Introductory and the equitable allocation of goods and services among

 Definition: Microeconomics, Macroeconomics and Economics the population.

 Central problems of an economy
The basic economic problem arises from the reality of
 Production Possibility Frontier (PPF) (Assumptions, how it
 illustrates the concepts of opportunity cost and economic scarcity. Resources such as land, labor, capital, and natural
 growth) resources are limited, while human wants and needs are
 Positive and normative economics (difference, examples) virtually unlimited. As a result, individuals, businesses, and
 Different Economic System (Definition, examples, comparative
societies must make choices and trade-offs to allocate
 analysis)
 Developing country and mixed economic system resources efficiently, optimize production and satisfy the
most pressing needs and desires.
I. Microeconomics, Macroeconomics Economics Economics as a social science discipline seeks to study and
analyze the basic economic problem and develop theories
Microeconomics is the branch of economics that studies the and models to understand how societies make decisions
behavior and decision-making of individual units, such as regarding resource allocation, production, and distribution in
consumers, firms, and industries. It focuses on how these the face of scarcity.
entities interact in specific markets to determine prices,
allocate resources, and distribute goods and services. Here are some of the ways that economic systems try to
address the fundamental economic problem:
Paul A. Samuelson:
“Microeconomics studies how individual people and firms • Market economies: Market economies are based on the
make economic decisions.” principle of supply and demand. Prices are determined
by the interaction of buyers and sellers in the market.
R. G. Lipsey: This system allows for the efficient allocation of
“Microeconomics deals with the small parts of the economy, resources, but it can also lead to inequality and
like consumers, firms, and industries.” environmental problems.
Macroeconomics is the branch of economics that deals with • Planned (command) economies: Planned economies
the economy as a whole. It studies large-scale economic are based on the principle of central planning. The
factors and aggregates such as national income, overall government decides what goods and services will be
employment, inflation, economic growth, and government produced and how resources will be allocated. This
policies. system can ensure that everyone's basic needs are met,
Paul A. Samuelson: but it can also be inefficient and inflexible.
“Macroeconomics looks at the economy’s total output, • Mixed economies: Mixed economies combine
income, and the level of employment.” elements of market economies and planned economies.
Dornbusch and Fischer: The government plays a role in the economy, but it also
“Macroeconomics studies the overall performance of the allows for some degree of free market activity. This
economy and government policies to improve it.” system is often seen as a way to balance the efficiency
of market economies with the equity of planned
II. Central problems of an economy economies.

The basic economic problem, also known as the fundamental III. Production Possibility Frontier (PPF)
economic problem, refers to the scarcity of resources in
relation to the unlimited wants and needs of individuals and The Production Possibility Frontier (PPF) is a graph that
societies. It is the central issue in economics and arises due shows all possible combinations of two goods or services that
to the imbalance between what people desire and the an economy can make using its available resources and
resources available to fulfill those desires. technology. The model is based on a few important
assumptions:
In essence, the basic economic problem can be summarized
by three key questions: Assumptions of the PPF:
1. What to produce: Since resources are limited, societies • Fixed Resources:
must decide what goods and services to produce and in The economy has a limited amount of land, labor,
what quantities. This involves making choices about capital, and other resources. These resources cannot be
which products or services are most needed or desired by increased immediately.
the population.
• Fixed Technology:
2. How to produce: Once the decision on what to produce The ways of producing goods (technology and methods)
is made, societies must determine the most efficient and remain constant during the period being studied.
effective methods of production. This involves deciding
• Full Employment:
on the combination of resources to use, such as labor,
Every resource available is used efficiently. There is no
capital, and technology, to produce the desired goods
wasted labor or idle machinery.
and services.
• Two Goods Model:
3. For whom to produce: After determining what and how
The model simplifies the real world by considering only
to produce, societies need to allocate the produced
two goods. This helps us easily see the trade-offs
goods and services to different individuals and groups.
between choosing one good over another.
This raises questions about the distribution of resources
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 • Efficiency:  Positive Economics:
The economy is assumed to be operating at its full Focuses on cause-and-effect relationships and “if-
potential, producing the maximum output with the then” scenarios, helping to understand how changes in
available resources. the economy might play out.
Economic Growth and the PPF:  Normative Economics:
Addresses broader societal goals, like equity and
• Economic Growth:
welfare, influencing debates on economic justice and
Economic growth happens when an economy can
ethics.
produce more goods and services than before. On the
PPF, this is shown by the curve shifting outward. ❖ Examples in Practice:
• Reasons for Growth:  Positive Economic Example:
The outward shift can happen when there is an increase “If the central bank raises interest rates, inflation will
in resources (like more workers or better machines) or decrease.”
new technology that makes production more efficient.  Normative Economic Example:
• Improved Living Standards: “The government should lower interest rates to boost
As the economy grows, it can provide more goods and employment, even if it risks slightly higher inflation.”
services. This often leads to higher living standards for
the people in the economy.
This simple model helps us understand that no economy has
endless resources.

IV. Positive vs. Normative Economics

Positive vs. Normative Economics
❖ Definition:
 Positive Economics:
Describes and explains economic events using facts
and data. It answers "what is" and can be tested.
 Normative Economics:
Involves opinions and value judgments about what
should be. It answers "what ought to be" and cannot
be easily tested. V. Different Economic System
❖ Nature of Statements: Overview of Economic Systems
 Positive Statements: An economic system is a framework by which societies
Factual and objective. For example, “Raising the organize the production, distribution, and consumption of
minimum wage by 10% may lower employment for goods and services.
some workers.”
❖ Traditional Economy
 Normative Statements:
Subjective and prescriptive. For example, “The ❖ Command (Planned) Economy
government should raise the minimum wage to help ❖ Market (Capitalist) Economy
reduce poverty.”
❖ Mixed Economy
❖ Basis for Analysis:
A. Traditional Economy
 Positive Economics:
Definition:
Uses data, experiments, and observations to test
A traditional economy is one in which economic activities and
hypotheses.
resource allocation are dictated by customs, traditions, and
 Normative Economics: long-established practices. These economies are typically
Relies on personal opinions, ethical views, and based on agriculture, hunting, and gathering, where methods
societal values. and production are handed down through generations.
❖ Influence on Policy: Examples:
 Positive Economics: ❖ Indigenous societies
Provides a factual basis for policy debates by
❖ Rural communities.
predicting likely outcomes of policy choices.
Key Features:
 Normative Economics:
Shapes policy recommendations by reflecting what ❖ Heavy reliance on agriculture, fishing, and artisan crafts.
people feel is fair or desirable. ❖ Barter systems or non-monetary forms of exchange.
❖ Perspective and Use:

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 ❖ Social roles and responsibilities are well defined by ❖ China (modern context)
tradition. Key Features:
❖ Limited technological innovation due to the focus on
❖ A balance between private enterprise and government
established practices.
regulation.
B. Command (Planned) Economy
❖ Government involvement in areas like healthcare,
Definition: education, and infrastructure.
In a command economy, economic decisions—including
❖ An aim to harness the efficiency of the market while
production, investment, prices, and incomes—are made mitigating inequality and social risks.
centrally by the government or a central planning authority.
The government determines what goods should be produced, ❖ Constantly evolving policies to adjust to new economic
how much should be produced, and sets prices, often aiming challenges.
for social welfare and equal distribution of resources. Comparative Analysis
Examples: A. Control of Resources
❖ Former Soviet Union ❖ Traditional Economy:
❖ Contemporary North Korea Control rests within community traditions and kinship
systems. Change is gradual, maintaining continuity with
❖ Cuba (to some degree) the past.
Key Features:
❖ Command Economy:
❖ Centralized decision-making and economic planning. The state centrally controls resources, with planning
committees determining production and investment.
❖ Emphasis on equality and social welfare over market
efficiency. ❖ Market Economy:
❖ Limited competition and often resulting in inefficiencies. Individual entities (businesses and consumers) decide on
resource allocation through market signals and
❖ Tends to prioritize large-scale industrial projects and competition.
social programs.
❖ Mixed Economy:
C. Market (Capitalist) Economy While individuals largely decide through market
Definition: mechanisms, the state regulates and supplements
A market economy, often synonymous with capitalism, is resource distribution in sectors where free markets fall
characterized by decentralized decision-making. Producers short.
and consumers interact in a market through supply and B. Allocation Efficiency and Innovation
demand. Prices are determined by voluntary exchanges, and
the role of the government is usually limited to enforcing ❖ Traditional Economy:
contracts and protecting property rights. Limited incentives for innovation lead to stable, but often
low, productivity. Efficiency is driven by tradition rather
Examples: than technological improvement.
❖ United States ❖ Command Economy:
❖ United Kingdom and other Western European nations Efficiency may suffer due to the absence of market
signals. Innovation is often hindered by bureaucracy and
❖ Hong Kong lack of competition, though large-scale projects can be
Key Features: implemented when aligned with state goals.
❖ Resource allocation is driven by market forces. ❖ Market Economy:
High potential for innovation due to competition and
❖ Strong protection of private property and individual
profit motives. However, market imperfections, such as
economic rights.
monopolies or externalities, can lead to inefficient
❖ Encourages innovation, efficiency, and entrepreneurship. outcomes.
❖ Can result in income inequality and market failures if not ❖ Mixed Economy:
regulated. Combines the dynamic innovation of market systems
D. Mixed Economy with state intervention to correct market failures, aiming
for a balanced, efficient outcome. Nonetheless, the
Definition: coexistence of two systems may sometimes result in
A mixed economy incorporates elements of both market and regulatory complications or conflicts of interest.
command systems. It features a coexistence of private
economic freedom with government intervention in certain C. Wealth Distribution and Social Welfare
sectors to correct market failures, provide public goods, and ❖ Traditional Economy:
ensure a more equitable distribution of wealth. Wealth distribution is typically uniform or based on
Examples: longstanding social hierarchies. Social bonds and
communal sharing tend to cushion inequality, but
❖ Scandinavian countries (e.g., Sweden, Norway) economic growth is often slow.
❖ Germany
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 ❖ Command Economy: ❖ South Africa: Has government programs for the poor
Designed to promote equitable distribution through along with a strong business sector.
central planning, yet this sometimes results in
inefficiencies and lack of individual incentive to excel,
Demand
 Demand (Curve, schedule with examples)
leading to lower overall economic performance.
 Factors affecting demand
❖ Market Economy:  Why demand curve slope downwards with examples
 Exception of Law of Demand
Wealth is generated and distributed according to market
 Elasticity of demand (Definition, factors affecting)
performance, leading to higher overall wealth but also
potentially significant inequality. Social welfare depends
on voluntary charity or later government intervention. I. Demand (Curve, schedule with examples)
❖ Mixed Economy: The willingness and ability of buyers to purchase different
Seeks to balance wealth creation with redistributive quantities of a good at different prices during a specific
mechanisms such as taxation, social security, and period.
healthcare benefits to mitigate extreme inequality and
Demand Schedule The numerical tabulation of the quantity
provide a safety net for disadvantaged populations.
demanded of a good at different prices. A demand schedule
is the numerical representation of the law of demand. A
VI. Mixed Economic System in a Developing Country demand schedule for good X is illustrated in Exhibit 1(a).
A mixed economic system is a type of economy where both A (downward-sloping) demand curve is the graphical
the government and private businesses work together. It representation of the inverse relationship between price and
combines features of both capitalism (private ownership) and quantity demanded specified by the law of demand. In short,
socialism (government control). Many developing countries a demand curve is a picture of the law of demand.
use this system to grow their economies and help their
people. II. Factors Affecting Demand
Key Features:
Factors Affecting Demand
❖ Government and Private Sector Together:
Demand means the desire to buy a good or service and the
The government controls important industries like
ability to pay for it. Many factors can affect how much of a
electricity, water, health, and education. Private
product people want to buy. These are called determinants
companies run businesses like farming, shops, and
of demand.
factories.
1. Price of the Product
❖ Government Regulation:
The government makes rules to control prices, protect ❖ When the price increases, demand usually decreases.
workers, and reduce unfair practices. This helps to ❖ When the price decreases, demand usually increases.
protect the poor and reduce inequality.
❖ This is called the Law of Demand.
❖ Support for Development:
The government invests in roads, schools, and hospitals. 2. Income of Consumers
Private companies create jobs and bring new technology. ❖ If people earn more money, they can buy more goods, so
❖ Welfare and Social Services: demand increases.
The government provides free or low-cost services like ❖ If income falls, people buy less, so demand decreases.
healthcare, education, and food support to help the poor.
3. Tastes and Preferences
❖ Public-Private Partnership (PPP):
❖ If a product becomes popular or fashionable, demand
Sometimes the government and private companies work
increases.
together on big projects like building highways, railways,
and power plants. ❖ If people stop liking a product, demand decreases.
Benefits for Developing Countries: 4. Prices of Related Goods
❖ Helps reduce poverty. ❖ Substitute Goods: If the price of tea goes up, people may
buy more coffee (demand for coffee increases).
❖ Creates jobs for people.
❖ Complementary Goods: If the price of petrol increases,
❖ Encourages foreign investment.
the demand for cars may decrease because both are
❖ Improves infrastructure and public services. used together.
❖ Balances social welfare with economic growth. 5. Future Expectations
Examples of Developing Countries with a Mixed Economy: ❖ If people expect prices to rise in the future, they may buy
❖ India: Has both public sector industries and a large more now (demand increases).
private sector. ❖ If they expect prices to fall, they may wait to buy later
❖ Brazil: The government supports agriculture and industry, (demand decreases).
but private companies are also important. 6. Population

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 ❖ If the population increases, demand for goods and 1. Giffen Goods
services increases.
These are very basic goods that poor people depend on.
❖ A larger population means more people need food, When the price goes up, they can’t afford better food, so they
clothes, houses, etc. buy more of the cheaper (inferior) item.
7. Government Policies Example:
❖ If the government gives subsidies, demand may increase. If the price of cheap rice goes up, a poor family may not afford
vegetables or meat anymore. So they end up buying more
❖ If the government increases taxes, demand may rice, even at the higher price.
decrease.
2. Veblen Goods (Luxury Goods)
8. Seasonal Factors
These are status symbols. Some rich people buy more when
❖ Demand changes with seasons. For example: the price is high because it shows off wealth.
 Umbrella demand increases in the rainy season. Example:
 Woolen clothes are in high demand during winter. Designer bags, luxury cars, or diamond jewelry—if the price
goes up, people might buy more to show they’re rich.
III. Why demand curve slope downwards with 3. Necessities (Essential Goods)
For essential items like medicine, people may buy them no
1. Law of Diminishing Marginal Utility
matter the price, because they need them to survive.
As people get more of a good, they enjoy each extra unit less.
Example:
So, they will only buy more if the price is lower.
If the price of insulin goes up, diabetic patients will still buy it
Example: First bottle of water when you’re thirsty feels great.
because they must have it.
The second is okay. The third? You’ll only drink it if it’s cheap.
4. Future Price Expectations
2. Substitution Effect
If people expect prices to go even higher in the future, they
When a product’s price drops, it becomes cheaper than other
may buy more now—even if the current price is already rising.
similar products, so people switch to it.
Example: If apples become cheaper than oranges, more Example:
people will buy apples instead. If people think petrol prices will rise more next week, they may
fill their tank today—even if the price is already high.
3. Income Effect
5. Fear of Shortage / Panic Buying
A lower price means people can afford more with the
same income. It feels like they are richer. In emergencies or during panic (like a lockdown), people buy
Example: If movie tickets get cheaper, you can go to the more—even when prices are high—because they fear
products will run out.
movies more often with the same amount of money.
Example:
4. New Buyers Enter the Market
Toilet paper or hand sanitizer during COVID-19. People rushed
When prices go down, more people can afford the product. to buy them at any price.
So, demand increases.
6. Ignorance
Example: A laptop that costs $500 may be too expensive for
some. But if it drops to $300, more people might buy it. Sometimes consumers don’t know the actual price or value,
so they assume higher price = better quality and buy more.
5. Bulk Buying or Stocking Up
Example:
When prices fall, people may buy more than they need now, to
A person may buy a ₹2000 perfume over a ₹500 one just
save money later.
thinking it’s better—even if the cheaper one is actually nice.
Example: If shampoo is on sale, people might buy 2 or 3
bottles instead of one. In Summary:
6. Attractive Deals and Discounts The law of demand says price ↑ → demand ↓, but these are
exceptions:
Lower prices make products more attractive. People may buy
more just because it’s a good deal. ❖ Giffen Goods
Example: “Buy one, get one free” offers make people buy even ❖ Veblen Goods
if they weren’t planning to.
❖ Necessities
7. Psychological Impact
❖ Future price expectations
People feel better buying something cheaper. So lower prices
can increase demand just because it "feels" like a smart ❖ Panic buying
decision. ❖ Ignorance about value
Example: A t-shirt at ₹400 feels more worth buying than the
same one at ₹800.
V. Elasticity of demand
IV. Exception of Law of Demand Elasticity of demand measures how much the quantity
demanded of a good or service changes in response to a

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change in price, income, or the price of related goods. It helps 7. Durability of the Product
businesses and policymakers understand consumer behavior ❖ Explanation:
and make better decisions.
Durable goods (like electronics or cars) tend to have more
Factors Affecting Elasticity of Demand elastic demand because people can delay purchases.
Elasticity of demand is influenced by several key factors that ❖ Example:
determine how sensitive consumers are to changes in price. If the price of a TV goes up, people might wait for a sale or
Here are the main ones: delay buying it, so demand is more elastic.
1. Availability of Substitutes Supply
❖ Explanation:  Supply (Curve, schedule with examples)
 Factors affecting Supply
If there are many close substitutes, consumers can easily
 Exception of Law of Supply
switch when the price changes, making demand more  Elasticity of supply (Definition, factors affecting, measurement of price
elastic. elasticity)

❖ Example:
If the price of Pepsi rises, people can switch to Coca- I. Supply
Cola. So, Pepsi has elastic demand.
The willingness and ability of sellers to produce and offer to
2. Necessity vs. Luxury sell different quantities of a good at different prices during a
❖ Explanation: specific period.
Necessities tend to have inelastic demand, while luxury Factors affecting Supply
goods have more elastic demand.
Great! Here's a clear and organized explanation of the factors
❖ Example: affecting supply, along with examples:
Insulin (a necessity for diabetics) has inelastic demand,
while a luxury car has elastic demand—people can Factors Affecting Supply
postpone buying or choose not to. Supply refers to the quantity of a good or service that
3. Proportion of Income Spent producers are willing and able to offer for sale at different
prices over a period of time. Several factors influence this:
❖ Explanation:
Goods that take up a large portion of income are more 1. Price of the Good
elastic; people are more sensitive to price changes. ❖ Explanation:
❖ Example: Generally, as the price of a good increases, the quantity
A price increase in housing will significantly affect supplied increases (and vice versa).
demand (more elastic), but a price increase in salt won't ❖ Example:
(more inelastic). If the price of wheat rises, farmers are likely to supply
4. Time Period more wheat to earn more profit.

❖ Explanation: 2. Cost of Production

Demand is usually more elastic over the long run than the ❖ Explanation:
short run, as people have more time to adjust their If production costs (like wages, raw materials, electricity)
behavior. rise, supply may decrease because it becomes less
❖ Example: profitable.
If fuel prices rise, in the short run people may keep using ❖ Example:
their cars (inelastic), but in the long run they might switch If the price of steel increases, car manufacturers may
to public transport or buy electric cars (more elastic). reduce car production due to higher costs.
5. Habitual Consumption 3. Technology
❖ Explanation: ❖ Explanation:
Goods that are habit-forming or addictive tend to have Advances in technology can make production more
inelastic demand. efficient, increasing supply.
❖ Example: ❖ Example:
Cigarettes and alcohol—people may continue buying New machinery in a textile factory can speed up cloth
even if prices rise. production, increasing the supply of clothes.
6. Definition of the Market 4. Prices of Related Goods
❖ Explanation: ❖ Explanation:
The broader the definition of a good, the more inelastic If the price of an alternative product increases, producers
the demand; narrower categories are more elastic. might switch to producing that instead.
❖ Example: ❖ Example:
"Food" as a whole has inelastic demand, but "ice cream" A farmer may switch from growing rice to maize if maize
may have elastic demand because there are many becomes more profitable, reducing the supply of rice.
alternatives.
5. Government Policies
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 ❖ Explanation: ❖ Example:
Taxes can reduce supply by increasing costs, while A bakery can easily bake more bread if flour and workers
subsidies can encourage more production. are available—so supply is more elastic.
❖ Example: 3. Mobility of Factors of Production
A subsidy for solar panel manufacturers may lead to an
❖ Explanation:
increase in the supply of solar panels.
If factors like labor and capital can be moved from one
6. Natural Factors use to another quickly, supply is more elastic.
❖ Explanation: ❖ Example:
Weather, natural disasters, or pests can affect the supply If workers can easily shift from making clothes to making
of agricultural and natural products. shoes, shoe supply can respond faster to price changes.
❖ Example: 4. Nature of the Product
A drought can reduce the supply of crops like sugarcane
❖ Explanation:
or wheat.
Perishable goods or items that take a long time to produce
7. Number of Sellers tend to have inelastic supply.
❖ Explanation: ❖ Example:
More sellers in the market usually mean a higher overall A mango tree takes years to grow—so mango supply can’t
supply. quickly respond to price changes.
❖ Example: 5. Level of Spare Capacity
If new companies start producing smartphones, the total ❖ Explanation:
supply of smartphones will increase.
Firms with unused capacity (like idle machines or extra
8. Expectations of Future Prices workers) can increase supply more easily—making
supply more elastic.
❖ Explanation:
If producers expect higher prices in the future, they may ❖ Example:
withhold current supply. A factory running below full capacity can quickly boost
production if prices rise.
❖ Example:
Oil producers might store oil instead of selling if they 6. Stock Levels (Inventories)
expect prices to rise.
❖ Explanation:
If a firm has a lot of goods in storage, it can quickly release
II. Definition of Elasticity of Supply them into the market when prices rise.

Elasticity of supply measures the responsiveness of the ❖ Example:

quantity supplied of a good or service to a change in its A company with warehouses full of t-shirts can instantly
price, while keeping other factors constant. increase supply when t-shirt prices go up.
Formula: 7. Technological Advancement
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒔𝒖𝒑𝒑𝒍𝒊𝒆𝒅 ❖ Explanation:
Elasticity of Supply (Es)= Better technology allows faster and more efficient
% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒔𝒖𝒑𝒑𝒍𝒚
production, increasing the elasticity of supply.
❖ Example:
Factors Affecting Elasticity of Supply
A textile mill with modern machines can increase output
Elasticity of supply tells us how quickly and easily producers quickly in response to price increases.
can respond to changes in price. Several factors influence this
Measurement of Elasticity of Supply (PED)
responsiveness:
1. Time Period Definition:

❖ Explanation: Price Elasticity of Supply (PES) measures the

Supply is usually more elastic in the long run than in the responsiveness of the quantity supplied of a good to a
short run because producers have more time to adjust. change in its price.

❖ Example:
A factory may not be able to increase production Formula:
overnight, but in a few months, it can buy more machines
% change in Quantity Supplied
and hire workers. 𝑬𝒔 =
% change in Price
2. Availability of Resources
Or:
❖ Explanation:
𝜟𝑸 𝑷
If inputs like raw materials or labor are easily available, 𝑬𝒔 = ×
firms can quickly increase supply when prices rise. 𝜟𝑷 𝑸
Where:
❖ 𝛥𝑄 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑
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 ❖ 𝛥𝑃 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 Production is the process of combining various inputs (like
❖ 𝑃 = 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒 land, labor, capital, and entrepreneurship) to create goods
and services that satisfy human wants.
❖ 𝑄 = 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑
In Simple Terms:
Methods of Measuring (𝑬𝒔 ):
Production means creating utility—by transforming raw
1. Percentage Method materials into usable products or services.
❖ Based on percentage changes in quantity and price. Example:
❖ Most common and basic method. Turning cotton into cloth, or using ingredients to bake a cake,
% change in 𝑸𝒔 are both examples of production.
𝑬𝒔 =
% change in Price Formula:
2. Point Method 𝑸 = 𝑭 (𝑳, 𝑲)
❖ Used when the change in price is very small. Factors of Production with examples
❖ Measures elasticity at a specific point on the supply 1. Land
curve.
Definition: All natural resources used in production (soil,
𝒅𝑸 𝑷 minerals, water, etc.).
𝑬𝒔 𝑎𝑡 𝑎 𝑝𝑜𝑖𝑛𝑡 = ×
𝒅𝑷 𝑸 Example: A farmer’s plot of arable land used to grow wheat.
2 3. Arc Method 2. Labor
❖ Used to measure elasticity between two points on the Definition: Human effort—physical and mental—used to
supply curve. produce goods and services.
❖ More accurate for larger changes in price. Example: Factory workers assembling smartphones.
𝜟𝑸 𝑷𝟏 + 𝑷𝟐 3. Capital
𝑬𝒔 = ×
𝜟𝑷 𝑸𝟏 + 𝑸𝟐 Definition: Man-made inputs used in production: machinery,
Types of Price Elasticity of Supply: buildings, tools, vehicles.
Example: A bakery’s ovens and mixers.
Value of 4. Entrepreneurship
Type Description
PES
Definition: The ability and willingness to combine land, labor,
Perfectly Inelastic Quantity supplied does not and capital, take risks, and innovate.
PES = 0
Supply change at all Example: A tech founder launching a new app and organizing
its team.
Relatively Quantity supplied changes
PES < 1
Inelastic Supply less than price
II. Short-run and long-run production
Unitary Elastic Quantity supplied changes
PES = 1 Definitions
Supply exactly as price
Short-run Production
Relatively Elastic Quantity supplied changes
PES > 1 In the short run, at least one factor of production is fixed,
Supply more than price
while others (like labor) can be varied to increase output.
Perfectly Elastic Small change in price ❖ Example: A factory can hire more workers but cannot
PES = ∞
Supply causes infinite change expand the building size immediately.
Long-run Production
Example: In the long run, all factors of production are variable,
meaning firms can adjust all inputs, including capital and
If the price of a good increases by 10% and the quantity
land.
supplied increases by 20%:
𝟐𝟎% ❖ Example: A company can build a bigger factory and buy
𝑬𝒔 = =𝟐 new machines to increase production.
𝟏𝟎%
→ Supply is relatively elastic. Differences Between Short-run and Long-run Production

Production Point of
Short-run Long-run
 Definition: Production, factors of Production with examples Difference
 Short-run and long-run production (Definition, difference)
 Total Product (TP), Marginal Product (MP) and Average Product (AP) Period with at least Period where all
Meaning
(Definition, Graphically representation, relationship between) one fixed input inputs are variable

I. Production

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Point of ❖ TP = Total Product
Short-run Long-run
Difference ❖ L = Units of Labor
Limited – only some Full flexibility – all
Flexibility inputs can be inputs can be It shows the efficiency or productivity per worker.
changed changed

Plant Size Fixed Can be changed

Entry and Exit Firms can enter or

Not easy
of Firms exit freely

Can change scale

Scale of Cannot change scale
(expand or reduce
Production (only intensity)
size)

Time Frame Relatively short Relatively long

Hiring more workers Building a new, Key Relationships:

Example
but same factory size larger factory
Situation TP MP AP

When MP is Increasing
III. TP, MP AP Rising Rising
rising faster
Total Product (TP)
When MP > AP Increasing Above AP Rising
Definition:
Equal to AP is at
Total Product refers to the total quantity of output produced When MP = AP Increasing
AP maximum
by a firm using a given amount of input (usually labor) over a
certain period of time, while keeping all other factors Increasing
When MP < AP Below AP Falling
constant. slowly
Formula: TP is at
When MP = 0 Zero Falling
maximum
𝑻𝑷 = ∑ 𝑶𝒖𝒕𝒑𝒖𝒕 𝒑𝒓𝒐𝒅𝒖𝒄𝒆𝒅 𝒃𝒚 𝒂𝒍𝒍 𝒖𝒏𝒊𝒕𝒔 𝒐𝒇 𝒍𝒂𝒃𝒐𝒓

Or simply: TP = Total Output When MP is

TP falls Negative Falling
negative
It shows the overall productivity level of the input used.
Marginal Product (MP)
Utility
Definition:
 Cardinal and Ordinal Utility Approach (Definition, key assumptions,
Marginal Product is the additional output that results from how does one differ from other)
employing one more unit of a variable input (typically labor),  Real world example of consumer behavior of both approach.
while keeping all other inputs fixed.
Formula:
I. Cardinal and Ordinal Utility Approach
𝚫TP 1. Cardinal Utility Approach
𝑴𝑷 =
𝚫L Definition:
Where:
The Cardinal Utility Approach assumes that utility can be
❖ ΔTP = Change in Total Product measured in exact numerical terms (like 1, 10, 100 utils). It’s
❖ ΔL = Change in Labor (usually 1 unit) mainly associated with economist Alfred Marshall.
It tells us how productive the next unit of labor is. Key Assumptions:
Average Product (AP) 1. Utility is Measurable: Consumers can assign numerical
values to satisfaction.
Definition:
2. Constant Marginal Utility of Money: The value of money
Average Product is the output per unit of the variable input remains the same for the consumer.
(usually labor). It is calculated by dividing the Total Product
(TP) by the number of units of labor employed. 3. Independent Utilities: Utility derived from one good does
not affect the utility of another.
Formula:
4. Rational Consumer: The consumer aims to maximize
TP
𝑨𝑷 = total utility within a given income.
L
Where: 2. Ordinal Utility Approach

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 Definition: ❖ 4th bar: 5 utils
The Ordinal Utility Approach assumes that utility cannot be You stop after the 4th bar because the marginal utility drops
measured numerically but can be ranked. Consumers can too low, and you feel you’re no longer getting value.
only say which bundle is preferred over another, not by how
Consumer Behavior:
much. This approach was developed by J.R. Hicks and R.G.D.
Allen. You are measuring your satisfaction and deciding when to
stop buying based on numerical utility values. This reflects
Key Assumptions:
the Law of Diminishing Marginal Utility, a core part of the
❖ Utility is Not Measurable: Only preferences or rankings cardinal approach.
are possible (e.g., A > B). 2. Ordinal Utility Approach – Real World Example
❖ Indifference Curve Analysis: Consumer choices are
Example: Choosing Outfits
represented using indifference curves.
You visit an online clothing store and see three outfits:
❖ Rational Behavior: Consumers aim to maximize
satisfaction. ❖ Outfit A: Formal suit
❖ Diminishing Marginal Rate of Substitution (MRS): As ❖ Outfit B: Casual wear
you consume more of one good, you’re willing to give up ❖ Outfit C: Sportswear
less of another.
You can’t assign numbers to how much you like each, but you
❖ Completeness and Transitivity of Preferences: rank them:
 Completeness: Consumer can compare and rank ❖ You prefer A over B, and B over C, so your ranking is: A >
bundles. B > C.
 Transitivity: If A > B and B > C, then A > C. You then choose Outfit A, because it gives you the highest
Differences Between Cardinal and Ordinal Utility satisfaction based on your personal preference.

Basis Cardinal Utility Ordinal Utility Consumer Behavior:

Here, you are not quantifying utility. You are simply ranking
Utility Measurable in Not measurable, only options based on satisfaction, which is the essence of the
Measurement numbers (e.g., 20 rankable ordinal approach.
utils)
Quick Comparison in Action:
Developed By Alfred Marshall Hicks and Allen
Cardinal
Situation Ordinal Example
Method Used Law of Indifference Curve Example
Diminishing Analysis
Marginal Utility Choosing soft “Coke gives me 30 “I prefer Coke over
drinks utils, Pepsi 25.” Pepsi.”
Assumptions Constant marginal Diminishing marginal
utility of money rate of substitution Choosing lunch “Burger = 50 utils, “I like burgers more
options Pizza = 40 utils.” than pizza.”
Consumer Maximizes total Maximizes
Behavior utility satisfaction using Deciding how Choose the best
Stop at the point
preference ranking much to bundle from your
where MU = price
consume budget
Practicality More theoretical, More realistic and
less realistic widely accepted

II. Real world example

Absolutely! Let’s look at real-world examples that illustrate
how consumers behave under both the Cardinal Utility
Approach and the Ordinal Utility Approach:
1. Cardinal Utility Approach – Real World Example
Example: Choosing Chocolate Bars
Imagine you go to a store and buy chocolate bars. You assign
specific utility values to each bar based on how much
satisfaction it gives you:
❖ 1st bar: 20 utils
❖ 2nd bar: 15 utils
❖ 3rd bar: 10 utils

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