Introductory Microeconomics
Workbook Class XII
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Contents Worksheet 1
Introduction
3
Worksheet 2
Consumer Equilibrium and Demand
9
Worksheet 3A
Producer Behaviour and Supply
17
Worksheet 3B
Cost and Revenue
25
Worksheet 4
Forms of Market and Price Determination
31
Solutions Numericals (with Solutions) CBSE Question Paper–2012
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Introduction
QUESTION SET–I Define the following concepts: 1. Microeconomics. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Scarcity. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Central problems of an economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Mixed economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Market economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Centrally planned economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Production possibility curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Opportunity cost. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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10. Marginal opportunity cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Marginal rate of transformation. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Macroeconomics. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Macro variables. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Microeconomics does not deal with aggregates. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Opportunity cost refers to explicit cost of production. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Production possibility curve may sometimes be convex to the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Central problems of an economy are found only in those economies which are not governed or regulated by the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Scarcity exists even when certain goods are available at zero price. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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6. Marginal opportunity cost falls as resources are shifted from Use-1 to Use-2. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. PPC is drawn on the assumption of constant technology. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Economising the use of resources means saving the resources for future use. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. If resources are not efficiently utilised, we are outside PPC. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. An economy produces goods and services in a manner such that it always operates on the PPC. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. Choice between consumer goods and capital goods refers to the problem of ‘how to produce’. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Choice between labour intensive technology and capital intensive technology refers to the problem of ‘what to produce’. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Choice between ‘production for the poor’ and ‘production for the rich’ refers to the problem of what to produce. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. In a market economy, the central problems are solved by the central authority of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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5. In a centrally planned economy, the central problems are solved by the forces of supply and demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. In a mixed economy, only public sector is engaged in the process of production. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Problem of resource allocation is automatically solved in a mixed economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Production possibility curve shows possibilities of production when different technologies are used. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Economic activity would not exist if resources were not scarce. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. A point below PPC points to under utilisation of resources. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–IV Complete the following sentences: 1. Mixed economy is the one in which __________________________________________________________ . 2. In a capitalist economy, the problem of resource allocation is solved by ____________________________ . 3. In a centrally planned economy, the decision regarding resource allocation is taken by the ___________ _________________________________________________________________________________________ . 4. Marginal opportunity cost refers to the loss of output of Good-1 when ____________________________ . 5. Growth of resources causes a shift in PPC to the _______________________________________________ . 6. When an economy is operating inside the PPC, it is a situation of _________________________________ . 7. In a state of economic slowdown (or recession) when there is massive unemployment and the economy fails to operate on the PPC, it tends to operate _________________________________________________ . 8. Destruction of resources causes a shift in PPC to the____________________________________________ . 9. Discovery of resources (or new technology) causes a shift in PPC to the____________________________ . Introductory Microeconomics
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NUMERICALS 1. Find opportunity cost, given the following possibilities of employment of Mr. X. Possibility 1:
employment in firm-A at the wage of ™1,500 P.M.
Possibility 2:
employment in firm-B at the wage of ™2,500 P.M.
Possibility 3:
employment in firm-C at the wage of ™4,000 P.M.
Ans. ________________________________________________________________________________________ 2. Find marginal rate of transformation, given the following information: Output of Good-Y
Output of Good-X
200
200
160
220
Ans. ________________________________________________________________________________________ 3. Find marginal opportunity cost, given the following situation when some resources are shifted from Use-2 to Use-1. Loss of output in Use-2 : 600 units
Gain of output in Use-1 : 300 units
Ans. ________________________________________________________________________________________ 4. Find marginal opportunity cost of watches when production of watches increases from 10 units to 15 units while the production of shoes decreases from 500 units to 100 units. Ans. ________________________________________________________________________________________ 5. The table shows production possibilities of two goods. Find marginal opportunity cost at different levels of the production of Good-1. Good-1
Good-2
0
100
1
90
2
75
3
55
4
30
5
0
Ans. ________________________________________________________________________________________
HOTS (Higher Order Thinking Skills) Write ‘true’ or ‘false’ with a reason: 1. With an efficient utilisation of resources, an economy can shift to point beyond the PPC. _________________________________________________________________________________ _________________________________________________________________________________
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2. When output of Good-1 increases from 100 units to 110 units and output of Good-2 decreases from 400 units to 350 units, marginal opportunity cost = 50 units. _________________________________________________________________________________ _________________________________________________________________________________ 3. When an economy moves from a situation of underemployment to full employment, PPC curve shifts to the right. _________________________________________________________________________________ _________________________________________________________________________________ 4. Marginal rate of transformation refers to the slope of PPC. _________________________________________________________________________________ _________________________________________________________________________________ 5. Convexity of PPC to the origin points to increasing slope of PPC and increasing marginal opportunity cost. _________________________________________________________________________________ _________________________________________________________________________________ 6. Problem of resource allocation would not arise if resources had not alternative uses. _________________________________________________________________________________ _________________________________________________________________________________ 7. If a country is operating inside the PPC, it is saving its resources for future growth. _________________________________________________________________________________ _________________________________________________________________________________ 8. If an economy is operating inside the PPC, it is possible to increase the production of Good-1 without any decrease in the production of Good-2. _________________________________________________________________________________ _________________________________________________________________________________ 9. Opportunity cost is an avoidable cost. _________________________________________________________________________________ _________________________________________________________________________________ 10. Even when resources and technology are constant, an economy may not operate on the PPC. _________________________________________________________________________________ _________________________________________________________________________________
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Consumer Equilibrium and Demand
QUESTION SET–I Define the following concepts: 1. Demand and quantity demanded. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Marginal utility and total utility. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Indifference curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Budget line/price line. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Consumer’s equilibrium. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Law of diminishing marginal utility. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Law of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Price elasticity of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Individual demand schedule and market demand schedule. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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10. Demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Demand function. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Substitute goods and complementary goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Normal goods, inferior goods, and giffen goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Extension and contraction of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Increase and decrease in demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Movement along the demand curve and shift in demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Demand for a commodity can exist independent of its price. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Quantity demanded is a specific amount of a commodity that the consumer is ready to buy against a specific price, while demand is not. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Demand for a commodity refers to the entire demand schedule. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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4. It is quantity demanded (and not demand for a commodity) that changes with respect to its own price. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Marginal utility of each unit of a commodity adds up to total utility. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Total utility will increase even when marginal utility decreases. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Total utility is maximum when marginal utility starts declining. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Increase in demand refers to extension of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Decrease in demand refers to contraction of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. In case of inferior goods, law of demand fails. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Giffen goods must be inferior goods, while inferior goods, may or may not be giffen goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. In case of substitute goods, a fall in price of Good-X causes a fall in demand for Good-Y. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. In case of complementary goods, a rise in price of Good-X causes a rise in demand for Good-Y. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Indifference curve is not convex to the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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15. MRS (marginal rate of substitution) along an indifference curve tends to diminish. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. All attainable combinations of Good-X and Good-Y are below the budget line of a consumer. _________________________________________________________________________________________ _________________________________________________________________________________________ MUX = MUM. PX _________________________________________________________________________________________
17. A consumer strikes his equilibrium when:
_________________________________________________________________________________________ MUY MUX = = MUM. PY PX _________________________________________________________________________________________
18. A consumer strikes his equilibrium when:
_________________________________________________________________________________________ PX . PY _________________________________________________________________________________________
19. A consumer strikes his equilibrium when: MRS =
_________________________________________________________________________________________ PX P is better than when MRS = X . PY PY _________________________________________________________________________________________
20. A situation when MRS >
_________________________________________________________________________________________ PX MUX P MUX is better than when X = > . PY MUY PY MUY _________________________________________________________________________________________
21. A situation when
_________________________________________________________________________________________
QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. MU must diminish as more and more standard units of a commodity are continuously consumed. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Cross price effect occurs in case of substitute goods, and not in case of complementary goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. In an indifference curve map, higher IC always points to higher level of satisfaction. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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4. Changes in income causes a shift in demand curve, while change in price does not. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Even when PX remains constant, QX may increase or decrease. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Elasticity of demand refers to change in quantity consequent upon change in price of the commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. When total expenditure on the commodity remains constant, price elasticity of demand also remains constant, no matter what the change in price is. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Elasticity of demand (with respect to price of the commodity) is constant along a straight line demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. If price elasticity of demand is zero, it means expenditure on the commodity does not change with change in price of the commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. A commodity showing high elasticity of demand often has a large number of close substitutes in the market. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Elasticity of demand tends to be high over a short period of time than the long period. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Complementary goods often exhibit low elasticity of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Luxuries of life often exhibit low elasticity of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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14. Higher the price level, higher should be the elasticity of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. A horizontal straight line demand curve shows zero elasticity of demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. A vertical straight line demand curve shows that demand rises to infinity even when price remains constant. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Price elasticity of demand is identical with slope of demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. From a point of intersection, a flatter demand curve shows greater elasticity of demand than a steeper demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. In case of normal goods, income effect is positive, while in case of inferior goods, it is negative. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. In case of giffen goods, income effect is always greater than the substitution effect. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–IV Complete the following sentences: 1. When price of the commodity increases, demand for the commodity _____________________________ . 2. When demand for the commodity increases, demand curve_____________________________________ . 3. When demand curve shifts, price of the commodity____________________________________________ . 4. In case of normal goods, there is a positive relationship between_________________________________ . 5. Moving along an indifference curve, we find that MRS tends to__________________________________ .
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6. Moving along a price line, we find that price ratio (PX /PY ) remains________________________________ . 7. In case of IC analysis, a consumer strikes his equilibrium when___________________________________. 8. In case of utility analysis (and one-commodity case) a consumer strikes his equilibrium when _________________________________________________________________________________________. 9. In case of utility analysis (and 2-commodity case) a consumer strikes his equilibrium when _______ ________________________________________________________________________________________ . 10. Demand curve slopes downward because of the law of__________________________________________ . 11. Downward sloping demand curve shows the law of_____________________________________________ . 12. Convexity of IC to the origin shows__________________________________________________________ . 13. Elasticity of demand (with respect to price of the commodity) shows______________________________ . 14. Law of demand fails in situations of (i) ______________, (ii) ______________ , and (iii) _______________ . 15. Demand curve shifts to the right because of (i) ________________________, (ii) _____________________, and (iii) ______________________ . 16. When price of tea increases, demand for sugar will tend to ______________________________________ . 17. Even when price of the concerned commodity remains constant, people tend to buy less of it, because (i) ________________________, (ii) _________________________, and (iii) _________________________ . 18. If demand curve is a rectangular hyperbola, elasticity of demand = _______________________________ . 19. At the mid-point of straight line downward sloping demand curve, elasticity of demand = ___________ . 20. In case of a perfectly elastic demand, demand curve for the concerned commodity is________________ . 21. In case of a perfectly inelastic demand, demand curve for the concerned commodity is ______________ .
HOTS (Higher Order Thinking Skills) Write ‘true’ or ‘false’ with a reason: 1. If 5% increase in PX causes 5% increase in expenditure on Good-X, elasticity of demand = 1. _________________________________________________________________________________ _________________________________________________________________________________ 2. If 5% increase in PX is accompanied with constant expenditure on the commodity, elasticity of demand = 1. _________________________________________________________________________________ _________________________________________________________________________________ Introductory Microeconomics
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3. If slope of two demand curves is the same, they show the same elasticity of demand. _________________________________________________________________________________ _________________________________________________________________________________ 4. When slope of demand curve = 0, price elasticity of demand = ¥ _________________________________________________________________________________ _________________________________________________________________________________ 5. When slope of demand curve =¥ , price elasticity of demand = 0. __________________________________________________________________________________ __________________________________________________________________________________
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Producer Behaviour and Supply
QUESTION SET–I Define the following concepts: 1. Production function. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Producer’s equilibrium _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Supply and quantity supplied. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Individual supply schedule and market supply schedule. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Law of supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Contraction of supply and decrease in supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Extension of supply and increase in supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. TP, AP and MP. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Returns to a factor. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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10. Law of variable proportions. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Increasing returns to a factor. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Diminishing returns to a factor. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Movement along the supply curve and shift in supply curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Joint supply and composite supply _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Price elasticity of supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Perfectly elastic and perfectly inelastic supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Elastic and inelastic supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Market period, short period and long period. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Fixed factors and variable factors. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Supply and stock. _________________________________________________________________________________________ _________________________________________________________________________________________
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QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Production function is only a technical relationship between physical inputs and physical output. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. A producer strikes his equilibrium when the difference between TR and TC is maximised. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Supply may remain constant even when quantity supplied changes. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Contraction of supply causes a shift in supply curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Extension and contraction of supply are related to factors other than price of the concerned commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Supply increases in response to increase in price of the concerned commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. TP is maximum only when MP = 0. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. MP can be negative, but not the AP. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Law of variable proportions must operate, even when all factors of production are variable. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Diminishing returns to a factor occur simply because supply of the factor cannot be increased. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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11. AP and MP tend to be U-shaped. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Stage of increasing returns (when MP is increasing) is economically redundant, because the producer will not strike his equilibrium in this stage. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. The producer strikes his equilibrium only when MP is diminishing. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. In the short period, production is done only by using the variable factors. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Law of variable proportions operates only if factor ratio happens to change. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. If a straight line upward sloping supply curve shoots from the origin, elasticity of supply is always equal to one. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. If a straight line upward sloping supply curve shoots from the Y-axis, elasticity of supply < 1. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. If a straight line upward sloping supply curve shoots from the X-axis, elasticity of supply > 1. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Stages of production are the consequences of the law of variable proportions. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Price elasticity of supply measures the change in quantity supplied in response to a change in price of the commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. MP must cut AP from its top. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. If AP is falling, AP > MP. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. If AP is rising, AP < MP. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. If AP is falling, MP must also fall. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. If AP is rising, MP must also rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. TP must rise as more and more units of a variable factor are combined with the fixed factor. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. MP is the rate of TP. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. When MP is decreasing, TP increases at a constant rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. When MP is increasing, TP increases at a decreasing rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. When MP is constant, TP is also constant. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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11. Increasing returns to a factor occur because the variable factor is abundantly used in production. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Diminishing returns to a factor occurs because fixed factor cannot be used as much as the variable factor. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Diminishing returns to a variable factor occur because the producer fails to buy the variable factor in the required quantity. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Supply never changes unless price changes. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. It is more profitable for the producer to be in a stage of increasing returns than the stage of diminishing returns. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. In a state of equilibrium, firm’s MC should be rising. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. A producer supplies more of a commodity only at a higher price. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. At a point of intersection of two supply curves, flatter curve shows higher elasticity of supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. In the long period, elasticity of supply tends to be lower than in the short period. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. If elasticity of supply = 0, supply curve becomes a horizontal straight line. _________________________________________________________________________________________ _________________________________________________________________________________________
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QUESTION SET–IV Complete the following sentences: 1. Variable factors are those factors ____________________________________________________________ . 2. Fixed factors are those factors _______________________________________________________________ . 3. In a state of equilibrium, the producer maximises ______________________________________________ . 4. Break-even point occurs when ______________________________________________________________ . 5. Shut-down point occurs when ______________________________________________________________ . 6. MP is the rate of __________________________________________________________________________ . 7. MP = 0, when ____________________________________________________________________________ . 8. TP starts declining when ___________________________________________________________________ . 9. TP increases at increasing rate when _________________________________________________________ . 10. TP increases at diminishing rate when _______________________________________________________ . 11. Increase in supply is caused by (i) ________________, (ii) ________________, and (iii) ________________ . 12. Decrease in supply is caused by (i) ________________, (ii) ________________, and (iii) ________________ . 13. Extension of supply is caused by _____________________________________________________________ . 14. Contraction of supply is caused by ___________________________________________________________ . 15. Upward movement along a supply curve occurs because of ______________________________________ . 16. Downward movement along a supply curve occurs because of ___________________________________ . 17. Two examples of technological progress causing a shift in supply curve are (i) _____________________, and (ii) ______________________ . 18. Owing to improvement in technology, firm’s supply curve will shift to the _________________________ . 19. If price of inputs rises, firm’s supply curve will shift to the________________________________________. 20. Increase in excise tax will shift the firm’s supply curve to the _____________________________________. 21. When a cost saving technology is introduced, firm’s supply curve shifts to the ______________________. 22. During short period, production can be increased _____________________________________________ . 23. During long period, production can be increased ______________________________________________ . 24. Production does not respond to any change in price when elasticity of supply = ____________________. 25. When farm productivity reduces owing to natural calamity, farmer’s supply curve shifts to the _________________________________________________________________________________________ . 26. Three important factors affecting supply of a commodity are (i) ________________________________, (ii) ________________________________, and (iii) ________________________________. 27. Law of variable proportions operates because (i) _____________________, (ii) _____________________, and (iii) _____________________ . Introductory Microeconomics
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HOTS (Higher Order Thinking Skills) 1. Draw a diagram showing that MR = MC when the difference between TR and TC is maximum.
2. Find TP when 10 units of the variable factor are combined with 05 units of the fixed factor and MP remains constant at 10 units. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. At the existing level of output, MP = AP = 10 units. Would AP be equal to MP when production is increased and law of variable proportions is in operation? _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Introduction of new technology increases MP. How would it affect supply curve of a firm? _________________________________________________________________________________________ _________________________________________________________________________________________ 5. How would you explain a situation when supply of a commodity increases without any increase in price of the commodity? _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Write an equation for a short period production function. Give an example. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Why should TP be maximum when MP = 0. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. If there is change in any other determinant of supply (other than price of the concerned commodity), the supply curve must shift to the right or left. Do you agree? Give reason. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Why a situation of increasing returns to a factor not sustainable? Give two reasons. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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Cost and Revenue
QUESTION SET–I Define the following concepts: 1. Fixed cost and variable cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Total cost, average cost and marginal cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Explicit cost and implicit cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Money cost and real cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Private cost and social cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Prime cost and supplementary cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Total revenue and marginal revenue. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Fixed cost is constant even when output is zero. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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2. Variable cost is incurred before production is started. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Fixed cost must be greater than variable cost when output is zero. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Variable cost reduces as output increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Average fixed cost curve is a rectangular hyperbola. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Average variable cost tends to fall, stabilise and rise as output increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Total fixed cost is indicated by a vertical straight line. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Marginal cost includes both fixed cost and variable cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Average cost includes both fixed cost and variable cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Total cost is the sum total of marginal costs. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Total revenue is the sum total of marginal revenues. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Average revenue is the same as market price of the commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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13. Marginal revenue can never be negative. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. When price is constant, AR > MR. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. When price reduces as output increases, AR = MR. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Under perfect competition, AR and MR curves tends to slope downward. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Under monopoly, AR and MR curves are indicated by horizontal straight lines. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. TR curve always shoots from the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. AR curve never shoots from the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. When MR = 0, TR is maximum. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. AC curve tends to be U-shaped. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. MC is greater than AC when production is in a state of diminishing returns. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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3. AC is greater than MC, so long as AC is falling. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. MC and AC are equal when AC tends to stabilise. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. TC and TVC curves are parallel to each other. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. The distance between AVC and AFC curves tends to reduce as output increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. The distance between AC and AVC curves tends to increase at higher levels of output. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Short period TC curve starts from Y-axis. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Long period TC curve starts from the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. AFC continuously reduces as output increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Greater production always means greater revenue. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. AR is always greater than MR under monopoly. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. ATC and AVC tend to intersect at some level of output. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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14. When MC > ATC, ATC must rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Area under MC curve = TVC. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. TR curve under perfect competition is a straight line, sloping upward from the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Under monopoly, TR curve increases only at a diminishing rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Under perfect competition, rate of TR never declines, but under monopoly and monopolistic competition, it can. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. AR = 0, when TR is maximum. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. MR tends to fall even when AR is constant. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–IV Complete the following sentences: 1. TFC = __________________________________________________________________________________ . 2. TVC = __________________________________________________________________________________ . 3. TC = ___________________________________________________________________________________ . 4. ATC is U-shaped, because of _______________________________________________________________ . 5. AFC is a rectangular hyperbola, because _____________________________________________________ . 6. ATC and AVC never intersect each other, because _____________________________________________ . 7. Area under MC curve = TVC, because _______________________________________________________ . 8. ATC is always above AVC, because ___________________________________________________________ . Introductory Microeconomics
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9. Three examples of fixed costs are (i) _______________________, (ii) ________________________, and (iii) ________________________ . 10. Three examples of variable costs are (i) _______________________, (ii) ________________________, and (iii) ________________________ . 11. TFC curve is parallel to X-axis, because ______________________________________________________ . 12. Average and marginal cost tend to fall as output rises, because ___________________________________ . 13. The concept of fixed cost is not relevant in the long period, because ______________________________ . 14. Under perfect competition, both AR and MR are indicated by the same horizontal straight line, because _________________________________________________________________________________________ . 15. AR curve is above MR curve under monopoly because __________________________________________ . 16. MR is the rate of __________________________________________________________________________ . 17. When TR is increasing at a decreasing rate, MR should be ______________________________________ . 18. When TR is increasing at a constant rate, MR should be ________________________________________ . 19. When price is constant, TR increases at a _____________________________________________________ . 20. When MR is negative, TR __________________________________________________________________ .
HOTS (Higher Order Thinking Skills) 1. Draw TC and TR curves in one diagram. Show that MR = MC only when TR and TC are parallel to each other.
_________________________________________________________________________________________ _________________________________________________________________________________________ 2. MC is always variable cost. Why? _________________________________________________________________________________________ _________________________________________________________________________________________
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Forms of Market and Price Determination
QUESTION SET–I Define the following concepts: 1. Pure competition and perfect competition. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Monopoly and monopolistic competition. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Oligopoly and duopoly. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Equilibrium price and equilibrium quantity. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Market and market equilibrium. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Homogeneous product and product differentiation. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Normal profits, extra-normal profits and extra-normal losses. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Break-even price, market price and normal price. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Patent rights and cartels. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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10. Excess demand and excess supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Economic viability and non-viability of an industry. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Control price and support price. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. There is a large number of buyers both under monopoly and monopolistic competition. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. A monopoly firm is a price maker. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. A firm under perfect competition has no control over price of the product. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Price of the product never changes under perfect competition. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Firm’s demand curve is indeterminate under oligopoly. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Product differentiation allows partial control over price. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. A monopolist can exercise price discrimination. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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8. A monopolist fixes price of his product on the basis of elasticity of demand for his product. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. For a perfectly competitive firm, there are only normal profits in the long run. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. A firm under monopolistic competition makes only normal profits in the long run. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. There are no selling costs in perfect competition and monopoly forms of the market. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Firm’s demand curve under perfect competition is a horizontal straight line. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Firm’s demand curve under monopolistic competition is more elastic than under monopoly. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. A firm under monopolistic competition cannot influence market price. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Under perfect competition, equilibrium price is determined by the forces of market demand and market supply. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. A firm under perfect competition gets only a break-even price in the long run. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Freedom of entry and exit ensures only normal profits in the long run. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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3. A perfectly competitive firm operates at the lowest point of AC curve in the long run. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. There is a high degree of interdependence among firms in oligopoly form of the market. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. In case of excess demand, equilibrium price must rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. For a non-viable industry, supply curve is placed above the demand curve. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Equilibrium price may not change even when market demand happens to change. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Equilibrium price never changes in a situation of perfectly elastic supply, no matter what the demand is. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. In a situation when productivity increases owing to improvement in technology, equilibrium price tends to fall. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. In a situation of war when people are fearing shortage of rice, equilibrium price of rice tends to rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Market price is always equal to or greater than the support price of a commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. In a situation when import of inputs becomes expensive, equilibrium price of the commodity tends to rise. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Microeconomics
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13. In case of inferior goods, a rise in income of the buyers causes a fall in equilibrium price of the commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Equilibrium price may fall even when market demand tends to rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. In a state of recession, when there is a substantial cut in production, and supply curve shifts to the left, equilibrium price may fall. _________________________________________________________________________________________ _________________________________________________________________________________________
QUESTION SET–IV Complete the following sentences: 1. Three important features of perfect competition are (i) ___________________ , (ii) __________________ , and (iii) ___________________ . 2. Two basic characteristics of monopoly are (i) ______________________ , and (ii) _____________________ . 3. Three notable features of monopolistic competition are (i) ______________________________________ , (ii) ______________________________________ , and (iii) ________________________________________ . 4. Two distinct features of oligopoly are (i) ________________________ , and (ii) _______________________ . 5. Price line under perfect competition _________________________________________________________ . 6. Price line under monopolistic competition is more elastic than under _____________________________ . 7. A perfectly competitive firm cannot make extra-normal profits __________________________________ . 8. In a state of perfectly elastic demand, increase or decrease in supply does not affect _________________ . 9. Owing to a forward shift in demand curve, equilibrium price tends to ____________________________ . 10. Rise in production cost owing to rise in input price, shifts the supply curve ________________________ . 11. Common features of monopoly and monopolistic competition are (i) ___________________________ , (ii) _______________________ , and (iii) ________________________ . 12. Common features of perfect competition and monopolistic competition are (i) _____________________, and (ii) ______________________ . 13. Price is equal to MC in a situation of __________________________________________________________ . 14. Price is greater than MC in a situation of ______________________________________________________ . 15. In case of increase in excise tax, equilibrium price tends to ______________________________________ . Introductory Microeconomics
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HOTS (Higher Order Thinking Skills) Write ‘true’ or ‘false’ with a reason: 1. Firm’s demand curve as a horizontal straight line under perfect competition shows that an individual producer has no control over price of his product. _________________________________________________________________________________ _________________________________________________________________________________ 2. A monopoly producer cannot control both price as well as quantity of his product. _________________________________________________________________________________ _________________________________________________________________________________ 3. It is because of high degree of interdependence that firm’s demand curve remains indeterminate under oligopoly. _________________________________________________________________________________ _________________________________________________________________________________ 4. A situation of excess demand or excess supply is automatically corrected under perfect competition. _________________________________________________________________________________ _________________________________________________________________________________ 5. In a situation of constant demand, equilibrium quantity does not change even when supply increases or decreases. _________________________________________________________________________________ _________________________________________________________________________________ 6. A monopoly firm can make abnormal profits in the long run, but not a firm under monopolistic competition. _________________________________________________________________________________ _________________________________________________________________________________ 7. Price exceeds MC under monopoly, but not under perfect competition. _________________________________________________________________________________ _________________________________________________________________________________
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SOLUTIONS Introductory Microeconomics
Worksheet–1
Unit-1: Introduction
QUESTION SET-I 1. Microeconomics is that branch of economics which studies economic problems (or economic issues) relating to individual economic units like a consumer or a producer. 2. Economy is the sum total of economic activities directed towards the satisfaction of unlimited wants using the scarce means. 3. Scarcity is a situation when demand for a good exceeds its supply even at a zero price. 4. Central problems are those problems which arise in every economy. At the micro level, these problems are: (i) What to produce? (ii) How to produce? and (iii) For whom to produce? At the macro level, these are (i) problem of fuller utilisation of resources, and (ii) problem of growth of resources. 5. Mixed economy is the one in which both private and public sectors play a significant role in production activity. Free play of the market forces is allowed but not without checks and balances by the government. 6. Market economy is the one in which decisions regarding what, how and for whom to produce are left to the market forces of supply and demand. 7. Centrally planned economy is the one in which decisions regarding what, how and for whom to produce are taken by some central authority. 8. Production possibility curve (or transformation curve) is a curve showing different possibilities of producing a set of two goods with (i) the given resources, and (ii) given technology. 9. Opportunity cost refers to value of a factor in its next best (or second best) alternative use. 10. Marginal opportunity cost refers to loss of output of Good-Y for producing an additional unit of Good-X, some resources are shifted from Good-Y to Good-X. 11. Marginal rate of transformation (MRT) is the same as marginal opportunity cost. It is estimated as under: é when some resources ù DY Loss of output of Y MRT= = êare shifted from Y to X ú DX Gain of output of X ë û 12. Macroeconomics is the study of economic relationships, economic problems or economic issues at the level of economy as a whole, like the problem of inflation or of unemployment. 13. Those economic variables which are studied at the level of economy as a whole are known as macro variables. Examples: GDP, Disposable Income, Household consumption, etc.
QUESTION SET-II 1. No. Microeconomics does deal with the aggregates. Example: market demand is the aggregation of individual demand. 2. No. Opportunity cost is the value of a factor in its second best alternative use. It is implicit cost, not an explicit cost. Explicit cost is paid-out cost. 3. No. PPC is always concave to the origin, as marginal opportunity cost (indicating slope of the curve) must rise as more and more resources are shifted from Good-2 (on Y-axis) to Good-1 (on X-axis). 4. No. Every economy faces the central problems, though these are solved differently in different economies. Because, scarcity of resources is common to all economies. 5. Yes. Scarcity is a situation when demand for a good exceeds its supply even at a zero price. Introductory Microeconomics
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6. No. Marginal opportunity cost increases as resources are shifted from Use-1 to Use-2. This is in accordance with the law of variable proportions. 7. Yes. PPC is drawn on the assumption of constant technology. Which is why PPC shifts in response to a shift in technology. 8. No. Economising the use of resources means that resources are to be used in a manner such that maximum output is realised per unit of input. It also means optimum utilisation of resources. 9. No. If resources are not fully utilised, total output in the economy will be less than the potential output and we are inside the PPC. 10. No. If resources are not fully utilised (or are under-utilised) an economy may as well be inside the PPC.
QUESTION SET-III 1. No. Choice between consumer goods and capital goods refers to the problem of ‘what to produce’. 2. No. Choice between labour intensive technology and capital intensive technology refers to the problem of ‘how to produce’. 3. No. Choice between ‘production for the poor’ and ‘production for the rich’ refers to the problem of ‘for whom to produce’. It is a problem relating to choice of users of goods and services. 4. No. In a market economy central problems are solved through the free play of the market forces. 5. No. In a centrally planned economy decisions relating to ‘what, how and for whom to produce’ are taken by some central authority of the government. 6. No. In a mixed economy both private and public sectors are engaged in the process of production. 7. In a mixed economy, problem of resource allocation, finds its solution through the market forces of supply and demand, but not without checks and balances by the government. 8. No. Production possibility curve shows different combinations of two goods which can be produced with the given resources on the assumptions that (i) resources are fully and efficiently utilised, and (ii) technique of production remains constant. 9. Yes. Because economic activity is related to the use of scarce means for the satisfaction of human wants. 10. Yes. A point below PPC points to under utilisation of resources. In such a situation actual output is less than potential output.
QUESTION SET-IV 1. both private as well as public sectors play a significant role in production activity. 2. free play of the market forces. 3. central authority or the government. 4. a unit more of Good-2 is produced by shifting the resources from Good-1 to Good-2. 5. right. 6. under utilisation or inefficient utilisation of resources. 7. inside the PPC. 8. left. 9. right.
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NUMERICALS 1. Opportunity cost = ™2,500 P.M. 2. Marginal rate of transformation = 2. 3. Marginal opportunity cost = 2 units. 4. Marginal opportunity cost = 80 units. 5. 10, 15, 20, 25, 30.
HOTS (Higher Order Thinking Skills) 1. False. With an efficient or fuller utilisation of resources, the economy operates on the PPC and cannot shift to point beyond the PPC because PPC shows attainable combinations of two goods with given resources and technology. 2. False. Marginal opportunity cost = 5 units. Because, Loss of output of Good - 2 Marginal opportunity cost = Gain of output of Good - 1 when some resources are shifted from Good-2 to Good-1. 3. False. When an economy moves from a situation of underemployment to full employment, the economy is on PPC. 4. True. MRT is the same as marginal opportunity cost which is the slope of PPC. 5. False. Convexity of PPC to the origin points to decreasing slope of PPC and decreasing marginal opportunity cost. However, PPC is always concave to the origin. Because marginal opportunity cost must rise as more and more resources are shifted from Use-1 to Use-2. 6. True. Problem of resource allocation arises because resources have alternative uses. 7. False. If a country is operating inside the PPC, it corresponds to under utilisation or inefficient utilisation of resources. 8. True. It is possible to increase the production of Good-1 without any decrease in the production of Good-2. Because, being inside the PPC points to a situation when resources are not fully utilized (or are not efficiently utilised). 9. False. Opportunity cost is the cost of a factor in its best alternative use. Accordingly, it is the minimum cost of a factor, and therefore unavoidable. 10. Yes. Because resources may not be efficiently utilised.
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Worksheet–2
Unit-2: Consumer Equilibrium and Demand
QUESTION SET-I 1. Demand refers to various quantities of a commodity that the consumer is ready to buy at different possible prices of that commodity. Quantity demanded refers to a specific quantity to be purchased against a specific price of the commodity. 2. Marginal utility is the utility derived from an additional unit of a commodity. Total utility is the sum total of marginal utilities from the consumption of different units of a commodity. 3. Indifference curve is a curve showing different combinations of a set of 2-Goods, each combination offering the same level of satisfaction to the consumer. 4. Budget line is a line showing different combinations of a set of 2-Goods that the consumer can buy, given his income and prices of the goods. It is also called price line, as it shows price ratio between Good-X and Good-Y. 5. A consumer is in a state of equilibrium when he maximises his satisfaction by spending his given income on different goods and services, with a given set of prices. 6. The law of diminishing marginal utility states that marginal utility derived from the consumption of a commodity declines as more units of that commodity are consumed at a point of time. 7. Law of demand states that, other things remaining constant, more of a commodity is purchased in response to decrease in its price. 8. The price elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to the change in its price. 9. Individual demand schedule is a table showing various quantities of a commodity which a consumer is ready to buy at different possible prices of the commodity at a point of time. Market demand schedule is a schedule showing various quantities of a commodity which all the buyers in the market are ready to buy at different possible prices of the commodity at a point of time. 10. Demand curve is a graphic presentation of demand schedule, showing inverse relationship between price and quantity demanded of a commodity. 11. Demand function shows the relationship between demand for a commodity and its various determinants. 12. Substitute goods are those goods which can be substituted for each other. Complementary goods are those goods which complete the demand for each other. 13. A normal good is that good in case of which there is a positive relationship between consumer’s income and quantity demanded. Implying that income effect is positive. An inferior good is that good in case of which there is a negative relationship between consumer’s income and quantity demanded. A giffen good is that good in case of which income effect is negative as well as greater than substitution effect. Implying that the law of demand fails. 14. When quantity demanded of a commodity changes due to change in own price of the commodity, other factors remain constant, it is a situation of extension and contraction of demand. 15. When quantity demanded of a commodity changes owing to a change in other factors, other than price of the concerned commodity, it is a situation of increase and decrease in demand. 16. Movement along the demand curve occurs when quantity demanded is related to changes in price of the commodity. Shift in demand curve occurs when demand for a commodity is related to factors other than price of the commodity. Introductory Microeconomics
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QUESTION SET-II 1. No. Demand for a commodity is always expressed with reference to price. 2. Yes. Because demand refers to various quantities of a commodity that the consumer is ready to buy against different possible prices. 3. Yes. Demand for a commodity refers to the entire demand schedule showing various quantities of the commodity that the buyers in the market are ready to buy at different possible prices at a point of time. 4. Yes. It is quantity demanded of a commodity that changes in response to change in its own price. Change in demand occurs even when price of the commodity remains constant. 5. Yes. Total utility is the sum total of marginal utilities. TU = SMU. 6. Yes. We know TU = SMU. Accordingly TU will increase so long as MU is positive, even when it is decreasing. 7. No. When marginal utility starts declining, total utility increases at a diminishing rate. Total utility is maximum when marginal utility is zero. 8. No. Increase in demand refers to increase in quantity demanded of a commodity at its existing price. It is a situation of forward shift in demand curve, not of extension of demand. 9. No. Decrease in demand refers to decrease in quantity demanded of a commodity at its existing price. It is a situation of backward shift in demand curve, not of contraction of demand. 10. No. In case of inferior goods, law of demand fails only when negative income effect is greater than substitution effect. When negative income effect is less than substitution effect law of demand does not fail. 11. Yes. Because giffen goods by definition are those inferior goods in case of which two conditions are satisfied: (i) income effect is negative, and (ii) income effect is greater than substitution effect. In case of inferior goods, on the other hand, only one condition needs to be satisfied: that income effect is negative. 12. Yes. Because, cheaper good replaces the one which is more expensive. 13. No. In case of complementary goods, a rise in price of Good-X causes a fall in demand for Good-Y. Because consumption of both goods X and Y goes together. 14. No. Indifference curve is convex to the origin, in accordance with the general law that MRS tends to diminish. 15. Yes. As we move along the indifference curve marginal rate of substitution (MRS) tends to diminish. Because when we have less of a commodity, intensity of its desire increases. Accordingly, less and less of it is sacrificed for every additional unit of the other commodity. 16. No. All attainable combinations of Good-X and Good-Y are below as well as along the budget line. MU X 17. Yes. A consumer attains his equilibrium when = MUM, in case of single commodity. PX 18. Yes. A consumer attains his equilibrium when
MU X MU Y = MUM in case of two commodities. = PX PY
19. Yes. In terms of indifference curve approach, a consumer strikes his equilibrium when: Slope of IC = Slope of Price Line Or P MRS = X PY 20. No. A consumer attains his equilibrium only when: MRS =
PX . It is a point of maximum satisfaction. PY
21. No. A consumer attains his equilibrium only when:
PX MU X . It is a situation of maximum satisfaction. = PY MU Y
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Introductory Microeconomics
QUESTION SET-III 1. Yes. MU must diminishes as more and more standard units of a commodity are continuously consumed. This is in accordance with the law of diminishing marginal utility. 2. No. Cross price effect can occurs in case of substitute goods as well as in case of complementary goods. Because substitute goods as well as complementary goods are related to each other. 3. Yes. Higher indifference curve shows higher level of satisfaction. Because, higher IC corresponds to higher level of income of the consumer or higher level of consumption of both goods X and Y. 4. Yes. Shift in demand curve occurs due to change in factors other than own price of the commodity such as change in income of the consumer, tastes or preferences. 5. Yes. QX may increase or decrease due to change in other determinants of demand even when PX remains constant. 6. No. Elasticity of demand is always measured as a percentage change in quantity demanded in response to a percentage change in price. 7. Yes. When total expenditure on the commodity remains constant, price elasticity of demand also remains constant (which is equal to one), no matter price of the commodity increases or decreases. 8. No. Price elasticity of demand along a straight line demand curve is different at different points on the lower segment demand curve. Because, at a particular point on the demand curve, Ed = , which tends upper segment to change from point to point. 9. No. When Ed = 0, demand remains constant, no matter what the price is. Implying that total expenditure may increase/decrease, but not the quantity demanded. 10. Yes. Elasticity of demand is high in case of goods with close substitutes. Because availability of close substitutes makes it possible for the consumer to switch from one commodity to the other in response to change in the relative price structure. 11. No. Elasticity of demand tends to be high over longer period of time. Because, during short periods consumers tend to be more sticky with regard to their consumption pattern. 12. Yes. Complementary goods often exhibit low elasticity of demand. Because, increase or decrease in the demand for Good-1 causes a simultaneous increase or decrease in the demand for Good-2 even when price of Good-2 has not changed. 13. No. Luxuries of life have greater elasticity of demand. Change in their prices has a great effect on their demand. Because, these goods are not essentials of life. 14. Yes. Elasticity of demand will be high at higher level of price of the commodity. Because corresponding æ lower segment ö to higher level of PX, the ratio çç ÷÷ tends to be high. upper segment è ø 15. No. A horizontal straight line demand curve parallel to X-axis shows infinite elasticity of demand (Ed = ¥). 16. No. A vertical straight line demand curve parallel to Y-axis shows no change in the demand irrespective of change in price. DQ P 17. No. We know Ed = ´ DP Q DP Slope of the demand curve = DQ 1 P So that, Ed = ´ Slope of Demand Curve Q
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18. Yes. From a point of intersection of the demand curve, flatter the curve, more elastic it is. Because, for a given change in PX, (at the point of intersection) flatter demand curve shows greater change in QX. 19. Yes. Income effect is positive when increase in income causes increase in demand. It occurs in case of normal goods. It is negative when increase in income causes decrease in demand. It occurs in case of inferior goods. 20. Yes. In case of giffen goods, income effect is higher than the substitution effect. Implying law of demand fails in case of giffen goods.
QUESTION SET-IV 1. contracts. 2. shifts to the right. 3. remains constant. 4. income of the consumer and demand. 5. diminish. 6. constant. 7. IC and price line are tangent to each other. MU X 8. = MUM. PX MU X MU Y = MUM. 9. = PX PY 10. diminishing marginal utility. 11. demand. 12. diminishing marginal rate of substitution. 13. percentage change in quantity demanded due to percentage change in price of the commodity. 14.
(i) articles of distinction (ii) ignorance of the buyer (iii) giffen goods.
15.
(i) increase in income of the consumer (ii) increase in price of substitute good (iii) decrease in price of complementary good.
16. decrease. 17.
(i) fall in income (ii) decrease in price of substitute good (iii) increase in price of complementary good.
18. 1 (one). 19. 1 (one). 20. horizontal straight line parallel to X-axis. 21. vertical straight line parallel to Y-axis.
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HOTS (Higher Order Thinking Skills) 1. False. It is a situation of zero price elasticity of demand. Because, when expenditure on the commodity is increasing proportionate to increase in price, total purchase of the commodity remains constant. Constant purchase means zero elasticity of demand. 2. True. Because increase in price is not causing any change in expenditure on the commodity. This is in accordance with expenditure method of measuring elasticity. 1 P 3. False. Because Ed = ´ Slope of Demand Curve Q When slope of two demand curves is the same, elasticity of demand depends on the initial price and initial quantity of the commodity. 4. True. We know Ed = =
1 P ´ Slope of Demand Curve Q 1 P ´ 0 Q
=¥ 5. True. We know Ed = =
1 P ´ Slope of Demand Curve Q 1 P ´ ¥ Q
=0
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Worksheet–3A
Unit-3A: Producer Behaviour and Supply
QUESTION SET-I 1. Production function refers to the functional relationship between physical inputs and physical output. 2. Producer’s equilibrium refers to the situation in which he maximises his profits. 3. Supply refers to the schedule showing various quantities of a commodity offered for sale at its different possible prices. Quantity supplied refers to a specific amount offered for sale at a specific price of the commodity. 4. Individual supply schedule is a table showing different quantities of a commodity that an individual firm is ready to sell at different prices. Market supply schedule is a table showing different quantities of a commodity that all the firms in a market are willing to sell at different prices of that commodity at a given time. 5. The law of supply states that, other things being equal, quantity supplied increases with increase in price and decreases with decrease in price of a commodity. 6. When a fall in price of a commodity causes a decrease in its quantity supplied, it is called contraction of supply. If quantity supplied falls due to factors other than own price of the commodity, it is a situation of decrease in supply. 7. When a rise in the price of a commodity causes an increase in its quantity supplied, it is called expansion/extension of supply. If the quantity supplied increases in the market due to factors other than own price of the commodity, it is a situation of increase in supply. 8. Total product (TP) is the total quantity of a commodity produced in a given period. Marginal product (MP) is additional quantity of the commodity produced by using an additional unit of a variable factor. Average product (AP) is the output per unit of the variable factor. 9. Returns to a factor refer to the behaviour of physical output owing to change in physical input of a variable factor, fixed factors remaining constant. 10. Law of variable proportions states that as more and more of the variable factor is combined with the fixed factor, marginal product (MP) of the variable factor may initially increase and subsequently stabilise, but must finally decrease. 11. Increasing returns to a factor occur when, due to increasing application of the variable factor, marginal product (MP) of the factor tends to rise. 12. Diminishing returns to a factor occur when, due to increasing application of the variable factor, marginal product (MP) of the factor tends to diminish. 13. The movement along the supply curve represents expansion and contraction of supply due to change in own price of the commodity. Shift in the supply occurs due to factors other than change in own price of the commodity. 14. Joint supply refers to supply of goods produced and sold jointly like cotton and cotton seeds. Composite supply refers to supply of a commodity through its different sources. 15. Price elasticity of supply is a percentage change in quantity supplied in response to a percentage change in price of the commodity. 16. Perfectly elastic supply refers to a situation when a slight change in price causes infinite change in quantity supplied of a commodity. The supply curve is parallel to X-axis.
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Perfectly inelastic supply refers to a situation when the quantity supplied remains unchanged whatever be the price of the commodity. The supply curve is parallel to Y-axis. 17. Supply is said to be elastic when Es > 1. Supply is said to be inelastic when Es < 1. 18. Market period is a period when supply of a product can be increased only upto the extent of its existing stock. Short period is a period of time when output can be increased only through greater application of the variable factors. Long period is a period of time when production can be increased through greater application of all factors of production. 19. Fixed factors are those factors of production, the application of which does not change with the change in output. Variable factors are those factors of production, the application of which changes with the change in output. 20. Supply refers to various quantities of a commodity that the producers wish to sell at different possible prices of the commodity at a point of time. Stock of a commodity refers to the total quantity of that commodity available with the producers (at a point of time) for present or future sale.
QUESTION SET–II 1. Yes. Production function is only a technical relationship between physical inputs and physical output. This tells us how best resources can be utilised for maximising output. 2. Yes. A producer strikes his equilibrium when he produces that amount of output at which the difference between total revenue and total cost is maximum. Because, gross profit = TR – TC. 3. Yes. Because, supply refers to the entire supply schedule (or supply curve) while quantity supplied refers to a specific point on the supply curve which changes with change in own price of the commodity. 4. No. Contraction of supply causes a downward movement along a supply curve. 5. No. Extension and contraction of supply are related to own price of the commodity, other factors remaining constant. 6. No. Supply expands in response to increase in price of the concerned commodity. It increases in response to factors other than price of the concerned commodity. 7. Yes. When TP is maximum, change in TP= zero. Implying, MP (which measures the change in TP) must be zero when TP is maximum. 8. Yes. MP can be zero or negative but AP is never. Because, AP is the ratio between TP and units of the variable factor (which is always positive) while MP is change in TP. (owing to an additional unit of the variable factor) which can be zero or negative. 9. No. Law of variable proportions operates basically because of the fixity of factors of production. 10. Yes. It is because some factors are fixed that output is increased by using more and more units of the variable factor. It disturbs the ideal factor ratio and diminishing returns set in. 11. No. AP and MP tend to be inverse ‘U-shaped’. 12. Yes. Because in a stage of increasing returns, cost of producing even additional unit of output tends to fall. Accordingly, it would be irrational for the producer to stop production in this stage. 13. Yes. A producer strikes his equilibrium only when MP is diminishing. Because, diminishing MP means rising MC. The producer stops production when rising MC matches with MR. Beyond this point, rising MC would exceed MR, causing loss of profit. Introductory Microeconomics
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14. No. In the short period production is done by using the both fixed and variable factors of production. In fact, short period is a period of time when some factors are fixed. 15. Yes. Factor ratio ought to change in case of law of variable proportions. It is precisely because the proportion of factors varies that the law is named as the law of variable proportions. 16. Yes. When a straight line upward sloping supply curve passes through the origin (no matter what the angle it forms), the elasticity of supply is equal to one. 17. No. When a straight line upward sloping supply curve shoots from the Y-axis, Es>1. 18. No. When a straight line upward sloping supply curve shoots from the X-axis, Es AP; when AP falls, MP < AP. Accordingly, it is only when AP is constant at its top, that AP = MP. Implying that MP curve cuts AP curve from its top. 2. Yes. When AP is falling, AP>MP. See AP and MP corresponding to output range MN in the diagram.
AP, MP
Y
AP=MP
AP O
M
X
N
UNITS OF LABOUR
MP
3. Yes. When AP is rising, AP MP. 4. Introduction of new technology increase MP. It implies a fall in MC. Accordingly supply curve of a firm shift to the right which shows that the producers are now willing to offer more quantity of a commodity at its existing price. 5. When supply of a commodity increases without any increase in price of the commodity, it is known as the situation of increase in supply. Increase in supply occurs when quantity supplied increases due to determinants other than price of the concerned commodity. 6. QX = f (L, K) Where, QX = Output of good-X L = Labour, a variable factor K = Capital, a fixed factor. Example: 25X = f (4L, 2K) From the above equation, it is clear that K is constant at 2 units. Output of commodity-X (25 units) can be produced by combining 4 units of L with 2 units of K. 7. MP is the rate of TP. When MP = 0, there is no change (or addition) in TP. Implying that TP should be maximum when MP = 0. 8. True. Shift in the supply curve occurs due to factors other than price of the concerned commodity. When other factors change in a positive direction, the supply curve shifts to the right, showing increase in supply; and when the changes occur in the negative direction, the supply curve shifts to the left showing a decrease in supply. 9. A situation of increasing returns to a factor is not sustainable owing to the following reasons: (i) some factors are fixed in supply. So that their use cannot be increased proportionate to the variable factors. (ii) factors of production are not perfect substitutes of each other.
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Worksheet 3B
Unit-3B: Cost and Revenue
QUESTION SET-I 1. Fixed cost refers to the expenditure incurred on the fixed factors of production like plant and machinery. Variable cost refers to the expenditure incurred on the variable factors of production like casual workers. 2. Total cost refers to all expenses incurred by the producer to produce a given quantity of output. Average cost is the cost per unit of output produced. Marginal cost is the change in total cost by producing one more or less unit of output. 3. Explicit costs are those cash payments which a firm makes to others for the purchase of goods and services. Examples: (i) wages paid to labourers, (ii) payment made for the purchase of raw material. Implicit costs are opportunity costs of self-owned and self-employed resources. Examples: (i) interest on entrepreneur’s own capital, (ii) rent on entrepreneur’s own land used in business. 4. Money cost refers to the sum of monetary expenses incurred by the producer for producing a commodity. Real cost refers to the pains, the discomfort and disutility involved in supplying the factors of production by their owners. 5. Private cost refers to the expenditure incurred by an individual firm for producing a commodity. Social cost is the total cost to society of a production activity. Like the cost the society has to bear on account of water pollution and noise pollution. 6. Prime or variable costs are those costs which change as the level of output changes. Fixed or supplementary costs are those costs which do not change with change in the level of output. 7. Total revenue is the sum total of money receipts by a firm from the sale of its total output. TR = Price × Quantity Marginal revenue is the change in total revenue as a result of selling one more or less unit of output. MR = TRn – TRn–1 Or DTR MR = DQ
QUESTION SET-II 1. Yes. Because fixed costs are incurred even before output actually starts. 2. No. Variable costs are the expenditure incurred by the producer on the use of variable factors of production. These are incurred only after output actually starts. 3. Yes. Because fixed costs are incurred even when output is zero, while variable costs are incurred only after output actually starts (so that variable costs are zero when output is zero). 4. No. As the output increases, variable cost also increases. Because variable costs are largely the costs of raw material. 5. Yes. Average fixed cost (AFC) curve is a rectangular hyperbola. Because TFC does not change with output.
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Y
6. Yes. Average variable cost tends to fall, stabilise and rise as output increase due to the law of variable proportions. See diagram. AVC
AVC
O
X
OUTPUT
7. No. Total fixed cost is indicated by a horizontal straight line parallel to X-axis. See diagram.
TOTAL FIXED COST
Y
TFC
20
10
O
1
2
X
3
4
5
OUTPUT
8. No. Marginal cost covers only the variable cost. Because, MC is an additional cost and it cannot be a fixed cost. 9. Yes. AC = AFC + AVC. 10. No. Sum total of marginal costs (MC) corresponding to different units of output become total variable cost (TVC). TVC = SMC. Because, marginal costs are variable costs only. 11. Yes. Sum total of marginal revenues for all the units of output is equal to total revenue. TR = SMR 12. Yes. We know that: AR = We also know that TR = P.Q
TR Q (Where P = Price, and Q = Quantity or Output sold.)
Relating the two equations, we can write that: TR AR = = P. Q Thus, it is proved that AR = Price. 13. No. MR can be negative, though only when price is declining as under monopoly and monopolistic competition. 14. No. When price is constant, AR is constant. Constant AR implies MR is also constant. Thus, when price is constant, AR = MR. 15. No. When price (= average revenue) reduces as output increases, MR declines faster than AR. So that AR > MR.
Y
16. No. Under perfect competition, AR and MR curves coincide and are a horizontal straight line parallel to X-axis. 17. No. Under monopoly, AR and MR curves slope downward, as in the diagram:
AR/MR
AR MR O
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X OUTPUT
Economics–XII
18. Yes. TR curve can shoots from the origin as TR = 0 when output is zero. 19. Yes. AR (= price) curve never shoots from the origin, because price of a commodity is often not zero. 20. Yes. MR is addition to TR. When MR = 0, addition to TR is zero, implying that TR is maximum.
QUESTION SET–III 1. Yes. AC curve is U-shaped in accordance with the law of variable proportions: it tends to fall owing to increasing returns to a factor, it tends to stabilise owing to constant returns to a factor, and it tends to rise owing to diminishing returns to a factor. 2. Yes. When the production is in a state of diminishing returns, MC will be rising in accordance with falling MP. AC is rising, with the rising MC but less than MC or MC > AC. 3. Yes. AC is greater than MC or MC is less than AC when AC falls. See AC and MC till point E in the diagram. In the diagram, AC is falling till point E and MC continues to be lower than AC.
Y
AC, MC
MC
AC
E
O
X
OUTPUT
Y
MC
AC, MC
4. Yes. MC and AC are equal when AC tends to stabilise or when AC is constant, MC = AC. See AC and MC corresponding to point E in the diagram where AC = MC.
AC
E
O
OUTPUT
X
5. Yes, it is true. TC and TVC curves are parallel to each other. Because the difference between TC and TVC is equal to TFC which is constant at all levels of output. Y
AVC AVC, AFC
6. No, it is not true. Initially as output increases the distance between AVC and AFC curves may tend to reduce but once the two curves cross each other (as in the diagram), the difference between the two tends to increase. Because, while AVC tends to rise after a certain level of output, AFC continuously falls.
AFC O
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OUTPUT
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Economics–XII
8. Yes. TC = TFC + TVC and TFC remains constant even at zero level of output. At zero level of output, TVC = 0
Y
AC AVC
AC, AVC
7. No. The distance between AC and AVC curves tends to reduce as output increases. This is because as output increases the component of AVC in AC tends to increase while the component of AFC in AC tends to decrease. See diagram.
O
X
OUTPUT
\ TC = TFC Accordingly, TC curve starts from the Y-axis in the short period. 9. Yes. Long period total cost (TC) curve starts from the origin (or zero) because in the long period, all costs are variable costs and variable costs always vary with output, so that when output is zero, variable costs are also zero. 10. Yes. AFC continuously reduces as output increases. Because TFC remains constant at all levels of output. 11. No. Greater production does not always mean greater revenue (TR). Price (AR) may fall so much that higher output yields lower TR. 12. Yes. AR>MR under monopoly because AR tends to fall, and falling AR implies falling MR at a higher rate. Y
14. Yes. When MC > ATC, ATC rises. See AC and MC beyond point E in the diagram. In the diagram, AC starts rising from point E and after that point E, MC > AC.
MC
AC, MC
13. No. Because ATC is the sum of AFC and AVC. Since AFC can never be zero, AVC can never be equal or greater than ATC. Thus, ATC always remains above AVC.
AC
E
O
15. Yes. Total variable cost is the area covered under MC curve corresponding to a given level of output. In the diagram area OLKM is total variable cost when output is OL.
OUTPUT
X
Y
M
MC
MC
K
O
L OUTPUT
X
16. Yes. Under perfect competition, AR and MR are constant. Constant MR implies TR increases at a constant rate. Therefore, TR is shown as a straight line sloping upward from the origin and it shoots from the origin. When Output= 0, TR = 0. 17. Yes. TR curve increases only at a diminishing rate because a monopolist can sell more only if he lowers the price of his product. 18. Yes. Because rate of TR is equal to MR which is constant under perfect competition, but tends to decline under monopoly and monopolistic competition. 19. No. When TR is maximum, MR = 0 even when AR is declining as under monopoly and monopolistic competition. 20. No. When AR is constant, MR is also constant and AR = MR. Introductory Microeconomics
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QUESTION SET-IV 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
TC – TVC. TC – TFC. TFC + TVC. law of variable proportions. TFC remains constant at all levels of output. AVC is only a component of AC. MC covers only variable costs. ATC = AFC + AVC. (i) rent of building (ii) cost of plant and machinery (i) purchase of raw material (ii) wages of daily workers it is constant at all levels of output. of increasing returns to a factor. all factors are variable factors in the long period. AR is constant. when AR is decreasing, MR must be decreasing faster than AR. TR. decreasing. constant. constant rate, because constant price (AR) implies that AR = MR. starts declining.
(iii) wages of permanent staff. (iii) payment of electricity bill.
HOTS (Higher Order Thinking Skills) 1.
Y COST, REVENUE AND PROFIT
A
a
Q1
b TR
c
O
TC
(a)
Q
Q2 (b)
REVENUE AND COST
Y
Note: The difference between TR and TC is maximum only when MR = MC
d B (Maximum P Profit)
X TP
MC
MR = MC
MR O
Q1
Q OUTPUT
Q2
X
Profit is maximised when the difference between TR and TC is maximum and when MR = MC. Distance between TR and TC curves is measured by drawing tangents on these curves. The distance is maximum when the tangent lines are parallel to each other. 2. Marginal cost is an additional cost and additional cost cannot be fixed cost, it can be variable cost. Accordingly, the sum total of marginal costs corresponding to different units of output become TVC. SMC = TVC. Introductory Microeconomics
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Worksheet 4
Unit-4: Forms of Market and Price Determination
QUESTION SET-I 1. A firm is said to be operating under conditions of pure competition when there are many firms, producing a homogeneous commodity with freedom of entry and exit, independent decision-making. Perfect competition is said to exist, when besides conditions of pure competition, two more conditions are satisfied, viz (i) there is perfect knowledge of the market conditions among buyers and sellers, and (ii) there is perfect mobility of factors of production. 2. Monopoly is a market form with a single seller and many buyers of a commodity. Monopolistic competition is a form of the market with many buyers and sellers, where differentiated product is sold with a partial control over price. 3. Oligopoly is a form of the market in which there is a large number of buyers, but only a few big sellers of a commodity. 4.
5.
6.
7.
8.
9.
10.
Duopoly is a form of market in which there are two sellers of a commodity with many buyers. Equilibrium price is the price which corresponds to the equality between market demand and market supply of a commodity. Equilibrium quantity is the quantity which corresponds to the equilibrium price in the market. Market refers to the mechanism of sale and purchase of goods and services. Market equilibrium is a situation of zero excess demand and zero excess supply. Or, it is a situation where: market demand = market supply. Homogeneous product refers to a product of which all units are identical in all respects. Product differentiation is a situation when different producers in the market try to differentiate their product (with respect to size, weight, packaging, etc.) with a view to attracting the buyers and exercising partial control over price. Profits are said to be normal when: TR = TC or AR = AC. Profits are said to be extra-normal or abnormal when: TR > TC or AR > AC. Extra-normal or abnormal losses occur when: TR < TC or AR < AC. Price which is equal to average cost is known as break-even price. Market price is the price that exists in the market at a particular point of time. Normal price is the price that prevails in the long period. Patent rights is the official recognition of the originators of a new product or technology. No one else can use their technology without obtaining a license. A cartel is a formal collusive agreement among rival firms in the market under oligopoly. Firms collude to avoid competition. When market demand exceeds market supply of a commodity at a given price it is known as excess demand. Excess supply means market supply of a commodity is more than market demand for a commodity at the given price.
11. Economic viability of an industry refers to the situation when demand and supply curves of the industry meet at some positive level of output. Non-viability of an industry refers to a situation when demand curve and supply curve do not intersect each other at any positive quantity. In such a situation, supply curve lies above the demand curve. 12. Control price means price of the good is fixed below its equilibrium price with a view to ensuring some minimum supply of the essential commodities to a targeted group of people. Support price is fixed by the government above the equilibrium price with a view to ensuring some minimum income to the farmers. Introductory Microeconomics
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QUESTION SET-II 1. Yes. In case of monopoly, there is single seller and large number of buyers. Under monopolistic competition, there are large numbers of both buyers and sellers. 2. Yes. Monopolist is a price maker because he is the single seller of a commodity with no close substitutes. 3. Yes. Under perfect competition, there are large number of buyers and sellers of a homogeneous product. No single seller by changing his supply can influence the price. 4. No. Under perfect competition, an individual firm cannot change the price. But market price can change owing to changes in demand and supply. 5. Yes. Firm’s demand curve is indeterminate or cannot be drawn under oligopoly because of high degree of interdependence between the firms. 6. Yes. Because of product differentiation, each firm can decide its price policy independently. So that each firm has a partial control over price of its product. 7. Yes. A monopolist can charge different prices for the same commodity from different buyers because of no close substitutes of his product. 8. Yes. Often, higher price is fixed when elasticity of demand is low. Low price is fixed when elasticity of demand is high. 9. Yes. Under perfect competition, only normal profits prevail in the long run because of freedom of entry and exit of the firms in the market. 10. Yes. A firm makes only normal profits in the long run under monopolistic competition because of freedom of entry and exit of the firms in the market. 11. Yes. It is because homogeneous products are sold at a uniform price under perfect competition and because monopoly product has no close substitutes in the market. 12. Yes. Because price of the product is given to a firm under perfect competition. 13. Yes. Firm’s demand curve under monopolistic competition is more elastic than under monopoly because of availability of close substitutes under monopolistic competition. 14. No. A firm under monopolistic competition has partial control over the price owing to product differentiation. 15. Yes. Under perfect competition, equilibrium price is determined at the point of intersection of market demand and market supply. An individual firm cannot change it.
QUESTION SET-III 1. Yes. A firm under perfect competition gets only a break-even price in the long run. It is a price which corresponds to normal profits in the long run. 2. Yes. It is due to the freedom of entry and exit feature of the market that normal profits prevail in the long run under perfect competition and under monopolistic competition. 3. Yes. A perfectly competitive firm makes only normal profits(AR= AC) in the long run which happens only at the lowest point on the AC curve. Y
5. No. In case of excess demand, market price is less than equilibrium price. Excess demand will push the market price back to its equilibrium level. i.e., equilibrium price is restored in the economy. 6. Yes. In case of non-viable industry, supply curve is entirely above the demand curve. These curves do not meet anywhere. See diagram.
PRICE
4. Yes. Because there is only a small number of big firms in the market.
Non-viable industry: supply curve is above the demand curve S
S
D D
O
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SUPPLY/DEMAND
X
Economics–XII
7. Yes. Because market supply may change proportionate to market demand. 8. Yes. Equilibrium price will remain unchanged when supply is perfectly elastic whether demand increases or decreases. See diagram. Here price remains constant at OP when demand increases to D1D1 and also remains constant at OP when demand decreases to D2D2. D1
Y
PRICE
D2
P
D
S
S D1 D D2
O
X
QUANTITY
9. Yes. Owing to improvement in technology supply of the good in the market will increase causing a rightward shift of the supply curve. Accordingly, equilibrium price will decrease. 10. Yes. Because, fearing shortage, demand curve for rice will shift forward, causing a rise in equilibrium price. 11. Yes. In a situation of support price (which is the minimum price assured to the producers) market price ought to be equal or greater than the support price. 12. Yes. When import of inputs become expensive, the supply of the commodity reduces and supply curve shifts to the left. Accordingly, equilibrium price of the commodity tends to rise. 13. Yes. The income effect for an ‘inferior good’ is negative. It implies that for an increase in income of its buyers, the demand for the good falls. Diagrammatically, demand curve, DD, as shown in the diagram shifts leftward, i.e., from DD to D1D1. The new equilibrium struck at point E1. The equilibrium price decreases from OP to OP1. Y
PRICE
D1
D S E
P
E1
P1
S
D D1
O
X
Q1 Q QUANTITY
14. Yes. Because supply may rise proportionately greater than the rise in demand. See diagram. Y
D1
D2 S1
PRICE
S2 P1 P2
D1 O
Introductory Microeconomics
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60
D2 X
Economics–XII
15. No. With a substantial cut in production, supply curve shifts to the left and equilibrium price will increase. See diagram. Y
PRICE
D
S1 S
P1 E
P S1
D
S O
Q1 Q QUANTITY
X
QUESTION SET-IV 1.
(i) large number of buyers and sellers (ii) homogeneous product (iii) freedom of entry and exit of firms.
2.
(i) single seller and large number of buyers (ii) no close substitutes.
3.
(i) large number of buyers and sellers (ii) product differentiation (iii) freedom of entry and exit of firms.
4.
(i) a few firms (ii) large number of buyers.
5. is a horizontal straight line parallel to X-axis. 6. monopoly. 7. in the long run. 8. equilibrium price. 9. increases. 10. to the left. 11.
(i) not a uniform price (ii) imperfect knowledge of market condition (iii) imperfect mobility of factors.
12.
(i) large number of buyers and sellers (ii) freedom of entry and exit of firms.
13. perfect competition. 14. monopoly. 15. increase.
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HOTS 1. True. Under perfect competition, demand curve of the firm is a horizontal straight line parallel to X-axis. It implies the firm will sell the product at the prevailing price which is determined by the industry. The individual firm cannot influence the price. Y
PRICE
Firm’s Demand Curve under Perfect Competition
P
O
AR=MR
Q2 Q1 OUTPUT
X
2. True. As a single seller he can fix whatever price he wishes to fix for his product. But he can sell more only by lowering the price of his product. 3. True. Firm’s demand curve is indeterminate under oligopoly because there is a high degree of interdependence between the firms. Price and output policy of one firm has a significant impact on the price and output policy of the rival firms in the market. When one firm lowers its price, the rival firms may also lower the price. And, when one firm raises the price, the rival firms may not do it. Accordingly, it becomes very difficult to estimate change in firm’s sales caused by a change in price. Implying that a precise relationship between price and sales cannot be established. Or, that the firm’s demand curve cannot be drawn. 4. True. In a situation of excess supply, supply is more than demand. Excess supply forces the market price to slide down to its equilibrium level. In a situation of excess demand, demand is more than supply. Shortage of supply shall push the price to its equilibrium level. 5. True. In a situation of constant demand or perfectly inelastic demand, increase or decrease in supply causes a full impact on price of the commodity but equilibrium quantity does not change. 6. True. A monopoly firm can make abnormal profits in the long run because of lack of freedom of entry and exit of firms in the market. Due to freedom of entry and exit of firms under monopolistic competition, a producer cannot earn abnormal profits in the long run. 7. True. Because under perfect competition AR = MR, while under monopoly AR > MR. While equilibrium in both cases is struck when MR = MC.
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NUMERICALS (With Solutions) Economics, Economy and Central Problems of an Economy
Sol. Ans. 2.
Sol.
3.
Sol. Ans. 4.
You have ` 1,000 as your pocket money. You can deposit this money in a bank and get ` 1,100 after an year. However, you have two other choices: (i) lend this money to your friend who is ready to pay you ` 1,050 after an year, or (ii) keep the money with you as cash in hand. What is opportunity cost of keeping the money as cash in hand? The opportunity cost of keeping the money as cash in hand is = ` 100 in terms the loss of interest that the bank would have paid. Opportunity cost = ` 100. Y If the slope of PPC remains constant (or does not change) with an increase in the production of Good-X (on horizontal axis) at the cost of Good-Y (on vertical axis), what is the shape of PPC? Draw the PPC. PPC in this case will be a downward sloping straight line touches X-axis and Y-axis. It happens when marginal opportunity cost (or marginal rate of transformation) is constant. See Fig. 1. Good-Y
1.
X
O Good-X An economy produces two goods: wheat and rice. These could be produced in only Figure 1 two combinations. Combination A: Wheat: 20,000 tonnes; Rice: 5,000 tonnes Combination B: Wheat: 10,000 tonnes; Rice: 9,000 tonnes What is the marginal opportunity cost of producing an extra tonne of rice at the cost of wheat. (Compare combination A with combination B.) Loss of wheat production 10,000 Marginal opportunity cost = = = 2.5. Gain of rice production 4,000
Marginal opportunity cost = 2.5. Calculate the marginal opportunity cost for the various combinations of Good-X and Good-Y in the following table: Combination
Good-X
Good-Y
A
0
95
B
10
85
C
20
73
D
30
58
E
40
41
F
50
22
G
60
0
Sol. Combination
Good-X
Good-Y
Marginal Opportunity Cost
A
0
95
—
B
10
85
10 =1 10
C
20
73
12 = 1.2 10
D
30
58
15 = 1.5 10
E
40
41
17 = 1.7 10
F
50
22
19 = 1.9 10
G
60
0
22 = 2.2 10
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5.
Draw PPC for the following PPC schedule. Also, calculate the marginal opportunity cost for different combinations: Combination
Rice (’000 tonnes)
Maize (’000 tonnes)
A
0
120
B
25
100
C
50
75
D
75
45
E
100
0
Sol. Combination
Rice (’000 tonnes)
Maize (’000 tonnes)
Marginal Opportunity Cost
A
0
120
—
B
25
100
20 = 0.8 25
C
50
75
25 =1 25
D
75
45
30 = 1.2 25
E
100
0
45 = 1.8 25
Production Possibility Curve (PPC) Y Maize (’000 tonnes)
120 A
B
100 80
C
60
D
40 20
E O
20
Figure 2 6. Sol.
Ans.
40
60
X
80 100
Rice (’000 tonnes)
Find opportunity cost when investment of ` 50,000 in the stock market, by way of withdrawal of demand deposit causes a loss of interest income of ` 5,000 per annum. Give logical reasoning. Opportunity cost of investment by way of withdrawal of demand deposit from the bank = ` 50,000 (the amount of funds withdrawn) + ` 5,000 (loss of interest income) = ` 55,000. Here, ` 50,000 is the explicit cost of investment and ` 5,000 is the implicit cost of investment. Opportunity cost is estimated as the total sacrifice involved in the act of investment. Opportunity cost = ` 55,000
Consumer’s Equilibrium—Utility Analysis 1.
The total utility schedule of individual ‘A’ is given below. Derive the marginal utility schedule. Units Consumed
0
1
2
3
4
5
Total Utility
0
15
27
38
48
55
Sol. Units Consumed
Total Utility
Marginal Utility
0
0
—
1
15
15
2
27
12
3
38
11
4
48
10
5
55
7
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2.
Calculate total utility for the various units of commodity-X, given the following information: Units of Commodity-X
1
2
3
4
5
6
7
8
MUX (Utils)
20
16
12
9
8
3
0
–5
Sol.
3. Sol.
Units of Commodity-X
MUX (Utils)
TUX (Utils)
1
20
20
2
16
36
3
12
48
4
9
57
5
8
65
6
3
68
7
0
68
8
–5
63
When the consumer is in equilibrium, MU of commodity-X is 45 and price of commodity-X is ` 9. Calculate the marginal utility of money. (Assuming marginal utility of money for the consumer is constant in equilibrium.) PX = ` 9 and MUX = 45
MUX = MUM PX 45 = MUM 9 MUM = 5
At equilibrium, Or, Or, Ans. 4.
Sol.
Marginal utility of money (MUM) = 5. Following is the total utility schedule of Mr. X: Units of Commodity-X
1
2
3
4
5
6
7
TUX (Utils)
20
37
51
61
66
66
64
(i) Derive MU schedule. (ii) Find out the level of consumption at which Mr. X reaches the saturation point. (iii) How many units should the consumer purchase to maximise satisfaction when the price of the commodity is ` 5? (Assume that utility is expressed in utils and 1 util = ` 2). Give reasons for your answer. (i) Units of Commodity-X
TUX (Utils)
MUX (Utils)
1
20
20
2
37
17
3
51
14
4
61
10
5
66
5
6
66
0
7
64
–2
(ii) Saturation poiont is struck when TU stops increasing even when consumption of the commodity is increased. In the present case, the saturation point is reached when 6 units of the commodity are consumed, as corresponding to the 6th unit, MU = 0. (iii) PX = ` 5 per unit, and MUM = 2 We know, equilibrium is struck when: MUX = MUM PX Introductory Microeconomics
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It happens when, MUX =2 5
5.
Or, when MUX = 10 Implying that the consumer purchases four units of the commodity-X to maximise satisfaction. Suppose, price of commodity-Y (PY) is ` 10 per unit. Also, assume that marginal utility of money (MUM) is 8 (and constant). Using the following marginal utility schedule of the consumer, find out equilibrium level of consumption and total expenditure on commodity-Y. Units Consumed Marginal Utility
Sol.
PY = ` 10 and MUM = 8 At equilibrium, Or,
Ans. 6.
1
2
3
4
5
6
170
130
110
80
30
0
MUY = MUM PY MUY =8 10
Or, MUY = 8 ´10 = 80 Implying that the consumer finds his equilibrium when he consumes four units of the commodity-Y. Total expenditure on commodity-Y at equilibrium level = 4 × 10 = ` 40. Equilibrium level of consumption = 4 units of commodity-Y. Total expenditure on commodity-Y = ` 40. Summit has ` 90 with him. He intends to purchase goods X and Y with his money. The market price of X and Y per unit is `10. The marginal utility schedule of goods X and Y is given below. Find out how many units of X and Y should Summit purchase so that he gets maximum satisfaction? Units of Commodity
MU of X
MU of Y
1
80
40
2
72
32
3
64
24
4
56
20
5
48
16
6
40
12
7
32
8
8
24
4
9
16
0
10
8
0
Sol. Equilibrium condition with respect to consumption of X and Y is that: MUX MUY = PX PY MUX PX Or, = MUY PY Here, PX = PY = `10, so that equilibrium would be struck when: MUX = MUY MUX 10 Or when, = =1 MUY 10
Ans.
It occurs when Summit purchases 7 units of X and 2 units of Y. Because at this combination, MUX (spending 7 × 10 = ` 70) = MUY (spending 2 × 10 = ` 20) = 32. Summit purchases 7 units of commodity-X and 2 units of commodity-Y.
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Theory of Demand 1. Sol. 2.
Suppose the price of a touch-screen mobile is ` 15,000. How would you expect its demand curve to be affected with a favourable shift in tastes and preferences of the consumers, price remaining unchanged? Demand curve of touch-screen mobile will shift to right due to the favourable shift in tastes and preferences of the consumers, price remaining unchanged. Following table represents the demand schedule of households, A, B and C. Derive market demand. Price (`)
Household A
Household B
Household C
8
6
12
22
7
7
13
23
6
8
14
24
5
9
15
25
4
10
16
26
Sol.
3.
Price (`)
Household A
Household B
Household C
Market Demand
8
6
12
22
40
7
7
13
23
43
6
8
14
24
46
5
9
15
25
49
4
10
16
26
52
Following table represents the market demand schedule and demand schedule of Ram, Sohan and Mohan: Price (`)
Ram
Sohan
Mohan
Market Demand
3
7
(i)
8
20
4
6
4
(ii)
16
5
4
3
3
(iii)
6
(iv)
2
1
5
(Assumption: Market includes three buyers.) Calculate the missing entries. Sol.
4.
Price (`)
Ram
Sohan
Mohan
Market Demand
3
7
5
8
20
4
6
4
6
16
5
4
3
3
10
6
2
2
1
5
Calculate the demand schedule of Raju, using following table. (Assuming market includes four buyers.) Price (`)
Ramesh
Raju
Rahim
Rina
Market Demand
5
19
—
7
6
32
4
20
—
10
9
44
3
21
—
12
11
51
2
22
—
14
15
61
1
23
—
18
19
74
Introductory Microeconomics
67
Economics–XII
Sol.
5.
Price (`)
Ramesh
Raju
Rahim
Rina
Market Demand
5
19
4
20
0
7
6
32
5
10
9
44
3
21
7
12
11
51
2
22
10
14
15
61
1
23
14
18
19
74
Individual demand schedules of Rakesh and Mohit for ice cream is given below. Derive market demand schedule for ice cream from the following: Price of Ice Cream (` per unit)
Demand of Rakesh (Units)
Demand of Mohit (Units)
10
1
2
9
2
3
8
3
4
7
4
5
6
5
6
Sol.
6.
Price of Ice Cream (` per unit)
Demand of Rakesh (Units)
Demand of Mohit (Units)
Market Demand (Units)
10
1
2
1+2=3
9
2
3
2 +3 = 5
8
3
4
3+4=7
7
4
5
4+5=9
6
5
6
5 + 6 = 11
Given below are the individual demand schedules of Maggi and Pasta. Derive market demand schedule and market demand curve (assuming market includes two buyers, Maggi and Pasta) from the following: Price (` per unit)
Maggi (Units)
Pasta (Units)
5
4
6
4
5
7
3
6
8
2
7
9
1
8
10
Sol. Price (` per unit)
Maggi (Units)
Pasta (Units)
Market Demand (Units)
5
4
6
10
4
5
7
12
3
6
8
14
2
7
9
16
1
8
10
18
Market Demand Curve
Y
Price (`)
5 4 3 2 1
O
4
8
12
16
20
X
Quantity (units)
Figure 3 Introductory Microeconomics
68
Economics–XII
Price Elasticity of Demand 1.
Find out elasticity of demand given the following information:
Sol.
Price per unit (`)
Quantity Demanded (kg)
10
20
9
25
Ed = (–)
P DQ ´ Q DP
P = ` 10; P1 = ` 9; DP = P1 – P = ` 9 – ` 10 = (–) ` 1 Q = 20 kg; Q1 = 25 kg; DQ = Q1 – Q = (25 – 20) kg = 5 kg 10 5 Ed = (–) ´ = 2.5 20 – 1 Ans. 2.
Elasticity of demand (Ed) = 2.5. A consumer purchased 10 units of a commodity when its price was ` 5 per unit. He purchased 12 units of the commodity when its price falls to ` 4 per unit. What is the price elasticity of demand for the commodity at that price? P DQ Sol. Ed = (–) ´ Q DP P = ` 5; P1 = ` 4; DP = P1 – P = ` 4 - ` 5 = (–) ` 1 Q = 10 units; Q1 = 12 units; DQ = Q1 – Q = (12 – 10) units = 2 units 5 2 Ed = (–) ´ = 1 (unity) 10 – 1
Ans. 3.
Elasticity of demand (Ed) is unity (= 1), or unitary elasticity of demand. As a result of 10 per cent fall in price of a good, its demand rises from 100 units to 120 units. Find out the price elasticity of demand. Sol. Percentage change in price = (–)10% DQ 120 - 100 Percentage change in quantity demanded = ´ 100 = ´ 100 Q 100 20 = ´ 100 = 20% 100 Percentage change in quantity demanded Price elasticity of demand (Ed) = (–) Percentage change in price 20% = (–) =2 -10% Ans. Price elasticity of demand = 2 (greater than unity). 4. A certain quantity of the commodity is purchased when its price is ` 10 per unit. Quantity demanded increases by 50 per cent in response to a fall in price by ` 2 per unit. Find elasticity of demand. Sol. Percentage change in quantity demanded = 50% -2 DP Percentage change in price = ´ 100 = ´ 100 = (–) 20% P 10 Percentage change in quantity demanded Elasticity of demand (Ed) = (–) Percentage change in price = (–)
Ans. 5. Sol.
50% = 2.5 – 20%
The elasticity of demand = 2.5. A consumer buys 80 units of a good at a price of ` 4 per unit. When the price falls, he buys 100 units. If price elasticity of demand is (–) 1, find out the new price. Elasticity of demand has been specified as – 1. Accordingly, we need not use ‘–’ sign as a prefix to the formula of measuring elasticity of demand. Thus, P DQ Ed = ´ Q DP
Introductory Microeconomics
69
Economics–XII
P = ` 4; P1 = ` X; DP = ` (X - 4) Q = 80 units; Q1 = 100 units; DQ = Q1 – Q = (100 – 80) units = 20 units Ed = (-) 1 Substituting given values: 4 20 1 ´ = 80 X - 4 X - 4 X–4=–1 X=–1+4 =3 (–) 1 =
Þ
Ans. 6. Sol.
Ans. 7. Sol.
New price = ` 3 per unit. When the price is ` 5 per unit a consumer buys 40 units of a commodity and his price elasticity of demand is (–) 1.5. How much will he buy if the price is reduced to ` 4 per unit? Q -Q P Ed = 1 ´ = (–) 1.5 P1 - P Q Substituting given values: Q 1 - 40 5 = – 1.5 ´ 4 -5 40 Q 1 - 40 1 ´ = – 1.5 -1 8 Q 1 - 40 = – 1.5 -8 Q1 – 40 = 12 Q1 = 12 + 40 = 52 The consumer will buy 52 units of the commodity when price reduces to ` 4 per unit. Price elasticity of demand of a good is (–) 1. At a price the consumer buys 60 units of the good. How many units will the consumer buy if the price falls by 10 per cent? Percentage change in quantity demanded Elasticity of demand (Ed) = (–) Percentage change in price Percentage change in quantity demanded (–) 1 = (–)10% Percentage change in quantity demanded = 10 DQ Þ ´ 100 = 10 Q DQ Þ ´ 100 = 10 60 Þ DQ = 6 New quantity = Q + DQ = 60 + 6 = 66
Ans. 8. Sol.
Ans.
New quantity = 66 units. At a given market price of a good a consumer buys 120 units. When price falls by 50 per cent he buys 150 units. Calculate price elasticity of demand. Percentage change in price = (–) 50% DQ 150 - 120 Percentage change in demand = ´ 100 = ´ 100 = 25% Q 120 Percentage change in quantity demanded Price elasticity of demand (Ed) = (–) Percentage change in price 25% Ed = (–) = 0.5 – 50% Price elasticity of demand = 0.5.
Introductory Microeconomics
70
Economics–XII
9.
Price elasticity of demand is found to be (–) 2. Price falls from ` 10 per unit to ` 8 per unit. Find the percentage change in quantity demanded.
Sol.
P = ` 10; P1 = ` 8; DP = ` 8 – ` 10 = (–) ` 2 Ed = (–) 2 DP Percentage change in price = ´ 100 P –2 = ´ 100 = (–)20% 10 Percentage change in quantity demanded Price elasticity of demand (Ed) = Percentage change in price Percentage change in quantity demanded (–) 2 = –20% Percentage change in quantity demanded = (–)2 × (–)20 = 40 Percentage change in quantity demanded = 40%. A commodity shows Ed = (–) 2. Quantity demanded reduces from 300 units to 150 units in response to increase in price. Find the increased price when initially it was ` 20 per unit. Initial price (P) = ` 20
Ans. 10. Sol.
Q = 300 units; Q1 = 150 units; DQ = Q1 – Q = (150 – 300) units = (–) 150 units Ed = (–)2 P DQ Elasticity of demand (Ed) = ´ Q DP 20 –150 (–) 2 = ´ 300 DP –10 –2= Þ DP 10 DP = Þ 2 DP = 5 Þ P1 = P + DP = 20 + 5 = 25 Ans. 11.
Sol.
Ans.
Increased price = ` 25. DP For a commodity, = –02, . and elasticity of demand is – 0.5. Find quantity demanded after a fall in price when initially it P was 60 units. Initially, quantity demanded = 60 units DP = –02, . Ed = (–) 0.5 P P DQ Ed = ´ Q DP P DQ Or, Ed = ´ DP Q Substituting given values: 1 DQ (–) 0.5 = ´ –0.2 60 DQ (–) 0.5 = Þ –12 DQ = 6 Þ Q1 = Q + DQ = 60 + 6 = 66 New quantity = 66 units.
Introductory Microeconomics
71
Economics–XII
12. Sol.
Ans. 13. Sol.
A consumer buys 80 units of a good at a price of ` 5 per unit. Suppose price elasticity of demand is (–) 2. At what price will he buy 64 units? Supposing the new price = ` X. We know, P DQ Price elasticity of demand (Ed) = (–) ´ Q DP P = ` 5; P1 = ` X; DP = ` (X – 5) Q = 80 units; Q1 = 64 units; DQ = (64 – 80) units = – 16 units Ed = (–) 2 Substituting given values: 5 –16 (–) 2 = ´ 80 X - 5 -1 –2= 1 = 2(X – 5) Þ Þ X- 5 1 = 2X – 10 Þ 2X = 11 Þ 11 X = = 5.5 2 New price = ` 5.5. When price of the commodity reduces from ` 5 per unit to ` 4 per unit, expenditure on the commodity reduces from ` 60 to ` 48. Find price elasticity of demand. (Using Percentage Method): Total expenditure = ` 60, PX = ` 5
Total expenditure PX 60 = = 12 units 5 Total expenditure = ` 48, PX = ` 4 Total expenditure QX = PX 48 = = 12 units 4 Thus, there is no change in quantity demanded even when price has reduced from ` 5 to ` 4 per unit. Hence, Ed = zero. Ed = 0 (zero). When price of a good rises from ` 5 per unit to ` 6 per unit, its demand falls from 20 units to 10 units. Compare expenditures on the good to determine whether demand is elastic or inelastic. QX =
Ans. 14. Sol.
Price (`)
Quantity Demanded (Units)
Total Expenditure (`)
5
20
100
6
10
60
Here, total expenditure decreases with rise in price, hence elasticity of demand is more than unity. It is a situation of elastic demand. Ans. 15.
Demand is elastic. When price of a good falls from ` 10 per unit to ` 9 per unit, its demand rises from 9 units to 10 units. Compare expenditures on the good to find price elasticity of demand.
Sol. Price (`)
Quantity Demanded (Units)
Total Expenditure (`)
10
9
90
9
10
90
Since, total expenditure remains constant, elasticity of demand is equal to unity. Ans.
Price elasticity of demand = 1.
Introductory Microeconomics
72
Economics–XII
Production Function and Returns to a Factor 1.
Calculate the average and marginal product from the following: Units of Labour
1
2
3
4
5
Total Product
18
38
50
60
72
Sol.
2.
Units of Labour
Total Product
Average Product
Marginal Product
1
18
18
18
2
38
19
20
3
50
16.67
12
4
60
15
10
5
72
14.4
12
Calculate the total and marginal product from the following: Units of Labour
1
2
3
4
5
Average Product
4
5
5
4
3
Sol.
3.
Units of Labour
Average Product
Total Product
Marginal Product
1
4
4
4
2
5
10
6
3
5
15
5
4
4
16
1
5
3
15
–1
Units of Labour
Total Product
Average Product
Marginal Product
1
40
—
—
2
—
—
60
3
—
—
50
4
180
—
—
5
—
36
—
6
—
—
–18
Units of Labour
Total Product
Average Product
Marginal Product
1
40
40
40
2
100
50
60
3
150
50
50
4
180
45
30
5
180
36
0
6
162
27
–18
Complete the following table:
Sol.
Introductory Microeconomics
73
Economics–XII
4.
Complete the following table: Input (Units)
Total Product
Average Product
1
20
—
Marginal Product —
2
—
—
18
3
—
—
16
4
—
—
14
5
—
—
12
6
—
—
10
Input (Units)
Total Product
Average Product
Marginal Product
1
20
20
20
2
38
19
18
3
54
18
16
4
68
17
14
5
80
16
12
6
90
15
10
Sol.
5. Following is known about a firm: Units of Labour (Input)
1
2
3
4
5
6
Total Output
50
110
150
180
180
150
State and explain the law underlying the change in output as input is changed. Also identify the various stages (or phases) in total product. Sol.
6.
Units of Labour
TP
AP
MP
Phases/Stages
1
50
50
50
2
110
55
60
Phase/Stage-I Increasing returns up to 2nd unit of labour employment. Here, MP increases.
3
150
50
40
4
180
45
30
5
180
36
0
6
150
25
30
Phase/Stage–II Diminishing returns between 2nd to 5th unit of labour employment. Here, MP diminishes. Phase/Stage–III Negative returns beyond 5th unit of labour employment. Here, TP diminishes and MP is negative.
Identify the different output levels which makes the different phases/stages of the operation of the law of variable proportions from the following data: Variable Input
0
1
2
3
4
5
Total Product
0
8
20
28
28
26
Sol. Variable Input
Total Product
Marginal Product
Phases/Stages
0
0
0
1
8
8
Phase/Stage-I Increasing returns to a factor; MP increases.
2
20
12
3
28
8
4
28
0
5
26
–2
Introductory Microeconomics
74
Phase/Stage-II Diminishing returns to a factor; MP diminishes. Phase/Stage-II Negative returns to a factor; MP turns negative. TP diminishes.
Economics–XII
Concepts of Cost 1.
From the following data on the cost of production of a firm calculate TFC, AFC, TVC, AVC and MC: Output (kg)
0
1
2
3
4
5
6
TC ( `)
60
80
100
111
116
130
150
Sol.
2.
Output (kg)
TC (`)
TFC (`)
AFC (`)
TVC (`)
AVC (`)
MC (`)
0
60
60
¥
—
—
—
1
80
60
60
20
20
20
2
100
60
30
40
20
20
3
111
60
20
51
17
11
4
116
60
15
56
14
5
5
130
60
12
70
14
14
6
150
60
10
90
15
20
From the following data regarding cost of a firm, calculate: (i) average fixed cost, and (ii) average variable cost. Output (Units)
0
1
2
3
4
5
6
Total Cost ( `)
60
78
90
102
112
120
126
Sol.
3.
Output (Units)
Total Cost (`)
Total Fixed Cost (`)
Average Fixed Cost (`)
Total Variable Cost (`)
Average Variable Cost (`)
0
60
60
¥
—
—
1
78
60
60
18
18
2
90
60
30
30
15
3
102
60
20
42
14
4
112
60
15
52
13
5
120
60
12
60
12
6
126
60
10
66
11
Calculate TVC and AVC with the help of the following data: Output (Units)
1
2
3
MC (`)
20
16
12
Sol.
4.
Output (Units)
MC (`)
TVC (`)
AVC (`)
1
20
20
20
2
16
36
18
3
12
48
16
Calculate ‘total variable cost’ and ‘total cost’ from the following cost schedule of a firm whose fixed costs are ` 10. Output (Units)
1
2
3
4
Marginal Cost (`)
6
5
4
6
Introductory Microeconomics
75
Economics–XII
Sol. Output (Units)
5.
Marginal Cost (`)
Total Fixed Cost (`)
Total Variable Cost (`)
Total Cost (`)
1
6
10
6
16
2
5
10
11
21
3
4
10
15
25
4
6
10
21
31
From the following data on the cost of production of a firm calculate (i) average fixed cost, and (ii) average variable cost of producing four units and the marginal cost of the fourth unit: Output (kg)
0
1
2
3
4
Total Cost (`)
80
102
122
140
156
Sol. Output
6.
(kg)
Total Cost (`)
Total Fixed Cost (`)
Average Fixed Cost (`)
Total Variable Cost (`)
Average Variable Cost (`)
Marginal Cost (`)
0
80
80
¥
0
—
—
1
102
80
80
22
22
2
122
80
40
42
21
3
140
80
26.6
60
20
4
156
80
20
76
22 20 18 16
19
From the following table, calculate average variable cost of each given level of output: Output (Units)
1
2
3
4
Marginal Cost (`)
40
30
35
39
Sol.
7.
Output (Units)
Marginal Cost (`)
Total Variable Cost (`)
Average Variable æ TVC ö ÷ (`) Cost çç = Q ÷ø è
1
40
40
40 = 40 1
2
30
70
70 = 35 2
3
35
105
105 = 35 3
4
39
144
144 = 36 4
Complete the following table: Output (Units)
Total Cost (`)
Average Fixed Cost (`)
1
20
6
2
26
3
3
39
2
Average Cost (`)
Variable Cost (`)
Sol. Output (Units)
Total Cost (`)
Average Fixed Cost (`)
Average Cost (`)
Total Fixed Cost (`)
Variable Cost (`)
1
20
6
20
6
14
2
26
3
13
6
20
3
39
2
13
6
33
Introductory Microeconomics
76
Economics–XII
8.
Complete the following table: Output (Units)
Total Variable Cost (`)
Average Variable Cost (`)
Marginal Cost (`)
1
20
—
—
—
—
16
12
3
54
—
—
—
—
20
26
Sol. Output (Units)
Total Variable Cost (`)
Average Variable Cost (`)
Marginal Cost (`)
1
20
20
20
2
32
16
12
3
54
18
22
4
80
20
26
Concept of Revenue 1.
Find out total revenue, average revenue and marginal revenue: Price (`)
1
2
3
4
5
6
7
Demand (Units)
10
9
8
7
6
5
4
Sol.
2.
Price (`)
Demand (Units)
Total Revenue (`)
Average Revenue (`)
Marginal Revenue (`)
1
10
10
1
10
2
9
18
2
8
3
8
24
3
6
4
7
28
4
4
5
6
30
5
2
6
5
30
6
0
7
4
28
7
–2
From the table given below, calculate total revenue and marginal revenue: Units Sold
Average Revenue (`)
Total Revenue (`)
Marginal Revenue (`)
3
8
4
7
5
6
Units Sold
Average Revenue = Price (`)
Total Revenue (`)
Marginal Revenue (`)
3
8
24
—
4
7
28
4
5
6
30
2
Sol.
[Hint: Average Revenue = Price.] Introductory Microeconomics
77
Economics–XII
3.
Find average revenue and marginal revenue from the following data: Units Sold
Total Revenue (`)
Average Revenue (`)
Marginal Revenue (`)
1
10
2
24
3
33
4
40
5
40
6
36
7
28
Units Sold
Total Revenue (`)
Average Revenue (`)
Marginal Revenue (`)
1
10
10
10
2
24
12
14
3
33
11
9
4
40
10
7
5
40
8
0
6
36
6
–4
7
28
4
–8
Sol.
4.
Find marginal revenue on the basis of the following data: Units Sold
Total Revenue (`)
Marginal Revenue (`)
1
10
2
18
3
24
4
28
5
30
Units Sold
Total Revenue (`)
Marginal Revenue (`)
1
10
10
2
18
8
Sol.
5.
3
24
6
4
28
4
5
30
2
Complete the following table: Output (Units)
Price (`)
Total Revenue (`)
Marginal Revenue (`)
1
7
—
—
2
6
—
—
3
4
—
—
4
2
—
—
Output (Units)
Price (`)
Total Revenue (`)
Marginal Revenue (`)
Sol.
1
7
7
7
2
6
12
5
3
4
12
0
4
2
8
–4
Introductory Microeconomics
78
Economics–XII
6.
Complete the following table: Output (Units)
Total Revenue (`)
Marginal Revenue (`)
Average Revenue (`)
1
14
¾
¾
2
24
¾
¾
3
24
¾
¾
4
16
¾
¾
Output (Units)
Total Revenue (`)
Marginal Revenue (`)
Average Revenue (`)
Sol.
7.
1
14
14
14
2
24
10
12
3
24
0
8
4
16
–8
4
Output (Units)
Marginal Revenue (`)
Total Revenue (`)
Average Revenue (`)
1
10
—
—
2
8
—
—
3
0
—
—
4
–2
—
—
Output (Units)
Marginal Revenue (`)
Total Revenue (`)
Average Revenue (`)
1
10
10
10
2
8
18
9
3
0
18
6
4
–2
16
4
Units Sold
Total Revenue (`)
Average Revenue (`)
Marginal Revenue (`)
1
20
—
—
2
—
18
—
Complete the following table:
Sol.
8.
Complete the following table:
3
—
—
12
4
56
—
—
5
—
—
4
6
—
—
0
Units Sold
Total Revenue (`)
Average Revenue (`)
Marginal Revenue (`)
1
20
20
20
2
36
18
16
3
48
16
12
4
56
14
8
5
60
12
4
6
60
10
0
Sol.
Introductory Microeconomics
79
Economics–XII
Producer’s Equilibrium 1. Sol.
Find out profit of the producer, when total revenue is ` 400, total variable cost is ` 270, average fixed cost is ` 25 per unit and 4 units of output are produced. Total Revenue = ` 400 Total Variable Cost = ` 270 Average Fixed Cost = ` 25 Total Fixed Cost = AFC ´ Output = ` 25 ´ 4 = ` 100 Total Cost = Total Fixed Cost + Total Variable Cost = ` 100 + ` 270 = ` 370 Profit = Total Revenue – Total Cost = ` 400 – ` 370 = ` 30
Ans. 2.
Profit = ` 30. Calculate the profit from the following: Output (Units)
Marginal Revenue (`)
Total Cost (`)
1
7
8
2
5
10
3
4
12
4
2
15
5
1
16
Sol.
3.
Output (Units)
Marginal Revenue (`)
Total Cost (`)
Total Revenue (`)
Profit (p = TR – TC) (`)
1
7
8
7
–1
2
5
10
12
2
3
4
12
16
4
4
2
15
18
3
5
1
16
19
3
Complete the following table: Output (Units)
Total Revenue (`)
Total Cost (`)
Profit (`)
1
6
8
—
2
—
9
–1
3
10
—
0
4
12
11
—
5
14
8
—
Output (Units)
Total Revenue (`)
Total Cost (`)
Profit (`)
1
6
8
–2
2
8
9
–1
3
10
10
0
4
12
11
1
5
14
8
6
Sol.
Introductory Microeconomics
80
Economics–XII
4.
Find the profit maximising level of output. Quantity Sold (Units)
Total Revenue (`)
Marginal Cost (`)
1
14
15
2
30
12
3
44
9
4
48
5
5
52
6
Sol. Quantity Sold (Units)
Total Revenue (`)
Marginal Cost (`)
Total Variable Cost (`)
Profit (p = TR – TVC) (`)
1
14
15
15
–1
2
30
12
27
3
3
44
9
36
8
4
48
5
41
7
5
52
6
47
5
Profit is maximised when the output level = 3 units.
5.
[Note: Profit is maximised at that level of output where the difference between TR and TC is maximised, or where the difference between TR and TVC is maximised, because fixed cost, by defination, remains constant.] Find producer’s equilibrium from the following table given below: Quantity Sold (Units)
Total Revenue (`)
Marginal Cost (`)
1
9
15
2
18
8
3
27
9
4
36
10
5
45
11
Sol.
6.
Quantity Sold (Units)
Total Revenue (`)
Marginal Cost (`)
Marginal Revenue (`)
1
9
15
9
2
18
8
9
3
27
9
9
4
36
10
9
5
45
11
9
The producer will strike his equilibrium when 3 units of output are produced. Because, it is here that: (i) MR = MC, and (ii) MC is rising. Given below is a cost and revenue schedule of a producer. At what level of output is the producer in equilibrium? Give reasons for your answer. Quantity Sold (Units)
Price (` per unit)
Total Cost (`)
1
15
14
2
16
24
3
17
30
4
18
51
5
19
75
Introductory Microeconomics
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Economics–XII
Sol. Quantity Sold (Units)
Price (` per unit)
TC (`)
TR (`)
MR (`)
MC (`)
Profit (p = TR – TC) (`)
1
15
14
15
2
16
24
32
15
14
1
17
10
8
3
17
30
51
19
6
21
4
18
51
72
21
21
21
5
19
75
95
23
24
20
Producer is in equilibrium when the level of output = 4 units. Reason: At output levels 3rd and 4th unit, the difference between total revenue and total cost (i.e., profit) is maximum which is equal to 21 in both the cases. But, producer is in equilibrium at 4th unit only where MR = MC (= 21).
Theory of Supply 1. Sol.
Price of a commodity increases from ` 10 to ` 12. As a result, its supply rises from 35 units to 42 units. Find out elasticity of supply. P = ` 10; P1 = ` 12; DP = P1 – P = ` 12 - ` 10 = ` 2 Q = 35 units; Q1= 42 units; DQ = Q1 – Q = (42 – 35) units = 7 units P DQ Elasticity of supply (Es) = ´ Q DP 10 7 Es = ´ = 1 (unity) 35 2
Ans. 2.
Elasticity of supply = 1. As a result of 15 per cent rise in the price of a commodity, its supply increases from 25 to 30 units. Calculate elasticity of supply.
Sol.
Percentage rise in price = 15% Q = 25 units; Q1 = 30 units; DQ = Q1 – Q = (30 – 25) units = 5 units DQ 5 Percentage rise in quantity supplied = ´ 100 = ´ 100 = 20% Q 25 Percentage change in quantity supplied Elasticity of supply (Es) = Percentage change in price =
20% = 1.33 15%
Ans. 3.
Elasticity of supply is 1.33. The price of a commodity is ` 12 per unit and its quantity supplied is 500 units. When its price rises to ` 15 per unit, its quantity supplied rises to 650 units. Calculate its price elasticity of supply. Is supply elastic?
Sol.
P = ` 12; P1 = ` 15; DP = P1 – P = ` 15 - ` 12 = ` 3 Q = 500 units; Q1= 650 units; DQ = Q1 – Q = (650 – 500) units = 150 units P DQ Price elasticity of supply (Es) = ´ Q DP 12 150 = 1.2 = ´ 500 3
Ans. 4. Sol.
Price elasticity of supply = 1.2; elastic supply. Price elasticity of supply for a product is ‘unity’. A firm supplies 25 units of this product at a price of ` 5 per unit. If the price of product rises to ` 6 per unit, how much quantity of the product will be supplied by the firm? Let the seller supply X units. P = ` 5; P1 = ` 6; DP = P1 – P = ` 6 - ` 5 = ` 1 Q = 25 units; Q1 = X units; DQ = Q1 – Q = (X – 25) units Es = 1
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P DQ ´ Q DP 5 X - 25 1= ´ 25 1 X – 25 = 5 X = 25 + 5 = 30
Price elasticity of supply (Es) =
Þ
Þ 1=
X - 25 5
Ans. 5.
The seller will supply 30 units. When the price of a commodity falls from `10 per unit to ` 9 per unit, its quantity supplied falls by 20 per cent. Calculate its price elasticity of supply. Is its supply elastic?
Sol.
Percentage fall in quantity supplied = (–) 20% P = ` 10; P1 = ` 9; DP = P1 – P = ` 9 - ` 10 = (–) ` 1 DP –1 Percentage fall in price = ´ 100 = ´ 100 P 10 = (–)10% Percentage change in quantity supplied Price elasticity of supply (Es) = Percentage change in price =
Ans. 6. Sol.
–20% =2 –10%
Price elasticity of supply = 2; supply is elastic. The quantity supplied of a commodity at a price of ` 8 per unit is 400 units. Its price elasticity of supply is 2. Calculate the price at which its quantity supplied will be 600 units. Let the new price be ` P1 P = ` 8; P1 = ` P1; DP = ` (P1 – 8) Q = 400 units; Q1= 600 units; DQ = Q1 – Q = (600 - 400) units = 200 units Es = 2
P DQ ´ Q DP 8 200 2= ´ 400 P1 - 8 4 2= P1 - 8
Price elasticity of supply (Es) = Þ Þ Þ
Ans. 7. Sol.
2(P1 - 8) = 4 2P1 - 16 = 4 2P1 = 4 +16 = 20 P1 = 10
New price = ` 10. When the price of a commodity rises from ` 10 to ` 11 per unit, its quantity supplied rises by 100 units. Its price elasticity of supply is 2. Calculate its quantity supplied at the increased price. P DQ Es = ´ Q DP P = ™ 10; P1= ™ 11; DP = P1 – P = ` 11 - ` 10 = ` 1 Q = M units; Q1= (M + 100) units; DQ = 100 units Es = 2 Substituting given values: 10 100 2= ´ M 1 Þ
Introductory Microeconomics
2M = 1,000
83
Economics–XII
Þ
Ans. 8. Sol.
1000 , = 500 2 Q1 = 500 + 100 = 600 M=
Quantity supplied at increased price is 600 units. The price elasticity of supply of a commodity is 2. When its price falls from ` 10 to ` 8 per unit, its quantity supplied falls by 500 units. Calculate the quantity supplied at the reduced price. P DQ Es = ´ Q DP P = ™ 10; P1= ™ 8; DP = P1 – P = ` 8 - ` 10 = (–) ` 2 Q = X units; Q1= (X – 500) units; DQ = (–) 500 units Es = 2 Substituting given values: 10 –500 2= ´ X –2 2,500 2= Þ 2X = 2,500 Þ X 2,500 X= = 1,250 Þ 2 Q1 = 1,250 – 500 = 750
Ans. 9. Sol.
Quantity supplied at reduced price is 750 units. DP = 0.6, find the percentage change in quantity supplied. For a commodity, if Es = 1.4 and P DP = 0.6 Es = 1.4 and P DP Percentage change in price = ´ 100 = 0.6 ´ 100 = 60 P Percentage change in quantity supplied Elasticity of supply (Es) = Percentage change in price 1.4 =
Percentage change in quantity supplied 60%
Percentage change in quantity supplied = 1.4 × 60 = 84 Ans. 10. Sol.
Percentage change in quantity supplied = 84%. The market price of a good changes from ` 5 to ` 20. As a result, the quantity supplied by the firm increases by 15 units. The price elasticity of supply is 0.5. Find the initial and final output levels of the firm. P DQ Es = ´ Q DP P = ™ 5; P1= ™ 20; DP = P1 – P = ` 20 - ` 5 = ` 15 Q = X units; Q1= (X + 15) units; DQ = 15 units Es = 0.5 Substituting given values: 5 15 0.5 = ´ X 15 5 0.5 = Þ Þ 0.5X = 5 X 5 X= = 10 Þ 05 . X1 = 10 + 15 = 25
Ans.
Initial output = 10 units. Final output = 25 units.
Introductory Microeconomics
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Economics–XII
CBSE Question Papers–2012 (Delhi, All India & Foreign)
Introductory Microeconomics
Economics–XII
85
Introductory Microeconomics
CBSE QUESTION PAPERS–2012 INTRODUCTORY MICROECONOMICS
1 MARK QUESTIONS 1. Give meaning of an economy. Ans. Economy is the sum total of economic activities directed towards the satisfaction of unlimited wants using the scarce means. 2. What is market demand? Ans. Market demand is the total demand by all buyers of a commodity in the market. 3. What is the behaviour of average fixed cost as output increases? Ans. Average fixed cost continuously decreases as output increases. 4. What is the behaviour of average revenue in a market in which a firm can sell more only by lowering the price? Ans. Average revenue continuously decreases in such a market in which a firm can sell more only by lowering the price. 5. What is a price taker firm? Ans. A price taker firm means that it has to accept the price as determined by the forces of market demand and market supply. 6. Define microeconomics. Ans. Microeconomics studies economic issues or economic problems at the level of an individual–an individual firm, an individual household or an individual consumer. 7. Give one reason for a shift in demand curve. Ans. Change in income of the consumer causes shift in demand curve. 8. What is the behaviour of total variable cost, as output increases? Ans. Initially, total variable cost increases at decreasing rate and eventually it increasing at an increasing rate. 9. What is the behaviour of marginal revenue in a market in which a firm can sell any quantity of the output it produces at a given price? Ans. Marginal revenue is constant at all levels of output in such a market in which a firm can sell any quantity of the output at a given price. 10. What is a price-maker firm? Ans. A price-maker firm refers to that firm which has complete control over price of the product in the market. 11. Define macroeconomics. Ans. Macroeconomics studies economic issues or economic problems at the level of the economy as a whole. 12. What does an indifference curve show? Ans. An indifference curve shows different combinations of two commodities between which a consumer is indifferent. 13. Define marginal cost. Ans. Marginal cost is the addition to total cost when a unit more of output is produced.
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14. What is the behaviour of average revenue in a market in which a firm can sell any quantity of a good at a given price? Ans. Average revenue is constant at all levels of output in a market in which a firm can sell any quantity of a good at a given price. 15. Define oligopoly. Ans. Oligopoly is a form of the market in which there are a few big sellers of a commodity and a large number of buyers.
3 MARKS QUESTIONS 1. What is opportunity cost? Explain with the help of a numerical example. Or What is opportunity cost? Explain with the help of an example. Ans. Opportunity cost is the value of a factor in its next best alternative use. Example: If Mr. X has three options of employment: A with ` 5,000 p.m., B with ` 6,000 p.m., C with ` 7,000 p.m. then Mr. X should be choosing the best option (C) of ` 7,000 p.m. and its opportunity cost would be ` 6,000 p.m. 2. Given price of a good, how does a consumer decide as to how much of that good to buy? Ans. Given price of a good, consumer purchases that much of the commodity where rupee worth of æ MU X ö additional satisfaction çç ÷÷ from the consumption of a unit more of a good is equal to marginal è PX ø utility of money (MUM ) for the consumer. So that, in a state of equilibrium: MU X = MUM PX Y
3. Draw average variable cost, average total cost and marginal cost curves in a single diagram.
ATC AVC
Cost
Ans. Fig. 1 shows average total cost (ATC), average variable cost (AVC) and marginal cost (MC). All the three curves are U shaped. Also, MC curve must cut both ATC and AVC from their lowest points (A & B in the diagram).
MC
B
A
O
Q
Figure 1
Q1 Output
X
4. An individual is both the owner and the manager of a shop taken on rent. Identify implicit cost and explicit cost from this information. Explain. Ans. As a manager, the owner is rendering his own services. Managerial services are not hired from the market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Rent paid of a shop is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market. 5. Explain the implication of large number of buyers in a perfectly competitive market. Or Explain why are firms mutually interdependent in an oligopoly market. Ans. The number of buyers of a commodity is very large under perfect competition. It is so large that by varying his purchase, an individual buyer cannot affect total market demand for a commodity. Accordingly, an individual buyer cannot affect market price. He can buy any quantity at the existing price of the commodity. An individual buyer is a price taker. Introductory Microeconomics
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Or In an oligopoly market, there is a small number of big firms. Accordingly, there is a high degree of mutual interdependence. Implying that, price and output policy of one firm has a significant impact on the price and output policy of the rival firms in the market. When one firm lowers its price, the rival firms may also lower the price. And, when one firm raises the price, the rival firms may not do so. It is because of this interdependence that it becomes very difficult to estimate change in firm’s sales caused by a change in price. Implying that a precise relationship between price and sales cannot be established. Or, that the firm’s demand curve cannot be drawn. 6. What is ‘marginal rate of transformation’? Explain with the help of an example. Or Explain the concept of marginal rate of transformation with the help of an example. Ans. Marginal rate of transformation is the rate at which output of Good-Y is to be sacrificed to produce a unit more of Good-X when the given resources are fully and efficiently utilised in the production of goods X and Y, and the technology remains constant. It refers to the slope of PPC (production possibility curve). It is also called opportunity cost of producing a unit more of Good-X. Example:
Output of Y 10 7
Output of X 10 11
When some resources are shifted from Use-Y to Use-X, there is a loss of output of 3 units of Y for a unit DY 3 more of Good-X. MRT = = = 3. [Here, DY refers to loss of output of Good-Y and DX refers to DX 1 gain of output of Good-X.] 7. A producer borrows money and opens a shop. The shop premises is owned by him. Identify the implicit and explicit costs from this information. Explain. Ans. Imputed rent of owner’s self-owned shop is implicit cost because implicit costs are incurred on the use of self-owned factors/inputs. Interest paid on the borrowed money is explicit cost because it is the expense incurred by the producer for borrowing money from the market. 8. State reasons why does an economic problem arise. Ans. Economic problem is a problem related to the allocation of resources (or problem of choice). It arises due to the following reasons: (i) Unlimited Wants: Human wants are unlimited. (ii) Limited or Scarce Means: Resources are scarce in relation to human wants. (iii) Alternative Uses: Resources have alternative uses. Land, for example, may be used to produce rice or wheat or it may be used for the construction of buildings. 9. A producer invests his own savings in starting a business and employs a manager to look after it. Identify implicit and explicit costs from this information. Explain. Ans. Imputed interest of owner’s self-owned savings is implicit cost because implicit costs are incurred on the use of self-owned factors/inputs. Salary paid to a manager to look after the business is explicit cost because it is the expense incurred by the producer for hiring the services of the manager from the market. 10. Define production possibilities curve. Explain why it is downward sloping from left to right. Ans. Production possibility curve (also called production possibility frontier) is a curve showing different combinations of two goods, which can be produced with the given resources and technique of production. It is also assumed that the given resources are efficiently utilised. The production possibility curve slopes downward from left to right. This is because (owing to fuller and efficient utilisation of the given resources, as well as given technology) output of Good-X can be increased only by sacrificing some output of Good-Y. Introductory Microeconomics
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11. A consumer consumes only two goods X and Y and is in equilibrium. Price of X falls. Explain the reaction of the consumer through the utility analysis. Ans. In a situation of equilibrium in case of two commodities: MU X MU Y = PX PY MU X MU Y . Implying that rupee worth of satisfaction is greater for X than Y. When PX falls, > PX PY Accordingly, the consumer will start buying more of X in place of Y. When consumption of X increases, MU X MUX must fall, while a cut in consumption of Y would mean a rise in MUY. Accordingly, will PX MU Y start falling while will start rising. The consumer will stop buying more of X (in place of Y) only PY MU X MU Y = . when PX PY Briefly, when PX falls, more of X will be purchased in place of Y. Y 80
TC
70
TVC
60
Cost (™)
12. Draw total variable cost, total cost, and total fixed cost curves in a single diagram. Ans. Fig. 2 shows total cost (TC), total variable cost (TVC) and total fixed cost (TFC). Total cost is the sum of total variable cost and total fixed cost. So TC curve is the vertical summation of TFC and TVC curves.
50 40 30 20
TFC
10
O
Figure 2
1
2
3
4
5
6
7
8
X
Output
Note: TC is parallel to TVC because TFC is constant.
13. A producer starts a business by investing his own savings and hiring the labour. Identify implicit and explicit costs from this information. Explain. Ans. Implicit costs are incurred on the use of self-owned factors/inputs. Accordingly, interest foregone by the producer on account of the use of his own savings is the implicit cost of production. Explicit cost is incurred when inputs are hired/purchased from the market. Thus, cost of hiring labour (wages) is an explicit cost of production. 14. Explain the implications of large number of sellers in a perfectly competitive market. Or Explain why there are only a few firms in an oligopoly market. Ans. The number of sellers of a commodity is very large under perfect competition. The number of firms selling a particular commodity is so large that an individual seller contributes only a small fragment to the market supply. Thus, any increase or decrease in supply by an individual firm hardly impacts the total market supply and consequently, an individual firm cannot impact price of the commodity. Or By definition, oligopoly is a form of the market in which there is a small number of big firms. Each firm is so big that it controls a significant segment of the market. Example: Firms producing cars in India. Why only a few firms? Because, (i) Production requires huge capital investment, that deters the entry of new firms. Introductory Microeconomics
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(ii) Technology used in production is so distinct that it is difficult for an ordinary firm to acquire it. (iii) The firms often form trusts and cartels, converting the market almost into a monopoly market, which becomes impregnable for the small firms. (iv) The firms often get patent rights for their products, and their branded products happen to achieve consumer’s loyalty over time. This keeps the new firms at bay. (v) The firms happen to achieve control over strategic inputs, making it difficult for the new firms to enter the market. (vi) Owing to their large scale production and economies of scale, the existing firms start incurring so much of advertisement expenditure that the entry of new firms virtually becomes impossible. 15. Explain the central problem of ‘how to produce’. Ans. The problem of how to produce is a problem relating to choice of technology. It is a central problem because no economy can ever escape it. Broadly, it is the problem of deciding input ratio of different factor inputs and efficient use of resources. There are two techniques of production: (i) Labour intensive technique in which labour is used more than capital, and (ii) Capital intensive technique in which capital is used more than labour. Optimum technology is the one that maximises productivity (output per unit of input) or minimises cost of production. 16. A farmer takes a farm on rent and carries on farming with the help of family members. Identify explicit and implicit costs from this information. Explain. Ans. The farmer is using the services of his family members for farming. Farming services are not hired or purchased from the market. So, these services involve an implicit cost. Because, working outside the family farm, the family members would have earned some wages. The wages foregone are the implicit costs. Rent paid of a farm taken on rent is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market. 17. A producer borrows money and starts a business. He himself looks after the business. Identify implicit and explicit costs from this information. Explain. Or A producer borrows money to start a business and looks after the business himself. Identify the implicit and explicit costs from this information. Explain. Ans. As a manager, the owner is rendering his own services. Managerial services are not hired from the market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Interest paid on borrowed money is explicit cost because it is the expense incurred by the producer for borrowing money from the market. 18. Explain, giving reason, why production possibilities curve is concave. æ D loss of Y ö Ans. PPC is concave to its origin because marginal opportunity cost çç ÷÷ of shifting resources è D gain of X ø from commodity-Y to commodity-X tends to rise. And, marginal opportunity cost tends to rise because of the law of diminishing returns. When more and more resources are allocated to X, additional gain of output (per unit of input) tends to decrease; and as more and more resources are withdrawn from Y, æ D loss of Y ö ÷÷ tends to rise. Implying a additional loss of output tends to rise. Accordingly, the ratio çç è D gain of X ø rise in the slope of PPC as more and more resources are shifted from Y to X. Rising slope of PPC means that PPC is concave to the origin. 19. A consumer consumes only two goods X and Y and is in equilibrium. Price of X rises. Explain the reaction of the consumer with the help of utility analysis. Ans. Equilibrium condition in case of two commodities: MU X MU Y = PX PY Introductory Microeconomics
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MU X MU X MU Y falls and < . Since X becomes relatively expensive (than Y), PX PX PX MU X will start rising the consumer will start consuming less of X and more of Y. As a consequence PX MU Y MU X MU Y while will start falling. The adjustment process would continue till = . Briefly, if PX PY PY PY rises the consumer will react by buying less of X.
When PX rises, the ratio
20. Draw supply curves showing price elasticity of supply equal to (i) zero,
(ii) one, and
(iii) infinity throughout.
Ans. (a)
P1
P
S Quantity
Y
(c)
S
Es = 0
O
(b)
Y
X
Es = 1
Price
Price
P1
S
Price
Y
P
S O
Q1 Q Quantity
X
P
O
Es = ¥
S
S
Q Quantity
Q1
X
Figure 3 21. Explain the implications of ‘homogeneous product’ in a perfectly competitive market. Or Explain the implications of ‘differentiated product’ in monopolistic competition. Ans. A product being perfectly homogeneous implies that all units of a commodity are identical in size, quality, shape, colour, weight, etc. In a state of perfect competition, a perfectly homogeneous product is sold in the market. Since a large number of sellers sell a homogeneous product, there is a zero control over price. All sellers in the market have to sell the product at a uniform price. If ever an individual firm tries to charge higher price, it would lose all its buyers to a large number of other sellers in the market. A firm is simply a price taker. Or Product differentiation or differentiated product is a distinct feature of monopolistic competition. Though the number of firms is large but their product differs in colour, shape, brand, quality, durability, etc. It has two important implications: (i) It allows a firm a partial control over price of its product, and (ii) It causes high elasticity of demand for the firm’s product owing to the availability of a large number of close substitutes. 22. A producer starts a business by investing his own savings. He employs a manager to look after the business. Identify the explicit and implicit costs from this information. Explain. Ans. Imputed interest of owner’s savings is implicit cost because implicit costs are incurred on the use of factors/inputs. Salary paid to a manager to look after the business is explicit cost because it is the expense incurred by the producer for hiring the services of the manager from the market. 23. A producer takes a building on rent for carrying out business. He looks after the business himself. Identify the implicit and explicit costs from this information. Explain. Ans. As the producer is carrying out the business himself, he is rendering his own services. Managerial services are not hired from the market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Rent paid of a building taken on rent is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market. Introductory Microeconomics
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4 MARKS QUESTIONS 1. Define an indifference curve. Explain why an indifference curve is downward sloping from left to right. Ans. Indifference curve is a curve showing different combinations of two commodities, each combination offering the same level of satisfaction to the consumer. The slope of an indifference curve shows the rate at which the consumer is willing to substitute one commodity for the other. Or, it shows the marginal rate of substitution. An indifference curve slopes downwards from left to right. This is because of monotonic preferences of a consumer. If a consumer is simultaneously buying two goods, he can have more of one good only when he has less of the other so that his total satisfaction (at any point on IC) remains the same. An IC, therefore, must slope downward. 2. When price of a good is ™7 per unit a consumer buys 12 units. When price falls to ™6 per unit he spends ™72 on the good. Calculate price elasticity of demand by using the percentage method. Comment on the likely shape of demand curve based on this measure of elasticity. Ans. Given, P = ` 7; P1 = ™ 6; DP = P1 – P = ™ 6 – ™ 7 = (–) ™ 1 72 Q = 12 units; Q1 = =12 units; DQ = Q1 – Q = (12 – 12) units = 0 6 P DQ 7 0 = (–) Ed = (–) ´ ´ =0 Q DP 12 -1 Price elasticity of demand = 0. Demand curve in this case will be a vertical straight line parallel to Y-axis. Because, no matter what the change in price is, there is no change in quantity demanded of the commodity. 3. What does the law of variable proportions show? State the behaviour of total product according to this law. Or Explain how changes in prices of other products influence the supply of a given product. Ans. Law of variable proportions states that as more and more of the variable factor is combined with the fixed factor, marginal product (MP) of the variable factor may initially increase and subsequently stabilise, but must finally decrease. Of course, initially, MP may rise owing to better coordination between the factors and better utilisation of the fixed factor. Thus, we have three phases of production viz. phases of increasing MP, decreasing MP and negative MP. It is further illustrated through Fig. 4. In a situation when MP is increasing, TP should be increasing at an increasing rate. When MP is decreasing, TP should be increasing at a decreasing rate. And, when MP is negative, TP should be declining. Of course TP should be maximum when MP = 0.
Y
TP TP
X Units of the Variable Factor
MP Phase I: Increasing Returns O
Phase III: Negative Returns
Phase II: Diminishing Returns
– ve MP Units of the Variable Factor M
X
Figure 4 Introductory Microeconomics
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Or
In case of a fall in prices of other goods, profit on the other good will start shrinking. The producers will start shifting to the production of the given good. Implying that the supply curve will shift to the right, from SS to S2S2 in Fig. 5.
Y S1 S S2 Price
Prices of other products may rise or fall. In case of a rise, other products start yielding greater profit than the given product, on the assumption that cost of production in case of all the goods remains constant. Accordingly, the producers will start shifting to the production of other goods. Less of the given good will be produced. Supply curve of the given good will shift to the left, from SS to S1S1 in Fig. 5.
S1 O
S
S2 X Quantity
Figure 5 SS : Initial supply curve S1S1: New supply curve when prices of other goods rise S2S2: New supply curve when prices of other goods fall
Of course, if the price of the substitute good rises, the buyers would shift from the substitute good to the given good. More of the given good will be purchased, even when own price of the good remains constant. Implying a forward shift in supply curve of the given good. 4. Define marginal rate of substitution. Explain why is an indifference curve convex. Ans. Marginal rate of substitution between Good-X and Good-Y is the rate at which the consumer is DGood - Y willing to sacrifice Good-Y for an additional unit of Good-X. It is expressed as: at any DGood - X point on IC. An indifference curve will ordinarily be convex to the point of origin. This implies that the slope of an indifference curve tends to fall as the consumer moves downward along the curve. The slope of the indifference curve is the same as marginal rate of substitution. The falling slope of IC thus implies that MRSXY tends to fall as the consumer moves downward along the curve. In other words, it is because of the diminishing MRSXY that the IC is convex to the origin. MRSXY tends to fall because marginal utility of X tends to fall as more and more of X is acquired, while marginal utility of Y tends to rise as less and less of it remains with the consumer. As a result, the consumer is willing to sacrifice less and less of Y for every additional unit of X. 5. A consumer buys 10 units of a good at a price of ™ 9 per unit. At price ™ 10 per unit he buys 9 units. What is price elasticity of demand? Use expenditure approach. Comment on the likely shape of demand curve on the basis of this measure of elasticity. Ans. Price (`)
Demand (Units)
Total Expenditure (`)
9
10
90
10
9
90
Since, total expenditure remains constant, price elasticity of demand is equal to unity. Price elasticity of demand = 1. Demand curve will be a rectangular hyperbola, provided total expenditure remains constant at all levels of price of the commodity.
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NOTE If elasticity of demand is found to be equal to unity (Ed = 1) corresponding to a given level of price of the commodity, the students are advised NOT to jump to the conclusion that the demand curve must be a rectangular hyperbola. The demand curve will be a rectangular hyperbola only when Ed = 1 (or total expenditure remains constant) at all levels of price of the commodity.
Y Ed = ¥
PX Ed = 1
Check Fig. 6.
Ed = 0
X O It shows Ed = 1 at the mid-point, Ed = 0 at the bottom-end QX and Ed = ¥ at the top-end of the demand curve. It is just a Figure 6 straight line demand curve, sloping downward. And, it The figure shows that Ed is different at different levels of price shows all possibilities of Ed. Important it is to note that Ed is of the commodity. Higher the level of price of the commodity, different at different points of demand curve. Exceptional higher the elasticity of demand. situations are:
(i) Rectangular hyperbola demand curve when Ed = 1 at all levels of price of the commodity. (ii) Horizontal straight line demand curve (parallel to X-axis) when Ed = ¥ at all levels of price of the commodity. (iii) Vertical straight line demand curve (parallel to Y-axis) when Ed = 0 at all levels of price of the commodity. 6. Define an indifference map. Explain why an indifference curve to the right shows higher utility level. Or Define an indifference map. Why does an indifference curve to the right show more utility? Explain. Ans. Indifference map refers to a set of indifference curves corresponding to different income levels of the consumer. An indifference curve to the right shows higher utility level. Because in a indifference map, a higher indifference curve represents those combinations which yield higher level of satisfaction than the combinations on the lower indifference curve. In other words, each point on a higher indifference curve shows that for a given level of consumption of Good-Y, the consumption of Good-X tends to be more than before. This implies higher level of utility in accordance with the monotonic preferences of the consumer. 7. A consumer buys 20 units of a good at a price of ™5 per unit. He incurs an expenditure of ™120 when he buys 24 units. Calculate price elasticity of demand using the percentage method. Comment upon the likely shape of demand curve based on this information. 120 Ans. Given, P = ` 5; P1 = = ` 5; DP = P1 – P = ` 5 – ` 5 = 0 24 Q = 20 units; Q1 = 24 units; DQ = Q1 – Q = (24 – 20) units = 4 units P DQ Ed = (–) ´ Q DP = (–)
5 4 20 ´ = =¥ 20 0 0
Price elasticity of demand = ¥ (infinity). Demand curve in this case will be a horizontal straight line parallel to X-axis, provided there is an infinite change in quantity demanded corresponding to all levels of price of the commodity. Introductory Microeconomics
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8. A consumer buys 10 units of a commodity at a price of ™10 per unit. He incurs an expenditure of ™200 on buying 20 units. Calculate price elasticity of demand by the percentage method. Comment upon the shape of demand curve based on this information. Ans. Given, P = ` 10; P = 200 = `10; DP = P – P = `10 – `10 = 0 1 1 20 Q = 10 units; Q1 = 20 units; DQ = Q1 – Q = (20 – 10) units = 10 units P DQ Ed = (–) ´ Q DP = (–)
Þ
10 10 100 ´ = =¥ 10 0 0
Price elasticity of demand = ¥ (infinity). Demand curve in this case will be a horizontal straight line parallel to X-axis. 9. What does the law of variable proportions show? State the behaviour of marginal product according to this law. Or Explain how changes in prices of inputs influence the supply of a product. Y
Ans. Law of variable proportions states that as more and more of the variable factor is combined with the fixed factor, marginal product (MP) of the variable factor may initially increase and subsequently stabilise, but must finally decrease. Initially, MP may rise owing to better coordination between the factors and better utilisation of the fixed factor. Thus, we have three phases of production viz. phases of increasing MP, decreasing MP and negative MP. These are illustrated through Fig. 7.
MP Phase I: Increasing Returns O
Figure 7
Phase II: Diminishing Returns
Phase III: Negative Returns
M – ve MP Units of the Variable Factor
X
Or
Price
Increase in input price shifts the marginal cost Y S1 S curve upward. Implying higher cost for the S2 same level of output, and therefore lower profits. Accordingly, supply curve shifts upward or to the left implying less supply at the same K T R P price (i.e., same supply at higher price). Fall in Supply curve shifts to input price shifts the marginal cost curve the right in case of decrease in the input price. downward. Implying lower cost for the same S1 Supply curve shifts to level of output, and therefore higher profits. S the left in case of increase S2 in the input price. Accordingly, supply curve shifts downward or X O to the right implying more supply at the same Quantity price (i.e., same supply at lower price). Fig. 8 Figure 8 illustrates this situation. SS is the initial supply curve. When input price increases, supply curve will shift to the left from SS to S1S1. When input price decreases, supply curve will shift to the right from SS to S2S2.
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10. Define a budget line. When can it shift to the right? Ans. Budget line is a line showing different combinations of a set of two goods that a consumer can buy, given his income and prices of the goods. It is also called price line, as it shows price ratio between Good-X and Good-Y. Position of the budget line depends on income of the consumer and prices of the two goods. If prices of two goods remain unchanged, then with an increase in income, budget line of the consumer shifts to the right. Similarly, if income of the consumer remains unchanged, the budget line will shift to the right when there is a proportionate fall in the prices of both goods X and Y. Thus, if the prices of both X and Y are reduced to half, the budget line will shift to the right showing twice the possible purchase of X and Y than before. 11. A consumer buys 14 units of a good at a price of ™ 8 per unit. At price ™ 7 per unit he spends ™ 98 on the good. Calculate price elasticity of demand by the percentage method. Comment upon the shape of demand curve based on this information. Ans. Given, P = ` 8; P1 = ` 7; DP = P1 – P = ` 7 – ` 8 = (–) ` 1 98 Q = 14 units; Q1 = = 14 units; DQ = Q1 – Q = (14 – 14) units = 0 units 7 P DQ Ed = (–) ´ Q DP = (–)
Þ
8 0 0 = ´ =0 14 –1 –14
Price elasticity of demand = 0. Demand curve will be a vertical straight line parallel to Y-axis, provided quantity demanded remains constant at all levels of price of the commodity. 12. What is budget set? Explain what can lead to change in budget set. Ans. Budget set refers to the attainable combinations of a set of two goods, given prices of the goods and income of the consumer. Consumption Possibilities for a Consumer Units of Good–1
Units of Good–2
0
15
10
10
20
5
30
0
[Note: This table is drawn on the assumptions that consumer’s income/budget = ™ 30, PGood–1 = ™ 1 per unit and PGood–2 = ™ 2 per unit.] A budget set is based on the assumptions that income of the consumer and prices of the two goods (consumed by the consumer) remain unchanged. Accordingly, a change, either in prices or in consumer’s income will lead to a change in the budget set. 13. A consumer buys 8 units of a good at a price of ™7 per unit. When price rises to ™8 per unit he buys 7 units. Calculate price elasticity of demand through the expenditure approach. Comment upon the shape of demand curve based on this information. Ans. Price (`)
Demand (Units)
Total Expenditure (`)
7
8
56
8
7
56
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Since, total expenditure remains constant, price elasticity of demand is equal to unity. Price elasticity of demand = 1. Demand curve is a rectangular hyperbola, if total expenditure remains constant at all levels of price of the commodity. 14. Explain why is an indifference curve downward sloping from left to right. State the conditions of consumer’s equilibrium in indifference curve analysis. Ans. An indifference curve slopes downwards from left to right. This is because of monotonic preferences of a consumer. If a consumer is simultaneously buying two goods, he can have more of one good only when he has less of the other so that his total satisfaction (at any point on IC) remains the same. An IC, therefore, must slope downward. In terms of indifference curve (IC) analysis, a consumer attains equilibrium when: (i) IC and price line are tangent to each other. or When: slope of IC and slope of price line are equal to each other. and (ii) IC is convex to the origin, at the point of equilibrium. 15. A consumer buys 13 units of a good at a price of ™11 per unit. When price rises to ™ 13 per unit he buys 11 units. Use expenditure approach to find price elasticity of demand. Also comment on the shape of the demand curve based on this information. Ans. Price (`)
Demand (Units)
Total Expenditure (`)
11
13
143
13
11
143
Since, total expenditure remains constant, price elasticity of demand is equal to unity. Price elasticity of demand = 1. Demand curve will be a rectangular hyperbola in case expenditure on the commodity remains constant at levels of price of the commodity. 16. How does the change in tax on a product influence the supply of that product? Explain. Or What is revenue? Explain the relation between marginal revenue and average revenue. Y S2
Supply curve after tax Price
Ans. When government imposes a tax on the production of the good, marginal and average costs of the production tend to rise. Other things remaining constant, it causes a cut in profits. Accordingly, producers will supply less of the good at the existing price, or they will sell the same quantity only at a higher price. This implies a backward shift in supply curve or decrease in supply as shown in Fig. 9. S 1 S 1 is the initial supply curve. When government imposes tax, supply curve will shift backward from S1S1 to S2S2.
S1 Supply curve before tax
K
P
T S2 S1
O
Quantity
X
Figure 9
Or Revenue refers to the money receipts of a firm from the sale of its output. Relationship between Marginal Revenue (MR) and Average Revenue (AR): Introductory Microeconomics
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(i) When average revenue is constant, it is equal to marginal revenue, as under perfect competition. (ii) When average revenue is diminishing, it is greater than marginal revenue. It is true in situations of monopoly and monopolistic competition. (iii) Marginal revenue can be zero or negative but not the average revenue. 17. Explain the concept of marginal rate of substitution with the help of a numerical example. Ans. Marginal rate of substitution (MRS) is the rate at which a consumer is willing to substitute Good-1 for Good-2. Or, it is the rate at which a consumer is willing to give up Good-2 for a unit more of Good-1. DGood-2 It is estimated as at any point on IC. DGood-1 The concept of MRS is explained with the help of a table as under: Marginal Rate of Substitution Combination
Apples
Oranges
MRS
A
1
10
—
B
2
7
3:1
C
3
5
2:1
D
4
4
1:1
Above table indicates that the consumer is willing to give up 3 oranges for getting the second apple, 2 oranges for getting the third apple and 1 orange for getting the fourth apple. In other words, marginal rate of substitution of apples for oranges goes on diminishing. It is because of the diminishing MRS that the IC becomes convex to the origin. 18. A consumer buys 11 units of a good at a price of ™10 per unit. He can buy 13 units of the same by incurring an expenditure of ™ 130. Calculate price elasticity of demand by the percentage method. Also comment on the shape of the demand curve based on this information. Ans. Given, P = ` 10; P = 130 = ` 10; DP = P – P = ` 10 – ` 10 = 0 1 1 13 Q = 11 units; Q1= 13 units; DQ = Q1 – Q = (13 – 11) units = 2 units P DQ 10 2 20 = (–) Ed = (–) ´ ´ = =¥ Q DP 11 0 0 Price elasticity of demand = ¥ (infinity). Demand curve will be a horizontal straight line parallel to X-axis, provided there is an infinite change in quantity demanded corresponding to all levels of price of the commodity. 19. What are monotonic preferences? Explain why an indifference curve to the right shows higher utility. Ans. Monotonic preferences mean that a rational consumer always prefers more of a commodity as it offers him a higher level of satisfaction. An indifference curve to the right shows higher utility level. Because each point on a higher IC shows that, corresponding to a given level of consumption of Good-Y, the consumption of Good-X is greater than before. Implying higher level of satisfaction, in tune with the assumption of monotonic preferences of the consumer. 20. A consumer buys 10 units of a good at a price of ™11 per unit. When the price falls to ™9 per unit, he spends ™ 90 on the good. Calculate price elasticity of demand using the percentage method. Also comment upon the shape of demand curve based on this information. Ans. Given, P = ` 11; P1 = ` 9; DP = P1 – P = ` 9 – ` 11 = (–) ™ 2 90 Q = 10 units; Q1= = 10 units; DQ = Q1 – Q = (10 – 10) units = 0 units 9 Introductory Microeconomics
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P DQ ´ Q DP 11 0 0 = (–) ´ = =0 10 – 2 20
Ed = (–) Þ
Price elasticity of demand = 0 (zero). Demand curve will be a vertical straight line parallel to Y-axis, provided there is no change in quantity demanded at all levels of price of the commodity.
6 MARKS QUESTIONS 1. Explain how do the following influence demand for a good: (i) Rise in income of the consumer. (ii) Fall in prices of the related goods. Ans.
(i) Effect of rise in income of the consumer on demand for a good is different in case of normal good and inferior good, as shown in Fig. 10: (a)
Y
Price of Coarse Grain
Price of Milk
D2 D1 P
K
T D2 D1
O
(b)
Y
Q2 Q1 Demand for Milk
X
D1 D2
K
P
T
D1 D2 O
X
Q2 Q1 Demand for Coarse Grain
Figure 10
(a) Normal Goods: When income rises, demand curve for the normal good (say milk) shifts to the right from PK to PT as shown in Fig. 10(a). Or, there is a positive relationship between income and demand for normal goods. (b) Inferior Goods: When income rises, demand curve for inferior good (say coarse grain) shifts to the left from PT to PK as shown in Fig. 10(b). Or, there is a negative relationship between income and demand for inferior goods.
(a) Substitute Goods: Substitute goods are those goods which can be substituted for each other. When price of a substitute good decreases, demand for a given good (Good-X) tends to fall. Demand curve for Good-X will shift to the left, implying quantity demanded decreases from PK to PS even when price of Good-X continues to be OP. (b) Complementary Goods: Complementary goods are those goods which complete the demand for each other. When price of complementary goods decreases, demand for Introductory Microeconomics
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Y
D1
D D2
Price of X
(ii) Related goods may be: (a) substitute goods, or (b) complementary goods. Fig. 11 illustrates how demand for a given good is influenced by a fall in price of a substitute good as well as a complementary good.
P
O
Initial demand curve
S
K
L
D1
D D2 QX Quantity of X
X
Figure 11 w Demand curve shifts to the left (from DD to D2D2) when
price of the substitute good decreases.
w Demand curve shifts to the right (from DD to D1D1) when
price of the complementary good decreases.
Economics–XII
Good-X tends to rise. Demand curve for Good-X will shift to the right, implying quantity demanded increases from PK to PL even when price of Good-X continues to be OP. 2. Explain the conditions of a producer’s equilibrium in terms of marginal cost and marginal revenue. Use diagram. Ans. Producer is said to be in equilibrium when he maximises his profits or minimises his losses. According to marginal cost and marginal revenue approach, producer strikes his equilibrium when two conditions are satisfied: (i) MR = MC, and (ii) MC is rising (or MC curve cuts MR curve from below) at the point of equilibrium. Y
This is illustrated through Fig. 12.
MC
Cost/Revenue
Fig. 12 shows that producer strikes his equilibrium at point Q where OL units of output are produced. Note Q AR=MR E P carefully that it is only when OL units of output are produced that MC = MR, and MC curve is rising. At point E also, MR = MC. But E is not the point of equilibrium. Because, here MC is falling. Since price is constant (implying constant MR), falling MC would mean MR>MC beyond point E (and between points X O E & Q). This points to the possibility of greater profits L Output (units) if output is increased beyond point E. Profits are Figure 12 maximised only at point Q where MR = MC and also MC is rising. Any attempt to raise output beyond point Q would mean getting into a situation where MR Increase in Supply, Price tends to rise owing to excess demand w (b) Situation 2: Increase in Demand < Increase in Supply, Price tends to fall owing to deficient demand w (c) Situation 3: Increase in Demand = Increase in Supply, Price does not change owing to proportionate increase in demand and supply
The diagrams (in Fig. 13) explain the following situations: (i) In Fig. 13(a), D1D1 is the initial demand curve and S1S1 is the initial supply curve. OP1 is equilibrium price and OQ1 equilibrium quantity. Due to increase in demand, D2D2 is the new demand curve. Due to increase in supply, S2S2 is the new supply curve. In the diagram, increase in Introductory Microeconomics
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demand (from D1D1 to D2D2) is more than increase in supply (from S1S1 to S2S2). It is a situation of excess demand. Accordingly, the market price will rise from OP1 to OP2, as in Fig. 13(a). Equilibrium quantity increases from OQ1 to OQ2. (ii) In Fig. 13(b), increase in demand (from D1D1 to D2D2) is less than increase in supply (from S1S1 to S2S2). It is a situation of excess supply. Accordingly, the market price falls from OP1 to OP2. Equilibrium quantity increases from OQ1 to OQ2. (iii) In Fig. 13(c), increase in demand is exactly equal to increase in supply. Accordingly, the market price remains unchanged, i.e., OP1. Equilibrium quantity increases from OQ1 to OQ2. Or Effect of a decrease in both the market demand and market supply of a commodity on its market price is discussed with reference to Fig. 14 (a, b, c) indicating three different situations.
D1
S2 S1
D2
Price
Price
D1 P1 P2 S2 S1 O
Figure 14
(b)
Y
D2
Q2 Q1 Quantity
S2
D2
S1
P2 P1
X
S1
P1 S1 D2
O
S2
D1 D2
D1
S2
D1
(c)
Y
Price
(a)
Y
Q2
Q1
S2 X
S1
O
Quantity
D2 Q2 Q1
D1 X
Quantity
w (a) Situation 1: Decrease in Demand > Decrease in Supply, Price tends to fall owing to deficient demand w (b) Situation 2: Decrease in Demand < Decrease in Supply, Price tends to rise owing to excess demand w (c) Situation 3: Decrease in Demand = Decrease in Supply, Price does not change owing to proportionate fall in demand and supply
The diagrams (in Fig. 14) explain the following situations: (i) In Fig. 14(a), D1D1 is the initial demand curve and S1S1 is the initial supply curve. OP1 is equilibrium price and OQ1 equilibrium quantity. Due to decrease in demand, D2D2 is the new demand curve. Due to decrease in supply, S2S2 is the new supply curve. In the diagram, decrease in demand (from D1D1 to D2D2) is more than decrease in supply (from S1S1 to S2S2). It is a situation of excess supply. Accordingly, the market price falls from OP1 to OP2, as in Fig. 14(a). Equilibrium quantity decreases from OQ1 to OQ2. (ii) In Fig. 14(b), decrease in demand (from D1D1 to D2D2) is less than decrease in supply (from S1S1 to S2S2). It is a situation of excess demand. Accordingly, the market price rises from OP1 to OP2. Equilibrium quantity decreases from OQ1 to OQ2. (iii) In Fig. 14(c), decrease in demand is exactly equal to decrease in supply. Accordingly, the market price remains unchanged, i.e., OP1. Equilibrium quantity decreases from OQ1 to OQ2. 4. Explain the difference between (i) inferior goods and normal goods and (ii) cardinal utility and ordinal utility. Give example in each case. Ans.
(i) A normal good is that good the consumption of which increases with increase in income of the consumer, so that there is a positive relationship between consumer income and demand for the good. Example: Milk. An inferior good is that good the consumption of which decreases with increase in income of the consumer, so that there is a negative relationship between consumer income and demand for the good. Example: Coarse grain. (ii) Cardinal utility refers to the measurement of utility in terms of units like 2, 4, 6, and 8. Whereas ranking of utility is called ordinal measurement of utility. In other words, in ordinal measurement system, utility is compared or expressed in terms of higher, lower or equal level of satisfaction across different situations.
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5. Explain the distinction between “change in quantity supplied” and “change in supply”. Use diagram. Ans. Change in quantity supplied refers to expansion and contraction of supply of a commodity caused by change in own price of the commodity. When price increases there is an upward movement (a ® b) along the supply curve, called expansion of supply; and when price decreases there is a downward movement (b ® a) along the supply curve, called contraction of supply. See Fig. 15(a). Change in supply refers to increase or decrease in supply of a commodity caused by change in factors other than own price of the commodity. When other factors change in a positive direction, the supply curve shifts to the right showing increase in supply; and when the changes occur in the negative direction, the supply curve shifts to the left showing a decrease in supply. See Fig. 15(b). (a)
Y
Expansion: a®b
S2 S
S
S1
P1
b
P
Price
Price
(b)
Y
a
P S1S1 ® Increase in Supply S2S2 ® Decrease in Supply
S2 S
Contraction: b®a
S
S1 O
Q Q1 Quantity
X
O
Q2
Q Q1 Quantity
X
Figure 15 6. Market for a good is in equilibrium. There is simultaneous “decrease” both in demand and supply but there is no change in market price. Explain with the help of a schedule how it is possible. Or Market for a good is in equilibrium. Explain the chain of reactions in the market if the price is (i) higher than equilibrium price and (ii) lower than equilibrium price. Ans. Price (`)
Quantity Demanded (Units)
Quantity Supplied (Units)
5
40
80
4
60
60
3
80
40
After Simultaneous Decrease in Demand and Supply 5
20
40
4
30
30
3
40
20
From the above schedule, it is clear that at price ™4 the market demand is equal to market supply of 60 units. Hence at ™4, the market is in equilibrium. For market price to remain unchanged or constant decrease in demand should be exactly equal to decrease in supply. In the above schedule, 50 per cent decrease in both demand and supply causes no change in market price. Therefore, new equilibrium is also struck at a price ™4 per unit.
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Or Y S
D Excess Supply
P1 Price (`)
The equilibrium price is the price at which market demand and market supply are equal to each other. In Fig. 16, DD is demand curve and SS is supply curve. They intersect each other at point E, where market demand = market supply. Thus, point E is the equilibrium point. This point shows that equilibrium price is OP and equilibrium quantity is OQ.
B
A E
P C
P2 S
F Excess Demand
D
(i) When price prevailing in the market (OP1) is X O Q higher than the equilibrium price (OP), then Quantity (Units) market demand will be less than market supply. Figure 16 There is excess supply in the market equal to AB. Excess supply will trigger competition and force the market price to decrease. This will lead to extension of demand and contraction of supply. The process of extension and contraction would continue till the equilibrium between supply and demand is struck. It is at point E, that the situation of excess supply is finally eliminated. Now, quantity demanded = quantity supplied = OQ. Thus, equilibrium price will be restored through the free play of market forces at point OP. The market will reach the point of equilibrium at a lower price than in a situation of excess supply. (ii) When price prevailing in the market (OP2) is lower than the equilibrium price (OP), then market demand will be more than market supply. There is excess demand in the market equal to CF. Pressure of excess demand will cause a rise in market price causing contraction of demand and extension of supply. The process of contraction and extension would continue till the equilibrium between supply and demand is struck. It is at point E, that the situation of excess demand is finally eliminated. Now, quantity demanded = quantity supplied = OQ. Equilibrium price will again be restored through the free play of market forces. The market will reach the point of equilibrium at a higher price than in a situation of excess demand. 7. Explain the distinction between: (i) ‘Change in demand’ and ‘Change in quantity demanded’ (ii) Budget set and Budget line. Ans.
(i) Change in Demand
Change in Quantity Demanded
1. Change in demand refers to increase or decrease in demand of a commodity at its existing price.
1. Change in quantity demanded refers to extension or contraction of demand in response to change in own of the commodity.
2. Change in demand occurs due to change in factors other than own price of the commodity.
2. Change in quantity demanded occurs due to change in own price of the commodity.
3. Diagrammatically, this is shown by a forward or backward shift in demand curve.
3. Diagrammatically, this is shown by a downward or upward movement on the same demand curve.
(ii) Budget set refers to a set of attainable combinations of two goods, given market price of the goods and income of the consumer. Whereas, budget line is a line showing different possible combinations of Good-1 and Good-2, which a consumer can buy, given his money income and the prices of Good-1 and Good-2. 8. State the phases of changes in total product in the law of variable proportions. Also explain the reason behind each phase. Use diagram. Ans. Phases of changes in total product in the law of variable proportions is shown with the help of Fig. 17. Introductory Microeconomics
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Y T
TP Total Product
(i) Phase I: It is between O to K on the TP curve. In this stage, MP tends to rise till OL units of labour are used with the constant application of land. When MP is rising, TP tends to rise at an increasing rate. This occurs till point K on the TP curve and point E on the MP curve. This is a situation of increasing returns to a factor. It occurs owing to: (a) fuller utilisation of the fixed factor, and (b) better coordination among the factors of production.
K
Phase I
O Y
Phase II
Phase III
S
L
Increasing Returns
X Negative Returns
Diminishing Returns
Marginal Product
(ii) Phase II: It is between K to T on the TP curve. Beyond OL units of labour, MP Phase I Phase II Phase III E tends to decline, and TP increases only at diminishing rate. This occurs between E and S on MP curve, and between K and T on TP curve. This corresponds to a X situation of diminishing returns to a O L S – ve factor. It occurs owing to: (a) excessive MP Units of the Variable Factor utilisation of the fixed factor and lower Figure 17 availability of the fixed factor (capital) per unit of the variable factor (labour). (b) Poor coordination among factors of production, owing to excessive employment of the variable factor. (iii) Phase III: It is beyond point T on the TP curve. Beyond OS units of labour, MP becomes negative. Now TP starts declining. This corresponds to a situation of negative returns. This occurs owing to: excessive employment of the variable factor to such an extent that some units of the variable factor (labour) remain absolutely unproductive even when they are apparently employed. This is like a situation of disguised unemployment when unproductive workers are only a hindrance in the efficiency of productive workers, so that marginal product is negative and total product starts declining. 9. Market for a good is in equilibrium. Explain the chain of reactions in the market when there is (i) “decrease” in supply (ii) “decrease” in demand. Or Market for a good is in equilibrium. There is simultaneous “increase” both in demand and supply but there is no change in price. Explain how is it possible. Use a schedule. (i) Effect of decrease in supply of a commodity on its equilibrium price and equilibrium quantity is discussed with reference to Fig. 18. Decrease in supply implies a shift in supply curve to the left from SS to S1S1. This sets in motion the following Chain of Effects: Decrease in supply implies that less is supplied at the existing price. Given the demand, price of the commodity will tend to increase, from OP to OP2: same quantity (OQ) will now be supplied at the price OP2. Or, at the price of OP, only OQ2 quantity will now be offered for sale. Rise in price Introductory Microeconomics
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Y P2
S1
D
S P1 Price
Ans.
E1 E
P S1
D S O
Q2
Q1 Q Quantity
X
Figure 18
Economics–XII
will cause contraction of demand and extension of supply. This process of extension and contraction will continue till quantity demanded is equal to quantity supplied (OQ1). The equilibrium price is struck at OP1. Y
(ii) Effect of decrease in demand for a commodity on its equilibrium price and equilibrium quantity is discussed with reference to Fig. 19.
S
E
P Price
Decrease in demand implies a shift in demand curve to the left. It is indicated by D1D1. This sets in motion the following Chain of Effects:
D D1
P1
E1
P2
D
Decrease in demand implies that less is S D1 demanded at the existing price. Given the X O supply, price of the commodity will tend to Q2 Q1 Q Quantity decrease, from OP to OP2: same quantity (OQ) Figure 19 will now be demanded at the price OP2. Or, at the price of OP, only OQ2 quantity will now be offered for demand. Fall in price will cause extension of demand and contraction of supply. This process of extension and contraction will continue till quantity demanded is equal to quantity supplied (OQ1). The equilibrium price is struck at OP1. Or Price (`)
Quantity Demanded (Units)
Quantity Supplied (Units)
5
10
30
4
20
20
3
30
10
After Simultaneous Increase in Demand and Supply 5
20
60
4
40
40
3
60
20
From the above schedule, it is clear that at price ™4 the market demand is equal to market supply of 20 units. Hence at ™4, the market is in equilibrium. For market price to remain unchanged or constant increase in demand should be exactly equal to increase in supply. In the above schedule, 100 per cent increase in both demand and supply causes no change in market price. Therefore, new equilibrium is also struck at a price ™4 per unit. zzz
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