Registration No.

:- IIMM/DH/02/2006/8154
:- Vikash Khichi

Answer 1. (a)

Father of Economics Adam Smith Published his book in 1776: He described economics as “The Science of wealth”. According to him “The acquisition of wealth is the main objective of human activity. Therefore, it is necessary to study how wealth is produced. This is the subject matter of the economics”. As this is a wealth oriented definition, thus it attracts many critism. Then came the definition of Alfred Marshall. He said “Political economy or Economics is a study of means and actions in the ordinary business of life”. Marshal was criticized for being restricted to the earning and spending class only. It did not answer the questions as to How, Why and What etc. There were many other definitions given by many economists, but the definition given by Liouel Robbins in 1932 was a definition, which is accepted by most of the economists. According to Robbins “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses”. Here ends refer to wants which are considered to be unlimited. The use and allocation of scarce resources to production of goods and services which will give maximize satisfaction. Scarcity of resources also compels us to decide how the different goods & services would be produced.

Production Possibility curve (PPC) This is a very basic tool but a very important one. We’ll use this tool to study the about the problem of scarcity by using this tool. The problem of scarcity was given focused by Prof. Samulson by using the production possibility curve of production possibility frontier. Basic Assumptions or Production Possibility Curve: 1) There is full employment in the society which means all the four factors of production are fully employed and there is no unemployment in the society. 2) The supply is limited which means that supply of factors are fixed and they can be reallocated or shifted within limits among different uses. 3) Technology is constant which means that there is no innovations’ going in the society. We can use this technique to illustrate the economizing problem with the help of an imaginary table containing some of the alternative combinations of breads and sewing machines, which the economy might choose. Products Breads (in hundred thousand) Sewing Machine (in Thousand) Notes: 1. Four factors of production- Land, Labour, Capital and Enterprise. 2. Improvement in existing technology.

A 0 10

B 1 9

C 2 7

D 3 4

E 4 0

If we closely observe the data we find that we have two extremes here. The alternative A and A B 8


Sewing Machine




0 1 alternative E. At ‘A’ there is no production of bread which mean all the resources available the production of only and only sewing machine. Same is the case with where there is production of only bread. The ‘D’’B’ and ‘C’ are the combination of the two goods. The economy generally adopts the ‘D’ ‘B’ or ‘C’ alternatives. As we move from ‘A’ to ‘E’ the economy changes the combinations. When the society is moving from ‘A’ to ‘E’ the society is consuming one sewing machine. At any point of time, a fully employed and fully producing economy must scarce; the economy cannot have all the commodities at one time. The above mentioned explanation can be explained graphically with the use of Production Possibility Curve (PPC). The PPC represents shifting of resources from one production to another. If a point falls on the Production Possibility Curve it means the factors of production are fully employed. If the production is taking place at point ‘U’ it means there’s under employment and there are some unemployed factors in the society. Whereas if the production takes place at point ‘P’, it shows the shortage of factors of production. Whereas if the economy wants to reach the point ‘P’ it will have to increase the efficiency and production capacity of the factors of production. 2

Answer.1 (a)

Micro and Macro Economics

Micro-Economics: Definitions The term ‘Micro’ has been derived from the greek word ‘mikros’ which means ‘small’. In micro-economic approach, attention is concentrated on a very small part or the individual units. Hanson terms it as “atomistic individualistic approach.” Boulding has described micro-economics as the study of “The particular firms, particular households, individual prices, wages, incomes, individual industries and particular commodities.” Thus micro economics is the study of the behavior of individual consumer’s, individual firm or workers. It studies, for example the motive of a business man in diverting his capital from the cotton textile industry to the Weller industry or that of an individual producer for increasing the production of commodity A rather than commodity B. Scope of Micro Economics: Micro-economic analysis explains the allocation of resources assuming that the total resources are given. The following chart given of the view of the scope of micro-economics.

Micro-economic Analysis

Theory of Commodity Pricing

Theory Factor Pricing

Welfare Economics

Theory of Demand

Theory of Supply





Macro-Economics: Definitions and Scope The term ‘Macro’ has also been derived from another Greek word ‘Makros’ meaning large. The word itself was coined in 1933 by Ragnar Frisch. Macro-economics implies a study of economic aggregates or the wholes. The problems like full employment, unemployment, economic stability and economic growth cannot be accurately investigated through the examination of infinitesimally small units like individual consumers, producers, workers or firms. The actions of a single employer cannot in any way, have a perceptible impact upon the employment situation of a country. The production or investment by a single firm is unlike to generate cyclical fluctuations. The proper analysis of such problem requires an aggregated thinking. Full employment, economic growth and instability are concerned with the entire economic system. Their analysis and solution in the right perspective can be possible only if a macro approach and aggregative instruments of analysis and policy are employed.


Prof. Gardner Ackely states that Macro-economics “concerns itself with such variables as the aggregate volume of output of an economy, with the extent to which its resources are employed, with the size of national income, with the general price level.” Hanson has interpreted macro-economics as “that branch of Economics which considers relationship between large aggregates such as the volume of employment, total amount of saving and investment, the national income, etc.’ Evolution of Macro-Economics The depression of The 1930’s was not simply instrumental in the tumbling down of the prices of securities and a consequent collapse of general economic activity; it pulled down even the old structure of economic analysis. The world was forced upon the aggregates like national income, aggregate output, expenditure, consumption, saving and investment. Keyne’s General Theory has a tremendously decisive impact on the post-Keynesian aggregative thinking. The main factors which contributed to the growth of aggregative in the 1930’s and which sustained the impetus for the development of such an approach were as follows: (i) (ii) (iii) (iv) Technological break through reflected in mass production methods. Continuous process of industrialization and urbanization in general. Increasing complexity and multiplicity of the phenomena influencing the present day economic life. The investigation of which requires more and more detailed information. Extension of public sector in every economy and the resulting growing importance of the role of government finance for growth, welfare and stability.


Managerial economics should be thought of as an applied branch of Micro economics, which studies the topics which are of great interest and importance to a manager. These topics involve components like demand, Supply, Production, Cost, revenue, Government regulations etc. Good

understanding of these topics is an important managerial talent, which helps the manager in decision making and forecasting. In general managerial economics can be used by the goal-oriented manager in two ways. Firstly, given an existing economic environment, the Principles of managerial economics provider a frame work or evaluating whether resources are being allocated efficiently. Secondly, the principles of economics help in decision making. For example one reason to cut down in the Labour cost could be because of larger use of the machinery. Managerial economics is the application of economic analysis to evaluate business decisions. It concentrates on the decision process, decision model and decision variables at the firm level. The firm is viewed as a microeconomics unit located within as industry, which exists in the context of a given socioeconomic environment of business. Managerial economics is concerned with the economics behavior of the firm. It is assumed that the firm maximizes profit. Profit is defined as the difference between revenue and costs. The flow of revenue is determined by the demand conditions in the market, whereas the costs are influenced by the supply conditions. Demand and supply interact with each other to determine prices commodity prices in the product market structure perfect or imperfect, free or regulated, buyer or seller etc. The firm placed in the context of a market environment, decides its economic strategy and tactics, keeping in view its objectives and constraints. Tactical decisions are reflected in the course of operational decision variables like price and, output, etc. , which affect the firm’s level of profit. The firm can then evaluate its performance in terms of return on an investment intended and achieved. The firm can estimate the element of risk and uncertainty, it is subject to and through its decision making process the firm can formulate strategies to minimize such risk through forecasting and forward planning. Definitions: There are many definitions of managerial economics, fun of them are as follows: 1) Prof. Spencer Siquelman “Managerial economics deals with integration of economic theory with business practice for the purpose of facilitating decision making and forward planning’. 2) Prof. Hague “Managerial Economics is concerned with using logic of economics mathematics and Statistics to provide effective ways of thinking about business decision problem”. 3) Mc Nair and Meriam “Business economics & managerial consists of the use of economic”.


The demand for a product is the desire for that product backed by willingness as well as ability to pay for it. It is always defined with reference to a particular time, place, price and given values of other variables on which it depends.

Law of Demand “Other things being equal, the higher the price of a commodity, the smaller is the quantity demanded and smaller the price, larger is the quantity demand”. Individual Demand Curve With the given income individual selects that combination of goods and services that maximized their personal satisfaction. We know that an individual distributes his income among different demands. Generally we study demand for one good to understand the individual demand curve. The Demand Schedule A demand curve considers only the price-demand relation, other things remaining the same. This price-demand relationship can be illustrated in the form of a table called demand schedule and the data from the table may be given a diagrammatic representation in the form of a curve. Demand Curve The graphical representation of individual or market demand schedule is known as demand curve as shown below: Demand Schedule Px (in Rs.) 2 3 4 5 6 Dx (in units) 12 10 8 6 4

It may be observed from the demand schedule and the demand curve above that the price of x and the demand for x move in opposite directions. Assumptions:

The Law of demand stands on some basic assumptions without which it losses its meaning. 1) No change in consumer’s income during the period or at the time of demand. 2) No change in fashion. 3) No change in technology. 4) No change in the price of substitute. 5) No change in consumer’s preference. 6) No change in government policy. 7) No change in weather conditions. The Law of demand which says that there is a inverse relation between quantity and price depends on the above assumptions. Types of Demand 1) Direct and Derived Demands Direct demand refers to demand for goods meant for final consumption. By contrast, derives derived. For Example, the demand for cement is derived from the demand for housing. Autonomous demand, on the other hand, is not derived or induced. All direct demand may be loosely called autonomous. In the context of econometric estimates of demand, this distinction is used to identify the determinates of demand. 2) Autonomous and Induced Demand When the demand for a product is tied to the purchase of some parent product, its demand is caved induced or derived. For Example, the demand for cement is derived from the demand for housing. Autonomous demand, on the other hand, is not derived or induced. All direct demand may be loosely called autonomous. In the context of econometric estimates of demand, this distinction is used to identify the determinates of demand. 3) Perishable and Durable Goods Demand Both consumer’s goods and producer’s goods are further classified into perishable, nondurable, single use goods, durable, non-perishable, repeated use goods. Non-durable goods meet immediate demand, but durable goods are designed to meet current as well as future demand as they are used more than ones. When durable items are purchased, they are considered to be an addition to stock of assets or wealth. Due to continuous use, durables suffer depreciation and thus call for replacement. Thus the demand for durable goods has two aspects replacement of old products, and expansion of total stock. 4) New Demand and Replacement Demand If the purchase of an item is meant as an addition to stock, it is a new demand. If the purchase of an item is meant for maintaining the old stock of capital/asset intact, it is replacement demand. Such replacement expenditure is to overcome depreciation in the existing stock. Answer.3(a) The Consumer’s Surplus The concept of consumer’s was introduced by Marshall, who maintained that it can be measured in monetary units.


Consumer surplus is equal to the difference between the amount of money that a consumer actually pays to buy a certain quantity of a commodity x, and the amount that he would be willing to pay for this quantity rather than do without it. Graphically the consumer’s surplus may be found by his demand curve for commodity x and the current market price, which, is assumed, he cannot affect by his purchases of this commodity. Assume that the consumer’s demand for x is a straight line (AB in the fig. Below and the market price is P. At this price consumer buy Q units of x and pays an amount (p) for it. However, he would be willing to pay P1 for q1, P2 for q2, P3 for q3 and so on. The fact that the price in the market is lower than the price he would be willing too pay for initial units of x implies that is actual expenditure is less than he would willing to spend to acquire the quantity q. This difference is the consumer’s surplus, and is the area of the triangle PAC in the fig. below. Px A P1 P2 P3 P C

Qx O q1 q2 q3 q B

Thus, consumer surplus may be defined as the excess of utility or satisfaction obtained by the consumer and is measured by the difference between what we are prepared to pay and what we actually pay. Consumer surplus Or Consumer surplus = = what one is prepared to pay - what one actually pays. Total utility obtained – Total amount spent

Assumptions of Consumer Surplus The Marshallian surplus is based on the following assumptions: 1) Marginal utility of money remains constant. 2) Utility of any particular commodity demands upon the quantity of that commodity alone, and is not determined by the quantities of other related goods. 3) Incomes, tastes, fashions, etc. had no role in consumption pattern. 4) Since the Marshallian consumer’s surplus may be found by consumer’s demand curve for a commodity, marshall assumed that all the assumptions that were applicable to the demand curve were applied to the concept of consumer’s surplus also 5) Substitute goods were regrouped together as single commodity and hence were not taken into consideration. Difficulties in Measuring Consumer’s Surplus

1) The cardinal measurement of utility is difficult because it is close to impossible for a consumer to say that the first unit of a commodity x gave him 10 units of satisfaction and the second unit of the commodity gave him 5 units of satisfaction. 2) Marginal utility for the same commodity id different to different consumers. Marginal utility for a particular commodity varies from person to person depending upon their income, tastes and preferences. 3) Existence of substitutes: In the real world, a number of substitutes for a commodity exist, thus making the work of measuring consumer’s surplus a complicated task. 4) Marshall based his concept of consumer’s surplus on the simplifying assumption that the marginal utility of money is constant. As the consumer buys more and more units of a commodity x, the amount of money with him diminishes, In this case, the marginal utility of money is bound to increase rather than remain constant. 5) Lack of awareness of different price it is not possible for a consumer to be aware of the entire demand schedule.



Demand forecasting is a specific type of forecasting, which enables the manger to minimize element of risk and uncertainty. The likely future event has to be given form and content in terms of projected course of variables, i.e. forecasting. The manager can conceptualize the future in definite terms. If he is concerned with future events in its order, intensity and duration, he can predict the future. If he is concerned with the course in like of future variables like demand, price or profit, he can project the future. Types of Forecasts 1) Economic and non-economic forecasts ‘Social’, technological and ‘political’ forecasts are all examples of non-economic forecasts. For example, one can forecast the crime rate, technological obsolescence, election result and so on. 2) Micro and Macro forecasts Micro-forecasts are at firm level, e.g. a demand or sales forecast. On the other hand, macroforecasts are at the industry level or the economy level for e.g. five year plan projections. 3) Active and Passive forecasts If the firm extrapolates the demand of previous years to yield the likely estimated demand for the coming year, it is an example of passive forecast. If the firm, on the other hand, tries to manipulate demand by changing price, product quality promotional effort, etc. Then it is an example of active forecast. 4) Conditional and non-conditional forecasts In ‘conditional’ forecasting, we estimate the likely impact of certain known or assumed changes in the independent variable on the dependant variable. ‘Non-conditional’ forecasting, in contrast, requires the estimation of the changes in the independent variables themselves. 5) Short-run and long-run forecasts An important consideration in forecasting is the time span relevant for a particular problem, which varies from problem to problem. In a long-term forecast, one has to consider long-term changes in population, tastes, preferences of the buyers, technology, product life-cycle etc. By contrast short-run forecasting concentrates on a few selected variables; here simple techniques based on analysis of past experience and information give fairly accurate forecasts. Steps in Demand Forecasting 1) Nature of forecast: One should be clear about the uses of forecast data how it is related to forward planning and corporate planning by the firm. Depending upon its use, one has to choose the type of forecast short-run, active or passive, conditional or non-conditional etc. 2) Nature of product The nature of the product for which one is attempting a demand forecasts has to be examined carefully to establish whether the product is: consumer goods or producer goods perished or durable


final or intermediate demand new demand or replacement demand etc.

For example, the demand for consumers, durables has two components new demand and replacement demand. As more and more people purchase these goods, the market become saturated where new demand declines and replacement demand rises. Buyer can delay replacement demand depending upon their socioeconomic condition, price and availability of consumer credit. Time element enters into demand forecasting with reference to the concept of ‘product life cycle’. When a new product is introduced, sales will increase slowly as more and more people come to know about it. If the product is success, the market will widen quickly and sales will increase rapidly. As the market begins to get saturated and substitute products also get introduced, sales will begin to taper off. The product life cycle curve is illustrated in fig. The forecasting of demand for a product must consider the stage where the product belongs to. Product Life Cycle Curve

Acceptance and growth


Annual Demand

Obsolescence and decline

3) Determinates of demand Time Depending on the nature of the product and nature of the forecasts, different determinants will assume different degrees of importance in difference demand functions. In addition to own price, related price, own income, disposable income and discretionary, related income, advertisements, price expectations, etc. It is important to consider socio-psychological determinates, specially demographic, sociological and psychological factors affecting demand. Such factors are particularly important for long-run active forecasts. 4) Analysis of determinants (factors) In an analysis of statistical demand functions, the explanatory factors determinants are classified into (a) Trend factors which affect demand over long-run (b) Cyclical factors, whose effects on demand are periodic in nature (c) Seasonal factors which are a little more certain compared to cyclical factors because there is some regularity with regard to their occurrence, and

Saturation and Maturity


Petering off

(d) Random factors, which create disturbance because they are erratic in nature, operation and effects are not very orderly. For a long-run demand forecast, trend factors are important but for a short-run demand forecast, cyclical and seasonal are important. 5) Choice of techniques The choice of technique has to be logical and appropriate. The choice depends on a number of factors like the degree of accuracy required, reference period of the forecast, complexity of the relationship postulated in the demand function, available time for forecasting exercise, size of cost budget for the forecast etc. 6) Testing accuracy Testing is needed to avoid or reduce the margin of error and thereby its validity for practical decision making purpose.


Laws of variable proportion The law of variable proportion is a Short-Run production function. Where some factors are fixed and others variable, like a land may be fixed and Labour may be variable. Variable means its quantity can be changed. Statement of the law “As equal increments of one point are added, the inputs of other productive services being held, constant, beyond a certain point the resulting increments of product will decrease i.e. the marginal product will diminish”. G Stigler. The law of variable proportions is also known as “The law of diminishing returns” this law refers to the amount of extra output secured by adding to a fixed input (or factor) more and more of variable inputs. If, for example we add increasing quantities of some variable factors (say Labour) to a fixed factor (say land) and as a result we get production more than proportionately, then it is known as increasing returns to scale. When, however, the resulting production is in the same proportion it is known as constant returns and when the output is less than the input it is the decreasing returns of scale. Assumption of the law 1) There is only one variable factor. All the others are constant. 2) The units of the variable factor are homogeneous in character. 3) It is possible to change the proportion in which the various factors are combined together. 4) The state of technology remains unchanged. 5) The time period is short. Based on these assumptions we try to understand this law. Lets take a numerical example to understand this law we assure that capital is fixed which is machinery here and the variable.

Units of Labour UL

Total Product TP

Marginal Product MP

Avg. Product AP

1 2 3 4 5 6 7 8 9 10

80 170 270 368 430 480 504 504 495 470

80 90 100 98 62 50 24 0 -7 -25

80 85 90 92 86 80 72 63 55 47

Let us now understand this graphically this graph is not based on the figures given above. Marginal and Avg. Product

I stage II stage

III stage





Total Product

F II stage

III stage


I stage

Labour Lets now study the diagram stage wiseStage-I TP till a point increases at a increasing rate. In the figure from origin to point F the TP is increasing at a increasing rate. After F till the beginning of stage II it increases at a slower pace, which means T.P. increases at diminishing rate. MP also rises accordingly and so dose the AP, MP reaches the maximum point when there’s a influx in the TP and after reaching the maximum starts falling. This happens because the factors are not being utilized to there full capacity. The Stage I ends where AP curve reaches its highest and MP cuts AP at the highest. MP remains higher than AP through out this Stage this is the ‘Increasing returns to Scale’. Stage-II In the Stage II TP continues to rise but at diminishing rate until it reaches its maximum. This is the most important stage, which is also known as the ‘Operational Stage’. Where MP behaviors like a demand curve for Labour in a firm. In this stage AP remains above MP. Any firm will like to be in this stage because it is using its resources to fullest and to the best of its use. This stage ends with TP maximum and MP as zero. AP still remains positive. Stage-III In the 3rd stage all the curves are falling TP, AP and MP where TP starts to fall at a increasing rate. AP is also falling. There is one thing special about AP and that is that it’ll never become negative. MP becomes negative this happens because due to too many variable factors the efficiency of the fixed factor decreases.



The Cost Function: Both in the short run and in the long run, total cost is a multivariable function. That is, total cost is determined by many factors. Symbolically, we may write the long-run function as C = f (X,T,Pf) And the short run cost function as C = (X,T,PfK) Where C = total cost X = output T = technology K = prices of factors Pf = fixed factor(s) Cost curves imply cost is a function of output C= f(X), Ceteris paribus: The clause ceteris paribus implies that all other factors which determine cost are constant. If these factor change, their effect on costs is shown graphically by a shift of the cost curve. This is the reason why determinants of cost other than output, are called shift factors. Any point on a cost curve shows the minimum cost at which a certain level of output may be produced. This is the optimality by the points of a cost curve. Concepts of Costs There are many types of concepts where costs are concered. 1) Money Cost Cost is not a unique concept on the contrary there are various types of costs. The most accepted is the money value or the money cost of production which means the total money involved in production of a commodity. For example money spend on rent, machinery interests, salary of the employee etc., from a producer’s point of view this is the most important cost concept. 2) Opportunity Cost This is a very important concept in modern economic analysis. We can understand this concept best by an example say if a person goes to market he has many things to buy he can buy a watch or a book or a T.V. anything for that matter he’ll choose one out of all the items. Now at the same time he foregoes other items. The cost of foregoing the other items in known as opportunity cost. We could say that the alternative or opportunity cost of any factor in the production of a

particular commodity is the maximum amount which the factor could have cared in some alternative use. 3) Real Cost According to Marshall, the real cost of production of a commodity expressed not in terms of money but in the efforts (of makers) and the sacrifices (of Entrepreneur) undergone in the making of a commodity. Money is paid to the factors of production to compensate them for their effort and sacrifice. Whether this money is adequate or not is entirely a different question the main difficulty with this concept is that it is purely subjective and psychological. 4) Accounting Cost and Economic Costs Accounting cost is also known as explicit costs or expenditure cost. We can say that these costs are contractual payments which are paid to the factors of production which do not belong to the employer himself. For example payments made for raw materials, Power, Light, and Wages. Economic costs are also known as implicit costs or non-expenditure costs. This arises in the case of those factors which are possessed and supplied by the employer himself. For example, and employer may contribute his own land, his own capital and may work as the manager of the firm. So he is entitled to. Interest and salary for himself. 5) Fixed Costs and Variable Costs Variable costs refer to those factors which are variable in Short-Run. These costs naturally vary with the changes in the level of output of the firm, increasing with an increase and diminishing with a decrease in the output. For example if a firm plans to increase the number of labor it will have to increase the expenditure or the salary of the workers. They are direct costs because all the units produced by the firm depend directly upon them. The supplementary or fixed costs are those costs which cannot be increased in Short-Run even if employer wishes to do so. They are called fixed costs because they do not change with every change in output, for example if the output is doubled, the rent of the land where the firm is operating will not change. It is important for a firm to cover the variable costs.


Answer.6.(b) The Cardinal Utility Theory Definition: In economics, utility is a measure of the relative happiness or satisfaction (gratification) gained by consuming different bundles of goods and services. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility. The theoretical unit of measurement for utility is the util. Utility is applied by economists in such constructs as the indifference curve, which plots the combination of commodities that an individual or a society requires to maintain a given level of satisfaction. Individual utility and social utility can be construed as the dependent variable of a utility function (such as an indifference curve map) and a social welfare function respectively. When coupled with production or commodity constraints, these functions can represent Pareto efficiency, such as illustrated by Edgeworth boxes and contract curves. Such efficiency is a central concept of welfare economics. Economists distinguish between cardinal utility and ordinal utility. When cardinal utility is used, the magnitude of utility differences is treated as an ethically or behaviorally significant quantity. On the other hand, ordinal utility captures only ranking and not strength of preferences. An important example of a cardinal utility is the probability of achieving some target. Assumptions 1) Rationality: The consumer is rational. He aims at the maximization of his utility subject to the constraint imposed by his given income. 2) Cardinal Utility: The utility of each commodity is measurable. Utility is a concept. Utility is measured by the monetary units that the consumer is prepared to pay for another unit of the commodity. 3) Constant marginal utility of money: This assumption is necessary if the unit is used as the measure of utility. The essential feature of a standard unit of measurement is that it is constant. If the marginal utility of money changes as income increase, the measuring- rod for utility becomes like as elastic ruler, inappropriate for measurement. 4) Diminishing Marginal Utility: The utility from successive unit of a commodity diminishes. The marginal utility of commodity diminishes as the consumer acquires larger quantities of it. This is the axiom of diminishing marginal utility. 5) The total utility of a ‘basket of good’s depend on the quantities of the individual commodities. If there are n commodities in the bundle with quantities x1, x2,--xn, the total utility is U = f (x1,x2,--xn) It is tempting when dealing with cardinal utility to aggregate utilities across persons. The argument against this is that interpersonal comparisons of utility are suspect because there is no good way to interpret how different people value consumption bundles. When ordinal utilities are used, differences in utils are treated as ethically or behaviorally meaningless: the utility values assigned encode a full behavioral ordering between members of a choice set, but nothing about strength of preferences. In the above example, it would only be possible to say that coffee is preferred to tea to water, but no more.

Answer.6.(C) Long Run Costs Curve In the short-period the firm does not have enough time to change the scale or size of the production unit or of the firm. But in long run there is no such problem because there is adequate time for the manager to adjest the requirement. Therefore there are no fixed factors in the Long-run. If suppose there is a increase in the demand for the product, there is time to increase the production of the firm. In long run every thing is variable including management, labour or be it machinery, when the scale of operations is changed, we need to draw a new short- run cost curve of the firm, because the old cost curve becomes outdated due to change in the scale of operations. That is why we have not one but many cost curve with past experience the firm will choose the best short- run cost curve and implement in the long run. We can thus draw a long- run average cost curve which will indicate the long- run cost of producing each level of output or different scale of production. 1) Long Run Average Cost Curve (LAC) LAC is the sum of various short- run cost curves depicting different production plan A at different time periods. In the long run, all inputs (factors of production) are variable and firms can enter or exit any industry or market. Consequently, a firm's output and costs are unconstrained in the sense that the firm can produce any output level it chooses by employing the needed quantities of inputs (such as labor and capital) and incurring the total costs of producing that output level. The Long Run Average Cost, LRAC, curve of a firm shows the minimum or lowest average total cost at which a firm can produce any given level of output in the long run (when all inputs are variable). In the long run, a firm will use the level of capital (or other inputs that are fixed in the short run) that can produce a given level of output at the lowest possible average cost. Consequently, the LRAC curve is the envelope of the short run average total cost (SR ATC) curves, where each SR ATC curve is defined by a specific quantity of capital (or other fixed input).

2) Long Run Marginal Cost Curve (LMC) The LMC bears the same relation to the long run LAC that any SMC bears with SAC i.e. LMC cuts LAC from down at the lowest point and till the LMC is lower than LAC it is profitable for the firm, but when the LMC goes above the LAC its indicates loss where as when LAC and LMC intersect each other that is known as the equilibrium point. In the long run the point L2 will be chosen from the figure given below:


Marginal Cost MC is the calculation of the change in rate of total cost. It is the change in TC due to additional unit of variable factor.



∆ TC ∆ Output

MC is a ‘u’ shaped curve. MFC (Marginal Fixed Cost) is zero that is why we don’t study MFC this is because fixed cost is constant throughout the production period. Therefore we take MVC = MC.


Answer.6(d). Definition In an oligopolistic market there are a small number of firms, so that sellers are conscious of their interdependence. Thus each firm must take into account the rivals reactions. The competition is not perfect, yet the rivalry among firms in high unless they make a collusive agreement. The products that the oligopolists produce may be homogenous (pure oligopoly) or differentiated (differentiated oligopoly). The seller must guess the rivals reactions. Their decisions depend on the ease of entry and the time lag, which they forecast to intervene between own action and the rival’s reactions. Given that there is a very large number of possible reactions of competitors, the behaviour of firms may assume various forms. Thus there are various models of oligopolistic behaviour, each based on different reaction patterns of rivals. Oligopoly is a common market form. As a quantitative description of oligopoly, the fourfirm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. Oligopsony is a market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in markets for inputs where a small number of firms are competing to obtain factors of production. This also involves strategic interactions but of a different nature than when competing in the output market to sell a final output. Oligopoly refers to the market for output while oligopsony refers to the market where these firms are the buyers and not sellers (eg. a factor market). A market with a few sellers (oligopoly) and a few buyers (oligopsony) is referred to as a bilateral oligopoly. The Main Features Its very important to study the feature or charaecteristic of oligopoly. How will you recognize the oligopoly market? The following are the main feature. 1) Interdependence – The producers are interdependent on each other for decision making. This is because the number of competitors are few so any change in the price, output, product etc. by a firm can have some effect on the other producer. 2) Importance of advertising and selling cost – To occupy the bigger share of market the producer plans a layout for advertising. For this various firms have to incur a good deal of costs on advertising. 3) Group Behaviour – In this type of market the producers come together to take decisions in every memebers common interest. We can broadly devide oligoploy into two parts collusive and non collusive oligoploy is the one in which the producers come together and determine a fixed price or output or share of the market etc.
Non-collusive oligopoly is the one in which the competitor applies own managerial skills to capture the market and is always alert of what the rival producer is planning. Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may collude to raise prices and restrict production in the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel.



Definition In economics, an isoquant (derived from quantity and the Greek word iso [meaning equal]) is a contour line drawn through the set of points at which the same quantity of output is produced while changing the quantities of two or more inputs. Another way of defining the isoquant is a curve that shows all possible quantities of inputs that result in the same level of output with a given production function. While an indifference curve helps to answer the utility-maximizing problem of consumers, the isoquant deals with the cost-minimization problem of producers. Isoquants are typically drawn on capital-labor graphs, showing the tradeoff between capital and labor in the production function, and the decreasing marginal returns of both inputs. Adding one input while holding the other constant eventually leads to decreasing marginal output, and this is reflected in the shape of the isoquant. A family of isoquants can be represented by an isoquant map, a graph combining a number of isoquants, each representing a different quantity of output. Isoquants are a geometric representation of the production function. The same level of output can be produced by various combinations of factor inputs. Assuming continuous variation in the possible combination of Labour and capital, we can draw a curve by plotting all these alternative combinations for a given level of output. This curve which is the locus of all possible combinations is called Isoquants or Iso-product curve. Properties of Isoquants (i) Each Isoquants corresponds to a specific level of output and shows different ways, of technological efficiency, for producing that quantity of output. The Isoquants are downward sloping and convex to the origin. The slope of an Isoquants is significant because it indicates the rate at which factors K and L can be substituted for each other while a constant level of output is maintained. As we proceed north eastward from the origin, the output level corresponding to each successive Isoquants increases, as a higher level of output usually required greater amounts of the two inputs. Two Isoquants do not interest each other as it is not possible to have two output levels for a particular inputs combination.

(ii) (iii)

An isoquant map where Q3 > Q2 > Q1. A typical choice of inputs would be labor for input X and capital for input Y. More of input X, input Y, or both is required to move from isoquant Q1 to Q2, or from Q2 to Q3.



A Weber’s Deductive Theory of Location of Industries Alfred Weber’s deductive theory of location of industries was presented in his book “Theory of the location of industries in 1909”. According to Weber, the economic reasons responsible for the location of industries are: (i) (ii) (iii) Primary causes or regional factors, and Secondary causes Primary Causes of Regional Factors

According to Weber, the two unavoidable expenditures incurred by an industry are on Expenditure on transport incurred by every firms is of two types. Expenditure on transport incurred by every firms is of two types. (a) Expenditure for transporting raw material to the site of the firm, and (b) Expenditure incurred for transporting the finished products to the respective markets. An industry should ideally be located where both the above expenditures are minimum. Weber has further divided raw material into two categories based on its availability. (a) “Ubiquitous” raw materials are those which are easily available at all places such as bricks, cement etc. The industry requiring these factors may be started anywhere, keeping in mind the proximity markets which reduce the cost on transport of its products. (b) “Localized factors” or localized raw materials are those factors of production which are available only at certain places such as coal, iron, oil, etc. Industries using these factors should be started where these localized factors are available. Weber further classified raw materials into (a) Pure and (b) Weight losing. “Pure” raw materials (such as cotton woll etc.) When used in the manufacturing process do not loose weight to any great extent. Industries using “pure” raw materials can be started anywhere. “Weight Losing” raw materials (such as iron ore, coal, etc.) are substantially reduced in weight when transformed into finished products. Industries using weight losing raw materials should be started in the vicinity of the supply of raw material. Taking into account all the above mentioned factors Weber prepared a “Material Index.” The Material index given the proportion of the weight of finished product to the weight of localized raw material: Material Index = Weight of the raw material Weight of the finished product The larger the material index the greater is the possibility of the industry being attracted towards the supply of raw material and the smaller the value of the material index, the greater is possibility of the industry being attracted towards the market. The industry which is localized at a particular place on the basis of the material index may be shifted from that place to any other place if the expenditure incurred on Labour is large. In such case, the industry will shift and localize at a place where Labour cheap. x 100


Weber put forth the concept “Labour Coefficient”. The Labour coefficient is based on the “Labour Cost Index”. “Labour cost index” is the proportion of expenditure incurred on Labour and the locational weight.


Sign up to vote on this title
UsefulNot useful

Master Your Semester with Scribd & The New York Times

Special offer for students: Only $4.99/month.

Master Your Semester with a Special Offer from Scribd & The New York Times

Cancel anytime.