Kerala Plus Two Economics (DHSE) cheat sheet

Microeconomics studies individual units (household, firm, market); macroeconomics studies aggregates (national income, general price level, employment).

Scarcity means wants exceed the resources available to satisfy them; it is the root of all economic problems.

Three central problems: what to produce and in what quantities, how to produce (choice of technique), and for whom to produce (distribution).

Opportunity cost of a good is the value of the next best alternative forgone; it is the true cost concept behind the production possibility frontier.

Production possibility frontier (PPF) is downward sloping (trade-off) and concave to the origin when marginal opportunity cost rises.

Points on the PPF are efficient, points inside are inefficient (unemployment or underuse of resources), points beyond are unattainable with current resources.

A rightward shift of the PPF follows growth of resources or improvement in technology; a rotation occurs when improvement is specific to one good.

Positive economics deals with 'what is' (testable statements); normative economics deals with 'what ought to be' (value judgements).

Centrally planned economy: decisions by government/planning authority; market economy: decisions through price mechanism; mixed economy: both coexist (India).

Total utility (TU) is the sum of utilities from all units; marginal utility (MU) = change in TU / change in quantity = dTU/dQ.

Law of diminishing marginal utility: as consumption of a good increases, MU of each successive unit falls; TU rises at a decreasing rate and peaks where MU = 0.

Consumer's equilibrium in single-good case: MU = price (in money terms); with two goods: MUx/Px = MUy/Py = MUm.

Law of demand: price and quantity demanded move inversely, other things equal; causes are income effect, substitution effect and new buyers.

Movement along the demand curve is caused by own price change; a shift of the demand curve is caused by income, tastes, prices of related goods, expectations.

Normal goods: demand rises with income; inferior goods: demand falls with income; substitutes have positive cross-price elasticity, complements negative.

Indifference curve: all combinations giving equal satisfaction; slopes downward, is convex to the origin, and higher curves represent higher satisfaction.

Budget line equation: Px·x + Py·y = M; slope = −Px/Py; a change in income shifts it parallel, a change in one price rotates it.

Consumer's optimum under indifference analysis: MRS = Px/Py, i.e. the budget line is tangent to the highest attainable indifference curve.

Production function: Q = f(L, K); short run has at least one fixed input, long run has all inputs variable.

Law of variable proportions: MP first rises, then falls, and may turn negative; AP rises while MP > AP, falls while MP < AP, and is maximum where MP = AP.

Total product is maximum where marginal product is zero; TP rises as long as MP is positive.

Returns to scale: increasing, constant and decreasing, described by how output responds when all inputs are scaled up proportionally.

TC = TFC + TVC; TFC is constant and TVC is zero at zero output, so TC at zero output equals TFC.

AC = TC/Q, AVC = TVC/Q, AFC = TFC/Q; AVC + AFC = AC; AC and AVC are U-shaped, AFC falls continuously.

MC = change in TC / change in output = change in TVC / change in output; MC cuts AVC and AC at their minimum points.

Since MC is independent of fixed cost, MC = change in TVC/change in Q; the gap between AC and AVC equals AFC and narrows as output rises.

Costs are flows of expenditure; explicit costs are actual payments, implicit costs are imputed values of self-owned factors, and economic cost includes both.

Perfect competition: many buyers and sellers, homogeneous product, free entry and exit, perfect knowledge, no transport cost; the firm is a price taker.

Under perfect competition the firm's demand curve is horizontal at the market price, so P = AR = MR.

Profit = TR − TC; profit is maximised where MR = MC and MC is rising (second-order condition).

For a price-taking firm, the profit-maximising condition reduces to P = MC with MC rising.

Break-even point: P = minimum AC, where normal profit is earned (economic profit zero).

Shut-down point: P = minimum AVC; below this the firm loses less by stopping production in the short run.

Short-run supply curve of a competitive firm is the rising part of its MC curve above minimum AVC.

In the long run, free entry and exit drive price to minimum long-run AC, so firms earn only normal profit.

TR = P × Q; AR = TR/Q = P; MR = change in TR / change in Q; elasticity relation MR = AR(1 − 1/e).

Market equilibrium occurs where market demand equals market supply; excess demand pushes price up, excess supply pushes it down.

A demand increase raises both equilibrium price and quantity; a supply increase lowers price and raises quantity.

Monopoly: single seller, no close substitute, strong entry barriers; the firm is a price maker and faces a downward-sloping demand curve.

A monopolist maximises profit where MR = MC; MR lies below AR, and MR = 0 where total revenue is maximum.

Monopoly equilibrium price exceeds MC, and output is lower than under perfect competition; deadweight loss arises.

Monopolistic competition: many sellers, differentiated products, free entry, selling costs; short-run equilibrium can show excess profit or loss, long-run profit is normal due to entry.

Price discrimination: charging different buyers different prices for the same good; possible when markets can be separated and resale is prevented.

Price ceiling below equilibrium creates excess demand and shortages (rationing, queues); a price floor above equilibrium creates excess supply (surplus).

Minimum support price is a price floor; a ceiling is binding only when set below the equilibrium price.

GDP is the market value of all final goods and services produced within domestic territory in a year; GNP = GDP + net factor income from abroad.

NNP at market prices = GNP at market prices − depreciation; NNP at factor cost = national income.

GDP at market prices = GDP at factor cost + indirect taxes − subsidies.

Expenditure method: GDP = C + I + G + (X − M); income method: sum of factor incomes (rent, wages, interest, profit).

Value added = value of output − intermediate consumption; only final goods are counted to avoid double counting.

Nominal GDP uses current prices; real GDP uses base-year prices; GDP deflator = nominal GDP / real GDP × 100.

Personal income = national income − corporate tax − undistributed profit + transfer payments + net interest; personal disposable income = personal income − direct taxes.

Intermediate goods are used up in production within the year; final goods are for final consumption or capital formation.

Transfer payments (pensions, scholarships) are not included in national income as they are not against any productive service.

Money functions: medium of exchange, unit of account, store of value, standard of deferred payment.

M1 = currency with public + demand deposits + other deposits with RBI; M3 = M1 + time deposits with banks (M3 is broad money).

Commercial banks create credit; money multiplier = 1 / reserve ratio; total deposits = initial deposit × 1/CRR.

CRR is the fraction of net demand and time liabilities kept as cash reserves with the RBI; SLR is held in approved securities.

Repo rate: rate at which RBI lends to banks against securities; reverse repo is the rate at which RBI absorbs liquidity.

Bank rate is the long-term lending rate of the central bank; an increase in repo, CRR or SLR reduces credit creation.

RBI functions: currency issue (monopoly), banker to government, banker's bank, lender of last resort, custodian of foreign exchange, credit control.

Demand deposits are payable on demand and chequable; time deposits are fixed-period and not chequable, so only demand deposits are part of money supply M1.

High-powered money = currency with public + cash reserves of banks; money supply = money multiplier × high-powered money.

Aggregate demand = C + I + G + (X − M); equilibrium income is where AD = AS (or planned saving = planned investment).

Consumption function: C = a + bY, where a is autonomous consumption and b is marginal propensity to consume (0 < b < 1).

APC = C/Y; APC + APS = 1; MPC + MPS = 1.

Investment multiplier k = 1/(1 − MPC) = 1/MPS; change in income = k × change in autonomous expenditure.

Excess demand causes inflationary gap; deficient demand causes deflationary gap; fiscal policy can correct either.

Paradox of thrift: an attempt by all to save more can lower equilibrium income without raising total saving.

Government budget: revenue receipts + capital receipts = revenue expenditure + capital expenditure + fiscal deficit financing.

Fiscal deficit = total expenditure − total receipts excluding borrowings; primary deficit = fiscal deficit − interest payments.

Revenue deficit = revenue expenditure − revenue receipts; it indicates borrowing for consumption purposes.

Budget is an annual statement of estimated receipts and expenditure of the government; it is a statement of the fiscal policy of the year.

Revenue receipts are non-redeemable (tax and non-tax); capital receipts create liabilities or reduce assets (borrowings, disinvestment).

Revenue expenditure does not create assets or reduce liabilities; capital expenditure creates assets or reduces liabilities.

Direct taxes (income tax, corporate tax) cannot be shifted; indirect taxes (GST, customs) can be shifted to consumers.

Budgetary deficit types: revenue deficit, fiscal deficit, primary deficit; fiscal deficit is the most comprehensive measure of borrowing need.

Fiscal deficit is financed by borrowing from the public, RBI and abroad; a large deficit raises interest burden and can crowd out private investment.

Deficit financing may be inflationary when it adds to aggregate demand beyond full-employment output.

Public debt: internal debt is owed to domestic lenders, external debt to foreigners; interest payments form part of non-plan revenue expenditure.

Zero primary deficit means the government borrows only to pay interest; a primary surplus means fiscal deficit is less than interest payments.

Balance of payments = current account + capital account + errors and omissions; it always balances in accounting terms.

Current account records trade in goods and services, income and unilateral transfers; capital account records foreign investment, loans and banking capital.

Trade balance = exports of goods − imports of goods; current account balance also includes services and transfers.

Current account deficit means the country is a net borrower from abroad; it must be financed by a capital account surplus or reserves depletion.

Nominal exchange rate is the price of one currency in terms of another; real exchange rate adjusts for price levels: e_r = e × P*/P.

Currency depreciation (market-determined) makes exports cheaper and imports dearer; devaluation is a deliberate official reduction of the fixed parity.

Appreciation raises the foreign price of exports and lowers import prices; it can worsen the trade balance if demand is inelastic.

Fixed exchange rate is maintained by central bank intervention; flexible rate is determined by demand and supply of foreign exchange.

A rise in demand for imports raises demand for foreign currency and depreciates the domestic currency, other things equal.

Planning in India: Five Year Plans from 1951–56; NITI Aayog replaced the Planning Commission in 2015 as a policy think tank.

Mahalanobis strategy of the Second Plan emphasised heavy industry and capital goods; the First Plan focused on agriculture.

Economic reforms of 1991: liberalisation, privatisation and globalisation (LPG), with devaluation of the rupee and industrial delicensing.

Green Revolution raised wheat and rice output through HYV seeds, irrigation and fertilisers, mainly in Punjab, Haryana and western UP.

India's structural change: the share of services in GDP has risen fastest while agriculture's share has fallen but still employs a large workforce.

Kerala's development is noted for high literacy, low infant mortality and low fertility achieved at relatively low per capita income (human development focus).

Kerala's remittance economy from Gulf migration supports consumption; the state faces relatively low industrial growth and high unemployment among the educated.

China's reforms from 1978 began in agriculture (household responsibility system) and moved to special economic zones and exports.

Pakistan and Bangladesh show lower human development indicators than Kerala; comparison of neighbours uses per capita income, HDI and sectoral shares.