NUMERICALS FROM UNIT-1 TO UNIT -8

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1 UNIT-1 INTRODUCTION NUMERICALS FROM UNIT-1 TO UNIT A country produces two goods Its production possibilities are shows in the following table. Calculate MOC and draw PPC. Give reason. (AISSCE-2015) Possibilities Good-X(UNITS) Good-Y(UNITS) A B 95 1 C 85 2 D A chartered accountant is earning Re 1 lac per month from his own practice. He could earn Rs p.m. from a job in Reliance industries or Rs p. m. from a consultancy. What will be his opportunity cost? (Rs 75000) 3. Calculate MOC in the following example. Plot the PPC by taking cloth consumption on the X- axis.comment on t6he shape the curve. (22,25,28,30) (AISSCE-2001) Food Consumption Cloth Consumption UNIT-2 CONSUMER S BEHAVIOUR AND DEMAND 1. A commodity has Rs 5 as price per unit. His TU Schedule is given below. Determine equilibrium point. (Rs.5) Units of good TU A consumer consumes only two goods X and Y whose prices are Rs.5 and Rs. 4 respectively. If the consumer chooses a combination of the two goods with MU of X equal to 4 and that of Y equal to 5, is the consumer in equilibrium? Why or why not? What will a rational consumer do in this equal? Use utility analysis. (AISSCE-2015) 3. A consumer wants to consume two goods I and II. Price of two goods are Rs.8 and Rs 10. Consumer s income is Rs. 80. Write down the equation of budget line and determine units of

2 good I and II bought by him and the slope of the budget line. (X=10 Units, Y=8Units and slope=4/5) 4. Suppose a consumer wants to consume two goods, which are available only in integer units. The two goods are equally priced at Rs. 10 and consumer s income is Rs.40. (i)make all the possible bundles that are available to the consumer. (ii) Among the bundles that are available to the consumer, identify those which cost him exactly Rs Suppose there are three buyers A,B And C in a market for commodity X Demand functions for these buyers are as under: Dxa=30-0.5Px Dxb=20-o.4Px Dxc=10-0.2Px If prices of x commodity in rupees are 10,20,30, Draw the market demand function and estimate the market demand. (49, 38 and 27) 6. A consumer buys 27 units of a good at a price of Rs. 10 per unit. When the price falls to Rs. 9 per unit, the demand rises to 30 units. What can you say about price elasticity of demand of good through the expenditure approach? (ed=1) (AISSCE-2014) 7. A consumer spends Rs on a good priced at Rs. 8 per unit. When price rises by 25% consumer continues to spend Rs,1000 on the good. Calculate price elasticity of demand by percentage method. (ed=0.8) (AISSCE-2015) 8. What will be the effect of 10% rise in price of a good on its demand if price elasticity of demand is (a) 0 (b) -1 (c) -2 (AISSCE-2016) 9. Given Px=Rs2 and Py=Re 1, income=rs 12 Find how a consumer spends her income in order to maximize TU AND CAL CULATE tu RECEIVED BY THE CONSUMER. Show that equilibrium conditions for the consumer are satisfied (TU=93) Q MUx MUy A consumer spends Rs 40 on a good at a price of Re 1 per unit and Rs 60 at a price of Rs 2 per unit. What is the price elasticity of demand? What kind of good it is? What shape its demand curve will take? (Ed=0.25) (inelastic demand like food demand curve will be steeper) 11. Price elasticity of demand of a good is (-) 3. If the price rises from Rs 10 per unit to Rs 12 per unit. What is the % change in demand? (Ed=1) (AISSCE-2008) UNIT: 3 PRODUCER S BEHAVIOUR AND SUPPLY 1. The price elasticity of good X is half the price elasticity of supply of good Y. A 10% rise in the price of good Y results in a rise in its supply from 400 units to 520 units. Calculate the percentage change in quantity supplied of good X when its price falls from RS.10 to Rs.8 per unit. (30%) (AISSCE-2010) 2. Complete the following: Output AR(Rs) MR(Rs) TR(Rs)

3 Given below is the cost schedule of a firm. Its TFC is Rs Calculate the MC and AVC at each level of output. Output(units) ATC Following information is available regarding the production of a firm Labour TP Determine various stages of production. 5. The ratio of elasticity of supply of commodities A and B is 1: % fall in price of A results 40% gall in supply. Calculate the percentage increase in supply of B, If its price rises from Rs.10 per unit to Rs. 11 per unit. (30%) (AISSCE-2010) 6. The price elasticity of supply of a commodity is 2.0 A firm supplies 200 units of it at a price of Rs. 8 per unit. At what price will it supply 250 units. (Rs.9) (AISSCE-2013) 7. When the price of a commodity is Rs. 10 per unit, its quantity supplied is 100 units.when its price rises by 10 %, its quantity supplied rises by 9 units. Calculate its elasticity of supply. Is its supply elastic? Give reasons. (0.9, NO) (AISSCE-2014) 8. Find out (a) Explicit Cost (b) Implicit Cost SL.No. Items Rs in thousands i Investment in fixed assets 2000 ii Borrowings at 12% interest per annum 1500 iii Wages paid during year 120 iv Annual rental value of the owner s factory building 180 v Annual depreciation 100 vi Estimated annual value of the management services of the owner Using following data find out producer s equilibrium using MR-MC Approach Output(units) TR(Rs) TC(Rs) TFC is Rs 90 complete the table (AISSCE-2002) Output (units) AVC (Rs) TC (Rs) MC(Rs) Calculate TR, MR AND AR (AISSCE- 2006) OUTPUT PRICE (Rs) 50 1

4 A seller of potatoes sells 80 quintals a day when the price of potatoes is Rs 4 per Kg. The elasticity of supply of potatoes is known to be 2. How much quantity will this seller supply when the price rises to Rs 5 per Kg? UNIT: 4 FORMS OF THE MARKET AND PRICE DETERMINATION 1. When demand function is given as Qd= 100-p and supply function is Qs=60+p Determine equilibrium price and equilibrium quantity. Draw demand and supply curves. (p=rs.20 and quantity=80 units) 2. Market demand and supply schedule of apples (per day) are given Price (per Kg) Q(in Kg) Q(in Kg) Determine (a) Equilibrium price and equilibrium quantity (b) Excess demand at Re 1 per Kg (c) Excess supply at Rs 5 per Kg UNIT 5 NATIONAL INCOME (NUMERICALS) 1) Calculate NNPfc by product method Items (Rs. Crore) a) Intermediate consumption of i) Primary sector 500 ii) Secondary sector 400 iii) Tertiary sector 300 b) Value of Output of i) Primary sector 1000 ii) Secondary sector 900 iii) Tertiary sector 700 c) Net factor income from abroad -20 d) Consumption of fixed capital 40 e) Net indirect taxes 10 Ans. NNPfc = (b-a)+c+d+e

5 = ) Calculate GDPmp by Income method a) Rent 10 b) Emoluments of employees 400 c) Mixed income 650 d) Operating surplus 300 e) Consumption of fixed capital 40 f) Interest 5 g) Net indirect taxes 10 Ans. GDPmp = b+d+c+e+g = ) Calculate NNPmp by Expenditure method a) Personal consumption expenditure 4000 b) Gross domestic capital formation 1000 c) Government consumption expenditure 2000 d) Net export 100 e) Depreciation 200 f) Net factor income from abroad -100 Ans. NNPmp = a+b+c+d-e+f = ) Calculate national income a) Net Export 15 b) Net factor income to abroad -10 c) Net domestic fixed capital formation 180 d) Consumption of fixed capital 100 e) Net indirect taxes 50 f) Private final consumption expenditure 900 g) government final consumption expenditure 400 h) change in stock 0

6 Ans. NNPfc = a+c+f+g+h+d-d+b+e = ) Find National income a) Subsidy 5 b) Change in stock 7 c) Net domestic capital formation 50 d) Indirect taxes 30 e) Government final consumption expenditure 100 f) Net factor income from abroad 10 g) Private final consumption expenditure 400 h) Net export -20 Ans. NI = g+e+c+h-f-d+a = 495 6) Calculate GDPfc a) Consumption of fixed capital 120 b) Mixed income of self employed 7000 c) Interest 250 d) Rent 300 e) Profit 800 f) Compensation of employees 2000 Ans. GDPfc = b+c+d+e+f+a = ) Calculate NNPfc a) Profit 1000 b) Mixed income c) Dividend 200 d) Interest 400 e) Compensation of employee 7000 f) Net factor income to abroad 100 g) Depreciation 400 h) Rent 500 Ans. NNPfc = e+a+b+d+h-f

7 = ) Calculate NNPmp a) Gross domestic fixed capital formation 400 b) Private final consumption expenditure 8000 c) Government final consumption expenditure 3000 d) Change in stock 50 e) Consumption of fixed capital 40 f) Net indirect taxes 100 g) Net export -60 h) Net factor income to abroad -80 i) Dividend 100 Ans. NNPmp = a+b+c+d+g-e-h = ) Calculate national income by income method a) Mixed income 2500 b) Net factor income from abroad -50 c) Rent 500 d) Corporate tax 700 e) Profit 300 f) Compensation of employees 1600 g) Interest 500 h) Dividend 60 Ans. NI = f+a+c+e+g+b = ) Calculate National income a) Rent 200 b) Wages and salaries 700 c) Undistributed profit 20 d) Corporation tax 30 e) Interest 150 f) Social security contributions 100 g) Dividend 50 h) Net factor income to abroad 10

8 Ans. NI = a+b+c+d+e+f+g-h = 1240 UNIT-7 DETERMINATION OF INCOME AND EXPENDITURE Q.1. Ans: Q.2. Ans: Find consumption expenditure from the following: National Income= Rs 5000/- Autonomous consumption= Rs 1000/- Marginal propensity to consume=0.80 C=c +b.y =Rs (0.8)x5000 =Rs Rs Rs 5000/-.(Ans) Find National Income from the following: Autonomous Consumption=Rs 100/- Marginal propensity to consume=0.60 Investment=Rs 200/- At equilibrium Y=C+I Y=c +b.y+i =100+(0.6)Y+200 =300+(0.6)Y (0.4)Y=300 Y=Rs 750 (Ans) Q.3 Find Investment from the following: National Income= Rs 600 Autonomous consumption= Rs 150 Marginal propensity to consume=0.70 Ans: I=Y-C =600-[150+(0.7)x600] =600-[ ] = =30 (Ans) Q.4 An economy is in equilibrium. Calculate the Investment Expenditure from the following: National Income=Rs 800 Marginal propensity to sale=0.3 Autonomous consumption=rs 100 Ans: At Equilibrium Y=C+I I=Y-C Or at Equilibrium I=S

9 S=(-)s+(1-b)Y =(-)100+(1-0.3)x800 =460 (Ans) Q.5 An economy is in Equilibrium. Calculate the MPS from the following: National Income=1000 Autonomous Consumption=100 Investment=120 Ans: C=Y-I = =880 C=c +b.y 880=100+b.1000 b=780/1000=0.78 (Ans) Q.6 An Economy is in Equilibrium. Calculate the National Income from the following: Autonomous Consumption=120 Marginal propensity to save=0.2 Investment expenditure=150 Ans: MPC=1-MPS=1-0.2=0.8 At Equilibrium Y=C+I C=c +b.y =120+(0.8)Y Y=120+(0.8)Y Y=270 Y=1350 (Ans) Q.7 From the data given below for an Economy, Calculate a)investment Expenditure ; b) Consumption Expenditure Equilibrium level of Income=5000 Autonomous Consumption=500 Marginal propensity to consume=0.4 Ans: C=c +b.y C=500+(0.4)x5000 =2500 I=Y-C = =2500 (Ans) Q.8 In an Economy, C= Y is the consumption function where C is consumption Expenditure and Y is National Income. Investment expenditure is Calculate equilibrium level of Income and Consumption Expenditure. Ans: At Equilibrium y=c+i Y= Y Y=4200 Y=16800 and C=200+(0.75)x16800 =12800 (Ans) Q.9 From the following data about an Economy, Calculate

10 Ans: a) Equilibrium level of National Income b) Total consumption expenditure at equilibrium level of National Income (i) C= Y is the Consumption function where C is the consumption expenditure and Y is the National Income (ii) Investment Expenditure is 1500 At equilibrium Y=C+I Y= Y Y=1700 Y=3400 (Ans) Q.10 Calculate marginal propensity to consume from the following data about an economy which is in equilibrium National Income=2000 Autonomous consumption expenditure=200 Investment Expenditure=100 Ans: At Equilibrium Y=C+I Y=c +b.y+i 2000=200+b.(2000)+100 b=1700/2000=0.85 (Ans) Q.11 Calculate Investment Expenditure from the following data about an economy which is in Equilibrium: National Income=1000 Marginal propensity to save=0.20 Autonomous consumption expenditure=100 Ans: MPC=1-MPS =1-0.2=0.8 At Equilibrium Y=C+I Y=c +b.y+i 1000=100+(0.8).1000+I I= =100 (Ans) Q.12 Calculate autonomous consumption expenditure from the following data about an economy which is in equilibrium: National Income=500 Marginal propensity to save=0.3 Investment expenditure=100 Ans: C=Y-I C= =400 We know C=c +b.y 400=c+(1-0.3)x =c+(0.7)x500 c= =50 (Ans) Q.13. In an economy C= Y and I=1000 (where C=Consumption, Y=Income, I=Investment Calculate the following: a) Equilibrium level of income

11 Ans: b) Consumption expenditure at equilibrium level of income At Equilibrium Y=C+I Y= Y Y=1500 Y=15000 (Ans) Q.14. In an economy the ratio of APC and APS is 5:3. The level of Income is Rs How much are Savings, Calculate. Ans: APC:APS=5:3 Consumption=(5/8)x6000=3750 And Savings= =2250 Alternatively; (3/8)x6000=2250 (Ans) Q.15 Complete the following table: Income Consumption Expenditure Ans: Y=C+S S=Y-C MPS=(ΔS)/(ΔY) APC=C/Y MPS APC Income Consumption Saving MPS APC Expenditure Q.16. In an economy, the equilibrium level of income is Rs The ratio of MPC to MPS is equal to3:1. Calculate the additional investment required to reach a new equilibrium level of income of Rs Ans: MPC=3/4=0.75 MPS=1/4=0.25 K=1/MPS=1/0.25=4 K=(ΔY)/(ΔI) ΔI=8000/4 [As ΔY= =8000] =2000 (Ans)

12 Q.17. An increase of Rs 250 in investment in an economy resulted in total increase in income of Rs Calculate the following: a) MPC(Marginal propensity to consume) b) ΔS(Change in Saving) Ans: K=(ΔY)/(ΔI)=1000/250=4 We know K=1/(1-MPC)=4 K=1/MPS=4 MPS=0.25 MPS=(ΔS)/(ΔY)=0.25 ΔS=(0.25)(ΔY)=(0.25)(1000)=250 (Ans) UNIT-8 GOVT. BUDGET AND ECONOMY Q.1 From the following data about a govt. budget, find a)revenue deficit, b)fiscal deficit, c)primary deficit i) Tax Revenue ii) Capital Receipts iii) Non tax revenue iv) Borrowings v) Revenue Expenditure vi)interest payments Ans: a) Revenue Deficit=Revenue Expenditure-Tax Revenue-Non-tax revenue = =23 b Fiscal Deficit=Borrowings=32 c) Primary Deficit=Fiscal Deficit-Interest payments =32-20=12 Q.2. Ans: From the following data about a govt. budget, find a)revenue deficit, b)fiscal deficit, c)primary deficit i)plan Capital Expenditure ii)revenue Expenditure iii)non-plan expenditure iv)revenue Receipt v)capital receipts net of borrowing vi)interest pyment a) Revenue Deficit=100-70=30 b)fiscal deficit= =90 c)primary deficit=fiscal deficit-interest payment=90-30=60

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15 CLASS- XII ECONOMICS PART: A Introductory Micro Economics Capsules UNIT: I TOPIC: INTRODUCTION A: Basic concepts 1. Definition of Economics 2. Central problems of an economy 3. Production possibility curve 4. Opportunity Cost 5. Micro Economics and Macro Economics Definition of Economics: Economics is a Social Science. It seeks to answer questions relating to the economic behavior of the people of the society and the economy. Central Problems of an economy: I) Problem of allocation of recourses a) What to produce & How much to produce? b) How to produce? c) For whom to produce? II) Fuller utilization of resources III) Growth of resources of economic development. 1. The what problem refers to which goods and services will be produced in an economy and in what quantities. 2. The how problem refers to the choice of methods of production of goods and services. 3. The for whom problem concerns with the distribution of income and wealth. Marks : 4 Production possibility curve. A production possibility curve depicts those different combinations of two commodities that an economy can produce with the help of available resources. 4. Normally, the production possibility curve is concave to the origin. It is because of increasing marginal opportunity cost. 5. A production possibility curve shifts out due to technological progress or increases in the supply of resources available to an economy or both. Opportunity Cost. It refers to the cost of a factor in the next best use/ activity. Micro and Macro Economics: ECONOMICS Q1-XII-3

16 Micro economics studies the economic activities of individual units in the economy like a consumer, a producer, a market. Macro economics studies aggregates at the level of the economy like aggregate demand, aggregate supply, total saving, total investment, population etc..positive Economics and Normative Economics Positive Economics deals with what is and Normative Economics deals with what ought to be. B: Question Answer: Very short answer type questions with answers ( 1 mark each) 1) What is meant by economic problem? Ans. By economic problem we mean the problem of choice. 2) Why does economic problem arise? Ans. The economic problem arises due to scarcity of resources. 3) What is the shape of production possibility curve? Ans. PPC is concave to the origin and slopes downwards. 4) Who is known as the Father of economics? Ans. Adam Smith. 5) What is meant by scarcity definition? Ans. Economics is a science that studies human behavior as a relationship between ends and scarce means which have alternative uses. 6) What are the main features of human wants? Ans. i.wants are unlimited. ii. They arise again and again (wants are recurrent). 7) Who gave the welfare definition of economics? Ans. Dr. Marshall 8) What do you mean by allocation of resources? Ans. It means the distribution of resources for the production of consumer goods and services. 9) What is meant by economising resources? Ans. Making the best utilization of scarce resources. 10) Why do all economies have similar economic problems? Ans. Scarcity of resources gives birth to economic problems in all economies. 11) Use production possibility curve technique to show growth of resources in an economy. Ans: ECONOMICS Q1-XII-4

17 12) Define marginal opportunity cost along the PPC? Ans: Marginal Opportunity cost refers to the loss of output of good-y when resources are shifted from Y to produce an additional unit of good-x. Short answer type questions with answers (3 or 4 marks each) 1. Draw a production possibility curves and show the following situations in the diagram. a) Full employment of resources b) Under utilization of resources c) Growth of resources Ans. 2. What are the central problems of the economy? Ans. They are as follows: a) The problem of allocation of resources i. What to produce and how much to produce ii. How to produce? iii. For whom to produce? b) How to achieve fuller utilization of resources c) How to achieve growth of resources. 3. What are the economic activities of economy? Explain them. Ans. 1) Production: The production is the process of creation of utility like wood into furniture as Table, chair etc. 2) Consumption: The process of using up the commodity for the satisfaction of wants. 3) Investment: Addition made to the stock of capital. 4.What are the characteristics of PPC? Ans. i) The production possibility curve slopes downwards to the right indicating that the economy has to sacrifice,more and more amount of the other good per unit increase in the production of the good in question. ECONOMICS Q1-XII-5

18 ii) It is concave to the point of origin: it shows the operation of the law of increasing marginal opportunity cost. 5. An economy always produces on, but not inside, a PPC. Define or refute? Ans. In the economy with the given resources being fully employed and technology given, the combination of two goods will be any where on PPC. The society decides any combination like A,B on PPC. If there is inefficient use of resources or unemployment in any form in the economy, the economy will operate strictly within the PPC, for example, at point G. 6. Distinguish between Micro and Macro economics. Micro 1.It deals with the behaviour of individual economic units. 2. Demand and supply are the main tools of analysis. 3.It explains how resources are allocated among various goods and services and how N.I. is distributed in the economy 4.It is concerned with the determination of equilibrium level of prices of goods and services of a firm. Macro 1.It deals with the study of the economy as whole 2.Aggregate demand and aggregate supply are the main tools of analysis. 3.It explains how productive capacity and N.I. of the country increase over time. 4.It is concerned with the determination of equilibrium level of output, employment and income etc. of the economy. 7. Explain the central problems facing an economy. Scarcity of resources is a common feature of all types of economics.every economy has to face problems relating to choice which are known as central problems. 1. Problem of allocation of resources. Every economy has to allocate its available resources in the production of goods and services. While allocating resources the economy has to decide what, how and for whom to produce. 2. Problem of Efficient utilization of resources. The problem refers how to use available resources in the best possible manner and to get maximum production. 3. Problem of Growth of Recourses. It has become most essential for under developed countries not only to make the full use of their resources but to increase their production capacities also through the growth of resources. ECONOMICS Q1-XII-6

19 UNIT-II Consumer s Equilibrium and demand CHAPTER II Consumer Choice and demand curve A. Basic Concepts: 1. Consumers are the persons who make demand for final goods and services. 2. Producers are those who supply final goods and services. 3. Final goods are the things consumed by household. 4. Intermediate goods are consumed by producers. 5. Utility refers to the want satisfying power of a commodity. 6. Total utility refers to the total psychological satisfaction obtained by a consumer from consuming a given amount of particular good. 7. Marginal utility is the extra or additional utility obtained from the last unit consumed. 8. Law of diminishing marginal utility states that as a consumer consumes more and more of a commodity, the M.U. derived from each additional unit goes on diminishing. 9. The consumer is in equilibrium when he maximizes his satisfaction at a given income and price of commodity and it is attained when = Its price M.U. of a Product M.U. of a Rupee Marks : 13 Or, M.U. of a Product = M.U. of a rupee Consumers equilibrium through IC approach; Consumer equilibrium refers to a situation, in which a consumer derives maximum satisfaction, with no intention to change it and subject to given prices and his given income. The point of maximum satisfaction is achieved by studying indifference map and budget line together. On an indifference map, higher indifference curve represents a higher level of satisfaction than any lower indifference curve. So, a consumer always tries to remain at the highest possible indifference curve, subject to his budget constraint. The consumer s equilibrium under the indifference curve theory must meet the following two conditions: (i) MRSXY = Ratio of prices or PX/PY Let the two goods be X and Y. (iii) The first condition for consumer s equilibrium is that MRSXY = PX/PY a. If MRSXY > PX/PY, it means that the consumer is willing to pay more for X than the price prevailing in the market. As a result, the consumer buys more of X. As a result, MRS falls till it becomes equal to the ratio of prices and the equilibrium is established. b. If MRSXY < PX/PY, it means that the consumer is willing to pay less for X than the price prevailing in the market. It induces the consumer to buys less of X and more of Y. As a result, MRS rises till it becomes equal to the ratio of prices and the equilibrium is established. (ii) MRS continuously falls: The second condition for consumer s equilibrium is that MRS must be diminishing at the point of equilibrium, i.e. the indifference curve must be convex to the origin at the point of equilibrium. Unless MRS continuously falls, the equilibrium cannot be established. Thus, both the conditions ECONOMICS Q1-XII-7

20 need to be fulfilled for a consumer to be in equilibrium. Let us now understand this with the help of a diagram:, IC1, IC2 and IC3 are the three indifference curves and AB is the budget line. With the constraint of budget line, the highest indifference curve, which a consumer can reach, is IC2. The budget line is tangent to indifference curve IC2 at point E. This is the point of consumer equilibrium, where the consumer purchases OM quantity of commodity X and ON quantity of commodity Y. All other points on the budget line to the left or right of point E will lie on lower indifference curves and thus indicate a lower level of satisfaction. As budget line can be tangent to one and only one indifference curve, consumer maximizes his satisfaction at point E, when both the conditions of consumer s equilibrium are satisfied: (i) MRS = Ratio of prices or PX/PY: At tangency point E, the absolute value of the slope of the indifference curve (MRS between X and Y) and that of the budget line (price ratio) are same. Equilibrium cannot be established at any other point as MRSXY > PX/PY at all points to the left of point E and MRSXY < PX/PY at all points to the right of point E. So, equilibrium is established at point E, when MRSXY = PX/PY. (ii) MRS continuously falls: The second condition is also satisfied at point E as MRS is diminishing at point E, i.e. IC2 is convex to the origin. Demand and its determinants 1.Demand is the quantity of a good that that the consumer is willing to buy at a price at a time. 2.Price of related goods, income and tastes of the consumer are the determinants of demand. 3.Law of demand states that other things remaining same, as the price of commodity increases, the quantity demanded by a consumer falls and vice-versa. 4.Demand curve slopes downwards because of operation of diminishing marginal utility, income effect and substitution effect. 5.Exceptions to the law of demand conspicuous consumption, Giffen goods, Necessary goods, Expectations of future change in price. 6.Change in quantity demanded or Movement along the demand curve- whenever there is a change in the price of commodity, the quantity demanded of the commodity changes, other things remaining constant.. 7. Increase and decrease of demand: when demand changes not due to price but due to other factors like income, tastes & preferences then it is termed as change in demand. Elasticity of demand 1. The degree of responsiveness of demand to a change in the price of a commodity. 2. Price elasticity - the percentage change in quantity demanded divided. by the percentage change in the price of the commodity. Ep = %Change in Quantity Demanded % Change in price Measurement of Elasticity of demand.1. Proportionate or percentage method. ECONOMICS Q1-XII-8

21 (i) e p = (Q 1 -Q 0 )/Q 0 (P 1 -P 0 )/P 0 OR (ii) e p = Q/ P x P 0 / Q 0 Types of Elasticity of demand 1. Perfectly inelastic demand. 2. Inelastic demand. 3. Unitary elastic demand. 4. Elastic demand. 5. Perfectly Elastic demand. Determinants of Elasticity of demand or Factors affecting elasticity of demand. 1. Availability of close substitutes 2. Habits. 3. Change in income 4. Proportion of income spent on a particular good. 5. Postponement of demand. B. Question-Answer [1 mark each] 1. What is equilibrium?, Ans. The position or state of rest. 2. What are final goods? Ans. All those goods which are used for consumption or for capital formation. Example - Bread, vegetables, machines.etc. 3. What are intermediate goods? Ans. They are the raw materials consumed in producing other goods. 4. What is total utility? Ans. The total psychological satisfaction obtained by a consumer from consuming a particular commodity., 5. What is marginal utility? Ans. The utility derived from the last unit consumed. 6. State the law of diminishing marginal utility. Ans. The law states that after consuming a certain amount of a good or service the Marginal utility from it diminishes as more and more is consumed. 7. State the condition of consumer's equilibrium. Ans.The condition is - Marginal utility of a product =its price. Marginal utility of a Rupee 8.What are inferior goods? Ans.Inferior goods are those for which demand falls as income increase. ECONOMICS Q1-XII-9

22 Short type questions - answers [3/4 marks each] 1. What is meant by income effect? Ans. Income effect is the part of the price effect. When the price of a commodity falls, real income of the individual increases. As a result, more of the goods will be bought and his demand increases. This part of the increase in demand due to increase in real income is income effect of a fall in the price of a good on its demand. 2. What is substitution effect? Ans. When the price of a commodity falls, the commodity becomes relatively cheaper than its substitutes. So the people consuming.the substitute also start demanding this commodity and its demand increases. This is substitution effect. 3. Can the demand curve slope upwards? Ans. In some cases the demand curve slopes upwards. i) Giffen goods. Inferior goods have large negative income effect. ii) Demand increases when prestige is attached to the possession of a good, 4. What is meant by Elasticity of demand? Ans. Elasticity of demand shows the degree of responsiveness of demand to change in the price of a commodity. 5. Price of a commodity rises from Rs. 5 to Rs. 6. As a result its demand falls from 100 units to 80 units. Find out price elasticity of demand by percentage method. Ans: E P = Q/ P X P/Q = 20/1 X 5/100 =1 6. On the basis of information given below compare the price elasticities of good A and B. a) Good A (b) Good B Price Total expenditure (Rs) Price Total expenditure(rs) Ans: (a) Price T.E QD (b) price T.E QD E P = Q/ P X P/ Q E P = Q/ P X P/Q = 1/1 x 4/5=0.8 = 1/ 1 x 3/5 = 0.6 Demand for good A is more elastic than that of good B.. 7. Differentiate between change in demand and change in quantity demanded. Ans. Change in demand or Shift of the demand curve: i) This happens when at the same price more or less is demanded. ii) Other factors affecting demand change causing a right or leftward shift of the demand curve. iii) It is of two types - increase in demand (rightward shift) and decrease in demand (leftward shift). Change in Quantity demanded ECONOMICS Q1-XII-10

23 Change in quantity demanded or movement along the demand curve: i) This happens, when at a lower(higher) price, more(less) is demanded. ii) Other factors affecting demand remain constant. iii) It is of two types expansion(downward movement along a demand curve and contraction of demand (upward movement along a demand curve). Long questions [ 6 Marks each] 1. What are the determinants of demand? Explain. Ans. Following are the determinant of demand. / (i)income of the consumer - The effect of change in Income on the demand depends on the Nature of commodity.... Normal Goods: - If Income Increases the demand for normal goods Increases. Inferior goods :- Their demand falls with an increase in the income. ii) Prices of related goods: Substitute goods:- There is a direct (positive) relationship between the price of a good and demand of its substitute goods. If the price of coffee increases, its demand will fall and people will start consuming its substitute-tea. Complementary goods :- There is a negative or inverse relationship between the price and demand of complementary goods. If the price of sugar increases, demand for tea will decrease. iii) Tastes - If there is a favorable change in taste, demand will increase and the demand curve shifts rightwards and vice-versa. iv) Expectations: If the expectation is for the prices to rise in future, then there is increase in demand and ECONOMICS Q1-XII-11

24 if the expectation is for the prices to fall in future then there is fall in demand.. 2. Explain the factors affecting price elasticity of demand. Ans. Elasticity of demand is the responsiveness of demand to changes in the price of a commodity. i) Availability of close substitutes - If close substitutes of a product are available, elasticity is high because a small increase in price will make the consumers switch over to other products in a big way. As a result, there is a proportionately large fall in demand for the product. In the absence of close substitutes the elasticity is likely to be small. ii) Nature of the commodity. Demands for essential products are likely to be in elastic whereas demand for luxury items is relatively elastic. iii) Proportion of total expenditure spent on the product. If the amount spent on a product forms a small proportion of the, total expenditure on all goods and services we consume, then the price elasticity is likely to be small.. iv) Habits - If a person gets into the habit of consuming a commodity, it becomes difficult for him to reduce the consumption of that commodity even at a higher price and hence for such commodities demand is relatively inelastic. Production and Costs A: Basic Concepts UNIT- III Producer Behaviour and Supply Chapter - 3 Production - is the transformation of inputs into output. Production function It is a relationship between inputs used and output produced by the firm. Various combinations of inputs. Factors inputs are classified as (i) Fixed factors and (ii) variable factors. [Marks 13] i) Fixed Factors are those factors which do not vary to change the level output. Their costs remain fixed even with the change in output e.g. land, machinery, top management etc. ii) Variable Factors are those factors which vary to change the level of output. The costs of such factors vary with level of output. E.g. labour, raw material etc. ECONOMICS Q1-XII-12

25 The Short run and The Long run: Short run refers to that period when all the factors can not be changed by a firm to change the level of output. Some factors of production are fixed and some are variable. Long run refers to the period when all the factors can be changed by a firm to change the level of output. All factors are variable and no factor is fixed. Law of variable proportions and Law of Diminishing Returns : Law of variable proportions : It says that the marginal product of a factor input initially rises with its employment level. But after reaching a certain level of employment, it starts falling. Law of Diminishing marginal product or law of diminishing returns : It says that if we keep increasing the employment of an input, with other inputs fixed, eventually a point will be reached after which the marginal product of that input will start falling. The reasons behind the law of diminishing returns or the law of variable proportions. (i) Initially, the factor proportions become more and more suitable for the production, as a result marginal product increases. (ii) After a certain level, the production process becomes too crowded with the variable input and the factor proportions become less and less suitable for production. As a result marginal product of the variable input starts falling. Returns To A Variable Factor Units of Labour Total product AP MP (Quintals) (Quintals) (Quintals) Stage I Stage of increasing returns to a factor Stage II Stage of Diminishing returns to a factor Stage III Stage of negative returns to a factor ECONOMICS Q1-XII-13

26 According to this law as more and more units of a variable factor are applied with fixed factors, in the short run, initially the TP increases at an increasing rate ; after a certain level of employment the TP increases at diminishing rate and finally, total product starts declining with every increase in the variable input. First Stage : i) TPP increases at an increasing rate ii) MPP increases and reaches its maximum point. Second Stage : i) TPP increases at a diminishing rate ii) MPP decreases but remains positive & finally becomes zero. Third Stage : i) TPP begins to fall. ii) MPP becomes negative.. COSTS A: Basic Concept: COSTS : The expenses incurred by the producer on hiring & Purchasing the factors of production are known as the cost of production. Total cost is the amount of money incurred on the production of a given level of output. Short Run: There are two types of costs 1. Fixed Costs are those costs which do not vary with the level of output. These costs include depreciation allowance, interest on fixed capital, rent of building, wages and salaries of permanent employees, insurance premium etc. These are called overhead costs. ECONOMICS Q1-XII-14

27 2. Variable costs are those costs that change with the level of output. For e.g. labour costs and costs of raw materials. TC = Total Fixed Cost (TFC) + Total variable cost (TVC) (a) Total fixed cost curve is horizontal because fixed costs do not change with the change in output. (b) TVC and TC increase with the output. These curves are upward sloping. (c) Total cost curve is the vertical summation of the total fixed cost and total variable cost curves. (a) At the zero level of output, TC = TFC because TVC is zero, when output is zero. COST T C T V C T F C OUT PUT Output TFC TVC TC Average cost is the cost per unit of output : AC = TC/Q TC = Total cost, Q = Quantity of output. Average cost is the sum of average fixed cost and average variable cost. AC = AFC + AVC Reasons for U - shape of the SAC Curve. (i)operation of the law of variable proportions. ECONOMICS Q1-XII-15

28 (ii)the shapes of AFC and AVC curves. Average fixed cost is the per unit fixed cost of producing a commodity. AFC = TFC/Q TFC = Total Fixed Cost, Q = Quantity of output. AFC can be calculated by dividing total fixed cost by quantity of output produced. The shape of AFC curve is rectangular hyperbola. Average variable cost is the per unit variable cost of producing a commodity. AVC =TVC/Q TVC = Total variable cost, Q = Quantity of output. AVC is obtained by dividing total variable cost by the quantity of output. Note : i) The AFC curve continuously decreases as output increases because the numerator of the ratio TFC / Q is constant while the denominator increases. ii) The AVC and ATC curves slope downwards initially and then rise upwards i.e. they are U-shaped. Marginal cost is defined as the change in total cost when one extra unit of output is produced. Inotherwords, it is the additional cost of producing an extra unit of output. Total costs and total variable costs differ only by a constant amount i.e. TFC. MC is the increase in TVC when one extra unit is produced. TVC = the sum of MCs. = The area under the marginal cost curve. Output : MC(Rs) : Here, the TVC of producing 5 units of output is Rs ( ) = Rs. 27. Similarly, the TVC of producing 9 units will be Rs( ) = Rs. 100 The MC is initially decreasing in output and then it is increasing i.e. it is U ` shaped. The reason behind the U shape of the MC curve is the law of diminishing returns. i.e. other inputs remaining the same, when a firm raises a variable input in the short run, initially the MP rises which leads to a fall in MC ; after a certain point the employment of Input leads to a decrease in its marginal product and then MC rises. As more and more output is produced, initially the rate of increase in the requirement of the variable input will be less and less ; and after a certain point, it will be more and more. Initially, the rate of increase in the variable cost which is same as the MC will be less as output increase and then, it will be more and more when output increases further. so the MC curve is U- shaped. ECONOMICS Q1-XII-16

29 Relationship between AVC, ATC and MC. 1. AVC, ATC and MC curves are U shaped. 2. MC curve cuts the AVC and ATC curves at their minimum points. 3. MC is the addition to both the TVC and the TC. (a) The AVC curve is decreasing in the range of output from O to q 0. At any output level in this range MC<AVC (b) At any output greater than q 0, AVC is increasing in output, hence MC>AVC. (c) (a) and (b) together imply that the MC curve must cut the AVC curve at the AVC s minimum point. Relationship between TC and MC. 1. When the TC rises at a diminishing rate, the MC declines. 2. When the rate of increase in TC stops, the MC is at its minimum. 3. When the rate of increase in TC starts rising, the MC is increasing. Chapter - 4 The Theory of the Firm under Perfect Competition A: Basic Concepts: Revenue : The money receipts from the sale of the product. Total Revenue : refers to the total amount of money received by the firm from the sale of its products. TR = Price x output. Average Revenue is the revenue per unit of the output AR = TR / Q = P X Q / Q = P AR is always equal to price. Marginal Revenue is defined as the change in total revenue when one extra unit is sold. i.e. it is the revenue obtained from one extra or last unit sold.suppose the firm s output has increased from q0 to (q0+1). Given market price is P, notice that MR= ( TR from output(q0+1) ) (TR from output q0) = (P * (q0+1) ) (pq0) = P In other words, for a price taking firm, marginal revenue equals the market price. ECONOMICS Q1-XII-17

30 A Competitive firm is a price taker. If it sells one extra unit, the extra revenue generated will be equal to whatever the price is MR = P for a competitive firm. Profit : the difference between TR and TC. Producer s equilibrium : an equilibrium notion in the sense that if the firm selects the level of output at which profit is maximized, it would like to stay or rest at that level of output ; there is no incentive for it to increase or decrease output from that level. Producer s equilibrium : The Basis of the supply curve 1. TVC = the areas under the marginal cost curve. 2. TR is equal to the area under the price line The Profit maximizing condition : A competitive firm faces the market price Po i.e. PoA is the price line and its marginal cost curve is denoted by MC. A competitive firm s profit is maximized at the point where the price line intersects the MC curve i.e. P = MC (i.e. at point q 0 ) with P denoting the market price. This is the profit maximizing condition or the condition for producer s equilibrium. Why is profit maximized where the price line intersects the MC curve? Gross profit = TR TVC = profit + TFC. Since TFC is constant, profit is maximized where gross profit is maximized and vice-versa. At the market price Po, the gross profit is maximized at the output q 0, where the price line Po inter sects the MC curve. TR = the area under the price line = OPoAq 0. TVC = the area under the MC curve = ODAq 0 Gross profit = OPoAq 0 ODAq 0 = DPoA At any output less than q 0 say q, the gross profit = DPoA B. This is less than DPoA. ECONOMICS Q1-XII-18

31 At the level of output greater than q 0 i.e. q, the total revenue = OPoA q and the total variable cost = ODCq. Gross profit = OPoAOq ODPCq = DPoA ACA This is also less than DPoA. Hence, at any level of output either less or greater than q 0, the gross profit is less. Hence, profits are maximum at q 0 where P=MC. Rational behind the condition P = MC. Producer s equilibrium condition P = MC be increasing with output. Starting from the level of output at which P = MC, the firm decides to produce one unit more. Given that MC is increasing in output, P will be less than MC. But P and MC are respectively equal to extra revenues earned & extra costs incurred. Hence, extra revenues will be less than the extra costs, implying that the profits will be less. Suppose the firm decides to produce one unit less than where P = MC. In this case the revenues sacrificed (equal to P) are greater than savings in costs. (equal to MC) Hence profits will also be less. Increasing or decreasing output from where P = MC results in less profits. Profit is maximized where P = MC as long as MC is increasing in output. A competitive firm chooses an output only on the rising portion of the MC curve. General profit maximizing condition : For a competitive firm, P = MR, MR = MC Law of supply and the supply curve : Supply : Quantity of a commodity which a firm or an industry is willing to produce at a particular price, during a given time period. Law of supply : Other things remaining unchanged, an increase in the price of a product leads to an increase in the quantity supplied of it and vice-versa. Supply schedule : The table which shows the quantities of a commodity supplied at various prices during a given time period. Supply curve : The graphical representation of a supply schedule. The rising part of the MC curve is the supply curve itself. All price output combinations are simply the points of the rising part of the MC curve. Change in quantity supplied : a movement along a given supply curve because of a price change. Change in supply : a shift of the supply curve due to a change in other factors. Determinants of supply or the supply curve : the factors that change the supply are the determinants of supply ECONOMICS Q1-XII-19

32 1. Technological Change : Science and research laboratories and business firms look for new technology or methods that reduce costs of production. Such a technological advance lowers marginal costs at any given level of output. Since the MC curve is essentially the supply curve, a technological progress shifts the supply curve to the right. 2. Input Prices : changes in raw material prices, wages to workers etc. can also affect the MC curve and the supply curve. An increase (a decrease) in an input price shifts the supply curve to the left (right). 3. Unit Tax : A tax that the government imposes per unit sale of output. Hence they add to the TVC, and a change in the rate of this tax affects the overall MC. An increase (a decrease) in the unit tax shifts the supply curve to the left (right) 4. The prices of related products An increase (a decrease) in the price of a substitute good in production shifts the supply curve of a good to the left (right). Market supply curve is derived by the horizontal summation of the individual supply curves. Factors affecting the market supply curve: i) Technological change ii) Change in input prices iii) No, of firms: An increase (a decrease) in the number of firms shifts the market supply curve to the right (left). iv) More (less) competition shifts the market supply curve to the right (left). v) Time Horizon: In a short period within which firms cannot adjust their output to any change in price, the supply curve of a firm or the whole industry is vertical. In a longer run the supply curve will be upward sloping because inputs can be changed. Movement along a supply curve : When other factors influencing supply do not change, and the own price of the commodity changes, the change in supply takes place along the curve only. This is called movement along a supply curve. A movement from one point to another on the same supply curve is also referred to as a change in quantity supplied. Shifts of the supply curve : When supply changes due to changes in factors other than the own price of the commodity, it results in a shift of the supply curve. This is also referred to as a change in supply. ECONOMICS Q1-XII-20

33 Extension and Contraction of Supply: Other things remaining the same, the rise in supply of a commodity due to rise in its price is called extension of supply. Extension of supply leads to an upward movement along the supply curve. price P1 S P S O Q Q1 Q.S. Other things remaining the same, the fall in supply of a commodity due to fall in its price is called contraction of supply.contraction of supply leads to a downward movement along the supply curve. price P E S P1 E1 O Q1 Q Q.S. Increase and Decrease in Supply: The price of the commodity remaining the same, rise in supply of the commodity due to other factors like improvement in technology, low input price etc. is known as increase in supply. Increase in supply leads to a rightward shift of the supply curve. Price S S1 P E E1 O Q Q1 Q.S. ECONOMICS Q1-XII-21

34 The price of the commodity remaining the same, fall in the supply of a commodity due to other factors like rise in input prices, rise in unit tax etc.is known as decrease in supply.decrease in supply leads to a leftward shift of the supply curve. S1 Price S P O Q1 Q Q.S. PRICE ELASTICITY OF SUPPLY: Quantifies the responsiveness of quantity supplied to a change in price of a commodity. e s = P / S x s / p denotes the change If the supply curve is vertical, then the price elasticity of supply is obviously zero. Supply curve is positively sloped. The price elasticity is positive. B: Question-Answer Very short answer questions : (1 mark each) 1) What is production function? Production function is the technological relationship between factors of production and physical quantities of output. 2) What is meant by total physical product (TPP)? TPP refers to the total volume of goods and services produced during a specified period at a particular level of employment of an input when the employment of other inputs is unchanged. TPP = Σ MPP or TPP = APP x L (L = variable factor) 3) What is meant by average physical product? APP is production per unit of the variable factor. APP = TPP/L 4) What is marginal physical product? MPP = TPP n TPP n 1 5) How is the TPP derived from MPP schedule? By adding up marginal physical product of various units of a variable factor. TPP = Σ MPP. 6) What is meant by returns to a factor? ECONOMICS Q1-XII-22

35 Returns to a factor explain the behaviour of the output while the employment of one input varies, keeping other inputs constant. 7) State the law of variable proportions. If one factor is increased keeping other factors constant, MPP initially increases with an increase in the employment of the input, then it diminishes and finally becomes negative. 8) State the law of diminishing returns. The employment of other inputs remaining the same as more of a particular input is used in production, after a certain level, the MPP decreases with further employment of it. 9) What is meant by fixed factors? Those factors of production whose supply cannot be increased in the short run. 10) What are variable factors? Those factors whose supply can be changed at any time according to requirement for more production. 11) What is meant by fixed cost? Those short run costs which do not vary with the level of output are known as fixed costs. For e.g. depreciation of machines, interest on fixed capital. 12) What is meant by variable cost? Those costs which vary with the level of output ; e.g. Cost of raw material. 13) What is total cost? It is the total of all costs equal to the sum of total fixed costs and total variable costs. 14) What is total variable costs? It is the total of all costs that vary with the level of output. 15) What is average cost? It is the total cost divided by the output AC = TC/ Q 16) What is average fixed cost? It is the total fixed costs divided by the output. AFC = TFC / Q 17) What is average variable cost? It is the total variable cost divided by the output. AVC = TVC / Q 18) What is meant by marginal cost? MC is the increase in total cost or total variable cost incurred when an extra unit of output is produced. 19) What is the general shape of AFC? AFC is a rectangular hyperbola. 21) What do you mean by volume discount? It is the discount on price when a large quantity of input is purchased by a firm. ECONOMICS Q1-XII-23

36 22) What does producer s equilibrium mean? It is a situation when a producer maximizes his profits, minimizes losses (if any) in the production of goods and services. 23) What is the condition of producer s equilibrium? P = MC in perfect market. MR = MC in imperfect market. 24) What is price-line? It is the horizontal line that represents the market price facing a competitive firm. 25) What is profit? Profit is the difference between total revenue and total cost. 26) What is market structure? It refers to the no. of firms, the nature of competition between them and the nature of the product. 27) What is market period? It is that short a period within which firms cannot adjust their output to any change in price and thus a firm s output is given. 28) What is overhead cost? It is the total of all costs that are independent of the level of output. 29) What does supply mean? Supply refers to the quantity of a commodity that a seller offers for sale at a given price, at a point of time in specific market. 30) What does stock imply? Stock of a commodity refers to the total quantity of a commodity which at any point of time a seller can make available for sale in the market. 31) State the law of supply. Other things remaining the same, higher the price, greater the quantity supplied and lower the price, smaller the quantity supplied. 32) What is supply schedule? A supply schedule is a tabular statement that gives a full account of supply of a particular commodity at different prices at a point of time in a specific market. 33) What is supply curve? It is the graphic presentation of quantity supplied of a product showing that higher the price, the greater is the quantity supplied and vice-versa. 34) What is market supply curve? Market supply curve is the graphic presentation of market supply schedule which shows total quantities offered for sale at various prices by different firms producing a particular commodity. 35) What is meant by change in supply? If the price of the commodity remains constant and the supply is changed by the changes in other factors, it is known as change in supply. 36) What is extension in supply? ECONOMICS Q1-XII-24

37 Other things being equal, when quantity supplied of a commodity increases due to rise in price alone, it is known as extension in supply. 37) What is contraction in supply? When there is a fall in supply due to a fall in price, it is known as contraction in supply. 38) What is increase in supply? When supply of a product increases due to other factors like improvement in technique of production, changes in goals of firms etc. it is known as increase in supply. 39) What does decrease in supply mean? When supply of a product falls due to other factors like expected fall in prices in future, rise in factor prices etc. it is known as decrease in supply. 40) What is price elasticity of supply? Elasticity of supply is the responsiveness of supply of a commodity to a change in its price. 41) Write the formula for elasticity of supply. e s = P / S x s / p 42) What does supply function mean? It is a functional relation between supply of a commodity and its various determinants. 43) What effect does a cost saving technical progress have on the supply curve? Supply curve shifts rightward. 44) What effect does an increase in input price have on supply curve? Supply curve shifts leftward. 45) What effect does an increase in excise tax rate have on the supply curve of the product? Leftward shift of the supply curve. Short Answer Question [ 3 or 4 marks each ] 1. Explain the determinants of supply i) Price of the commodity Higher the price, greater would be the supply. ii) Prices of factors of production with he rise in prices of factors of production, cost of product will rise. So the supply will fall. iii) Goals of the firms If the firm has the goal of profit maximisation, supply will rise. 2. Distinguish between short run and long run Short Run Long Run i) The period when all the factors cannot i) All the factors of production be changed become variable ii) Some factors are fixed and some are ii) All are variable variable 3. Returns to a factor Returns to scale i) Short run concept i) Long run concept ii) Only one or some inputs can be changed ii) All factors are variable keeping other inputs fixed. iii) Factor ratio changes iii) No change in factor ratio iv) There is no change in scale of production iv) change in scale of production v) Refers to change in output when one input v) Refers to change in output when all ECONOMICS Q1-XII-25

38 input is variable. 4. What is the relationship between AP and MP? i) When MP increases, AP also increases ii) iii) iv) MP increases at a greater rate as compared to AP. At one stage AP becomes equal to marginal product. AP falls when MP falls at a greater rate. v) AP falls even when MP is zero. 5. What is the relationship between TP & MP? i) When MP increases TP increases at an increasing rate. ii) iii) iv) When MP falls, TP increases at a diminishing rate. When TP is maximum, MP is zero and AP falls. When MP is negative, TP diminishes. 6. Differentiate between fixed cost and variable cost Fixed cost inputs are variable. Variable cost i) amount spent on fixed factor i) amount spent on variable factors ii) does not vary with the change in output ii) varies with the change in output iii) remains the same even when output is zero iii) It s zero when output is nil iv) Example - rent, insurance premium iv)example cost of raw materials, salaries of permanent workers. 7. Explain the relationship between MC and AC i) When MC<AC, AC falls. ii) iii) iv) When MC = AC, AC is at its minimum. When MC>AC, AC increases. When MC starts rising, AC continue of fall. v) Minimum point of MC comes before the minimum points of AC. 8. What is the relationship between MC and TC. i) When TC rises at a decreasing rate MC falls ii) When the rate of increase in TC starts diminishing, MC becomes minimum iii) When TC increases at an increasing rate MC increases 9. Why are the MR and AR of a perfectly competitive firm equal? Because price of the good remains same at all levels of output due to the existence of a large number of firms and the firms produce and sell homogeneous product. Output Price TR AR ECONOMICS Q1-XII-26

39 Why is the AC curve U shaped? i) Because of law of variable proportion :- In the beginning, with increase in output, AC falls because of the operation of the law of increasing returns. After reaching the minimum point, when we increase the output, AC starts increasing due to the operation of diminishing returns. ii) Indivisibilities of the factor In the short run when a firm increases the output, due to indivisibilities of some fixed factors of production, AC curve falls in the beginning. After the optimum point, AC increases. Thus AC curve gets U-shape. 11. What is producer s equilibrium? Write the condition of producer s equilibrium? A producer is in equilibrium when it maximizes profits and has no tendency to move away from this situation till circumstances remain unchanged. Conditions: i) ii) MR = MC MC curve cuts MR from below. 12. Calculate TFC, TVC, AFC, AVC, MC when Output : TC : Ans: Output TC TFC TVC AFC AVC MC Differentiate between increase in supply and decrease in supply Increase in supply More quantity at the same price Same quantity at a lower price Decrease in supply Less quantity at the same price Same quantity at a higher price ECONOMICS Q1-XII-27

40 ii) Causes Causes Improvement in technique of production Obsolete technology Change in goals of firm Changes in goals of firm Fall in factor prices Rise in factor prices Increase in number of firms Decrease in number of firms Tax concessions and subsidies Increase in tax rates Increase in prices of related goods Fall in prices of related goods. 14. Distinguish between extension in supply and contraction in supply Extension in supply Contraction in supply i) A rise in supply of a commodity due to i) There is a fall in supply due to fall in rise in its price, other things remaining price, other factors remaining unchanged. Constant. Note : Draw the diagram below the explanation. 15. Mention the factors affecting market supply curve. i) No. of firms. ii) Possibility of expected change in price iii) Taxes and subsidies. iv) Change in technology v) Input price changes vi) Agreement among producers. 16. Mention the factors determining elasticity of supply. i) Nature of commodity ECONOMICS Q1-XII-28

41 Perishable and agricultural goods-inelastic Durable goods elastic ii) Cost of production If the production is subject to diminishing costs supply will be more elastic. In case of increasing costs, supply will be less elastic. iii) Time period During short period, supply will be less elastic In long period, supply is more elastic iv) Technique of production Goods using simple technique of production elastic supply In case of complex goods, less elastic v) Risk bearing capacity The goods will have elastic supply if risk bearing capacity of the firms is large. If producers are unable to bear risk, they will produce less elastic goods. 17. When the price of wheat was Rs. 500 per quintal, a producer supplies 10 quintals but when price rises to Rs. 550 per quintal, he supplies 12 quintals of wheat. Determine price elasticity of supply. e s = P / S x s / p = 500 / 10 x 2 / 50 Thus, e s = A seller sells 80 Kgs of potatoes a day when the price of potatoes is Rs. 4 per kilogram. The price elasticity of supply of potatoes is known to be 2, how much quantity of potatoes will the seller supply when the price rises to Rs. 5 per Kgs. e s = P / S x s / p 2 = 4 / 80 x s /1 2 = 4 s / 80 4 s = 80 x 2 4 s = 160 s = 160 / 4 = 40 Total supply by the seller at price of Rs. 5 = S + S = = 120 Kgs 19. The co-efficient of elasticity of supply is 1 5. What percentage change in supply will happen if its price rises by 40%. e s = % change in quantity supply / % change in price 1 5 = x% / 40% x% =1.5 x 40 = 60 Long Answer Questions (6 marks each) 1. Explain the law of variable proportion with the help of a suitable diagram. ECONOMICS Q1-XII-29

42 The law of variable proportions states that if the input of one resource is increased by equal amount per unit of time while the inputs of other resources are held constant, total output will increase, but beyond some point the resulting output increases will become smaller and smaller. Assumptions of the law : i) There is one variable input and the other inputs are fixed. ii) Units of variable input are increased by an equal amount each time. iii) All the units of variable input are homogeneous. iv) The state of technology is given. v) Different factors can be employed in varying proportions. Units of labour Total product Marginal Product Average Product Stage I : Stage II : Stage III : Stages Total Product Marginal Product Average Product 1st TP increases at an increasing At initial stage MP increases AP also increases Stage rate and reaches maximum level 2nd TP increases at a diminishing Decreases and becomes Zero AP falls, becomes equal Stage rate and becomes the highest. to MP. Starts decreasing further but never becomes zero. 3rd Starts declining Becomes negative Further decreases but ECONOMICS Q1-XII-30

43 Stage never becomes zero or negative. UNIT IV Forms of Market and Price determination CHAPTER 5 Price determination under perfect competition with simple applications A. Basic concepts 1) Excess demand pushes up the market price by causing competition among buyers. Excess supply pushes down the market price by causing competition among the sellers. 2) At the market equilibrium, there is no excess demand or excess supply and demand and supply curves intersect. 3) Equilibrium price is the price at which the quantity demanded is equal to quantity supplied. 4) A non-viable industry is one in which demand and supply curves do not intersect. The supply curve lies above the demand curve and thus nothing is produced. 5) A rightward (left ward) shift of the demand curve leads to an increase (a decrease in) price and quantity transacted. If the demand curve shifts to the right and the supply curve to the left, the price rises. 6) A rightward (leftward) shift of the supply curve leads to a decrease (an increase) in price and an increase (a decrease) in quantity transacted. 7) An increase in the price of a substitute (complementary) good in consumption leads to an increase (a decrease) in price and quantity transacted of a good in question. 8) An increase in income results in higher (a lower) price and quantity transacted if the good is normal (inferior). 9) A favourable (unfavourable) taste shift leads to a higher (lower) price and quantity transacted. 10)A cost reducing technological progress leads to a lower price and more quantity being sold. 11)An increase in an input price leads to a higher price, and less quantity being sold. 12)An increase in rate of exise duty leads to a higher price and less quantity being exchanged. 13)A price control system includes a rationing scheme. Marks : 10 14)A price support system leads to a surplus of output, which is purchased by the government. B: Question Answer ECONOMICS Q1-XII-31

44 Very short type questions : (1 mark each) 1. Give the meaning of excess demand for a product? Ans: When quantity supplied is less than quantity demanded of a product. 2. What do you mean by excess supply of a product? Ans: When quantity demanded is less than quantity supplied of a product. 3. Define market equilibrium. Ans: It refers to a market situation in which demand equals supply. 4. What is meant by equilibrium price. Ans: The price at which quantity demanded is equal to quantity supplied. 5. What is the relationship between the control price and the equilibrium price? Ans: The control price is less than equilibrium price. 6. What is the relationship between the support price and the equilibrium price? Ans: The support price is higher than the equilibrium price. 7. What is equilibrium quantity? Ans: The quantity sold at the equilibrium price. 8. What is control price? Ans: The price fixed by the government in case of essential commodities. 9. When will an increase in demand imply an increase in price but no change in quantity supplied? Ans: When the supply is perfectly inelastic during very short period. 10. What is black marketing? Ans: It refers to a situation in which a particular commodity is sold at a price higher than the price fixed by the government (control price). Short type questions [3 or 4 marks] 1. How does an increase in input price affect the equilibrium quantity exchanged in the product market? Ans: An increase in an input price leads to a higher price and less quantity being exchanged. Use diagram showing supply curve shifting to the left. 2. How does an increase in the income affect the equilibrium price of a product? Ans: An increase in income results in a higher (a lower) price and quantity exchanged according as the good is normal (inferior). [Hints: Use diagram showing demand curve shifting to the right in case of normal goods, as income increases. 3. What will be impact on market price and quantity exchanged when there is a rightward shift in the demand curve? Ans: Supply remaining the same, a rightward shift in the demand curve means higher price and higher quantity sold. Use diagram. 4. What will be impact on market price and quantity exchanged when the demand curve is perfectly elastic and the supply curve shifts out? Ans: No change in the market price, equilibrium quantity will increase. 5. What will be impact on market price and quantity exchanged when both the demand and supply curve decrease in same proportion? Ans: Price remains the same, equilibrium quantity decreases. Use diagram. Long answer type questions [ 6 Marks] ECONOMICS Q1-XII-32

45 1. Equilibrium price may or may not change with shifts in both demand and supply curves Comment. Ans: i) If both demand and supply curves increase in same proportion, there will be no change in equilibrium price but equilibrium quantity will increase. ii) When both the demand and supply curve decrease in same proportion, price remains the same but the equilibrium quantity will decrease. iii) If the supply curve increases in a greater proportion than the demand curve, price of the product will decrease. Note: Use diagram in each case. A: BASIC CONCEPTS: CHAPTER - 6 FORM OF MARKET STRUCTURE Imperfectly competitive markets are of three types: monopoly, monopolistic competition and oligopoly. In perfect competition there are a large number of sellers selling a homogeneous product. In monopoly there is a single seller selling a product which has no close substitute. Monopolistic competition is a market having a large number of sellers selling differentiated products. It consists of competitive and monopolistic elements. In other words, the monopolistic compete with each other in this market structure. A monopoly market structure emerges from licensing, granting of a patent or forming a cartel. A monopoly is a price maker. A perfectly competitive firm is a price taker. In perfect competition price remains low and hence consumers are gainers. In monopoly a higher price is charged and less is sold. Patents encourage discovery and invention. Oligopoly market has few sellers.a perfect oligopoly market produces only homogeneous products whereas an imperfect oligopoly market produces differentiated products. In collusive oligopoly market,firms cooperate with each other in taking price and output decisions whereas in non-collusive oligopoly, firms compete with each other in taking price and output decisions, B: QUESTION-ANSWER: Very short type questions: [1 Mark each] 1. What is perfect competion? Ans. It is a market situation in which there are large number of buyers and sellers selling a homogeneous product at a uniform price. ECONOMICS Q1-XII-33

46 2. What is abnormal profit? Ans. It is equal to the producer s excess earning over the opportunity cost. 3. What is normal profit? Ans. It is the profit which a firm must earn in the long run to remain in business. 4. What is monopoly? Ans. It is a market situation in which there is a single seller selling a commodity which has no close substitute. 5. What is monopolistic competition? Ans. It is a market situation where there are large number of sellers selling differentiated products. 6. What is the shape of the demand curve under Monopoly? Ans. It is downward sloping and price-inelastic. 7. What is the shape of demand curve under Monopolistic competition? Ans. It is down ward sloping & price - elastic. 8. Why is the demand curve under monopoly downward sloping? Ans. It is so because a monopolist can sell more only by reducing price. 9. Why is the demand curve under monopolistic competition flatter? Ans. The demand curve is flatter because a large number of substitutes(differentiated product) are sold in this market. 10. What is the shape of demand curve under perfect competition? Ans. A perfectly competitive firm faces a perfectly elastic demand curve. Short answer questions (3 or 4 marks) 11. What are the main features of prefect competition? Ans. Perfect competition has the following features: (a) There are a large number of buyers and sellers in the market. (b) Product is homogeneous (c) There is free entry and exit of firms. 12. What are the conditions for monopoly market? Ans. (a) There must be a single seller of the commodity. (b) No close substitute of the product of the firm is available. (c) There are barriers to entry. The barriers can be economic, institutional or artificial in nature. These barriers are so strong that they prevent entry of any firm except the one firm which is already in the field. 13. What are the main features of monopolistic competition? Ans. It is a market situation which has both the competitive elements and monopolistic elements. It has the following features : (a) There are a large number of sellers and buyers. (b) There is free entry and exit in the long run. ECONOMICS Q1-XII-34

47 (c) There is product differentiation i.e. each firm produces a brand that is unique and different from what other firm produces. 14. How is a firm under perfect competition a price-taker but the industry is a price-maker? On the other hand, the number of firms in the industry is so large that any individual firm, through its action, can not influence the market price. They have to take the price determined at the industry level as given. So, the firms are considered to be price takers. Under perfect competition, the price is determined by intersection of demand and supply curve of the industry as a whole. So, the industry is called the price maker. 15. Why is the shape of the demand curve under monopoly less elastic? Explain : Ans. (a) The demand curve facing a monopolist is downward sloping as he can expect to sell more by reducing the price. This is shown in the diagram. The monopolist sells OM quantity at OP price. If he wants to increase his sales by MM 1 he can do this by reducing price by PP 1, as a fall in price will cause an increase in quantity demanded. (b) The demand curve under monopoly is also very steep, that is, the demand curve DD in the diagram is in-elastic due to the absence of close substitutes. 16. Why is the shape of the demand curve under monopolistic competition more elastic? Explain : Ans. (a) The demand curve facing a producer under monopolistic competition is downward sloping as shown by the demand curve DD in the diagram. A producer in such a market can increase his sales by reducing his price. Quantity demanded i.e. sale can be increased by MM 1 if price is reduced by PP 1. (b) (c) The demand curve is more elastic as the differentiated products are close substitutes of each other. Number of firms is large. 17. Long answer questions (6 marks each) Ans. Differentiate between Perfect competition and monopolistic competition. ECONOMICS Q1-XII-35

48 Perfect Competition Monopolistic competition a) Infinitely large number of firms a) A large numbers of firms b) Homogeneous products b) Differentiated products c) Firms have no control over price. c) Firms have some control over price. d) Demand is infinitely elastic d) Demand is more elastic e) Demand curve (AR) is a straight line e) Demand curve is a flatter downward parallel to horizontal axis shown below showing greater elasticity f) P = MC at equilibrium point. f) P>MC at equilibrium point. g) No selling costs incurred g) Selling costs are important features in this competition. h) Price is lower than the price in h) Price is higher than competitive price due monopolistic competition. to the monopoly element. i) AR = MR i) AR>MR or MR<AR 18. Differentiate between monopoly and monopolistic competition. Monopolistic competition Monopoly a) There are a large number of sellers. a) There is a single seller. b) There is product differentiation, products b) Unique products with no close are close substitutes for each other. substitutes. c) Price elasticity of demand is more c) Price elasticity of demand is less. d) Firms have some control over price. d) Monopolist has considerable control over price. e) Presence of selling cost is an important e) No selling cost as there is no feature. competition. f) Free entry and exit of the firm f) Barriers to entry of a new firm g) Price discrimination can not be followed. g) Price discrimination may be followed under certain conditions. 19. Explain the relationship between TR and MR under monopoly with the help of a schedule and diagram : Ans. TR increases as long as MR is positive. TR is maximum when MR = O TR decreases as MR is negative. Table Output Price TR MR (in units) (in Rs.) (in Rs.) (in Rs.) ECONOMICS Q1-XII-36

49 If we plot the above schedule on the graph paper we obtain the TR and MR curves. The TR curve is inverse U-shaped because the monopolist can sell more by reducing the price. So, the TR first increases with output and then it decreases. Thus, the shape of the TR curve is different under monopoly, than the one under a competitive firm SIMPLE APPLICATION TOOLS Price Ceiling:- means maximum price of a commodity fixed by the government that the sellers can charge from the buyers. It is imposed on necessary commodities like wheat, rice, kerosene, oil, sugar etc. Price ceiling results in excess demand and less supply in the market. It is below the equilibrium price.the shortage of commodity in the market results in following implications a) Emergence of black market b) Rationing Price Floor (minimum support Price) :- it is fixed by the government necessarily above the equilibrium price. Sometimes when government feels that the price for a particular good or service should not fall below certain level and sets a floor or a minimum price for these goods and services Example: - Imposition of support price on agricultural commodities in case of requirement the government fixes the support price above the equilibrium price. Price floor results in excess supply and less demand Part - B I ntroductory M acro Economics Capsules UNIT V National I ncome and Related aggregates A: Basic concepts: 1. National Income(NNP FC ) : N.I. is the sum of domestic factor income (NDP FC ) and net factor income from abroad (NFIA). MARKS 10 ECONOMICS Q1-XII-37

50 2. Closed Economy : An Economy which does not have economic relations with other countries. 3. Open Economy : An Economy which has economic relations with other countries. 4. Final Goods : All goods which are meant either for consumption or for investment. 5. Net Domestic product : It is the gross domestic product less consumption of fixed capital. 6. Accounting period : An accounting year or a financial year often does not coincide with a calendar year. It covers the period from 1 st April of the present year up to 31 st March of the next year 7. Nominal GNP : GNP measured in terms of current market prices. 8. Real GNP : GNP computed as per constant prices. 9. Real Flow : The flow of income in terms of goods and services. 10. Money Flow : The flow of income in terms of money. B: Question- Answers Very short answer-questions (1 mark) 1. Define National income at current prices? Ans. N.I. at current prices is the money value of final goods and services estimated at current prices produced by normal residents during an accounting year. 2. Define factor income? Ans. Income earned by a factor of production i.e. in form of Rent, wages, interest and profit, in the process of production. 3. What is the name of income earned from property and entrepreneurship? Ans. Operating surplus. 4. What are the components of profit. Ans. (i) Undistributed profit, (ii) corporation tax, (iii) dividends. 5. Define personal Income? Ans. It is defined as current income of persons or household from all sources. 6. Define personal disposable income. Ans. It is that part of the personal income which is available to the households for expenditure 7. What is meant by double counting? Ans. Double counting means counting the value of the commodity more than once. 8. What is meant by Net indirect taxes? Ans. Net indirect taxes is the difference between indirect taxes and economic subsidies. 9. What are the main components of operating surplus? Ans. (i) Rent (ii) Interest (iii) Profit 10. Who prepares the National Income estimates of the country? Ans. Central Statistical Organization (C. S. O.) 11. What is added to domestic factor income to obtain national income? Ans. Net factor income from abroad is added to domestic factor income to obtain national income. 12. What is final consumption expenditure? Ans. Expenditure incurred on final goods and services is called final expenditure. ECONOMICS Q1-XII-38

51 13. What is primary sector? Ans. It is the sector which produces goods by exploiting natural resources like land, water, mines, forests etc. 14. What are intermediate goods/ inputs? Ans. The goods or inputs which get used up in producing other goods or are meant for resale are called intermediate goods/ inputs. 15. Why is imputed rent included in national income? Ans. Housing services are productive. Therefore imputed rent of owner-occupied houses forms a part of national income. 16. Define the concept of value added? Ans. It is defined as the difference between total value of output of a firm and value of inputs bought from others. 17. What is called Green GNP? Ans. Green GNP would help to attain sustainable use of the natural resources and equitable distribution of the benefits of development. 18. When is national income equal to domestic income? Ans. When net factor income from abroad is zero. 19. What are transfer payments? Ans. Transfer payments are payments for which no goods or services are provided in exchange. 20. Explain the meaning of non-market activities. Ans. Non market activities are those activities which have no market price. Ex. An electrical fault can be repaired by himself. Short answer type questions (3 & 4 marks) 1. Explain briefly the components of domestic factor income. Ans. Domestic factor income has been classified into three parts : (1) Compensation of employees : All payments by residents producers of wages and salaries to their employees in kind and in cash, social security contributions paid by employers etc. (2) Operating Surplus : The income earned from property and entrepreneurship is called operating surplus. They are rent, interest and profit. (3) Mixed income of self employed : Income of own account workers, profits and dividends of unincorporated enterprises. 2. What are the main components of Gross Domestic product at market price by Expenditure Method? Ans. There are four components : (1) Private final consumption expenditure. ECONOMICS Q1-XII-39

52 (2) Govt. final consumption expenditure. (3) Gross Domestic capital formation. (4) Net exports (Exports Imports). 3. Differentiate between intermediate goods and final goods with example. Ans. Intermediate goods Final Goods (1) These goods get used up in (1) These are used for final producing other goods and services. consumption or for capital formation. (2) These are for resale (2) These are not for resale. (3) Value of these commodities are not (3) Value of these commodities are included in N.I. included in the N.I. (4) Ex : Coal used in factory. (4) Ex : Coal used at home for cooking. 4. State the components of net factor income from abroad. Ans. The normal resident of a country earn income from abroad and income is paid to non-residents for their factor services within the domestic territory. The difference between these two is net factor income from abroad. Components : 1) Net compensation of employees. 2) Net income from property and entrepreneurship. 3) Net retained earning of resident companies from abroad. 5. Differentiate between current transfer and capital transfers. Ans. Current Transfers Capital Transfers (1) Current transfers are made from current (1) Capital transfer are made out of the income. past savings and wealth of the donor. (2) They contribute to the current income of (2) They contribute to capital formation of the recipient. of the recipient. (3) They are used for current consumption (3) They are used for long term expenditure. expenditure.. 7. Calculate Net value added at factor cost from the following data : Items Rs. in Crores 1) Intermediate consumption 30 2) Consumption fixed capital 12 3) Indirect taxes 10 4) Sales 120 5) Closing Stock 40 6) Subsidies 6 7) Opening Stock 12 Ans. Solution : Net value added at factor cost = Sales + Closing stock opening stock Intermediate consumption consumption of fixed capital Indirect taxes + subsidies = = ( ) ( ) ECONOMICS Q1-XII-40

53 = = 102 Rs. Crores 8. From the following data calculate the Gross National product at market price. Rs. in Crores 1) Value of output in primary sector ) Intermediate consumption of secondary sector 700 3) Net factor income from abroad ( ) 40 4) Net indirect taxes 200 5) Value of output in secondary sector ) Value of output in tertiary sector ) Intermediate consumption of primary sector 800 8) Intermediate consumption of teritiary sector 1500 Ans. Solution : GNP MP = [Value of output in primary sector value of intermediate consumption in primary sector] + [Value of output in secondary sector value of intermediate consumption in secondary sector] + [Value of output in Teritiary value of intermediate consumption in Teritiary sector] + Net factor income from abroad. = [ ] + [ ] + [ ] + ( ) 40 = = = 3060 Rs. Crores. 9. Show the circular flow of income with two-sector Economy with the help of a diagram. Ans. ECONOMICS Q1-XII-41

54 Long answer questions (6 Marks each) 1. What precautions will be taken for calculating national income by expenditure method? Ans. (1) Expenditure on second hand goods is to be excluded since the same is not incurred on currently produced goods. (2) All govt. expenditure on transfer payments should be excluded. (3) To avoid double counting expenditure on intermediate goods and services should be excluded. (4) Expenditure on purchases of shares, bonds etc. should not be included since they are just transfer of ownership of physical assets. 2. Explain briefly the income method of measuring national income. Also state any two precautions to be taken in using this method. Ans. N.I. is measured in terms of payments made to the primary factors of production. Income method is also called as Factor payment method. It involves different steps : Step I : Identification and classifications of producing enterprises : (a) Primary (b) secondary (c) tertiary sectors Step II : Classification of factor income into different types : (i) Compensation of employees (ii) Rent (iii) Interest (iv) profit (v) mixed income Step III : Estimate factor income in every sector Step IV : Adding up factor income of all sectors to get NDP FC Step V : Add NIFA to NDP FC to arrive at National Income (NNP FC ). Precautions: (1) Imputed rent of owner occupied houses and value of production for self-consumption should be included. (2) Illegal income from smuggling, gambling are not included in estimating N.I. ECONOMICS Q1-XII-42

55 3. Distinguish between GDP and GNP. How are they related to each one another? Ans. GDP: It is the total value of all goods and services produced within the domestic territory of a country in an accounting year. When GDP is computed at current prices it is called GDP MP. But on the other hand, when it is estimated on some base-year s price, it is known as GDP at constant price. GNP: It is a wider concept than the concept of GDP. It is the gross money value of all the final goods and services produced by normal residents of a country within and outside the country. If net factor income from abroad is positive then GNP is greater than GDP. GDP is greater than GNP, when net factor income from abroad is negative. GDP = GNP Net factor income from abroad. GNP = GDP + Net factor income from abroad. 5. From the following data Calculate the GDP at Factor cost by (a) Expenditure method and (b) Income method. Items : Rs.in Crores 1) Personal consumption expenditure 700 2) Wages and salaries 700 3) Employer s contribution to social security schemes 100 4) Gross domestic capital formation 70 5) Rent 100 6) Mixed income 600 7) Net factor income from abroad 25 8) Consumption of fixed capital 25 9) Indirect taxes 10 10) Net exports 35 11) Government final consumption expenditure ) Profit 63 13) Interest 12 14) Subsidies 5 Ans. Solutions: 1) GDP FC by Expenditure Method: GDP MP = Personal consumption expenditure + Govt. final consumption expenditure + Gross domestic capital formation + net exports. = = 1605 Rs. in Crores. GDP FC = GDP MP Indirect taxes + Subsides = ECONOMICS Q1-XII-43

56 = = 1600 Rs. in Crores. 2) GDP FC by Income Method: (i) GDP FC = Rent + Interest + wages & salaries + employer s contribution to social security schemes + profit + mixed income + consumption of fixed capital = = 1600 Rs. Crores. GDP FC by Exp. method = 1600 Rs. Crores GDP FC by Income Method = 1600 Rs. Crores 6. Calculate NNP FC by Income method and expenditure methods. Items Rs.in Crores (a) Compensation of employees 250 (b) Govt. final consumption expenditure 250 (c) Indirect taxes 20 (d) Gross fixed capital formation 75 (e) Operating surplus 360 (f) Changes in stock 60 (g) Imports 64 (h) Exports 130 (i) Net factor income from abroad 25 (j) Subsidies 5 (k) Mixed income of self employed 16 (l) Consumption of fixed capital 10 (m) Private final consumption expenditure 200 (n) Interest on national debt 20 Ans. Solutions: i) NNP FC by income Method: = Compensation of employees + Operating surplus + Mixed income of self- employed + Net factor income from abroad = = 651 Rs. Crores. ii) NNP FC by Expenditure Method: Step I: GDP MP = Private final consumption exp. + Govt. final Consumption exp. + Gross fixed capital formation + changes in stock + Exports Imports = = = 651 Rs. in Crores. Step II: NNP FC = GDP MP - Depreciation + Net factor income from abroad Indirect taxes + subsidies = ECONOMICS Q1-XII-44

57 A: BASIC CONCEPT: = = 651 Rs. in Crores. UNIT VI MONEY AND BANKING The main function of money in an economy is to facilitate the exchange of goods and services. The exchange of goods against goods is called barter system. Money performs four specific functions a unit of value, a medium of exchange, a standard of deferred payments and a store of value (functional definition). India follows a managed paper currency standard with a minimum reserve system of note issue. Money supply is the total stock of money of various kinds at a particular point of time. Banking is the process of accepting deposits and advancing loans. [M ARKS=6] The central bank is the apex institution of a country s monetary system. Its main responsibility is to design and control the monetary policy of the country. MONEY CREATION/DEPOSIT CREATION/CREDIT CREATION BY COMMERCIAL BANK Let us understand the process of credit creation with the following example. Suppose there is an initial deposit of Rs and L.R.R. is 20% i.e., the banks have to keep Rs. 200 and lend Rs. 800/-. All the transactions are routed through banks. The borrower withdraws his Rs. 800/- for making payments which are routed through banks in the form of deposits account. The Bank receives Rs. 800/- as deposit and keeps 20% of Rs.800/- i.e., Rs.160/- and lends Rs.640/-. Again the borrower uses this for payment which flows back into the banks thereby increasing the flow of deposits. 95 Deposits (in Rs.) Loans (in Rs.) Cash Reserve Ratio (20%) Initial deposit First round Second round Total MONEY MULTIPLIER: Money Multiplier = 1/LRR. In the above example LRR is 20% i.e., 0.2, so money multiplier is equal to 1/0.2=5. Why only a fraction of deposits is kept as Cash Reserve? a) All depositors do not withdraw the money at the same time. b) There is constant flow of new deposits into the banks. CENTRAL BANK MEANING: An apex body that controls, operates, regulates and directs the entire banking and monetary structure of the country. FUNCTIONS OF CENTRAL BANK: i) Currency authority or bank of issue: Central bank is a sole authority to issue currency in the country. Central Bank is obliged to back the currency with assets of equal value (usually gold coins, gold bullions, foreign securities etc.,) Advantages of sole authority of note issue: a) Uniformity in note circulation b) Better supervision and control c) It is easy to control credit d) Ensures public faith e) Stabilization of internal and external value of currency ii) Banker to the Government: As a banker it carries out all banking business of the ECONOMICS Q1-XII-45

58 Government and maintains current account for keeping cash balances of the government. Accepts receipts and makes payments for the government. It also gives loans and Advances to the government. 96 iii) Banker s bank and supervisor: Acts as a banker to other banks in the country a) Custodian of cash reserves:- Commercial banks must keep a certain proportion of cash reserves with the central bank (CRR) b) Lender of last resort: - When commercial banks fail to need their financial requirements from other sources, they approach Central Bank which gives loans and advances. c) Clearing house: - Since the Central Bank holds the cash reserves of commercial banks it is easier and more convenient to act as clearing house of commercial banks. iv) Controller of money supply and credit: - Central Bank or RBI plays an important role during the times of economic fluctuations. It influences the money supply through quantitative and qualitative instruments. Former refers to the volume of credit and the latter refers to regulate the direction of credit. v) Custodian of foreign exchange reserves. Another important function of Central Bank is the custodian of foreign exchange reserves. Central Bank acts as custodian of country s stock of gold and foreign exchange reserves. It helps in stabilizing the external value of money and maintaining favourable balance of payments in the economy. QUANTITATIVE INSTRUMENTS: i) Bank Rate policy: - It refers to the rate at which the central bank lends money to commercial banks as a lender of the last resort. Central Bank increases the bank rate during inflation (excess demand) and reduces the same in times of deflation (deficient demand) ii) Open Market Operations: It refers to the buying and selling of securities by the Central Bank from/ to the public and commercial banks. It sells government securities during inflation/excess demand and buys the securities during deflation/deficient demand. iii) Legal Reserve Ratio: R.B.I. can influence the credit creation power of commercial banks by making changes in CRR and SLR Cash Reserve Ratio (CRR): It refers to the minimum percentage of net demand and time liabilities to be kept by commercial banks with central bank. Reserve Bank increases CRR during inflation and decreases the same during deflation 97 Statutory Liquidity Ratio (SLR): It refers to minimum percentage of net demand and time liabilities which commercial banks required to maintain with themselves. SLR is increased during inflation or excess demand and decreased during deflation or deficient demand. Reverse Repo Rate: Securities are acquired by the RBI from the commercial banks with a simultaneous commitment to re-sell them to the commercial banks at predetermined rate and date QUALITATIVE INSTRUMENTS: 1. Margin Requirements: It is the difference between the amount of loan and market value of the security offered by the borrower against the loan. Margin requirements are increased during inflation and decreased during deflation. 2. Moral suasion: It is a combination of persuasion and pressure that Central Bank applies on other banks in order to get them act in a manner in line with its policy. 3. Selective credit controls: Central Bank gives direction to other banks to give or not to give credit for certain purposes to particular sectors. B: QUESTION ANSWER Very short Answer type (1 mark) : ECONOMICS Q1-XII-46

59 1. What is the main function of money in an economic system? 2. What is barter system? 3. What is money? 4. What is currency? 5. What monetary system does India follow? 6. What is money supply? 7. Which is the most liquid form of money supply? 8. What is bank rate? 9. What is an overdraft? 10. What is open market operation? 11. What is cash reserve ratio? Answer : 1. The main function of money in an economic system is to facilitate the exchange of goods and services. 2. The exchange of goods against goods is called barter system. 3. Money is a thing which performs four function (a) a units of value (b) a medium of exchange (c) a standard of deferred payments and (d) a store of value 4. Currency is the money issued by the central bank including paper currencies and coins. 5. India is following a convertible paper standard with minimum reserve system. 6. Money supply is the total stock of money of various kinds in existence at any particular point of time. 7. M 1 is the most liquid form of money supply M 1 = C + DD + OD 8. Bank rate is the rate at which the RBI lends funds to commercial banks against approved securities or eligible bills of exchange. 9. Overdraft is a facility provided by commercial banks under which a customer is given an advance allowing him to over-draw his current account up to an agreed limit. 10. Open market operation is the buying and selling of Govt. securities by the central bank from and to the public and banks on its own account respectively. 11. This is the portion of net demand and time liabilities every bank is required to deposit with the RBI. Short Answer Type (3/4 marks) : 1. What are the drawbacks of Barter system? 2. Explain the important functions of money. 3. What are the various measurements of money supply? 4. What are the differences between central bank and commercial bank. 5. How can money be classified? Answer : 1. The drawback of barter system are : ECONOMICS Q1-XII-47

60 1) Absence of a common unit of measurement There was no single unit of measuring the value of different goods as different countries were using different things as money. 2. Lack of double coincidence of wants There is no guarantee that both the parties (buyers and sellers) will be agreed to exchange their goods at a time. 3. Problem of future payments There was no single unit to engage in contracts involving future payments. 4. Storage and transfer problem There was no general method of saving purchasing power. Storage may need more cost or high depreciation. Transferring immovable goods was also impossible. 2. Important functions of money are : a) A unit of value Money is the generally accepted as a unit of value of all goods and services. b) Medium of exchange Money facilitates the buying and selling of goods and services. c) A standard of deferred payment Money helps in settling the loan taken and repayment is made in future date. d) Storage of value Store of value means shifting of purchasing power from the present to the future. As such, the holders of money are holders of generalised purchasing power from present to the future. 3. There are four alternative measurement of money supply : a) M 1 = C + DD + OD Whose, C = currency held by the public. DD = demand deposits in the bank (net). OD = Other deposits with the RBI. b) M 2 = M 1 + Savings deposits with post office savings banks. M 3 = M 1 + (net) time deposits with the banks M 4 = M 3 + total deposits with post office savings Organisation (excluding National Savings Certificate) 4. Central Bank Commercial Bank a) It s a govt. bank It s a public bank. b) Bank of note issue It can t issue currencies c) It s the apex bank in the banking system. There are large number of commercial banks. d) It controls credit in the economy. It creates credit in the economy e) It s main aim is the monetary management of It s main aim is profit earning. the economy. 5. Money can be classified as : a) Full bodied money This is a money whose value as a commodity for non monetary purpose is as great as its value as money. (Intrinsic value = Extrinsic value) b) Representative full bodied money Its a paper money which represents in circulation an amount of money with a commodity value equal to the value of the money. (Extrinsic value is greater than intrinsic value) ECONOMICS Q1-XII-48

61 c) Credit money It s the money whose value as money is greater than the commodity value of the material from which money is made. Credit money may be of token coins, representative token money, circulating promissory notes issued by the central bank and deposits at banks. Long Answer Type (6 marks) : 1. Functions of a commercial bank? (Explain in brief any four main functions of Commercial bank) 2. Explain in brief any four functions of a central bank? Answer : 1. The main functions of a commercial bank are : a) Acceptance of deposits The bank accepts three types of deposits i) Current account deposits they are payable on demand and can be withdrawn by cheque without any restriction. No interest is paid ii) Termed / fixed deposits they are fixed for a certain time period ; are not payable on demand and bear high rate of interest. iii) Savings accounts deposits these are payable on demand and withdrawable by cheque but with restriction and bears lower rate of interest. b) Giving loans Banks advance loans to the borrowers in different forms : Cash credit Demand loans Short term loans. c) Overdraft Under this system, the customer can get more than what they have deposited, but with extra interest and a short period of time. This facility is generally given to the businessmen. d) Discounting bills of exchange The bank discounts the bills of exchange a document acknowledging an amount of money in consideration for goods received after deducting the commission and pays the present value of the bill to the party. e) Investment The bank invests extra funds in terms of purchasing securities. f) Agency function The bank performs certain agency functions for its worthy customers in return for a commission. g) Miscellaneous function It includes purchase and sale of foreign exchange, issue of traveller s cheque, provision of locker and underwriting activities. 2. As the apex institution in the monetary system of a country the central bank s functions are : a) Currency Authority The central bank is the sole authority for the issue of currency in the country - its monetary liability. The central govt. also borrows from it. b) Banker to Govt. The central bank carries out all the banking business of the govt. and manages public debt. c) Bankers Bank and supervisor All the commercial banks keep a part of their cash reserves with the central bank, which is used as an instrument of monetary and credit control. It also provides clearing and remittance facilities. This bank also supervises, regulates and controls the commercial banks. d) Controller of money supply & credit Credit is an important element of the money supply. The central bank controls the supply of credit through quantitative measures and qualitative measures. ECONOMICS Q1-XII-49

62 UNIT VII DETERMINATION OF INCOME & EMPLOYMENT Aggregate demand & Aggregate Supply in M acro Economics [Marks=12] A: BASIC CONCEPTS 1. Aggregate Demand (AD) is the total demand for goods and services in the economy in a year. 2. Aggregate Supply (AS) is the total supply of goods and services in the economy in a year. 3. In classical economics, AS perfectly inelastic with respect to prices at full-employment level of output. 4. Equilibrium may be of two types full-employment equilibrium and under employment equilibrium. 5. Full employment equilibrium is that equilibrium where all resources available in the economy are employed efficiently. 6. Under employment equilibrium is that equilibrium where all resources available are not employed, that is, some are lying unused. 7. In Keynesian economics, AS is perfectly elastic due to (a) wage-price rigidity and (b) constant marginal product of labour. Very short Answer type Question : 1. What is aggregate demand? 2. Define aggregate supply? 3. What is meant by full employment level of output? 4. What is involuntary unemployment? 5. State the Say s law of market. Answer : 1. Aggregate Demand is the total demand for goods and services in the economy. 2. Aggregate supply is the total supply of goods and services in the economy. 3. The full employment level of output (goods and services) is the maximum output that the economy is capable of producing by using all the available resources efficiently. 4. It is a situation when those who seek work at the prevailing wage rate do not get it. 5. Supply creates its own demand. Short answer type (3/4 marks) : 1. How is the classical concept of aggregate supply different from the Keynesian concept of aggregate supply? 2. Explain the concept of full employment equilibrium Answer : 1. In classical concept : aggregate supply is perfectly inelastic to prices As curve is a vertical straight line at equilibrium level of output. ECONOMICS Q1-XII-50

63 Any change in the prices has no impact on the AS curve. AS is constant at the full employment level regardless of price level. In Keynesian concept : AS is perfectly elastic with respect to price level. AS curve in a horizontal straight line up to equilibrium level of output. After the equilibrium point the AS curve becomes perfectly in-elastic 2. Full employment equilibrium is an equilibrium state where all the available resources are fully (efficiently) utilized ; It s a classical concept. To the Classical, there is always full employment in the economy consequent upon wage price flexibility and the Say s law of market. If any disequilibrium takes place, it is a short run phenomenon and will be corrected automatically by the price mechanism. Diagrammatically E = Equilibrium point OP = Equilibrium price OQ = Equilibrium output at full employment. Aggregate demand and its components Basic Concepts : The components of aggregate demand (AD) are consumption, investment, govt. expenditure and net export. The relationship between consumption and income is called consumption function. Saving is the surplus of income over consumption. The relationship between saving and income in known as saving function. Investment means addition to the stock of capital goods in the form of structures, equipments or inventories. Investment demand and the rate of interest are inversely related. Net export is the difference between exports and imports. The equilibrium level of income is that level of income where AD = AS and planned savings = planned investment. Deficient demand is the shortage of AD at a level with respect to the AD at full employment level (AD < AS) Excess demand is the surplus of AD at a level with respect to AD at full employment level. (AD > AS) Excess and deficient demand may be corrected through fiscal policy and monetary policy measures. B: QUESTION ANSWER: ECONOMICS Q1-XII-51

64 Very Short Answer type (1 mark) : 1. What are the components of aggregate demand? 2. What is consumption function? 3. What is marginal propensity to consume (MPC)? 4. What is saving function? 5. What is marginal propensity to save (MPS)? 6. What is average propensity to save (APS)? 7. What is average propensity to consume (APC)? 8. What is investment? 9. Define interest. 10. If the consumption function is C = Y, what is the value of MPC? 11. If consumption in Rs. 800 when income is Rs. 1000, What would be APS? Answer : 1. The components of AD are consumption, investment, govt. expenditure and net export. 2. The relationship between consumption and income is called consumption function. C = f(y) 3. MPC is the ratio of change in consumption to change in income. MPC = C/ Y denoted by b. 4. The relationship between savings and income is called savings function. S = f(y) 5. MPS is the ratio of change in savings to change in income. MPS = S/ Y 6. APS is the ratio of savings to income. APS = S/Y 7. APC is the ratio of consumption to income. APC = C/Y 8. Investment is the addition to stock of capital in the form of equipment, structures and inventories. 9. Interest is the price paid for the borrowing of capital. 10. MPC = APS = S/Y = ( )/1000 = 200/1000 = 0.2 Short Answer Type : (3/4 marks) 1. Explain the concept of consumption function. 2. Draw a hypothetical propensity to save curve from the propensity to consume curve. 3. Explain the relationship between MPC and MPS. 4. Explain the concept of multiplier. 5. Explain the concept of deficient demand / excess demand with diagram. 6. What fiscal and monetary policies can be adopted to control inflationary gap? 7. What fiscal and monetary policies can be adopted to correct deflationary gap? Answer : 1. The relationship between consumption and income is called the consumption function Symbolically, C = f (Y) In equation, C = C + by C > 0 ; 0 < b < 1 Where, C = consumption ECONOMICS Q1-XII-52

65 C b Y = autonomous consumption at zero level of income. = MPC = level of income. As the consumption function shows, there is a positive relationship between income and consumption. The slope of the curve is MPC, which is equal to C/ Y. 2. We know that Y = C + S. If Y = C, then the savings is zero. Therefore, the savings curve must intersect the axis at the same income level where consumption function and 45º line, intersects. As such, at zero level of income, the total consumption (autonomous) is to be equal to dissavings. 3. MPC MPS a) MPC = C / Y MPS = S / Y b) Y = C+S Y = C+S Y = C + S Y = C + S Y/ Y = C / Y+ S/ Y Y/ Y = C / Y+ S/ Y C/ Y = Y / Y- S/ Y (i) S/ Y = Y / Y- C/ Y (i) Thus MPC = 1 MPS (ii) Thus MPS = 1 MPC (ii) c) If MPS = 0.2, If MPC = 0.8, MPC = MPS = = 0.8 = The concept of multiplier was developed by J.M. Keynes, which is better known as investment multiplier. This principle studies the relationship between investment and resulting change in income, because change in investment causes change in income at a multiple rate. This multiple is called multiplier. For example, if an increase in investment by Rs. 8 crores result in an increase in income of Rs. 32 crores, then the multiplier is 32/8 = 4, that is, Y/ I NOTE : (Use capital letters for MPC, MPS) ECONOMICS Q1-XII-53

66 As such,. if an economy wants to earn more, then the investment must increase. The multiplier has a positive relationship with MPC but negative with MPS. 5. If the AD at a level of output is less than the full employment level, it is known as deficient demand. Deficient demand gives rise to a deflationary gap. (Fig. I) If the AD at a level of output is more than the full employment level, it is known as excess demand. Excess demand gives rise to an inflationary gap. (Fig = II) Diagrammatically, Deflationary gap appears at full employment equilibrium to the magnitude of FG- fig(i) Inflationary gap appears after full employment level of income and employment is reached which is equal to FG as shown in figure(ii) 6. Measures to control inflationary gap are Excess demand results is in inflationary gap which causes a rise in the price level or inflation ; the value of money will fall. To control this situation ; we can take the following steps Fiscal measures a) reducing the govt. expenditure. b) increasing the rate and base of taxes. Monetary Measures a) increase the rate of interest. b) increase the reserve ratio. c) increase the bank rate. d) increase the selling of securities in the open market. e) strict directions are to be given to the banks by the RBI not to advance loans. 7. In a deflationary situation, the following measures may be taken to control the deficient demand. Fiscal measures a) increasing govt. expenditure. b) reducing the tax rate and tax base. Monetary Measures a) decrease the rate of interest. b) decrease the reserve ratio. c) decrease the bank rate. d) purchasing of the securities by the commercial banks. ECONOMICS Q1-XII-54

67 Long answer Type : (6 mark) : e) liberal in lending loans 1. Explain the determination of equilibrium level of output in consumption - investment approach. Answer : 1. The economy, as shown in the diagram, is in equilibrium at point E on the 45º line. The equilibrium level of output is OM, whose aggregate demand (desired level of spending) is equal to the level of output. C + I or aggregate demand curve is upward sloping with a positive intercept. If the economy is beyond OM output (OM 1 ) the aggregate demand line (C + I curve) will be below the 45º line which implies that the planned spending in less than the planned output. As a result, the rise in inventory will lead to reduction in employment and output which will continue up to equilibrium level of output. On the other hand if the economy is at a lower level (OM 2 ) the C+I line will lie above 45º line. As a result, the inventory will decrease leading to expansion in employment and output till the equilibrium level in attained. This is how the equilibrium will be maintained permanently Marks 6 UNIT VIII Government Budget and the Economy A. Basic concepts The budget is an annual statement of the estimated receipts and expenditures of the government over the fiscal year, which runs form April 1 to March 31. The government implements its policies through the budget. The budget impacts the economy through aggregate fiscal discipline, resource allocation and provision of programmes and delivery of services. The budget is divided into revenue budget and capital budget. Revenue may be divided into revenue receipts and capital receipts. Expenditure may be classified as revenue vs. capital, plan vs non-plan and developmental vs non-developmental. Budgets are of three types surplus, balanced and deficit. Three components of deficit are fiscal deficit, revenue deficit and primary deficit. ECONOMICS Q1-XII-55

68 B. Question-Answer : Very short answer questions (1 mark each) 1. What is a budget? A budget is an annual statement of the estimated receipts and expenditures of the government over the fiscal year, which runs form April 1 to march What are the two parts of budget? The two parts of the budget are: a) Revenue budget b) Capital budget. 3. What does capital budget consist of? Capital budget consists of capital receipts and payments. 4. What does revenue budget consist of? Revenue budget consists of revenue receipts and expenditures. 5. What are capital receipts? Receipts from disposition of assets and incurrence of liabilities are called capital receipts. 6. What are revenue receipts? The receipts of the government which do not either create liability or lead to reduction in assets are called revenue receipts. 7. What is revenue expenditure? Any expenditure that does not result in the creation of assets is treated as revenue expenditure. 8. What is capital expenditure? Expenditure on acquisition of assets or reduction of liabilities is called capital expenditure. 9. What is plan expenditure? Current development and investment expenditures due to plan proposals is called plan expenditure. 10. What is non-plan expenditure? Expenditure other than plan expenditure is called non-plan expenditure. 11. What is development expenditure? Expenditure related to economic and social development is called development expenditure. 12. What is non-development expenditure? Expenditure on essential general services of government is called non-development expenditure. 13. What is a surplus budget? A surplus budget is one where estimated revenues are greater than estimated expenditures. 14. What is a deficit budget? A deficit budget is one where the estimated revenue is less than the estimated expenditure. 15. What is a balanced budget? ECONOMICS Q1-XII-56

69 A balanced budget is one where estimated revenue equals estimated expenditure. 16. What is budget deficit? The budget deficit is the difference between the total expenditure on one hand and current revenue and net internal and external capital receipts of the government on the other. 17. What is fiscal deficit? Fiscal deficit = Total budget expenditure Revenue receipts Capital receipts excluding borrowing. 18. What is revenue deficit? Revenue deficit = Total revenue expenditure > total revenue receipts. Short answer questions: 1. What are the objectives that are pursued by the government through the budget? The Objectives that are persued by the government through the budget are as follows: i) Activity to secure a reallocation of resources: The government reallocates the resources in line with social and economic considerations if the market fails to do so, or does so inefficiently. ii) Re-distributive activities : The government redistributes income and wealth to reduce in equalities by expenditure on social security, subsidies, public works etc. iii) Stabilising activities: The government tries to present business fluctuations and maintain economic stability. iv) Management of public enterprise: The government undertakes commercial activities that are of the nature of natural monopolies, heavy manufacturing etc. 2. State the impacts of the budget on the economy? The impacts of the budget on the economy are as follows: 1) It helps to maintain aggregate fiscal discipline by having control over expenditures, given the quantum of revenues. 2) It helps to allocate resources based on social priorities. 3) Effective and efficient provision of programmes and delivery of services are possible through budget provisions. ECONOMICS Q1-XII-57

70 A. Basic Concepts: UNIT IX Foreign Exchange Rate & Balance of Payments Marks-6 1. The market in which currencies of various countries are exchanged or traded or converted is called a foreign Exchange Market. 2. Functions of foreign Exchange Market transfer function, Credit function and hedging function. 3. Foreign Exchange Rate : It is the price of the currency stated in terms of another currency. It expresses the ratio of exchange between the currencies of two countries. 4. Determination of Exchange Rate : By the forces of demand and supply in the international exchange market. So a free exchange rate tends to be such as to equal the demand for and supply of foreign Exchange. 5. Currency depreciation takes place when there is an increase in the domestic currency price against the price of foreign currency. 6. Currency appreciation takes place when there is a decrease in the domestic currency price against the price of foreign currency. 7. Types of exchange Rate determination : Fixed Exchange Rate system. Adjustable peg system, flexible Exchange Rate. 9. BOP is a systematic record of all economic transactions between the resident of the reporting country and the residents of foreign countries during a given period of time. 10. The essentials of Balance of Payments are visible, invisible items and capital transfers. 11. BOP maintains double Entry system of recording therefore it always balances. 12. Balance of trade takes into account only those items (visible) which are exported and imported. Accounts of Balance of payments are current Account and capital Account. Current account includes imports, exports of goods and services and unilateral transfers. Capital account includes private transaction, official transactions, Direct investment, portfolio investments. Other items included are errors and omissions and official reserve transactions. 13. Disequilibrium in Balance of Payments The factors are Economic, Political and Social. 14. Equilibrium exchange rate is often unfavourable in LDC S due to too much of dependence on development expenditure. B: Question Answers [1 mark answer] : 1. What is international trade? Ans. It is a trade between countries. 2. What is the meaning of foreign exchange rate? Ans. Foreign exchange rate is the price of one currency in terms of another. 3. What is the significance of foreign exchange Rate? Ans. In help in the comparison of international costs and prices. 4. What is foreign exchange market? Ans. Where the national currencies are traded for one another. 5. What is Hedging function? ECONOMICS Q1-XII-58

71 Ans. To protect against foreign exchange risks. 6. Why do people want to acquire foreign exchange? Ans. i) To purchase goods and services from other countries. ii) To purchase financial assets in a particular country. 7. What is the shape of the demand curve in the foreign exchange market? Ans. The demand curve is downward sloping. 8. What is the meaning of Balance of payments? Ans. Systematic records of all economic transactions of a country with rest of the world in a year. 9. Who is considered as a resident of a country? Ans. Resident includes individuals, business unit, Government and their agencies. 10. What is balance of trade? Ans. Those transactions arising out of the exports and imports of goods. It s the difference between exports and imports of goods. 11. Name two accounts of Balance of payment. Ans. Current account and Capital account. 12. What is unilateral transfer? Ans. These are the receipts which residents of a country receive, or payment that the residents make without getting anything in return. 13. Name two capital account transactions. Ans. i) Private foreign investments. ii) Portfolio investment. 14. What is meant by Portfolio investment? Ans. It is the acquisition of an asset that does not give the purchaser control over the asset. 15. Give an economic cause of disequilibrium in the BOP. Ans. A large scale development expenditure that may cause large imports. 3/4 mark Answer: 1. Difference between balance of payments and Balance of trade : Ans. Balance of Trade Balance of payments i) Records only visible items i) Records visible and invisible items ii) BOT can be deficit, surplus or balanced ii)bop is always balanced 2. Explain the components of capital account. Ans. The capital account records all international transactions that involve a resident of the domestic country changing his assets or his liabilities with a foreign resident. i) Private Transactions ii) Official Transactions iii) Direct Investment iv) Portfolio Investment. 3. Describe the causes of disequilibrium in the BOP. Ans. i) Economic factors ii) Political factors iii) Social factors 4. Describe the equilibrium in the foreign exchange market. Ans. Equilibrium in the foreign exchange market is determined in the same way as the price of a commodity through the forces of demand and supply. The intersection of the supply and demand curve ECONOMICS Q1-XII-59

72 determines the equilibrium foreign exchange rate. The demand curve for foreign exchange is downward sloping and the supply curve is upward sloping. ECONOMICS Q1-XII-60

73 VKM/KVCH/ECO/ /0 FOR XII 0

74 MOST EXPECTED QUESTIONS: 2018 VKM/KVCH/ECO/ /1 1. What is economics all about? Distinguish between its two branches Micro and Macro Economics. Ans: - Economics is all about making choices in the presence of scarcity. Sl. No. i Difference between Micro and Macro Economics Micro Economics Microeconomics is the branch of economics which study individual economic variable / unit. ii The main tools of micro economics are demand and supply. iii The main problem studied is price determination. iv Microeconomics is a partial equilibrium analysis. v The major microeconomic variables are price, individual consumer s demand, wages, rent, profit, revenue, etc. Macro Economics Macroeconomics is the branch of economics which study economy as whole and its aggregates. The main tools of macro economics are aggregate demand and aggregate supply. The main problem studied is income and employment determination. Macro economics is a general equilibrium analysis. The major macroeconomic variables are National income, aggregate demand, aggregate supply, inflation, poverty, unemployment, etc. 2. Distinguish between Positive and Normative Economics. Ans: - Difference between Positive and Normative Economics Sl. No. Positive Economics 1 Positive Economics deals with the economic problem as they are and how they are actually solved. 2 This is generally relate to what is, what was and what will be under given circumstances. Normative Economics Normative Economics is suggestive in nature. It examines events from moral angle. the economic This is generally relate to what ought to be or what should be under given circumstances. 3 This deals with realistic situation. This deals with idealistic situation. 4 These statements can be These statements cannot be empirically empirically verified as they are based on fact. verified as they are not based on fact. 5 E.g- There is poverty in India. E.g.- Poverty in India should be reduced. 1

75 VKM/KVCH/ECO/ /2 3. What do you mean by economic problem? Why does an economic problem arise? Explain. Ans: - Economic problem The problem of choice that arises due to multiplicity of wants and scarcity of resources is called economic problem. The main reasons for arising economic problems are as follows - i. Unlimited wants - Human wants are many in numbers and recurring in nature. A man can not satisfy all of his wants and therefore it has to make a choice in order of priority/urgency. ii. Limited resources - The resources are limited in relation to need for them. Therefore it has to make a choice that how to use the resources. iii. Alternative use of resources - A resource can be utilised in a different way and for different purposes. Therefore choice has to be made among different uses of resources. 4. Explain the problem of 'what to produce' with the help of an example. Ans: - What to Produce - It is the problem of selection of goods. It has two aspects- what commodity is to be produced and in what quantity. This problem arises because economy has to produce so many types of goods like consumer goods - capital goods, war goods - civil goods, necessity goods - luxury goods etc. An economy has limited resources and the wants are unlimited, so all goods and services cannot be produced. Therefore, economy has to decide which goods are to be produced. The decision is generally depend on the demand of the society. For example, on a given piece of land, all crops cannot be grown. If it is used for growing wheat, then on the area on which wheat is grown other crops cannot be grown. This is the problem of what to produce. 5. Explain the problem of 'how to produce' with the help of an example. Ans: - How to Produce - This problem relates to selection of the technique of production of goods. Generally, most of the goods can be produced by using more than one technique. Mainly there are two techniques: labour intensive technique (a technique in which more labour and less capital is used) and capital intensive (a technique in which more capital and less labour is used). Since the resources are scarce, so a decision is to be taken that which technique to be used. For example, cloth can be produced with labour intensive technique as well as capital intensive technique. Which technique to choose is the problem of how to produce. 6. Explain the problem of For whom to produce. Ans: - For whom to produce - This is the problem of distribution of goods and services produced among various people and factors of production in the economy. The production of goods and services is the result of combined effort of 2

76 VKM/KVCH/ECO/ /3 factors of production namely, land, labour, capital and entrepreneur. The output emerging from production is distributed in the form of money income i.e. rent, wages, interest and profit, on the basis of contribution of each individual factor of production. The economy needs to decide the best suitable mechanism for distribution - to reduce inequality of income, to reduce poverty, to add to the social welfare and standard of living of people. 7. Define opportunity cost, marginal opportunity cost and economy. Ans: - Opportunity cost - The amount of next best alternative which has been given up (scarified) in order to produce a good is called opportunity cost. Marginal opportunity cost - The amount of other good which has been given up (scarified) in order to produce an additional unit of a good is called marginal opportunity cost. Economy is a system in which and by which people get their living. In other words it s a framework within which all the economic activities of a country take place. 8. Define Production Possibility Curve (PPC) or Production Possibility Frontier and explain its main characteristics. Ans: - Production Possibility Curve is a curve which shows all the possible combinations of two goods which an economy can produce with full and efficient utilisation of its given resources and technology in a given period of time. Production Possibilities Production Possibility Commodity A Commodity B A B = 1 C =2 D =3 E =4 F =5 Marginal opportunity cost of commodity A Commodity A 3

77 Characteristics of PPC- VKM/KVCH/ECO/ /4 i) PPC is downward sloping- PPC assume that all the resources in the economy are fully and efficiently utilized so in order to increase the production of one good economy has to decrease the production of other good. Thus it is downward sloping. ii) PPC is concave to origin PPC is concave to origin because of increasing Marginal rate of transformation (MRT) / Marginal opportunity cost (MOC). Marginal rate of transformation (MRT) increases because it assumes that all the resources are not equally efficient to produce all the goods. Therefore, as resources are transferred from one good to another good, less and less efficient resources are transferred it increases the cost and MRT. 9. What shape will PPC take when Marginal Rate of Transformation decreases, constant and increases? Ans: - Marginal rate of transformation and shape of production possibility curve MRT Nature of PPC Shape of PPC Increasing Concave to origin Constant Downward sloping straight line Decreasing Convex to origin 10.What do you mean by Utility? Briefly explain the concept of Total utility, Marginal Utility and Average Utility with the help of an examples. Ans: - Utility - The want satisfying power of a commodity is called utility. 4

78 VKM/KVCH/ECO/ /5 Total utility- The total amount of satisfaction which a consumer derives by consuming given units of commodity is called total utility. It can be obtained by two ways- By summing up the marginal utilities derive from various units of commodity. TU= MU 1 + MU 2 + MU 3 + MU MU n TU= ΣMU By multiplying average utility by numbers of units of commodity consumed. TU= AU Q Marginal Utility- The change in total utility by consuming an additional unit of a commodity is called marginal utility. In other worlds it is the utility derive from the consumption of the last unit of the commodity. It can be obtained by two ways- MU=TU n -TU n-1 or MU ΔTU ΔQ E.g. - Suppose by consuming 10 units of a commodity total amount of satisfaction derived by consumer is 50 and by consuming 11 units total satisfaction derived is 54. Then MU will be as follows- MU = TU n - TU n-1 = TU 11 TU 11-1 = TU 11 TU 10 = = 4 Average Utility- It is the utility per unit of a commodity consumed which can be obtained by dividing total utility by number of units of commodity consumed. AU TU Q E.g.- Suppose by consuming 10 units of a commodity total amount of satisfaction derive is 50. Then AU will be as follows- AU TU Q = 5 11.Define the law of Diminishing Marginal Utility and Principle of Equi- Marginal Utility. Ans: - Law of diminishing Marginal Utility - This law states that other things remain constant as a consumer consumes more and more units of a commodity, the marginal utility derive from the successive units of that commodity tends to decrease. 5

79 VKM/KVCH/ECO/ /6 Principle of Equi-Marginal Utility It states that consumer will allocate his expenditure on different goods in such a way that the utility gained from the last rupee spent on each commodity is equal. 12. Define consumer equilibrium. Explain one (single) commodity model of consumer equilibrium through utility analysis. Ans :- Consumer s equilibrium - It refers to a situation in which a consumer gets maximum satisfaction and he has no tendency to change in his existing expenditure (consumption) pattern. Consumer equilibrium Single commodity case If consumer consumes only one good then consumer s equilibrium is attained when marginal utility of commodity in terms of money becomes equal to its price i.e. MU X = P X. Since it is difficult to compare MU of a good (expressed in utiles) with its price (expressed in ). Therefore MU of a good is first converted in terms of money by dividing MU of a good by MU of a rupee. MU X = MU X (in terms of money) MU X (in utiles ) MU M Where MU M = Marginal utility of money Marginal utility of money refers to the extra satisfaction which a consumer derives by spending an additional unit of rupee on other available goods. We can explain one commodity model with the help of example as follows: Suppose a consumer is purchasing commodity X and the price of each unit of X is 4. Hypothetical marginal utility schedule of commodity X is given as: Units of commodity X Consumed Marginal Utility (in terms of ) Price ( ) Remark MU > P MU = P MU < P 6

80 VKM/KVCH/ECO/ /7 In above table and diagram, when consumer will purchase 3 units of commodity X he will reach an equilibrium position because the condition of consumer s equilibrium MU X (in ) = P X is satisfied. At this level of consumption, the marginal utility of X is equal to the price of commodity X i.e. 4. If he purchases less than 3 units say 2 units then the marginal utility derived from 2 units is 6 and the price which he pays is 4.Since his MU X > P X.Therefore he will purchase more quantity of commodity X and vice versa. Hence consumer will be in equilibrium only at that point where MU X = P X. 13.What are monotonic preferences? Explain with the help of an example. Ans:- Monotonic preferences- A consumer preferences are said to be monotonic if and only if, between any two bundles of the two goods, he prefers that bundle which has at least more quantity of one good but no less of other good. Example - If bundle A (3,5) and bundle B (3,2) are available to the consumer, then consumer will prefer bundle A over bundle B as bundle A consists of more units of good 2 than bundle B. 14.What do you mean by Indifference curve? Explain its main Features. Ans: - Indifference curve is a curve which shows various combinations of two goods which give same level of satisfaction to the consumer. For example, there are two goods i.e. good X and good Y. The different combinations of these two goods are given below in table that gives same level of satisfaction to the consumer. Indifference Schedule Combinations Good X Good Y A 1 10 B 2 6 C 3 3 D 4 1 In above diagram, all combinations give same level of satisfaction to the consumer. So by joining points A, B, C and D the curve derived is Indifference Curve. Properties or Feature of Indifference curve- 1. IC is downward sloping - It is always downward sloping because IC assumes that the combination of both the goods gives a certain level of satisfaction to the consumer. So, in order to increase the consumption of one commodity consumer has to decrease the consumption of another commodity. 7

81 VKM/KVCH/ECO/ /8 2. IC is convex to origin - It is convex to origin because of decreasing Marginal rate of substitution (MRS). This is because, as the consumer has more and more units of X, its marginal significance to him declines. So he is willing to give up less and less units of Y for an increment in X. 3. Higher IC shows higher level of satisfaction - As compared to lower IC, certainly higher IC show higher level of satisfaction. It is because higher IC has more quantity of one good without reducing quantity of another good. 4. ICs do not intersect each other - Each IC represents different level of satisfaction, so there intersection is ruled out. 15. Explain the concept of Indifference Map and Marginal Rate of Substitution (MRS)? Ans: - Indifference Map - The set of indifference curves is known as indifference map. The different curves of indifference map shows different level of satisfaction and higher indifference curve always shows higher level of satisfaction. In diagram, there are three indifference curves IC 1, IC 2 and IC 3. IC 1 is the lowest and IC 3 is the highest curve.so IC 3 will show highest satisfaction. Marginal Rate of Substitution (MRS) - The amount of other commodity which has been sacrificed (given up) in order to consume an additional unit of a commodity is called marginal rate of substitution. MRS MRS XY XY Change Change ΔY ΔX in quantity in quantity of good Y of good X Marginal Rate of Substitution (MRS XY ) is the slope of indifference curve. 16. Briefly explain the concept of Budget Set. Write the equation of budget set. Ans: - Budget Set- It refers to all the bundles or set of bundles available to the consumer with given price and given income. In other words, it is the collection of all the bundles that consumer can purchase with his given income at the prevailing market prices. Budget constraint- It shows that a consumer can choose any bundle as long as it costs less or equal to income. 8

82 VKM/KVCH/ECO/ /9 Let X 1 be the amount of good 1. X 2 be the amount of good 2. P 1 be the price of good 1. P 2 be the price of good 2. P 1 X 1 = Total money spent on good 1 P 1 X 2 = Total money spent on good 2 M is total income Thus P 1 X 1 + P 2 X 2 M will be the equation of budget set. 17. Define Budget line. Give the formula for calculating the slope of the budget line. Briefly explain the factors that cause changes in the Budget line. Ans: - Budget line - It s a line which shows various combinations of two goods which a consumer can purchase with his given income and given prices of the goods. The equation of budget line is P 1 X 1 + P 2 X 2 = M We can derive budget line with help of an example as under- Suppose consumer income is 20 and price of good X is 4 and price of good Y is 2. Then the different combinations of two goods which consumer will be able to purchase by spending his entire income will be as follows- Combinations Good X Good Y A 0 10 B 1 8 C 2 6 D 3 4 E 4 2 F 5 0 In above schedule and diagram the different combinations which consumer can purchase by spending his given income and prices of goods are A, B, C, D, E and F. In diagram by joining these points the curve derive is budget line. Slope of the budget line- It is equal to the ratio of the prices of the two commodities. Slope of the budget line ( ) P 1. P 2 9

83 VKM/KVCH/ECO/ /10 Where P 1 is price of good 1 and P 2 is price of good 2. The budget line has negative slope or it is downward sloping which indicates that the consumer can purchase extra units of one commodity only by sacrificing some units of other good Changes in the Budget line - The factors which cause change in budget line area) Change in consumer Income - If consumer income increases, then he can purchase more quantities of both the goods. Therefore, budget line of consumer shifts rightward and vice versa. AB- Original budget line A 1 B 1 - New budget line after increase in income. AB- Original budget line A 1 B 1 - New budget line after decrease in income. b) Change in prices of commodities - If prices of both the commodities decreases then, consumer can purchase more quantities of both the goods. So, budget line shifts rightward and vice versa. AB- Original budget line A 1 B 1 - New budget line after decrease in prices of both the goods. AB- Original budget line A 1 B 1 - New budget line after increase in prices of both the goods. 18.Explain the concept of consumer equilibrium with help of indifference curve approach. Ans: - Consumer s Equilibrium - A consumer shall be in equilibrium where he can maximize his satisfaction subject to his budget constraint and does not want to bring any change in it. Indifference curve approach explains the consumer equilibrium with the help of indifference map and budget line. 10

84 VKM/KVCH/ECO/ /11 Conditions of Consumer s Equilibrium If consumer is consuming two goods say good X and good Y. Then at equilibrium pointi) Budget line should be tangent to indifference curve i.e. slope of indifference curve and budget line is equal to each other. It means MRS XY PX PY ii) Indifference curve should be convex to the point of origin i.e. MRS XY is decreasing. We can explain it with the help of following diagram- In diagram, AB is budget line and three indifference curves are IC 1, IC 2 and IC 3. The various combinations of good X & good Y which consumer can purchase with his given income are M, E and N. But M & N lie on IC 1 whereas E lies on IC 2. Since E is on higher indifference curve, so it will give more satisfaction to the consumer as compared to M & N. At point E budget line is tangent to IC 2, and IC 2 is convex to origin. So E is equilibrium point where consumer will get maximum satisfaction by consuming OX 1 quantity of good X and OY 1 quantity of good Y. 19. What do you mean by demand and Market Demand? Explain the determinants of demand for a commodity. Ans: - Demand - The quantity of a commodity which a consumer wish to purchase at given price and given period of time is called demand. Market demand- The quantity of a commodity which all the consumers in the market wish to purchase at a given price and given period of time is called market demand. Determinants of demand- The main determinants of demand for a commodity are as follows- i) Price of the commodity- When the price of a commodity increases the demand for that commodity decreases and vice versa. It means there is inverse relationship between price of commodity and quantity demanded. ii) Income of the consumer - The income of consumer affects the demand of commodity as follows- The demand for normal goods tends to increase with increase in consumer income and vice-versa. On the other hand, the demand for inferior goods tends to decrease with increase in consumer income and vice-versa. iii) Taste and preferences- When taste and preferences are in favour of the commodity demand for commodity increases and vice versa. 11

85 VKM/KVCH/ECO/ /12 iv) Future expectation of change in price of good- If it is expected that price of commodity will increase in future,consumer starts purchasing the commodity more at present. Therefore demand of commodity increases at present and vice versa. v) Price of related goods - The related goods are of two types- complementary goods (The goods which are used together) and supplementary good (The goods which are used in place of each other). In case of complementary goods, demand of a good rises with fall in price of complementary good and vice versa. In case of supplementary (substitute) goods, demand of a good falls with a fall in the price of other substitute goods and vice versa. The above five factors affect the individual demand. But for market demand some more factors including above are as under - vi) Government policy - When government increases the tax on a particular commodity, the commodity become costlier, so less number of consumers will purchase the commodity. Hence demand of commodity decline and vice versa. vii) Population- With increase in population of a country demand for commodity rises. However, if the population is decreasing, then demand will fall. viii) Climate - If climate of an area is favourable for the consumption of a good then demand for the good will be more and vice versa. 20. Explain the law of demand with the help of a demand schedule and demand curve. Ans: - Law of demand- This law states that other things remain constant a consumer purchases more quantity of a commodity at lesser price and less quantity at higher prices. It means there is inverse relationship between price of commodity and quantity demanded. Assumptions of law of demand - (Other things remain constant) No change in consumer s income. No change in prices of other related goods. No change in taste and fashion. No change in future expectation regarding change in price of commodity Explanation of law- We can explain it with the help of following schedule and diagram: Price Quantity demanded ( ) (Units)

86 VKM/KVCH/ECO/ /13 The above schedule and diagram show that as price falls quantity demanded rises. Hence prove the law of demand. 21. How is demand of a commodity affected by change in the price of related goods? Explain with the help of diagram. Ans: - Related good can be of two type - substitute and complementary. Substitute goods are those goods, which can be used in place of each other. E.g. coffee and tea. An increase in the price of a substitute good (Coffee) causes an increase in the demand for the commodity (Tea). This will cause rightward shift of demand curve and vice versa. Complementary goods are those goods, which are used with each other. E.g. car and petrol etc. In case of complementary goods, the demand for a commodity raises with the fall in the price of other commodity. If the price of the car falls its demand will rise, then the demand for petrol will also rise. This will cause a rightward shift of demand curve of given commodity and vice versa. Y Y Price D 2 D D 1 Rise in price of substitute good Price D 2 D D 1 Fall in price of complementary good O Fall in price of su bstitute good D 1 D 2 D Demand X O Rise in price of complementary good D 2 D D 1 Demand X 22. Define Demand Curve. What is slope of demand curve? Explain. Ans: - Demand Curve: - Demand curve is a curve which shows various quantities of a commodity which a consumer wishes to purchase at different alternative prices in a given period of time. In other words the graphical presentation of demand schedule is called demand curve. Price ( ) Quantity demanded (Units) Demand Schedule Demand Curve In above diagram DD is a demand curve. 13

87 VKM/KVCH/ECO/ /14 Demand curves are of two types - individual demand curve and Market demand curve. The market demand curve can be obtained by horizontal summation of individual demand curves. Slope of the Demand Curve - The slope of the demand curve equals to the change in price divided by the change in quantity. It is because the slope of a curve is defined as the change in the variable on the Y-axis divided by the change in the variable on the X-axis. 23. Distinguish between a) Movement along a demand curve and Shift of demand curve b) Contraction of demand and decrease in demand. Ans:- a) Difference between change in demand and change in quantity demanded Sl. No. i ii Movement along a demand curve Other things remain constant, if demand for a commodity changes (rises or falls) due to change in its price, is called. As in this case due to change (rises or falls) in price of commodity, a consumer moves leftward or rightward on same demand curve so it is also called movement along a demand curve. The main cause is change in price of commodity. Price ( ) Demand (Units) Shift of demand curve Keeping price constant, if demand of the commodity changes due to change in some other factors, such as change in consumer income, change in prices of substitute goods etc. is called change in demand. As in this case consumer shifts on a new demand curve so it is also called movement along a demand curve The main causes are- change in consumer income, change in prices of substitute goods, change in taste and preferences etc. iii Demand Schedule - Demand Schedule - Price Demand ( ) (Units)

88 VKM/KVCH/ECO/ /15 iv Movement along a demand curve- Shift of demand curve - b) Contraction of demand and decrease in demand Sl. No. Contraction of demand i Other things remain constant, if demand of commodity decreases due to increase in price of the commodity is called contraction of demand. ii The reason of contraction of demand is increase in price. iii In this case consumer purchase less quantity of commodity at higher price. Therefore consumer moves leftward on the same demand curve. Decrease in demand iv Demand Schedule Demand Schedule Price ( ) Demand (Units) Price ( ) v Demand Curve Demand Curve Keeping price constant, if demand of a commodity decreases due to some other factors affecting demand is called decrease in demand. The main reasons of decrease in demand are - decrease in income of consumer in case of normal good, fall in price of substitute good, rise in price of complementary good, unfavorable change in taste etc. In this case consumer purchase less quantity of commodity at same price. Therefore consumer shifts leftward on a new demand curve. Demand (Units)

89 VKM/KVCH/ECO/ /16 24.What do you mean by increase in demand? Name any five factors that shift the demand curve to the right. Ans:- Increase in demand - Keeping price constant, if demand of a commodity increases due to some other factors affecting demand, such as increase in consumer income for normal goods, decrease in price of complementary good, change in taste and fashion in favour of a commodity etc. is called increase in demand. In this case a consumer shifts rightward on a new demand curve so also called rightward shift of demand curve. We can express it with the help of schedule and diagram as under- Price ( ) Demand (Units) The Factors those shift the demand curve to the right or responsible for increases in demand are - Increase in income of consumer in case of normal good. Rise in price of substitute goods. Fall in price of complementary goods. Favorable change in taste etc. Future expectation to increase the price of commodity. 25. Define price elasticity of demand. Briefly explain the factors affecting price elasticity of demand. Ans: - Price elasticity of demand It measures the degree of responsiveness of the quantity demanded of a good to a change in its price. Let Initial price = P Final price = P 1 Initial quantity = Q Final quantity = Q 1 Change in quantity (ΔQ) = Final quantity - Initial quantity = Q 1 Q Change in price (ΔP) = Final price - Initial price = P 1 - P % change in quantity demanded Ed % change in price 16

90 VKM/KVCH/ECO/ /17 Q 100 = Q ( ) P 100 P = ( ) ΔQ P Q P Ed ( ) ΔQ P Δp Q Price elasticity of demand has negative sign as it shows inverse relationship between price and quantity demanded. Elasticity of demand has no unit as it s a coefficient. Factors affecting Price Elasticity of demand i) Number of Substitutes - A commodity will have elastic demand if there are more number of substitutes available. E.g.- Pepsi, Coca-Cola, and Frooti etc. A commodity having less number of substitutes, such as salt will have inelastic demand. ii) Nature of the Commodity- Generally, the demand for necessities is inelastic (less elastic) and demand for luxuries is elastic (more elastic). This is so because certain goods which are essential to life will be demanded at any price, whereas goods meant for luxuries can be disposed off easily if they appear. iii) Different uses of commodity- If the commodity has different uses its demand will be elastic. iv) Habits- Commodities in habit of the consumers have less price elasticity. v) Level of income - If consumer belongs to richer section then his demand will not be affected by change in price, hence demand will be inelastic. 26. Briefly explain percentage method of measuring price elasticity of demand. Ans: - Percentage Method- This method measures elasticity of demand as a ratio of percentage change in demand to percentage in price. Ed % change in demand % change in price On the basis of this method elasticity of demand is of three types- i) More than unitary elastic demand (E d >1) - When percentage change in demand of a commodity is more than the percentage change in its price, such demand is called highly elastic demand. Suppose due to 5% increase in price of a commodity, demand of commodity decreases by 8% then elasticity of demand will be more than 1. 17

91 Ed % change in demand % change in price VKM/KVCH/ECO/ / ii) Unitary elastic demand(e d =1) - When percentage change in demand of a commodity is equal to the percentage change in its price, such demand is called unitary elastic demand. Suppose due to 5% increase in price of a commodity, demand of commodity decreases by 5% then elasticity of demand will be equal to 1. Ed % change in demand % change in price iii) Less than unitary elastic demand(e d < 1) - When percentage change in demand of a commodity is less than the percentage change in its price, such demand is called less than unitary elastic demand. Suppose due to 5% increase in price of a commodity, demand of commodity decreases by 4% then elasticity of demand will be equal to 1. Ed % change in demand % change in price 27.Define the followinga) Production Function. b) Market Period c) Total Physical Product. d) Normal Profit Ans:- a) Production Function- It shows technological relationship between physical inputs and physical outputs. It can be written as follows: Q = f (f 1, f 2, f 3.f n ). Where Q is physical quantity produced and f 1, f 2, f 3.f n are the physical quantities of different factors of production used. b) Market period It is defined as a very short time period in which supply of commodity cannot be changed by changing the unit of factors of production. In this case all the factors of production remain constant. 18

92 VKM/KVCH/ECO/ /19 c) Total Product: - The total amount of commodity (Good) produced by employing given units of variable factors with fixed factors is called Total Product. It can be obtained by two ways: i) By summing up the marginal physical product derived from various units of variable factor employed. TPP = MPP 1 + MPP 2 + MPP 3 + MPP 4 + +MPP n TPP= ΣMPP ii) By multiplying average physical product by number of units of variable factor employed. TPP APP N d) Normal Profit - Normal profit is the minimum amount of profit which is essential to keep an entrepreneur in production in the long run. 28. Define MPP and APP. Is it possible MPP decrease but APP increase? Give reasons to support your answer. Ans : - Marginal Product: The change in total product by employing an additional unit of a variable factor is called marginal product. It can be obtained by two ways: MPP = TPP n - TPP n-1 E.g. Suppose by employing 10 units of variable factor 50 units of a good are produced and by employing 11 units, total 54 units are produced.then MPP will be as follows- MPP = TPP n - TPP n-1 =TPP 11 TPP 11-1 =TPP 11 TPP 10 = = 4 units Average Product: It is the product per unit of a variable factor. This can be obtained by dividing total physical product by number of units of variable factor employed. APP TPP N E.g. suppose by employing 10 units of variable factor 50 units of a good are produced. Then APP will be as follows- APP TPP N = 5 units 19

93 VKM/KVCH/ECO/ /20 Yes, it s possible MPP decrease but APP increase. It happens only when MPP is decreasing but more than APP. In above diagram shaded areas shows that MPP decreasing but APP increasing as MPP > APP. 29.What do you mean by returns to a factor? Explain the reasons for increasing returns to a factor. Ans: - Returns to a factor means keeping other inputs constant, the change in physical output by increasing only one physical input. Causes of increasing return:- Following factors lead to increasing returns to a factori. Indivisibility of the factors - Increase in units of variable factor leads to better and fuller utilisation of fixed factor. This causes the production to increase at a rapid rate. ii. Efficient utilisation of variable factor - When more units of variable factor are employed with fixed factor, then variable factor is utilised in more efficient way. iii. Optimum combination of factors - In the beginning when quantities of a variable factors are applied to fixed factors, the system moves towards achievement of optimum combination of factors because then underutilised fixed factors (building, machine, land etc) are better and more fully used. Thus lead to increasing returns. iv. Specialisation- With more use of labour, process based division of labour and specialisation becomes possible which increases efficiency and productivity. 30.Explain the likely behaviour of Total Product and Marginal Product when only one input is increased while all other inputs are kept unchanged. Or Briefly explain law of variable proportion or returns to variable factor. 20

94 VKM/KVCH/ECO/ /21 Ans: - Law of variable proportion or returns to variable factor - This law state that keeping other factors of production constant, when only one variable factor is increased, in the beginning total physical product increases at an increasing rate, then increases at a decreasing rate and ultimately decline. This law is applicable in short period only. This law has three phases- I- Increasing returns to a factor - In this phase MPP increases so TPP increases at an increasing rate. Reasons for increasing returns to a factor are - better utilisation of fixed factor, increase in efficiency of variable factor, indivisibility of fixed factors. II- Diminishing returns to a factor - In this phase MPP decreases but positive so TPP increases at decreasing rate.this phase ends when MPP is zero & TPP is maximum. Reasons for diminishing returns is that factors of production are imperfect substitutes of each other and after optimum combination of factors when more and more units of variable factors are increased, pressure of production start falling on fixed factors and MPP start decreasing. III-Negative returns to a factor - In this phase MPP becomes negative so TPP decreases. It happens when variable factor become too much as compared to fixed factors then coordination between variable and fixed factor become very poor and efficiency of factors decrease. Explanation: The law of variable proportion can be explained with the help of a schedule and a diagram as follows. Fixed factor Land in acres Variable factor [Units] MPP [Units] TPP [Units] Phase I II III 21

95 VKM/KVCH/ECO/ /22 In above table and diagram- First unit to third unit MPP increasing so TPP increases at an increasing rate. Therefore it s a phase of increasing return. Fourth unit to sixth unit MPP decreasing but positive & TPP increases at decreasing rate. Therefore it s a phase of decreasing return. Sixth unit onward MPP become negative & TPP is decreasing. Therefore it s a phase of negative return. 31. What do you mean by Total Fixed Cost (TFC), Total Variable Cost (TVC) and Total Cost (TC) of a firm? How they are related? Ans Total Fixed Cost (TFC):- The total amount of money spends on fixed factors of production is called fixed cost. It can be obtained by subtracting, total variable cost from total cost TFC = TC - TVC Total Variable Cost (TVC):- The total amount of money spends on variable factors of production is called total variable cost. It can be obtained by subtracting, total fixed cost from total cost TVC = TC - TFC Total (TC):- The total amount of money spends on all the factors (fixed and variable) of production is called total cost. It can be obtained by summing up, total fixed cost and total variable cost TC = TFC + TVC The relationship among TC, TFC and TVC is as under- When output is zero, variable costs are also zero but even then fixed costs are still incurred. Thus at a zero level of output total fixed cost and total variable costs are equal. As output increases total fixed costs remain constant but total costs and total variable costs goes on increasing. An increase in TC indicates an increase in TVC only as TFC remain same. Thus the difference between TC and TVC is equal to TFC. 22

96 VKM/KVCH/ECO/ / Distinguish between fixed cost and variable cost. Ans: Difference between fixed cost and variable cost Sl. No. i ii iii iv Fixed Cost The amount of money spent on fixed factors of production is called fixed cost. Fixed cost does not change with change in level of output. Fixed cost can never be zero even when production is stopped. E.g.:- Rent of building, salaries of permanent employees etc. Variable Cost The amount of money spent on variable factors of production is called variable cost. Variable cost changes with change in the level of output. Variable cost is zero when production is stopped E.g.:-Cost of raw material, wages of temporary labour etc. 33. Why does the difference between Average Total Cost (ATC) and Average Variable Cost (AVC) decrease with increase in the level of output? Can these two be equal at some level of output? Explain. Ans :- Average cost is the sum of average fixed cost and average variable cost. Hence ATC (AC) = AFC + AVC So, ATC - AVC = AFC This shows that difference between ATC and AVC is equal to AFC. AFC is obtained by dividing total fixed cost by output, i.e. And total fixed cost (TFC) is constant. Therefore, with the increase in the level of output, AFC falls. AFC TFC Q Thus, the difference between ATC and AVC decreases with increase in output. No, ATC and AVC cannot be equal at any level of output as gap between them i.e. AFC can never be zero because TFC is constant and positive. 23

97 Cost VKM/KVCH/ECO/ / Define Average cost and Marginal cost. Briefly explain the relationship between average cost and marginal cost? Ans: - Average Cost: It is the cost per unit of output produced. This can be obtained by dividing total costs (TC) by the units of output (Q). AC TC Q Marginal Cost: - It is the change in total costs resulting from a unit increase in output. MC = TC n TC n-1 Relationship between marginal cost and average cost (i)when marginal cost is less than average cost, average cost falls. (ii) When marginal cost is equal to average cost, average cost is minimum. (iii) When marginal cost is greater than average cost, average cost rises. O Y MC AC Output X 35. Define Total Revenue, Average Revenue and Marginal Revenue with the help of examples. Explain the relationship between total revenue and marginal revenue with diagram. Ans: - Total Revenue: The total amount of money which a seller receives by selling given units of a commodity is called total revenue. It can be obtained by two ways: By summing up the marginal revenue receive by selling different units of commodity. TR = MR 1 + MR 2 + MR 3 + MR 4 + MR n = ΣMR By multiplying average revenue (price) by number of units of commodity sold. TR = AR (P) Q E.g. suppose by selling 10 units of a commodity money received by seller is 50.Then his total revenue is 50. Average Revenue: It is the revenue per unit of a commodity sold. This can be obtained by dividing total revenue by number of units of commodity sold. AR TR Q E.g. suppose by selling 10 units of a commodity money received by seller is 50. Then AR will be as follows- AR TR Q = 5 24

98 VKM/KVCH/ECO/ /25 Marginal Revenue - The change in total revenue by selling an additional unit of a commodity is called marginal revenue. It can be obtained by two formulae- MR =TR n - TR n-1 or MR ΔTR ΔQ E.g. suppose by selling 10 units of a commodity money received by seller is 50 and by selling 11 units, he receives 54.Then MR will be as follows- MR =TR n - TR n-1 =TR 11 TR 11-1 =TR 11 TR 10 = = 4 Relationship between marginal revenue and total revenue When marginal revenue is positive, total revenue increases. When marginal revenue is zero, total revenue is maximum. When marginal revenue is negative, total revenue decreases. 36.Explain the relationship between average revenue and marginal revenue under perfect competition? Ans: - Relationship between MR and AR under Perfect competition Under Perfect Competition the relationship between marginal revenue (MR) and average revenue (AR) can be studied as under- Under perfect competition price of commodity remain constant therefore average revenue also remain constant as it is always equal to price. AR =P.. (1) Since price is constant therefore revenue received by selling an additional unit of commodity i.e. marginal revenue will also equal to price which is constant or same. MR = P.. (2) From equation 1 and 2 AR =P=MR AR =MR Thus under perfect competition marginal revenue and average revenue are equal and constant. Therefore AR-MR curve is parallel to X-axis. 25

99 We can explain it with the help of a schedule and diagram: Units of commodity sold Price (P) ( ) Total Revenue TR=P Q ( ) Marginal Revenue MR=TR n - TR n-1 ( ) VKM/KVCH/ECO/ /26 Average Revenue ( ) AR TR Q In above diagram AR/MR line shows average revenue marginal revenue curve. 37. What is meant by producer's equilibrium? Explain MR-MC Approach of Producer s Equilibrium. Ans: - Producer's Equilibrium - The situation when a producer earns maximum profits is called producer's equilibrium. MR-MC Approach of Producer s Equilibrium- A producer is said to be in equilibrium when he produces such a level of output at which his profit is maximum. Under perfect competition, Price = MR = AR which is parallel to X axis. Conditions of producer s Equilibrium Two conditions must be satisfied to achieve producer s equilibrium. At equilibrium point- (i) MR=MC, (ii) MC cuts MR from below. 26

100 P / M R / M C VKM/KVCH/ECO/ /27 We can explain it with the help of diagram as follows- Y In diagram, at point E 1, MR=MC and MC cuts MR MC equilibrium at this point. So E 1 is equilibrium point P E E 1 AR/MR firm produces less than OQ 2 then profit are not maximise. On the other hand, if firm produces more O Q 1 Q 2 Output will be reduced. Thus equilibrium will be at E 1 only where both conditions of equilibrium are satisfied. 38. Define Supply and Market Supply. Explain any four determinants of supply of a commodity. Ans: - Supply- The quantity of a commodity that the producer is willing to sell at a given price during a given period of time is called supply. Market Supply -The quantity of a commodity which all the sellers in the market wish to sale at a given price and given period of time is called market supply. The factors affecting supply or Determinants of supply - i) Technological changes - Technological advancement in the field of production leads to decrease the cost of production and increases the production and supply of good. The technological progress shifts supply curve to the right and vice versa. ii) Price of other goods - With the fall in the price of other goods, supply of good increase. The supply curve shifts to the right and vice versa. iii) Change in input price - If the price of factor inputs decreases it decreases the cost of production and increase the production & supply of good. The supply curve shifts to the right and vice versa. iv) Change in the excise tax rate - If the excise duty decreases, it decreases the production cost and increases the production & supply of good. The supply curve shifts to the right and vice versa. 39.Explain the followinga) Supply Schedule. b) Supply curve c) Slope of supply curve d) Supply function. 27

101 VKM/KVCH/ECO/ /28 Ansa) Supply Schedule:-Supply schedule is a table which shows various quantities of a commodity which a seller wishes to sale at different alternative prices in a given period of time. Supply schedule is of two types:- Individual supply schedule It s a table which shows various quantities of a commodity which an individual seller wishes to sale at different alternative prices in a given period of time. We can show it as follows- Price ( ) Quantity supplied by Mr. A (Units) Market supply schedule It s a table which shows various quantities of a commodity which all the sellers in the market wish to sale at different alternative prices in a given time is called market supply schedule. We can show it as follows- Price ( ) Quantity supplied by Market supply(a+b) A B (Units) b) Supply Curve :- Supply curve is a curve which shows various quantities of a commodity which a seller wishes to sale at different alternative prices in a given period of time. In other words the graphical presentation of supply schedule is called supply curve. Supply curve is of two types. Individual supply curve It s a curve which shows various quantities of a commodity which an individual seller wishes to sell at different alternative prices in a given period of time. In other words the graphical presentation of individual supply schedule is called individual supply curve. We can show it as follows- 28

102 VKM/KVCH/ECO/ /29 In above diagram, SS shows individual supply curve. Market supply curve It s a curve which shows various quantities of a commodity which all the sellers in the market wish to sell at different alternative prices in a given period of time is called supply schedule. In other words the graphical presentation of market supply schedule is called market supply curve We can show it as follows- In above diagram, S M S M shows market supply curve. The market supply curve can be obtained by horizontal summation of individual supply curves. c) Slope of supply curve- The slope of the supply curve equals to the change in price divided by the change in quantity supplied. It is because the slope of a curve is defined as the change in the variable on the Y-axis divided by the change in the variable on the X-axis. Slope of supply curve Δ Y Change in price Δ X Change in quantity supplied d) Supply function-it shows functional relation between supply of a commodity and various factors affecting it. Symbolically S X = f (P X, P O, Y, T, E, G,.) Where S X Supply of good X. P X Price of good X P O Price of other goods G Government policy T Technology E Future expectations regarding change in price of good 29

103 40.Distinguish between a) Extension of supply and Contraction of supply Price ( ) Supply (Units) Price ( ) VKM/KVCH/ECO/ /30 b) Change in supply' and 'Change in quantity supplied' of a commodity. Ans:- a) Difference between Extension of supply and Contraction of supply Sl. No Extension of Supply i Other things remain constant, if supply of commodity increases due to increase in its price, is called extension of supply. ii iii The main cause is increase in price of commodity. It results rightward movement along a supply curve. Contraction of Supply Other things remain constant, if supply of commodity decrease due to decrease in its price, is called contraction of supply. The main cause is decrease in price of commodity. It results leftward movement along a supply curve. iv Supply Schedule - Supply Schedule - v Supply curve- Supply curve- Supply (Units) b) Difference b/w Change in supply and Change in quantity supplied Sl. No. i ii Change in Supply Keeping price constant, if supply of a commodity increases or decreases due to change in factors other than price, is called change in supply. The main causes are - change in technology, change in prices of factors of production etc. 30 Change in Quantity Supplied Other things remain constant, when supply of commodity rises or falls due to change in price, is called change in quantity supplied The main cause is change in price (increase or decrease in price) of commodity.

104 Price Price iii It is also called shift of supply curve. iv Supply Schedule - Supply Schedule - Price ( ) Supply (Units) Price ( ) VKM/KVCH/ECO/ /31 It is also called movement along a supply curve. (Leftward movement is due to decrease in price and rightward movement is due to increase in price.) Supply (Units) v Supply curve Y Supply curve Y S 2 S. S S 1 S 2 S S O S 1 Supply X O Supply X 41. Define price elasticity of supply. How is it measured by percentage method? Ans :- Price elasticity of supply - It measures degree of responsiveness of supply of a commodity due to a change in its price. In other words, price elasticity of supply of a commodity can be expressed as a ratio of percentage (proportionate) change in supply of a commodity to percentage change in price. % change in quantity supplied Es % change in price Percentage Method of measuring elasticity of supply: This method measures elasticity of supply as a ratio of percentage change in supply to percentage in price. % change in supply Es % change in price On the basis of this method elasticity of supply is of three typesiv) More than unitary elastic supply (E s >1):- When percentage change in supply of a commodity is more than the percentage change in its price, such supply is called highly elastic supply. v) Unitary elastic supply (E s =1):- When percentage change in supply of a commodity is equal to the percentage change in its price, such supply is called unitary elastic supply. 31

105 VKM/KVCH/ECO/ /32 vi) Less than unitary elastic supply (E s < 1):- When percentage change in supply of a commodity is less than the percentage change in its price, such supply is called less than unitary elastic supply. 42. What do you mean by perfect competition? State its main features? Ans :- Perfect competition is a market where there are large numbers of buyers and sellers and sellers sell homogeneous commodity at uniform price. Under Perfect Competition a firm is only price taker. Main features of perfect competition are as under - (i) Large number of buyers and sellers - Under perfect competition buyers and sellers are in such a large number so that neither a single buyer nor a single seller can influence the market. It is because each seller sells a very small portion of the market supply, similarly the demand of each buyer is also very small in the market. (ii) Homogeneous product - The product sold in the market is homogeneous or identical in all respect i.e. shape, size, colour, composition, etc. (iii) Free entry and exit of firms - Under perfect competition there are no barrier to entry and exit of firms in industry. But entry and exit may take time so it happens only in long runs. (iv)perfect knowledge of market- In this market all the sellers as well as buyers have the complete information about the market situation. It means they are well aware about the product and its price. (v) Perfect mobility The factors of production i.e. land, labour, capital and entrepreneur are perfectly mobile. There is no geographical and occupational restriction on their movement. It means factors of production are free to move from one place to another place and one job to another job in which they get better price. 43. What do you mean by monopoly? State its main features? Ans :- Monopoly is a market situation where there is a single seller of a commodity which has no close substitutes. Main features of a monopoly market are: (i) Single seller- Under monopoly there is only seller of commodity in the industry, so the difference between firm and industry get vanished. It means the monopolist has full control over the supply and price of commodity. (ii) No close substitute - The monopolist produces a distinct product which has no close substitute in the market. Therefore the monopoly firm has no fear of competition from any other commodity. (iii) Barriers on entry - There are strong or significant barrier to the entry of new firms. These barriers may be legal barriers like- patent right or licensing etc., as a result monopolist firm can earn abnormal profit in the long run. 32

106 VKM/KVCH/ECO/ /33 (iv) Price discrimination- When a monopolist charge different prices from different buyers for the same product is called price discrimination. It s a distinct feature of monopoly market. (v) Independent price policy - In monopoly, firm and industry are same so the firm has complete control over the output and it fixes its price by itself. Thus firm is price market in monopoly 44. What is meant by monopolistic competition? Write its main features. Ans: - Monopolistic Competition - It s a market situation where there are large numbers of firms which sell closely related but differentiated product such as market of toothpaste, soap etc. The main features of monopolistic competition are as under: Large Number of Buyers and Sellers: There are large number of firms but not as large as under perfect competition. Free Entry and Exit of Firms Product Differentiation High Selling Cost Lack of Perfect Knowledge Less Mobility More Elastic Demand 45.Explain the implication of the feature product differentiation under Monopolistic Competition and freedom of entry & exit of firms under perfect competition. Ans: - Product differentiation under Monopolistic Competition - It is a distinct feature of monopolistic market. It means that buyers differentiate between the products produced by different firms. Therefore, they are willing to pay different prices for the products of different firms. Different groups of buyers prefer products of different firms. This gives an individual firm some monopoly power, i.e. power to influence the demand for its product by changing price. Free entry and exit of firms under perfect competition - It means that there is no barrier for entry and exit of firms in the industry. This freedom ensures that firms earn just the normal profits in the long run. 33

107 VKM/KVCH/ECO/ /34 If the existing firms earn above-normal profits, new firms enter in the industry, raise supply, which brings down the price. The profits fall till each firm is once again earning only the normal profits. If the existing firms are having losses, the firms start leaving, supply falls and price goes up. The price continues to rise till the losses are wiped out and firms are just earning normal profits. 46. What is meant by oligopoly? Define Collusive, Non-Collusive, Perfect and Imperfect oligopoly. Ans: - Oligopoly is a market structure in which there are few large sellers of a commodity, which sell homogenous and differentiated product. Under this market situation firms are interdependent. The Oligopoly is the most common market structure. The main features of oligopoly are - few firms, Interdependence of firms, Barriers to entry, Differentiated products, advertising is often important. Perfect Oligopoly - If the firms produce homogeneous products, it is called perfect oligopoly. Imperfect Oligopoly - If the firms produce differentiated products, it is called imperfect oligopoly. Collusive Oligopoly is one in which the firms cooperate with each other in deciding price and output. Non Collusive Oligopoly is one in which firms compete with each other. 47.Define equilibrium price. Explain how price is determined under perfect competition with the help of schedule and a diagram. Ans: - Equilibrium price is the price at which demand and supply of commodity are equal. Under perfect competition the market equilibrium is determined by equality between quantity demanded and quantity supplied of a commodity in the industry. It means at equilibrium point - Quantity Demanded = Quantity Supplied The price determined at equilibrium point is called equilibrium price. The price has a tendency to persist. If at a price, market demand is not equal to market supply there will be either excess demand or excess supply and the price will have tendency to change until it reach a point where demand and supply are equal. Explanation We can show it with the help of demand-supply schedule and curve. 34

108 VKM/KVCH/ECO/ /35 Price Market Demand Market Supply Equilibrium ( ) (Units) (Units) Excess demand Market Equilibrium Excess supply In the above schedule and diagram market equilibrium is established at a price of 3 per unit, because at this price both the market demand and market supply are equal. This is the price which has a tendency to persist. If a price less than the equilibrium price, suppose it is 2 per unit. At this price market demand is greater than market supply. It is called an excess demand situation. In this case the buyers will not be able to buy all what they want to buy. The pressure of excess demand will push the market price up. This will have two effects - Extension of supply and contraction of demand. The tendency of supply going up and demand going down will continue till market demand and supply become equal. This is achieved at price 3 per unit where equilibrium is restored and vice versa. 48.How does an increase in demand of a commodity affect its equilibrium price? Explain with the help of a diagram. Ans :- An increase in demand of a commodity results in a rightward shift of demand curve which lead to increase in price. It can be explain by diagram as follow- 35

109 Price P 1 P O Y D 1 D S VKM/KVCH/ECO/ /36 In the diagram, demand and supply of good are equal at point E. So E is equilibrium S point. At this point OP is equilibrium price and OQ is equilibrium quantity. When E 1 demand increases, demand curve shifts to E F right i.e. D 1 D 1, then at OP price there is EF excess demand. This results competition among buyers which will raise the price. At D 1 a higher price, quantity demanded will fall D and quantity supplied will increase, resulting X in upward movement along new demand Q Q 1 Q 2 Quantity curve and given supply curve. This reduces the gap between quantity demanded and quantity supplied. These changes will continue till we reach the new equilibrium point E 1 where quantity demanded is equal to quantity supplied. Now OP 1 is new equilibrium price. Since new equilibrium price [OP 1 ] is higher than the old equilibrium price [OP] which shows that equilibrium price has increased. 49.How does an increase in the supply of a commodity affect its equilibrium price? Explain with the help of a diagram. Ans :- An increase in supply of a commodity results in a rightward shift of supply curve which lead to decrease in price. It can be explain by diagram as follow - We can explain it with the help of following diagram: In diagram, demand and supply of good Y Price S are equal at point E. So E is equilibrium D S point. At this point OP is equilibrium 1 E E P 2 price and OQ is equilibrium quantity. E 1 P 1 When supply increases new supply curve S 1 S 1 shifts to right, it shows that at OP S S 1 D price, there is EE X 2 excess supply. This O Q Q 1 Q 2 Quantity excess supply results competition among A fall in price results in rise in qua ntity the demanded sellers leading (extension to fall of in demand) the price. and fa ll in quantity supplied (contraction of supply). These changes will continue till quantity demanded and supplied are equal at point E 1. So E 1 is new equilibrium point and OP 1 is new equilibrium price. Since OP 1 < OP which shows that equilibrium price has decreased. 36

110 VKM/KVCH/ECO/ /37 50.Answer the followingi) Non-Viable industry ii) Define Control Price or Price Ceiling. What are its implications? Write in brief. iii) What is Support price (Floor Price)? iv) Give one example each of government direct intervention and indirect intervention in market mechanism. Ans: - I) Non-viable industry- An industry in which production cost is very high and firm is unable to produce the good. At a given price no buyer is ready to purchase the product. In this case demand curve and supply curve do not intersect each other at any positive level of output and supply curve lies above the demand curve. II) Control Price (Price Ceiling):- When government fixes price of a product at a level lower than the equilibrium price, the price is called control price (or price ceiling). Ceiling means the maximum limit. Producers cannot sell their products above this price. Control price or ceiling price is the maximum price that can be charged for a commodity. This is done so that necessary goods become available to common people. Since control price is lower than the equilibrium price, it leads to excess demand and short supply. Suppose, the equilibrium price of sugar in a free market is 40 per kg at which both demand and supply of sugar are equal, i.e., 50 tones. When government fixes price at 35 per kg, the demand for sugar rises to 60 tones and supply falls to 40 tones, this create disequilibrium. The implication or consequence of price control can be any of the following: a) Rationing: It is a system of distributing essential goods in limited quantities at control prices. b) Black market: It is a market in which controlled goods are sold unlawfully at prices higher than the price fixed by the government. c) Dual marketing: It is a system of having two prices for the same commodity at the same time. III) Support price (Floor Price):- When government fixes price of a product at a level higher than equilibrium price, it is called support price (or floor price). Floor means the lowest limit. Support price or floor price is the minimum price at which 37

111 VKM/KVCH/ECO/ /38 a commodity can be purchased. As a result, the supply becomes in excess of demand. Support price is fixed to safeguard the interests of producers. This price is sometimes called floor price because it is the minimum price fixed by the government. Government generally fixes floor price for mostly agricultural products like food grains, sugar, etc. IV) Fixing prices of a product by the government directly is an example of direct intervention. The levying of taxes and granting of subsidies which indirectly change the market price of a product is an example of indirect intervention. 51.What do you mean by National income? State main features of national income. Ans :- National Income The money value of all the final goods and services produced by normal residents of a country during a financial year is called national income. Features of National Income National Income always takes the monetary value which can be obtained by multiplying quantity of commodity by their respective prices. It includes only the value of final good. The value of intermediate goods is not taken into consideration. It includes only factor income, transfer income is not included in it. It is a flow variable as it is measured during a period of one year. It is always measured during a financial year i.e. from 1 April to 31 March. 52.What do you mean by consumption and capital goods? Ans :- Consumption Goods- The goods which are purchased by consumer to satisfy their wants are called consumption goods. These goods satisfy human wants directly such as pen, pencil, bread, butter etc. These goods can be further divided into following categories- Durable Goods: These are the goods which can be used again and again in consumption over a long period of time. Such as T.V., Computer, Fan etc. Semi-durable Goods: The goods which can be use for limited period of time are known as Semi durable Goods. These goods have a life span of around one year. Such as clothes, crockery, shoes etc. Non-durable Goods: The goods which are used up in a single act of consumption are called non durable Goods or perishable good. Services Services are produced and consumed simultaneously; it means there is no time gap between their production and consumption. These are rendered for direct consumption. Such as services of doctor, teacher etc. 38

112 VKM/KVCH/ECO/ /39 Capital goods - The goods which help in production of other goods and services and added in the capital stock of a country at the end of an accounting year are called capital goods. It includes durable goods like car, fridge, road etc. Stock of semi finished, finished goods and raw material are also part of it. 53.What do you mean by stock and flow variable? Ans: - Stock -The economic variables that are measured at a particular point of time are called stock variables. Stock is static concept. It has no time dimensions. E.g. bank balance as on 1 st Oct 2011 is Flow-The economic variables that are measured during a period of time are called flow variables. Flow is a dynamic concept. It has time dimensions. E.g. Interest earned on bank deposits for 1 year, i.e. from 1 st April 2011 to 31 st March Distinguish between Intermediate Goods and Final Goods. Ans :- Difference between Intermediate Goods and final goods Sl. No. i Intermediate Goods The goods which are purchased for resale or further production are called Intermediate goods. ii These goods lie within the production boundary so further value can be added in these good. iii These goods are not included in estimation of national income. Final Goods The goods which are meant for final consumption and investment are called final goods. These goods lie out of the production boundary so further value cannot be added in these goods. These goods are included in estimation of national income. 55.Distinguish between Factor income and transfer income. Ans: - Factor income and transfer income Sl. No. i Factor Income The amount of money that a factor of production earns by rendering its factor service in production process is called factor income. Transfer Income The amount of money that an individual receive without providing any service in return is called factor income. ii It s an earned concept. It s a receipt concept. iii It s a bilateral concept. It s a unilateral concept. iv It is included in national income and domestic income. It is not included in national income and domestic income. v E.g. Rent, interest, wages and profit E.g. Scholarship, old age pension, unemployment allowance etc. 39

113 VKM/KVCH/ECO/ /40 56.What do you mean by investment or capital formation? Name its various concepts. Ans: - Investment or Capital Formation- The addition in the capital stock of a country is called investment or capital formation. E.g. - Construction of building, purchase of machinery, addition to the inventories of goods etc. Investment can be of two types- 1- Gross Investment: The total addition made to the capital stock of economy in a given period is termed as gross investment. It consists fixed assets and unsold stock. 2-Net Investment: The actual addition made to the capital stock of economy in a given period of time is called net investment. It can be obtained by subtracting depreciation or consumption of fixed capital from gross investment. Net Investment = Gross Investment Depreciation 57.What do you mean by circular flow of income? Briefly explain its various types. Ans: - Circular flow of income- The flow of income among different sectors of the economy is called circular flow of income. Circular flow is of two types: money flow and real flow Money flow It refers to the flow of money in the form of factor payment and consumption expenditure. In other words money flow refers to the flow of factor payments from firms to household for their factor services and corresponding flow of consumption expenditure from household to firm for purchase of goods and services produced by the firms. It is also called nominal flow. Payment for factor services Household Firms Payment for goods & services Real flow- It refers to the flow of factor services from household to firms and the corresponding flow of goods and services from firms to households. It is also known as product flow. Goods & services Household Firms Factor services 40

114 VKM/KVCH/ECO/ /41 58.Briefly explain the production method of measuring national income. Ans: - Production Method: This method measures the national income by taking the value of final goods and services produced by the different industrial sectors of the economy. Steps of Measurement: i) Classify all the production units- It means grouping production units into different sectors in the domestic (or economic) territory. The production units are classified into primary, secondary and tertiary sectors. ii) Estimate NVA FC of each industrial sector by taking the following sub-steps- (A) Estimate gross value of output: Gross value of output (GVO) is the total worth of goods produced.it can be estimated in two ways: (a) As sum of sales and net addition to stocks Value of output = Sales + change in stock Where, Change in stock = Closing stock Opening stock (b) Quantity of output multiplied by price. Value of output = Price Quantity (B) Estimate value of intermediate consumption and deduct the same from gross value of output (GVO) to arrive at GVA MP. Gross value added (GVA MP ) = GVO - Intermediate consumption (C) Estimate consumption of fixed capital (depreciation) and deduct it from GVA MP to arrive at NVA MP. NVA MP = GVA MP - consumption of fixed capital (depreciation) (D) Find out net indirect tax by subtracting subsidies from indirect taxes (NIT= indirect tax Subsidies) and deduct it from NVA MP to arrive at NVA FC of an industrial sector. NVA FC = NVA MP Net Indirect Tax (NIT) iii) Take the sum of NVA FC of all the production units of all the industrial sectors of the economy to get NDP FC. NDP FC =Σ NVA FC iv) Estimate net factor income from abroad and add the same to NDP FC to get the NNP FC or national income. NNP FC (N.I) = NDP FC + Net factor income from abroad (NFIFA) Precautions : While estimating national income by the production method / value added method the following precautions must be taken: i) Avoid double counting of output. 41

115 VKM/KVCH/ECO/ /42 ii) Value of own-account production should be included in total output. iii) The value of intermediate goods should not be included. iv) Do not include sale of second hand goods. 59. Briefly explain the income method of measuring national income. Ans: -Income Method:-This method is also called income distribution method, because in this method we measure the factor incomes paid out (i.e., distributed) to the owners of factors of production by the various industrial sectors of the economy. Steps in Measurement i) Classify all the production units - It means grouping production units into different sectors in the domestic (or economic) territory. The production units are classified into primary, secondary and tertiary sectors. ii) Estimate domestic factor income by each industrial sector: -There are three components of domestic factor income compensation of employees, operating surplus and mixed income of the self-employed. a) Compensation of employees refers to all payments by producers to their employees in the form of wages and salaries both in cash and kind. It also includes social security contributions such as pension, provident fund, gratuity etc. b) Operating Surplus is the sum of income from property (interest and rent) and income from entrepreneurship (profits = dividend, corporate tax, and undistributed profits). Thus, it is the sum of interest, rent and profits. Operating Surplus = Rent + Interest + Profits c) Mixed income of the self-employed is the income earned by self-employed people like doctors, lawyers, chartered accountants, cobblers, barbers, shopkeepers, farmers etc. A part of their income is wage income and another part is property income. Thus it is called mixed income. NVA FC = COE +OS+MI iii) Estimation of NDP FC : Take the sum ofnva FC i.e., the factor incomes of all the industrial sectors to arrive at NDP FC NDP FC = NVA FC iv) Estimation of NNP FC - Add net factor income from abroad (NFIA) to NDP FC to get NNP FC or National Income. NNP FC (National Income) = NDP FC + NFIA Precautions-The following precautions are required to be taken while estimating national income by the expenditure method: 42

116 VKM/KVCH/ECO/ /43 i) The imputed value of factor services rendered by the owners of production units should be included in NI. ii) Do not include any transfer incomes. iii) Do not include income from sale of second hand goods. iv) Do not include income arising from the sale of financial assets. v) Do not include income from illegal sources. 60. Briefly explain Expenditure Method of measuring national income. Ans:-Expenditure Method- In expenditure method we measure the expenditures incurred on final goods and services produced by production units located within the domestic (economic) territory of a country during a given year. Steps of Measurement - i) Identify and classify production units: Classify all the production units into primary, secondary and tertiary sectors. ii) Estimate final expenditure on goods and services produced by these industrial sectors. These final expenditures are categorized as follows: a) Private final consumption expenditure (PFCE) - It is the expenditure of household and non-profit making institutions serving households for durable goods (T.V., Fan etc.), semi-durable goods (clothes, shoes etc.) and non-durable goods (vegetable, bread etc.). b) Government s final consumption expenditure (GFCE) - It is the expenditure incurred by government on the purchase of goods and services which are needed to provide facilities to the general public, such as, expenditure on road, school, bridge, hospital etc. c) Gross domestic capital formation (GDCF) - It refers to the expenditure incurred on the purchase of capital goods, such as plant, equipments, buildings, machine etc. It has two parts- Gross Domestic Fixed Capital Formation (GDFCF) and Inventory Investment or Change in Stock. d) Net exports (X-M) - It is the difference between exports of goods & services and imports of goods & services during the given period of time. It refers to the demand of foreigners for our goods & services over domestic demand for foreign countries goods & services. iii) Estimation of GDP MP - The sum of these final expenditures is GDP MP GDP MP =PFCE + GFCE + GDCF + Net Exports iv) Estimation of NDP FC - Estimate the consumption of fixed capital (Depreciation) and net indirect taxes and deduct these from GDP MP to get NDP FC NDP FC =GDP MP Consumption of fixed capital (CFC) Net indirect tax (NIT) 43

117 VKM/KVCH/ECO/ /44 v) Estimation of NNP FC - Add net factor income from abroad (NFIA) to NDP FC to get NNP FC or National Income. NNP FC (National Income) =NDP FC + NFIA Precautions:-The following precautions are required to be taken while estimating national income by the expenditure method: i) Do not include expenditure on intermediate goods and services. ii) Include imputed expenditure on self-consumed or own account produced output used for consumption and investment. iii) Do not include expenditure on transfer payments. iv) Do not include expenditure on financial assets such as share, bond, debenture etc. v) Do not include expenditure on purchase of second hand goods. 61.Explain the following concepts- a) Sectors of economy b) Injection c) Withdrawal d) Double Counting e) Depreciation Ans: - a) Different sectors of economy - There are three sectors of the economyi) Primary sector- It includes all those production units which exploit natural resources for production. Such as Agriculture, mining, quarrying etc. ii) Secondary sector- It includes all those production units which transform one good in to another. Such as Industries, construction etc. iii) Tertiary sector- It includes all those production units which provide services. Such as banking, insurance, transport, communication etc. b) Injection: The amount of money which is added in the circular flow of income is called injection. Injections increase the speed of flow of income. Some examples of injections are investment (I), government expenditure (G) and export (X). c) Withdrawal: The amount of money which is taken out from the circular flow of income is called withdrawal. Withdrawals decrease the speed of flow of income. Some examples of withdrawals are savings (S), taxes (T) and import (M). d) Double Counting If the value of an item is estimated more than one time in estimation of national income is called double counting. It leads to over estimation of national income. 44

118 It can be avoided by two waysi) By taking the value added by each enterprise ii) By taking the value of final product VKM/KVCH/ECO/ /45 e) Depreciation: The reduction in the value of capital assets due to normal wear and tear is called depreciation. These are the foreseen losses so cannot be insured. It is also called consumption of fixed capital. Whenever we subtract net value from the gross value we get depreciation. Depreciation = Gross Net 62.Distinguish between domestic product and national product. Ans: - Difference between domestic product and national product Sl. No. Domestic Product National Product I ii iii Domestic product is the money value of all the final goods and services produced within domestic territory of a country during a financial year. It includes the income of all the residents of the country. Net factor income from abroad (NFIFA) is not included in it. National product is the money value of all the final goods and services produced by the normal residents of a country during a financial year. It includes the income of only normal residents of the country. Net factor income from abroad (NFIFA) is included in it. 63.Distinguish between Nominal GDP and Real GDP. Ans: - Difference between domestic product and national product Sl. No. Nominal GDP Real GDP i ii iii iv The money value of all the final goods and services produced within domestic territory of a country during a financial year at current year prices is called Nominal GDP. It is also known as GDP at current prices. Nominal GDP is affected by change in both output and prices. It is not a good indicator of measuring growth of an economy. The money value of all the final goods and services produced within domestic territory of a country during a financial year at base year prices is called Real GDP. It is also known as GDP at constant prices. Real GDP is affected by change in output only. It is not affected by change in prices. It is a good indicator of measuring growth of an economy. 45

119 VKM/KVCH/ECO/ / Answer the followinga) When will the domestic income be greater than the national income? Ans: - If net factor income from abroad (NFIFA) is negative. b) Why are net exports (X-M) a part of domestic income, and not a part of NFIFA? Ans: - Exports are goods produced within the domestic territory so treated as a part of domestic income. 65. Will the following factor incomes be included in domestic factor income of India? Give reasons for your answer. (i) Compensation of employees to the residents of embassy in Japan. (ii) Profits earned by a branch of foreign bank in India. Japan working in Indian (iii) Rent received by an Indian resident from Russian embassy in India. (iv) Profits earned by a branch of State Bank of India in England. Ans : - (i) Yes, It will be included in domestic factor income of India because the Indian embassy in Japan is a part of domestic territory of India. (ii) Yes, It will be included in domestic factor income of India because the foreign bank is located in the domestic territory of India. (iii) No, It will not be included in domestic factor income of India because Russian embassy in India is not a part of domestic territory of India. (iv) No, It will not be included in domestic factor income of India because branch of State Bank of India which is earning profit is in England which is not a part of domestic territory of India. 66. What is meant by gross domestic product? Explain any three limitations of gross domestic product as a measure of economic welfare. Ans :- Gross domestic product (GDP) refers to the money value of all the final goods and services produced with in domestic territory of a country during a financial year inclusive of consumption of fixed capital or depreciation. Welfare means sense of material well being among the people. This depends upon greater availability of goods and services. So it may be concluded that higher level of GDP is an index of greater well being of people. But this generalisation is not correct due to some limitations. Limitations of GDP as a measure of economic welfarei) Distribution of GDP- If with increase in GDP inequality of income increase, poor become poorer while rich become richer. This may lead to decline in welfare even though GDP has increased. 46

120 VKM/KVCH/ECO/ /47 ii) Non-monetary transactions- GDP remains underestimated as non-monetary transactions like services of housewife, barter exchanges, enjoyment from hobbies like gardening, painting etc. are not included in GDP. Although they increase economic welfare. iii) Composition of GDP- If GDP increases due to more production of war goods like weapons, tanks etc. it will not increase economic welfare. iv) Externalities- Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalized). Externalities do not have any market in which they can be bought and sold. Such as carrying out the production of refinery may also be polluting the nearby river and create pollution. This may cause harm to the people who use the water of the river. Such harmful effects that the refinery is inflicting on others, for which it does not have to bear any cost, are called externalities. Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases GDP will underestimate the actual welfare of the economy. 67.What do you mean by barter system? What are its main difficulties? How money overcome the problem of barter system? Explain Ans: - Barter System implies direct exchange of goods against goods without the use of money. It is also called C-C economy, i.e. Commodity-for-Commodity exchange economy. E.g. When a weaver gives cloth to the farmer in return for getting wheat from him, it is called barter exchange. Main drawback of barter system are- i) Lack of double coincidence of wants ii) Lack of common measure iii) Lack of divisibility iv) Lack of storability v) Problem of deferred payment Money has solved the problem of barter exchange in the following ways: a) Money as a medium of exchange solves the problem of lack of double coincidence of wants. b) In terms of money the value of other goods can be expressed. c) Money is of a manageable size and shape, unlike some barter standards, such as cattle. d) The value of money changes less where as bartered goods may lose their value after some time. e) In term of money future payments can be easily made as value of money changes less. 47

121 VKM/KVCH/ECO/ /48 68.What is money? State the four functions of money. Ans: - Money is anything that is generally accepted by people of a country as a medium of exchange and measure of value. Functions of Money- i) Medium of exchange- People can sale and purchase (exchange) goods and services through money. ii) Measure of Value (Unit of value)- The values of different goods and services can be expressed in term of money iii) Standard of deferred payments- Future transactions or payments can be made in terms of money. iv) Store of value - The money has a quality of storability.so value of goods can be stored in term of it for long period of time. 69.Define money supply. State two components of money supply. Ans:- Money supply is the stock of coin, currency and demand deposits held with public at a particular point of time in an economy. The main components of money supply are- (i) Currency held with the public. (ii) Demand deposits with commercial banks 70.What do you understand by double coincidence of wants and demand deposits Ans: - Double coincidence of wants is the situation in which both parties agree to sell and buy commodities of each other. What a person desires to sell is exactly what the other wishes to buy. This problem exists in case of the barter system of exchange. Demand Deposits - The deposits that can be withdrawn any time by cheque or otherwise are known as demand deposits. 71. What do you mean by money /credit creation? Explain the process of Credit (deposit) creation by the commercial banks with the help of numerical example. Also explain its Limitations. Ans: - Money/Credit creation - The Process of multiplying the deposits by commercial bank is called credit creation. Money creation or deposit creation or credit creation by the bank is determine by (i) The amount of the initial fresh deposits and (ii) The Legal Reserve Ratio (LRR) i.e. the minimum ratio of deposit legally required to be kept as cash by banks. It is assumed that all the money that goes out of bank is re-deposited in to the banks. 48

122 VKM/KVCH/ECO/ /49 Let the LRR be 20% and there is a fresh deposit of 10,000. As required, the banks keep 20% i.e. 2,000 as cash. Suppose the bank lend the remaining Those who borrow use this money for making payments. As assumed who receive payments put the money back in to the bank. In this way bank receive fresh deposit of 8,000. The bank again keeps the 20% i.e. 1,600 as cash and lends 6,400 which is also 80% of the last deposit. The money again comes back to the banks leading to a fresh deposit of 6,400. The money goes on in multiplying in this way, and ultimately total money creation is 50,000. Given the amount of fresh deposit and the LRR, the total money creation formula is: 1 Money creation Initial deposit LRR 1 Money creation % = 50,000 Limitations to credit creation - There are following limitations to credit creation by banks: 1. The total amount of cash reserves in the banking system. Larger the cash reserves more will be the credit creation. 2. Cash reserve ratio fixed by the central bank. More is the ratio, less is the power to create credit and vice versa. 3. Banking habits of the people of the country- It means banking transactions through cheques, drafts, bills etc. Good banking habit results in keeping smaller amount of cash with the banks and therefore, more can be lent. This will create large credit. 72. Define Central bank. What are the main functions of central Bank? Explain. Ans: - Central bank: A central bank is an apex institution of a country that controls and regulates the monetary and financial systems of a country. In India Reserve Bank of India (RBI) is the central bank. Main functions of a central bank are: i) Issue of Currency - The central bank has monopoly of issuing currency in the country. Currency issued by it, is its monetary liability so it has to keep a reserve in the form of gold and foreign securities. It promotes efficiency in the financial system. Firstly, because this leads to uniformity in the issue of currency. Secondly, because it gives Central Bank a direct control over money supply. 49

123 VKM/KVCH/ECO/ /50 ii) Bankers to Government- Central bank acts as the bank of central and state governments. It carries out all banking business of the govt. The govt. keeps its cash balances on current a/c with the central bank. It gives loans to central government for short period and manages the public debt of the country. It also transfers government funds and buys and sells securities, treasury bills etc. on behalf of the government. iii) Bankers Bank & Supervisor- As the banker to banks the central bank holds a part of cash reserve of banks, lends them short-term funds and provides them with centralized clearing and remittance facilities. The central bank supervises, regulates and controls the commercial banks. The regulation of these banks may be related to their licensing, branch expansion, liquidity of assets, management, merging of banks etc. The control is exercised by periodic inspection of banks and the returns filed by them. iv) Controller of Money Supply- The central bank of the country tries to control the availability of credit in the market with its many tools like CRR, SLR, bank rate, open market operation etc which are also called the instruments of Monetary policy. Central bank regulates the money supply and credit in the best interest of the country. v) Lender of Last Resort- It helps the commercial banks in times of financial difficulties. Scheduled banks can take the loans by rediscounting first class bills or short term approved securities, whenever they do not get funds from any other sources. 73.What is credit control? How central bank control the credit? Explain. Ans :- Credit Control :- The Central Bank controls the money supply and credit in the best interests of the economy. The bank does this by taking recourse to various instruments. These are: i) Bank Rate Policy: The bank rate is the rate at which the central bank lends funds to banks. The effect of a change in the bank rate is to change the cost of securing funds from the central bank. A rise in the bank rate will increase the cost of borrowing from the central bank then causes the commercial banks to increase the interest rates at which they lend. This will discourage businessmen and others from taking loans. Thus reduces the volume of credit and vice versa. ii) Open Market Operations: The act of buying and selling of government securities by the Central Bank from / to the public and banks is called open market operations. When the Central Bank buys securities from the banks and public it adds to cash balances in the economy. If cash balances are increased in the economy there will 50

124 VKM/KVCH/ECO/ /51 be more deposits with the commercial banks which raise the banks ability to give credit and thus increase the money supply. When the Central Bank sells securities to the banks and public it withdraws cash balances from the economy. If cash balances are decreased in the economy there will be lesser deposits with the commercial banks which reduce the banks ability to give credit and thus decrease the money supply. iii) Legal Reserve Ratio (LRR) LRR is the minimum ratio of deposits which every bank legally is required to keep as liquefied reserve. There are two components of LLR namely CRR and SLR. Cash Reserve Ratio (CRR): The minimum percentage of their total deposits which is to be kept by commercial banks with the Central Bank is called Cash Reserve Ratio. A change in CRR affects the power of commercial bank to create the credit. An increase in the CRR reduces the lending capacity of commercial banks to grant loan. Then the commercial banks will increase the interest rates at which they lend. This will then discourage businessmen and others from taking loans. Thus reduces the volume of credit and vice versa. Thus the CRR should be increased when credit is to be contracted and it (CRR) should be decreased when credit is to be increased. Statutory Liquidity Ratio (SLR): Commercial Banks are required to maintain a specified percentage of their net total in the form of designated liquid assets or cash with themselves. This specific percentage is called Statutory Liquidity Ratio (SLR). An increase in the SLR reduces the lending capacity of commercial banks to grant loan. Then the commercial banks will increase the interest rates at which they lend. This will then discourage businessmen and others from taking loans. Thus reduces the volume of credit and vice versa. Thus the SLR should be increased when credit is to be contracted and it (SLR) should be decreased when credit is to be increased. iv) Repo Rate: When the commercial banks are in need of funds for a short period, they can borrow from the Central Bank. The rate of interest charged by the Central Bank on such lending is called Repo Rate. Raising Repo Rate makes such borrowings by the commercial banks costly. As such when Repo Rate is raised, banks are also forced to raise their lending rates. This has a negative effect on demand for borrowings from the commercial banks and vice versa. v) Reverse Repo Rate: When the commercial banks have surplus funds they can deposit the same with the central bank and earn interest. The rate of interest paid by the Central Bank on such deposits is called Reverse Repo Rate. 51

125 VKM/KVCH/ECO/ /52 When this rate is raised, it encourages the commercial banks to keep their funds with the central bank. This has the negative effect on the lending capability of the commercial banks and vice versa. vi) Margin Requirements: A margin is the difference between the amount of the loan and market value of the security offered by the borrower against the loan. If the margin imposed by the Central Bank is 20%, then the bank is allowed to give a loan only up to 80% of the value of the security. By altering the margin requirements, the Central Bank can alter the amount of loans made against securities by the banks. So higher margin requirements decreases the demand for credit and vice versa. 74.What is Aggregate Demand? What are its main components? Ans: - Aggregate Demand is the total demand for all the final goods & services by all the consumers in the economy during a year. The main determinants of Aggregate demand are i) Private final consumption demand (C) - It is the demand of household and non-profit making institutions serving households for durable goods (T.V., Fan etc.), semi-durable goods (clothes, shoes etc.) and non-durable goods (vegetable, bread etc.). ii) Government final consumption demand (G)- It is the expenditure incurred by government on the purchase of goods and services which are needed to provide facilities to the general public, such as, expenditure on road, school, bridge, hospital etc. The level of government expenditure is determined by the government policy. iii) Private investment demand (I)- It refers to the expenditure incurred by the private firm on the purchase of capital goods, such as plant, equipments, buildings, machine etc. The investment is made in the economy in order to increase the production capacity as well as to maintain the present level of production. The rate of interest affects the investment demand inversely. iv) Net exports (X-M) - It is the difference between exports of goods & services and imports of goods & services during the given period of time. It refers to the demand of foreigners for our goods & services over domestic demand for foreign countries goods & services. 75. Define APC and APS. Derive the relationship between APC and APS. Ans: - APC (Average Propensity to consume) is defined as the ratio of total consumption to total income. Mathematically APC C Y Where, C= Consumption, Y= Income APS (Average Propensity to Save) is defined as the ratio of total saving to total income. Mathematically APS S Y 52

126 VKM/KVCH/ECO/ /53 Where, S= saving, Y= Income Relationship between APC and APS The sum of consumption and saving is equal to income. So, C + S = Y Dividing both sides by Y we get C S Y = Y Y C + S = 1 Y Y APC + APS = 1. Thus the sum of average propensity to consume and average propensity to save is equal to one. 76. Explain the concept of MPC with the help of table and diagram. Why can the value of MPC be not greater than 1? Ans: - MPC (Marginal Propensity to consume) is defined as the ratio of change in consumption to change in income. Mathematically Where C = change in consumption, Y= change in income. MPC ΔC ΔY For example, if income increases from 200 crores to 250 crores and consumption increases from 20 crores to 40 crores, it implies that 0.4 is the MPC or 40% increase in the income is being consumed. This can further be explained with the help of a table and a diagram. If income and consumption are: Income (Y) Consumption Expenditure (C) Marginal propensity to consume MPC MPC can also be explained with the given diagram. ΔC ΔY In the diagram, x-axis represents consumption level. So, MPC BC AC national income and y-axis represents 53

127 VKM/KVCH/ECO/ /54 The value of MPC cannot be greater than 1 - It is because change in consumption can never be greater than change in income. 77. What do you mean by Consumption Function? Briefly explain Linear Consumption Function. Ans: - Consumption Function: - Consumption Function shows functional relationship between total consumption and total income. C = f (Y) Where, C = Consumption; Y= Level of income Linear consumption function: - If the consumption function is given on the basis of constant marginal propensity to consume, is called linear consumption. C = C + by Where, C = Consumption; C = Autonomous consumption / minimum level of consumption; b = Marginal propensity to consume; Y= Level of income. 78. Define:- a) Psychological law of consumption b) Ex-ante Investment c) Ex-post investment. d) Involuntary unemployment e) Full employment Ans: - a) Psychological law of consumption: It state that as income in an economy increases consumption also increases but less than increase in income. b) Ex-ante Investment:- Ex-ante Investment refers to the planned or intended investment during a particular period of time. It is planned on the basis of future expectations. So it is imaginary (intended), in which a firm assumes the level of investment on its own. c) Ex-post Investment:- Ex-post Investment refers to the actual level of investment during a particular period of time. It signifies the existing investment of a particular time. d) Involuntary Unemployment refers to a situation in which people are ready to work at prevailing wage rate, but do not find work. e) Full Employment refers to a situation in which all the persons in the economy those who wish to work at prevailing wage rate, are getting the work. It means there is no involuntary unemployment 54

128 VKM/KVCH/ECO/ / Explain the meaning of equilibrium level of income with the help of a diagram. Ans: - The level of income and output in an economy is determined at that point where; aggregate demand is equal to aggregate supply. AD= C+I AS=C+S AS=Y (refers to countries national income) At equilibrium point AD=AS. Equilibrium can be achieved at full employment and even at under employment situation. It may not be always at full employment condition in an economy. We can explain it with the help of following schedule and diagram- Income Y) ( ) Consumption(C) ( ) Investment (I) ( ) AD=C+I ( ) AS=Y ( ) Remark AD>AS AD=AS The above schedule shows equilibrium level of income is 300=300. We can explain it with the help of diagram as follows- AD<AS 300 where AD=AS In diagram OY is the equilibrium level of income because at E aggregate demand is equal to aggregate supply. Before this equilibrium level of income and output, when income falls to OY 0, AD is D 0 Y 0 against AS is S 0 Y 0. This AD > AS indicates planned spending > planned output then there will be more demand for goods and services so the firms will increase the output.consequently, employment,output and income will be increased till the equilibrium level of income and output OY is reached where AD = AS. On the other hand, when AD < AS it means planned spending < planned output, then there will be unsold stock of goods with the firm so the firm will reduce the 55

129 Investment &Saving VKM/KVCH/ECO/ /56 level of output to the equilibrium output. Consequently, output, income and employment will be reduced till the equilibrium level of income and output OY is reached where AD = AS. 80.How equilibrium level of income and output is determined by the investment and saving in the economy. In an economy planned savings exceed planned investment. How will the equality between the two be achieved? Explain. Ans:- In an economy, equilibrium level of income and output will be determined at that point where investment is equal to saving. At equilibrium I=S Excess of planned savings over planned investment means that the expenditure in the economy is less than what the producers had expected. This would result in undesired or unplanned build up of unsold stock. To correct this situation producer will produce less. This will reduce level of output and income. Fall in income will result in fall in savings. These changes will continue till income falls to a level at which savings equal investment. Y S I E I O Y X Y 1 Inco me S 81.What do you mean by multiplier? Explain the working of investment multiplier with the help of a numerical example? Ans :- Multiplier is the ratio of change in income to change in investment. K Y, Where Y is change in income and I is change in investment. I Working of the multiplier -The working of the multiplier is based on the fact that one person's expenditure is other person's income. When investment increases, it increases the income consequently consumption also increases. And increase in consumption lead to increase in income. Symbolically: I Y C Y It can be explain with the help of an example as follows. Suppose in an economy investment increases by 1,000 and MPC is 0.5 or 50%. How increase in investment affect income can be shown in the following table: 56

130 Rounds Increase in Investment ( I) [ ] Increase in Income ( Y) [ ] VKM/KVCH/ECO/ /57 Increase in Consumption ( C) [ ] i 1,000 1, (= 0.5 1,000) ii (= ) iii (= ) iv v Total 1,000 2,000 1,000 In example,the initial increase in investment is of 1,000.The impact of this new investment of 1,000 will be that the income of employees working in the economy will increased by 1,000.The MPC is 0.5 or 50% so they will spend 500(50% 1,000) on their new consumption goods. The producers of these goods will have an extra income of 500 and this will increase their consumption expenditure by 250 (50% 500).This process continues till the effect of all is over or change in consumption is zero. We can get it by calculation as follows- 1 Y 1 MPC I 1 Y 1, , = 2 1,000 = 2,000 By calculation, we see that the increase in investment of 1,000 has increase the income by 2,000.Thus income is increasing twice of the increase in investment which shows value of multiplier is two. 82.Explain how the multiplier is related with MPS and MPC. Ans: - Relationship between multiplier and MPS Since, 1 K so the value of multiplier varies inversely with the value of MPS. MPS Higher the value of MPS, the smaller will be the value of multiplier and lower the value of MPS; the larger will be the value of multiplier. Relationship between multiplier and MPC 1 Since, K so the value of multiplier varies directly with the value of 1 MPC MPC. Higher the value of MPC, the larger will be the value of multiplier and lower the value of MPC, the smaller will be the value of multiplier. 57

131 VKM/KVCH/ECO/ /58 83.Explain the meaning of inflationary gap with the help of diagram and also write measures to correct it. Ans: - Inflationary Gap- The excess of actual aggregate demand over aggregate supply at full employment equilibrium point is called inflationary gap. When AD > AS this lead to price rise or inflation so it s called inflationary gap. We can show it with the help of diagram as follows. In diagram EF shows inflationary gap. Impact on the Economy- As aggregate demand is greater than aggregate supply; producers want to produce more output. But output cannot increase as there is nonavailability of resources due to full employment. Income - Real income cannot increases because real output can t increase only money income will increase. Price - Price will increase. It will lead to an increase in monetary income. Measures to correct inflationary gap- Reduction in government expenditure - Increase in taxes Reduction in availability of credit - By increase in bank rate, increase in CRR & SLR, sale of securities by central bank, increase in margin requirement etc. 84. Explain the meaning of deflationary gap (deficient demand) in an economy with the help of diagram and also write measures to correct it. Ans:- Deflationary Gap- The extent to which actual aggregate demand fall short to aggregate supply, at full employment equilibrium point is called deflationary gap. When AD < AS this lead to fall in price regularly or deflation so it s called deflationary gap. In diagram EF shows deflationary gap. 58

132 VKM/KVCH/ECO/ /59 Impacts on the Economy: - As AD < AS, producers wish to produce less. The level of output and income will reduce. Impacts on output - Output will reduce. Employment - Level of employment will decrease. Price - Price will fall Measures to correct deflationary gap- Increase in government expenditure Decrease in taxes Increase in availability of credit - by decrease in bank rate, decrease in CRR & SLR, purchase of securities by central bank, decrease in margin requirement etc. 85.Define a government budget. State any four of its main objectives. Ans: - Government Budget - It is an annual financial statement of estimated receipts and expenditure of the government for coming financial year. Objectives of a Government Budget - (i) Reallocation of resources - The Government has to reallocate resources from less priority areas to more priority areas, to achieve its social and economic objectives. (ii) Reduction of inequalities - Through the budget government can adopt progressive taxation policy and spend more on requirement of the poor to reduce the inequalities of income and wealth. (iii) Economic growth- To promote rapid and balanced economic growth so as to improve living standard of the people. (iv) Economic stability- The Government tries to prevent business fluctuations and maintain economic stability to maintain price stability and correct business cycles. (v) Reduction of poverty and unemployment- To eradicate (reduce) mass poverty and unemployment by creating employment opportunities and providing maximum social benefits to the poor. (vi) Management of public enterprises - Government undertakes commercial activities that are of the nature of natural Monopolies, heavy manufacturing etc., through its public enterprises. 86.What do you mean by revenue receipts? Why is tax, profits of public sector undertakings, corporation tax, fee of Government College, grant and aid treated as revenue receipts? Ans: - Revenue receipt is a receipt which neither reduces an asset nor creates any liability. Tax neither reduces assets nor creates a liability for the government. So treated as a revenue receipt. 59

133 VKM/KVCH/ECO/ /60 Corporation tax neither reduces assets nor creates any liability for the government. So treated as a revenue receipt. Fee of Government College neither reduces assets nor creates any liability for the government. So treated as a revenue receipt. Grant and aid neither reduces assets nor creates any liability for the government. So treated as a revenue receipt. Profits of public sector undertakings neither reduce assets nor create any liability for the government. So treated as a revenue receipt. 87.Define tax. What is direct and indirect taxes give some examples of each. Ans: - Tax Tax is a legally compulsory payment imposed by the government. Direct tax- A tax in which liability to pay tax and actual burden of the tax falls on the same person. The burden of these taxes cannot be shifted to other person. These taxes can be made progressive easily. Examples- income tax, corporation tax, wealth tax, gift tax etc. Indirect tax- A tax in which liability to pay tax is of one person but actual burden of the tax falls on the some other person. The burden of these taxes can be shifted to some other person. These taxes cannot be made progressive easily. These can be made progressive by imposing more taxes on luxury items which are mainly used by the high income group people. Examples- sales tax, excise duty, service tax, VAT etc. 88.What do you mean by capital receipts? Why are borrowings, recovery of loans and disinvestment treated as capital receipts? Ans: - Capital receipt is a receipt which either reduces an asset or creates any liability. Borrowings treated as capital receipts because borrowings create a liability. Recovery of loans treated as capital receipts because recovery of loans reduces an asset. Disinvestment treated as capital receipts because disinvestment reduces an asset. 89.What do you mean by revenue expenditure? Why is payment of interest and subsidies revenue expenditure? Ans: - Revenue expenditure is an expenditure which neither creates an asset nor reduces any liability. Payment of interest neither creates an asset nor reduces any liability. So treated as revenue expenditure. Subsidies neither create an asset nor reduce any liability. So treated as revenue expenditure. 60

134 VKM/KVCH/ECO/ /61 90.What do you mean by Capital expenditure? Why is repayment of loan, purchase of railway coach from Japan, construction of a bridge and purchase of share in a company a capital expenditure? Ans: - Capital expenditure is an expenditure which either creates an asset or reduces any liability Repayment of loan reduces the liability of government. So treated as capital expenditure. Purchase of railway coach from Japan creates an asset. So treated as capital expenditure. Construction of a bridge creates an asset. So treated as capital expenditure. Purchase of share in a company creates an asset. So treated as capital expenditure. 91.What is the basis of classify government expenditure into revenue expenditure and capital expenditure? Give an example of each. Ans: - There are two basis of classifying the expenditurei) Creation of an asset ii) Reduction of any liability. Any expenditure that neither creates an asset nor reduces any liability is called revenue expenditure. Example- Payment of salaries, subsidies, interest payment etc. Any expenditure that either creates an asset or reduces any liability is called capital expenditure. Example- Construction of factory, repayment of loan, purchase of share etc 92.What are the various types of deficits in government budget? Also write their implications. Ans: - There are 3 types of deficits: - Revenue Deficit- The excess of government revenue expenditure over revenue receipts is called revenue deficit. Revenue Deficit = Revenue Expenditure - Revenue Receipts Implications It implies dissavings of government. It indicates the inability of the government to meet its regular and recurring expenditure. A high revenue deficit gives a warning signal to the government to either curtail its expenditure or increase its revenue. Revenue deficit is financed through capital receipts like borrowings and used to meet the consumption expenditure of the government. It leads to inflationary pressure in the economy. 61

135 VKM/KVCH/ECO/ /62 Fiscal Deficit- The excess of total expenditure of the government over its total receipts excluding borrowing is called fiscal deficit. Fiscal Deficit = Total Expenditure - Total Receipts excluding borrowing Implications- It indicates total borrowing requirements of the government. Borrowing create problem of not only payment of interest but also repayment of loans.if it continuously increases it means government takes more loans to repay the previous loans. As a result country is caught in debt trap. If government borrows from central bank, central bank issue new currency notes. It increases money supply and generates inflationary pressure in the economy. When government borrows from rest of the world, it raises the country s dependence on other countries. Primary Deficit- the excess of fiscal deficit over interest payments is called primary deficit. Primary Deficit = Fiscal Deficit - Interest Payments Implications: It indicates how much of the government borrowing are going to meet expenses other than interest payments. If it is zero, it indicates that government is only borrowing to repay the interest of previous loans. 93. Distinguish between Balance of Trade and Balance of Payments. Ans :- Difference Balance of Trade and Balance of Payments Sl. No. i Balance of Trade (BOT) Balance of trade is the difference between the money value of exports and imports of goods during a given period of time. Balance of Payments (BOP) BOP is a systematic record of all the economic transactions of residents of a country with rest of world during a given period of time. ii It includes only visible items. It includes both visible and invisible items. iii It s a narrow concept as it is a part of balance of payment. It s a wider concept as it includes balance of trade in it. iv v It can be favourable, un- favourable or balance. It is not a true indicator of economic condition of a country. 62 It is always balanced. It represents a better picture of a country s economic condition than the balance of trade.

136 VKM/KVCH/ECO/ / What is meant by visible and invisible items in the Balance of payments account? Give some examples of each. Ans: - Visible items refer to items relating to trade of material goods with other countries. Examples - tea, clothes, machinery etc. Invisible items refer to items relating to trade of services with other countries and unilateral transfers. Examples- Transport services, Insurance and banking services etc. 95. Differentiate between Current Account and Capital Account of BOP. Ans:- Difference between current account and capital account of BOP- Sl. No. i ii iii Current Account It is the account which records exports and imports of goods, services and unilateral transfers. Items of current account do not cause change in the assets and liability status of the residents of a country & its government. The main components of current account are export and import of goods, services and unilateral transfers. Capital Account It records capital transactions such as loan and investment between a country and rest of the world. Items of capital account cause change in the assets and liability status of the residents of a country & its government. The main components of capital account are private capital transaction, official capital transaction and baking capital transaction etc. 96.Differentiate b/w autonomous and accommodating items of BOP. Ans:- Autonomous and Accommodating items of BOP Sl. No. i ii iii Autonomous items These refer to those international economic transactions that take place due to some economic motive such as profit maximisation. These items are independent of the state of BOP account. These transactions occur in both current account and capital account. Accommodating items These refer to those transactions that occur due to other activities of BOP. These items are meant to maintain the balance in BOP account. These transactions occur only in capital account. 63

137 VKM/KVCH/ECO/ /64 iv These items are also called above the line items because they are recorded as first items before calculating surplus or deficit in BOP. These items are also called below the line items because they are recorded after calculating surplus or deficit in BOP. 97.What is meant by foreign exchange rate? How it can be determined in a free market? Explain. Ans: - Foreign Exchange Rate It is a rate at which the currency of one country is exchanged with the currency of other country e.g., $1 = 48 or one Indian rupee 1/48 th $. Determination of the FER The rate is determined in the foreign exchange market by the interaction of the demand for and supply of foreign exchange. Demand for Foreign exchange comes from - Domestic residents purchase goods and services from other countries (imports), for sending gifts to foreigners, by the domestic residents to purchase financial assets in other country, speculative purpose and tourists going abroad etc. There is inverse relationship between foreign exchange rate and demand for foreign exchange. So demand curve for foreign exchange is downward sloping. Supply of Foreign exchange comes from - The foreigner s purchasing goods and services (exports), the foreigners who invest in home country through joint ventures, remittances from abroad, foreign tourists come to visit a country. There is direct relationship between foreign exchange rate and supply of foreign exchange. So supply curve of foreign exchange is upward sloping. Y FER R D f E S f In diagram, D f D f is demand and S f S f is supply curve of foreign exchange.they are equal at point E, so E is equilibrium point. At this point OR is O S f M Foreign Exchange D f X determined as equilibrium foreign exchange rate. 98.When exchange rate of foreign currency rise its supply rises? Explain. Ans: - A rise in foreign exchange rate makes home country s goods cheaper to foreigners so they will purchase more goods and services, as a result demand for country s goods increases in foreign market which leads to increase in country s exports. At the same time foreigners who want to invest in home country will invest more, more foreign tourists will come to visit home country. This brings a greater supply of foreign exchange. Hence supply of foreign currency rises. 64

138 VKM/KVCH/ECO/ /65 99.Explain the following terms. a) Foreign Exchange Market b) Spot Market c) Forward Market d) Managed Floating e) Dirty floating f) Deficit of balance of payment g) Devaluation of a currency h) Depreciation of a currency Ans: - a) Foreign Exchange Market: The foreign exchange market is the market where the national currencies of various countries are converted, exchanged or traded for one another. b) Spot Market: The exchange rate that prevails in the spot market for foreign exchange is called Spot Rate. c) Forward Market: A market in which foreign exchange is bought and sold for future delivery is known as forward market. Exchange rate that prevails in a forward contract for purchase or sale. d) Managed Floating: This is the combination of fixed and flexible exchange rate. Under this, country manipulates the exchange rate to adjust the deficit in the balance of payment by following certain guidelines issued by I.M.F. e) Dirty floating: If the countries manipulate the exchange rate without following the guidelines issued is called dirty floating: f) Deficit in BOP- If in current account of balance of payment (BOP), autonomous receipts are less than autonomous payments, then balance of payment (BOP) is said to be in deficit. It reflects disequilibrium in BOP. g) Devaluation of a currency means reduction in the external value of a country s currency as a conscious policy measure adopted by the Government of a country. In other words, we make our currency cheaper in terms of foreign currency. This makes our goods cheaper to foreign buyers and foreign goods costlier to our buyers. Hence exports increase, imports fall and the gap in trade balance becomes smaller. When a country suffers from continued deficit in its balance of payments, it may resort to devaluation of its currency with a view to encouraging exports and restricting imports and thus narrowing down or covering its trade gap and balance of payments deficit. It takes place in Fixed Exchange Rate System. h) Depreciation of a currency means fall in value of domestic currency in terms of foreign currency. Example: if value of rupee in terms of US dollars falls, say from Rs. 45 to Rs. 50 per dollar, it will be a case of depreciation of 65

139 VKM/KVCH/ECO/ /66 Indian rupee because more rupees are required now to buy one US dollar. It occurs in Flexible Exchange Rate System 100. Differentiate between fixed exchange rate and flexible exchange rate system. Ans: - Difference between fixed exchange rate and flexible exchange rate system Sl. No. i ii iii Fixed Exchange Rate System The system in which exchange rate is officially declared by government or central bank of a country and only a very small deviation from this fixed value is possible is called Fixed Exchange Rate System. Advantages (Merits) 1-It ensures stability, in the exchange rate which encourages international trade. 2- It prevents speculations in foreign exchange market. 3- It helps co-ordination of macroeconomics policies across different countries of the world. 4- It implies low risk and low uncertainty of future payments so. Disadvantages (Demerits) 1-This system requires huge reserves of gold and international currencies. 2-In this system the benefits of free markets are deprived. Flexible Exchange Rate System The system in which exchange rates are determined by the demand and supply forces of foreign exchange in the market is called Flexible Exchange Rate System. Advantages (Merits) 1-This system does not require huge reserves of gold and international currencies. 2-This system does not require the huge back-up of international reserves so encourage the movement of capital across different parts of the world. 3-Deficit and surplus in BOP is automatically corrected. Disadvantages (Merits) 1-It encourages speculation leading to fluctuations in exchange rate. 2- It discourages investment and international trade. With Best Wishes Vinod Kumar Mathpal Principal Kendriya Vidyalaya Command Hospital - Mathpalvk@gmail.com 66

140 STUDY MATERIAL INTRODUCTION UNIT-1 GIST OF THE LESSON Meaning of economics: Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses. Meaning of an economy:-economy is the system which provides people the means to work and earn a living. Or it is a frame work within which economic activities like production, consumption, and capital formation are undertaken. Meaning of scarcity:-it is defined as excess of demand over available supply, i.e, demand of resourses>supply of resources. Economic problem:-the problem of making a choice is called economic problem. Causes of economic problem:- It arises due to Scarcity of resources Unlimited human wants Resources can be put to alternative uses Scarcity and Choice go together:-scarcity and choice are not separable because resources are limited or scarce and the problem of choice arises due to it. Economising of resources:-our wants are unlimited and resources are limited, so we have to use the resources fully and efficiently. It means that resources should be best utilized. This is called economizing of resources. Central Problems of an Economy:-Central problem of an economy is Allocation of resources.the three central problems relating to allocation of resources are:- What to produce:-the problem of what to produce and in what quantity is the first basic or central problem. It is related to the selection of goods. Our resources are limited. So first problem that we have to face is which goods and services are to be produced e.g consumer goods or capital goods, war time or peace time goods. After the decision has been taken the quantities of these goods should also be decided. How to produce:- The second important problem is the problem of choice of technique of production. That means we have to decide whether to use labour intensive technique(it uses more of labour than capital) or capital intensive technique(it uses more of capital than labour).how ever the choice of technique depends on the objective of the producer.the producer can use labour intensive,capital intensive or both technique of production.the main aim is to use the efficient technique of production. For whom to produce:-this is also called the problem of distribution of National Income among the factor of production. For whom to produce is actually the problem of determining wage rate for the use of labour,rent for the use of land, interest for the use of capital and profits for the producer to ensure equitable distribution of income and welfare in the society. Production possibility curve or frontier A production possibility curve/ frontier shows different combinations of two commodities that can be produced by an economy with the full use of given resources and technology.

141 (i) Normally, the production possibility curve is concave to the origin. It is because of increasing marginal opportunity cost. (ii) A production possibility curve shifts out due to technological progress or increase in the supply of resources available to an economy or both. Assumptions of PPC-1)Resources are constant. 2)Technology is given. 3)Resources are fully and efficiently used. 4)Production of only two goods can be shown in a PPC. Features of PPC-1) It is downward sloping. 2) It is concave to the origin. PPC can be explained with the help of a schedule

142

143 . Shifting/Rotation of PPC Change of Resources

144 (ii)change in technology Efficient technology for the production of Commodity X: Efficient technology for the production of Commodity X would mean more production of commodity X with the same resources. Accordingly, PPC would rotate (NOT SHIFT) as shown in Fig Efficient technology for the production of Commodity Y : Efficient technology for the production of commodity Y would mean more production of Y with the same resources. Accordingly, PPC would rotate (NOT SHIFT) as shown in Fig

145 Efficient technology for the production of both X and Y: Efficient technology for the production of both X and Y would mean much greater production of both X and Y with the same resources. Accordingly, PPC would shift to the right as shown in Fig. Opportunity Cost (Transformation cost)-

146 The opportunity cost of a factor is equal to the value of a factor in its next best alternative use.eg-a plot of land can be used for wheat and rice production.production of wheat provides earning of Rs. 1 lakh and Production of rice provides earning of Rs If we produce wheat then its opportunity cost is Rs ,which is the value of rice sacrificed. Marginal opportunity cost(or Marginal Rate of Transformation)- The marginal opportunity cost of good X is the rate of sacrifice of the other good, say, Y, per unit increase in the production of good X. Or The marginal opportunity cost of good X is defined as the amount / quantity sacrificed of good Y per unit increase in production of good X. Marginal opportunity cost along a PPC. Production of Good X Production of Good Y Marginal Opportunity Cost of Good X in terms of Good Y or amount sacrificed of good Y per unit increase in good X Note: The above table shows the case of increasing marginal opportunity cost. To produce one more unit of Good X, increasing units of Good Y have to be sacrificed. For example, to produce the first, second, third, fourth and fifth unit of Good X, 1, 2,3,4 and 5 units of Good Y have been sacrificed respectively. The shape of PPC depends on MOC : 1. If MOC is increasing PPC is concave. 2. If MOC is decreasing, PPC is convex. 3.If MOC is constant, PPC is a straight line.

147 The Fig Illustrates the concept of marginal opportunity cost. It is assumed that initially resources are employed such that, output in Use-1 = OK and output in Use-2=OL M.O.C = Loss of Output of Good Y/Gain of Output of Good X = KK1 / LL1 = ab / bc = Slope of production possibility curve Micro and Macro Economics: Micro economics studies the behaviour of individual economic units of an economy like a consumer, a producer for different goods and services. Macroeconomics studies aggregates at the level of the economy as a whole like aggregate demand, aggregate supply, problem of full employment, total saving, total investment, aggregate price level, etc. DIFFERENCE MICROECONOMICS MACROECO0NOMICS 1. It studies individual economic units. 1. It studies aggregate economic units. 2. It deals with determination of price and 2. It deals with determination of general price output in individual markets. level and national output in the country. 3. It aims at optimal allocation of resources. 3. It aims at determination of aggregate output, national income, price level and employment level in the economy.

148 4. Example-Theory of demand, theory of supply, theory of price determination,etc. 4. Example- Aggregate demand, aggregate supply, national income,etc. QUESTIONS FOR BRIGHT LEARNERS VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. Why is there a need for economizing of resources? Ans. Because resources are limited. Q.2. Why does economic problem arise? Ans. It arises mainly because of scarcity of resources. Q.3. Why is PPC downward sloping from left to right? Ans. Because in situation of full employment of resources, production of one good can be increased only with less of other good. Q.4. What does a rightward shift of PPC indicate? Ans. The rightward shift of PPC indicates growth of resources or technological progress. Q.5. Why does the problem of choice arise? Ans. Relative scarcity of resources having alternative uses in relation to unlimited wants, gives rise to an economic problem. Q.6. Why does PPC look concave to the origin? Ans. PPC is concave to the origin because of increasing marginal rate of transformation (or increasing marginal opportunity cost). Q.7. Which factor lead to a shift of PPC towards right hand side? Ans. Growth of resources or technological progress leads to a shift of PPC towards right-hand side. Q.8. What does a point below PPC indicate? Ans. It shows inefficient/underutilization of resources. Q.9.What is the slope of PPC? What does it show? Ans. Slope of PPC refers to MRT (marginal rate of transformation).it shows that in order to produce more units of one good, say X, some units of the other good, say Y must be sacrificed. So slope of PPC= Y/ X Q.10. When allocation of resources is considered as inefficient? Ans. Allocation of resources is considered as inefficient when economy performs below the PPC curve. Q.11.When can PPC be a straight line? Ans.When MOC is constant. Q.12 What is the opportunity cost of opting for higher studies rather than a job? Ans.It is the amount of wage/salary the person would have earned in a job. SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. (a) (b) (c) Draw PPC and show the following:- Full employment of resources, Underutilisation of resources, and Growth of resources.

149 Y (a) Full employment of P (c) Growth of Resources Commodity Y O. (b) Underutilisation of Resources Commodity X P P X Ans. (a) Full employment of resources - A point anywhere on the PPC, shows the efficient use or full employment of resources. (b) Underutilisation of resources - A point anywhere inside of the curve, shows inefficient/under utilisation of resources. (c) Growth of resources It refers to the shift in PPC. If more resources are generated, the level of production will increase. In the figure it is represented by a shift in PPC from PP to P P. Q.2. Why does PPC look concave to the origin? Explain. Ans. PPC looks concave to the origin because of increasing marginal rate of transformation/substitution (or increasing marginal opportunity cost). It means that more and more units of commodity y are to be sacrificed, to get each additional unit of commodity x. Q.3. What does a PPC show? When will it shift to the right? Ans. Production Possibility Curve shows the different combinations of two goods which an economy can produce with available technology and resources. It would shift towards right-hand side in case of growth of resources or technological progress. Q.4. Does production take place only on the PP curve? Ans. Yes and no, both. Yes, if the given resources are fully and efficiently utilized. No, if the resources are underutilized or inefficiently utilized or both.

150 Y A B PPC Cloth C. U D O Wheat X Refer to the above figure; on a point anywhere on the PPC the resources are fully and efficiently employed. On point U, below the PPC or any other point but below the PPC, the resources are either underutilized or inefficiently utilised or both. Any point below the PP curve thus highlights the problem of unemployment and inefficiency in the economy. Q.5. Why does an economic problem arise? Explain. Ans. Reasons- 1. Unlimited wants - Human wants go on multiplying with the expansion of education, knowledge, scientific advancement and economic growth. A man can not satisfy all of his wants and therefore he has to make a choice in order of urgency. 2. Limited resources - The resources are limited in relation to need for them. It is the main cause of economic problem. 3. Alternative use of resources - A resource can be utilized in a different way and for different purposes. Therefore choice has to be made among different uses of resources. Q.6. Calculate MRTXY at different production possibilities from the following hypothetical data. Draw a PPC on the basis of the schedule Ans. Production Possibilities Commodity X Commodity Y A 0 15 B 1 14 C 2 12 D 3 9 E 4 5 F 5 0 Production Possibility Schedule:

151 Production Possibilities Commodity X Commodity Y Marginal Rate of Transformation (MRT) =ΔY/ΔX A B Y : 1X C Y : 1X D Y : 1X E Y : 1X F Y : 1X Y PPC Commodity Y X Commodity X Value based question:- Q1 A basic economic problem is that there is oil shortage in INDIA. What measures do you suggest to mee t the growing demand of oil? Ans:-Measures taken are : 1) oil is limited so it should be efficiently and fully(optimum use)used. 2)Massive awareness on shortage of oil and people should be encouraged to use public transport system. Q2. The state govt. has sanctioned acertain amount to increase production in rural areas. Which technique of production will you suggest to the state govt. for this project? Ans.:-Labour intensive technique of production. Q3. Why is it that on one hand coal is found in plenty, yet it is scarce, while a rotten fruit is rare but not scarce?

152 Ans:- Coal is scarce because its demand is greater than its supply.a rotten fruit is not scarce because there is no demand for rotten fruits. Q4. For a devolepmental project, logs of wood another building material have to be carried to the upper floor of building under renovation by the labour.alternatively elevators and lifts can do the job,which one will you choose and buy? Ans:- I will choose the second alternative as it is efficient and time and money saving method. Q5. If more and more resources are constantly explored and new and new technique of production are constantly discovered,don t you think a day will come when our central problems will be solved once for all? Ans:-When new resources are explored and new technology is discovered,ppcwouldexpand,indicating larger and larger flow of goods &services in the economy.but our wants are limlted, so scarcity of resources in relation to human wants will always exist.and,so long as limited resources are to colliding with unlimited wants,central problems can never be solved once for all. QUESTION FOR LATE BLOOMERS Q1.What is microeconomics? Ans:Microecomics is the study of an individual economic unit like a firm, a consumer. Q2.What is PPC? Ans:Production possibility curve shows different combinations of two goods which can be produced with given resources and technology. Q3.What is Opportunity Cost? Ans:It is the value of a factor in its next best alternative use. Q4.What is marginal opportunity cost? Ans:It is the rate at which output of good Y is to be sacrificed for every additional unit of good X. Q5.Write two properties of PPC. Ans:PPC slopes downward from left to right. And PPC is concave to the origin. Q6.Why does an economic problem arise? Ans:An economic problem arises because resources are limited,our wants are unlimited and resources have alternative uses. Q7.What are the 3 basic economic problems of an economy? Ans.The 3 basic economic problems are: 1.What to produce and in what quantity? 2.How to produce? 3.For whom to produce? Q8.Explain the meaning of what to produce? Ans: For answer see gist of the chapter. Q9.Explain the meaning of how to produce? Ans.For answer see gist of the chapter. Q10.Explain the meaning of For whom to produce? Ans:see gist of the chapter for this answer.

153 Q11.Draw PPC and show the following: 1.Overutilisation of resources. 2.Fullutilisation of resources. 3.Underutilisation of resources. Q12.Write differences between microeconomics and macroeconomics. Ans.See gist of the lesson. TEST PAPER:-CLASS XII CHAPTER :- 1 INTRODUCTION TIME: 45min FM-30 Q.1 What is an economy?( 1) Q.2 What is scarcity.{1} Q.3 Name the central problems of an economy.{1} Q.4 Why do economic problems arise?.{1} Q.5 What is the problem of what to produce? {1} OR Q.6 What is the problem of How to produce? {1} Q.7 What is the problem of for whom to produce? {1} Q.8 Define a PPC? {1} Q.9 Define opportunity cost.{1} OR Q.10 What is marginal opportunity cost or marginal rate of transformation? {1} Q.11 Define:) Micro economics.{1} OR Q.12 Define M acro economics.{1} Q.13 What does a point on PPC indicate?{1} Q.14 FILL IN THE BLANKS. 1. The PPC would shift to right when there is _ of resources. 2) The basic economic problem is the problem of _ )Cotton textile industry is the subject matter of _ economics. 3x1 Q.15 What is Rotation of PPC? Explain with diagram. {3} OR Q 16 What is shift in PPC? Explain with diagram {3} Q.17 Why is PPC concave? Explain.{3} Q18. Does production take place only on theppc? Explain with diagram. {3} Q.19A lot people died and many factories were destroyed in an earthquake{ natural calamity}. How will it affect the PPC? {3} Q20 Draw a ppc to represent the following on it.

154 a) Underemployment of resources. b) Growth of resources c) Fuller utilization of resources. {4} OR Q21. Draw the shape of PPC when MOC is (a) Decreasing (b) Constant (c) Increasing. {4} OR Q22. Plot the PPC by taking Rice consumption on the X axis. Comment on the shape of the curve. {4} RICE CONSUMPTION FUEL CONSUMPTION

155 CONTENT ENRICHMENTONE DAY WORKSHOP On at KV SALTLAKE NO-2 Topic: Consumer s Equilibrium-MU Analysis By -Dr.J.S.P.Pandey from K.V, Asansol(W.B.) POINTS TO REMEMBER:- Consumer :is an economic agent who consumes final goods and services. Total utility :It is the sum of satisfaction from consumption of all the units of a commodity at a given time. Marginal Utility :It is a net increase in total utility by consuming an additional unit of a commodity. Law of Diminishing Marginal Utility :As consumer consumes more and more units of commodity. The Marginal utility derived from the last each successive units goes on declining. Consumer Equilibrium :Consumer is in equilibrium when he gets maximum satisfaction from his limited income. Lej.kh; fcanq mihkksdrk % ogvkffkzd,tsuvgstksvafreolrqvksa o lsokvksadkmihkksxdjrkgsa dqymi;ksfxrk %,d fuf'pr le; es a olrq dh lhkhbdkb;ks a dkmihkksxdjusijizkir larqf"vdkdqy ;ksx] dqymi;ksfxrkdgykrkgsa lhekarmi;ksfxrk % olrq dh,d vfrfjdrbdkbzdkmihkksxdjusijdqymi;ksfxrk es a gksusokyh 'kq¼ of` ¼ dkslhekarmi;ksfxrkdgrsgasa àlekulhekarmi;ksfxrkfu;e % fdlholrqdhbdkb;ks a dkmùkjksùkjmihkksxdjusij izr;sdvxyhbdkbzlsizkirgksusokyhlhekarmi;ksfxrkøe'k%?kvrhpyhtkrhgsa mihkksdrklarqyu %&mihkksdrklraqyudhvolfkkes a rcgksrk g S tcogviuhlhekar vk; lsvf/drelarqf"vizkirdjrkgsa

156 Meaning with formula Utility:- It is the want satisfying power of a commodity. This is measured in terms of utils. Utility can be of two types. (a) Total Utility:- TU is the sum total of satisfaction that the consumer derives when a certain number of units of a particular commodity are consumed. Tux= f(qx) or TU = MU (b) Marginal Utility:- MU is the additional satisfaction derived from the consumption of an additional unit of the commodity. MU n = TU n TU n-1 Alternatively; MUx= TUx/ /Qx Q. Define Consumer Equilibrium Consumer equilibrium refers to such a situation when a consumer maximizes her satisfaction out of her given money income and the price of the desired good(s). Q.Whataretheconditions of consumerequilibrium? Incaseofone good:mux/px=mum ormux/mum=pxor Mux=PX Q.DefineMarginalUtilityofmoney. Itreferstothemarginalutilityofmoneyincomewhichmeanstheutilityderi vedfromspendingtheadditional/extraunitofmoneyonthedesiredgoodb ytheconsumer. Q. Consuming two goods, a consumer attains equilibrium when price remain same: a) MU X >MU Y b) MU Y >MU X c) MU X =MU Y d) TU X =TU Y ans (C) Q. when marginal utility is negative, total utility is: a) zerob) diminishing c)maximumd) minimum ans- (B)

157 Q. A consumer consumes only two goods X and Y. Marginal utilities of X and Y are 3and 4 respectively. Price of X and y are 4 per unit each. Is consumer in equilibrium? What will be further reaction of the consumer? Give reasons.(3marks) CBSE 2016 Ans: The consumer is not in anequilibrium because- MU X MU Y P x P Y = Since per rupeemu x is lower than per rupee MU Y the consumer will start buying less of X and more of Y till MU x risesandmu Y fails enough to make. MU X P x P Y MU Y < or ¾< 4/4 Q. What happens if MU X / P x >MU Y /P Y? Ans: In this situation, the buyer buys more of good X than Y since he is deriving more utility from good X. As he keeps on good buying more units of good X, the MU on good X keeps on falling while the MU on good Y keeps on rising due to Law of diminishing marginal utility effect. In other words, the good which is sacrificed, the desire to have more of it increase,& therefore on every additional unit of goods X the MUon good Y rises. The Process continues till both MU X /P X & MU Y /P Y are equal to each other. Q. Explain where does a consumer derive maximum satisfaction in case of two goods under cardinal approach. Ans: In case of more than one good, the consumer decides to purchase that quantity of goods when the ratio of MU and price of the desired goods are equal to each other. This can be explained with the help of the following example for good A, B, and c: Given the price of good X and y is Rs. 4 & Rs. 6,andMU m as Re.1=I util.

158 Units MUx MUy In this situation a consumer will purchase 5 units of good X, 3 Units of good y to maximize her satisfaction. The reason is that the ratio of MU and price of these two goods is 1 which is also equal to Mum. If the price of these goods is assumed to be Rs.2, the consumer will purchase 6 and 5 units of good X & Y respectively. Q. Given price of a good, how does a consumer decide as to how much of that good to buy? Ans. Consumer purchases upto the point where marginal utility is equal to the price (MU=P). So long as marginal utility is greater than price, he keeps on purchasing. As he makes purchases MU falls and at a particular quantity of the good MU becomes equal to price. Consumer purchasesupto this point. Q. A consumer consumers only two goods X and Y. State & explain the conditions of consumers equilibrium with the help of utility analysis. Ans. There are two conditions of consumer equilibrium : (i) MU X MU Y P = P x Y Explanation : If MU X P x = P Y MU Y Similarly if the consumer is not in equilibrium because he can raise his total utility by buying less of Y and more of X.

159 MU X P x = P Y MU Y the consumer is not in equilibrium as he can raise his total utility by buying less of X and more of Y. (ii) MU falls as consumption increases : If MU does not fall asconsumption increases the consumer will end up buying only good which is unrealistic or consumer will never reach the equilibrium position. Q. Explain relationship between total utility and marginal utility with the help of a schedule. Ans. Quantity (Units) Total utility Marginal utility (1) As long as MU is positive, TU increases. (2) When marginal utility is equal to zero then total utility is maximum. 3)When marginal utility is negative; Total utility starts diminishing. Q. Define marginal utility. State the law of diminishing marginal utility. Ans. Marginal Utility :It is addition more to the total utility as consumptionis increased by one more unit of the commodity. Law of Diminishing Marginalutility :It states that as consumerconsumes more and more units of a commodity, the utility derived from each successive unit goes on decreasing. According to this law TU increases at decreasing rate and MU decreases.

160 Q. DefineLaw of diminishing marginal utility (DMU) and What are its assumptions? Law of diminishing marginal utility (DMU):- As a consumer goes on consuming more and more units of a commodity the additional benefit that he derives from the additional unit of a commodity goes on falling. This law is based on following assumptions:- 1. Standard unit of measurement is used. 2. Homogeneous commodity. 3. Continuous consumption. 4. Mental and Social condition of the consumer must be normal. 5. No change in income, tastes, fashion and price. Q.Explain the relationship between total utility and marginal utility with the help of schedule and diagram. Ans.Utility schedule and utility curve:- The law of DMU is numerically illustrated in terms of utility schedule. It shows the TU & MU derived by a consumer as he consumes more and more of good X. Utility function:- Quantity of Good X TUx MUx = ( TUx/ /Qx)

161 Mam m C T U. T TU Total Utility A B No. of Units Consumed Marginal Utility No. of Units Consumed D Ea 3u Max = 0 Relationship between TU and MU When MU diminishes TU increases as shown in the diagram point A to C and B to D. When MU is zero TU is maximum (point C & D) When MU is negative TU declines (point E & T) Q. Consumer s Equilibrium:- The main aim of the rational consumer is to maximize satisfaction with the given resources (budget constraint) and he does not want to bring any change in it. Suppose a consumer wants to buy a commodity. How much of it should he buy? Ans: (Two approaches are used for getting an answer to this question.)- Consumer s Equilibrium with Utility approach:-cardinal measurement of utility where utility of different units of a good not be added or subtracted. 2. Consumer s Equilibrium with Indifference curve approach:- Ordinal measurement of utility where the utility can be compared or ranked. In this theory, utility of different units can not be added or subtracted. I. Utility approach:-marshall explained it with cardinal measurement of utility. Assumptions of Utility approach:- 1. Consumer is rational i.e. Maximum Satisfaction out of his limited income. 2. Utility can be measured in cardinal numbers. 3. Marginal utility of money is constant. 4. Utility of each commodity is independent of the prices and utilities of other commodities.

162 5. No change in the taste and prices of the commodities and income of the consumer. Consumer s Equilibrium Single commodity case:- It is attained when marginal utility of commodity in terms of money becomes equal to its price. MUx = Px Since it is difficult to compare MU of a good (expressed in utils) with its price (expressed in Rs) therefore MU of a good is first converted in terms of money by dividing MU of a good with MU of a rupee. (MU of good/mu of a rupee) = Price of the commodity The above condition can be explained with utility schedule. Units of X Price of X (Px) MUx Mu > p Mu = p Mu < p Y Mu>P C Mu Price P E Mux=Px(mum) P D Mu<P mux O Q 1 Q Q 2 X MUx = Px (MUm) -->Point E MU>P MU<P -->Point C -->Point D Consumer Equilibrium in case of two commodities When a consumer wants to buy two commodities his equilibrium will be determined in accordance with the law of equi-marginal utility. He will distribute his money income

163 among these goods in such a way as he gets equal marginal utility in terms of money from all the goods. In case of two goods consumer equilibrium would be: MUx MUy = = MUm Px Py It can be explained with the help of following table and a diagram. Unit of Money MUx - good (units) MUy - good (units) 1 14 (1) 10 (3) 2 12 (2) 8 (5) 3 10 (4) (6) MUx MUy = = MUm Px Py 8 units 8 units = 1 unit 1 unit In this case when consumer spends 4 units of money on x-good and 2 units of money on y-good, he gets equal marginal utility of 8 units. When Marginal utilities are equalised TU is maximised. Here, TU = = 62 units. In no other case, consumer can get utility of 62 units or more than. Mux Px Mux Px = Muy Py S 1 Muy Py R LOSS. E S Muy Py Mux Px O T M O 1

164 Utility is maximumwhen MUx MUy = = MUm Px Py MUx MUy > Px Py At point T where, It shows that OT is spent on good x and O, T on good y. Accordingly the consumer is at point R on the MUx curve and at points on MUy curve. There is a loss of utility shown by the shaded area. This prompts the consumer to transfer some of expenditure from y to x till he reaches to point E Q.What is the condition of consumer equilibrium in case of more than one good? Explain with the help of illustration. Incaseofmorethanonegood:TheratioofMUandpriceof Allthedesiredgoods areequaltoeachother,andfinallytheseratiosare equaltomum.thiscanbeexpressedas: MUxMUy MUz MUn MUm = = = = P x P Y P Z P n Illustration: GiventhemarketpriceofagoodasRs4,howdoesaconsum erdecidetopurchaseagood? shalldepend Uponthepointwheretheconsumermaximizehersatisfactionanddonoten dtopurchasethegoodatthatpointoftime. Units TU MU Price MU>P MU=P MU<P

165 From this table we see that the consumer purchase 5 units of the good because the Equal to MU, and will not like to purchase more units because the price of the good is great satisfaction derive from the extra units of MU. When the consumer purchase 1st unit Exceeds the price, and therefore she purchase 2 nd unit at which the MU still exceeds the price. Q.StatetheLawofDiminishingMarginalUtility.Explainwiththehelpofanillustrati on. Ans: Thelawstatesthat, asaconsumergoesonconsuming More&moreunitsofagood,less& lessshewantstohavemoreofit,ceterisparibus. Units TUx( in Utils) MUx Consumed (in Util)

166 2 Q.Giventhemarketpriceofagood,howdoesaconsumerdecideastohowman yunitsofthatgoodtobuy?explain.(3 Marks)(CBSE 2008) Ans: Consumer,comparespricewithmarginalutility(MU). HecontinuestobuysolongasMUisgreaterthanprice.Ashebuysmore MUfallsandbecomesequaltopriceatacertainquantity.Hestopsbuying WhenMU=P.This maximizes utility.buyingmorewillmakemulessthanprice,andreducesutility. Q. What happens to MU when TU is maximum? Ans: MU is Zero Q.What is about TU, When MU is negative? Ans-TU declines Q. What is about MU, when TU increases at decreasing rate?

167 Ans-MU decreases. Q.What will you say about TU, when MU is zero? Ans-TU is maximum Q. (a) Given Px = Rs 2, Py= Rs 1, income = Rs 12. Find how a consumer spends her income in order to maximize total utility. (b) Calculate TU receive by the consumer. Show that the equilibrium condition for the consumer are satisfied. Ans) (a) Consumer will spend 1 st and 2 nd rupe to buy 1 st and 2 nd units of Y. This will give total of U units. If the 1 st two rupees were spent on 1 st unit of X then 16 units would be received. (b) TU = 93 units (c) MUx/ Px = MUy/ Py subject to PxX + PyY = M 12/2 = 6/1. subject to (2)(3) + (1) (6) = 12 NOTE: Please usekurtidev font to show hindi question and answer. THE END

168 1.Define Budget line? Consumer s Equilibrium with IC approach Ans: Budget line shows the combination of two goods that a consumer can buy with the given income and the prices of two goods. 2. Explain Consumers Equilibrium in case of indifference curve Approach? Ans: Indifference Curves: Indifference curve shows different combination of two goods that yield the same level of utility or satisfaction to the consumer. Consumers equilibrium: A consumer is said to be in equilibrium when he/she maximises his/her satisfaction with the given lncome and prices of two commodities. Assumptions: (i) Rationality (ii) Ordinality (iii) Consistency of choice Conditions of equilibrium: i) Slope of IC=Slope of budget line or MRSxy=Px/Py ii) Budget line must be tangent ot IC at the point of equilibrium. Indifference Map Budget Line

169 3.Define Indifference map. Ans: A group of indifference curves is called indifference map. 4.What is meant by monotonic preference? Ans: Monotonic preference refers to that preference of a consumer of a bundle which has at least one commodity more than the other bundle. 5.What is Budget set of a consumer? Ans: A set of two goods that a consumer can buy with given income in his hand and prices of two goods. 6.Explain three properties of indifference curve. Ans. i) ICs are downward sloping. ii) ICs are convex to the origin. iii) ICs never intersect each other. 7.Explain why is an Indifference curve (a) downward sloping and (b) convex. Ans: a) In order to maintain the same level of satisfaction a consumer has sacrifice one good to get one unit of another good. b) ICs are convex to the origin due to diminishing MRS. 8. Explain the concept of MRS with the help of a numerical example. Also explain its behaviour along an Indifference curve. OR to

170 Explain the concept of marginal rate of substitution with the help of schedule and diagram. Give reason behind diminishing MRSxy. Ans: Marginal Rate of Substitution of X for Y rfers to the number of units of good Y that a consumer is willing to forego for an additional unit of good X, so as to maintain the same level of satisfaction. MRS= X/ Y The concept of MRS can be understood with the help of following table: Combination Units of X Units of Y MRS A B Y:1X C Y:1X D Y:1X E Y:1X When consumer moves from combination A to B he sacrifices 4 units of good Y for an additional unit of good X to maintain the same level of satisfaction. Therefore, MRS at this stage is 4. When consumer moves from B to C, from C to D and from D to E, MRS diminishes as the consumer increases the units good X and decreases the units of Good Y. In other words, he acquires constant quantity of good X and gives up smaller and smaller quantity of good Y. 09. Explain the conditions of consumer equilibrium with IC analysis. OR Show diagrammatically the conditions for consumer s equilibrium, in Hicksian analysis of demand. Ans: As per Hicksian analysis, the given consumer attains equilibrium when the two conditions are met: a) MRS=Px/Py Slope of IC=Slope of Budget line b) MRS falls as more is consumed of one good at the cost of other. The given budget line AB is tangent to the indifference curve IC2 at point E in the given diagram. This is the consumers equilibrium. The utility maximising combination of the two goods is OQx of good X and OQy of good Y.

171 Q 10. Explain the concept of marginal rate of substitution. Explain the reaction of the consumer when marginal rate of substitution is higher than the rationof prices. i.e., MRS>Px/Py Ans: Marginal Rate of Substitution of X for Y refers to the number of units of good Y that the consumer is willing to forego for an additional unit of good X, so as to maintain the same level of satisfaction. MRS= Y/ X As the given consumer moves downwards along the indifference curve, we observe that MRS(the slope of the indiffeence curve) continuously declines. This implies that the indifference curve is convex. According to question, when MRS>Px/Py, This means to get one more unit of commodity X consumer is willing to sacrifice more units of commodity, Y than the market requires. Consumer will now buy more of commodity and buy less of commodity Y. This will bring down MRS till it becomes equal to Px/Py and the equilibrium is achieved. Q.11. A consumer consumes only two goods X and Y both priced at Rs3 per unit. If the consumer chooses a combination of these two goods with Marginal Rate of Substitution equal to 3, is the consumer in equilibrium? Give reasons. What will a rational consumer do in this situation? Explain. Or A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the MRS is higher than the ratio of prices. Explain the reaction of the consumer. Ans: Given, Px=3 and Py=3, MRS=3 We know that a consumer is said to be in equilibrium when MRS=Px/Py. On substituting the above values, 3=3/3( that is MRS>Px/Py) In this case the consumer is not in equilibrum. This implies that the consumer is willing to pay more for good X than the market requires. Thus the consumer will buy more and more units of X.As a result the MRS will fall due to law of diminishing marginal utility. This will continue till the MRS=Px/Py. 12. Define a Budget line. When can it shift to the right? Ans: Budget line shows the combination of two goods which can be purchased with the given income and the prices of given two goods. Budget line can shift to the right due to the following: i) There is rise in income of the consumer, with prices remaining same ii) Fall in the Px, with no change in income and price of good Y iii) Fall in the Py, with no change in income and the price of good X.

172 UNIT II: CONSUMER BEHAVIOUR & DEMAND (MARKS 13) 1. What is Demand? Demand for a commodity refers to willingness and ability of a consumer to purchase a good at a given price and at a given unit of time. By the term demand we mean the quantity of a good which a consumer purchases at a given price and at a given unit of time. 2. What is Demand Function? Demand function is an expression which establishes a precise functional relationship between the demand for a good and its various determinants i.e. Qdx = f (Px, Py, Y, T ) 3. Explain briefly the determinants of Demand i.e. the factors which affect the demand for a good d # Price of a good (Px) is the most p important factor which may bring the change in the demand for a good. The rise in price leads to the fall in the demand for a good if other things remaining same and p o p 1 d # Price of other related good (Py) is also one of the determinant of the demand for a good. The change in the price of a good (say Tea) may bring the change in the demand for other good (say, Coffee or Milk). In case of a substitute good, the rise in the price of good X (say Tea) will lead to the increase in the demand for the good Y(say Coffee), and vice versa. Thus the change in both is directly related. In case of a complementary good, the price rise in one good (say Car) may lead to the decrease in the demand for the related good (say Petrol), & vice versa. Thus, both this are negatively related. Shift in dd incase of substitute good Shift in dd incase of substitute good P d 1 P d d

173 d 1 p 0 p 0 d o d 1 d o q 0 q 1 q q 0 q 1 q d1 # Income of the consumer (Y):The change in income of a consumer may lead to the change in demand for a good, and vice versa. Incase of a normal good, the rise in income leads to rise in its demand because the purchasing power of the consumer will rise with the rise in income, and vice versa. On the other hand, the rise in income leads to decrease in demand for a inferior good. P R I C E P 0 Y d 1 Y d P R I C E P 0 d 1 d O Q 0 Q 1 X O Q 1 Q 0 Qty.of Demand Shift in dd in case of Normal good due to rise in income Qty.of Demand Shift in dd in case of an inferior good due to rise in income # the change in Taste, habit and fashion also has the direct influence on the demand for a good. For e.g. the taste for using Addjel pens is on rise these days by the students. B coz of this, the demand for this kind of pens is also rising. # the size of population or a family also determines the demand for a good. The increase in the size of a family may lead to the rise in the demand for a good. For e.g, if a man gets married then obviously the no. of members in his family will increase.

174 This will lead to the rise in the demand for milk & other essential goods. # Weather & climatic conditions may also have the influence upon the demand for a good. A poor weather condition may lead to fall in demand for a certain good, and vice versa. For e.g, too hot climate may raise the demand for cold drinks. 4. State the law of demand. While other things remaining same, the demand for a good rises with the fall in its price, and vice versa. Thus this law tells us that there is an inverse relationship between both the price of a good and its demand. 5. Define Demand schedule & demand curve. It refers to a tabular presentation of the relationship between price of a good and its demand, while Demand curve is the graphical representation of the demand schedule. 6. What are Giffen goods or Inferior goods? These are those goods whose demand rises with the fall in income and vice versa. Some of the inferior goods are bajra, wet rice, maize etc. 7. Define Substitute goods & complementary goods. Substitute goods can be defined as those goods which can be in use in place of other goods. In other words, the fall in the price of these goods lead to the rise in the demand for the other substitute good. For e.g. the Tea & coffee, pen & pencil etc. Complementary goods refer to those goods which are used together or those goods which are demanded together. The fall in the price of a complementary good leads to the rise in demand for the other good. For eg., pen & ink, car & petrol etc. 8.Define Price Elasticity of Demand. Price elasticity of demand can be defined as the measure/ degree of responsiveness in the change in demand for a good due to the change in its price. 9. Show how to calculate price elasticity of demand. Percentage change in qty. demanded Coefficient of price elasticity of demand (Ep)= Percentage change in its price (Change in qty. / Initial qty.) 100 ( q / q) 100

175 Thus, Ep = = (Change in price / Initial price) 100 ( p / p) 100 Ep = q 100 q p p

176 10.What are the Degrees of price elasticity of demand according to Percentage Method? Show with the diagram. 1. Unitary elastic demand (Ep=1); 2. Relatively elastic demand (Ep>1) ; 3. Relatively Inelastic demand (Ep<1); 4. Perfectly Inelastic demand (Ep=0); 5. Perfectly elastic demand (Ep= ).

177 CONSUMER BEHAVIOUR AND DEMAND ( HOTS ) Q 1) What is the curve showing different combinations of two goods, maintaining the same level of satisfaction known as? Ans. Indifference curve Q. 2) Give the formula for calculating slope of budget line. Px Ans. Slope of budget line is equal to the ratio of the prices of the two commodities i.e. Py Q. 3) What is slope of indifference curve? Ans. Slope of indifference curve is equal to MRS i.e. marginal rate of substitution. Q. 4) If the consumer is indifferent between combination A and B of two goods what does this imply? Ans. It implies that for a consumer, combination A is as good as combination B,i.e. both combination give equal satisfaction to him and they are equally preferable. Q. 5) Why is the indifference curve convex to the origin? Ans. Indifference curve is convex to the origin due to diminishing MRS. Q. 1) How would you comment on the elasticity of Demands when 8% decrease in price of a commodity causes 2% increase in the expenditure of commodity? Ans. Elasticity of demand must be greater than unity when expenditure on the commodity responds inversely to any change in price of the commodity.

178 Q. 2) If demand curve is found to be positively sloped, what it could be due to? Give your answer in terms of nature of the commodity, income effect and substitution effect. Ans. Positively sloped demand curve violates the law of demand. It is found in case of giffen goods. These are those inferior goods in case of which income effect is negative and greater than substitution relation effect, so that net effect points to a positive between price and quantity demanded of the commodity. Q. 3) Mention one determinant of demand for a commodity other than price. Ans. Price of related goods affects the demand for a good. Q. 4) When demand for a good falls due to rise in its own price, what is the change in demand called? Ans. Contraction of demand Q. 5) When will rise in demand be called expansion of demand and when it will be called an increase in demand? Ans. When the rise in demand is due to fall in the price of the commodity, it is called expansion of demand and when the rise in demand is due to factors other than price such as increase in the income of the buyer etc. it is called increase in demand. Q. Short answer question ( 3 or 4 marks) Q. 6) Define law of demand? Draw a unitary elasticity of demand with the help of a demand schedule. Ans-6 (P) (D)

179 1.1. Inverse relation between price and demand i.e., when price increase and demand for a commodity decreases and vice verse 1.2. Schedule :-Shows q. of demand at different price c)demand curve :- DD curve slopes downward from left to right. 2. A consumer boys 160 units of a good at a price of Rs 8 per unit. Price falls to Rs 6 per unit. How much quantity will the consumer buy at the new price if price elasticity of demand is (-)2)? A. X = 160 = +80 X = = 240 The Consumer will buy 240 units. Q.3. How would you comment on the elasticity of demand when 8% decrease in price of a commodity causes 2% increase in expenditure of the commodity? Ans: Elasticity of demand must be greater than unity (implying a situation of elastic demand) when expenditure on the commodity responds inversely to any change in price of the commodity.

180 Q. 4. The elasticity of demand for X is twice the elasticity of demand for Y. Price of X falls by 5% and Price of Y rises by 5%. What will be the % change in the quantity demanded of X and Y? A.2 Suppose elasticity of demand for Y = 1, and elasticity of demand for X will be = 2 So, % decrease in qt. demanded of Y will be 5%, because price rises by 5%, and % increase in qt. demanded of X will be 10%, because price falls by 5%. Q5.Causes of Rightward shift / Leftward shift of demand curve. Ans.1.Increase/ decrease in income of consuers. 2. increase / decrease in habits of consumers 3. increase /decrease in size of population. Q 6.What are the factors determine the price elasticity of demand? Ans.1. price of the commodity. 2. Nature of ;the commodity. 3. Number of uses of the commodity. 4. Proportion of income spent on consumption. Long answer type question. ( 6 marks) 1.. Explain the factors that affect the market demand of a commodity. (or) Distinguish between increase in demand and expansion of demand (rise in quantity demanded). Use diagram. (6) Ans-Expansion demand due to price change and Increase in demand is due to other than price change. Previous one is movement along with same demand curve.

181 Expansion due to price falls, Increase demand due t Income rise. Expansion Later one is shifting DD. 2.. Distinguish between :(a) Individual demand and market demand and (b) Change in demand and change in quantity demanded Ans- a) Quantity demanded of a commodity by a buyer at a given price during a given period is called individual demand. Quantity demanded of a commodity by all the buyers is called market demand. 3 (b) Change in demand due to change in own price of the given good is called change in quantity demanded. Change in demand of a good due to any factor other than the own price of the good is called change in demand 3 3. Explain the Consumer s equilibrium, in case of an single commodity. Ans.. Consumer s Equilibrium Single commodity case:- It is attained when marginal utility of commodity in terms of money becomes equal to its price. MUx = Px Since it is difficult to compare MU of a good (expressed in utils) with its price (expressed in Rs) therefore MU of a good is first converted in terms of money by dividing MU of a good with MU of a rupee. (MU of good/mu of a rupee) = Price of the commodity The above condition can be explained with utility schedule. Units of X Price of X (Px) MUx Mu > p Mu = p Mu < p 5 5 3

182 MUx = Px (MUm) Point E MU>P Point C MU<P Point D Q.4). Differentiate between Changes in Quantity demanded and Change in demand Ans.. Change in Quantity demanded Change in demand 1. Other things being equal if quantity 1. If more or less quantity of a commodity demanded increases or decreases is demanded, at the same price, due to due to fall or rise in the price of change in factors other than price of the commodity it is known as movement commodity, it is called shift in the along a demand curve or change in demand curve or change in demand. quantity demanded 2. The movement is either upward or 2. There is either rightward shift or downward along the same leftward shift of the demand curve. demand curve 3. An upward movement shows 3. Rightward shift indicates increase in contraction in demand and demand, leftward shift shows decrease downward movement shows in demand. expansion in demand.

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184 1 Mark questions [COST] 1. What do you mean by cost? Cost and Revenue Board Questions Ans. Cost is the sum of explicit and implicit cost. 2. Define explicit costs. Ans. Those monetary payments by producer on factor and non factor payments is called explicit cost. Which are not owned by himself 3. Which cost curve is parallel to ox-axis? Why? Ans. Total fixed cost because TFC remain constant at all level of output. 4. What do you mean by implicit costs? Ans. Implicit cost is the cost of self owned resources of producer. 5.Define marginal cost. Ans.Marginal cost is the net addition to total cost when one additional unit of output is produced. 6. Why does the difference between average total cost and average variable cost falls with increase in output? Ans. It is because average fixed cost goes on falling with increase in output. 7. Give an example of explicit cost Ans. Wages paid to labourers 8.Give another name of fixed cost Ans. Indirect costs 9. What is meant by per unit cost of a good? Ans. Average cost 10. Give an example of implicit cost Ans. Interest on entrepreneur's own capital 1 Mark questions ( Revenue) 1. Define Revenue. Ans. Revenue is the amount received from sale of output. 2. What do you mean by marginal revenue? Ans. Marginal revenue is net additions to total revenue by sale of one additional unit of output. 3. State any two conditions of producers equilibrium according to marginal revenue and marginal cost approach. Ans. 1. MR = MC 2. Rising portion of Marginal cost curve intersects marginal revenue curve 4. What will be the behaviour of total revenue when marginal revenue is zero? Ans. Total revenue will be maximum.

185 5. Which concept of revenue is called price? Ans. Average revenue 6. What is another name of price line? Ans. Firm's demand curve 7. At what rate average and marginal revenue falls, with fall in per unit price of a good? Ans. Marginal revenue falls twice the rate of average 8.What will be the behaviour of Average revenue when total revenue increases at constant rate? Ans. Average revenue remains constant. 9.what is government revenue? Ans. Government revenue includes all amounts of money (i.e., taxes and fees) received from sources outside the government entity. Large governments usually have an agency or department responsible for collecting government revenue from companies and individuals 10.What is association non-dues revenue? Ans. Association non-dues revenue is revenue generated through means besides association membership fees. This revenue can be found through means of sponsorships, donations or outsourcing the association's digital media outlets. 3 Marks questions 1.what is the difference between fixed cost and variable cost? Ans. 2.Does long period TC starts from origin? Ans. Yes, long period TC curve starts from origin because in long period, all costs are variable costs and variable cost always vary without output, so that when output is zero, variable costs are also zero.

186 3.Read the following carefully. Write true and false with reason. a.fixed cost is constant even when output is zero b.total fixed cost is indicated by a vertical straight line c.average cost include both fixed and variable cost. a.true because fixed cost are incurred even before output actually starts b.false. Total fixed cost indicates horizontal straight line parallel to x-axis c.true. AC=AFC+AVC 4.why is short run average cost curve u shaped? Ans.The nature of short period Average Cost Curve is U shaped. To begin with, the Average Costs are high at low levels of output because both the Average Fixed Costs and Average Variable Costs are more. 5.A producer can sell more of a good at same price..prepare a total revenue and marginal revenue schedule. Take four output levels( all india 2010) Ans. 6.What is meant by TR,AR and MR? Ans. TR- Total revenue is the sum of all sales, receipts or income of a firm. AR- The average revenue curve shows that the price of the firm s product is the same at each level of output. MR- The marginal revenue is the change in total revenue resulting from selling an additional unit of the commodity. 7. how does changes in marginal revenue affects total revenue? Ans. Marginal revenue measures the change in revenue that results from a change in the amount of goods or services sold. It indicates how much revenue increases for selling an additional unit of a good or service. To calculate marginal revenue, divide the change in total revenue by the change in the quantity sold. Therefore, the marginal revenue is the slope of the total revenue curve. 8.Explain the relationship between marginal revenue and total revenue Ans.Relationship between Marginal Revenue and Total Revenue is as follows: (i) TR increases at increasing rate, if MR is increasing.

187 (ii) TR increases at diminishing rate, if MR is diminishing. (iii) TR is constant and maximum, if MR is zero. (iv) TR decreases, when MR becomes negative. 9.Explain the relationship between marginal revenue and average revenue using diagram Ans.Marginal revenue is the addition to total revenue by selling one more unit of the commodity. Algebraically it is the total revenue earned by selling n units of the commodity instead of n- 1. Thus, MR n = TR n TR n-1 ; where MR n = Marginal revenue of the n th unit TR n = Total revenue of n units TR n-1 = Total revenue of n-1 units 10.Explain marginal and average revenue curve under perfect competition Ans.Perfect competition is the term applied to a situation in which the individual buyer or seller (firm) represent such a small share of the total business transacted in the market that he exerts no perceptible influence on the price of the commodity in which he deals. Thus, in perfect competition an individual firm is price taker, because the price is determined by the collective forces of market demand and supply which are not influenced by the individual. When price is the same for all units of a commodity, naturally AR (Price) will be equal to MR i.e., AR = MR..Giving example, explain the meaning of cost in economics. 6 Marks question1 2.Explain the relationship between TC and MC (All India 2008)

188 3.What is the difference between average total cost and average variable cost decrease with the increase in level of output? ( Delhi 2008) 4.Define variable cost. Explain the behaviour of total variable cost as output increase. (All India 2011)5.Draw total fixed cost, total variable cost and total cost in a single diagram. State the relationship between total variable cost and total cost 5. What is the relationship between total revenue, profit and total cost? Ans. A small-business owner seeks to maximize both total revenue and profit. When she prepares her annual business plan, the owner and her team determine the expenditures that are required to reach the revenue goals she has set for the upcoming year. To maximize profit, she has to carefully control costs and make difficult decisions about which expenditures are absolutely necessary. By understanding the relationship between total revenue, profit and total costs -- RPC for short -- she can see how each of the decisions she makes impacts her profitability. 6. Is there any difference between revenue and income? Explain.

189 Ans. Many people mistake income and revenue as the same thing. However, there are many small differences between the two financial concepts. Both income and revenue are financial and business terms. Their meanings closely resemble each other because they are often used in the same context. Both concepts are applicable in accounting and economic disciplines. Revenue, for instance, is the total amount of money that a business earns by doing its activities. These activities include selling a product or a service, but it can also be earned by an indirect means. Indirect business revenue can be gained if a business has placed money in investments. On the other hand, income, also known as net profit, is the money left for a business after it subtracts costs and expenses from its revenue. Costs and expenses include the operational costs (salaries and wages, upkeep of machinery, security, expenses for rawmaterials, to name a few), depreciation, and capital. Costs can be categorized into many types (usually in tandem) that include fixed and variable costs, direct and indirect costs, and lastly, product and period costs. Income can also be categorized as positive or negative. Positive income means there is more revenue or less expenses while negative income accounts for a low revenue or high expenses. 7. The following table shows the total cost schedule of a firm. What is the total fixed cost schedule of this firm. Calculate TVC,TFC,AVC,SAC and SMC schedules of the firm. Q TC x

190 PRODUERS EQUILIBRIUM SHORT- QUESTION ANSWERS 1. What is producer s equilibrium? Ans- producer equilibrium means the level of output where the firm is maximizing its profit and therefore has no tendency to change its output. 2. State the two conditions of Firm s equilibrium under perfect competition. Ans- (a) MC=MR=AR (P) (b) MC curve should cut the MR curve from below. 3. What is explicit cost? Ans payment made by a firm for purchasing or hiring inputs from other firm. 4. What is opportunity cost? Ans cost of a factor in its next best alternate use, which is given up. 5. What is meant by normal profit? Ans- it is the profit level which is required to cover the explicit cost and opportunity cost. 6. What is the condition of a competitive firm s when it earns super normal profit in short run? Ans when MC=MR=AR(P)>SAC OR TR>TC. 7. In the situation of losses, when does competitive firm continue to its production in the shortrun? Ans- when firm AR(P) is equal to or greater than SAVC. 8. When does a competitive firm decide to stop production in the short run? Ans- when firm s price becomes less than SAVC. 9. What should be the minimum price of a competitive firm in the short run,if it produces positive level of output? Ans - the minimum price should be equal to minimum short run AVC. 10. How much maximum losses a competitive firm can bear in the short run? Ans A competitive firm in the short run can bear the maximum losses equivalent to its fixed cost. 11. What is producer s Equilibrium? State conditions of firm s equilibrium under perfect competition. 12. Explain why the output level where marginal revenue is greater than marginal cost (MR>MC) cannot be the profit maximizing level of output. 13. Explain why the output level where marginal revenue is less than marginal cost (MR<MC) cannot be the profit maximizing level of output. 14. Can a firm earn supernormal profit in the short run? What is the condition of firm s equilibrium in this condition? 15. What should be the minimum price for a competitive firm in the short run, if it is produces positive level of output? Ans the minimum price should be equal to minimum SAVC. 16. How much profit a competitive firm can earn in the long run? Ans- only normal profit. 17. What is the condition of of long run equilibrium of a firm under perfect competition.

191 Ans- MC=MR=AR=minimumLAC. 18. What is break even point? Define it? Ans- where TR is just equal to TC 19. What do you understand by Producer s Profit? Ans- Excess of revenue over cost is called producer s profit. 20. When does producers profit become the maximum? Ans- when the difference between TR and TC becomes positive and maximum. LONG QUESTION ANSWERS 1. Explain producers equilibrium through MC and MR approach with the help of schedule and diagram. 2. What is meant by firm s equilibrium? Explain the conditions necessary for firm s equilibrium under perfect competition. 3. Can there be a positive level of output that a profit maximizing firm produces in a competitive market at which the price is not equal to marginal cost? Give explanation. 4. Will a profit maximizing firm in a competitive market ever produce a positive level of output in the range where the MC is falling? Give explanation. 5. Will a profit maximizing firm in a competitive market ever produce a positive level of output if the price is less than the minimum of SAVC. Give explanation. 6. Will a profit maximizing firm in a competitive market ever produce a positive level of output if the price is greater than the minimum of SAVC,but less than the minimum of SAC? Give explanation. 7. With the help of diagram, explain the shut-down point of a profit maximizing competitive firm in the short run.

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193 UNIT:-PRODUCTION FUNCTION QUESTION BANK 1-Mark Questions 1. Define production. -Transformation of inputs into outputs is called production. 2.Define production function. -It explains the functional relationship between physical inputs and physical outputs. 3.Define Marginal Physical Product(MPP)? -It refers to addition to total product when one more unit of variable factor is employed. MPP=TPPn-TPPN-1 4.Define average physical product. -It refers to output per unit of variable input.app=tpp/q 5.Define Total physical product(tpp). -It refers to the total quantity of output produced by employing a given factor inputs during a specified period of time. 6.What is short-run? -It refers to the time period during which one factor of production is fixed. 7.What is long-run? -It refers to the time period during which all factor inputs can be changed.. 8.What happens to TPP, when MPP becomes negative? -TPP diminishes 9. What happens to TPP, when MPP increases? -TPP increases at an increasing rate. 10.What happens to TPP, when MPP becomes zero? -TPP reaches maximum.

194 3 or 4-Marks -Define marginal product. State the behavior of marginal product when only one input is increased and other inputs are held constant. - Define production function. Distinguish between short run and long run production functions. -State the behavior of marginal product in the view of variable proportions. Explain the causes of this behavior. -What does the Law of variable Proportions show? State the behavior of total product according to this law. -Giving reasons, explain the 'Law of Variable Proportions. -What does the Law of variable Proportions show? State the behavior marginal product according to this law. 6-MARK QUESTIONS What are the different phases in the Law of Variable Proportions in terms of marginal product? Give reason behind each phase. Use diagram. Explain the law of Variable Proportions with the help of total product and marginal product curves. State the different phases of changes in Total Product and Marginal Product in the Law of Variable proportions. Also show the same in a single diagram. Explain the law of Variable Proportions with the help of total product and marginal product curves. Explain the law of variable proportions with the help of total product and marginal product curves. Explain the law of variable Proportions through the behavior of both Total Product and Marginal Product. Give reasons. What does the Law of variable proportion show? State the behavior of TP according to this law.

195 Define a) Market Period b) Production Function. c) Marginal Physical Product(MPP). d) Normal Profit Ans:- CONTENT ENRICHMENT C B S E MODEL ANSWERS a) Market period It is defined as a very short time period in which supply of commodity cannot be changed by changing the unit of factors of production. In this case all the factors of production remain constant. b) Production Function- It shows technological relationship between physical inputs and physical outputs. It can be written as follows: Q = f (f1, f2, f3.fn). Where Q is physical quantity produced and f1, f2, f3.fn are the physical quantities of different factors of production used. c) Marginal Physical Product - The change in total physical product (TPP) by employing an additional unit of variable factor is called Marginal Physical Product (MPP). MPP = TPPn TPPn-1 d) Normal Profit - Normal profit is the minimum amount of profit which is essential to keep an entrepreneur in production in the long run. What do you mean by returns to a factor? Explain the reasons for increasing returns to a factor. Ans: - Returns to a factor means keeping other inputs constant, the change in physical output by increasing only one physical input.

196 Causes of increasing return:- Following factors lead to increasing returns to a factor- i. Indivisibility of the factors - Increase in units of variable factor leads to better and fuller utilisation of fixed factor. This causes the production to increase at a rapid rate. ii. Efficient utilisation of variable factor - When more units of variable factor are employed with fixed factor, then variable factor is utilised in more efficient way. iii. Optimum combination of factors - In the beginning when quantities of a variable factors are applied to fixed factors, the system moves towards achievement of optimum combination of factors because then underutilised fixed factors (building, machine, land etc) are better and more fully used. Thus lead to increasing returns. iv. Specialisation- With more use of labour, process based division of labour and specialisation becomes possible which increases efficiency and productivity. Explain the likely behaviour of Total Product and Marginal Product when only one input is increased while all other inputs are kept unchanged. Or Briefly explain law of variable proportion or returns to variable factor. Ans: - Law of variable proportion or returns to variable factor - This law state that keeping other factors of production constant, when only one variable factor is increased, in the beginning total physical product increases at an increasing rate, then increases at a decreasing rate and ultimately decline. This law is applicable in short period only. This law has three phases- I- Increasing returns to a factor - In this phase MPP increases so TPP increases at an increasing rate. Reasons for increasing returns to a factor are - better utilisation of fixed factor, increase in efficiency of variable factor, indivisibility of fixed factors. II- Diminishing returns to a factor - In this phase MPP decreases but positive so TPP increases at decreasing rate.this phase ends when MPP is zero & TPP is maximum. Reasons for diminishing returns is that factors of production are imperfect substitutes of each other and after optimum combination of factors when more and more units of variable factors are increased, pressure of production start falling on fixed factors and MPP start decreasing.

197 III-Negative returns to a factor - In this phase MPP becomes negative so TPP decreases. It happens when variable factor become too much as compared to fixed factors then coordination between variable and fixed factor become very poor and efficiency of factors decrease. Explanation: The law of variable proportion can be explained with the help of a schedule and a diagram as follows.

198 In above table and diagram- First unit to third unit MPP increasing so TPP increases at an increasing rate. Therefore it s a phase of increasing return. Fourth unit to sixth unit MPP decreasing but positive & TPP increases at decreasing rate. Therefore it s a phase of decreasing return. Sixth unit onward MPP become negative & TPP is decreasing. Therefore it s a phase of negative return.

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201 aa Explain how input price are a determinant of supply of a good by a firm?

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