PRINCIPLE

OF

ECONOMICS
Disclaimer: All are samples - Writers are not liable for these questions and answers.

MD SAIDUL ALAM RAJAN

 Principle of Economics
Module-A: Economics Introduction
Definition; Micro vs. Macro; Positive vs. Normative Economics, Scarcity, Resources,
Opportunity Cost, Circular Flow, Production Possibility Curve, Economic Models.
Economic Systems – Market Economy and Regulated economy.

Question 1. What is economics and why is it important to study?

Answer: Economics is the social science that studies the production, distribution, and consumption of
goods and services. It is concerned with how individuals, businesses, and governments make choices in
the face of scarcity, and how these choices ultimately affect the allocation of resources in society.
Studying economics is important for several reasons. First, it helps us to understand how the economy
works and how economic policies can affect our lives. Second, it provides us with tools and frameworks
to analyze and make sense of complex economic phenomena, such as inflation, unemployment, and
economic growth. Third, it enables us to make informed decisions as consumers, producers, and
policymakers, by helping us to weigh the costs and benefits of different options. Finally, studying
economics can be personally and professionally rewarding, as it can lead to a career in a variety of fields,
such as finance, consulting, or public policy.

Question 2. What is the difference between microeconomics and

macroeconomics?
Answer: Microeconomics and macroeconomics are two main branches of economics that focus on
different aspects of the economy.

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 Principle of Economics
Question 3. What is scarcity and how does it affect economic decision-
making?
Answer: Scarcity refers to the condition where human wants and needs exceed the resources available to
fulfill them. In other words, there are limited resources to meet unlimited wants and needs.
Scarcity affects economic decision-making in several ways. First, scarcity forces individuals and societies
to make choices about what goods and services to produce and consume. Since resources are limited,
every choice involves a trade-off; choosing to produce more of one good or service means producing less
of another. Therefore, individuals and societies must prioritize their wants and needs and allocate
resources accordingly.
Second, scarcity also affects how goods and services are produced. Because resources are limited,
individuals and firms must make choices about how to produce goods and services in the most efficient
manner possible. This involves choosing the most efficient production methods and technologies, as well
as making decisions about how to allocate resources between producing different goods and services.
Finally, scarcity also affects the distribution of goods and services. Since resources are limited, not
everyone can have everything they want or need. Therefore, societies must make choices about how to
distribute goods and services among individuals and groups. This involves making decisions about issues
such as income distribution, social welfare programs, and taxation.
In summary, scarcity is a fundamental economic problem that requires individuals and societies to make
choices about what goods and services to produce and consume, how to produce them, and how to
distribute them among different groups.

Question 4. What is positive economics and how does it differ from

normative economics?
Answer: Positive economics and normative economics are two approaches to studying and analyzing
economic phenomena.
Positive economics is concerned with describing and explaining how the economy works. It focuses on
the objective analysis of economic facts and data, and seeks to develop theories that can be tested and
verified through observation and experimentation. Positive economics is therefore empirical and value-
free, and seeks to answer questions such as "what is?" and "how does it work?" Examples of positive
economic statements include "an increase in the minimum wage leads to a decrease in employment" and
"the demand for gasoline increases when the price of oil falls."
In contrast, normative economics is concerned with analyzing how the economy should work. It focuses
on developing policies and recommendations for how the economy ought to be structured and run.
Normative economics is subjective and value-laden, and seeks to answer questions such as "what ought
to be?" and "what is the best policy?" Examples of normative economic statements include "the
government should provide universal healthcare to all citizens" and "tax rates on the rich should be higher
to reduce income inequality."
In summary, positive economics describes and explains how the economy works, while normative
economics prescribes how the economy should work. Positive economics is empirical and objective, while
normative economics is subjective and value-laden.

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 Principle of Economics
Question 5. What are resources and how are they allocated in a
market economy?
Answer: Resources are the inputs used to produce goods and services in an economy. They include natural
resources (such as land, water, and minerals), labor (human effort), capital (machinery, tools, and
infrastructure), and entrepreneurship (the ability to combine the other resources to create new products or
services). In a market economy, resources are allocated through the price mechanism, which is determined
by the forces of supply and demand.
In a market economy, the allocation of resources is based on the decisions of buyers and sellers in the
marketplace. Consumers signal their preferences for goods and services by the prices they are willing to
pay for them, while producers respond to these signals by producing and supplying goods and services
that are in demand. The prices of goods and services, in turn, are determined by the interaction of supply
and demand.
Through this price mechanism, resources are allocated to their most efficient and productive uses. For
example, if the demand for a certain good or service increases, the price will rise, signaling to producers
that there is an opportunity for profit. Producers will respond by increasing production of the good or
service, which will lead to a reallocation of resources from less profitable sectors to more profitable ones.
In summary, in a market economy, resources are allocated through the price mechanism based on the
decisions of buyers and sellers. Prices serve as signals that coordinate the actions of buyers and sellers,
leading to the allocation of resources to their most efficient and productive uses.

Question 6. What is opportunity cost and how does it relate to the

production possibility curve?
Answer: Opportunity cost refers to the value of the next best alternative forgone when making a choice.
In other words, it is the cost of choosing one option over another, in terms of the benefits that could have
been gained from the foregone option.
The production possibility curve (PPC) is a graphical representation of the maximum output combinations
of two goods that an economy can produce with its available resources and technology. It illustrates the
concept of opportunity cost by showing the trade-offs that an economy faces in allocating its scarce
resources between the production of two goods.
The PPC shows that as an economy produces more of one good, it must give up some production of the
other good, because resources are not infinitely available. The opportunity cost of producing one good is
the forgone production of the other good.
For example, suppose an economy can produce either cars or computers with its resources. The PPC shows
the combinations of cars and computers that the economy can produce given its resources and technology.
As the economy produces more cars, it must give up some production of computers, and vice versa. The
opportunity cost of producing one more car is the forgone production of some computers, and the
opportunity cost of producing one more computer is the forgone production of some cars.
In summary, the production possibility curve illustrates the concept of opportunity cost by showing the
trade-offs that an economy faces in allocating its scarce resources between the production of two goods.
As an economy produces more of one good, it must give up some production of the other good, and the
opportunity cost of producing one good is the forgone production of the other good.

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 Principle of Economics
Question 7. What is the circular flow model and how does it illustrate
economic activity in a market economy?
Answer: The circular flow model is a simplified representation of how the economy works. It illustrates
the flows of goods, services, and money between households and firms in a market economy.
In the circular flow model, households supply labor, land, and capital to firms in exchange for income.
This income is then used by households to purchase goods and services from firms. Firms, in turn, use the
revenue from sales to pay for inputs such as labor, land, and capital, and to invest in new production
processes and technologies.
The circular flow model consists of two main components: the product market and the factor market. The
product market is where goods and services are exchanged between firms and households. The factor
market is where the factors of production (such as labor, land, and capital) are exchanged between
households and firms.
In the product market, households purchase goods and services from firms, and firms receive revenue
from these sales. In the factor market, firms purchase the factors of production (such as labor, land, and
capital) from households, and households receive income from these sales. This income is then used by
households to purchase goods and services from firms, completing the circular flow.
The circular flow model illustrates the interdependence of households and firms in a market economy. It
shows how households and firms rely on each other to generate income and produce goods and services.
It also highlights the importance of the price system in coordinating economic activity in a market
economy, as prices serve as signals that coordinate the actions of buyers and sellers.

Question 8. What is the production possibility curve and how can it

be used to illustrate trade-offs?
Answer: The production possibility curve (PPC) is a graphical representation of the maximum output
combinations of two goods that an economy can produce with its available resources and technology. The
PPC illustrates the concept of trade-offs, which is the idea that in order to produce more of one good, the
economy must give up some production of another good.
The PPC shows the combinations of two goods that an economy can produce given its resources and
technology. Each point on the PPC represents a combination of two goods that the economy can produce
with its available resources. The slope of the PPC represents the opportunity cost of producing one good
in terms of the other good. The steeper the slope, the higher the opportunity cost of producing one good
in terms of the other good.
The PPC can be used to illustrate trade-offs in several ways. First, the PPC shows that the economy faces
a scarcity of resources, which means that it cannot produce an unlimited amount of both goods. Second,
the PPC shows that the opportunity cost of producing one good is the forgone production of the other
good. Third, the PPC shows that the economy must make choices about how to allocate its scarce resources
between the productions of two goods.
In summary, the production possibility curve is a graphical representation of the maximum output
combinations of two goods that an economy can produce with its available resources and technology. The
PPC illustrates the concept of trade-offs by showing that in order to produce more of one good, the
economy must give up some production of another good.

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 Principle of Economics
Question 9. What are economic models and how are they used in
economics?
Answer: Economic models are simplified representations of economic systems or processes used to
analyze and understand economic phenomena. These models can take the form of graphs, equations, or
narratives, and they often make assumptions about how the economy works to simplify complex
interactions and highlight key relationships between economic variables.

Economic models are used in economics to study a wide range of issues, such as how markets allocate
resources, the effects of government policies on the economy, and the behavior of consumers and firms.
They can be used to make predictions about economic outcomes, test theories, and evaluate the impacts
of different policies or economic conditions.

Economic models typically involve identifying key variables and assumptions that are relevant to the issue
being studied. These variables can include things like prices, quantities, production levels, and consumer
behavior. Assumptions are made about how these variables interact with one another, and how they
respond to changes in other economic factors.

Once a model has been constructed, it can be used to analyze different scenarios and evaluate the likely
outcomes of different policy choices or economic conditions. For example, an economic model might be
used to predict the impact of a tax increase on consumer behavior and the overall economy. By examining
how changes in tax rates affect key economic variables like consumer spending and investment,
economists can make informed predictions about the likely outcomes of different policy choices.

In summary, economic models are simplified representations of economic systems or processes used to
analyze and understand economic phenomena. They are an important tool in economics, allowing
economists to make predictions, test theories, and evaluate the impacts of different policies or economic
conditions. By making assumptions about key economic variables and their interactions, economic models
help to simplify complex economic interactions and highlight key relationships between economic
variables.

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 Principle of Economics
Question 10. What are the main differences between a market
economy and a regulated economy?
Answer: A market economy is a type of economic system in which prices and production are determined
by supply and demand, without government intervention. In a market economy, private individuals and
businesses own the factors of production, such as land, labor, and capital, and make economic decisions
based on their own self-interest.

In contrast, a regulated economy is an economic system in which the government plays an active role in
controlling and regulating economic activity. In a regulated economy, the government may set prices,
regulate production levels, or control the distribution of goods and services.

The main differences between a market economy and a regulated economy are as follows:

Resource allocation: In a market economy, resources are allocated through the price mechanism,
which is determined by supply and demand. In a regulated economy, the government determines
how resources are allocated.
Efficiency: A market economy is generally considered to be more efficient than a regulated
economy, as prices provide incentives for firms to produce goods and services at the lowest
possible cost. In a regulated economy, government regulations can create inefficiencies and reduce
the incentives for firms to innovate.
Equity: A regulated economy may be better at ensuring a more equitable distribution of resources,
as the government can use regulations and policies to promote social welfare goals such as income
redistribution. In a market economy, the distribution of resources is determined by the forces of
supply and demand, which may result in greater income inequality.
Innovation: A market economy is typically more conducive to innovation and technological
progress, as firms have a greater incentive to innovate in order to stay competitive. In a regulated
economy, government regulations and bureaucracy may stifle innovation.
Economic growth: A market economy is generally associated with higher rates of economic
growth, as the incentives for innovation and efficiency lead to increased productivity and output.
In a regulated economy, government control and regulation may restrict economic growth.

In summary, a market economy is characterized by decentralized decision-making and minimal

government intervention, while a regulated economy involves more government control and intervention
in economic activity. The main differences between the two systems relate to resource allocation,
efficiency, equity, innovation, and economic growth.

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 Principle of Economics
Module-B: Basics of Microeconomics
Market forces of Demand and Supply; Market Equilibrium; Shifts and Changes in the
Demand and Supply; Consumer‘s equilibrium – Utility analysis and Indifference Curve
Analysis; Consumer Surplus; Price Ceiling and Floor, Elasticity and its application.

Question 1. What is the difference between a change in quantity

demanded and a change in demand in microeconomics?
Answer: In microeconomics, the terms "change in quantity demanded" and "change in demand" refer to
different concepts.
A change in quantity demanded refers to a movement
along the demand curve, which is caused by a change
in the price of a good. When the price of a good
changes, the quantity demanded also changes, but the
demand curve itself does not shift.

Graphically, it means movement along the demand

curve. At price OP, the demand is OQ. When price
falls to OP2, demand rises to OQ2. In this case the
consumer moves from A to B downwards but remains
on the same demand curve. When price rises to OP1,
demand falls to OQ1. Once again the consumer moves
along the same demand curve from A to C.

Change in demand (or shift in demand curve) is

associated with the change in demand for a
commodity caused by factors other than the price of
a commodity such as price of related goods, income
of the consumer etc. It is expressed in the form of an
increase or decrease in demand. When at the given
price, the demand of a good increases, it is called
increase in demand. When at the given price, the
demand decreases, it is called decrease in demand.

Graphically it means, shift of the demand curve. At

price OP, the demand is OQ. When there is an
increase in demand at a given price, the demand curve
shifts to the right. If there is a decrease in demand at
the given price, the demand curve shifts to the left.

Therefore, the key difference between a change in quantity demanded and a change in demand is that the
former is caused by a change in the price of a good, while the latter is caused by other factors that affect
the entire demand curve.
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 Principle of Economics
Question 2. How do market forces of demand and supply determine
the price and quantity of goods in a competitive market?
Answer: Forces of demand and supply determine the equilibrium price when they are same and
graphically the point at which demand and supply intersect is equilibrium point and price is determined.

The demand curve represents the quantity of a good that consumers are willing and able to buy at different
prices, while the supply curve represents the quantity of the same good that producers are willing and able
to sell at different prices.

The intersection of the demand and supply curves

is the market equilibrium point, which determines
the price and quantity of the good in the market. At
this point, the quantity of the good demanded by
consumers equals the quantity of the good
supplied by producers, resulting in no excess
demand or supply in the market.

If the price of the good is initially below the

equilibrium price, then the quantity demanded
exceeds the quantity supplied, leading to excess
demand or a shortage in the market. This creates
upward pressure on the price, as consumers
compete to buy the limited supply of the good, and
producers respond by increasing their prices to
earn higher profits.

Conversely, if the price of the good is initially above the equilibrium price, then the quantity supplied
exceeds the quantity demanded, leading to excess supply or a surplus in the market. This creates downward
pressure on the price, as producers compete to sell their excess supply, and consumers respond by
decreasing their demand due to the higher price.

In both cases, the market forces of demand and supply interact to adjust the price and quantity of the good
until the equilibrium point is reached, where the quantity demanded equals the quantity supplied, resulting
in a stable market price and quantity for the good.

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 Principle of Economics
Question 3. How do shifts and changes in demand and supply affect the
equilibrium price and quantity of a good?
Answer: Shifts and changes in demand and supply can affect the equilibrium price and quantity of a good
in different ways.
Changes in demand: An increase in demand
leads to a rightward shift of the demand curve,
which means that at each price level, consumers
are willing and able to buy more of the good. This
increase in demand results in a new equilibrium
with a higher price and quantity. Conversely, a
decrease in demand leads to a leftward shift of the
demand curve, which means that at each price
level, consumers are willing and able to buy less
of the good. This decrease in demand results in a
new equilibrium with a lower price and quantity.

Changes in supply: An increase in supply leads

to a rightward shift of the supply curve, which
means that at each price level, producers are
willing and able to sell more of the good. This
increase in supply results in a new equilibrium
with a lower price and higher quantity.
Conversely, a decrease in supply leads to a
leftward shift of the supply curve, which means
that at each price level, producers are willing and
able to sell less of the good. This decrease in
supply results in a new equilibrium with a higher
price and lower quantity.

Simultaneous shifts in demand and supply: When both demand and supply shift at the same time, the
resulting changes in price and quantity are dependent on the magnitude and direction of the shifts. If both
demand and supply increase, then the equilibrium quantity will increase, but the price change will depend
on which shift is larger. If demand increases more than supply, then the equilibrium price will also
increase. If supply increases more than demand, then the equilibrium price will decrease. Similarly, if both
demand and supply decrease, then the equilibrium quantity will decrease, but the change of price will
depend on larger shift.
In summary, shifts and changes in demand and supply can affect the equilibrium price and quantity of a
good in different ways, and the resulting changes in price and quantity depend on the magnitude and
direction of the shifts.

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 Principle of Economics
Question 4. How do utility analysis and indifference curve analysis
help to determine consumer equilibrium in microeconomics?
Answer: In microeconomics, consumer equilibrium refers to a situation where a consumer is maximizing
their satisfaction or utility given their budget limit. Utility analysis and indifference curve analysis are two
tools that help to determine consumer equilibrium by analyzing the preferences of the consumer and the
limitations they face.

Utility analysis assumes that consumers have a certain level of satisfaction or utility from consuming
goods and services. The utility analysis is done by measuring the utility that a consumer receives from
consuming a good or service, and this is typically done using a utility function. A utility function is a
mathematical representation of the consumer's preferences, and it shows the amount of utility the
consumer receives from different combinations of goods and services. The utility function helps to
determine the level of satisfaction or utility that the consumer derives from consuming a particular
combination of goods and services.

Indifference curve analysis, on the other hand,

assumes that consumers have a preference for
certain combinations of goods and services that
provide the same level of satisfaction or utility. An
indifference curve is a graphical representation of
all the combinations of two goods that provide the
same level of utility or satisfaction to the
consumer. Indifference curves are typically
downward-sloping, which means that as the
consumer consumes more of one good, they are
willing to consume less of the other good to
maintain the same level of utility.

To determine consumer equilibrium, both utility analysis and indifference curve analysis are used
together. Consumer equilibrium occurs at the point where the budget constraint is tangent to the highest
possible indifference curve. In other words, the consumer is choosing a combination of goods that provides
the highest possible level of satisfaction or utility, given their budget constraint.

The budget constraint is determined by the consumer's income and the prices of the goods and services
that they consume. The budget constraint represents all the possible combinations of goods and services
that the consumer can purchase given their income and the prices of the goods and services.
By analyzing the consumer's preferences and budget constraint, utility analysis and indifference curve
analysis help to determine the optimal combination of goods and services that a consumer can purchase
to maximize their satisfaction or utility. This combination is the consumer equilibrium, and it is
determined by the intersection of the budget constraint and the highest possible indifference curve.

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 Principle of Economics
Question 5. What is consumer surplus and how is it calculated in
microeconomics?
Answer: Consumer surplus is a measure of the difference between the maximum price that a consumer is
willing to pay for a good or service and the actual price that they pay. In other words, it is the benefit that
consumers receive from being able to purchase a good or service at a price lower than what they are
willing to pay.

Consumer surplus is calculated in microeconomics as the area between the demand curve and the actual
market price of a good or service. To calculate consumer surplus, we first need to know the demand curve
for the good or service, which shows the quantity of the good or service that consumers are willing and
able to buy at different prices.

Next, we need to determine the actual market price of the good or service. Consumer surplus is the
difference between the maximum price that consumers are willing to pay for the good or service, as
indicated by the demand curve, and the actual market price of the good or service.

The consumer surplus can be calculated as the area between the demand curve and the market price, up to
the quantity that is actually purchased. Mathematically, it can be represented as:

Consumer surplus = (½) x Qd x ΔP

 Qd = the quantity at equilibrium where
supply and demand are equal

 ΔP = Pmax – Pd, or the price at

equilibrium where supply and demand are
equal
 Pmax = the price a consumer is willing to
pay

Consumer surplus always increases as the price of a good falls and decreases as the price of a good rises.
For example, suppose consumers are willing to pay $50 for the first unit of product A and $20 for the 50th
unit. If 50 of the units are sold at $20 each, then 49 of the units were sold at a consumer surplus, assuming
the demand curve is constant. Consumer surplus is zero when the demand for a good is perfectly elastic.
But demand is perfectly inelastic when consumer surplus is infinite.

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 Principle of Economics
Question 6. How do price ceilings and floors affect the market for a
good?
Answer: Price ceilings and floors are government-imposed price controls that limit the price at which a
good or service can be sold in a market. Price ceilings set a maximum price that can be charged for a good
or service, while price floors set a minimum price that must be charged.

Price ceiling refers to the maximum price of a

commodity that sellers can charge from buyers.
Often, the government fixes this price to be lower
than the equilibrium market price so that the
commodity remains within the reach of the poorer
sections of the society. When the ceiling price is
lower than the equilibrium price, there is likely to be
excess demand in the market, leading to a shortage of
the commodity.

A price floor is a government-imposed minimum

price for a product or service designed to regulate the
market. Agricultural price floors are a common
example, where the government sets a minimum
price for crops to ensure that farmers receive a fair
price for their produce. This helps ensure that farmers
can cover their production costs and maintain their
livelihoods, even in market volatility.

Price ceilings and floors can have unintended consequences, such as creating shortages or surpluses,
reducing the quality of the goods or services provided, or leading to black markets where the good or
service is sold at a higher price. Overall, price controls can distort the functioning of the market and reduce
overall welfare for both consumers and producers.

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 Principle of Economics
Question 7. What is elasticity of demand and how is it measured in
microeconomics?
Answer: Elasticity of demand is a measure of how responsive the quantity demanded of a good or service
is to changes in its price. It is a key concept in microeconomics that helps to determine the impact of
changes in price on the quantity demanded of a good or service.

The formula for elasticity of demand is:

This formula measures the percentage change in the quantity demanded of a good or service in response
to a percentage change in its price. If the elasticity of demand is greater than one, the good or service is
considered to be elastic, meaning that a small change in price leads to a large change in the quantity
demanded. If the elasticity of demand is less than one, the good or service is considered to be inelastic,
meaning that a change in price has a small impact on the quantity demanded.

Let us take the simple example of gasoline. Now let us assume that a surge of 60% in gasoline price
resulted in a decline in the purchase of gasoline by 15%. Using the formula as mentioned above, the
calculation of price elasticity of demand can be done as:

Percentage change in Demand

Price Elasticity of Demand = Percentage change in price

Price Elasticity of Demand = -15% ÷ 60%

Price Elasticity of Demand = -1/4 or -0.25

Overall, elasticity of demand is an important concept in microeconomics as it helps to determine how

changes in price and other factors affect the demand for goods and services in a market.

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 Principle of Economics
Question 8. How does the law of supply and demand explain the
relationship between the price and quantity of goods in a market?
Answer: The law of supply and demand is the theory that prices are determined by the relationship
between supply and demand. If the supply of a good or service exceeds the demand for it, prices will fall.
If demand exceeds supply, prices will rise.

The law of demand states that as the price of a good or service increases, the quantity demanded will
decrease, and as the price decreases, the quantity demanded will increase. This relationship is due to the
fact that consumers are generally willing to purchase more of a good or service when it is cheaper, and
less of it when it is more expensive.

The law of demand states that as the price of a good or

service increases, the quantity demanded will decrease,
and as the price decreases, the quantity demanded will
increase. This relationship is due to the fact that
consumers are generally willing to purchase more of a
good or service when it is cheaper, and less of it when it
is more expensive.

For Example, If the price of the fuel is $2.00 per liter,

people willingly purchase 60 liters per week. In case of a
price drop, $1.70 per liter, there may be a rise in
consumption of say 70 liters per week. With a further
reduction in prices: $1.50, people may purchase up to 75
liters each week.

The law of supply, on the other hand, states that as the

price of a good or service increases, the quantity supplied
will increase, and as the price decreases, the quantity
supplied will decrease. This relationship is due to the fact
that producers are generally willing to supply more of a
good or service when the price is higher, and less of it
when the price is lower.

For example, As the price of milk increases, say, from

$1.00 per gallon to $2.20 per gallon, the quantity supplied
increases from 500 million gallons to 720 million gallons.
Conversely, as the price decreases, the quantity supplied
decreases.

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 Principle of Economics
When the forces of supply and demand are in balance,
the market reaches a state of equilibrium, where the
quantity demanded is equal to the quantity supplied at
a specific price. If the price of a good or service is too
high, the quantity supplied will exceed the quantity
demanded, leading to a surplus of the good or service.
If the price is too low, the quantity demanded will
exceed the quantity supplied, leading to a shortage.

Overall, the law of supply and demand is a key

principle in microeconomics that helps to explain how
the price and quantity of goods are determined in a
market, and how changes in supply and demand can
affect the equilibrium price and quantity of a good or
service.

Question 9. ‘Marginal utility decreases as a consumer consumes more

of a good’-explain.
Answer: Marginal utility is the concept used by economists to quantify the amount of satisfaction that is
gained by the consumption of additional units of a good or service. It is an important concept that is used
by economists to determine how much quantity of an item a customer is willing to purchase.
Positive marginal utility is said to occur when the consumption of an additional item increases the total
utility, while negative marginal utility occurs when the consumption of an additional item decreases the
total utility of the item.
The marginal utility formula used to calculate the level of satisfaction of consumers is:
Change in Total Utility
MARGINAL UTILITY =
Change in the Number of Units

When people are thirsty, the highest level of satisfaction they gain is from the first glass of water or juice
they consume. However, as they proceed to the glass of water or juice for the second time, it is less
satisfying as they are not as thirsty as they were before having the first glass of water/juice. Thus, their
urge to consume it reduces with every additional glass.
Units Total Utility Marginal Utility
1 10 10
2 19 9
3 27 8
4 22 5
5 20 2
6 19 1

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 Principle of Economics
Module-C: Production and Cost
Concepts of Production; Production in the Short run; Short-run Costs of Production;
Relations between Short-run Cost and Production; Production ISOQUANTS and
ISOCOST Curves, Optimal Combination of Inputs; Optimization and Cost; Expansion
Path and Returns to Scale; Long Run Costs, Relationship between SR and LR Cost.

Question 1. Why the marginal product of labor is likely to increase

initially in the short run as more of the variable input is hired?
Answer: Marginal product refers to the change in the total output by employing one additional unit
of labor. In other words the marginal product of labor refers to the additional output produced by
employing one additional unit of labor while holding other inputs constant.

Marginal Change in total product

= Change in labor units
Product
When additional units of labor are added to a fixed quantity of capital, we see the marginal product of
labor rise, reach a maximum, and then decline. The marginal product of labor increases because, as
the first workers are hired, they may specialize in those tasks in which they have the greatest ability.
Eventually, with the quantity of capital fixed, the workplace becomes congested and the productivity
of additional workers declines.

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 Principle of Economics
There is a factory which produces toys. When there are no workers in the factory, no toys are produced.
When there is one worker in the factory, six toys are produced per hour. When there are two workers
in the factory, eleven toys are produced per hour. There is a marginal product of labor of five when
there are two workers in the factory compared to one. When the marginal product of labor is
increasing, this is called increasing marginal returns. However, as the number of workers increases,
the marginal product of labor may not increase indefinitely. When not scaled properly, the marginal
product of labor may go down when the number of employees goes up, creating a situation known as
diminishing marginal returns. When the marginal product of labor becomes negative, it is known as
negative marginal returns.

Question 2. What is the relationship between marginal product and

average product & marginal product and total product?
Answer: The function that explains the relationship between physical inputs and physical output (final
output) is called the production function. There are three types of production function:
Total Product: Total Product as the total volume or amount of final output produced by a firm using
given inputs in a given period of time.
Total Product = Ʃ Marginal Product
Marginal Product: Marginal product refers to the change in the total output by employing one
additional unit of labor.
Marginal Product = Change in Output/ Change in Input
Average Product: Average Product (AP) is the total number of units a firm produced divided by the
quantity of inputs used.
Average Product = Total Product/ Input Quantity
Relationship between Marginal Product and Total
Product
When the Marginal Product (MP) increases,
the Total Product is also increasing at an
increasing rate.
When the MP declines but remains positive,
the Total Product is increasing but at a
decreasing rate.
When the MP is declining and negative, the
Total Product declines.
When the MP becomes zero, Total Product
reaches its maximum.

Relationship between Average Product and Marginal Product

When Average Product is rising, Marginal Product lies above Average Product.
When Average Product is declining, Marginal Product lies below Average Product.
At the maximum of Average Product, Marginal and Average Product equal each other.

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 Principle of Economics
Question 3. Explain the law of diminishing marginal product.
Answer: The Law of Diminishing Marginal Product is an economics concept. It says that, at early
stages of production, if we increase 1 production variable and the rest of the things remain the same,
the product total production may increase. If, however, we continue to increase the input of that
production variable, it will produce lesser returns (on average) per production variable. In simple
words, an increase in the quantity of 1 production variable will increase the output up to a certain
point. After that point, it will give less gain for each unit added. The return on investment goes down.

‘Too many cooks spoil the broth’. The law of diminishing returns discusses this in the context of
production. The law of diminishing marginal productivity helps in understanding why increased
manufacturing is not always the best way to increase profitability.

For example, Dominos opens for business but with a single worker. The worker produces six pizzas
in a day. However, the business owner decides to add workers to increase productivity. The table
below shows the schedule of hired workers and the input:

Input Output
Marginal
(No. of (No. of
Product
workers) Pizzas)

0 0 –
1 6 6
2 14 8
3 17 3
4 19 2
5 19 0
6 16 -3

From the table, we can see that marginal product began to diminish from the third worker until it
became negative by the sixth worker. On the other hand, total output began to stagnate at the fifth
worker and fell at the sixth worker. It could be that as the workers increased, the space in the kitchen
became smaller. As such, the productivity of each worker fell because they started getting in each
other’s way.

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 Principle of Economics
Question 4. What is isoquant map? What does an isoquant map
reflect?
Answer: An isoquant is a level set of the long-run production function also known as equal product
curves/iso-product curve. It is a curved line that shows all possible combinations of inputs keeping the
level of output the same. In other words, an iso-quant curve is a geometric representation of the production
function, wherein different combinations of labor and capital are employed to have the same level of
output. The iso-quant curve is also known as Iso-Product Curve. The term “Iso” means same and “quant”
or “product” means quantity produced.
Suppose there are two input factors Labor and Capital. The different combinations of these factors are
used to have the same level of output as shown in the schedule below:
Labor Capital Output
Combination
(unit) (Unit) (Number)
A 1 10 100

B 2 9 100

C 3 8 100

D 4 7 100

Iso-quant Map: An iso-quant map shows the different iso-quant curves representing the different
combinations of factors of production, yielding the different levels of output. Thus, higher the iso-quant
curve, the higher is the level of output.

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 Principle of Economics
Isoquants are Convex to the Origin: Like indifference curves, isoquants are convex to the origin because
convexity of an isoquant implies that the MRTS diminishes along the isoquant.

MRTSLK = – ∆K/∆L
Where,
∆K = is the change in capital and
AL = is the change in labor.

Equation states that for an increase in the use of labor, fewer units of capital will be used. In other words,
a declining MRTS refers to the falling marginal product of labor in relation to capital. To put it differently,
as more units of labor are used, and as certain units of capital are given up, the marginal productivity of
labor in relation to capital will decline.

As we move from point A to B, from

B to C and from C to D along an
isoquant, the marginal rate of
technical substitution (MRTS) of
capital for labor diminishes. Every
time labor units are increasing by an
equal amount (AL) but the
corresponding decrease in the units of
capital (AK) decreases. Thus it may
be observed that due to falling
MRTS, the isoquant is always convex
to the origin.

Marginal rate of technical substitution (MRTS): The slope of an iso-quant curve is called the rate of
technical substitution, which means how much capital are to be substituted for the labor to give the same
quantity of production if the labor is reduced by 1 unit. MRTS, on the graph shows the rate at which a
given input, either labor or capital, can be substituted for the other while keeping the same output level.
The MRTS is represented by the absolute value of an isoquant's slope at a chosen point. A decline in
MRTS along an isoquant for producing the same level of output is called the diminishing marginal rate of
substitution.

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 Principle of Economics
Returns to Scale: Returns to scale in economics refers
to a term that states that the degree of change in input
factors changes the output proportionally and
concurrently during the production process. It reflects
the quantitative change that applies in the long-term
using similar technology. It forms the basis of
measuring a firm’s or industry’s efficiency of
production capacity. There are three kinds of returns to
scale: constant returns to scale (CRS), increasing
returns to scale (IRS), and decreasing returns to scale
(DRS).
Increasing returns to scale: when the output increases in
a greater proportion than the increase in input. If the
proportional change in the output of an organization is
greater than the proportional change in inputs, the
production is said to reflect increasing returns to scale.
A movement from A to B shows that the amount of input
is doubled. When labor and capital are doubled from 2 to
4 units, output increases more than double, that is, from
50 units to 120 units. This is increasing returns to scale,
which occurs because of economies of scale.
Constant returns to scale: when an increase in input
results in a proportional increase in output. It means when
the output increases in the same proportion as the input
increases.
A movement from A to B shows that the amount of input
is doubled. When labor and capital are doubled from 2 to
4 units, output also doubles from 50 units to 100 units.
This is constant returns to scale.
Decreasing returns to scale: When all production
variables are increased by a certain percentage resulting
in a less-than-proportional increase in output.
Diminishing returns to scale refers to a situation in which
output increases in lesser proportion than increase in
factor inputs.
A movement from A to B shows that the amount of input
is doubled. When labor and capital are doubled from 2 to
4 units, output increases less than double that is from 50
units to 80 units. This is diminishing returns to scale.
Diminishing returns to scale is due to diseconomies of
scale, which arises because of managerial inefficiency.

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 Principle of Economics
Module-D: Market Structure
Various Forms of Markets; Characteristics of Perfect Competition – Profit Maximization
in the Short run (SR) and Long run (LR); Nature of Monopoly and Monopolistic
Competition- SR and LR Equilibrium under Monopoly and Monopolistic Competition;
Strategic Decision Making in Oligopoly Markets.

Question 1. Identify and compare features of the four major market

structures.
Answer: Market structure refers to the characteristics of a market that determine how firms
interact with one another and their customers. There are several different types of market structures:

Perfect competition: This market structure is characterized by a large number of small firms that
produce identical products and have no market power. Firms in perfect competition are price takers,
meaning they must accept the market price and cannot influence it.

Monopoly: A monopoly is a market structure in which there is only one seller of a particular product,
and no close substitutes are available. This gives the monopolist substantial market power and the
ability to set prices above the competitive level.

Monopolistic competition: This market structure is characterized by a large number of firms

producing differentiated products. Firms have some degree of market power, but it is limited by the
availability of close substitutes.

Oligopoly: An oligopoly is a market structure in which a few large firms dominate the market. Each
firm has some degree of market power, and their behavior is interdependent, meaning that they must
take into account the actions of their rivals when making strategic decisions.
These market structures differ from one another in terms of the number and size of firms, the degree
of market power they have, and the level of product differentiation. The characteristics of each market
structure have important implications for the behavior of firms and the outcomes of markets.

Question 2. ‘A perfectly competitive firm earns zero or normal profit

in the long run’- Why and How?
Answer: Perfect competition is a theoretical market structure that produces the best possible
economic outcomes for both consumers and society. In a perfectly competitive market, firms can only
experience profits or losses in the short run. In the long run, profits and losses are eliminated because
an infinite number of firms are producing infinitely divisible, homogeneous products. Because so
many firms producing the same products that none of the firms can attain enough power in the long
run to influence the industry. Thus, eventually, all of the possible causes of profits are assumed away.

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 Principle of Economics
Question 3. ‘The conditions for profit maximization by a firm is when
MC = MR and MC cuts MR from’-Explain your answer.
Profit maximization is the process of finding the level of production that generates the maximum amount
of profit for a business. Profit will be maximized at the point of production and sales where Marginal
Revenue = Marginal Cost. Theoretically, the point at which the marginal cost and marginal revenue
become equal allows for the maximum gap between the MR and MC. As a result, the profit at this point
is always maximum.

In the above graph, Q1 (output) is the point that

intersects MR and MC. The above graph shows
that if the firm produces less output than
equilibrium quantity Q1, then MR becomes greater
than MC. As a result, the firm is gaining more
revenue than the cost it is spending on producing
goods, leading to an overall enhancement of profit.
As the output by the firm approaches the level of
Q1, initially, the MR is slightly greater than MC.
Subsequently, as the output crosses Q1, the
marginal cost will substantially increase over the
marginal revenue. As a result, the firm will
experience a revenue loss.
Question 4. Explain short run and long run equilibrium situations in a
monopolistic market situation.
Answer: Short Run Equilibrium: In a monopolistically competitive market, the short-
run equilibrium occurs when each firm’s plant size is fixed and the total number of firms in the market
is also fixed. In the short run, firms should produce a quantity where marginal revenue equals
marginal cost. Doing so, they maximize their profit or minimize their losses, depending on their
average total cost (ATC).

In Figure 1 above, you can see that the output

quantity is represented on the x-axis, and price
and cost are illustrated on the y-axis. First, we
look at the point where marginal revenue
(MR) is equal to marginal cost (MC). This
intersection point of marginal revenue and
marginal cost is point 1. This point also helps
us to define the firm’s equilibrium output. If
we look at the corresponding value on the x-
axis, we can see that the output quantity in the
short-run equilibrium is A in this case.

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 Principle of Economics
Next, we should find the price. Since we know the equilibrium output (which is A), all we have to do
is look at the corresponding value on the demand curve. Assume that we draw an imaginary vertical
line from the equilibrium output up and this line meets the demand curve at point 3. The
corresponding price for point 3 on the y-axis determines the value of the price, in this case, it is C.
Similarly, we can find the corresponding value of the Average Total Cost at the equilibrium output,
which is equal to B.

Long Run Equilibrium: Firms’ supernormal profits in the short run will encourage other
firms to enter in the long run. As a result, the supply of the group increases, and the market share of
individual firms will decline. So, the demand curve of the firms will shift down, implying that each
firm can sell less quantity at every price than he sold in the short run. The market will be at equilibrium
in the long run only if there is no exit or entry in the market anymore. The firms will not exit or enter
the market only if every firm makes zero profit. This is the reason why we name this market structure
monopolistic competition.

We can see a firm in monopolistic competition

and is making zero profit in the long-run
equilibrium. As we see, the equilibrium
quantity is defined by the intersection point of
the MR and MC curve, namely at A. We can
also read the corresponding quantity (Q) and
the price (P) at the equilibrium output level. At
point B, the corresponding point at the
equilibrium output level, the demand curve is
tangent to the average total cost curve.

If we want to calculate the profit, normally we take the difference between the demand curve and the
average total cost and multiply the difference with the equilibrium output. However, the difference is
0 since the curves are tangent. As we expect, the firm is making zero profit in the equilibrium.

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 Principle of Economics
Question 5. What is the collusion? Why is it very difficult to maintain
an oligopoly cartel?
Answer: Collusion in economics refers to a situation in which a group of companies cooperates
to set prices higher than a competitive benchmark or close enough to resemble a monopoly. This
practice aims to take control of the prices of commodities and maximize industry earnings as a whole.
This is an illegal means to acquire additional money. It eliminates healthy competition, and market
equilibrium faces disruption. There are two types of collusive methods: tacit and explicit.

Cartels are difficult to maintain. The problem is that cartel members will be tempted to cheat on their
agreement to limit production. By producing more output than it has agreed to produce, a cartel
member can increase its share of the cartel's profits. Some following obstacles for Oligopoly cartel:

 The number and size distribution of sellers.

 The similarity/dissimilarity of the products
 Cost Structure
 Order size and frequency
 The strength and severity of retaliation
 The degree of external competition

Question 6. Why Monopoly is considered as inefficient as compared to

that of perfect competition and monopolistic market structure?
Answer: Monopoly is considered inefficient compared to perfect competition and monopolistic
market structures due to several reasons:
 Lack of competition: In a monopoly, there is only one seller or producer in the market, which
means there is no competition. Without competition, there is less pressure to innovate,
improve efficiency, or offer competitive prices.
 Higher prices: Because the lack of competition Monopolies often charge higher prices for
their products or services. This can result in a misallocation of resources and reduced
consumer surplus.
 Restricted output: Monopolies may restrict the quantity of goods or services produced to
keep prices artificially high. This limitation on output can lead to inefficiencies, as the market
is not operating at its full potential.
 Lack of consumer choice: Monopolies limit consumer choice by offering a single product or
service. Consumers have no alternatives or substitutes to choose from, which can reduce their
welfare.
 Reduced innovation: Monopolies often have less incentive to invest in research and
development or innovation compared to competitive markets. Since they face limited or no
competition, there is less pressure to improve products, reduce costs, or introduce new
technologies.
In contrast, perfect competition and monopolistic competition promote efficiency through
competitive pressures. In these market structures, multiple firms compete, leading to lower prices,
increased output, consumer choice, and incentives for innovation and efficiency gains.

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 Principle of Economics
Module-E: Market Failure and Market
Intervention
Concepts of Market Failure and Externalities, Market Failure and Policy Intervention
in the financial sector.
Question 1. Explain two sources of externalities, externalities in
production and externalities in consumption.
Answer: Externalities refer to the cost or benefit experienced by an entity without producing,
consuming, or paying for it. It implies that this indirect cost or benefit affects an entity other than its
producer or consumer. They can arise from both production and consumption processes. Let's explore
two sources of externalities: externalities in production and externalities in consumption.

Externalities in Production: Externalities in production occur when the production of a

good or service affects parties outside the production process, resulting in costs or benefits to those
parties. These external effects can be positive or negative.

 Negative production externality: A negative production externality arises when the

production of a good or service imposes costs on third parties.
 Positive production externality: A positive production externality occurs when the
production of a good or service confers benefits on third parties.

Externalities in Consumption: Externalities in consumption arise when the consumption

of a good or service by one party affects the well-being of others. These external effects can also be
positive or negative.

 Negative consumption externality: A negative consumption externality occurs when the

consumption of a good or service imposes costs on others.
 Positive consumption externality: A positive consumption externality arises when the
consumption of a good or service benefits others.

In both cases, externalities can result in a misallocation of resources since the costs or benefits are not
fully accounted for in the market price. Governments and policymakers often intervene to address
these externalities through regulations, taxes, subsidies, or other measures to internalize the costs or
benefits and promote a more efficient allocation of resources.

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 Principle of Economics
Question 2. Draw a supply-and-demand diagram to explain the effect
of a negative externality that occurs as a result of a firm’s
production process.
Answer: Negative externalities are responsible for the inefficient allocation of resources in the
economy due to the cost they impose on third parties. The negative externalities graph shows how
inefficient allocation of resources occurs due to negative externalities.
The supply curve given by MPC reflects the
firm’s private costs of production and the
marginal social cost curve given by MSC
represents the full cost of production to
society. The vertical difference between
MPC and MSC represents negative
externality. Therefore for each level of
output, Q1, social costs given by MSC are
greater than the firm’s private costs by the
amount of externality. The optimal
production quantity is Q*, but the negative
externality results in production of Q1.

Question 3. Define and give an example of a public good. Can the

private market provide this good on its own?-Explain.
Answer: Public goods are commodities or services that benefit all members of society, and which
are often provided for free through public taxation. To be classified as a public good, the product or
service must remain non-excludable and non-rivalrous. The types of public goods include security,
education, knowledge, infrastructure, environment and health.
I think the safety net that a state should provide depends on the country's wealth and especially the
abilities of the people paying for that safety net. The ability of the private market to provide public
goods on its own is a subject of debate among economists and policymakers. Because the private
market is profit-driven, it produces only those goods for which it can hope to earn a profit. Private
firms are driven by profit motives and generally seek to maximize their own gains. Public goods, on
the other hand, are often in the interest of society as a whole, but individual firms may not have
sufficient incentives to provide them if they cannot capture the full economic benefits.
However, there are cases where the private market can contribute to the provision of public goods,
either partially or entirely. For examples, Private individuals and organizations can voluntarily
contribute to the provision of public goods through donations, grants, or philanthropic efforts. This
can apply to areas such as education, healthcare, research, and environmental conservation.
In summary, the private market can contribute to the provision of certain aspects of public goods, it is
often insufficient to rely on the private sector alone.

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 Principle of Economics
Question 4. How Price Ceiling in the case of Natural Monopoly could
be beneficial for the common people?
Answer: A price ceiling in the case of a natural monopoly can potentially benefit the common people
by preventing the monopolistic company from charging excessively high prices and exploiting its market
power. Here are some ways in which a price ceiling can be advantageous:
 Consumer Protection: A price ceiling sets a maximum limit on prices, ensuring that the company
cannot charge excessively and protects consumers from overcharging.
 Increased Affordability: The price ceiling ensures that the monopolistic company cannot take
advantage of its market dominance and keeps prices within a reasonable range.
 Promoting Equity: price ceiling promotes equity by ensuring that the benefits of efficiency and
cost reduction are shared with the public.
 Enhanced Consumer Surplus: Lower prices resulting from the price ceiling enable consumers
to access the product or service at a more favorable price point, leading to increased satisfaction
and welfare.
 Economic Access: By preventing excessive price increases, Price ceilings can provide an
individual with limited financial means can still afford critical services necessary for their well-
being, thereby reducing inequality and promoting social inclusion.
It's important to note that implementing a price ceiling requires careful consideration of the market
dynamics and the cost structures of the natural monopoly.

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