to utility
from national defence minus tax paid.
• There is no utility from zero national defence.
Utility from Net Utility from Utility from
Citizen National
Defence
National
`
Defence - tax
No National
Defence
Votes
For
0.1 – 1 =
0.1 - 0.9
0
0.7 – 1 =
0.7
- 0.3 0
2.5 – 1 =
2.5 1.5
0
Total net utility from national defence = -0.9 -0.3 +1.5 = 0.3
whereas total net utility from no national defence = 0. National
Defence is best choice for society which is rejected by voting.
Homework
Economics
Session 15-17
Market Power
MARKET POWER
• Market power comes from entry barrier.
• Government Approved:
– In Istambul, Turkey, return on taxi
license outperform stocks as govt.
restricts it.
– Only companies with a patent are
allowed to produce medicine.
– Govt. allows only Indian Railways
to provide railways service. It is a
Natural monopoly.
More Barriers to Entry
• Government Induced:
– Prohibition of goods makes only a
Mafia to sell things.
– Lack of anti-trust laws help firms collude and
charge a monopoly price.
• High Cost of Entry:
– Cost of entry is prohibitively high for other
firms to start working.
• Type of Good
Marginal Revenue
● Change in revenue resulting from a one-unit increase in
output.
P=6–Q
Total Revenue (TR) = P*Q = (6-Q)*Q = 6Q – Q2
Marginal Revenue (MR) = TR’(Q)= 6 – 2Q

Total, Marginal, and Average Revenue
Total Marginal Average
Price (P) Quantity (Q) Revenue (R) Revenue (MR) Revenue (AR)
$6 0 $0 --- ---
5 1 5 $5 $5
4 2 8 3 4
3 3 9 1 3
2 4 8 -1 2
1 5 5 -3 1
AVERAGE REVENUE AND MARGINAL
REVENUE
Note that
Marginal Revenue
is below the
Demand Curve.
THE MONOPOLIST’S OUTPUT DECISION
• Profit maximization
Condition:
MR = MC
• Q* is the output
level at which MR =
MC.
MONOPOLY PRICING AND ELASTICITY
Now, we can set marginal revenue equal to marginal cost:
which can be rearranged to give us
Equivalently, we can rearrange this equation to express

price directly as a markup over marginal cost:
MONOPOLY POWER
• The Rule of Thumb for Pricing
Elasticity of Demand and Price Markup
The markup (P − MC)/P is equal to minus the inverse of the elasticity of demand facing the firm.
If the firm’s demand is elastic, as in (a), the markup is small and the firm has little monopoly power.
The opposite is true if demand is relatively inelastic, as in (b).
The Elasticity of Market Demand
• Because the demand for oil is fairly
inelastic (at least in the short run),
OPEC could raise oil prices far above
marginal production cost during the
1970s and early 1980s.
– In 1973, crude oil price jumped up to
$20/barrel from $2/barrel, overnight.
• Because the demands for such

commodities as coffee, cocoa, tin,
and copper are much more elastic,
attempts by producers to cartelize
these markets and raise prices have
largely failed.
The Inefficiency of Monopoly
THE SOCIAL COSTS OF MONOPOLY POWER
● Rent Seeking: Spending money in socially

unproductive efforts to acquire, maintain, or
exercise monopoly.
● In 1995 The Cato Institute put their imprimatur on
a paper that said each dollar of Archer Daniels Midland's
ethanol profit cost the American taxpayer $30!
● In 1996, the Archer Daniels Midland Company
successfully lobbied the Clinton administration for
regulations requiring that the ethanol (ethyl alcohol) used
in motor vehicle fuel be produced from corn.
● Why? Because ADM had a near monopoly on corn-
based ethanol production, so the regulation would
increase its gains from monopoly power.
● natural monopoly Firm that can produce the entire output of the
market at a cost lower than what it would be if there were several
firms.
● A firm is a natural monopoly

because it has economies of
scale (declining average and
marginal costs) over its entire
output range.
● If price were regulated to be
Pc the firm would lose money
and go out of business.
● Setting the price at Pr yields
the largest possible output
consistent with the firm’s
remaining in business; excess
profit is zero.
Homework
PRICE DISCRIMINATION
WHY PRICE DISCRIMINATION?
● Single Price Monopoly
Can maximize profit but
still profit is less than
having entire consumer
surplus Price
● Entire consumer MC
surplus is bigger than PM
profit and can be tapped
in by price discrimination.
● Anyone with some

MR D
consumer loyalty
(some monopoly QM Quantity
power) can use price
discrimination.
● FIRST-DEGREE PRICE DISCRIMINATION Practice of charging each
customer her reservation price.
 Perfect First Degree Price Discrimination
 Imperfect First Degree Price Discrimination

● SECOND-DEGREE PRICE DISCRIMINATION Practice of charging
different prices per unit for different quantities of the same good or
service.
● Block pricing Practice of charging different prices for different

quantities or “blocks” of a good.
 Per gram price is Less for bigger packets

 Total price is more for More for them
● REVERSE SECOND-DEGREE PRICE DISCRIMINATION Practice
of charging different prices per unit for different quantities of the same
good or service but
 Per gram price is More for bigger packets

 Total price is more for More for them
● Why?
 Since Colgate wants to expand its base to reach

rural and unreached market
 Convenience shopping does not allow others to

replicate this action.
● Third-degree price discrimination Practice of
dividing consumers into two or more groups with
separate demand curves and charging different prices
to each group.
 Resale of the product must be difficult or unlikely.
SM Street, Calicut
Rs. 699/-
A Textile
mill in
Tirupur
JC Penny, USA
$19.99
CREATING CONSUMER GROUPS
1. Geographic: Difference in prices in
different markets.
• SM Street vs. J C Penny.
2. Time of purchase: For airline tickets,

the time of purchase helps producer
charge the consumers differently.
• Tomorrow Calicut Delhi Ticket costs
Rupees 12,500 whereas the one
purchased weeks ago costs Rupees
5,500.
3. Habit based: Departmental stores

practise this through
• Loyalty Cards
• Coupon based rebates
PRICE DISCRIMINATION
Third-Degree Price Discrimination
Creating Consumer Groups
(11.1)
Determining Relative Prices
(11.2)
In-Class Problem Solving
 A satellite company broadcasts TV to subscribers in Delhi

and Hyderabad. The demand functions for each of these two
groups are:
QH = 60 − 0.25PH
QD = 100 − 0.50PD
 The cost of providing Q units of service is given by
C = 1000 + 40Q
 If the firm is forced to charge the same in both markets, what
are the profit maximizing prices and quantities?
 What are the profit maximizing prices and quantities for the
Hyderabad and Delhi markets?
 In which of these case does the firm earn a higher profit?

No Price Discrimination
Monopoly
• Total Demand Q = QH + QD = 160 – 0.75P
• P = (160 – Q)/0.75
• TR = (160Q – Q2)/0.75
• MR = (160 – 2Q)/0.75
• MR = MC = 40
• Q = 65
• P = 126.67
• Profit = 65*126.67 – (1,000 + 65*40) =
8233.33 – 3,600 = 4,633.33
• QH = 60 − 0.25PH which means
PH = (60 – QH)/0.25
• TRH = PH* QH = (60 QH– QH2)/0.25
• MRH = (60– 2QH)/0.25
• QD = 100 − 0.5PD which means
PD = (100 – QD)/0.5
• TRD = PD* QD = (100 QD– QD2)/0.5 and MRD
= (100– 2QD)/0.5
• MRH = MRD = MC = 40
• QH = 25 and QD = 40
• PH = 140 and PD = 120
• Profit = 8300 – (1000 + 40*65) = 4700
Homework
INTERTEMPORAL PRICE DISCRIMINATION
AND PEAK-LOAD PRICING
● Intertemporal price
discrimination Practice of
separating consumers with
different demand functions into
different groups by charging
different prices at different
points in time.
● Peak-load pricing Practice of
charging higher prices during
peak periods when capacity
constraints cause marginal
costs to be high.
THE TWO-PART TARIFF
• Form of pricing in which
consumers are charged
both an entry and a
usage fee.
• The consumer has

demand curve D. The
firm maximizes profit by
setting usage fee P
equal to marginal cost
and entry fee T* equal to
the entire surplus of the
consumer.
POLAROID CAMERA STRATEGIES
In 1971, Polaroid introduced its SX-
70 camera. This camera was sold,
not leased, to consumers.
Nevertheless, because film was
sold separately, Polaroid could
apply a two-part tariff to the pricing
of the SX-70.
Why did the pricing of Polaroid’s
cameras and film involve a two-part
tariff?
Because Polaroid had a monopoly on both its camera
and the film, only Polaroid film could be used in the
camera.
CELLULAR PHONE SERVICE
Most telephone service

is priced using a two-
part tariff: a monthly
access fee, which may
include some free
minutes, plus a per-
minute charge for
additional minutes.
This is also true for cellular phone service, which has
grown explosively, both in the United States and around
the world.
Because providers have market power, they must think
carefully about profit-maximizing pricing strategies.
The two-part tariff provides an ideal means by which
cellular providers can capture consumer surplus and turn it
into profit.
Economics
Session 18-20
Social Interactions
Jargons of Game Theory
Player:
decision
Player: makers
decision
makers
Payoffs: the
value accruing to
each player for a
particular
strategy profile
Strategy Profile: 1.Advertise by Maruti and Advertise by Hyundai

2. Advertise by Maruti and Don’t Advertise by Hyundai
3. Don’t Advertise by Maruti and Advertise by Hyundai
4. Don’t Advertise by Maruti and Don’t Advertise by Hyundai
DOMINANT STRATEGIES
● Any firm’s choice has an impact on both the

firms.
● dominant strategy - a strategy which is the

best choice for a player regardless of what the
other players do.
Equilibrium in dominant
strategies
A strategy profile in which each player is playing a dominant

strategy, is called Dominant Strategy Equilibrium.
How About a Game without
Dominant Strategy Equilibrium?
Nash Equilibrium:
Best Response meets Best Response
Nash Equilibrium: A Nash Equilibrium is

strategy profile where Nash
Equilibrium: also defined as
every player’s strategy is where no unilateral
his best response to the Both Firms
Advertise profitable departure
strategies of the other is possible.
players.
Battle of Sexes
HUSBAND
Action Movie Romantic Movie
WIFE
Action
Movie 1,2 0,0
Romantic
Movie 0,0 2,1
Multiple Nash Equilibria!

Matching Pennies
JILL
HEAD TAIL
HEAD
1,-1 -1,1
JACK
TAIL
-1,1 1,-1
No Nash Equilibrium!
Story
• KGB picks two “enemies of the state”
at midnight.
• KGB tells them
– If you both confess, both will be sent to
Gulag for 20 years
– If you both do not confess, there will be
prison for 2 years.
– If one of you confess and the other not, the
confessing partner will be state witness
(imprisonment of 1 year). But, the non-
confessing partner will be sent to Gulag
(Siberia) for 30 years.
Prisoner's Dilemma
PRISONER B
Confess Don't
confess
Confess
PRISONER A
-20,-20 -1,-30
Don't
confess -30,-1 -2,-2
• Both of them confess of the crime!
OLIGOPOLY
 In oligopolistic markets, the products may or may not
be differentiated. What matters is that only a few firms
account for most or all of total production.
 Some or all firms earn substantial profits over the long
run because barriers to entry make it difficult or
impossible for new firms to enter
 Complex environment – price, quantity, investment
decisions affects rivals and elicit reaction from rivals
COURNOT MODEL
 Oligopoly model in which firms
produce a homogeneous good
 each firm treats the output of its

competitors as fixed
 and all firms decide simultaneously

how much to produce.
Example
• Demand Curve: P = 30 – Q1 – Q2
• Q1 and Q2 are quantities supplied by firms
1 and 2.
• Marginal Cost is Zero; Fixed Cost Zero.
• Clearly, if one of the firms supply more,
the other firms demand is lower.
• The profit of one firm depends on the other
firm.
Page 421, Chapter 12 of the Text Book
Profits of Firm 2
Reaction
Curve
Relationship
between a firm’s
profit-maximizing
output and the
amount it thinks its
competitor will
produce.
OLIGOPOLY
• The Linear Demand Curve—An Example
Figure 12.5
Duopoly Example
The demand curve is P =

30 − Q, and both firms
have zero marginal cost.
In Cournot equilibrium,
each firm produces 10.
The collusion curve shows
combinations of Q1 and Q2
that maximize total profits.
If the firms collude and
share profits equally, each
will produce 7.5.
Also shown is the
competitive equilibrium, in
which price equals
marginal cost and profit is
zero.
BERTRAND MODEL: PRICE COMPETITION
● Firms produce a homogeneous good,
● Each firm treats the price of its competitors as

fixed,
● All firms decide simultaneously what price to

charge.
The firms set price at marginal cost and make

no profit.
ENTRY DETERRENCE
The disposable diaper industry in the United States

has been dominated by two firms: Procter &
Gamble, with an approximately 50-percent market
share, and Kimberly-Clark, with another 30–40
percent.
How do these firms compete? And
why haven’t other firms been able to
enter and take a significant share of
this $5-billion-per-year market?
The competition occurs mostly in the
form of cost-reducing innovation. As a
result, both firms are forced to spend
heavily on research and development
in a race to reduce cost.
Homeworks
REPEATED GAMES
• What if Prisoner’s Dilemma game is
played repeatedly?
• If repeated for a finite number of times
– History does not matter in the last period.
– In the last period, it is like a one-shot
game.
– What happens in the last period?
– What happens in the penultimate period?
– What happens in the period before the
penultimate period?’
– What happens in the first period?
INFINITELY REPEATED GAMES
● Robert Axelrod organized tournaments for game

theory practitioners from various disciplines to
come up with the appropriate strategy for an
infinitely repeated prisoner’s dilemma game in
1979-80.
● tit-for-tat strategy Repeated-game strategy in

which a player responds in kind to an opponent’s
previous play, cooperating with cooperative
opponents and retaliating against uncooperative
ones.
Anatol Rapoport ● The starting point for a tit-for-tat strategy is

cooperation.
● Tit-for-tat strategy was the overall best one.

Professor-Student Dialogue
• feels better to assign a grade B to
a student rather than assigning her
a grade of A.
• says: “If you do not assign me

an A, I will hold my breath until I
am blue (HBUB).”
• What would the professor do?

A Sequential Game
The Equilibrium
is Professor
Grade A Grade B assigning a
Grade B and the
student
Professor 1
Student 2 accepting it!
Accept HBUB
Professor 2 Professor 0
Student 1 Student 0
Empty Threats
• The threat of the student is

not tenable in equilibrium.
• Pricing of computers and Word

Processors (Page 502;
Table 13.11)
• Can irrationality be important in having a Credible
Commitment?
Irrationality Wins!
The Equilibrium
is Professor
Grade A Grade B assigning a
Grade A!
Professor 1
Student 2
The Student
Accept HBUB
behaves
irrationally!
Professor 2 Professor 0
Student 1 -1 Student 0
Credible Commitment
• Production Choice Problem (Page 503;
Table 13.12 (a) and (b)).
– By destroying own facility, Far Out Engine can
make a credible commitment to Race Car
Motors.
• The birth of the idiom of “Burn the
boat” post the Norman conquest
of England in 1066.
A sequential look into
simultaneous move game
Romantic Movie is
chosen by both
players.
Action Movie Romantic Movie
Action Movie Romantic Movie Action Movie Romantic Movie
Wife 1 Wife 0 Wife 0 Wife 2

Husband 2 Husband 0 Husband 0 Husband 1
First Mover Advantage
• Although simultaneous game has two
equilibria, the sequential game has only
one.
• The first mover can have a better chance
of its preferred equilibrium.
– The establishment can act as an equilibrium.
• The Walmart story
• Strategic entry deterrence
Stackelberg Model: Redo the
example with one firm as Leader
and the other as Follower.
Page 500; Table 13.10

• Firm 1 can choose three
strategies of quantity, Q1 = The Stackelberg
equilibrium is that
7.5, 10 and 15. Firm 1 will choose
• Similarly, Firm 1 can Q1 = 15 and Firm 2
will choose Q2 =
choose three strategies of 7.5.
quantity, Q1 = 7.5, 10 and
15.
Stackelberg: The power of the
first mover
• The first mover gets the “cartel level” profit.
– If both firms constitute a cartel, they can produce
the monopoly output of 15 units together.
– Profit is 225 and each firm is entitled to 112.5.
– The profit in Stackelberg for the Leader is exactly
the same.
Game Theory in Practise - I
• Bruce Bueno de Mesquita of New York
University predicted that Egypt’s
president, Hosni Mubarak, would fall
from power within a year in May 2010 .
– Nine months later Mr. Mubarak fled Cairo
amid massive street protests.
http://www.economist.com/node/21527025
Game Theory in Practise - II
• In online auction of 2006 of radio-spectrum
licenses by America’s Federal
Communications Commission, Paul
Milgrom, a consultant and Stanford
University professor, customised his
game-theory software.
– Two of his clients, Time Warner and Comcast,
paid about a third less than their competitors
for equivalent spectrum, saving almost $1.2
billion.
Homeworks
• Page 521, Chapter 13, Exercise 3, parts b-
c
Economics
Session 21-22
Information Asymetries
ADVERSE SELECTION
● asymmetric information: Situation in
which a buyer and a seller possess different
information about a transaction – hidden
information and hidden action.
• Tughlaq introduced a leather-copper
currency equivalent to gold.
– Counterfeiting becomes huge
– Monetary system collapsed
– Foreign merchant refused
Quality Uncertainty And The Market For Lemons
● Market for Used Cars by

George Akerlof (1970)
● Suppose the quality is

Known, then the market
functions alright.
● And, what happens when the

quality is not known…..
● An example may help!

An Illustrative Used Car Market
Low quality car High quality

(Lemon) car (Plum)
Value to seller 180,000 280,000
Value to buyer 200,000 300,000
Proportion of
0.50 0.50
total cars
• Expected value of a car to the buyer is
0.50 × 200,000 + 0.50 × 300,000
= 250,000
• No High Quality car seller will sell in this
price.
• Only Low Quality cars will
come to market at that price!
• The lemons problem:
With asymmetric information, low-quality
goods can drive high-quality goods out of
the market.
Adverse Selection
● adverse selection: Form of market failure resulting
when products of different qualities are sold at a single
price because of asymmetric information, so that too
much of the low-quality product and too little of the
high-quality product are sold.
– The Market for Insurance: People

who buy insurance know much more
about their general health than any
insurance company can hope to know, even if it
insists on a medical examination.
– The Market for Credit: Borrowers know more

about their credit risk (default probabilities) than
lenders.
Relevance of Adverse Selection
Now!
• In a globalised world, information
asymmetries could be huge.
– Adverse selection is more relevant than ever
before.
• The informal institutions were often geared
towards addressing problems arising out
of information asymmetry.
WHAT TO DO ABOUT ADVERSE
SELECTION?
 Use publicly available relevant information.
 Carfax
 Legally mandate information.
 Credit and insurance market
 Certification by independent bodies.
 Provide information voluntarily – signaling

equilibrium
Warranty as a Signal
1. The signal must be more costly for low
quality cars.
• A one-year warranty costs
– 30,000 for a Plum Seller
– 140,000 for a Lemon Seller
2. The signal cannot be so expensive that even
owners of high quality cars are unwilling to
send it.
• The warrantee is valued at
– 25,000 for a buyer
With Without
Warranty Warranty
Price: 325,000 Price: 200,000
Plum Profit = Profit =
325,000 – 280,000 200,000 –
– 30,000 = 15,000 280,000 – Zero
= – 80,000
Lemon Profit = Profit =

325,000 – 180,000 200,000-180,000
– 140,000 – Zero
= 5,000 = 20,000
Signaling Equilibrium
• Job market signaling via education

 Michael Spence (1973); Nobel prize (2001)).
• Education does nothing to increase one’s productivity,
but it signals the current productivity level of the workers.
• It is more costly for low productivity workers to attain a
certain level of education than for high productivity
workers.
• In equilibrium, only high productivity workers
obtain more education than low productivity
workers and thus earn higher wages.
MARKET SIGNALING
Job market signaling does not

end when one is hired. This is
especially true for workers in
knowledge-based fields such as
engineering, computer
programming, finance, law,
management, and consulting.
Given this asymmetric information, what policy should
employers use to determine promotions and salary
increases? Workers can often signal talent and productivity
by working harder and longer hours.
Employers rely increasingly on the signaling value of long
hours as rapid technological change makes it harder for
them to find other ways of assessing workers’ skills and
productivity. The worker will know more about his abilities
than the employer.
Homework
MORAL HAZARD
• Moral hazard exists when the unobserved actions
(hidden action) of one party influences the gains
from trade of the other party
• Principal-agent problem:
– Two actors,
• the principal
• the agent.
– Principal benefits from the
unobservable action taken by the agent.
– Actions favorable to the principal are expensive for
the agent to undertake
– The principal must reward the agent for a good
outcome and punish for a bad outcome.
Employer and employee
• Employers pay employees bonus.
Insurer, insured
• Insurers make the insured pay the first
deductible.
If insurers did not
pay for the
deductible, they
have every
reason to not
take care of the
insured wealth.
Shareholders and management
• Shareholders
want the
management to
hold a significant
amount shares.
• CEOs are
awarded a lot of
compensation
through company
stocks.
Lender and borrower
• Lenders hold collateral from the borrower.
• This collateral may not social capital for
micro finance.
India - Value of collateral needed for a loan (% of the loan amount)

World Bank
Different Cases of Contracts
• When principal’s and agent’s interests are
aligned…
• If actions are observable and
enforceable…
• If agent are risk neutral....
• If agents are risk-averse and their actions
are unobservable…
When principal’s and agent’s
interests are aligned…
• Sportsperson have their
contracts with their employers
(BCCI/ Club) but their interests
are aligned!
• Whenever agent has her brand, interest
alignment is observed
– Actors
– Politicians
– Authors
If actions are observable and
enforceable
• Although interests are not aligned still no
moral hazard problem, as actions are
observable or enforceable.
• In army, actions are
observable and enforceable
through culture/policy.
• Observability can be found in routine jobs
and enforceability is made through culture.
If agent are risk neutral....
• If agent’s interest is neither aligned with
that of principal nor it is observable, still
we not face the moral hazard problem if
the agent is risk neutral.
• Principal can pass on the
entire risk to the agent
– Dealership
– Licensee
– agency
If agents are risk-averse and their
hidden actions are unobservable…
• We must make agent take consequence of
her action and make her pay variable to the
outcome
• But her pay cannot be made too variable,
otherwise, we would end up paying more
than we want.
A Numerical Example
• Suppose that you employ a salesperson. If the person
makes a sale, you earn 60,000, if not, you earn 0.
These figures do not include the wages you pay to the
salesperson.
• The salesperson decides on the effort level.
Effort Probability of Sale Disutility
kill himself 0.50 40
work hard 0.40 20
try (but not hard) 0.25 10
laze 0.05 0
• The best outside alternative of the salesperson is where

he makes 10,000 with no disutility of effort.
• So in order to make the salesperson work for you, you
must pay him a expected utility of at least √10,000 =
100.
What if?
• If actions were observable and
enforceable, the principal would
specify the action in the contract.
• you can contractually fix the

salesperson's effort level
– The First Best
Different Contracts in Observable Case
• If you wish the salesperson to laze, then w must
satisfy
– sqrt(w) – 0 = 100
– or w = 10,000.
– With this wage your net profit is 0.05(60,000) –
10,000 = -7,000.
• If you wish the salesperson to try, then w must

satisfy
– sqrt(w) – 10 = 100
– or w = 12,100.
12,100 = 2,900.
Different Contracts in Observable Case
• If you wish the salesperson to work hard, then w
must satisfy
– sqrt(w) – 20 = 100
– or w = 14,400.
14,400 = 9,600.
• If you wish the salesperson to kill himself, then w

must satisfy
– sqrt(w) – 40 = 100
– or w = 19,600.
19,600 = 10,400.
The Best from
Principal’s point
of view
Certainty Vs Motivation
• Now suppose you cannot fix the salesperson's effort
level contractually - unobservable or
unenforceable.
• However, the salesperson is risk averse
– If you assume all the risk and give him a fixed
wage, then since you cannot verify his effort, the
salesperson lazes – a losing proposition for you.
• To motivate the salesperson, you have to give him
some incentive to exert effort
– make the amount received when a sale occurs
greater than what he makes if he comes back
without a sale.
• But don’t go too far, which will be too risky for him –
find the right balance.
A Trial Contract
• Suppose you write a contract for the salesperson that specifies that
– he gets a base wage of 9500, regardless of whether a
sale is made or not.
– Moreover, he gets a bonus of 15000 if he makes a
sale.
Effort Bonus Utility from Disutility Net Utility Net Profit
package
kill himself 0.50× 0.50×√24,500+0. 40 100.42 0.50×45,000

15,000 50×√9,500 – 9,500
=13,000
work hard 0.40× 0.40×√24,500+0. 20 101.09 8,500

15,000 60×√9,500
try (but not 0.25× 0.25×√24,500+0. 10 102.23 1,750
hard) 15,000 75×√9,500
laze 0.05× 0.05×√24,500+0. 0 87.00 -7,250

15,000 95×√9,500
Reaching for an Optimal Contract
• (9,500, 15,000) is not bad, but can we do better?
– This does not encourage the agent to go beyond try
– Profit of 1,750 is far lower than the first best of
10,400.
– Shall we increase the incentive to work hard?
• (9,500, 20,000)
– But the agent is getting too much!
• (8,000, 20,000)
– Good! But is it the best?
• (8,700, 17,000)
– The best!
– Can we make the agent kill himself?
– (1530, 56500)
What we have abstracted from?
– Pride
– Self-satisfaction
– Loyalty
– Threat of losing the job at the sales
department
– Career ambition
– Work culture (peer pressure)
– Reputation
TOURNAMENTS
• Several salespersons; you give your
salespersons a base wage and then a bonus to
the top salesperson or top 25% salespersons –
tournament incentive schemes.
• Collusion
• Sabotage
GROUP INCENTIVES
• The other extreme from tournaments are incentives (bonuses) tied
to group performance. The main problem with this scheme is that
since individual work has little impact on group output, motivation to
work hard may be less.
• Why still used?

– Measurement; group output measurement is all that is possible
– Collaboration helps generate more output
– Good peer group monitoring raises output
– Good enforcement of hard-working group norm
DYNAMICS
• Salesperson earns a bonus for improving sales level from the
previous year by, say, 5%.
• Problems:
– Disincentive to beat last year’s sales figure by more than 5%
– Three-quarters of the way through the year, the salesperson who
realizes that 5% improvement cannot be achieved, takes it easy
for the rest of the year, to make the next year easier.
– Salesperson with a really good year has the incentive to get
another job, because the hurdle for the next year would be
impossibly high.
• But the use of time and the promise (threat) of good (bad) treatment
in the future do provide strong incentives. For example, career
aspirations are strong incentives for executives early in their career;
there may be no need to tie their immediate compensation to their
immediate performance. For them, these dynamic incentive
schemes are more effective.
Homework
Economics
Session 23-24
The Networked Economy
Is Data the New Oil?
• The frontier of the economy
has become knowledge and
innovation.
• Information revolution has created the
scope for knowledge economy where
capital is not a constraint anymore.
• Matching markets in case of repugnant
markets is another
phenomenon.
Examples of Network and
Knowledge Economy
• Uber, the world's largest taxi
company, owns no vehicles.
• Facebook, the world's most
popular media owner, creates
no content.
• Alibaba, the most valuable
retailer, has no inventory.
• And Airbnb, the world's largest
accommodation provider, owns
no real estate.
Case Study: IT Industry
• Why have India’s IT Industry slowed down?
Case Study: IT Industry
• In the four quarters before the collapse of Lehman
Brothers, Infosys saw revenue increase an average
29% in constant-currency terms.
– Back then, Dublin-based Accenture’s growth was
just half as high.
• the dominant trio of Tata Consultancy,
Infosys and Wipro between them had
1.5 times more workers doing digital stuff
last year than Accenture.
• But the revenue they garnered was
40% less than what the latter chalked
up from newer technologies.
• Lack of Innovation is the chief reason.
Two Kinds of Innovation
processes
• Incremental Innovation
– Collaboration is the key.
– A lot of knowledge is kept as tacit.
– Establishment continues their story.
• Radical/Disruptive Innovation
– Competition is the key
– The focus is on codified knowledge (for patent
purpose)
– Establishment is displaced!
Repugnant Markets
• Why slave-trade and indentured labourers
are banned?
– “The material (not psychological) condition of
the lives of slaves compared favorably with
those of free industrial workers.”
– Slaves were paid 90% of the salary.
• The asymmetric information is
simply too large for regulation and
correction.
Repugnant Markets
• Sale of Human Organs

• Adoption
• Child Labour
• Predatory (Mortgage) lending
• In these cases, we need a

matching framework.
– Kidney Exchange
Kidney Exchange
• Right now in the United States, there are
100,000 people waiting for a kidney.
• Many cases there is a kidney donor for
someone who requires a kidney but the
type of the kidney does not match for the
intended recipient.
• A good first step thinking is
letting people swap whenever
possible!
Alvin Roth (2012 Nobel)
• Roth proposed an algorithm that
facilitated kidney exchange by multiple
times.
• The exchange algorithm looks for long
chains and offers a way
to prompt matching.
• This algorithm has
facilitated good life for
many thousands.
School Choice
• In India, schooling is largely a middle class

concern and most of the good schools are
private.
• In US, the public schools are quite
common destination for children.
• School allocation is a critical decision for
the students.
• Students have some preferences.
And, schools too!
The Boston Mechanism
• In Round 1 only the first choices of the students
are considered.
• For each school, consider the students who

have listed it as their first choice and assign
seats of the school to these students one at a
time following their priority order until either there
are no seats left or there is no student left who
has listed it as his first choice.
• Round 2: Consider the remaining students. In

Round 2 only the second choices of these
students are considered.
• Round k: Only the kth choices are considered.

Simulation Time!
• Let’s simulate the school allocation

problem.
• How about a random match? What is the
efficiency of the algorithm.
• How about a “Boston School Mechanism”
match? What is the efficiency of the
algorithm.
• Is “Boston School Mechanism” a strategy
proof mechanism?
Organization and Market Economics
SE7EN SENSES
I. Demand and Supply framework is must for
analysing socio-economics problems!
II. Accounting is not economics!
III. Free entry serves economic growth.
IV. Economic growth is not socially efficient!
V. Monopolies do serve the economy, a lot of
the times!
VI. Information sharing is key to building an
institution.
VII. Knowledge Economy demands efficient
matching process.
Thank You

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Organization and Market

The Demand Curve

The demand curve,

As dollar values are Y

Demand For Diesel

Quantity Demanded Quantity Demanded

More under cross price elasticity

The supply curve, labeled S in

If production costs fall, firms

Supply and Demand

The market clears at price P0

At the higher price P1, a surplus

At the lower price P2, there is a

• North Korea is a non-market

• Babur was born in Central Asia. He

Demand Supply Quantity Price

Increases Increases Increases Ambiguous

Decreases Decreases Decreases Ambiguous

Increases Decreases Ambiguous Increases

Decreases Increases Ambiguous Decreases

The price elasticity of

For a horizontal demand

Goods that are perfectly

For a vertical demand

Commodities that has

Tomato Hyundai Car Car Salt

-∞ -4.6 -4.3 -1.3 E = -1 -0.1 0

 Abs(e) > 1 ; demand is elastic; TR’(Q) > 0

● income elasticity of demand Percentage change in

● cross-price elasticity of demand Percentage change

For each inmate put to death, the studies

(a) In the short run, an GASOLINE

In the longer run,

(b) The opposite is true for

In the longer run, however,

Income elasticities also differ from the short run to the

For most goods and services—foods, beverages, fuel,

For a durable good, the opposite is true. The short-run

● consumer surplus Difference between what a consumer is willing to

Consumer surplus is the total

Individual consumer surplus

Producer surplus for a

1. Consumer preferences: Survey

2. Budget constraints: publicly

Consumer choices: Observed

1.Completeness: For any two market baskets A and B, a

Note that these preferences ignore costs. A consumer

● market basket (or bundle) List with

Because more of each

● utility function Formula that assigns a level of utility

A utility function can be

● marginal utility (MU) Additional

● Law of diminishing marginal utility

• The magnitude of the slope of

• The decline in the MRS

● Perfect Substitutes Two goods for

● Perfect Complements Two goods

In (a), Bob views orange juice

TABLE 3.2 Market Baskets and the Budget Line