UNIT I INTRODUCTION QUESTIONS BASED ON HOTS WITH MODEL ANSWERS. VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each)

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1 UNIT I INTRODUCTION QUESTIONS BASED ON HOTS WITH MODEL ANSWERS VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. Why is there a need for economizing of resources? Ans. Because resources are limited. Q.2. Why does economic problem arise? Ans. It arises mainly because of scarcity of resources. Q.3. Why is PPC downward sloping from left to right? Ans. Because in situation of full employment of resources, production of one good can be increased only with less of other good. Q.4. What does a rightward shift of PPC indicate? Ans. The rightward shift of PPC indicates growth of resources or technological progress. Q.5. What does a point below PPC indicate? Ans. It shows inefficient/under-utilization of resources. Q.6. What does slope of PPC show? Ans. Negative slope of PPC shows that in order to produce more units of one good, some units of the other good must be sacrificed. Q.7. When allocation of resources is considered as inefficient? Ans. Allocation of resources is considered as inefficient when economy performs below the PPC curve. SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Does production take place only on the PP curve? Ans. Yes and no, both. Yes, if the given resources are fully and efficiently utilized. No, if the resources are underutilized or inefficiently utilized or both. Refer to the above figure; on a point anywhere on the PPC the resources are fully and efficiently employed. On point U, below the PPC or any other point but below the PPC, the resources are either underutilized or inefficiently utilised or both. Any point below the PP curve thus highlights the problem of unemployment and inefficiency in the economy. 1

2 Cloth Y A B PPC C. U D O Wheat X Q.-3 Massive unemployment will shift the PPC to the left. Defend or refute. Ans.- Production is drawn on the basis that the given resources are fully as well as efficiently utilized. Massive unemployment is a situation when resources are not fully utilized. Or it is a situation of under employment. It would only mean that the economy is not operating on the PPC but some-what inside the PPC. Therefore PPC will not shift to leftward. UNIT- II CONSUMER S CHOICE AND DEMAND ANALYSIS VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.-1 All points below the budget line shows the various possible bundles which cost exactly equal to consumer s income. Is it right or wrong? Ans.- Wrong. Q.-2 If Ram is offered Ice Cream free of cost. How much Ice Cream will he consume? Ans.- Ram should consume Ice-Cream to that extent to which the marginal utility of Ice-Cream becomes equal to zero 2

3 Q.-3 What happens to the budget set if both the prices as well as the income doubled? Ans.- The budget set remains same. Q.-4 A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the ratio of marginal utility of price in case of X is higher than in case of Y. Explain the reaction of the consumer. Ans.- The consumer will increase the consumption of good-x and will decrease the consumption of good-y. Q.-5 Does a fall in income have the same effect on the demand for the given commodity? Ans.- No, it will depend upon the nature of the good. If good is normal then its demand will increase and if the good is inferior then its demand will decrease Q.-6 There is train and bus service between New Delhi and Jaipur. Suppose that the train fare between the two cities comes down. How will this affect demand curve for bus travel between the two cities? Ans.- As train and bus service are substitute to each-other, the demand curve for bus service between the two cities will shift leftward to the initial demand curve of bus service Q.-7 Determine how the following changes (or shifts) will affect market demand curve for a product. (a) A new steel plant comes up in Jharkhand people who were previously unemployed in the area are now employed. How will this affect the demand for colour T.V. and Black and White T.V. in the region? (b) In order to encourage tourism in Goa. The Government of India suggests Indian Airlines to reduce air fare to Goa from the four major cities of Chennai, Kolkata, Mumbai and New Delhi. If the Indian Airlines reduces the fare to Goa, How will this affect the market demand curve for air travel to Goa? (c) There are train and bus services between New Delhi and Jaipur. Suppose that the train fare between the two cities comes down. How will this affect demand curve for bus travel between the two cities? Ans: (a) There will be rightward shift in market demand curve for colour and Black and White T.V. This is because of increase of income of the people due to employment in the new steel plant. 3

4 (b) The demand for travel to Goa will expand in response to reduction in the air fare. However, this will be reflected by a movement along the demand curve. There will be no shifts in the demand curve. (c) As train fare comes down the demand for bus travel will reduce. Demand curve for the bus travel will shift to the left showing less demand at the same price. Q 8. If a good can be used for many purposes, the demand for it will be elastic. Why? Ans: If a good can be used for many purposes, the demand for it will be more elastic because with a decrease in its price it is put to several uses and with a rise in its price it is withdrawn from its many existing uses. So that, there is a considerable change in demand in response to some change in price. Q 9. If a product price increases, a family s spending on the product has to increase. Defend or refute. Ans: When product price increases, expenditure on the commodity will not increase in the situation when E d >1 (elasticity of demand is greater than unity). It will increase only in situation when E d <1. In a situation when E d =1. Expenditure will remain constant, even when prices rise. Q 10. Suppose there are 30 consumers for a good, having identical demand function: d(p) =10-3P for any price less than or equal to 10/3 and d(p)=0 for any price greater than 10/3. Write the market demand function. Ans: Market demand function is simply a horizontal summation of individual demand functions. Since demand function for all the 30 consumers is identical, we can write market demand simply as individual demand function multiplying by a factor of 30. Thus: Individual demand function : D(p)= 10-3P Market demand function: M d (p)=10 x 30 3 (30)P = P. Q.11 How would you comment on the elasticity of demand when 8% decrease in price of a commodity causes 2% increase in expenditure of the commodity? Ans: Elasticity of demand must be greater than unity (implying a situation of elastic demand) when expenditure on the commodity responds inversely to any change in price of the commodity. 4

5 Q12. A dentist was charging Rs.300 For a standard cleaning job and per month it used to generate TR is equal to Rs. 30,000. She has since last month increased the price of dental cleaning to Rs.350. As a result fewer customers are now coming for dental cleaning, but the TR is now Rs. 33,250.From this, what can we conclude about the elasticity of demand for such a dental service? Ans. PRICE TOTAL EXPENDITURE (Rs.) , ,250 When price increases, total expenditure also increases. So elasticity is less than 1. Q. 13. The elasticity of demand for X is twice the elasticity of demand for Y. Price of X falls by 5% and Price of Y rises by 5%. What will be the % change in the quantity demanded of X and Y? Ans. Suppose elasticity of demand for Y = 1, and elasticity of demand for X will be = 2 So, % decrease in qt. demanded of Y will be 5%, because price rises by 5%, and % increase in qt. demanded of X will be 10%, because price falls by 5%. Q.14 If prices of salt and cigarettes, both rises by 10%, will the qt. demanded of both goods affected in an equal manner? Ans. No, because the nature of the two goods is different. Salt, a necessary good, will have constant consumption and marginal consumers will reduce the consumption of cigarettes, which is non-essential. Q 15. Given e D = , and percentage increase in price = 20%, find change in expenditure on the commodity. 5

6 Implying that expenditure on the commodity increses by 15.2% owing to increase the commodity by 20%. Which is why e d is less than 1.. MUX MUY Q. 16 If, then the consumer should buy more of commodity Y and PX PY less of commodity X to reach the equilibrium position. Is it right or wrong? 6

7 Ans.- Wrong. Because in that situation consumer should increase consumption of good-x so that the ration of MU X to its price may become equal to the ratio of MU Y to its price. Q. 17 Law of diminishing marginal utility will operate even if consumption takes place in intervals. Defend or refute. Ans.- No, the of diminishing marginal utility will operate even if consumption takes place in intervals. Because it is based on the assumption that consumption is taking place in continuation Q. 18 What changes will take place in TU, when: (i) MU curv remain above the X-axis, (ii) MU curve touches the X-axis, (iii) MU curve lies below the X- axis. Ans.- (i) TU increases at decreasing rate. (ii) TU becomes maximum. And (iii) TU starts to decline Q. 19 A good may be an inferior good for one consumer and normal for another consumer. Defend or refute. Ans.- Yes it is right. A good may be inferior for a higher income person and the same good may be a superior good for a low income person UNIT III PRODUCER BEHAVIOUR AND SUPPLY VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. What happens to MPP when TPP increases at decreasing rate? Ans. MPP falls but remains positive. Q.2. As the variable input is increased by one unit, total output falls. What would you say about of marginal productivity labour? Ans. Marginal productivity of labour is negative. Q.3. Why is MC curve in short run U-shaped? Ans. MC Curve in short run is U-shaped due to operation of the law of returns to a factor. Q.4. Why does fixed cost not influence marginal cost? Ans. Because marginal cost do not include fixed cost. Q.5. When a seller sells his entire output at a fixed price, what will be the shape of AR & MR curves? Ans. Both AR & MR are equal and coincide with each other on a horizontal line. 7

8 Q.6. Show that average revenue equals price. AR TR PXQ = = = P = Pr ice Ans. Q Q Q.7. What effect does a cost saving technical progress have on the supply curve? Ans. Supply curve will shift to the right. Q.8. What effect does an increase in excise tax have on the supply curve? Ans. Supply curve will shift to the left. Q.9. What happens to TPP when marginal productivity of variable input is negative? Ans. TPP falls. Q.10. When is TPP maximum in relation to MPP? Ans. When MPP is zero. Q.11. What happens to MPP when TPP is declining? Ans. MPP declines and remains negative. Q.12. How does fall in MPP affect TPP? Ans. TPP increases at decreasing rate. Q.13. What effect does an increase in input price have on the supply curve? Ans. The supply curve will shift towards left-hand side. Q.14. Why does average cost fall as output rises? Ans. AC falls due to operation of the law of increasing returns to a factor as output rises. Q15. Does fixed cost affect marginal cost? Give the answer with reason. Ans. No, because fixed cost is not subject to change and it is not considered while calculating MC. Q.16. What would be the effect of increase in the output on the TFC? Ans. There would not be any effect of increase in the output on the TFC, It will be constant at different levels of production. Q.17. If marginal revenue falls, will total revenue fall? Ans. It may fall when MR falls and becomes negative. If MR falls but remains positive then TR may increase with diminishing rate. Q.18. What is the price elasticity of supply of a commodity whose straight line supply curve passes through the origin forming an angle of 25º? Ans. Price elasticity of supply will be equal to one when a straight line supply curve passes through the origin; angle does not matter anything. Q. 19. Can MC be equal to TVC? Ans.- Yes MC may be equal to TVC at output level one. 8

9 Q. 20 Why does the minimum point of AC curve fall towards right of AVC curve? Ans.- Because AC is sum total of AVC and AFC. Q.21. The two inversely S-shaped short run cost curves are parallel to each other and maintain a constant distance of Rs. 50. What is indicated by Rs. 50? Also identify the two inversely S-shaped short run cost curves. Ans.- Rs. 50 is TFC. And two inversely S-shaped cost curves are TVC and TC respectively. Q. 22. The equality of MC and MR is a condition necessary for equilibrium, but it is not by itself sufficient to ensure the attainment of producer s equilibrium. Comment. Ans.- Yes. For consumers equilibrium it is also essential that after the equilibrium level of production MC should be greater than MR. Other-wise there will be an incentive to increase the output in order to maximize the profit. Q. 23. Ram produces both Jeans and Shirts. How will an increase in the price of Jeans affect the supply curve of Shirts? Ans.- An increase in the price of Jeans will decrease the supply of Shirts, because now it will be profitable to the producer to produce and sell more of Jeans instead of Shirts, as it has become expensive. Q. 24. Will a firm stop production at break-even point in short run? Why? Ans.- No, firm will not stop the production at break-even point because that firm has given best employment to its factors of production. SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Why is more of a commodity supplied only at a higher price? Ans.- Because increase in production leads to decrease in returns to a factor. That in turn leads to increase in cost. That is why more of a commodity supplied only at a higher price Q. 2. Suppose the functions of demand and supply curves of a commodity are given by: q D = 100-p q S = 60 + p for p 15 = 0 for 0 p<15 9

10 (i) (ii) (iii) What does p =15 indicate? Find the equilibrium price and equilibrium quantity. Whether the given commodity comes under the category of viable industry. (iv) Calculate market demand and supply at price of Rs. 25 and Rs. 10. Show that at price of Rs. 25, there is excess supply and at price of Rs. 10, there is excess demand. Ans.- (i) (ii) (iii) (iv) P=15 indicates that the minimum average cost of the firm is Rs. 15 and firm will not supply the commodity for any price less than Rs. 15 Equilibrium Price = Rs. 20 and equilibrium quantity = 80 units Yes, the given commodity comes under the category of viable industry as there is some price, at which supply and demand happens to coincide. At price Rs. 25 market demand = 75 units and market supply = 85 units. Therefore there will be excess supply of 10 units And at price of Rs. 10 market demand = 90 units and market supply = 70 units. Therefore there will be excess demand of 20 units. Q. 3. There are three different supply curves passing through the origin. A curve makes an angel of 60 o. Curve B makes an angel of 45 o and curve C makes an angel of 30 o. What will be the price elasticity of curve A, B and C? Ans.- Price elasticity of supply of good will be equal to one if supply curve is passing through the origin point, irrespective of the angel made by it with the origin. Q. 4. Why should MC curve cut MR curve from below to achieve producer s equilibrium? Ans.- Because after equilibrium level of output, marginal cost should become greater than the marginal revenue. Other-wise there will be an incentive to increase the output in order to maximize the profit. 10

11 Q. 5. The gap between AC and AVC keeps on decreasing with rise in output, but they never meet each other. Comment. Ans.- Yes it is right statement. Because the gap between AC and AVC is equal to AFC which goes on diminish as output increases. Since TFC is fixed at all levels of output, AFC goes on diminish as output increases Q. 6. If TVC=0, TC is also zero. Is it true or falls? Give reason for your answer. Ans.- It is falls. Because in short TC = TFC + TVC. Therefore in short run TC will be some-thing positive even if TVC=0. But in long run TC = TVC. Therefore in long run TC will be zero if TVC=0. Q. 7. Why increasing MP not sustainable? Ans. Decrasing MP set in due to following reasons:- 1. Fixity of the factor: As more and more units of the variable factor continue to be combined with the fixed factor, the later gets over-utilized. 2. Imperfect Substitution among Factor: Beyond a certain limit, factors of production cannot be substitute for one another e.g. more and more of labour cannot be continuously used in place of additional capital. Q. 8. Why MC cuts AC at its minimum? Ans. because (i) When MC < AC, AC falls. (ii) When MC = AC, AC is minimum. (iii) When MC > AC, AC rises. (iv) MC falls & rises faster than AC. (v) Both are obtained from TC. AC TC Q MC TC =, = Q 11

12 Q. 9. How do changes in MR affect TR? Ans. i) If MR increases, TR increases at increasing rate. ii) If MR is constant, TR increases at constant rate. ii) IF MR falls, TR increases at diminishing rate. Q.10. What is MR? How is it related to AR? Ans. MR refers to the change in TR due to sale of an additional unit. Relation (i) If AR (Price) is constant, MR = AR (ii) If AR (Price) falls, MR < AR. (iii) If AR (Price) rises, MR > AR. Q. 11. What will be the price elasticity of supply if the supply curve is a positively sloped straight line? Ans. Es = 1 if the curve starts from the origin point. Es> 1 if the curve starts from the y-axis and E<1 if the curve starts from the x-axis. Q. 12. State the relation between marginal revenue and average revenue when a firm: (i) is able to sell more quantity of output at the same price. (ii) is able to sell more quantity of output only by lowering the price. Ans. Marginal revenue is the addition to total revenue from producing one more unit of output. 12

13 (i) MR = AR at all levels of the output. (In case of perfect completion market) (ii) MR will be less than AR at all levels of the output. (In case of monopoly and monopolistic market) LONG ANSWER TYPE QUESTIONS: (6 Marks Each) Q. 1. In the following table, identify the different phases of the law of variable proportions and explain them with the help of the table and a diagram. Variable input (units) Total product (units) Ans. Law of Variable Proportion states that if we go on using more and more units of a variable factor along with a fixed factor, the total output initially increases at an increasing rate, after that it increases at diminishing rate and finally it declines. It can be explained through the following three stages: Units of labour TPP MPP Stages of Production Stage I Stage II Stage III 13

14 Y Stage I Stage II Stage III TPP & MPP TPP X Labour MPP Y Stage 1: TPP increases at an increasing rate. MP increases and reaches at its maximum at the end of the stage. This is also called stage of increasing returns. Stage 2: TPP increase but at diminishing rate. MPP starts decline but remains positive. This stage comes to an end when TPP is maximum and MPP is zero. Stage 3: TP starts decline. MP becomes negative. This is also called stage of decreasing/negative returns. 14

15 NUMERICAL PROBLEMS WITH SOLUTIONS: PRODUCTION: Q. 1. Find out APP and MPP. Labour TPP Ans. APP MPP Q. 2. Find out the TPP and APP. Labour MPP Ans. TPP APP Q. 3. Calculate the APP and MPP. Labour TPP Ans. APP MPP Q. 4. The following table gives APP of a factor. It is also known that (TPP) total product at O level of employment is O. Determine its total product and marginal product. Labour APP Ans. TPP MPP

16 COST: Q. 1. Calculate the TVC, AFC,AVC, and MC. Output TC Ans. TFC TVC AFC AVC MC Q. 2. Calculate TC and AVC. Output AFC MC Ans. TC TFC TVC AVC Q. 3. Calculate MC and AC if fixed cost is 40. Output TVC Ans. MC TC AC Q.4 OUTPUT AC AVC MC ANS. OUTPUT AC AVC

17 MC REVENUE: Q. 1. Find AR and MR. Output TR Ans. AR MR Q. 2. Find out TR and MR. Output AR Ans. TR MR Q. 3. Complete the following table: Output Price MR TR Ans. Output Price MR TR Q. 4. Calculate TR and AR Output MR Ans. TR AR

18 ELASTICITY OF SUPPLY: Q.1. If price elasticity of supply of a commodity is 5. A producer supplies 500 units of this product at a price of Rs. 5 per unit. How much quantity of this product will be supplied, at the price of Rs. 6 per unit? Ans. e s = 5 P Q q = x x p = 1 p = 5 q = 500 e = q p x p q 5 = x = x = x = x x = 1000 (units) Q.2. Due to a 10 per cent rise in the price of a commodity, its quantity supplied rises from 400 units to 450 units. Calculate its price elasticity of supply. Is the supply elastic? Ans. P = 10% Change in quantity % Change in quantity supplied = x 100 Original quantity x 100 = = 12.5% e s = e s =

19 Q.3. e s = 1.25 (Yes, its supply is elastic.) The quantity supplied of a commodity at a price of Rs. 8 per unit is 400 units. Its price elasticity of supply is 2. Calculate the new price at which its quantity supplied will be 600 units? Ans. es = 2 p q q = p = x - 8 x 600 p = 8 q = 400 e = e 2 2 q p x p q 200 = x x = x Q.4. 2 (X - 8) = 4 2 x - 16 = 4 2 x = x = 20 x = 10 Hence the new price is Rs. 10. When the price of a commodity rises from Rs.10 to Rs.12 per unit, its quantity supplied rises by 100 units. If e s = 2, Calculate its quantity supplied at increased price. Ans. e s = 2 q = 100 p = 2 p = 10 e = q p x p q 2 = x 2 q 4q = 1000 q = 250 (original quantity) 19

20 Quantity supplied at increased price = = 350 units Q.5. If e s = 3, A seller supplies 20 units of the commodity at a price of Rs.8 per unit. How much quantity of the commodity will the seller supply when price rises by Rs.2 per unit? Ans. e s = 3 q = 20 p = 8 p = 2 e = q p x p q 3 = q 8 x q = 120 q = 15 (change in quantity) Quantity supplied at increased price = = 35 units UNIT-IV FORMS OF MARKET AND PRICE DETERMINATION VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q. 1. What is the value of MR when demand curve is elastic? Ans. MR is positive. Q. 2. In which market DD curve is indeterminate? Ans.- Oligopoly Market. Q 2. Who determines price under perfect competition? Ans: Price under perfect competition is determined by the forces of market demand and market supply in industry. Q 3. How much loss can a firm bear? Ans: A firm can bear losses upto its total fixed costs in short run. Q 4. Explain the motivation behind granting patent rights. Ans: Motivation behind granting patent rights are: (A) To encourage research and development; and (B) To encourage new discoveries and innovations. 20

21 SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each) Q 1. Explain how the efficiency may increase if two firms merge? Ans: When the two firms merge, their combined efficiency is expected to improve owing to: (A) Increase in the scale of output and the consequent economies of scale. (B) Better division of labour and specialization; and (C) Use of better technology, saving the cost of production. Q 2. Why is the demand curve facing a monopolistically competitive firm likely to be very elastic? Ans: It is because the products produced by the monopolistically competitive firms are close substitutes to each other. If products are close substitutes to each other the elasticity of demand is high, which is what makes the firm s demand curve(under monopolistic competition) very elastic. Q 3. Why is the demand curve facing a firm perfectly elastic under perfect competition but less than perfectly elastic under monopolistic competition? Ans. The demand curve under perfect competition is perfectly elastic. Perfectly elastic demand curve means any quantity can be sold only at a given price. Under perfect competition, the price of the product is determined by the industry by the forces of demand and supply and the firm has no option but to accept it. Uniform price prevails because all firms are selling a homogeneous product. A firm cannot influence or alter the price. Implying that a firm can sell any quantity at the given price. Therefore, the demand curve will be a straight line parallel to the X-axis as shown in Fig. ; which is perfectly elastic, showing E d =infinity The demand curve under monopolistic competition is less than perfectly elastic. It means more can be sold only at lower price. Under monopolistic competition, the seller sells a differentiated product, so he exercises partial control over price. But he can sell more only by lowering the price; certainly not at the existing price. This is what makes the demand curve less than perfectly elastic. Q 4. Which features of monopolistic competition are monopolist in nature? Ans. (i) Product differentiation (ii) Control over price (iii) Downward sloping demand curve 21

22 Q 5. How does an increase in the price of a substitute good in consumption affect the equilibrium price? Ans: With increase in the price of the substitute good, the equilibrium price of the concerned good will increase owing to shift in demand curve to the right. Q 6. Changes in both demand any supply of a commodity may or may not affect its equilibrium price. Explain. Ans: If the demand and supply of a commodity change equally, and in the same direction there will be no effect on its price. On the other hand, an unequal change in demand and supply will affect equilibrium price. When demand increases more than supply, equilibrium price will rise. On the other hand, when supply increases more than demand, equilibrium price will fall. Q 7. When will the equilibrium price of a commodity not change even if its demand and supply both increase? Explain with the help of a diagram. Ans. If both increases equally. Q 8. A severe drought results in a drastic fall in the output of wheat. Analyze how will it affect the market price of wheat? Ans: As a result of severe drought, the output of wheat is reduced. It means the supply of wheat in the market will reduce, causing a shift of supply curve to the left. Accordingly, market price of wheat will increase. 22

23 Q 9. Suppose the demand for jeans increases. At the same time, because of an increase in price of cotton, the supply of jeans decreases. How will it affect the price and quantity sold of jeans? Ans: Increase in market demand for jeans along with a decrease in the supply of jeans should raise the price of jeans and the quantity sold will decline. Q 10. China is a big manufacturer of technology of telephone instruments. It has recently become a member of W.T.O., which means it can sell its products in other member countries like India. Suppose that it does export a large number of telephone instruments to India: (A) How will it affect the price and quantity sold of telephone instruments in India? (B) Suppose that the demand for telephone instruments is relatively elastic. How will it affect India s total expenditure on telephone instruments? Ans: (A) As a result of large export of telephone instruments by Chine to India, the market supply of telephone instruments increases. It reduces the price of telephone instruments while the quantity sold will increase. (B) If the demand for telephone instruments is relatively elastic, reduction in price should increase total expenditure on telephone instruments in India. Q 11. Mrs. Ramgopal says that economists say inconsistent things: as price falls, demand rises, but as demand rises, price rises. Defend or refute. Ans: The statement of Mrs. Ramgopal that as price falls, demand rises, but as demand rises, price rises, can be defended. The first part of the statement i.e. as price falls demand rises is the general behavior of the consumer in the market. This is simply a forward movement along a demand curve. Demand changes due to change in the price of the commodity. But, there may also be situation when increase in demand leads to increase in price. When the supply of the commodity remains unchanged. And demand increases (due to factors other than price such as increase in income of the consumer or change in taste preference of the consumer.) The demand curve shifts upward and it raises the market price. Fig. illustrates the two situations: 23

24 Q 12. Answer all the questions in terms of shifts in or movements along the demand and supply curves. (A) In 2001, the Supreme Court of India banned smoking in public places. How is this likely to affect the average price of cigarettes and the quantity sold? (B) New discoveries of oil reduce the price of petrol and diesel. Consider their effects on the market for new cars. (C) New environmental regulations require the drug industry to use a more environment friendly technology whose running cost are higher but which discharges less chemicals than before. How would it affect the price of drug? Ans: (A) A ban on cigarette smoking in public places should cause a backward shift in demand curve. Consequently average price of cigarettes should fall. Fall in average price of cigarette should cause a fall in quantity sold. (B) New discoveries of oil reducing the price of petrol/diesel should imply increase in demand for cars (in terms of shift in demand curve to the right), as cars and petrol/diesel are complementary goods. (C) Due to the use of costlier (environment friendly) technology, supply curve of drug will shift to the left, causing a rise in the price of drug. Q 13. In a state of equilibrium, price greater than MC is ruled out for a perfectly competitive firm. Show diagrammatically. Ans: Fig illustrates how prices greater than MC is ruled out for a perfectly competitive firm in a state of equilibrium. Equality between price (AR) and MC is struck at point Q where all the conditions of equilibrium are satisfied. OL is the equilibrium level of output. Suppose the firm decides to produce 24

25 OL1 output where AR(=L 1 Q 1 )>MC(=L 1 T 1 ). As a consequence of shifting from Q to Q 1 ; loss of TR=Q 1 L 1 LQ, while the TC is saved to the tune of Q 1 TQ. Evidently, reduction in TC (=Q 1 TQ) is only a part of reduction in TR(=Q 1 L 1 LQ). Implying that the differential between TR and TC(= profit) would reduce in case the firm shifts from Q to Q 1 Profit is maximized only at point Q where price = MC. Q 14. In a state of equilibrium, price lesser than MC is ruled out for a perfectly competitive firm. Show diagrammatically.(question for practice) Q 15. What is firm s supply curve in the short run, operating under perfect competition? Ans: It is MC curve of the firm starting from a point where MC=AVC (minimum). In Figure, short period supply curve of the firm is MC curve starting from point Q where AR= AVC (minimum). Q.16 In which market situation, the influence of an individual seller is zero? 25

26 Ans. In the Perfectly Competitive market situation. Q.17 How is a single buyer a price taker in perfect competition? Ans. A single buyer s share in total market demand is so significant that the buyer cannot influence the market price on his own by changing his demand. Q.18 Normal profit means zero economic profit. Why? Ans. Suppose the existing firms are earning above normal profits. Attracted by the positive profits, the new firms enter the industry.the market supply increases and the price comes down. New firms continue to enter and the price continues to fall till economic profits are reduced to zero. In case of losses, firms start leaving the industry, supply falls and prices starts going up and all this continues till losses are wiped out. Remaining firms in the industry then once again earn just normal profits / zero profit. Q. 19. Why does there are few firms in oligopoly market? Ans.- There are only few firms in oligopoly market because there are some restrictions on the entry of firms in the market. Which are inter-dependence of firms, big requirements of funds, great competition among the firms. The only firms which can break these restrictions are able to enter the market. Q. 20. Does a monopolist has full control over the price? Ans. No, because price is determined by the forces of demand and supply. a monopolist controls only the supply side and demand side remain uncontrolled. 26

27 UNIT VI NATIONAL INCOME AND RELATED AGGREGATES VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. When is the national income less than domestic income? Ans. When NFIA is negative. Q.2. When is the national income larger than domestic factor income? Ans. When NFIA is positive. Q.3. What is the effect of an indirect tax and a subsidy, on the price of the commodity? Ans. The effect of an indirect tax on a commodity is to increase the price and the effect of subsidy is to reduce the price in the market. Q.4. Are the wages and salaries received by Indians working in American Embassy in India a part of Domestic Product of India? Ans. No, because American embassy is not a part of domestic territory of India. Q.5. Why is the study of the problem of unemployment in India considered a macro economic study? Ans. The problem of unemployment in India is an economic issue at level of economy as a whole, hence considered as macroeconomic study. Q.6. When is gross domestic product of an economy equal to gross national product? Ans. When NFIA is zero. Q.7 Name a product whose value is included in GDP but its consumption reduce welfare? Ans. Liquor. Q.8 Why is interest paid by consumers not a factor payment? Ans. Because consumer borrow money for consumption purpose. Q.9 If compensation of employees in a firm constitutes 55 % of net value added at factor cost of the firm, find the proportion of operating surplus. Ans. 100 % - 55 % = 45 % ( assuming mixed income is Zero) SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Will the following be included in gross domestic product / Domestic Income of India? Give reasons for each answer. (i) Consultation fee received by a doctor. 27

28 (ii) Purchase of new shares of a domestic firm. (iii) Services charges paid to a dealer (broker) in exchange of second hand goods. Ans. (i) Yes, It is a factor income. It is his salary. (ii) No, It is not included in GDP, because it is a merely financial transaction which does not help directly in production. (iii) It is included because it is his factor income (salary). Q.2. State whether the following is a stock or flow: (a) Wealth, (b) Cement production, (c) Saving of a household, and (d) Income of household.(e)profit Ans. Stock (a) & (b), since these are variables measurable at a point of time. Flow (c), (d)& (e), since these are variables measurable over period of time. Q.3. State whether the following is a stock or flow: (a) National capital, (b) Exports, (c) Capital formation, and (d) Expenditure on food by households. Ans. Stock (a), since national capital is a variable measurable at a point of time. Flow (b), (c) & (d), since these are variables measurable over period of time. Q.4. Are the following included in the estimation of National Income a country? Give reasons. (i) Bonus received by employees. (ii) Government expenditure on defence. (iii) Money sent by a worker working abroad to his family. (iv) Profit earned by a branch of Indian Bank in London. (V) Expenditure by government in providing free education. Ans. (i) It should be included in NI because it is a part of the compensation of employees (salary in cash). (ii) It should be included in NI because defence service is considered final service so far as it provides peaceful and secure environment to the citizens. (iii) It is included in NI because it is a part of NFIA. (iv) It is included in NI of India because it is a part of NFIA. (v) yes, it is a part of government final consumption expenditure. Q.5. Are the following included in the estimation of National Income a country? Give reasons. (i) Rent free house to an employee by an employer. (ii) Purchases by foreign tourists. (iii) Purchase of a truck to carry goods by a production unit. (iv) Payment of wealth tax by a household. 28

29 Ans. (i) It should be included in NI because it is a part of the compensation of employees (salary in kind). (ii) It is included in NI because it is a part of the final consumption expenditure on domestic product. (iii) It should be included in NI because it is an addition to the capital stock of the production unit. (iv) It should not be included in NI because it is a compulsory transfer payment and paid from past savings of the tax payers. Q.6. Is net export a part of NFIA? Explain. Ans. No, it is not.net export, the difference between export and import (X- M), is a part of expenditure on domestic product. While NFIA is the difference between income earned from abroad by the normal residents of a country and income earned by non-residents in the domestic territory of that country. It is not included in the domestic product rather it is a component of NI. Therefore both are different concepts. Q.7 Should we treat subsidy as transfer payment? Ans. No, value addition has already accrued. In fact, subsidies tend to lower the market value of the good produced.accordingly, these are added to the market price to make it equal to the factor cost. Subsidies are a part of NNP FC which is why these are deducted from factor cost to equate it with market price. LONG ANSWER TYPE QUESTIONS: (6 Marks Each) Q. 1. Will the following be included in gross domestic product / Domestic Factor Income of India? Give reasons for each answer. (i) interest free loan to bank employees from bank (ii) Factor income from abroad. (iii) Compensation of employees given to residents of china working in Indian embassy in China. (iv) Profit earned by a company in India, which is owned by a nonresident. Ans. (i) no, it is to be repayed. (ii) No, because factor income is earned not within the domestic territory of a country but from abroad. (iii) Yes, because Indian embassy in China is a part of domestic territory of India. (iv) Yes, because the company within India s domestic territory earns profit. 29

30 Q.2. Why are exports included in the estimation of domestic product by the expenditure method? Can gross domestic product be greater than gross national product? Explain.(4+2) Ans. Expenditure method estimates expenditure on domestic product, i.e. expenditure on final goods and services produced within the economic territory of the country. It includes expenditure by residents and non- residents both. Exports, though purchased by non- residents, are produced within the economic territory, and therefore, a part of domestic product. Domestic product can be greater than national product if factor income paid to the rest of the world is greater than the factor income received from the rest of the world is i.e. when net-factor income received from abroad is negative. Q.3. Are the following included in the estimation of National Income of India? Give reasons for each answer. (i) profits earned by Dabur India in U.K. (ii) Money received from sale of shares. (iii) Salary paid to Americans working in Indian embassy in America. (iv) payment of electricity bill by a factory (v) direct purchases of government in a foreign country. (vi) Remittances from aboard. Ans. (i) Yes, it is a part of factor income earned from abroad. (ii) No, it is only a transfer of paper claims. (iii) No, this factor income belongs to non-residents. (iv) No. it is intermediate consumption. (v) Yes, it is government final consumption expenditure. (vi) No, it is only a transfer payment. No commodity is sent or services rendered return for this. Q.4. Will the following be included National Income? Give reasons for each answer. (i) Services of owner occupied houses. (ii) Purchase of new shares of a domestic firm. (iii) Purchase of second-hand machine from a domestic firm. (iv) Consultancy fee paid to a foreign expert. (v) Commission paid to agent for the sale and purchase of shares. (vi) Dividend received on shares. Ans. (i) Yes, Imputed rent of owner occupied houses will be included in NI. (ii) No, because it is a financial transaction which does not help directly in production. (iii) No, because it is not related with current flow of goods and services. (iv) No, as it is a factor income paid abroad (it is earned by non-residents). (v) Yes, It is included in NI since it is paid for rendering productive services. 30

31 (vi) Yes, dividends are a part of corporate profit and therefore, include in NI. Q.5. Will the following be included National Income? Give reasons for each answer. (i) Free Medical facility to employees by the employer. (ii) Money received from sale of old house. (iii) Government expenditure on street lighting. (iv) Interest received by a household from a commercial bank. (v) Receipts from sale of land. (vi) Interest on public debt. Ans. (i) Yes, as it is a supplementary income paid in kind and hence a part of compensation of employees. (ii) No, as it has already been taken into account when the house was constructed. (iii) Yes, It is a part of Government final consumption expenditure and it adds to flow of services. (iv) Yes, as it is payment for use of capital. (v) No, as it does not add to flow of goods & services. (vi) It should not be included in NI because public debt is a loan taken on to meet consumption expenditure by the government. Q.6. Are the following included in the estimation of National Income a country? Give reasons. (i) Services rendered by family members to each other. (ii) Wheat grown by a farmer but used entirely for family s consumption. (iii) Expenditure government on providing free education. (iv) Payment of fees to a lawyer engaged by a firm. (v) Man of the match award to a player of the Indian cricket team. (vi) Payment of the match fee to players of Indian cricket team. Ans. (i) Services rendered by family members to each other should not be included in NI because these are not rendered for the purpose of earning income. (ii) Imputed value of self-consumed wheat grown by a farmer must be included in NI, because it adds in the flow of goods. (iii) It should be included in NI because the government expenditure on the free services is considered as a part of government final consumption expenditure. (iv) Yes, as it is factor income against the service of lawyer. (v) It should not be included in NI because it is a windfall gain and it does not add in the flow of goods and services. (vi) It should be included in NI of India because they render productive services as professionals. 31

32 Q.7. Are the following included in the estimation of National Income a country? Give reasons. (i) Unemployment allowance under NREGA. (ii) Indirect tax (Sale tax/excise duty). (iii) Salary received by the workers under NREGA. (iv) Income tax. (v) Corporation tax. (vi) Travelling expenses paid to salesman by the employer. Ans. (i) It is transfer payment received by those persons who are not employed; therefore it should not be included in NI. (ii) It is not included in NI because it does not add in the flow of goods and services. (iii) It is included in NI because it is a factor income. (iv) It is a part of compensation of an employee (income). While calculating NI by income method, compensation of employees is to be included while doing so, income tax to be paid by them should not be included separately. (v) It is a part of profit of corporate sector. While calculating NI by income method, profit is to be included while doing so, Corporation tax should not be included separately. (vi) Travel expenses incurred by employees for business purpose which are reimbursed by the employers are excluded because these are a part of intermediate consumption of the employers NUMERICAL PROBLEMS WITH SOLUTIONS: Q.1. Calculate private income, personal income, personal disposable income and National disposable income from the following data: (Rs. in Crores) (i) National income 3000 (ii) Savings of private corporate sector 30 (iii) Corporate tax 80 (iv) Current transfer from government 60 (v) Income from property and entrepreneurship to government 150 (vi) Current transfers from rest of the world 50 (vii) Savings of non-departmental government sector 40 (Viii) Net indirect taxes 250 (ix) Direct taxes paid by household 100 (x) Net factor income from abroad (-) 10 32

33 Solution: - Private income = (i) - (iv + vii) + (iv + vi) = ( ) + ( ) = 2920 Crores. Personal income = (ii) - (iii) = = Rs 2810 Crores. Personal Disposable Income = (ix) = = Rs 2710 Crores. National Disposable Income = (i) + (vi) + (viii) = =Rs 3300 Crores. Q2. Calculate NI by income and expenditure method: (Rs. in Crores) (i) Subsidies 5 (ii) Private final consumption expenditure 100 (iii) NFIA (-) 10 (iv) Indirect Tax 25 (v) Rent 5 (vi) Government final consumption expenditure 20 (vii) Net domestic fixed capital formation 30 (viii) Operating surplus 20 (ix) Wages 50 (x) Net export (-) 5 (xi) Addition to stock (-) 5 (xii) Social security contribution by employers 10 (xiii) Mixed income 40 Solution: - Income method NI= (ix) + (xii) + (viii) + (xiii) (iii) = =Rs 110 Crores. Expenditure method NI = (ii) + (vi) + (vii) + (xi) + (x) - (iv) + (i) + (iii) = (-) 5 + (-)

34 =Rs 110 Crores. Q.3. Calculate the value added by Firm A and Firm B from the following data: - (Rs. in Lakhs) (i) Purchase by Firm A from the rest of the world 40 (ii) Sales by Firm B 100 (iii) Purchases by Firm A from Firm B 60 (iv) Sales by Firm A 120 (v) Exports by Firm A 40 (vi) Opening stock of Firm A 45 (vii) Closing stock of Firm A 30 (viii) Opening stock of Firm B 40 (ix) Closing stock of Firm B 30 (x) Purchases by Firm B from Firm A 60 Solution: - Value Added by Firm A = (iv) + [(vii) (vi)] (i) (iii) = [30 45] = Rs 5 Lakhs. Value Added by Firm B = (ii) + [(ix) (viii)] - (x) = [30 40] - 60 = Rs 30 Lakhs. Q.4. Estimate (i) Personal Income, (ii) Private Income and (iii) Personal Disposable Income with the help of the following data. (Rs. in Crores) (i) National income 1300 (ii) Corporate tax 15 (iii) Direct personal taxes 40 (iv) Savings of private corporate sector 25 (v) Income from property and entrepreneurship accruing to Government Administrative Departments 35 (vi) Current transfer from government administrative departments 30 (vii) National Debt Interest 10 (viii) Savings of non departmental government enterprises 5 (ix) Current transfers from rest of the world 15 Solution: - Private Income = (i) - (v) (viii) + (vii) + (vi) + (ix) = = Rs crores. 34

35 Personal Income = Private Income (ii) (iv) = = Rs 1275 crores. Personal Disposable Income = Personal Income (iii) = = Rs 1235 Crores. Q.5. Estimate (i) Personal Disposable Income, (ii) Private Income and (iii) National Income from the following data: (Rs. in Crores) (i) Personal income 1225 (ii) Saving of private corporate sector 12 (iii) Corporate tax 23 (iv) Current transfer from government administrative departments 30 (v) Current transfer from rest of the world 25 (vi) Income from property and entrepreneurship accruing to Government Administrative Departments 25 (vii) Savings of non departmental government enterprises 20 (viii) Net indirect tax 195 (ix) Direct tax paid by the households 25 Solution: - Personal Disposable Income = Personal income - Direct tax = = 1200 Crores Private Income = Personal income + Saving of private corporate sector + Corporate tax = = 1260 Crores National Income = Private Income (iv) (v) + (vi) + (vii) = = 1260 Crores 35

36 Q.6. Estimate the following with the help of given data: (i) GDP MP, (ii) Net Value Added at factor cost; and (iii) prove that it is equal to the income generated. (Rs. in Crores) (i) Increase in the stock of unsold goods 1000 (ii) Sales 10,000 (iii) Net indirect tax 800 (iv) Purchase of raw materials from other firms 1650 (v) Purchase of fuel and power 850 (vi) Consumption of fixed capital 500 (vii) Rent 700 (viii) Wages and salaries 3500 (ix) Interest payment 1000 (x) Dividend 1500 (xi) Corporate gain tax 300 (xii) Undistributed profit 200 Solution: - GDP MP = Sales + Increase in the stock - Purchase of raw materials - Purchase of fuel and power. = 10, = 11, = 8500 Crores. Net Value Added at factor cost = Sales + Increase in the stock - Purchase of raw materials Purchase of fuel and power - Consumption of fixed capital - Net indirect tax. = 10, = 11, = 7200 Crores. Income generated = Rent + Wages and salaries + Interest + Dividend + Corporate gain tax + Undistributed profit. = = 7200 Crores. Hence it is proved that Net Value Added at factor cost = Income Generated 36

37 UNIT VII DETERMINATION OF INCOME AND EMPLOYMENT VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q. 1 Can consumption exceed income? If yes, what is the saving then? Ans. Yes, when income is zero or less than subsistence level of consumption. Saving is ve. Q.2 How much new income will be generated in an economy with an increase in investment by Rs. 200 and when two-third of rise in income spent on consumption. Ans. 600 Rs. Q.3 Why can the value of MPC be not greater than 1? Ans. It is because change in consumption can never be greater than change in income. Q.4 Does an excess of AD over AS always imply a situation of inflationary gap? Ans. No. Inflationary gap occurs only when AD>AS corresponding to full employment level of employment. Q.5 What happens in an economy, when credit availability is restricted and credit is made costlier? Ans. Aggregate demands falls SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each) Q.1 What happens if AD>AS prior to full employment level of employment? Ans. It is a state of disequilibrium in economics. When AD>AS, producers have to cater to demand out of their existing stock of goods, implying that the desired level 37