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BUSINESS ECONOMICS – SEMESTER-1
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Question No. 2
Production Possibilities Curve:
Refrigerators
(a) (i)
03
Robots
The assumptions are:
Full employment
½
Productive efficiency
½
Fixed supplies of resources
½
Fixed technology
½
(ii) Cost of one more refrigerator and one more robot:
Cost of refrigerator (million)
=
2 ÷ 12
=
0.17
01
Cost of robot (million)
=
15 ÷ 2
=
7.50
01
Increasing opportunity costs:
Increasing opportunity costs are reflected in the concave-from-the-origin shape of the curve.
This means the economy must give up larger and larger amounts of robots to get constant
added amounts of refrigerators – and vice versa.
02
(b) Mrs. Saira is not buying the utility-maximizing combination of bread and milk since the marginal
utility per rupee spent on each good is not equal. The marginal utility per rupee of bread is 0.8 (80
utils ÷ Rs.100); the utility per rupee of milk is 1.75 (70 utils ÷ Rs.40). Mrs. Saira should buy more
milk and less bread.
04
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
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Question No. 3
(a) Factors that can influence a company’s share price:
General influences on share prices:
These influences on share price themselves result from the interplay of a large number of factors;
these factors can be divided into two categories:
01
Internal factors are heavily influenced by management policy and action and include such
things as rate of new product development, marketing activity, financial management and
control of costs.
01
External factors include wider developments such as economic recession and demographic
change; and events and forces specific to the industry concerned, such as the degree of
competition in the market and the behaviour of suppliers and customers.
01
Financial influences on share price:
The causes of share price variation can be analysed as changes in reported profits, changes in
forecast profits, and changes in required rate of return.
01
If the expected cash flows increase, predictably enough, the current market value will
increase and vice versa. Changes in the immediate future will have a larger effect than those
in the more distant future.
01
An increase in the cost of equity will reduce the current market value and vice versa.
01
(b) Though it is true that “all firms compete for the rupees of consumers” it is playing on words to
hold that pure monopoly does not exist. For example, the pure monopoly enjoyed by the local
electricity company in any town. If you wish electric lights, you have to deal with the single
company. It is a pure monopoly in that regard, even though you can switch to oil or natural gas
for heating. Of course, you can use oil, natural gas, or kerosene for lighting too – but these are
hardly convenient options.
03
The concept of cross elasticity of demand can be used to measure the presence of close
substitutes for the product of a monopoly firm. If the cross elasticity of demand is greater than
one, then the demand that the monopoly faces is elastic with respect to substitute products, and
the firm has less control over its product price than if the cross elasticity of demand were
inelastic. In other words, the monopoly faces competition from producers of substitute products.
03
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
SUGGESTED SOLUTIONS/ ANSWERS – SPRING 2016 EXAMINATIONS
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Question No. 4
(a) Types of internal economies:
Economies of scale are those cost-saving advantages which firms get due to large-scale
production. The advantages which a single firm gets from the expansion of business are called
“Internal economies”.
Internal economies are classified under five types:
1.
Technical economies arise when it is possible to use larger or more efficient machinery.
Like;
(i)
Increased specialization and division of labour
(ii) Large scale producers can also use specialized machinery and reduce unit cost
(iii) The initial cost and the operating costs of one large machine may be lower than two or
more small machines doing the same work
(iv) Production on large scale means less wastage of materials and energy
2.
Managerial: In large-scale production, management can be split into specialized jobs,
employing an expert for each one. There are production manager, marketing manager,
purchase manager, sales manager, accounts manager etc. In this way, per unit cost is lower.
3.
Commercial (or Marketing economies): A large firm buys from cheaper market and sells in
dearer market. When a firm buys raw materials in bulk, it gets concessional rate.
4.
Financial: Large firms can get easy credit from banks on more favourable terms. So, it is
easier and cheaper for UNILEVER to get a bank loan of Rs.500 million than for a small soap
factory to get a loan of Rs.50,000.
5.
Risk Bearing: Large firms “do not put all eggs in one basket”. Often they produce a whole
variety of goods to eliminate the risk.
Any four (4) types @ 1.5 marks each =
06
With the same costs, the pure monopolist will charge a higher price, have a smaller output,
and have higher economic profits in both the short-run and the long-run than the pure
competitor. As a matter of fact, the pure competitor will have no economic profits in the
long-run even though it might have some in the short-run. Because the monopolist does not
produce at the point of minimum ATC and does not equate price and MC, its allocation of
resources is inferior to that of the pure competitor. Specifically, resources are under allocated
to monopolistic industries. Since a pure monopolist is more likely than the pure competitor to
make economic profits in the short-run and is, moreover, the only one of the two able to
make economic profits in the long-run, the distribution of income is more unequal with
monopoly than with pure competition.
04
(ii) In pure competition, MR = P because the firm’s supply is so insignificant that its output has
no effect on price. It can sell all that it wishes to at the price established by demand and the
total industry supply. The firm cannot force the price up by holding back part or all of its
supply.
01
(b) (i)
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electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
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The monopolist, on the other hand, is the industry. When it increases the quantity it
produces, price drops. When it decreases the quantity it produces, price rises. In these
circumstances, MR is always less than price for the monopolist; to sell more it must lower the
price on all units, including those it could have sold at the higher price had it not put more on
the market. When the monopolist equates MR and MC, it is not selling at that price: The
monopolist’s selling price is on the demand curve, vertically above the point of intersection of
MR and MC. Thus, the monopolist’s price will be higher than the pure competitor’s.
02
(iii) Economies of scale may be such as to ensure that one large firm can produce at lower cost
than a multitude of small firms. This is certainly the case with most public utilities. And in
such industries as basic steelmaking and car manufacturing, pure competition would involve
a very high cost. On the other hand, monopolies may suffer from X-inefficiency, the
inefficiency that a lack of competition allows. Monopolies may also incur non-productive
costs through “rent-seeking” expenditures. For example, they may try to influence legislation
that protects their monopoly powers.
02
The implications of the lower costs that economies of scale may give a monopolist not only
produce at a lower cost than pure competitors but, in some cases, may also sell at a lower
price. If such is the case, the misallocation of resources is reduced.
01
Question No. 5
(a) Completion of consumption and saving table:
Level of
Average
Marginal
Average
Marginal
Output and
Propensity
Propensity
Consumption Saving
Propensity
Propensity
Income
to
to
[Rs. ‘000’] [Rs. ‘000’]
to Save
to Save
(GDP = DI)
Consume
Consume
(APS)
(MPS)
[Rs. ‘000’]
(APC)
(MPC)
300
310
–10
1.03
-0.03
–
–
330
330
0
1.00
0.00
0.67
0.33
360
350
10
0.97
0.03
0.67
0.33
390
370
20
0.95
0.05
0.67
0.33
420
390
30
0.93
0.07
0.67
0.33
450
410
40
0.91
0.09
0.67
0.33
480
430
50
0.90
0.10
0.67
0.33
510
450
60
0.88
0.12
0.67
0.33
540
470
70
0.87
0.13
0.67
0.33
OR
1.8
+
1.8
+
1.8
+
1.8
+
1.8
01
01
01
01
01
01
01
01
01
=
09
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
SUGGESTED SOLUTIONS/ ANSWERS – SPRING 2016 EXAMINATIONS
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(b) (i)
Graphical schedules of consumption and saving:
540
510
C
Consumption
480
450
420
02
390
360
330
300
300 330 360 390 420 450 480 510 540
Real GDP
Saving
100
80
60
S
40
02
20
300 330 360 390 420 450 480 510 540
Real GDP
(ii) Break-even Level of Income:
Break-even income = Rs.330,000.
01
Households dissave borrowing or using past savings.
01
Question No. 6
(a) Quantity Theory of Money asserts that the value of money depends largely on the quantity of
money. If the quantity of money is increased without corresponding increase in volume of
production, the value of money will decrease and vice-versa.
01
According to Irwin Fisher, the function of money primarily is to serve as a medium of exchange. It
has an indirect or derived demand because it is demanded for its purchasing power and not for
its own sake. Therefore, the value of money entirely depends upon its quantity in circulation
within the country. It is also called Cash Transactions Approach or Fisher's Approach.
02
According to Irwin Fisher,
“Other things remaining the same, value of money falls in proportion to increase in quantity of
money in circulation."
01
It means if the quantity of money is increased by 25%, whereas other things remain unchanged,
the value of money will fall by 25%, and vice versa. Thus, the quantity of money and its value are
inversely related.
01
Irwin Fisher explained the relationship between the quantity of money and its value in the form of
an equation of exchange.
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
SUGGESTED SOLUTIONS/ ANSWERS – SPRING 2016 EXAMINATIONS
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01
Where, P stands for general price level, or P = the value of money.
T stands for total transactions (total amount of goods and services) exchanged for
M stands for actual money
M' stands for credit money
V stands for velocity (rate of exchanging hands) of actual money
V' stands for velocity of credit money
Fisher contends that, in the short period, T, V, and V’ remains constant. Likewise, the proportion
of M to M' also remains constant. Thus, P varies directly with M. In other words; P or value of
money varies inversely with M or quantity of money.
Fisher’s Quantity Theory of Money can also be explained with the help of a simple example.
Suppose, the supply of actual money (M) issued by the government and the Central Bank, in
circulation in the country at certain time is Rs. 1,000 and its velocity (V) is 10. The amount of
credit money (M’) in circulation is Rs. 2,000 and its velocity (V') is 5. The total volume of
transaction (T) is 500. The equation of exchange will be as under:
02
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.
SUGGESTED SOLUTIONS/ ANSWERS – SPRING 2016 EXAMINATIONS
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(b) Consequences of balance of payments deficits:
A current account deficit is the excess of expenditure abroad over earnings from abroad. It leads
to three possible consequences.
(i)
A country may borrow more and more from abroad, to build up external liabilities which
match the deficit on its current account, for example encouraging foreign investor to lend
more by purchasing the government’s bonds.
01
(ii) A country may sell more and more of its assets.
01
(iii) Reserves of foreign currency held by the central bank may be run down.
01
Consequences of a balance of payments surplus:
If a country has a surplus on current account year after year, it might invest the surplus abroad or
add it to official reserves. The balance of payments position would be strong. There is the
problem, however, that if one country which is a major trading nation has a continuous surplus on
its balance of payments current account, other countries must be in continual deficit. These other
countries can run down their official reserves, perhaps to nothing, and borrow as they can to
meet the payments overseas, but eventually, they will run out of money entirely and be unable
even to pay their debts. Political pressure might therefore build up within the importing countries
to impose tariffs or import quotas or calls on the country with the surplus to raise its exchange
rate and/or buy more imports.
03
THE END
DISCLAIMER: This solution including write-ups, tables, charts, diagrams, graphs, figures etc., therein are the property of ICMA Pakistan, which is uploaded for the use of ICMA Pakistan members,
students and faculty members only. No part of it can be reproduced, stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including
electronic, mechanical, photocopying, recording or otherwise without prior permission of the ICMA Pakistan. The suggested answers provided on and made available through the
Institute’s website may only be referred, relied upon or treated as a guide and substitute for professional advice. The Institute does not take any responsibility about the accuracy,
completeness or currency of the information provided in the suggested answers. Therefore, the Institute is not liable to attend or receive any comments, observations or critiques
related to the suggested answers.