Teachers' Manual in Economics For PGT 2012

Teachers' Manual

in

Economics

For PGT

2012

State Council of Educational Research & Training

Varun Marg, Defence Colony, New Delhi-110024

Guidance and Supervision

Rashmi Krishnan, IAS.

Director, SCERT

Dr. Pratibha Sharma

Joint Director, SCERT

Co-ordinator / Editor

Dr. Seema Srivastava, Sr. Lecturer, DIET Moti Bagh

Ms. Meenakshi Yadav, Sr. Lecturer, SCERT

Contributors

Prof. Ramesh Chandra (Retd.) Professor NCERT

Mr. Bharat Thakur, Lecturer RPVV, Surajmal Vihar

Mr. Shiv Kumar, D.C. Arya, Sr. Sec. School, Lodhi Colony

Ms. Reema Agarwal , Sarvodya Vidhyalaya , Ali Ganj Lodhi Road

Dr. Seema Srivastava, Sr. Lecturer, DIET Moti Bagh

Ms. Meenakshi Yadav, Sr. Lecturer, SCERT

Publication Officer

Mr. Mukesh Yadav

Publication Team

Sh. Navin Kumar Ms. Radha

Sh. Jai Baghwan

Printed By: Sonu Printing Press (P) Ltd. S-217, Bank Street Munirka, New Delhi - 110067

Foreword Teachers’ role in the development and implementation of curriculum is vital. All the changes and developments taking place in school curriculum, therefore, have necessarily to percolate in the Teacher Education Programmes. Teachers have to be sensitized about the new circular concerns, issues and transactional approaches through In-Service mode. Quality education has always remained a major concern for educationists. There is constant need to make the curriculum pragmatic and teaching – learning process child centric. Teachers have to be oriented about these changes in the textbooks and latest technologies for effective implementation in classrooms. SCERT has been uploading the Support Material on its website (www.scertdelhi.nic.in) in different subjects including Economics since 2011 to make it accessible to all teachers .NCERT and CBSE have brought in the desirable changes and the text books and examination pattern to connect the text with real world of work in true sense. NCF 2005 also strongly emphasizes on the departure from rote learning to child centered –processes which is the core of Constructivist Approach. The support material developed by SCERT is an initiative in this direction for capacity building of teachers. Print material in the form Teacher’s Manual in different subject is an additional support. Teacher’s Manual developed by SCERT and DIET faculty in different subject at Senior Secondary level is an attempt to expose the teachers with changes in syllabus, methodology and the hard spots. There has been remarkable improvement in Government School result of class X & XII in recent past. Still there is a need to improve and strengthen the teaching- learning process in the class rooms by involving students actively. I appreciate and thank the entire team of co-coordinators and contributors who have developed these Teachers Manuals. I sincerely hope that this will enable our teachers to make class-room process more interactive and activity based for enhancement of overall performance of children in Government schools. Yours suggestions and comments regarding the Manual is welcome.

Ms Rashmi Krishnan,IAS

Director, SCERT

Editorial In the modern technology driven economy, things change fast, affecting all sectors of economy. A common man is also affected by Government Policies, Change in Demand and Supply of Goods in Domestic Market and also by the trends in International Market. Declining Rupee Value, Slump in the Job Markets, Inflationary Trends and Rising Prices of even Common Goods, fluctuating scenario in Stock Exchange Market, and these all are concerns of a common man. Economics at Secondary and Senior Secondary level deals significantly with these in School Education. Preparing students for these issues and concerns are vital as they will be job seekers in future. Teacher role in making this subject easy, simplified, understandable is very crucial. Teachers in today’s time have to think beyond the textbook to relate the textbook content with real world of work which is one of the major concerns of National Curriculum Framework’ 2005. The Senior Secondary Curriculum in Economics and other subjects reflect new changes and trends in terms of Board Papers and its Evaluation Patterns. In the recent past it has became more objective with the inclusion of High Order Thinking Skills (HOTS) questions which have to be answered very precisely. We, as teachers, have to prepare our students for the real world of trade and economy. Linking school education with the real world is challenge for Curriculum Planners and Educationist. The present Manual has some section on selected topics with adequate examples. The writers have tried to deal the complex concepts in simplified versions with relevant activities for better understanding. Some text is given in Question –Answers form also. HOTS on selected topics are also included. The Appendix at the end includes the content analyses of the text on the bases of level of difficulty and the recent CBSE Board papers with Answer Scheme. I take this opportunity to express a deep sense of reverence and there thanks to Ms Rashmi Krishnan, Director SCERT and Dr.Pratibha Sharma, Joint Director for their continuous academic support and encouragement. Special thanks are also extended to the team of Contributors / Subject Experts, their concerned Authorities’ Principals and Teacher of Government School, Aided/Public schools for providing valuable suggestion and support at all stages of development of this Manual. The observation suggestions and comments related to the Manual are welcome.

Dr Seema Srivastava Ms Meenakshi Yadav

CONTENT

S. No Topic Page

1. Demand and Consumer Equilibrium

2 Supply, Market Supply, Determinants of Market Supply

3 Revenue and Supply

4 Theory of Cost and Revenue

5 National Income Accounting

6. Question Bank

7. High Order Thinking Skills (HOTS)

8. Introduction Macroeconomics

Appendix

Content Analysis on the basis of level of difficulty

Answer Key (HOTS)

Question Paper of CBSE with Answer Scheme for the year 2012

Demand and Consumer Equilibrium

Abstract

Economics is basically an interesting study of resources and choices. Optimization of resources by choosing the best alternative is the key to all the central problems of an economy. The present module gives you an exposure to the meaning of Economics, Micro Economics and Macro Economics, Central Problems of an Economy, Production Possibility Curve and Consumer Equilibrium Demand is one chapter which is very important and forms the basis of understanding Supply and later relationship between the two that determines the price of a commodity. In fact if you look closely you will find everything in economy is responding and reacting to the forces of demand and supply. Making students understand the meaning of Demand, the dynamics in determination of price and how it affects and gets affected by supply of goods in determining the Price of a commodity is very crucial in understanding the fundamentals of Micro-Economics. The present unit is given in Question-Answer form. Use this section after teaching the chapter in the class room to give them practice in answering accurately and precisely.

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MICRO ECONOMICS

Q1. What is Economics about?

Ans. Economics is the study of the problems of choice arising out of scarcity of means in relation to unlimited wants in an economy.

Q2. What is Micro Economics?

Ans. Micro Economics deals with the individual parts of the economic system i.e. individual household, individual firms etc.

Q3. What is meant by Economic Problem?

Ans. Economic Problem is a problem of choice arising due to limited means and unlimited wants.

Q4. Why does economic problem arise?

Ans. Economic problem arises because of:

(i) Resources are limited in relation to our demand.

(ii) Resources have alternative uses.

Q5. Why economic problem is regarded as a problem of choice?

Ans. Economic problem is regarded as a problem of choice because resources have alternative uses. If land is used only to grow sugarcane than there is no problem. But land can be used to grow wheat as well as sugar cane. Hence the problem of choice arises.

Q6. What is meant by Scarcity of Resources?

Ans. It is a situation when the requirement of goods and services exceeds their availability so that goods acquire market value or price. Since the requirement of goods and services does not match the supply the scarcity arises. Greater the Scarcity higher will be the prices.

Q7. What is meant by economizing of resources?

Ans. Economizing of resources means, resources are to be used in such a manner that maximum output is obtained per unit of input.

Q8. Explain how scarcity and choice go together?

Ans. Resources are not only scarce but also have alternative uses. Thus land can be used for producing wheat as well as rice. Hence problem of choice arises which is the essence of any economic problem. Due to scarcity choice has to be made amongst various alternatives and therefore scarcity and choice go together.

Q9. Which factors lead to shift of PPC?

Ans. The following factors lead to shift of PPC.

(i) With the increases or decreases in Resourses.

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(ii) Change in/of technology.

Q10. What is meant by PPC?

Ans. Production possibility ensue which shows the different possibilities of production of two goods a and b with the given resources and technology.

Q11. Why does technological advancement or growth of resources shift the PPC to the right?

Ans. Technological advancement shift PPC to the right, because better technology means more can be produced with the given resources.

Q12. “An economy always produces on, but not inside a PPC”. Defend or refute?

Ans. Production on PPC implies efficient utilization of Resources, but in an economy all the resources are not fully employed all the time. Hence production on the PPC is an ideal situation which an economy wants to achieve. Hence production inside a PPC is a realistic situation.

Q13. Define Marginal Opportunity Cost?

Ans. Marginal Opportunity Cost is the ratio between additional loss of output and additional gain of output when some resources are shifted from y use to x use.

Q14. Define opportunity cost?

Ans. Opportunity cost of any commodity is the amount of other good which has been given up in order to produce that commodity.

Q15. Define Marginal Opportunity Cost along a PPC?

Ans. MOC along a PPC refer to the additional output of ab of good X causes loss of cd of good Y. Hence cd is the MOC of ab.

MOC = =

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Q16. Draw a PPC showing the following situations.

(i) Full Employment of Resources.

(ii) Under Employment of Resources.

(iii) Growth of Resources.

Q17. Explain the problem of ‘what to produce’ with the help of an example.

Ans. An economy has only limited resources and the wants are unlimited. Wants are satisfied by goods and services which are to be produced with the help of resources, so all goods and services cannot be produced. The economy has to decide which goods are to be produced.

Example- On a given piece of land, all crops cannot be grown. If it is used for growing wheat then on the area on which wheat is grown, other crops cannot be grown. This is the problem of what to produce.

Q18. Explain the problem of ‘how to produce’ with the help of an example.

Ans. The problem relates to choosing the the technique of production for producing goods. Generally, most goods can be produced by using more than one technique. It has to be an optimal mix of labour and capital. More labour and less capital and less labour and more capital can be used. It can be either Capital Intensive or Labour Intensive. Since the resources are scarce a decision is to be taken as to which technique/ Mix has to be used.

Example- Cloth can be produced with Capital Intensive technique. It can also be produced with Labour Intensive technique. Which technique to choose is the problem of how to produce?

Q19. Explain the problem of ‘For Whom to Produce’ with the help of an example.

Ans. Goods and services are produced specifically for the people who can purchase them. Purchasing power depends on distribution of National among factors of Production. The problem amounts to how the National Product is to be distributed among the people. It means who should get how much of the total amount of goods and services. Those people

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have the larger income would have larger capacity to buy and hence will get larger amount of goods. People with different incomes will demand different goods. Therefore the guiding principle of how much is to be produced depends on people with different purchasing power.

Q20. Explain the problem of ‘What to produce’ with the help of Production Possibility Curve.

Ans. Since resources are limited all goods and services desired cannot be produced. If more resources are used for producing one good then fewer resources are left for producing other goods. This is the problem of what to produce.

PP is the PPC. All points on the curve represent all possible combinations of goods A & B that can be produced with the given resources. Which combination is to choose is the problem of ‘What to produce’.

Q21. Explain PPC with the help of table and curve of PPC.

Ans. PPC is a curve that depicts all possible combinations of two goods, which an economy can produce with the help of given resources and technology.

Combination Good A Good BA 0 20B 1 18c 2 14D 3 8E 4 0

According to the curve there can be different possibilities of production as indicated by points B, C, D and by joining points A, B, C, D and E. We get the production possibility curve.

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Q22. Differentiate between Micro and Macro economics.

Macro Economics Micro Economics

Macro economics studies the aggregates of the Economy

Micro economics is the study of individuals and small groups of individuals

Macro economics is the study of N.I., Expenditure and employment

Micro economics is the study of the prices of different commodities and factors.

Macro economics starts with the under lying assumption of underemployment of resources

Micro economics is based on the assumption of full employment in the Economy as a whole.

Macro economics is called Theory of Income & Employment. Micro economics is called the price theory.

Q23. Why does the PPC look concave to the origin?

Ans. Increase in the production of a commodity along a PPC means sacrifice of the other commodity. The rate of this sacrifice is called the MOC of increasing commodity. PPC is concave due to increasing MOC. Therefore one has to sacrifice more of a commodity to produce another commodity every time. This makes the PPC cancave.

Q24. What does a rightward shift of PPC indicate?

Ans. The rightward shift of PP curve indicates growth of resources.

Q25. What do you mean by central problem of an Economy? Explain the central problem of an Economy.

Ans. Every economy has to face certain similar problems. These problems are called central problems. These are as follows.

(a) Problem of allocation of resources

(i) What to produce

(ii) How to produce

(iii) For whom to produce

(b) Problem of full and efficient utilization of resources

(c) Problem of economic growth.

Q26. Explain the solution of the central problems in a Capitalistic economy.

Ans. Solution of the Central problems

Central problems are solved differently in different economics.

Capitalistic Economy

In a capitalist economy the means of production are owned, controlled and operated by private persons and production is done mainly to earn profit. In such economy central

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problems are solved through price mechanisms. The market price of the commodity guides the producers ‘what’ how and for whom to produce. In a capitalist economy, free forces of Demand and Supply of the commodity determine the market price of the commodity.

Socialist Economy

In a socialist economy, the means of production are owned, controlled and operated by the Govt. In such an economy the basic problems are solved through Central Planning.

The Central Authority decides which goods and how much & how to produce in a given period of time, It solves the problem of what, how and for whom to produce. The aim of the Govt. is to maximize social welfare.

Mixed Economy

A mixed economy is one in which Govt. and private sector exists side by side. Private sector represent the features of a capitalist economy, Where as public sector indicate the features of socialism. In Mixed Economy Central problems are solved through modified price or regulated price system to attain maximum social welfare the Govt uses various measures like subsidies, price control, support price and rationing system etc. But in private sector market forces of demand and supply solve the central problems.

Thus central problems in mixed economy are solved partly through Planning and partly through Modified Price Mechanism.

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DEMAND

Q1. What is demand?

Ans: - Demand refers to the quantity of a commodity or service a consumer is willing to buy at given price in a given period of time.

Q2. What is Demand Schedule?

Ans. Demand Schedule refers to the quantity of a commodity which is demanded by the consumers at different prices.

Q3. What is an Individual Demand Schedule?

Ans. Individual Demand Schedule refers to the relationship between price and quantity demanded of a commodity by an individual.

Price Rs. Quantity

1 10

2 8

3 6

4 4

5 2

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Q4. What is Market Demand Schedule? Explain with table & diagram.

Ans. Market Demand Schedule is the sum of the individual demand schedule for a commodity in the market at different prices of the commodity.

On the assumption that there are three buyers in the market, Market Demand Schedule may be drawn as follows.

Price per Unit /Firm

A B C Total

1 10 5 20 352 8 4 16 283 6 3 12 214 4 2 8 145 2 1 4 7

Market Demand Curve

A Market Demand Curve has been drawn on the basis of table. The Market Demand Curve shows that, when price is Rs. 1 per Kg apple the total demand of the market is 35kg, but when price is increased to Rs.5 total demand of apples become7kg. This slope of this demand curve is negative, showing inverse relationship between price of the commodity and its quantity demanded.

Q5. Define Normal Goods?

Ans. Normal good is a good whose demand increases with rise in income and decreases with a fall in income of the consumer. With the rise in income the demand for normal goods will rise because of rising purchasing power with increased income.

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Income effect of normal goods is positive. Example: - Grain, Rice & wheat.

Q6. What are Giffin Goods?

Ans. Giffin goods are those inferior goods in the case of which there is a positive relationship between price and quantity demanded.

Q7. Define Inferior Goods.

Ans. Inferior good is a good whose demand decreases with rise in income and increases with a fall in income of consumers. The Income Effect of Inferior Goods is Negative. For Example- Coarse Gram.

Q8. Explain Law of Demand with the help of Example

Ans. Law of Demand states that if the Price of a commodity decreases then consumer demand more of its quantity and if price increase than the consumer demand less of its quantity.

Price Quantity

1 10

2 8

3 6

4 4

5 2

The table shows that when the price was Rs. 1, at that time the demand of the commodity was 10, but when the price increase to re 5 the demand for the commodity falls to 2 units.

Demand Curve

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Thus it is true with an increase in the price of the commodity demand decreases and with a fall in the price demand increases.

Q9. What are the factors affecting the Demand of a commodity?

Ans.Factors affecting thedemand of a commodity are:-

Price of a commodity

Priceis an important determinant of Demand. Demand for a commodity rises when it is offered at low price and it falls when the commodity is available at higher price.

Income of the consumer

With the rise in income of the consumer his purchasing power increases. As a result he can buy more of a commodity that he was not buying earlier due to monetary constraint. Similarly a fall in income of the consumer will force him to cut down his expenditure and he will demand less of a commodity.

Price of related goods

Related goods are of two types i.e. Substitute goods and complementary good.

Substitute Goods

Substitute goods are those which can be used in place of each other with equal ease. Example - Pepsi Cola and Coca-Cola. Of the two given goods the demand will be higher for the goods which have comparatively lower price and vice versa.

Complementary goods

Complementary Goodsare those goods which are used together for consumption and are incomplete without each other. It means they complete the deficiencies of each other.

Example - Car and Petrol

A fall in the price of one commodity leads to rise in the demand of its complementary good. Example: - If the price of petrol falls then demand for car will rise.

Taste and preferences

Tastes and Preferences of the consumers will also affect the demand of the

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commodity. A student will demand more of books and pens then utensils because of his preference for the same.

Similarly old television sets were replaced by Plasma T.V.

Miscellaneous

Some other factors that affect the demand of commodity are-

Demand for SeasonalGoods- The consumer will demand woolen clothes in winter only.

If Government reduces the Tax Rate then it enhances the purchasing power of the consumer and his demand for goods will also increase.

If the population of an area increases then their demand will also increase and they will demand more consumer goods and vice versa.

Q10. How do changes in income affect demand for a commodity?

Ans.With the increase in income of the consumer his purchasing power increases, he can spend more than what he was spending earlier. Income affects demand for a commodity depends upon, whether a commodity is Inferior, Normal or Essential

Normal Goods

The demand for normal goods rises with the increase in income of the consumer. I.e. income effect is positive. If the income of the consumer decreases then the demand for such goods also decreases.

Inferior Goods

For Inferior Goods Income,Effect is negative. So he demands fewergoods of inferior quality with the increase in income and vice versa.

Essential /Necessities

The goods that are essential for human beings are called necessities. The demand for such goods does not change with the increase or decrease in income.

Example- Life saving Drugs, Common Salt etc.

Q11. Why does Demand Curve for a commodity slope downwards to the right?

Ans. The Demand Curve for commodity slopes downwards to the right because of the

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following reason:.

Law of Diminishing Marginal Utility

The law states that with the consumption of an additional unit of a commodity, the utility from each successive unit goes on diminishing.

Example- Utility form first chapati /Loaf of Bread to a hungry man is maximum, utility from second chapatti is lesser, from the third still lesser, because a part of his hunger is satisfied from the first one and the second one and It goes on diminishing .The utility in terms of satisfaction derived with each successive chapati diminishes .This depicts the Law of Diminishing Marginal Utility.

Income effect

A change in the quantity demanded as a result of change in real income caused by change in price of the commodity is called Income effect. When the price of a commodity falls, less has to be spent on the purchase of that commodity. From that money a consumer can by more quantity of that good, thus the real income of the consumer is increased. However increase in the price of the good decreases the real income of the consumer. Therefore he will buy less of its commodity from that income.

Substitution effect

It means that substitution of one commodity in place of the other commodity when it becomes relatively cheaper Example=A rise in the price of coca-cola, in relation to coca-cola. The consumer will maximize his satisfaction therefore he will buy more of Pepsi than of coca cola.

Number of consumers

When the price of a commodity falls, consumers buys it at the reduced price, therefore the number of consumers increases because the old ones also consuming it in the same quantity or more than what they were consuming before fall in the price of that commodity.

Different uses of the commodity

A commodity used is consumed more at a lower price but if its price goes up then consumption get restricted to very essential use.

For example milk is used for many purposes e.g. Drinking, Making curd, paneer , tea etc. but if the price goes up the consumption of milk is restricted to say baby food only.

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Q12. How is demand of a commodity affected by change in the price of related good? Explain with the help of a diagram.

Ans. Related goods may be of two types- Substitute goods Complementary good.When the price of a substitute food falls (rises) it becomes relatively cheaper (costlier), so it is substituted for the given commodity decreases (increases), this result in rightward (leftward) shift in demand curve.

When the price of complementary good falls (rises) its quantity demanded rises (falls). The demand for the given commodity increases (decreases) as complementary good are used together. This will cause a rightward (leftward) shift of demand curve of given commodity.

Diagrams showing the effect of Substitute Goods and Complementary Goods

Q13. What is meant by Cross Price Eeffects?

Ans. Cross Price Effect means how the demand for one particular product is affected by a change in the price of another commodity. Cross price effects originate from related goods:

(a) Substitute good- If the price of tea falls, the quantity demanded for coffee would fall because people will use more of a tea than coffee.

(b) Complementary good- If the price of car falls down, then quantity demanded for petrol would go up because people will purchase more car and petrol.

Q14. Briefly explain the factors that shift the demand curve left or right.

ANS- The following are the factors that shift the demand curve to the right or left.

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1. Change in Income

if the income of the consumer increases the demand for the normal product increases similarly with the decrease in income the demand for the product decreases and the demand curve shift to the left. Increase in income shift the demand curve to the right.

2.Change in the of related goods

Substitute good- when the price of a substitute good falls (rires) then it becomes relatively cheaper or costlier, so it is substituted for the given commodity and the demand arrive shift to the right or (left)

Complementary good-as the price of a complementary good increases, the price of the given product and its quantity demanded both decreases and the demand curve shift to the left. With the decrease in the price of the complementary good, the price of the given product and its quantity demanded both increase and the the demand curve shift to the right.

Change in taste- A favourable change in the taste shift the demand curve to the right as s result price as well as the total quantity demanded will increase similarly an infavourable change in taste will shift the demined curve to the left and both price and quantity will fall.

Q15. Distinguish between the following:

1. Contraction in Demand Decrease in Demand

This is caused by change in the price only.

It results in upward movement along demand curve when demand falls due to the rise in priceonly, it is called contraction in demand.

This is caused by change in the determents of demand other than price. It result in the left ward shift in demand curve When demand falls due to change in fact to other than price it is called decrease in decrease

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2. Extension in DemandThis is caused by changed in price onlyIt results in downward movement along the demand curve.When demand increases due to falls in price only, it is called contraction in demand.

Increase in DemandThis is caused by change in the factors other than price of the commodity. It results in the rightward shift in demand curve.When demand increases due to changes factors other than price, it is called increase in demand.

3. Change in Quantity Demanded Change in Demand a) Change in quantity demanded is

caused by change in the price of the commodity.

b) Change in quantity demanded is movement along a demand curve.

c) Example-Price of sugar falls from Rs.16 per kg to Rs.12 per kg as a result quantity demanded increases to 6tons from 4 tons.

a) Change in demand is caused by factors other than price of the commodity.

b) Change in demand is a shift of the demand curve.

c) Example- Income of the consumer increases from Rs. 5000 to Rs. 12000. As a result demand for sugar increases to 3kg from 2 kg per month.

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4. Substitute goods Complementary goods

1. Substitute goods may be used in place of each other

2. The price of substitute good has positive relationship with the quantity demanded of other substitute good. Example- Tea & Coffee

a) Complementary good are used together.

b) The price of one complementary good has negative relationship with another complementary good.

Example- Car and Petrol

5. Normal Goods Inferior Goods1) Income effect is Positive.2) Demand increase with the

increase in income.3) Income demand curve of normal

goods slopes upward to the left.

1) Income effect is Negative Demand decreases with the increase in income.2)Income demand curve of inferior good slopes down rightwards.

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Q16. Define Derived Demand.

Ans. Derived Demand is the demand that has been derived from the demand for some other commodity it helps to produce. Demand for factors of production is called derived demand because it is derived from demand of such goods, which the factor helps to produce.

Example- Demand for Shoe is direct demand but the demand for Labour is Derived Demand because it does not satisfy the consumer demand directly but it arises due to demand for shoe.

Q 17. Determine how the following changes will affect the Market Demand Curve for a Product:

a) A new Plant comes in Jharkhand. Many people who were previously unemployed are now employed. How will this affect the demand curve for Colour TV and Black and White TV in the region?

Ans – An increase in income of households will result in the increase in demand for TV sets. The demand curve for both TVs will shift rightward.

b) There are train and bus services between New Delhi and Jaipur. Suppose the train fare between New Delhi and Jaipur comesdown. How it will affect the demand curve for bus travel between the two cities?

Ans- Train and bus services are substitute to each other. If train fair comes down the demand for bus travel willdecrease as a result there wouldbe left ward shift of demand curve for the bus travel

Q 18.What is the importance of Elasticity of Demand?

Price Elasticity of Demand is a useful concept for the following reasons:

(a) Producer- A producer adopts a price discriminatory policy when elasticity of demand from different consumers is different.Those consumers for whom demand is inelasticcan be charged a higher price than those with more elastic demand.

(b) Foreign Trade- The country in which a product has less elastic demand can be charged a higher price than a country having a more elastic demand

(c) Government- Goods and services likecigarettes, liquor, and other luxury goods have inelastic demand. The Government taxes more commodities whose demand is inelastic, so that the scale of such commodities does not fall and burden of tax is borne by rich class.

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(d) Factor Pricing- Factors having less elastic demand can charge higher prices than those having more elastic demand. For Example A Pilot gets more salary as compared to Doctors, since their demand is less elastic. The concept of elasticity helps in explaining the relative shares to factors of production in the output.

Example 1 Price of a good falls from Rs. 100 to Rs. 80. As a result its demand rises from 4000 units to 5000 units. Calculate Price Electricity of Demand by Expenditure Method

Original expenditure = P x Q-

= 100 x 4000 = 4, 00,000

Expenditure after increase in Price = 80 x 5000

= 4,00,000

Since the total expenditure is same even after the change in price, the elasticity of demand is unity

Ed=1

Example 2

A consumer demands 1000 units of the price of Re 10 per unit. If the price of the said commodity is increased to Rs.14,the demand for the product falls to 600. Calculate Price Elasticity of Demand.

The ED for good x is known to be twice that of good X price of X falls by 5% while that of good Y rises by 5%. What is the % age change in the quantities of X and Y?

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Consumers’ Equilibrium

Q1. What is Consumers’ Equilibrium?Ans. A consumer is in a state of equilibrium when he maximizes his satisfaction by

spending his given income on different goods and services.

Q2. DefineTotalUtility(TU)Ans. Totalutilityisthetotalpsychologicalsatisfactionderivedbyaconsumerfrom

consumption of all units of a particular commodity.

Q3. DefineMarginalUtility(MU)Ans. MarginalUtility isadditionalutilityderived fromconsumptionofanadditional

unit of a commodity. MU=TUn–TUn-1

Q4. HowisTotalUtilityisderivedbysummingupofmarginalutilities.Ans. TotalUtilitysderivedbysummingupofMarginalUtilities.

Q5. What is utility?Ans. Utilitymeanswantsatisfyingcapacityofacommodity.

Q6. What is Indifference set?Ans. It is a set of combinations of two commodities which offer a consumer the same

level of satisfaction, So that he is indifferent between there combinations.

Q7. What is meant by Budget Line.?Ans. It is a line showing different possible combinations of good 1 and good 2, which

consumer can buy, within the given income at the price of good 1 and good 2.

Q8. What is meant by Indifference Curve?Ans. An indifference curve is a curve which represents all those combinations of two

good that gives equal satisfaction to the consumer.

Q9. What is meant by marginal rate of substitution?Ans. Marginalrateofsubstitutionistherateatwhichtheconsumeriswillingtogive

up good 1 to get an additional unit of good 2 and be indifferent.

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Q10. What is the assumptions of indifference curve?Ans. Thefollowingaretheassumptions:-

(i) Theconsumerbehavesrationallyandtriestoobtainmaximumsatisfactionfrom his expenditure.

(ii) The consumer is able to arrange available combinations of goodsaccording to his preference

(iii)Itisbasedonordinalmeasuresofutility.

Q.11. Write down the Properties of Indifference Curve?Ans. ThefollowingaretheProperties.

(i) Indifferencecurveslopedowntotheright. (ii)Higherindifferencecurvedenoteshigherlevelofsatisfaction. (iii)Indifferencecurvesarecurvestotheorigin (iv)Indifferencecurvescannotmeetorintersect.

Explain Consumer’s Equilibrium in case of single commodity with the help of a utility schedule. Consumers Equilibrium means a situation when a consume buys that much quantity of a commodity which gives him maximum satisfaction. How much quantity of a commodity he should buy is explained with the help of a marginal utility schedule. UnitsconsumedifA MUofA TUofA1 14 142 12 263 10 364 8 44Condition:- MUx =PxSupposethepriceofAisRs.5/-perunitMarginalUtilityofRs.1/-=2

ThenforeachunitofAhehastosacrifice10utility.HewillcomparetheMUofeachunitofAwiththeUtilityhesacrifices.Hewillgoonbayingtill themarginalutilityofA isequal to theutility thathesacrifices.Fromthe table it isclear, thathewillbuythree units because at third unit, what he pages is just equal to what he gets. So the consumer is in equilibrium.

Conditionofequilibrium=MUofgood = MUofarupee Price of good

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Explain Consumer’s Equilibrium with the help of indifference curve.A consumer is said to be in equilibrium when he gets maximum satisfaction, or at the combination at which budget line touches one of the indifference curves would be the equilibrium point.

InthegivenfigurePistheequilibriumpointatwhichbudgetlineMtouchesthehighestattainable indifference curve 1C, within consumer budget. Bundles on IC2 are not affordable within budget whereas bundles on IC are certainly inferior to those on IC1. Hence optimum bundle is located at point P where budget line is tangent to the indifference curve IC1.

Explain the relationship between TU & MU.

TotalUtilityincreasessolongasmarginalutilityismorethanzero.(ii) Totalutilityismaximumwhenmarginalutilityiszero.(iii) TotalUtilitystartsdecliningwhenmarginalutilitybecomesnegative.Explain the law of diminishing marginal utility.

Law of Diminishing Marginal Utility.Thelawstatesthatasmoreandmoreunitofacommodityareconsumed;marginalutilityderivedfromsuccessiveunitsgoesonfalling.Example:-Ahungrymanwantstoeat.Thefirstchapattiwhichheeatswillgivehimmaximumutilitysay100unitsbecauseit saves him from hunger. Second chapatti will also fetch him utility but not as much as thefirstonebecauseapartofhishungerissatisfiedbyeatingthefirstchapatti,say80units.Forthesamereasonletutilityfromthethirdchapattibe50unitsandatlastitmay be negative. In short as more and more chapattis are consumed, marginal utility

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from them goes on diminishing because intensity of wants for the chapatti declines.

Units Mu Tu1234567

1085210-3

10182325262623

TheabovediagramshowsthatasmoreandmoreunitsareconsumedMUdeclines.

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Supply Schedule, Supply Curve and Elasticity

Recapitulate

In previous chapters, Supply, Market Supply, Determinants of Market Supply were covered. Recap that Supply is defined as the quantity that a firm is willing to sell at a given price and at a given time.

Abstract

The present unit will explain the Supply Schedule, how it is prepared. Supply Curve, Movement along and Shift in Supply Curve, Price Elasticity of Supply, Measurement of Price Elasticity- Percentage Change Method and Geometric Method.

Learning Objectives After going through the content you will be able to:

1. State the meaning of Supply Schedule.

2. Define Supply Curve.

3. Draw the Supply Curve.

4. Explain Movement along the Supply Curve and Shift in Supply Curve.

5. Define Elasticity of Supply.

6. Explain different degrees of Elasticity of Supply.

7. Represent the different degrees of Elasticity of Supply diagrammatically.

8. Solve numerical examples to determine the Price Elasticity of Supply.

9. Measure the Price Elasticity of Supply by- Percentage Change Method and Geometric Method

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Supply Schedule - A Supply Schedule is a table which shows how much one or more firms will be willing to supply ay a particular price.

It is a table listing or showing the exact quantities of a single type of goods or services that potential sellers would offer to sell at varying prices during a particular time period.

Example of Supply Schedule

Table A

Price Quantity Supplied 1 12 2 28 3 42 4 52 5 60

We can also say that Supply Schedule is a depiction in tabular form, of price and quantity supplied at a point of time keeping other* factor constant. (*Price of related goods, Condition/Technology in Production, Seller’s Expectations etc.)

Supply Curve

It is a curve that shows relationship of price and quantity supplied graphically or we can say the relationship of price and quantity supplies that can be exhibited graphically is termed as Supply Curve.

Keeping other factors constant the Supply Curve depicts the relationship between two variables only. These are:

• Price

• Quantity Supplied.

For example: - By plotting the data given above in Table A (Supply Schedule), we can get or draw a supply Curve which is as follows.

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The Supply Curve is generally positively sloped which shows direct positive relationship between Price and quantity supplied. It clearly indicates that at higher price, larger quantities are supplied for sale to make more profits.

Movement along and Shift in Supply Curve

A change in the price of commodity leads to a change in the quantity supplied. This results in the movement along the same Supply Curve, whereas the shift in the Supply Curve comes from the outside forces.

Movement along the supply is due to change in either the Quantity Supplied or the Price. Movement is the extension of the supply curve with the change in Price or quantity supplied

A shift of the supply curve comes from outside forces such as change in consumer wants / need / preference / economic changes or changes due to technology etc. It shows the change in position of Supply Curve from one place to other.

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Movement along the Supply Curve

Shift in Supply Curve

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Factor that shift the Supply Curve:

1. Change in Output Cost 2. Increasing use of technology in production 3. Change in size of the industry

Measurement of Price Elasticity of Supply

Price Elasticity of Supply measures the responsiveness of quantity supplied to change in price, as percentage change in Quantity Supplied induced by percentage change in Price.

There are two methods of measuring Price Elasticity of Supply:‐

1. Percentage – Change Method

2. Geometric method

1. Percentage – change Method

According to this method Price Elasticity of supply (Es) is measured as under:‐

Price Elasticity of Supply (Es) = % Change in Quantity Supplied

% Change in Price

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Where

Q – Change in Quantity supplied Q – initial Quantity Supplied

P – Change in Price P - Initial Price

2. Geometric Method

Under this method five different situations of Price Elasticity can be described as follows:-

a) Unitary Elasticity or Es=1

In this situation the supply curve slopes upward in a straight line which starts from point of origin. This shows the percentage change in Quantity supply is exactly equals to percentage change in price.

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b) Greater than Unitary Elasticity or Es ≥ 1

When a straight line upward sloping curve starts from Y-axis, then this is a case of Unitary Elasticity. This depicts that percentage change in quantity supplied is greater than percentage change in price.

c) Less than Unitary Elasticity or Es ≤ 1

When a straight line upward sloping curve starts from X-axis then this is a case of less than Unitary Elasticity. This represents that percentage change in quantity supplied is less than percentage change in price.

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d) Perfectly Inelastic Supply or Es = 0

It is a situation where there is no change in supply regardless of change in price. It shows that supply remain unchanged with the change in price. In such situation supply curve is vertical straight line curve.

e) Perfectly Elastic Supply or Es = 0

In this situation supply is infinite corresponding to a particular price of the commodity. Accordingly a slightest fall in price caused an infinite change in supply, reducing it to zero. In this case supply curve is horizontal straight line.

Es=0

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Check your Progress

1. Draw a Supply Curve based on the Supply Schedule given below:

Price (Rs.) Quantity Supplied

2 10

4 16

6 28

8 35

10 60

2. Differentiate between Movement along the Supply Curve and Shift in Supply Curve.

3. Explain the factors that results in Shift in Supply Curve.

4. Define Price Elasticity of Supply.

5. In the Diagram given below, state the nature of Elasticity of Supply of the different Supply Curves.

6. A 20% raise in the price of the Commodity A leads to a rise in its supply from 400 to 500 units. Calculate its Elasticity of Supply and comment on it.

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Summary

Supply Schedule is a table that shows quantity supplied of goods and services at particular price and at given point of time. A Supply Curve is a Graphical representation of quantity supplied of goods and services against the given prices. Movement along the Supply Curve is due to change in quantity supplied or the price. There is Shift in Supply Curve is due to other factors such as Consumer’s Needs and Preferences, Change in Technology etc.Price Elasticity is the responsiveness of quantity supplied to change in price. Price Elasticity of Supply can be measured through Percentage Change Method and Geometric Method. Elasticity of Supply can be interpreted as 1, Greater than 1, Less than 1, 0 or infinity.

Technical Terms

Supply Schedule: It is the depiction in tabular form; the Price and Quantity Supplied by an individual firm at a point of time keeping other factors constant. It is a tabular representation of Law of Supply.

Supply Curve: It is a graphic representation of Law of Supply which shows the relationship of Price and Quantity Supplied at a point of time.

Market Supply: It is obtained from the horizontal summation of Supply of individual firms. It is affected by all factors that influence individual Supply and the number of firms in the market.

Elasticity of Supply: It measures the degree of responsiveness of Supply to change in the Price of the commodity. It is measured as:

a) Proportionate method‐

Where:

Q – Change in Quantity supplied Q – initial Quantity Supplied

P – Change in Price P - Initial Price

b) Geometric Method-

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Es= CQ

---------------

OQ

Where CQ is the distance between where Supply Curve cuts the X- axis and Quantity Supplied; and OQ is the Quantity Supplied at a given price.

Various degrees of Elasticity of Supply

Perfectly Elastic Is defined as a situation when an infinitely small change in price causes an infinitely large change in quantity supplied. It has a value of infinity.

Perfectly Inelastic has a value Zero. This is defined as a situation when quantity supplied does not change irrespective of price change.

Relatively Elastic has a value of more than one. Here percentage change on Quantity Supplied is more than the percentage change in Price.

Relatively inelastic has a value less than one. Here, the percentage change on Quantity Supplied is less than the percentage change in Price.

Unitary Elastic has an absolute value of ‘1’. Supply change by the same extent as price changes.

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URL’s

Making Supply Schedule

http://www.youtube.com/watch?v=ucXqf8wEzt4

Shift in supply Curve

http://www.youtube.com/watch?v=SzP6ISwcHqY&feature=related

Shift in Supply

http://www.youtube.com/watch?v=CTUpItRj81M&feature=related

Change in Supply and shift in Supply

http://www.youtube.com/watch?v=JiGhGzCL7Js&feature=related

Change in Supply

http://www.youtube.com/watch?v=z6ZZhH‐vHHo

Elasticity of Supply

http://www.mindbites.com/lesson/7772‐economics‐identifying‐determinants‐of‐elasticity

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http://www.youtube.com/watch?v=ucXqf8wEzt4

http://www.youtube.com/watch?v=SzP6ISwcHqY&feature=related

http://www.youtube.com/watch?v=CTUpItRj81M&feature=related

http://www.youtube.com/watch?v=JiGhGzCL7Js&feature=related

http://www.youtube.com/watch?v=z6ZZhH-vHHo

http://www.mindbites.com/lesson/7772-economics-identifying-determinants-of-elasticity

Revenue and Supply

Overview of the pervious concept / component related units (Units II & Unit III)

Previous Concepts

In the previous chapters students have already been taught about, Demand, Elasticity of Demand, Cost- its types (TC, TFC, AFC, TVC, AVC, MC; etc - meaning and their relationships. These concepts have to be revised before proceeding to the concept of Revenue). The teachers must ensure that Student have adequate knowledge of the concepts like-

• Costs – Economic Cost, Private Cost vs. Social Cost, the time element and cost (very short run, short run large run )

• Explicit Cost, Implicit cost and Normal Profits

• Total Fixed Cost (TFC), Total Variable Cost (TVC), Total Cost (TC = TFC + TVC), computations and projection of TC, TFC, TVC.

• AFC, AVC (Definition and projection in graphs/ Curves) (ATC=AVC+AFC),Marginal Cost-Its concept and computation)

• Depiction of MC, Relationship between TC and MC relationship between AVC and MC.

• Relationship between ATC, AVC & MC.

Note: One must ensure that students can define the above mentioned terms and draw the curves related to the concepts; different relationships and can interpret in terms of different costs computations. Adequate practice of the same is essential

Abstract

This material deals with the concepts of Revenue -its types; Total Revenue (TR), Average Revenue (AR), Marginal Revenue (MR), Meaning of Producer’s Equilibrium, Determination of Producer’s Equilibrium in terms of MR & MC. It will also elaborate on the concept of Supply, Market Supply and Determinants of supply. The term ‘Revenue’ states the income of the Firm that it earns when it sells a given level of output. The main objective of the firm is Profit Maximisation where Profit = Revenue – *Cost of Production (*the expenditure incurred by a firm for producing a given level of output). Difference between Revenue and Profit has also been explained for clarity. The concepts of TR, AR, MR and Producer’s Equilibrium in terms of MC & MR has been explained in general. In later units these will be used in various types and Forms of Market and competition.

The unit will also explain the Supply, Markets Supply and Determinants of supply.

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Learning Objectives

After going through the Material / Unit you will be able to:

1. Define the Terms - Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR). 2. Compute TR, AR, & MR; 3. Explain the relationship between TR, AR and MR. 4. State and depict (draw curves) Producers Equilibrium in terms of MR and MC. 5. Define terms like Supply, Market Supply. 6. Compute Market Supply 7. Explain the determinants of Supply. 8. State some exceptions to the Law of Supply.

Teaching points

• Concept of Revenue

• Types of Revenue – Total Revenue (TR), Average Revenue (AR)and Marginal Revenue (MR)

• Relationship between TR, AR and MR

• Producers’ Equilibrium – meaning and its condition in terms of MR and MC.

• Supply, computing market supply, Determinants of supply, Exceptions to the Law of Supply.

Basic Concepts

1. Revenue:

Recapitulate the relationship that exists between Revenue, Cost and Profit. For calculating Profit the firm deducts the total expenditure or cost incurred from the Revenue. Reinstate:

How is Revenue defined?

Generally “Revenue” is termed as” Earnings”. It is the income that a firm receives from its business activities, usually from sale of goods and service to customers.

Hence Revenue can be defined as:

How is Revenue Calculated?

Revenue is calculated by multiplying the price at which goods and services are sold by the number of units sold. It can be put algebraically as under:-

Profit = Revenue – Cost

In business, Revenue is income that a company receives from its normal business activities usually from sale of goods and service to customers.

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Example

One firm sells Rs 10 per bottle in the market. If the firm sells total 100 bottles, then calculate Total Revenue for the firm.

Solution: Apply the formula:

R = P x Q

= 10 x 100

= Rs. 1000

Continuing with the same example, if the cost of producing 100 bottles is Rs 800, then what will be the profit earned by the firm?

As: - Profit = Revenue – Cost

= 1000 – 800

= Rs. 200

1.1 Types of Revenue There are three types which have to be explained one by one:

i. Total Revenue (TR) ii. Average Revenue (AR) iii. Marginal Revenue (MR)

Here the difference between the Revenue and Profit must be made clear, so that there is clarity about the term ‘Revenue’

Formula: R= P x Q , where

R= Revenue of the firm

P = Price per unit of the output sold

Q = Quantity / Units sold

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Total Revenue: Total Revenue refers to the total amount of money received by the firm during specific periods. It is derived by multiplying the number of units sold by the price per unit. Therefore Revenue in general refers to Total Revenue. It is denoted as TR.

Formula for calculation of TR is;-

TR = P x Q

Where TR is total revenue of the firm during a specific period

P is price per unit of the output

Q is quantity sold.

Example: A firm has sold 5 dozens of pens. The cost per pen was Rs. 20. The total revenue of the firm is:

TR = p x q

= 20 x 60

= Rs. 1200

1.1.2. Average Revenue: - Average Revenue is the revenue generated per unit of output sold. It can also be defined as total revenue per unit of output sold.

The average revenue received by a firm is Total Revenue divided by quantity. It is expressed as:-

AR=TR q Where AR = Average Revenue TR= Total Revenue q = Quantity sold Average Revenue is more widely used as Price. At times, it is also helpful in calculating Total Revenue I.e. Total Revenue= Average Revenue (P) × quantity (q) Example:- Unit/quantity Total Revenue Average Revenue

2 20 104 40 10 5 60 12 6 90 15

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1.1.3. Marginal Revenue: - Marginal Revenue is the increase in revenue from selling one additional unit of output. It is also called as revenue obtained from the last unit sold. It is calculated by taking the difference between Total Revenue before and after an increase in the rate of production.

Marginal Revenue can also be depicted as change in Total Revenue/Change in quantity

MR = Change in Total Revenue ---------------------------------- Change in Quantity MR = ∆TR ∆Q (When price of product is constant, Marginal Revenue is the same as Price. This will be applicable in conditions of Prefect Competition to be dealt with in later chapter) The same can also be explained with the example given below:- Relationship Between Average and Marginal Revenue No. Of Units TR (1) AR (2) MR (3)1 10 10 10 2 18 9 8 3 24 8 6 4 28 7 45 30 6 2 6 28 4.6 -2.6 7 21 3 -7

Diagram -1

Relation between Average Revenue (AR) and Marginal Revenue (MR)

Example: In a firm sells 10 object @ Rs.20 each and further it sells 11 object @ Rs. 19 each, then the marginal revenue from the 11th object is -

(10× 20) - (11×19) = Rs. 9

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2.1 Producers Equilibrium in terms of MC = MR

Producer’s Equilibrium:

Equilibrium is a condition where quantity demanded is equal to quantity supplied at a particular price.

Producers’ equilibrium is established at level of their Profit Maximisation. The condition of Profit Maximisation would take place at a point where his Marginal Revenue (MR) is equal to his Marginal Cost (MC). We can also say that beyond this point, if producers’ produces goods and services then he starts loosing MR therefore we can say that:-

Produces equilibrium is established when firm maximises its profit & minimises its losses.

The following condition is necessary for establishing equilibrium: -

1. MC = MR

So long as benefit is greater than cost, or MR Is greater than MC, it is profitable to produce more. The equilibrium is not achieved because it is possible to add to profit by producing more units.

When MC = MR, the benefit is equal to cost, the producers is its equilibrium subject to that MC becomes greater than MR beyond this level of output.

For example

In terms of output TR MR MC Profit 8 2 16 8 8 8 3 24 8 6 8 4 32 8 8 Level of profit maximum

8 5 40 8 10

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Diagram 2

Producer’s Equilibrium when MC = MR

3.1 Supply

Supply: - The total amount of product i.e. good or services available for purchase at any specified price is called as Supply.

Market Supply – It refers to amount of some product which the producers are willing and are able to sell at a given price keeping other related factors constant.

Market Supply focuses primarily on the one to one relation between Supply Price and Quantity Supplied. It can be shown diagrammatically as:

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Diagram- 3

Market Supply

It is a positive sloped curve that exhibits that quantity supplied at higher price is more than the quantity supplied at lower price.

3.2 Market Supply: Market Supply is the combined supply of every seller in the market. It is derived by adding the quantity supplied by each seller at different price. It operates according to the law of supply i.e. upward sloping Curve or we can say that for higher price the quantity supplied by all sellers in the market combined is greater than the quantity supplied for lower Prices.

3.3 Determinants of supply

There are many factors and circumstances that could affect supply of the product:

1. Price of the commodity: - The price of the commodity affects the supply of the commodity. Increase in price will increase the quantity supplied at a given point of time. There is a direct relationship between price and quantity supplied.

2. Price of related goods – Generally related goods refers to goods from which inputs are derived to be used in the production of primary goods. The prices of such goods also affect the price of commodity produced.

3. Conditions / Technology used in production – There is a direct relation between the technological advancement, goods production, and supply. It means that as the use of technology increases there will be an increase in production and also the supply of goods.

4. Seller’s expectations – Expectations of sellers concerning future market condition can directly affect supply. For e.g. If a seller believe that the demands of product ‘A’ will increase in future then the firm owner may immediately increase production. In such condition the supply curve will shift upwards.

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5. Cost of production – If the cost of production which includes cost of land, labour, energy and raw material rises then the seller may reduce his supply and the seller may charge extra for each unit of unit.

3.4 Exceptions to the Law of Supply As Supply is defined as the quantity that a firm is willing to sell at given price and at a given time and various factors like own price, Cost of Production, Production Techniques, Price of related Commodities, Rate of Taxation and Goals of a firm, but there are certain exceptions to the Law of Supply as there are some goods that do not follow the Law of Supply and hence negate some of assumptions.

1. Expectations of future change in price: It is normal for any firm to supply more when the price increases ,but when a supplier anticipates that the price will rise in future he will restrict supply in the hope of making more profits in future in the anticipation .Hence even if the price rises ,the firm restrains its present supply.

2. High Quality goods, antiques/ rare commodities: These are also the exceptions to the Law of Supply .For a creative work like Painting, the higher price of painting may not work as an inspiration. He/her may need other reasons of inspiration. Antiques are also limited in quantity and hence supply does not increase as the price of commodity increases.

Check Your Progress

1. Using the Marginal Cost- Marginal approach find the Profit Maximisation level of output from the table given below. Output (in units) Price (Rs) Average Total Cost (Rs) 7 20 4 8 19 5 9 18 6 10 17 7

2. What change in Total Revenue will result in (i) Decrease in Marginal Revenue and (ii) An increase in Marginal Revenue?

3. What will be the effect of the following changes in Total Revenue on Marginal Revenue? (i) Total Revenue increase at a decreasing rate (ii) Total Revenue increased at a constant rate

4. Explain the relationships between TR, AR and MR with the help of a diagram when price is reduced as output sold increases.

5. Describe the impact of an increase in Petrol prices to the supply of transport services. Use a diagram to explain your answer.

6. Explain three factors that influence the supply of mobile phones in the market. Summary The Concept of Revenue that describes the earning of the firm that it receives by selling its output at a given point of time. Types of Revenue have also been explained in terms of Total

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Revenue (TR) which is total amount received by the firm during a specific period; Average Revenue (AR)which is the revenue generated per unit of output; and Marginal Revenue (MR) which is increase in revenue by selling one additional unit of output. The material also talks about the relationship between TR, AR and MR and computation of these by using the formulae such as:

(i) TR = P x Q

(ii) AR=TR q (iii) MR= Change in Total Revenue ---------------------------------- Change in Quantity Producers’ Equilibrium has also been elaborated in terms of MR and MC, that if a firm produces beyond the level of equilibrium than it starts incurring loses. The concept of Supply i.e. the total amount of product available for purchase at any specified price; Market supply is the combined supply of every seller in the market. Major Determination of supply such as Price of the commodity, Price of related goods ,Conditions / Technology used in production, Seller’s expectations, Cost of production have also been discussed. Exceptions to the Law of Supply: Expectations of future changes in price and high Quality goods, antiques, rare commodities do not follow the assumptions of law of supply.

Technical Terms

1. Total Revenue (TR): Amount of money a firm receives when it sells a given level of output.

2. Average Revenue (AR): It is the per unit price of the commodity. AR is downward sloping indicating that in order to increase the sale of the firm, it needs to reduce the per unit price of commodity. AR is obtained by dividing Total Revenue by the total number of units sold at a given point of time. AR curve is also the Demand Curve faced by the firm.

3. Marginal Revenue (MR): It is the additional revenue earned by a firm when it sells an additional unit of output.

4. Producer’s Equilibrium: It is defined as the level of output that maximises the profits of the firm. The equilibrium condition of a producer’s Equilibrium is Marginal Revenue+ Marginal Cost.

5. Break Even Point: The level of output at which the firm neither makes loss nor profit. Its revenue covers for all costs, including normal profit.

6. Supply: It is defined as the quantity that a firm is willing to sell at a given price and at a given time.

7. Market supply: It is obtained from the horizontal summation of supply of individual firms. It is affected by all factors that influence individual supply and the number of firms in the market.

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Additional Support Material.

In order to teach effectively in the classroom for better comprehension of concepts by students, the following web links, PPT (Power Point Presentation), e-books, even video clipping supporting the concepts are also given for facilitating better Teaching- Learning Process.

NOTE : PPT ON THEORY OF COST OF REVENUE IS GIVEN IN NEXT SEGMENT

1 URL:

Free Market Economy http://www.youtube.com/watch?v=4YwUnjqsIQM Market Economy Vs Planned Economy http://www.youtube.com/watch?v=6q3zjyG8Dpg&NR=1 Four Market Structures Simulation http://www.youtube.com/watch?v=KGrmnynjHjI Budget Constraints ands Demand http://www.youtube.com/watch?v=avOqv5wTNAU ACN Video- U.S. Energy Natural Gas & Electricity Services http://www.youtube.com/watch?v=eKzad5FSVW4 Episode 25- Market Structures http://www.youtube.com/watch?v=9Hxy-TuX9fs Graph the Supply Curve http://www.youtube.com/watch?v=T3ZvnqjvzA0 Introduction to Microeconomics 101 http://www.youtube.com/watch?v=gfiQ1xZfqV4 Lecture 19 - Chap 9 - oligopoly.wmv http://www.youtube.com/watch?v=6G_awGuSra4 Mrs Tan, Mr Lee and the Price Elasticity of demand http://www.youtube.com/watch?v=96KXjOPkF3M Opportunity Cost http://www.youtube.com/watch?v=ezOdQUzLVAo Price Elasticity of Supply Jonathan Yap Howard Sun David Jiang http://www.youtube.com/watch?v=K_2DQHcyJTw Price Elasticity of Supply http://www.youtube.com/watch?v=20b_zVHmZG0

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Private vs Social CostsPrivate vs Social CostsPrivate vs Social CostsPrivate vs Social Costs

•• Private Costs : incurred by a firm when itPrivate Costs : incurred by a firm when it•• Private Costs : incurred by a firm when it Private Costs : incurred by a firm when it produces a commodityproduces a commodity

E t f t i lE t f t i l–– Eg: cost of raw materialEg: cost of raw material

•• Social Costs : borne by society as a whole when Social Costs : borne by society as a whole when y yy ya firm produces a commoditya firm produces a commodity

–– Eg: loss of marine life from pollutants from productionEg: loss of marine life from pollutants from production–– Eg: loss of marine life from pollutants from production Eg: loss of marine life from pollutants from production processprocess

Economic CostsEconomic CostsEconomic CostsEconomic Costs

Explicit costExplicit cost Implicit costImplicit costVSVS

•• Fast Fans Ltd Fast Fans Ltd borrows money borrows money

•• Fast Fans Ltd uses Fast Fans Ltd uses its own money its own money yy

from the bank @ from the bank @ 8% p.a. to buy a 8% p.a. to buy a machinemachine

yy(reserves and (reserves and surplus) to buy a surplus) to buy a machinemachinemachinemachine machinemachine

•• Opportunity cost of Opportunity cost of using the firm’s using the firm’s own money is own money is the Implicit Costthe Implicit Costthe Implicit Costthe Implicit Cost

Economic CostsEconomic CostsEconomic CostsEconomic Costs

Explicit CostsExplicit Costs Implicit CostsImplicit Costs Normal ProfitsNormal Profits

•• Incurred when Incurred when a firm hires or a firm hires or purchases a purchases a

•• Imputed costs of Imputed costs of a firm when it a firm when it uses its own uses its own

•• Minimum Minimum profits required profits required to keep the to keep the

factor of factor of productionproduction

factors of factors of productionproduction

entrepreneur in entrepreneur in production in production in the long runthe long run

•• Termed as Termed as Money CostsMoney Costs

•• Calculated based Calculated based on opportunity on opportunity costcost

gg

Types of CostsTypes of CostsTypes of CostsTypes of Costs

•• Economic CostsEconomic Costs

•• Private vs SocialPrivate vs Social

•• Time Element & CostsTime Element & Costs

IntroductionIntroductionIntroductionIntroduction

•• Main objective of a firm : Profit MaximisationMain objective of a firm : Profit Maximisation

•• Profit = RevenueProfit = Revenue Cost of ProductionCost of Production•• Profit = Revenue Profit = Revenue –– Cost of ProductionCost of Production

•• Cost of production is the expenditure incurred by a Cost of production is the expenditure incurred by a fi h d i i l l ffi h d i i l l ffirm when producing a given level of outputfirm when producing a given level of output

•• Revenue is the total income earned by a firm when it Revenue is the total income earned by a firm when it sells a given level of outputsells a given level of output

Theory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and RevenueTheory of Costs and Revenue

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200 Total Variable CostTotal Variable CostTotal Variable CostTotal Variable CostTFC(Rs)

TVC(Rs)

Output(Q)

160

100100100100

0203035

0123

120TVC

100100100100

35456080

34567Co

st (

Rs)

Cost

(Rs)

80

TFC100 1267

Varia

ble

CVa

riabl

e C

40

80

Tota

l VTo

tal V

0

40

00 1 2 3 4 5 6 7

Output

200 Output(Q)

TFC(Rs)

Total Fixed CostsTotal Fixed CostsTotal Fixed CostsTotal Fixed Costs

160

(Q)

01

(Rs)

100100

120

1234

100100100100t

(Rs)

t (R

s)

80

TFC56

100100

Fixe

d Co

stFi

xed

Cost

40

80

Tota

l FTo

tal F

0

40

00 1 2 3 4 5 6

Output

Costs in the Short RunCosts in the Short RunCosts in the Short RunCosts in the Short Run

•• Total Fixed Cost (TFC)Total Fixed Cost (TFC)

–– Costs that do not change with the change in outputCosts that do not change with the change in output

•• Total Variable Cost (TVC)Total Variable Cost (TVC)

–– Costs that change with the change in outputCosts that change with the change in output

•• Total Cost Total Cost

–– TC = TFC + TVCTC = TFC + TVC

Time Element and CostsTime Element and CostsTime Element and CostsTime Element and Costs

Very Short Run Very Short Run Short Run Short Run Long RunLong Run•• All factors are fixedAll factors are fixed

•• Costs remainCosts remain

•• One factor is One factor is variable; others variable; others fi dfi d

•• All factors are All factors are variablevariable

Costs remain Costs remain constantconstant

Fi d tFi d t

fixedfixed

•• Cost changes to Cost changes to •• Costs changeableCosts changeable

V i bl tV i bl t•• Fixed costsFixed costs the extent of the extent of variable factorvariable factor

•• Variable costsVariable costs

•• Variable cost & Variable cost & Fixed costFixed cost


Very Short Run Very Short Run Short Run Short Run •• All factors are fixedAll factors are fixed

•• Costs remainCosts remain

•• One factor is One factor is variable; others variable; others fi dfi dCosts remain Costs remain

constantconstant

Fi d tFi d t

fixedfixed

•• Cost changes to Cost changes to •• Fixed costsFixed costs the extent of the extent of

variable factorvariable factor

•• Variable cost & Variable cost & Fixed costFixed cost


Very Short Run Very Short Run •• All factors are fixedAll factors are fixed

•• Costs remainCosts remainCosts remain Costs remain constantconstant

Fi d tFi d t•• Fixed costsFixed costs

( 56 )

Distinction between fixed costs and Distinction between fixed costs and a iable costsa iable costs

Distinction between fixed costs and Distinction between fixed costs and a iable costsa iable costsvariable costsvariable costsvariable costsvariable costs

Fixed costsFixed costs Variable costsVariable costs

Do not vary with the quantity of Do not vary with the quantity of output producedoutput produced

Vary with the quantity of output Vary with the quantity of output producedproduced

Can never be zero in the short Can never be zero in the short run. Have to be incurred even if run. Have to be incurred even if production falls to zeroproduction falls to zero

Can fall to zero in the short run, Can fall to zero in the short run, as they are directly related to the as they are directly related to the level of output producedlevel of output produced

In the short run a firm can In the short run a firm can continue production even if fixed continue production even if fixed

t t tt t t

In the short run a firm will stop In the short run a firm will stop production if variable costs are production if variable costs are

t tt tcosts are not metcosts are not met not metnot met













240 TCTotal CostTotal CostTotal CostTotal Cost

200

160

TVC120

TVC

TFCCost

(Rs)

Cost

(Rs)

TFC80

Tota

l CTo

tal C TFC

0

40

00 1 2 3 4 5 6 7

Output

240 TCTotal CostTotal CostTotal CostTotal Cost

200

160

TVC120

TVC

TFCCost

(Rs)

Cost

(Rs)

80

Tota

l CTo

tal C

0

40

00 1 2 3 4 5 6 7

Output

Total CostTotal CostTotal CostTotal Cost

Output TFC TVC TC = TFC + TVC(Q)

0

(Rs)

100

(Rs)

0

(Rs)

100012

100100100

02030

1001201302

34

100100100

303545

130135145

56

100100

6080

160180

7 100 126 226

( 57 )

Average Total CostAverage Total CostAverage Total CostAverage Total Cost

•• Cost incurred per unit of outputCost incurred per unit of output•• ATC = AVC +AFCATC = AVC +AFC

Schedule of AFC AVC ATCSchedule of AFC AVC ATCSchedule of AFC, AVC, ATCSchedule of AFC, AVC, ATCOutputOutput AFCAFC AVCAVC ATCATC

00 -- -- --11 100100 2020 12012022 5050 1515 656533 33 333 3 11 711 7 454533 33.333.3 11.711.7 454544 2525 11.25*11.25* 36.2536.2555 2020 1212 323266 16.616.6 13.313.3 29.9*29.9*77 14.314.3 1818 32.332.3

* - min.pt.

Average Variable CostAverage Variable CostAverage Variable CostAverage Variable Cost

•• UU--shaped curveshaped curveAVCAVC •• Reflects the law of Reflects the law of

variable proportionsvariable proportions

Cost

Cost

AVCAVC

•• Downward sloping part Downward sloping part of curve of curve

Increasing Returns to aIncreasing Returns to age V

aria

ble

Cge

Var

iabl

e C

–– Increasing Returns to a Increasing Returns to a factorfactor

•• Upward sloping part ofUpward sloping part of

Aver

agAv

erag

Upward sloping part of Upward sloping part of curvecurve

–– Decreasing returns to a Decreasing returns to a Quantity of outputQuantity of outputOO

factorfactor

Average Fixed Cost (AFC)Average Fixed Cost (AFC)Average Fixed Cost (AFC)Average Fixed Cost (AFC)

•• As output increases,As output increases,As output increases,As output increases,AFC falls AFC falls continuouslycontinuously

d Co

std

Cost

•• AFC tends towards AFC tends towards the xthe x--axis, but does axis, but does

Aver

age

Fixe

dAv

erag

e Fi

xed

not touch itnot touch it

•• AFC is never equal to AFC is never equal to AFCAFC

AA

qqzero, as TFC is never zero, as TFC is never zerozero

Quantity of outputQuantity of outputOO


•• Average cost per unit cost of productionAverage cost per unit cost of production–– average fixed cost (average fixed cost (AFCAFC))

AFC = AFC = TFCTFCQQQQ

–– average variable cost (average variable cost (AVCAVC))AVC = AVC = TVCTVC

QQ–– average total cost (average total cost (ATCATC))

ATCATC TCTCATC = ATC = TCTCQQ

ATC = AFC + AVCATC = AFC + AVC

Points to RememberPoints to RememberPoints to RememberPoints to Remember

•• TC is obtained by adding TVC and TFCTC is obtained by adding TVC and TFC•• Shape of the TC is dependent upon the shape of Shape of the TC is dependent upon the shape of

the TVCthe TVC•• Vertical distance between the TFC and TC gives Vertical distance between the TFC and TC gives

the TVCthe TVC








In the short run a firm can In the short run a firm can continue production even if fixed continue production even if fixed

t t tt t t

In the short run a firm will stop In the short run a firm will stop production if variable costs are production if variable costs are

t tt tcosts are not metcosts are not met

Related to the fixed factors of Related to the fixed factors of productionproduction

not metnot met

Related to the variable factors of Related to the variable factors of productionproductionproductionproduction

Eg: rentEg: rent

productionproduction

Eg: wageEg: wage

( 58 )


•• Marginal costMarginal cost–– additional cost incurred in producing an additional unit additional cost incurred in producing an additional unit

of the outputof the outputMCMC TCTC–– MC = MC = TCTC

QQ–– Suppose the cost of producing 3 fans is Rs 135 and theSuppose the cost of producing 3 fans is Rs 135 and the–– Suppose the cost of producing 3 fans is Rs 135 and the Suppose the cost of producing 3 fans is Rs 135 and the

cost of producing 2 fans is Rs 130cost of producing 2 fans is Rs 130•• Marginal Cost of the 3Marginal Cost of the 3rdrd fan is Rs 5fan is Rs 5


ATCAs AFC tends to zero,

ATC tends to AVC

AVC

Cos

tsC

AFC

Output (Q)a b0


ATCBeyond output ob:

• AFC fall < AVC rise

ATC i

AVC• ATC rises

Cos

tsC

AFC

Output (Q)a b0


ATCBetween output ab:

• AFC fall > AVC rise

ATC f ll

AVC• ATC falls

Cos

tsC

AFC

Output (Q)a b0


ATCUptil output oa:

• AFC falls

AVC f ll

AVC• AVC falls

• ATC falls

Cos

tsC

AFC

Output (Q)a0


AFC: Average Fixed Cost

AVCAVC: Average Variable Cost

Cos

tsC

AFC

Output (Q)0

( 59 )

Relationship between AVC and MCRelationship between AVC and MCRelationship between AVC and MCRelationship between AVC and MC

•• Prior to point A, MC < AVC;Prior to point A, MC < AVC;AVCAVC

MCMC AVCAVC

Rs)

Rs)

Cost

s (R

Cost

s (R

AA

OutputOutputOO

Relationship between TC and MCRelationship between TC and MCRelationship between TC and MCRelationship between TC and MCTCTC

•• Prior to point A, MC is falling. Prior to point A, MC is falling. TC is increasing at aTC is increasing at aTC is increasing at a TC is increasing at a diminishing rate. (Law of diminishing rate. (Law of Diminishing Costs)Diminishing Costs)

Quantity of outputQuantity of outputOO •• At point A, MC is at its At point A, MC is at its minimum TC is at point ofminimum TC is at point of

MCMC

minimum. TC is at point of minimum. TC is at point of inflexioninflexion

AA

•• Beyond point A, MC is Beyond point A, MC is increasing. TC is increasing at increasing. TC is increasing at an increasing rate (Law ofan increasing rate (Law of


an increasing rate. (Law of an increasing rate. (Law of Increasing Costs)Increasing Costs)

Relationship between TC and MCRelationship between TC and MCRelationship between TC and MCRelationship between TC and MCTCTC

•• Beyond point A, MC is Beyond point A, MC is i i TC ii i TC iincreasing. TC is increasing. TC is increasing at an increasing at an


increasing rate. (Law of increasing rate. (Law of Increasing Costs)Increasing Costs)

MCMC

AA


Relationship between TC and MCRelationship between TC and MCRelationship between TC and MCRelationship between TC and MC

•• At point A MC is at itsAt point A MC is at its

TCTC

•• At point A, MC is at its At point A, MC is at its minimum. TC is at point minimum. TC is at point f i fl if i fl iof inflexionof inflexion


MCMC

AA


Relationship between TC and MCRelationship between TC and MCRelationship between TC and MCRelationship between TC and MC

•• Prior to point A, MC is Prior to point A, MC is TCTC

falling. TC increases at falling. TC increases at a diminishing rate. (Law a diminishing rate. (Law of Diminishing Costs)of Diminishing Costs)


MCMC

AA


Marginal CostMarginal CostMarginal CostMarginal Cost

Schedule of TC, TVC and MCSchedule of TC, TVC and MCO TC TVC MCO TC TVC MCOutput TC TVC MCOutput TC TVC MCof fans (in Rs) (in Rs) (in Rs)of fans (in Rs) (in Rs) (in Rs)

00 100100 -- --

ost

ost

MCMC

11 120120 2020 202022 130130 3030 101033 135135 3535 55 M

argi

nal C

oM

argi

nal C

o

44 145145 4545 101055 160160 6060 1515


•• MC is UMC is U--shapedshaped

•• Reflects the change in TVCReflects the change in TVC

Q y pQ y p

gg

•• Area under MC gives TVCArea under MC gives TVC

( 60 )

Relationship between ATC and MCRelationship between ATC and MCRelationship between ATC and MCRelationship between ATC and MC

•• Prior to point A, MC < ATC;Prior to point A, MC < ATC;ATCATC

•• Between points A and C MCBetween points A and C MC

MCMC ATCATC

•• Between points A and C, MC Between points A and C, MC < ATC; ATC< ATC; ATC

•• At point C , MC = ATC;At point C , MC = ATC;Rs)

Rs)

At point C , MC ATC;At point C , MC ATC;ATC is at its minimumATC is at its minimum

Cost

s (R

Cost

s (R

AACC

OutputOutputOO




MCMC ATCATC


Rs)

Rs)

Cost

s (R

Cost

s (R

AACC

OutputOutputOO



MCMC ATCATC

Rs)

Rs)

Cost

s (R

Cost

s (R

AA

OutputOutputOO



•• Between points A and B MCBetween points A and B MC

MCMC AVCAVC

•• Between points A and B, MC Between points A and B, MC < AVC; AVC< AVC; AVC

•• At point B , MC = AVC;At point B , MC = AVC;Rs)

Rs)

At point B , MC AVC;At point B , MC AVC;AVC is at its minimumAVC is at its minimum

•• After point B , MC > AVC;After point B , MC > AVC;

Cost

s (R

Cost

s (R

BBAA

ppAVC starts to riseAVC starts to rise

OutputOutputOO




MCMC AVCAVC


•• At point B , MC = AVC;At point B , MC = AVC;Rs)

Rs)

At point B , MC AVC;At point B , MC AVC;AVC is at its minimumAVC is at its minimum

Cost

s (R

Cost

s (R

BBAA

OutputOutputOO




MCMC AVCAVC


Rs)

Rs)

Cost

s (R

Cost

s (R

BBAA

OutputOutputOO

( 61 )

Long Run Average CostLong Run Average CostLong Run Average CostLong Run Average Cost

S h dS h d

LAC = Long Run Total Cost

Output •• Saucer shapedSaucer shaped

•• Based on returns to ScaleBased on returns to Scale

Output

•• Downward sloping part due Downward sloping part due to increasing returns to saleto increasing returns to saleLAC to increasing returns to sale to increasing returns to sale (Decreasing Average Cost)(Decreasing Average Cost)

U d l i t d tU d l i t d tsts

(Rs)

sts

(Rs)

CRS

LAC

•• Upward sloping part due to Upward sloping part due to diminishing returns to scale diminishing returns to scale (Increasing Average Cost)(Increasing Average Cost)

Cos

Cos

OutputOutputOO


S h dS h d




Output


sts

(Rs)

sts

(Rs)

LAC

Cos

Cos

OutputOutputOO


S h dS h d



•• Based on returns to scaleBased on returns to scale

Output

LAC

sts

(Rs)

sts

(Rs)

LAC

Cos

Cos

OutputOutputOO

Costs in the Long RunCosts in the Long RunCosts in the Long RunCosts in the Long Run

•• Long Run Total Cost (LTC)Long Run Total Cost (LTC)

L R A C (LAC)L R A C (LAC)•• Long Run Average Cost (LAC)Long Run Average Cost (LAC)

Long Run Marginal Cost (LMC)Long Run Marginal Cost (LMC)•• Long Run Marginal Cost (LMC)Long Run Marginal Cost (LMC)

•• No distinction between fixed and variable costsNo distinction between fixed and variable costs•• No distinction between fixed and variable costsNo distinction between fixed and variable costs

Relationship between ATC, AVC and MCRelationship between ATC, AVC and MCRelationship between ATC, AVC and MCRelationship between ATC, AVC and MC

MCMC ATCATC

AVCAVC

(Rs)

(Rs)

CC

Cost

s (

Cost

s (

AA

BB

OutputOutput

AA

OO

MC cuts ATC and AVC at their respective minimum pointsMC cuts ATC and AVC at their respective minimum points




MCMC ATCATC


•• At point C , MC = ATC;At point C , MC = ATC;Rs)

Rs)

At point C , MC ATC;At point C , MC ATC;ATC is at its minimumATC is at its minimum

•• After point C , MC > ATC;After point C , MC > ATC;

Cost

s (R

Cost

s (R

AACC

ppATC starts to riseATC starts to rise

OutputOutputOO

( 62 )

Average RevenueAverage RevenueAverage RevenueAverage Revenue

AR = AR = Total RevenueTotal RevenueOutput soldOutput sold

==

pp

p x qp x q= p= p qq p p

AR = per unit price of the commodityAR = per unit price of the commodity

Average RevenueAverage RevenueAverage RevenueAverage Revenue

AR = AR = Total RevenueTotal RevenueOutput soldOutput soldpp

Total RevenueTotal RevenueTotal RevenueTotal Revenue

•• Uptil point A, TR is Uptil point A, TR is increasingincreasing

AA

c eas gc eas g

•• At point A, TR is At point A, TR is maximummaximuml r

even

uel r

even

ue TRTR

maximummaximum

•• Beyond point A, TR Beyond point A, TR t t d li it t d li i

Tota

Tota

starts decliningstarts declining

Q tit f f ldQ tit f f ld

OO

Quantity of fans soldQuantity of fans sold

Theory of RevenueTheory of RevenueTheory of RevenueTheory of RevenueTheory of RevenueTheory of RevenueTheory of RevenueTheory of Revenue

•• Total RevenueTotal Revenue Total Revenue ScheduleTotal Revenue ScheduleO t t f f T t l R (R )O t t f f T t l R (R )

–– Total money Total money earned by a firm earned by a firm when it sells awhen it sells a

Output of fans Total Revenue (Rs)Output of fans Total Revenue (Rs)00 0011 1010

when it sells a when it sells a given amount of given amount of outputoutput

22 181833 242444 2828

–– TR = p x q,TR = p x q,where:where:

55 282866 2424

•• p is the per unit p is the per unit priceprice

•• q is the quantityq is the quantity•• q is the quantity q is the quantity of output soldof output sold

Long Run Marginal CostLong Run Marginal CostLong Run Marginal CostLong Run Marginal Cost

LMC =LMC = Long Run CostLong Run CostLMC LMC Factor InputsFactor Inputs

Rs)

Rs) LMCLMC

LACLAC

•• Also U Also U -- shapedshaped•• Cuts LAC at its minimum Cuts LAC at its minimum

pointpoint

Cost

s (R

Cost

s (R

pointpoint

OutputOutputOO


S h dS h d




Output


U d l i t d tU d l i t d tsts

(Rs)

sts

(Rs)

CRS

LAC

•• Upward sloping part due to Upward sloping part due to diminishing returns to scale diminishing returns to scale (Increasing Average Cost)(Increasing Average Cost)

Cos

Cos

OutputOutputOO

( 63 )

Marginal RevenueMarginal RevenueMarginal RevenueMarginal Revenue•• MR =MR = Change in Total RevenueChange in Total Revenue

Change in units of output soldChange in units of output sold

venu

eve

nue

•• MR =MR = TRTRQQ

Mar

gina

l rev

Mar

gina

l rev

Marginal Revenue ScheduleMarginal Revenue Schedule

Output Total Revenue Marginal RevenueOutput Total Revenue Marginal RevenueMRMRQuantity of fans soldQuantity of fans sold

MM

00 00 --

11 1010 1010

22 1818 8822 1818 88

33 2424 66

44 2828 44

55 2828 00

66 2424 --44





Output Total Revenue Marginal RevenueOutput Total Revenue Marginal Revenue

00 00 --

11 1010 1010

22 1818 8822 1818 88

33 2424 66

44 2828 44

55 2828 00

66 2424 --44




Average RevenueAverage RevenueAverage RevenueAverage RevenueAverage RevenueAverage Revenue

OutputOutput Total Total AverageAverage

Revenue (Rs)Revenue (Rs) Revenue (Rs)Revenue (Rs)

00 00 --

11 1010 1010 ueue11 1010 1010

22 1818 99

33 2424 88

rage

rev

enu

rage

rev

enu

44 2828 77

55 2828 5.65.6

66 2424 44

ARAR


Aver

Aver

•• As more units of output sold, price must fallAs more units of output sold, price must fall

•• AR as QAR as Q•• AR as QAR as Q

•• AR curve is the demand curve faced by the firmAR curve is the demand curve faced by the firm




00 00 --

11 1010 1010 ueue11 1010 1010

22 1818 99

33 2424 88

rage

rev

enu

rage

rev

enu

44 2828 77

55 2828 5.65.6

66 2424 44

ARAR


Aver

Aver

AR Curve downward sloping




00 00 --

11 1010 101011 1010 1010

22 1818 99

33 2424 88

44 2828 77

55 2828 5.65.6

66 2424 44

( 64 )

Relationship of TR, MR & AR underRelationship of TR, MR & AR underP f t C titiP f t C titi

Relationship of TR, MR & AR underRelationship of TR, MR & AR underP f t C titiP f t C titiPerfect CompetitionPerfect CompetitionPerfect CompetitionPerfect Competition

•• TR rises at a constant rateTR rises at a constant rateTRTR •• TR rises at a constant rateTR rises at a constant rate

•• AR is constantAR is constant

/ M

R/

MR

AR = MRAR = MR

TRTR

•• MR is constantMR is constant

•• AR = MRAR = MRTR /

AR /

TR /

AR / AR = MRAR = MR

TR, AR and MR under perfect competitionTR, AR and MR under perfect competition

Units of output soldUnits of output soldOO

, p p, p p

Units sold Market Price per unit (Rs) TR(Rs) AR(Rs) MR(Rs)Units sold Market Price per unit (Rs) TR(Rs) AR(Rs) MR(Rs)

11 33 33 33 33

22 33 66 33 33

33 33 99 33 33

Relationship of TR, MR & AR underRelationship of TR, MR & AR underf t titif t titi

Relationship of TR, MR & AR underRelationship of TR, MR & AR underf t titif t titiperfect competitionperfect competitionperfect competitionperfect competition

•• TR rises at a constant rateTR rises at a constant rateTRTR •• TR rises at a constant rateTR rises at a constant rate

•• AR is constantAR is constant

/ M

R/

MR

AR = MRAR = MR

TRTR

•• MR is constantMR is constant

•• AR = MRAR = MRTR /

AR /

TR /

AR / AR = MRAR = MR


Relationship of TR, MR & AR underRelationship of TR, MR & AR underf t titif t titi

Relationship of TR, MR & AR underRelationship of TR, MR & AR underf t titif t titiperfect competitionperfect competitionperfect competitionperfect competition

•• TR rises at a constant rateTR rises at a constant rateTRTR •• TR rises at a constant rateTR rises at a constant rate/

MR

/ M

RTRTR

TR /

AR /

TR /

AR /


Relationship between AR and MRRelationship between AR and MRRelationship between AR and MRRelationship between AR and MR

•• When MR = AR, AR is atWhen MR = AR, AR is atWhen MR AR, AR is at When MR AR, AR is at its maximumits maximum

•• When MR is decreasing When MR is decreasing and is less than AR, AR and is less than AR, AR is fallingis falling

MR can be 0; AR canMR can be 0; AR canvenu

e (R

s)ve

nue

(Rs)

•• MR can be 0; AR can MR can be 0; AR can never be 0never be 0ARAR

Rev

Rev

MRMR Output soldOutput soldOO

Relationship between TR & MRRelationship between TR & MRRelationship between TR & MRRelationship between TR & MR

•• Prior to point A, MR is Prior to point A, MR is ueue TRTR

AA

positive but falling, TR positive but falling, TR increases at a diminishing increases at a diminishing raterateTo

tal r

even

uTo

tal r

even

u TRTR

raterate

•• At point A, MR = 0 and TR At point A, MR = 0 and TR is maximumis maximumOutput soldOutput sold

TT

OOis maximumis maximum

•• Beyond point A, MR is Beyond point A, MR is falling and negative; TRfalling and negative; TRev

enue

even

ue

falling and negative; TR falling and negative; TR starts fallingstarts falling

Mar

gina

l re

Mar

gina

l re

MRMR Output soldOutput soldOO



venu

eve

nue


Mar

gina

l rev

Mar

gina

l rev


Output Total Revenue Marginal RevenueOutput Total Revenue Marginal RevenueMRMRQuantity of fans soldQuantity of fans sold

MM

00 00 --

11 1010 1010

22 1818 88

MR CurveMR Curve

•• Downward slopingDownward sloping

Could be negativeCould be negative22 1818 88

33 2424 66

44 2828 44

•• Could be negativeCould be negative

55 2828 00

66 2424 --44

( 65 )

Gross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit Approach

MCMC

nue

(Rs)

nue

(Rs) FFAA

P = MRP = MR At Output OQ*:

P > MC

TR OAFQ*

osts

/ r

even

osts

/ r

even

BB

TR = OAFQ*

TVC= OBGQ*

Profit = AFGBCoCo

BB Profit = AFGBGG

Quantity of outputQuantity of output

OO QQ**


MCMC

nue

(Rs)

nue

(Rs)

EEAA

P = MRP = MR At Output OQ:

P= MC

TR OAEQ

osts

/ r

even

osts

/ r

even

BB

TR = OAEQ

TVC= OBEQ

Profit = AEBCoCo

BB Profit = AEB


OO QQ


MCMCnu

e (R

s)nu

e (R

s)

P = MRP = MR P = MR: Initial Price Line

MC: Marginal

osts

/ r

even

osts

/ r

even

gCost Curve

CoCo


OO

Gross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit ApproachGross Profit Approach

•• Profit = Revenue Profit = Revenue –– CostCost

•• TC = TFC + TVCTC = TFC + TVC•• TC = TFC + TVCTC = TFC + TVC

•• TFC is constantTFC is constant

•• Gross profit = Revenue Gross profit = Revenue –– TVCTVC

•• Area under MC curve = TVCArea under MC curve = TVC

•• Area under MR curve = TRArea under MR curve = TRArea under MR curve TRArea under MR curve TR

Producer’s EquilibriumProducer’s EquilibriumProducer’s EquilibriumProducer’s EquilibriumProducer s EquilibriumProducer s EquilibriumProducer s EquilibriumProducer s Equilibrium

•• That level of output produced and sold, That level of output produced and sold, whereby a firm maximises profitswhereby a firm maximises profits

•• Profits = Revenue Profits = Revenue –– CostCost

2 methods of determining produces equilibrium2 methods of determining produces equilibrium•• 2 methods of determining produces equilibrium2 methods of determining produces equilibrium

–– Gross Profit ApproachGross Profit Approach

–– Marginal Revenue Marginal Revenue –– Marginal Cost ApproachMarginal Cost Approach

Relationship of TR, AR & MR under Relationship of TR, AR & MR under Imperfect CompetitionImperfect Competition

Relationship of TR, AR & MR under Relationship of TR, AR & MR under Imperfect CompetitionImperfect CompetitionImperfect CompetitionImperfect CompetitionImperfect CompetitionImperfect Competition

AA

•• Firm retains some flexibility to Firm retains some flexibility to determine pricedetermine price

tal r

even

ueta

l rev

enue

TRTR

•• As price falls As price falls quantity sold quantity sold increases => AR curve is increases => AR curve is

Output soldOutput sold

Tot

Tot

OOdownward slopingdownward sloping

MR l dMR l d

Output soldOutput soldOO

•• MR also reducesMR also reduces

•• TR increases at an diminishingTR increases at an diminishing

MR /

AR

MR /

AR

•• TR increases at an diminishing TR increases at an diminishing rate and then fallsrate and then falls

Output soldOutput soldOO

ARAR

MRMR

( 66 )

Marginal Cost Marginal Cost –– Marginal Revenue ApproachMarginal Revenue ApproachMarginal Cost Marginal Cost –– Marginal Revenue ApproachMarginal Revenue Approach

MCMC

nue

(Rs)

nue

(Rs)

P = MRP = MR At point E, P = MC

Output produced

EE

osts

/ r

even

osts

/ r

even

p pOQ

CoCo


OO QQ


MCMC

nue

(Rs)

nue

(Rs)

P = MRP = MR P = MR: Initial Price Line

MC: Marginal

osts

/ r

even

osts

/ r

even

gCost Curve

CoCo


OO


MCMCnu

e (R

s)nu

e (R

s)

EEAA

P = MRP = MR Profits are maximised at OQ, where

osts

/ r

even

osts

/ r

even

BB

P = MC

CoCo

BB


OO QQ


MCMC

CCFirm loses profits

by this area

nue

(Rs)

nue

(Rs) AA

P = MRP = MR

DDEE

At Output OQ’:

Profit is LESS than at OQ by

osts

/ r

even

osts

/ r

even

BB

Q yECD

CoCo

BB


OO QQll


MCMC

CC

nue

(Rs)

nue

(Rs)

DDAA

P = MRP = MR At Output OQ’:

P < MC

TR OADQ’

EE

osts

/ r

even

osts

/ r

even

BB

TR = OADQ’

TVC= OBCQ’

Profit = AEBCoCo

BB Profit = AEB minus ECD


OO Q’Q’


MCMC

nue

(Rs)

nue

(Rs)

FF EEAA

P = MRP = MR At Output OQ*:

Profit is LESS than at OQ by

osts

/ r

even

osts

/ r

even

BB

Q yFEG

Fi ld illCoCo

BBGG Firm could still

earn this profit


OO Q Q **

( 67 )


MCMC

CC

Marginal Loss

nue

(Rs)

nue

(Rs)

P = MRP = MR Reduce output

as long as P<MCEE DD

osts

/ r

even

osts

/ r

even

CoCo


OO QQ Q’’Q’’


MCMC

CC

Marginal Loss

nue

(Rs)

nue

(Rs)

P = MRP = MR At output OQ’’:

P < MC

MR: DQ’’

EE DD

osts

/ r

even

osts

/ r

even MR: DQ’’

MC: CQ’’

CoCo




MCMC

CC

nue

(Rs)

nue

(Rs)

P = MRP = MR At output OQ’’:

P < MC

MR: DQ’’

EE DD

osts

/ r

even

osts

/ r

even MR: DQ’’

MC: CQ’’

CoCo




MCMC

Marginal Profit

nue

(Rs)

nue

(Rs)

P = MRP = MR Increase output

as long as P>MCEEAA

osts

/ r

even

osts

/ r

even

CoCo BB


OO QQQ’Q’


MCMC

Marginal Profit

nue

(Rs)

nue

(Rs)

P = MRP = MR At output OQ’:

P > MC

MR: AQ’

EEAA

osts

/ r

even

osts

/ r

even MR: AQ’

MC: BQ’

CoCo BB


OO QQQ’Q’


MCMC

nue

(Rs)

nue

(Rs)

P = MRP = MR At output OQ’:

P > MC

MR: AQ’

EEAA

osts

/ r

even

osts

/ r

even MR: AQ’

MC: BQ’

CoCo BB


OO QQQ’Q’

( 68 )

Break Break –– Even AnalysisEven AnalysisBreak Break –– Even AnalysisEven Analysis

BreakBreak--even charteven chart

yyyy

BreakBreak--even charteven chartOutput TVC TFC TC AR = P TR Profit/Loss Profit/LossOutput TVC TFC TC AR = P TR Profit/Loss Profit/Loss

00 00 2020 2020 00 00 --2020 LossLoss

1010 1212 2020 3232 22 2020 --1212 LossLoss1010 1212 2020 3232 22 2020 1212 LossLoss

2020 2020 2020 4040 22 4040 00 BreakBreak--EvenEven

3030 2424 2020 4444 22 6060 1616 ProfitProfit3030 2424 2020 4444 22 6060 1616 ProfitProfit



yyyy


00 00 2020 2020 00 00 --2020 LossLoss





yyyy


00 00 2020 2020 00 00 --2020 LossLoss




yyyy


00 00 2020 2020 00 00 --2020 LossLoss


•• Defined as the level of output where TR = TCDefined as the level of output where TR = TC

•• Costs include: Fixed, Variable, Normal ProfitsCosts include: Fixed, Variable, Normal Profits

•• At break At break –– even, firm earns normal profiteven, firm earns normal profit


MCMC

nue

(Rs)

nue

(Rs)

EE P = MRP = MR Profits are maximised at OQ, where

osts

/ r

even

osts

/ r

even P = MC

CoCo


OO QQ

( 69 )

Break Break ––Even AnalysisEven AnalysisBreak Break ––Even AnalysisEven Analysis

At breakeven:At breakeven:ue (

Rs)

ue (

Rs)

At breakeven:At breakeven:TR = TCTR = TC

and

reve

nuan

d re

venu

TRTR

TCTC

=>=> TRTRqq

TCTCqq==Co

sts

aCo

sts

a

BB

=> AR = ATC=> AR = ATCSupernormal profitSupernormal profit

BreakBreak--even or Normal profiteven or Normal profit

LossLoss

OutputOutputOO



yyyy


00 00 2020 2020 00 00 --2020 LossLoss




4040 2626 2020 4646 22 8080 3434 ProfitProfit



yyyy


00 00 2020 2020 00 00 --2020 LossLoss




4040 2626 2020 4646 22 8080 3434 ProfitProfit

( 70 )

National Income Accounting

Abstract

The present unit will deal with National Income Accounting: Concept and Meaning of National Income, its measurement, their components and different methods of computing. Factors affecting National Income have also been explained. Light has also been thrown on uses of National Income Statistics and Limitations of National income. Ample examples with problems and solutions are given for your conceptual clarity. Few question based on the computation are also given which you can take up in the class room. National income is major yardstick for development of any country. Hence its computation and components are very significant for students learning. Concept of Double Counting, Tranfer Payments, its treatment and precautions while computing National Income is also covered in the present unit.

Recall:

Please make students recall the meaning of GDP, NDP, NNP etc. and component of Depreciation which was taken up in previous week, the clarity in calculating NNP at FC and NNP at Market Price is must. Concept of National Income and Methods of Measurement of National Income should be taken up one by one i.e. Value Added Method, Income Method and Expenditure Method.

( 71 )

Teaching Points

Concept and Meaning of National Income

Measurement of National Income- Value Added, Income Method and Expenditure Method.

Relevant related concepts of Nation Income

Factors affecting National Income

Uses of National Income Statistics

Limitations of National Income

What is National Income?

1. Concept and Meaning of National Income

National Income is a measure of the total flow of earning of the factor-owners through the production of goods and services. In simple words, it is the total amount of income earned by the aggregate output.

The total value of the level of aggregate output is called Gross National Product or GNP. GNP is a measure of the total market value of all final goods and services currently produced by all the citizens of a nation within a period, usually a year.

Focus on the important points mentioned below:-

It Measures how much people produce.

It Counts current production only

It Counts the level of output with a market value.

It relies on the market prices of goods and services as a measure.

2. Methods of Measuring National Income

There are mainly Three Approaches to measure GNP

( 72 )

The relationship of these approaches is shown in the diagram given below.

Product market

Households Firms

The 3 arrows in the diagram show the overall level of economics activities.

Based on these 3 directions of Flows i.e. Flow of output, Flow of Income and a Flow of Expenditure, economists develop three approaches to measure GNP.

2.1 Output or value added approach

The total value of all final goods and services (i.e. outputs) can be found out by adding up the total values of outputs produced at different stages of production .This method it to avoid the so-called double-counting or an over-estimation of GNP. However, there are difficulties in the collection and calculation of data obtained; caution should be taken to take Final Goods not Intermediate goods as it will result in Double Counting.

For example in a Cycle Manufacturing Unit, computing the total value of cycles produced in a year the final value of the cycle ( Multiplied by total no of units produced) which is ready to be marketed for sale will be taken not the cost of intermediate goods which are used in the process of manufacture as it will result in double counting. i.e. The market price of a cycle is suppose Rs.2000 which includes say profit margin of Rs.200 besides the cost of manufacturing of Rs.1800.This 1800 includes all costs including components and parts etc. (these are intermediate goods which are used in the process of production.)If the costs of parts etc. are also taken while computing final value of total units produced, it will give inflated figure and hence result in double counting error. Same way at macro level, while computing the National Income under Value Added Method the value of final goods and services should be taken up to avoid the double counting error as the cost of Intermediate Goods are already counted in the final value of the product.

( 73 )

2.2. Expenditure approach

Amount of Expenditure refers to all spending on currently-produced final goods and services only in an economy. In an economy, there are three main agencies which buy goods and services. These are: Households, Firms and the Government

In Economics, we use the following Terms:

C = Private Consumption Expenditure (of all Households)

I = Investment Expenditure (of all firms)

G = Government Consumption Expenditure (of the local government)

In an economy the entire output which is produced in a year is not fully consumed by that economy as some goods are exported and in the similar way the domestic consumption(expenditure) may also include imports. Hence under the expenditure approach to measure the GNP, the value of exports must be added to C, I and G whereas the values of imports must be deducted from the above amount.

Finally, we have:

GNP at market prices = C+I+G+X-M

(Where X-M = Exports –Imports)

Gross Domestic Product (GDP)

We can only find the amount of outputs which are produced within the domestic boundary of an economy in a specific period, say a year. To arrive at the value of GNP, Net Factor Income Earned from Abroad (NFIA) has to be added to the GDP.

Income from abroad = income earned by local citizens form the provision of factors services abroad

Income to abroad = income earned by foreign citizens form the provision of factors services locally

Net Factor Income from abroad – Income earned from abroad – Income sent to abroad

GNP = GDP + Net Factor Income Earned from Abroad

( 74 )

2.3 Income approach

The Income approach tries to measure the total flows of income earned by the factor-owners in the provision of final goods and services in a current period. There are four types of factors of production and four types of factors incomes accordingly i.e. Land, Labour, Capital, and Organization as Factors ofProduction and Rent, Wages, Interest and Profit as Factor Incomes correspondingly.

National Income = Wages+ Interest Income + Rental Income +*Profit

The term* Profit can be further sub-divided into; profit tax; dividend to all those shareholders; and retained profit (or retained earnings).

3. Relevant concepts of National Income

3.1 Net National Product (NNP)

The investment expenditure of the firms is made up of two parts. One part is to buy new capital goods and machinery for production. It is called net investment because the production capacity of the firms can be expanded.

Another part- consumption allowance or depreciation- is spent on replacing the used-up capital goods or the maintenance of existing capital goods will face wear and tear out over time. Depreciation refers to all non cash provision charged against profit each year to replace the fixed assets due to wear and tear, obsolescence, destruction and accidental loss etc.

The sum of these two amounts is called Gross Investment in economics.

Gross Investment= Net investment + Depreciation

Net investment will increase the production capacity and output of a nation, but not by depreciation expenditure. So we have,

NNP = GNP-Depreciation

3.2 GNP at Factor Cost

The amount of National Income calculated under the Income Approach will not be the same as the amount of GNP at market prices found by the expenditure approach.

In the expenditure approach, the value of GNP included some types of expenses which are not factor incomes earned by the citizens. They include depreciation, indirect business taxes, and government subsidies.

GNP at factor Cost = GNP at market price = Indirect Business Taxes + Subsidies = GNP at market price = Indirect Business Taxes less Subsidies

( 75 )

GNP at factor cost carries the meaning that we are measuring the total output by their costs of production. As output generates income to the factor-owners, it is also related with the value of national income.

GNP at factor Cost = National Income + Depreciation

Depreciation is also a type of costs of production but will not become a source of income directly. So it is included in the factor cost but excluded in the value of national income.

3.3 GNP (GNP at Current Market Prices)

GNP is a measure based on market prices which are expressed in terms of money. In reality, market prices changes all the time. The same amount of outputs may different total market values provided that price change.

In order to isolate the effect of prices change on the value of GNP, economists have developed the concept and techniques of constant market prices.

GNP at the base year (1990) = 1X 6 + 2 x 4 +2 x 2m. = 18 million

GNP at current market prices in 1995 = 1x 6 +2 x6 +3 x 4m. = 30 Million

The 2 value of GNP at current market prices in 1995 & 2000 are calculated by using the money prices in that year, eg. The nominal growth rate is 66.67 % between 1990 to 2000.

GNP at constant market prices of 1995 = 1 x 6 + 2 x 6 +2 x 4m. = 26 million

The real output changes from 18 to 26 million from 1990 to 1995. GNP at constant marker prices is called real GNP.

The growth rate of real GNP is called real growth rate of GNP.

Real GNP

The value of the real GNP is based on the prices of the base year. However, there are too many different values of prices of goods and services. To make the calculation of GNP easier, economists use a price index to find the real GNP.

A Price index is a number showing the changes in the overall level of prices. It shows a change in the general price level of an economy.

With the value of the price index, the real GNP of anyone year can be found

Real GNP = Nominal GNP x (Price Index at base year/Price index at current year)

( 76 )

4. Factors Affecting National Income

4.1 Factors of production

Normally the more efficient and richer the resources, higher will be the level of National Income or GNP

4.1.1 Land

Resources like coal, iron and timber are essential for heavy industries so that they must be available and accessible. In other words, the geographical location of these natural resources affects the level of GNP.

4.1.2 Capital

Capital is generally determined by investment. Investment in turn depends on other factors like profitability, political stability etc.

4.1.3 Labour and Entrepreneur

The quality or productivity of human resources is more important than quantity. Manpower planning and education affect the productivity and production capacity of an economy.

4.1.4. Technology

This factor is more important for Nations with fewer natural resources. The development in technology is affected by the level of invention and innovation in production.

4.1.5. Government

Government can help to provide a favorable business environment for investment. It provides law and order, regulations.

4.1.6 Political Stability

A stable economy and political system helps in appropriate allocation of resources. Wars, strikes and social unrests will discourage investment and business activities.

5. Uses of National Income Statistics

5.1 Standard of living

The per capita GNP allows us to compare the standard of living of different nations. In general, a nation has a higher standard of living if its per capita GNP is higher than that of another nation.

5.2. Policy formulation

In the compilation of GNP statistics, the Government gathers lot of information of the economy. The Government can use this as base to plan and decide its policies.

( 77 )

5.3 International comparison

By converting the local GNP figures into a common unit (usually in US$), we can compare the standard of living of different nations. It helps to show the rate of growth or development of different nations.

5.4 Business Decision

The GNP figures can show the level of development of different industries and sectors of an economy. It helps the business to plan for production.

6. Limitations of National Income Statistics

GNP is a measure of the overall flow of goods and services, as well as to show the general welfare of the people. It aims not only at the level of cost of living but also the standard of living. It is quite correct to show the cost of living but there are some limitations on the GNP statistics to indicate the standard of living of an economy like

6.1 Price Changes

A higher nominal GNP of a nation may not mean that the standard of living is better. If the price increasesat a high rate, the real GNP may even fall.

6.2 Omission or under-estimation

6.3 Voluntary services

GNP figures do not include the contribution of the voluntary agencies which raise the general welfare, e.g. the Tung Wah group of Hospitals. In this respect, the GNP figures under-estimate the level of welfare.The voluntary work of housewives is also neglected by the GNP figures. It again underestimates welfare of people or standard of living.

It is also a source of welfare and raises our standard of living e.g. the welfare enjoyed with a New Year holiday, however, the monetary value is difficult to calculate.

6.4 Illegal Activities

Drug trafficking and illegal gambling are activities omitted in the value of GNP. It is difficult to determine its effect on the welfare of an economy.

6.5 Undesirable Effects of Production

GNP figures have not considered the effects of pollution, traffic congestion on the economy. They have lowered our standard of living.

6.6 Problem of Comparison

6.7 Output Composition

( 78 )

Nations with the same GNP may have different living standard because their output composition may be different. In general, a higher level of consumer goods and services in the GNP indicates a higher current level of living standard.

6. 8 Distribution of National Income and wealth

If income is obtained by a small rate of people in a nation, the general living standard is still lowcompared with a nation having a more evenly distributed income or GNP

6.9 Population Size

A large population has a lower living standard even if its GNP is the same as that of a small population. The per capita GNP is more useful to compare the two nations.

6.10 National Defense

If a nation has spent a lot of resources in the production of weapons and so on, its living standard may not be improved.

6.11 Time

Technology will be improved overtime; this may not be shown in GNP figures because there may be small changes in cost and price only.Besides, durable goods provide welfare to us over a period of time (usually more than 1 year). This cannot be shown by GNP figures within a year.

COMPONENTS OF VALUE OF OUTPUT AND VALUE ADDED

Gross output of the Market OrSales + change in stockOrSales +closing stock – opening stock= Gross value of output at MPLessIntermediate consumption

= Gross value added at MPLessConsumption of fixed capital (Depreciation)(Fall in the value of fixed assets)= Net value added at MPLessNet direct taxes= Net value added at FC

( 79 )

Check your progress/examples

1. Calculate Gross value added at factor cost from the following :-(i) Gross value of output at MP 10,500(ii) Depreciation 1000(iii) Indirect taxes 750(iv) Economic subsidies 200(v) Intermediate consumption 4000(vi) Compensation of employees 2000

Solution

Gross value added at Factor cost will be calculated as under:-

Gross value of output at MP 10,500+ Economic Subsidies +200- Intermediate Consumption -4000- Indirect Taxes -750

Rs.5950/-

2. From the following data, estimate the net value added at factor cost and show that it is equal to the sum of factor incomes :-(i) Sales 9600(ii) Increase in stock 2080(iii) Intermediate Consumption 2370(iv) Depreciation 450(v) Wages and salaries 5400(vi) Internet 250(vii) Rent 750(viii) Profit 2150(ix) Net indirect Taxes 310

Solution

Value added at FC = Sales + increase in stock – Intermediate Consumption – Depreciation- Net Indirect Taxes

= 9600 + 2080- 2370- 450- 310

= Rs. 8550/-

( 80 )

Sum of Factor Incomes

Wages & salaries = 5400

+ Interest = 250

+ Rent = 750

+ Profit = 2150

8550

Hence value added at FC cost equals sum of factor incomes

Check your progress

Q. 1 Find out “Net value added at FC by an enterprise from the following data:

Rs. In crores

(i) Consumption of Fixed Capital 10(ii) Subsidies 5(iii) Indirect Taxes 25(iv) Purchase of material and 75

Services from other production units(v) Value of output 125

(Ans. = 70 Corers)

Q 2. Calculate value added by Firm A & B from the following data:-

Rs. (Lakh)

(i) Purchase by Firms B from Firm A 40(ii) Sales by Firm B 80(iii) Imports by Firm B 10(iv) Rent Paid by Firm B 05(v) Opening stock of Firm B 15(vi) Closing stock of Firm B 20(vii) Purchases by Firm A from Firm B 20(viii) Closing stock of Firm A 20(ix) Opening stock of Firm A 10

( 81 )

Solution

Value of output of Firm A

= Sales + stock

= 40 + (20-10)

= 50 Lakhs

Value added By Firm A

Value of output – Intermediate Consumption

= 50-20

= 30 Lakhs

Value of output of Firm B

= Sales + change in stock

= 20 + 80 + (20-15)

= 105 Lakhs

Value added By Firm B

Value of output – Purchase-Imports –Rent

=105-40-10-5

= 50 Lakhs

( 82 )

II Income Method of Computing National Income

Steps involved in calculating NI by Income method

Step 1. Identification and classification of producing enterprises which employ factor inputs into primary, secondary and territory sector

Step 2. Classification of factors income into Compensation to Employees, Operating Surplus & Mixed Income.

Step 3 Estimation of National Income

NNP at fC (National Income)

1. Compensation to employees2. Operating surplus3. Mixed income and self employed

= Net domestic product at factor cost4. Net factor income from abroad5. Net national product at factor cost

Process involved in estimating NI by Income method

Any income corresponding to which there is no flow of goods and services or value added, it should not be included in calculation of National Income

1. Transfer payment like scholarships, olf age pensions, gifts etc. is not a productive activity. So they are excluded. These are unilateral payments. A distinction is made between old age pension is a transfer payment and retirement pension is a part of compensation of employees.

2. Income from the sale of second hand goods or capital gains is excluded from national income because their sale has been accounted in the year they were purchased. However the brakeage/commission paid is included as factor income.

3. Illegal income from smuggling, black marketing, theft, scarcity. Gambling is net included as it is not only illegal but also difficult to count as nobody reveals it.

4. Income arising from sales of financial assets like shares, bonds, debentures in the market is not treated as income as there is no corresponding production of goods and services when such sales are made. It reflects a mere transfer of ownership rights.

5. Imputed value of services rendered by owners of production units are to be included e.g. rental of owner-occupied houses on the basis of prevailing market rate.

( 83 )

6. Imputed value of own account production must be included as it is equivalent to selling the good to himself and earning factor income.

7. Income from windfall gains like lotteries is not included, as its is not earned by providing any productive activity. It is a transfer receipt.

Numerical Example

1. Calculate national income from the following data:-

(Rs. Crores)

(i) Consumption of fixed capital 50(ii) Employers contribution to social security 75(iii) Interest 160(iv) Net Indirect Taxes 55(v) Rent 130(vi) Dividends 45(vii) Corporate Tax 15(viii) Undistributed profit 10(ix) Net factor income from abroad -10(x) Wages and salaries 450

Solution

NDP fc = (X) + (ii) + (iii) + (v) + (vi) + (Vii) + (Viii)

= 450 + 75*+ 160 +130+45+15+10 = 885 Cr.

NNP at fc = NDP fc + (ix)

= 885 + (-10) = 875 Cr.

Notes of solution

*Since wages and salaries and employees contribution to social security are given separately, these must be added to obtain compensation to employees.

Dividend, undistributed profit and corporate taxes are to be added to get Total profit/ Retained Earnings.

Net indirect taxes, is not required in this question. Similarly consumption of fixed capital is also not required in this question.

( 84 )

III Expenditure Method

The other way of calculating National Income is to measure total spending on final good by the different sectors of the economy.

Expenditure method is National Income Accounting method that measures GDP by adding all the spending for final goods during a period of time.

GNP mp = C+I+G+(X-M)

The Factors Income earned by the Factors of Production is spent on (Disposed off) goods and services that are produced by firms. That is why expenditure method is also called income disposal method.

Expenditure is undertaken by all sectors of an Economy-Households, Government, Firms and Rest of the World. Let us understand the kind of expenditure that is incurred by the different sectors.

1. Personal or Private Consumption Expenditure (C) Private Consumption Expenditure is the money value of final goods and services purchased by the resident households, including non-profit institutions of an economy in a given year.

2. Gross Domestic Capital Formation (I)Capital formation or investment is an addition to capital stock of an economy in a given time period. This is the sum of two components i.e.

(i) Gross Domestic fixed capital formation and (ii) Change in stock

This includes investments by firms as well as governments sectors

3. Government Final Consumption Expenditure (G)This category includes the value of goods and service purchased by Government.

4. Net Exports (X-M)The last component in GDP Expenditure Account is Net Exports, expressed in the formula (X-M). Exports (X) are expenditure by foreigners for Indian domestic product. Imports (M) is the expenditure on goods and services produced by the rest of the world by resident household firms and government.

( 85 )

Steps involved in calculation of National Income ( NI) by expenditure method

Step 1. Identification of economic units incurring final expenditure

Step 2. Classification of final expenditure (C+I+G+(X-M))

Step 3 Estimation of NI by expenditure Method:-

Please Note

1. Only final expenditure is to be included to avoid double counting.2. Intermediate expenditure like on raw materials, etc, is not included in the

calculation of National Income.3. Expenditure on second-hand goods is not included as they have already been

included when they were purchased originally.4. Expenditure on shares and bonds is not included because buying financial

assets is not a production activity because financial assets are neither good nor services. These are also known as Paper Money or Barren Money.

5. Expenditure on transfer payments by the government is excluded in total expenditure because transfer payment is a payment against which no services are rendered therefore, no production takes place and hence are not considered in computing National Income.

6. The imputed expenditure value or self use of own produced final products is included.

( 86 )

Numerical Example

Calculate national income from the data given below by expenditure method.

Item Rs. (In crores)

(i) Personal consumption expenditure 3500(ii) Consumption of fixed capital 50(iii) Net fixed capital formation 1250(iv) Change in stock 500(v) Exports 400(vi) Imports 750(vii) Net indirect taxes 40(viii) Governments’ consumption expenditure 1600(ix) Net factor income from abroad (-) 10(x) Wages and salaries 450

Solution Rs. (In crores)

Personal Consumption expenditure 3500

+ Net fixed Capital Formation 1250

+ Change in Stock 500

+ Govt. Consumption Expenditure 1600

+ Net Exports (Exports-Imports) -350

Net Domestic product at market price 6500

(-) Net Indirect Taxes 40

Net Domestic product at Factor Cost 6460

+ Net factor Income from abroad (-) 10

NNP FC (National Income) 6450

Please Note

1. Since Net Fixed Capital Formation is given, we are asked to calculate net National Product at factor cost. Thus, consumption of fixed capital is not required here.

2. Since, fixed capital is given, we need to add change in stock to get the total domestic capital formation (Investment)

3. The entry wages and salaries are not required here.

( 87 )

Question Bank

Abstract

Friends, till now we were uploading support material in content areas from the week-wise syllabus from July, 2011.In this section we intend to give you different types of questions based on Board pattern along with expected Answers /Solutions. Hope this will enable you to prepare students accordingly. As preparing test - items for a balanced question paper is an art, answering appropriately and precisely is also a skill which we have to equip our children with. Understanding the question and using appropriate terminology. Language for framing answers is very important for high scoring in examinations. This requires practice and teachers play an important role in providing this skill in class rooms. This is an exemplar, try your own question- bank preparation based on small section of content covered.

I Question Bank (with Answer/Solution)

Producers Behavior and Supply

Very Short answer Type Questions (1 mark)

1 How does fall in total product affect marginal product?

2 Which Cost Curve is parallel to OX- axis? Why?

3 What do you mean by Fixed Factors of Production?

4 What is meant by Market Period?

5 What causes a downward Movement along the Curve?

6 When does the Elasticity of Supply of commodity is equal to Unity?

7 Draw TVC Curve.

8 “At Producers’ Equilibrium Marginal Cost should be falling.” True/ False. Give reason.

9 What happens to Supply of a Good when price of inputs used rise while producing the same ?

( 88 )

10 The vertical distance between ATC and AVC should fall or rise or remain constant with the increase in output? Give reason.

11 In this formula what does P stand for?

II Short answer Type Questions (3-4 marks)

1 Draw ATC, AVC and MC Curves in single diagram.

2 Distinguish between Total Fixed Cost and Total Variable Cost.

3 What changes will take place in Total Revenue when:a) Marginal Revenue is falling but is positiveb) Marginal Revenue is Zeroc) Marginal Revenue is negative

4 Find the level of output yielding maximum profit by MC and MR approach

Output 1 2 3 4 5AR 10 9 8 7 6TC 10 11 14 18 25

5 Define Marginal Revenue. Explain the relationship between Average and Marginal Revenue when price is constant at all levels of output.

6 Complete the following table:

Output(Unit) Total Variable cost(Rs)

Average Variable Cost(Rs)

Marginal Cost(Rs)

1 10 - -- - 8 63 27 - -- - 10 13

7 Following information is given about a firm:

Output(in units)

0 1 2 3 4 5 6

Total Cost(Rs)

20 25 28 30 36 45 60

From the above information find:a) Average Fixed Cost of producing 4 units.

( 89 )

b) Average Variable Cost of producing 5 units.c) Marginal Cost of producing 3rd unit.d) Average Cost of producing 6 units.

8 Whether statements are True or False? State reasonsi) As long as MC is rising, ATC will also rise.ii) At an output of one unit, ATC is equal to MC.iii) Total Revenue declines as long as Marginal Revenue is falling.

9 State three reasons of a Rightward Shift of a Supply Curve.

10 Using diagrams explain the difference between Contraction and Decrease in Supply.

11 In the diagram given below state the nature of Elasticity of Supply of the different Supply Curve

12 A 20% rise in the price of commodity A leads to a rise in its supply from 400 to 500 units. Calculate its Elasticity of Supply and comment on it.

13 The Price elasticity of Supply of a commodity is 2. When its price falls from Rs 10 to 8 per unit, its Quantity Supplied falls by 500 units. Calculate the Quantity Supplied at reduced price.

14 Using a diagram explain how a relatively flatter Supply curve has a higher Elasticity of Supply for a given rise in price?

III Long Answer Type Questions (6 Marks)

1. Explain the effect on output when only one input is increased?

2. Explain three factors that influence the Supply of Ice Creams in the market.

3. Using a hypothetical example, explain how the Market Supply Curve is determined from Individual Supply Curve of three firms?

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4. a) Explain the effect of technical progress on the supply of a good. Use diagram. b) Using diagram explain the impact of drought on the Market Supply of wheat.

6 Explain the conditions of Producer’s Equilibrium with MC and MR approach. Use schedule & diagram.

7 State whether following statements are true or false. Give reasons:a) Diminishing returns to a factor is applicable only when Average Product starts fallingb) AC and AVC Curves do not intersect each otherc) Supply remains constant in Market Period.

Answer/Solution

Unit 3: Producer Behavior and Supply

Very short Answer type Questions (1 Mark)

1. Marginal Product becomes negative2. Total Fixed Cost curve is parallel to OX- axis because TFC is always positive even at

zero level of output.3. Fixed factors are those factor inputs whose quantity does not change as level of output

changes.4. The very short period when supply cannot be changed with the change in the price is

referred to as Market Period.5. Fall in the price causes a downward movement along the supply curve.6. When the value of the Co-efficient of Elasticity of supply is equal to one and supply

curve passes through origin is extended.

7. TVC Curve

8. False. At producers Equilibrium Marginal cost should be rising because falling MC causes more profit.

9. The supply of good decreases as the cost of production rises with the increase in input prices.

10. The vertical distance between ATC and AVC should fall with the increase in output as the difference between ATC and AVC is AFC and that falls with increases in output.

11. In the formula p stands for change in price (New price – Original price)

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Short Answer Type Questions

Ans. 1 ATC, AVC and MC Curves

Note:

• The vertical distance between ATC & AVC should decreases with increase in output.

• MC should cut AVC and ATC at its minimum point.• The Minimum Point of AVC should come before minimum point of ATC.

2. Distinction between Total Fixed Cost &Total Variable Cost

Total Fixed Costs Total Variable CostsDo not vary with the quantity of output produced

Vary with the quantity of output produced

Can never be zero in the short run. Have to be incurred even if production falls to zero

Can fall to zero in the short run, as they are directly related to the level of output produced

Example :- Rent Example :- wages

3. The following changes will take place :a) Total Revenue will rise at diminishing rate.b) Total Revenue is maximumc) Total Revenue falls

4 Output AR TC TR MC MR

1 10 10 10 - 102 9 11 18 1 8 MR>MC 3 8 14 24 3 64 7 18 28 4 4 Equilibrium MR= MC5 6 25 30 7 2 MC>MR

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At output level of 4 unit, the project is maximum as here MC = MR

5 Marginal Revenue of a firm is the additional revenue it earns when it sells an additional unit of the output.

Marginal Revenue = Change in Total Revenue Change in output

Since a Firm’s Price is constant, Marginal Revenue is also constant and AR also remains constant and is equal to MR at all output levels. (P = AR). The AR and MR curves are the same and are parallel to x- axis. (AR=MR=Price)

y

AR/MR AR = MR

0 x Output

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6 Output TVC AVC MC ∑ MC = TVC or TVC TVC AVC x Q Q Output

1 10 10 102 16 8 63 27 9 114 40 10 13

7

Output TC TFC TVC AFC AVC MC ATC0 20 20 0 - 0 - -1 25 20 5 20 5 5 252 28 20 8 10 4 3 143 30 20 10 6.6 3.3 2 104 36 20 16 5 4 6 95 45 20 25 4 5 9 96 60 20 40 3.3 6.6 15 10

Formula Used:

AFC = TFC , AVC = TVC , ATC = TC

Output Output Output

MC = TC TC at 0 level of output is TFC because TVC is 0 at this level.

Output

TC = TFC + TVC

8

I. False, AC can fall even when MC is rising when MC < AC and MC rising.

II. False, at an output of one unit ATC is equal to TC and MC is less than ATC as

MC is change in TVC only.

III. False, Total Revenue rising at diminishing rate when MR is falling but is positive.

TR falls only when MR is negative.

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9. Three causes of Rightward Shift of the Supply Curve.

I. Fall in Input Price

II. Improvement in Technology

III. Reduction in Taxation Rate

10. Difference between Contraction and Decrease in Supply

Contraction in Supply Decrease in Supply

A reduction in supply due to a fall in a price of the commodity is termed as contraction.

A decrease in supply is defined as a situation when the seller is willing to supply lesser of quantity at the same price.

Contraction results in downward movement on the supply curve

Decrease in supply results in leftward shift of supply curve because of Increase in Input Price or taxation rate etc.

There is a downward movement from A to B. When the price falls, from P to P1 and quantity supply at falls from Q to Q1.

There is leftward shift of supply curve from SS to SS’ because of change in factors other than price.

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11 ySA

Price SBSC

Quantity Supplied X

SA – Unitary Elastic Supply (ES=1)SB - Elastic Supply (ES>1)SC – Inelastic Supply (ES<1)

12Elasticity of Supply = % Change in Quantity Supplied

% Change in Price

q1 – q0 X 100 q0

% Change in Price OR 500-400

400 X 100

20

= 25 = 1.25 20

Elasticity of Supply is greater than 1, hence it is elastic.

Where –q1 – New Quantityq0 – Old quantity

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13

Given -

ES = 2

p (Change in Price) New Price – Old Price

= - 2 (8 – 10)

Q (Change in Quantity Supplied)

= 500

New Supply - ?

q0 = 1250 Where

New quantity Q = Change in Quantity Supplied

1250 – 500 p = Change in Price

= 750 p = Original Price

q0 = Original quantity

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14

In the above diagram SA and SB are two Supply Curves. SB Curve is more flatter. Elasticity of Supply measures impact of change in price on change in quantity supplied. When price rises from OP to OP1 than according to law of supply, supply increases from Q to Q2 for Supply Curve SA and from Q to Q1 for SB. Change in Quantity Supplied is greater (Q – Q1) for the flatter supply curve SB.

Long Answers

1. The effect on output when only one input is increased and all other inputs are held Constant relates to short period production function which is better known as Law of Variable Proportion.

Statement

As additional units of a variable factor are combined with a given level of fixed factors and technology, the marginal product of the variable factor first increases and then decreases.

Phase I – TP increases at increasing RateThis phase occur when Marginal Product is increasing. It ends at the point when MP is at its maximum value. Here total product increases at increasing rate.

Phase II TP is increasing at a diminishing rateIn this phase the marginal product is declining but is positive. It occurs between the point at which MP is at its maximum and ends when MP becomes zero.

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Phase IIIIn the third phase the Marginal Product is declining and is negative. Here the total product starts falling.

2. Three Factors affecting Supply of Ice Creams are as under:

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Price of Input

The production of ice cream will depend on the prices of input required to make ice cream i.e. milk, sugar, flavour etc. The increase in the price of input will lead to increase in cost of production thus reduction in production and supply.

Improvement in Technology

Any betterment in the technology of producing ice cream will lead to reduction in cost and increase in production and supply.

Government Taxation Policy

The various Indirect Taxes by the government on the production and sales of goods affect the cost of production. More Taxes less Supply and Less Taxes more supply.

Ans : 3Market Supply is the collective supply of all individual firms of a given commodity at a given price at a given time period.

Market Supply Schedule for ice creams MarketPer unit Price (Rs.) Quantity Supplied Quantity Supplied Supply (A+B) by Mother Dairy by Amul

(A) (B)

20 5 20 25 30 10 30 40 4040 15 40 55 55

Quantities of firm A & B has been horizontally added to find Market Supply

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Market Supply Curve

It is the graphical representation of the quantity of a community that all firms in a market are willing to supply at a given price at a given time, assuming all other factors influencing supply are held constant.

4 (a) Effect of technical progress on the supply of good

The betterment of technology reduces the cost per unit of production. This leads to

firm’s profit maximization and there is increase in the supply.

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4 (b) Impact of Drought on Market Supply of Wheat: The drought will result in less production of wheat which further cause less supply. So the supply S Curve will shift leftwards to S1.

5. Producer’s Equilibrium is the level of output produced and sold by a firm that maximizes its profit.According to MC- MR Approach, the level of output that maximizes the profit should fulfill two conditions.

Condition -1 – Marginal Revenue = Marginal CostOutput (Amt) MR(Rs) MC(RS)

1 10 5 2 10 3 MR>MC; Profit earned in the last unit, overall profit is 3 10 2 increasing, therefore increase output

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4 10 5 5 10 7 6 10 10 MR=MC= Producer’s Equilibrium 7 10 13 MR<MC Loss on the last unit overall profit is decreasing; 8 10 15 therefore, decrease output.

Condition-2 Marginal Cost should be rising – As long as Marginal Cost is falling producers’ keep on maximising profit. So it is only when MC rises and becomes more than MR, producer’s start incurring loss.

6 (a) False . Diminishing Returns to factor starts when the Marginal Cost start falling. At this point Average Cost is rising because MC>AC.

(b) True. AC and AVC curve can not intersect each other though the vertical distance between them keeps on reducing with Increase in output. The reason behind this is falling AFC which can not be zero as TFC cannot be zero.

(C) True . Supply remains constant in the Market Period because Market Period is the time period when supply can not be changed to any change in the price level. The time is very short for any changes.

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QUESTIONS ON MARKET COMPETITION AND MARKET

EQUILIBRIUM (PRICE DETERMINATION)

Very Short Answer Questions (1 mark)

1 Under which market form a firm is a Price Taker?

2 Draw a Demand Curve under Perfect Competition.

3 Define Equilibrium price.

4 When does the situation of excess supply Curve arise?

5 What is the Profit Maximisation condition for Perfect Competition?

Short Answer Questions (3-4 marks)

1Why is a firm under Perfect Competition a price taker?

2Explain three feature of Perfect Competition.

3Explain the determination of Equilibrium Price under Perfect Competition with the help of

Schedule.

4Show that an increase in demand leads to a fall in the price of the commodity.

5Diagrammatically represent the impact of a decrease in Supply on Equilibrium Price.

6What will be the impact of increase in excise duty on the Equilibrium Price and Quantity of a

Commodity? Use diagram.

7Explain the feature’ Large number of firms and Buyers under Perfect competition’.

Long Answer Questions ( 6marks)

1. How does an increase in price of Steel affect the equilibrium price and quantity of

cars? Explain with the help of diagram.

2. With the help of a diagram explain how a rise in the income level impacts the

Equilibrium Price of shirts.

3. “There is a Simultaneous change in demand and supply of a Commodity and

Equilibrium price increases”. Explain this with the help of a example.

4. Explain the following features of Perfect competition:

a) Large number of firms and buyers

b) Homogeneous Product

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ANSWERS OF PERFECT COMPETITION AND MARKET

EQUILIBRIUM (PRICE DETERMINATION)

VERY SHORT ANSWER TYPE QUESTIONS (01 MARK)

1. Under Perfect Competition a firm is a price taker.2. Demand Curve under a Perfect Competition.

Price AR/ Demand Curve

X

3. Equilibrium Price is the price of a commodity at which its quantity demanded equals to quantity supplied in the market.

4. The situation of Excess supply arise when at a given price, the market supply of a commodity is more than its market demand.

5. The firm maximises profit in perfect competition where MR = MC since AR = MR in perfect competition. So we can also say P = AR = MR = MC

SHORT ANSWER TYPE QUESTIONS (3-4 Marks)

1. FIRM IS A PRICE TAKER IN PERFECT COMPETITION A seller is a price taker in perfect competition. In perfect competition, there are a large number of buyers and sellers in the Market. Each seller sells so little and each buyers buys so little that none of them is able to influence the price in the market. The Industry as a whole determines the price with two market forces demand and supply.

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Ans 2. Three Features of Perfect Competition:i) Very Large number of Buers and Sellers:There is such a large number of buyers

and sellers that none of them is in a position to influence the price in a market. The price of good is determined by the whole industry.

Homogeneous Product: Product sold in this kind of market are homogeneous or identical in every respect like quality, size, design, colour etc. The products are perfect substitutes of one- another.

iii) Free Entry and Exit: Buyers and sellers are free to enter or leave the market at any time they like large profit will induce firms into the market and loss exit if any.

3 Determination of Equilibrium price under Perfect competition: Price is determined in a perfectly competitive market at a point where Market Demand is equal to Market Supply.

Demand and Supply SchedulePrice (Rs) Market Demand Market Supply Situation 20 120 40 Demand>Supply 30 100 60 Demand>Supply 40 80 80 Demand=Supply 50 60 100 Demand<Supply 60 40 120 Demand<Supply

In the schedule given above, at the price of Rs 40 per unit the demand and supply are equal to each other. Before this point there is competition among the buyers and therefore prices rise till Demand and Supply are not equal once again. In case of Excess supply, there is competition amongst sellers which leads to the fall in the price till it reach to equilibrium level.

4. Increase in Demand leads to a fall in the price of the commodity.

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This can happen when increase in supply is more than increase in Demand. In the diagram the initial equilibrium is at E point where OP is the price and OQ is the quantity. Then demand curve shifts to its right due to increase in supply, which is more than increase in demand. Due to this change price falls to P1 and new equilibrium point is E1, where the market price is OP1 and Market equilibrium quantity is OQ1.

5 Impact of a decrease in Supply on Equilibrium Price and Quantity when demand is perfectly elastic.

In the above diagram initial market equilibrium is achieved at E point where market price is OP and Market equilibrium quantity OQ. When supply decreases and shifts to left new equilibrium point is achieved at E1 point where Market Price OP remains same but the quantity is reduced from OQ to OQ1.

6 . Impact of increase in excise duty on the equilibrium price and quantity of a commodity.

Any increase in the rate of excise duty by the government will increase cost of production for the producer. This will result in decrease in supply.

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The decrease in supply creates the situation of Excess Demand. Competition amongst buyers raises the price till Demand and Supply are once again equal. Price rise results in extension in supply and contraction in demand. New Market equilibrium establishes at E1 point.

7 Large numbers of buyers and sellers under perfect competition

There is large number of buyers and sellers, each firm or seller in a Perfectly Competitive market- forms an insignificant part of the market. So, no single seller has the ability to determine or influence the price at which commodity is sold. The forces of market demand and supply determine the price. So a firm is a Price Taker while an industry is Price Maker.

LONG ANSWER TYPE QUESTION

1. With the increase in the price of steel the marginal cost of production of car will increase. This will result in decrease in supply. Assuming that Demand for the car remains constant the market equilibrium price will rise.

In the above diagram with Left ward shift of supply curve the price goes up from OP to OP1 and quantity falls to OQ to OQ1.

2. With a rise in the Income Levels of the consumer, the demand for the product will increase. This will result in a rightward shift of demand curve. Assuming supply to be constant, the rise in demand creates excess demand. This will cause competition among the buyers and sellers.

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The price will rise till demand and Supply are once again equal. So the Market Equilibrium price as well as quantity will rise. In diagram initial equilibrium price OP rises to OP1 and quantity OQ to Q2.

3. There is a simultaneous change in demand and supply of a commodity and equilibrium price increases. This can happen in following two situations-

a. When the supply of a commodity increases less than the increase in demand, then the equilibrium price Increases (P-P1) and the equilibrium quantity also increases (Q-Q1).

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b. When the supply of a commodity decreases more than the decrease in demand, then equilibrium price (P-P1) increases and equilibrium quantity decreases (Q-Q1)

4 (a) Very large number of firms and buyers

There are a very large number of buyers and sellers in this form of market. No individual buyer can influence the market price. Similarly, each firm or seller in a perfectly competitive market forms an insignificant part of the market. So, no single seller has the ability to determine the price at which the commodity is sold. It is the market forces of Demand and Supply that determine the price of a commodity, so firms become price taker and industry becomes price maker.

(b) Homogeneous Product

In a perfectly competitive market, firm sell homogeneous products. Homogeneous products are identical in all respects i.e. there is no difference in packaging, quality, color etc. They are perfect- substitutes for each other. Since the product of one firm has a large number of identical substitutes available for it, demand is Perfectly Elastic.

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HIGH ORDER THINKING SKILL (HOTS)

In Board Exams the HOTS questions of 1 Mark each are asked which are based on the entire Textbook of Economics-Class XII

The questions given below are exemplar based on selected text. Please give orientation to students so that they read the text carefully and learn to answer correctly and precisely.

Try to develop your own HOTS Question Bank in similar pattern.

Q.1 What do you mean by Micro Economics? Q.2 What do you mean by scarcity of resources? Q.3 What do you mean by economizing of resources? Q.4 Give two examples of micro economic variable. Ans. Demand, Supply, individual price of a commodity. Q.5 What do you mean by economic problem? Q.6 What factors lead to shift of the PPC? Q.7 How does the technological advancement or growth of resources shift the PPC to the right? Q.8 Define marginal opportunity costs? Q.9 What does a rightward shift of a demand curve mean? Q.10 What does a leftward shift of a demand curve mean? Q.11 State the condition of consumer’s equilibrium? Q.12 What is meant by Cross Price effect? Q.13 What do you mean by marginal utility? Q.14 What do you mean by derived demand? Q.15 What is demand function? Q.16 How does availability of close substitutes of a good affect elasticity of demand of the

good? Q.17 What is meant by elasticity of demand? Q.18 What is meant by price elasticity of demand? Q.19 What is production function? Q.20 What are normal goods? Give two examples. Q.21 What are substitute goods? Give two examples. Q.22 When a good called inferior good? Q.23 What happens to the demand for a good when the price of a substitute goods falls? Q.24 What is the value of elasticity of on a rectangular hyperbola demand curve? Q.25 What is meant by marginal physical product? Q.26 When TPP is maximum what will be the MPP? Q.27 What is meant by cost? Q.28 What is meant by marginal cost? Q.29 Define variable cost? Q.30 Can the average cost be less than the marginal cost when average cost is rising? Q.31 When AC is rising what is the relationship between MC and AC?

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Q.32 What is meant by marginal revenue? Q.33 What is meant by Producer’s Equilibrium? Q.34 Define market supply.

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PART-B

Introduction Macroeconomics

Abstract

After completing the units on Micro-Economics in Part 'A' of the syllabus, the present unit deals with the contents of Macro-Economics. A brief introduction to Macroeconomics and comparison of Micro and Macro has also been explained. Same basic concepts like Consumption goods, Capital goods, Final goods, Intermediate goods, Stock and Flow, Gross Investment and Depreciation has also been explained in simple words and examples wherever necessary, are given for better comprehension. The Circular Flow of Income method of calculating National Income - Value Added or Product Method has been explained. Several terms like 'Injections' to the flow and. 'Leakage' from the flow and its impact on Circular Flow has also been taken up. Brief concept of National Income, its calculation under Value Added Method is also given. An attempt has been made to simplify it so that you can also explain to students accordingly.

Teaching Points

• National Income and Related Aggregates.

• Some Basic Concepts: Consumption goods, Capital goods, Final goods, Intermediate goods, Stocks & Flow, Gross Investment and Depreciation.

• Circular Flow of Income method of calculating National Income - Value Added or Product method.

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1. Introduction to Macro economics

Friends before you begin with Part-B Introduction to Macro Economics, it is essential that

you, yourself develop an understanding of what Macroeconomics is and how it is different

from Microeconomics. You must have noticed that these terms are invariably used by all;

but as Economics Teacher you must have a deeper insight about what these terms connote

and make students understand in simpler words how Macroeconomics is different from

Microeconomics and also how both are important for understanding Individual Behaviour

and Aggregated Indicators i.e. GDP, Unemployment Rate, Price Indices etc.

Macroeconomics

Microeconomics is derived from Greek Prefix "macr(o)" meaning "large" + economics)

is a branch of economics dealing with the performance, structure, behavior, and decision

making of the entire economy. This includes a national, regional, or global economy.

Microeconomics and Macroeconomics are two most general fields in Economics. (From

Wikipedia, the free encyclopedia).

1.1 What is the difference between Microeconomics and Macroeconomics?

Microeconomics is primarily focused on the Individual Agents i.e. Firms and Consumers

and how their behaviors determine Price and Quantities in specific markets.

Macroeconomics is a broad field of study. It studies Aggregated Indicators such as GDP,

Unemployment Rates, and Price Indices to understand how the whole economy functions.

Macroeconomists develop models that explain relationship between factors such as

National Income, Output, Consumption, Unemployment, Inflation, Saving, Investment,

International Trade and International Finance.

Macroeconomics models and their forecasts are used by both Governments and large

corporations to assist in the development and evaluation of economic policy and business

strategies.

Fiscal Policy and Monetary Policies are good examples of how economic management is

achieved through these government strategies.

It is also vital to point out here that to avoid major Economic Shocks, such as Great

Depression, Recession, Melt down etc., Government makes adjustments through policy

changes, they hope, will stabilize the economy.

2. Same Basic Concepts

Computation of National Income is important as it reflects the leveled growth &

development of any country. But before you introduce children with the concept, meaning

and definition of National Income/GDP and other related terms, introduce and explain the

basic concepts/terms which will invariably be used in the computation of National Income.

These concepts are explained briefly as under:

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2.1 Consumption Goods

Consumption refers to the act or a process to consume which means using up of goods and

services by consumers for satisfaction of their wants. Consumption good or service is that

which is used (without further transformation in production) by Households or

Government units for the direct satisfaction of individual needs or wants or the collective

needs of members of community.

It can also be defined as any commodities that are used by the household for their personal

use.

Consumer goods are final goods specifically intended for mass market. These goods do not

include investment, for example Bread, butter, milk, tea, coffee, etc. which are directly

used by consumers for satisfaction of their needs. These are example of One Time

Consumption goods (also known as single use consumer goods) but there can be

examples like machine, furniture, readymade clothes which are repeatedly used but they

are used directly and hence fall in the category of Durable Consumption Goods. Hence

consumer goods are the end result of the production.

2.2 Capital Goods

Goods that are used in producing other goods, rather than being bought by consumers

directly for satisfaction of their needs are called Capital Goods. These are tangible Explain

to students that final goods may be divided in to two categories i.e. Consumer goods &

Producers goods. Assets of an organization which are used to produce goods and services

are called Capital goods. These goods include items such as Buildings, Equipments, and

Machinery etc. Capital goods are not used up by producer in a single year of production.

These exist for many years and are repeatedly used over a period of time.

Capital goods may undergo capital improvement which typically extend their life and

increases their productivity.

These are also known as producer's goods as they are being used to create other goods.

2.3 Final Goods

Final goods are goods that are ultimately consumed rather than used in the production of

other goods. It refers to finished goods which are sold in the market for consumption &

investment purpose. These goods satisfy the wants of ultimate producers or consumers or

both. Buying of furniture by a household consumer for his house is final good for him

whereas the same when bought by a producer for his office is producer’s final goods.

Another example can be flour used by the household are final good whereas the same

flour used by the baker is a producer's goods.

Here make a distinction between Consumer goods & Producers goods under the

category of Final Goods

On the lines of examples given above, ask students to think of different examples with

justification as to which category of final goods they fall in. i.e. Consumer goods or

Producer goods.

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2.4 Intermediate Goods

All those goods which are used by the producers for producing other goods are known as

Intermediate goods.

These goods are used as inputs in the production of other goods such as partially finished

goods. These goods are demanded for producing other goods. Thus intermediate goods are

those goods which are sold by one industry to another either for resale or for producing

other goods. Stocks of Raw Materials and Semi finished goods fall under the category of

intermediate goods. Another example can be of raw cotton used for the production of yarn

is an Intermediate good and when the same yarn is sold to the owner of the textile mill for

the production of cloth then the same yarn becomes intermediate good for the owner.

2.5 Stocks & Flows

Stocks & Flows have natural meaning in many contexts outside of business and its related

fields. Let us define/give meaning to both the terms 'Stock' & 'Flow' and then show the

relatedness of the two and how these are impacting on an economy/business.

Stock

A 'Stock' refers to the value of goods & services at a particular point of time. It is an entity

that is accumulated over by inflows and/or depleted by outflows. Therefore, we can say

that the 'stock' can only be changed by a 'flow'.

'Stocks' typically have a certain value of each moment of time, for example the size of

population at a certain moment. i.e.

As per census 2001, the population of India stood at 102 billion, whereas according to

1991 census the population of India 'stood at 84.6 billion. The change/Increase in the

figure at two census i.e. 1991 & 2001 is because of the additional population (flow) in 10

years.

Flow

It is change in stock over period of time. Change refers to inflows (adding to the stock)

and outflows (subtracting from the stock). Flows typically are measured over a certain

interval of time. For example the increase in population census 1991 to census 2001 is due

to increase in number of births in a period of 10 Years. To conclude we may say that

'Stock' is a Static concept whereas 'Flows' represents Dynamic concept.

2.6 Depreciation

To explain the meaning of depreciation, ask students to recall the meaning of Capital

Goods (i.e. fixed assets like Machinery, Building, Equipment, Furniture etc.). And also

elaborate upon the nature and usage of such capital goods for repeated use for production

of goods, and then state that these Capital goods diminish in value & efficiency when they

are repeatedly used. Now explain that this fall in the value of assets (Fixed Assets) occur

due to wear & tear, obsolescence, efflux of time, is termed as Depreciation

'Depreciation' also stands for the measure of the decrease in value of an asset over a

specific period of time. It can also be defined as the decrease in the economic potential of

an asset over its productive & useful life.

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Depreciation results because of the following reasons:

• Wear & tear (due to repeated use in production of goods and services)

• Efflux of time (with passage of time- Book Value vs. Present Value.)

• Obsolescence (Outdated due to introduction of new technology/products)

Depreciation is in fact a non-cash expense or a provision which is created against the

value of an asset spread over its useful life and is set aside (charged against profit each

year), so that there are sufficient funds for its repair/maintenance or replacement. Most

assets lose their value over time & have to be replaced once the end of their useful life

is reached.

Example

Machinery is purchased for Rs.2, 00,000.Its estimated useful life is suppose 10

years. Depreciation, under the straight line method is charged at 10% of the cost

of the asset. Hence Rs.20, 000 will be set aside as depreciation every year for 10

years(Spread across the estimated life of the asset -10years) so that firm can use

the amount for repairs or maintenance or for replacement at the end of its useful

life i.e. 10 years

Even the amount of depreciation can be calculated as: (assuming there is no salvage value

at the end) i.e. Cost of Asset-*Salvage Value /Estimated Life of the Asset

Cost of asset Rs. 2, 00, 000 -Zero

----------------- -= -------------------=Rs. 20,000(which comes to 10 % of the cost)

Estimated life of the asset 10 years

*Salvage Value is the amount which it is expected to fetch at the end of estimated life of

Asset.

There are many methods of providing depreciation, the knowledge of which is not

required here.

2.7 Gross Investment

It is a measure of additions to the capital stock that does not subtract the depreciation from

the existing capital. These may be machine, tools & equipments, buildings, office spaces,

store houses and infrastructure etc. The capital goods produced in a year do not constitute

an addition to the capital stock already existing. A significant part of current output of

capital goods goes in for maintains or replacing part of the exiting stock of capital goods.

That indicates these capital goods include an element of Depreciation (see the meaning

explained before as to how they reduce the value of Gross Investment)

Therefore in order to compute the Net Investment we deduct depreciation from Gross

Investment i.e.

Net Investment = Gross Investment - Deprecation

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3 MEASURING THE CIRCULAR FLOW OF INCOME

The Circular Flow of Income is a simple model of economy showing flows of goods &

services and factors of production between firms and households. In the absence of government

and international trade, this simple model shows that households provide the factors of

production for firms who produce grads and services, in return the factors of production receive

factor payments i.e. Land receives rent, Labour receives wages, Capital receives interest,

Organization earns profits (losses). These factor incomes - wages, rent, interest and profits are

spent on the output of firms. The basic flow is shown in the diagram below:

Diagram-1 (Circular Flow of Income)

In reality the households do not spend all their current income. The 'savings' by them

represents a leakage from the circular flow. Firms also have, besides, consumer spending,

investment spending. This is injected to the circular flow of income, as it does not

originate from consumer's current income.

Additional leakage and injections are also thee in the circular flow in real world. i.e.

Government's spending are injected and taxation will leak from it. Similarly Export

flows will be injected and import flows leaked.) But for class XII students simple circular

flow of Income is sufficient. Once children understand how and what transactions result in

injections to the flow and what results in leakage, the examples can be given as they very

well understand what Export means and what Import results in, where Govt. spends and

how and why people pay taxation which is revenue for Government.

( 118 )

Any Economic Activity is flow

Flow can be of two types:

(i) Flow of goods & Services.

(ii) Flow of money.

How these flows are measured and also the volume and magnitude of flow indicates the

amount of economic activity.

Economists maintain that there are three possible ways of measuring this flow. The

computation under all methods of measurement remains same. The three methods of

measuring flow of income are as under:

I The output Method Total amount of goods and services produced in one

year.

II. The Expenditure Method The total amount of spending: Domestic, consumers,

Firms, Government and Foreigners.

III. The Income Method: The total incomes earned by factors of production involved

in the production of goods & services in the period of one year.

4 What is National Income Accounting?

N.I.A. is the process where by countries measures these flows. The process of calculating

National Income (Domestic Income + Net Factor Incomes earned from Abroad) is different

under all three methods but the Gross Domestic Income/Gross Domestic Product remains

the same. The National Income is a major important yardstick and has variety of uses

like-

• Determining the extent of Economic Growth.

• Measuring changes in Living Standards overtime.

• In making comparisons of Economic Performance and Living Standards between

countries.

• Examine and judge the Performance of different Sectors of Economy.

4.1 Measuring National Income

To measure how much output, spending and income has been generated in a given time

period, we use National Income Accounts. These accounts measure three things:

1. Output

2. Spending

3. Income

( 119 )

Before computing the National Income the meaning of term 'National Income' should be

taken up.

*It is taken up in detail in the next week syllabus.

National Income

National Income is the money value of final flow of output of goods & services produced

within an economy over a period of time, usually one year and net factor income earned

from abroad.

National Income (NI) = NNP at Factor Cost

** (will be taken up in detail in the next module)

Now explain these terms:

1. Gross Domestic Product

Gross Domestic Product (GDP) is the total market value of the final goods & services

produced within the domestic territorial limits of country over a period of time (1 Year).

There are three ways of calculating GDP which is based on the different methods of

calculating Nation Income i.e. Income method, Expenditure method & Value Added

method; however the computed value of GDP remains the same under all methods.

• Expenditure Approach It measures GDP as the sum of expenditures of** final goods

and services.

• Final Goods Those goods and services that are not purchased for the purpose of

producing other goods and services or for resale.

• Income Approach It measures GDP as the sum of incomes of factors of production

(wages, salary, rent, Interests etc.)

• Value Added Approach It measures GDP as the sum of value added at each stage of

production (form initial to final stage)In Product Method the aggregate value of goods

and services produced in a year is calculated, The term that is used to denote the net

contribution made by a firm is called its value added.

2. Net Factor Income From rest of world / (Net Factor Income Earned from abroad

(NFIA)

Net Factor Income from rest of world comprises of net income receipts from rest of the

world such as (i) Investment incomes including Interests, Dividends and Branch Periods.

(ii) Earnings of residents working of road.

(iii) Other factor income of normal residents.

This item therefore represents the difference between factor incomes of residents from

abroad and income accruing to foreign.

( 120 )

Suppliers of Factor services

NFIA includes:

(i) Net* compensation of employee.

(ii) Net Income from property and entrepreneurship (Interest, Rent, Dividends & Profits)

including reinvested earnings of foreign companies.

Here:

Net stands for receipts of current income by residents abroad - Disbursement of current

incomes to Non - residents in India.

Here teachers can introduce the term Gross National Product where G.N.P. presents the

total income earned by the domestic citizens regardless of the country in which their

factors of production are located.

Since 'Depreciation' has already been explained even calculation and Impact of this on

GDP can also be taken up i.e. GDP includes the element of depreciation (Gross (G) in

GDP represents inclusion of depreciation and when depreciation is deducted from GDP, It

becomes Net Domestic Product.

NDP = GDP - Depreciation

*National Income - Meaning and Computation will be taken up in next unit.

Methods of calculating National Income-Value Added and Expenditure Method will

be covered in detail in next Module.

Technical Terms

1. Macroeconomics Macroeconomics is a broad field of study. It studies Aggregated

Indicators such as GDP, Unemployment Rates, and Price Indices to understand how the

whole economy functions. Macroeconomists develop models that explain relationship

between factors such as National Income, Output, Consumption, Unemployment,

Inflation, Saving, Investment, International Trade and International Finance.

2. Consumption Goods Consumption Good or service is that which is used (without further

transformation in production) by Households or Government units for the direct

satisfaction of individual needs or wants or the collective needs of members of community.

It can also be defined as any commodities that are used by the households for their

personal use.

3. Capital Goods Goods that are used in producing other goods, rather than being bought by

consumers directly for satisfaction of their needs are called Capital Goods. These are

tangible Explain to students that final goods may be divided in to two categories i.e.

Consumer goods & Producers goods. Assets of an organization which are used to produce

goods and services are called Capital goods. These goods include items such as Buildings,

Equipments, and Machinery etc. Capital goods are not used up by producer in a single

( 121 )

year of production. These exist for many years and are repeatedly used over a period of

time.

4. Final Goods Final goods are goods that are ultimately consumed rather than used in

the production of other goods. It refers to finished goods which are sold in the market

for consumption & investment purpose. These goods satisfy the wants of ultimate

producers or consumers or both.

5. Intermediate Goods All those goods which are used by the producers for producing

other goods are known as Intermediate goods. These goods are used as inputs in the

production of other goods such as partially finished goods. These goods are demanded

for producing other goods. Thus intermediate goods are those goods which are sold by

one industry to another either for resale or for producing other goods. Stocks of Raw

Materials and Semi finished goods fall under the category of intermediate goods

6. Stocks and Flow

Stocks & Flows have natural meaning in many contexts outside of business and its related

fields.

Stock

A 'Stock' refers to the value of goods & services at a particular point of time. It is an entity

that is accumulated over by inflows and/or depleted by outflows. Therefore, we can say

that the 'stock' can only be changed by a 'flow'.'Stocks' typically have a certain value of

each moment of time, for example the size of population at a certain moment or a

particular point of time.

Flow

It is change in stock over period of time. Change refers to inflows (adding to the stock)

and outflows (subtracting from the stock). Flows typically are measured over a certain

interval of time. For example the increase in population census 1991 to census 2001 is due

to increase in number of births in a period of 10 Years. 'Stock' is a Static concept whereas

'Flows' represents Dynamic concept.

7. Gross Investment It is a measure of additions to the capital stock that does not subtract

the depreciation from the existing capital. These may be machine, tools & equipments,

buildings, office spaces, store houses and infrastructure etc.

8. Depreciation It stands for the measure of the decrease in value of an asset over a

specific period of time. It can also be defined as the decrease in the economic

potential of an asset over its productive & useful life. This fall in the value of assets

(Fixed Assets) occur due to wear & tear, obsolescence, efflux of time, is termed as

Depreciation

Depreciation is in fact a non-cash expense or a provision which is created against the

value of an asset spread over its useful life and is set aside, so that there are sufficient funds

for its repair/maintenance or replacement. Most assets lose their value over time & have to

be replaced once the end of their useful life is reached.

( 122 )

9. Circular Flow of Income The Circular Flow of Income is a simple model of

economy showing flows of goods & services and factors of production between

firms and households. In the absence of government and international trade, simple

model shows that households provide the factors of production for firms who produce

grads and services, in return the factors of production receive factor payments i.e.

Land receives rent, Labour receives wages, Capital receives interest, Organization

earns profits (losses). These factor incomes - wages, rent, interest and profits are

spent on the output of firms.

10. National Income is the money value of final flow of output of goods & services

produced within an economy over a period of time, usually one year and net factor

income earned from abroad.

11. Gross Domestic Product (GDP) is the total market value of the final goods &

services produced within the domestic territorial limits of country over a period of

time, usually one year.

13. GNP is the total market value of the final goods & services produced within the

domestic territorial limits of country over a period of time (1 Year).

14. Net Factor Income From rest of world / (Net Factor Income Earned from abroad

(NFIA)

Net Factor Income from rest of world comprises of net income receipts from rest of the

world such as (i) Investment incomes including interests, Dividends and Branch

Periods.(ii) Earnings of residents working of road.(iii) Other factor income of

normal residents.

This item therefore represents the difference between factor incomes of residents from

abroad and income accruing to foreign.

Check Your Progress

1. State the difference between Micro and Macro-economics.

2. Distinguish between 'Stock' and 'Flow' give two examples of each.

3. State what represents 'Stock' and what represents 'Flow', give two examples each.

4. What are Intermediate goods'? Explain with example.

5. Define 'Depreciation'. State the causes of fall in the value of fixed assets.

6. Give meaning of 'Gross Domestic Product. How GDP is different form GNP?

7. Define Net Factor Income from abroad (NFIA). List the components of NFIA.

( 123 )

APPENDIXContent Analyses on the basis of Difficulty level

Answer key HOTS

Question Paper and Marking Scheme

Economic – class XII

Need Areas/ Content Analysis

Content Analysis on the Basis of Difficulty Level

1. Distinction between Micro Economics and Macro Economics. (E)

2. Economic Problems (With Examples)– a. What to produce b. How to produce c. For whom to produce

3. Production Possibilities Curve formation & definition. a. Demand

(D) b. Definition as Individual & Market demand. c. Why Downward Sloping Shape? d. Exceptions to the Law of Demand. e. Elasticity of Demand (Price Elasticity), Numericals f. Factors affecting Demand. g. Change in Demand / Shift in Demand.

4. Cost & Revenue (D) a. Forms of Market – with examples b. Basic concepts TR, AR and MR and its relation to

different Forms of Markets. 5. Supply (D)

a. Basic concepts b. Market Supply, Factors determining Supply c. Elasticity of Supply d. Measurement of Elasticity of Supply.

6. Market Equilibrium (VD)

a. Equilibrium Price and Quantity under Perfect Competition

b. Effects of change in Demand and Supply on the Equilibrium Price

7. a. Project Work on Economics (E to D)

b. Economics in our Daily Life/Applied part of Economics.

VD- Very Difficult

D- Difficult

E- Easy

HIGH ORDER THINKING SKILL (HOTS)

Answer Key for HOTS

Ans 1. It is the study of an individual part of the economic system, i.e., a firm, a house hold. Ans 2. When the demand of a good exceed its supply than it is called scarcity of resources. Ans3. Economizing of resources means, resources are to be used in such a manner that maximum output is to be obtained per unit of output. or If the production of a commodity is does not change with the increase in input variables than it is called optimum utilization of resources. Ans 4. Demand, Supply, individual price of a commodity. Ans 5. Economic problem is a problem of choice arising out due to limited resource and unlimited wants. Ans 6. The following are the factors; (i) Increase or decrease in resources (ii) Change in technology. Ans 7. Technological advancement shift the PPC to the right, because better technology means more can be produced with the given resources. Ans 8. Marginal opportunity costs are the ratio between additional loss of output and additional gain of output when some resources are shifted from Y use to X use. Ans 9. A rightward shift of a demand curve means an increase in demand for a product. Ans 10. A leftward shift of a demand curve means a decrease in demand for a product. Ans 11. Marginal utility in terms of money is equal to the price. Or _Marginal utility of a Product = Its Price Marginal Utility of a Rupee Ans 12. It means how the demand for one particular product is affected by the change in the

price of other product. Ans 13. MU is the additional utility derived from consumption of an additional unit of a

commodity. It means it is the utility from the last unit of a commodity consumed. Ans 14. It is the demand that has been derived from the demand for some other commodity it

help to produce. Ans 15. It refer to the functional relationship between the price and the quantity demanded of

a commodity. Ans 16. When the good has a large number of its substitutes, the demand for it is usually very

elastic. Ans 17. It is the responsiveness of demand to change in its various determinants, i.e., income of

the consumer, price of the commodity, price of related goods etc. Ans 18. Price elasticity of demand is the degree of responsiveness of demand for a commodity

to a change in its price. Ans 19. It is the functional relational relationship between the physical input and physical

outputs of a firm. It can be written as Q=f(f1, f2, f3…………fx) Ans 20. Normal goods are those goods whose demand increases with the increase in income of

the consumers. Ex. Milk, Cloth etc. Ans 21. Substitute goods are those goods which can be used in place of each other. Ex. Tea and

coffee, coca cola and pepsi cola.

Ans 22. When demand decreases with the increase in income. Ans 23. When the price of a substitute goods falls then the demand for a given good also falls. Ans 24. A rectangular hyperbola demand curve indicates unit elasticity f demand. Ans 25. MPP is an addition to the total product when an additional unit of a variable input is

employed. i.e., MPPn = TPPn – TPPn-1 Ans 26. MPP will be zero. Ans 27. Cost refers to the total expenses incurred in the production of a commodity. Ans 28. Marginal cost is addition made to the total post when an additional unit of a commodity

is produced. Ans 29. Variable costs are the costs which change with change in the level of output, e.g.,

expenditure on raw material, power and fuel etc. Ans 30. Yes Ans 31. MC AC Ans 32. Marginal revenue is the change in the total revenue, which results from the change in

the sale by one unit of output. Ans 33. Producer’s equilibrium is the level of output that gives a producer maximum profits and

he has no urge to change his output. Ans 34. Market supply refers to the aggregates of supply by all the firms in the market

producing a particular commodity.

Teachers' Manual in Economics For PGT 2012

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