economics (general)

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A c a d e m y o f C o m m e r c e & I TP a g e | 1

PRINCIPLES OF ECONOMICSQ1:- Explain the subject matter of economics? Or

Explain briefly various concepts of economics?Ans: - There is no single definition of economics. Different economists at

different times defined it in different ways. We may broadly classify them intofollowing three headings:

1. Wealth definition:-This concept was given by Adam Smith. Adam Smith

who is also known as father of economics published his famous book entitled Anenquiry in to the nature and causes of wealth of nations in 1776, where he definedeconomics as, the great object of political economy of every country is to increasethe riches and power of that country. In other words economics is the science ofwealth. Besides Adam Smith other classic economists like J.B. Say, J S Mill, andWalker etc. too regarded economics as science of wealth.

Criticism:-

Distribution of wealth had been ignored. Religious sentiments of people had been ignored.

2 Welfare definition:-this concept was propounded by Prof. Marshall, according to

him, Economics is the study of mankind in the ordinary business of hislife thus it is on one side the study of wealth and on the other and moreimportant side the study of man. He said that wealth is only a means and theend being the welfare of man. But in the later stage he totally ignored theservices side, as he said that welfare can only be gained from the things whichare made of some material. More precisely his definition is material welfaredefinition. He has been criticized on the ground that he had ignored services.

3 Scarcity Definition:-As per this definition, Economics is a science of scarcity. This

definition was propounded by Prof. Robbins. He not only criticized Marshallsdefinition but also Adam smith and his followers. He gave a new definition ofeconomics in 1931 which is stated as, Economics is the science which studieshuman behaviour as a relationship between ends and scarce means whichhave alternative uses.

Q2:- Define economic problem? What are the reasons which give rise to the

economic problem?Ans: -Economic problem is essentially a problem arising from the necessity of choice;choice of manner in which limited resources with the alternative uses are disposedoff. It is the problem of husbandry of resources.Economic problem arises because of the following reasons:

Unlimited wants.

Limited resources.

Limited resources with alternative uses.

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Different priorities.

Q3:- Is economics a science or an art?Ans: -Economics is both a science and an art. Art is the practical side of science.Every art is backed by scientific knowledge and every science manifests itselfthrough art. Art enables us to realize out objectives. Therefore, art and science arenot competitive but complementary.Q4:- Explain whether economics is a positive or a normative science?Ans: -Economics is basically a social science. In economics we study the economicaspect of mans life. However science is of two types:

(a) Positive Science (b) Normative SciencePositive Science: - A positive science studies the facts as they are and not as they

ought to be. It is lighter giving. Positive science makes a critical analysis of the

existing facts and draws conclusions without bothering as to what should be or whatshould not be. In other words positive science is the study of cause and effectrelationship.Normative Science: - Itstudies the facts not as they are but as they ought to be,it is not neutral between ends. It lays down certain norms and objectives and effortsare made to attain these objectives. Marshall and his pupil Pigou assigned toeconomics the role of normative science. Economics is a social science, as such; itcan not ignore the norms- the betterment of mankind. As per Frazer Economics isconcerned with value theory or equilibrium analysis or resource allocation..Q5:- What do you mean by goods? Discuss various kinds of goods?Ans: -according to Dr. Marshall Goods are desirable things. All things that satisfy

human wants are called goods in economics these are mainly of the following types: Material and non material goods:- material goods can be explained as those

which are made of some material, that is those things which can be touchedand seen. In other words all those things are called goods which are in physicalform.

Non material goods are those goods which can neither be seen nor touched butcan simply be felt. These are more precisely called as services. These are not indefinite form such as the ability of a teacher, goodwill of a business etc.

Economic and non-economic goods:- economic goods are those goods forwhich we need to pay some price, only then we can acquire some units of it.On the other hand non economic goods are those for which we need not to pay

any price to acquire some units of it like air, oxygen, sunlight. Consumer and Producer Goods:- consumer goods are those goods which are

directly used for the satisfaction of wants. The utility of consumer goods aredestroyed immediately after their use if they are not durable, on the otherhand producer goods are those goods which are used for further productionlike machines and tools and seeds.

Q6:- Define utility, what are the characteristics and types of utility?


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Ans:- Utility can be defined as want satisfying power of a good. The power orcapacity of a good to satisfy human wants is called utility. So we can say that powerbecomes the cause and the satisfaction is the result. We want different goods atdifferent intervals of time because our wants are diverse.Characteristics of Utility:-

Utility is subjective: - subjective means something which differs from personto person. When same thing is having more utility for one person and lessutility for other. A person who is busy with playing foot ball, water is havingmore utility for him than a person who is at rest.

Utility is different from pleasure:- More often utility is confused withpleasure. Goods are used at times that do not have any pleasure but still areused, e.g. medicine is used by patients even if it does not provide anypleasure.

Utility has no social consideration: - Utility means the benefit that aconsumer gets after using a commodity. It has no social consideration. Alcohol

is used by the consumer because he draws a utility out of it, it is in its essencehaving deleterious affect on the society.

Types of Utility:-1. Form utility: - when the shape of a thing is changed, it creates its utility.

When the soil is converted in to bricks its form is changed and utility is created,it is called form utility.

2. Place utility: - when we change the place of certain goods, utility is created,suppose we bring the forest wood to cities it is used most efficiently, henceutility is created. This utility is called place utility. In other words when goodsare transported from the place of abundance to the place of scarcity, placeutility is created.

3. Time utility: - when same good is having more utility at one time than atother time, it is called time utility. Woollen clothes has hardly any utility in thesummers and are having great utility in winters in the same way ice creamsare having less utility in winter but more utility in summer.

Price: - value of a good in terms of money is called price. Price of different goodscan go up or down simultaneously, but value can not as it is expressed in relativeterms.

Value: - value of a thing is the amount of other good which the first can command.In economics value means value in exchange. According to Marshall, the value thatis the exchange value is the amount of the second thing which can be got there andthen in exchange for the first. Thus, the term value is relative and expresses the

relationship between two things at a particular time and place. Any thing is havingvalue if the following three attributes are found:

Utility. Any thing which possesses value must have utility. Utility means want

satisfying power of a good.

Scarcity. Scarcity is an essential feature of a good before it can have value. In

other words its supply must be less than demand. Water is available everywhere that is why it is having no price or very little price.


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Transferability. It is one of the distinct features of a thing to have value. It isalso called marketability. It means to change the ownership of a thing. Thosewho sell their goods must feel less quantity of the same, other wise it is nothaving value in economics e.g. honesty or good will of a business.

Wealth: - All goods which have value are called wealth in economics. Accordingto Lord Keynes, All those goods which have value and the capacity to satisfyhuman wants are called wealth in Economics. In other words goods havingutility, scarcity and transferability are called wealth. Wealth which is in thepossession of an individual is called private or individual wealth. Wealth which ispossessed by the society is called social wealth like public parks. When wealth ispossessed by the whole country it is called national wealth like petroleum, iron,minerals etc. when the whole countries of the world are having the right over acertain wealth it is called international wealth like IMF, IBRD etc.

Capital: - capital is that part of wealth which is used for further production. If aperson is having a house but he is not residing in it but uses it for earning rent, it is

called capital. On other words capital is called Produced means of production.Money used as capital is called money capital or financial capital in economics.

Q: - What do you understand by consumption, gives various types ofconsumption?Ans:- Every process of production is backed by consumption, consumption as perDr. Marshall is sole end and purpose of all production. Consumption can best bedefined as destruction of utility provided it serves your purpose and purpose beingthe satisfaction of the consumer. Mere destruction of utility will not meanconsumption. According to Ely, Consumption in its broadest sense means the use of

economic goods and personal service in the satisfaction of human wants.Kinds of consumption:-(a): Slow and Fast Consumption:- Slow consumption can be defined as theconsumption where utility gets destroyed over a period of time e.g. pen, book, chairetc. on the other hand when the utility is destroyed at a point of time it is called asquick consumption e.g. fruits, food etc.(b): Direct and indirect consumption:- when goods are directly consumed forthe satisfaction of current wants. On the other hand when goods are consumed nowbut the satisfaction is attained in future, it is called future consumption. In the formercase it is also called as current consumption and in the later case it is calledpostponed consumption.

(c): Wasteful Consumption:- there are generally two opinions about thewasteful consumption, while on the one hand some economists said that it isconsumption while as others said that it is not consumption. If a newly constructedhouse caught fire, its utility gets destroyed, some are in favour of calling it beconsumption while others do not.

Consumption has assumed a great importance in the theory of economics. Westudy consumption even before production. It is said that necessity is the mother of


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invention. That is why every consumer is treated like a sovereign by the producers.The line of production is always determined by the tastes of the consumers.Q: - Explain Wants, what are the types of wants? Also mention itscharacteristics?Ans: -According to Penson, All those desires for the satisfaction of which a man hasthe means and the willingness to use those means for satisfaction are calledwants. Thus wants can be simply explained as the desires backed by the purchasingpower.There are generally three types of wants taking in to consideration the income of theconsumers; these are Necessities, Comforts, and Luxuries.

Necessities: - Those things the consumption of which is necessary for eachand every consumer irrespective of the level of income. These are generally food,shelter and clothing; these are the things which are required by the population as awhole. There is no doubt that if these are not used by the consumers, will result inthe loss of efficiency of the same.

Comforts: - comforts are those articles of consumption, the use of which doesnot increase our efficiency but it simply adds to our comforts and welfare. These aregenerally perceived when the necessities are fulfilled. As the income of the consumeris above the amount required for the fulfilment of necessaries, the remaining amountcan be spent on these goods.

Luxuries: - these are those goods which do not increase our welfare but arehaving more demonstration effect. These articles include costly cars, goldornaments, diamond etc. according to Sydney Chapman, luxuries are things whichwhen consumed do not appreciably add so and may detract from a personsefficiency. These include the articles like wine, opium, dancing etc. In short thesegoods are used for self display.

Q:- Explain law of Equi-Marginal ?Ans:- This law is very important law of consumption. The law of diminishing MarginalUtility is applicable only when the consumer is utilizing only one commodity or ishaving only one want. But normally we find that individuals have more than one wantto satisfy with a little income. This law gives us an idea of how the consumerallocates his limited resources on the purchase of different commodities in themarket. This law is known by different names such as; law of substitution, law ofindifference, and law of maximum satisfaction. The law of equi-margnal utility statesthat the consumer will distribute his money income between the goods in such a way

that the utility derived from last rupee spent on each good is equal.Lets illustrate the law of equi-marginal with the help of a table given below:

Marginal Utility of Good X and Y (table1)

Units MUx (utils) MUy (utils)

12345

2018161412

242118159


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6 10 3

Let the price of good X be Rs 2 and of good Y be Rs 3 and the person having Rs 24 ashis income. Reconstructing the above table by dividing marginal utilities of X by Rs 2and MUy by Rs3, we get the following table:

Marginal Utility of Money Expenditure table (2)Units MUx/Px MUy/Py

123456

1098765

876531

By looking at table 2 it will become clear MUx/Px is equal to 5 utils when theconsumer purchases 6 units of good X and MUy/Py is equal to 5 utils when he buys 4units of good Y. Therefore consumer will be in equilibrium spending 2x6 + 3x4= 24on them. At this combination all the conditions are fulfilled i.e. he is gettingmaximum satisfaction of 71 utils, using both the goods simultaneously, and isindifferent about other combinations which are available.

Q: - Define consumer surplus? Explain it with suitable example?Ans:- The law of consumer surplus is one of the most important contributions of Dr.Marshall to economic theory. According to him, the excess of the price which aconsumer would be willing to pay rather than to go with out the thing over that whichhe actually does pay, is the economic measure of consumer surplus. In other wordsthe difference between potential payment and actual payment is called theconsumer surplus or it may be defined as; price which a consumer is willing to pay

price what he actually pays.A consumer continues to use the good as soon as he gets more utility from the

consumption of the good and will stop consumption at a point where the price isequal to the utility he draws. Market price is always somewhat fixed and constantwhile utility drawn is more in the first instance and starts falling there after as perlaw of diminishing marginal utility.Lets give a table

Commodities Marginal Utility Market Price ConsumerSurplus

1

234

60

402010

10

101010

60-10=50

40-10=3020-10=1010-10=0

Total MU=130 P=40 CS=90

The consumer is willing to pay Rs 60 for the first unit but he actually pays Rs 10, inthis case consumer surplus is 50 utils and so on.


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When the consumer uses the first unit he isready to pay Rs 60, but he actually paysonly Rs10 thus gets a surplus utility of 50utils and so on, this excess utility is calledconsumers surplus.

PRODUCTIONQ: - What do you mean by production? There are mainly 4 factors ofproduction, comment?Ans:- As consumption means destruction of utility, production means creation ofutility. So far as the natural science is concerned, matter in this world is fixed. It canneither be created nor can it be destroyed, what can be done simply is that we canarrange appropriate quantities of the matter in order to create the utility out of thegiven matter, in other words we change the form and make it more useful. It is thusclear that production consists in crating utility in goods for the satisfaction of humanwants. This utility may be created by either changing the form, by changing theplace or by changing the time. According to Fairchild, production consists ofcreation of utility in wealth.

There is long debate on the number of factors of production. If we takeseparately each and every factor in to consideration then there are thousands of


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factors of production. According to Dr. Benham, anything which helps in the processof production is a factor of production.According to J S Mill, Land and Labour are the main two factors of productionFinally there was a consensus that there are only four factors of production theseare; Land, Labour, Capital, Entrepreneur.

Q: - What do you mean by Land? Give its characteristics?Ans:- All those things which are bestowed by the God or nature upon the humanbeings as free gifts of nature are included in land. It does mean only the meresurface of soil. According to Dr. Marshall, by land is meant not merely land in thestrict sense of the word, but whole of the materials and forces which nature givesfreely for mans aid in land and water, in air and light and heat. Thus we see thatminerals, air, light, sunshine, water, soil etc. are all included in land which is bothunder and above the earth.

Characteristics of land:-Land has been described as the most important factor of production. Without landthere would be no concept of other factors of production. Land is the only source offood and shelter. However there are certain other characteristics of land which are asunder:

Land is free gift of nature, it is fixed and unchangeable.

We can not increase the supply of land; it is independent of needs of

man.

Land is the passive factor of production, it does not play direct role inproduction.

Land is the original factor of production. Its qualities can not be

destroyed.

Economic development of a country depends up on its land and naturalresources.

Q: - What do you mean by intensive and extensive cultivation?Ans: - Intensive cultivation is that method of production in which same land is usedfor more and more production. This type of production is feasible for those countrieswhere there is scarcity of land like Brittan, Denmark, and Germany etc. In thesecountries there is no scarcity of other factors. Newer methods of cultivation are usedlike new technology and high yielding varieties are used.On the other hand Extensive cultivation is that cultivation where in order to increasethe production new and new land is taken in to cultivation. Countries like, USA,Canada, Australia etc. in these countries vast areas of land are lying uncultivated and

land is cheaply available.

Q:- What is labour? Also comment on its role in production?


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Ans:- labour is any activity done mentally or physically, but is done not for the sakeof pleasure but with a view to earning money for the satisfaction of material wants.According to Dr. Marshall, By labour is meant the economic work of man whetherwith hand or head. Labour like land is treated as the basic factor of production. Landand labour when combined in a right proportion produce wealth. Labour is treated asthe most active factor of production.The various types of labour are:-

1. Mental and Manual Labour:- Mental labour can be explained as the labourwhich is done by professionals like Teachers, Lawyers, Doctors etc. On theother hand physical labour is the labour which is done by ordinary men.

2. Skilled and Unskilled Labour:- skilled labour is done by skilful persons while therest of the labour is unskilled labour, it needs no training and can be done without spending too much time on acquiring techniques of production.

3. Direct and Indirect Labour:- The labour which is done for producing goodswhich satisfy directly human wants is called direct labour while as labour whichcreates utility for people is called indirect labour like banking and insuranceservices.

Characteristics of Labour:- Labour cannot be accumulated like land or capital. It must be rendered now

and neither can nor is saved for tomorrow.

Labour can not be separated from the labourer i.e. why it is taken as most

immobile factor of production.

Labour can nor be increased with the increase in the demand for labour.Labour can be increased by migration or immigration.

Labourer is a means of production as well as an end because he is the

consumer too. Whatever is produced is also consumed by the labour force.

It is regarded as the most active factor of production compared to land orcapital.

Q: - Explain Malthusian theory of population? Give its various features?Ans:- T R Malthus was an English clergyman. He made a scientific study in to theproblem of the quantitative aspect of population and formulated the theory ofpopulation in the year 1798 published in his book An essay on population he wasan expert in Maths History and polity. He made a detailed study of Europe and USA.The following are the main conclusions of his theory:

1. Contact between men and women are natural, as a result population increasesin geometric progression and that of food supply increases in arithmetic

progression.2. The growth of population can be checked by two ways either by positivechecks or preventive checks. Preventive checks are those which are practisedby man himself while as positive checks are those which are practised by thenature.

3. Man should make use of preventive checks otherwise he has to bear the painof positive checks.


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4. If population growth remains unchecked then population will double afterevery 25 years.

5. The law of diminishing returns operates on land hence food growth slow. Thisupsets the balance population and food supply giving rise to hue and cry.

Criticism:-

The view of Malthus regarding arithmetic progression of food is invalid ashe ignores new technology.

His contention of population doubles in 25 years is also invalid

He was severely criticized on the grounds that man does not come onlywith a mouth but with two hands also.

He describes poverty in his own way and held the increasing population asmainly responsible for poverty.

Q: - Define capital? Explain its characteristics and role in the production?Ans:- All that which is possessed by a man and helps him in the process of

production is called capital. In other words we can explain capital as produced meansof production. In ordinary language capital means riches or money. But in economicsit means money capital or financial capital. Hence all machinery, tools, equipmentsand all the things which help us in further production is called capital. According toDr. Marshall, Capital consists of those kinds of wealth, other than the free gifts ofnature, which yield income. According to Adam Smith, Capital is that part of hisstock from which he expects to derive an income.Characteristics of Capital:

1. Capital is the result of accumulation; it is the result of saving of man.2. Value of capital can be depreciated or appreciated over time, if as a result of

the use of capital it gets depreciated.

3. Capital has been explained as the most mobile.4. It is passive factor of production, but it results in the massive production.5. It is the most flexible factor of production as it can be altered at will.Role of capital:-Capital plays a very vital role in the process of development. With out capitalmassive production would not have been possible, it is only because of capitalthat industrialization had become possible and the standard of life had increasedof the world as a whole. However its role can best be explained with the help offollowing points:

Because of capital the subsistence of lower class or labour class has becomepossible.

Capital means produced means of production like modern appliances and othertools increases the productivity of the labour.

It is only because of the capital that goods can be transported from the placeof abundance to the place of scarcity.

Q:- What are the different kinds of capital?


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Ans:- there are generally two types of capital which can be named as fixed andvariable capital, but there are other types of capital as well taking in to considerationthe function of capital, these are:

1. Fixed capital is that capital which remains fixed through out the process ofproduction. On the other hand circulating capital is that capital which can beused for production but for once.

2. Sunken capital is that capital which is specialized and has taken a definiteshape, while as capital may be defined as floating; it is that capital which canbe in the use in which we want.

3. That part of capital which is used for the purpose of giving payments andwages to the labourers is called remuneratory capital.

4. Human capital is that capital which is an acquired capacity by the people likecertain techniques of production e.g. Doctors and Engineers, Teachers andArtisans.

5. Loanable, Business and Working capital, capital which is invested in business iscalled business capital and capital used for payment of wages and purchase ofraw materials is called working capital and the capital used for giving loans iscalled Loanable capital.

Q:- Explain the relationship between Economic development andInnovation?Ans:- there is a great relationship between economic development and innovation.According to Rostow, The propensity to innovate and apply science and technologyfor purpose of economic growth is one of the basic conditions of economicdevelopment. Schumpeter tried to show that the main source of private profit issuccessful innovation and this in turn is the essence of economic development.

Q: - Explain the meaning of entrepreneur and its role in the over allproduction?Ans: - It will not be desirable to say that production is a function of land labour andcapital alone, there must be some one who will organise the functions of thesefactors in right proportion and initiate the process of production and also bear therisk involved in it. This factor is known as entrepreneur. The entrepreneur is alsocalled organiser, risk lover, risk taker and also risk bearer. He is also called themanager, but in these days of specialization, the task of manager and organiser hasbecome different from that of the entrepreneur. The real task of the entrepreneur isto initiate the production work and not to manage the business affairs.

Role or functions of entrepreneur:There is controversy about the role or functions of entrepreneur. Various economistshave laid stress on the different functions of the entrepreneur. According toSchumpeter, the function of the entrepreneur is to introduce the innovation, whileKnight emphasized the uncertainty bearing function of the entrepreneur. In the shortthe following are the main functions of an entrepreneur:


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Planning becomes the basis of any economic activity; an organiser imaginesand prepares a plan for the business. Then he gives it a practical shape byexecuting the same.

It is the most important function of the organiser to collect and organise the

other factors in right proportions so that production can be effected properly. In most of the production processes, it must be borne in mind by the

entrepreneur either to start the production at small or at large scale.

One of the functions of the organiser is to provide the market to the production

for that he hires people for its marketing.

In the process of production, he must take care of the quantity and quality ofthe product.

He must offer the remuneration to labourers as per their productivity so that

they must feel comfortable because it is the industry of these labourers thatproduction becomes possible.

As is discussed above that the chief activity of the organiser is innovation and

research n development.

Q: - Explain law of returns to a variable factor? OrExplain law of variable proportions? OrExplain short-run production function?

Ans:- the law of variable proportions or returns to a variable factor occupies animportant place in the modern economic analysis. The law expresses the relationshipbetween the units of a variable factor and output in the short run, keeping otherthings as constant.

According to this law if one factor of production is kept variable and all otherare kept constant, the total output will increase a an increasing rate in the firstinstance, and then at a diminishing rate, or the average and the marginal productwill rise up to a certain stage, and then eventually decline. The law assumes thatthere is no change in the techniques of production.

In order to understand the stages, it is better to first numerically and thengraphically illustrate the production function with one factor variable:

FixedFactor

VariableFactor

TotalProduct

MarginalProduct

AverageProduct


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1010101010101010

12345678

100220270300320330330320

100110907564554740

100120503020100

-10

I

II

III

If we look at the table carefully we will find three stages operating in the tablethese are:

1. Stage First. The first stage goes from the origin to the point where theaverage product and the marginal product are equal. The marginal productfirst increases and then starts decreasing in the region. However the totalproduct increases first at an increasing rate and then at a diminishing rate.

2. Stage Second. The second stage begins from a point where average and themarginal product curves intersect each other. And ends at a point where MPbecomes zero. This is a stage where TP reaches its maximum.

3. Stage Third. The stage begins from the point where the marginal product

becomes zero and ends at the point where the total product and averageproduct also becomes zero. In other words, in this stage the increasing use oflabour yields smaller total product. This stage is also called the stage ofnegative returns.If we look at the table carefully we will find three stages operating in the table

these are:4. Stage First. The first stage goes from the origin to the point where the

average product and the marginal product are equal. The marginal product


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MP

AP MP

TP


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first increases and then starts decreasing in the region. However the totalproduct increases first at an increasing rate and then at a diminishing rate.

5. Stage Second. The second stage begins from a point where average and themarginal product curves intersect each other. And ends at a point where MPbecomes zero. This is a stage where TP reaches its maximum.

6. Stage Third. The stage begins from the point where the marginal productbecomes zero and ends at the point where the total product and averageproduct also becomes zero. In other words, in this stage the increasing use oflabour yields smaller total product. This stage is also called the stage ofnegative returns.

Q:-Explain law of returns to scale? Or Explain Long run productionfunction?Ans:- The law expresses the functional relationship between the quantities of out putand the scale of production in the long run when all factor inputs are increased in thesame proportion. In short returns to scale refers to the effect of scale relationship.

Now the question arises as to what rate the output increases when all factorinputs are varied in the same proportion. According to this law there can be threepossibilities in this regard. The increase in output may be more than, equal to or lessthan proportionate increase in factor input. Accordingly returns to scale are of threetypes;

1. Increasing returns to scale2. Constant returns to scale3. Diminishing returns to scale.

The concept of law of returns to scale can be explained with the help of the followingtable however it is to be remembered that we take into consideration physical unitsof input and output.

REURNS TO SCALEUnits of labour Capital Total Returns Marginal Returns

AB

CDEFG

12

34567

++

+++++

12

34567

1021

3345576878

1011 Increasing

1212 Constant1211 Decreasing10

This can be explained with the help of the following diagram.


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B C

D


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Marginal Returns

As is clear from the above diagram, as scale of production increases, marginalreturns go up from A to B then becomes constant from B to C and finally begins tofall from C to D.

Lets explain the three stages separately:1. Increasing Returns To Scale. When proportionate increase in the total

output is more than proportionate increase in inputs is called increasing

returns to scale. In the above example this stage runs from combination A to Cwhen with the proportionate increase in combination of factor inputs, totalproduct increases more than proportionate increase in factor inputs andmarginal product also increases.

2. Constant Returns To Scale. When total product increases at a constant rateand therefore marginal product remains constant, it is called constant returnsto scale. In the above example this stage runs from combination D to E whereproportionate increase in factor inputs leads to proportionate increase inoutput and hence marginal product remains constant.

3. Diminishing Returns To Scale. When total product is increasing atdecreasing rate and thus marginal product starts diminishing, it is called

diminishing returns to scale. In the above example this stage runs fromcombination F onwards where proportionate increase in inputs leads to lessthan proportionate increase in total product and hence M P starts diminishing.

COSTSQ: - Define cost or explain cost of production?Ans:- Cost refers to the sacrifice that must made to do or to acquire some thing what is

sacrificed may be money, goods, leisure, time, power etc.Cost of production refers to the expenditure made by a firm on the purchase of raw

material and factor services for producing a commodity.Q: - Define Money Cost or Nominal Cost and Real Cost?


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Ans: - Money Cost. When the cost of production of a commodity is expressed in terms ofmoney is called money cost. When a producer starts business, he makes payments to thefactors of production and raw material in terms of money, this is called money cost ornominal cost.

Real Cost. The efforts, sacrifice, discomfort, pain etc. undergone for producing a

commodity is called real cost for example land lord sacrifices use of land and waits for rent,labour sacrifices his services for wages etc.Q: - Define total cost and average cost?Ans: - Total Cost. Total cost is that cost which is incurred on the production of given output.It is the sum total of variable and fixed costs. Symbolically;

TC= TVC+ TFCIt can be calculated when total number of units produced is multiplied by cost of

production per unit of commodity i.e. average costThus TC= no. of units produced X average costAverage Cost. Average cost is the cost of production per unit of output produced. It

can be calculated by dividing the number of units produced by total cost as;AC = Total Cost/Q

Q: - Define total fixed cost and total variable cost?Ans: - total fixed cost. Fixed cost is also called as over head cost or supplementary cost.Fixed costs are those costs which are independent of the level of output i.e. they do notchange with the change in output. Even if the firm closes down for some time, these costsare still borne by it. These costs include charges such as contractual rent, insurance fee,maintenance costs, salaries of permanent employees etc.

COS FC

T

0 PRODUCT

Total Variable Costs. Variable cost is also called as prime cost. It may also be calledas direct cost. It includes expenditure made in the purchase of raw materials used formaking a commodity, depreciation of machinery etc. in short variable costs are those costswhich varies with the volume of output i.e. if production increases variable costs alsoincreases and vice-versa.

VCCOS

T

O PRODUCT

Q: - Define marginal cost?Ans: -marginal cost refers to the additional cost for producing one additional unit ofcommodity. In other words, marginal cost is the increase in total cost resulting fromone unit increase in output. It is calculated by using the following formula;

MC = TCn TCn-1


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Where n stands for any volume of output, for example, if the total cost of producing 5units is Rs. 35 and the total cost of producing 6 units is Rs. 43, MC i.e. the cost of the6th unit will be RS. 43 35 = 8. It should be remembered that MC has nothing to dowith fixed cost.Q: - Define Average Fixed Cost and Average Variable Cost?

Ans: -Average Fixed Cost. It is obtained when we divide total fixed cost by thenumber of units produced thus;

AFC = TFC/QHere total fixed cost is the cost incurred on the production of commodity here it mustbe noted that it remains fixed thorough out the production.

0

Average Variable Cost. It is obtained when we divide total variable cost bythe number of units of output produced thus;

AVC = TVC/Q

Here it must be noted that total variable cost is the cost which is having directrelationship with production and it increases with the increase in the scale ofproduction. These costs will be zero if the production is zero.Q: - Explain the relationship between Marginal Cost and Average Cost?

Ans: -The relationship between average and marginal cost can be explained with thehelp of following table and diagram:

Unitsofoutput

TotalCost(TC)

MarginalCost(MC)

AverageCost(AC)

12

345678

1830

40526582106140

1812

101213172434

1815

13.34131313.6715.1417.5


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AFC

X

Y

OUTPUT

Average Fixed Cost

ACMC


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COST

OUTPUT

From the above table and diagram following points of relationship between AC andMC are obtained:

Average cost falls when marginal cost remains below it, hence MC < AC in this

range of output.

When marginal cost becomes equal to average cost, marginal cost curve cuts

average cost curve from below.

AC starts rising when marginal becomes higher than average cost hence MC >AC.

Q: - What do you mean by the term Market?Ans: -in ordinary language or sense market means any particular place or localitywhere goods are bought and sold. But in economics market does not mean aparticular place where goods are bought and sold. In economics market meansexistence of close contact between buyers and sellers, so that transaction i.e. saleand purchase of a commodity at an agreed price takes place.

According to Cournot, Economists understand by the term market not anyparticular place in which things are bought and sold but the whole of any region inwhich buyers and sellers are in such a free intercourse with one another that theprice of some good tends to be equality and quickly.Q: - Define perfect competition? Also discuss its features?Ans: -Perfect competition market is a market situation where there are large numberof buyers and sellers of a homogeneous product. In a perfect competitive market, thepotential buyers and sellers are fully aware of the price so that no buyer or seller canindividually effect the price. Thus under perfect competition market a firm is pricetaker rather than price maker.

Features of perfect competition: -1. Large number of buyers: - there is large number of buyers, each buyer buys

a small fraction of total output and no buyer is in position or is so strong toinfluence the price in his own favour.

2. Large number of sellers: - there is large number of sellers of a commodity,each seller sells a small fraction the total output and no seller is in a position toinfluence price in his favour. In other words every seller is a price taker.

3. Homogeneous product: - All firms sell and produce homogeneous product inthe market, homogeneity may be in the form of packing, style, technique etc.

4. Free entry and exit: - There if free entry and exit i.e. any new firm can enterin to the industry and any old firm can leave the industry at any time there is


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no restriction, as the contribution of every single firm is very small to the totaloutput.

5. Uniform price: - all the firms in the market are price taker and no one is pricemaker. This means that only one price prevail in the whole market.

6. Perfect Knowledge: - All buyers and sellers have perfect knowledge aboutthe market situation. It is working on the principle of caveat emptor whichmeans let the buyer know.

7. Perfect Mobility of the factors of production: - Labour and capital moveeasily from one place to other place. As there prevails only one remunerationfor the whole of factors of production.

8. Normal Profit: - Firms under perfect competition earns only normal profitsdue to competition. Since there is free entry for all the potential firms whowant to enter the market, if there is any situation of abnormal profits the newfirms will enter the market and will vanish it automatically.

Q: - Define Monopoly and discuss its features?Ans: - The word Monopoly is made of two Greek words Mono and Poly whichmeans single and seller respectively. Thus monopoly is that market situationwhere there is only one seller or producer of a product. The good which monopolysells has no close substitutes. This implies that monopoly has sole control over thesupply of the product and its price. Since monopoly is a price maker and not pricetaker and hence earn abnormal profits.

Features of Monopoly

Single Seller: - The first and the important feature of monopoly is that thereis a single seller or producer producing the commodity in the market.

No Close Substitute: - The second important feature of monopoly is that themonopoly produces that commodity which has no close substitute, as there is

only one seller and is the person who produces it. Barrier To Entry: - The entry of new firms into the industry in monopoly

market is completely prohibited or made impossible. If new firms inter into theindustry, monopoly itself breaks down.

Price Discrimination: - The monopoly charges different prices for the sameproduct from different consumers. As there is only seller in the market thebuyers has no other choice to choose than to accept the price.

Full Control over Price: - The contraction and extension of the supply of theproducty is in the hands of monopoly.

Earns Abnormal Profits: - Monopolist earns abnormal profits because he hassole control over the price and supply of the product.

Q: - What do you mean by Monopolistic Competition, discuss briefly itsfeatures?Ans: - Monopolistic Competition market is a market situation where there arelarge number of sellers selling differentiated products which are close substitutes toeach other. The firm under this competition has some control over the price andsupply of its product as it has monopoly power over his own product. This powermanifests itself


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Features of Monopolistic Competition:1. Large Number of Sellers: - There are large numbers of sellers or firms

producing commodity in the market. Each firm controls a very small share oftotal output.

2. Freedom of Entry and Exit: - Every firm is free to enter into the industry andcome out from the industry whenever it wishes. The total output in the marketis so high that each firm contributes a very small portion of total product.

3. Product Differentiation: - Each firm produces a product that is somewhatdifferent from the products of its competitors. The product may bedifferentiated in many ways for example by changing brand name, trade mark,design, size, weight etc.

4. Each firm is monopolist for its product: - Every firm has monopoly over itsproduct i.e. no other firm can manufacture the product of his brand name e.g.Dettol is a brand manufactured by its own firm and no other firm can produceit.

5. Selling Cost: - Every firm seeks to modify consumers preference through ads,this gives rise to what is known as selling cost thus there is no pricecompetition.

6. Some control over the price: - As a result of differences in the brands everyfirm has a monopoly over the product and as result of this they enjoy somecontrol over the price. The difference in the price cannot be so big, as it candivert the consumers to its substitutes which are available at a cheap price.

Q: - Explain how price is determined under perfect competition? OrExplain Determination of equilibrium price under perfect

competition?Ans: -There was a dispute among economists about how the price is determined of

the commodity in the perfect market. Some economists were of the opinion thatprice of the commodity depends on marginal utility and is determined by demand.Others were of the opinion that price of a commodity depends on cost of productionand is determined by supply. It was Marshall who subside this dispute by saying thatprice of a commodity is determined by both demand and supply of a commodity inthe perfect competition.

He gave a famous example of a pair of scissors, We might be reasonablydisputed whether it is under blade or upper blade which cuts the paper, but actuallyboth together cuts it. Similarly both demand and supply determine price.

The determination of equilibrium price under perfect competition can beexplained with the help of following table and diagram.

Price/unit of comm. QuantityDemanded QuantitySupplied Price Trend

302010

101520

201510

FallingBalanceRising


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S

P2

P

P1

0 Quantity Demanded & Supplied

E

M

G

X

Y

D

DS


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It is clear from the above table that at the price of Rs. 30 Quantity demanded is 10and supplied is 20 units; this creates the situation of excess supply. This excesssupply pushes the price below so that equilibrium between demand and supply ismaintained. Now price falls to Rs. 20, at this price demand is 15 units and supply isalso 15 units. Thus Rs. 20 is equilibrium price and quantity 15 is equilibrium quantity.If price falls to Rs. 10 demand becomes more than supply this excess demandpushes the price back to equilibrium level.

In the above diagram DD is demand curve and SS is supply curve. DD and SScurves meet each other at point E where OP is Equilibrium price and OQ isEquilibrium quantity. If price rises to OP1, excess supply LM will bring down priceback to OP similarly if price falls to OP2, excess demand BG will push up price back toOP. Thus equilibrium price will be maintained by the forces of demand and supply.

NATIONAL INCOMEQ: - Define National Income?

Ans: - National Income can be defined as the sum of total of income earned byvarious factors of production viz, land, labour, capital and entrepreneur in aneconomy during one year. In other words national income is the money value of allfinal goods and services produced in the economy in an accounting year.

According to Pigou, That part of objective income of the commodity includingof course income earned from abroad which can be measured in terms of money.Thus national income of a country can be defined as the value expressed inmonetary terms. It is therefore, the monetary measure of the current flow of net finalgoods and services resulting from the production activities of the normal residents ofa country in the year.Q: - Explain the various concepts of national income?

Ans: -there are generally eight alternative concepts of national income which can beexplained as follows:1. Gross Domestic Product at Market Price (GDPMP): - Gross domestic product

at market price is the market value of all final goods and services produced withinthe domestic territory of a country in an accounting year. Gross domestic producthas following components:

(1)Value of final consumer goods produced in one year by house holdsdenoted by C


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(2)Value of new capital goods produced and addition to inventories calledgross private investment denoted by I

(3)Govt. purchases of goods and services denoted by G(4)Net exports X-M which is equal to value of exports x minus imports

mThus GDPMP = C+I+G+(X-M)

2. Gross National Product at Market Price (GNPMP): - Gross domestic product atmarket price is the market value of the final goods and services produced withinthe domestic territory of country by; the normal residents during an accountingyear along with net factor income from abroad and consumption of fixed capital ordepreciation.GDPMP becomes GNP if net factor income from abroad is added to it. Thus GDP MP +Net Factor Income from abroad = GNPMP

3. Net Domestic product at Market Price (NDPMP): - Net domestic product atmarket price is the market value of the final goods and services produced withinthe domestic territory of a country, exclusive of depreciation.

NDPMP = GDPMP Depreciation4. Net National Product at Market Price (NNPMP): - Net national product at

market price is the market value of all final goods and services produced withinthe domestic territory of a country along with net factor income from abroadduring an accounting year.Some capital goods are used up in the production process largely as wear andtear. The cost to replace these capital goods is called capital consumption ordepreciation. Deducting the depreciation from GNPMP we get NNPMP Thus, NNPMP =GNPMP Depreciation

5. Net Domestic Product at factor Cost or Net Domestic Income (NDPFC): -

Net domestic product at factor cost is the sum total of factor incomes generatedwithin the domestic territory of a country during a period of time. It is brieflycalled domestic income, it is equal to net domestic product at factor cost. Thus

NDPFC = NDPMP INDIRECT TEX + SUBSIDIES ORNDPFC = NDPMP - NET INDIRECT TEXES

While Net Indirect Taxes = Indirect Tax Subsidies6. Gross Domestic Product at Factor Cost (GDPFC): - Gross domestic product at

factor cost is the sum total of factor incomes (rent + interest + wages + profit)generated within the domestic territory of a country, along with consumption offixed capital during a year. Thus

GDPFC = NDPFC + Depreciation

7. Net National Product at Factor Cost(NNPFC): - Net national product at factorcost is the sum total of factor incomes generated within the domestic territory of acountry, along with the factor incomes from the rest of the world during a year.This is also called as National Income.

NNPFC = NDPFC + Net Factor Income from abroad.8. Gross National Product at Factor Cost (GNPFC): - Gross national product at

factor cost is the sum total of factor incomes earned by normal residents ofcountry, along with consumption of fixed capital during a year. In other words


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when the depreciation is not deducted from the national income it remains grossincome. Thus

GNPFC = NNPFC + DepreciationQ: - Explain various methods of National Income? What are the difficultiesfaced by this method?Ans: - There are generally three methods of measuring national incomenamely; Income Method, Product Method and Expenditure Method.

1. Income Method: - this method is also called as Distributive Share Method orFactor Payment Method. It is that method which measures national incomefrom the side of payments made in the form of wages , rent, interest andprofits to the primary factors of production i.e. labour, land, capital andentrepreneur respectively for their productive services in an accounting year.Thus income method measures the national income from the distribution side.Difficulties of Income Method:

Determination of factor share: - there is no unique way to determine and

estimate the contribution of entrepreneur in the process of production . Change in price: - in the period of boom and inflation, price rise is

experienced which affects the value of stocks with the producers.

Allocation of mixed income: - This is another hurdle in the computation of

national income by the income method. As the income of the farms isincluded in factor income, the income from ownership of farm buildings aswell as financial assets is not included in the factor income.

Allocation of dividends: - allocation of dividends also poses another threat in

the computation of national income. Dividends paid to households, govt.,and non-profit making organizations etc. are included in factor income. Buton the other hand, inter corporate dividends are not regarded as a part of

national income.2. Product Method: - this method is also called as value added method; it is

that method which measures the national income by estimating thecontribution of each producing enterprise to production in the domesticterritory of the country in an accounting year. According to this method,national income is the sum total value of all final goods and services produced.These totals are known as the net domestic product at market price.

Difficulties of Product Method:

Problem of double counting: - This method only includes final goods and

services in the calculation of national income, but if the value ofintermediate goods is also included in the national income, there exists the

problem of double counting. Problem of imputed values: - In national income accounting goods and

services for self consumption are also included, but to compute value ofthese goods and services is really a difficult job.

Insufficient Data: - In countries like India there is lack of data which poses a

severe threat to the national income accounting.


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3. Expenditure Method: -The third method of measuring the national income isexpenditure method. This is also called Income Disposal Method. This methodmeasures the final expenditure on gross domestic product at market priceduring an accounting year. This total final expenditure is equal to the grossdomestic product at market price.

Difficulties in Expenditure Method: - Consumer durable goods are a serious problem.

Some times it becomes difficult to differentiate between government

consumption expenditure and government investment expenditure.

Interest on national debit paid by govt. is not included in govt. expenditure.

There is not sufficient data regarding consumption expenditure and

investment expenditure particularly in unorganized sectorQ. Inflation- MeaningInflation is a phenomenon of excess demand. It is a state of affairs in which there isexcess demand for goods in the economy as a whole. It means that the level of

spending directed towards the home produced goods exceeds the maximum outputof goods which is attainable in the long period, given the existing productiveresources.According to Emele James, Inflation is a self-perpetuating and irreversible upwardmovement of prices caused by an excess of demand over capacity to supply.According to Keynes, Inflation is the result of the excess of aggregate demand overthe available aggregate supply and true inflation starts only after full employment.According to A.J. Hagger, By inflation we shall mean a situation, in which there ispersistent upward movement in the general price level, or in which there would besuch a persistent upward movement, but for the presence of direct control overprices.

Thus, it is clear from the above that inflation may be defined as a sustained rise inthe general level of commodity prices over some period of time.

Q. Causes of InflationInflation may be due to the operation of one or more of the following factors. Some ofthem result in increased demand for goods, while others result in shortage of goodson the supply side. These factors are:(a) Increase in money supply- This may take place in two ways like more currencymay be issued, Banks may create more credit. Both may increase simultaneously.(b) During wars, need of the military have to be met with first of all. The supply ofgoods for the civilians is reduced. Prices look up.(c) Sometimes, producer and traders may stock commodities to charge higher pricesin future. This creates artificial scarcity and prices rise in the market.(d) Strong trade unions may be able to increase their wages without an equalincrease in productivity. Wage rise pushes up cost, which, in turn, pushes up prices,which again pushes up costs and so on the expanding spiral.


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(e) Hoarded money may be brought into the market in the form of greater demandfor consumers goods and for investment goods. Such increase in demand may pushup prices.(f) The government spends, more than its revenues. This often results in the puttingof new notes. Quantity of money increases. A price goes up.(g) The government may be repaying old debts. This increases the purchasing powerof the people.(i) As population increases demand for goods and services, increases, prices rise.(j) There may, too much rain or too little rain. Agricultural goods decline in supply.Their prices rise.(k) If there is lack of industrial peace in the country, strikes and lock-outs arecommon, then production falls in the country and prices go upQ. Effects of InflationInflation affects different people, differently. This is because of the fall in the value ofmoney. When the value of money falls or prices rise, same groups of the society gainsome lose and some stand in between.(a) During periods of rising prices, debtors gain and creditors lose. When prices rise,the value of money falls. Though debtors return the same amount, but they pay lessin terms of goods and services. This is, because the value money is less than, whenthey borrowed the money. Thus, the burden of the debt is reduced and debtors gain.On the other hand creditors lose.Although they get back the same amount of money, which they lent, they receiveless, in real terms, because the value of money falls.(b)Salaried workers such as clerks, teachers, and other white collar people lose,when there is inflation. The reason is that their salaries are slow to adjust, whenprices are rising.

(c) Pensioners, recipient of interest and rent. Similarly, the rentier class, consisting ofinterest and rent receivers, get fixed payments. The same is the case with theholders of fixed interest bearing securities, debentures and deposits. All such personslose, because they receive fixed payments, while the value of money continues to fallwith rising prices.(d) When prices start rising, production is encouraged. Producers earn windfall profitsin the future. They invest more in anticipation of higher profits in the future. Thistends to increase employment, production and income. But, this is only, possible upto the full employment level. Further increase in investment beyond this level, willlead to severe inflationary pressures within the economy, because prices rise, morethan the production as the resources are fully employed. So, inflation, adversely

affects production after the level of full employment.(e) Inflation affects, adversely, the balance of payments of a country, when pricesrise, more rapidly, in the home country than in foreign countries. Our productsbecome costly compared to foreign products. This tends to increase imports andreduces export, thereby making the balance of payments unfavourable for ourcountry.(f) Inflation encourages speculation. During inflationary periods, the energies of thebusiness community are dissipated in speculative activities to earn quick profits.


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Q. How inflation can be controlledAs we know that inflation is caused by the failure of aggregate supply to equal theincrease in aggregate demand. Inflation can, therefore be controlled by increasingthe supplies and reducing money incomes in order to control aggregate demand. Thevarious measures taken to control inflation are as follows:(a) One of the important monetary measures is monetary policy. The central bank ofthe country adopts a number of methods to control the quantity and quality of credit.For this purpose it raises the bank rate, sells securities in the open market, raises thereserve ratio, and adopts a number of selective credit control measures.(b) However, one of the monetary measures is to demonetize currency of higherdenominations.(C) The most extreme monetary measure is the issue of new currency in place of theold currency. Under this system, one new note is exchanged for number of notes ofthe old currency.Q. DeflationDeflation is just the opposite of inflation. It is associated with falling prices.According to Prof. Paul Einzing, It is a state of disequilibrium in which a contractionof economic power tends to cause, or is the effect of a decline of price level. Thusdeflation refers to a situation where prices fall causing thereby increase inunemployment, reduction in output and decrease in the incomes of the factors ofproduction.Q.Consequences of deflationThe consequences and result of deflation are just the opposite of inflation. Duringperiods of deflation the total expenditure of the community is less than the value ofcurrent output. This generates a deflationary gap. When prices fall the producerssuffer heavy losses and thus curtail output and employment. Hence, deflation has

adverse effects on employment and production. During deflationary period, themarket is gutted with commodities but there are no customers. This creates asituation of poverty amidst plenty. Deflation also affects the distribution of incomeand wealth in the economic system. Deflation distributes income in favour of themiddle classes and adversely, affects the interests of businessmen, debtors, etc.during deflation, there is a tendency to save as the value of money appreciates butdue to the falling level of income, power to save is reduced. Deflation is consideredto be worse than inflation due to its adverse effects on production and employment.Q.Types of Inflation(a) Creeping Inflation: It is the mildest form of inflation and is not considered to have anydangerous effects on the economy. As a matter of fact, creeping inflation is thought to bethe inevitable consequence of economic development. It is argued that creeping inflation

does not allow the economy to fall a prey to economic stagnation. According to Kent, Whenprices rise by not more than 3% per annum, the situation may be described as that ofcreeping inflation.(b) Walking Inflation: The next stage, from the point of view of rapidity of inflation, is thewalking inflation. When, over a decade the prices rise above from 30% to 40% this may bedescribed as walking inflation. It is significant in so far as it gives us the red signal ofhyperinflation.


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(c) Running Inflation or Galloping Inflation: When the sped of price rise accelerateswalking inflation gets converted into running inflation. Running inflation would record a 100%increase in prices over a period of ten years. In galloping inflation, prices rise every moment.(d) Deficit Induced Inflation: Is that which is the result of deficit financing by thegovernment i.e., spending more than revenue either by taking resort to printing press or by

borrowing from the banking system etc.(e) Wage Induced Inflation:Is that which is caused by an increase in money wages.(f) Profit Induced Inflation: Is that which is due to an increase in the profits of themanufacturers.

economics (general)

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