Microeconomics for Business

Microeconomics for Business

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Microeconomics for Business

Satya P. Das

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Copyright © Satya P. Das, 2007

All rights reserved. No part of this book may be reproduced or utilised in any form or by any means,

electronic or mechanical, including photocopying, recording or by any information storage or

retrieval system, without permission in writing from the publisher.

First published in 2007 by

Sage Publications India Pvt Ltd

B 1/I1, Mohan Cooperative Industrial Area

Mathura Road, New Delhi 110 044

www.sagepub.in

Sage Publications Inc

2455 Teller Road

Thousand Oaks, California 91320

Sage Publications Ltd

1 Oliver’s Yard

55 City Road

London EC1Y1SP

Sage Publications Asia-Pacific Pte Ltd

33 Pekin Street

#02-01 Far East Square

Singapore 048763

Published by Vivek Mehra for Sage Publications India Pvt Ltd, typeset in 10/12 Palatino Roman by

Quick Sort (India) Private Limited, Chennai and printed at Chaman Enterprises, New Delhi.

Library of Congress Cataloging-in-Publication Data

Das, Satya P.

Microeconomics for business/Satya P. Das.

p. cm.

Includes bibliographical reference and index.

1. Managerial economics. 2. Microeconomics. 3. Managerial economics--India. I. Title.

HD30.22.D37 33.8—dc22 2007 2007035314

ISBN: 978-0-7619-3592-6 (PB) 978-81-7829-753-8 (India-PB)

The Sage Team: Sugata Ghosh, Samprati Pani and Mathew P.J.M.

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Dedicated to Sanghamitra, Arpita and Arup

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Contents

List of Figures 8

List of Tables 12

Foreword by J. K. Goyal 14

Preface 15

0. Setting Norms 17

1. Introduction 21

2. Demand 39

3. Supply 68

4. Consumer Behaviour 83

5. Applications of Consumer Theory 129

6. Demand Estimation and Forecasting 146

7. Demand for Assets 158

8. Types of Firms, their Goal and Production 176

9. Costs of Production and the Financing of a Firm 202

10. Profit-maximisation, Perfect Competition and the Supply Curve 217

11. Demand, Supply and Market Equilibrium 236

12. Optimality of a Competitive Market Structure, Market Failure and Corrective

Measures 267

13. Game Theory and Economic Applications 282

14. Monopoly 292

15. Monopolistic Competition and Oligopoly 316

16. Factor Markets 336

General Appendix 352

Partial Answers to Selected Questions 355

Index 365

About the Author 371

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List of Figures

1.1 The Production Possibility Curve 26

1.2 The PPC (Numerical Example 1.3) 29

1.3 Shift of the PPC 29

1.4 The PPCs before and after the Shifts (Numerical Example 1.4) 30

2.1 Demand Curves 42

2.2 Effect of an Increase in Income on Demand 44

2.3 Effect of an Increase in the Price of a Related Good 46

2.4 Market Demand Curve 49

2.5 Market Demand Curve in Numerical Example 2.2 51

2.6 Point Elasticity 55

2.7 Computing Point Elasticity 55

2.8 Unitarily Elastic, Perfectly Inelastic and Perfectly Elastic Demand 56

2.9 Comparing Demand Elasticities 58

2A.1 Deriving the Point Elasticity Formula 64

3.1 Supply Curve 70

3.2 An Input Price Increase and the Supply Curve 71

3.3 Technological Improvement and the Supply Curve 72

3.4 An Increase in the Price of a Substitute Good and the Supply Curve 72

3.5 Market Supply Curve 74

3.6 Point Elasticity of Straight Line Supply Curve 76

3.7 Unitarily Elastic Supply Curves 77

3.8 Special Cases 77

3.9 Point Elasticity of a General Supply Curve 78

3.10 Comparing Supply Elasticities 78

4.1 Total Utility and Marginal Utility Curves 85

4.2 Optimal Purchase Rule 89

4.3 The Demand Curve 90

4.4 Indifference Curve 94

4.5 Various Indifference Curves 95

4.6 An Indifference Map 96

4.7 Special Cases 96

4.8 Marginal Rate of Substitution 98

4.9 Indifference Curve with an Economic ‘Bad’ 99

4.10 Some Properties of Indifference Curves 100

4.11 Price Line 104

4.12 Consumer’s Equilibrium 106

4.13 Corner Solution 109

4.14 Income Effect 112

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4.15 Income Consumption Curves 112

4.16 Engel Curves 113

4.17 Price Effect 114

4.18 Hicksian Substitution Effect 115

4.19 Inferior Good 116

4.20 Slutsky’s Substitution Effect 118

4.21 Price Consumption Curves 119

4.22 Deriving Demand Curve from the Price Consumption Curve 120

4.23 Composite Good 122

4.24 Substitution Effect in the Revealed Preference Approach 123

5.1 Consumer Surplus 131

5.2 Consumer Surplus Calculation (Numerical Example 5.1) 132

5.3 Cash versus Kind Subsidy 133

5.4 Direct versus Indirect Taxes 136

5.5 Budget 138

5.6 Effect of an Interest Rate Increase on the Budget Line 139

5.7 Consumer’s Equilibrium 140

5.8 Interest Rate Increase Affecting a Borrower 142

5.9 Interest Rate Increase Affecting a Lender 143

6.1 Scatter Diagram 148

6.2 The Regression Line 149

6.3 Scatter Diagram Showing a Positive Relationship 150

6.4 Time-series of Total Number of Refrigerators Sold in India 153

7.1 A Share Certificate 168

7.2 A Bond Certificate 170

7.3 A Mutual Fund Certificate 172

8.1 The Total Physical Product Curve Corresponding to Table 8.2 182

8.2 Marginal Physical Product Curve and Average Physical Product

Corresponding to Table 8.3 183

8.3 Smooth TPP, MPP and APP Curves 184

8.4 TPP, MPP and APP Curves in a Single Graph 185

8.5 An Isoquant 190

8.6 Special Cases of Isoquants 191

8.7 An Iso-cost Line 193

8.8 Cost Minimisation 194

8.9 An Input Price Change 195

8.10 An Increase in Output 196

8.11 Expansion Path 196

9.1 TFC, TVC and TC Curves 204

9.2 MC, AVC and ATC Curves 205

9.3 An Increase in the Plant Size 208

9.4 Long-run Total Cost Curve 209

9.5 Long-run Average and Marginal Cost Curves 209

9.6 The Short-run and the Long-run Cost Curve 211

9.7 The Private and Social Costs 212

List of Figures 9

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10.1 The Total Revenue Curve 220

10.2 The Price Line 221

10.3 Profit-maximisation by a Competitive Firm 221

10.4 Profit-maximisation Once Again 222

10.5 Profits, Losses and the Shut-down Condition 224

10.6 Supply Curve in the Market Period 227

10.7 Long-run Competitive Equilibrium 228

10.8 Short-run versus Long-run Supply Curve 229

10.9 Long-run Market Supply Curve with Entry and Exit 231

11.1 Market Equilibrium 238

11.2 Marshallian Stability 239

11.3 A Non-sustainable Industry 240

11.4 Effects of Demand Shifts 242

11.5 Effects of Supply Shifts 243

11.6 Effects of a Simultaneous Increase in Demand and Decrease in Supply 244

11.7 Sales Tax and the Shift of the Demand Curve 248

11.8 Sharing of a Sales Tax Burden 249

11.9 Elasticity and Sales Tax Burden 250

11.10 The Currency Market 252

11.11 FAD Theory of Famines 254

11.12 Sen’s Distribution Theory of Famines 256

11.13 Control Price and Support Price 259

12.1 Measuring Social Welfare 269

12.2 A Negative Externality 271

12.3 Negative Externality and the Pigovian Tax 272

12.4 Pigovian Tax Once Again 272

12.5 Non-rivalry of Public Goods and Market Failure 275

13.1 Location of Ice-cream Vendors 283

14.1 TR, AR and MR Corresponding to Table 14.2 300

14.2 General TR, AR and MR Curves 301

14.3 Profit-maximisation by a Monopoly Firm 301

14.4 Profit-maximisation by a Monopolist Once Again 302

14.5 Monopoly Equilibrium when AC = MC 303

14.6 Regulating a Natural Monopolist 311

15.1 Monopolistic Competition in the Short Run 318

15.2 A Monopolistically Competitive Industry in the Long Run 318

15.3 The Kinked Demand Curve Model 321

15.4 Market Price in the Cournot Model 323

15.5 Output Choice in Cournot Duopoly 323

15.6 Best Response Curves 324

15.7 Nash Equilibrium in Quantity Competition 325

15.8 Changes in Parameters 326

15.9 Bertrand Price Competition 327

15.10 Cartel Problems 330

16.1 Factor Price Line 338

10 Microeconomics for Business

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16.2 The VMP Curve 340

16.3 Factor Employment Decision 340

16.4 Product Price Increase and Factor Demand 343

16.5 Technological Change and Factor Demand 344

16.6 Demand, Supply and Market Equilibrium for a Particular Skill 347

16.7 Labour Unions and Unemployment 348

16.8 Land Rent 349

A.1 Maximisation and Minimisation of a Function 353

List of Figures 11

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List of Tables

1.1 Production Possibilities 25

1.2 Marginal Opportunity Cost along the PPC 27

1.3 Production Possibility Combinations (Numerical Example 1.3) 28

1.4 Marginal Opportunity Cost (Numerical Example 1.3) 28

1.5 Table for Numerical Example 1.4 31

2.1 Demand for Ice-cream by Sunita during Summer Months 42

2.2 Original Market Demand Schedule of Mr Yamada (Numerical Example 2.1) 45

2.3 Mr Yamada’s Demand after an Increase in Income (Numerical Example 2.1) 45

2.4 Individual Demand Schedules (Numerical Example 2.2) 50

2.5 Market Demand Schedule (Numerical Example 2.2) 51

2.6 Price Change and Its Impact on Total Expenditure 59

3.1 A Supply Schedule 69

3.2 Table for Numerical Example 3.1 71

4.1 Total Utility 85

4.2 Utilities in Terms of Rupees 86

4.3 Marginal Utility (Numerical Example 4.1) 87

4.4 Total Utility (Numerical Example 4.1) 87

4.5 Marginal Utility in Terms of Money (Numerical Example 4.1) 87

4.6 Total Utility (Numerical Example 4.3) 91

4.7 Marginal Utilities (Numerical Example 4.3) 91

4.8 Bundles between which the Consumer is Indifferent 93

4.9 An Indifference Schedule 97

4.10 Marginal Rate of Substitution (Numerical Example 4.4) 98

4.11 Bundles that Ravi can Buy, Given Prices and His Income 103

4.12 Table for Numerical Example 4.5 106

6.1 Price–Quantity Sold Data 148

7.1 Benefits and Costs 163

8.1 Production Function 180

8.2 A Total Physical Product 182

8.3 Marginal Physical and Average Physical Schedules 183

8.4 MPP Schedule (Numerical Example 8.1) 187

8.5 TPP and APP Schedules (Numerical Example 8.1) 188

8.6 Production Functions (Numerical Example 8.2) 192

8.7 MRTSs (Numerical Example 8.2) 192

8.8 Cost Minimisation along the Isoquant U 198

9.1 MC Schedule (Numerical Example 9.1) 206

9.2 TC and TVC Schedules (Numerical Example 9.1) 206

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10.1 Short-run Total Cost Schedule (Numerical Example 10.2) 225

10.2 Short-run Marginal Cost Schedule (Numerical Example 10.3) 226

10.3 Long-run Marginal Cost Schedule (Numerical Example 10.4) 232

10.4 Market Demand Schedule (Numerical Example 10.4) 232

10.5 Long-run Average Cost Schedule (Numerical Example 10.4) 233

11.1 Effects of Demand and Supply Shifts 244

13.1 Payoffs in the Prisoners’ Dilemma Game 285

13.2 Advertising Game 286

13.3 Payoffs in the Trade Policy Game 286

14.1 A Demand Schedule 298

14.2 TR, AR and MR under Monopoly 299

14.3 Demand Schedule (Numerical Example 14.1) 303

14.4 Total Cost Schedule (Numerical Example 14.1) 304

14.5 AR, TR and MR Schedules (Numerical Example 14.1) 304

14.6 MC Schedule (Numerical Example 14.1) 304

14.7 MR Schedules (Numerical Example 14.3) 309

16.1 TPP, MPP, TVP and VMP Schedules 339

16.2 TPP Schedule (Numerical Example 16.1) 341

16.3 VMP Schedule (Numerical Example 16.1) 342

List of Tables 13

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Foreword

Among all major branches of social science, students treat economics with respect as well as

fear. Economics commands respect since it facilitates careers in commerce, accounting, man￾agement and so on. Nevertheless, it is regarded as a tough subject on grounds of its abstract

content, diagrams, use of mathematics, complexity of data and so on. To an average student,

economics remains a dry and alien subject. We, the teachers of economics at various levels,

are partly to be blamed for this alienation. The near-absence of standard textbooks, written

exclusively for the students of this subcontinent, is the other reason for this sorry state of

affairs. The present work by Dr Satya P. Das aims to fill this gap.

It is heartening to note that a person of Prof. Satya P. Das’s stature and intellect has

written a textbook for undergraduate students of management and related disciplines. As a

classmate and close friend, I have known Satya for the past three decades. After teaching in

various well-known universities of the United States for two decades, Dr Das settled down

in India about a decade ago. Dr Das writes in a very simple, lucid style. His choice of exam￾ples (gleaned from day-to-day experiences) dispels the fear of alienation from the student.

The detailed exercises, case-studies and assignments will make it much easier for both the

students as well as the instructors not only to understand the concepts but also to apply it

to management decision-making process. Microeconomics for Business would prove to be

immensely useful for management graduates. I wish Dr Das writes another volume entitled

Macroeconomics for Business as well very soon.

Dr J. K. Goyal

Director

Jagannath Institute of Management Sciences

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