Economics

Dr.
SACOE ECONOMIC ANALYSIS FOR BUSINESS (BA7103) DOMS
Dr. SIVANTHI ADITANAR COLLEGE OF ENGINEERING
TIRUCHENDUR
DEPARTMENT OF MANAGEMENT STUDIES
BRANCH / SEMESTER : MBA / I
NAME OF THE SUBJECT : ECONOMIC ANALYSIS FOR BUSINESS
SUBJECT CODE : BA 7103
NAME OF THE FACULTY : C.UTHAIYA
DESIGNATION : ASSISTANT PROFESSOR
HEAD OF THE DEPARTMENT
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Dr.SACOE ECONOMIC ANALYSIS FOR BUSINESS (BA7103) DOMS
TWO MARKS QUESTIONS
UNIT I
1. Brief out externalities.

2. Distinguish between productive efficiency and economic efficiency.
3. What do you mean by positive and negative externalities?
4. What is allocative efficiency?
5. What do you mean by scarcity?
6. What do you mean by stabilization policy?
7. Differentiate micro and macro economics.
8. State the fundamental economic problems.
9. Define economics.
10. Define public goods.
11. What is positive and normative economics?
UNIT II
1. When does market equilibrium occur?

2. What do you mean by consumer surplus?
3. What is generalized supply function?
4. What do you mean by short run production?
5. State the meaning of market economy.
6. What do you mean by consumer equilibrium?
7. What is Elasticity of Demand?
8. What is Autonomous Demand and Negative Demand?
9. What is market clearing price?
10. What do you mean by long run production?
11. Explain returns to scale.
12. Give a brief account on competitive equilibrium.
13. State the Law of Demand.
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UNIT III
1. Write a note on factor market.

2. What is Marginal Revenue product?
3. What is the condition of profit maximization of a firm under short run production in perfect
competition?
4. Define Lerner Index.
5. What is the meaning of pure rent in Factor Market?
6. When imperfect markets occur?
7. List down the determinants of factor price.
8. What are the barriers to entry?
9. Define profit. What are the determinants of profit?
10. What is zero profit long run equilibrium?
11. Define discrimination.
UNIT IV
1. What does fiscal policy denote?

2. What do you understand by macro economics?
3. What is potential GDP?
4. Define the macroeconomic equilibrium.
5. Define ‘Multiplier’.
6. What do you understand by supply shocks in macro economic analysis?
7. What is balanced budget multiplier?
8. What is aggregate demand?
9. What is marginal efficiency of capital?
10. Define ‘National Income’.
UNIT V
1. State Okun’s Law.

2. Bring out the meaning of inflation rate.
3. Define crowding – out effect.
4. What does Phillips curve state?
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5. Define Deflation.
6. What is money market?
7. What does monetary policy?
8. What is NAIRU?
9. What are the objectives of macro economics?
10. Define Money Multiplier.
16 MARKS QUESTIONS
UNIT I
1. Explain the production possibility frontier with example.
2. What are the three fundamental economic problems? Explain the role of government in
solving these three problems.
3. “Scarcity and efficiency are the twin themes of economics”- Discuss.
UNIT II
1. Discuss the factors and determine the demand for a commodity

2. Examine the relationship between production and cost function in detail
3. Explain the types of elasticity of demand and supply
UNIT III
1. Elucidate the different types of market structure
2. ‘Demand for labour reflects marginal productivity’ - explain
3. Compare price output equilibrium under monopolistic competition with that under perfect
competition
UNIT IV
1. What is national income? Explain the methods of determining the national income.
2. Give an account of fiscal policy examine its impact
3. Explain the multiplier effect with varying price level
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UNIT V
1. Explain the types and impacts of inflation
2. What is unemployment? Explain its causes and types.
3. Explain the critical view about the role of monetary policy
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Two Marks – Answers
UNIT I
1. Brief out externalities.

An externality is a cost or benefit, not transmitted through prices, incurred by a party who
did not agree to the action causing the cost or benefit. A benefit in this case is called positive
externalities or external benefit, while a cost is called a negative externalities or external cost.
2. Distinguish between productive efficiency and economic efficiency.

Production efficiency measures whether the economy is producing as much as possible
without wasting precious resources
Economic Efficiency: When goods are produced in the least costly manner and
distributed to those who value them most.
3. What do you mean by positive and negative externalities?

Positive externality exists when an individual or firm making a decision does not receive
the full benefit of the decision. The benefit of the individual or firm is less than the benefit to
society.
Negative externality occurs when an individual or making a decision does not have to pay
the full cost of the decision.
4. What is allocative efficiency?

The right amount of right products must be produced. Those products that yield most consumer
satisfaction per unit of resource required to produce them should be the products produced.
This is called allocative efficiency.
5. What do you mean by scarcity?

Scarcity is the fundamental economic problem of having humans who have unlimited
wants and needs in a world of limited resources. It states that society has insufficient productive
resources to fulfill all human wants and needs.
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6. What do you mean by stabilization policy?

➢ Stabilization policy involves policy to attempt to stabilize the fluctuation of real GDP around
trend.
➢ The primary ways that government can stabilize the economy is through fiscal and monetary
policy.
➢ This involves attempting to reduce output growth above trend during an expansion &
attempting to reduce the reduction of growth below trend.
7. Differentiate micro and macro economics.
Microeconomics Macroeconomics
1. Microeconomics studies the 1. Macroeconomics studies

economic behavior of individual the economy as a whole.
entities such as individuals,
households, firms, industry, etc.
2. Microeconomics explains the 2. Macroeconomics explains

interrelationships between about the total national
economic units like consumers, income, aggregate demand
commodities, firms, industries, and supply, general price
markets ,etc. level, total employment, etc.
8. State the fundamental economic problems.

To make the best use of economic resources the following questions need to be
answered.
➢ What to produce?
➢ How to produce?
➢ For whom to produce?
9. Define economics.
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Economics is the study of how societies use scarce resources to produce valuable
Commodities & distribute them among different people.
10. Define public goods.

A product that one individual can consume without reducing its availability to another
individual and from which no one is excluded. Economists refer to public goods as "non-
rivalrous" and "non-excludable".
11. What is positive and normative economics?
Positive statements are objective statements dealing with matters of fact or they
question about how things actually are. Positive statements are made without obvious value-
judgments and emotions. They may suggest an economic relationship that can be tested by
recourse to the available evidence.
Normative statements are subjective - based on opinion only - often without a basis
in fact or theory. They are value-laden, emotional statements that focus on "what ought to be".
UNIT II
1. When does market equilibrium occur?

Market equilibrium is a situation in which, at the prevailing price, consumers can buy all
of a good they wish and producers can sell all of the good they wish.
2. What do you mean by consumer surplus?

Consumer’s surplus as, excess of the price which a consumer would be willing to pay rather
than go without a thing over that which he actually does pay, is the economic measure of this
surplus satisfaction. This is called consumer surplus.
3. What is generalized supply function?

Supply of goods or services refers to the quantities that the seller is willing to and able to
offer for sale at various prices within a given time period, other factors held constant.
4. What do you mean by short run production?
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Short run is defined as a period in which fixed cannot be varied. However it is possible to
increase the quantities of one input while keeping the quantities of other inputs constant in
order to have more output.
5. State the meaning of market economy.

Market economy is the one in which individuals & Private firms make the major decision
about production and consumption. Based on market demand and supply, consumers are free
to buy goods and services of their choice and producer allocate their resources based on the
demand.
6. What do you mean by consumer equilibrium?

A consumer is said to be in equilibrium when he maximizes his satisfaction with the
available money income.
7. What is Elasticity of Demand?

Elasticity of demand may be defined as the ratio of the percentage change in demand
to the percentage change in price.
8. What is Autonomous Demand and Negative Demand?

Autonomous demand for a commodity is one that arises independent of the demand
for any other commodity.
Negative demand refers to the demand where consumers dislikes the product and even
pay price to avoid that particular product.
9. What is market clearing price?

Market-clearing price is the price that achieves a market balance. Because quantity
demanded and quantity supplied are equal at the market-clearing price, there is no shortage nor
surplus in the market, which means that neither buyers nor sellers are inclined to change the
price, which is the primary condition for equilibrium.
10. What do you mean by long run production?
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Long run is a period in which all the factors of production are vary. Adjustments among
the various inputs can be made easily made in the long run.
11. Explain returns to scale.

Returns to scale refers to the responsiveness of total product when all the inputs are
changed proportionately.
12. Give a brief account on competitive equilibrium.

▪ Competitive equilibrium is an equilibrium condition where the interaction of profit –
maximizing producer and utility maximizing consumers in competitive markets with freely
determined prices will give rise to an equilibrium price.
▪ At this equilibrium price, the quantity supplied is equal to the quantity demanded.
13. State the Law of Demand.
Law of demand explains the relationship between change in quantity demanded and
change in price. It states that higher the price, the lower would be the quantity demanded in
the market and vice versa.
UNIT III
1. Write a note on factor market.

It refers to markets where the factors of production are bought and sold such as the labor
market, the capital market, the market for raw materials and the market for management or
entrepreneurial resources.
2. What is Marginal Revenue product?

It is defined as the addition to the total revenue resulting from the employment of one more
unit of the variable and sale of the additional product. In mathematical notation, MRP a = MPa
. MRx
Where, a – Factor of production
x – Commodity
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3. What is the condition of profit maximization of a firm under short run production in perfect
competition?
➢ The first order condition requires that marginal revenue must be equal to marginal cost.
➢ The second order condition requires that the necessary condition must be satisfied under the
condition of decreasing MR and rising MC.
4. Define Lerner Index.

The difference between price (p) and marginal cost (mc) as a fraction of price, that is
[p-mc]/p. The Lerner index is usually taken as an indicator of market power because the larger
the index, the larger the difference between price and marginal cost, that is, the larger the
distance between the price and the competitive price. The Lerner index depends on the
elasticity of demand. The Lerner index is also called the price-cost margin.
5. What is the meaning of pure rent in Factor Market?
Modern economists use the word rent as an “economic surplus or transfer earnings
which means the earning of a factor of production in excess of the minimum amount necessary
to keep it in its present use”. It is not a differential surplus, the difference between the superior
inferior grades of lands, as Ricardo meant by rent.
6. When imperfect markets occur?

Imperfect competition is a market situation wherein one or more conditions of perfect
competition are absent. Following conditions are responsible for occurrence of imperfect
competition:
➢ Limited number of sellers
➢ Product differentiation
➢ Restrictions of entry or exit
➢ Dependent behavior
7. List down the determinants of factor price.

It is made clear that the forces of demand and supply are the two determining forces in
factor pricing.
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8. What are the barriers to entry?

The existence of high start-up costs or other obstacles that prevent new competitors from
easily entering an industry or area of business. Barriers to entry benefit existing companies
already operating in an industry because they protect an established company's revenues and
profits from being whittled away by new competitors.
9. Define profit. What are the determinants of profit?

A financial benefit that is realized when the amount of revenue gained from a business
activity exceeds the expenses, costs and taxes needed to sustain the activity.
Determinants of profit
➢ Price level
➢ Economies of scale
➢ Wages
➢ Consumption
➢ Productivity
➢ Innovation and product differentiation
10. What is zero profit long run equilibrium?
➢ Economic profit is zero in the long run because firms are able to enter and exit the market, in
perfectly competitive market.
➢ There would be an incentive for new firm to enter, supply would increase, causing an increase
in quantity and the price to be driven back down to equilibrium (ie) no profit.
11. Define discrimination.

Discrimination is the prejudicial or distinguishing treatment of an individual based on
their actual or perceived membership in a certain group or category, such as their race, gender,
sexual orientation, ethnicity, national origin, or religion.
UNIT IV
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1. What does fiscal policy denote?

Fiscal policy is a policy under which government uses its expenditure and revenue
programs to produce desirable effects and avoid undesirable effects on the national income,
production and employment.
2. What do you understand by macro economics?

Macroeconomics studies the economy as a whole. It explains about the total national
income, aggregate demand and supply, general price level, total employment, etc.
3. What is potential GDP?

Gross Domestic Product (GDP) is the measure of the market value of all goods and services
produced by factors- labor and property – located within the boundaries of a country, during a
specified period of time.
4. Define the macroeconomic equilibrium.

Macroeconomic equilibrium is a situation in which the aggregate demand is equal to
aggregate supply. It is useful for evaluating factors and conditions which affect the level of
GDP and the level of inflation.
5. Define ‘Multiplier’.
An effect in economics in which an increase in spending produces an increase in
national income and consumption greater than the initial amount spent.
6. What do you understand by supply shocks in macro economic analysis?

A supply shock is an event that suddenly changes the price of a commodity or service.
It may be caused by a sudden increase or decrease in the supply of a particular good. This
sudden change affects the equilibrium price.
7. What is balanced budget multiplier?
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A balanced budget is a budget with revenues equal to expenditures, and neither a

budget deficit nor a budget surplus. More generally, it refers to a budget with no deficit, but
possibly with a surplus.
8. What is aggregate demand?

Aggregate demand is the total demand for final goods and services in a economy at a given
period of time and price level.
9. What is marginal efficiency of capital?

The marginal efficiency of capital (MEC) is that rate of discount which would equate the
price of a fixed capital asset with its present discounted value of expected income.
10. Define ‘National Income’.

National income is the money value of all the final goods and services produced by a
country during a period of one year.
UNIT V
1. State Okun’s Law.
Okun’s law explains relationship between an economy’s GDP gap and the actual
unemployment rate. There is an inverse relationship between unemployment rate and the
growth of output.
2. Bring out the meaning of inflation rate.

Inflation is a state, in which the value of money is falling, i.e., prices are rising.
3. Define crowding – out effect.

Crowding out effect occurs when governments borrow funds from other countries to
finance government spending usually through expansionary fiscal policies.
4. What does Phillips curve state?
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Phillips curve is a downward sloping curve, named after A.W.Phillips, exhibiting the
inverse relation between rate of inflation and the rate of unemployment.
This inverse relation implies a trade – off, that is, for reducing unemployment, price in
the form of high rate of inflation has to be paid and for reducing the rate of inflation, price in
terms of a high rate of unemployment has to be paid.
5. Define Deflation.
Deflation is a decrease in the general price level of goods and services. Deflation occurs
when the inflation rate falls below 0%.
6. What is money market?

Reserve bank of India describe the Money Market as, “The center for dealings, mainly
of a short term character, in monetary assets; it meets the short – term requirements of
borrowers and provides liquidity or cash to the lenders”.
7. What does monetary policy?

It deals with monetary system of a country. It is concerned with monetary decisions and
measures. Non – monetary decisions and measures having monetary effects are also dealt with
under the monetary policy.
8. What is NAIRU?
According to popular economics inflation tends to accelerate once the rate of
unemployment falls to below a certain percentage. The rate of unemployment below which the
rate of inflation tends to accelerate is labeled as the Non-Accelerating Inflation Rate of
Unemployment or NAIRU.
9. What are the objectives of macro economics?

The objectives of macro economics are:
➢ High level of output
➢ Full employment
➢ Price stability
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➢ Sustainable Balance of Payment

➢ Rapid economic growth
10. Define Money Multiplier.

Money multiplier is the degree to which money supply is expanded as the result of the
increase in high powered money.
M=H.m
16 Marks - Answers
UNIT I
1. Explain the production possibility frontier with example.
Production possibility frontier is a graph that shows the different combinations of the
quantities of two goods that can be produced in an economy at any point of time, subject to the
availability of resources. It also depicts the trade off between any two items produced. This curve
not only represent the opportunity cost but it also actually measures opportunity cost by indicating
the opportunity cost of increasing one items production in terms of other forgone.
Assumptions of PPC
• Resources are used to produce one or both of only two goods.

• The quantities of labor, capital ,land and entrepreneurship do not change
• The information and knowledge about the production is fixed.
• Resources are used in a technically efficient way.
Diagrammatic representation of PPC
According to the assumptions of production possibility curve, the economy is using all
resources with given technology to efficiently produce goods rice and blue jeans. Consider if all
the factors of production are used for the production of the rice only and then 80 tons of rice can
be produced. On the other hand if all the resources are employed for the production of blue jeans
only the 5 bales of blue jeans will be produced. if all the factors are applied for the production of
both goods various combinations of these goods can be produced.
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As shown in the schedule that if production performed under A combination and 80 tonne
of rice produced without any production of blue jeans. In other condition if production carried
under F combination and then 5 bales of blue jeans will be produced without the production if rice.
Now plotting these combinations on a graph.
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This curve presents the alternative combinations of rice and blue jeans that the economy
can produce . The vertical axis measures the production of rice and the horizontal axis measures
the production of blue jeans.
The primary possibility is 80 tonne production of rice and zero units of blue jeans. This is
represented by A and point F represents the possibility of 5 bales blue jeans and zero units of rice.
In the same way B,C ,D and E marked different combinations of rice and blue jeans. By joining
these combinations AF is formed. It is called production possibility curve.
Point G outside the production possibility curve represents the unachievable combination
from the available resources and point H inside the production possibility curve represents the
unproductive combination from available resources.
Limitations of PPC
• Hypothetical and static

• No practical use
• Irrelevant assumptions
• No analytical device
• Environmental consequences
• Downside effects
• Short run phenomena
2. What are the three fundamental economic problems? Explain the role of government in
solving these three problems.
To make the best use of economic resources the following questions need to be answered.
1. What to produce?
In reality, it is not possible to produce all goods and services that people want because
resources are limited. Every society should decide what goods and services are to be produced and
in what quantities. These decisions require an evaluation of opportunity cost. All the material
goods cannot be produced which desire, so tend to choose which to produce out of scare resources.
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In choosing a particular good to produce, preference ratings should be considered on each and
every good that tend to produce.
2. How to produce?
After answering the first question, society must decide not only what goods and services it
wants, but also hoe these goods and services should be produced. This question tackles the method
of producing the goods and services. As a rule of thumb, goods and services must be developed or
produced at its optimum level – that is maximum input without sacrificing the quality.
3. For whom to produce?
In this economic question, tend to answer the question, “who should consume the
produced goods and services?” we should answer also what is the basis of rationing the said final
product to the different consumers. In short, this is a problem of distribution.
The economic role of government
Governments have 3 main economic functions in a market economy. These
Functions are
➢ Increasing efficiency.
➢ promoting equity &
➢ Fostering macro – economic stability & growth.
➢ Governments foster macroeconomic stability and growth – reducing unemployment and
inflation while encouraging economic growth – through fiscal policy and monetary
regulation.
We will examine briefly each function.
Increasing efficiency
Governments increase efficiency by promoting competition, curbing externalities like

pollution, and providing public goods.
➢ Perfect Competition:
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Adam Smith recognized that the virtues of the market mechanism are fully realized
only when the checks and balances of perfect competition are present.
Perfect competition refers to a market in which no firm or consumer is large enough

to affect the market price.
➢ Imperfect Competition:
One serious deviation from an efficient market comes from imperfect competition or
Monopoly. Whereas under perfect competition no firm or consumer can affect prices,
imperfect competitions occur when a buyer or seller can affect a good’s price.
➢ Externalities:
A second type of inefficiency arises when there are spillovers or externalities,

which involve involuntary imposition of costs and benefits on other outside the market
place.
Governments are generally more concerned with negative externalities than

positive ones. Government regulations are desired to control externalities like air and water
pollution, damage from strip mining, hazardous wastes, unsafe drugs and radioactive
materials.
➢ Public Goods:
While negative externalities like pollution or global warming command most of the
headlines, positive externalities may well be economically more significant. Important
examples of positive externalities are construction of a highway network, operation of a
national weather service and provision of measures to enhance public health.
Public goods are commodities which can be enjoyed by everyone and from which
no one can be excluded. Because private provision of public goods is generally insufficient,
the government must step in to encourage the production of public goods.
Promoting Equity
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Governments promote equity by using tax and expenditure programs to redistribute income
toward particular groups.
Markets do not necessarily produce a fair distribution of income. A market economy may
produce inequalities in income and consumption that are not acceptable to the electorate.
Government can engage in progressive taxation, taxing large income at a higher rate than
small income.
Secondly, low tax rate cannot help those who have no income at all, government can make
transfer payments, which are money payment to people. Such transfers include aid for the elderly,
blind, disabled, for the unemployed etc.
Macro- Economic Growth & Stability:
Government can use fiscal and monetary policies to stabilize the economic growth against
business cycles & stimulate growth.
3. “Scarcity and efficiency are the twin themes of economics”- Discuss.
Twin themes of economics are:
i) Scarcity
ii) Efficiency
i) Scarcity
Resources are scarce. Scarcity is the relationship between how much there is of something
and how much of it is wanted. Resources are scarce compared to all the uses we have for them. If
we use more than there is of an item, it is scarce.
Main Features of Scarcity
The principal features of scarcity are as follows:
1. Human wants are unlimited: The scarcity definition of Economics states that human
wants are unlimited. If one want is satisfied, another want crops up. Thus, different wants
appear one after another.
2. Limited means to satisfy human wants: Though wants are unlimited, yet the means
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for satisfying these wants are limited. The resources needed to satisfy these wants are limited. For
example, the money income (per month) required for the satisfaction of wants of an
individual is limited. Any resource is considered as scarce if its supply is less than its demand.
3. Alternative uses of scarce resources: Same resource can be devoted to alternative
lines of production. Thus, same resource can be used for the satisfaction of different types of
human wants. For example, a piece of land can be used for either cultivation, or building a
dwelling place or building a factory shed, etc.
4. Efficient use of scarce resources: Since wants are unlimited, so these wants are to be
ranked in order of priorities. On the basis of such priorities, the scarce resources are to be used in
an efficient manner for the satisfaction of these wants.
5. Need for choice and optimization: Since human wants are unlimited, so one has to
choose between the most urgent and less urgent wants. Hence, Economics is also called a
science of choice. So, scarce resources are to be used for the maximum satisfaction (i.e.,
optimisation) of the most urgent human wants.
ii) Efficiency
Efficiency denotes that most effective use of a society’s resources in satisfying people
wants and needs.
In economic efficiency is a situation where all available resources are being used in the
most effective way possible to meet the greatest possible level of consumer wants.
Productive efficiency
Productive efficiency occurs when the economy is utilizing all of its resources efficiently.
The concept is illustrated on a production possibility frontier (PPF) where all points on the curve
are points of maximum productive efficiency (i.e., no more output can be achieved from the given
inputs). An equilibrium may be productively efficient without being allocatively efficient— i.e. it
may result in a distribution of goods where social welfare is not maximized.
Productive efficiency occurs when production of one good is achieved at the lowest
resource (input) cost possible, given the level of production of the other good(s). Equivalently, it
occurs when the highest possible output of one good is produced, given the production level of the
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other good(s). In long-run equilibrium for perfectly competitive markets, this is at the base of the
average total cost curve—i.e. where marginal cost equals average total cost.
Productive efficiency requires that all firms operate using best-practice technological and
managerial processes. By improving these processes, an economy or business can extend its
production possibility frontier outward, so that efficient production yields more output.
Economic efficiency
In economics, the term economic efficiency refers to the use of resources so as to maximize
the production of goods and services. An economic system is said to be more efficient than another
(in relative terms) if it can provide more goods and services for society without using more
resources. In absolute terms, a situation can be called economically efficient if:
• No one can be made better off without making someone else worse off
• No additional output can be obtained without increasing the amount of inputs.
• Production proceeds at the lowest possible per-unit cost.
UNIT II
1. Discuss the factors and determine the demand for a commodity
The main demand determinants are price, income, price of related goods and advertising.
Therefore, demand is a multivariate relationship, i.e., it is determined by many factors
simultaneously.
1. Price of the Commodity: The law of demand states that if other things remain the same.
The demand of the commodity is inversely related to its price. It implies that a rise in price
of a commodity brings about a fall in its purchase and vice-versa.
2. Price of the related goods: The demand for a commodity is also affected by the changes
in the price of its related goods. Related goods may be complementary or substitute goods.
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(a) Substitute goods: Two commodities are deemed to be substitute for one another if
change in the price of one affects the demand for the other in the same direction. For
instance, commodities X and Y are considered as substitute for one another if a rise in
the price of X increases demand for Y and vice versa.
(b) Complements: Two goods are termed as complementary to one another if an increase
in the price of one causes a decrease in demand for the other. By definition, there is an
inverse relation between the demand for a good and the price of its complement.
3. Consumers’ Income: Income is the basic determinant of quantity of a product demanded
since it determines the purchasing power of the consumer. That is why people with higher
income spend a larger amount on consumer goods and services than those with lower
income.
4. Consumer’s Taste and Preference: Consumer’s taste and preference play an important
role in determining the demand for a product. If the consumers develop the taste for a
commodity they buy whatever may be the price. A favorable change in consumer
preference will cause the demand to increase. Likewise an unfavorable change in consumer
preferences will cause the demand to decrease.
5. Advertisement: In modern times, the preference of consumers can be altered by
advertisement and sales propaganda. Advertisement helps in increasing demand by
informing the potential consumers about the availability of the product, by showing the
superiority of the product, and by influencing consumer choice against the rival products.
6. Consumer’s Expectation: A consumer’s expectation about the future changes in price and
income may affect his demand. If a consumer expects a rise in prices he may buy large
quantities of that particular commodity. Similarly, if he expects its prices to fall in future,
he will tend to buy less at present.
7. Growth of Population: The growth of population is also another important that affects the
market demand. With the increase in population, people naturally demand more goods for
their survival.
8. Weather conditions: Seasonal factors also affect the demand. The demand for certain
items purely depends on climatic and weather conditions.
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9. Tax Rates: The tax rate also affects the demand. High tax rate would generally mean a
low demand for those goods. At certain times government restricts the consumption of a
commodity and uses the tax as a weapon.
10. Availability of Credit: The purchasing power is influenced by the availability of credit. If
there is availability of cheap credit, the consumers try to spend more on consumer durables
thereby the demand for certain products increase.
11. Pattern of Savings: Demand also influenced by pattern of saving. If people begin to save
more, their demand will decrease. It means the disposable income will be less to purchase
the goods and services. On the contrary, if saving is less their demand will increase.
12. Circulation of Money: An expansion or a contraction in the quantity of money will affect
demand. When more money circulate among people, more of a thing is demanded by the
people because they have more purchasing power, and vice versa.
2. Examine the relationship between production and cost function in detail.
Short run production function
In the short run the technical conditions of production are rigid so that the various inputs
used to produce a given output are in fixed proportions. However in the short run it is possible to
increase the quantities of one input while keeping the quantities of other inputs constant in order
to have more output. This aspect of production function is known as law of variable proportions.
Long run production function
In the long run production function all inputs are variable. Production can be increased by
changing one or more of the inputs. The firm can change its plants or scale of production. In the
long run it is possible for a firm to change all inputs up or down in accordance with its scale. This
is known as returns to scale.
Relationship between production and cost function
The cost function approach to the analysis of a producing unit has certain convenient
features. It is easier to estimate cost function than the generalized production functions. A
constrained minimizations problem has to be solved in order to derive input demand functions
25
from an estimated production function. This may be quite a difficult task except when the
production function has some simple form. The input demand functions thus derives may have a
complex implicit form.
The production function shows for a given state of technological knowledge the
relationship between physical quantities of factor inputs and physical quantities of output involved
in producing goods and services. 26ince the quantity of output depends upon the quantities of input
used the relationship can be depicted notation ally as Q=f(I1,I2,I3….)
Where Q= output of a product and I etc are quantities of the various factor inputs used in
producing the output.
However whether it is economically viable to supply the product depends not so much on
the physical input-output relationship but on the costs of producing the output. Thus, market
analysis focuses on the least costly way of producing a given output. The cost function depicts the
general relationship between the cost of factor inputs and the cost of output factors. In order to
determine the cost of producing the particular output, it is necessary to know not only the required
quantities of the various inputs but also their prices. The cost function can be derived from
production function by adding the information about factor prices. It tale the general form
Qc=f(P1I1,P2I2….PnIn)
Where, Qc is the cost of producing a particular output Q and P1, P2 etc are the prices of the
various factors used while I1,I2, etc, are the quantities of factors 1,2 etc required. The factor prices
P1, P2 etc which a firm must pay in order to attract units of these factors will depend upon the
interactions of the forces of demand and supply in factor markets.
3. Explain the types of elasticity of demand and supply
ELASTICITY OF DEMAND:
26
The term elasticity of demand is used to denote a measure of the rate at which demand
changes in response to the change in price.
TYPES OF ELASTICITY OF DEMAND:
There are various types of elasticity of demand; the important ones are given below:
➢ Price Elasticity of demand

➢ Income Elasticity of demand
➢ Cross Elasticity of demand
➢ Promotional Elasticity of demand
➢ Price Elasticity of demand
According to Prof. Lipsey, “Elasticity of demand may be defined as the ratio of the percentage
change in demand to the percentage change in price.”
Price Elasticity (Ep) = % Change in Quantity demanded
%Change in Prices
Types of price Elasticity:
Price elasticity of demand is classified in to five categories:
1. Perfectly elastic demand (E=α)
In case of perfectly elastic demand, the demand for a commodity changes even though
there is no change in price. It also implies that with a very small percentage change in price,
the quantity demanded would change indefinitely and so the seller would not change the price.
27
In the above figure we can see a straight line demand curve to X-axis. The diagram
shows that at the ruling price OD, any amount of the commodity can be sold which is a case
of perfectly elastic demand.
2. Perfectly Inelastic Demand (E=0)
If the demand for a commodity does not change in spite of an increase or decrease in
its price, the demand is perfectly inelastic. If suppose, the price of product increases by 50%
but the change in demand is 0, then it is said to be a perfectly inelastic demand.
In the above figure a rise in price of a commodity is followed by absolutely no increase

in the quantity demanded. Thus elasticity becomes zero.
3. Unitary Elastic Demand (E=1)
Price elasticity of demand is unity when the change in demand is exactly proportionate
to the change in price. The demand curve is a rectangular hyperbola.
28
4. Elastic Demand (E>1)
If the percentage change in quantity demanded is greater than the percentage change in
price, price elasticity of demand is greater than one. This is known as elastic demand. For e
5. Inelastic Demand (E<1)
If the percentage change in quantity demanded is less than the percentage change in price,
price elasticity of demand is less than one. This is known as inelastic demand.
29
➢ Income Elasticity of demand
Income elasticity of demand is defined as the percentage change in the

quantity demanded of a good divided by the percentage change in the income of the consumer.
Types of Income Elasticity of Demand:
1. High Income Elasticity: When the quantity demanded of good increases by large
percentage as compared with the income of the consumer, income elasticity of the demand
is high.
2. Unitary Income Elasticity: When the percentage change in quantity is equal to the
percentage change in income, income elasticity of demand is unitary.
3. Low Income Elasticity: When the quantity demanded of good increases by smaller
percentage as compared with the income of the consumer, income elasticity of the demand
is low.
4. Zero Income Elasticity: When the quantity of demanded of a good remains unchanged
upon the change of income, income elasticity of demand is zero.
5. Negative Income Elasticity: When the quantity demanded of a good falls in response to
an increase in income, the income elasticity of demand is negative.
➢ Cross Elasticity of demand
30
A change in the demand for one good in response to a change in the price of another good
represents cross elasticity of demand of the former good for the latter good.
Ec = %change in quantity demanded of good A

% change in price of good B
➢ Advertising and Promotional Elasticity of demand
The promotional elasticity of demand is a measure of the responsiveness of demand for a

commodity for a consumer to the change in outlay on advertisement and other promotional
efforts.
Ea= % change in demand__________________________
% change in expenditure on advertisement and other promotional efforts
Elasticity of Supply
According to Samuelson, “Elasticity of supply is defined as a measure of the degree of
responsiveness of supply to the change in price”.
Elasticity of Supply = Percentage change in Quantity Supplied
------------------------------------------------
Percentage Change in price
Kinds of Elasticity of Supply:
There are five types of elasticity of supply which are given below
(I) Perfectly elastic supply:
It is a case where a very slight change in price causes an Infinite change in supply. A slight
fall in prices brings quantity supplied to zero. In such a case the supply curve runs parallel to X -
axis. The supply curve takes the shape of a horizontal straight lit line. In the diagram given below
'SS' is the supply curve which shows that an infinitesimally small change in price causes an
infinitely large change in the quantity supplied.
31
(2) Perfectly inelastic supply:
The supply of a commodity is said to be perfectly inelastic when the supply of commodity
is completely non-responsive to changes in price. It is a case where quantity supplied remains the
same despite the change in price. A perfectly inelastic supply curve is a vertical straight line which
is parallel to OY-axis. In the diagram given below 'SS' is the perfectly inelastic supply curve that
runs parallel to OY-axis.
(3) Relatively elastic supply:
The supply is relatively elastic when a given change in price produces more than
proportionate change in quantity supplied. A doubling in price will result in more than double the
quantity supplied. In the diagram shown below, a given change in price from OP to OP, is attended
by a much more change in supply, supply curve 'SS' is relatively
32
(4) Relatively inelastic supply:
When a certain change in price causes a smaller proportionate change in quantity supplied
of a Commodity, the supply is said to be relatively less elastic. The percentage change in price is
more than the percentage change in quantity supplied. In the diagram as shown, below a rise in
price from OP, to OP brings about less than proportionate change in supply from OS, to OS. Hence
the supply curve SS is relatively inelastic.
(5) Unitary elastic supply:
In such a situation the proportionate change in supply equals the proportionate change in
price. In the diagram given below SS is the unitary elastic supply curve. Increase in price from OP
to OP is accompanied by a proportionate change in supply from OS to OS.
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UNIT III
1. Elucidate the different types of market structure
DIFFERENT MARKET STRUCTURE:
The types of market depend on the degree of competition prevailing in the market. There
are two types of competition in the markets. They are:
➢ PERFECT MARKET OR COMPETITION

➢ IMPERFECT MARKET OR COMPETITION
PERFECT MARKET OR COMPETITION:
According to R.G.Lipsey, “perfect competition is a market structure in which all firms in

an industry are price- takers and in which there is freedom of entry into, and exit from, industry”.
FEATURES OF PERFECT MARKET:
Perfect competition is characterized by the following features:
❖ Large number of buyers and sellers:
34
The first condition is that there are large number of buyer and sellers. If that is no,
no single producer or purchaser will be able to influence the market price by varying
respectively his supply and demand.
❖ Homogeneous product:
The article produced by all firms should be standardized or exactly identical as a
result no buyer has any preference for the product of any individual seller over others.
❖ Free entry and exit:
Under perfect competition all firms in the industry will be earning normal profit.
This will happen only if there are no restrictions on the firms’ entry into or exit from that
industry.
❖ Perfect knowledge:
The buyers and sellers should have perfect knowledge of the market. The buyers
and sellers should be fully aware of the prices that are being offered and accepted.
❖ Absence of transport costs
Here free transport facilities have to be assumed. If the same price is to rule, it is
necessary that no cost of transport has to be incurred. If the cost of transport is here prices
must differ in different sectors of the market.
❖ Perfect mobility of the factors of production:
This mobility is essential in order to enable the firms to adjust their supply to
demand.
❖ Absence of artificial restrictions:
There is complete openness in buying and selling of goods. Sellers are free to sell
their goods to any buyers and the buyers are free to buy from any sellers.
❖ Absence of selling costs:
The costs of advertising, sales-promotion, etc. do not arise because all firms
produce a homogeneous product.
IMPERFECT MARKET OR COMPETITION:
Imperfect competition is the competitive situation in any market where the conditions
necessary for perfect competition are not satisfied. It is a market structure that does not meet the
conditions of perfect competition. Forms of imperfect competition include:
35
❖ Monopoly
❖ Monopolistic Competition
❖ Oligopoly
❖ Duopoly
❖ MONOPOLY:
Monopoly is a situation of a single seller producing for many buyers. Its product is
necessarily extremely differentiated since there are no competing sellers producing near
substitute product.
FEATURE OF MONOPOLY MARKET:
✓ One seller and large number of buyers: Under monopoly there should be a single
producer of the commodity. But the buyer of the product is in large number. Consequently,
no buyer can influence the price but the seller can.
✓ Monopoly is also an industry: under monopoly situation, there is only one firm and the
difference between firms and industry disappears.
✓ Restrictions on the entry of the new firms: under monopoly, there are some barriers or
restrictions on the entry of new firms into monopoly industry. These barriers may take
several forms as patent rights, government laws, economies of scale, etc.
✓ No close substitutes: the commodity produced by the firm should have no close substitute;
otherwise the monopolist will not be able to determine the price of his commodity.
✓ Price- maker: a monopolist is a price- maker. A price-maker is one who has got control
over the supply of the product. A monopolist has full control over the supply of the
commodity.
✓ Price discrimination: a monopolist may be able to charge different prices for the same
product from different customers. Thus, monopolist can practice price discrimination.
✓ Absence of Supply Curve: The monopolist does not have a supply curve independent of
demand. The monopolist simultaneously examines demand and cost when deciding how
much to produce and what to charge.
MONOPOLISTIC COMPETITION:
36
Monopolistic competition refers to a market situation where there are many sellers offering
differentiated product to many buyers.
FEATURE OF MONOPOLISTIC COMPETITION:
❖ Large number of sellers: In a monopolistically competitive market there are a large number
of sellers who individually have a small share in the market. Unlike perfect competition,
these large numbers of firms do not produce perfect substitutes. Instead, they produce and
sell products which are close substitutes of each other. This makes the competition among
firms real and tough.
❖ Product differentiation: They produce and sell products which are close substitutes of each
other. This makes the competition among firms real and tough. The products of different
sellers are differentiated on the basis of brands.
❖ Freedom of entry or exit: New firms are free to enter into the market and existing firms are
free to quit it.
❖ Independent behavior: In monopolistic competition, every firm has independent policy.
Since the number of sellers is large, none controls a major portion of the total output.
❖ Selling Costs: Under monopolistic competition where the product is differentiated, selling
costs are essential to push up sales.
❖ Non-price competition: Under monopolistic competition, a firm increase sales and profits
of his product without a cut in the price. The monopolistic competitor can change his product
either by varying its quality, packing, etc. or by changing promotional programmes.
OLIGOPOLY:
In oligopoly, there are a few sellers selling homogeneous or differentiated but close
substitute product for many buyers.
FEATURES OF OLIGOPOLY MARKET:
❖ Interdependence: The most important feature of oligopoly is interdependence in decision

making of the few firms which comprise the industry. This is because when the number of
competitors is few any change in price, output, product by a firm will have direct effect on the
37
fortune of the rivals, who will then retaliate in changing their own prices, output or advertising
techniques as the case may be.
❖ Importance of advertising and selling costs: A direct effect of interdependence of
oligopolists is that the various firms have to employ various aggressive and defensive
marketing weapons to gain a greater share in the market or to maintain their hare.
❖ Group behavior: The theory of oligopoly is a theory of group behavior, not of mass or
individual’s behavior and to assume profit maximizing behavior on oligopolist’s part may not
be very valid. There is no generally accepted theory of group behavior.
❖ Few sellers: In oligopoly market the number of sellers is small.
❖ Aggressive and defensive marketing methods: Oligopoly firms resort to various aggressive
or defensive marketing techniques to increase their share of the market or to maintain their
share of market.
❖ Competition and combination: In oligopoly the competition is not perfect. There may be
fierce, violent, cruel and cut throat competition on the one hand. But on the other hand
oligopolists realize the disadvantage of competition and rivalry. Therefore, the oligopolist
firms may work out some policy of collusion to avoid harmful competition.
DUOPOLY:
A special form of oligopoly is called a duopoly market where there are only two sellers,
competing with each other.
PRICE DETERMINATION AND EQUILIBRIUM OF FIRM UNDER PERFECT

COMPETITION
Condition for Equilibrium of a firm:
A firm in order to attain the equilibrium position has to satisfy two conditions:
i) The marginal revenue should be equal to the marginal cost. i.e. MR=MC. If MR is
greater than MC, there is always an incentive for the firm to expand its production
further and gain by sale of additional units adds more to cost than to reduce output since
an additional unit adds more to cost than to revenue. Profits are maximum only at the
point wher MR=MC.
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ii) The MC curve should cut MR curve from below. In other words, MC should have
positive slope.
2. Demand for labour reflects marginal productivity explain.
Marginal productivity theory
Marginal productivity theory is the oldest and the most significant theory of distribution or
factor pricing. It was propounded by german economist von thunen. According to Marginal
productivity theory under perfect competition each factor of production gets remuneration equal
to its marginal revenue productivity.
Factors are demanded for their capability of producing goods and services, capability to
produce goods and services is called productivity of the factor. This, a factor is demanded for its
productivity. To know productivity of a factor it is necessary to put to use an additional unit of that
factor, keeping other factor constant. As a result increase in total production will mainly be due to
additional unit of that factor. This increase in total production will be called marginal productivity
of that factor. Under perfect competition when factors get fully employed , then their supply
becomes constant. Hence their price is determined by their demand or marginal productivity.
Explanation of Marginal productivity theory
Under perfect competition cost of a factor being given to a firm, the only decision that a
firm is to take is to how much of the factor is to be employed. According to this theory a firm
under perfect competition will employ that number of a factor at which marginal factor cost is
equal to the marginal revenue product or value of its marginal physical product. Thus form the
point to view of a firm the theory indicates how many units of a factor it should be demand.
Thus the basic rule with respect to employment of a factor by a firm may be summed up as follows:
• If for a particular factor MRP>MFC the firm would employ more units of a factor.
• If for a particular factor MRP<MFC the firm would decrease the employment of the factor.
• The firm is in equilibrium when for a particular factor MRP=MFC
We can conclude with:
39
A profit maximizing competitive firm will employ units of a variable productive resource until
the point is reached where the value of the marginal product of the input is equal to input price. In
other words the profit maximizing amount of a factor should satisfy the following conditions:
• When there is only one variable factor labour

• When there are more than one variable factor , suppose labour and capital. A firm will
employ the profit maximizing combination of factors when the price of each factor is equal
to its marginal revenue product.
• Any level of output will be produced with the least cost combination of resources when the
marginal product per rupee’s worth of each input is the same.
3. Compare price output equilibrium under monopolistic competition with that under
perfect competition.
Equilibrium of a firm
In a monopolistic competition market since the product is differentiated between firms,

firms does not face perfectly elastic demand for its products.
Conditions for the equilibrium of individual firm
MC=MR
MC curve must cut MR curve from below
Short run equilibrium:
Assumptions
• The number of sellers is large and they act independently of each other.
• The product of each seller is differentiated from other products.
• The firm has a determinate demand curve which is elastic
• The factor services are in perfectly elastic supply for the production of the product
• The short run cost curves of each firm differ from each other
• No new firms enter the industry
40
Super normal profit:
The short run marginal cost curve cuts the MR curve at E. This equilibrium point
establishes the price QA and output OQ. As a result the firm earns supernormal profit represented
by the area PABC.
Normal profit:
It indicates the same equilibrium points of price and output. But in this case, the firm jut
covers the short run average unit cost as represented by the tangency of demand curve D and the
short run average unit cost curves SAC at A. it earns normal profit.
Minimum loss:
It shows a situation where the firm is not able to cover its short run average unit cost and
therefore incurs losses. Price set by the equality of SMC and MR curves at point E is QA which
covers only the average variable cost. The tangency of the demand curve D and the average
41
variable cost curve AVC at A makes it a shutdown point. However at this point the firm will incur
losses equal to the area CBAP during the short run.
Long run equilibrium of the industry:
If the firms in a monopolistic competition industry can earn super normal profits in the
short run , there will be an incentives for new firms to enter the industry. As more firms enter the
profits per firm will go on decreasing at the total demand of the product will be shared among a
number of firms. Thus in the long run all the firms will earn only normal profits. In fig all the firms
are in long run equilibrium at point E where LMC=MR and LMC cuts MR from below and the
LAC curve is tangent to the AR curve at point A. since price QA=LAC at point A each firm is
earning normal profits an no firms have the tendency to enter or leave the industry.
UNIT IV
1. What is national income? Explain the methods of determining the national income.
42
Determination of National Income
National income can be determined by two approaches
1. Classical Approach
2. Keynesian Approach
1. Classical Approach:
According to classical theory of employment generally capitalist economy is in equilibrium

at the level of full employment. Full employment means absence of involuntary unemployment. It
means that all those who want at work at the existing wage rate.
Determination of output and employment:
According to classical theory output and employment in an economy is determined by

aggregate production function and equilibrium between demand and supply of labour.
Production function expresses the functional relationship between factor of production and
volume of production.
Q=f (N)
Where,
Q=Volume of output
N=Level of employment
Demand for Labour:
It is a function of real wages. DL=f (W/P) The producer will make demand for labour up to
that limit where the marginal physical productivity of labour becomes equal to real wage. When
more and more laborers are employed the MPP of labour goes on diminishing. Therefore, the
demand for labour will increase when real wage fall and vice-versa. Thus, demand curve for labour
has a negative scope.
Supply of Labour:
43
It is also a function of real wage (W/P). it means there is a positive relation between wage
rate and supply of labour. Therefore, supply curve slopes positively. Thus, S L=f (W/P)
Where,
W=Money wages
P=Price Level
The level of output and employment is determined by the intersection of demand curve and
supply curve for labour. The equality between demand and supply of labour determine the level of
employment which in turn determines the level of output. It is illustrated in the above figure.
44
DL is the demand curve for labour and SL is the supply curve of labour. The aggregate
production curve is shown in the upper part of the figure.
In the lower part of figure SL and DL intersect each other at E is the equilibrium point of
the economy and equilibrium level of employment is ON at W/P real wage point ‘E’ is the full
employment equilibrium point because all get employments who want to work at (W/P) wage rate.
If the real wage rate goes above the equilibrium wage rate (W/P), the supply of labour will
exceed the demand for labour and there will be involuntary unemployment. On the contrary, if
wage rate falls below the equilibrium wage rate, then there will be excess supply of labour. Thus,
it is clear that the economy is in equilibrium at E point which is a full employment equilibrium
position. The determination of the volume of output is shown in the upper part of the figure. At
full employment level ON the volume of output is OQ.
Explanation of Classical Theory of Employment
The classical theory of employment is based upon two facts
➢ Say’s Law of Market

➢ Flexibility of wage rate, prices and interest rates.
➢ Say’s Law of Market
According to Say’s law of market – “Supply always creates its own demand”. It is
production which creates market for goods. It means the demand always increases in the
same proportion in which supply increases. Whenever a new productive process is initiated
and a certain output results, the demand for that output is also simultaneously generated on
account of the payment of remuneration to the factor of production
Assumptions:
1. All incomes of the household are spent on consumption of goods and services.
2. There is no government activity.
3. It is a closed economy.
4. Assumes full employment of resources of the economy.
45
Implications of Say’s Law
1. There is automotive adjustment of every element with the working of the economy.
2. Overproduction is impossible.
3. No general unemployment.
4. It helps to increase the volume of goods and services in the community.
5. It has built-in-flexibility.
Criticism
1. All incomes earned are not always spent on consumption.

2. Similarly whatever is saved is not automatically invested.
3. The law based on wrong analysis of market.
4. Aggregate supply and aggregate demand not always equal
5. Capitalist system is not always self adjusting.
6. Perfect competition is an unrealistic assumption.
7. Money is a dominant force in the economy.
8. The law only applicable for long period.
➢ Flexibility of wage rate, prices and interest rates:

According to them, the amount of production which the business firms can supply
does not depend only on aggregate demand or expenditure but also on the prices of
products. If the rate of interest temporarily fails to bring about equality between savings
and investment and as a result deficiency of aggregate expenditure arises, even then the
problem of general overproduction and unemployment will not arise. This is because they
thought that the deficiency in aggregate expenditure would be made up by changes in the
price level.
When due to increase in the savings of the people, the expenditure of the people
declines; it will then affect the prices of products. As a result of fall in aggregate or demand,
the price of products would decline and at reduced prices their quantity demand will
increase and as a result all the quantity produced of goods will be sold out at lower prices.
2. Keynesian Approach:
46
To explain the Keynes theory of income determination, the entire economy is divided in
to four sectors,
➢ Household sector
➢ Firms or the business sector
➢ Government sector
➢ Foreign Sector
The Keynesian theory of income determination is present in the following three models
❖ Two-sector model
❖ Three-sector model
❖ Four-sector model
❖ Two-sector model
In the two sector model of income determination of an economy consists only of
domestic and business sector.
The issue Keynes was addressing is what happens if planned aggregate production and
planned aggregate expenditure are not equal, i.e., how both of them would adjust unil they
are equal. When they are equal we have
C+S = C+I
i.e.,
Aggregate output = Aggregate expenditure
Subtracting C from both sides, we have
S=I ------------------------------------- (1)
Thus, S = I is called the equilibrium condition. It tells us that as long as planned

savings are greater than planned investment, inventories would be building up and firms
would be decreasing production so that their inventories are at their desired level.
Similarly, as long as planned savings are less than planned investment,

inventories would be lower than the desired and firms will be increasing production so
47
that their plans are met. Only when planned savings equal to planned investment will
there is no effort to change behavior. In combination, the four equation of the model are
the following
C =a+bY (Consumption expenditure) ------------------------------------- (2)
I = IO (Investment expenditure) ------------------------------------- (3)
Y = C+S ------------------------------------- (4)
C+S = C+I or S = I ------------------------------------- (5)
Where,
a = autonomous investment
b = Marginal propensity to consume
Y = National income or output
Substituting equation (3) into equation (5) gives
S = Io
Substituting this equation and equation (2) into equation (4) gives
a+bY+ Io = Y
Subtracting bY from both sides lead to
a+ Io = Y (1-b)
Dividing both side by (1-b) we have
a+ Io / 1-b = Y
or
Y = [1/1-b]( a+ Io)
❖ Three-sector model
48
In all economies today including the free-market capitalist economies such as such as those
of USA, Britain and Japan, the government expenditure on goods and services plays an
important role in the determination of national income and therefore it should also be include
in the analysis of income determination. Thus in the three-sector economy when we take into
account the income generating effects of government expenditure, we get the following
equation for the equilibrium level of national income.
Y = C+I+G
Where,
Y = National income or output
C+I+G = Aggregate demand including government expenditure, G.
Y = a+bY+I+G
Y-bY = a+I+G
Y (1-b) = a+I+G
Y = 1/1-b (a+I+G)
❖ Four-sector model
To determine the national income in an open economy four sector model is used. This
means we shall have to add import and export and government expenditures.
Y = C+I+G+(X-M) ------------------------------------ (6)
Where,
C =a+bY
I=I
G=G
X=X
M =M+gY
Yd = Y-T
By substituting on these relations in equation (6)
49
Y = a+b(Y-T) +I+G+X-(M+gY)
= 1/1-b+g(a-bT+I+G+X+M)
2. Give an account of fiscal policy examine its impact.
Fiscal policy
It may be defined as the part of governmental economic policy which deals with taxation
expenditure, borrowing and the management of public debt in an economy. It is an instrument
of modern public finance.
The term fiscal policy embraces the tax and expenditure policies of the government. Thus,
fiscal policy through the control of government expenditures and tax receipts. It encompasses
two separate but related decisions public expenditures and the level and structure of taxes. The
amount of public outlay the incidence and effects of taxation, and the relation between
expenditure and revenue exert a significant impact upon the free enterprise economy.
Impact of fiscal policy:
Business investment decisions:
The government might also use tax allowance to stimulate increases in research and
development and encourage more business start ups. A favorable tax regime could also be
attractive to inflows of foreign direct investment to the economy that might benefit both
aggregate demand and supply.
Work incentives:
Consider the impact of an increase in the basic rate of income tax or an increase in the rate
of national insurance contributions. The rise in direct tax has the effect of reducing the post tax
income of those in works because for each hour of work taken the total net income is now
lower. This might encourage the individual to work more hours to maintain his/her target
income.
Pattern of demand:
50
Changes to indirect taxes in particular can have an effect on the pattern of demand for
goods and services. In contrast, a government financial subsidy to producers has the effect of
reducing their costs of production , lowering the market price and encouraging an expansion
of demand.
Labour productivity:
Some economists argue that taxes can have a significant effect on the intensity with which
people work and their overall efficiency an productivity. But there is little substantive
empirical evidence to support this view.
Capital formation:
Fiscal policy has played a very important role in raising the rate of capital formation in
country in private as well as public sector. A major part of budgetary resources has been
invested in public sector enterprises which have resulted in increase in gross domestic capital
formation.
Reduction in inequality of income and wealth:
Fiscal policy of the country has been making constant endeavor to reduce inequality of
income and wealth. Resources have been mobilized from rich class to poor by way of
progressive taxes, wealth tax and capital gains and this money has been utilized for the welfare
of poor people.
Export promotion:
Exports have been encouraged by way of providing subsidies, concessions, tax exemptions,
cash subsidies. Import duty on raw material and capital goods used for production of goods
meant for export has also been reduced with a view to encourage exports.
3. Explain the multiplier effect with varying price level.
MULTIPLIER EFFECT
Multiplier is an important concept of Keynes’ theory of income, output and employment.

This concept relates to change in income as a result of change in investment. But increase in
51
income is not exactly the same as increase in investment; rather it is many times more than the
increased investment. The number of times it is increased is called multiplier.
According to Kurihara, “the multiplier is the ratio of change in income to the change
in investment.
Assumptions:
➢ Marginal propensity to consume remains constant throughout.

➢ Consumption is a function of current income.
➢ There are no time lags in the multiple processes.
➢ It is a closed economy.
➢ It is not only works in money term but also in real terms.
➢ Price of goods has been assumed to be constant.
➢ There is less than full employment level in the economy.
➢ Consumption is a function of current income.
Diagrammatic representation of Multiplier:
We have explained that the level of national income is determined by the equilibrium
between aggregate demand and aggregate supply. In other words, level of national income is fixed
at the level where C+I curve intersects the 45o income line.
52
In this figure C represents marginal propensity to consume. C+I represents aggregate

demand curve. The aggregate demand curve C+I which intersects the 45o line at point E so that
the level of income equal to OY1 is determined.
If the investment increases by the amount EH we can then find out how much increment
in income will occur as a result of this. As a consequence of increase in investment by EH, the
aggregate demand curve shifts upward to the new position C+I’. This new aggregate demand curve
C+I’ intersects the 45o income line at point F so that the equilibrium level of income increases to
OY2. Hence as a result of net increase in investment equal to EH, income has increased by Y1Y2.
On measuring, it will be found that Y1Y2 is twice the length of EH.
Leakages in the multiplier process:
Savings is a leakage in the multiplier process. If there is no savings the marginal propensity
to consume is equal to 1, the multiplier would have been equal to infinity. Since marginal
propensity to consume is less than 1, some savings does take place. Therefore, multiplier is less
than infinity.
We explain below the various leakages that occur in the income stream and reduce the size
of multiplier in the real world.
1. Paying off Debt: The first leakage in the multiplier process occurs in the form of
payment of debts by the people, especially by businessman. In the real world, all
income received by the people as a result of some increase in investment is not
consumed. A part of the increment in income is used to paying back the debts which
the people have taken from money lenders, banks or other financial institution.
2. Holding of idle cash balances: If the people hold a part of their increment in income
as idle cash balances and do not use it for consumption, they also constitute leakage in
the multiple process.
3. Imports: In our above analysis of the multiplier process we have taken the example of
a closed economy that is an economy with no foreign trade. If it is an open economy
as is usually the case, then a part of increments in income spent on the imports of
consumer goods. The proportion of increments in income spent on the imports of
consumer goods will generate income in other countries and will not help in raising
53
income and output in the domestic economy. Therefore, imports constitute another
important leakage in the multiplier process.
4. Taxation: Taxation is another important leakage in the multiplier process. The
increments in income which the people receive as a result of increase in investment are
also in part used for payment of taxes. Therefore, the money used for payment of taxes
does not appear in the successive rounds of consumption expenditure in the multiplier
process, and the multiplier is reduced that extent.
5. Increase in Prices: Price inflation constitutes another important leakage in the working
of the multiplier process in real terms. As we have noted above, the multiplier works
in real terms only when as a result of increase in money income and aggregate demand,
output of consumer goods is also increased. When output of consumer goods cannot be
easily increased, a part of the increase in the money income and aggregate demand
raises prices of the goods rather than their output. Therefore, the multiplier is reduced
to the extent of price inflation.
Importance of the concept of Multiplier:
➢ The theory of multiplier has been used to explain the cumulative upward and downward
swings of the trade cycles that occur in free-enterprise capitalist economy.
➢ It has a great practical importance in the field of fiscal policy to be pursued by the
government to get out of the depression and achieve the state of full employment
➢ To get rid of depression and remove unemployment, government investment in public
works was recommended.
➢ The multiple increases in income and demand will also encourage the increase in private
investment.
UNIT V
1. Explain the types and impacts of inflation
Inflation:
54
According to Crowther: Inflation is a state in which the value of money is falling ie. Prices
are rising.
Types of inflation:
According to rate of rise in price:
• Creeping inflation: when the rise in prices is very slow like that of snail, it is called
creeping inflation.
• Walking inflation: when the rise in price becomes more pronounced as compared to a
creeping inflation ,there exits walking inflation in the economy.
• Running inflation: when the movement of price accelerates rapidly, running inflation
emerges.
• Galloping inflation/hyper inflation: in the case of hyperinflation , prices rise every
moment, and there is no limit to the height to which prices might rise.
According to the factors influences money supply and demand for goods and services:
• Excessive money supply inflation: this is classical types of inflation , where there is an
excess of money supply in relation to the availability of real goods and services.
• Cost inflation: when inflation emerges on account of a rise in factor cost, it is called cost
inflation.
• Deficit inflation: when the government budgets contain heavy deficit financing, through
creating new money , the purchasing power in the community increases and prices rise.
According to coverage or scope point of view:
• Comprehensive inflation: when prices of every commodity throughout the economy rise,
it is called economy wide or comprehensive inflation.
• Sporadic inflation: this is a kind of sectional inflation. It consists of cases in which the
averages of a group of prices rise because of increases in individual prices due to shortage
of specific goods.
According to government’s reaction:
55
• Open inflation: when the government does not attempt to prevent a price rise , inflation
is said to be open.
• Repressed inflation: when the government interrupts a price rise, there is repressed or
suppressed inflation.
According to Keynesian view:
• Demand pull inflation: it is caused by increases in aggregate demand due to increased

private and government spending.
• Cost push inflation: it is caused by a drop in aggregate supply.
• Profit inflation: according to Keynes, the price level of consumption goods is a function
of the investment exceeding savings.
• Semi inflation: according to Keynes , as long as there are unemployed resources , the
general price level will not rise as output increases.
• True inflation: when the economy reaches the level of full employment , any increase in
aggregate expenditure will raise the price level in the same proportion.
Impact of inflation:
• Distorts consumer behavior: high inflation distorts consumer behavior.

• Redistributes income of people: high inflation redistributes the income of people.
• High wages: trade unions may demand for higher wages at times of high inflation.
• Difficulty in predicting future: during a high inflation period , wide fluctuations in the
inflation rate make it difficult for business organizations to predict the future and
accurately calculate prices and returns from investments.
• Create trade deficit: when inflation in a country is more than that in a competitive
country , the exports from former country will be less attractive compared to the other
country.
2. What is unemployment? Explain its causes and types.
UNEMPLOYMENT
56
An economic condition marked by the fact that individuals actively seeking jobs remain
unhired. Unemployment is expressed as a percentage of the total available workforce. The level of
unemployment varies with economic conditions and other circumstances.
Unemployment is a status in which individuals are without job and seeking a job. It is one
of the most pressing problem of any economy especially the underdeveloped ones.
Types of Unemployment:
Unemployment is found in almost all the countries. However the nature and the severity of
the problem are different in different economics. The following are the various types of
unemployment.
1. Cyclical Unemployment:
Cyclical unemployment arises due to cyclical fluctuations in the economy. A business
cycle consists of alternating periods of booms and depressions. It is during the downswing of the
business cycle that wide spread unemployment arises. Hence unemployment caused by recession
and depression is cyclical in nature.
2. Structural Unemployment:
Structural unemployment occurs when a labour market is unable to provide jobs for
everyone who wants one because there is a mismatch between the skills of the unemployed
workers and the skills needed for the available jobs. Structural unemployment is hard to separate
empirically from frictional unemployment, except to say that it lasts longer.
3. Classical Unemployment:
Classical unemployment is caused when wages are ‘too’ high. This explanation of
unemployment dominated economic theory before the 1930s, when workers themselves were
blamed for not accepting lower wages, or for asking for too high wages. Classical unemployment
is also called real wage unemployment.
4. Seasonal Unemployment:
Seasonal unemployment exists because certain industries only produce or distribute their
products at certain times of the year. Industries where seasonal unemployment is common include
farming, tourism, and construction.
5. Frictional
57
Frictional unemployment, also called search unemployment, occurs when workers lose
their current job and are in the process of finding another one. There may be little that can be done
to reduce this type of unemployment, other than provide better information to reduce the search
time. This suggests that full employment is impossible at any one time because some workers will
always be in the process of changing jobs.
6. Voluntary
Voluntary unemployment is defined as a situation when workers choose not to work at the
current equilibrium wage rate. For one reason or another, workers may elect not to participate in
the labour market. There are several reasons for the existence of voluntary unemployment
including excessively generous welfare benefits and high rates of income tax. Voluntary
unemployment is likely to occur when the equilibrium wage rate is below the wage necessary to
encourage individuals to supply their labour.
CAUSES FOR UNEMPLOYMENT
The major causes which have been responsible for the wide spread unemployment can be
spelt out as under.
1) Rapid Population Growth:
It is the leading cause of unemployment in Rural India. In India, particularly in rural areas,
the population is increasing rapidly. It has adversely affected the unemployment situation largely
in two ways. In the first place, the growth of population directly encouraged the unemployment by
making large addition to labour force. It is because the rate of job expansion could never have been
as high as population growth would have required.
It is true that the increasing labour force requires the creation of new job opportunities at
an increasing rate. But in actual practice employment expansion has not been sufficient to match
the growth of the labor force, and to reduce the back leg of unemployment. This leads to
unemployment situation secondly; the rapid population growth indirectly affected the
unemployment situation by reducing the resources for capital formation. Any rise in population,
over a large absolute base as in India, implies a large absolute number.
58
It means large additional expenditure on their rearing up, maintenance, and education. As
a consequence, more resources get used up in private consumption such as food, clothing, shelter
and son on in public consumption like drinking water, electricity medical and educational facilities.
This has reduced the opportunities of diverting a larger proportion of incomes to saving and
investment. Thus, population growth has created obstacles in the way of first growth of the
economy and retarded the growth of job opportunities.
2) Limited land:
Land is the gift of nature. It is always constant and cannot expand like population growth.
Since, India population increasing rapidly, therefore, the land is not sufficient for the growing
population. As a result, there is heavy pressure on the land. In rural areas, most of the people
depend directly on land for their livelihood. Land is very limited in comparison to population. It
creates the unemployment situation for a large number of persons who depend on agriculture in
rural areas.
3) Seasonal Agriculture:
In Rural Society agriculture is the only means of employment. However, most of the rural
people are engaged directly as well as indirectly in agricultural operation. But, agriculture in India
is basically a seasonal affair. It provides employment facilities to the rural people only in a
particular season of the year. For example, during the sowing and harvesting period, people are
fully employed and the period between the post harvest and before the next sowing they remain
unemployed. It has adversely affected their standard of living.
4) Fragmentation of land:
In India, due to the heavy pressure on land of large population results the fragmentation of
land. It creates a great obstacle in the part of agriculture. As land is fragmented and agricultural
work is being hindered the people who depend on agriculture remain unemployed. This has an
adverse effect on the employment situation. It also leads to the poverty of villagers.
59
5) Backward Method of Agriculture:
The method of agriculture in India is very backward. Till now, the rural farmers followed
the old farming methods. As a result, the farmer cannot feed properly many people by the produce
of his farm and he is unable to provide his children with proper education or to engage them in any
profession. It leads to unemployment problem.
6) Decline of Cottage Industries:
In Rural India, village or cottage industries are the only mans of employment particularly
of the landless people. They depend directly on various cottage industries for their livelihood. But,
now-a-days, these are adversely affected by the industrialisation process. Actually, it is found that
they cannot compete with modern factories in matter or production. As a result of which the village
industries suffer a serious loss and gradually closing down. Owing to this, the people who work in
there remain unemployed and unable to maintain their livelihood.
7) Defective education:
The day-to-day education is very defective and is confirmed within the class room only.
Its main aim is to acquire certificated only. The present educational system is not job oriented, it
is degree oriented. It is defective on the ground that is more general then the vocational. Thus, the
people who have getting general education are unable to do any work. They are to be called as
good for nothing in the ground that they cannot have any job here, they can find the ways of self
employment. It leads to unemployment as well as underemployment.
8) Lack of transport and communication:
In India particularly in rural areas, there are no adequate facilities of transport and
communication. Owing to this, the village people who are not engaged in agricultural work are
remained unemployed. It is because they are unable to start any business for their livelihood and
they are confined only within the limited boundary of the village. It is noted that the modern means
60
of transport and communication are the only way to trade and commerce. Since there is lack of
transport and communication in rural areas, therefore, it leads to unemployment problem among
the villagers.
9) Inadequate Employment Planning:
The employment planning of the government is not adequate in comparison to population

growth. In India near about two lakh people are added yearly to our existing population. But the
employment opportunities did not increase according to the proportionate rate of population
growth. As a consequence, a great difference is visible between the job opportunities and
population growth.
On the other hand it is a very difficult task on the part of the Government to provide
adequate job facilities to all the people. Besides this, the government also does not take adequate
step in this direction. The faulty employment planning of the Government expedites this problem
to a great extent. As a result the problem of unemployment is increasing day by day.
3. Explain the critical view about the role of monetary policy.
Rapid economic development:
When the country aspires for rapid economic development , it adopts economic planning.
In the process , financial planning needs the support of credit planning and appropriate monetary
management.
Stability:
Countries are most susceptible to inflation. However the maintenance of stability in the
domestic price level and a fixed, realistic exchange rate are very essential preconditions for
achieving a maximum rate of sustained economic growth. This needs equilibrium of savings and
investment.
61
Promotional role of monetary authorities:
The growth objective of monetary policy implies the promotional role of monetary
authorities. Briefly, the promotional role of the monetary authority in an underdeveloped country
may be to improve the efficiency of the banking system as a whole or extend sound credit needed.
Improve money and capital markets:
It is an important task of the monetary authority to improve the conditions of unorganized

money and capital markets in poor countries in the interest of rapid economic development and
the successful working of monetary management.
Suitable interest rate structure:
An important function of monetary policy in an underdeveloped economy is to have and

also to make use of a most suitable interest rate structures.
Public debt management:
Public debt management responsibility also lies with the monetary authority of the country.
In a growing economy, thus it is very important and difficult task.
Extend the process of monetization:
It is the prime duty of the monetary authority to extend the process of monetization in these
barter section of the economy. This will tend to improve the working and effectiveness of the
monetary policy.
62

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Dr.

SACOE ECONOMIC ANALYSIS FOR BUSINESS (BA7103) DOMS

Dr. SIVANTHI ADITANAR COLLEGE OF ENGINEERING

DEPARTMENT OF MANAGEMENT STUDIES

BRANCH / SEMESTER : MBA / I

NAME OF THE SUBJECT : ECONOMIC ANALYSIS FOR BUSINESS

SUBJECT CODE : BA 7103

NAME OF THE FACULTY : C.UTHAIYA

DESIGNATION : ASSISTANT PROFESSOR

HEAD OF THE DEPARTMENT

TWO MARKS QUESTIONS

1. Brief out externalities.

1. When does market equilibrium occur?

1. Write a note on factor market.

1. What does fiscal policy denote?

1. State Okun’s Law.

1. Discuss the factors and determine the demand for a commodity

1. Elucidate the different types of market structure

2. ‘Demand for labour reflects marginal productivity’ - explain

2. Give an account of fiscal policy examine its impact

3. Explain the multiplier effect with varying price level

1. Explain the types and impacts of inflation

2. What is unemployment? Explain its causes and types.

3. Explain the critical view about the role of monetary policy

Two Marks – Answers

1. Brief out externalities.

2. Distinguish between productive efficiency and economic efficiency.

3. What do you mean by positive and negative externalities?

4. What is allocative efficiency?

5. What do you mean by scarcity?

6. What do you mean by stabilization policy?

7. Differentiate micro and macro economics.

1. Microeconomics studies the 1. Macroeconomics studies

2. Microeconomics explains the 2. Macroeconomics explains

8. State the fundamental economic problems.

10. Define public goods.

1. When does market equilibrium occur?

2. What do you mean by consumer surplus?

3. What is generalized supply function?

4. What do you mean by short run production?

5. State the meaning of market economy.

6. What do you mean by consumer equilibrium?

7. What is Elasticity of Demand?

8. What is Autonomous Demand and Negative Demand?

9. What is market clearing price?

10. What do you mean by long run production?

11. Explain returns to scale.

12. Give a brief account on competitive equilibrium.

1. Write a note on factor market.

2. What is Marginal Revenue product?

4. Define Lerner Index.

6. When imperfect markets occur?

7. List down the determinants of factor price.

8. What are the barriers to entry?

9. Define profit. What are the determinants of profit?

11. Define discrimination.

1. What does fiscal policy denote?

2. What do you understand by macro economics?

3. What is potential GDP?

4. Define the macroeconomic equilibrium.

6. What do you understand by supply shocks in macro economic analysis?

7. What is balanced budget multiplier?

A balanced budget is a budget with revenues equal to expenditures, and neither a

8. What is aggregate demand?