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Question Paper Economics - I (MSF1A3): July 2008

• Answer all 74 questions.• Marks are indicated against each question.

Total Marks : 100

1. Rationality on the part of firms do not only imply stating the objectives but also has to take care of constraints. Which of the following is/ are the constraint(s) for firms?

I. Productive capacity.II. Market size.III. Size of budget.

(a) Only (I) above(b) Only (II) above(c) Only (III) above(d) Both (I) and (II) above(e) Both (I) and (III) above. ( 1 mark)

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2. Which of the following statements is not true?

(a) In a mixed economy governments compete in input markets and product markets to obtain the resources and products they need to supply goods and services

(b) The concept of marginalism assumes that the independent variable changes by a single unit(c) Opportunity cost is the highest valued benefit that must be sacrificed as a result of choosing

an alternative(d) Partial equilibrium analysis is useful and relevant to apply when there is interrelationship

between commodities or between factors(e) General equilibrium considers simultaneous equilibrium of all the markets taking into account

all effects of changes in price in one market over others. ( 1 mark)

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3. Veblen effect is one of the exceptions to the law of demand. According to this effect the consumers buy more amount of a commodity as the price increases because they feel that

(a) The commodity is essential for them(b) The commodity is scarce(c) There is an improvement in the quality of the commodity(d) There will be a further increase in the price of the commodity in future(e) It is a pride to buy a commodity with higher price. ( 1 mark)

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4. A change in which of the following will not cause a shift in the demand curve of a commodity?

(a) Income of the consumer(b) Price of the same commodity(c) Price of the related commodity(d) Taste and preferences of the consumer(e) Wealth of the consumer. ( 1 mark)

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5. If the price elasticity of demand is a negative number then it can be termed as

(a) Perfectly elastic (b) Perfectly inelastic(c) Relatively elastic(d) Relatively inelastic(e) Unitary elastic. ( 1 mark)

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6. When price elasticity of demand is equal to one, the marginal revenue will be

(a) Equal to one(b) Zero(c) Less than zero(d) Greater than zero but less than one(e) Greater than one. ( 1 mark)

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7. The demand function of product ‘m’ for Mr. Khan is given as follows:

Qm = 6,550 – 6Pm + 0.15Y.

Where, Y = income of Mr. Khan = Rs.10,000, Pm = price of m = Rs.225 per kilogram. What is the income

elasticity of demand of product m for Mr. Khan?

(a) 0.117(b) 0.617(c) 0.224(d) 0.297(e) 0.327. ( 2 marks)

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8. The cross price elasticity of demand for two goods which are perfect substitutes is

(a) Infinity(b) One(c) Zero(d) Between zero and one(e) Less than zero. ( 1 mark)

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9. The elasticity of a straight line supply curve parallel to the X-axis is said to be

(a) Equal to infinity(b) More than one but less than infinity(c) Equal to one(d) Less than one but more than zero(e) Equal to zero. ( 1 mark)

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10. A firm supplied 5,000 pet bottles at the rate of Rs.12 per pet bottle to 10 departmental stores in Hyderabad in the month of March 2008. Next month, due to a rise in the price to Rs.18 per pet bottle, the supply of the pet bottle increases to 7,250 pet bottles. What is the arc elasticity of supply of the pet bottles?

(a) 0.42(b) 0.72(c) 0.92(d) 1.44(e) 1.97. ( 2 marks)

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11. The total market demand for good X consist individual demand of three individuals Mr. A, Mr. B and Mr. C. The demand schedule of these individuals is given below:

Price of thegood (Rs.)

Quantity demanded (Units)A B C

30 2 0 425 2 0 820 4 2 1615 8 4 24

What is the absolute value of arc price elasticity of demand for the good, when the price decreases from Rs.20 to Rs.15 per unit?

(a) 1.689(b) 2.708(c) 2.991(d) 3.554(e) 4.215. ( 2 marks)

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12. A firm fixes the price of its product at Rs. 1,500 per unit and the absolute value of price elasticity of demand for the product is 5. What is the marginal revenue?

(a) Rs. 1,000(b) Rs. 1,200(c) Rs. 1,300

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(d) Rs. 1,400(e) Rs. 1,500. ( 1 mark)

13. The demand and supply functions of a product are estimated as follows:

Qd = 4,200 – 100P. Qs = 3,200 + 20P.

If the government imposes a specific tax of Rs.10 per unit, new equilibrium price of the product would be

(a) Rs.11.75(b) Rs.20.00(c) Rs.10.00(d) Rs. 8.50(e) Rs.15.30. ( 2 marks)

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14. The demand function for a commodity is estimated to be as follows:

Qd = 2,50,000 – 35A.

What will be the arc advertising elasticity of demand, if the advertising expenditure increases from Rs.4,000 and Rs. 5,000?

(a) – 1.02(b) – 1.44(c) – 1.70(d) – 0.35(e) – 0.68. ( 2 marks)

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15. Refer to the diagram below:<Answer>



The satiation quantity is represented as

(a) Q1

(b) Q2

(c) Q3

(d) Q4

(e) Q5. ( 1 mark)

16. The magnitude of slope of an indifference curve is called

(a) Consumer surplus(b) Substitution effect(c) Income effect(d) Marginal rate of substitution (e) Marginal utility. ( 1 mark)

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17. The shape of indifference curve in case of perfect substitutes is

(a) U- Shaped(b) L- Shaped(c) Convex to origin(d) Concave to origin(e) Downward sloping straight line. ( 1 mark)

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18. Which of the following statements is not true?

(a) In case of income effect the price of a commodity remains constant but the utility changes(b) Substitution effect measures the change in the relative price of a commodity(c) In Slustsky’s measure of substitution effect, when the price of any commodity falls, income is

changed by the amount of the cost difference(d) The sum of income effect and substitution effect is price effect(e) In case of a Giffen commodity the income effect is negative and weaker than substitution

effect. ( 1 mark)

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19. The utility function of a consumer is given as U = X1.5 Y. Prices of good X and Y are Rs.3 and Rs.6 respectively. Consumer’s weekly budget is Rs.1,500. What is the optimum allocation of expenditure in terms of units of both the products for the consumer?

(a) 100 units of X and 200 units of Y(b) 300 units of X and 100 units of Y(c) 200 units of X and 150 units of Y(d) 250 units of X and 125 units of Y(e) 150 units of X and 175 units of Y. ( 2 marks)

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20. Mr. Raj consumes two goods, X and Y. At equilibrium, marginal utility of X is 250 utils and the price of X is Rs. 50. If the price of Y is Rs. 70, the marginal utility of good Y at equilibrium is

(a) 200 utils(b) 250 utils(c) 300 utils(d) 350 utils(e) 400 utils. ( 1 mark)

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21. The total utility function of Mrs. Tina is estimated as:

TU = 40XY.

Where, X and Y represent the quantities of two goods consumed. The price of goods X and Y are Rs.2 and Rs.4 respectively. If Mrs. Tina attains equilibrium by consuming 40 units of commodity X, the number of units of good Y consumed by Mrs. Tina is

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(a) 10 units(b) 20 units(c) 30 units(d) 35 units(e) 40 units. ( 2 marks)

22. The utility function of Ms. Manju is estimated as:

U = 30X1.5.

If the price of the good is Rs.90 per unit, how many units of good X the consumer would consume?

(a) 3 units(b) 4 units(c) 5 units(d) 7 units(e) 11 units. ( 1 mark)

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23. Refer to the diagram below:

Here, the income consumption curve is bending backwards, it implies that

(a) Commodity q1 is an inferior commodity and commodity q2 is a normal commodity

(b) Commodity q1 is a normal commodity and commodity q2 is an inferior commodity

(c) Both q1 and q2 are inferior commodities

(d) Both q1 and q2 are normal commodities

(e) Commodity q1 is an inferior commodity and commodity q2 is a luxury commodity. ( 1 mark)

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24. According to Cassels (law of variable proportion), there are three stages in the production process. The third stage of production process is characterized by

(a) Decreasing TP, decreasing AP and decreasing MP (b) Increasing TP, decreasing AP and decreasing MP(c) Decreasing TP, decreasing AP and zero MP(d) Decreasing TP, decreasing AP and negative MP(e) Decreasing TP, decreasing AP and increasing MP. ( 1 mark)

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25. For a production function to be called a linear homogenous production function, the degree of homogeneity of the production function should be

(a) Greater than one(b) Zero(c) Equal to one(d) Between zero and one(e) Less than zero. ( 1 mark)

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26. A point where the average product is equal to the marginal product, <Answer>



(a) The average product is minimum and marginal product is decreasing(b) The average product is maximum and marginal product is decreasing(c) The average product is maximum and marginal product is increasing(d) The average product is minimum and marginal product is zero(e) The average product is minimum and marginal product is maximum. ( 1 mark)

27. Which of the following statements is false?

(a) The locus of all input combinations for which the MRTS is equal to factor price ratio is called expansion path

(b) The points on expansion path are the most efficient combinations of the two inputs(c) In the long run as all factors of production are variable, there is no limitation to expansion of

output (d) If both the factors are non-inferior then the expansion path will be upward rising (e) If the production function of the firm is non-homogenous then the optimal expansion path will

a straight line through origin only when the ratio of the factor prices remain constant. ( 1 mark)

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28. Which of the following production functions will give constant returns to scale?

I. Q = K 1/2+L 1/2.II. Q = 3K+4L.III. Q = 5K 1/2 L 1/2. IV. Q = K 1/2 L 2/3.

(a)Both (I) and (II) above(b)Both (II) and (III) above(c)(I), (II) and (III) above(d)(I), (III) and (IV) above(e)(II), (III) and (IV) above. ( 2 marks)

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29. The production function of a firm is estimated as:

Q = 50K0.5L0.5.

What is the least cost combination of K and L to produce 500 units of output given that wage rate and cost of capital are Rs.50 and Rs.2 respectively?

(a) 50 units and 2 units (b) 2 units and 50 units (c) 25 units and 2 units (d) 2 units and 25 units (e) 50 units and 4 units. ( 2 marks)

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30. A firm’s production function is estimated as follows:

Q = 400 K0.5 L0.5.

Factor prices paid by the firm are given as follows:

Labor (w) = Rs.40 Capital (r) = Rs.80

If firm produces 16,970 units, what is the lowest possible cost?

(a) Rs. 4,000(b) Rs. 4,400(c) Rs. 4,600(d) Rs. 4,800(e) Rs. 4,200. ( 2 marks)

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31. The short run production function of a firm is given as Q = 9L2 – 0.5L3. The firm employs only one factor of production that is labor. The price of the product Rs.4 per unit. The market going wage rate is Rs.120.What is range of labor input over the first stage of production function?

(a) 0 < L ≤ 9(b) 9 < L ≤ 16

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(c) 9 < L ≤ 18(d) 9 < L ≤ 24(e) 9 < L ≤ 12. ( 2 marks)

32. The production function of a firm is given as Q = 20L0.6K0.4. If the price of labor is Rs. 40 and the price of capital is Rs. 40, then what is the equation of expansion path of the firm?

(a) K = 0.605L(b) K = 0.644L(c) K = 0.667L(d) K = 0.629L(e) K = 0.699L. ( 2 marks)

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33. If the average product function of labor is given as APL = 75L – L2, the maximum possible total product of labor

(TPL) is

(a) 60,000 units(b) 62,500 units(c) 65,000 units(d) 65,500 units(e) 66,000 units. ( 2 marks)

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34. The production function of XYZ Ltd., is Q = 400L0.5K0.5.The current wages (w) and cost of capital (r) are Rs.100 and Rs.50, respectively. Market price of the good produced by the company is Rs.10. If XYZ Ltd., is currently using 100 units of capital (K), which is fixed, the quantity of labor that the firm should use to maximize its total profit is

(a) 15,000 units(b) 25,000 units(c) 30,000 units(d) 40,000 units(e) 50,000 units. ( 2 marks)

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35. Which of following statements is false regarding the relationship between a firm’s cost curves and its product curves?

(a) Over the range of rising marginal product, marginal cost is falling(b) When marginal product is maximum, marginal cost is minimum(c) Over the range of rising average product, average variable cost is falling(d) When average product is maximum, average variable cost is minimum(e) Over the range of diminishing marginal product, marginal cost is constant. ( 1 mark)

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36. Which of the following statements is true?

(a) The operating cost of a fixed asset like machine is a fixed cost(b) The shape of the fixed cost curve reflect the law of diminishing returns(c) The short run total cost curve starts from origin(d) The average fixed cost curve is a horizontal straight line(e) The shape of average cost curve is U-shaped but flatter than the average variable cost curve. ( 1 mark)

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37. The total cost function for a firm is estimated as:

TC = 48Q – 8Q2 + 2Q3.

The minimum possible average cost is

(a) Rs. 31(b) Rs. 32(c) Rs. 33(d) Rs. 34(e) Rs. 40. ( 2 marks)

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38. The total cost function of a firm is given as follows:

TC = 400 + 15Q – 7.5Q2 + 0.25Q3.

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The output at which the marginal cost will be minimum is


39. The fixed and variable costs of producing different quantity of output of a firm are given below:Quantity

(units)Fixed Cost (Rs.) Variable Cost

(Rs.)1 500 502 500 1503 500 3504 500 6505 500 1,050

What is the marginal cost of producing 5th unit of output?

(a) Rs. 100(b) Rs. 200(c) Rs. 400(d) Rs. 500(e) Rs. 50. ( 1 mark)

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40. A travel bag manufacturing company has incurred a fixed cost of Rs.7,80,000. It sells each unit for Rs.850. The average variable cost is Rs.50. What will be the break-even quantity and revenue respectively?

(a) 975 units and Rs.8,28,750 (b) 895 units and Rs.8,28,750(c) 980 units and Rs.8,28,750 (d) 960 units and Rs.7,52,000 (e) 940 units and Rs.8,28,750. ( 2 marks)

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41. The total cost function of a firm is estimated as follows:

TC = 500 – 2Q + 3Q2.

If the current output is 50 units, average cost is

(a) Rs.150(b) Rs.152(c) Rs.154(d) Rs.156(e) Rs.158. ( 1 mark)

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42. A producer produces 200 units of a commodity by spending Rs.1,50,000. He expects an increase in demand. If his total expenditure for producing 300 units is Rs.3,80,000, what is the marginal cost per unit?

(a) Rs.2,300(b) Rs.3,800(c) Rs.1,500(d) Rs. 500(e) Rs.2,800. ( 1 mark)

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43. The total cost function of a firm producing Computer Peripherals is estimated as

TC = 4,000 + 40Q – 2.8Q2 + 0.2Q3.

At what level of output will the average variable cost be at a minimum?


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44. Which of the following statements is false?

(a) The long run average cost curve is also known as the planning curve(b) The long run average cost is the locus of the tangency points of the short run average cost

curves(c) The long run marginal cost curve is derived from the short run marginal cost curves and

‘envelope’ them(d) The long run marginal cost curve is formed from points of intersection of the short run

marginal cost curves with the vertical line drawn from the points of tangency of the corresponding short run average cost curves and the long run average cost curve

(e) The long run marginal cost must be equal to the short run marginal cost for the output at which the corresponding short run average cost curve is tangent to the long run average cost curve. ( 1 mark)

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45. Which of the following statements is true with regard to various economies of scales?

I. Division of labor, apart from increasing the skills of the labor force, results in saving of the time usually lost in going from one type of work to another.II. Technical economies are associated with the ‘fixed capital’ which includes all types of machinery and other equipment.III. Inventory economies are sometimes called ‘stochastic economies’, because the role of inventories is to meet the random changes in the input and the output sides of the operation of the firm.IV. Managerial costs are partly production costs and partly selling costs, since the managerial team in a firm is concerned with both the production and the distribution activities of the firm.

(a)Both (I) and (II) above (b) Both (II) and (III) above(c) (I), (II) and (III) above(d) (I), (II) and (IV) above(e) All (I), (II), (III) and (IV) above. ( 1 mark)

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46. The economies accruing to the firm due to discounts that it can obtain due to its large scale operations are termed as

(a) Technical economies(b) Managerial economies(c) Inventory economies(d) Marketing economies(e) Pecuniary economies. ( 1 mark)

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47. Which of the following are long run cost functions?

I. TC = 500 + Q.II. TC = 25Q + 18Q2.III. TC = 200 + 9Q + 18Q2 + 36Q3.IV. TC = 45Q + 24Q2 + 50Q3.

(a) Both (I) and (II) above(b) Both (II) and (IV) above(c) Both (III) and (IV) above (d) (I), (II) and (III) above(e) (I), (II) and (IV) above. ( 1 mark)

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48. The demand for a competitive firm’s output is _____________ at the market price.

(a) Infinitely elastic(b) Infinitely inelastic(c) Relatively elastic(d) Relatively inelastic(e) Unitary elastic. ( 1 mark)

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49. According to the second order condition for profit maximization, in a perfectly competitive market the slope of marginal cost and marginal revenue curves will respectively be

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(a) Zero and positive(b) Positive and zero(c) Zero and zero(d) Positive and negative(e) Zero and negative. ( 1 mark)

50. Refer to the diagram below:

At which equilibrium point the firm will earn negative profit?

(a) E1

(b) E2

(c) E(d) E3

(e) N. ( 1 mark)

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51. Which of the following statements is not true about long run in a perfectively competitive market?

(a)The long run supply curve of the firm is again the upward rising portion of the marginal cost curve which lies above the AVC curve

(b)In the long run firms are in equilibrium when they have adjusted their plant so as to produce at the minimum point of their long run AC curve, which is tangent to the demand curve defined by the market price

(c)In the long run the firms will be earning just normal profits, which are included in the LAC(d)In the long run if they are making excess profits new firms will be attracted in the industry,

this will lead to a fall in price and an upward shift of the cost curves due to the increase of the prices of factors of production as the industry expands

(e)If the industry is a constant cost industry, the long run supply curve will be a horizontal straight line. ( 1 mark)

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52. The condition for the long run equilibrium of a firm operating under perfect competition is that the

(a) LAC = P = MR(b) SMC = LMC = LAC = SAC = P (c) SMC = LAC = SAC = P = MR(d) LMC = LAC = P (e) SMC = LMC = LAC = SAC = P = MR.

(SAC: Short run Average Cost, SMC: Short run Marginal Cost LAC : Long run Average Cost, LMC : Long run Marginal CostP :Price, MR: Marginal Revenue) ( 1 mark)

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53. Which of the following statements is false about taxation in a perfectly competitive market?

(a)The analysis of the effects of a lump sum tax is similar to that of an increase in the fixed cost, since the lump sum tax is like a fixed cost to the firm

(b)The imposition of a lump sum tax will result in an upward shift of the AFC curve(c) The imposition of a lump sum tax will not have any impact on average variable cost

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(d) The lump sum tax will result in a downward shift in the marginal cost curve(e)The imposition of a lump sum tax will result in an upward shift of the ATC curves. ( 1 mark)

54. There are 100 firms operating in a perfectly competitive market, producing a homogenous product ‘X’. They have identical cost function, given as TC = 20 + Q + 2Q2. The market demand function is estimated to be Q = 500 – 50P. What is the market price of each unit of ‘X’ and total industrial output respectively?

(a) Rs. 7 and 120 units(b) Rs. 8 and 100 units(c) Rs. 7 and 150 units(d) Rs. 8 and 80 units(e)Rs. 9 and 90 units. ( 2 marks)

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55. The market supply and demand functions for a good in are given as follows:

Qs = 5,500 + 40P.Qd = 20,000 – 60P.

The industry for the good exhibits all the features of a perfectly competitive market. The variable cost function of an individual firm is given as:

AVC = 145 – 24Q + Q2.

If the fixed costs are Rs. 500, the profit earned by the firm is

(a) Rs.1,548(b) Rs.1,648(c) Rs.1,584(d) Rs.1,554(e) Rs.1,564. ( 2 marks)

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56. Ramesh & Co. is operating in a perfectly competitive market and produces a product X. The price estimated for X is Rs.60 per unit, but the AVC at the level of output produced is Rs.90. Ramesh & Co. should

(a) Change its level of output and produce that level where MC equals MR(b) Shut down and lose only its total fixed cost(c) Reduce the price of product X and increase the number produced and offered for sale(d)Increase the price of product X and reduce the number produced(e) Change its level of output and produce that level where MC equals AR. ( 1 mark)

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57. Ruby Ltd., a firm operating under perfect competition has the long run average cost function given asLAC = 17,500 – 1,250Q + 25Q2.

If the existing market price of the commodity produced by the firm is Rs.120, what is the total revenue of the firm at optimum level of output?

(a) Rs. 2,050(b) Rs. 2,850(c) Rs. 3,000(d) Rs. 3,220(e) Rs. 4,020. ( 2 marks)

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58. A firm operating in a perfectly competitive market has the following Average Variable Cost function :

AVC = 2,072 – 252Q + 9Q2.

What is the price below which the firm has to shut-down its operations in the short run?


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59. Alpha Ltd., is operating in a perfectly competitive industry. The total cost function of Alpha Ltd., is estimated to be TC = 1,200 + 600Q – 50Q2 + Q3. Industry supply function is Qs = 200 + 4P. If profit maximizing output for

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Alpha Ltd., is 150 units, equilibrium output for the industry is

(a) 2,11,600 units(b) 2,12,000 units(c) 2,12,600 units(d) 2,11,000 units(e) 2,10,000 units. ( 2 marks)

60. According to Bain’s concept on the condition of entry, which of the following market structure(s) the condition of entry (E) is zero?

I. Oligopoly.II. Perfect competition.III. Monopolistic competition.IV. Monopoly.

(a) Only (I) above (b) Only (II) above(c) Only (IV) above(d) Both (I) and (II) above(e) Both (II) and (III) above. ( 1 mark)

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61. The Learner’s measure of the index of monopoly power ranges from

(a) 0 to 1(b) –1 to 1(c) –1 to 0(d) 0 to ∞(e) 1 to ∞. ( 1 mark)

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62. What is/are the factor(s) that make price discrimination possible under monopoly?

I. Consumer preferences.II. Nature of the good.III. Distance and frontier barriers.

(a) Only (I) above(b) Only (II) above(c) Only (III) above(d) Both (I) and (II) above(e)All (I), (II) and (III) above. ( 1 mark)

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63. There are six firms in an industry. Two firms are big each of them catering 30% of total sales of the industry and the remaining four are equal sized firms. In this case what is the value of Herfindahl index?

(a) 0.15(b) 0.17(c) 0.19(d) 0.22(e) 0.25. ( 1 mark)

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64. Which of the following statements is false regarding monopoly?

(a) There are barriers to entry(b)A monopolist’s individual demand curve possesses the same general properties as the

industry demand curve for a perfectly competitive market(c) A monopolist may maximize profit with respect to variations in output only(d)A monopolist does not have a supply curve(e) A monopolist can charge different price to different buyers. ( 1 mark)

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65. The marginal revenue in a monopoly is

(a) Always equal to price(b) Always greater than price(c) Lower than price for all units other than the first(d)Less than price at low levels of output and greater than price at high levels of output

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(e) Always less than price. ( 1 mark)

66. For a monopolist, if the absolute value of price elasticity of demand of a product is equal to 5 and the marginal revenue is Rs.16, then the price of the product is

(a) Rs.20(b) Rs.15(c) Rs.10(d) Rs. 5(e) Rs. 2. ( 1 mark)

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67. A monopolist’s demand functions in two effectively segmented markets A and B are given as follows:

PA = 400 – 50QA.

PB = 500 – 50QB.

Total cost function of the monopolist is TC = 10 + 100Q. If the monopolist practices price discrimination, what is the equilibrium level price of market A and market B respectively?

(a) Rs.250, Rs. 300(b) Rs.300, Rs. 200(c) Rs.320, Rs. 400(d) Rs.340, Rs. 420(e) Rs.204, Rs. 302. ( 1 mark)

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68. Devi Ltd., has a monopoly in producing a special type of health drink. The demand function for this health drink is estimated as Q = 125 – P. The total cost function is TC = 25Q. The profit earned by Devi Ltd. is

(a) Rs. 2,500 (b) Rs. 2,625 (c) Rs. 2,725 (d) Rs. 2,600 (e) Rs. 2,450. ( 2 marks)

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69. Which of the following statements is false regarding monopolistic competition?

(a)Under monopolistic competition excess capacity remains in each firm in the sense that more output can be produced at a lower cost

(b)Monopolistically competitive markets are characterized by brand names and by continual product development and improvement

(c)As a result of advertising, each monopolistically competitive firm produces less than it would otherwise

(d)The demand curve for a monopolistically competitive firm is downward sloping because of product differentiation

(e)The demand curve for a monopolistically competitive firm is relatively elastic since there are close substitutes for the product of a firm. ( 1 mark)

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70. For a monopolistically competitive firm the short run cost and revenue functions are estimated as follows:

TC = 15,000 + 30Q – 20Q2 + Q3.TR = 30Q – 2Q2.

The profit maximizing level of output for the firm is


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71. Which of the following is not a condition which prevails in a monopolistically competitive market?

(a) There are relatively large number of firms, each satisfying a small, but not microscopic, share of the market demand for a similar but not identical products

(b) The product of each firm is not a perfect substitute for the products of competitive firms. The

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product is differentiated from any other product. A product group represents several closely related, but not identical, products that serve the same general purpose for consumers. The sellers in each product group can be considered competing firms within the industry

(c) The firms in the market consider the reactions of their rivals when choosing their product prices or annual sales targets

(d) Relative freedom of entry and exit of firms exists in monopolistically competitive markets(e) Neither the opportunity nor the incentive exists for the firms in the market to cooperate in

ways that decrease competition. ( 1 mark)

72. Which of the following statements is/are false about to Cournot’s model of Duopoly?

I. In Cournot’s model of Duopoly there are large numbers of buyers.II. There are two independent firms selling differentiated products.III. Each duopolist seeks to maximize his total profit in each period.

(a) Only (I) above (b) Only (II) above(c) Only (III) above(d) Both (I) and (II) above(e) Both (II) and (III) above. ( 1 mark)

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73. Which of the following are decided by the central agency in a Cartel?

I. Quantity to be produced.II. Price of the product.III. Allocation of production among the members.IV. Distribution of profits among the members.

(a) Both (I) and (II) above(b) Both (III) and (IV) above(c) (I), (II) and (III) above(d) (I), (II) and (IV) above(e) All (I), (II), (III) and (IV) above. ( 1 mark)

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74. The market demand function for a cartel consisting of two firms with equal market share is given as Q = 200 – 20P. The total cost function of each of the duopolists is TC = 10 + 0.4Q2. The total profit of each of the duopolists is


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END OF QUESTION PAPER

Suggested Answers Economics - I (MSF1A3): July 2008

Answer Reason

1. d Constraint for a firm is assessing its productive capacity and market size. Whereas the size of budget is a constraint for a consumer

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2. d Option (d) is not true. Partial equilibrium analysis is not useful and relevant to apply when there is interrelationship between commodities or between factors

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3. c According to this Veblen effect, the consumers buy more amount of a commodity because they feel that there is an improvement in the quality of the commodity.

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4. b A change in the own price of the commodity will not cause a shift in the demand curve unless there is a change in demand at every change in price. Other wise a change in price will cause a movement along the demand curve.

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5. d If the price elasticity of demand is a negative number then it can be termed as relatively inelastic

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6. b When price elasticity of demand is equal to one then the marginal revenue will be zeroBecause MR =

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7. c The income elasticity of demand is given as follows:ey =

Differentiating the demand function with respect to Y, we have, = 0.15

From the demand function, we have,Qm = 6,550 – 6 x 225 + 0.15 x 10,000

= 6,550 – 1,350 + 1,500 = 6,700Substituting the values of Y and Qm for ey, we have,

eY = 0.15 x = 0.224.

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8. a The cross price elasticity of demand for two goods which are perfect substitutes is infinity. The smallest possible increase (decrease) in the price of one good causes an infinitely large increase (decrease) in the quantity demanded of the other good.

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9. a The elasticity of a straight line supply curve parallel to the X-axis is said to be equal to infinity.

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10. c The price elasticity of supply ises =

Where P1 and Q1 are the initial price-quantity combination and P2 and Q2 are

the changed price-quantity combination. In the above question.P1 = Rs.12

P2 = Rs.18

Q1 = 5,000

Q2 = 7,250

Putting the values of P1, Q1, P2 and Q2, we have,

es = = 0.92.

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11. a The market for a product consists of all the individuals who demand the good. Therefore, by summing up the demand of all the individuals in the market, we can get the market demand at a particular price.

Price of the good A B C Total30 2 0 4 625 2 0 8 1020 4 2 16 2215 8 4 24 36

Absolute value of Arc price elasticity of demand for the good = = .

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12. b MR = ∴ MR = (since AR = price) = 1,500 ( 4/5) = Rs.1,200.

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13. c When tax is imposed, the supply function becomes Qs = 3200 + 20(P – 10)Thus, at equilibrium, 3200 + 20 (P – 10) = 4200 – 100P4200 – 3200 + 200 = 120POr, P = 1200/120 = Rs. 10.

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14. c The demand function is Qd = 2,50,000 – 35A

When advertising price is Rs.4,000 per unit,Qd = 2,50,000 – 35 (4000)

= 2,50,000 –1,40, 000 = 1,10,000 unitsWhen advertising price is Rs.5,000 per unit,Qd = 2,50,000 – 35 (5000)

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= 2,50,000 – 1,75, 000 =75,000 unitsArc elasticity of demand is Ep = = = -1.70

15. d A particular quantity of good can be considered as satiation quantity when the marginal utility of the product becomes zero. At this level the total utility will be maximum.

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16. d The magnitude of slope of an indifference curve is called marginal rate of substitution.

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17. e The shape of indifference curve in case of perfect substitutes is a downward sloping straight line.

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18. e A Giffen commodity is considered as an inferior commodity hence its income effect is negative and stronger than the substitution effect. It should be noted that all Giffen commodities are inferior but all inferior commodities are not necessarily Giffen commodities.

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19. b The consumer can maximize his satisfaction by equating9Y = 3X∴ X = 3YGiven the budget of Rs.1,500,Hence the optimum allocation is X = 300 units and Y = 100 units.

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20. d MUX/PX = MUY/PY

That gives 250/50 = MUY/70 or MUY = 350 utils.

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21. b Total utility = U = 40XYMUX = U/ X = 40Y

MUY = U/ Y = 40X

At equilibrium, MUX/PX = MUY/PY

40Y/2 = 40X/4 Or, 20Y = 10XOr, 2Y = XThus, if X = 40, Y = X/2 = 40/2 = 20 units.

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22. b The consumer would consume the good up to a point where MU = P. TU = 30X1.5

MU = 45X0.5 = 90X0.5 = 2Or, X = 4 units.

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23. b In the given case the commodity q1 is an inferior commodity and the

commodity q2 is a normal commodity

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24. d The third stage of production process is characterized by decreasing TP, decreasing AP and negative MP.

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25. c If the degree of homogeneity of function is equal to one then we have constant returns to scale which is also called as linear homogenous production function.

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26. b A point where the average product is equal to the marginal product, the average product is maximum and marginal product is decreasing

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27. e If the production function of the firm is non-homogenous then the optimal expansion path will not be a straight line even if the ratio of the factor prices remains constant.

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28. b I. Q = K1/2 + L1/2

When K = 1 and L = 1, Q = (1)1/2 + (1)1/2 = 2When K = 2 and L = 2, Q = (2)1/2 + (2)1/2 = 2.82When inputs are doubled, output are less than doubled. It is a case for decreasing returns to scale.

II. Q = 3K + 4LWhen K = 1 and L = 1, Q = 3+ 4 = 7When K = 2 and L = 2, Q = 6 + 8 = 14When inputs are doubled, output are also doubled.∴ It is a case of constant return to scale.

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III. Q = 5K1/2 L1/2

When K = 1 and L = 1, Q = 5 (1)1/2 (1)1/2 = 5When K = 2 and L = 2, Q = 5 (2)1/2 (2)1/2 = 10∴ It is a constant return to scale.

IV. Q = K1/2 L2/3

When K = 1 and L = 1, Q = (1)1/2. (1)2/3 = 1 × 1 = 1When K = 2 and L = 2, Q = (2)1/2 (2)2/3 = 1.41 × 1.58 = 2.23∴ It is an increasing return to scale.

29. a Given production function Q = 50K0.5L0.5 The output rate is determined by substituting the equation for the expansion path into the production function.Equation of expansion path,500 500 = 50 (25)0.5LL = 2K = 50Hence to produce 500 units of output, the least cost combination of K and L is 50 units and 2 units respectively.

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30. D Production function of the firm isQ = 400 K0.5 L0.5

MPL = = [400 × 0.5] = 200

MPK = = [400 × 0.5] = 200

Optimum input combination for the firm is where =

= =

K = 0.5 L (or) L = 2KIf the targeted output is 16,970.16,970 = 400 K0.5 (2K)0.5

16,970 = 400 K K = = 30 L = 2K = 60 ∴ Optimum input combination for an output of 16970 units is K = 30 L = 60 Cost of production = w.L + r.K = 40 × 60 + 80 × 30 = Rs. 2,400 +Rs. 2,400 =Rs. 4,800.

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31. a First stage of production function ends when APL is higher and second stage

ends when MPL = 0

APL is highest when APL=MPL

By equating APL to MPL

∴ First stage of production is over the range of labor input 0-9.

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32. c An equation of the expansion path can be determined by first substituting the marginal product functions and input prices into the efficiency condition and then by solving for capital as a function of labor. The corresponding marginal productivities of the production are given as follows:Similarly,MPK =

Substituting these value in the efficiency conditions we haveSolving the above equations we have

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33. b APL= 75L – L2 < TOP >



TPL = APL × L = 75L2 – L3

TPL can be maximized when MPL = 0

Therefore, ∂ TPL / ∂ L =150L – 3L2 = 0

L (150– 3L) = 0L =0 or L = 50.∴Output can be maximized by employing 50 labors.∴ Maximum possible TPL = 75(50)2 – (50)3 = 1,87,500 – 1,25,000 = 62,500

units.34. d Substituting the value of K, K = 100, into the given production function, we get

400 L0.5 (100)0.5 = Q = 4000 L0.5

To maximize profits, the firm should hire labor until MRPL = W. Since P =

MR = Rs.10, we have MRPL = MR x MPL

MPL =

= 2,000 L-0.5

= 2000/L0.5

=10 x 2000/L0.5

MRPL = MR x MPL

20000/L0.5 = 100200 = L0.5

Or, L = 40,000 units.

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35. e Over the range of diminishing marginal product, marginal cost is rising. < TOP >

36. e a. Is not true because the operating cost of a fixed asset like machine is a variable cost for example fuel and electricityb. Is not true because the shape of the variable cost curve reflect the law of diminishing returnsc. Is not true because the short run total cost curve does not start from origin.d. Is not true because the average fixed cost curve is rectangular hyperbola.e. Is true because the shape of average cost curve is U-shaped but flatter than the average variable cost curve.

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37. e AC = TC/Q = 48 – 8Q + 2Q 2AC is minimum when AC/ Q = 0= – 8 + 4Q = 04Q = 8Q = 2At Q = 2, AC = 48 – 8(2) + 2(2) 2 = Rs. 40

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38. b TC = 400 + 15Q – 7.5Q2 + 0.25Q3

Then, MC = ∂TC/∂Q = 15 – 15Q + 0.75Q2

MC will be minimum when ∂MC/∂Q = 0∂MC/∂Q = -15 + 1.5Q = 0Or, 1.5Q = 15Or, Q = 15/1.5Q = 10 units.

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39. c Marginal cost at a given level of output is the increment made in total cost to produce an extra unit of output.So, marginal cost of 5th unit is equal to total cost of fifth unit minus total cost of fourth unit. Total cost = Total fixed cost + total variable costTotal cost of 5th unit = 1,050 + 500 =Rs. 1,550Total cost of 4th unit = 650 + 500 =Rs. 1150

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Marginal cost of 5th unit = 1550 – 1150 = Rs. 40040. a Quantity required break even (Qx) = fixed cost / P – AVC

= 7,80,000/850 – 50 = 7,80,000/800 = 975 = 975 units.Total revenue at the toy manufacturer’s break even is equal to the price of the product multiplied by break even quantity = 975 850 = Rs. 8,28,750

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41. e TC = 500 – 2Q + 3Q2 AC = 500/Q – 2 + 3Q = 500/50 – 2 + 150 = Rs.158.

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42. a The marginal cost of producing 100 additional units is 3,80,000 – 1,50,000 = 2,30,000Per unit marginal cost = 2,30,000/100 = Rs.2,300

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43. D The average variable cost is obtained by dividing the total variable cost by Q.Here total variable cost = 40Q – 2.8Q2 + 0.2Q3( Just removing fixed cost (4000) from TC)

= 40 – 2.8Q + 0.2Q2

Average variable cost is minimum, when it is equal to Marginal cost.MC = = 40 – 5.6Q + 0.6Q2

Now equating MC and AVC we get40 – 5.6Q + 0.6Q2 =40 – 2.8Q + 0.2Q2 = – 5.6Q + 0.6Q2 = – 2.8Q + 0.2Q2

= – 2.8Q + 0.4Q2 = 0= Q(– 2.8 + 0.4Q) = 0= Q = 0 and – 2.8 + 0.4Q = 0Q = Since quantity cannot be zero Q = 7 units

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44. c The long run marginal cost curve is derived from the short run marginal cost (SMC) curves but does not ‘envelope’ them.

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45. e All the given statements are true.• Division of labor, apart from increasing the skills of the labor force, results in saving of the time usually lost in going from one type of work to another.• Technical economies are associated with the ‘fixed capital’ which includes all types of machinery and other equipment.• Inventory economies are sometimes called ‘stochastic economies’, because the role of inventories is to meet the random changes in the input and the output sides of the operation of the firm.• Managerial costs are partly production costs and partly selling costs, since the managerial team in a firm is concerned with both the production and the distribution activities of the firm.

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46. e The economies accruing to the firm due to discounts that it can obtain due to its large scale operations are termed as pecuniary economies.

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47. b As nothing is fixed in the long run or we can say that everything is variable, so there will not be any fixed cost in the total cost function. In the given functions, the function (II) and (IV) does not contain any fixed cost.

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48. a The demand for a competitive firm’s output is infinitely elastic at the market price

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49. b The second order condition for profit maximization requires that < 0, i.e. – < 0 or, <

That is, the slope of MR curve should be less than the slope of the MC curve. In perfect competition, MR = P which is constant. Hence, the slope of MR curve is zero. Hence, the second order condition implies that the slope of MC curve should be positive or the MC must be rising

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50. b At point E2 the firm is earning negative profits for total revenue = area < TOP >



OP1E2Q2 while total cost = area OB1 BQ2. Hence the loss is equal to P1B1BE2

51. a The short run supply curve of the firm is again the upward rising portion of the marginal cost curve which lies above the AVC curve. However, in the long run, the MC curve is not the supply curve of the firm because in the long run, only one point of the MC curve can be the equilibrium point where the firm earns only normal profit.

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52. e The condition for the long run equilibrium of a firm operating under perfect competition is that the SMC = LMC = LAC = SAC = P = MR.

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53. d The imposition of lump sum tax will not have any impact on the marginal cost of a firm

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54. c Cost function of each firm is TC = 20 + Q + 2Q2

MC = 1 + 4QEach firm can maximize profits by ensuring that MR = MC Since we are assuming perfect competition MR = P∴ MR = MC = PP = 1+ 4QQ = 0.25P - 0.25∴the profit maximizing output of the industry Qs = 100Q (as there are 100 firms)= 100 (0.25P - 0.25 )= 25P – 25The industry will be in equilibrium when the quantity supplied is equal to the quantity demanded.∴ 25P – 25 = 500 – 50P ( market demand function)75P = 525P = Rs.7Qs = 25(7) – 25=175 – 25 = 150 units.

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55. a GivenQs = 5,500 + 40P Qd = 20,000 – 60PMarket will be in equilibrium at the price where Qd = Qs20,000 – 60P = 5,500 + 40P 14,500 – 100P = 0P = 145Since the industry is operating under perfection competition firms are price takers.∴P = AR = MR. AVC function of the firm isAVC = 145 – 24Q + Q2

VC = 145Q – 24 Q2 + Q3

MC = 145 – 48Q + 3Q2

The firm will be in equilibrium at the output where MR =MC∴ 145 = 145 – 48Q + 3Q2

48Q - 3Q2 = 016Q - Q2 = 0Q (16 – Q) = 0Q = 0, Q =16Thus the profit maximizing output is 16.Profit earned by the firm is measured as TR – TC TR = P Q= 145 16 = 2,320TC = FC + VC= 500 + 145(16) – 24(16)2 + (16)3 = 772∴ Profit = 2,320 – 772 = Rs.1,548.

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56. b The firm should always shut down even in the short run if the average revenue < TOP



it is receiving is lower than the average variable cost as it is then making a loss greater than its fixed costs.

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57. c The firm operating in a perfectly competitive industry earns only normal profits in the long run because of free entry and exit of the firms. The firm operating at its minimum average cost can only prevail in the market. Thus, the equilibrium condition in the long run is when the firm is operating at Min. LAC.If AC = 17,500 – 1,250Q + 25Q2 LTC = 17,500Q – 1,250Q2 + 25Q3 LMC = = 17,500 – 2,500Q + 75Q2

LAC is minimum, when LMC =LAC Thus, 17,500 – 2,500Q + 75Q2 = 150 – 1,250Q + 25Q2

Or, 1,250Q = 50Q2

Or, 50Q = 1250Or, Q = 25 units.TR = P × Q = 120 × 25 = Rs.3,000

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58. d A firm will shut down its operations if the price is less than average variable cost. Since under perfect competition, price is also equal to marginal revenue, the firm will continue operations in the short run so long as price is at least equal to average variable cost. Thus the minimum price, at which the firm will shut down, is the minimum average variable cost. AVC = 2072 – 252Q + 9Q2

Minimum average variable cost: AVC/ Q = 0Thus, -252 + 18Q = 0Or, Q = 14When the firm is producing 14 units, then AVC = 2072 – 252(14) + 9(196) =Rs. 308Thus, if price falls below Rs.308, the firm has to shut-down its operation in the short run.

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59. c To maximize profits, a perfectly competitive firm produces an output where P = MCMC = ∂TC/∂Q = 600 – 100Q + 3Q2

P = 600 – 100Q + 3Q2, where Q = 150 units (given)Hence, P = 600 – 100(150) + 3(150)2 = 53,100Thus, total industrial production is equal to (200 + 4 x 53,100) = 2,12,600 Units.

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60. e In case of oligopoly the condition for entry(E) is positive. In case of perfect competition and monopolistic competition it is zero and in case of monopoly it is indeterminate as the entry is totally restricted.

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61. a The Learner’s measure of the index of monopoly power lies between zero and one.

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62. e (I) is a factor responsible for price discrimintion because price discrimination due to consumer preferences is possible under the following conditions:

• When a consumer is unaware that another consumer is paying different price for the same good• When a consumer has an irration feeling that he is paying a high price for a better quality, though, in fact it may not be true.• When the difference in the price is so small that the consumer is not worried about it.

(II) is also a factor responsible for price discrimintion. For some product resale of direct service is not possible, these provide enough scope for price discrimination.(III) is also a factor responsible for price discrimintion. Price discrimination in this case is possible due to tariffs, transport cost etc.

Hence option (e) is the correct answer.

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63. d H = 2(0.30)2 + 4(0.10)2 = 0.18 + 0.04 = 0.22 < TOP >

c A monopolist may maximize profit with respect to variations of either output or < TOP



64. price >

65. c The marginal revenue in a monopoly is lower than price for all units other than the first.

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66. a MR = P(1 • 1/|E|)16 = p [1–1/5]16 = p (0.8) p = Rs. 20.

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67. a TRA = PA × Q = 400Q – 50Q2

MR = 400 – 100QTC = 10 + 100QMC = 100Equilibrium level of output MR = MC 400 – 100Q = 100QA= 3

PA = 400 – 150 = Rs. 250

TRB = PB × Q = 500Q – 50Q2

MR = 500 – 100QTC = 10 + 100QMC = 100Equilibrium level of output MR = MC 500 – 100Q = 100QB= 4

PB = 500 – 200 = Rs. 300

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68. a Demand function of the firm is given as Q = 125 – PP = 125 – Q TR = P Q= 125Q – Q2

MR = 125 – 2QTC = 25QMC = 25Profit maximizing output is obtained when MR = MC= 125 - 2Q = 252Q = 100 Q = 50P = 125 – Q= 125- 50 = 75 Profit = TR – TC TR = P Q= 75 50 = 3750TC = 25Q= 25 50 = 1250∴ Profit = 3750 – 1250 =Rs.2,500.

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69. c Advertising can affect the level of demand for a firm’s product and the price elasticity of that demand. It should be kept in mind that advertising is an alternative to price reduction as a means of selling more per year and increasing profits. In the long run, however, free entry ensures that these profits will disappear. New entrants and the firm’s existing rivals will copy its advertising campaigns. Ultimately, it will become more costly to gain additional sales through advertising. As a result of advertising, each monopolistically competitive firm produces more than it would otherwise. This reduces the excess capacity in its industry. However, it does not benefit consumers because the price does not fall to reflect the lower average costs of production. Instead, selling costs are added to production costs

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a The profit maximizing output is where MC = MR < TOP



70. 30 – 40Q + 3Q2 = 30 – 4QOr, 3Q2 = 36QOr, Q = 12At output of 12 units, total cost = 15000 + 30(12) – 20(12)2 + (12)3 = 15000 + 360 – 2880 + 1728 = Rs.14,208.

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71. c The firms in the market do not consider the reactions of their rivals when choosing their product prices or annual sales targets.

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72. b In Cournot’s model of Duopoly there are two interdependent firms selling homogeneous goods.

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73. e The firms after forming a cartel appoints a central agency. The central agency is delegated the authority to decide:I. Total quantity of the product to be produced.II. Price of the product.III. Allocation of production among the members of the cartel.IV. Distribution of the maximum joint profits among the members.Hence option (e) is the correct answer.

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74. d The demand function of each of the duopolists can be represented asQ = 100 – 10P P = 10 – 0.1Q or,TR = 10Q – 0.1Q2 or,MR = 10 – 0.2QThe MC of each of the duopolist isMC = = 0.8Q.Under equilibrium condition, MR = MC. Therefore, we have:10 – 0.2Q = 0.8Q or, Q = 10 units. The price charged by each of the firms is P = 10 – 0.1Q = 10 – 0.1 × 10 = Rs.9The total revenue of each of the firms is TR = 10x 10 – 0.1 × 102 = 100 – 10 = Rs.90. Therefore, the profit for each of the firms is= TR – C = 90 – (10 + 0.4Q2)

= 80 – 0.4 × 100 = Rs. 40

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