Microeconomics/ theory and applications
Microeconomics/ theory and applications
Dwivedi, D.N.
- 2nd ed.
- Delhi: Pearson, 2012.
- xxvii,649p.
Part I Introduction
1. Introduction to Microeconomics /
What Is Economics?—3
Economics Is a Social Science 4
Why Economizing Behaviour? 4
Two Major Branches of Economics 5
What Is Microeconomics?—6
Is Microeconomics a Positive or a Normative Science?—7
Microeconomics As a Positive Science 7
Microeconomics As a Normative Science 8
Methodology of Positive Economics: Model Building andTheorization—8
The Uses and Limitations of Microeconomic Theories—10
The Uses of Microeconomic Theories 10
Limitations of Microeconomic Theories 11
Limitations Do Not Matter Much 12
Review Questions and Exercises 12
Endnotes 13
Further Readings 14
2, The Economy: Its Basic Problems
and Working System 15
What Is an Economy?—16
Economic Activities Are Interrelated and Interdependent 16
The Economic System Works Automatically 16
How an Economy Works?—17
The Circular Flow Model of a Simple Economy 17
The Basic Problems of an Economy—19
Problems in Maximizing Production and Optimizing Distribution 19
Problems in Achieving Gro)wth, Full Employment and Stability 20
V ...
How Market Mechanism Solves the Basic Economic Problems?—21
Drawbacks of the Free Enterprise System—22
The Government and the Economy—24
The Mixed Economy System Is the Order of the Day 25
The Production Possibility Frontier—26
Some Implications of PPF 28
Shift in PPF 29
Review Questions and Exercises 31
Endnotes 32
Further Readings 32
Part II Market Mechanism: How Markets Work
N
3. The Market Forces: Demand and Supply 35
The Concept of Market—36
The Demand Side of the Market—36 ./
Meaning of Demand 36
The Law of Demand 37
The Demand Schedule 37
The Demand Curve 38
The Factors Behind the Law of Demand 38
Exceptions to the Law of Demand 40
The Market Demand 40
Determinants of Market Demand 42
Demand Function 47
Shift in Demand Curve 50
The Supply Side of the Market—52 ^
Market Supply 52 ^
The Law of Supply 52
The Supply Schedule and Supply Curve -52
Shift in the Supply Curve 53
Supply Function 55
The Market Equilibrium: The Equilibrium of Demand and Supply-55
Determination of Price in a Free Market 55
The Concept of Market Equilibrium 55
Detprmination of Market Price 56
Market Mechanism: How Market Brings About Balance 56
Graphical Illustration of Price Determination 57
Price Determination by Demand and Supply Functions 58
Shift in Demand and Supply Curves and Market Equilibrium—59
Shift in Demand Curve 59
Shift in Supply Curve 60
Parallel Shift in Demand and Supply Curves 60
Stability of Market Equilibrium—62
Market Equilibrium Under Dynamic Conditions 62
Conclusion—66
Review Questions and Exercises 66
Endnotes 69
Further Readings 69
4. Elasticity of Demand and Supply 70
The Elasticity of Demand—71
Price Elasticity of Demand—71
The Arc and Point Elasticity 73
Measuring Arc Elasticity 73
Measuring Point Elasticity 75
Price Elasticity Varies Along the Demand Curve 78
The Slope of Demand Curve and Price Elasticity 80
Determinants of Price Elasticity of Demand—84
Measuring Price Elasticity from a Demand Function—85
Measuring Price Elasticity from a Linear Demand Function 86 ^
Price Elasticity from a Non-linear Demand Function 87
Price Elasticity and Sales Revenue—88
Price Elasticity and Marginal Revenue 89
Relation Between MR and AR 90
Price Elasticity and Total Revenue 92
Price Elasticity and Consumption Expenditure—94
Other Elasticities of Demand—95
Cross-Elasticity of Demand 95
Income Elasticity of Demand 96
Application of Demand Elasticity—98
Price Elasticity of Supply—98
Definition and Measurement 98
Determinants of the Price Elasticity of Supply 100 ^
Review Questions and Exercises 100
Endnotes 104
Further Readings 104
5. Application of Market Laws and Elasticities 105
Excise Tax: Its Effects and Incidence—106
Luifip-Sum and Ad Valorem Excise Tax 106
The Effects of Excise Tax on Production and Price 107
Who Bears the Tax Burden? 107
Production Subsidy and Its Effects—109
The Effect of Production Subsidy 110
Who Benefits from Production Subsidy? 111
Import Tariffs and Export Subsidies—111
Import Tariffs 111
Export Subsidy 112 ^
Review Questions 113
Endnotes 114
Further Readings 114
Part III Theory of Consumer Demand
6, Theory of Consumer Demand: Cardinal
Utility Approach 117
Introduction—117
Cardinal Utility Approach to Demand Analysis—118
The Concept of Cardinal Utility and its Measurement 118
The Total and Marginal Utility 119
The Law of Diminishing Marginal Utility—119 • ^
Numerical Example 120
Graphical illustration 120
Assumptions 120
Consumers's Equilibrium; Cardinal Utility Approach—122 X
Assumptions 122
1 Consumer Equilibrium: A Single Commodity Case 122 ' - '
Consumer Equilibrium: The Multiple Commodity 124
Derivation of Demand Curve—125
Drawbacks of Cardinal Utility Approach—127
Review Questions and Exercises 127
Endnotes 128
Further Readings 129
7. Theory of Consumer Demand: Ordinal %
Utility Approach ^ 130
Ordinal Utility Concept and Its Assumptions—131
Assumptions of the Qrdinal Utility Theory 131
Indifference Curve—132
indifference Map 133
The Concept of Marginal Rate of Substitution (MRS) 134
Postulates of Diminishing MRS 135
Why the MRS Declines 136
Properties of Indifference Curves—137
Indifference Curves Have a Negative Slope 138
Indifference Curves Are Convex with Reference to the Origin 138
indifference Curves Neither intersect Nor Are Tangential to
One Another 138
Higher indifference Curves Represent a Higher Level of Satisfaction
Than the Lower Ones 139
Other Types of Indifference Curves—140
Perfect Substitutes 140
Complementary goods 140
Goods, Bads and Neuters—141
What Are the Bads and the Neuters? 141
Indifference Maps for Goods, Bads and Neuters 142
Budgetary Constraint and the Budget Line—145
What Causes Shifts in the Budget Line 146
Slope of the Budget Line 146
Consumer Equilibrium; The Ordinal Utility Approach—148
Corner Solution: The Extreme Choice 150
Composite Goods Case 151
Changes in Income and Consumer Behaviour—152
Income Effects on Consumer Behaviour Towards Normal Goods 152
Inferior Goods 153
Income and Consumption: The Engel Curve 154
Engel and Demand Curves 155
Engel Curve and Income Elasticity of Demand 156
Changes in Prices and Consumer Behaviour—157
Changes in Price and Consumer Behaviour: Case of Normal Goods 157
Derivation of Consumer Demand Curve 158
Graphical Derivation of Demand Curve 160 /
Income and Substitution Effects of Price Change:
Normal Goods Case—161
Hicksian Approach 161
Slutskian Approach 164
Comparison of the Hicksian and Slutskian Methods 165
Measurability of Income and Substitution Effects 166
Income and Substitution Effects: Inferior Goods—167
Effect of Rise in Money Income 167
Income and Substitution Effects of Price Change:
Case of Inferior Goods 167
Giffen Paradox 169 ^
Comparison of Cardinal and Ordinal Utility Approaches—171
Similarity Between the Two Approaches 171
Superiority of the Indifference Curve Approach 171
Drawbacks of Indifference Curve Approach—172
Appendix 173
Review Questions and Exercises 174
Endnotes 177
Further Readings 179
8. Application of Indifference Curve Analysis 180
Introduction—180
Measuring Welfare Effects of Income and
Excise Taxes—181
Choice Between Taxes 181
Measuring Effects of Excise and Income Subsidies—182
Measuring the Financial Cost of Excise Subsidy 182
Measuring the Financial Cost of Lump-Sum Income Subsidy 183
Making Choice of Policy 184
Measuring Welfare Effect of Commodity Exchange
Between Individuals—184
Derivation of Labour Supply Curve—186
Income-Leisure Choice 186
Wage-Labour Offer Curve and Labour Supply Curve 188
Evaluating Rationing of Consumer Good—190
Rationing of One Commodity 190
Rationing of More Commodities 191
Review Questions and Exercises 193
Endnotes 194
Further Readings 194
9. Revealed Preference Theory " ^ 195
Introduction—195
Revealed Preference: Assumptions and Axioms—196
Assumptions 196 /
Revealed Preference Axiom 196
Decomposition of Substitution and Income Effects and
Derivation of Demand Curve—198
Derivation of Indifference Curve—199
Appraisal of Revealed Preference Theory—201
Review Questions and Exercises 202
Endnotes 202
Further Readings 202
10. Consumer Surplus n 203
Introduction—203 >
Marshallian Concept of Consumer Surplus
and Its Measurement—204
Assumptions 205
Critical Appraisal 205
Hicksian Method of Measuring Consumer Surplus—206
Measuring Consumer Surplus under Constant ML) of Money 206
Measuring Consumer Surplus under Variable MU of Money 207
Extentions of Hicksian Approach to Consumer Surplus—208
Hicks'Four Concepts of Consumer Surplus 208
Application of Consumer Surplus—211
The Deadweight Loss of Commodity Taxation 212
Deadweight Loss from Sales Tax: Tax on Consumers 212
Measuring Gains of Subsidy 215
Deadweight Loss of Price Control 216
Deadweight Loss of Trade Barriers 217
Review Questions 219
Endnotes 219
Further Readings 220
Part IV Theory of Production and Analysis of Cost
11. Theory of Production: Laws of
Returns to a Variable Input 223
Introduction—223
Some Basic Concepts—224
Meaning of Production 224
Input and Output 224 f
Short Run and Long Run 225
Production Function—225
Short-run and Long-run Production Function 227
Assumptions 227
Production with One Variable Input: The Short-run
Laws of Production—228
The Laws of Returns to Variable Input (Labour) 228
' Assumptions 228
Marginal Productivity of Labour 229
Average Productivity of Labour 230
The Three Stages in the Law of Diminishing Returns 230
Factors Behind the Laws of Returns 231
Applicability of the Law of Diminishing Returns 231
Graphical Derivation of Marginal and Average Product Curves—231
Derivation of Marginal Product Curve (MP^) 232
Derivation of Average Product Curve (AP^^) 233
The Three Stages of Production—233
The Three Stages of Production and Production Decisions—235
What About Stage II? 235
Review Questions and Exercises 235
Endnotes 237
Further Readings 238
12. Theory of Production: Laws of Returns to
Two Variable Inputs 239
Introduction—239
The Isoquant Curve—240
Derivation of Isoquant Curve—240
Assumptions 240
Properties of Isoquant Curves—241
Isoquants Have a Negative Slope 242
Isoquants Are Convex to the Origin 242
Isoquants Do Not Intersect or Are Tangent to Each Other 242
Upper Isoquants Represent a Higher Level of Output 243
Marginal Rate of Technical Substitution (MRTS)—244
Isoquant Map and Economic Region of Production—245
IsoquantMap 245
Economic Region of Production 246
Other Forms of Isoquants—247
Perfect Substitutes and Linear Isoquants 247
The Fixed Factor Technology and L-shaped Isoquant 248
The Kinked or Linear Programming Isoquants 249
Elasticity of Technical Substitution—251
The Laws of Returns to Scale—252
Three Laws of Return to Scale 252
The Law of Increasing Returns to Scale 253 ^ ^
The Law of Constant Returns to Scale 254
The Law of Decreasing Returns to Scale 255
Production Function and Returns to Scale—256
Cobb-Douglas Production Function and Returns to Scale 257 /
Laws of Variable Proportions and Returns to Scale Compared—258
Graphic Comparison 259
Are the Laws of Returns Compatible? 260
Can the Two Kinds of Laws Operate Simultaneously? 260
Appendix 260
Review Questions and Exercises 262
Endnotes 264
Further Readings 265
13. Optimum Combination of Inputs ^ 266
Introduction—266
Derivation of Isocost—267
The Least Cost Criteria of Optimum Input Combination—269
Criterion in Value Terms 270
Choice of Optimal Expansion path—271
Effects of Change in Input Prices—272
Change in Input Prices and Isocosts 272
Change in Input Prices and Expansion Path 273
Change in Relative Price of Inputs 273
Substitution and Resource Effects of Change in Input Prices 274
Review Questions and Exercises 276
Further Readings 276
14. Theory of Cost 278
Introduction—278
Cost Concepts—279 j
Contents | xiii
Accounting Cost Concepts 279
Analytical Cost Concepts 280
Policy Related Cost Concepts: Private and Social Costs 281
Theory of Cost: An Overview—281
Theory of Short-run Cost—282
Short-run Cost Measures 282
The Short-run Cost-Output Relationship 283
Short-run Cost Function and Cost Curves—286
Numerical Example 286
Derivation of Behavioural Cost Equations 287
Long-run Cost-Output Relationship—290
Derivation of Total Long-run Cost (LTC) Curve 290
Derivation of Long-run Average Cost (LAC) curve 292
Derivation of Long-run Marginal Cost (LMC) Curve 293
Optimum Size of the Firm in the Long Run 293
Economies and Diseconomies of Scale: Factors
Behind Cost Behaviour—294
The Economies of Scale: Factors Causing Decrease in LAC 294
Diseconomies of Scale: Why LAC Increases 296 /
Modern Approach to the Theory of Cost—297
Modern Approach to Short-run Cost Behaviour 298
What Happens to the Average Variable Cost (AVC) ? 299
The SAVC and SMC Curves 299
The Short-run Average Cost (SAC) Curves 300
Modern Approach to Long-run Cost Behaviour:
The L-shaped Scale Curve 301
Derivation of the LAC Curve 302
Review Questions and Exercises 304
Endnotes 305
Further Readings 306
Part V Theory of Firm: Determination of Price and
Output
15. The Objectives of Business Firms and
Their Market Powers 311
The Objectives of Business Firms—311
Profit Maximization as Business Objective 312
Profit-Maximization Conditions 312
Numerical Illustration 314
Graphical Instruction 315
Controversy on Profit-Maximization Objective 317
Alternative Objectives of Business Firms 318
Conclusion 321
The Market Structure and Power of Firms—321
Perfect Competition 322
Imperfect Competition 323
f/lonopoly 323
A Prelude to the Theory of Firm—324
Review Questions and Exercises 324
Endnotes 325
Further Readings 325
16. Price and Output Determination under
Perfect Competition 327
Characteristics of Perfect Competition—328
Perfect versus Pure Competition 329
Role of a Firm in a Perfectly Competitive Market—329
What Are the Firm's Options 330 \
Short-run Equilibrium of the Firm—330
Assumptions 330
Does a Firm Always Make Profit in the Short-run? 331
Shut-down or Close-down Point 332 /
Derivation of Supply Curve: A Digression—333
Derivation of Firm's Supply Curve 333
Derivation of Industry Supply Curve 334
Short-run Equilibrium of Industry and Firm—334
Link Between Short-run Equilibrium of the Industry
and the Firm 335
Long-run Equilibrium of the Firm and Industry—336
Equilibrium of the Firm in the Long-run 336
Equilibrium of Industry 337
Long-run Supply Curve of a Competitive Industry—338 ^
Constant Cost Industry 338
Increasing Cost Industry 339 >
Decreasing Cost Industry 340 ^ .
Whether Decreasing Cost 341 '
Conclusion—341
Review Questions and Exercises 341
Endnotes 343
Further Readings 343
17. Price iand Output Determination Under Monopoly 344
Introduction—344
Monopoly and Sources of Monopoly Power—345
Definition and Features 345
Sources and Kinds of Monopolies 346
Cost and Revenue Curves Under Monopoly—346
AR and MR Curves under Monopoly 347
Short-run Equilibrium of the Monopoly: Price and Output
Determination—348
Monopoly Equilibrium by Total Revenue-Total Cost
Approach 349
Monopoly Equilibrium by MR-MC Approach 350
Algebra of Profit Maximization: A Numerical Illustration 351
Does a Monopoly Firm always Make Pure Profit? 352
Profit Maximization by Using MC and Price Elasticity 354
No Supply Curve Under Monopoly: A Digression—354
Monopoly Equilibrium in the Long Run—355
Capacity Utilization Under Monopoly—357
Equilibrium of a Multi-plant Monopoly—358
The Long-run Adjustments 359
Price Discrimination Under Monopoly—361
Price Discrimination 361
Necessary Conditions for Price Discrimination 361
Degrees of Price Discrimination 362
Is Price Discrimination Desirable? 365 /
The Gain to Monopolist from Price Discrimination 367
Monopoly Vs. Perfect Competition—369
Comparison of Long-run Price and Output 369
The Deadweight Loss under Monopoly 370
Some Other Monopoly-related Issues—373
Incidence of Taxes and Effect of Subsidy Under Monopoly 373
Peak-Load Pricing by a Monopoly 376
Government Regulation of Monopoly Prices—378
Measures of Monopoly Power—379
Measures of Monopoly Power 379
Appendix 381 ^ n
Review Questions and Exercises 384 ^
Endnotes 387
Further Readings 388
18. Price and Output Determination Under Monopolistic
Competition 389
Introduction—389
Monopojistic Competition: Definition and
Characteristics—390
Definition of Monopolistic Competition 390
Characteristics of Monopolistic Competition 391
Chamberlin's Theory of Monopolistic Competition—392
Basic Elements of Chamberlin's Theory 392
Product Differentiation and Firm's Perceived Demand Curve 392
Selling Costs and Firm's Cost Structure 394
Concept of Industry and Product Groups 397
Firm's Equlilbrlum Under Monopolistic Competition—397
Assumptions 398
Short-run Equilibrium of the Firm 398
Long-run Equilibrium of the Firm 400
Excess Capacity Under Monopolistic Competition—401
Ideal Output and Excess Capacity 401
Non-price Competition and Excess Capacity 403
Selling Cost and Firm's Equilibrium: Non-price
Competition—404
Individual Equilibrium with Selling Cost 404
Group Equilibrium 405
Monopolistic Competition Versus Perfect Competition:
A Comparison—407
Criticism of Chamberlin's Theory of Monopolistic
Competition—408
Appendix 410
Review Questions and Exercises 414
Endnotes 416 y
Further Readings 417 /
19. Price and Output Determine Oligopoly 418
Introduction—418
Oligopoly: A Market of Few Sellers—419
Definition of Oligopoly 419
Factors Causing Oligopoly 419
Features of Oligopoly 420
The Oligopoly Models: An Overview—421
Duopoly Models of Oligopoly—422
Cournot's Duopoly Model 422 >
Bertrand's Duopoly Model 427
Edgeworth's Duopoly Model 428
Stackelberg's Leadership Model 429
Oligopoly Models—430
Non-Collusive Models of Oligopoly 430
Sweezy's Model of Oligopoly: Kinked-Demand Curve Model 432
Collusive Model of Oligopoly—436
What is a Cartel Form of Collusion? 436
Price Leadership Models 441
Price Leadership by a Low-Cost Firm 442
Price Leadership by the Dominant Firm 445
Tire Barometric Price Leadership 449
Baumou's Theory of Sales Maximization: An Alternative
Theory—449
Baumol's Model without Advertising 450
Baumol's Model with Advertising 451
The Game Theory—453
The Nature of the Problem: Prisoners' Dilemma 453
Application of Game Theory to Oligopolistic Strategy 454
Concluding Remarks—456
Review Questions and Exercises 457
Endnotes 459
Further Readings 461
Part VI Factor Market and Factor Pricing
20. The Factor Market: Factor Demand and Supply 465
Introduction—465
The Theory of Distribution and Factor Pricing: An Overview—466
Peculiarities of Factor Demand and Supply 467
Development of Theories of Factor Pricing 467
Factor Demand: Why a Factor is Demanded—467
Factor Demand is a Derived Demand 468
tvlarginal Revenue Productivity: The Basic Determinant of Facto/Demand 468
Marginal Productivity and Factor Demand—469
Factor Supply: Supply of Labour—470
Derivation of Individual Labour Supply Curve 471
fiAarket Labour Supply Curve 472
Determination of Market Wage Rate: A Simple Theory—473
Shift in Factor Market Equilibrium and its Stability 474
Review Questions and Exercises 474
Endnotes 475
Further Readings 475
21. Wage Determination under Perfect Competjtion 477
Introduction—477
Wage Determination in a Perfectly Competitive Market—478
Derivation of Labour Demand Curve 478
Derivation of Labour Demand Curve with Two Variable Inputs 483
Industry Demand Curve for a Variable Factor: Labour 484
Determination of Market Wage Rate 485
Non-Homogeneous Labour and Wage Differentials—486
Dynamic Wage Differentials 487
Static Wage Differentials 487
Wage Differentials due to Heterogeneity of Labour 487
The Nature and Causes of Persisting Wage Differentials 489
Summary—490
Review Questions and Exercises 490
Endnotes 491
Further Readings 491
22. Wage and Employment Determination under Imperfect
Competition 493
Introduction—493
Wage Determination Under Product Monopoly and Perfect Competition in
Labour Market—494
Derivation of MRP^ Curve under Product Monopoly 495
Expioitation of Labour by Monopoly 498
Wage Determination Under Product Monopoly and Factor
Monopsony—500
Marginal Cost of a Variable Factor (Labour) 501
Wages and Employment under Monopsony: Single Variable
Factor (Labour) 502
Factor Price and Employment under Monopsony: Two Variable Factors
Case 502
Perfect Competition In Commodity Market and Monopoly in Labour
Market: The Case of Labour Union—505
Wage Determination Under Bilateral Monopoly: The Case of Cpllective
Bargaining—506
Equilibrium under Bilateral Monopoly is Indeterminate 506
Indeterminateness of Bilateral Monopoly 507
Labour Union and Monopsonistic Exploitation 508
Application of the Wage Determination Theory—509
Effects of Minimum Wage Laws in Perfectly Competitive Markets 510
Why is Minimum Wage Law Justified? 512
Minimum Wage Laws, Monopsony and Trade Unions 512
Review Questions and Problems 514
Endnotes 514
Further Readings 515 >
23. Theory of Rent 516
Introduction—516
Land as a Factor of Production—516
Historical Background of Rent Theory—517
The Ricardian Theory of Rent—518
Ricardian Definition of Rent 518
Th§ Ricardian Theory of Rent 518
Criticism 519
Transfer Earning and Economic Rent: The Modern Approach—519
Elasticity of Factor Supply and Economic Rent 520
Quasi-rent: The Short-term Earning of Fixed Factors—522
Graphical lliustration of Quasi-rent 522
Is Rent Price Determined or Price is Rent Determined?—524
— A Classical Controversy 524
Modern View 524
Rent Controls: An Application of Rent Theory—525
Does This Happen in Reality? 526
'Who Loses and Who Benefits?' 526
Review Questions and Exercises 527
Endnotes 527
Further Readings 528
24. Theories of Interest and Investment Decisions 529
introduction—529
Capital as a Factor of Production—530
Some Early Thoughts on Interest Theory—530
Theories of Interest—531
Bohm-Bawerk's Theory of Interest 531
Fisher's Theory of Interest: The Time Preference Theory 532
Criticism 533
The Classical Theory of Interest 534
Keynes' Criticism of Classical Theory 535 /
The Loanable Fund Theory of Interest 536
Classical vs Neo-Classical Theory of Interest 536
Criticism 537
Interest and Investment Decisions—538
The Time Value of Money 538
Present Value and Investment Decisions 538
NPV and Investment Decision 540
\RR and Investment Decision 540
IRRs vs Present Value 541
Risk, Uncertainty and Investment Decisions—544
Risk-Adjusted Discount Rate Approach 544
Properties 545
The Mean-Standard Deviation Method 545 .
The Finite-Horizon Method 545 n n n
Drawback 546
The Probability Theory Approach 546
Review Questions and Exercises 548
Endnotes 549
Further Readings 550
25. Theories of Profit 551
Introduction—551
Meaning of Pure Profit—551
Profit Theories: What Are the Sources of Profits?—552
Walker's Theory of Profit: Profit Is Rent of Ability 552
Clark's Theory of Profit: Profit Is Reward for Dynamic
Entrepreneurship 553
Hawley's Risk Theory of Profit: Profit Is Reward for Risk Bearing 555
Knight's Theory of Profit: Profit Is a Return to Uncertainty Bearing 556
Schumpeter's Innovation Theory of Profit: Profit Is Reward for
Innovations 557
Does Profit Enter the Cost of Production?—559
Review Questions and Exercises 559
Endnotes 560
Further Readings 560
26. Product Exhaustion Theorem 561
Introduction—561
The Adding-up Problem—562
Euler's Theorem—562
The Clark-Wicksteed-Walras Theorem—563 ^
Change in Relative Factor Shares and Income Distribution—565
The Elasticity of Factor Substitution and Relative Factor Shares 565
Technological Progress and Income Distribution—567 ^
Neutral Technological Progress 568
Capital Deepening 568
I Labour Deepening 568
Review Questions and Exercises 569
Endnotes 570
Further Readings 570
Part VII General Equilibrium and Welfare Economics
27. General Equilibrium Analysis ^ 573
introduction—573
Interrelationship and Interdependence of Markets—574
Interrelationship between the Markets 574
Interdependence of Markets 575
The Conditions of Static General Equilibrium—576
The Condition for Consumers' General Equilibrium 576
The Condition for Production General Equilibrium 577
The Condition for Producers' General Equilibrium 577
Thb Condition for Factor Qwners' General Equilibrium 577
General Equilibrium in Exchange—577
Edgeworth Box Diagram 578
The Condition for General Equilibrium in Exchange 579
Efficient Allocation of Goods 580
General Equilibrium in Production—581
The Condition for General Equilibrium in Production 582
- Producer's Equilibrium in a Competitive Input Market 583
The Production Possibility Frontier—584
The Slope of PPF and Marginal Rate of Transformation (MRT) 585
General Equilibrium in Competitive Product Market—586
Review Questions and Exercises 587
Endnote 588
Further Readings 588
28. Welfare Economics: Pareto Optimality 589
introduction—589
Definitions and Nature of Welfare Economics—590
Definition of Welfare Economics 590
is Welfare Economics a Positive or a Normative Science? 590
The Concept and Measurement of Social Welfare—591
Some Early Concepts of Welfare 591
Pareto's Concept of Welfare 591
Pareto's Welfare Economics—592
Pareto Optimum: Definition 592 ^
Pareto Optimality Conditions 593
Assumptions 594
Pareto Optimality in Exchange 594
Pareto Optimality in Production: Optimum Aiiocation of Factor
inputs 596
Optimum Distribution of Goods Between Firms: Optimum Specialization of
Firms 597
Summary of Pareto Optimally Conditions 600
Some Additional Conditions of Pareto Optimality 601
Total Conditions of Pareto Optimality 601
Perfect Competition and Pareto Optimality—601
Efficiency in Exchange 602 ^
Efficiency in Production 602 ^
Efficiency in Production and Exchange 602
Some Exceptions 603
Externalities and Pareto Optimality—604
Externalities in Production 604
External Economies in Production 605
External Diseconomies in Production 606
Externalities in Consumption 607
External Economies in Consumption 607
Extdrnai Diseconomies in Consumption 608
Externalities of Public Goods 609
indivisibility and Pareto Optimality 610
Conclusion—610
Review Questions and Exercises 611
Endnotes 613
Further Readings 614
29. New Welfare Economics 616
Introduction—616 .
The Kaidor-Hlcks Compensation Criterion—617 .
Shortcomings of Kaldor-Hicks Criterion 618
The Scitovsky Double Criteria—620
The Bergson Criterion: The Social Weifare Function—620
Weakness of Bergson Criterion 621
Arrow's Theorem of Democratic Group Decision—622
Problems in Arrow's Theorem 622
Grand Utility Possibility Frontier and Welfare Maximization—623
Derivation of Grand Utiiity Possibility Frontier 623
Determination of the Point of Bliss: The Point of Maximum
Social Welfare 624 \ //
The Theory of Second Best—625
Lipsey-Lancaster Refute the Second Best Theory 626
Conclusion—626
Review Questions and Problems 627 /
Endnotes 627
30. Market Failures and Public Goods 629
Introduction—629
Growth of Monopoly Power and Market Failure—630
Imperfect Market Information—631
. Existence of Public Goods—632
What Are Public Goods? 632
Characteristics of Pure Public Goods 633 ^ 'j
Public Goods and Market Failures 634
Externalities and Market Failure—635 >
Public Provision of Public Goods—635 ,, •
Externalities and Their Correction—636
Treatment of External Costs 637 ''
Treatment of External Benefits 638
Review Questions and Exercises 639
Endnotes 639
^ Further Readings 640
y
Index Q41
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9788131759400
338.5 / DWI/M
Part I Introduction
1. Introduction to Microeconomics /
What Is Economics?—3
Economics Is a Social Science 4
Why Economizing Behaviour? 4
Two Major Branches of Economics 5
What Is Microeconomics?—6
Is Microeconomics a Positive or a Normative Science?—7
Microeconomics As a Positive Science 7
Microeconomics As a Normative Science 8
Methodology of Positive Economics: Model Building andTheorization—8
The Uses and Limitations of Microeconomic Theories—10
The Uses of Microeconomic Theories 10
Limitations of Microeconomic Theories 11
Limitations Do Not Matter Much 12
Review Questions and Exercises 12
Endnotes 13
Further Readings 14
2, The Economy: Its Basic Problems
and Working System 15
What Is an Economy?—16
Economic Activities Are Interrelated and Interdependent 16
The Economic System Works Automatically 16
How an Economy Works?—17
The Circular Flow Model of a Simple Economy 17
The Basic Problems of an Economy—19
Problems in Maximizing Production and Optimizing Distribution 19
Problems in Achieving Gro)wth, Full Employment and Stability 20
V ...
How Market Mechanism Solves the Basic Economic Problems?—21
Drawbacks of the Free Enterprise System—22
The Government and the Economy—24
The Mixed Economy System Is the Order of the Day 25
The Production Possibility Frontier—26
Some Implications of PPF 28
Shift in PPF 29
Review Questions and Exercises 31
Endnotes 32
Further Readings 32
Part II Market Mechanism: How Markets Work
N
3. The Market Forces: Demand and Supply 35
The Concept of Market—36
The Demand Side of the Market—36 ./
Meaning of Demand 36
The Law of Demand 37
The Demand Schedule 37
The Demand Curve 38
The Factors Behind the Law of Demand 38
Exceptions to the Law of Demand 40
The Market Demand 40
Determinants of Market Demand 42
Demand Function 47
Shift in Demand Curve 50
The Supply Side of the Market—52 ^
Market Supply 52 ^
The Law of Supply 52
The Supply Schedule and Supply Curve -52
Shift in the Supply Curve 53
Supply Function 55
The Market Equilibrium: The Equilibrium of Demand and Supply-55
Determination of Price in a Free Market 55
The Concept of Market Equilibrium 55
Detprmination of Market Price 56
Market Mechanism: How Market Brings About Balance 56
Graphical Illustration of Price Determination 57
Price Determination by Demand and Supply Functions 58
Shift in Demand and Supply Curves and Market Equilibrium—59
Shift in Demand Curve 59
Shift in Supply Curve 60
Parallel Shift in Demand and Supply Curves 60
Stability of Market Equilibrium—62
Market Equilibrium Under Dynamic Conditions 62
Conclusion—66
Review Questions and Exercises 66
Endnotes 69
Further Readings 69
4. Elasticity of Demand and Supply 70
The Elasticity of Demand—71
Price Elasticity of Demand—71
The Arc and Point Elasticity 73
Measuring Arc Elasticity 73
Measuring Point Elasticity 75
Price Elasticity Varies Along the Demand Curve 78
The Slope of Demand Curve and Price Elasticity 80
Determinants of Price Elasticity of Demand—84
Measuring Price Elasticity from a Demand Function—85
Measuring Price Elasticity from a Linear Demand Function 86 ^
Price Elasticity from a Non-linear Demand Function 87
Price Elasticity and Sales Revenue—88
Price Elasticity and Marginal Revenue 89
Relation Between MR and AR 90
Price Elasticity and Total Revenue 92
Price Elasticity and Consumption Expenditure—94
Other Elasticities of Demand—95
Cross-Elasticity of Demand 95
Income Elasticity of Demand 96
Application of Demand Elasticity—98
Price Elasticity of Supply—98
Definition and Measurement 98
Determinants of the Price Elasticity of Supply 100 ^
Review Questions and Exercises 100
Endnotes 104
Further Readings 104
5. Application of Market Laws and Elasticities 105
Excise Tax: Its Effects and Incidence—106
Luifip-Sum and Ad Valorem Excise Tax 106
The Effects of Excise Tax on Production and Price 107
Who Bears the Tax Burden? 107
Production Subsidy and Its Effects—109
The Effect of Production Subsidy 110
Who Benefits from Production Subsidy? 111
Import Tariffs and Export Subsidies—111
Import Tariffs 111
Export Subsidy 112 ^
Review Questions 113
Endnotes 114
Further Readings 114
Part III Theory of Consumer Demand
6, Theory of Consumer Demand: Cardinal
Utility Approach 117
Introduction—117
Cardinal Utility Approach to Demand Analysis—118
The Concept of Cardinal Utility and its Measurement 118
The Total and Marginal Utility 119
The Law of Diminishing Marginal Utility—119 • ^
Numerical Example 120
Graphical illustration 120
Assumptions 120
Consumers's Equilibrium; Cardinal Utility Approach—122 X
Assumptions 122
1 Consumer Equilibrium: A Single Commodity Case 122 ' - '
Consumer Equilibrium: The Multiple Commodity 124
Derivation of Demand Curve—125
Drawbacks of Cardinal Utility Approach—127
Review Questions and Exercises 127
Endnotes 128
Further Readings 129
7. Theory of Consumer Demand: Ordinal %
Utility Approach ^ 130
Ordinal Utility Concept and Its Assumptions—131
Assumptions of the Qrdinal Utility Theory 131
Indifference Curve—132
indifference Map 133
The Concept of Marginal Rate of Substitution (MRS) 134
Postulates of Diminishing MRS 135
Why the MRS Declines 136
Properties of Indifference Curves—137
Indifference Curves Have a Negative Slope 138
Indifference Curves Are Convex with Reference to the Origin 138
indifference Curves Neither intersect Nor Are Tangential to
One Another 138
Higher indifference Curves Represent a Higher Level of Satisfaction
Than the Lower Ones 139
Other Types of Indifference Curves—140
Perfect Substitutes 140
Complementary goods 140
Goods, Bads and Neuters—141
What Are the Bads and the Neuters? 141
Indifference Maps for Goods, Bads and Neuters 142
Budgetary Constraint and the Budget Line—145
What Causes Shifts in the Budget Line 146
Slope of the Budget Line 146
Consumer Equilibrium; The Ordinal Utility Approach—148
Corner Solution: The Extreme Choice 150
Composite Goods Case 151
Changes in Income and Consumer Behaviour—152
Income Effects on Consumer Behaviour Towards Normal Goods 152
Inferior Goods 153
Income and Consumption: The Engel Curve 154
Engel and Demand Curves 155
Engel Curve and Income Elasticity of Demand 156
Changes in Prices and Consumer Behaviour—157
Changes in Price and Consumer Behaviour: Case of Normal Goods 157
Derivation of Consumer Demand Curve 158
Graphical Derivation of Demand Curve 160 /
Income and Substitution Effects of Price Change:
Normal Goods Case—161
Hicksian Approach 161
Slutskian Approach 164
Comparison of the Hicksian and Slutskian Methods 165
Measurability of Income and Substitution Effects 166
Income and Substitution Effects: Inferior Goods—167
Effect of Rise in Money Income 167
Income and Substitution Effects of Price Change:
Case of Inferior Goods 167
Giffen Paradox 169 ^
Comparison of Cardinal and Ordinal Utility Approaches—171
Similarity Between the Two Approaches 171
Superiority of the Indifference Curve Approach 171
Drawbacks of Indifference Curve Approach—172
Appendix 173
Review Questions and Exercises 174
Endnotes 177
Further Readings 179
8. Application of Indifference Curve Analysis 180
Introduction—180
Measuring Welfare Effects of Income and
Excise Taxes—181
Choice Between Taxes 181
Measuring Effects of Excise and Income Subsidies—182
Measuring the Financial Cost of Excise Subsidy 182
Measuring the Financial Cost of Lump-Sum Income Subsidy 183
Making Choice of Policy 184
Measuring Welfare Effect of Commodity Exchange
Between Individuals—184
Derivation of Labour Supply Curve—186
Income-Leisure Choice 186
Wage-Labour Offer Curve and Labour Supply Curve 188
Evaluating Rationing of Consumer Good—190
Rationing of One Commodity 190
Rationing of More Commodities 191
Review Questions and Exercises 193
Endnotes 194
Further Readings 194
9. Revealed Preference Theory " ^ 195
Introduction—195
Revealed Preference: Assumptions and Axioms—196
Assumptions 196 /
Revealed Preference Axiom 196
Decomposition of Substitution and Income Effects and
Derivation of Demand Curve—198
Derivation of Indifference Curve—199
Appraisal of Revealed Preference Theory—201
Review Questions and Exercises 202
Endnotes 202
Further Readings 202
10. Consumer Surplus n 203
Introduction—203 >
Marshallian Concept of Consumer Surplus
and Its Measurement—204
Assumptions 205
Critical Appraisal 205
Hicksian Method of Measuring Consumer Surplus—206
Measuring Consumer Surplus under Constant ML) of Money 206
Measuring Consumer Surplus under Variable MU of Money 207
Extentions of Hicksian Approach to Consumer Surplus—208
Hicks'Four Concepts of Consumer Surplus 208
Application of Consumer Surplus—211
The Deadweight Loss of Commodity Taxation 212
Deadweight Loss from Sales Tax: Tax on Consumers 212
Measuring Gains of Subsidy 215
Deadweight Loss of Price Control 216
Deadweight Loss of Trade Barriers 217
Review Questions 219
Endnotes 219
Further Readings 220
Part IV Theory of Production and Analysis of Cost
11. Theory of Production: Laws of
Returns to a Variable Input 223
Introduction—223
Some Basic Concepts—224
Meaning of Production 224
Input and Output 224 f
Short Run and Long Run 225
Production Function—225
Short-run and Long-run Production Function 227
Assumptions 227
Production with One Variable Input: The Short-run
Laws of Production—228
The Laws of Returns to Variable Input (Labour) 228
' Assumptions 228
Marginal Productivity of Labour 229
Average Productivity of Labour 230
The Three Stages in the Law of Diminishing Returns 230
Factors Behind the Laws of Returns 231
Applicability of the Law of Diminishing Returns 231
Graphical Derivation of Marginal and Average Product Curves—231
Derivation of Marginal Product Curve (MP^) 232
Derivation of Average Product Curve (AP^^) 233
The Three Stages of Production—233
The Three Stages of Production and Production Decisions—235
What About Stage II? 235
Review Questions and Exercises 235
Endnotes 237
Further Readings 238
12. Theory of Production: Laws of Returns to
Two Variable Inputs 239
Introduction—239
The Isoquant Curve—240
Derivation of Isoquant Curve—240
Assumptions 240
Properties of Isoquant Curves—241
Isoquants Have a Negative Slope 242
Isoquants Are Convex to the Origin 242
Isoquants Do Not Intersect or Are Tangent to Each Other 242
Upper Isoquants Represent a Higher Level of Output 243
Marginal Rate of Technical Substitution (MRTS)—244
Isoquant Map and Economic Region of Production—245
IsoquantMap 245
Economic Region of Production 246
Other Forms of Isoquants—247
Perfect Substitutes and Linear Isoquants 247
The Fixed Factor Technology and L-shaped Isoquant 248
The Kinked or Linear Programming Isoquants 249
Elasticity of Technical Substitution—251
The Laws of Returns to Scale—252
Three Laws of Return to Scale 252
The Law of Increasing Returns to Scale 253 ^ ^
The Law of Constant Returns to Scale 254
The Law of Decreasing Returns to Scale 255
Production Function and Returns to Scale—256
Cobb-Douglas Production Function and Returns to Scale 257 /
Laws of Variable Proportions and Returns to Scale Compared—258
Graphic Comparison 259
Are the Laws of Returns Compatible? 260
Can the Two Kinds of Laws Operate Simultaneously? 260
Appendix 260
Review Questions and Exercises 262
Endnotes 264
Further Readings 265
13. Optimum Combination of Inputs ^ 266
Introduction—266
Derivation of Isocost—267
The Least Cost Criteria of Optimum Input Combination—269
Criterion in Value Terms 270
Choice of Optimal Expansion path—271
Effects of Change in Input Prices—272
Change in Input Prices and Isocosts 272
Change in Input Prices and Expansion Path 273
Change in Relative Price of Inputs 273
Substitution and Resource Effects of Change in Input Prices 274
Review Questions and Exercises 276
Further Readings 276
14. Theory of Cost 278
Introduction—278
Cost Concepts—279 j
Contents | xiii
Accounting Cost Concepts 279
Analytical Cost Concepts 280
Policy Related Cost Concepts: Private and Social Costs 281
Theory of Cost: An Overview—281
Theory of Short-run Cost—282
Short-run Cost Measures 282
The Short-run Cost-Output Relationship 283
Short-run Cost Function and Cost Curves—286
Numerical Example 286
Derivation of Behavioural Cost Equations 287
Long-run Cost-Output Relationship—290
Derivation of Total Long-run Cost (LTC) Curve 290
Derivation of Long-run Average Cost (LAC) curve 292
Derivation of Long-run Marginal Cost (LMC) Curve 293
Optimum Size of the Firm in the Long Run 293
Economies and Diseconomies of Scale: Factors
Behind Cost Behaviour—294
The Economies of Scale: Factors Causing Decrease in LAC 294
Diseconomies of Scale: Why LAC Increases 296 /
Modern Approach to the Theory of Cost—297
Modern Approach to Short-run Cost Behaviour 298
What Happens to the Average Variable Cost (AVC) ? 299
The SAVC and SMC Curves 299
The Short-run Average Cost (SAC) Curves 300
Modern Approach to Long-run Cost Behaviour:
The L-shaped Scale Curve 301
Derivation of the LAC Curve 302
Review Questions and Exercises 304
Endnotes 305
Further Readings 306
Part V Theory of Firm: Determination of Price and
Output
15. The Objectives of Business Firms and
Their Market Powers 311
The Objectives of Business Firms—311
Profit Maximization as Business Objective 312
Profit-Maximization Conditions 312
Numerical Illustration 314
Graphical Instruction 315
Controversy on Profit-Maximization Objective 317
Alternative Objectives of Business Firms 318
Conclusion 321
The Market Structure and Power of Firms—321
Perfect Competition 322
Imperfect Competition 323
f/lonopoly 323
A Prelude to the Theory of Firm—324
Review Questions and Exercises 324
Endnotes 325
Further Readings 325
16. Price and Output Determination under
Perfect Competition 327
Characteristics of Perfect Competition—328
Perfect versus Pure Competition 329
Role of a Firm in a Perfectly Competitive Market—329
What Are the Firm's Options 330 \
Short-run Equilibrium of the Firm—330
Assumptions 330
Does a Firm Always Make Profit in the Short-run? 331
Shut-down or Close-down Point 332 /
Derivation of Supply Curve: A Digression—333
Derivation of Firm's Supply Curve 333
Derivation of Industry Supply Curve 334
Short-run Equilibrium of Industry and Firm—334
Link Between Short-run Equilibrium of the Industry
and the Firm 335
Long-run Equilibrium of the Firm and Industry—336
Equilibrium of the Firm in the Long-run 336
Equilibrium of Industry 337
Long-run Supply Curve of a Competitive Industry—338 ^
Constant Cost Industry 338
Increasing Cost Industry 339 >
Decreasing Cost Industry 340 ^ .
Whether Decreasing Cost 341 '
Conclusion—341
Review Questions and Exercises 341
Endnotes 343
Further Readings 343
17. Price iand Output Determination Under Monopoly 344
Introduction—344
Monopoly and Sources of Monopoly Power—345
Definition and Features 345
Sources and Kinds of Monopolies 346
Cost and Revenue Curves Under Monopoly—346
AR and MR Curves under Monopoly 347
Short-run Equilibrium of the Monopoly: Price and Output
Determination—348
Monopoly Equilibrium by Total Revenue-Total Cost
Approach 349
Monopoly Equilibrium by MR-MC Approach 350
Algebra of Profit Maximization: A Numerical Illustration 351
Does a Monopoly Firm always Make Pure Profit? 352
Profit Maximization by Using MC and Price Elasticity 354
No Supply Curve Under Monopoly: A Digression—354
Monopoly Equilibrium in the Long Run—355
Capacity Utilization Under Monopoly—357
Equilibrium of a Multi-plant Monopoly—358
The Long-run Adjustments 359
Price Discrimination Under Monopoly—361
Price Discrimination 361
Necessary Conditions for Price Discrimination 361
Degrees of Price Discrimination 362
Is Price Discrimination Desirable? 365 /
The Gain to Monopolist from Price Discrimination 367
Monopoly Vs. Perfect Competition—369
Comparison of Long-run Price and Output 369
The Deadweight Loss under Monopoly 370
Some Other Monopoly-related Issues—373
Incidence of Taxes and Effect of Subsidy Under Monopoly 373
Peak-Load Pricing by a Monopoly 376
Government Regulation of Monopoly Prices—378
Measures of Monopoly Power—379
Measures of Monopoly Power 379
Appendix 381 ^ n
Review Questions and Exercises 384 ^
Endnotes 387
Further Readings 388
18. Price and Output Determination Under Monopolistic
Competition 389
Introduction—389
Monopojistic Competition: Definition and
Characteristics—390
Definition of Monopolistic Competition 390
Characteristics of Monopolistic Competition 391
Chamberlin's Theory of Monopolistic Competition—392
Basic Elements of Chamberlin's Theory 392
Product Differentiation and Firm's Perceived Demand Curve 392
Selling Costs and Firm's Cost Structure 394
Concept of Industry and Product Groups 397
Firm's Equlilbrlum Under Monopolistic Competition—397
Assumptions 398
Short-run Equilibrium of the Firm 398
Long-run Equilibrium of the Firm 400
Excess Capacity Under Monopolistic Competition—401
Ideal Output and Excess Capacity 401
Non-price Competition and Excess Capacity 403
Selling Cost and Firm's Equilibrium: Non-price
Competition—404
Individual Equilibrium with Selling Cost 404
Group Equilibrium 405
Monopolistic Competition Versus Perfect Competition:
A Comparison—407
Criticism of Chamberlin's Theory of Monopolistic
Competition—408
Appendix 410
Review Questions and Exercises 414
Endnotes 416 y
Further Readings 417 /
19. Price and Output Determine Oligopoly 418
Introduction—418
Oligopoly: A Market of Few Sellers—419
Definition of Oligopoly 419
Factors Causing Oligopoly 419
Features of Oligopoly 420
The Oligopoly Models: An Overview—421
Duopoly Models of Oligopoly—422
Cournot's Duopoly Model 422 >
Bertrand's Duopoly Model 427
Edgeworth's Duopoly Model 428
Stackelberg's Leadership Model 429
Oligopoly Models—430
Non-Collusive Models of Oligopoly 430
Sweezy's Model of Oligopoly: Kinked-Demand Curve Model 432
Collusive Model of Oligopoly—436
What is a Cartel Form of Collusion? 436
Price Leadership Models 441
Price Leadership by a Low-Cost Firm 442
Price Leadership by the Dominant Firm 445
Tire Barometric Price Leadership 449
Baumou's Theory of Sales Maximization: An Alternative
Theory—449
Baumol's Model without Advertising 450
Baumol's Model with Advertising 451
The Game Theory—453
The Nature of the Problem: Prisoners' Dilemma 453
Application of Game Theory to Oligopolistic Strategy 454
Concluding Remarks—456
Review Questions and Exercises 457
Endnotes 459
Further Readings 461
Part VI Factor Market and Factor Pricing
20. The Factor Market: Factor Demand and Supply 465
Introduction—465
The Theory of Distribution and Factor Pricing: An Overview—466
Peculiarities of Factor Demand and Supply 467
Development of Theories of Factor Pricing 467
Factor Demand: Why a Factor is Demanded—467
Factor Demand is a Derived Demand 468
tvlarginal Revenue Productivity: The Basic Determinant of Facto/Demand 468
Marginal Productivity and Factor Demand—469
Factor Supply: Supply of Labour—470
Derivation of Individual Labour Supply Curve 471
fiAarket Labour Supply Curve 472
Determination of Market Wage Rate: A Simple Theory—473
Shift in Factor Market Equilibrium and its Stability 474
Review Questions and Exercises 474
Endnotes 475
Further Readings 475
21. Wage Determination under Perfect Competjtion 477
Introduction—477
Wage Determination in a Perfectly Competitive Market—478
Derivation of Labour Demand Curve 478
Derivation of Labour Demand Curve with Two Variable Inputs 483
Industry Demand Curve for a Variable Factor: Labour 484
Determination of Market Wage Rate 485
Non-Homogeneous Labour and Wage Differentials—486
Dynamic Wage Differentials 487
Static Wage Differentials 487
Wage Differentials due to Heterogeneity of Labour 487
The Nature and Causes of Persisting Wage Differentials 489
Summary—490
Review Questions and Exercises 490
Endnotes 491
Further Readings 491
22. Wage and Employment Determination under Imperfect
Competition 493
Introduction—493
Wage Determination Under Product Monopoly and Perfect Competition in
Labour Market—494
Derivation of MRP^ Curve under Product Monopoly 495
Expioitation of Labour by Monopoly 498
Wage Determination Under Product Monopoly and Factor
Monopsony—500
Marginal Cost of a Variable Factor (Labour) 501
Wages and Employment under Monopsony: Single Variable
Factor (Labour) 502
Factor Price and Employment under Monopsony: Two Variable Factors
Case 502
Perfect Competition In Commodity Market and Monopoly in Labour
Market: The Case of Labour Union—505
Wage Determination Under Bilateral Monopoly: The Case of Cpllective
Bargaining—506
Equilibrium under Bilateral Monopoly is Indeterminate 506
Indeterminateness of Bilateral Monopoly 507
Labour Union and Monopsonistic Exploitation 508
Application of the Wage Determination Theory—509
Effects of Minimum Wage Laws in Perfectly Competitive Markets 510
Why is Minimum Wage Law Justified? 512
Minimum Wage Laws, Monopsony and Trade Unions 512
Review Questions and Problems 514
Endnotes 514
Further Readings 515 >
23. Theory of Rent 516
Introduction—516
Land as a Factor of Production—516
Historical Background of Rent Theory—517
The Ricardian Theory of Rent—518
Ricardian Definition of Rent 518
Th§ Ricardian Theory of Rent 518
Criticism 519
Transfer Earning and Economic Rent: The Modern Approach—519
Elasticity of Factor Supply and Economic Rent 520
Quasi-rent: The Short-term Earning of Fixed Factors—522
Graphical lliustration of Quasi-rent 522
Is Rent Price Determined or Price is Rent Determined?—524
— A Classical Controversy 524
Modern View 524
Rent Controls: An Application of Rent Theory—525
Does This Happen in Reality? 526
'Who Loses and Who Benefits?' 526
Review Questions and Exercises 527
Endnotes 527
Further Readings 528
24. Theories of Interest and Investment Decisions 529
introduction—529
Capital as a Factor of Production—530
Some Early Thoughts on Interest Theory—530
Theories of Interest—531
Bohm-Bawerk's Theory of Interest 531
Fisher's Theory of Interest: The Time Preference Theory 532
Criticism 533
The Classical Theory of Interest 534
Keynes' Criticism of Classical Theory 535 /
The Loanable Fund Theory of Interest 536
Classical vs Neo-Classical Theory of Interest 536
Criticism 537
Interest and Investment Decisions—538
The Time Value of Money 538
Present Value and Investment Decisions 538
NPV and Investment Decision 540
\RR and Investment Decision 540
IRRs vs Present Value 541
Risk, Uncertainty and Investment Decisions—544
Risk-Adjusted Discount Rate Approach 544
Properties 545
The Mean-Standard Deviation Method 545 .
The Finite-Horizon Method 545 n n n
Drawback 546
The Probability Theory Approach 546
Review Questions and Exercises 548
Endnotes 549
Further Readings 550
25. Theories of Profit 551
Introduction—551
Meaning of Pure Profit—551
Profit Theories: What Are the Sources of Profits?—552
Walker's Theory of Profit: Profit Is Rent of Ability 552
Clark's Theory of Profit: Profit Is Reward for Dynamic
Entrepreneurship 553
Hawley's Risk Theory of Profit: Profit Is Reward for Risk Bearing 555
Knight's Theory of Profit: Profit Is a Return to Uncertainty Bearing 556
Schumpeter's Innovation Theory of Profit: Profit Is Reward for
Innovations 557
Does Profit Enter the Cost of Production?—559
Review Questions and Exercises 559
Endnotes 560
Further Readings 560
26. Product Exhaustion Theorem 561
Introduction—561
The Adding-up Problem—562
Euler's Theorem—562
The Clark-Wicksteed-Walras Theorem—563 ^
Change in Relative Factor Shares and Income Distribution—565
The Elasticity of Factor Substitution and Relative Factor Shares 565
Technological Progress and Income Distribution—567 ^
Neutral Technological Progress 568
Capital Deepening 568
I Labour Deepening 568
Review Questions and Exercises 569
Endnotes 570
Further Readings 570
Part VII General Equilibrium and Welfare Economics
27. General Equilibrium Analysis ^ 573
introduction—573
Interrelationship and Interdependence of Markets—574
Interrelationship between the Markets 574
Interdependence of Markets 575
The Conditions of Static General Equilibrium—576
The Condition for Consumers' General Equilibrium 576
The Condition for Production General Equilibrium 577
The Condition for Producers' General Equilibrium 577
Thb Condition for Factor Qwners' General Equilibrium 577
General Equilibrium in Exchange—577
Edgeworth Box Diagram 578
The Condition for General Equilibrium in Exchange 579
Efficient Allocation of Goods 580
General Equilibrium in Production—581
The Condition for General Equilibrium in Production 582
- Producer's Equilibrium in a Competitive Input Market 583
The Production Possibility Frontier—584
The Slope of PPF and Marginal Rate of Transformation (MRT) 585
General Equilibrium in Competitive Product Market—586
Review Questions and Exercises 587
Endnote 588
Further Readings 588
28. Welfare Economics: Pareto Optimality 589
introduction—589
Definitions and Nature of Welfare Economics—590
Definition of Welfare Economics 590
is Welfare Economics a Positive or a Normative Science? 590
The Concept and Measurement of Social Welfare—591
Some Early Concepts of Welfare 591
Pareto's Concept of Welfare 591
Pareto's Welfare Economics—592
Pareto Optimum: Definition 592 ^
Pareto Optimality Conditions 593
Assumptions 594
Pareto Optimality in Exchange 594
Pareto Optimality in Production: Optimum Aiiocation of Factor
inputs 596
Optimum Distribution of Goods Between Firms: Optimum Specialization of
Firms 597
Summary of Pareto Optimally Conditions 600
Some Additional Conditions of Pareto Optimality 601
Total Conditions of Pareto Optimality 601
Perfect Competition and Pareto Optimality—601
Efficiency in Exchange 602 ^
Efficiency in Production 602 ^
Efficiency in Production and Exchange 602
Some Exceptions 603
Externalities and Pareto Optimality—604
Externalities in Production 604
External Economies in Production 605
External Diseconomies in Production 606
Externalities in Consumption 607
External Economies in Consumption 607
Extdrnai Diseconomies in Consumption 608
Externalities of Public Goods 609
indivisibility and Pareto Optimality 610
Conclusion—610
Review Questions and Exercises 611
Endnotes 613
Further Readings 614
29. New Welfare Economics 616
Introduction—616 .
The Kaidor-Hlcks Compensation Criterion—617 .
Shortcomings of Kaldor-Hicks Criterion 618
The Scitovsky Double Criteria—620
The Bergson Criterion: The Social Weifare Function—620
Weakness of Bergson Criterion 621
Arrow's Theorem of Democratic Group Decision—622
Problems in Arrow's Theorem 622
Grand Utility Possibility Frontier and Welfare Maximization—623
Derivation of Grand Utiiity Possibility Frontier 623
Determination of the Point of Bliss: The Point of Maximum
Social Welfare 624 \ //
The Theory of Second Best—625
Lipsey-Lancaster Refute the Second Best Theory 626
Conclusion—626
Review Questions and Problems 627 /
Endnotes 627
30. Market Failures and Public Goods 629
Introduction—629
Growth of Monopoly Power and Market Failure—630
Imperfect Market Information—631
. Existence of Public Goods—632
What Are Public Goods? 632
Characteristics of Pure Public Goods 633 ^ 'j
Public Goods and Market Failures 634
Externalities and Market Failure—635 >
Public Provision of Public Goods—635 ,, •
Externalities and Their Correction—636
Treatment of External Costs 637 ''
Treatment of External Benefits 638
Review Questions and Exercises 639
Endnotes 639
^ Further Readings 640
y
Index Q41
/
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338.5 / DWI/M