NCERT NOTES

ECONOMICS
12th Standard

Introductory
Microeconomics

1.

 Content Sheet

1. Introduction 3
2. Theory of Consumer Behaviour 5
3. Production and Costs 8
4. The Theory of the Firm under Perfect Competition 10
5. Market Equilibrium 12
6. Non-Competitive Markets 14
Content Sheet

2.
 1 Introduction

Chapter 1
Resources with the society are scarce, the production possibility set of the
when compared to the needs of various economy.
goods and services. Because of the
scarcity of resources, it is crucial to Production Possibility Frontier:
allocate resources efficiently. yy It is a point in the curve that shows the
maximum amount of a good that can be
Central Problems of an Economy: produced in the economy for any given
Production, exchange and consumption amount of another good and vice-versa.
of goods and services are among the yy The production possibility frontier gives
basic economic activities of life. In the the combinations of goods that can be
course of these activities, every society produced when the resources of the
face scarcity of resources which gives economy are fully utilised.
rise to the various economic problems.
The central economic problems of an
economy are very often summarised as
follows:
yy Every society must decide on how much
of each of the many possible goods and
services it will produce. For example,
whether to produce more of food,
clothing, housing or to have more of Fig 1.1: Production possibility frontier (for cotton
luxury goods. and corn)
yy Every society has to decide on how
much of which of the resources to yy In this above figure, AE represents the
use in the production of each of production possibility curve which
the different goods and services. shows the various combinations of the
For example, whether to use more two goods (e.g., Cotton and Corn) which
labour or more machines. the economy can produce with a given
yy The society has to decide who gets how number of resources.
much of the goods that are produced in yy A point lying strictly below the
the economy. production possibility frontier
yy How should the produce of the economy represents a combination of goods that
be distributed among the individuals in will be produced when all or some of the
the economy. resources are either underemployed or
yy In addition, the choice between public are utilised in a wasteful fashion.
and private goods.
The collection of all possible Opportunity Cost:
combinations of the goods and services yy It is also called economic cost.
that can be produced from a given yy It is the cost of having a little more of
Introduction

number of resources and a given stock one good in terms of the amount of the
of technological knowledge is called other good that has to be forgone.

3.
Chapter 1

yy Simply, the opportunity costs of a yy All goods or services come with a price
product are only the best alternative which is mutually agreed upon by the
forgone and not any other alternative. buyers and sellers and at which the
exchanges take place.
Organization of Economic Activities yy In a market economy, the price
reflects society’s valuation of the good
Centrally Planned Economy: or service. Therefore, if the buyers
yy In a centrally planned economy, the demand more of a certain good, the
government or the central authority price of that good will rise and vice
plans all the important activities in the versa.
economy. yy Moreover, the price and consumer
yy All important decisions regarding demand for goods or services are the
production, exchange and consumption important determinant of production in
of goods and services are made by the a market economy.
government. Today, most of the economies are mixed
yy The central authority decides allocation economies where some important
of resources and a consequent decisions are taken by the government
distribution of the final combination of and the economic activities are by
goods and services. and large conducted through the
yy The government is also responsible for market.
the equitable distribution of the final Since Independence, the Government of
mix of goods and services. India has played a major role in planning
economic activities. However, the role of
Market Economy: the government in the Indian economy
yy In a market economy, all economic activ- has been reduced considerably in the
ities are organised through the market. last couple of decades.
Introduction

4.
 2 Theory of Consumer Behaviour

Chapter 2
Consumer behaviour is referred to the commodity, the desire of the consumer
study which analyses how consumers to have still more of it becomes weaker.
make decisions when obtaining various
goods and services. It also studies Law of Diminishing Marginal Utility:
various factors that influence consumers yy It states that marginal utility from
decisions. Therefore, understanding consuming each additional unit of a
the behaviour of consumers is crucial commodity declines as its consumption
to analyse the potential consumers increases, while keeping consumption
towards a new product or service. of other commodities constant.
yy Marginal utility (MU) becomes zero at
Important terms related to Consumer a level when total utility (TU) remains
Behaviour constant. In the example, TU does not
Utility: change at 5th unit of consumption and
yy Utility of a commodity is its want therefore MU5 = 0. Thereafter, TU starts
satisfying capacity. A consumer usually falling and MU becomes negative.
decides his demand for a commodity on
the basis of utility (or satisfaction) that
he derives from it.
yy The more the need of a commodity or
the stronger the desire to have it, the
greater is the utility derived from the
commodity.
yy Utility is subjective. Different individuals
can get different levels of utility from
the same commodity.
Fig 2.1: Diminishing marginal utility curve
yy Total Utility: Total satisfaction derived
from consuming the given amount of
some commodity. Indifference Curve:
yy An indifference curve is a graph which
Marginal Utility: shows combination of two goods that
yy It is the change in total utility due to give the consumer equal satisfaction
consumption of one additional unit of a and utility.
commodity. yy Quantitative measure of utility is
Theory of Consumer Behaviour

yy Total utility can be derived from difficult. At the most, it can be ranked
marginal utility. Total utility is the in terms of having more or less utility
sum of marginal utility of number of in various alternative combinations of
commodities consumed. goods consumed.
yy The marginal utility diminishes with yy The indifference curve joins all points
increase in consumption of the representing the different bundles
commodity. This happens because of goods, in which the consumer is
having obtained some amount of the indifferent that is the total Utility

5.
Chapter 2

derived from each combination is the by the consumer is likely to change as

same. well.
yy Indifference curve slopes downward.
yy Higher indifference curve gives greater Demand Curve and the Law of Demand:
level of utility. yy The demand curve is a relation between
yy Two indifference curves never intersect the quantity of good chosen by a
each other. consumer and the price of the good. It
shows the quantity demanded by the
consumer at each price.
yy The amount of a good that the consumer
optimally chooses, becomes entirely
dependent on its price, if the prices of
other goods, the consumer’s income
and her tastes and preferences remain
unchanged.
yy The relation between the consumer’s
optimal choice of the quantity of a
good and its price is very important,
and this relation is called the demand
function.

Fig 2.2: Indifference curve

Marginal rate of Substitution:

yy It is defined as the rate at which a
consumer is ready to exchange one
good for another at the same level of
utility.
yy It is used to analyse the indifference Fig 2.3: Demand Curve
curve.
Theory of Consumer Behaviour

Demand: yy The Law of Demand states that when

The quantity of a commodity that a price of the commodity increases,
consumer is willing to buy and is able demand for it falls and when price of
to afford, given prices of goods and the commodity decreases, demand for
consumer’s tastes and preferences is it rises, other factors such as consumer
called demand for the commodity. taste and preferences, income, etc
Whenever one or more of these variables remaining the same. The law of demand
change, the quantity of the good chosen signifies that there is a negative

6.
 Chapter 2
relationship between the demand for a increase in price of tea may reduce the
commodity and its price. demand for sugar as well.
The quantity of a good that the consumer
demands can increase or decrease
with the rise in income depending on Substitutes: The goods which are
the nature of the good. Goods can be not consumed with each other
further classified into: like tea and coffee. Here, the
yy Normal Goods: For most of the goods, demand for a good moves in the
the quantity that a consumer chooses to same direction of the price of its
consume increases as the consumer’s substitute good. Put simply, an
income increases and decreases as the increase in the price of coffee may
consumer’s income decreases. Such drive consumers to consumer
goods are called normal goods. The more tea instead of coffee.
demand for a normal good, moves in
the same direction as the consumer’s
income. Elasticity of Demand:
yy Inferior Goods: For Items like low yy Price elasticity of demand is a measure
quality food, coarse cereals etc. the of the responsiveness of the demand
demand for them decreases as the for a good to changes in its price. It
income of the consumer increases, due is defined as the percentage change
to now attained better affordability. in demand for the good divided by the
Demand for an Inferior Good moves in percentage change in its price.
the opposite direction of the income of yy When the percentage change in quantity
the consumer. demanded is less than the percentage
yy Giffen Goods: It refers to a good that change in market price, the demand for
people consume more of as the price the good is said to be inelastic at that
rises. The demand for such a good price. Demand for essential goods is
can be inversely or positively related often found to be inelastic.
to its price. If the good can easily be yy When the percentage change in quantity
substituted then the demand would demanded is more than the percentage
remain inversely related, however in change in market price, the demand is
a scenario where substitution cannot said to be highly responsive to changes
work in line with income change, the in market price. The demand for the
Theory of Consumer Behaviour

demand of such a good would be good is said to be elastic at that price.

positively related to its price. Demand for luxury goods is often found
yy Complementary Goods: These are to be elastic.
those goods which are used together, yy When the percentage change in quantity
in compliment to each other like Tea demanded equals the percentage
and Sugar. Here, the demand for a good change in its market price, the demand
move in the opposite direction of the for the good is said to be Unitary-elastic
price of its complementary goods. The at that price.

7.
 3 Production and Costs
Chapter 3

Production is the process by which yy Long Run: All factors of production can
inputs are transformed into ‘output’. be varied, due to the long time frame
Production is carried out by producers being considered. There is no fixed
or firms. A firm uses different factors factor in this concept.
of production (inputs) such as land,
labour, machines, raw materials etc. Other Important Terms related to
to produce output. This output can be Production:
consumed by consumers or used by yy Total Product (TP): It is a relationship
other firms for further production. between the variable input and
output. Total product is the output
However, to acquire inputs a firm has received at a particular level of the
to pay for them. This is called the cost Variable Input, keeping all other factors
of production. Once output has been constant.
produced, the firm sell it in the market yy Average product (AP): It is defined as
and earns revenue. The difference the output per unit of variable input.
between the revenue and cost is called yy Marginal product of an input (MP): It
the firm’s profit. is defined as the change in output per
unit of change in the input when all
Production Function: other inputs are held constant. For any
yy It is a relationship between inputs used level of an input, the sum of marginal
and output produced by the firm. products of every preceding unit of that
yy It gives an idea about the maximum input gives the total product.
quantity of output that can be produced yy Law of Variable Proportions: It is defined
for various quantities of inputs used. as Marginal Product of a variable factor
yy It is defined for a given technology. If input initially rises with its input level
the technology improves, the maximum but after reaching a certain level of
levels of output obtainable for different employment, it starts falling.
input combinations increase. We then
have a new production function.

Time concepts in Production:

yy Short Run: In short run, at least one of
the factors: labour or capital – cannot
be varied, and therefore, remains fixed.
Therefore, to vary the output level, the
firm can vary only the other factor. The
Production and Costs

factor that remains fixed is called the

fixed factor whereas the other factor
which the firm can vary is called the
variable factor. Fig 3.1: Curve (TP, AP and MP)

8.
 Chapter 3
Beyond a certain point, the production yy Total Fixed Cost: In the short run, some
process becomes too crowded with the of the factors of production cannot be
variable input and further effectiveness varied, and therefore, remain fixed. The
can only be attained by enhancing the cost that a firm incurs to employ fixed
fixed input. However, this is a Short inputs is called the total fixed cost.
Run concept as in the Long Run all the yy Total Variable Cost: To produce any
factors are Variable. required level of output, the firm, in
the short run, can adjust only variable
Returns to Scale: inputs. Accordingly, the cost that a firm
yy It is the quantitative change in output incurs to employ these variable inputs
of a firm resulting from a proportionate is called the total variable cost (TVC).
increase in all inputs.
yy When a proportional increase in all
inputs results in an increase in output Key points:
by the same proportion, the production yy Total cost of a firm is the sum of
function shows a Constant Return to fixed and variable cost.
Scale (CRS). yy In order to increase the production
yy When a proportional increase in all or output, the firm must employ
inputs results in an increase in output more of the variable inputs. As
by a larger proportion, the production a result, total variable cost and
function is said to display Increasing total cost will increase. Therefore,
Returns to Scale (IRS). as output increases, total variable
yy Decreasing Returns to Scale (DRS) holds cost, and total cost increase.
when a proportional increase in all
inputs results in an increase in output
by a smaller proportion. yy Short Run Average Cost: It is defined
as the total cost per unit of output. At
Costs: zero output, short run average cost is
Cost is the monetary value of all undefined.
the expenditures for raw materials, yy Short Run Marginal Cost: It is defined
equipment, labours, etc. required to as the change in total cost per unit of
produce goods and services. For every change in output.
level of output, the firm chooses the yy Average Variable Cost: It is defined as
least cost input combination in order the total variable cost per unit of output
to achieve price competitiveness and to in short term production. If the price of a
maximise profit. good is higher than the average variable
Production and Costs

Thus, the cost function describes the cost of the good, the firm is covering
least cost of producing each level all the variable costs and a percentage
of output given prices of factors of of the fixed costs. In this case, firms
production and technology. continue production.

9.
 4 The Theory of the Firm under
Perfect Competition
Chapter 4

Every firm works in varied kinds of Supply Curve of a Firm:

environments. One such environment yy A firm’s ‘supply’ is the quantity that it
is that of perfect competition. Perfect chooses to sell at a given price, given
competition describes a market technology, and given the prices of
structure where competition is at its factors of production.
greatest possible level. yy The supply curve of a firm shows the
levels of output (plotted on the X-axis)
Features of Perfect Competition: that the firm chooses to produce
yy The market consists of a large number corresponding to different values of the
of buyers and sellers.
yy No individual buyer or seller can
influence the market by their size.
yy Each firm selling a homogeneous
product (i.e., the products cannot be
differentiated).
yy Entry and exit into the market are free
for the firms.
yy Perfect flow of information, which
means both buyers and sellers are
perfectly informed about prices, quality,
and other market aspects.
Fig 4.1: Supply Curve
Price Taking Behaviour of the Perfect
Competitive Market: market price (plotted on the Y-axis),
yy A price taker is an individual buyer or again keeping technology and prices of
seller who buy and sell products at
The Theory of the Firm under Perfect Competition

factors of production unchanged.

prevailing market price. yy When the supply curve is vertical, supply
yy A price-taking firm believes that if it is completely insensitive to price and the
sets a price above the market price, it elasticity of supply is zero. In other cases,
will be unable to sell any quantity of when supply curve is positively sloped,
the good that it produces. However, if it with a rise in price, supply rises and
set price which is less than or equal to hence, the elasticity of supply is positive.
market price; the firm can sell as many yy The quantity that the firms supply
units of the good as it wants to sell. at the given price level, can change
yy From a buyer end, a buyer will not without any corresponding change in
purchase any products from the seller the market price, due to the change in
if it sells at a price higher than the other factors, such as:
prevailing market price. ⚪⚪ Technological Progress: Improvement
in technology allows the firm to

10.
 Chapter 4
produce more output, from the same yy It measures the responsiveness of the
amount of input allowing to sell quantity of goods supplied in the market
more at the same market price. This with the changes in prices.
causes the curve to shift to the right yy If the supply of goods ceases completely
due to increase in supply. when the price of the goods drops
⚪⚪ Input Prices: Due to an increase the slightly, and the supply of the goods
input prices, the firm now sells less become infinite when there is even a
at the same Market Price, causing little increase in the price of the goods,
the supply curve to shift to the left the supply is said to be perfectly
and vice-versa in case of reduced elastic.
input prices. yy If supply does not get affected due to
change in price, the supply is said to be
Price Elasticity of Supply: perfectly inelastic.
yy It is the ratio of the percentage change yy If price of goods exactly equal to the
in quantity supplied to percentage supply of goods in the market, the
change in price. supply is said to unitary elastic.

The Theory of the Firm under Perfect Competition

11.
 5 Market Equilibrium
Chapter 5

Market equilibrium is a condition where

the demand and supply curve intersect
to set the market price and amount of
goods sold.

Market Equilibrium, Excess Demand

and Excess Supply
Equilibrium:
yy In equilibrium, the aggregate quantity
that all firms wish to sell equals the
quantity that all the consumers in the
market wish to buy.
Fig 5.1: Market equilibrium with fixed number of
yy If at a price, market supply is greater firms
than market demand, then there is an
excess supply in the market at that
price. On the contrary, if market demand
exceeds market supply at a price, it is
said that excess demand exists in the
market at that price.
yy Equilibrium in a perfectly competitive
market can be defined alternatively as
zero excess demand-zero excess supply
situation.
yy Whenever market supply is not equal to
market demand, and hence the market Fig 5.2: Shifts in demand from the equilibrium
point
is not in equilibrium, there will be a
tendency for the price to change.
yy In the below graph (Fig. 5.1), SS represents get disturbed and reaches to new
the market supply, DD represents the equilibrium point.
market demand and equilibrium point is yy In the above graph (Fig. 5.2), original
the point of intersection of DD and SS. Market Demand (DD0) shifts to the new
market demand (DD1). Due to which
Shift in Demand and Supply: the original equilibrium point E gets
yy The equilibrium points may shift if there disturbed, and a new equilibrium Point
is shift in the demand and supply curve. (Point F) is derived where the new and
yy The demand and supply curve may shift changed market demand now meets
upward or downward due to any change the market supply.
Market Equilibrium

in the factors like technology, consumer

Preferences etc. Market Equilibrium: Free Entry and Exit
yy Due to such shifts in demand or Under perfect competition, an
supply, the existing market equilibrium important feature being the free entry

12.
 Chapter 5
and exit firms, also has certain other yy However, due to the price ceiling the
implications. suppliers get discouraged to supply at a
yy In equilibrium, no firm earns supernormal price lower than the market determined
profit or incurs loss by remaining in equilibrium price. Moreover, the quantity
production (i.e., in other words, the they are willing to supply is lower than
equilibrium price will be equal to the quantity that the consumers want to
minimum average cost of the firms). consume.
yy If firms at the prevailing prices are able yy To tackle such situations, government
to earn Super Normal Profits, this case uses policies like rationing so that no
will attract new firms into the market, individual can buy more than a certain
and due to free entry, they would be amount. This stipulated amount, is the
able to do so easily and quickly. distributed through ration shops also
yy Due to new firms entering, the Market called Fair Price Shops.
Supply will increase, but the demand
remains constant due to which the Price Floor:
Market Price to fall, eventually wiping yy The lower limit imposed by the
out the super normal profits. Similarly, Government on the price that may be
in the scenario of Losses, certain firms charged for a particular good or service
will exit the market reducing the supply is called price floor.
and hence driving the Market Price up. yy This is used in areas like purchase price
yy Thus, with free entry and exit, each firm for agricultural Produce.
will always earn normal profit at the yy Government sets up an agricultural price
prevailing market price. support programme, to fix prices of the
produce above the market determined
Applications of Demand-Supply Analysis price.
Price Ceiling: yy Similarly, it also used to set a floor
yy The upper limit imposed by the wage rate which is above the market
Government on the price of a good or determined wage rate.
service is called Price Ceiling. yy This leads to excess supply situation in
yy It is generally imposed on necessary the market, and to prevent the prices
items like wheat, rice etc. as a large from falling as a result, the government
section of population may not be able needs to purchase the excess
to afford these items at the market supply and produce available in the
determined prices. market.
Market Equilibrium

13.
 6 Non-Competitive Markets
Chapter 6

Under perfect competition, both the yy Price of the commodity under perfect
buyers and sellers are price takers. competition is lower compared to
However, there exists other forms monopoly.
of market structures which may not yy The profit earned by the perfectly
satisfy one or more conditions of the competitive firm is also smaller
perfect competitive market. A market is compared to monopoly.
non-competitive when the firms acting yy The profits earned by the monopolistic
in such a market have the power to firms, do not go away in the long run,
influence the price, directly or indirectly. unlike in perfect competition.
yy In general sense, monopolies are
Monopoly: considered to be exploitative and
yy It is market structure in which there is a charge the consumers comparatively a
single seller or producer of a particular higher price.
commodity.
yy In monopoly, no other commodity works However, it is very difficult for such
as a substitute for this commodity. a monopoly to exist in the real word
yy To maintain the monopolistic nature of as substitutes for all commodities
the market sufficient restrictions are exist. New firms are taking up new
required to be in place to prevent any technologies and coming up with
other firm from entering the market and newer products in an ever-changing
to start selling the commodity. economy.
yy For a monopolistic firm, the price
depends on the quantity of the Oligopoly:
commodity sold as firm can sell a larger yy It is a market structure, where for a
quantity of the commodity only at a particular commodity there exist only a
lower price and vice versa. few sellers (more than one).
yy The firm can also decide the price at yy In oligopoly market, the product sold by
which it wishes to sell its commodity, the firms is homogenous.
and therefore, determines the quantity yy The special case of oligopoly where
to be sold. there are exactly two sellers is termed
duopoly.
Differences between Perfect yy In the oligopoly market each firm is
Competition and Monopoly: relatively large as compared to the size
yy Perfectly competitive market provides of the market.
production and sale of a larger quantity Each firm can affect the total supply
Non-Competitive Markets

yy
of the commodity compared to a in the market, and thus influence the
monopoly firm. market price.

14.
 Chapter 6
yy Any change in supply or price by one
firm can significantly impact all the Cartel: A cartel is an association of
other firms as well. manufacturers or suppliers formed
yy In oligopoly, firms can also act as to manipulate price of a particular
a “cartel” and create monopolistic product in order to maximise their
conditions. On the other hand, they profits and dominate the market.
can keep on undercutting each other’s
prices to attract more consumers.

Non-Competitive Markets

15.