2016


Time: 3 Hours

Max Marks: 50


PART – A


Answer the following question in one sentence each. (10 x 1 = 10)


Q1. What is micro-economics?

Ans. Microeconomics is the study of decisions made by people and businesses regarding the allocation of resources, and prices at which they trade goods and services. In other words, microeconomics tries to understand human choices, decisions and the allocation of resources.


Q2. What do you mean by utility?

Ans. Utility is a term in economics that refers to the total satisfaction received from consuming a good or service. The economic utility of a good or service is important to understand, because it directly influences the demand, and therefore price, of that good or service.


Q3. What is demand?

Ans. Demand is an economic principle referring to a consumer’s desire to purchase goods and services and willingness to pay a price for a specific good or service. Holding all other factors constant, an increase in the price of a good or service will decrease the quantity demanded, and vice versa.


Q4. What is law of supply?

Ans. The law of supply is the microeconomic law that states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice versa. The law of supply says that as the price of an item goes up, suppliers will attempt to maximize their profits by increasing the quantity offered for sale.


Q5. Define monopoly.

Ans. Monopoly is a firm who is the sole seller of its product, and where there are no close substitutes. An unregulated monopoly has market power and can influence prices. Examples: Microsoft and Windows, DeBeers and diamonds, your local natural gas company.


Q6. What is National income?

Ans. National income means the value of goods and services produced by a country during a financial year. Thus, it is the net result of all economic activities of any country during a period of one year and is valued in terms of money.


Q7. Define inflation.

Ans. Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.


Q8. Define bank rate.

Ans. A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks, often in the form of very short-term loans. Managing the bank rate is a method by which central banks affect economic activity.


Q9. What is unemployment?

Ans. Unemployment is a term referring to individuals who are employable and actively seeking a job but are unable to find a job. Usually measured by the unemployment rate, which is dividing the number of unemployed people by the total number of people in the workforce, unemployment serves as one of the indicators.


Q10. What do you mean by real GNP?

Ans. Real GNP (Gross National Product) is the total value of all goods and services produced by a country's residents, adjusted for inflation, which provides a more accurate measure of economic growth than nominal GNP. It is calculated using prices from a specific base year, so changes in real GNP reflect only changes in the actual physical output, not just price fluctuations. This makes it a better tool for comparing economic performance over time and between different countries.  


PART – B


Answer the following questions in 4-5 lines each. (4 x 4 = 16)


Q11. What are the basic problems of an economy?

Ans. Four basic problems of an economy are as follows:


1) What to Produce?

What does a society do when the resources are limited? It decides which goods/service it wants to produce. Further, it also determines the quantity required.


2) How to Produce?

The production of a good is possible by various methods. For example, you can produce cotton cloth using handlooms, power looms or automatic looms. While handlooms require more labour, automatic looms need higher power and capital investment. society must choose between the techniques to produce the commodity.


3) For whom to Produce?

It has to decide on who gets what share of the total output of goods and services produced. In other words, society decides on the distribution of the goods and services among the members of society.


4) What provision should be made for economic growth?

Can a society use all its resources for current consumption? Yes, it can. However, it is not likely to do so. The reason is simple. If a society uses all its resources for current consumption, then its production capacity would never increase. Therefore, the standard of living and the income of a member of the society will remain constant. Subsequently, in the future, the standard of living will decline. Hence, society must decide on the part of the resources that it wants to save for future progress.


Q12. Write the features of capitalistic economy?

Ans. The main features of a capitalist economy are as follows:

 

  1. Right to Private Property: This is the essence of capitalism. This right means that private property such as property, factories, machines, plants etc. can be owned under private individuals and companies. Every individual can acquire any amount of property, he can use these properties as he wishes, he also has the right of inheritance. So, he can inherit the property from his forefathers. And he can also pass it on to his successors on his death.


  1. Price Mechanism: Price mechanism is like an invisible hand that controls the workings of a capitalist economy. The forces of supply and demand will determine the prices and the level of productions in the economy. The government will not have any interference in this matter.


  1. Profit Motive: The driving force behind any capitalist economy is the profit motive. All companies wish to produce and sell their products to maximize their profits. This also induces healthy competition in the economy.


  1. Freedom of Enterprise: In capitalism, every individual is free to make his own economic choices without any intervention. This includes both the consumer and the producers. So, a producer is free to produce any goods or services. And the consumer is free to buy whatever he desires and from whomever, he wants without restrictions.


Q13. Describe the features of Indifference Curve.

Ans. Following are the features of Indifference Curve:


1. Indifference curve always slopes downwards from left to right: An indifference curve has a negative slope, i.e., it slopes downward from left to right. Reason: If a consumer decides to have one more unit of a commodity (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same.


2. Indifference curve is always convex to the origin: Due to the law of diminishing marginal utility a consumer is always willing to sacrifice lesser units of a commodity for every additional unit of another good.


3. Higher indifference curve represents higher level of satisfaction: Higher indifference curve represents larger bundles of goods i.e., bundles which contain more of both or more of at least one. It is assumed that consumer’s preferences are monotonic i.e., he always prefers larger bundle as it gives him higher satisfaction.


4. Indifference Curve never touches X and Y Axis: An indifference curve never touches the X or Y axis because it is based on the assumption that a consumer wants a positive quantity of both goods to achieve a certain level of satisfaction. If the curve touched an axis, it would imply the consumer is consuming only one of the goods, with zero quantity of the other, which would mean a different level of utility than the one represented by the curve.


5. Two Indifference Curve never intersect each other: Two indifference curves cannot intersect because each curve represents a different, distinct level of satisfaction or utility. If they intersected, it would imply that the same combination of goods at the intersection point provides two different levels of satisfaction, which is a logical impossibility. 


Q14. Explain the factors determining supply.

Ans. Factors determining supply are as follows:


1. Production Costs - Changes in the cost of raw materials, labour, or other inputs directly affect production costs. For example, if the price of coffee beans increases, the cost of producing coffee will also increase, potentially leading to a decrease in supply.

Advancements in technology can lower production costs by making processes more efficient or enabling the use of new materials. This can lead to an increase in supply. 


2. Number of Sellers – If more firms enter a market, the overall supply will increase. Conversely, if firms exit the market, the supply will decrease. Increased competition among sellers can also influence the overall supply.


3. Government policies -  Taxes on production can increase costs and decrease supply, while subsidies can lower costs and increase supply. 


4. Speculations - If sellers expect future prices to be higher, they may decrease current supply to sell more later. Conversely, if they expect prices to fall, they may increase current supply to avoid losses.


5. Price of Related Goods - If the price of a substitute good increases, sellers may shift production towards that good, potentially decreasing the supply of the original product. If the price of a complementary good increases, the supply of the original product may also increase as it becomes more profitable to produce both together.


PART – C


Answer the following questions in 400 words each. Attempt any three of your choice. (3 x 8 = 24)


Q15. What is consumer surplus? Explain by using diagram.

Ans. The concept of consumer surplus is derived from the law of diminishing marginal utility. As per the law, as we purchase more of a commodity, its marginal utility reduces. Since the price is fixed, for all units of the goods we purchase, we get extra utility. This extra utility is consumer surplus.


British Economist, Alfred Marshall, defines consumer’s surplus as follows: “Excess of the price that a consumer would be willing to pay rather than go without a commodity over that which he actually pays.”

Hence, Consumer’s Surplus = The price a consumer is ready to pay – The price he actually pays.


Limitations:


1. It is difficult to measure the marginal utilities of different units of a commodity consumed by a person. Hence, the precise measurement of consumer’s surplus is not possible.


2. For necessary goods, the marginal utilities of the first few units are infinitely large. Hence the consumer’s surplus is infinite for such goods.


3. The availability of substitutes also affects the consumer’s surplus.


4. Deriving the utility scale for prestigious goods like diamonds is very difficult.


5. We cannot measure the consumer’s surplus in terms of money. This is because the marginal utility of money changes as a consumer makes purchases and his stock of money diminishes.


6. This concept is acceptable only on the assumption that we can measure utility in terms of money or otherwise. Many modern economists are against the concept.


Q16. What is Elasticity of Demand? Explain various methods of its measurement.

Ans. The term Elasticity of Demand refers to the degree of co-relation between price and demand. It is the measure of responsiveness to the change in price.  


Methods of measuring elasticity of demand:

The main methods for measuring elasticity of demand are the percentage method, the total expenditure method, the point method, and the arc method. The percentage and point methods are used for a specific price change, while the arc and expenditure methods are used for larger price changes.


1. Percentage Method


  1. What it is: Measures elasticity by dividing the percentage change in quantity demanded by the percentage change in price.


  1. How it works: Compares the percentage change in demand to the percentage change in price to determine if the demand is elastic (>1), inelastic (<1), or unit elastic (=1).


  1. Formula: Ed = Percentage change in quantity demanded / Percentage change in price


2. Total Expenditure Method


  1. What it is: Analyses how a change in price affects the total amount of money spent on a good.


  1. How it works:
  2. If total expenditure increases when price decreases, demand is elastic.
  3. If total expenditure decreases when price decreases, demand is inelastic.
  4. If total expenditure remains the same, demand is unit elastic.


3. Point Method


  1. What it is: Measures elasticity at a specific point on the demand curve.


  1. How it works: It calculates the ratio of the percentage change in quantity demanded to the percentage change in price for a very small change.


  1. Formula: On a straight-line demand curve, elasticity at a given point is calculated as Lower Segment / Upper Segment of the curve below and above that point, respectively.


4. Arc Method


  1. What it is: Measures elasticity over a range of prices, from an initial point to a new one.


  1. How it works: It calculates the percentage change in quantity demanded relative to the percentage change in price, using the average of the initial and new prices and quantities.


Q17. Define Monopolistic Competition. How is price and output determined in it?

Ans. Monopolistic competition occurs when an industry has many firms offering products that are similar but not identical. Unlike a monopoly, these firms have little power to curtail supply or raise prices to increase profits. Firms in monopolistic competition typically try to differentiate their products in order to achieve above-market returns. Heavy advertising and marketing are common among firms in monopolistic competition and some economists criticize this as wasteful.


Under monopolistic competition, organizations need to make optimum adjustments in the prices and output sold to attain equilibrium. Apart from this, under monopolistic competition, organizations also need to pay attention toward the design of the product and the way the product is promoted in the market.


As we know every seller, irrespective of the market structure, is willing to maximize his/her profits. In monopolistic competition, profits are maximized at a point where marginal revenue is equal to marginal cost. The price determined at this point is known as equilibrium price and the output produced at this point is called equilibrium output. When marginal cost is greater than marginal revenue, organizations would incur losses.


The characteristics of monopolistic competition include the following:

  1. The presence of many companies.
  2. Each company produces similar but differentiated products.
  3. Companies are not price takers.
  4. Free entry and exit in the industry.
  5. Companies compete based on product quality, price, and how the product is marketed.


Price determination in a monopolistic competition:


In monopolistic competition, firms determine their price and output level by following the profit-maximization rule of producing where marginal cost (MC) equals marginal revenue (MR). However, the outcomes differ between the short run and the long run due to the freedom of entry and exit of firms. 


  1. Short Run Determination


  1. Output: The firm produces the quantity of output where its short-run marginal cost (SMC) curve intersects its marginal revenue (MR) curve (MC=MR).


  1. Price: The price is determined by the demand (Average Revenue, AR) curve at that profit-maximizing level of output. The firm has some control over the price due to product differentiation, so the demand curve is downward-sloping and the price is set above marginal cost.


  1. Profits: In the short run, the firm can earn supernormal profits (AR > Average Cost), incur losses (AR < Average Cost), or make a normal profit (AR = Average Cost), depending on the market conditions and the relationship between its average cost and price. 


  1. Long Run Determination


  1. Output: The long-run equilibrium output is still determined by the condition where long-run marginal cost (LMC) equals marginal revenue (MR).


  1. Price: Due to the free entry and exit of new firms, any supernormal profits in the short run will attract new competitors. The entry of new firms increases the supply of close substitutes, causing the demand curve (and thus the AR and MR curves) of existing firms to shift to the left (downwards). This process continues until the demand curve is tangent to the long-run average cost (LAC) curve.


  1. Profits: In the long run, firms in monopolistic competition earn only normal profits (zero economic profit), meaning their average revenue equals their average cost (AR = AC). There is no incentive for new firms to enter or existing firms to leave the market when only normal profits are being made. 


In essence, the desire for profit maximization (MR=MC) dictates the production level in both periods, but market entry and exit dynamics ensure that economic profits are eliminated in the long run. 


Q18. What is Money? Explain functions of money.

Ans. Money is any item or medium of exchange that symbolizes perceived value. As a result, it is accepted by people for the payment of goods and services, as well as for the repayment of loans. Economies rely on money to facilitate transactions and to power financial growth.

As a medium of exchange, money is a value that buyers give to sellers when they buy goods and services. Money is accepted by sellers because they know that they can use it to buy other goods and services.


According to G. Crowther, "Money can be defined as anything that is generally accepted as a means of exchange and at the same time acts as a measure and a store of value". 


Functions of Money:

Functions of money are as follows: -


1. Medium of Exchange –

Money is serving as a medium of exchange. It facilitates all transactions and it acts as a common medium of exchange. It helps in buying and selling commodities. It is also acceptable as a means of payment for any transaction.


2. Measure of Value –

The value of various goods and services can be expressed in terms of money. Hence, it is called as a measure of value.

This function has helped in overcoming the problem of barter system, which lacked common measure of value.

Now money is a common measure of value in exchange, also in dispersal of rewards and different factors like rent, wages etc.


3. Store of Value –

Money is referred to as store of power. It is a generalised purchasing power and it can be used in present as well as future. People save and store money for all types of transactions.

Barter system had difficulties in storing of value but money has helped in overcoming this problem by its rise as an efficient store of value.


4. Standard of Deferred Payments –

Money acts as a standard of deferred payments. Modern economic transactions are widely based on credit transactions and money has helped in future payments and receipts.

Borrowing and lending activities have become simple even for future activities.


Classification of Money:

Money can be classified into four forms: -


1. Fiat Money – money that is issued by order/authority of the government. It includes all notes and coins which people in a country are legally bound to accept as a medium of exchange.


2. Fiduciary Money – the money which is accepted as a medium of exchange because of trust between payer and payee. For eg.: cheques fall in the category of fiduciary money.


3. Full Bodied Money – unit of currency whose face value is equal to its intrinsic, or commodity value. This means the value of the metal or material the money is made from is the same as the value it represents in exchange of goods and services. For eg.: silver rupee coin from British era.


4. Credit Money – money created through the lending and borrowing process, where its value is based on a future obligation or claim to repay, rather than a physical commodity. For eg.: bank loans. 


Types of Money Supply:

There are 4 types of Money Supply: -


1. M1 (Narrow Money) – it includes currency with public (coins, currency notes), Net Demand Deposits held by the public with commercial banks and other deposits with RBI. It is the most liquid portion of a country’s money supply.

M1 is called "narrow money" because it represents the most liquid forms of money, meaning the assets that are readily and immediately accessible for transactions, such as cash (notes and coins) and demand deposits in bank accounts. The term "narrow" emphasizes the restricted and limited scope of these highly spendable assets, differentiating them from broader measures of the money supply that include less liquid forms like savings or time deposits. 


2. M2 (Narrow Money) – it includes M1 + Post Office Savings


3. M3 (Broad Money) – it includes M1 + Time Deposits with the banking system (such as fixed deposits).

M3 is called "broad money" because it represents a comprehensive measure of the total money supply in an economy, encompassing a wider range of assets than "narrow money" (M1). It includes less liquid forms of money, like time deposits, along with the more liquid components found in M1, such as currency and demand deposits.


4. M4 (Broad Money) – it includes M3 + all deposits with post office savings organisations, excluding National Savings Certificates.

It is the least liquid portion of a country’s money supply.