Comprehensive Guide to Microeconomics: From PPC to Isoquants
Production Possibility Curve (PPC) or Production Possibility Frontier (PPF)
PPC or PPF shows the various combinations of two commodities that can be produced with the latest technology available and within given resources utilized fully and efficiently.
Assumptions
- Only 2 commodities
- Latest technology
- Fuller utilization of resources
Features of Production Possibility Curve
- PPC slopes downward: Production of one good can be increased only after sacrificing the production of some quantity of the other good.
- PPC is concave to the origin: A production possibility curve is concave to the point of origin because of the increasing marginal rate of transformation (MRT) or increasing marginal opportunity cost (MOC).
- Marginal opportunity cost is the opportunity cost of good X gained in terms of good Y given up. It is also called the Marginal Rate of Transformation (MRT).
- Concave shape of PPC means that the slope of PPC increases which implies that MRT increases.
- It means that for producing an additional unit of a good, the sacrifice of units of other goods (i.e. opportunity cost) goes on increasing.
Taxation
- Taxation is the means by which a government or the taxing authority imposes or levies a tax on its citizens and business entities.
- Taxation refers to the practice of government collecting money from its citizens to pay for public services.
- A tax is a mandatory fee or financial charge levied by any government on an individual or an organization to collect revenue for public works providing the best facilities and infrastructure.
Law of Demand
Statement: “Other things remain constant, the quantity demanded of a commodity increases when its price falls and decreases when its price rises”
Elasticity of Demand
- It refers to the degree of responsiveness to change in quantity demanded of a commodity due to change in price or any other factors.
- It was put forward by Alfred Marshall
- 3 Types of elasticity of demand:
- Price Elasticity
- Income Elasticity
- Cross Elasticity
Price Elasticity of Demand (ep)
- It refers to the degree of responsiveness to change in quantity demanded of a commodity due to change in price.
Types of Price Elasticities of Demand
- Perfectly elastic demand
- Perfectly inelastic demand
- Unit elastic demand / Unitary elastic demand
- Elastic demand / More elastic demand
- Inelastic demand / Less elastic demand
Perfectly Elastic Demand
- With a small change in price, there would be an infinite change in quantity demanded. It is an ideal and imaginary situation.
- The demand curve would be a horizontal straight line parallel to the x-axis
- In this case, price elasticity would be infinity
Perfectly Inelastic Demand
- With a small change in price, there would be no change in quantity demanded. It exists in the case of essentials like life-saving drugs.
- The demand curve would be a vertical straight line parallel to the Y-axis
- In this case, price elasticity would be Zero
Unit Elastic Demand/Unitary Elastic Demand
- With a given change in price, there would be an equal and proportionate change in quantity demanded for the commodity. It exists in the case of normal goods.
- ep = 1
More Elastic Demand/Elastic Demand
- With a given change in price, there would be a more than proportionate change in quantity demanded of the commodity. It exists in the case of luxuries.
- Ep > 1
Inelastic Demand /Less Elastic Demand
- With a given change in price, there would be a less than proportionate change in quantity demanded of the commodity. It exists in the case of necessities like food, fuel, etc.
- Ep < 1
Deadweight Loss
- A deadweight loss is a cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium.
- A deadweight loss is the irrecoverable reduction in economic efficiency that occurs when a free-market equilibrium is disturbed by a market intervention or other shock to supply and/or demand.
Shutdown Point
- A shutdown point is a point where the firm experiences no benefit in continuing operations or productions.
- The shutdown point is defined as that point where the market price of the product is equal to the AVC in the short run
- P = AVC
Break-Even Point
- It is a method used to study the relationship between TC and TR
- The break-even point (BEP) is used to understand this relationship
- BEP is the point where TC equals TR. No profit, no loss (zero profit)
- BEP: TC = TR
- Profit / Loss = TR – TC
- Profit / Loss = (Px Q) – (TFC + TVC)
Revenue
Revenue means receipts from the sale of output by a firm in a given period.
Total Revenue (TR)
- It is the total amount of money received by a firm from the sale of goods and services during a certain period
- TR = Q x P i.e PQ
- Q = Quantity
- P = Price
Average Revenue (AR)
- AR = TR/Q
- P x Q / Q = P i.e AR = P
Marginal Revenue (MR)
- It is the addition to total revenue from the sale of an additional unit of output
- MR = TRn – TRn-1
- MR = d(TR) / d(Q)
The Law of Variable Proportion
- It is also known as the Law of Diminishing Returns, Returns to Factor, Short-run Production Function
- The law examines the short-run relationship between one variable input and output produced while keeping all other factor inputs constant
Statement of Law
The law of variable proportion states that as more and more units of a variable factor are applied to a given quantity of a fixed factor, the total product increases at an increasing rate initially, but eventually, it will increase at a diminishing rate.
Stages of the Law of Variable Proportion
- STAGE 1: Increasing Returns to Factor (IRF):
- TP, AP, MP increases at an increasing rate in the initial stage of production.
- This is due to the fuller utilization of fixed factors and the division of labor.
- STAGE 2: Diminishing Returns to Factor (DRF):
- The most relevant stage in production
- MP falls and TP increases at a diminishing rate
- At the end of the second stage, TP reaches max and MP reaches zero
- AP also falls.
- STAGE 3: Negative Returns to Factor (NRF):
- MP becomes negative, TP falls but remains positive.
- AP remains falling
Observations
- When MP > AP, AP Rises
- When MP = AP, AP remains constant
- When MP < AP, AP Falls
Isoquants
- It is a curve that shows various combinations of two-factor inputs that give the same level of output.
- ISO means equal and QUANT means quantity.
- It is also called Isoproduct curves and Equal product curves.
Properties of Isoquants
- Isoquants are negatively sloped
- Isoquants are convex to the origin
- Two isoquants cannot cut each other
- An isoquant lying above and to the right of another isoquant represents a higher level of output.
- Isoquants need not be parallel