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MICROECONOMICS
Marginal Utility
Marginal utility from the consumption of nth unit of the good:
Mun = TUn – TUn-1
Or
MU = change in TU (ΔTU) / change in quantity (ΔQ)
Here, TU represents total utility and Q represents quantity.

Marginal utility of money

MUm = MUx / Px
Here, MUx is the marginal utility derived from good x and Px is the price of good x.

Consumer Equilibrium
Consumer equilibrium in case of one commodity: MUm = MUx / Px
Consumer equilibrium in case of one commodity: MUm = MUx / Px = MUy / Py
It is also called the Law of Equi-Marginal Utility
At equilibrium an agent will allocate expenditures so that the ratio of marginal utility to price
(marginal cost of acquisition) is equal across all goods and services.

Utility Maximization
Let a consumer consumes q1 units of a good and he derives utility as:
U1 = U1(q1): Total utility
U’1 = U’1(q1): Marginal Utility

dU1 d 2U1
 0 and 0
dq1 dq 201

TU is rising at a decreasing rate and MU is positive but decreases as more and more units of
q1 are being consumed.

Inverse demand function

As per the FOC, MUx = ʎPx or Px = MUx/ʎ
MU x
Px =


Slope of Indifference curve (MRS)

MRS = ΔY / ΔX
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ΔY represents the change in the consumption of good Y and ΔX represents the change in the
consumption of good X.
MRS shows the rate at which the consumer is willing to sacrifice good Y for an additional
unit of good X.

Budget Constraint
M  P1 X 1 + P2 X 2
P1 X 1 : The amount spent on good 1
P2 X 2 : The amount spent on good 2
M : Income of the consumer
Slope of budget line: (- P1 / P2)
This is also called the price ratio. The negative sign depicts the negative slope of the budget
line from left to right.

Consumer equilibrium
MRS = (- P1 / P2)
Slope of indifference curve = Slope of the budget line

Engle Law
As income rises the proportion of income spent on food grains or basic goods decreases. In
other words, income elasticity of demand for basic goods is less than 1

Price Effect or Total Price Effect

Due to the fall in the price of one good, there exists a change in the quantity demanded for
that good, considering M and Py constant. PE = SE + IE
Here, PE is the price effect, SE is the Substitution effect and IE is the price effect.

dx  P 
SE = → always ( − ) ve  when Px →  x  → substitute more of X for Y → Demnd X 
dPx  P 
 y 

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Price Elasticity of Demand or Simply Elasticity of Demand

Percentage change in the quantity demanded for a good
ed =
Percentage change in the price of the good

=−
( q / q ) 100
( p / p ) 100
q p
=− 
q p
q p
=− 
p q

Where, p = Initial price

q = Initial quantity
Δq = (q1 – q2) = Change in quantity demanded
Δ p = (p1 – p2) = Change in price

Geometric Method/Point Method

Case 1: Straight Line Demand Curve
The elasticity of demand at any point on a straight-line demand curve is given by the ratios of
the lower segment and the upper segment of the demand curve at that point i.e.
Lower segment
ed =
Upper Segment

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Case 2: Rectangular Hyperbola Demand Curve

If the demand curve is a rectangular hyperbola (as depicted in the following figure), then
elasticity at every point along the demand curve will be equal to 1. This curve is also known
as unitary elastic demand curve.
Total Expenditure Method
There can be following three possible situations of total expenditure.
1. If with a rise (or fall) in the price of good, the total expenditure remains constant, then
demand for the good is said to be unitary elastic i.e. | e d | = 1.
2. If with a rise (or fall) in the price of a good, the total expenditure falls (or rises), then
demand for the good is said to be greater than unitary elastic i.e. | e d | > 1.
3. If with a rise (or fall) in the price of a good, the total expenditure rises (or falls), then
demand for the good is said to be less than unitary elastic i.e. | e d | < 1.

Cross price elasticity (elasticity of good x with respect to the price of good y)
Qd x PY
 XP = 
y
PY Qd x

It has a value zero for perfect complement and a value of 1 for perfect substitutes.

Income Elasticity of Demand

Elasticity of good X with respect to income (M)
Qd x M
 XM = 
M Qd x

It is negative for inferior goods and positive for normal goods.

Indirect Utility Function

Direct and Indirect Utility Function U = U (x, y) → Direct Utility Function
Now, if we substitute the values of x* and y* in the direct utility function, we get the indirect
utility function.

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Engel Aggregation
p1 x p y
1=  xm + 2  ym
M M
where
p1 x
= Share of money spent on good x
M
 xm = Income elasticity of demand for good x
p1 x
= Share of money spent on good y
M
 ym = Income elasticity of demand for good y

Roy’s Identity
M2
Indirect Utility function: V =
4 Px2 Py
dV M2
− 2
dP 4 Px Py M
x1 ( p1 , p2 , M ) = − x = − =
dV 2M 2 Px
dM 4 Px Py
M
So, x =
2 Px

Relationship between the three Elasticities

Consumer Surplus
q*
 d ( q ).dq − p*q*
0

where
f ( q ) : demand function
p*: equilibrium price
q*: equilibrium quantity

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Producer surplus
q*
p*q* −  s ( q ).dq
0

where
f ( q ) : supply function
p*: equilibrium price
q*: equilibrium quantity

Marginal Rate of Technical Substitution (MRTS): Slope of Isoquants

K
MRTS =
L
K = Change in Capital
K = Change in Labour

Average Product
Average product of labour (APL)
TP
APL =
L
TP = Total Product
L = Labour units
Average product of capital (APK)
TP
APK =
K
TP = Total Product
K = Capital units

Marginal product
Marginal product of labour
TP
MPL =
L
TP = Change in total Product
L = Change in Labour units

Marginal product of capital

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TP
MPK =
K
TP = Change in total Product
K = Change in Capital units

Output Elasticities of Labour

Output Elasticities of Capital

Similarly, we can estimate the output elasticity of capital

Elasticity of substitution
( L)
 K
K
% in K/L
= = L
% in MRTS d ( MRTS )
MRTS

Total cost (TC)

TC = Total variable cost (TVC) + Total fixed cost (TFC)

Total Variable cost (TVC)

n
TVC =  MC
i =1

Average variable cost (AVC)

AVC = TVC / Q

Average fixed cost (AVC)

AFC = TFC / Q

Average Cost (AC)

AC = TC / Q
Or
AC = AVC + AFC
Where TC is the total cost, an Q is the output.

Marginal cost (MC)

MC = change in TC / Change in Q
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Or
MC = Change in TVC / Change in Q (since TFC is constant, changes in TC happens due to
change in TVC).

Output maximization Condition

MPL K w
MRTS L , K =  =
MPK L r

Total revenue (TR)

TR = Price (P) * Quantity (Q) or TR = AR * Q

Marginal revenue (MR)

MR = Change in TR / Change in Q

Average revenue (AR)

AR = TR / Q

Profit (P)
P = Total revenue – Total cost or TR – TC

Lerner’s Index (L)

The index is the percent markup of price over marginal cost

Herfindahl – Hirschman Index

HHI is used popularly to ascertain market concentration. Calculated by squaring the share of
entire market by each firm in the industry and then summing across all firms in the industry.

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Expected value
Expected value = (prob of success * Event A) + (prob of failure * Event B)

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