Microeconomics Docs
Microeconomics Docs
Microeconomics Docs
1. Definition of economics.
Answer: Economics comes from the ancient Greek word “oikonomia”
Or “oikonomikos.” Oikonomikos translates to “the task of managing a household.”
French mercantilists used “economy politique” or political economy as a term for
matters related to public administration.
Definition: Economics is a social science discussing how goods and services are
produced using scarce resources, and distributed for consumption.
Top 3 definitions of economics by different authors:
Adam Smith’s definition of Economics:
Adam Smith was a Scottish philosopher, widely considered as the first
Modern economist. Smith defined economics as “an inquiry into the nature and
causes of the wealth of nations.”
Criticism of Smith’s definition
1. The wealth-centric definition of economics limited its scope as a subject and
was seen as narrow and inaccurate. Smith’s definition forced the subject to ignore
all non-wealth aspects of humane existence.
2. The Smithian definition over-emphasized the material aspects of well- being.
3. The Smithian prevents the subject from exploring the concept of resource
scarcity. The allocation and use of scarce resources are seen as a central topic of
analysis in modern economics.
Alfred Marshal’s definition of economics:
British economist Alfred Marshal defined economics as the study of man in the
ordinary business of life. Marshal argued that the subject was both the study of
wealth and mankind. He believed it was not a natural science such as physics or
chemistry, but rather a social science.
Criticism of Marshal’s definition
1. The Marshallian definition, like the Smithian definition, ignored the problem of
scarce resources, which possess unlimited potential uses.
2. Marshal’s definition restricted economics as a subject to only analyze the
material aspects of human welfare. Non-material aspects of welfare were ignored.
Critics of the Marshallian definition asserted that it was difficult to separate
material and non-material aspects of welfare.
3. The Marshallian definition does not provide a clear link between the acquisition
of wealth and welfare. Marshall’s critics claimed that it left the subject in a state of
perpetual confusion.
Lionel Robin’s definition of economics:
Lionel Robin, another British economist, defined economics as the subject that
studies the allocation of scarce resources with countless possible uses. In this 1932
text, “An Essay on the Nature and Significance of Economic Science,” Robbins
said the following about the subject: “Economics is the science which studies
human behaviour as a relationship between ends and scarce means which have
alternative uses.”
Criticism of Robbins definition
1. Robbin’s definition of economics transformed the subject from a normative
social science into a positive science with an undue emphasis on individual choice.
His definition prevented the subject from analyzing topics such as social choice
and social interaction theory, which are important topics within the modern
microeconomic theory.
2. Robbin’s definition prevented it from analyzing macroeconomic concepts such
as national income and aggregate supply and demand. Instead, economics was
merely used to analyze the action of individuals, using stylized mathematical
models.
Modern Definition of Economics
The modern definition, attributed to the 20th-century economist, Paul Samuelson,
builds upon the definitions of the past and defines the subject as social science.
According to Samuelson, “Economics is the study of how people and society
choose, with or without the use of money, to employ scarce productive resources
which could have alternative uses, to produce various commodities over time and
distribute them for consumption now and in the future among various persons and
groups of society.
Conclusion: Economics studies how individuals, businesses, governments, and
nations make choices about how to allocate resources. Economics focuses on the
actions of human beings, based on assumptions that humans act with rational
behavior, seeking the most optimal level of benefit or utility.
#Micro Economics:
1. Microeconomics analyzes the market mechanisms that enable buyers and sellers
to establish relative prices among goods and services.
5. Microeconomic theory typically begins with the study of a single rational and
utility maximizing individual. To economists, rationality means an individual
possesses stable preferences that are both complete and transitive.
The technical assumption that preference relations are continuous is needed to
ensure the existence of a utility function. Although microeconomic theory can
continue without this assumption, it would make comparative statics impossible
since there is no guarantee that the resulting utility function would be
differentiable.
7. The utility maximization problem is the heart of consumer theory. The utility
maximization problem attempts to explain the action axiom by imposing
rationality axioms on consumer preferences and then mathematically modeling and
analyzing the consequences. The utility maximization problem serves not only as
the mathematical foundation of consumer theory but as a metaphysical explanation
of it as well. That is, the utility maximization problem is used by economists to not
only explain what or how individuals make choices but why individuals make
choices as well.
The sources and methods employed in the collection of data differ from
investigation to investigation. The result therefore, may differ even with the same
problem.
(iii) The inductive method is time-consuming and expensive.
The above analysis reveals that both methods have weaknesses. We cannot rely
exclusively on any one of them. Modern economists are of the view that both these
Methods are complimentary. The partner sand not rivals. Alfred Marshall has
rightly remarked. Inductive and Deductive methods are both needed for scientific
thought as the right and left foot is both needed for walking.
A positive science only explains what is and normative science tells us what ought
to be, right or wrong of a thing positive science describes, while the normative
science evaluates. When we say, for instance, that the businessmen, while making
decisions, use profit maximization as the criterion, it is positive economics, but
when we ask "ought they use this criterion, " we enter the field of normative
economics.
Definition of positive economic:
Positive economics is concerned with the development and testing of positive
statements about the world that are objective and verifiable. Positive statements
can be tested, at least in theory, if not always in practice. For example: If the price
of fish were higher, people will buy less. Or, as the money supply increases, the
price level will rise.
Definition of normative economic:
Normative economics derives from an opinion or a point of view. Thus the words
'should', 'ought to ', or ' it is better to ' frequently occur. The validity of normative
statements can never be tested. For example: people who earn large incomes ought
to pay more income tax than people who earn a low income.
Description of positive or normative economics:
* Positive economics is the study of economic issues subject to verification. It
deals with economic issues related to the past, present and future. The statements
in positive economics represent ' what was', what is ' and 'what would be '. Here,
facts and figures are used to verify the truth.
* Normative economics refers to the study of economic issues which involve a
value judgment. It deals with the opinions of economists related to solutions for
economic issues or problems. The statements in normative economics represent
'what ought to be '. It involves value judgment and opinions by economists.
Whether or not raising farm prices in developing countries is a good thing is
another question. To say that 'raising farm Prices in developing countries is a good
thing ' is a normative statement. On the other hand, the assertion that 'raising farm
prices in developing countries will improve rural incomes in those countries ' is a
positive statement. Why? Because, again, it could, in theory, be tested. It does not
say that rural incomes in developing countries ought to be raised, just that higher
farm prices will have that effect.
We will notice that positive statements can often be broken down into a cause and
an effect. Whether the effect is described or not is a normative question that will
depend upon the subjective opinion of those affected. Economists practicing
positive economics can help analyze the effects in greater detail by breaking them
down into positive and testable statements in the way we have done above. They
can advise policymakers in government, business and other organizations both on
the effects of specific policies and on the specific policies that need to be
implemented in order to achieve desired effects. However, it is ultimately
politicians and managers, and the people that empower them, that decide - on the
basis of normative judgments - what is ’desirable ' or what is not.
It is important to realize that economists practicing positive economics do,
however, make value judgments. Any analysis involves an element of subjectivity.
Economic decisions have many different effects and it is rarely possible to
examine them all in detail.
Indeed, whether to economic a problem from an economic perspective at all, or
whether to focus instead on alternative perspectives, such as those provided by the
disciplines of sociology, biology or political science, depends in large part on
normative/subjective views of the world.
9. Discuss about opportunity cost.
Answer: Opportunity cost is the next best alternative foregone.
● Opportunity cost is the forgone benefit that would have been derived by an
option not chosen.
● To properly evaluate opportunity costs, the costs and benefits of every
option available must be considered and weighed against the others.
● Considering the value of opportunity costs can guide individuals and
organizations to more profitable decision-making.
For example:
If we spend that 20$ on a textbook, the opportunity cost is the restaurant meal we
cannot afford to pay.
If you decide to spend two hours studying on a Friday night. The opportunity cost
is that you cannot have those two hours for leisure.
Opportunity Cost Formula and Calculation:
Opportunity Cost=FO−CO
Where:
FO=Return on best foregone option
CO=Return on chosen option
The formula for calculating an opportunity cost is simply the difference between
the expected returns of each option.
Say that you have option A: to invest in the stock market hoping to generate capital
gain returns. Option B, on the other hand is: to reinvest your money back into the
business, expecting that newer equipment will increase production efficiency,
leading to lower operational expenses and a higher profit margin.
Assume the expected return on investment in the stock market is 12 percent over
the next year, and your company expects the equipment update to generate a 10
percent return over the same period.
The opportunity cost of choosing the equipment over the stock market is (12% -
10%), which equals two percentage points. In other words, by investing in the
business, you would forgo the opportunity to earn a higher return.
The concept of opportunity cost does not always work, since it can be too difficult
to make a quantitative comparison of two alternatives. It works best when there is a
common unit of measure, such as money spent or time used.
Economics is the study of the general methods by which men cooperate to meet
their material needs. According to the French economist J.B.Says, Economics is
the science which treats wealth. There is a great controversy among economists
regarding the nature of economics, whether it is science or arts. It is however,
necessary to understand the true nature of economics
Economics as a Science:
If we have a clear concept about science, we can easily decide whether economics
is a science or not.
Basically, science is a systematic study of knowledge and fact which develops the
correlation-ship between cause and effect.
There are the following characteristics of any science subject, such as;
1) It is based on a systematic study of knowledge or facts;
2) It develops correlation-ship between cause and effect;
3) All the laws are universally accepted;
4) It can make a future prediction;
5) It has a scale of measurement;
According to some economists, ‘Economics’ has also several characteristics
similar to other science subjects.
1) Economics is also a systematic study of knowledge and facts. All the theories
and facts related to both micro and macroeconomics are systematically collected,
classified and analyzed.
2) Economics deals with the correlation-ship between cause and effect.
3) All the laws of economics are also universally accepted, like, the law of
demand, the law of supply, the law of diminishing marginal utility etc.
4) Theories and laws of economics are based on experiments, like, the mixed
economy too is an experimental outcome between capitalist and socialist
economics
5) Economics has a scale of measurement. Such as money is used to measure rod
in economics.
The human development index (HDI) is used to measure the economic
development of a country.
All these lead us to the conclusion that economics is a part of science.
Economics as an Arts:
Economics is also considered an art. Science gives us principles of any discipline
however, arts turn all these principles into reality. It is a science in its methodology
and an art in its application. It has a theoretical aspect and is also an applied
science in its practical aspects. According to T.K.Mehta,
`Knowledge is science, the action is arts.’ Therefore, considering the activities in
economics, it can be claimed as art also, because it gives guidance to the solutions
of all the economic problems. Therefore, from all the above discussions we can
conclude that economics is neither a science nor an arts only. However, it is a
golden combination of both. Hence, economics is considered as both a science as
well as art.
—◑—
Unit:2 Theory of Demand
Chapter: 5- Utility Analysis of Demand
UNITS
UTILITY
CONSUMED
POINT DERIVED (PACKETS OF
(UTILS)
CHOCOLATES)
C 3rd Packet 50
D 4th Packet 25
UNITS
UTILITY
CONSUMED
POINT DERIVED (PACKETS OF
(UTILS)
CHOCOLATES)
E 5th Packet 0
(Point
of
Satiety)
F 6th Packet
She ate the first one being delighted and was extremely satisfied with consuming
it. She then grabbed the second one, but her satisfaction level from this packet
was slightly low.
Refer to the table. Where will our consumer stop? It depends upon the price. If the
price is 6 Paise per toast, then he will stop at the 5th, for there the marginal utility
is equal to the price (marginal utility being represented in Paise units). If the price
is 11 Paise per toast, he will stop at the 4th, and, if they are free, then he will go on
consuming till the additional utility comes down to zero (i.e., up to the 6th unit).
He will not go beyond this point because disutility will be the result. The consumer
stops at a point where the price and the marginal utility are just equal. This is
called the marginal purchase and the extra utility at this point is called the marginal
utility. It is a point where we consider just worthwhile to purchase, for here the
pain of parting with the money and the benefit derived from the purchase of the
commodity just balance.
Marginal utility has also been defined as the addition made to the total utility by
the consumption of the last unit considered just worthwhile. In other words, it may
be defined as the change in total utility resulting from a unit change in the quantity
of the commodity consumed. Thus, if we buy 5 toasts, the 5th is the marginal toast.
But marginal utility is not the utility of the 5th toast, because all the toasts are
supposed to be alike. It only refers to the addition made to the previous total by the
consumption of this particular toast. Marginal utility is the increase in total utility
resulting from the consumption of the marginal unit. The following formula may
be used to measure it.
The margin is not something rigid or fixed. It shifts forward and backward
according to changes in price. If the price fails, it will become worthwhile to
purchase more of the commodity and the margin will descend and vice-versa.
Schedule:
Money Income 60 Tk.
Price of Good ‘X’ 10 Tk.
Price of Good ‘Y’ 5 Tk.
1 100 35 10 7
2 90 30 9 6
3 80 25 8 5
4 70 20 7 4
5 60 15 6 3
6 50 10 5 2
So we can see that our ‘Marginal Utility of Money’ of both goods has been
matched in 3 places(Highlighted).
Now let us find out where the consumer will be most satisfied with the help of the
consumer’s Money Income.
Suppose the marginal utility of money is constant at 7 units, the consumer will buy
4 units of commodity ‘X’ and 1 unit of commodity ‘Y’.
His total expenditure will be,
(Tk 10 × 4) + (Tk 5 × 1) = 45 Tk.
Here we can see that the whole income which is 60 Tk. Has not fully spent. So the
consumer will not get full satisfaction. And he will not be in equilibrium.
Again suppose the marginal utility of money is constant at 5 units, the consumer
will buy 6 units of commodity ‘X’ and 3 unit of commodity ‘Y’.
His total expenditure will be,
(Tk 10 × 6) + (Tk 5 × 3) = 75 Tk.
Here the consumer will not be able to afford it because his money income is Tk.
60. So he will not get any satisfaction. As a result, he will not be in equilibrium.
Lastly suppose the marginal utility of money is constant at 6 units, the consumer
will buy 5 units of commodity ‘X’ and 2 unit of commodity ‘Y’.
His total expenditure will be,
(Tk 10 × 5) + (Tk 5 × 2) = 60 Tk.
At this expenditure his satisfaction is maximized because he has spent all of his
money income and he will be in equilibrium.
1. Indivisibility of Goods:
The theory is weakened by the fact that many commodities like a car, houses etc.
are indivisible. In the case of indivisible goods, the law is not applicable.
The theory is based on the assumption that the marginal utility of money is
constant. But that is not really so.
Marshall States that the price a consumer is willing to pay for a commodity is
equal to its marginal utility. But modern economists argue that, if two persons are
paying an equal price for given commodity, it does not mean that both are getting
the same level of utility. Thus utility is a subjective concept, which cannot be
measured, in quantitative terms.
This law assumes that commodities are independent and therefore their marginal
utilities are also independent. But in real life commodities are either substitutes or
complements. Their utilities are therefore interdependent.
5. Types of Demands
=Three kinds of demands may be distinguished:
1. Price demand
2. Income demand and
3. Cross demand
Price Demand: When demand changes due to change in price by keeping it stable
in other conditions, it is called price demand. The demand for a commodity
depends on its price, that is, if the price goes up, the demand goes down and if the
price goes down the demand goes up. If we form the price demand line in the
figure we get the downward demand line which is shown in the figure below.
Income Demand: When the demand of the consumer changes due to the change in
income while remaining stable in other conditions, it is called price demand. The
relationship between income and demand is positive. That is, the more a person's
income increases, the more his demand will increase. However, it is not applicable
to inferior products. Because there is a negative relationship between income and
the demand for inferior goods. The inferior product is the product that the customer
wants to give up when the income increases. In other words, when income
increases, the demand for inferior goods decreases.
The income demand line for common goods and inferior goods is shown below.
In the case of common goods, the demand line goes up from left to the right and in
the case of inferior goods; the demand line goes up from right to the left.
Cross Demand : If the price of one commodity increases or decreases and it
affects the demand for another commodity then it is called cross demand. In this
case, it can be said that the demand for coffee has increased due to the increase in
the price of tea or a drop in demand for coffee due to rising sugar price. Here sugar
and coffee are complementary goods and tea and coffee are substitutes goods.
Complementary Goods : If the price of one commodity increases then the
demand for another decreases then it is called complementary goods.
Substitute Goods : In the case of substitute goods , if the price of one product
increases, the demand for another product increases. That is, there is a positive
relationship between the price of one commodity and the demand for another
commodity.
The cross demand line for complementary goods and substitute goods is shown
below.
The demand for coffee has decreased due to the increase in the price of sugar and
the cross demand line of complementary goods goes up from the right to the left.
The demand for coffee has increased due to the increase in the price of tea and the
cross demand line of substitute goods goes up from the left to the right.
According to the schedule, when the price of the product is 10 taka, then the
demand is 30 units. When the price of a commodity increases from 10 to 20 taka
and 30 taka respectively, the quantity of demand decreases 30 to 20 and 10 units.
This has been the general human behavior on relationship between the price of the
commodity and the quantity demanded. The factors held constant refer to other
determinants of demand, such as the prices of other goods and the consumer's
income. There are, however, some possible exceptions to the law of demand, such
as Geffen goods and Veblen goods.
So we can say that demand is inversely related to the price of goods. And this is
the law of demand.
for the product is 100 units. As the price of the product decreased slightly to 40,
the demand for the product was 200 units. Again we can see in the picture that if
the price of the product is 30 then the demand is 300 units, if the price is 20 then
the demand is 400 and if the last price is 10 then the maximum demand is 500
units. And finally adding DD line gives Demand Curve. The demand curve is also
known as the Average Revenue Curve.
Answer :
Elastic demand: A change in demand is not always proportionate to the change in
price.A small change in price may lead a great change in demand.In that case,we
shall say that the demand is elastic or sensitive or responsive. If a product is elastic
a small change in the price will have a big impact on the supply or demand of the
product. If a client can easily replace the product with a substitute, then the product
will be elastic. For example, if people like both coffee and tea and the price of tea
goes up, people will have no problem switching over to coffee. The demand for tea
will thus fall, and the demand for coffee will increase the products are substitutes
for each other.
If a purchase is optional, there is a bigger chance that a rise in the price will ensure
a fall in quantity demanded. If you are considering buying a new laptop because
your old laptop is slow, but the price goes up just before you buy the computer,
there is a good chance that you will not purchase the computer and instead stick it
out with your old laptop until it breaks.
1)Price Elasticity
Definition and Explanation: The concept of price elasticity of demand is
commonly used in economic literature. Price elasticity of demand is the degree of
responsiveness of quantity demanded of a good to a change in its price. Precisely,
it is defined as:
"The ratio of proportionate change in the quantity demanded of a good caused by a
given proportionate change in price".
Formula: The formula for measuring price elasticity of demand is:
Price Elasticity = Percentage in Quantity Demand / Percentage Change in
price
Ed = Δq / p x P/Q
Example:
Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day.
The decline in price causes the quantity of the good demanded to increase from
125 units to 150 units per day. The price elasticity using the simplified formula
will be:
Ed = Δq / p x P/Q
Δq = 150 - 125 = 25
Δp = 10 - 9 = 1
Original Quantity = 125
Original Price = 10
Ed = 25 / 1 x 10 / 125 = 2
The elasticity coefficient is greater than one. Therefore the demand for the good is
elastic.
Types: The concept of price elasticity of demand can be used to divide the goods in
to three groups.
(i) Elastic.
When the percent change in quantity of a good is greater than the percent
change in its price, the demand is said to be elastic. When elasticity of
demand is greater than one, a fall in price increases the total revenue
(expenditure) and a rise in price lowers the total revenue (expenditure).
(ii) Unitary Elasticity.
When the percent change in quantity of a good demanded is less than the
percentage change in its price, the demand is called inelastic. When
elasticity of demand is inelastic or less than one, a fall in price decreases
total revenue and a rise in its price increases total revenue.
Δq = 8 - 6 = 2
Δp = $6000 - $4000 = $2000
When two goods are substitute of each other, such as coke and Pepsi, an
increase in the price of one good will lead to an increase in demand for
the other good. The numerical value of goods is positive.
For example: there are two goods. Coke and Pepsi which are close substitutes. If
there is increase in the price of Pepsi called good y by 10% and it increases the
demand for Coke called good X by 5%, the cross elasticity of demand would be:
Exy = %Δqx / %Δpy
Exy = 10% / 5% = 0.2
Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.
(ii) Complementary Goods.
The two goods which are unrelated to each other, say apples and pens, if
the price of apple rises in the market, it is unlikely to result in a change
in quantity demanded of pens. The elasticity is zero of unrelated goods.
1) Nature of Commodities :-
In developing countries of the world, the per capital income of the people is
generally low. They spend a greater amount of their income on the purchase of
necessaries of life such as wheat, milk, cloth etc. They have to purchase these
commodities whatever be their price. The demand for goods of necessities is less
elastic or inelastic. The demand for luxury goods, on the other hand is greatly
elastic.
For example :
If the price of burger falls, its demand in the cities will go up.
If a good has greater number of close substitutes available in the market, the
demand for the good will be greatly elastic.
For example :
If the price of coca cola rises in the market, people will switch over to the
consumption of Pepsi Cola, which is its close substitude. So the demand for Coca
Cola is elastic.
For example :
If the price of coal falls, its quantity demanded will rise considerably because
demand will be coming from households, industries, railways etc.
6) Joint Demand :-
If two goods are jointly demand, then the elasticity of demand depends upon
the elasticity of demand of the other jointly demanded good.
For example :
With the rise in price of cars, its demand is slightly affected, then the demand
for petrol will also be less elastic .
8) Income Level:
Elasticity of demand for any commodity is generally less for higher income
level groups in comparison to people with low incomes. It happens because rich
people are not influenced much by changes in the price of goods. But, poor people
are highly affected by increase or decrease in the price of goods. As a result,
demand for lower income group is highly elastic.
9) Level of price:
Level of price also affects the price elasticity of demand. Costly goods like
laptop, Plasma TV, etc. have highly elastic demand as their demand is very
sensitive to changes in their prices. However, demand for inexpensive goods like
needle, match box, etc. is inelastic as change in prices of such goods do not change
their demand by a considerable amount.
For example :
If the price of a box of matches or salt rises by 50%, it will not affect the
consumers demand for these goods. The demand for salt, match box therefore will
be inelastic. On the other hand, If the price of a car rises from 6 lakh to 9 lakh and
it takes a greater portion of the income of the consumers, its demand would fall.
The demand for car is elastic.
11 )Market Imperfections :-
Owing to ignorance about market trends, the demand for a good may not
increase when it price falls for the simple reason that consumers may not be aware
of the fall in price.
For example :
The elasticity of demand is greater in the long run than in the short run for the
simple reason that the consumer has more time to make adjustments in his scheme
of consumption. In other words, he is able to increase or decrease his demand for a
commodity
.
For example :
If the price of electricity goes up, it is very difficult to cut back its
consumption in the short run. However, If the rise in price persists, people will
plan substitution gas heater, fluorescent bulbs etc. So that they use less ^
electricity. So the electricity of demand will be greater in the long run than in the
short run.
14) Conclusion :-
The above discussion confirms us in the view that it is not possible to lay
down any hard and fast rule as to which commodity has an elastic demand and
which inelastic. When we want to know whether the demand is elastic or inelastic,
we must first know the class of people with reference to whom we wish to
ascertain the fact.
When demand is perfectly inelastic, quantity demanded for a good does not
change in response to a change in price. Such as medicine.
P1
ECEC
PRIC
CE
O Q X
QUANTITY
Perfectly in elastic demand (vertical) demand curve
Y
CEEE
EEEE
PRI
P D
O Q Q1 X
QUANTITY
d
Y
P1
PRICE
d’
O Q X
QUANTITY
When the percentage change produced in demand is less than the percentage
change in the price of a product. For example, if the price of a product increases by
30% and the demand for the product decreases only by 10%, then the demand
would be called relatively inelastic.
d
Y
P1
PRI
C
E
d’
O Q1 Q X
DEMAND
5) RELATIVELY ELASTIC DEMAND:
Relatively elastic demand refers to the demand when the proportionate change
produced in demand is greater than the proportionate change in price of a product.
d
Y
P1
PRICE
P
d’
O Q Q1 X
QUANTITY
We can apply indifferent curve technique for the measurement of price elasticity.
For this purpose,we take into consideration the shape of the price consumption
curve. We can lay down the following proposition .
1. When the price consumption curve slopes downward, the price elasticity of the
demand is greater then unity or one ,i,e ,demand is elastic.
2 .When the shape of the price consumption curve is a horizontal straight line, the
price elasticity of demand is unity or one i,e its constant.
3. When the price consumption is curve is upward sloping, then the then the price
elasticity of demand is less than the unity i,e,the demand is inelastic.
Answer :
1. Taxation:
The tax will no doubt raises the prices but the demand being inelastic,
people must continue to buy the same quantity of the commodity. Thus the
demand will not decrease.
2. Monopoly prices:
3. Joint products:
In such cases separate costs are not ascertainable the producers will be
guided mostly by demand and its nature fixing his price. The transport
authorities fix their rate according to this principle when we say that they
charge what the 'traffic will bear'
4. Increasing returns:
6. Wages:
7. Poverty in plenty:
9. Economies policies:
Modern governments regulate output and prices. The government can create
public utilities where demand is inelastic and monopoly element is present.
10.International trade:
11.Price determination:
With fixing the rate of exchange, the government has to consider the
elasticity or otherwise of its imports and exports.
When all is said and done the concept of elasticity of demand is not merely
of theoretical interest. But it has also practical application in diverse
economic fields as explained above.
Question no 8: Explain the theoretical importance of elasticity of demand.
Answer:
Apart from the practical importance of the elasticity of demand, the concept play a
crucial role in economic theory and is extensively used as a tool of economic
analysis. The following point highlight the main areas of the theorical importance
of elasticity of demand.
1. Price Determination:
e
Price or AR = MR (e−1) Also Piece or
e
AR =MC (e−1) * since in equilibrium MR = MC
.
3. Price Discrimination.
The concept of elasticity of demand is useful in explaining the conditions
under which price discrimination by a monopolist becomes profitable. Price
discrimination is found to be profitable is elasticity of demand in one market
is different from elasticity of demand is less and a lower price where
elasticity of demand is less and a lower where elasticity is greater.
9. Market Forms.
10.Incidence of Taxes.
11.Theory of Distribution.
—◑—
Unit- III
Chapter: 13- Factors of production
Answer: The term land has been given a special meaning in economics.It does not
mean soil as in the ordinary speech,but it is used in a much wider sense.In the word
of Marshall "Land means the materials and the forces which nature gives freely for
man's aid,in land and water in air and light and heat". Lands stands for all natural
resources which yield an income or which have exchange value.It represents those
natural resources which are useful and scarce,actually or potentially.
Peculiarities of Land : In contrast to the other factors of production,land presents
certain well marked peculiarities:
1. Land is nature's gift to man.
2. Land is fixed in quality.It is said that land has no supply price.That is,price
of land prevailing in the market cannot affect its supply;the price may be
high or low,it supply remains the same.
3. Land is permanent.There are inherent properties of the land which Ricardo
called original and indestructible.
4. Land looks mobility in the geographical sense.
5. Finally,land provides infinite variation of degrees of fertility and situation so
that no two pieces of land are exactly alike. This peculiarity explains the
concept of margine cultivation.
These are few peculiarities of land and they have a bearing on economic rent.
Answer: Generally, labour is meant by physical labor. But in economics the term
labor is used in a special and broad sense. Labor is the amount of physical, mental,
and social effort used to produce goods and services in an economy. In return,
laborers receive a wage to buy the goods and services they don't produce by
themselves. Labor is one of the four factors of production that drive supply. It
supplies the expertise, manpower, and service needed to turn raw materials into
finished products and services.
peculiarities of labour: Labour is a commodity to be bought and sold but
unlike Other goods it has certain features as it is not only a means of
production but also an end of a production. Labour is a living factor of
production and therefore different and another factor of production.
Characteristics that make it different are known as the peculiarities of
labour.
Labour is inseparable from the labourer: Labour and the labourer go
together. When the seller sells a commodity he does not necessarily go with
the commodity. But the labourer can supply his labour only when he goes
with it. Moreover, when a seller sells a commodity he parts with it. But
when a labourer sells his labour, he retains the quality with him. He may
gain the satisfaction out of his services, but he cannot be separated from his
labour.
A Labourer sells his Labour and not Himself: A labourer sells his labour
for wages and not himself. ‘The worker sells work but he himself remains
his own property’. For example, when we purchase an animal, we become
owners of the services as well as the body of that animal. But we cannot
become the owner of a labourer in this sense.
The supply of labour can be increased to a limited extent by importing labour from
other countries in the short period. The supply of labour depends upon the size of
the population. Population cannot be increased or decreased quickly. Therefore, the
supply of labour is inelastic to a great extent. It cannot be increased or decreased
immediately.
Question - 05 : factors determining efficiency of labours.
Answer: Labour is a commodity that is supplied by labourers in exchange for a
wage paid by demanding firms. There are many factors which determining
efficiency of labours. The following points highlight the five important factors
affecting the efficiency of labour.
The factors are:
Personal Qualities of Labourers.
Working Conditions.
Conditions of the Country.
Organisational and Managerial Ability.
Other Factors.
They are:
a. Labour Policy of the Government : Labour policy of the government
also affects the efficiency of a labourer. If the policy of the
government is favourable towards labourer, it will create confidence
in labourer and their efficiency will improve. If policy is unfavorable
the labourer may feel disappointed.
b. Trade Unions: If trade union is well organised the workers will have
upper hand and they will get more wages and their standard of living
will improve.
c. Sense of Patriotism:Country in which workers are loyal to the country
and have sense of patriotism the efficiency of workers will
automatically go up. Love for the country encouraged them to do
more efficiently.
Question no-9: Meaning of capital formation
Answer : Capital formation is a term used to describe the net capital accumulation
during an accounting period for a particular country. The term refers to additions
of capital goods, such as equipment, tools, transportation assets, and electricity.
Countries need capital goods to replace the older ones that are used to produce
goods and services. If a country cannot replace capital goods as they reach the end
of their useful lives, production declines. Generally, the higher the capital
formation of an economy, the faster an economy can grow its aggregate income.
As an example of capital formation, Caterpillar (CAT) is one of the largest
producers of construction equipment in the world. CAT produces equipment that
other companies use to create goods and services. The firm is a publicly traded
company, and raises funds by issuing stock and debt. If household savers choose to
purchase a new issue of Caterpillar common stock the firm can use the proceeds to
increase production and to develop new products for the firm’s customers. When
investors purchase stocks and bonds issued by corporations, the firms can put the
capital at risk to increase production and create new innovations for consumers.
These activities add to the country's overall capital formation.
—◑—
Chapter: 18- Laws of return
Question no.1:Explain the law of diminishing return with its three aspects.
Answer: The law of diminishing return was supposed to have a special application
to agriculture.It is the practical experience of every farmer that “successive
applications of labor and capital to a given area of land most untimely, other things
remaining the same , yield a less than proportionate increase in produce.” If by
doubling labor and capital he could double the yield of his land and so on, it can be
easily seen that one acre of land could be made to produce as much wheal as could
suffice for the entire population of the world.That this cannot be done is simply
due to the operation of the law of diminishing returns.If investment is increased,the
total yield will no doubt increase,but at a diminishing rate .
Marshall stated the law thus: “An increase in capital and labor applied in the
cultivation of land causes in general less than proportionate increase in the amount
of produce raised, unless it happens to coincide with an improvement in the arts of
agriculture.” The phrase 'in general’ in this statement is important.It means that
there may be cases where the law does not hold good.It refers to limitations of the
law.
From the Table,it appears that there are three different aspects of the law of
Diminishing Returns :
(1) Law of total Diminishing Returns (column 2 ).In this sense,the return begin to
diminish from the 9th worker..Every Successive worker employed does make
some addition to the total output.But the 8th adds nothing and the 9th and 10th are
a positive nuisance.As workers cannot be had gratis,no prudent farmer will employ
more than seven workers in the conditions represented by this table.
(2) Law of Diminishing Marginal Returns (column 3) Marginal returns go on
increasing up to the 3rd worker.This is so because the proportion of workers to
land was at first insufficient and the land was not being properly tilled. This phase
of cultivation is unstable and will not be found in practice.When the farmer knows
that he can get more than proportionate return by employing extra hand, he will
certainly do so .The marginal, i.e. ,the additional,return goes on falling from the
3rd man onwards till it drops down to zero at the 8th.The 9th and 10th men are
responsible in making the marginal return negetive.The point at which the addition
made to the total output by each successive unit of the variable factor starts
diminishing is known as the point of diminishing marginal returns.
It can be seen that the total output is at its maximum when marginal output is zero.
(3)Law of Diminishing Average Returns (column 4). The average return reaches
the maximum at the 4th worker. One step later than the marginal return reaches the
maximum.Then the marginal return falls more sharply.The two equalize
somewhere between the 4th and 5th, i.e., when the 5th worker works part-time.But
we do not employ men in fractions in real life.Therefore,it is not always possible to
equalize the marginal and the average returns.It is also clear that It is possible for
the average output to increase while the marginal output falls.
Question no-02:Law of variable proportions and the assumption of the law of
variable proportions.
The law of variable Proportions: The law of variable Proportions states that
keeping other input/factor fixed and increase quantity of only one factor/input
(variable factor/input), the total Production initially increase at an increases rate
then increases at a diminishing rate and finally at a negative rate. The law an
occupies a very important Place in economic theory.
Economists have explained the rule of the law of variable Proportions in different
ways. According to Stigler, "As equal increments of one input are added, the inputs
of other productive services being held constant, beyond a certain point the result
in increment product will decrease, the marginal product will diminish." Professor
Samuelson states the law thus, "An increase in some inputs relative to be the fixed
inputs will, in a given state of technology, cause output to increase; but after a
point the extra output resulting from the same additions of extra inputs will become
less and less."
The law of variable Proportions Describes the production function with one
variable factor while the quantities of other factors of production are fixed. That is,
it describes the input-output relation in a situation when the output is increased by
increasing the quantity of one input, keeping the other inputs constant. When the
quantity of one factor is increased and the quantities of the other factors of
production are kept constant, naturally the proportion between the variable factors
and the fixed factor is altered. That is, the ratio of the variable factor to that of the
fixed factors goes on increasing as a quantity of the variable factor is increased. It
is because that in this law we study the effect on output' of variations in factor
proportion, this law is called the law of variable proportions. Infect, the law of
variable proportions is the new name for the well known law of diminishing
returns. Up till Marshall, 4 was thought that there were three separate laws of
production, viz., the laws of diminishing, increasing and constant returns. The
modern economists are of the view that these three laws are not three separate laws
but are only three phases of one general law of variable proportions.
There is only one law which applies everywhere and which is called the Law of
Variable Proportions; 'This law applies to all fields of production like agriculture,
industries etc. although its different stages are to be found in different industries or
its different stages are larger or shorter indifferent industries.
We find from the statements of the law of variable proportions given above that
this law relates to the behavior of output as the quantity of one factor is varied
keeping the quantities of' the other factors constant. It states further that the
marginal product and the average product of the factor kept constant will
eventually diminish.
ASSUMPTIONS OF THE LAW OF VARIABLE PROPORTIONS
The main assumptions of the law of variable proportions are given below-
The law of diminishing returns operates in the short run when we can’t change all
the factors of production. Further, it studies the change in output by varying the
quantity of one input.Technically, the law states that as we increase the quantity of
one input which is combined with other fixed inputs, the marginal physical
productivity of the variable input must eventually decline.
Marshall has explained the law of diminishing returns, in general terms which is
subject to criticism. This means that the law is not applicable in all cases.
The law of diminishing returns does not apply to all situations.There are several
exceptions to the law as it applies in agriculture.
1. New Soil
The law of diminishing returns does not hold well in case of new soil.When a
virgin soil is brought under cultivation, the additional return for each successive
dose of labor and capital may increase for a time.But after a point, the tendency of
diminishing return will set in.Hence, in case of a new soil,the law of diminishing
return does not apply in the beginning.
Man's ingenuity is ever striving to counteract the operation of this law but
improving the techniques of cultivation. In modern times, when there are
improved methods of cultivation, this law is not applicable. The improved methods
of production are cropping pattern, new seeds, and fertilizer, mechanization and
irrigation facilities.But science can not keep pace with the increasing demand for
food. When these methods are used, there are good chances of more production.
Thus, there are chances of increasing returns even in agriculture sector.
3. Shortage of Capital
The law of diminishing returns does not apply in case of shortage of capital or
insufficiency of capital. If, we have ample stock of capital, the law of increasing
returns would operate and not the law of diminishing returns. These factors can
check the operation of the law of diminishing returns temporarily. But this law is
bound to apply ultimately. These can be delayed in the application of the law but
the law is definite to apply sooner or later.
These are the limitations of the law of diminishing return.Though, these
limitations, the law of diminishing returns has a very wide,almost universal
application. Whenever we found that some factors of production are fixed and can
not be varied, then the techniques of production remaining the same, diminishing
returns are bound to follow, sooner or later.There is no escape.
The Law of increasing returns operates : We have already seen when economies
can be reaped if the scale of production is increased. Advantages of specialization
of labor and machinery and other commercial and miscellaneous economies make
it possible to lower the cost of production, and we have increasing returns.
Economies. Among the economies of mass production which contribute to greater
productivity at less cost may be mentioned.
(i)Use of non-human and none-animal power resources (water end wind power,
steam, electricity, atomic energy);
(ii)automatic self-adjusting mechanism;
(iii)use of standardized, interchangeable parts;
(iv)breakdown of complex processes into simple repetitive operations;
(v)Specialization of functions and division of labor and
(vi)many other technological factors.
No Scarcity of Factors. The law of diminishing returns operates when there is
dearth of an essential factor. But if there is no dearth, the law of increasing returns
will operate.”The expansion of an industry,provided that there is no dearth of
suitable agents of production,tends to be accompained,other things being equal, by
increasing returns.”
Right combination. The law of diminishing returns operates when the factors have
been combined in wrong proportions. Now when we try to correct the
combination,increasing returns will follow till the balance is completely restored.
Full use of indivisable Factors. The concept of indivisibility,too,has a close bearing
on the law of increasing returns. A manufacturer sets up a plant to cope with a park
demand,but in actual practice it may be producing below capacity.In that case, if
an addition is made to some other factors or factors, the indivisible factor will be
more fully employed, and increasing returns will follow.
Question no. 5: Distinction between the law of returns and returns to scale.
Law of returns:
The law of returns states that with every additional unit in one factor of production
while all other factors are held constant, the incremental output per unit will
decrease at some point.
For example, a restaurant hiring more cooks while keeping the same kitchen space
can increase total output to a point, but every additional cook takes up space,
eventually leading to smaller increases in output as there are too many cooks in the
kitchen. The total output can decrease at some point, resulting in negative returns if
too many cooks get in each other's way and eventually become unproductive.
Returns to scale:
Returns to scale refers to the proportion between the increase in total input and the
resulting increase in output.
For example, if a soap manufacturer doubles its total input but gets only a 40%
increase in total output, then it can be said to have experienced decreasing returns
to scale. If the same manufacturer ends up doubling its total output, then it has
achieved constant returns to scale. If the output increased by 120%, then the
manufacturer experienced increasing returns to scale.
Comparison chart:
Answer:
In Economics, the term “Market” does not refer to a particular place as such but it
refers to a market for a commodity or commodities. It refers to an arrangement
whereby buyers and sellers come in close contact with each other directly or
indirectly to sell and buy goods.
Further, it follows that for the existence of a market, buyers and sellers need not
personally meet each other at a particular place. They may contact each other by
any means such as a telephone or telex. Thus, the term “Market” is used in
economics in a typical and specialised sense. It does not refer only to a fixed
location. It refers to the whole area of operation of demand and supply. Further, it
refers to the conditions and commercial relationships facilitating transactions
between buyers and sellers. Therefore, a market signifies any arrangement in
which the sale and purchase of goods take place.
1. The existence of a commodity. For example- The market for gold or silver,
cotton, wheat and rice etc. Thus, there will be as many markets as are commodities
and if there be several types or variance of a commodity, then each type or variety
will have a separate market of its own.
2. That there be buyers and sellers who are in touch with one another either
through post, telegraph, telephone or through middlemen.
3. That there is perfect competition among buyers and sellers so that through such
competition, the price of the commodity in question is influenced.
Thus, the essentials of a market are; (a) A commodity which is dealt with; (b)The
existence of buyers and sellers; (c)A place, be it certain region, a country or the
entire world; and (d) Such Intercourse between buyers and sellers that only 1 price
should prevail for the same commodity at the same time.
Answer:
Historically, the size of a market has coincided with its domestic market. However,
in a globalized world, a country’s market may or may not coincide with its political
borders. Market size is therefore defined as a combination of country size and
foreign markets.
Economic research, in line with the current GCI, suggests two ways through which
market size affects productivity: economies of scale in production and incentives
for innovation.
In general, market size produces efficiency gains by allowing for specialization—
an idea that remains as true today as when Adam Smith proposed it in 1776.
Furthermore, large markets can take advantage of economies of scale in the
production of goods and services. Public goods tend to have high fixed costs and
low marginal costs, and consequently the per capita cost of services such as justice,
defense, and infrastructure decreases in places where a greater number of taxpayers
pay for them.
In the case of some commodities, the market is very wide covering the whole
country or even the whole world, whereas in certain other cases, the size of the
market is very limited covering a small village. The size of the market depends
upon several factors:
Character the commodity. In order to have wide market, a commodity must be (i)
portable, (ii)durable, (iii)suitable for sampling, grading and exact description; and
(iv)such as its supply can be increased. Such commodities are wheat, gold,
government securities etc. Bulky articles like bricks and perishable like fresh fruit
and vegetables have a narrow market.
Means of communication and transport. The size of the market depends upon
the extent to which means of communication and transport have been developed. A
properly developed transport and communication system has enabled commodities
be carried long distances and establish wide contacts. This has widened the market.
Peace and security. Obviously, goods cannot be marketed in distant places unless
peace and order prevail. In war-time, due to insecurity in war zones, markets get
restricted. Thus, the extent of the market depends on the peace prevailing in the
region.
Currency and credit system. If the currency and credit system of the country are
well developed marketing can be conveniently and profitably carried on over
extensive areas. The extent of the market very largely depends on the state of the
currency and the confidence it inspires.
Policy of the state. Markets may be restricted by the policy of the state.
Prohibitive duties and quotes restrict the market. The zoning system (e.g., wheat
zones) which allows free movement of goods only within a certain zone has the
same effect. Thus, a government policy can also affect the extent of the market.
Market:
Market is a mechanism, here the buyers and sellers meet either directly or
indirectly to exchange their goods and services for monetary benefits.
Classification of market:
Markets may be classified;
1. On the Basis of Area:
under this area following markets have been included:
Local
National
International
Local: When the competition between purchaser and seller is localized and
limited at a specific market then it is called Local Market. In this market mostly
perishable goods are purchased and sold.
For example: Sale of vegetable, fish, egg etc.
International:
If the competition of goods is world-wide, the market will be international.
For example: Gold, silver, oil is known as an international market.
Very short period: The supply of goods is stable; therefore, the price of goods is
determined according to the demand of the goods. If the demand cut down the
price will fall and vice-versa.
For example: The demand of vegetables, fish or eggs etc.
Short period market: The market is slightly longer than very short period. Here
the supply can be slightly adjusted.
For example: The demand of fish or milk or eggs.
Long period market: If the demand for goods increases, there is time to increase
the supply. Here the price is influenced more by supply of the goods.
Perfect market:
A theoretical market in which buyers and sellers are a large number and well
informed that monopoly is absent and market price cannot be manipulated.
Imperfect Market:
A market is said to be imperfect when some buyers or sellers or both are not aware
of the offers being made by others. Naturally, therefore, different prices come to
prevail for the same time in an imperfect market.
Following are the classification of Imperfect Market:
a. Monopoly
b. Duopoly
c. Oligopoly
Duopoly: In duopoly, there are two sellers, selling either a homogeneous product
or a differentiated product. These two sellers enjoy a monopoly in the sale of the
product produced by them.
For example: smartphones- Apple & Android, soft drink: Coca-cola & Pepsi etc.
Mixed market: Mixed market is that market where several types of goods are
purchased and sold simultaneously. All goods are available at one place. This is
also called “General Market”.
Specialized Market: Specialized market is that market where only one kind of
goods are sold and purchased.
For example: Only wheat market or cloths market. This type of market is mostly
found in Metropolitan Town.
Sample market: Sample market is that where goods are purchased and sold as
specimen of any variety of goods. In this market purchaser only sees the specimen
of goods and places order for the good.
For example: Woolen cloths are purchased by seeing only sample booklets.
Marketing by grades: In this market, goods are purchases and sold according to
grades. It means the goods are first classified into various grades as per the quality
of the goods.
Black Market or Illegal market: In this market the seller charges higher price
fixed by the government. This price is taken by seller secretly. This is also known
as illegal price or smuggling price.
2.Normal Profit: In the long-run consumers are not being exploited as the firm is
earning normal profits.
3.Lower prices: Competition between firms in the industry will help lower prices
and make them more competitive for consumers.
Answer
There are few perfect markets; those selling commodities, such as agricultural
products, represent the closest approximation of a perfect market.
In a perfect market, there are no restrictions either on the buyers or on the sellers,
they should be absolutely free to buy from or sell to anybody they like. There
should be no monopolies.
Perfect competition is a benchmark, or "ideal type," to which real-life market
structures can be compared. Perfect competition is theoretically the opposite of
a monopoly, in which only a single firm supplies a good or service and that firm
can charge whatever price it wants since consumers have no alternatives and it is
difficult for would-be competitors to enter the marketplace.
Under perfect competition, there are many buyers and sellers, and prices
reflect supply and demand. Companies earn just enough profit to stay in business
and no more. If they were to earn excess profits, other companies would enter the
market and drive profits down.
Cheap and Efficient Transport and Communication:
Same price for the commodity will not rule if the information about changes in
prices cannot be quickly transmitted or if the commodity cannot be cheaply or
speedily transported. Transport and communication should be quick. Thus cheap
and efficient means of transport and communication are must.
Since efficient transportation is linked with social welfare and economic
opportunities, investments in transportation infrastructure are expected to create
positive multiplying effects. However, developing countries have been impacted
by a lack of transport infrastructure investments, a lack of capacity, managerial
deficiencies, a lack of coordination between modes and challenges in supporting
national and international distribution imperatives. Globalisation has been
associated with rising mobilities of passengers and freight and has spurred
investments in the development of ports, airports, railways and highways across a
wide range of countries and contexts. Impacts are contingent upon the existing
level of development and the existing quality and efficiency of infrastructure as
well as modal preferences.
Wide Extend:
Sometimes a wide market is regarded as the same thing as the perfect market. For a
wide market, the commodity should have permanent and universal demand. The
commodity should be portable, durable, gradable and should have wide demand.
The extent of a market depends on the nature of the commodity, whether it is
durable or perishable, and the nature of demand for it, whether it is steady or
fluctuating.
Question No. 6- Market forms or market structures
Answer:
“Market structures” refer to the different market characteristics that determine
relations between sellers to each another, of sellers to buyers and more. There are
several basic defining characteristics of a market structure, such as the following:
Homogeneous
2. Perfect oligopoly A few
Differentiated
3. Imperfect oligopoly A few
Pure or absolute One Homogeneous
monopoly
Question No. 7- Pure Competition
Answer:
INTRODUCTION
Pure competition is a market situation where there is a large number of
independent sellers offering identical products. It means it is a term for an industry
where competition is stagnant and relatively non-competitive. Companies within
the pure competition category have little control of price or distribution of
products. Pure competition is said to exist in a market where-
There are a large number of buyer and sellers;
Products are homogenous; and
There is freedom of entry and exists of buyer and sellers.
In the sense of perfect competition is not only pure but also free from other
perfection. It is a broader concept of pure competition. The essentials feature of
pure competition is the absence of any monopoly element.
In the word of Chamberlin, pure competition means “competition unalloyed with
monopoly elements,” whereas perfect competition involves “perfection in many
other respects than the absence of monopoly”. It is possible to come across pure
competition in real life but not perfect competition. Structure influences conduct
which, in turn, affects performance.
Pure Competition
Meaning:
Pure competition is a market situation where there is a large number of
independent sellers offering identical products. It means it is a term for an industry
where competition is stagnant and relatively non-competitive. Companies within
the pure competition category have little control of price or distribution of
products.
Pure competition involves-
Very large number
Standardized product
Price Takers
Free entry and exit
A very large number– a very large number of independently acting sellers, e.g.,
farm product, stock market, foreign exchange market.
Price taker- Individual firm exert no significant control over the market price.
Each firm’s quantity is too small to affect the market supply or price.
Competitive are price takers, they cannot affect the price, but adjust to it.
None of the sellers can ask for a higher price.
None will sell at a lower price.
Free entry and free exit- New firms can freely enter and existing firms can freely
leave the market. No significant, technological, financial, or other obstacles
prohibit new firms from selling their output in the market.
DEFINITION
The purely competitive markets are used as the benchmark to evaluate market
performance. It is generally believed that market structure influences the behavior
and performance of agents with in the market. Structure influences conduct which,
in turn, affects performance. Pure competition and Monopoly are at each end of the
spectrum of markets. In fact probably neither occur in market economies. Pure
competition and monopoly are the boundaries and the “real world” (wherever that
is) lies somewhere between the two extremes. Pure competition provides the
benchmark that can be use to evaluate markets. The physician who attends you
knows that 98.6o is a benchmark. Your temperature may not be precisely 98.6o,
but if it deviates significantly, that deviation suggests problems. It might be in your
best interests to know what the “normal” temperature is and the cause of the
deviation from “normal.”
CHARACTERISTICS
There are three characteristics of pure competition:
Large number of buyers and sellers: There are a large number of buyers and
sellers and no one can influence the price of the commodity. A firm produces a
small part of the total market output and as such a change in its output will not
affect the market supply much. The price is determined by the industry as a whole.
Therefore, a firm is a price taker rather than the price maker.
Homogenous products: The products of all firms in the industries are
homogenous. The buyers are unconcerned about the source of the product; no
single seller’s product is preferred to that of any other seller. Similarly, sellers also
do not care to whom they sell and no preferences among the buyers exist in the
market. Homogeneity of the product refers to the “physical characteristics” of the
product, such as color size, etc. and to the “environmental factors”, such as the
location of the seller, credit facilities, etc. The products are therefore
indistinguishable from one another or are perfect substitutes for one another. This
implies that the firm can sell any amount of the product at the prevailing price
only.
Free entry and exit from industry: The new firms are free to enter the industry
and the existing firms are free to leave the industry. There are no restrictions as
such on the entry and exit on the firms. When the existing firms make excess
profits in the short run, other firms are attracted by it and enter the industry. On the
other hand, when the existing firms incur losses in the short run, some firms would
leave the industry. This ensures that the firms earn only normal profits in the long
run and as a result, there will not be any tendency for the firms to enter or leave the
industry.
AR=MR
Output x
Average Revenue and Marginal Revenue
OX and OY are the two awes. Along OX is represented the output and along OY
the Price Revenue. At OP price, a seller can sell as much as he likes. He cannot
charge more and he will not charge less. If he raises the price, he will lose all his
customers and if he charges less, he will be unnecessarily losing.
Question No.8- Perfect Competition
Answer:
There is said to be perfect competition when every purchaser and seller is so small
relative to the entire market that he can not influence the market price that
increasing or decreasing his purchases or his output.
Perfect competition is wider term than pure competition. Besides, the two
conditions of pure competition are the homogeneity of the product and the
existence of large number of dealers, several other conditions must also be fulfilled
to make it perfect competition.
Thus, the conditions of perfect competition are: -
(a) Large number of buyers and sellers
(b) Homogenous product
(These conditions of pure competition have already been discussed above)
€ Free entry or exit. There should be no restrictions, legal or other otherwise, on
the firm’s entry into or exit from, the industry. In this situation all the firms will be
making just normal profit. If the profit is more than normal, new firms will enter
and the extra profit will be competed away; and if, on the other hand, profit is less
than normal, some firms will quit, raising the profits for the remaining firms. But
if there are restrictions on the entry if new firms may continue to enjoy super
normal profit. Only when there are no restrictions on entry or exit, the firms will
earn normal profit.
(d) Perfect knowledge. Another assumption of perfect competition is that the
purchasers and sellers should be fully aware of the prices that are being offered and
accepted. In case there is ignorance among the dealers, the same price can not rule
in the market for the same commodity. When the producers and the customers
have the full knowledge of the prevailing price, nobody will offer more and none
will accept less. And the same price will rule through out the market. The
producers can sell at the price as much as they like and the buyers also can buy as
much as they like.
€ Nature of transport costs. If the same price is to rule in a market, it is necessary
that no cost of transport is there, the prices must differ to that extent in different
sectors of the market.
(f) Perfect Mobility of the factors of production. The mobility is essential in order
to enable the firms to adjust their supply to demand. If the demand extends supply,
additional factors will move into the industry and in the opposite case, move out.
Mobility of the factors of production is essential to enable the firms and the
industry to achieve an equilibrium position.
Mr. Robinson thus defines perfect competition, ‘‘When the number of firms being
large, so that a change in the output of any of them has a negligible effect. Upon
the total output of the commodity. The commodity is perfectly homogenous in the
sense that the buyers are alike in respect of their preferences (or indifference)
between one firm and its rivals, the competition is perfect, and the elasticity of
demand for the individual firm is finite.’’
Chamberlin thus brings but the decision between pure competition and perfect
competition. ‘‘Purity requires only the absence of monopoly, which is realized
when there are many buyers and sellers of the same (perfectly standardized)
product. Perfection is concerned with other matters as well: mobility of resources,
perfect knowledge, etc. Perfection is a different thing from its purity, meaning by
the latter its freedom. From monopoly elements.’’
In short, Pure or perfect competition is a theoretical market structure in which the
following criteria are met:
This can be contrasted with the more realistic imperfect competition, which exists
whenever a market, hypothetical or real, violates the abstract tenets of neoclassical
pure or perfect competition.
Since all real markets exist outside of the plane of the perfect competition model,
each can be classified as imperfect. The contemporary theory of imperfect versus
perfect competition stems from the Cambridge tradition of post-classical economic
thought.
Question no 9: Imperfect Competition
Answer:
Imperfect competition takes three main forms: -
1. Monopolistic Competition;
2. Oligopoly, and
3. Monopoly.
2. Oligopoly: The word Oligopoly is defined from two Greek word – “Oligi
“means few and “Polein” means to sell.
Oligopoly is defined as a market structure with a small number of firms,
none of which can keep the others from having significant influence. The
basic characteristic of an oligopolistic situation is the fact that every output
policies of his rivals. This is due to the fact that the number of sellers is not
very large and each seller controls a substantial portion of the supply.
Oligopoly differs from monopoly and monopolistic in this that, in
monopoly, there is a single seller, in monopolistic competition, there is
quite large number of them, but in oligopoly, there is only a small number
of sellers.
Now I will classify markets in accordance with the three criteria mentioned above.
This formula measures the degree to which the sales of the firm are affected by the
price charged by the firm in the industry. If the elasticity is high, the products of
the two firms will be close substitutes. In the case of perfect substitutes (i.e.
Homogeneous products), the price cross-elasticity between every pair of products
are differentiated, but can be substituted for one another, the price cross-elasticity
will be finite and positive. If products are not substitutes, their price cross-elasticity
will tend to zero.
Let me now explain the ‘condition of entry’ which is expressed by the following
notations:
E = Pa – Pc/Pc
E stands for the condition of entry, Pc is the price under perfect competition, and
Pa is the actual price charged by firms. It is obvious that if the Value of E is
reduced to zero (i.e., there is no barrier to entry into the market), the market is said
to be a perfectly competitive one and monopolistically competitive one. Under
monopoly, entry is blockaded.