Key Economics Concepts: Demand, Markets, Money, Inflation

Posted on Feb 1, 2026 in Economy

What Is Demand? Its Determinants

Demand refers to the quantity of a commodity that consumers are willing and able to buy at a given price and time.

Determinants of Demand

  • Price of the commodity: Demand decreases when price increases and vice versa.
  • Income of consumers: Higher income increases demand for normal goods.
  • Price of related goods:
    • Substitute goods: If the price of a substitute rises, demand increases.
    • Complementary goods: If the price of a complement rises, demand decreases.
  • Taste and preference: Favorable taste increases demand.
  • Population size: A larger population leads to higher demand.
  • Future expectations: Expected price rises increase present demand.

Difference Between Microeconomics and Macroeconomics

Microeconomics

Microeconomics: Study of individual units of the economy.

  • Individual consumer, firm, price
  • Price of a single commodity
  • Individual income
  • Demand, supply, elasticity

Macroeconomics

Macroeconomics: Study of the whole economy.

  • National income, inflation, employment
  • General price level
  • GDP, inflation, unemployment

Relationship Between Average Revenue and Marginal Revenue

Definitions

Average Revenue (AR): Revenue earned per unit of output.
Formula: AR = TR / Q

Marginal Revenue (MR): Additional revenue earned by selling one extra unit.
Formula: MR = ΔTR / ΔQ

Relationship between AR and MR

  1. When AR is constant (Perfect Competition):
    • AR is a horizontal straight line.
    • MR is equal to AR at all levels of output.
    • Price remains constant.

    AR = MR

  2. When AR is downward sloping (Imperfect Competition):
    • AR falls as output increases.
    • MR lies below AR.
    • MR falls faster than AR.
  3. MR falls twice as fast as AR:
    • The slope of MR may be twice the slope of AR.
    • If AR decreases gradually, MR decreases more sharply.
  4. When AR is maximum:
    • MR becomes zero.
    • Total Revenue (TR) is maximum at this point.
  5. When AR is falling:
    • MR becomes negative after reaching zero.
    • Selling extra units reduces total revenue.

Price and Output in Perfect Competition: Long Run

The long run is a period in which all factors of production are variable and firms are free to enter or leave the industry.

Assumptions of Perfect Competition

  • Large number of buyers and sellers
  • Homogeneous product
  • Free entry and exit of firms
  • Perfect knowledge
  • Firms are price takers

In the long run, a firm reaches equilibrium at the output level where: AR = MR = LMC = LAC.

Price Determination

Price is determined by the intersection of market demand and market supply. In the long run, price equals the minimum of average cost.

Output Determination

Each firm produces output where LMC = MR. Industry output is the sum of output of all firms.

Properties of the Indifference Curve

An indifference curve shows different combinations of two goods that give the consumer the same level of satisfaction.

Main Properties of an Indifference Curve

  1. Indifference curve slopes downward: To maintain the same level of satisfaction, an increase in one good requires a decrease in the other. If it slopes upward, satisfaction would increase, which is not consistent with indifference.
  2. Indifference curves are convex to the origin: This reflects a diminishing marginal rate of substitution (MRS). As consumption of one good increases, the consumer is willing to sacrifice less of the other good.
  3. Higher indifference curves represent higher satisfaction: Curves farther from the origin correspond to higher utility; more goods mean higher utility.
  4. Indifference curves never intersect: Intersection would imply one combination gives two different satisfaction levels, which is illogical.
  5. Indifference curves do not touch the axes: It is assumed that the consumer wants some quantity of both goods. Zero quantity of one good gives no satisfaction.
  6. Indifference curve is thin (not thick): Each indifference curve shows only one level of satisfaction. A thick curve would represent multiple satisfaction levels.

Primary and Secondary Functions of Money

Money is anything that is generally accepted as a medium of exchange and a measure of value.

Primary Functions of Money

  • Medium of exchange: Money is used to buy and sell goods and services. It removes the difficulties of the barter system, such as the double coincidence of wants.
  • Measure of value: Money acts as a common unit for measuring the value of goods and services. Prices are expressed in terms of money.

Secondary Functions of Money

  • Store of value: Money can be saved and stored for future use. It preserves purchasing power over time.
  • Standard of deferred payments: Money is used for future payments such as loans, rent, wages, and taxes. It makes credit transactions possible.
  • Transfer of value: Money helps in transferring purchasing power from one person or place to another (for example, through bank transfers or remittances).

Profit Maximization in Monopoly

Monopoly is a market structure where there is a single seller, no close substitutes, and high barriers to entry.

Determination of Output and Price

  1. Determination of output: The monopolist determines output where Marginal Revenue (MR) equals Marginal Cost (MC). This output level is called the equilibrium output.
  2. Determination of price: After determining output, the monopolist fixes the price from the Average Revenue (AR) curve. Price is higher than MR because the AR curve is downward sloping.

Under monopoly, profit is maximized by producing at MR = MC and charging the price from the AR curve. Due to the absence of competition, a monopolist can earn supernormal profit even in the long run.

Functions of Money in Modern Economies

A. Primary Functions

  1. Medium of exchange: Facilitates buying and selling; removes barter system difficulties.
  2. Measure of value: Expresses the value of goods in monetary terms.

B. Secondary Functions

  1. Store of value: Money stores wealth.
  2. Standard of deferred payments: Useful for future payments.
  3. Transfer of value: Helps in transferring purchasing power.

C. Contingent Functions

  • Basis of credit
  • Helps in national income measurement
  • Promotes economic growth

Causes and Adverse Effects of High Inflation Today

Causes of High Inflation

  • Demand-pull inflation: Excess demand over supply; increased government spending.
  • Cost-push inflation: Rise in wages, fuel, and raw materials.
  • Global factors: Supply chain disruptions, the Russia–Ukraine war, energy and food crises.
  • Monetary expansion: Excess money supply and easy credit policies.

Adverse Effects of High Inflation

  1. Reduces purchasing power: Real income of people falls.
  2. Affects fixed-income groups: Salaried persons and pensioners suffer most.
  3. Increases inequality: The rich may benefit while the poor suffer.
  4. Discourages saving: The value of money falls.
  5. Economic uncertainty: Affects investment and growth.

Income Effect and Income-Consumption Curve (ICC)

Income effect refers to the change in quantity demanded of a commodity due to a change in the consumer’s real income, while prices remain constant.

When real income increases, demand for normal goods increases. When real income decreases, demand for normal goods decreases.

The Income-Consumption Curve (ICC) shows the locus of equilibrium points resulting from changes in income, keeping prices constant.

Derivation of ICC (Both Goods Normal) — Assumptions

  • The consumer is rational.
  • Prices of goods X and Y are constant.
  • Income changes.
  • Both goods are normal goods.

Derivation Steps

  1. Draw the initial budget line with given income.
  2. The consumer reaches equilibrium at the tangency of IC1 and budget line BL1.
  3. When income increases, the budget line shifts parallel outward to BL2.
  4. New equilibrium is at the tangency of IC2 and BL2.
  5. Join all equilibrium points to obtain the Income-Consumption Curve (ICC).