Business Economics Question Papers
2012 (May)
(General / Speciality)
Course: 202
(Business Economics)
Full Marks: 80
Pass Marks: 32
1. Answer as Directed: 1x8=8
(a) Business Economics is micro/macro economics in nature.
Ans: micro
(b) Business Economics is also known as Managerial Economics.
(c) Draw a perfectly inelastic demand curve.
(d) Give an example of Joint Demand.
Ans: Ink and pen
(e) If marginal product is zero, how much will be the total product?
Ans: TP becomes maximum
(f) Total revenue = Price x Quantity.
(g) Mention the type of market where a particular commodity is sold at uniform price.
Ans: perfect competition
(h) Give an example if selling cost.
Ans: advertisement
2. Answer the following questions in brief: 4x4=16
(a) Mention four chief characteristics of Business economics.
Ans: Nature or Characteristics of Managerial Economics:
- Managerial Economics is a Science: Managerial economics is a science because it establishes relationship between causes and effects. It studies the effects of a change in price of a commodity factors and forces on the demand of a particular product. It also studies the effects and implications of the plans, policies and programmes of a firm on its sales and profit.
- Managerial Economics is an Art: Managerial economics may also be called an art. Because it also develops the best way of doing things. It helps management in the best and most efficient utilization of limited economic resources of the firm.
- Managerial Economics is a Micro Economics: Entire study of economics may be divided into two segments – Macro economics and Micro economics. Managerial economics is mainly micro-economics. Micro economics is the study of the behaviour and problems of individual economic unit. In managerial economics unit of study is firm or business organization and an individual industry. It is the problem of business firms such as problem of forecasting demand, cost of production, pricing, profit planning, capital, management etc.
- Managerial Economics is the Economics of firms: Managerial economics largely use that body of economic concepts and principles which is known as ‘Theory of the Firm’ or ‘Economics of the Firm’.
(b) What is demand? Mention the assumptions which are necessary for law of demand analysis.
Ans: Law of Demand: Among the many causal factors affecting demand, price is the most significant and the price- quantity relationship called as the Law of Demand is stated as follows: "The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchasers, or in other words, the amount demanded increases with a fall in price and diminishes with a rise in price" (Alfred Marshall).
Assumptions to law of demand
1. Income level should remain constant: The law of demand operates only when the income level of the buyer remains constant. If the income rises while the price of the commodity does not fall, it is quite likely that the demand may increase.
2. Tastes of the buyer should not alter: It often happens that when tastes or fashions change people revise their preferences. As a consequence, the demand for the commodity which goes down the preference scale of the consumers declines even though its price does not change.
3. Prices of other goods should remain constant: Changes in the prices of other goods often affect the demand for a particular commodity. Therefore, for the law of demand to operate it is imperative that prices of other goods do not change.
4. No new substitutes for the commodity: If some new substitutes for a commodity appear in the market, its demand generally declines. This is quite natural, because with the availability of new substitutes some buyers will be attracted towards new products and the demand for the older product will fall even though price remains unchanged. Hence, the law of demand operates only when the market for a commodity is not threatened by new substitutes.
(c) Write four factors on which supply of a commodity depends.
Ans: Determinants of Supply are follows:
- Price of the Commodity: There is a direct relationship between price of a commodity and its quantity supplied. Generally, higher the price, higher the quantity supplied, and lower the price, lower the quantity supplied.
- Price of Related Goods: The supply of a good depends upon the price of related goods. Example, Consider a firm selling tea. If price of coffee rise in the market, the firm will be willing to sell less tea at its existing price. Or, it will be willing to sell the same quantity only at a higher price.
- Number of Firms: Market supply of a commodity depends upon number of firms in the market. Increase in the number of firms implies increase in market supply, and decrease in the number of firms implies decrease in market supply of a commodity.
- Goal of the Firm: If goal of the firm is to maximize profits, more quantity of the commodity will be offered at a higher price. On the other hand, if goal of the firm is to maximize sales (or maximize output or employment) more will be supplied even at the same price.
(d) Write short notes on internal economics.
Ans: Internal Economies: A producer drives a number of advantages when he expands the size of his factory. These advantages are called internal economies. They arise because of increase in the scale of production (i.e. output that can be produced). These are secured only by the firm expanding its size. They are dependent on the efficiency of the organizer and his resources. So internal economies are those advantages which are obtained by a producer when he increases or expands the size of his firm. Internal economies are divided into various classes as follows. When a firm increases its scale of production it enjoys several economies. These economies are called internal economies.
3. (a) Explain how economic theories are applied to Business Economics. 11
Ans: Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making. Economic theories and techniques of economic analysis are applied in analyze business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision. Managerial economics is thus constituted of that part of economic knowledge, logic theories and analytical tools that are used for rational business decision making.
Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies.
Managerial economics is that discipline which uses economic concepts, principles and economic analysis in taking business decision and formulating future plans. It integrates economic theory with business practice for choosing business policies. Managerial economics lies on the borderline between economics and business management and bridges the gap between the two.
Definition of Managerial Economics:-
According to McNair and Meriam: “Managerial economics ……. Is the use of economics modes of thought to analyze business situation.”
According to Mansfield: “Managerial economics is concerned with the application of economic concepts and economics analysis to the problems of formulating rational decision making”.
Use of economic theories in business economics:
In the words of Haynes “The relation of managerial economics to economic theory is much like that of engineering to physics, or of medicine to biology or bacteriology. It is the relation of an applied field to the more fundamental but more abstract basic discipline from which it borrows concepts and analytical tools. The fundamental theoretical fields will no doubt on the long run make the greater contribution to the extension of human knowledge. But the applied fields involve the development of skills that are worthy of respect in themselves and that require specialized training. The practicing physician may not contribute much to the advance of biological theory but he plays an essential role in producing the fruits of progress in theory. The managerial economist stands in a similar relation to theory with perhaps the difference that the dichotomy between the pure and the “applied” is less clear in management than it is in medicine.”
Managerial economics has been defined as economics applied in decision-making. It is a special branch of economics bridging the gap between economic theory and managerial practice. The relationship between managerial economics and traditional economics is facilitated by considering the structure of traditional study. The traditional fields of economic study about theory, Micro economics focuses on individual consumers firms and industries. Macro economics focuses on aggregations of economics units, especially national economics. The emphasis on normative economics focuses on prescriptive statements that are established rules on the specified field. Positive economics focuses on description that describes that manner in which economics forces operate without attempting to state how they should operate. The focus of each field of study is sufficiently well defined to warrant the breakdown suggested.
Since each area of economics has some bearing on managerial decision making, managerial economics draws from them all. In practice, some are more relevant to the business firm that others and hence to managerial economics. Both micro-economics and macro-economics are important in managerial economics but the micro economic theory of the firm is especially significant. The theory of firm is the single most important element in managerial economics. However, because the individual firm is influenced by the general economy, that is domain of macro economics. Managerial economics is certainly on normative theory. We want to establish decision rules that will help managers attain the goals of their firm, agency or organization; this is the essence of the word normative. If managers are to establish valid decision rules, however, they must thoroughly know the environment in which they operate for this reason positive or descriptive economics is important.
Surveys conducted in various countries showed that business economists have found economic concepts such as price elasticity of demand, income elasticity of demand, opportunity casts, the multiplier, propensity to consume, marginal revenue products,. Speculative motive, production function, balanced growth, liquidity preference etc., quite useful and of frequent application. They have also found the following main areas of economics as useful in their works:
- Demand theory
- Theory of the firm-price and output
- Business financing
- Public Finance and Fiscal Policy
- Money and banking
- National income and Social accounting
- Theory of international trade, and
- Economics of developing countries.
Or
(b) Explain the basic problems of an economic system. 11
Ans: Basic Problems of an economic system or Problems of business economics: The problem of scarcity of resources which arises before an individual consumer also arises collectively before an economy. On account of this problem and economy has to choose between the following:
(i) Which goods should be produced and in how much quantity?
(ii) What technique should be adopted for production?
(iii) For whom goods should be produced?
These three problems are known as the central problems or the basic problems of an economy. This is so because all other economic problems cluster around these problems. These problems arise in all economics whether it is a socialist economy like that of North Korea or a capitalist economy like that of America or a mixed economy like that of India. Similarly, they arise in developed and under-developed economics alike.
1. What to produce?
There are two aspects of this problem— firstly, which goods should be produced, and secondly, what should be the quantities of the goods that are to be produced. The first problem relates to the goods which are to be produced. In other words, what goods should be produced? An economy wants many things but all these cannot be produced with the available resources. Therefore, an economy has to choose what goods should be produced and what goods should not be. In other words, whether consumer goods should be produced or producer goods or whether general goods should be produced or capital goods or whether civil goods should be produced or defense goods. The second problem is what should be the quantities of the goods that are to be produced.
2. How to produce?
The second basic problem is which technique should be used for the production of given commodities. This problem arises because there are various techniques available for the production of a commodity such as, for the production of wheat, we may use either more of labour and less of capital or less of labour or more of capital. With the help of both these techniques, we can produce equal amount of wheat. Such possibilities exist relating to the production of other commodities also.
Therefore, every economy faces the problem as to how resources should be combined for the production of a given commodity. The goods would be produced employing those methods and techniques, whereby the output may be the maximum and cost of production is the minimum.
3. For whom to produce?
The main objective of producing a commodity in a country is its consumption by the people of the country. However, even after employing all the resources of a country, it is not possible to produce all the commodities which are required by the people. Therefore, an economy has to decide as to for whom goods should be produced. This problem is the problem of distribution of produced goods and services. Therefore, what goods should be consumed and by whom depends on how national product is distributed among various people.
All the three central problems arise because resources are scarce. Had resources been unlimited, these problems would not have arisen. For example, in the event of resources being unlimited, we could have produced each and every thing we had wanted, we could have used any technique and we could have produced for each and everybody.
4. The problem of efficient use of resources: An economy has to face the problem of efficiently using its resources. Production can be increased even by improving the use of resources. Resources will be deemed to be better utilised when by reallocating them in various uses, production of a commodity can be increased without adversely affecting the production of other commodities.
5. The problem of fuller employment of resources: In many economies, especially in developing economies, there is a tendency towards under-utilisation of resources. Resources lying idle or not being utilised fully is a recurring problem in many economies. This problem is particularly acute in labour-abundant economies like that of India where large scale unemployment exists. In many economies, a vital resource like land too remains under-utilised. Resources being relatively scarce, they should not be allowed to remain idle as it is a waste.
6. The Problem of Growth: The last problem is of growth. Every economy strives to increase its production for increasing standards of living of its people. Economic growth of a country depends upon the fact as to what extent; it can increase its resources. This problem is not confined to developing economies alone. It is also faced by developed economies which strive for increasing their resources in order to increase the material comforts of their technically advanced societies.
4. (a) Explain the percentage or proportional method of measuring price elasticity of demand. The price of per kilogram mango is Rs. 20 and demand for it is 40 kilograms. Now price of mango falls to Rs. 16 per kilogram and demand for mango increases to 44 kilograms. Find out price elasticity of demand using percentage or proportional method. 5+6=11
Or
(b) What is price elasticity of demand? Explain the importance of price elasticity of demand. 4+7=11
Ans: Introduction: Demand is desire backed by willingness to pay and ability to pay i.e. a wish to have a commodity does not become demand. A person wishing to have a commodity should be willing to pay for it and should have ability to pay for it. Thus a desire becomes demand if it is backed by willingness to pay and ability to pay. Demand is meaningless unless it is stated with reference to a price.
Decisions regarding what to produce, how to produce and for whom to produce are taken on the basis of price signals coming from the market. The law of demand explains inverse relationship between price and quantity demanded. When price falls quantity demanded of that commodity will increase. The deficiency of law of demand is removed by the concept of elasticity of demand.
MEANING AND DEFINITION OF ELASTICITY OF DEMAND
The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.
Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.
According to E.K. Estham, “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price”.
According to Muyers “Elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve”.
According to A.K. Cairncross “The elasticity of demand for a commodity it is the rate at which quantity bought changes as the price changes.”
Importance of Elasticity of Demand
1. Determination of price policy: While fixing the price of this product, a businessman has to consider the elasticity of demand for the product. He should consider whether a lowering of price will stimulate demand for his product, and if so to what extent and whether his profits will also increase a result thereof.
2. Price discrimination: Price discrimination refers to the act of selling the technically same products at different prices to different section of consumers or in different in sub-markets. The policy of price-discrimination is profitable to the monopolist when elasticity of demand for his product is different in different sub-markets. Those consumers whose demand is inelastic can be charged a higher price than those with more elastic demand.
3. Shifting of tax burden: To what extent a producer can shift the burden of indirect tax to the buyers by increasing price of his product depends upon the degree of elasticity of demand. If the demand is inelastic the larger part of the indirect tax can be shifted upon buyers by increasing price. On the other hand if the demand is elastic than the burden of tax will be more on the producer.
4. Taxation and subsidy policy: The government can impose higher taxes and collect more revenue if the demand for the commodity on which a tax is to be levied is inelastic. On the other hand, in ease of a commodity with elastic demand high tax rates may fail to bring in the required revenue for the government. Govt., should provide subsidy on those goods whose demand is elastic and in the production of the commodity the law of increasing returns operates.
5. Importance in international trade: The concept of elasticity of demand is of crucial importance in many aspects of international trade. The success of the policy of devaluation to correct the adverse balance of payment depends upon the elasticity of demand for exports and imports of the country.
6. Importance in the determination of factors prices: Factor with an inelastic demand can always command a higher price as compared to a factor with relatively elastic demand. This helps the trade unions in knowing that where they can easily get the wage rate increased. Bargaining capacity of trade unions depend upon elasticity of demand for workers services.
7. Determination of sale policy for supper markets: Super Markets is a market where in a variety of goods are sold by a single organization. These items are generally of mass consumption. Therefore, the organization is supposed to sell commodities at lower prices than charged by shopkeepers in the other bazaars. Thus, the policy adopted is to charge a slightly lower price for items whose demand is relatively elastic and the costs are covered by increased sales.
8. Pricing of joint supply products: The goods that are produced by a single production process are joint supply products. The cost of production of these goods is also joint. Therefore, while determining the prices of these products their elasticity of demand is considered.
9. Effect of use of machines on employment: The use of machines may reduce the cost of production and price. If the demand of the product is elastic then the fall in price will increase demand significantly. As a result of increased demand the production will also increase and more workers will be employed.
10. Public utilities: The nationalization of public utility services can also be justified with the help of elasticity of demand. Demands for public utilities are generally inelastic in nature. If the operation of such utilities is left in the hand of private individuals, they may exploit the consumers by charging high prices.
11. Output decisions: The elasticity of demand helps the businessman to decide about production. A businessman chooses the optimum product- mix on the basis of elasticity of demand for various products. The products having more elastic demand are preferred by the businessmen. The sale of such products can be increased with a little reduction in their prices.
From the above discussion it is amply clear that price elasticity of demand is of great significance in making business decisions.
5. (a) What is the law of variable proportions? Explain the law of variable proportions with the help of suitable diagram. 4+8=12
Ans: Law of Variable Proportion: The law of variable proportion is one of the fundamental laws of economics. It is also known as the 'Law of Diminishing Marginal Returns' or the 'Law of Diminishing Marginal Productivity.' This Law of variable proportion shows the input-output relationship or production function with one variable factor, i.e., a factor, which can be changed, while other factors of production are kept constant.
In short-period when the output of a good is sought to be increased by way of additional application of the variable factor, law of variable proportions comes into operation. When the number of one factor is increased while all other factors remain constant, then the proportion between the factors is altered. On account of change in the proportion of factors there will also be a change in total output at different rates. In economics, this tendency is called Law of Variable Proportions. The law stats that as the proportion of factors is changed, the total production at first increases more than proportionately, then equi-proportionately and finally less than proportionately.
According to Samuelson, “The law states than an increase in some inputs relative to other fixed input will, in a given state of technology, cause total output to increase, but after a point the extra output resulting from the same addition of extra inputs is likely to become less and less.”
Assumptions: The law of variable proportions functions is based on following assumptions:
- Constant technology: The technology is assumed to be constant because technological changes will result into rise of marginal and average product.
- Snort-run: The law operates in the short-run because it is here that some factors are fixed and others are variable. In the long-run, all factors are variable.
- Homogeneous input: The variable input employed is homogeneous or identical in amount and quality.
- Use of varying amount of variable factor: It is possible to use various amounts of a variable factor on the fixed factors of production.
Explanation of the Law: Law of variable proportion can be explained with the help of following table and diagram:
Units of Land | Units of Labour | Total Product | Marginal Product | Average Product |
1 | 1 | 2 | 2 | 2 |
1 | 2 | 5 | 3 | 2.5 |
1 | 3 | 9 | 4 | 3 |
1 | 4 | 12 | 3 | 3 |
End of the first State Beginning of the Second Stage | ||||
1 | 5 | 14 | 2 | 2.8 |
1 | 6 | 15 | 1 | 2.5 |
1 | 7 | 15 | 0 | 2.1 |
End of the Second Stage Beginning of the Third Stage | ||||
1 | 8 | 14 | -1 | 1.7 |
Explanation: From the above Table and Diagrams drawn on the assumption that production obeys the law of variable proportions, one can easily discern three stages of production. These are elucidated in the following table:
Three States of Production
States | Total Product | Marginal Product | Average Product |
1. Stage | Initially it increases at an increasing rate. Later at diminishing rate. | Initially increases and reaches the maximum point. The starts decreasing. | Increases and reaches its maximum point |
2. Stage | Increases at diminishing rate and reaches its maximum point. | Decreases and becomes zero. | After reaching its maximum begins to decrease. |
3. Stage | Begins to fall | Becomes Negative. | Continues to diminish. |
Causes of Applicability: Main causes accounting for the application of the law of variable proportions are as follows:
- Under utilization of Fixed Factor: In the initial stage of production, fixed factor of production like land or machine is under-utilized. More units of variable factor, like labour are needed for its proper utilization. Thus, as a result of employment of additional units of variable factor there is proper utilization of fixe factor. Consequently, total production begins to increase.
- Fixed Factors of production: The principal cause of the operation of this law is that some of the factors of production are fixed during the short period. When the fixed factor is used with variable factor, then its ratio if compared to variable factor falls. Production is the result of the cooperation of all factors. Consequently, marginal return of the variable factor begins to diminish.
- Optimum Production: After making the optimum use of a fixed factor if it is combined with increasing units of variable factor, then the marginal return of such variable factor begins to diminish.
- Imperfect Substitute: It is the imperfect substitution of factors that is mainly responsible for the operation of the law of diminishing returns. One factor cannot be used in place of the other factor. Consequently, when fixed and variable factors are not combined in an appropriate ratio, the marginal return of the variable factors begins to diminish.
Postponement of the Law: Postponement of the law of variable proportions is possible under the following conditions:
- Improvement in Technique of Production: Operation of the law can be postponed if along with the increase in variable factors technique of production is improved.
- Perfect Substitute: The law can also be postponed if factors of production are made perfect substitutes, i.e. when one factor can be substituted for the other.
Or
(b) Explain the iso – product curve with the help of suitable diagram. Mention the properties of iso – product curve. 6+6=12
Ans: Isoquants and its Properties
The word an isoquant is a locus of points, representing different combinations labour and capital .An isoquant Curve. ‘ISO’ is of Greek origin and means equal or same and ‘quant’ means quantity. An isoquant may be defined as a curve showing all the various combinations of two factors that can produce a given level of output. The isoquant shows- the whole range of alternative ways of producing- the same level of output. The modern economists are using isoquant, or ‘ISO’ product curves for determining the optimum factor combination to produce certain units of a commodity at the least cost.
The concept of Iso-quant can be further comprehended through an illustration below: Suppose there are two input factors Viz. Labour and Capital. The different combinations of these factors are used to have the same level of output as shown in the schedule below:
Combination | Labour (unit) | Capital (Unit) | Output (Number) |
Combination A | Labour (unit)1 | Capital (Unit)10 | Output (Number)100 |
Combination B | Labour (unit)2 | Capital (Unit)9 | Output (Number)100 |
Combination C | Labour (unit)3 | Capital (Unit)8 | Output (Number)100 |
Combination D | Labour (unit)4 | Capital (Unit)7 | Output (Number)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.
Properties or Features of Isoquant
The following are the important properties of isoquants:
1. Isoquant is downward sloping to the right. This means that if more of one factor is used less of the other is needed for producing the same output.
2. A higher isoquant represents larger output.
3. No isoquants intersect or touch each other. If so it will mean that there will be a common point on the two curves. This further means that same amount of labour and capital can produce the two levels of output which is meaningless.
4. Isoquants need not be parallel to each other. It so happens because the rate of substitution in different isoquant schedules need not necessarily be equal. Usually they are found different and therefore, isoquants may not be parallel.
5. Isoquant is convex to the origin. This implies that the slope of the isoquant diminishes from left to right along the curve. This is because of the operation of the principle of diminishing marginal rate of technical substitution.
6. No isoquant can touch either axis. If an isoquant touches X axis then it would mean that without using any labour the firm can produce output with the help of capital alone. If an isoquant touches Y axis, it would mean that without using any capital the firm can produce output with the help of labour alone. This is impossible.
7.Isoquants have negative slope. This is so because when the quantity of one factor (labour) is increased the quantity of other factor (capital) must be reduced, so that total output remains the same.
6. (a) What are the objectives of a business firm? Explain the profit maximization hypothesis. 4+7=11
Ans: Objectives of Business Firms – Main and Alternative Objectives
Conventional theory of firm assumes profit maximisation, as the main objective of business firms. Recent researchers on this issue reveal that the objectives that business firms pursue are more than one. Some important alternatives objectives, other than profit maximisation, are:
- Maximisation of Sales Revenue.
- Maximisation of Firm’s growth rate.
- Maximisation of manager’s utility function.
- Long-run survival of the firm.
Main Objectives - Profit Maximisation Goal of a Business Firm
According to traditional economic theory profit maximisation is the sole objective of business firms. The traditional theory suggests a number of reasons as to why does a firm want to maximize profits. All these reasons essentially fall into the following categories:
- Traditional economic theory assumes that the firm is owner-managed, and therefore maximizing profit would imply maximizing the income of the owner; Owner would like to have adequate return for his activity as an entrepreneur.
- Firm may pursue goals other than profit-maximisation, but they can achieve these subsidiary goals much easier if they aim for profit maximisation.
Under perfect competition individual firms have to maximize their profits at price determined by industry. Under imperfect competition firms search their profit maximizing price output as they are price makers. The profit can be defined as the difference between total revenue and total cost. i.e. Profit = Total Revenue – Total Cost.
A firm will maximize its profit at that level of output at which the difference between total revenue and total cost is maximum. Generally conventional price theory determines profit maximizing price-output in terms of marginal cost and marginal revenue.
Marginal Revenue: Marginal revenue is the addition to total revenue from the sale of an additional unit of a commodity.
Marginal Cost: Marginal cost is the addition to total cost from the production of an additional unit of a commodity.
The two profit maximizing conditions are:
1. MC = MR: - We take first condition
- If MC < MR total profits are not maximized because firm will earn more profits by increasing output.
- If MC > MR the level of total profit is being reduced and firm can increase profit by decreasing production.
- If MC = MR the profits could not increase either by increasing or decreasing output and hence profits are maximized.
- MC cuts MR from below: - Now we take the second condition. The second condition of profit maximisation requires that MC be rising at the point of its intersection with the MR curve.
Criticism of profit Maximisation Approach:
- The real world business environment is more complex than what convention theory of firm thought. The modern business firms face lot of risk and uncertainty. Long-run survival is more important than short-run profit.
- The other objectives such as – sales maximisation, growth rate maximisation etc. describe real business behavior more accurately.
- Profit maximisation objective cannot be realized without the exact measurement of marginal cost and marginal revenue.
- Profits are not only measure of firm’s efficiency.
- Profit maximisation assumption may require expansion of business which means more risks. But firms may prefer less profit instead of bearing additional uncertainties.
Or
(b) What are the characteristics of perfect competition market? Explain how price is determined under perfect competition market. 4+7=11
Ans: Features of Perfect Competition: Different definitions given by different economists point out the distinct features of perfect competition. We can list various features which point out that the form of a market is perfectly competitive. In other words, there are some necessary conditions which must be satisfied if the market is to be perfectly competitive. We can explain these below:
- Large number of small, unorganized firms: The first condition which a perfectly competitive market must satisfy is concerned with the seller’s side of the market. The market must have such a large number of sellers that on one seller is able to dominate in the market. No single firms can influence the price of the commodity. These firms must be all relatively small as compared to the market as a whole. Their individual outputs should be just a fraction of the total output in the market.
- A large number of small, unorganized buyers: On the buyer’s side the perfectly competitive market must also satisfy this condition. There must be such a large number of buyers that no one buyer is able to influence the market price in any way. Each buyer should purchase just a fraction of the market supplies. Further the buyers should not have any king of union or organization so that they compete for the market demand on an individual basis.
- Homogeneous products: Another pre-requisite of perfect competition is that all the firms or sellers must sell completely identical or homogeneous goods. Their products must be considered to be identical by all the buyers in the market. There should not be any differentiation of products by sellers by way of quality, variety, colour, design, packing or other selling conditions of the product.
- Free entry and free exit for firms: under perfect competition, there is absolutely no restriction on entry of new firms in the industry or the exit of the firms from the industry which want to leave it. This condition must be satisfied especially for long period equilibrium of the industry.
Price and Output Determination under Perfect Competition
Though perfect competition is rare, almost a non-existent situation, yet we study price determination under the situation. A perfectly competitive market is one in which the number of buyers and sellers is very large, All engaged in buying and selling a homogeneous product without any artificial restriction and possessing perfect knowledge of a market at a time.
There are two parties which bargain in such a market, the buyers and the sellers. It is only when they agree, a commodity can be bought and sold at a certain price. Thus product pricing is influenced both by buyers and sellers that is by demand and supply.
The demand and supply are the two forces, which move in the opposite directions. Price is determined at a point where these two forces are equal, that is known as equilibrium price. In a perfectly competitive market, market demand and market supply determine the equilibrium price.
Equilibrium of a Firm under Perfect Competition
Meaning of Firm’s Equilibrium: A firm is in equilibrium when it is satisfied with its existing amount of output. A firm in equilibrium has no tendency either to increase or decrease its output. . It needs neither expansion nor contraction. It wants to earn maximum profits.
In the words of A.W. Stonier and D.C. Hague, “A firm will be in equilibrium when it is earning maximum money profits.”
Equilibrium of the firm can be analysed in both short-run and long-run periods. A firm can earn the maximum profits in the short run or may incur the minimum loss. But in the long run, it can earn only normal profit.
Equilibrium of the firm can be studied by two approaches:
- Total Revenue and Total Cost Approach.
- Marginal Cost and Marginal Revenue Approach.
Total Revenue and Total Cost Approach: According to this approach, profits are the difference between total revenue and total cost.
Marginal Revenue and Marginal Cost Approach: This analysis is based on the following assumptions:
- All firms in an industry use homogeneous factors of production.
- Their costs are equal. Therefore, all cost curves are uniform.
- They use homogeneous plants so that their SAC curves are equal.
- All firms are of equal efficiency.
- All firms sell their products at the same price determined by demand and supply of the industry so that the price of each firm is equal to AR = MR.
According to this approach, a firm is in equilibrium when two conditions are fulfilled:
- Marginal Cost should be equal to Marginal Revenue (MC = MR)
- MC curve cuts MR curve from below.
Determination of Equilibrium of the Firm: Equilibrium of the firm can be analysed in both short-run and long-run periods. A firm can earn the maximum profits in the short run or may incur the minimum loss. But in the long run, it can earn only normal profit.
7. (a) What are the necessary conditions for price discrimination? How does a discriminating monopoly determine output and price? 4+7=11 out of syllabus
Or
(b) Explain any two models applied for determining price under Oligopoly market. 11 Out of syllabus