Question Paper Economics – I (121) : April 2003

Section A : Basic Concepts (40 Points)
• This section consists of questions with serial number 1 - 40. • Answer all questions. • Each question carries one point. 1. An implicit cost can be defined as the a. b. c. d. e. 2. Payment to the non-owners of the firm for the resources they supply Money payment which the self-employed resources could have earned in their best alternative employment Costs which the firm incurs but does not disclose Costs which do not change over a period of time None of the above.

Cartel agreements tend to be unstable because a. b. c. d. e. Cartel agreements tend to lower profits. A firm can increase its profits by cheating on the agreement. Agreements become unnecessary as the number of firms in the cartel increases. Cutting output and raising prices will benefit each firm in the cartel. Cartels are not legally permitted

3.

If the total expenditure of the consumer increases as a result of an increase in the price of the commodity, the elasticity of demand for the commodity is a. b. c. d. e. Infinity. Greater than one. Less than one. Equal to one. None of the above.

4.

Which of the following cost curves is not ‘U’ shaped? a. b. c. d. e. Long run average cost curve Long run marginal cost curve Short run average cost curve Average variable cost curve Average fixed cost curve.

5.

Which of the following is not a legal barrier to entry? a. b. c. d. e. Franchise Government license Patent Innovation Copy rights

6.

A monopolist who faces a negatively sloped demand curve operates in the region where the elasticity of demand is a. b. c. d. e. Less than one Equal to one Greater than one Between zero and one Zero.

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7.

If the demand curve for product B shifts to the right as the price of product A declines, it can be concluded that a. b. c. d. e. A and B are substitute goods A and B are complementary goods A and B are not related goods A is a superior and B an inferior good B is a superior and A an inferior good.

8.

Which of the following is not true? a. b. c. d. e. Indifference curve describes all the possible combinations of two goods which give equal satisfaction to the consumer Total utility is the sum of marginal utilities of all units of a good consumed When price of a product increases, demand for its complement increase Utility is a psychological concept and therefore cannot be precisely measured Consumer surplus of a good and its economic value are different.

9.

Which of the following statements is true? a. b. c. d. e. If 10% decrease in the inputs leads to 15% decrease in the output, increasing returns to scale are said to be in operation. If the output remains constant in spite of 10% reduction in the quantities of inputs, constant returns to scale are said to be in operation. The slope of isoquant is price ratio of the factor inputs Isoquants are concave to the origin. The slope of the Isocost line increases as we move from Y-axis to X-axis.

10. Which of the following statements is/are true? I. The slope of the indifference curve measures the price ratio. II. If two indifference curves intersect each other it implies that the marginal rate of substitution starts diminishing from that point. III. Money income of the consumer remaining constant, if prices of the two commodities fall by the same percentage, the Price Line will shift leftwards. IV. The consumer is in equilibrium at that point on the indifference curve where the price ratio is equal to the marginal rate of substitution. a. b. c. d. e. Only (I) above Only (II) above Only (III) above Only (IV) above Both (I) and (IV) above.

11. In the diagram below, the point that indicates normal profit for a monopolist is

a. b. c. d. e.

A B C D E.

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12. Which of the following is/are the reason(s) for using average or arc elasticity to measure the elasticity of demand? a. b. c. d. e. Most demand curves are shaped like an arc. It measures the elasticity of the entire demand curve, not just over a price range. Because when a single point is chosen to calculate elasticity, its value will change depending on the base, or the starting point. Price elasticity never varies along a straight-line demand curve. Both (a) and (b) above.

13. Which of the following statements is not true? a. b. c. d. e. Every choice involves opportunity costs. Opportunity costs are the highest-valued alternatives that must be forgone when a choice is made. Opportunity costs can always be expressed in money terms. The full cost of an activity includes the opportunity costs. Economists refer to the forgone benefits of the next-best alternative as opportunity costs.

14. The cost advisor of a bicycle manufacturing company estimated that output can be increased infinitely with a proportionate increase in inputs. Which of the following statements is true, if the input prices remain constant? a. b. c. d. e. Average cost increases with the increase in output. Average cost remains constant irrespective of the level of output. Marginal cost decreases with the increase in output. Average cost decreases with the increase in output. Both (b) and (c) above.

15. BAAZ Ltd., an alkaline battery manufacturer, is operating in a perfectly competitive market. If you were the manager of BAAZ Ltd., you should spend more time on decisions making relating to a. b. c. d. e. Promotional spending Pricing of the product Price of your competitors’ products Cost of production Design of your product.

16. Which of the following statements is true with respect to monopolistic competition? a. b. c. d. e. The market is efficient because there are no entry barriers in the long run. The market is efficient because in the long run firms produce at the minimum average total cost. The market is efficient because there are no economic profits in the long run. The market is not efficient because the equilibrium output is less than the optimum output. The market is not efficient because the equilibrium output is greater than the optimum output.

17. Maruti Udyog Ltd. is facing a stiff competition from its competitors in the car industry. The firm has launched a mass advertising campaign to promote its vehicles. Soon, its competitors also launched similar advertising campaigns. It implies that the market is a. b. c. d. e. Monopolistically competitive Oligopolistic A bilateral monopoly Perfectly competitive A monopoly.

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18. Governments across the world enact anti-monopoly laws to achieve efficiency through a. b. c. d. e. Regulation Competition Increased market power Public ownership None of the above.

19. The daily income of Kamesh is Rs.100. He spends all his income on goods X and Y. Currently, the prices of goods X and Y are Rs.6 and Rs.4, respectively. Mr. Kamesh daily buys 10 units of good X and 10 units of good Y. If the utility of the last unit of good X and good Y consumed added same amount of utility to the total utility, then we can say that a. b. c. d. e. The current consumption pattern of Mr. Kamesh gives him the maximum possible utility. He obtains higher additional utility per rupee from good X than from good Y. He should buy more of good X and fewer of good Y. He should buy more of good Y and fewer of good X. Both (b) and (c).

20. If a company is faced with diseconomies of scale up to a certain point and economies of scale beyond that point, the long run average cost curve of the company must be a. b. c. d. e. Upward sloping Downward sloping U-shaped Inverted U-shaped Horizontal.

21. A Digital Camera manufacturer proposes to lower the price so as to increase his revenue. This will work only if the demand for Digital Cameras is a. b. c. d. e. Unitary elastic Price inelastic Price elastic Perfectly elastic Perfectly inelastic.

22. Which of the following illustrates price discrimination? a. b. c. d. e. Price of a meal in Hyderabad is more than that in a small town. A super market offers special discounts on purchases during 9 a.m. to 12 a.m. A fire insurance company is charging higher premium on expensive stores than on cheaper ones. A retail cloth merchant has a ‘buy one, get one free’ offer. All of the above.

23. For a product, the industry is perfectly competitive with constant costs. If price of the complementary good of the product falls, then in the long run, a. b. c. d. e. Equilibrium price will remain constant but equilibrium quantity will increase. Equilibrium price will increase but equilibrium quantity will remain the same. Both equilibrium quantity and price will increase. Equilibrium price will fall, but equilibrium quantity will increase. Equilibrium price will increase, but equilibrium quantity will decrease.

24. Ampro Ltd., a monopolist, produces good X and faces a downward sloping demand curve. With liberalization of industrial licensing, a large number of firms entered the market, transforming the market into a perfectly competitive market. The new demand curve for the industry will be a. b. c. d. e. Downward sloping Upward sloping Horizontal Vertical Rectangular hyperbola. 4

25. In a pure oligopoly, a price war refers to a. b. c. d. e. Continuous price cuts by firms to increase revenues and profits Unexpected price cut by a firm to improve its sales volumes. A decrease in quantity supplied by the competitive firms to raise prices in order to maximize profits. Entry of a new firm in the industry who charges a lower price. Successive and continued price cuts by competitive firms with an aim to increase market share.

26. The total product (TP) curve changes its curvature from convex to concave, when a. b. c. d. e. Marginal revenue is equal to marginal cost. Average cost curve intercepts marginal cost curve. Marginal cost curve reaches its minimum. Average product is equal to zero. Marginal product curve cuts the horizontal axis.

27. Which of the following represents the marginal rate of technical substitution (MRTS)? a. b. c. d. e. Slope of the isocost curve Slope of the indifference curve Slope of the isoquant curve Slope of the budget line Slope of the average cost curve.

28. In an industry, if the cross-price elasticity of demand is 2.5, then the industry is said to be a a. b. c. d. e. Perfectly competitive industry Monopoly Monopolistic competition Pure oligopoly Cartel.

29. The difference between additional revenue gained by a firm from selling a unit and the additional cost incurred for producing the unit is a. b. c. d. e. Average profit Average revenue Marginal profit Marginal revenue None of the above.

30. Which of the following statements is true with respect to product differentiation? a. b. c. d. e. It exists only when similar goods are sold at different prices in different markets It exists only when the goods cannot be resold in other markets It exists only when the market can be differentiation based on the different price elasticities of demand It is possible only when consumers distinguish the products (a), (b) and (c) above.

31. Among the following goods which has the highest income elasticity of demand? a. b. c. d. e. Tea Ice cream Milk Rice Water.

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32. A consumer spends all his daily income of Rs.250 on goods X and Y. Which of the following is true if the quantity of goods X and Y are taken on X-axis and Y-axis respectively and the price of good X doubles? a. b. c. d. e. The budget line will shift parallelly towards left The Y-intercept remains the same but the X-intercept falls The Y-intercept remains the same but the X-intercept increases The budget line will shift parallelly towards right The budget line will not be affected.

33. For an increase in the price of a good, both income and substitution effects have worked in the same direction. It means that the good is a a. b. c. d. e. Giffen good Inferior good Normal good Luxury good Necessary good.

34. A profit maximizing firm seeks to maximize the difference between a. b. c. d. e. Marginal revenue and marginal cost Marginal revenue and average cost Total revenue and marginal revenue Total revenue and average cost Average revenue and average cost.

35. Which of the following statements is not correct? a. b. c. d. e. The fixed cost of a firm in the long run will be less than the fixed cost of the firm in the short run. Fixed costs are not dependent on the firm’s level of output. The difference between average total cost and average variable cost indicates the amount of average fixed cost of a firm. With the increase in output, the average fixed cost of the firm initially decreases at a decreasing rate and later at an increasing rate. When the output is zero, the total cost of the firm will be just equal to its fixed costs.

36. Which of the following can result in formation of a natural monopoly? a. b. c. d. e. Government regulation Product differentiation Economies of large scale production Ownership of critical raw materials Licenses.

37. A firm will shut down its operations in the short run if a. b. c. d. e. It incur losses Fixed costs exceed its revenue Variable costs exceed its revenue Total revenue falls short of total cost Total fixed cost exceeds its total variable costs.

38. Kajol sees a dress worth Rs.3,000 in Big-B showroom. She suspected that she might find the same dress in another showroom for a lesser price. However she did not know which other store is selling the same dress. She finally brought the dress for Rs.3,000 as she felt that it would take more time in locating other showrooms. The above situation reflects which of the following market structures? a. b. c. d. e. Perfect competition Monopolistic competition Monopoly Monopsony Pure oligopoly. 6

39. To a consumer, Arun ice-cream and Kwality ice-cream sold by a local ice-cream vendor are perfect substitutes. If he spends all his income on ice-cream, the shape of his indifference curve will be a. b. c. d. e. Linear L-shaped Concave Rectangular hyperbola Convex

40. Suppose that the market equilibrium monthly rent per room in a city is Rs.3,000. At this rent 8000 rooms per year are rented. If a local rent control ordinance establishes a ceiling of Rs.3,500 per room, which of the following is true? a. b. c. d. e. Shortage of rooms as the quantity of housing demanded increases. Shortage of rooms as the quantity of housing supplied decreases. The equilibrium remains unaffected. Surplus of rooms as the quantity of housing demanded decreases. Surplus of rooms as the quantity of housing supplied increases. END OF SECTION A

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Section B : Problems (60 Points)
• This section consists of questions with serial number 41 - 71. • Answer all questions. • Points are indicated against each question. 41. Beta, a shoe manufacturer, is operating in a perfectly competitive industry. The total cost function of Beta is estimated to be TC = 200 + 300Q – 40Q2 + Q3 Industry supply function for shoes is Qs = 100 + 2P If profit maximizing output for Beta is 50 units, equilibrium output for the industry is a. b. c. d. e. 2667 Units 3800 Units 7700 Units 8100 Units 2800 Units. (2 points) 42. There are 100 firms, with identical cost functions, in a perfectly competitive industry. The demand function for the industry is estimated to be Qd = 2000 – 200P If the cost function of a firm is TC = 200 – 50Q + 2Q2 equilibrium price of the product is a. b. c. d. e. 9.93 3.33 16.35 14.98 18.10. (2 points) 43. The demand and supply functions for a product are Qd = 4200 – 100P Qs = 3000 + 20P If the government imposes a specific tax of Rs.10 per unit, new equilibrium price of the product would be a. b. c. d. e. Rs.11.67 Rs.20.00 Rs.12.32 Rs. 8.33 Rs.18.33. (2 points)

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44. A firm’s average variable cost function is AVC = 20 – 10Q + 0.25Q2. If the fixed cost is 100, the output at which the marginal cost will be minimum is a. b. c. d. e. 13.33 15.33 26.67 30.00 20.00. (2 points) 45. Vinod has a monthly income of Rs.340. Being an addict to fruit juices, he spends all his income on Apple, Mango and Orange juices. The prevailing prices of Apple, Mango and Orange juices are Rs.20 per bottle, Rs.40 per bottle and Rs.50 per bottle, respectively. The total utility schedule of Vinod is given below: Total Utility (Utils) Bottles Consumed Apple Juice Mango Juice Orange Juice 1 140 170 320 2 260 330 580 3 340 420 820 4 410 500 1020 5 460 570 1180 6 500 630 1300 7 520 670 1360 The maximum total utility Mr. Vinod can attain is a. 1160 Utils b. 1690 Utils c. 1580 Utils d. 1910 Utils e. 2550 Utils. (3 points) 46. The demand function for Delco Communications’ cell phones is estimated to be Q = 23500 – 10P + 5Pc + 2.5I + 0.5A Where, Q = P = Pc = I = A = Demand for Delco cell phones per year (in units) Price of each Delco cell phone (Current price is Rs.5000) Price of each cell phone sold by the competitor company (Current price is Rs.4500) Per capita income of the country (Current income is Rs.10000) Promotional expenditure made by Delco (Current expenditure is Rs.8000)

The price elasticity of demand for Delco is a. b. c. d. e. –2 0.9 –1 –3 1. (1 point)

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47. The cost and profit functions of a firm are TC = 200 + 10Q Profit = - 10Q2 + 200Q – 200 If the firm aims at maximizing total revenue, the output should be a. b. c. d. e. 10.0 9.5 10.5 6.3 19.0. (2 points) 48. The production function of Ramco Ltd. is Q = 200L0.5K0.5 The current wages (w) and cost of capital (r) are Rs.50 and Rs.25, respectively. Market price of the good produced by the company is Rs.5. If Ramco Ltd. is currently using 100 units of capital (K) the quantity of labor that the firm should use to maximize its total profit is a. b. c. d. e. 10,000 500 5,000 25,000 1,000. (2 points) 49. Zenith Bros. is a pioneer in manufacturing of luxury soaps. The demand function faced by Zenith Bros. is estimated to be P = 16000 – 8Q. The long run average cost function of the firm is LAC = 16000 – 14Q + 0.004Q2 Assuming that Zenith Bros. operate under a monopolistically competitive market, the excess capacity of the firm at long run equilibrium is a. b. c. d. e. 1750 units 1900 units 250 units 350 units 1500 units. (3 points) 50. For a product, demand is perfectly elastic at a price of Rs.20. The supply function is Qs = 100+10P. If the government imposes a tax of Rs.2 per unit, change in consumer surplus is a. b. c. d. e. Zero Rs. 40 Rs.300 Rs.600 Insufficient data.

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51. The short run production function of a firm is estimated to be Q = 18L2 – L3 The output is sold at a price of Rs.8 per unit and the wage rate is Rs.40 per unit of labor. If the firm is a rational entity, it would employ labor in the range of a. b. c. d. e. 0 to 6 0 to 9 6 to 9 6 to 12 9 to 12. (3 points) 52. In an industry, there are only three consumers – A, B and C and three firms – X, Y and Z. The demand functions for the three consumers are: QA = 130 – 0.2P QB = 50 – 0.4P QC = 70 – 0.4P – 0.05P2 The supply functions for the three firms are: QX = 100 + 0.5P QY = 50 + 0.5P QZ = 50 + 1.5P + 0.1P2 The equilibrium price of the product is a. b. c. d. e. 10.00 15.00 5.00 3.33 33.33. (2 points) 53. A consumer consumes three units of a product. Marginal utilities derived from the three units are Rs.200, Rs.175 and Rs.150, respectively. If the price of the good is Rs.100 per unit, the consumer surplus is a. b. c. d. e. Rs. 50 Rs. 75 Rs.100 Rs.225 Rs.525. (1 point) 54. Ampro is a monopolist operating in two distinct markets – A and B. The cost of producing one unit of the product is constant at Rs.10. At profit maximizing prices the absolute price elasticities of demand in the markets A and B are 2 and 5, respectively. The absolute value of slopes of the demand curves in markets A and B are 1 and 0.5, respectively. If Ampro is maximizing profit, total output is a. b. c. d. e. 5 units 15 units 20 units 12.5 units 10 units. (3 points)

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55. There are two players, Ramco and Tamco, in a market. The reaction functions of Ramco and Tamco are QR = 50 – 0.5QT QT = 60 – QR Where, QR is quantity produced by Ramco and QT is quantity produced by Tamco. If the market is transformed into a perfectly competitive market, the output for the industry would be a. 40 units b. 50 units c. 60 units d. 70 units e. 90 units. (3 points) Questions 56-57 are based on the following information: In an industry there are only six firms. Sales data for the six firms is given below: Name of the Firm Alpha Beta Gamma Delta Epsilon Kappa 56. The 4-firm concentration ratio for the industry is a. b. c. d. e. 0.32 0.22 0.57 0.89 0.97. (1 point) 57. The value of Herfindahl Index for the industry is a. b. c. d. e. 0.67 0.33 0.59 1.01 0.97. (3 points) 58. The production function of a firm is Q = 50KL + L + 2K. Input prices are Labor (w) = Rs.10 Capital (r) = Rs.20. If the firm’s budget constraint is Rs.1,000, what is the efficient allocation of budget? a. b. c. d. e. Rs.500 on labor and Rs.500 on capital Rs.333 on labor and Rs.667 on capital Rs.667 on labor and Rs.333 on capital Rs.200 on labor and Rs.800 on capital Rs.800 on labor and Rs.200 on capital. (3 points) Sales Volume 4000 16200 20400 5000 400 1000

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59. The demand function for a product is P = 20 – 2Q. If the current market price is Rs.10, what is the price elasticity of demand? a. b. c. d. e. -1 -2 1.5 -3 None of the above. (1 point) 60. The total cost (TC) schedule of a firm is Output 1 2 3 4 5 Marginal cost of the third unit is a. b. c. d. e. 30 40 150 60 190. (1 point) 61. Two companies, Alpha and Beta Ltd., are duopolists producing a homogenous product and face identical demand functions. The demand function faced by Alpha is PA = 100 – QA Where QA is total quantity sold by Alpha and PA is price per unit Total cost functions of Alpha and Beta Ltd. are: TCA = 100 + 20QA TCB = 200 + 30QB If Alpha is enjoying price leadership through low-cost, what is the amount of profit sacrificed by Beta Ltd. to avoid a price war? a. b. c. d. e. 1025 25 2400 125 2275. (3 points) Questions 62-63 are based on the following information: Mr. Khan took over his father’s business of table manufacturing. Earlier he used to work in a bank for a salary of Rs.3,000 per month. Mr. Khan saw good growth in the business and in the process of expansion he even occupied premises which used to fetch him a rent Rs.5,000 per month. He also employed five men at a salary of Rs.1,000 per month each. He proposed to spend an amount of Rs.2,000 per month towards promotional expenditure. Raw material costs incurred for manufacturing a table works out to be 25Q2 and the price of a table is Rs.2,000. TC 100 150 190 250 340

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62. If table making business is in a monopolistically competitive market, how many tables should Mr. Khan produce to maximize his profits? a. b. c. d. e. 25 40 144 60 100. (1 point) 63. If Mr. Khan is producing 50 tables per month, his accounting and economic profits are a. b. c. d. e. Rs.30,500 and Rs.22,500, respectively Rs.30,500 and Rs.10,500, respectively Rs.27,500 and Rs.22,500, respectively Rs.27,500 and Rs.10,500, respectively None of the above. (2 points) Questions 64 – 65 are based on the following information: A cloth merchant, who supplies cotton cloth in both Andhra Pradesh and Tamil Nadu, has the following demand functions: Andhra Pradesh Tamil Nadu : : PA = 600 – QA PT = 400 – QT 15, 000 + 100. Q

The average cost function of the merchant is estimated to be AC =

64. If price discrimination is illegal, what is the profit maximizing price of the merchant? a. b. c. d. e. 180 250 275 300 400. (2 points) 65. If price discrimination is legalized, what is the maximum possible profit the monopolist can earn? a. b. c. d. e. 1,24,640.00 65,000.00 70,000.00 1,24,840.00 1,24,862.50 (3 points) 66. Alok, a premier toy manufacturer, recorded an increase in sales by 10 percent. During the year, Alok reduced the prices by 10 percent. Per capita income in the economy increased by 2.5 percent and the competitor, Blok, reduced the prices of his toys by 5 percent. Income elasticity of demand for the toys is estimated to be 2 and cross-price elasticity between Alok toys and Block toys is estimated to be 0.5. Given the situation, what is the price elasticity of demand for Alok toys? a. b. c. d. e. 7.50 0.75 -7.50 -0.75 2.50. (2 points)

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67. If the total cost function of a perfectly competitive firm is TC = 100 + 300Q – 10Q2 + Q3, what is the minimum price below which the firm does not supply any goods to the market? a. b. c. d. e. 233.33 275.00 3.33 525.00 366.66. (2 points) 68. For a product the demand curve is linear with a slope of -0.5. When the price is Rs.0, quantity demanded is 10 units. If the current market price of the product is Rs.3, the quantity demanded is a. b. c. d. e. 4.0 8.5 11.5 16.0 8.0 (1 point) 69. Average productivity of labor for a firm is 25 when labor employed is 50 units. When labor employed is increased to 52 units, average productivity of labor declines to 24 units. At current input level the marginal productivity of labor is a. b. c. d. e. -1 unit -2 units 1 unit 2 units None of the above. (1 point) 70. The demand and supply functions of a product are given by Supply function : P = 0.2Qs – 20 Demand function : P = 40 – 0.1Qd If the government enforces a price floor of Rs.10 for the product a. b. c. d. e. Excess supply of the product will be 150 Excess supply of the product will be 300 Shortage of the product will be 150 Shortage of the product will be 300 Price floor will not have any affect on the market. (1 point) 71. A firm has a production function of the form Q = K + 2L, where Q is output, K is the capital input and L is the labor input. If both wage rate and cost of capital are equal to Rs.100 per unit, the cost minimizing output a. b. c. d. e. Is achieved by producing at any point along the isoquant Is achieved by using labor input only Is achieved by using the capital input only Is impossible to achieve Is achieved by using labor and capital in equal amounts. (1 point) END OF SECTION B

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Suggested Answers Economics – I (121) : April 2003
Section A : Basic Concepts
1. Answer : (b) Reason : Implicit cost is also known as opportunity cost. These costs are not paid out-of-the pockets. It refers to income that could have been earned by factor input in their best alternative use. a. b. Payments to the non-owners of the firm for the resources they supply constitute an out-ofthe- pocket cost. Hence (a) is not correct. Implicit cost is also known as opportunity costs. It refers to income that could have earned by factor input in their best alternative use. Money payment, which the self-employed resources could have earned in their best alternative employment, signifies opportunity cost of self-employed resources. An undisclosed cost does not constitute implicit costs. Fixed cost is the cost that remains same during a period of time. Fixed costs consist of both implicit and explicit costs. Is not the answer because (b) is correct.

c. d. e. 2.

Answer : (b) Reason : Cartels are aimed at increasing profits. But for any individual firm the incentive of huge profits by breaking away from or cheating the Cartel and charging a price less than the Cartel price make Cartels unstable. a. b. c. d. e. Cartels tend to maximize profits by avoiding competition. Cartels agreements tend to be unstable because the member firms wants to maximize their profits by cheating on the agreement. When the number of firms increases cartel become unstable, but it does not mean that they are unnecessary. It is true that cutting output and raising prices benefit each firm in the cartel. But this will not lead to instability of cartels. Not all cartels are legally restricted.

3.

Answer : (c) Reason : Consumers expenditure increases when he buys same amount of goods even after the increased price. This is possible when the demand of the consumer is inelastic (i.e. less than one). Answer : (e) Reason : a. Long run average cost (LAC = LTC/Q) is U-shaped because of economies of scale initially and diseconomies of scale at later stages of production. Long run marginal cost (LMC = ∂LTC/∂Q) is U-shaped as cost of producing additional units reduces at the beginning because of economies of scale, but raises later due to diseconomies of scale. c & d. Short run average cost (SAC = STC/Q) and AVC (= TVC/Q) falls and raises due to operation of ‘law of diminishing marginal productivity’. e. Average fixed cost (AFC = TFC/Q) falls at a decreasing rate with the increase of output because of constant total fixed cost. b.

4.

5.

Answer : (d) Reason : Franchise is a license given by a manufacturer authorizing him to produce and sell its branded good/service. This forms a legal license for the franchise to manufacture/produce given good/service. Patents and copy rights are legal rights given to few people and they form legal barriers to entry. Innovation can be done by anyone and is not a legal barrier to entry. Hence (d) is the correct answer. 16

6.

Answer : (c) Reason : ep > 1 ep = 1 ep < 1 ep = 0 D MR a. b. If ep <1, MR < 0, hence the monopolist would not like to operate on this segment. If ep = 1, MR = 0, If the objective of the monopolist is to maximize total revenue, he may operate at this point. But generally the objective of any firm is to maximize profits and would like to operate in the range where MR > 0. This is to ensure MR = MC. If ep > 1, MR > 0. This is the range where a monopolist would operate. If 0 < ep < 1, MR < 0 . Monopolist would not operate in this range. If ep = 0, MR < 0 and the monopolist would not operate in this range.

c. d. e. 7.

Answer : (b) Reason : (a) When goods A and B are substitutes, decrease in price of product A will lead to leftward shift in the demand curve for product B. This is because, when price of product A decrease consumers tend to substitute good A for good B and demand for product B decrease. (b) When goods A and B are compliments, decrease in price of product A will lead to rightward shift in the demand curve for product B. This is because, when price of product A decrease consumers tend to consume more of product A and also product B along with product A. Hence demand for product B increases. (c) When goods A and B are unrelated, decrease in price of product A will not have any impact on the demand curve for product B. (d) The given information is inadequate to comment on the nature of the goods (e) The given information is inadequate to comment on the nature of the goods

8.

Answer : (c) Reason : (a) True. Indifference curve is various combinations of two goods which give the same level of total utility (b) True. Total utility is the sum of marginal utilities of all the goods consumed. (c) False. When price of a product increases demand for the product decreases. As complimentary goods are consumed together, demand for the compliment also decreases. (d) True. Utility is subjective and varies from individual to individual and from time to time for the same individual, hence cannot be measured precisely. (e) True. Consumer surplus is the difference between what the consumer is willing to pay and what he actually pays. Economic value is the market value of a good.

9.

Answer : (a) Reason : (a) True. When change in output is more than proportionate to the change in inputs, increasing returns to scale are in operation. (b) False. Constant returns to scale are in operation when the change in output is proportionate to the change in inputs. (c) False. The slope of the isoquant is MRTS. (d) False. Isoquants are convex to the origin. (e) False. The slope of isocost line is constant, which is the ratio of the prices of inputs.

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10. Answer : (d) Reason : (I) False. Slope of indifference curve indicates MRS. (II) False. Two indifference curves never intersect. (III) False. If price of both the goods fall by the same percentage, price line will shift to the right, as real income of the consumer increase. (IV) True. The consumer will be in equilibrium where the budget line is tangent to the indifference curve. Therefore, the answer is (d). 11. Answer : (e) Reason : Normal profit is the level of profit required to keep the firm in the industry. Any profit above this level is considered to be supernormal or abnormal profit. When the firm is earning normal profit, Average Cost will be equal to Average Revenue. (a) is not the answer as it indicates the price at which the monopolist can maximize the profit. (b) is not the answer as it indicates the Average Cost at the profit maximizing output. (c) is not the answer as it indicates the equilibrium point of the profit maximizing monopolist (d) is not the answer as it indicates the point at which Marginal Cost is equal to Average Revenue. Is the answer as it indicates the point where Average Cost is equal to Average Revenue. 12. Answer : (c) Reason : Is not the answer as the shape of the demand curve can also be of other shapes, like a straight line. (b) Is not the answer as the arc elasticity measures elasticity over a segment rather than the entire demand curve. (c) Arc elasticity is used to mitigate the problem of dependence of the elasticity on the base chosen for the same set of data. By averaging the prices and quantities, elasticity is estimated at the mid-point. (d) Is not the answer as price elasticity of demand varies along the straight-line demand curve. As the price increases, elasticity increases and elasticity decreases as the price decreases. (e) Is not the answer as both (b) and (c) are not the answers. 13. Answer : (c) Reason : (a) True. Whenever we make choice, we choose something over the other. Therefore, opportunity cost of the choice is the value of the alternative forgone. (b) True. Opportunity cost is defined as the value of the best alternative forgone. (c) False. It may not always be possible to express opportunity cost in monetary terms. (d) True. In economics, costs include opportunity costs also. (e) True. Opportunity cost is defined as the value of the best alternative forgone. 14. Answer : (b) Reason : If the firm can produce higher output by a proportional increase in inputs, its average cost remains the same. This indicates that the company is experiencing constant returns to scale (CRS). a. Average cost increases with the increase of output if the firm operates under decreasing returns to scale. b. Average cost remains the same if the firm operates under constant returns to scale. c. When the firm operates under constant returns to scale, the marginal cost remains the same. d. Average cost decreases with the increase of output if the firm operates under increasing returns to scale. e. Is not the answer as (c) is not correct.

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15. Answer : (d) Reason : In a perfect competition, the market price of the good is determined by the market forces – supply and demand. Hence, a perfectly competitive firm will have no control on the market price. Thus, a perfectly competitive firm is only a price taker and not a price maker. a. In a perfect competition, the product is homogenous and is not differentiable with respect to products of other firms. Promotional spending is not a feature of perfect competition, in fact it is source of imperfection in the market. b. Since the firm is only price taker, he has no control on the price. Hence, decisions relating to pricing are not necessary for a perfectly competitive firm. c. Market price of a good in a perfectly competitive market is determined by supply and demand factors of the market. The price of the competitor’s good and its goods remains same i.e. competitors as well as the firm are only price takers in the market. d. A perfectly competitive firm can control its costs of production to maximize its profits by minimizing its costs. Hence, the firm should spend more time on decisions making relating to cost of production. e. In a perfect competition, the products of different sellers will be homogenous and the consumers cannot differentiate the product of one seller with other. As the firm produces only homogenous goods, it need not spend much time on the design of the product. 16. Answer : (d) Reason : A monopolistically competitive industry is characterized by ‘excess supply’. A monopolistic firm can reduce its average cost if it produces a higher output, but it produces an output just equal to average cost curve in the long run because of its downward sloping demand curve. a. Although there is relative no entry barriers in monopolistically competitive industry, this will not result in market efficiency. b. A monopolistically competitive firm produces an output where LMC = LAC, but it does not produce at minimum average total cost. c. Presence of normal profits may not result in market efficiency. d. A monopolistic firm can reduce its average cost if it produces a higher output, but it produces an output just equal to average cost curve in the long run because of its downward sloping demand curve. Hence, the market is not efficient because the equilibrium output is less than the optimum output. e. In a monopolistically competitive market, equilibrium output is less than the optimum output. Hence the statement is not correct. 17. Answer : (b) Reason : Car industry in India is an oligopolistic market; firms are highly interdependent on each other. That means, if one firm increases it sales, it affect the share of market of other firms. Hence, when one firm launches a mass advertising campaign to promote its product, the other firms will also follow the same to avoid losing of its potential customers. a. Car industry has entry barriers in the form of heavy investments and entry costs. Hence, it does not fall under monopolistically competitive industry. b. Car industry in India falls under oligopolistic market because of presence of only few players in the market. As members firms in oligopolistic market are highly interdependent on each other, if one firm increases it sales others will also reduce the price to maintain their market share. c. A bilateral monopoly has one buyer and one seller. d. Advertising campaigns create product differentiation, which is not a characteristic of perfect competition. e. A monopoly has only one seller. Since there are more than one producer in the market, it does not fall under monopoly.

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18. Answer : (b) Reason : Governments across the world enact anti-monopoly laws to achieve efficiency through competition. If competition is encouraged then competitive firms sell goods at a lower price by controlling their costs. This results in development of efficiency in the market. 19. Answer : (d) Reason : To maximize his total utility, a consumer should spend his income such that the last rupee spent on all goods gives same amount of additional utility i.e. MUx/Px = MUy/Py. The marginal utilities of last good X and good Y are same, hence it can be written as MUx/Px = MUx/Py. As the price of good X is more than good Y, MUx/Px < MUx/Py, which means that the consumer has not achieved maximum possible satisfaction. In order to reach maximum satisfaction, he should, thus, consume more of good Y and less of good X because marginal utility per rupee from good Y is more than good X. 20. Answer : (d) Reason : As long as the firm experiences diseconomies of scale, the average cost of the firm increases. Conversely, the firm’s average cost decreases during the range of production where the firm experiences economies of scale. As the firm is experiencing diseconomies of scale initially and later economies of scale, the average cost increases initially, but decreases eventually. Hence, the firm’s long-run average cost curve will rise initially, but falls later and forms an inverted Ushaped curve. 21. Answer : (c) Reason : % Change in total revenue = % Change in quantity + % Change in price. With law of demand in operation, the percentage change in total revenue will be positive (negative) if the percentage change in quantity sold is more (less) than the percentage change in price. (a) If the demand for a product is unit elastic, any given percentage change in the price will resulting an equal but opposite percentage in quantity demanded. The net effect would be no change in total revenue because the downward force would exactly offset the upward force on revenue. (b) Suppose the demand for a product is inelastic, the percentage increase in quantity demanded caused by price cut would be smaller than the percentage fall in price that caused it. Under such circumstances, the upward influence on the price cut on revenue would be stronger than the effect of the increase in quantity demanded on revenue. (c) Suppose the demand for a product is elastic, the percentage increase in quantity demanded caused by price cut would be larger than the percentage fall in price that caused it. Under such circumstances, the depressing effect of the price cut on revenue would be lower than the effect of the increase in quantity demanded on revenue and hence the revenue will increase. (d) A horizontal demand curve represents the perfectly elasticity of demand for the good. It also implies that the firm can sell any amount of good at a given price. When at given price he can sell whatever quantity he wants, he finds no incentive to reduce the price of the good. Hence, (d) is not correct. (e) If the demand for a product is inelastic, then the percentage increase in quantity demanded caused by price cut would be zero. Under such circumstances, it is advisable to increase/maintain the price at the same level than to lower the price. 22. Answer : (b) Reason : a. Meal costs more in cities because the firm incur higher cost of living. This does not constitute price discrimination. b. When a super market offers special sale prices for goods during 9 a.m. to 12 a.m. it means that they have sub-divided the market into two based on the timing and is charged with different prices. Hence, this constitutes price discrimination. c. The insurance company is charging higher premium on expensive stores because of higher risk. This does not constitute to price discrimination. d. Buy one and get one free is available to everyone and hence is not an example of price discrimination.

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23. Answer : (a) Reason : If the price of a complement falls, the demand for X will increase, increasing quantity and increasing price in the short run. Economic profits will induce new firms to enter the market and the supply curve will shift to the right. Since it is a constant cost industry, the long-run supply curve will be horizontal and the price comes to its initial price level. 24. Answer : (a) Reason : In a monopoly, the firm’s demand curve is the demand curve of the industry. When the market transforms to perfect competition, the demand curve of the firm will turn horizontal. But, the market demand curve remains downward sloping. Hence, the statement (a) is the correct. 25. Answer : (e) Reason : A price war in an oligopoly refers to successive and continued price cuts by the member firms to increase sales and revenues. A price war aims at increasing market share, but not profits. Hence (a) is not correct. 26. Answer : (c) Reason : According to the law of diminishing returns, the marginal product first increases and then decreases after reaching a maximum point. Because of this reason, TP curve is first convex from below and then concave. So long as the TP curve is convex, MP will be increasing. When MP decreases, TP curve turns concave. That means, the total product curve changes from convex to concave at the point where MP reaches its maximum point. a. A firm maximizes its profits when its marginal revenue equals marginal cost. b. When marginal cost curve intercepts average cost, it indicates that the average cost is at its minimum position. Average product curve (AP) is the mirror image of average cost curve (AC). Hence, when AC is minimum AP will be at its maximum position. c. Marginal product curve (MP) is the mirror image of marginal cost curve (MC). Hence when marginal cost curve is minimum, marginal product curve will be at its maximum position. As curvature of total product curve changes from convex to concave at the maximum point of marginal product, the statement given is correct. d. Average product cannot be zero, unless no output is produced. e When marginal product curve cuts the horizontal axis, it represents that the marginal product is zero. When MP is zero, TP will be maximum. 27. Answer : (c) Reason : The slope of the isoquant represents the Marginal Rate of Technical Substitution (MRTS) between labor (L) and capital (K). MRTS is equal to the ratio of the marginal productivities of two factors. a. The slope of the isocost curve represents ratio of wages (w) and interest (r). b. The slope of the indifference curve signifies marginal rate of substitution of goods (MRS). c. The slope of the isoquant curve signifies the marginal rate of technical substitution (MRTS) between labor and capital. d. The slope of the budget line represents ratio of price of good X and good Y. e. The slope of the average cost curve only shows the rate of change in average cost curve with respect change in output. 28. Answer : (c) Reason : The degree of substitutability of products can be measured by the cross-price elasticity of demand for goods produced by the firms. If the substitutability is perfect (that is if the two firms are selling a homogenous product), the cross-price elasticity will be infinity. On the other hand, if the products are differentiated, the cross-price elasticity of demand will be positive and finite. If the products have no substitutes then the cross-price elasticity of those goods will be zero. (a) In perfect competition, since the products are homogenous, the cross-price elasticity will be infinity. (b) In a monopoly there will be no substitutes and hence the cross-price elasticity of goods is zero. 21

(c) (d)

(e)

In monopolistic competition and differentiated oligopoly the products are differentiated but not homogenous, hence the cross-price elasticity will be between 0 to infinite. In pure oligopoly and perfect competition, the products are homogenous and hence the cross-price elasticity is infinity. As the cross-price elasticity of demand is 2.5, the correct answer is (c). Cartels create artificial monopoly and hence the cross-price elasticity will be zero.

29. Answer : (c) Reason : The difference between marginal revenue gained by a firm and the marginal cost incurred for producing the good indicates the additional profit the firm has gained by selling one additional unit; which is known as marginal profit. a. Net revenue = Total revenue – Total cost = Profits. Hence is not the correct answer. b. Average revenue = Total revenue/Quantity sold. c. Marginal profit = Marginal revenue – marginal cost d. Marginal revenue = change in total revenue/change in units sold. 30. Answer : (d) Reason : Product differentiation exists only when consumers can differentiate the product sold by one producer from another. There are two conditions that must be fulfilled for price discrimination (i) the market must be divided into sub-markets with different price elasticities and (ii) there must be effective separation of the sub-markets so that no reselling can take place from a lowprice market to a high-price market. But these two conditions are not necessary for product differentiation. Hence (a), (b) and (c) are not correct. 31. Answer : (b) Reason : Tea, milk, rice and water are necessary because of their importance in daily life. Ice cream is considered to be luxury. For luxuries the income elasticity of demand will be high. 32. Answer : (b) Reason : When the price of good X doubles, the consumer can buy less of the good X with the given income, but can buy same quantity of another good. Hence, the budget line will fan inside at Yintercept to the left. 33. Answer : (c) Reason : Price effect = Income effect + substitution effect. For any good, the substitution effect is positive. That is, when a good becomes relatively cheaper, it is substituted for other goods. a. In the case of Giffen good, negative income effect is greater than the positive substitution effect; hence price and quantity demanded of the good are positively related. b. Income effect will be negative in case of inferior good as fewer quantities are demanded when real income increases. c. For normal goods, both income effect and substitution effect work in the same direction. d. Normal good can be classified into luxury good and necessary good based on the magnitude of change of quantity demanded with respect to change in income. However, as we know only that income effect and substitution effect operated in the same direction, we cannot categorize them into luxury and necessity. 34. Answer : (e) Reason : The profit of a firm refers to the difference between total revenue and total cost. Hence, to maximize the profits, the firm should maximize the difference between total revenue and total cost. The difference between average revenue (AR) and average cost (AC) represents the average profit of the firm. Hence maximization of difference between average revenue and average cost also indicates profit maximization. A firm maximizes its profit when it produces and sells an output at which marginal revenue (MR) is equal to marginal cost (MC). 35. Answer : (d) Reason : In long run, all costs are variable, which means there will be no fixed costs. a. In the long run, the fixed cost will be zero. Hence, the fixed cost of a firm in the long run will be lesser than the fixed cost of the firm in the short run. 22

b. c. d. e.

Fixed costs remain constant, i.e. are independent to the firm’s level of output. The difference between average total cost and average variable costs signifies the amount of average fixed cost of a firm. With the increase of output The average fixed cost falls at a decreasing rate. Hence the statement (d) is not correct. When the firm is not producing anything, its variable cost will be zero. Hence, the total cost of the firm will be just equal to its fixed costs.

36. Answer : (c) Reason : A large economy of scale leading to existence of a single firm in an industry is defined as a natural monopoly. Government regulation, ownership of critical raw materials and licenses because sources of monopoly, but not result in natural monopoly. 37. Answer : (c) Reason : When the variable costs of the firm exceed its revenue, it can reduce the losses by shutting down its operations. Even if its fixed costs exceed its revenue, the firm may not shut down its operations because the firm can reduce its fixed cost loss through sales. a. In the short run, the firms will continue their operations even though they incur losses. b. If the revenue is more than variable costs, it can reduce the losses caused by fixed costs. c. When the variable costs of the firm exceed its revenue, it can reduce the losses by shutting down its operations d. If total revenue is more than total costs it signifies losses. In the short run, the firms will continue their operations even though they incur losses. e. Revenue is more important to take a decision on continuation of operation. 38. Answer : (b) Reason : Ignorance and costs of obtaining information often make the products of one firm an imperfect substitute for another. (a) The given situation does not represent a perfect competition because there is no free flow of information. (b) The chief characteristic of monopolistic competition is product differentiation. Product differentiation can arise depending on the location and accessibility. Here, the sentence “she finally brought the dress as she felt that if would take more time in locating other showrooms” signifies product differentiation in the form of location. (c) In monopoly, there should be only one seller. But in the given situation, there is more than one show- room in the city. (d) Monopsony is a complementary form of monopoly. In this market form there exists only one buyer and a large number of sellers with other conditions remaining the same to that of monopoly. Kajol is not the only one buyer of garments and hence the market does not reflect monopsony. (e) Under pure oligopoly, the products produced will be homogeneous. Here, there is product differentiation in the form of location. Hence the market does not resemble pure oligopoly. 39. Answer : (a) Reason : The shape of the indifference curves reveals the degree of substitutability between two goods. In case of perfect substitutes, as there is perfect degree of substitutability between goods, the indifference curve will be linear. For complementary goods – goods that cannot be substituted for each other at all – the indifference curve will be L-shaped. Indifference curves are convex to origin because the marginal rate of substitution decreases as we move right. 40. Answer : (c) Reason : Price ceiling inevitably result in shortages when they are set below market equilibrium price. Because the rent ceiling is more than the market equilibrium rent, it will not have any impact on the equilibrium rent, quantity of house demanded and supplied.

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Section B : Problems
41. Answer : (c) Reason : To maximize profits, a perfectly competitive firm produces an output where P = MC MC = ∂TC/∂Q = 300 – 80Q + 3Q2 P = 300 – 80Q + 3Q2, where Q = 50 units (given) Hence, P = 300 – 80(50) + 3(50)2 = 300 – 4000 + 7500 = 3800 Thus, total industrial production is equal to (100 + 2 x 3800) = 7700. 42. Answer : (b) Reason : For a firm operating in a perfectly competitive industry, the MC curve above the AVC curve is the supply curve of the firm. MC = ∂TC/∂Q = - 50 + 4Q = P Or, 4Q = P + 50 Or, Q = 0.25P + 12.5 There are 100 firms, hence Qs = 100 x Q = 25P + 1250 Equilibrium price is where, Qs = Qd 2000 – 200P = 25P + 1250 Or, 225P = 750 Or, P = 3.33. 43. Answer : (a) Reason : When a specific tax is imposed, the tax burden is shared by the buyers and sellers in the ratio of there opposite elasticities of price i.e. B : S ::: Es : Ed. Ed = ∂Q/∂P x P/Q = -100 x P/Q Es = ∂Q/∂P x P/Q = 20 x P/Q Taking the absolute figures, the ratio of Es : Ed ::: 20 : 100 Or, 1 : 5 Burden on buyers = 10 x 1/6 = 1.67 Equilibrium price before imposition of tax: 4200 – 100P = 3000 + 20P Or, 120P = 1200 P = 10. Equilibrium price after imposition of tax: = 10 + 1.67 = 11.67. Alternatively, When tax is imposed, the supply function becomes Qs = 3000 + 20(P – 10) Thus, at equilibrium, 3000 + 20 (P – 10) = 4200 – 100P 4200 – 3000 + 200 = 120P Or, P = 1400/120 = 11.67. 44. Answer : (a) Reason : MC = ∂TC/∂Q Where, TC = TFC + TVC TVC = AVC x Q = (20 – 10Q + 0.25Q2) Q = 20Q – 10Q2 + 0.25Q3 Thus, TC = 100 + 20Q – 10Q2 + 0.25Q3 Then, MC = ∂TC/∂Q = 20 – 20Q + 0.75Q2 MC will be minimum when ∂MC/∂Q = 0 ∂MC/∂Q = -20 + 1.5Q = 0 Or, 1.5Q = 20 Or, Q = 20/1.5 Q = 13.33. 24

45. Answer : (b) Reason : Maximum utility can be achieved by the consumer by allocating his spending in such a way that MU per one rupee spent on each good should be same. From the table MU/P = 4.00 is common for all juices. Hence, Mr. Vinod should consume 3 bottles of apple juice, 2 bottles of mango juice and 4 bottles of orange juice. Thus, total utility = 340 + 330 + 1020 = 1690. Apple Juice Consump tion 1 2 3 4 5 6 7 MU 140 120 80 70 50 40 20 MU/P 7.0 6.0 4.0 3.5 2.5 2.0 1.0 Mango Juice MU 170 160 90 80 70 60 40 MU/P 4.25 4.0 2.25 2.0 1.75 1.5 1.0 Orange Juice MU 320 260 240 200 160 120 60 MU/P 6.4 5.2 4.8 4.0 3.2 2.4 1.2

46. Answer : (a) Reason : At current market prices, Q = 23500 – 10 (5000) + 5(4500) + 2.5 (10000) + 0.5 (8000) = 25000. Thus, price elasticity of demand (Ep) = ∂Q/∂P x P/Q = - 10 (5000/25000) = - 2 47. Answer : (c) Reason : Revenue = Profits + Total Cost = -10Q2 + 200Q – 200 + (200 + 10Q) = -10Q2 + 210Q Revenue will be maximum, when ∂R/∂Q = 0 ∂R/∂Q = -20Q + 210 = 0 Or, Q = 210/20 = 10.5. 48. Answer : (a) Reason : Substituting the value of K, K = 100, into the given production function, we get 200 L0.5 (100)0.5 = 2000 L0.5 To maximize profits, the firm should hire labor until MRPL = W. Since P = MR = Rs.5, we have MRPL = MR x MPL = 5 x 1000/L0.5 5000/L0.5 = 50 100 = L0.5 Or, L = 10,000. 49. Answer : (c) Reason : The long run equilibrium of a monopolistically competitive firm is where P = LAC. 16000 – 8Q = 16000 – 14Q + 0.004Q2 Or, 0.004Q2 = 6Q Or, 0.004Q = 6 Or, Q = 1500 units. Optimum output is where the LAC is minimum. Min. LAC is where ∂LAC/∂Q = 0 -14 + 0.008Q = 0 Or, Q = 14/0.008 = 1750 units. Excess capacity = 1750 – 1500 = 250 units. 50. Answer : (a) Reason : When the demand is perfectly elastic, entire tax burden will be borne by the producer. That means, price remains at Rs.20. When price remains same there will not be any change in consumer surplus. 25

51. Answer : (e) Reason : First stage of production function ends when APL is highest and second stage ends when MPL = 0. APL is highest when APL = MPL. Q = 18L2 – L3 APL = Q/L = 18L – L2 MPL = ∂Q/∂L = 36L – 3L2 By equating APL and MPL, 18L – L2 = 36L – 3L2 2L2 = 18L Or, L = 9 Thus, first stage of production is over the range of labor input 0 to 9. At the end of the second stage of production function, MPL = 0 36L – 3L2 = 0 Or, L = 12. Thus, the second stage of production function is over the range of labor input 9 < L < 12. A rational firm would operate only in the second stage of production function. This is because of increasing APL in the first stage and negative MPL in the third stage. 52. Answer : (a) Reason : Demand for the industry = (130 – 0.2P) + (50 – 0.4P) + (70 – 0.4P – 0.05P2) = 250 – P – 0.05P2 Supply of the industry = (100 + 0.5P) + (50 + 0.5P) + (50 + 1.5P + 0.1P2) = 200 + 2.5P + 0.1P2 At equilibrium Qd = Qs 250 – P – 0.05P2 = 200 + 2.5P + 0.1P2 Or, 50 – 3.5P – 0.15P2 = 0 This is a quadratic equation in the form of ax2 + bx + c = 0 Where x = [-b ± (b2 – 4ac)0.5]/2a Thus, P = -33.33 (or) 10 Since price cannot be negative, equilibrium price = Rs.10. 53. Answer : (d) Reason : Consumer surplus = (200 – 100) + (175 – 100) + (150 – 100) = 225. 54. Answer : (b) Reason : A monopolist maximizes his profits when MC = MR. MR = P (1 – 1/|ep|) Thus, for market A. the profit maximizing condition is MC = MRA 10 = MRA = PA (1 - 1/2) = 0.5P Or, PA = 20 Similarly, for market B, the profit maximizing condition is where MRB = MC = PB (1 – 1/|ep|): 10 = MRB = PB (1 - 1/5) = 0.8P Or, PB = 12.5 Price elasticity of demand (Ep) = ∂Q/∂P x P/Q = 1/slope of the demand curve x P/Q Thus, for market A: 1/1 x 20/Q = 2 Or, Q = 10 For market B: 1/0.5 x 12.5/Q = 5 Or, Q = 5 Thus, the profit maximizing output for the firm is 10 + 5 = 15.

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55. Answer : (e) Reason : Given, Thus,

QR = 50 – 0.5QT and QT = 60 – QR QT = 60 – (50 – 0.5 QT) QT = 60 – 50 + 0.5 QT 0.5 QT = 10 Q, QT = 20 When QT = 20, QR = 50 – 0.5 (20) = 40 Thus, Qn = 40 + 20 = 60 Qn = Qp (n/n+1) Where, Qp = Total output in perfect competition n = Number of competitive firms in the market Thus, 60 = Qp (2/3) Qp = 60 × 3/2 = 90.

56. Answer : (e) Reason : 4-firm concentration ratio = Sales of top 4 firms/Total sales of the industry = (20400 + 16200 + 4000 + 5000)/(4000 + 16200 + 20400 + 5000 + 400 + 1000) = 45600/47000 = 0.97. 57. Answer : (b) Reason : Herfindahl Index = Sum of Squares of firms’ share = 0.3262 = 0.33. Name of the firm Alpha Beta Gamma Delta Epsilon Kappa Market share 4000 16200 20400 5000 400 1000 47000 Market share (%) 0.0851 0.3446 0.4340 0.1063 0.0085 0.0212 Square of Market Share (%) 0.0072 0.1188 0.1883 0.0113 0.0000 0.0004 0.3262

58. Answer : (a) Reason : To operate efficiently, the firm should equalize the MP of last rupee spent on all inputs. That is, MPL/w = MPK/r MPL = 50K + 1 MPK = 50L + 2 Thus, MPL/w = MPK/r = (50K + 1)/10 = (50L + 2)/20 Or, 100K + 2 = 50L + 2 Or, 100K = 50L Or, L = 2K Budget constraint: 10L + 20K = 1000 Or, 20K + 20K = 1000 40K = 1000 K = 25 And, L = 25 x 2 = 50. Allocation of budget: (10 x 50) = 500 = Labor (20 x 25) = 500 = Capital

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59. Answer : (a) Reason : Price elasticity of demand = ∂Q/∂P × P/Q Given P = 10 Demand function: P = 20 – 2Q Or, 2Q = 20 – P Or, Q = 10 – 0.5P Thus, ∂Q/∂P × P/Q = -0.5 × 10/5 = -1 60. Answer : (b) Reason : Marginal cost = Change in the total cost as a result of producing one additional unit of output. Thus, marginal cost of producing third unit is equal to total cost of producing three units ‘minus’ total cost of producing two units = 190 – 150 = 40. 61. Answer : (b) Reason : To avoid price war, Beta Ltd. should charge same price as charged by the leader, Alpha Ltd. Alpha charges a price where it maximizes its profits. It is possible when MRA = MCA. PA = 100 – QA When Beta charges same price, it sells the same quantity of output as Alpha i.e. QA = QB. Thus, PA = 100 – QA Or, TRA = (100 – QA)QA = 100QA – QA2 Thus, MRA = 100 – 2QA At equilibrium, 100 – 2QA = 20 Or, QA = 80/2 = 40 Or, PA = 100 – 40 = 60. Thus, price charged by Beta is also Rs.60 Thus, total revenue of Beta = 60 x 40 = 2400 And, total cost = 200 + 30(40) = 1400 Profits = 2400 – 1400 = 1000. The profit maximizing output for Beta is where MRB = MCB TRB = (100 – QB)QB = 100QB – Q 2 B MRB = 100 – 2QB At equilibrium, 100 – 2QB = 30 Or, QB = 70/2 = 35 And, PB = 100 – 35 = 65. Total revenue of beta at price Rs.65 = 65 x 35 = 2275 Total cost = 200 + 30 (35) = 1250 Profits = 2275 – 1250 = 1025 Hence, profits sacrificed = 1025 – 1000 = Rs.25. 62. Answer : (b) Reason : To maximize profits, a monopolistically competitive firm should produce an output where MR = MC. Total cost in economics includes both accounting costs and opportunity costs. Thus, Total cost (TC) = (3000 + 5000 + (1000 x 5) + 2000) + 25Q2 = 15000 + 25Q2 Thus, MC = 50Q Total Revenue (TR) = 2000Q Thus, MR = 2000 Or, 50Q = 2000 Or, Q = 40.

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63. Answer : (a) Reason : Total revenue: 2000 x 50 = 100,000 Total economic cost = 3000 + 5000 + (1000 x 5) + 2000 + 25Q2 = 15000 + 25(50)2 = 77,500. Economic profit = 100,000 – 77,500 = 22,500. Total accounting cost = (1000 x 5) + 2000 + 25Q2 = 7000 + 62500 = 69,500. Accounting profit = 100,000 – 69,500 = 30,500. 64. Answer : (d) Reason : When price discrimination is not allowed, then PA = PT and QA + QT = Q (total output). It can be written as QA = 600 – PA = 600 – P QT = 400 – PT = 400 – P Or, Q = QA + QT = 600 – P + 400 – P = 1000 – 2P Or, P = 500 – 0.5Q At profit maximization, MR = MC MC = ∂TC/∂Q Where, TC = AC x Q = (15000/Q + 100) Q = 15000 + 100Q And, MC = 100 TR = (500 – 0.5Q) Q = 500Q – 0.5 Q2 Thus, MR = 500 – Q At equilibrium, MR = MC 500 – Q = 100 Or, Q = 400 Or, P = 500 – 0.5 (400) = 300. 65. Answer : (c) Reason : When price discrimination is permitted, At equilibrium, MRA = MC and MRT = MC TRA = (600 – QA)QA = 600QA – QA2 MRA = 600 – 2QA Thus, at equilibrium in Andhra Pradesh, MRA = MC or, 600 – 2QA = 100 Or, 2QA = 500 Or, QA = 250 and PA = 600 – QA = 600 – 250 = 350. TRT = (400 – QT) QT Or, 400QT – QT2 Or, MRT = 400 – 2QT At equilibrium in Tamil Nadu MRT = MC, 400 – 2QT = 100 Or, 2QT = 300 Or, QT = 150 and PT = 400 – QT = 400 – 150 = 250. Thus, total equilibrium output for the monopolist is 250 + 150 = 400. Profit = (PA × QA + PT × QT) - TC = (350 × 250 + 250 × 150) – (15,000 + 100 × 400) = (87,500 + 37,500) (–) 55,000 = 70,000. 66. Answer : (d) Reason : Increase in sales because of increase in per capita income = 2 x 2.5 = 5 percent Decline in sales because of reduction in prices of competitor’s goods = 0.5 x – 5 = 2.5 percent Thus, increase in sales because of decline in price = 10 – 5 – (-2.5) = 7.5 Price elasticity of demand = % Change in Quantity demanded/% Change in Price = 7.5/ (-10) = (-0.75). 29

67. Answer : (b) Reason : The price below which the firm will be forced to shut down its operations is the minimum price at which the firm supplies goods to the market. A firm is forced to shut down its operation, if the price falls below Min. AVC AVC = TVC/Q = (300Q – 10Q2 + Q3)/Q = 300 – 10Q + Q2 Min. of AVC = ∂AVC/∂Q = 0 –10 + 2Q = 0 Or, Q = 5 And, P = 300 – 10(5) + (5 x 5) = 300 – 50 + 25 = 275. 68. Answer : (a) Reason : Demand function: Q = 10 + 1/(-0.5)P = 10 – 2P When market price = Rs.3, quantity demand = 10 – 2 (3) = 4 69. Answer : (a) Reason : TP (when labor = 50 units) = 50 x 25 = 1250 TP (When labor = 52 units) = 52 x 24 = 1248 Thus, MP = (1248 – 1250)/(52 – 50) = -2/2 = -1 unit. 70. Answer : (e) Reason : Equilibrium price is where Qd = Qs 0.2Qs = P + 20 Or, Qs = 5P + 100 0.1Qd = 40 – P Or, Qd = 400 – 10P At equilibrium, 5P + 100 = 400 - 10P 15P = 300 P = 300/15 = 20 When price floor is less than the equilibrium price, it will not have any affect on the market. 71. Answer : (b) Reason : To operate efficiently, the firm has to allocate the budget such that MPL/w = MPK/r. MPL = ∂TPL/∂Q = 2 MPK = ∂TPK/∂Q = 1 Thus, MPL/w = 2/100 = 0.02 And, MPK/r = 1/100 = 0.01. As MPL/w is more than MPK/r, it is clear that the marginal productivity of labor for one rupee is more than that of capital. Hence, the firm can produce cost minimizing output by using labor input.

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