Teachers' Manual
in
Economics
For PGT
2012
State Council of Educational Research & Training
Varun Marg, Defence Colony, New Delhi-110024
Guidance and Supervision
Rashmi Krishnan, IAS.
Director, SCERT
Dr. Pratibha Sharma
Joint Director, SCERT
Co-ordinator / Editor
Dr. Seema Srivastava, Sr. Lecturer, DIET Moti Bagh
Ms. Meenakshi Yadav, Sr. Lecturer, SCERT
Contributors
Prof. Ramesh Chandra (Retd.) Professor NCERT
Mr. Bharat Thakur, Lecturer RPVV, Surajmal Vihar
Mr. Shiv Kumar, D.C. Arya, Sr. Sec. School, Lodhi Colony
Ms. Reema Agarwal , Sarvodya Vidhyalaya , Ali Ganj Lodhi Road
Dr. Seema Srivastava, Sr. Lecturer, DIET Moti Bagh
Ms. Meenakshi Yadav, Sr. Lecturer, SCERT
Publication Team
Publication Officer
Mr. Mukesh Yadav
Sh. Navin Kumar
Ms. Radha
Sh. Jai Baghwan
Printed By: Sonu Printing Press (P) Ltd.
S-217, Bank Street Munirka, New Delhi - 110067
Foreword
Teachers’ role in the development and implementation of curriculum is vital. All the
changes and developments taking place in school curriculum, therefore, have necessarily
to percolate in the Teacher Education Programmes. Teachers have to be sensitized about
the new circular concerns, issues and transactional approaches through In-Service mode.
Quality education has always remained a major concern for educationists. There is
constant need to make the curriculum pragmatic and teaching – learning process child
centric. Teachers have to be oriented about these changes in the textbooks and latest
technologies for effective implementation in classrooms.
SCERT has been uploading the Support Material on its website (www.scertdelhi.nic.in)
in different subjects including Economics since 2011 to make it accessible to all teachers
.NCERT and CBSE have brought in the desirable changes and the text books and
examination pattern to connect the text with real world of work in true sense. NCF 2005
also strongly emphasizes on the departure from rote learning to child centered –processes
which is the core of Constructivist Approach. The support material developed by SCERT
is an initiative in this direction for capacity building of teachers.
Print material in the form Teacher’s Manual in different subject is an additional support.
Teacher’s Manual developed by SCERT and DIET faculty in different subject at Senior
Secondary level is an attempt to expose the teachers with changes in syllabus,
methodology and the hard spots. There has been remarkable improvement in Government
School result of class X & XII in recent past. Still there is a need to improve and
strengthen the teaching- learning process in the class rooms by involving students
actively.
I appreciate and thank the entire team of co-coordinators and contributors who have
developed these Teachers Manuals. I sincerely hope that this will enable our teachers to
make class-room process more interactive and activity based for enhancement of overall
performance of children in Government schools.
Yours suggestions and comments regarding the Manual is welcome.
Ms Rashmi Krishnan,IAS
Director, SCERT
Editorial
In the modern technology driven economy, things change fast, affecting all sectors of
economy. A common man is also affected by Government Policies, Change in Demand
and Supply of Goods in Domestic Market and also by the trends in International Market.
Declining Rupee Value, Slump in the Job Markets, Inflationary Trends and
Rising Prices of even Common Goods, fluctuating scenario in Stock Exchange Market,
and these all are concerns of a common man. Economics at Secondary and Senior
Secondary level deals significantly with these in School Education.
Preparing students for these issues and concerns are vital as they will be job seekers in
future. Teacher role in making this subject easy, simplified, understandable is very
crucial. Teachers in today’s time have to think beyond the textbook to relate the textbook
content with real world of work which is one of the major concerns of National
Curriculum Framework’ 2005. The Senior Secondary Curriculum in Economics and
other subjects reflect new changes and trends in terms of Board Papers and its Evaluation
Patterns. In the recent past it has became more objective with the inclusion of High Order
Thinking Skills (HOTS) questions which have to be answered very precisely. We, as
teachers, have to prepare our students for the real world of trade and economy. Linking
school education with the real world is challenge for Curriculum Planners and
Educationist.
The present Manual has some section on selected topics with adequate examples. The
writers have tried to deal the complex concepts in simplified versions with relevant
activities for better understanding. Some text is given in Question –Answers form also.
HOTS on selected topics are also included. The Appendix at the end includes the content
analyses of the text on the bases of level of difficulty and the recent CBSE Board papers
with Answer Scheme.
I take this opportunity to express a deep sense of reverence and there thanks to Ms
Rashmi Krishnan, Director SCERT and Dr.Pratibha Sharma, Joint Director for their
continuous academic support and encouragement. Special thanks are also extended
to the team of Contributors / Subject Experts, their concerned Authorities’ Principals and
Teacher of Government School, Aided/Public schools for providing valuable suggestion
and support at all stages of development of this Manual.
The observation suggestions and comments related to the Manual are welcome.
Dr Seema Srivastava
Ms Meenakshi Yadav
CONTENT
S. No
Topic
1.
Demand and Consumer Equilibrium
2
Supply, Market Supply, Determinants of Market Supply
3
Revenue and Supply
4
Theory of Cost and Revenue
5
National Income Accounting
6.
Question Bank
7.
High Order Thinking Skills (HOTS)
8.
Introduction Macroeconomics
Appendix
¾
Content Analysis on the basis of level of difficulty
¾
Answer Key (HOTS)
¾
Question Paper of CBSE with Answer Scheme for the year 2012
Page
Demand and Consumer Equilibrium
Abstract
Economics is basically an interesting study of resources and choices.
Optimization of resources by choosing the best alternative is the key to all the
central problems of an economy. The present module gives you an exposure
to the meaning of Economics, Micro Economics and Macro Economics,
Central Problems of an Economy, Production Possibility Curve and Consumer
Equilibrium Demand is one chapter which is very important and forms the basis
of understanding Supply and later relationship between the two that determines
the price of a commodity. In fact if you look closely you will find everything in
economy is responding and reacting to the forces of demand and supply. Making
students understand the meaning of Demand, the dynamics in determination of
price and how it affects and gets affected by supply of goods in determining
the Price of a commodity is very crucial in understanding the fundamentals of
Micro-Economics. The present unit is given in Question-Answer form. Use this
section after teaching the chapter in the class room to give them practice in
answering accurately and precisely.
(9)
MICRO ECONOMICS
Q1.
What is Economics about?
Ans. Economics is the study of the problems of choice arising out of scarcity of means in
relation to unlimited wants in an economy.
Q2.
What is Micro Economics?
Ans. Micro Economics deals with the individual parts of the economic system i.e. individual
household, individual firms etc.
Q3.
What is meant by Economic Problem?
Ans. Economic Problem is a problem of choice arising due to limited means and unlimited
wants.
Q4.
Why does economic problem arise?
Ans.
Economic problem arises because of:
Q5.
(i)
Resources are limited in relation to our demand.
(ii)
Resources have alternative uses.
Why economic problem is regarded as a problem of choice?
Ans. Economic problem is regarded as a problem of choice because resources have
alternative uses. If land is used only to grow sugarcane than there is no problem. But land
can be used to grow wheat as well as sugar cane. Hence the problem of choice arises.
Q6.
What is meant by Scarcity of Resources?
Ans. It is a situation when the requirement of goods and services exceeds their availability
so that goods acquire market value or price. Since the requirement of goods and services
does not match the supply the scarcity arises. Greater the Scarcity higher will be the prices.
Q7.
What is meant by economizing of resources?
Ans. Economizing of resources means, resources are to be used in such a manner that
maximum output is obtained per unit of input.
Q8.
Explain how scarcity and choice go together?
Ans. Resources are not only scarce but also have alternative uses. Thus land can be used
for producing wheat as well as rice. Hence problem of choice arises which is the essence of
any economic problem. Due to scarcity choice has to be made amongst various alternatives
and therefore scarcity and choice go together.
Q9.
Which factors lead to shift of PPC?
Ans.
The following factors lead to shift of PPC.
(i)
With the increases or decreases in Resourses.
( 10 )
(ii)
Change in/of technology.
Q10. What is meant by PPC?
Ans. Production possibility ensue which shows the different possibilities of production of
two goods a and b with the given resources and technology.
Q11. Why does technological advancement or growth of resources shift the PPC to the
right?
Ans. Technological advancement shift PPC to the right, because better technology means
more can be produced with the given resources.
Q12. “An economy always produces on, but not inside a PPC”. Defend or refute?
Ans. Production on PPC implies efficient utilization of Resources, but in an economy all
the resources are not fully employed all the time. Hence production on the PPC is an ideal
situation which an economy wants to achieve. Hence production inside a PPC is a realistic
situation.
Q13. Define Marginal Opportunity Cost?
Ans. Marginal Opportunity Cost is the ratio between additional loss of output and
additional gain of output when some resources are shifted from y use to x use.
Q14. Define opportunity cost?
Ans. Opportunity cost of any commodity is the amount of other good which has been
given up in order to produce that commodity.
Q15. Define Marginal Opportunity Cost along a PPC?
Ans. MOC along a PPC refer to the additional output of ab of good X causes loss of cd of
good Y. Hence cd is the MOC of ab.
MOC =
=
( 11 )
Q16. Draw a PPC showing the following situations.
(i)
Full Employment of Resources.
(ii)
Under Employment of Resources.
(iii)
Growth of Resources.
Q17. Explain the problem of ‘what to produce’ with the help of an example.
Ans. An economy has only limited resources and the wants are unlimited. Wants are
satisfied by goods and services which are to be produced with the help of resources, so all
goods and services cannot be produced. The economy has to decide which goods are to be
produced.
Example- On a given piece of land, all crops cannot be grown. If it is used for growing wheat
then on the area on which wheat is grown, other crops cannot be grown. This is the problem
of what to produce.
Q18. Explain the problem of ‘how to produce’ with the help of an example.
Ans. The problem relates to choosing the the technique of production for producing
goods. Generally, most goods can be produced by using more than one technique. It has
to be an optimal mix of labour and capital. More labour and less capital and less labour and
more capital can be used. It can be either Capital Intensive or Labour Intensive. Since the
resources are scarce a decision is to be taken as to which technique/ Mix has to be used.
Example- Cloth can be produced with Capital Intensive technique. It can also be produced
with Labour Intensive technique. Which technique to choose is the problem of how to
produce?
Q19. Explain the problem of ‘For Whom to Produce’ with the help of an example.
Ans. Goods and services are produced specifically for the people who can purchase them.
Purchasing power depends on distribution of National among factors of Production. The
problem amounts to how the National Product is to be distributed among the people. It
means who should get how much of the total amount of goods and services. Those people
( 12 )
have the larger income would have larger capacity to buy and hence will get larger amount
of goods. People with different incomes will demand different goods. Therefore the guiding
principle of how much is to be produced depends on people with different purchasing
power.
Q20. Explain the problem of ‘What to produce’ with the help of Production Possibility
Curve.
Ans. Since resources are limited all goods and services desired cannot be produced. If
more resources are used for producing one good then fewer resources are left for producing
other goods. This is the problem of what to produce.
PP is the PPC. All points on the curve represent all possible combinations of goods A & B that
can be produced with the given resources. Which combination is to choose is the problem
of ‘What to produce’.
Q21. Explain PPC with the help of table and curve of PPC.
Ans. PPC is a curve that depicts all possible combinations of two goods, which an economy
can produce with the help of given resources and technology.
Combination
A
B
c
D
E
Good A
0
1
2
3
4
Good B
20
18
14
8
0
According to the curve there can be different possibilities of production as indicated
by points B, C, D and by joining points A, B, C, D and E. We get the production possibility
curve.
( 13 )
Q22. Differentiate between Micro and Macro economics.
Macro Economics
Micro Economics
Macro economics studies the aggregates of Micro economics is the study of individuals
the Economy
and small groups of individuals
Macro economics is the study of N.I., Micro economics is the study of the prices
Expenditure and employment
of different commodities and factors.
Macro economics starts with the under Micro economics is based on the assumption
lying assumption of underemployment of of full employment in the Economy as a
resources
whole.
Macro economics is called Theory of Income
Micro economics is called the price theory.
& Employment.
Q23. Why does the PPC look concave to the origin?
Ans. Increase in the production of a commodity along a PPC means sacrifice of the other
commodity. The rate of this sacrifice is called the MOC of increasing commodity. PPC is
concave due to increasing MOC. Therefore one has to sacrifice more of a commodity to
produce another commodity every time. This makes the PPC cancave.
Q24. What does a rightward shift of PPC indicate?
Ans.
The rightward shift of PP curve indicates growth of resources.
Q25. What do you mean by central problem of an Economy? Explain the central problem
of an Economy.
Ans. Every economy has to face certain similar problems. These problems are called
central problems. These are as follows.
(a) Problem of allocation of resources
(i)
What to produce
(ii)
How to produce
(iii)
For whom to produce
(b) Problem of full and efficient utilization of resources
(c) Problem of economic growth.
Q26. Explain the solution of the central problems in a Capitalistic economy.
Ans. Solution of the Central problems
Central problems are solved differently in different economics.
Capitalistic Economy
In a capitalist economy the means of production are owned, controlled and operated by
private persons and production is done mainly to earn profit. In such economy central
( 14 )
problems are solved through price mechanisms. The market price of the commodity guides
the producers ‘what’ how and for whom to produce. In a capitalist economy, free forces of
Demand and Supply of the commodity determine the market price of the commodity.
Socialist Economy
In a socialist economy, the means of production are owned, controlled and operated by the
Govt. In such an economy the basic problems are solved through Central Planning.
The Central Authority decides which goods and how much & how to produce in a given
period of time, It solves the problem of what, how and for whom to produce. The aim of the
Govt. is to maximize social welfare.
Mixed Economy
A mixed economy is one in which Govt. and private sector exists side by side. Private
sector represent the features of a capitalist economy, Where as public sector indicate the
features of socialism. In Mixed Economy Central problems are solved through modified
price or regulated price system to attain maximum social welfare the Govt uses various
measures like subsidies, price control, support price and rationing system etc. But in
private sector market forces of demand and supply solve the central problems.
Thus central problems in mixed economy are solved partly through Planning and partly
through Modified Price Mechanism.
( 15 )
DEMAND
Q1. What is demand?
Ans: - Demand refers to the quantity of a commodity or service a consumer is willing
to buy at given price in a given period of time.
Q2. What is Demand Schedule?
Ans. Demand Schedule refers to the quantity of a commodity which is demanded by
the consumers at different prices.
Q3. What is an Individual Demand Schedule?
Ans. Individual Demand Schedule refers to the relationship between price and
quantity demanded of a commodity by an individual.
Price Rs.
Quantity
1
10
2
8
3
6
4
4
5
2
( 16 )
Q4. What is Market Demand Schedule? Explain with table & diagram.
Ans. Market Demand Schedule is the sum of the individual demand schedule for a
commodity in the market at different prices of the commodity.
On the assumption that there are three buyers in the market, Market Demand
Schedule may be drawn as follows.
Price per Unit /
Firm
A
B
C
Total
1
10
5
20
35
2
8
4
16
28
3
6
3
12
21
4
4
2
8
14
5
2
1
4
7
Market Demand Curve
A Market Demand Curve has been drawn on the basis of table. The Market
Demand Curve shows that, when price is Rs. 1 per Kg apple the total demand of
the market is 35kg, but when price is increased to Rs.5 total demand of apples
become7kg. This slope of this demand curve is negative, showing inverse
relationship between price of the commodity and its quantity demanded.
Q5. Define Normal Goods?
Ans. Normal good is a good whose demand increases with rise in income and
decreases with a fall in income of the consumer. With the rise in income the
demand for normal goods will rise because of rising purchasing power with
increased income.
( 17 )
Income effect of normal goods is positive. Example: - Grain, Rice & wheat.
Q6. What are Giffin Goods?
Ans. Giffin goods are those inferior goods in the case of which there is a positive
relationship between price and quantity demanded.
Q7. Define Inferior Goods.
Ans. Inferior good is a good whose demand decreases with rise in income and
increases with a fall in income of consumers. The Income Effect of Inferior
Goods is Negative. For Example- Coarse Gram.
Q8.
Explain Law of Demand with the help of Example
Ans. Law of Demand states that if the Price of a commodity decreases then consumer
demand more of its quantity and if price increase than the consumer demand
less of its quantity.
Price
Quantity
1
10
2
8
3
6
4
4
5
2
The table shows that when the price was Rs. 1, at that time the demand of the
commodity was 10, but when the price increase to re 5 the demand for the
commodity falls to 2 units.
Demand Curve
( 18 )
Thus it is true with an increase in the price of the commodity demand decreases
and with a fall in the price demand increases.
Q9. What are the factors affecting the Demand of a commodity?
Ans.Factors affecting thedemand of a commodity are:
Price of a commodity
Priceis an important determinant of Demand. Demand for a commodity rises
when it is offered at low price and it falls when the commodity is available at
higher price.
Income of the consumer
With the rise in income of the consumer his purchasing power increases. As
a result he can buy more of a commodity that he was not buying earlier due to
monetary constraint. Similarly a fall in income of the consumer will force him to
cut down his expenditure and he will demand less of a commodity.
Price of related goods
Related goods are of two types i.e. Substitute goods and complementary good.
Substitute Goods
Substitute goods are those which can be used in place of each other with
equal ease. Example - Pepsi Cola and Coca-Cola. Of the two given goods
the demand will be higher for the goods which have comparatively lower price
and vice versa.
Complementary goods
Complementary Goodsare those goods which are used together for consumption
and are incomplete without each other. It means they complete the deficiencies
of each other.
Example - Car and Petrol
A fall in the price of one commodity leads to rise in the demand of its
complementary good. Example: - If the price of petrol falls then demand for
car will rise.
Taste and preferences
Tastes and Preferences of the consumers will also affect the demand of the
( 19 )
commodity. A student will demand more of books and pens then utensils
because of his preference for the same.
Similarly old television sets were replaced by Plasma T.V.
Miscellaneous
Some other factors that affect the demand of commodity areDemand for SeasonalGoods- The consumer will demand woolen clothes in
winter only.
If Government reduces the Tax Rate then it enhances the purchasing power of
the consumer and his demand for goods will also increase.
If the population of an area increases then their demand will also increase and
they will demand more consumer goods and vice versa.
Q10. How do changes in income affect demand for a commodity?
Ans.With the increase in income of the consumer his purchasing power increases,
he can spend more than what he was spending earlier. Income affects demand for a
commodity depends upon, whether a commodity is Inferior, Normal or Essential
Normal Goods
The demand for normal goods rises with the increase in income of the consumer. I.e.
income effect is positive. If the income of the consumer decreases then the demand
for such goods also decreases.
Inferior Goods
For Inferior Goods Income,Effect is negative. So he demands fewergoods of inferior
quality with the increase in income and vice versa.
Essential /Necessities
The goods that are essential for human beings are called necessities. The demand
for such goods does not change with the increase or decrease in income.
Example- Life saving Drugs, Common Salt etc.
Q11. Why does Demand Curve for a commodity slope downwards to the right?
Ans. The Demand Curve for commodity slopes downwards to the right because of the
( 20 )
following reason:.
Law of Diminishing Marginal Utility
The law states that with the consumption of an additional unit of a commodity, the
utility from each successive unit goes on diminishing.
Example- Utility form first chapati /Loaf of Bread to a hungry man is maximum, utility
from second chapatti is lesser, from the third still lesser, because a part of his hunger
is satisfied from the first one and the second one and It goes on diminishing .The utility
in terms of satisfaction derived with each successive chapati diminishes .This depicts
the Law of Diminishing Marginal Utility.
Income effect
A change in the quantity demanded as a result of change in real income caused
by change in price of the commodity is called Income effect. When the price of a
commodity falls, less has to be spent on the purchase of that commodity. From that
money a consumer can by more quantity of that good, thus the real income of the
consumer is increased. However increase in the price of the good decreases the real
income of the consumer. Therefore he will buy less of its commodity from that income.
Substitution effect
It means that substitution of one commodity in place of the other commodity when
it becomes relatively cheaper Example=A rise in the price of coca-cola, in relation to
coca-cola. The consumer will maximize his satisfaction therefore he will buy more of
Pepsi than of coca cola.
Number of consumers
When the price of a commodity falls, consumers buys it at the reduced price, therefore
the number of consumers increases because the old ones also consuming it in the
same quantity or more than what they were consuming before fall in the price of that
commodity.
Different uses of the commodity
A commodity used is consumed more at a lower price but if its price goes up then
consumption get restricted to very essential use.
For example milk is used for many purposes e.g. Drinking, Making curd, paneer , tea
etc. but if the price goes up the consumption of milk is restricted to say baby food only.
( 21 )
Q12. How is demand of a commodity affected by change in the price of related good?
Explain with the help of a diagram.
Ans. Related goods may be of two types- Substitute goods Complementary good.When
the price of a substitute food falls (rises) it becomes relatively cheaper (costlier), so it
is substituted for the given commodity decreases (increases), this result in rightward
(leftward) shift in demand curve.
When the price of complementary good falls (rises) its quantity demanded rises (falls).
The demand for the given commodity increases (decreases) as complementary good
are used together. This will cause a rightward (leftward) shift of demand curve of given
commodity.
Diagrams showing the effect of Substitute Goods and Complementary Goods
Q13. What is meant by Cross Price Eeffects?
Ans. Cross Price Effect means how the demand for one particular product is affected
by a change in the price of another commodity. Cross price effects originate from
related goods:
(a)
Substitute good- If the price of tea falls, the quantity demanded for coffee
would fall because people will use more of a tea than coffee.
(b) Complementary good- If the price of car falls down, then quantity
demanded for petrol would go up because people will purchase more car
and petrol.
Q14. Briefly explain the factors that shift the demand curve left or right.
ANS- The following are the factors that shift the demand curve to the right or left.
( 22 )
1. Change in Income
if the income of the consumer increases the demand for the normal product increases
similarly with the decrease in income the demand for the product decreases and the
demand curve shift to the left. Increase in income shift the demand curve to the right.
2.Change in the of related goods
Substitute good- when the price of a substitute good falls (rires) then it becomes
relatively cheaper or costlier, so it is substituted for the given commodity and the
demand arrive shift to the right or (left)
Complementary good-as the price of a complementary good increases, the price of
the given product and its quantity demanded both decreases and the demand curve
shift to the left. With the decrease in the price of the complementary good, the price of
the given product and its quantity demanded both increase and the the demand curve
shift to the right.
Change in taste- A favourable change in the taste shift the demand curve to the
right as s result price as well as the total quantity demanded will increase similarly an
infavourable change in taste will shift the demined curve to the left and both price and
quantity will fall.
Q15. Distinguish between the following:
1. Contraction in Demand
Decrease in Demand
This is caused by change in the price This is caused by change in the determents
only.
of demand other than price.
It result in the left ward shift in demand
It results in upward movement along curve
demand curve when demand falls When demand falls due to change in fact
due to the rise in priceonly, it is called to other than price it is called decrease in
contraction in demand.
decrease
( 23 )
2. Extension in Demand
This is caused by changed in price only
It results in downward movement along
the demand curve.
When demand increases due to falls
in price only, it is called contraction in
demand.
Increase in Demand
This is caused by change in the factors
other than price of the commodity. It
results in the rightward shift in demand
curve.
When demand increases due to changes
factors other than price, it is called
increase in demand.
3. Change in Quantity Demanded
a) Change in quantity demanded is
caused by change in the price of
the commodity.
b)Change in quantity demanded
is movement along a demand
curve.
c)Example-Price of sugar falls
from Rs.16 per kg to Rs.12 per
kg as a result quantity demanded
increases to 6tons from 4 tons.
Change in Demand
a)Change in demand is caused
by factors other than price of the
commodity.
b) Change in demand is a shift of the
demand curve.
c) Example- Income of the consumer
increases from Rs. 5000 to Rs.
12000. As a result demand for
sugar increases to 3kg from 2 kg
per month.
( 24 )
4. Substitute goods
Complementary goods
a)Complementary good are used
1.Substitute goods may be
together.
used in place of each other
b)The price of one complementary
2. The price of substitute good
good has negative relationship
has positive relationship with
with another complementary good.
the quantity demanded of
other substitute good.
Example- Car and Petrol
Example- Tea & Coffee
5. Normal Goods
1) Income effect is Positive.
2)
Demand increase with the
increase in income.
3) Income demand curve of normal
goods slopes upward to the left.
Inferior Goods
1) Income effect is Negative
Demand
decreases with the increase in income.
2)Income demand curve of inferior good
slopes down rightwards.
( 25 )
Q16.
Define Derived Demand.
Ans. Derived Demand is the demand that has been derived from the demand for
some other commodity it helps to produce. Demand for factors of production is called
derived demand because it is derived from demand of such goods, which the factor
helps to produce.
Example- Demand for Shoe is direct demand but the demand for Labour is
Derived Demand because it does not satisfy the consumer demand directly but
it arises due to demand for shoe.
Q 17. Determine how the following changes will affect the Market Demand Curve for
a Product:
a) A new Plant comes in Jharkhand. Many people who were previously unemployed
are now employed. How will this affect the demand curve for Colour TV and Black and
White TV in the region?
Ans – An increase in income of households will result in the increase in demand for TV
sets. The demand curve for both TVs will shift rightward.
b) There are train and bus services between New Delhi and Jaipur. Suppose the train
fare between New Delhi and Jaipur comesdown. How it will affect the demand curve
for bus travel between the two cities?
Ans- Train and bus services are substitute to each other. If train fair comes down the
demand for bus travel willdecrease as a result there wouldbe left ward shift of demand
curve for the bus travel
Q 18.What is the importance of Elasticity of Demand?
Price Elasticity of Demand is a useful concept for the following reasons:
(a)
Producer- A producer adopts a price discriminatory policy when elasticity of
demand from different consumers is different.Those consumers for whom demand is
inelasticcan be charged a higher price than those with more elastic demand.
(b)
Foreign Trade- The country in which a product has less elastic demand can be
charged a higher price than a country having a more elastic demand
(c) Government- Goods and services likecigarettes, liquor, and other luxury goods
have inelastic demand. The Government taxes more commodities whose demand is
inelastic, so that the scale of such commodities does not fall and burden of tax is borne
by rich class.
( 26 )
(d)
Factor Pricing- Factors having less elastic demand can charge higher prices
than those having more elastic demand. For Example A Pilot gets more salary as
compared to Doctors, since their demand is less elastic. The concept of elasticity
helps in explaining the relative shares to factors of production in the output.
Example 1 Price of a good falls from Rs. 100 to Rs. 80. As a result its demand rises
from 4000 units to 5000 units. Calculate Price Electricity of Demand by Expenditure
Method
Original expenditure = P x Q
= 100 x 4000
= 4, 00,000
Expenditure after increase in Price =
80 x 5000
4,00,000
=
Since the total expenditure is same even after the change in price, the elasticity of
demand is unity
Ed=1
Example 2
A consumer demands 1000 units of the price of Re 10 per unit. If the price of the said
commodity is increased to Rs.14,the demand for the product falls to 600. Calculate
Price Elasticity of Demand.
The ED for good x is known to be twice that of good X price of X falls by 5% while that
of good Y rises by 5%. What is the % age change in the quantities of X and Y?
( 27 )
Consumers’ Equilibrium
Q1. What is Consumers’ Equilibrium?
Ans.A consumer is in a state of equilibrium when he maximizes his satisfaction by
spending his given income on different goods and services.
Q2. Define Total Utility (TU)
Ans. Total utility is the total psychological satisfaction derived by a consumer from
consumption of all units of a particular commodity.
Q3. Define Marginal Utility (MU)
Ans. Marginal Utility is additional utility derived from consumption of an additional
unit of a commodity.
MU= TUn – TUn-1
Q4. How is Total Utility is derived by summing up of marginal utilities.
Ans. Total Utility s derived by summing up of Marginal Utilities.
Q5. What is utility?
Ans. Utility means want satisfying capacity of a commodity.
Q6. What is Indifference set?
Ans.It is a set of combinations of two commodities which offer a consumer the same
level of satisfaction, So that he is indifferent between there combinations.
Q7. What is meant by Budget Line.?
Ans.It is a line showing different possible combinations of good 1 and good 2, which
consumer can buy, within the given income at the price of good 1 and good 2.
Q8. What is meant by Indifference Curve?
Ans.An indifference curve is a curve which represents all those combinations of two
good that gives equal satisfaction to the consumer.
Q9.What is meant by marginal rate of substitution?
Ans. Marginal rate of substitution is the rate at which the consumer is willing to give
up good 1 to get an additional unit of good 2 and be indifferent.
( 28 )
Q10. What is the assumptions of indifference curve?
Ans. The following are the assumptions:
(i) T
he consumer behaves rationally and tries to obtain maximum satisfaction
from his expenditure.
(ii) The consumer is able to arrange available combinations of goods
according to his preference
(iii)It is based on ordinal measures of utility.
Q.11. Write down the Properties of Indifference Curve?
Ans. The following are the Properties.
(i) Indifference curve slope down to the right.
(ii) Higher indifference curve denotes higher level of satisfaction.
(iii)Indifference curves are curves to the origin
(iv)Indifference curves cannot meet or intersect.
Explain Consumer’s Equilibrium in case of single commodity with the help of a
utility schedule.
Consumers Equilibrium means a situation when a consume buys that much quantity
of a commodity which gives him maximum satisfaction. How much quantity of a
commodity he should buy is explained with the help of a marginal utility schedule.
Units consumed if A
MU of A
TU of A
11414
21226
31036
4844
Condition:- MUx = Px
Suppose the price of A is Rs. 5/- per unit
Marginal Utility of Rs. 1/- =2
Then for each unit of A he has to sacrifice 10 utility. He will compare the MU of each
unit of A with the Utility he sacrifices. He will go on baying till the marginal utility of
A is equal to the utility that he sacrifices. From the table it is clear, that he will buy
three units because at third unit, what he pages is just equal to what he gets. So the
consumer is in equilibrium.
Condition of equilibrium = MU of good Price of good
( 29 )
=
MU of a rupee
Explain Consumer’s Equilibrium with the help of indifference curve.
A consumer is said to be in equilibrium when he gets maximum satisfaction, or at the
combination at which budget line touches one of the indifference curves would be the
equilibrium point.
In the given figure P is the equilibrium point at which budget line M touches the highest
attainable indifference curve 1C, within consumer budget. Bundles on IC2 are not
affordable within budget whereas bundles on IC are certainly inferior to those on
IC1. Hence optimum bundle is located at point P where budget line is tangent to the
indifference curve IC1.
Explain the relationship between TU & MU.
Total Utility increases so long as marginal utility is more than zero.
(ii)
Total utility is maximum when marginal utility is zero.
(iii) Total Utility starts declining when marginal utility becomes negative.
Explain the law of diminishing marginal utility.
Law of Diminishing Marginal Utility.
The law states that as more and more unit of a commodity are consumed; marginal
utility derived from successive units goes on falling. Example:- A hungry man wants to
eat. The first chapatti which he eats will give him maximum utility say 100 units because
it saves him from hunger. Second chapatti will also fetch him utility but not as much as
the first one because a part of his hunger is satisfied by eating the first chapatti, say
80 units. For the same reason let utility from the third chapatti be 50 units and at last it
may be negative. In short as more and more chapattis are consumed, marginal utility
( 30 )
from them goes on diminishing because intensity of wants for the chapatti declines.
Units
1
2
3
4
5
6
7
Mu
10
8
5
2
1
0
-3
Tu
10
18
23
25
26
26
23
The above diagram shows that as more and more units are consumed MU declines.
( 31 )
Supply Schedule, Supply Curve and Elasticity
Recapitulate
In previous chapters, Supply, Market Supply, Determinants of Market Supply were covered.
Recap that Supply is defined as the quantity that a firm is willing to sell at a given price and at a
given time.
Abstract
The present unit will explain the Supply Schedule, how it is prepared. Supply Curve,
Movement along and Shift in Supply Curve, Price Elasticity of Supply, Measurement of Price
Elasticity- Percentage Change Method and Geometric Method.
Learning Objectives After going through the content you will be able to:
1. State the meaning of Supply Schedule.
2. Define Supply Curve.
3. Draw the Supply Curve.
4. Explain Movement along the Supply Curve and Shift in Supply Curve.
5. Define Elasticity of Supply.
6. Explain different degrees of Elasticity of Supply.
7. Represent the different degrees of Elasticity of Supply diagrammatically.
8. Solve numerical examples to determine the Price Elasticity of Supply.
9. Measure the Price Elasticity of Supply by- Percentage Change Method and Geometric
Method
( 32 )
Supply Schedule - A Supply Schedule is a table which shows how much one or more firms will
be willing to supply ay a particular price.
It is a table listing or showing the exact quantities of a single type of goods or services that
potential sellers would offer to sell at varying prices during a particular time period.
Example of Supply Schedule
Table A
Price
1
2
3
4
5
Quantity Supplied
12
28
42
52
60
We can also say that Supply Schedule is a depiction in tabular form, of price and quantity
supplied at a point of time keeping other* factor constant. (*Price of related goods,
Condition/Technology in Production, Seller’s Expectations etc.)
Supply Curve
It is a curve that shows relationship of price and quantity supplied graphically or we can say the
relationship of price and quantity supplies that can be exhibited graphically is termed as Supply
Curve.
Keeping other factors constant the Supply Curve depicts the relationship between two variables
only. These are:
•
Price
•
Quantity Supplied.
For example: - By plotting the data given above in Table A (Supply Schedule), we can get or
draw a supply Curve which is as follows.
( 33 )
The Supply Curve is generally positively sloped which shows direct positive relationship between Price and quantity supplied. It clearly indicates that at higher price, larger quantities are supplied for sale to make more profits. Movement along and Shift in Supply Curve A change in the price of commodity leads to a change in the quantity supplied. This results in the movement along the same Supply Curve, whereas the shift in the Supply Curve comes from the outside forces. Movement along the supply is due to change in either the Quantity Supplied or the Price. Movement is the extension of the supply curve with the change in Price or quantity supplied A shift of the supply curve comes from outside forces such as change in consumer wants / need / preference / economic changes or changes due to technology etc. It shows the change in position of Supply Curve from one place to other. ( 34 )
Movement along the Supply Curve Shift in Supply Curve ( 35 )
Factor that shift the Supply Curve: 1. Change in Output Cost 2. Increasing use of technology in production 3. Change in size of the industry Measurement of Price Elasticity of Supply Price Elasticity of Supply measures the responsiveness of quantity supplied to change in price, as percentage change in Quantity Supplied induced by percentage change in Price. There are two methods of measuring Price Elasticity of Supply:‐ 1. Percentage – Change Method 2. Geometric method 1. Percentage – change Method According to this method Price Elasticity of supply (Es) is measured as under:‐ Price Elasticity of Supply (Es) = % Change in Quantity Supplied % Change in Price ( 36 )
Where
Q – Change in Quantity supplied
Q – initial Quantity Supplied
P – Change in Price
P - Initial Price
2. Geometric Method
Under this method five different situations of Price Elasticity can be described as follows:a) Unitary Elasticity or Es=1
In this situation the supply curve slopes upward in a straight line which starts from point of
origin. This shows the percentage change in Quantity supply is exactly equals to
percentage change in price.
( 37 )
b) Greater than Unitary Elasticity or Es ≥ 1
When a straight line upward sloping curve starts from Y-axis, then this is a case of
Unitary Elasticity. This depicts that percentage change in quantity supplied is greater
than percentage change in price.
c) Less than Unitary Elasticity or Es ≤ 1
When a straight line upward sloping curve starts from X-axis then this is a case of less than
Unitary Elasticity. This represents that percentage change in quantity supplied is less
than percentage change in price.
( 38 )
d) Perfectly Inelastic Supply or Es = 0
It is a situation where there is no change in supply regardless of change in price. It shows
that supply remain unchanged with the change in price. In such situation supply
curve is vertical straight line curve.
e) Perfectly Elastic Supply or Es = 0
In this situation supply is infinite corresponding to a particular price of the commodity.
Accordingly a slightest fall in price caused an infinite change in supply, reducing it
to zero. In this case supply curve is horizontal straight line.
Es=0
( 39 )
Check your Progress 1. Draw a Supply Curve based on the Supply Schedule given below: Price (Rs.) Quantity Supplied 2 10 4 16 6 28 8 35 10 60 2. Differentiate between Movement along the Supply Curve and Shift in Supply Curve. 3. Explain the factors that results in Shift in Supply Curve. 4. Define Price Elasticity of Supply. 5. In the Diagram given below, state the nature of Elasticity of Supply of the different Supply Curves. 6. A 20% raise in the price of the Commodity A leads to a rise in its supply from 400 to 500 units. Calculate its Elasticity of Supply and comment on it. ( 40 )
Summary Supply Schedule is a table that shows quantity supplied of goods and services at particular price and at given point of time. A Supply Curve is a Graphical representation of quantity supplied of goods and services against the given prices. Movement along the Supply Curve is due to change in quantity supplied or the price. There is Shift in Supply Curve is due to other factors such as Consumer’s Needs and Preferences, Change in Technology etc.Price Elasticity is the responsiveness of quantity supplied to change in price. Price Elasticity of Supply can be measured through Percentage Change Method and Geometric Method. Elasticity of Supply can be interpreted as 1, Greater than 1, Less than 1, 0 or infinity. Technical Terms
Supply Schedule: It is the depiction in tabular form; the Price and Quantity Supplied by an individual firm at a point of time keeping other factors constant. It is a tabular representation of Law of Supply. Supply Curve: It is a graphic representation of Law of Supply which shows the relationship of Price and Quantity Supplied at a point of time. Market Supply: It is obtained from the horizontal summation of Supply of individual firms. It is affected by all factors that influence individual Supply and the number of firms in the market. Elasticity of Supply: It measures the degree of responsiveness of Supply to change in the Price of the commodity. It is measured as: a) Proportionate method‐ Where:
Q – Change in Quantity supplied
Q – initial Quantity Supplied
P – Change in Price
P - Initial Price
b) Geometric Method-
( 41 )
Es=
CQ
--------------OQ
Where CQ is the distance between where Supply Curve cuts the X- axis and Quantity Supplied;
and OQ is the Quantity Supplied at a given price.
Various degrees of Elasticity of Supply
Perfectly Elastic Is defined as a situation when an infinitely small change in price causes an
infinitely large change in quantity supplied. It has a value of infinity.
Perfectly Inelastic has a value Zero. This is defined as a situation when quantity supplied does
not change irrespective of price change.
Relatively Elastic has a value of more than one. Here percentage change on Quantity Supplied is
more than the percentage change in Price.
Relatively inelastic has a value less than one. Here, the percentage change on Quantity Supplied
is less than the percentage change in Price.
Unitary Elastic has an absolute value of ‘1’. Supply change by the same extent as price changes.
( 42 )
URL’s
Making Supply Schedule http://www.youtube.com/watch?v=ucXqf8wEzt4 Shift in supply Curve http://www.youtube.com/watch?v=SzP6ISwcHqY&feature=related Shift in Supply http://www.youtube.com/watch?v=CTUpItRj81M&feature=related Change in Supply and shift in Supply http://www.youtube.com/watch?v=JiGhGzCL7Js&feature=related Change in Supply http://www.youtube.com/watch?v=z6ZZhH‐vHHo Elasticity of Supply http://www.mindbites.com/lesson/7772‐economics‐identifying‐determinants‐of‐elasticity ( 43 )
Revenue and Supply
Overview of the pervious concept / component related units (Units II & Unit III)
Previous Concepts
•
•
•
•
•
•
In the previous chapters students have already been taught about, Demand,
Elasticity of Demand, Cost- its types (TC, TFC, AFC, TVC, AVC, MC; etc - meaning
and their relationships. These concepts have to be revised before proceeding to
the concept of Revenue). The teachers must ensure that Student have adequate
knowledge of the concepts likeCosts – Economic Cost, Private Cost vs. Social Cost, the time element and cost
(very short run, short run large run )
Explicit Cost, Implicit cost and Normal Profits
Total Fixed Cost (TFC), Total Variable Cost (TVC), Total Cost (TC = TFC + TVC),
computations and projection of TC, TFC, TVC.
AFC, AVC (Definition and projection in graphs/ Curves) (ATC=AVC+AFC),Marginal
Cost-Its concept and computation)
Depiction of MC, Relationship between TC and MC relationship between AVC and
MC.
Relationship between ATC, AVC & MC.
Note: One must ensure that students can define the above mentioned terms and draw
the curves related to the concepts; different relationships and can interpret in terms of
different costs computations. Adequate practice of the same is essential
Abstract
This material deals with the concepts of Revenue -its types; Total Revenue (TR), Average
Revenue (AR), Marginal Revenue (MR), Meaning of Producer’s Equilibrium,
Determination of Producer’s Equilibrium in terms of MR & MC. It will also elaborate on
the concept of Supply, Market Supply and Determinants of supply. The term ‘Revenue’
states the income of the Firm that it earns when it sells a given level of output. The main
objective of the firm is Profit Maximisation where Profit = Revenue – *Cost of Production
(*the expenditure incurred by a firm for producing a given level of output). Difference
between Revenue and Profit has also been explained for clarity. The concepts of TR, AR,
MR and Producer’s Equilibrium in terms of MC & MR has been explained in general. In
later units these will be used in various types and Forms of Market and competition.
The unit will also explain the Supply, Markets Supply and Determinants of supply.
( 44 )
Learning Objectives
After going through the Material / Unit you will be able to:
1.
2.
3.
4.
5.
6.
7.
8.
Define the Terms - Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR).
Compute TR, AR, & MR;
Explain the relationship between TR, AR and MR.
State and depict (draw curves) Producers Equilibrium in terms of MR and MC.
Define terms like Supply, Market Supply.
Compute Market Supply
Explain the determinants of Supply.
State some exceptions to the Law of Supply.
Teaching points
•
•
•
•
•
Concept of Revenue
Types of Revenue – Total Revenue (TR), Average Revenue (AR)and Marginal Revenue (MR)
Relationship between TR, AR and MR
Producers’ Equilibrium – meaning and its condition in terms of MR and MC.
Supply, computing market supply, Determinants of supply, Exceptions to the Law of Supply.
Basic Concepts
1. Revenue:
Recapitulate the relationship that exists between Revenue, Cost and Profit. For calculating Profit
the firm deducts the total expenditure or cost incurred from the Revenue. Reinstate:
Profit = Revenue – Cost
How is Revenue defined?
Generally “Revenue” is termed as” Earnings”. It is the income that a firm receives from its business
activities, usually from sale of goods and service to customers.
Hence Revenue can be defined as:
In business, Revenue is income that a company receives from its normal
business activities usually from sale of goods and service to customers.
How is Revenue Calculated?
Revenue is calculated by multiplying the price at which goods and services are sold by the
number of units sold. It can be put algebraically as under:-
( 45 )
Formula: R= P x Q , where
R= Revenue of the firm
P = Price per unit of the output sold
Q = Quantity / Units sold
Example
One firm sells Rs 10 per bottle in the market. If the firm sells total 100 bottles, then calculate Total
Revenue for the firm.
Solution: Apply the formula:
R=PxQ
= 10 x 100
= Rs. 1000
Continuing with the same example, if the cost of producing 100 bottles is Rs 800, then what will be
the profit earned by the firm?
As: - Profit = Revenue – Cost
= 1000 – 800
= Rs. 200
Here the difference between the Revenue and Profit must be made clear, so that there is clarity
about the term ‘Revenue’
1.1 Types of Revenue
There are three types which have to be explained one by one:
i. Total Revenue (TR)
ii. Average Revenue (AR)
iii. Marginal Revenue (MR)
( 46 )
Total Revenue: Total Revenue refers to the total amount of money received by the firm during
specific periods. It is derived by multiplying the number of units sold by the price per unit. Therefore
Revenue in general refers to Total Revenue. It is denoted as TR.
Formula for calculation of TR is;TR = P x Q
Where
TR is total revenue of the firm during a specific period
P is price per unit of the output
Q is quantity sold.
Example: A firm has sold 5 dozens of pens. The cost per pen was Rs. 20. The total revenue of the
firm is:
TR
=
pxq
=
20 x 60
=
Rs. 1200
1.1.2. Average Revenue: - Average Revenue is the revenue generated per unit of output sold. It can
also be defined as total revenue per unit of output sold.
The average revenue received by a firm is Total Revenue divided by quantity. It is expressed as:AR=TR
q
Where AR = Average Revenue
TR= Total Revenue
q = Quantity sold
Average Revenue is more widely used as Price. At times, it is also helpful in calculating Total Revenue
I.e. Total Revenue= Average Revenue (P) × quantity (q)
Example:Unit/quantity
2
4
5
6
Total Revenue
20
40
60
90
Average Revenue
10
10
12
15
( 47 )
1.1.3. Marginal Revenue: - Marginal Revenue is the increase in revenue from selling one additional
unit of output. It is also called as revenue obtained from the last unit sold. It is calculated by taking
the difference between Total Revenue before and after an increase in the rate of production.
Example: In a firm sells 10 object @ Rs.20 each and further it sells 11 object @ Rs. 19 each, then
the marginal revenue from the 11th object is (10× 20) - (11×19) = Rs. 9
Marginal Revenue can also be depicted as change in Total Revenue/Change in quantity
MR = Change in Total Revenue
---------------------------------Change in Quantity
MR = ∆TR
∆Q
(When price of product is constant, Marginal Revenue is the same as Price. This will be applicable
in conditions of Prefect Competition to be dealt with in later chapter)
The same can also be explained with the example given below:Relationship Between Average and Marginal Revenue
No. Of Units
1
2
3
4
5
6
7
TR (1)
10
18
24
28
30
28
21
AR (2)
10
9
8
7
6
4.6
3
MR (3)
10
8
6
4
2
-2.6
-7
Diagram -1
Relation between Average Revenue (AR)
and Marginal Revenue (MR)
( 48 )
2.1
Producers Equilibrium in terms of MC = MR
Producer’s Equilibrium:
Equilibrium is a condition where quantity demanded is equal to quantity supplied at a particular
price.
Producers’ equilibrium is established at level of their Profit Maximisation. The condition of Profit
Maximisation would take place at a point where his Marginal Revenue (MR) is equal to his Marginal
Cost (MC). We can also say that beyond this point, if producers’ produces goods and services then
he starts loosing MR therefore we can say that:Produces equilibrium is established when firm maximises its profit & minimises its losses.
The following condition is necessary for establishing equilibrium: 1. MC = MR
So long as benefit is greater than cost, or MR Is greater than MC, it is profitable to produce more.
The equilibrium is not achieved because it is possible to add to profit by producing more units.
When MC = MR, the benefit is equal to cost, the producers is its equilibrium subject to that MC
becomes greater than MR beyond this level of output.
For example
In terms of
8
8
8
8
output TR
2
3
4
5
MR
16
24
32
40
MC
8
8
8
8
( 49 )
Profit
8
6
8
10
Level of profit maximum
Diagram 2
Producer’s Equilibrium when MC = MR
3.1 Supply
Supply: - The total amount of product i.e. good or services available for purchase at any specified
price is called as Supply.
Market Supply – It refers to amount of some product which the producers are willing and are able to
sell at a given price keeping other related factors constant.
Market Supply focuses primarily on the one to one relation between Supply Price and Quantity
Supplied. It can be shown diagrammatically as:
( 50 )
Diagram- 3
Market Supply
It is a positive sloped curve that exhibits that quantity supplied at higher price is more than the
quantity supplied at lower price.
3.2 Market Supply: Market Supply is the combined supply of every seller in the market. It is
derived by adding the quantity supplied by each seller at different price. It operates according to the
law of supply i.e. upward sloping Curve or we can say that for higher price the quantity supplied by
all sellers in the market combined is greater than the quantity supplied for lower Prices.
3.3
Determinants of supply
There are many factors and circumstances that could affect supply of the product:
1. Price of the commodity: - The price of the commodity affects the supply of the commodity.
Increase in price will increase the quantity supplied at a given point of time. There is a direct
relationship between price and quantity supplied.
2. Price of related goods – Generally related goods refers to goods from which inputs are
derived to be used in the production of primary goods. The prices of such goods also affect
the price of commodity produced.
3. Conditions / Technology used in production – There is a direct relation between the
technological advancement, goods production, and supply. It means that as the use of
technology increases there will be an increase in production and also the supply of goods.
4. Seller’s expectations – Expectations of sellers concerning future market condition can
directly affect supply. For e.g. If a seller believe that the demands of product ‘A’ will
increase in future then the firm owner may immediately increase production. In such
condition the supply curve will shift upwards.
( 51 )
5. Cost of production – If the cost of production which includes cost of land, labour, energy
and raw material rises then the seller may reduce his supply and the seller may charge extra
for each unit of unit.
3.4 Exceptions to the Law of Supply
As Supply is defined as the quantity that a firm is willing to sell at given price and at a given time
and various factors like own price, Cost of Production, Production Techniques, Price of related
Commodities, Rate of Taxation and Goals of a firm, but there are certain exceptions to the Law of
Supply as there are some goods that do not follow the Law of Supply and hence negate some of
assumptions.
1. Expectations of future change in price: It is normal for any firm to supply more when the
price increases ,but when a supplier anticipates that the price will rise in future he will
restrict supply in the hope of making more profits in future in the anticipation .Hence even if
the price rises ,the firm restrains its present supply.
2. High Quality goods, antiques/ rare commodities: These are also the exceptions to the Law
of Supply .For a creative work like Painting, the higher price of painting may not work as an
inspiration. He/her may need other reasons of inspiration. Antiques are also limited in
quantity and hence supply does not increase as the price of commodity increases.
Check Your Progress
1. Using the Marginal Cost- Marginal approach find the Profit Maximisation level of output
from the table given below.
Output (in units)
Price (Rs)
Average Total Cost (Rs)
7
20
4
8
19
5
9
18
6
10
17
7
2. What change in Total Revenue will result in
(i) Decrease in Marginal Revenue and
(ii) An increase in Marginal Revenue?
3. What will be the effect of the following changes in Total Revenue on Marginal Revenue?
(i) Total Revenue increase at a decreasing rate
(ii) Total Revenue increased at a constant rate
4. Explain the relationships between TR, AR and MR with the help of a diagram when price is
reduced as output sold increases.
5. Describe the impact of an increase in Petrol prices to the supply of transport services. Use a
diagram to explain your answer.
6. Explain three factors that influence the supply of mobile phones in the market.
Summary
The Concept of Revenue that describes the earning of the firm that it receives by selling its
output at a given point of time. Types of Revenue have also been explained in terms of Total
( 52 )
Revenue (TR) which is total amount received by the firm during a specific period; Average
Revenue (AR)which is the revenue generated per unit of output; and Marginal Revenue
(MR) which is increase in revenue by selling one additional unit of output. The material also
talks about the relationship between TR, AR and MR and computation of these by using the
formulae such as:
(i)
TR = P x Q
(ii)
AR=TR
q
(iii)
MR=
Change in Total Revenue
---------------------------------Change in Quantity
Producers’ Equilibrium has also been elaborated in terms of MR and MC, that if a firm produces
beyond the level of equilibrium than it starts incurring loses. The concept of Supply i.e. the total
amount of product available for purchase at any specified price; Market supply is the combined
supply of every seller in the market. Major Determination of supply such as Price of the commodity,
Price of related goods ,Conditions / Technology used in production, Seller’s expectations, Cost of
production have also been discussed. Exceptions to the Law of Supply: Expectations of future
changes in price and high Quality goods, antiques, rare commodities do not follow the assumptions
of law of supply.
Technical Terms
1. Total Revenue (TR): Amount of money a firm receives when it sells a given level of output.
2. Average Revenue (AR): It is the per unit price of the commodity. AR is downward sloping
indicating that in order to increase the sale of the firm, it needs to reduce the per unit price
of commodity. AR is obtained by dividing Total Revenue by the total number of units sold at
a given point of time. AR curve is also the Demand Curve faced by the firm.
3. Marginal Revenue (MR): It is the additional revenue earned by a firm when it sells an
additional unit of output.
4. Producer’s Equilibrium: It is defined as the level of output that maximises the profits of the
firm. The equilibrium condition of a producer’s Equilibrium is Marginal Revenue+ Marginal
Cost.
5. Break Even Point: The level of output at which the firm neither makes loss nor profit. Its
revenue covers for all costs, including normal profit.
6. Supply: It is defined as the quantity that a firm is willing to sell at a given price and at a given
time.
7. Market supply: It is obtained from the horizontal summation of supply of individual firms. It
is affected by all factors that influence individual supply and the number of firms in the
market.
( 53 )
Additional Support Material.
In order to teach effectively in the classroom for better comprehension of concepts by students, the
following web links, PPT (Power Point Presentation), e-books, even video clipping supporting the
concepts are also given for facilitating better Teaching- Learning Process.
NOTE : PPT ON THEORY OF COST OF REVENUE IS GIVEN IN NEXT SEGMENT
1 URL:
Free Market Economy
http://www.youtube.com/watch?v=4YwUnjqsIQM
Market Economy Vs Planned Economy
http://www.youtube.com/watch?v=6q3zjyG8Dpg&NR=1
Four Market Structures Simulation
http://www.youtube.com/watch?v=KGrmnynjHjI
Budget Constraints ands Demand
http://www.youtube.com/watch?v=avOqv5wTNAU
ACN Video- U.S. Energy Natural Gas & Electricity Services
http://www.youtube.com/watch?v=eKzad5FSVW4
Episode 25- Market Structures
http://www.youtube.com/watch?v=9Hxy-TuX9fs
Graph the Supply Curve
http://www.youtube.com/watch?v=T3ZvnqjvzA0
Introduction to Microeconomics 101
http://www.youtube.com/watch?v=gfiQ1xZfqV4
Lecture 19 - Chap 9 - oligopoly.wmv
http://www.youtube.com/watch?v=6G_awGuSra4
Mrs Tan, Mr Lee and the Price Elasticity of demand
http://www.youtube.com/watch?v=96KXjOPkF3M
Opportunity Cost
http://www.youtube.com/watch?v=ezOdQUzLVAo
Price Elasticity of Supply Jonathan Yap Howard Sun David Jiang
http://www.youtube.com/watch?v=K_2DQHcyJTw
Price Elasticity of Supply
http://www.youtube.com/watch?v=20b_zVHmZG0
( 54 )
Introduction
• Main objective of a firm : Profit Maximisation
• Profit = Revenue – Cost of Production
Theory of Costs and Revenue
• Cost of production is the expenditure incurred by a
fi
firm
when
h producing
d i a given
i
level
l
l off output
• Revenue is the total income earned by a firm when it
sells a given level of output
Types of Costs
Economic Costs
• Economic Costs
• Private vs Social
Explicit Costs
• Time Element & Costs
Economic Costs
Explicit cost
• Fast Fans Ltd
borrows moneyy
from the bank @
8% p.a. to buy a
machine
VS
Implicit Costs
• Incurred when
a firm hires or
purchases a
factor of
production
• Imputed costs of
a firm when it
uses its own
factors of
production
• Termed as
Money Costs
• Calculated based
on opportunity
cost
Normal Profits
• Minimum
profits required
to keep the
entrepreneur in
production in
the long
g run
Private vs Social Costs
Implicit cost
• Private Costs : incurred by a firm when it
produces a commodity
• Fast Fans Ltd uses
its own moneyy
(reserves and
surplus) to buy a
machine
– Eg:
E costt off raw material
t i l
• Social Costs : borne byy societyy as a whole when
a firm produces a commodity
• Opportunity cost of
using the firm’s
own money is
the Implicit Cost
– Eg: loss of marine life from pollutants from production
process
( 55 )
Time Element and Costs
Time Element and Costs
Very Short Run
Very Short Run
• All factors are fixed
Short Run
• All factors are fixed • One factor is
variable; others
• Costs remain
fixed
fi d
constant
• Cost changes to
• Fi
Fixed
d costs
t
the extent of
variable factor
• Costs remain
constant
• Fixed
Fi d costs
t
• Variable cost &
Fixed cost
Time Element and Costs
Very Short Run
Short Run
Costs in the Short Run
Long Run
• All factors are fixed • One factor is
variable; others
• Costs remain
fixed
fi d
constant
• Cost changes to
• Fixed
Fi d costs
t
the extent of
variable factor
• Total Fixed Cost (TFC)
• All factors are
variable
– Costs that do not change with the change in output
• Costs changeable
• Total Variable Cost (TVC)
V i bl costs
t
• Variable
– Costs that change with the change in output
• Variable cost &
Fixed cost
• Total Cost
– TC = TFC + TVC
Total Fixed Costs
Total F
Fixed Costt (Rs)
160
120
TFC
0
1
2
3
4
5
6
Output TFC
(Q) (Rs)
200
Output TFC
(Q) (Rs)
100
100
100
100
100
100
100
0
1
2
3
4
5
6
7
160
Total Variable
V
Cost (Rs)
C
200
80
40
120
100
100
100
100
100
100
100
100
TVC
(Rs)
Total Variable Cost
0
20
30
35
45
60
80
126
TVC
TFC
80
40
0
0
0
1
2
3
4
5
6
0
Output
1
2
3
4
5
6
Output
( 56 )
7
Total Cost
Output
(Q)
TFC
(Rs)
TVC
(Rs)
Total Cost
240
TC
200
TC = TFC + TVC
(Rs)
160
100
100
100
100
100
100
100
100
0
20
30
35
45
60
80
126
100
120
130
135
145
160
180
226
Total C
Cost (Rs)
0
1
2
3
4
5
6
7
TVC
120
TFC
80
40
0
0
1
2
3
4
5
6
7
Output
Total Cost
240
Distinction between fixed costs and
variable
a iable costs
TC
200
Total C
Cost (Rs)
160
Fixed costs
Variable costs
Do not vary with the quantity of
output produced
Vary with the quantity of output
produced
TVC
120
TFC
TFC
80
40
0
0
1
2
3
4
5
6
7
Output
Distinction between fixed costs and
variable
a iable costs
Distinction between fixed costs and
variable
a iable costs
Fixed costs
Variable costs
Fixed costs
Variable costs
Do not vary with the quantity of
output produced
Vary with the quantity of output
produced
Do not vary with the quantity of
output produced
Vary with the quantity of output
produced
Can never be zero in the short
run. Have to be incurred even if
production falls to zero
Can fall to zero in the short run,
as they are directly related to the
level of output produced
Can never be zero in the short
run. Have to be incurred even if
production falls to zero
Can fall to zero in the short run,
as they are directly related to the
level of output produced
In the short run a firm can
continue production even if fixed
costs
t are nott mett
In the short run a firm will stop
production if variable costs are
nott mett
( 57 )
Distinction between fixed costs and
variable
a iable costs
Fixed costs
Variable costs
Do not vary with the quantity of
output produced
Vary with the quantity of output
produced
Can never be zero in the short
run. Have to be incurred even if
production falls to zero
Can fall to zero in the short run,
as they are directly related to the
level of output produced
In the short run a firm can
continue production even if fixed
costs
t are nott mett
In the short run a firm will stop
production if variable costs are
nott mett
Related to the fixed factors of
production
Related to the variable factors of
production
Eg: rent
Eg: wage
Points to Remember
• TC is obtained by adding TVC and TFC
• Shape of the TC is dependent upon the shape of
the TVC
• Vertical distance between the TFC and TC gives
the TVC
Costs in the Short Run
Average Fixed Cost (AFC)
• Average cost per unit cost of production
• As output increases,
AFC falls
continuously
Average Fixed
A
d Cost
– average fixed cost (AFC)
AFC = TFC
Q
– average variable cost (AVC)
AVC = TVC
Q
– average total cost (ATC)
ATC = TC
Q
• AFC tends towards
the xx--axis, but does
not touch it
AFC
O
• AFC is never equal
q
to
zero, as TFC is never
zero
Quantity of output
ATC = AFC + AVC
Average Variable Cost
Average Total Cost
• U-shaped curve
Averag
ge Variable C
Cost
AVC
• Cost incurred per unit of output
• ATC = AVC +AFC
• Reflects the law of
variable proportions
Schedule of AFC
AFC, AVC
AVC, ATC
Output
AFC
0
1
100
2
50
3
33.3
33 3
4
25
5
20
6
16.6
7
14.3
• Downward sloping part
of curve
– Increasing Returns to a
factor
O
Quantity of output
• Upward sloping part of
curve
– Decreasing returns to a
factor
( 58 )
AVC
20
15
11.7
11 7
11.25*
12
13.3
18
ATC
120
65
45
36.25
32
29.9* * - min.pt.
32.3
Average Total Cost
Average Total Cost
Uptil output oa:
ATC
• AFC falls
AFC: Average Fixed Cost
• AVC falls
f ll
AVC: Average Variable Cost
AVC
AVC
C
Costs
C
Costs
• ATC falls
AFC
AFC
a
0
0
Output (Q)
Output (Q)
Average Total Cost
Average Total Cost
Between output ab:
• AFC fall > AVC rise
Beyond output ob:
ATC
• AFC fall < AVC rise
• ATC falls
f ll
ATC
• ATC rises
i
C
Costs
AVC
C
Costs
AVC
AFC
0
a
AFC
b
a
0
Output (Q)
b
Output (Q)
Average Total Cost
Costs in the Short Run
As AFC tends to zero,
ATC tends to AVC
ATC
• Marginal cost
– additional cost incurred in producing an additional unit
of the output
– MC = ' TC
'Q
– Suppose the cost of producing 3 fans is Rs 135 and the
cost of producing 2 fans is Rs 130
C
Costs
AVC
• Marginal Cost of the 3rd fan is Rs 5
AFC
0
a
b
Output (Q)
( 59 )
Relationship between TC and MC
Marginal Cost
TC
• Prior to point A, MC is
falling. TC increases at
a diminishing rate. (Law
of Diminishing Costs)
Schedule of TC, TVC and MC
TC
(in Rs)
100
120
130
135
145
160
TVC
(in Rs)
20
30
35
45
60
MC
(in Rs)
20
10
5
10
15
MC
Marginal Co
ost
Output
O
of fans
0
1
2
3
4
5
O
O
Quantity of output
MC
Quantityy of output
Q
p
• MC is U
U--shaped
g in TVC
• Reflects the change
A
• Area under MC gives TVC
O
Relationship between TC and MC
Quantity of output
Relationship between TC and MC
TC
TC
• Beyond point A, MC is
i
increasing.
i
TC is
i
increasing at an
increasing rate. (Law of
Increasing Costs)
• At point A
A, MC is at its
minimum. TC is at point
off iinflexion
fl i
O
O
Quantity of output
Quantity of output
MC
MC
A
O
A
O
Quantity of output
Relationship between AVC and MC
Relationship between TC and MC
O
Quantity of output
• Prior to point A, MC is falling.
TC is increasing at a
diminishing rate. (Law of
Diminishing Costs)
MC
• At point A, MC is at its
minimum TC is at point of
minimum.
inflexion
Costs (R
Rs)
TC
MC
A
O
Quantity of output
Quantity of output
• Beyond point A, MC is
increasing. TC is increasing at
an increasing rate
rate. (Law of
Increasing Costs)
A
O
( 60 )
Output
AVC
• Prior to point A, MC < AVC;
AVC
Relationship between AVC and MC
MC
AVC
Relationship between AVC and MC
• Prior to point A, MC < AVC;
AVC
MC
AVC
A
O
• Between points A and B,
B MC
< AVC; AVC
Costs (R
Rs)
Costs (R
Rs)
• Between points A and B,
B MC
< AVC; AVC
B
A
O
Output
Relationship between AVC and MC
MC
AVC
• Prior to point A, MC < AVC;
AVC
• At point B , MC = AVC;
AVC is at its minimum
B
Output
Relationship between ATC and MC
• Prior to point A, MC < AVC;
AVC
MC
ATC
• Prior to point A, MC < ATC;
ATC
A
Costs (R
Rs)
Costs (R
Rs)
• Between points A and B,
B MC
< AVC; AVC
• At point B , MC = AVC;
AVC is at its minimum
B
• After p
point B , MC > AVC;
AVC starts to rise
O
A
O
Output
Relationship between ATC and MC
MC
ATC
Output
Relationship between ATC and MC
• Prior to point A, MC < ATC;
ATC
MC
A
O
• Prior to point A, MC < ATC;
ATC
• Between points A and C,
C MC
< ATC; ATC
Costs (R
Rs)
Costs (R
Rs)
• Between points A and C,
C MC
< ATC; ATC
ATC
C
A
O
Output
( 61 )
Output
C
• At point C , MC = ATC;
ATC is at its minimum
Relationship between ATC and MC
Relationship between ATC, AVC and MC
MC
MC
ATC
AVC
Costs ((Rs)
Costs (R
Rs)
• Between points A and C,
C MC
< ATC; ATC
• At point C , MC = ATC;
ATC is at its minimum
C
A
C
B
• After p
point C , MC > ATC;
ATC starts to rise
O
ATC
• Prior to point A, MC < ATC;
ATC
A
Output
O
Output
MC cuts ATC and AVC at their respective minimum points
Costs in the Long Run
Long Run Average Cost
LAC = Long Run Total Cost
Output
• Long Run Total Cost (LTC)
• Saucer
S
shaped
h
d
• Based on returns to scale
• Long
L
Run
R Average
A
Cost
C
(LAC)
LAC
Cossts (Rs)
• Long Run Marginal Cost (LMC)
• No distinction between fixed and variable costs
O
Long Run Average Cost
Output
Long Run Average Cost
LAC = Long Run Total Cost
LAC = Long Run Total Cost
Output
Output
• Saucer
S
shaped
h
d
• Saucer
S
shaped
h
d
• Based on returns to Scale
O
• Downward sloping part due
to increasing returns to sale
(Decreasing Average Cost)
LAC
Cossts (Rs)
Cossts (Rs)
LAC
• Based on returns to Scale
O
Output
( 62 )
CRS
Output
• Downward sloping part due
to increasing returns to sale
(Decreasing Average Cost)
• Upward
U
d sloping
l i partt due
d to
t
diminishing returns to scale
(Increasing Average Cost)
Long Run Average Cost
Long Run Marginal Cost
LAC = Long Run Total Cost
Output
• Saucer
S
shaped
h
d
• Based on returns to Scale
O
CRS
• Downward sloping part due
to increasing returns to sale
(Decreasing Average Cost)
• Upward
U
d sloping
l i partt due
d to
t
diminishing returns to scale
(Increasing Average Cost)
Long Run Cost
Factor Inputs
LAC
LMC
Costs (R
Rs)
Cossts (Rs)
LAC
LMC =
• Also U - shaped
• Cuts LAC at its minimum
point
O
Output
Output
Total Revenue
Theory of Revenue
Total Revenue Schedule
– Total money
earned by a firm
when it sells a
given amount of
output
– TR = p x q,
where:
Output
O
t t off ffans
0
1
2
3
T
Total
t lR
Revenue (R
(Rs))
0
10
18
24
4
5
6
28
28
24
• p is the per unit
price
TR
• At point A, TR is
maximum
• Beyond point A, TR
starts
t t d
declining
li i
O
• q is the quantity
of output sold
Quantity
Q
tit off fans
f
sold
ld
Average Revenue
AR =
• Uptil point A, TR is
increasing
c eas g
A
Total revenue
• Total Revenue
Average Revenue
Total Revenue
p sold
Output
AR =
=
Total Revenue
p sold
Output
pxq
q
=p
AR = per unit price of the commodity
( 63 )
Average Revenue
Average Revenue
Average Revenue
Average
Revenue (Rs)
Output Total
Revenue (Rs)
Average
Revenue (Rs)
Revenue (Rs)
0
0
-
0
0
-
1
10
10
1
10
10
2
18
9
2
18
9
3
24
8
3
24
8
4
28
7
4
28
7
5
28
5.6
5
28
5.6
6
24
4
6
24
4
Averrage revenu
ue
Average Revenue
Output Total
AR
Quantity of fans sold
AR Curve downward
sloping
Marginal Revenue
Average Revenue
Average Revenue
• MR =
Average
Revenue (Rs)
Revenue (Rs)
0
0
-
1
10
10
2
18
9
3
24
8
4
28
7
5
28
5.6
6
24
4
• MR =
Averrage revenu
ue
Output Total
Change in Total Revenue
Change in units of output sold
¨TR
¨Q
AR
Quantity of fans sold
• As more units of output sold, price must fall
• AR
as Q
• AR curve is the demand curve faced by the firm
• MR =
• MR =
Marginal Revenue
• MR =
¨TR
¨Q
• MR =
Marginal Revenue Schedule
Output
Total Revenue
Change in Total Revenue
Change in units of output sold
¨TR
¨Q
Marginal revvenue
M
Marginal Revenue
Change in Total Revenue
Change in units of output sold
Marginal Revenue Schedule
Marginal Revenue
Output
Total Revenue
Quantity of fans sold
Marginal Revenue
0
0
-
0
0
-
1
10
10
1
10
10
2
18
8
2
18
8
3
24
6
3
24
6
4
28
4
4
28
4
5
28
0
5
28
0
6
24
-4
6
24
-4
( 64 )
MR
Marginal Revenue
Marginal Revenue Schedule
Output
Total Revenue
A
Total
T
revenu
ue
Quantity of fans sold
TR
MR
Marginal Revenue
O
Output sold
MR Curve
0
0
-
1
10
10
• Downward sloping
2
18
8
• Could be negative
3
24
6
4
28
4
5
28
0
6
24
-4
O
Relationship of TR, MR & AR under
perfect
f t competition
titi
• When MR = AR, AR is at
its maximum
• TR rises at a constant rate
TR / AR / MR
TR
• When MR is decreasing
and is less than AR, AR
is falling
Revvenue (Rs)
• At point A, MR = 0 and TR
is maximum
MR Output sold
Relationship between AR and MR
AR
• Prior to point A, MR is
positive but falling, TR
increases at a diminishing
rate
• Beyond point A, MR is
falling and negative; TR
starts falling
Marginal re
evenue
• MR =
¨TR
¨Q
Relationship between TR & MR
Marginal revvenue
M
• MR =
Change in Total Revenue
Change in units of output sold
• MR can be 0; AR can
never be 0
Units of output sold
O
MR Output sold
O
Relationship of TR, MR & AR under
P f tC
Perfect
Competition
titi
Relationship of TR, MR & AR under
perfect
f t competition
titi
TR
• TR rises at a constant rate
TR
• MR is constant
• AR = MR
O
• AR is constant
TR / AR / MR
TR / AR / MR
• AR is constant
AR = MR
Units of output sold
• TR rises at a constant rate
AR = MR
• MR is constant
• AR = MR
Units of output sold
O
TR,, AR and MR under perfect
p
competition
p
Units sold
( 65 )
TR(Rs)
AR(Rs)
1
Market Price per unit (Rs)
3
3
3
MR(Rs)
3
2
3
6
3
3
3
3
9
3
3
Relationship of TR, AR & MR under
Imperfect Competition
Producer’s
Producer s Equilibrium
Tottal revenue
A
O
• That level of output produced and sold,
whereby a firm maximises profits
• Firm retains some flexibility to
determine price
TR
• Profits = Revenue – Cost
• As price falls Æ quantity sold
increases => AR curve is
downward sloping
Output sold
• 2 methods of determining produces equilibrium
– Gross Profit Approach
MR / AR
• MR also
l reduces
d
AR
O
– Marginal Revenue – Marginal Cost Approach
• TR increases at an diminishing
rate and then falls
Output sold
MR
Gross Profit Approach
Gross Profit Approach
MC
• Profit = Revenue – Cost
• TC = TFC + TVC
P = MR
Co
osts / reven
nue (Rs)
• TFC is constant
• Gross profit = Revenue – TVC
• Area under MC curve = TVC
P = MR: Initial
Price Line
MC: Marginal
g
Cost Curve
• Area under MR curve = TR
O
Quantity of output
Gross Profit Approach
Gross Profit Approach
E
A
MC
P = MR
At Output OQ:
Co
osts / reven
nue (Rs)
Co
osts / reven
nue (Rs)
MC
P= MC
TR = OAEQ
TVC= OBEQ
Profit = AEB
B
O
F
A
P > MC
TVC= OBGQ*
B
G
Q*
Quantity of output
( 66 )
At Output OQ*:
TR = OAFQ*
O
Q
Quantity of output
P = MR
Profit = AFGB
Gross Profit Approach
Gross Profit Approach
MC
MC
F
A
P = MR
E
At Output OQ*:
Co
osts / reven
nue (Rs)
Co
osts / reven
nue (Rs)
C
Profit is LESS
than at OQ
Q byy
FEG
B
O
G
Firm could
Fi
ld still
ill
earn this profit
E
A
P < MC
TVC= OBCQ’
Profit = AEB
minus ECD
B
O
Q*
Q’
Quantity of output
Quantity of output
Gross Profit Approach
Gross Profit Approach
MC
C
E
P = MR
At Output OQ’:
Co
osts / reven
nue (Rs)
Firm loses profits
by this area
A
Profit is LESS
than at OQ
Q byy
ECD
D
B
O
Profits are
maximised at
OQ, where
P = MC
B
O
Ql
P = MR
E
A
Quantity of output
Q
Quantity of output
Marginal Cost – Marginal Revenue Approach
Marginal Cost – Marginal Revenue Approach
MC
MC
P = MR: Initial
Price Line
E
Co
osts / reven
nue (Rs)
P = MR
Co
osts / reven
nue (Rs)
At Output OQ’:
TR = OADQ’
MC
Co
osts / reven
nue (Rs)
P = MR
D
MC: Marginal
g
Cost Curve
O
Q
Quantity of output
( 67 )
At point E, P =
MC
Output
p produced
p
OQ
O
Quantity of output
P = MR
Marginal Cost – Marginal Revenue Approach
Marginal Cost – Marginal Revenue Approach
MC
MC
Marginal Profit
P = MR
E
P > MC
MR: AQ’
MC: BQ’
B
O
Q’
A
Co
osts / reven
nue (Rs)
Co
osts / reven
nue (Rs)
A
At output OQ’:
At output OQ’:
P > MC
MR: AQ’
MC: BQ’
B
O
Q
P = MR
E
Quantity of output
Q’
Q
Quantity of output
Marginal Cost – Marginal Revenue Approach
Marginal Cost – Marginal Revenue Approach
MC
MC
C
Marginal Profit
P = MR
E
Increase output
as long as P>MC
B
O
Q’
E
Co
osts / reven
nue (Rs)
Co
osts / reven
nue (Rs)
A
P < MC
Q
Q’’
Quantity of output
Marginal Cost – Marginal Revenue Approach
Marginal Cost – Marginal Revenue Approach
MC
MC
C
C
Marginal Loss
Marginal Loss
D
P = MR
At output OQ’’:
P < MC
MR: DQ’’
MC: CQ’’
Q
E
Co
osts / reven
nue (Rs)
E
Co
osts / reven
nue (Rs)
At output OQ’’:
MC: CQ’’
Quantity of output
O
P = MR
MR: DQ’’
O
Q
D
Q’’
O
Quantity of output
Q
Quantity of output
( 68 )
D
Q’’
P = MR
Reduce output
as long as P<MC
Break – Even Analysis
Marginal Cost – Marginal Revenue Approach
• Defined as the level of output where TR = TC
MC
• Costs include: Fixed, Variable, Normal Profits
Co
osts / reven
nue (Rs)
Profits are
maximised at
OQ, where
P = MR
E
• At break – even, firm earns normal profit
P = MC
O
Q
Quantity of output
Break – Even Analysis
y
Break – Even Analysis
y
Break
Break--even chart
Output
0
BreakBreak-even chart
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
0
20
20
0
0
-20
Loss
Output
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
0
0
20
20
0
0
-20
Loss
10
12
20
32
2
20
-12
Loss
Break – Even Analysis
y
Break – Even Analysis
y
Break--even chart
Break
Output
BreakBreak-even chart
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
Output
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
Loss
0
0
20
20
0
0
-20
Loss
0
0
20
20
0
0
-20
10
12
20
32
2
20
-12
Loss
10
12
20
32
2
20
-12
Loss
20
20
20
40
2
40
0
BreakBreak-Even
20
20
20
40
2
40
0
BreakBreak-Even
30
24
20
44
2
60
16
( 69 )
Profit
Break – Even Analysis
y
Break – Even Analysis
y
Break--even chart
Break
BreakBreak-even chart
Output
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
Output
TVC
TFC
TC
AR = P
TR
Profit/Loss
Profit/Loss
Loss
0
0
20
20
0
0
-20
Loss
0
0
20
20
0
0
-20
10
12
20
32
2
20
-12
Loss
10
12
20
32
2
20
-12
Loss
20
20
20
40
2
40
0
BreakBreak-Even
20
20
20
40
2
40
0
BreakBreak-Even
30
24
20
44
2
60
16
Profit
30
24
20
44
2
60
16
Profit
40
26
20
46
2
80
34
Profit
40
26
20
46
2
80
34
Profit
Costs and
a revenu
ue (Rs)
Break –Even Analysis
At breakeven:
TR = TC
TR
TC
=> TR
q
B
Supernormal profit
=
TC
q
=> AR = ATC
Break
Break--even or Normal profit
Loss
O
Output
( 70 )
National Income Accounting
Abstract
The present unit will deal with National Income Accounting: Concept and Meaning of
National Income, its measurement, their components and different methods of computing.
Factors affecting National Income have also been explained. Light has also been thrown on
uses of National Income Statistics and Limitations of National income. Ample examples with
problems and solutions are given for your conceptual clarity. Few question based on the
computation are also given which you can take up in the class room. National income is major
yardstick for development of any country. Hence its computation and components are very
significant for students learning. Concept of Double Counting, Tranfer Payments, its
treatment and precautions while computing National Income is also covered in the present
unit.
Recall:
Please make students recall the meaning of GDP, NDP, NNP etc. and component of
Depreciation which was taken up in previous week, the clarity in calculating NNP at FC and
NNP at Market Price is must. Concept of National Income and Methods of Measurement of
National Income should be taken up one by one i.e. Value Added Method, Income Method
and Expenditure Method.
( 71 )
Teaching Points






Concept and Meaning of National Income
Measurement of National Income- Value Added, Income Method and Expenditure
Method.
Relevant related concepts of Nation Income
Factors affecting National Income
Uses of National Income Statistics
Limitations of National Income
What is National Income?
1. Concept and Meaning of National Income
National Income is a measure of the total flow of earning of the factor-owners through the
production of goods and services. In simple words, it is the total amount of income earned by the
aggregate output.
The total value of the level of aggregate output is called Gross National Product or GNP. GNP is
a measure of the total market value of all final goods and services currently produced by all the
citizens of a nation within a period, usually a year.
Focus on the important points mentioned below:



It Measures how much people produce.
It Counts current production only
It Counts the level of output with a market value.
It relies on the market prices of goods and services as a measure.
2. Methods of Measuring National Income
There are mainly Three Approaches to measure GNP
( 72 )
The relationship of these approaches is shown in the diagram given below.
Product market
Households
Firms
The 3 arrows in the diagram show the overall level of economics activities.
Based on these 3 directions of Flows i.e. Flow of output, Flow of Income and a Flow of
Expenditure, economists develop three approaches to measure GNP.
2.1 Output or value added approach
The total value of all final goods and services (i.e. outputs) can be found out by adding up the
total values of outputs produced at different stages of production .This method it to avoid the socalled double-counting or an over-estimation of GNP. However, there are difficulties in the
collection and calculation of data obtained; caution should be taken to take Final Goods not
Intermediate goods as it will result in Double Counting.
For example in a Cycle Manufacturing Unit, computing the total value of cycles produced in a
year the final value of the cycle ( Multiplied by total no of units produced) which is ready to
be marketed for sale will be taken not the cost of intermediate goods which are used in the
process of manufacture as it will result in double counting. i.e. The market price of a cycle is
suppose Rs.2000 which includes say profit margin of Rs.200 besides the cost of manufacturing
of Rs.1800.This 1800 includes all costs including components and parts etc. (these are
intermediate goods which are used in the process of production.)If the costs of parts etc. are
also taken while computing final value of total units produced, it will give inflated figure and
hence result in double counting error. Same way at macro level, while computing the National
Income under Value Added Method the value of final goods and services should be taken up
to avoid the double counting error as the cost of Intermediate Goods are already counted in
the final value of the product.
( 73 )
2.2. Expenditure approach
Amount of Expenditure refers to all spending on currently-produced final goods and services
only in an economy. In an economy, there are three main agencies which buy goods and
services. These are: Households, Firms and the Government
In Economics, we use the following Terms:
C=
Private Consumption Expenditure (of all Households)
I =
Investment Expenditure
(of all firms)
G = Government Consumption Expenditure (of the local government)
In an economy the entire output which is produced in a year is not fully consumed by that
economy as some goods are exported and in the similar way the domestic consumption
(expenditure) may also include imports. Hence under the expenditure approach to measure the
GNP, the value of exports must be added to C, I and G whereas the values of imports must be
deducted from the above amount.
Finally, we have:
GNP at market prices = C+I+G+X-M
(Where X-M = Exports –Imports)
Gross Domestic Product (GDP)
We can only find the amount of outputs which are produced within the domestic boundary of an economy
in a specific period, say a year. To arrive at the value of GNP, Net Factor Income Earned from Abroad
(NFIA) has to be added to the GDP.
Income from abroad = income earned by local citizens form the provision of factors services abroad
Income to abroad = income earned by foreign citizens form the provision of factors services locally
Net Factor Income from abroad – Income earned from abroad – Income sent to abroad
GNP = GDP + Net Factor Income Earned from Abroad
( 74 )
2.3 Income approach
The Income approach tries to measure the total flows of income earned by the factor-owners in the
provision of final goods and services in a current period. There are four types of factors of production and
four types of factors incomes accordingly i.e. Land, Labour, Capital, and Organization as Factors of
Production and Rent, Wages, Interest and Profit as Factor Incomes correspondingly.
National Income = Wages+ Interest Income + Rental Income +*Profit
The term* Profit can be further sub-divided into; profit tax; dividend to all those shareholders; and
retained profit (or retained earnings).
3. Relevant concepts of National Income
3.1 Net National Product (NNP)
The investment expenditure of the firms is made up of two parts. One part is to buy new capital
goods and machinery for production. It is called net investment because the production capacity
of the firms can be expanded.
Another part- consumption allowance or depreciation- is spent on replacing the used-up capital
goods or the maintenance of existing capital goods will face wear and tear out over time.
Depreciation refers to all non cash provision charged against profit each year to replace the fixed
assets due to wear and tear, obsolescence, destruction and accidental loss etc.
The sum of these two amounts is called Gross Investment in economics.
Gross Investment= Net investment + Depreciation
Net investment will increase the production capacity and output of a nation, but not by
depreciation expenditure. So we have,
NNP = GNP-Depreciation
3.2 GNP at Factor Cost
The amount of National Income calculated under the Income Approach will not be the same as the
amount of GNP at market prices found by the expenditure approach.
In the expenditure approach, the value of GNP included some types of expenses which are not factor
incomes earned by the citizens. They include depreciation, indirect business taxes, and government
subsidies.
GNP at factor Cost = GNP at market price = Indirect Business Taxes + Subsidies
= GNP at market price = Indirect Business Taxes less Subsidies
( 75 )
GNP at factor cost carries the meaning that we are measuring the total output by their costs of production.
As output generates income to the factor-owners, it is also related with the value of national income.
GNP at factor Cost = National Income + Depreciation
Depreciation is also a type of costs of production but will not become a source of income directly. So it is
included in the factor cost but excluded in the value of national income.
3.3 GNP (GNP at Current Market Prices)
GNP is a measure based on market prices which are expressed in terms of money. In reality,
market prices changes all the time. The same amount of outputs may different total market
values provided that price change.
In order to isolate the effect of prices change on the value of GNP, economists have developed
the concept and techniques of constant market prices.
GNP at the base year (1990)
= 1X 6 + 2 x 4 +2 x 2m. = 18 million
GNP at current market prices in 1995 = 1x 6 +2 x6 +3 x 4m. = 30 Million
The 2 value of GNP at current market prices in 1995 & 2000 are calculated by using the money
prices in that year, eg. The nominal growth rate is 66.67 % between 1990 to 2000.
GNP at constant market prices of 1995 = 1 x 6 + 2 x 6 +2 x 4m. = 26 million
The real output changes from 18 to 26 million from 1990 to 1995. GNP at constant marker prices
is called real GNP.
The growth rate of real GNP is called real growth rate of GNP.
Real GNP
The value of the real GNP is based on the prices of the base year. However, there are too many different
values of prices of goods and services. To make the calculation of GNP easier, economists use a price
index to find the real GNP.
A Price index is a number showing the changes in the overall level of prices. It shows a change in the
general price level of an economy.
With the value of the price index, the real GNP of anyone year can be found
Real GNP = Nominal GNP x (Price Index at base year/Price index at current year)
( 76 )
4. Factors Affecting National Income
4.1 Factors of production
Normally the more efficient and richer the resources, higher will be the level of National Income or GNP
4.1.1 Land
Resources like coal, iron and timber are essential for heavy industries so that they must be available and
accessible. In other words, the geographical location of these natural resources affects the level of GNP.
4.1.2 Capital
Capital is generally determined by investment. Investment in turn depends on other factors like
profitability, political stability etc.
4.1.3 Labour and Entrepreneur
The quality or productivity of human resources is more important than quantity. Manpower planning and
education affect the productivity and production capacity of an economy.
4.1.4. Technology
This factor is more important for Nations with fewer natural resources. The development in technology is
affected by the level of invention and innovation in production.
4.1.5. Government
Government can help to provide a favorable business environment for investment. It provides law and
order, regulations.
4.1.6 Political Stability
A stable economy and political system helps in appropriate allocation of resources. Wars, strikes and
social unrests will discourage investment and business activities.
5. Uses of National Income Statistics
5.1 Standard of living
The per capita GNP allows us to compare the standard of living of different nations. In general, a nation
has a higher standard of living if its per capita GNP is higher than that of another nation.
5.2. Policy formulation
In the compilation of GNP statistics, the Government gathers lot of information of the economy. The
Government can use this as base to plan and decide its policies.
( 77 )
5.3 International comparison
By converting the local GNP figures into a common unit (usually in US$), we can compare the standard
of living of different nations. It helps to show the rate of growth or development of different nations.
5.4 Business Decision
The GNP figures can show the level of development of different industries and sectors of an economy. It
helps the business to plan for production.
6. Limitations of National Income Statistics
GNP is a measure of the overall flow of goods and services, as well as to show the general welfare of the
people. It aims not only at the level of cost of living but also the standard of living. It is quite correct to
show the cost of living but there are some limitations on the GNP statistics to indicate the standard of
living of an economy like
6.1 Price Changes
A higher nominal GNP of a nation may not mean that the standard of living is better. If the price increases
at a high rate, the real GNP may even fall.
6.2 Omission or under-estimation
6.3 Voluntary services
GNP figures do not include the contribution of the voluntary agencies which raise the general
welfare, e.g. the Tung Wah group of Hospitals.
In this respect, the GNP figures under-estimate the level of welfare.
The voluntary work of housewives is also neglected by the GNP figures. It again
underestimates welfare of people or standard of living.
It is also a source of welfare and raises our standard of living e.g. the welfare enjoyed with a New
Year holiday, however, the monetary value is difficult to calculate.
6.4 Illegal Activities
Drug trafficking and illegal gambling are activities omitted in the value of GNP. It is difficult to
determine its effect on the welfare of an economy.
6.5 Undesirable Effects of Production
GNP figures have not considered the effects of pollution, traffic congestion on the economy.
They have lowered our standard of living.
6.6
Problem of Comparison
6.7 Output Composition
( 78 )
Nations with the same GNP may have different living standard because their output composition
may be different. In general, a higher level of consumer goods and services in the GNP indicates
a higher current level of living standard.
6. 8 Distribution of National Income and wealth
If income is obtained by a small rate of people in a nation, the general living standard is still low
compared with a nation having a more evenly distributed income or GNP
6.9
Population Size
A large population has a lower living standard even if its GNP is the same as that of a small
population. The per capita GNP is more useful to compare the two nations.
6.10
National Defense
If a nation has spent a lot of resources in the production of weapons and so on, its living standard
may not be improved.
6.11 Time
Technology will be improved overtime; this may not be shown in GNP figures because there may
be small changes in cost and price only.
Besides, durable goods provide welfare to us over a period of time (usually more than 1 year).
This cannot be shown by GNP figures within a year.
COMPONENTS OF VALUE OF OUTPUT AND VALUE ADDED
Gross output of the Market
Or
Sales + change in stock
Or
Sales +closing stock – opening stock
= Gross value of output at MP
Less
Intermediate consumption
= Gross value added at MP
Less
Consumption of fixed capital (Depreciation)
(Fall in the value of fixed assets)
= Net value added at MP
Less
Net direct taxes
= Net value added at FC
( 79 )
Check your progress/examples
1. Calculate Gross value added at factor cost from the following :(i)
Gross value of output at MP
10,500
(ii)
Depreciation
1000
(iii)
Indirect taxes
750
(iv)
Economic subsidies
200
(v)
Intermediate consumption
4000
(vi)
Compensation of employees
2000
Solution
Gross value added at Factor cost will be calculated as under:Gross value of output at MP
+ Economic Subsidies
- Intermediate Consumption
- Indirect Taxes
10,500
+200
-4000
-750
Rs.5950/-
2. From the following data, estimate the net value added at factor cost and show that it is equal
to the sum of factor incomes :(i)
Sales
9600
2080
(ii)
Increase in stock
(iii)
Intermediate Consumption 2370
(iv)
Depreciation
450
(v)
Wages and salaries
5400
(vi)
Internet
250
(vii)
Rent
750
(viii) Profit
2150
(ix)
Net indirect Taxes
310
Solution
Value added at FC = Sales + increase in stock – Intermediate Consumption –
Depreciation- Net Indirect Taxes
= 9600 + 2080- 2370- 450- 310
=
Rs. 8550/-
( 80 )
Sum of Factor Incomes
Wages & salaries
= 5400
+ Interest
= 250
+ Rent
= 750
+ Profit
= 2150
8550
Hence value added at FC cost equals sum of factor incomes
Check your progress
Q. 1 Find out “Net value added at FC by an enterprise from the following data:
Rs. In crores
(i)
(ii)
(iii)
(iv)
(v)
Consumption of Fixed Capital
Subsidies
Indirect Taxes
Purchase of material and
Services from other production units
Value of output
10
5
25
75
125
(Ans. = 70 Corers)
Q 2. Calculate value added by Firm A & B from the following data:Rs. (Lakh)
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
Purchase by Firms B from Firm A
Sales by Firm B
Imports by Firm B
Rent Paid by Firm B
Opening stock of Firm B
Closing stock of Firm B
Purchases by Firm A from Firm B
Closing stock of Firm A
Opening stock of Firm A
40
80
10
05
15
20
20
20
10
( 81 )
Solution
Value of output of Firm A
= Sales + stock
= 40 + (20-10)
= 50 Lakhs
Value added By Firm A
Value of output – Intermediate Consumption
= 50-20
= 30 Lakhs
Value of output of Firm B
= Sales + change in stock
= 20 + 80 + (20-15)
= 105 Lakhs
Value added By Firm B
Value of output – Purchase-Imports –Rent
=105-40-10-5
= 50 Lakhs
( 82 )
II Income Method of Computing National Income
Steps involved in calculating NI by Income method
Step 1. Identification and classification of producing enterprises which employ factor
inputs into primary, secondary and territory sector
Step 2. Classification of factors income into Compensation to Employees, Operating
Surplus & Mixed Income.
Step 3
Estimation of National Income
NNP at fC (National Income)
1. Compensation to employees
2. Operating surplus
3. Mixed income and self employed
= Net domestic product at factor cost
4. Net factor income from abroad
5. Net national product at factor cost
Process involved in estimating NI by Income method
Any income corresponding to which there is no flow of goods and services or value added,
it should not be included in calculation of National Income
1. Transfer payment like scholarships, olf age pensions, gifts etc. is not a productive
activity. So they are excluded. These are unilateral payments. A distinction is made
between old age pension is a transfer payment and retirement pension is a part of
compensation of employees.
2. Income from the sale of second hand goods or capital gains is excluded from national
income because their sale has been accounted in the year they were purchased. However
the brakeage/commission paid is included as factor income.
3. Illegal income from smuggling, black marketing, theft, scarcity. Gambling is net included
as it is not only illegal but also difficult to count as nobody reveals it.
4. Income arising from sales of financial assets like shares, bonds, debentures in the market
is not treated as income as there is no corresponding production of goods and services
when such sales are made. It reflects a mere transfer of ownership rights.
5. Imputed value of services rendered by owners of production units are to be included e.g.
rental of owner-occupied houses on the basis of prevailing market rate.
( 83 )
6. Imputed value of own account production must be included as it is equivalent to selling
the good to himself and earning factor income.
7. Income from windfall gains like lotteries is not included, as its is not earned by providing
any productive activity. It is a transfer receipt.
Numerical Example
1. Calculate national income from the following data:(Rs. Crores)
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
Consumption of fixed capital
Employers contribution to social security
Interest
Net Indirect Taxes
Rent
Dividends
Corporate Tax
Undistributed profit
Net factor income from abroad
Wages and salaries
50
75
160
55
130
45
15
10
-10
450
Solution
NDP fc = (X) + (ii) + (iii) + (v) + (vi) + (Vii) + (Viii)
= 450 + 75*+ 160 +130+45+15+10 = 885 Cr.
NNP at fc = NDP fc + (ix)
= 885 + (-10) = 875 Cr.
Notes of solution



*Since wages and salaries and employees contribution to social security are given
separately, these must be added to obtain compensation to employees.
Dividend, undistributed profit and corporate taxes are to be added to get Total profit/
Retained Earnings.
Net indirect taxes, is not required in this question. Similarly consumption of fixed capital
is also not required in this question.
( 84 )
III
Expenditure Method
The other way of calculating National Income is to measure total spending on final good
by the different sectors of the economy.
Expenditure method is National Income Accounting method that measures GDP by
adding all the spending for final goods during a period of time.
GNP mp = C+I+G+(X-M)
The Factors Income earned by the Factors of Production is spent on (Disposed off) goods
and services that are produced by firms. That is why expenditure method is also called
income disposal method.
Expenditure is undertaken by all sectors of an Economy-Households, Government, Firms
and Rest of the World. Let us understand the kind of expenditure that is incurred by the
different sectors.
1. Personal or Private Consumption Expenditure (C)
Private Consumption Expenditure is the money value of final goods and services
purchased by the resident households, including non-profit institutions of an economy
in a given year.
2. Gross Domestic Capital Formation (I)
Capital formation or investment is an addition to capital stock of an economy in a
given time period. This is the sum of two components i.e.
(i)
(ii)
Gross Domestic fixed capital formation and
Change in stock
This includes investments by firms as well as governments sectors
3. Government Final Consumption Expenditure (G)
This category includes the value of goods and service purchased by Government.
4. Net Exports (X-M)
The last component in GDP Expenditure Account is Net Exports, expressed in the
formula (X-M). Exports (X) are expenditure by foreigners for Indian domestic
product. Imports (M) is the expenditure on goods and services produced by the rest of
the world by resident household firms and government.
( 85 )
Steps involved in calculation of National Income ( NI) by expenditure
method
Step 1.
Identification of economic units incurring final expenditure
Step 2. Classification of final expenditure (C+I+G+(X-M))
Step 3
Estimation of NI by expenditure Method:-
Please Note
1. Only final expenditure is to be included to avoid double counting.
2. Intermediate expenditure like on raw materials, etc, is not included in the
calculation of National Income.
3. Expenditure on second-hand goods is not included as they have already been
included when they were purchased originally.
4. Expenditure on shares and bonds is not included because buying financial
assets is not a production activity because financial assets are neither good nor
services. These are also known as Paper Money or Barren Money.
5. Expenditure on transfer payments by the government is excluded in total
expenditure because transfer payment is a payment against which no services
are rendered therefore, no production takes place and hence are not considered
in computing National Income.
6. The imputed expenditure value or self use of own produced final products is
included.
( 86 )
Numerical Example
Calculate national income from the data given below by expenditure method.
Item
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
Rs. (In crores)
Personal consumption expenditure
Consumption of fixed capital
Net fixed capital formation
Change in stock
Exports
Imports
Net indirect taxes
Governments’ consumption expenditure
Net factor income from abroad
Wages and salaries
3500
50
1250
500
400
750
40
1600
(-) 10
450
Solution
Rs. (In crores)
Personal Consumption expenditure
3500
+ Net fixed Capital Formation
1250
+ Change in Stock
500
+ Govt. Consumption Expenditure
1600
+ Net Exports (Exports-Imports)
-350
Net Domestic product at market price
6500
(-) Net Indirect Taxes
40
Net Domestic product at Factor Cost
6460
+ Net factor Income from abroad
(-) 10
NNP FC (National Income)
6450
Please Note
1. Since Net Fixed Capital Formation is given, we are asked to calculate net National
Product at factor cost. Thus, consumption of fixed capital is not required here.
2. Since, fixed capital is given, we need to add change in stock to get the total domestic
capital formation (Investment)
3. The entry wages and salaries are not required here.
( 87 )
Question Bank
Abstract
Friends, till now we were uploading support material in content areas from the week-wise
syllabus from July, 2011.In this section we intend to give you different types of questions
based on Board pattern along with expected Answers /Solutions. Hope this will enable you
to prepare students accordingly. As preparing test - items for a balanced question paper is
an art, answering appropriately and precisely is also a skill which we have to equip our
children with. Understanding the question and using appropriate terminology. Language
for framing answers is very important for high scoring in examinations. This requires
practice and teachers play an important role in providing this skill in class rooms. This is
an exemplar, try your own question- bank preparation based on small section of content
covered.
I Question Bank (with Answer/Solution)
Producers Behavior and Supply
Very Short answer Type Questions (1 mark)
1
How does fall in total product affect marginal product?
2
Which Cost Curve is parallel to OX- axis? Why?
3
What do you mean by Fixed Factors of Production?
4
What is meant by Market Period?
5
What causes a downward Movement along the Curve?
6
When does the Elasticity of Supply of commodity is equal to Unity?
7
Draw TVC Curve.
8
“At Producers’ Equilibrium Marginal Cost should be falling.” True/ False. Give reason.
9
What happens to Supply of a Good when price of inputs used rise while producing the same ?
( 88 )
10 The vertical distance between ATC and AVC should fall or rise or remain constant with the
increase in output? Give reason.
11
II
In this formula what does P stand for?
Short answer Type Questions (3-4 marks)
1
Draw ATC, AVC and MC Curves in single diagram.
2
Distinguish between Total Fixed Cost and Total Variable Cost.
3
What changes will take place in Total Revenue when:
a)
Marginal Revenue is falling but is positive
b)
Marginal Revenue is Zero
c)
Marginal Revenue is negative
4 Find the level of output yielding maximum profit by MC and MR approach
Output
AR
TC
1
10
10
2
9
11
3
8
14
4
7
18
5
6
25
5 Define Marginal Revenue. Explain the relationship between Average and Marginal
Revenue when price is constant at all levels of output.
6 Complete the following table:
Output(Unit)
1
3
-
Total Variable
cost(Rs)
10
27
-
Average Variable
Cost(Rs)
8
10
Marginal Cost(Rs)
6
13
7 Following information is given about a firm:
Output(in 0
units)
Total
20
Cost(Rs)
1
2
3
4
5
6
25
28
30
36
45
60
From the above information find:
a) Average Fixed Cost of producing 4 units.
( 89 )
b) Average Variable Cost of producing 5 units.
c) Marginal Cost of producing 3rd unit.
d) Average Cost of producing 6 units.
8
Whether statements are True or False? State reasons
i) As long as MC is rising, ATC will also rise.
ii) At an output of one unit, ATC is equal to MC.
iii) Total Revenue declines as long as Marginal Revenue is falling.
9
State three reasons of a Rightward Shift of a Supply Curve.
10
Using diagrams explain the difference between Contraction and Decrease in Supply.
11
In the diagram given below state the nature of Elasticity of Supply of the different
Supply Curve
12
A 20% rise in the price of commodity A leads to a rise in its supply from 400 to 500
units. Calculate its Elasticity of Supply and comment on it.
13
The Price elasticity of Supply of a commodity is 2. When its price falls from Rs 10 to
8 per unit, its Quantity Supplied falls by 500 units. Calculate the Quantity Supplied at
reduced price.
14
Using a diagram explain how a relatively flatter Supply curve has a higher Elasticity
of Supply for a given rise in price?
III
Long Answer Type Questions (6 Marks)
1.
Explain the effect on output when only one input is increased?
2.
Explain three factors that influence the Supply of Ice Creams in the market.
3.
Using a hypothetical example, explain how the Market Supply Curve is determined
from Individual Supply Curve of three firms?
( 90 )
4.
a) Explain the effect of technical progress on the supply of a good. Use diagram.
b) Using diagram explain the impact of drought on the Market Supply of wheat.
6
Explain the conditions of Producer’s Equilibrium with MC and MR approach. Use
schedule & diagram.
7
State whether following statements are true or false. Give reasons:
a) Diminishing returns to a factor is applicable only when Average Product starts falling
b) AC and AVC Curves do not intersect each other
c) Supply remains constant in Market Period.
Answer/Solution
Unit 3: Producer Behavior and Supply
Very short Answer type Questions
(1 Mark)
1. Marginal Product becomes negative
2. Total Fixed Cost curve is parallel to OX- axis because TFC is always positive even at
zero level of output.
3. Fixed factors are those factor inputs whose quantity does not change as level of output
changes.
4. The very short period when supply cannot be changed with the change in the price is
referred to as Market Period.
5. Fall in the price causes a downward movement along the supply curve.
6. When the value of the Co-efficient of Elasticity of supply is equal to one and supply
curve passes through origin is extended.
7.
TVC Curve
8. False. At producers Equilibrium Marginal cost should be rising because falling MC
causes more profit.
9. The supply of good decreases as the cost of production rises with the increase in input
prices.
10. The vertical distance between ATC and AVC should fall with the increase in output
as the difference between ATC and AVC is AFC and that falls with increases in
output.
11. In the formula p stands for change in price (New price – Original price)
( 91 )
Short Answer Type Questions
Ans. 1
ATC, AVC and MC Curves
Note:
•
•
•
The vertical distance between ATC & AVC should decreases with increase in
output.
MC should cut AVC and ATC at its minimum point.
The Minimum Point of AVC should come before minimum point of ATC.
2. Distinction between Total Fixed Cost &Total Variable Cost
Total Fixed Costs
Total Variable Costs
Do not vary with the quantity of output Vary with the quantity of output produced
produced
Can never be zero in the short run. Have to Can fall to zero in the short run, as they are
be incurred even if production falls to zero
directly related to the level of output
produced
Example :- Rent
Example :- wages
3. The following changes will take place :
a) Total Revenue will rise at diminishing rate.
b) Total Revenue is maximum
c) Total Revenue falls
4 Output
1
2
3
4
5
AR
10
9
8
7
6
TC
10
11
14
18
25
TR
10
18
24
28
30
MC
1
3
4
7
( 92 )
MR
10
8
6
4
2
MR>MC
Equilibrium MR= MC
MC>MR
At output level of 4 unit, the project is maximum as here MC = MR
5 Marginal Revenue of a firm is the additional revenue it earns when it sells an
additional unit of the output.
Marginal Revenue = Change in Total Revenue
Change in output
Since a Firm’s Price is constant, Marginal Revenue is also constant and AR also
remains constant and is equal to MR at all output levels. (P = AR). The AR and MR
curves are the same and are parallel to x- axis. (AR=MR=Price)
y
AR/MR
AR = MR
0
x
Output
( 93 )
6
Output
TVC
∑ MC = TVC or
AVC x Q
AVC
TVC
Q
1
2
3
4
MC
TVC
Output
10
16
27
40
10
8
9
10
10
6
11
13
7
Output
0
1
2
3
4
5
6
TC
20
25
28
30
36
45
60
TFC
20
20
20
20
20
20
20
TVC
0
5
8
10
16
25
40
AFC
20
10
6.6
5
4
3.3
AVC
0
5
4
3.3
4
5
6.6
MC
5
3
2
6
9
15
ATC
25
14
10
9
9
10
Formula Used:
AFC = TFC
,
AVC = TVC ,
Output
MC =
TC
ATC = TC
Output
Output
TC at 0 level of output is TFC because TVC is 0 at this level.
Output
TC = TFC + TVC
8
I.
False, AC can fall even when MC is rising when MC < AC and MC rising.
II.
False, at an output of one unit ATC is equal to TC and MC is less than ATC as
MC is change in TVC only.
III.
False, Total Revenue rising at diminishing rate when MR is falling but is positive.
TR falls only when MR is negative.
( 94 )
9. Three causes of Rightward Shift of the Supply Curve.
I.
Fall in Input Price
II.
Improvement in Technology
III.
Reduction in Taxation Rate
10. Difference between Contraction and Decrease in Supply
Contraction in Supply
Decrease in Supply
A reduction in supply due to a fall in a A decrease in supply is defined as a situation
price of the commodity is termed as when the seller is willing to supply lesser of
contraction.
quantity at the same price.
Contraction
results
in
downward Decrease in supply results in leftward shift of
movement on the supply curve
supply curve because of Increase in Input Price
or taxation rate etc.
There is a downward movement from A There is leftward shift of supply curve from SS
to B. When the price falls, from P to P1 to SS’ because of change in factors other than
and quantity supply at falls from Q to Q1. price.
( 95 )
11
y
SA
Price
SB
SC
Quantity Supplied
X
SA – Unitary Elastic Supply (ES=1)
SB - Elastic Supply
(ES>1)
SC – Inelastic Supply
(ES<1)
12
Elasticity of Supply = % Change in Quantity Supplied
% Change in Price
Where –
q1 – New Quantity
q0 – Old quantity
q1 – q0 X 100
q0
% Change in Price
OR
500-400
400
20
X 100
= 25 = 1.25
20
Elasticity of Supply is greater than 1, hence it is elastic.
( 96 )
13
Given ES = 2
p (Change in Price) New Price – Old Price
= - 2 (8 – 10)
Q (Change in Quantity Supplied)
= 500
New Supply - ?
q0 = 1250
Where
New quantity
Q = Change in Quantity Supplied
1250 – 500
p = Change in Price
= 750
p = Original Price
q0 = Original quantity
( 97 )
14
In the above diagram SA and SB are two Supply Curves. SB Curve is more flatter.
Elasticity of Supply measures impact of change in price on change in quantity
supplied. When price rises from OP to OP 1 than according to law of supply, supply
increases from Q to Q2 for Supply Curve SA and from Q to Q 1 for SB. Change in
Quantity Supplied is greater (Q – Q1) for the flatter supply curve SB.
Long Answers
1.
The effect on output when only one input is increased and all other inputs are held
Constant relates to short period production function which is better known as Law of
Variable Proportion.
Statement
As additional units of a variable factor are combined with a given level of fixed factors
and technology, the marginal product of the variable factor first increases and then
decreases.
Phase I – TP increases at increasing Rate
This phase occur when Marginal Product is increasing. It ends at the point when MP is at
its maximum value. Here total product increases at increasing rate.
Phase II TP is increasing at a diminishing rate
In this phase the marginal product is declining but is positive. It occurs between the point at
which MP is at its maximum and ends when MP becomes zero.
( 98 )
Phase III
In the third phase the Marginal Product is declining and is negative. Here the total product
starts falling.
2.
Three Factors affecting Supply of Ice Creams are as under:
( 99 )
Price of Input
The production of ice cream will depend on the prices of input required to make
ice cream i.e. milk, sugar, flavour etc. The increase in the price of input will lead to
increase in cost of production thus reduction in production and supply.
Improvement in Technology
Any betterment in the technology of producing ice cream will lead to reduction in
cost and increase in production and supply.
Government Taxation Policy
The various Indirect Taxes by the government on the production and sales of goods
affect the cost of production. More Taxes less Supply and Less Taxes more
supply.
Ans : 3
Market Supply is the collective supply of all individual firms of a given commodity at a
given price at a given time period.
Market Supply
Per unit Price (Rs.)
(A+B)
Schedule for ice creams
Quantity Supplied Quantity Supplied
by Mother Dairy
(A)
20
30
40
40
55
Market
Supply
by Amul
(B)
5
10
20
30
25
40
15
40
55
Quantities of firm A & B has been horizontally added to find Market Supply
( 100 )
Market Supply Curve
It is the graphical representation of the quantity of a community that all firms in a
market are willing to supply at a given price at a given time, assuming all
other factors influencing supply are held constant.
4 (a)
Effect of technical progress on the supply of good
The betterment of technology reduces the cost per unit of production. This leads to
firm’s profit maximization and there is increase in the supply.
( 101 )
4 (b) Impact of Drought on Market Supply of Wheat: The drought will result in less
production of wheat which further cause less supply. So the supply S Curve will shift
leftwards to S1.
5. Producer’s Equilibrium is the level of output produced and sold by a firm that
maximizes its profit.
According to MC- MR Approach, the level of output that maximizes the profit should
fulfill two conditions.
Condition -1 – Marginal Revenue = Marginal Cost
Output (Amt) MR(Rs)
1
10
2
10
3
10
MC(RS)
5
3
MR>MC; Profit earned in the last unit, overall profit is
2
increasing, therefore increase output
( 102 )
4
5
6
7
decreasing;
8
10
10
10
10
5
7
10
13
MR=MC= Producer’s Equilibrium
MR<MC Loss on the last unit overall profit is
10
15
therefore, decrease output.
Condition-2
Marginal Cost should be rising – As long as Marginal Cost is falling producers’ keep on
maximising profit. So it is only when MC rises and becomes more than MR, producer’s start
incurring loss.
6 (a) False . Diminishing Returns to factor starts when the Marginal Cost start falling. At
this point Average Cost is rising because MC>AC.
(b) True. AC and AVC curve can not intersect each other though the vertical distance
between them keeps on reducing with Increase in output. The reason behind this is falling
AFC which can not be zero as TFC cannot be zero.
(C) True .
Supply remains constant in the Market Period because Market Period is the
time period when supply can not be changed to any change in the price level. The time is
very short for any changes.
( 103 )
QUESTIONS ON MARKET COMPETITION AND MARKET
EQUILIBRIUM (PRICE DETERMINATION)
Very Short Answer Questions (1 mark)
1
Under which market form a firm is a Price Taker?
2
Draw a Demand Curve under Perfect Competition.
3
Define Equilibrium price.
4
When does the situation of excess supply Curve arise?
5
What is the Profit Maximisation condition for Perfect Competition?
Short Answer Questions (3-4 marks)
1 Why is a firm under Perfect Competition a price taker?
2 Explain three feature of Perfect Competition.
3 Explain the determination of Equilibrium Price under Perfect Competition with the help of
Schedule.
4 Show that an increase in demand leads to a fall in the price of the commodity.
5 Diagrammatically represent the impact of a decrease in Supply on Equilibrium Price.
6 What will be the impact of increase in excise duty on the Equilibrium Price and Quantity of a
Commodity? Use diagram.
7 Explain the feature’ Large number of firms and Buyers under Perfect competition’.
Long Answer Questions ( 6marks)
1. How does an increase in price of Steel affect the equilibrium price and quantity of
cars? Explain with the help of diagram.
2. With the help of a diagram explain how a rise in the income level impacts the
Equilibrium Price of shirts.
3. “There is a Simultaneous change in demand and supply of a Commodity and
Equilibrium price increases”. Explain this with the help of a example.
4. Explain the following features of Perfect competition:
a) Large number of firms and buyers
b) Homogeneous Product
( 104 )
ANSWERS OF PERFECT COMPETITION AND MARKET
EQUILIBRIUM (PRICE DETERMINATION)
VERY SHORT ANSWER TYPE QUESTIONS (01 MARK)
1. Under Perfect Competition a firm is a price taker.
2. Demand Curve under a Perfect Competition.
Price
AR/ Demand Curve
X
3. Equilibrium Price is the price of a commodity at which its quantity demanded equals
to quantity supplied in the market.
4. The situation of Excess supply arise when at a given price, the market supply of a
commodity is more than its market demand.
5. The firm maximises profit in perfect competition where MR = MC since AR = MR in
perfect competition. So we can also say P = AR = MR = MC
SHORT ANSWER TYPE QUESTIONS (3-4 Marks)
1. FIRM IS A PRICE TAKER IN PERFECT COMPETITION
A seller is a price taker in perfect competition. In perfect competition, there are a
large number of buyers and sellers in the Market. Each seller sells so little and each
buyers buys so little that none of them is able to influence the price in the market. The
Industry as a whole determines the price with two market forces demand and supply.
( 105 )
Ans 2. Three Features of Perfect Competition:
i)
Very Large number of Buers and Sellers:There is such a large number of buyers
and sellers that none of them is in a position to influence the price in a market. The
price of good is determined by the whole industry.
Homogeneous Product: Product sold in this kind of market are homogeneous or
identical in every respect like quality, size, design, colour etc. The products are
perfect substitutes of one- another.
iii)
Free Entry and Exit: Buyers and sellers are free to enter or leave the market
at any time they like large profit will induce firms into the market and loss exit if any.
3 Determination of Equilibrium price under Perfect competition: Price is
determined in a perfectly competitive market at a point where Market Demand is
equal to Market Supply.
Demand and Supply Schedule
Price (Rs)
20
30
40
50
60
Market Demand
120
100
80
60
40
Market Supply
40
60
80
100
120
Situation
Demand>Supply
Demand>Supply
Demand=Supply
Demand<Supply
Demand<Supply
In the schedule given above, at the price of Rs 40 per unit the demand and supply are equal to
each other. Before this point there is competition among the buyers and therefore prices rise
till Demand and Supply are not equal once again. In case of Excess supply, there is
competition amongst sellers which leads to the fall in the price till it reach to equilibrium
level.
4. Increase in Demand leads to a fall in the price of the commodity.
( 106 )
This can happen when increase in supply is more than increase in Demand. In the diagram
the initial equilibrium is at E point where OP is the price and OQ is the quantity. Then
demand curve shifts to its right due to increase in supply, which is more than increase in
demand. Due to this change price falls to P1 and new equilibrium point is E1, where the
market price is OP1 and Market equilibrium quantity is OQ1.
5 Impact of a decrease in Supply on Equilibrium Price and Quantity when
demand is perfectly elastic.
In the above diagram initial market equilibrium is achieved at E point where market
price is OP and Market equilibrium quantity OQ. When supply decreases and shifts to
left new equilibrium point is achieved at E1 point where Market Price OP remains
same but the quantity is reduced from OQ to OQ1.
6 . Impact of increase in excise duty on the equilibrium price and quantity of a
commodity.
Any increase in the rate of excise duty by the government will increase cost of production for
the producer. This will result in decrease in supply.
( 107 )
The decrease in supply creates the situation of Excess Demand. Competition amongst buyers
raises the price till Demand and Supply are once again equal. Price rise results in extension in
supply and contraction in demand. New Market equilibrium establishes at E1 point.
7
Large numbers of buyers and sellers under perfect competition
There is large number of buyers and sellers, each firm or seller in a Perfectly
Competitive market- forms an insignificant part of the market. So, no single seller
has the ability to determine or influence the price at which commodity is sold.
The forces of market demand and supply determine the price. So a firm is a Price
Taker while an industry is Price Maker.
LONG ANSWER TYPE QUESTION
1. With the increase in the price of steel the marginal cost of production of car will
increase. This will result in decrease in supply. Assuming that Demand for the car
remains constant the market equilibrium price will rise.
In the above diagram with Left ward shift of supply curve the price goes up from
OP to OP1 and quantity falls to OQ to OQ1.
2. With a rise in the Income Levels of the consumer, the demand for the product will
increase. This will result in a rightward shift of demand curve. Assuming supply to be
constant, the rise in demand creates excess demand. This will cause competition
among the buyers and sellers.
( 108 )
The price will rise till demand and Supply are once again equal. So the Market
Equilibrium price as well as quantity will rise. In diagram initial equilibrium price OP
rises to OP1 and quantity OQ to Q2.
3. There is a simultaneous change in demand and supply of a commodity and
equilibrium price increases. This can happen in following two situationsa. When the supply of a commodity increases less than the increase in demand, then
the equilibrium price Increases (P-P1) and the equilibrium quantity also increases
(Q-Q1).
( 109 )
b. When the supply of a commodity decreases more than the decrease in demand,
then equilibrium price (P-P1) increases and equilibrium quantity decreases (Q-Q1)
4 (a) Very large number of firms and buyers
There are a very large number of buyers and sellers in this form of market. No
individual buyer can influence the market price. Similarly, each firm or seller in a
perfectly competitive market forms an insignificant part of the market. So, no single
seller has the ability to determine the price at which the commodity is sold. It is the
market forces of Demand and Supply that determine the price of a commodity, so firms
become price taker and industry becomes price maker.
(b) Homogeneous Product
In a perfectly competitive market, firm sell homogeneous products. Homogeneous
products are identical in all respects i.e. there is no difference in packaging, quality,
color etc. They are perfect- substitutes for each other. Since the product of one firm has
a large number of identical substitutes available for it, demand is Perfectly Elastic.
( 110 )
HIGH ORDER THINKING SKILL (HOTS)
In Board Exams the HOTS questions of 1 Mark each are asked which are based on the entire
Textbook of Economics-Class XII
The questions given below are exemplar based on selected text. Please give orientation to
students so that they read the text carefully and learn to answer correctly and precisely.
Try to develop your own HOTS Question Bank in similar pattern.
Q.1
Q.2
Q.3
Q.4
Ans.
Q.5
Q.6
Q.7
right?
Q.8
Q.9
Q.10
Q.11
Q.12
Q.13
Q.14
Q.15
Q.16
Q.17
Q.18
Q.19
Q.20
Q.21
Q.22
Q.23
Q.24
Q.25
Q.26
Q.27
Q.28
Q.29
Q.30
Q.31
What do you mean by Micro Economics?
What do you mean by scarcity of resources?
What do you mean by economizing of resources?
Give two examples of micro economic variable.
Demand, Supply, individual price of a commodity.
What do you mean by economic problem?
What factors lead to shift of the PPC?
How does the technological advancement or growth of resources shift the PPC to the
Define marginal opportunity costs?
What does a rightward shift of a demand curve mean?
What does a leftward shift of a demand curve mean?
State the condition of consumer’s equilibrium?
What is meant by Cross Price effect?
What do you mean by marginal utility?
What do you mean by derived demand?
What is demand function?
How does availability of close substitutes of a good affect elasticity of demand of the
good?
What is meant by elasticity of demand?
What is meant by price elasticity of demand?
What is production function?
What are normal goods? Give two examples.
What are substitute goods? Give two examples.
When a good called inferior good?
What happens to the demand for a good when the price of a substitute goods falls?
What is the value of elasticity of on a rectangular hyperbola demand curve?
What is meant by marginal physical product?
When TPP is maximum what will be the MPP?
What is meant by cost?
What is meant by marginal cost?
Define variable cost?
Can the average cost be less than the marginal cost when average cost is rising?
When AC is rising what is the relationship between MC and AC?
( 111 )
Q.32
Q.33
Q.34
What is meant by marginal revenue?
What is meant by Producer’s Equilibrium?
Define market supply.
( 112 )
Introduction Macroeconomics
PART-B
Abstract
After completing the units on Micro-Economics in Part 'A' of the syllabus, the present unit
deals with the contents of Macro-Economics. A brief introduction to Macroeconomics and
comparison of Micro and Macro has also been explained. Same basic concepts like
Consumption goods, Capital goods, Final goods, Intermediate goods, Stock and Flow,
Gross Investment and Depreciation has also been explained in simple words and examples
wherever necessary, are given for better comprehension. The Circular Flow of Income
method of calculating National Income - Value Added or Product Method has been
explained. Several terms like 'Injections' to the flow and. 'Leakage' from the flow and its
impact on Circular Flow has also been taken up. Brief concept of National Income, its
calculation under Value Added Method is also given. An attempt has been made to simplify
it so that you can also explain to students accordingly.
Teaching Points
•
National Income and Related Aggregates.
•
Some Basic Concepts: Consumption goods, Capital goods, Final goods, Intermediate
goods, Stocks & Flow, Gross Investment and Depreciation.
•
Circular Flow of Income method of calculating National Income - Value Added or
Product method.
( 113 )
1.
Introduction to Macro economics
Friends before you begin with Part-B Introduction to Macro Economics, it is essential that
you, yourself develop an understanding of what Macroeconomics is and how it is different
from Microeconomics. You must have noticed that these terms are invariably used by all;
but as Economics Teacher you must have a deeper insight about what these terms connote
and make students understand in simpler words how Macroeconomics is different from
Microeconomics and also how both are important for understanding Individual Behaviour
and Aggregated Indicators i.e. GDP, Unemployment Rate, Price Indices etc.
Macroeconomics
Microeconomics is derived from Greek Prefix "macr(o)" meaning "large" + economics)
is a branch of economics dealing with the performance, structure, behavior, and decision
making of the entire economy. This includes a national, regional, or global economy.
Microeconomics and Macroeconomics are two most general fields in Economics. (From
Wikipedia, the free encyclopedia).
1.1
What is the difference between Microeconomics and Macroeconomics?
Microeconomics is primarily focused on the Individual Agents i.e. Firms and Consumers
and how their behaviors determine Price and Quantities in specific markets.
Macroeconomics is a broad field of study. It studies Aggregated Indicators such as GDP,
Unemployment Rates, and Price Indices to understand how the whole economy functions.
Macroeconomists develop models that explain relationship between factors such as
National Income, Output, Consumption, Unemployment, Inflation, Saving, Investment,
International Trade and International Finance.
Macroeconomics models and their forecasts are used by both Governments and large
corporations to assist in the development and evaluation of economic policy and business
strategies.
Fiscal Policy and Monetary Policies are good examples of how economic management is
achieved through these government strategies.
It is also vital to point out here that to avoid major Economic Shocks, such as Great
Depression, Recession, Melt down etc., Government makes adjustments through policy
changes, they hope, will stabilize the economy.
2.
Same Basic Concepts
Computation of National Income is important as it reflects the leveled growth &
development of any country. But before you introduce children with the concept, meaning
and definition of National Income/GDP and other related terms, introduce and explain the
basic concepts/terms which will invariably be used in the computation of National Income.
These concepts are explained briefly as under:
( 114 )
2.1
Consumption Goods
Consumption refers to the act or a process to consume which means using up of goods and
services by consumers for satisfaction of their wants. Consumption good or service is that
which is used (without further transformation in production) by Households or
Government units for the direct satisfaction of individual needs or wants or the collective
needs of members of community.
It can also be defined as any commodities that are used by the household for their personal
use.
Consumer goods are final goods specifically intended for mass market. These goods do not
include investment, for example Bread, butter, milk, tea, coffee, etc. which are directly
used by consumers for satisfaction of their needs. These are example of One Time
Consumption goods (also known as single use consumer goods) but there can be
examples like machine, furniture, readymade clothes which are repeatedly used but they
are used directly and hence fall in the category of Durable Consumption Goods. Hence
consumer goods are the end result of the production.
2.2
Capital Goods
Goods that are used in producing other goods, rather than being bought by consumers
directly for satisfaction of their needs are called Capital Goods. These are tangible Explain
to students that final goods may be divided in to two categories i.e. Consumer goods &
Producers goods. Assets of an organization which are used to produce goods and services
are called Capital goods. These goods include items such as Buildings, Equipments, and
Machinery etc. Capital goods are not used up by producer in a single year of production.
These exist for many years and are repeatedly used over a period of time.
Capital goods may undergo capital improvement which typically extend their life and
increases their productivity.
These are also known as producer's goods as they are being used to create other goods.
2.3
Final Goods
Final goods are goods that are ultimately consumed rather than used in the production of
other goods. It refers to finished goods which are sold in the market for consumption &
investment purpose. These goods satisfy the wants of ultimate producers or consumers or
both. Buying of furniture by a household consumer for his house is final good for him
whereas the same when bought by a producer for his office is producer’s final goods.
Another example can be flour used by the household are final good whereas the same
flour used by the baker is a producer's goods.
Here make a distinction between Consumer goods & Producers goods under the
category of Final Goods
On the lines of examples given above, ask students to think of different examples with
justification as to which category of final goods they fall in. i.e. Consumer goods or
Producer goods.
( 115 )
2.4 Intermediate Goods
All those goods which are used by the producers for producing other goods are known as
Intermediate goods.
These goods are used as inputs in the production of other goods such as partially finished
goods. These goods are demanded for producing other goods. Thus intermediate goods are
those goods which are sold by one industry to another either for resale or for producing
other goods. Stocks of Raw Materials and Semi finished goods fall under the category of
intermediate goods. Another example can be of raw cotton used for the production of yarn
is an Intermediate good and when the same yarn is sold to the owner of the textile mill for
the production of cloth then the same yarn becomes intermediate good for the owner.
2.5
Stocks & Flows
Stocks & Flows have natural meaning in many contexts outside of business and its related
fields. Let us define/give meaning to both the terms 'Stock' & 'Flow' and then show the
relatedness of the two and how these are impacting on an economy/business.
Stock
A 'Stock' refers to the value of goods & services at a particular point of time. It is an entity
that is accumulated over by inflows and/or depleted by outflows. Therefore, we can say
that the 'stock' can only be changed by a 'flow'.
'Stocks' typically have a certain value of each moment of time, for example the size of
population at a certain moment. i.e.
As per census 2001, the population of India stood at 102 billion, whereas according to
1991 census the population of India 'stood at 84.6 billion. The change/Increase in the
figure at two census i.e. 1991 & 2001 is because of the additional population (flow) in 10
years.
Flow
It is change in stock over period of time. Change refers to inflows (adding to the stock)
and outflows (subtracting from the stock). Flows typically are measured over a certain
interval of time. For example the increase in population census 1991 to census 2001 is due
to increase in number of births in a period of 10 Years. To conclude we may say that
'Stock' is a Static concept whereas 'Flows' represents Dynamic concept.
2.6
Depreciation
To explain the meaning of depreciation, ask students to recall the meaning of Capital
Goods (i.e. fixed assets like Machinery, Building, Equipment, Furniture etc.). And also
elaborate upon the nature and usage of such capital goods for repeated use for production
of goods, and then state that these Capital goods diminish in value & efficiency when they
are repeatedly used. Now explain that this fall in the value of assets (Fixed Assets) occur
due to wear & tear, obsolescence, efflux of time, is termed as Depreciation
'Depreciation' also stands for the measure of the decrease in value of an asset over a
specific period of time. It can also be defined as the decrease in the economic potential of
an asset over its productive & useful life.
( 116 )
Depreciation results because of the following reasons:
•
Wear & tear
•
Efflux of time
(with passage of time- Book Value vs. Present Value.)
•
Obsolescence
(Outdated due to introduction of new technology/products)
(due to repeated use in production of goods and services)
Depreciation is in fact a non-cash expense or a provision which is created against the
value of an asset spread over its useful life and is set aside (charged against profit each
year), so that there are sufficient funds for its repair/maintenance or replacement. Most
assets lose their value over time & have to be replaced once the end of their useful life
is reached.
Example
Machinery is purchased for Rs.2, 00,000.Its estimated useful life is suppose 10
years. Depreciation, under the straight line method is charged at 10% of the cost
of the asset. Hence Rs.20, 000 will be set aside as depreciation every year for 10
years(Spread across the estimated life of the asset -10years) so that firm can use
the amount for repairs or maintenance or for replacement at the end of its useful
life i.e. 10 years
Even the amount of depreciation can be calculated as: (assuming there is no salvage value
at the end) i.e. Cost of Asset-*Salvage Value /Estimated Life of the Asset
Cost of asset
-----------------
Rs. 2, 00, 000 -Zero
-= -------------------=Rs. 20,000(which comes to 10 % of the cost)
Estimated life of the asset
10 years
*Salvage Value is the amount which it is expected to fetch at the end of estimated life of
Asset.
There are many methods of providing depreciation, the knowledge of which is not
required here.
2.7
Gross Investment
It is a measure of additions to the capital stock that does not subtract the depreciation from
the existing capital. These may be machine, tools & equipments, buildings, office spaces,
store houses and infrastructure etc. The capital goods produced in a year do not constitute
an addition to the capital stock already existing. A significant part of current output of
capital goods goes in for maintains or replacing part of the exiting stock of capital goods.
That indicates these capital goods include an element of Depreciation (see the meaning
explained before as to how they reduce the value of Gross Investment)
Therefore in order to compute the Net Investment we deduct depreciation from Gross
Investment i.e.
Net Investment = Gross Investment - Deprecation
( 117 )
3
MEASURING THE CIRCULAR FLOW OF INCOME
The Circular Flow of Income is a simple model of economy showing flows of goods &
services and factors of production between firms and households. In the absence of government
and international trade, this simple model shows that households provide the factors of
production for firms who produce grads and services, in return the factors of production receive
factor payments i.e. Land receives rent, Labour receives wages, Capital receives interest,
Organization earns profits (losses). These factor incomes - wages, rent, interest and profits are
spent on the output of firms. The basic flow is shown in the diagram below:
Diagram-1
(Circular Flow of Income)
In reality the households do not spend all their current income. The 'savings' by them
represents a leakage from the circular flow. Firms also have, besides, consumer spending,
investment spending. This is injected to the circular flow of income, as it does not
originate from consumer's current income.
Additional leakage and injections are also thee in the circular flow in real world. i.e.
Government's spending are injected and taxation will leak from it. Similarly Export
flows will be injected and import flows leaked.) But for class XII students simple circular
flow of Income is sufficient. Once children understand how and what transactions result in
injections to the flow and what results in leakage, the examples can be given as they very
well understand what Export means and what Import results in, where Govt. spends and
how and why people pay taxation which is revenue for Government.
( 118 )
Any Economic Activity is flow
Flow can be of two types:
(i)
Flow of goods & Services.
(ii)
Flow of money.
How these flows are measured and also the volume and magnitude of flow indicates the
amount of economic activity.
Economists maintain that there are three possible ways of measuring this flow. The
computation under all methods of measurement remains same. The three methods of
measuring flow of income are as under:
4
I
The output Method
year.
Total amount of goods and services produced in one
II.
The Expenditure Method The total amount of spending: Domestic, consumers,
Firms, Government and Foreigners.
III.
The Income Method: The total incomes earned by factors of production involved
in the production of goods & services in the period of one year.
What is National Income Accounting?
N.I.A. is the process where by countries measures these flows. The process of calculating
National Income (Domestic Income + Net Factor Incomes earned from Abroad) is different
under all three methods but the Gross Domestic Income/Gross Domestic Product remains
the same. The National Income is a major important yardstick and has variety of uses
like-
•
Determining the extent of Economic Growth.
•
Measuring changes in Living Standards overtime.
•
In making comparisons of Economic Performance and Living Standards between
countries.
•
Examine and judge the Performance of different Sectors of Economy.
4.1
Measuring National Income
To measure how much output, spending and income has been generated in a given time
period, we use National Income Accounts. These accounts measure three things:
1.
Output
2.
Spending
3.
Income
( 119 )
Before computing the National Income the meaning of term 'National Income' should be
taken up.
*It is taken up in detail in the next week syllabus.
National Income
National Income is the money value of final flow of output of goods & services produced
within an economy over a period of time, usually one year and net factor income earned
from abroad.
National Income (NI) = NNP at Factor Cost
** (will be taken up in detail in the next module)
Now explain these terms:
1.
Gross Domestic Product
Gross Domestic Product (GDP) is the total market value of the final goods & services
produced within the domestic territorial limits of country over a period of time (1 Year).
There are three ways of calculating GDP which is based on the different methods of
calculating Nation Income i.e. Income method, Expenditure method & Value Added
method; however the computed value of GDP remains the same under all methods.
2.
•
Expenditure Approach It measures GDP as the sum of expenditures of** final goods
and services.
•
Final Goods Those goods and services that are not purchased for the purpose of
producing other goods and services or for resale.
•
Income Approach It measures GDP as the sum of incomes of factors of production
(wages, salary, rent, Interests etc.)
•
Value Added Approach It measures GDP as the sum of value added at each stage of
production (form initial to final stage)In Product Method the aggregate value of goods
and services produced in a year is calculated, The term that is used to denote the net
contribution made by a firm is called its value added.
Net Factor Income From rest of world / (Net Factor Income Earned from abroad
(NFIA)
Net Factor Income from rest of world comprises of net income receipts from rest of the
world such as (i) Investment incomes including Interests, Dividends and Branch Periods.
(ii) Earnings of residents working of road.
(iii) Other factor income of normal residents.
This item therefore represents the difference between factor incomes of residents from
abroad and income accruing to foreign.
( 120 )
Suppliers of Factor services
NFIA includes:
(i) Net* compensation of employee.
(ii) Net Income from property and entrepreneurship (Interest, Rent, Dividends & Profits)
including reinvested earnings of foreign companies.
Here:
Net stands for receipts of current income by residents abroad - Disbursement of current
incomes to Non - residents in India.
Here teachers can introduce the term Gross National Product where G.N.P. presents the
total income earned by the domestic citizens regardless of the country in which their
factors of production are located.
Since 'Depreciation' has already been explained even calculation and Impact of this on
GDP can also be taken up i.e. GDP includes the element of depreciation (Gross (G) in
GDP represents inclusion of depreciation and when depreciation is deducted from GDP, It
becomes Net Domestic Product.
NDP = GDP - Depreciation
*National Income - Meaning and Computation will be taken up in next unit.
Methods of calculating National Income-Value Added and Expenditure Method will
be covered in detail in next Module.
Technical Terms
1.
Macroeconomics Macroeconomics is a broad field of study. It studies Aggregated
Indicators such as GDP, Unemployment Rates, and Price Indices to understand how the
whole economy functions. Macroeconomists develop models that explain relationship
between factors such as National Income, Output, Consumption, Unemployment,
Inflation, Saving, Investment, International Trade and International Finance.
2.
Consumption Goods Consumption Good or service is that which is used (without further
transformation in production) by Households or Government units for the direct
satisfaction of individual needs or wants or the collective needs of members of community.
It can also be defined as any commodities that are used by the households for their
personal use.
3.
Capital Goods Goods that are used in producing other goods, rather than being bought by
consumers directly for satisfaction of their needs are called Capital Goods. These are
tangible Explain to students that final goods may be divided in to two categories i.e.
Consumer goods & Producers goods. Assets of an organization which are used to produce
goods and services are called Capital goods. These goods include items such as Buildings,
Equipments, and Machinery etc. Capital goods are not used up by producer in a single
( 121 )
year of production. These exist for many years and are repeatedly used over a period of
time.
4.
Final Goods Final goods are goods that are ultimately consumed rather than used in
the production of other goods. It refers to finished goods which are sold in the market
for consumption & investment purpose. These goods satisfy the wants of ultimate
producers or consumers or both.
5. Intermediate Goods All those goods which are used by the producers for producing
other goods are known as Intermediate goods. These goods are used as inputs in the
production of other goods such as partially finished goods. These goods are demanded
for producing other goods. Thus intermediate goods are those goods which are sold by
one industry to another either for resale or for producing other goods. Stocks of Raw
Materials and Semi finished goods fall under the category of intermediate goods
6. Stocks and Flow
Stocks & Flows have natural meaning in many contexts outside of business and its related
fields.
Stock
A 'Stock' refers to the value of goods & services at a particular point of time. It is an entity
that is accumulated over by inflows and/or depleted by outflows. Therefore, we can say
that the 'stock' can only be changed by a 'flow'.'Stocks' typically have a certain value of
each moment of time, for example the size of population at a certain moment or a
particular point of time.
Flow
It is change in stock over period of time. Change refers to inflows (adding to the stock)
and outflows (subtracting from the stock). Flows typically are measured over a certain
interval of time. For example the increase in population census 1991 to census 2001 is due
to increase in number of births in a period of 10 Years. 'Stock' is a Static concept whereas
'Flows' represents Dynamic concept.
7. Gross Investment It is a measure of additions to the capital stock that does not subtract
the depreciation from the existing capital. These may be machine, tools & equipments,
buildings, office spaces, store houses and infrastructure etc.
8. Depreciation It stands for the measure of the decrease in value of an asset over a
specific period of time. It can also be defined as the decrease in the economic
potential of an asset over its productive & useful life. This fall in the value of assets
(Fixed Assets) occur due to wear & tear, obsolescence, efflux of time, is termed as
Depreciation
Depreciation is in fact a non-cash expense or a provision which is created against the
value of an asset spread over its useful life and is set aside, so that there are sufficient funds
for its repair/maintenance or replacement. Most assets lose their value over time & have to
be replaced once the end of their useful life is reached.
( 122 )
9.
Circular Flow of Income The Circular Flow of Income is a simple model of
economy showing flows of goods &
services and factors of production between
firms and households. In the absence of government and international trade, simple
model shows that households provide the factors of production for firms who produce
grads and services, in return the factors of production receive factor payments i.e.
Land receives rent, Labour receives wages, Capital receives interest, Organization
earns profits (losses). These factor incomes - wages, rent, interest and profits are
spent on the output of firms.
10. National Income is the money value of final flow of output of goods & services
produced within an economy over a period of time, usually one year and net factor
income earned from abroad.
11. Gross Domestic Product (GDP) is the total market value of the final goods &
services produced within the domestic territorial limits of country over a period of
time, usually one year.
13. GNP is the total market value of the final goods & services produced within the
domestic territorial limits of country over a period of time (1 Year).
14. Net Factor Income From rest of world / (Net Factor Income Earned from abroad
(NFIA)
Net Factor Income from rest of world comprises of net income receipts from rest of the
world such as (i) Investment incomes including interests, Dividends and Branch
Periods.(ii)
Earnings of residents working of road.(iii) Other factor income of
normal residents.
This item therefore represents the difference between factor incomes of residents from
abroad and income accruing to foreign.
Check Your Progress
1.
State the difference between Micro and Macro-economics.
2.
Distinguish between 'Stock' and 'Flow' give two examples of each.
3.
State what represents 'Stock' and what represents 'Flow', give two examples each.
4.
What are Intermediate goods'? Explain with example.
5.
Define 'Depreciation'. State the causes of fall in the value of fixed assets.
6.
Give meaning of 'Gross Domestic Product. How GDP is different form GNP?
7.
Define Net Factor Income from abroad (NFIA). List the components of NFIA.
( 123 )
APPENDIX
Content Analyses on the basis of Difficulty level
Answer key HOTS
Question Paper and Marking Scheme
Economic – class XII
Need Areas/ Content Analysis
Content Analysis on the Basis of Difficulty Level
1. Distinction between
Economics.
Micro
Economics
and
Macro
(E)
2. Economic Problems (With Examples)–
a. What to produce
b. How to produce
c. For whom to produce
3. Production Possibilities Curve formation & definition.
a. Demand
(D)
b. Definition as Individual & Market demand.
c. Why Downward Sloping Shape?
d. Exceptions to the Law of Demand.
e. Elasticity of Demand (Price Elasticity), Numericals
f. Factors affecting Demand.
g. Change in Demand / Shift in Demand.
4. Cost & Revenue
(D)
a. Forms of Market – with examples
b. Basic concepts TR, AR and MR and its relation to
different Forms of Markets.
5. Supply
(D)
a. Basic concepts
b. Market Supply, Factors determining Supply
c. Elasticity of Supply
d. Measurement of Elasticity of Supply.
6. Market Equilibrium
(VD)
a. Equilibrium Price and Quantity under Perfect
Competition
b. Effects of change in Demand and Supply on the
Equilibrium Price
7.
a. Project Work on Economics
(E to D)
b. Economics in our Daily Life/Applied part of
Economics.
VD- Very Difficult
D- Difficult
E-
Easy
HIGH ORDER THINKING SKILL (HOTS)
Answer Key for HOTS
Ans 1. It is the study of an individual part of the economic system, i.e., a firm, a house hold.
Ans 2. When the demand of a good exceed its supply than it is called scarcity of resources.
Ans3. Economizing of resources means, resources are to be used in such a manner that
maximum output is to be obtained per unit of output. or
If the production of a commodity is does not change with the increase in input variables
than it is called optimum utilization of resources.
Ans 4. Demand, Supply, individual price of a commodity.
Ans 5. Economic problem is a problem of choice arising out due to limited resource and
unlimited wants.
Ans 6. The following are the factors; (i)
Increase or decrease in resources (ii) Change in
technology.
Ans 7. Technological advancement shift the PPC to the right, because better technology means
more can be produced with the given resources.
Ans 8. Marginal opportunity costs are the ratio between additional loss of output and
additional gain of output when some resources are shifted from Y use to X use.
Ans 9. A rightward shift of a demand curve means an increase in demand for a product.
Ans 10.A leftward shift of a demand curve means a decrease in demand for a product.
Ans 11.Marginal utility in terms of money is equal to the price. Or
_Marginal utility of a Product = Its Price
Marginal Utility of a Rupee
Ans 12.It means how the demand for one particular product is affected by the change in the
price of other product.
Ans 13.MU is the additional utility derived from consumption of an additional unit of a
commodity. It means it is the utility from the last unit of a commodity consumed.
Ans 14.It is the demand that has been derived from the demand for some other commodity it
help to produce.
Ans 15.It refer to the functional relationship between the price and the quantity demanded of
a commodity.
Ans 16.When the good has a large number of its substitutes, the demand for it is usually very
elastic.
Ans 17.It is the responsiveness of demand to change in its various determinants, i.e., income of
the consumer, price of the commodity, price of related goods etc.
Ans 18.Price elasticity of demand is the degree of responsiveness of demand for a commodity
to a change in its price.
Ans 19.It is the functional relational relationship between the physical input and physical
outputs of a firm. It can be written as Q=f(f1, f2, f3…………fx)
Ans 20.Normal goods are those goods whose demand increases with the increase in income of
the consumers. Ex. Milk, Cloth etc.
Ans 21.Substitute goods are those goods which can be used in place of each other. Ex. Tea and
coffee, coca cola and pepsi cola.
Ans 22.When demand decreases with the increase in income.
Ans 23.When the price of a substitute goods falls then the demand for a given good also falls.
Ans 24.A rectangular hyperbola demand curve indicates unit elasticity f demand.
Ans 25.MPP is an addition to the total product when an additional unit of a variable input is
employed. i.e., MPPn = TPPn – TPPn-1
Ans 26.MPP will be zero.
Ans 27.Cost refers to the total expenses incurred in the production of a commodity.
Ans 28.Marginal cost is addition made to the total post when an additional unit of a commodity
is produced.
Ans 29.Variable costs are the costs which change with change in the level of output, e.g.,
expenditure on raw material, power and fuel etc.
Ans 30.Yes
Ans 31.MC
AC
Ans 32.Marginal revenue is the change in the total revenue, which results from the change in
the sale by one unit of output.
Ans 33.Producer’s equilibrium is the level of output that gives a producer maximum profits and
he has no urge to change his output.
Ans 34.Market supply refers to the aggregates of supply by all the firms in the market
producing a particular commodity.