Micro economics

CA Final – Economics & Finance

Micro‑Economics: Study Notes

Audience: CA Final students preparing for the Economics & Finance paper.
Purpose: Provide a concise, self‑contained refresher that can be turned into a quick‑reference sheet.

1. Simple Explanation

Micro‑economics studies individual decision‑makers (households, firms) and markets that trade goods and services.
It analyses how these agents allocate scarce resources, how prices are determined, and how various market structures and government policies affect allocation efficiency and distribution.

Key concepts:

2. Key Points (Bullet‑style)

2.1 Demand and Supply

• Demand curve: downward sloping; (Q_d = f(P, Y, P_{sub})).
• Supply curve: upward sloping; (Q_s = g(P, W, T)).
• Equilibrium: (Q_d = Q_s); price (P^) and quantity (Q^).
• Shifts vs. movements: change in (Q_d) for fixed (P) vs. change in (P) for fixed (Q_d).

2.2 Elasticities

• Price Elasticity of Demand (PED): (\varepsilon_d = \frac{%\Delta Q_d}{%\Delta P}).
  • Elastic (>1), Inelastic (<1), Unitary (=1).
• Income Elasticity of Demand (YED).
• Cross‑Price Elasticity (XED).
• Price Elasticity of Supply (PES).
• Elasticity of Cost and Profit used for cost‑minimisation and revenue optimisation.

2.3 Production Theory

• Production function: (Q = f(K, L)).
• Marginal Product (MP), Average Product (AP).
• Law of diminishing returns: MP falls as more units of a variable factor are added.

2.4 Cost Theory

• Total Cost (TC) = (TFC + TVC).
• Average Cost (AC) = (TC/Q).
• Marginal Cost (MC) = (\frac{dTC}{dQ}).
• Short‑Run vs. Long‑Run:
  • SR: at least one factor fixed.
  • LR: all factors variable (no fixed cost).
• Minimum Efficient Scale (MES): output where AC is minimal.

2.5 Profit Maximisation

• Profit: (\pi = TR - TC).
• Optimal rule: Produce where (MR = MC) (subject to (P) in competitive markets).
• Price‑setting in imperfect competition: Use MR derived from demand curve.

2.6 Market Structures

2.7 Game Theory (Oligopoly)

• Dominant strategy: best regardless of others.
• Nash equilibrium: no firm wants to deviate.
• Tit‑for‑Tat: cooperation in repeated games.

2.8 Market Failure & Government Intervention

• Externalities: Pigouvian taxes/subsidies to align private cost with social cost.
• Public Goods: Non‑excludable, non‑rival; financed via taxes.
• Information Asymmetry: Adverse selection, moral hazard; solved by regulation and disclosure.
• Monopoly Power: Regulation, price‑cap, output‑control, or antitrust laws.

2.9 Welfare Analysis

• Consumer Surplus (CS): Area above price under demand curve.
• Producer Surplus (PS): Area below price above supply curve.
• Dead‑Weight Loss (DWL): Loss of CS + PS due to inefficiency.
• Cost‑effectiveness: Compare benefits with cost of interventions.

3. Worked Example

Problem

A monopolistic firm sells a product.
Demand: (Q = 120 - 2P).
Total cost: (TC = 500 + 10Q + 0.5Q^2).
Determine the price, quantity, profit, and dead‑weight loss if the firm were perfectly competitive.

Solution