Sample Question paper

EPGP Program
Indian Institute of Management, Kozhikode
Section B and D

Note: All the notations used in this question paper have their usual meaning. This model question paper is just a
guideline. It MAY NOT BE SUFFICIENT for the end term written exam.

1. Demand and supply curve of an agricultural commodity are as follows

Qd =a−b P
Qs =c +d P
Calculate price elasticity of demand and supply at the equilibrium point.
2. Explanation of price of egg and price of college education. Why real price of egg falls although the sells
increases.
3. Define cross price elasticity and income elasticity. Define perfect substitute and perfect complementary goods
by the cross price elasticity.
4. Write the axioms of consumer preferences. Completeness, trasitivity and more is preffered over less. What is
indifference curve? Combination of market basket same level of satisfaction is achieved by consumer. For two
normal commodities, how can you draw an indifference map? Graph containg a set of indifference curves
showing the market baskets among which which consumer is indifferent.

What are the properties of indifference curve?

1. It is negatively sloped 2.It is convex at origin, two indifference curves cannot intersects,4. Higher
indifference curve represents higher level of satisfaction or utility. 5. IC never touches x and y axis. 6.
They need not necessarily be parallel 7.It becomes complex for more than two quantities.
Can two indifference curves intersect? Give justification of your answer.
No, two indifference curve should not intersects
 the curve which is higher is more preferred than the the lower one. Now at
point A on U2 coincides with A on U1 which contradicts this believe and these can not intersects. B is
preferred more than D . A and D and A and B has same level of utility which is not possible as these are two
different curves
What will be the shape of indifference curve in case of perfectly substitute and perfectly complementary goods.
Perfectly substitute curve will be sloping down and touch the X and y axis. 2 goods for which marginal rate of
substitution of one for the other const. Means consumer will be indifferent to substitution A over B and will
have same level of satisfaction
Perfectly complementary goods will have right angle shaped curve. 2 goods for which MRS is infinite, rights
angle shaped
Define Marginal rate of substitution?
Maximum amount of good A a consumer is willing to give up to get additional good B. It is calculated as the
slope of an indifference curve.
For diminishing MRS what will be the shape of indifference curve?
When the MRS diminishes along an indifference curve , curve is convex

5. Define budget line.

A budget line is described as the combination of goods a consumer can purchase based on his income and
prices of goods.
Show graphically how individuals choose optimum quantity of two goods given their budget constraint.
No of units of a good a consumer can purchase= Income/price per unit of that good=I/Pc
Budget line=F+2C=80
Slope=-y/x=-40/80=-1/2=(I/Pc)/I/Pf=Pf/Pc so if price of food or cloth is known we can get slope or from slope
we can price of clothes if price of food is known.
 What will be the optimum choice of two commodities if the slope of the indifference curve is higher than
the budget line for the entire range? (Corner solution)
When the slope of the indifference curve is higher than the slope of the budget line for the entire
range, it indicates that the consumer's preferences (as represented by the indifference curve) cannot be
satisfied within the budget constraint. In other words, the consumer's utility-maximizing choice lies
outside the budget constraint, leading to a corner solution.
Mathematically, if 𝑀𝑅𝑆>𝑝𝑥/𝑝𝑦 (where 𝑀𝑅S is the marginal rate of substitution and 𝑝𝑥/𝑝𝑦 is the
slope of the budget line), then the consumer will choose a corner solution where one commodity is
consumed entirely, and the other is not consumed at all.
For example, if the indifference curve represents a higher preference for commodity X compared to
commodity Y, and the budget line indicates that the consumer cannot afford to consume both
commodities in quantities that lie on the indifference curve, the consumer will choose to consume only
commodity X and none of commodity Y.

6. What is price consumption curve (PCC)? Derive demand curve from PCC.
Curve tracing( curve formed by joining) the maximum utility or tangent points on utility , maximizing
combinations of two goods, when price of one changes.
Individual demand curve gives qty of a good that a single consumer will buy to its price
 A B and D are three different market baskets, on three utility curve. From U1 to U2, price of food decreases
hence, consumer will buy food more and less of cloth, further U2 U3, food prices decreses, and consumer will
buy more food and with money left he will buy buy now more cloth as well. Tanget at these curve are at A, B
and C joining these we will get price consumption curve.
Now since price is reducing, demand curve can be plotted at different
Price at E is highest that’s why qty purchased corresponding basket A is much less.
The demand curve can be derived from the Price Consumption Curve by plotting the quantity of the good
whose price is changing on the x-axis and its corresponding price on the y-axis. The demand curve will
typically slope downwards, indicating the inverse relationship between price and quantity demanded, as shown
by the law of demand.
7. What is income consumption curve (ICC)? Derive Engle curve form ICC. Define inferior commodity in terms
of Engle curve.
The Income Consumption Curve (ICC) is a graphical representation that shows the various combinations of
two goods that a consumer can afford at different income levels, while maintaining the same prices for both
goods. It illustrates how changes in income affect the quantity consumed of both goods, holding prices
constant.
Normal versus inferior good. Assume Hamburger as inferior to Steak as income consumption curve increases
 Engel Curve is related to Qty of good consumed to income. Hamburger ex, it is normal good till the time
income was 20 $ as income increase it started becoming a inferior good.
8. What is substitution effect? Show that the total price effect can be decomposes into substitution effect and
income effect.
In the Subsitution effect, the consumer tends to buy the good which has become cheaper or price has gone
down relatively and less of those goods which has become expensive. This does not alter or change his utility.
In income effect, consumer to tends to buy the goods as their income level has changed
Total price effect is = Substitution effect+Income Effect

F1E is a substitution effect as Consumer pref moved from A to D when price reduces. Similary. F2Eis the
income effect as the consumer pref moved D to B at same price level.Total effect= F1F2
 9. Define Normal, Inferior and Giffen goods. Using indifference curve approach, show that the demand curve of
a Giffen commodity is upward sloping. (income)

Normal Goods:
• • Definition: Normal goods are those for which the demand increases as consumer income
increases. This means that as people become wealthier, they tend to purchase more of the good,
assuming the price remains constant.
• • Example: Most commonly consumed goods, like clothing, electronics, and restaurant meals, are
considered normal goods. As people's income rises, they tend to spend more on these items.

Inferior Goods:
• • Definition: Inferior goods are those for which the demand decreases as consumer income
increases. This means that as people become wealthier, they tend to purchase less of the good, assuming
the price remains constant. They are often considered substitutes for more expensive goods.
• • Example: Instant noodles, bus tickets, and generic brands often fall under the category of inferior
goods. As people's income rises, they might shift towards more premium options like fresh meals, taxis, or
brand-name products.

Giffen Goods:

• Definition: Giffen goods are a rare type of inferior good with a unique characteristic. While
regular inferior goods show a decrease in demand with rising income, Giffen goods exhibit the
opposite behavior. In the case of Giffen goods, the demand actually increases as the price of the
good itself increases.
• Conditions: For a good to be classified as a Giffen good, it must fulfill two key conditions: 1.
Large share of income: The good must make up a significant portion of a consumer's budget,
especially in low-income situations.
2. Lack of close substitutes: There must be no close substitutes readily available for the good,
leaving consumers with limited options even when the price increases.

Example: Rice in some developing countries is often cited as a potential Giffen good. If rice
constitutes a large portion of a household's budget and there are no close substitutes readily
available (e.g., due to poverty or geographical limitations), an increase in rice prices might force
consumers to spend even more on it to maintain the same level of consumption, as other essential
goods become even less affordable. This phenomenon is called the Giffen paradox.

10. What is consumer surplus? Suppose the demand curve is Q=100-2P. What is the consumer surplus when the
consumer consumes 60 unit of the commodity?

Consumer surplus is the difference between the maximum price a consumer is willing to pay for a good or service
and the actual market price they pay. It represents the benefit consumers receive from purchasing a good or service
at a price below their maximum willingness to pay.

1. To find the consumer surplus when the consumer consumes 60 units of the commodity, we first need
to find the corresponding price at which the quantity demanded is 60 units.
2. Substitute 𝑄=60Q=60 into the demand curve equation and solve for
3. 𝑃: 60=100−2𝑃60=100−2P 2𝑃=100−602P=100−60 2𝑃=402P=40 𝑃=20P=20

Consumer Surplus=1/2×base×height

Consumer Surplus=1/2×60×20
 Consumer Surplus=600
11. What is production function?

A production function is a mathematical relationship that describes the maximum output that can be
produced by using various combinations of inputs, such as labor and capital, in the production process. It
represents the technological relationship between inputs and outputs, showing how inputs are transformed
into outputs given the available technology.

Mathematically, a production function is typically represented as 𝑄=𝑓(𝐾,𝐿) where:

𝑄 is the quantity of output produced, 𝐾 is the quantity of capital input, L is the quantity of labor input, and f
is the production function, which specifies how inputs are combined to produce output.

Define Average product and marginal product. What is the relationship between average product and marginal
product? Avg product= o/p produced per unit of particular input
Marginal Product- additional o/p produced as input increased by 1 unit
As input increases O/p also initially. Average product increase upto E , maximises and then decreases.
Similarly, marginal product also increases and is above the average product on the left hand side, coincided at
E, where marginal product is equal to average product after E average product is above the marginal product.

12. Define isoquant. What are the properties of isoquant?

An isoquant is a graphical representation of the combinations of inputs (such as labor and capital)
that can yield same level of output.
The term "isoquant" is derived from the Greek words "iso," meaning equal, and "quant," meaning
quantity, indicating that all points on the curve represent combinations of inputs that yield the same
quantity of output.
 Downward Sloping: Isoquants slope downwards from left to right. This reflects the principle of
diminishing marginal rate of technical substitution (MRTS), which states that as more of one input is
used, less of the other input is needed to produce the same level of output. Consequently, the slope
of the isoquant represents the rate at which one input can be substituted for another while keeping
output constant.
 Convex to the Origin: Isoquants are typically convex to the origin. This reflects the diminishing
marginal rate of technical substitution, where the marginal rate at which one input can be substituted
for another decreases as the quantity of one input increases relative to the other.
 Non-Intersecting: Isoquants do not intersect each other. This implies that each isoquant represents a
unique level of output, and combinations of inputs on different isoquants cannot produce the same
level of output.
 Higher Isoquants Represent Higher Levels of Output: Isoquants farther away from the origin
represent higher levels of output. This indicates that as one moves outward along an isoquant, the
level of output increases.
 Parallel Isoquants: Isoquants that are parallel to each other indicate constant returns to scale, where
doubling the inputs leads to a doubling of output. This occurs when the proportional change in
inputs results in an equal proportional change in output.

13. Define returns to scale. Suppose the production function of a firm is ¿ A K α L β . Put the restrictions on α ∧β
such that the production function will follow CRS.
The rate at which o/p changes as input changes proportionately.
Increasing ROS- o/p is more than double when input is doubled
Const ROS- O/p is doubled when input is doubled
Decreasing ROS- when O/p less than doubles when Input is doubled

In order for the production function to exhibit constant returns to scale (CRS), it must satisfy the condition that
if all inputs are multiplied by a positive constant factor, the output will also be multiplied by the same constant
factor. Mathematically, this condition can be expressed as:
14. What is a cost function of a firm? Define average cost, average fixed cost, average variable cost and marginal
cost. What is the shape of average fixed cost?
Cost function of a firm is defined as total cost required/incurred to produce a certain level of output. It can be
either fixed or variable.
Average total Cost- Firm total cost incurred div by Output
Average fixed cost- Firm fixed cost div by level of O/p
Average variable cost- Firm variablecost div by level of o/p
Marginal cost- Firm;s increase in cost to produce additional unit of O/P
 ATC= AVC+AFC curve
Marginal cost is prepared by joining the minimum points of Average fixed cost, Average variable cost and Avg
marginal cost
15. (Cost in the long run) What is iso-cost line? Show how a firm will choose the optimum output given the cost
constraint.
The iso-cost line, also known as the equal-cost line or budget line, represents all combinations of inputs that
can be purchased by the firm at a given total cost.

Here's how a firm chooses the optimum output given the cost constraint using the iso-cost line:

1. Iso-Cost Line:
 The iso-cost line is a straight line on a graph that represents the combinations of inputs (such
as labor and capital) that can be purchased by the firm at a given total cost.
 The equation of the iso-cost line is given by: 𝐶=𝑤𝐿+𝑟𝐾 where:
 𝐶is the total cost,
 𝑤 is the wage rate (cost of labor per unit),
 𝐿 is the quantity of labor input,
  𝑟 is the rental rate (cost of capital per unit), and
 𝐾 is the quantity of capital input.
Input cost K=C/r-w/rL
So isocost line slope = -w/r
2. Optimum Output:
 To choose the optimum output given the cost constraint, the firm seeks to maximize its output
subject to the cost constraint represented by the iso-cost line.
 The firm will choose the level of output where the iso-cost line is tangent to the highest
attainable isoquant (the production possibilities curve) given the total cost constraint.
 At the point of tangency, the slope of the iso-cost line is equal to the slope of the isoquant,
indicating that the marginal rate of technical substitution (MRTS) is equal to the ratio of input
prices (wage rate to rental rate).


MRTS= del K/del L= MPL/MPK
If the firm minimises the cost of production
MPL/MPK=w/r
Or
Mpl/w=Mpk/r
3. Graphical Representation:
 On a graph with quantity of labor (L) on the x-axis and quantity of capital (K) on the y-axis, plot
the iso-cost line representing the total cost constraint.
 Then, plot several isoquants representing different levels of output.
 The point of tangency between the iso-cost line and the highest attainable isoquant represents
the optimum output level given the cost constraint.
 At this point, the firm is maximizing its output subject to the given total cost.

16. Derive the long run cost curve from the short run cost curve.
Assume that a firm is uncertain about the future demand and for its product and considering three alterative
plants sizes. SAC1 represents plant where cost of production is 8 $ and if higher Quantity Q2 is expected to
produce then plant SAC3 is used. Now long run curve is drawin on optimum cost of production for each plant
with o/p Q1, Q2 and Q3.
 Identify Short-Run average Cost Curve for three plants: SAC1, SAC2 ,SAC3
Locate Optimal Short-Run Output Levels: point of minimum short run cost
Find Corresponding Long-Run Cost: For each plant, corresponding to short run, find the long run cost
(these are not on Optimum /minimum point of SAC1 SAC2 SAC3
Connect Points to Form Long-Run Cost Curve:

17. Define economics of scope. How can we measure economics of scope?

The situation in which the joint o/p of a single firm is greater than the two different firms when producing sinle
product.
Degree of economies of scope = % saving resulting when 2 or more products are produced jointly rather
individually C(q)= cost of producing output Q
SC=C(q1)+C(q2)-C(q1,q2)/ C(q1,q2)
18. What are the assumptions of a perfectly competitive market? Describe the equilibrium of a perfectly
competitive firm. Show that in the short run, firm can make super normal profit, normal profit or losses.
A perfectly competitive market is where there are many buyers and sellers of a homogenous product. Each one
has perfect information about prices and is acting independently.
Assumption of perfectly competitive market.
1. Many buyers and sellers
2. Price taking- none of the firm has influence over market price and thus takes the price as given. Since
each firm is selling small poportions of total, hence they can not impactthe market decision on price
3. Homogeneous product- product are identicle and perfect substitues
4. Free entry and exit
Equbm of a perfect comp market in short run is at when marginal cost = marginal revenue
…the short run, a perfectly competitive firm's equilibrium is determined by its profit-maximizing output level,
where marginal cost equals marginal revenue. In the short run, the competitive firm maximizes its profit by
choosing and out Q* at which Marginal cost MC = P or MR marginal revenue.If---

 If price (P) exceeds average total cost (ATC), the firm makes super-normal (economic) profit.
 If price (P) equals average total cost (ATC), the firm makes normal profit.
 If price (P) is below average total cost (ATC) but above average variable cost (AVC), the firm incurs
losses but may continue operating in the short run to cover variable costs

19. Is it possible to earn super normal profit in the long run for a perfectly competitive firm?
No, it is not possible for a perfectly competitive firm to earn super-normal, competitive profit (economic)
profit in the long run. In the long-run equilibrium of a perfectly competitive market, firms earn zero economic
profit.
20. Derive the supply curve of a perfectly competitive firm.

21.
22. What will be the shape of long run supply curve of the perfectly competitive industry?
23. What are the assumptions of a monopoly market? Derive the equilibrium conditions under monopoly.
 24. What is monopoly power? What are the sources of monopoly power? Show that the Lerner index of monopoly
1
power =
|e|
25. Show that the supply curve of a monopoly firm is absent.
26. What is the social cost of monopoly? (Dead weight loss)
27. What are different kinds of price discriminations of a monopoly? Derive the equilibrium price and quantities in
case of third degree price discrimination.
28. What is natural monopoly? What will be the impact on a natural monopoly if a regulator imposes a marginal
cost pricing restriction?

A natural monopoly occurs when a single firm can produce a good or service at a lower average total cost
than multiple firms producing the same quantity. This typically happens in industries with high fixed costs
and low marginal costs, such as utilities like water, electricity, and natural gas distribution, as well as
transportation infrastructure like railways and highways.

Here are the key characteristics of a natural monopoly:

1. High Fixed Costs: Natural monopolies often involve industries with high fixed costs, such as
infrastructure development and network establishment. These fixed costs are substantial relative to
variable costs.
2. Low Marginal Costs: Once the infrastructure is in place, the marginal cost of producing additional
units of the good or service is relatively low. This means that the cost of producing one more unit is
minimal compared to the fixed costs.
3. Economies of Scale: Natural monopolies benefit from economies of scale, where increasing
production leads to lower average total costs. As output increases, the average total cost decreases,
allowing the firm to produce goods or services at a lower cost per unit.
4. Barriers to Entry: Due to the high fixed costs and economies of scale, it is often economically
infeasible for new firms to enter the market and compete with the incumbent natural monopoly. This
creates barriers to entry and limits competition.

If a regulator imposes a marginal cost pricing restriction on a natural monopoly-

1. Profitability: Marginal cost pricing may not allow the natural monopoly to cover its fixed costs
adequately. Since the firm has high fixed costs and low marginal costs, setting prices equal to
marginal costs may lead to insufficient revenue to cover fixed costs, resulting in losses for the firm.
2. Underinvestment: Marginal cost pricing may discourage investment in maintaining and expanding
infrastructure. If the firm cannot recover its fixed costs, it may lack the financial resources to invest in
infrastructure maintenance, upgrades, and expansion, which could lead to deteriorating service
quality and reliability over time.
3. Cross-subsidization: Natural monopolies often serve diverse customer groups with different demand
patterns and cost structures. Marginal cost pricing may result in cross-subsidization, where customers
with higher demand pay lower prices than what would be necessary to cover the full cost of service
provision. This could lead to inequitable outcomes and distortions in resource allocation

29. What is monopolistic competition? Show that a firm under monopolistic competition can earn only the normal
profit in the long run.
30. Define oligopoly market. What is the reaction function under duopoly market? Derive the optimum quantity
and price under a duopoly market. Both Cournot’s and Bertrand’s model. Also determined the price and profit
of each firm. What will be the outcome under leadership model?
31. Explain price rigidity under oligopoly using kink demand curve model.