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Economics for Managers 16MBA12
Question Papers and Solutions
Module- 1
1. What is Cross Elasticity of Demand?(3 M) (June 2016)
The cross-price elasticity of demand is the responsiveness of change in demand for one product
‘A’ in response to a change in price of another Product ‘B’. In economics, the cross
elasticity of demand or cross-price elasticity of demand measures the responsiveness of the
demand for a good to a change in the price of another good. It is measured as the percentage change
in demand for the first good that occurs in response to a percentage change in price of the second
good. For example, if, in response to a 10% increase in the price of fuel, the demand of new cars
that are fuel inefficient decreased by 20%, the cross elasticity of demand would be:
 Complementary goods have a negative cross-price elasticity: as the price of one good increases,
the demand for the second good decreases. E.g., Car and Petrol
 Substitute goods have a positive cross-price elasticity: as the price of one good increases, the
demand for the other good increases. E.g., Coffee and Tea
 Independent goods have a cross-price elasticity of zero: as the price of one good increases, the
demand for the second good is unchanged. E.g., Bus and Book
2. Define Managerial Economics?(3 M) (Dec. 2016)
“Managerial Economics is economics applied in decision making. It is a special branch of economics
bridging the gap between abstract theory and managerial practice.” – Haynes, Mote and Paul.
“Business Economics consists of the use of economic modes of thought to analyse business situations.”
- McNair and Meriam
“Business Economics (Managerial Economics) is the integration of economic theory with business practice
for the purpose of facilitating decision making and forward planning by management.” – Spencer
and Sieegelman.
“Managerial economics is concerned with application of economic concepts and economic analysis to the
problems of formulating rational managerial decision.” – Mansfield
3. Explain the Baumol’s Sales revenue maximization? (7 M) (Dec. 2014)

Prof. Baumol (1982) argues that managers are more concerned with the maximization of sales or sales
Revenue rather than profits.
This is because:
• Manager’s salaries or remuneration are tied to sales and not profits.
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Department of MBA, SJBIT
• Larger sales revenue, i.e. bigger size of sales causes a firm to expand. When the size of the firm
increases, it provides better opportunities in the managerial cadre for promotion and higher status.
• Increasing sales enables the firm to capture more market and earn business reputation
There are many economists who have examined the objectives of the firms. According Baumol’s model
of most managers will try to maximize sales revenue. There are many reasons for this like an example.
(1) The salary and other earnings of managers are more closely related to sales revenue than to profits.
(2) Banks and financers’ looks at sales revenue while financing the corporation.
But according to Baumol’s model of sales revenue maximization, firm can increase his sale though
increase in sales revenue most firms have sidelined short-term profit as their objective firms are often
found to sacrifice their short-term profit for increasing the future long-term profit. Thus, for example,
firms undertake research and development expenditure, expenditure on new capital equipment or major
marketing programs which require expenditure initially but are meant to generate future profits. The
objectives of the firm is this to maximize the present of discounted value of all future profits
A careful inspection of the equation suggests how a firms manages and workers can influence its value
for example, in representatives work hard to increase its total revenues, while its production managers
and manufacturing engineers strive to reduce its total costs. At the same time, its financial managers
play a major role in obtaining capital, and hence influence the equation, while its research and
development personal invent and reduce its total cost.
In banking sectors variety of loan and financial help[s provided to the various customers. But Banks
provide it only those where, they can earn maximum returns of p0rofit by selling their loans. So Banks
and financers look at sales revenue while financing the corporations.
From maximizing of sales revenue, there will be increase in the strength of the firm. So, sales revenue
trend is a readily available indicator of performance of the firm. Growth in sales increases the
competitive strength of the firm.
Y Axis measures the annual profit rate- ROI
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X Axis measures the size of sales.

OA is the tradeoff curve between the size of sales and annual profit rate
OQ1 is the optimum sales that causes maximum profit rate NQ1. At this point, the indifference curve
for the manager IC1 (utility function of manager) intersects the tradeoff curve.
The managers’ utility function is the highest when it is tangent to the trade-off curve.
IC2 curve tangent at point E gives minimum profit OM that has been decided.
Thus the firm produces output OQ2 giving the maximum sales.
This means the managerial decision favours sales maximizing rather than profit maximizing level of
equilibrium output.
4. Define Price and Income Elasticities of demand. (5 M) (Dec. 2014)
1. Price Elasticity of Demand (EP) - Other things remaining the same due to certain percentage
change in price if certain percentage change in demand of commodity is there, it is known as price
elasticity of demand. It is measured as percentage change in quantity demanded divided by the
percentage change in price.
Ep =Percentage change in Quantity demanded

Percentage change in a price of the commodity
The measure of price elasticity (e) is called co-efficient of price elasticity. The measure of price
elasticity is converted into a more general formula for calculating coefficient of price elasticity
given as
Ep = % Δ Q
%Δ P
Where Ep = Price Elasticity

P = Price
Q = Quantity
Δ = Change
Types of Price Elasticity

Unit elasticity of demand (e = 1)
Elastic demand (e > 1), i.e., elasticity is greater than unity.
Inelastic demand (e < 1), i.e., elasticity is less than unity.
• Perfectly elastic demand;
• Perfectly inelastic demand;
• Relatively elastic demand;
• Unitary inelastic demand; and
• Relatively inelastic demand.
2. Income Elasticity of Demand

Other things remaining the same due to certain percentage change in consumer’s income if there
is certain percentage change in demand it is known as income elasticity of demand. It means the
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ratio of percentage change in quantity demanded due to percentage change in income of

consumers.
Ey =Percentage change in Quantity demanded

Percentage change in income
Ey = % Δ Q
%Δ y
Where Ey = Income Elasticity

y = Income
Q = Quantity
Δ = Change
Types of Income Elasticity

• Unitary income elasticity of demand; (em = 1);
• Income elasticity of demand greater than unity; (em > 1);
• Income elasticity of demand less than unity; (em < 1);
• Zero income elasticity of demand; (em = 0); and
• Negative income elasticity of demand. (em < 0);
5. What is advertising and promotional elasticity of demand? Explain its determinants. (7M)
(June 2015)
Advertising or Promotional Elasticity of Demand:
Firms spend considerable amounts of money on advertisement and other sales promotional
activities with the object of promoting its sales. Thus, sales differ in their responsiveness. It refers
to the responsiveness demand to change in advertising or other promotional expenses.
The formula to calculate the advertising elasticity is as follows:
Advertising elasticity of demand= Proportionate change in sales

Proportionate change in advertisement expenditure
Factors affecting AED
 Product Stage
 Competitors
 Demand
 The time gap between the advertising expenditure and the actual response of the sales to such
expenditure.
 The delay effect of the firms past advertising and the extent of its effect on current and future
sales.
Illustration: Practical Application

In practice, the price variations and differentials in several businesses such as hotels, air-lines,
ferries, coaches, time to time, reflect differences in the level of demand, particularly the varying
elasticity of demand at different times such as peak seasons and off-seasons over a year. A
telephone company also decides its rate structure into peak rate, standard rate, discount rate etc., at
different times of the day. For example, during working day 8.00 a.m. to 7.00 p.m. peak rate is
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charged on calls, while lower or discount rates are charged during night hours. On public holidays,
discount rate is charged. In all such cases, pricing is based on demand consideration rather than the
cost element.
6. Briefly explain the scope of Managerial economics. (10 M June 2015)

Scope of Managerial Economics:
Managerial Economics plays a vital role in managerial decision making and prescribes specific
solutions to the problems of the firm.
ME – helps in the following:
1. Estimation of product demand
2. Analysis of product demand
3. Planning of production schedule
4. Deciding the input combination
5. Estimation of cost of product
6. Achieving economies of scale
7. Determination of price of product
8. Analysis of price of product
9. Analysis of market structures
10. Profit estimation and planning
11. Planning and control of capital expenditure
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Module- 2
1. What is Production function? (3 M) (June 2016)
The rate of output of a commodity functionally depends on the quantity of inputs used per unit
of time. The technological-physical relationship between inputs and outputs is referred to as
the production function. Basically, production function is an engineering concept, but it is
widely used in business economics for studying production behavior. “The production function
is the name given to the relationship between rates of input of productive services and the rate
of output of product. It is the economist's summary of technical knowledge.
Production Function refers to the physical relationship between the use of the inputs (factors
of production) and resulting output of a product.
Definition
A production function refers to functional relationship, under the given technology, between
physical rates of input and output of a firm, per unit of time.
2. Explain the Law of Variable proportions. (10 M) (Dec. 2016)

Or
Explain the law of Variable Proportions with the help of a diagram indicating the
increasing, diminishing and negative returns. (10 M) (June 2017)
The Law of variable proportions
This is the modern version of the law of diminishing marginal returns. Under this law, it is assumed
that only one factor of production is variable while other factors are fixed. As we increase the
quantity of variable factor, while keeping other factors constant the output of variable factor may
increase more than proportionately in the initial stages of production but finally, It will not increase
proportionately. Prof. Ben ham states the law as follows:
“As the proportion of one factor in a combination of factors is increased after a point, the average
and marginal production of that factor will diminish.”
The conditions underlying the law are as follows:
 Only one factor is varied and all other factors should remain constant.
 The scale of output is unchanged, and the production plant or the size efficiency of the firm remains
constant.
 The technique of production does not change.
 All units of the factor input varied are homogeneous, i.e., all the units have identical characteristics
and equal efficiencies.
Under such circumstances, the physical relationship between input (variable factor proportions)
and output is described by the Law of Variable Factor Proportion or the Law of Non-proportional
Output.
The law of non-proportional output states that in the short run, the returns variable factors will be
more than proportionate initially, and after a point, returns will be less than proportionate. This is
what the law describes about the behaviour in total output resulting from increased application of
variable factors to fixed factors.
We shall once again state the law more elaborately thus: “In the short run, as the amount of variable
factor increases, other things remaining equal, output (or the returns to the factors varied) will
increase more than proportionately to the amount of variable inputs in the beginning, that it may
increase in the same proportion and ultimately it will increase less proportionately”.
To clarify the relationship further, we may adopt the following measurements of product:
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 Total Product (TP). Total number of units of output produced per unit of time by all factor inputs
is referred to as total product. In the short run, however, the total output obviously increases with
an increase in the variable factor input. Thus, TP = F(QVF), where TP denotes total produce and
QVF denotes the quantity of the variable factor.
 Average Product (AP). The average product refers to the total product per unit of a given variable
factor, we get average product. Symbolically:
AP = TP / QVF
Suppose the total product of a commodity is 400 units per day with 25 workers employed, then,
AP = 400/25 = 16 units per worker.
 Marginal Product (MP). Owing to the addition of a unit to a variable factor, all other factors being
held constant, the addition realised in the total product is technically referred to as the marginal
product. In formalised terms, the marginal product may be defined as: (MPn = TPn – TPn-1,) where,
MPn stands for the marginal product when n units of a variable factor are employed. TP refers to
total output and refers to the number of units of variable factor employed (n = QVF).
Suppose, when 26 workers are employed, the total product is increased to 440 units from 400 units
but when 25 workers are employed, the marginal product of the twenty sixth worker is measured
as:
MP = TP26 – TP25 = 440 _ 400 = 40 units.
It may be stated that the marginal product is the rate of measuring the change in the total product
in relation to a unit-wise change in the employment of the variable factor. Thus in mathematical
terms:
MP =
This ratio is, in fact, termed as ‘incremental product.’In graphical terms, in terms of calculus,
however, the marginal product is defined as
MP = where ∆ = a unit change measured by the derivative of the related to variable.
To illustrate the working of this law, let us take a hypothetical production schedule of a firm as
given in Table.
It is assumed that the amount of fixed factors, land and capital, is given and held constant
throughout. To this, labour - the variable factor - is added unit-wise in order to increase the
production of commodity X. The rate of technology remains unchanged. The input-output
relationship is thus observed in Table.
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Production Schedule
Units of Average Marginal
Total product Product (TPn -
variable inputs Product (AP)
(TP) TPn-1)
(labour) (n) (TPn)
1 20 20 20
2 50 25 30 Stage
3 90 30 1
4 120 30 40
5 135 27 30
6 144 24 15 Stage
7 147 21 2
8 148 18.5 9
9 148 16.4 3
10 145 14.5 1
0 Stage
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 The law of diminishing returns becomes evident in the marginal product column. Initially product
of the variable input (labour) rises. The total product rises at an increasing rate (=marginal product).
Average product also rises. This is a analytically described as stage of increasing return (stage 1).
 Reaching a certain point the marginal product begins to diminish. Thus the rate of increase in total
product slows down. This is the stage of diminishing returns (Stage II).
 When the average product is maximum, the marginal product is equal to average product. In our
illustration, when the 4th labour unit is employed, the average product is 30 and the marginal
product is also 30.
 As the marginal product tends to diminish, it ultimately becomes aero and negative thereafter (Stage
III)
 When the marginal product becomes zero, the total product is the maximum. In our illustration.
148 is the highest amount of total product, when the marginal product is zero 9 units of labour are
employed. Further, when the marginal product becomes negative, the total product begins to
decline in the same proportion. Even though the average product is decreasing at this stage, it
remains positive upon a certain point.
These points would be more explicit when the given production schedule is plotted graphically.
We represent a graphic illustration of the product curves and the law of diminishing returns in its
generalized form. So that smooth curves are drawn.
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The product curve
In the above figure, the X-axis measures the units of a variable factor employed, the Y-axis
measures the output. The total product curve (TP) shows similar information about the behavior
or total output as in production schedule in table. The total product curve has an upward slope up
to point b, and then it moves downward. However, the slope of TP curve changes at each point.
the curve (TP),however ,becomes steeper up to point n2.After this point, TP curve’s slope
becomes negative Evidently, TP moves through three stages 1)the first stage of increase in the
rate of total output 2)the second stage of decrease in the rate of total output 3)the third stage of
decline in total output.
These three stages are: basically confined to the behavior of the marginal product. The marginal
product is rising, diminishing and eventually it becomes negative. Hence, the marginal product
curve MP has an ‘upside down’ U shape. That means the MP curve is rising upward up to a point
and then it falls downward. The rate of change of slope of the TP curve has a bearing to the
formation of the MP curve. When the MP curve intercepts at point n2 on the X-axis, it corresponds
to point b on the TP curve, which signifies that when MP =0, TP =maximum. Again, the declining
part of the TP curve is in proportion to the negative part of MP curve.
Further, stages 1 and 2 pertaining to increasing and diminishing returns are regarded as rational
or practicable phases in the production process. Stages 3 of negative returns are, however,
considered as the irrational phase of production. Nevertheless, it is quite likely that a firm lacking
prefect knowledge may be operating in this stage. In agriculture, this may be very common. For
instance, evidences of overcrowding of boilers and layers in the poultry farms have been recorded
by some economists.
Explanation of the stages

The operation of the law of diminishing returns in the three stages is attributed to two fundamental
characteristics of factors of production
1) Indivisibility of certain fixed factors , and
2) Imperfect substitutability between factors.
Indivisibility of fixed factors implies that initially when a smaller quality of variable factor inputs
are employed along with a given set of factors, there is a bit of disproportionality between the two
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sets of factor components. On technical grounds, thus, the fixed factors are not very efficiently
exploited. For instance, a factor like machinery, on account of its lumpiness, will be grossly
underutilized when only a very few units of a variable input like labour are applied.
Increasing Returns
When the employment of variable inputs increased. a combination of fixed and variable factors
tends to be near to be nearer the optimum. Thus, when the short run production function is adjusted
to optimization the resulting output tends to be in greater proportion to the increase in the variable
factors units. This phenomenon is also attributable to certain internal economics such as managerial
and technical economics as the productive services of indivisible factors like manager and machines
will be used more efficiently when greater inputs of variable factors like labour and raw materials
are applied. In short, the stage of increasing marginal product of a variable factor is due to the
greater inefficiency in the use of certain divisible fixed factors when larger units of the variable
factors are combined with them. Similarly, an increase in the units of variable factors like labour,
may lead to a better utilization of their services on account of growing specialization.
It must be noted the increasing returns in the short run will be noticeable only if fixed factors
are indivisible, while the variable factors are obtainable in very small units. In some lines of
production, however, the firm may not visualize a stage of increasing returns very clearly if the
variable factor units are not obtainable in small units, say, for instance ,a worker cannot be hired
for less than a day or a month. Similarly, fixed factor units are not perfectly divisible into small
units, it is difficult to achieve increasing returns.
Diminishing returns
The reason for diminishing returns is nor far to seek. As in the short period, fixed factors cannot
be charged; the firm seeks to increase output by employing more and more units of variable factors,
thereby trying to substitute fixed factors. But due to imperfect and diminishing returns (decrease in
marginal product) follow. The marginal product decreases because a given quality of fixed factors
is combined with larger and larger amounts of variable factors. If the fixed factors involved are
very big size an indivisible , on technical grounds ,being inadaptable to factors with the small
amount of variable input, the marginal product of the variable input will initially rise sharply and
it will decline also very fast soon after the required units of variable factors are employed for their
efficient use.
Stage 2 is the only rational stage of production in the short run. It is area of operation in which
the firm can maximize its profits.
Negative Returns
Stage 3 is the stage of negative returns, when the input of a variable factor is much excessive in
relation to the fixed components in the production function. For instance, an excessive use of
chemical fertilizers on a farm may eventually spoil the farm output.
3. Briefly explain the properties of Iso-quant curves? ?(7 M) (June 2015)

Or
What are Isoquants? Explain their characteristics. (7 M) (Dec. 2014)
Equal Product Curve ( Iso-quant)
The same specific output quantity most efficiently produced by the different input
combinations of two factors; say, labour and capital. Iso-quant means equal quantity.
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Properties of Iso-Quants
1. An iso-quant is downward sloping to the right. i.e., negatively inclined. This implies that
for the same level of output, the quantity of one variable will have to be reduced in order to increase
the quantity of other variable.
2. A higher iso-quant represents larger output. That is with the same quantity of 0ne input
and larger quantity of the other input, larger output will be produced.
3. No two iso-quants intersect or touch each other. If the two iso-quants do touch or intersect
that means that a same amount of two inputs can produce two different levels of output which is
absurd.
4. Iso-quant is convex to the origin. This means that the slope declines from left to right along
the curve. That is when we go on increasing the quantity of one input say labour by reducing the
quantity of other input say capital; we see less units of capital are sacrificed for the additional units
of labour.
4. Explain the economies and diseconomies of scale. ?(7 M) (June 2015)
ECONOMIES OF SCALE:
Large –scale production is economical in the sense that the cost of production is low. The low
cost is a result of what is called “economies of scale”.
Definition: Ina broad sense, anything which serves to minimize average cost of production in
the long run as the scale of output increases is referred to as “economies of scale”. It is measured
in many terms.
The concept “economies of scale “may be viewed in two senses: broad and narrow.
In a narrow sense however, the term ‘economies of scale ’relates to the characteristics of the
production process by which average productivity is enhanced with the expanding scale of
output. Real economies are measured in physical terms. Increasing returns to scale are caused
by these real economies.
The economies of scale may be classified as :
i) Internal economies, and
ii) External economies.
 Internal Economies
Internal economies are those economies which are open to an individual firm when its size
expands. They emerge within the firm itself as its scale of production increases. Internal
economies in the scale of its output cannot be realisedunless the firm increases its output i.e.,
expands its size.
 External Economies
External economies are those economies which are shared by all the firms in an industry or in
a group of industries when their size expands. They are available o all firms from outside,
irrespective of their size and scale of production. They art h result of the growth and expansion
of any particular industry or a group of)in an industry when its size expands, Thus industries
as a whole. Hus, external economies are the function of the size of the industry. They are not
confined to one or two firms, but shared by all the firms (irrespective of their size in an industry
when its size expands. Thus, external economics can never be monopolized by any one firm in
an industry.
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In fact, external economies arise mainly due to the localization of industries. Thus, external
economies are enjoyed by a firm when some other firms grow large: these arise as a result of
the cost reducing effect of expansion and growth elsewhere. Briefly, thus, economies of size of
a firm are internal economies “and those of the size of industry are “external economies”.
In pecuniary sense, both internal and external economies imply cost reduction. It is, however,
difficult to draw a line of demarcation between internal and external economies because of
their overlapping nature. /when the size of a firm increases, it nous internal economies, but its
expanding size also causes the growth of industry which, in turn, leads to some external
economies. External economies, in turn, reduce the cost of production simultaneously with the
cost economies caused by the increasing scale of output in the firm. In practice, internal and
external economies arise in an overlapping or rewoven manners the distinction between the
two cannot be easily measured from a given cost function of a firm.
Forms of internal Economies

The principal types of internal economies of scale can broadly be grouped under six headings:
labor, technical, managerial, marketing, financial and risk-spreading.
i) Labor economies
Increased division of labor is a major source of labor economies. The exn of division of labor
is preconditioned by the scale of output. As output increases and labor force grows, a more and
more complex division of labor with a greater degree of specialization with all its advantages,
may become possible. Moreover, a large firm can react more efficient lab our, as a can offer a
wide vertical mobility, better prospects of promotion, as a slit of increasing specialization in
the production processes. As such, the skill, efficiency and productivity of labour as a whole in
such large firms rise, reducing the cot pr unit of output.
ii) Technical Economies
Technical economies \refer to reductions in the cost of the manufacturing process itself. These
relate to the methods and techniques of production, especially to the nature and forms of capital
employed.
Following Prof.Carincross, we may classify the various kinds of technical economies as
follows.
 Economies of superior technique. As a firm expends, it can use superior techniques and capital
goods. A small firm cannot install a high quality mach in or other capital goods which a big firm
can. Small firms generally make increasing us of ordinary machines operated by hand while large
firms make synchronized applications of big automatic machines worked by same or electricity.
Such automatic machines’ a quicker and more efficient, and their output are large as compared to
the ordinary machines. Thus, for instance, an automatic loom is more economical than a handloom.
But a villager weaver cannot afford to have an automatic loom, which a testily mill obviously can.
Similarly a rotary printing press, linotype machine, etc., are more economical then hand composing.
But a small job printer cannot afford to have such big machines which only a well-established
newspaper organization like “The times of India “can.
 Economies of increased dimensions.
Certain technical economies may become available just on account of increased dimensions.
This is purely a mechanical advantage of using large machines. Large pieces of equipment are
relatively more economical than smaller one and usually there is an optimal minimum of size
of any piece of equipment. The reason for this lies in the laws of physical universe which
govern the rate of increase of a various properties of inanimate bodies with an increase in their
size .for example a big ship is more economical than a small on. Similarly, a double deck bus
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is more economical than a single Dekker .for only one driver is needed, whether it is a double
Decker or single decker bus. Moreover the size of unit of machine can usually be doubled
without doubling labour and other material costs.
 Economies of linked process. A large plant usually enjoys the advantage of the linking of process,
by arranging production activities in a continuous sequence without any loss of time.
Prof.cairncross points out, “There is generally saving in time and saving in transport costs, since
two departments of the same factory are closer together than separate factories. “For the same
reason, processes of editing and printing of newspapers are generally carried out in the same
premises.
Similarly, in the iron and steel industry, the main production stages like melting iron ore into
pig iron, convening pig iron into mild steel, rolling still into sheet plate, etc., are linked together
to avoid waste of po Large units of machines and their continuous running bay large firm are
often more economical in their were, heating process, etc., and thus, to achieve economies.
 Economies in power. Large units of machines and their continuous running by a large firm are
often more economical in their power consumption as compared to a small machine.
 Economies of by-product. Large firms can make a more economical use of their raw materials.
A large firm can avoid waste of its raw materials, which it can economically use for manufacturing
certain by-products. Large chemical companies are, for instance, constantly developing new
varieties of by-products in this way. Similarly, cane pulp and molasses of big sugar factories can
be effectively used by the paper industry and liquor distilleries.
 Economies of continuation. Technical economy is also realized due to long run continuation of
the process of production. For example, in the printing press industry, there is an apparent economy
to be realized by printing more copies of a composed sht. Thus, if composing and printing cost of
1,000 copies per page is Rs.12, for 2,000 copies it would cost only Rs. 14, that is, just Rs. 2 more
for the extra 1,000 copies, because the same sheet plate which is composed once will remain in use
for printing extra copies. Hence there is only additional printing cost involved, while the composing
cost remains the same.
iii) Managerial Economies: As a result of the indivisibility of managerial factors, the cost per
unit of management will fall as output increases, thus, with the increasing scale of output,
greater managerial economist are enjoyed by and expanding firm. For, a good manager can
organize a large output with the same efficiency as he can organize a small output and his
remuneration normally remains the same whether the output is large or small. Moreover, a
large firm can hire a first-rate manager by paying a handsome salary, so its overall
administrating will be more efficient as well as economical. An entrepreneur can delegate some
of his functions to trained and specialized personnel in his variant departments and can get
better and more efficient productive management with scientific business administration. But
economies in management can be realized only when production is one large-scale. A small
producer cannot afford to have all such personnel with knowledge of scientific business
administration.
iv) Marketing Economies: Marketing economies are economies of buying (of raw materials) and
selling (goods produced). A large firm can generally buy more cheaply than a small one,
because it can purchase its raw materials on a large –scale at a low cost (paying wholesale
price.) Further, a big firm also employs purchasing experts to purchase the required raw
materials more economically and in time.
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Similarly, on the sales side, a big firm can reap advantages of large-scale marketing. Selling is
generally less expensive per unit when large quantities are distributed, because a selling
organization should b of an optimum size whatever be the volume of sales handled.
v) Financial economies: In financial matters, a large firm has relatively greater advantages than
a smaller one. Usually, it has a wider reputation and greater influence in the money market.
Big firms are usually regarded less risky by investors; hence, they may be willing to lend capital
to such firms even at a lower rate of interest than to small firms. Thus, the cost of obtaining
credit and capital is lower to a large concern than to a smaller one. Further, big firms can easily
raise their capital by issuing shares and debentures. The shares of a big concern number in
millions and are held by thousands of people. But a firm having no recognition in the capital
market cannot command such capital. It can only raise a modest capital from the personal
resources or loans from relatives or a bank or from moneylenders. And it cannot procure money
from the general public by offering shares for sale on the stock exchange. Briefly, thus, the
important financial advantage enjoyed by a large firm is the existence of a ready market for its
shares and its sound reputation in the capital market.
vi) Risk –minimizing Economies: A large firm by producing a wide range of products is in a
position to eliminate or minimize business risks by spreading them over. Risk spreading
advantages are sought by a big firm in the following ways:
 By diversification of output. As a big firm can produce a number of items and in different
varieties, the loss in one can be compensated by gain in others, .g: godrej soaps ltd. Is producing
soap, talcum powder, shaving cream, etc., various types of cosmetic products and thereby spreading
its business risks.
 By diversification of market: When a product is produced on a large-scale, it can have an
extended market throughout the country so that the danger of fluctuations in demand is reduced
market throughout the country so that the danger of in demand is reduced to the minimum. Thus,
demand for nationwide, popular product is more stable than a locally supplied article.
 By diversification of sources of supply as well as of process of manufacturing. In a large firm,
there are less chances of disruption of output as a result of scarcity of raw material or breakdown
of a particular process.
Forms of External Economies:

By external economies, we mean gains accruing to all the firms in an industry from the growth
of that industry. External economies are enjoyable by all the firms in th industry, irrespective
of their size. External economies are, in essence, the advantages of localization. An industry
expands when the number of firm’s increases or their size expands in a particular region. Thus,
localization of industry takes place and all the advantages of localization accrue to firms in that
industry.
The chief types of external economies ar:1) Economies of localization (2) Economies of
information (3) Economies of disintegration and (4) Economies of byproducts.
I. Economies of Localization: When a number of firms are located in one place, all of them
derive mutual advantages through the training of skilled labour, provision of better transport
facilities, and stimulation of improvmens.etc. These are in fact the benefits of localization.
Concentration of a particular industry in one area, in course of time, results in the development
of conditions helpful to the industry. And all the firms in that area reap mutual benefits.
Moreover, when there is an increasing concentration of firms, arrangement can be mad for
14
repairs and maintenance and special services required by the industry. the cost of production is
thereby reduced.
II. Economies of information or Technical and market intelligence: A large and growing
industry can bring out trade and technical publications to which every firm can have access.
Producers, are, thus, saved from independent research which is very costly, in a large industry,
research work is done jointly. There can be a research. Statistical, technical and other market
information becomes more readily available to all firms in a growing industry. As such, when
the industry progresses, the cost of production falls.
III. Economies of Vertical Disintegration: The growth of industry will make it possible to split
up production and some subsidiary jobs can be left to be done more efficiently by specialize
firms. New subsidiary industries may grow up to serve the needs of the main industry, e.g., in
the textile industry, the color manufacturing process may be taken up by a specialized chemical
firm and the mills may get better products at low costs. When a particular process is split up
and performed on a large-scale by a specialized firm, it can yield all the internal economies of
large-scale production. Hence, all firms in the industry will be able to get this process done at
a lower cost instead of attempting to meet their own needs by carrying it out them on a small
scale at a high cost. But the subsidiary, industry or specialized firm in a particular process may
spring up only when the industry is large enough to support it.
IV. Economies of By-products: A large industry can make use of waste materials for
manufacturing by-products. The firms using it can flourish when waste material available in
the industry is converting into by-product. For example, in a sugar factory belt, sugarcane pulp
can be used by the paper mill in producing paper. Sugar factory will gt some return for the
sugarcane pulp by selling it to the paper mill in the Vicinity. This means and indirect economy
in cost.
DISECONOMIES AS LIMITS TO LARGE-SCALE PRODUCTION

Beyond a particular limit, however, certain disadvantages of large-scale production emerge. When there is
an expansion of the firm beyond an optimum limit, the very internal and external economies turn out to b
diseconomies. These diseconomies, by raising the average cost of production, act as a limiting factor on the
further expansion of the firm. Since economies of large-scale are not available beyond a certain point, a
firm cannot expand its size indefinitely.
Generally, the following factors of diseconomies of scale limit the size of a firm:
 Difficulties of Management: As a firm expands, complexities and problems of management
increase. Thus, after a point, the manager finds it difficult to control the whole production
organization. The entrepreneur and management will not be able to maintain contact with each
other and check on all the departments of a very large concern. The problem of supervision becomes
complex and intractable, thus leading to increasing possibilities of mistakes and mismanagement.
All these prove to be uneconomical, for the defects in organization will lead to waste and result in
rising average costs.
 Difficulties of Coordination: The tasks of organization and co-ordination become progressively
more and more difficult with the increasing size of the firm. The management of the firm will
gradually face numerous problems of decision making and organization. I may, therefore, not
finding enough time to give careful thought out individual problems. Decisions so taken in a hurry
result in inefficacy and increase in the cost of goods.
15
 Difficulties in Decision making: A large firm cannot tale decisions and makes quick changes as
and when they are need, for it has to consult various departments for making any decisions and so
urgent matters requiring timely decisions are inevitably delayed. His may sometimes cause loss to
the firm.
 Increased Risks: As the scale of production increases, investments also increases, so too the risks
of business. The large r he output, obviously the greater will be the loss. To bar greater risks is an
important limitation to the expansion of the size of a firm from an error of judgment or misfortune
in business, therefore, unwilling to bear greater risks is an important limitation to the expansion of
the size of a firm.
 Labour Diseconomies: Extreme division of labour with a growing scale of output results in lack
of initiative and drive in the executive personnel. Thus, a large firm becomes more impersonal and
contact between management and workers become less. As such there are more chances of
occurrence of grievances and industrial disputes which prove out be costly to the large firm.
 Scarcity of factor supplies: Due to the increase in the concentration of firms in a particular
locality, each firm will find scarcity of available factors. Hence, competition among firms in
purchasing labour, raw materials, etc., will result in increased factor prices. Thus, extreme
concentration of external economies becomes of sort of diseconomies in further form of high factor
prices.
 Financial Difficulties:
A big concern needs huge capital which cannot always be easily obtainable. Hence, the
difficulty in obtaining sufficient capital frequently prevents s the further expansion of such
firms.
 Marketing Diseconomies:
When the industry expands and the firms grow, competition in the market tends to become
stiff. Thus, firms under monopolistic competition (which is the most realistic market situation
in many lines of production) will have to undertake extensive advertising and sales promotion
efforts and expenditure which ultimately lead to higher costs.
16
Module- 3
1. List out the three uses of Break-even Analysis? (3 M) (June 2015)
Usefulness of BEA
The BEA provides useful for decision in regard to pricing, cost control, product mix, channels of
distribution, etc.
 The BEA provides microscopic view of the profit structure of the firm.
 Empirical cost function required in BEA can be of great help for cot control in business.
 The BEA when it provides a flexible set of projections of cost and revenue under expected
future conditions can serve the purpose of profit prediction and becomes a tool for profit
making.
 The BEA can be used for determining the ’safety margin’ regarding the extent to which
the firm can permit a decline in sales without causing losses.
 Safety Margin = Sales-BEP *100
Sales
 The BEA can be useful in determining the target profit-sales volume.
 Target Sales volume = TFC- Target Profit

Contribution Margin
 It is useful in arriving at make or buy decision.
In short, BEA highly significant in business decision making pertaining to pricing policy,
sales projection, capital budgeting, etc. However, the technique is to be used cautiously.
2. What is Opportunity Cost? Explain with one example. ?(3 M) (Dec. 2014)
OPPORTUNITY COST OR ALTERNATIVE COST
Since the real production cost cannot be measured in an absolute sense, the concept of opportunity
cost is evolved to measure it in an objective sense. The concept of opportunity cost is based on the
scarcity and versatility (alternative applicabilities) characteristics of productive resources. It is the
most fundamental concept in economics.
It is a known economic fact that our wants are multiple, while or resources are scarce but capable
of alternative uses. So the problem of choice is involved. We have to choose the use of a given
resources for a particular purpose out of it alternative applicabilities. When we choose the resources
in one use to have one commodity for satisfying a particular want, it is obvious that its other use as
some other commodity that can be produced by it cannot be available simultaneously. This means,
the second alternative use of the resources (or another commodity) is to be sacrificed to have the
resource employed in one particular way, i.e., to get a particular commodity because the same
resource cannot be employed in two ways at the same time. Apparently, the employment of factors
in producing a commodity always involves the loss of opportunity of production of some other
17
commodity. The sacrifice or loss of alternative use of a given resource is termed as “opportunity
cost”. Thus, the opportunity cost is measured in terms of the forgone benefits from the next best
alternative use of a given resources. In other words, the opportunity cost of producing certain
commodity is the value of the other commodity that the resources used in its production could have
instead. It should be noted that opportunity cost of anything is just the next best alternative (the
most valuable commodity) forgone in the use of productive resources and not all alternative
possible uses.
The real cost of production of something using a given resource in an objective sense is the benefit
forgone (or opportunity lost) of some other thing by not using the resource in its best alternative
use. Some economists, therefore, describe it as alternative cost of production. “The alternative or
opportunity cost of one unit of product A is the amount of product B that has been sacrificed by
allocating the resources to product A rather than B.”
Importance of the concept of opportunity cost

The concept of opportunity cost has greater economic significance.
• Determination of relative price of goods. The concept of opportunity cost is useful in
explaining the determination of relative price of goods. For instance, if the same group of factors
can be produce either one car or six scooters, and then the price of one car will tend to be at least
six times more than that of one scooter.
• Determination of normal remuneration to a factor. The opportunity cost sets the value of
productive factor for its best alternative use. It implies that if a productive factor is to be retained
in its next best alternative use, it must be compensated for or paid at least what it can earn from its
next best alternative use. For instance, if a college professor can get an alternative employment in
a bank as an officer at a salary of Rs. 20,000 per month, the college has to pay at least Rs.20, 000
salary to retain him in the college.
• Decision making and effective resource allocation. The concept of opportunity cost is
essential in rational decision making by the producer. This can be explained with the help of an
example. Suppose, a producer in the automobile industry has to decide as to whether he should
produce motor cars or scooters out of his given resources. He can arrive at a rational decision by
measuring the opportunity costs of producing cars and scooters and making a comparison with the
prevailing market price of these goods. Suppose, opportunity cost of 1motor car is 6 scooters. The
price of scooter is Rs. 30,000, while the price of car is Rs. 2, 00,000. In this case, it is worthwhile
to produce cars rather than scooters. Because if he produces 6 scooters, he will get only Rs.1,80,000,
whereas a car fetches him Rs.2,00,000, that is, Rs.20,000 more. This would also mean an efficient
resource allocation. Likewise, a factor agent or owner will decide about the use of the economic
resources in that occupation where its opportunity cost is higher.
3. What is meant by breakeven analysis? What are its limitations? (5 M) (Dec. 2014)
The break-even analysis (BEA) has considerable significance for economic research, business
decision making, company management, investment analysis and public policy. The BEA is an
important technique to trace the relationship between cost, revenue and profits at the varying level
of output or sales. As Joel Dean (1976) puts it, the BEA presents flexible projections of the impact
of the volume of output upon cost, revenue and profits. As such, it provides an important bridge
between business behaviors and economic theory of the firm. In BEA, the break-even point is
located at the level of the output or sales at which the net income or profit is zero. At this point,
total cost is equal to total revenue. Hence, the break-even point is the no-point-no loss zone.
18
However, the object of the BEA is not just to determine the break-even point (BEP), but to
understand the functional relationship among cost, revenue and the rate of output.
Limitations of BEA:
The break-even analysis has certain major limitation as follows:
• It is static: In the BEA, everything is assumed to be constant. This implies a static condition.
It is not suited to a dynamic situation.
• It is unrealistic: It is based on many assumptions which do not hold goods in practice.
Linearity of cost and revenue function is true only for a limited range of output.
• It has many shortcomings: The BEA regards profit as a function of output only. It fails to
consider the impact of technological change, better management, division of labour, improved
productivity and such other factors influencing profits.
• It scope is limited to the short-run only: The BEA is not an effective tool for a long-run
analysis.
• It assumes horizontal demand curves with the given price of the product: But this is not so
in the case of monopoly firm.
• It is difficult to handle selling costs in the BEA: Selling costs do not vary with output. They
manipulate sales and affect the volume of output.
• The traditional BEA is very simple: It makes no provision for corporate income tax, etc.
Despite these limitations, however, the BEA serves some useful purpose in business decision
making. The BEA provides a rough guideline for the alternative possibilities and arriving at a better
decision. Of course, the BEA is not a perfect substitute for judgments of commonsense and intuition
possessed by the businessman. But, it can be a good supplement to the value judgment and logical
deduction made with commonsense.
4. Define Total , Average and marginal Cost?(3 M) (Dec. 2014)

Total Cost (TC):
Total cost is the aggregate of expenditure incurred by the firm in producing a given level of
output. Total cost is measured in relation to the production function by multiplying factor prices
with their quantities.
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If the production function is: Q= f (a, b, c,….,n), then total cost is TC=f(Q) which means total
cost varies with output.
For measuring the total cost of a given level of output, thus, we have to aggregate the product of
factor quantities multiplied by their respective prices.
Average Total Costs (ATC):

Average total cost or average cost is total cost divided by total units of output. Thus:
ATC or AC = TC
Q
In the short-run, since TC = TFC + TVC

ATC = TC/Q = (TFC+TVC)/Q = (TFC/Q) + (TVC/Q)
Since =TFC/Q = AFC and TVC/Q = AVC
Therefore ATC = AFC + AVC.
Hence, average total cost can be computed simply by adding average fixed cost and average
variable cost at each level of output. To take a above example, thus
ATC = Rs 1, 66.67 + Rs 1500 = Rs 2666.67
Marginal cost:
The marginal cost is also per unit cost of production. It is the addition made to the total cost by
producing 1 more unit of output. Symbolically, MCn = TCn – TCn-1, that is, the marginal costs
of the nth unit of output is the total cost of producing. n units minus the total cost of producing n-
1(i.e., one less in the total) units of output.
Suppose, the total cost of producing 4 chairs (i.e., n=4) is rs 10,000 while that for 3 chairs (i.e., n-
1 is rs 8,000.Marginal cost of producing the 4th chair, therefore, works out as under :
MC=TC-TC= RS 10,000- RS 8,000= RS 2,000.
5. Explain Total, Average and marginal Cost in short run with an example. (7 M) (Dec. 2014)
Total cost (TC). It is the cost preparing to the entire factor inputs at any given level of output. It is the total
cost of production derived by aggregating total fixed costs and variable costs together.
Thus, TC = TFC + TVC
Table No 10.1 contains a much simplified hypothetical production schedule of total costs of an illustrative
firm. Data in the table show the behavior of TFC, TVC and TC in the short-run.
The data are based on the following assumptions:
 Labour and capital are the two factor inputs.

 Labour is the variable cost.
 Capital is the fixed factor.
 Price of labour is Rs 10 per unit. Price of capital is Rs 25 per unit.
 Since 4 unit of capital are used as fixed factors, the total fixed cost (TFC) Rs 100 remains constant
throughout. (See column 4 in table 10.1).
 The total variable cost (TVC) varies with the variation in the labour units. (See column 5).
 Column 6 measures the total costs. It is TFC and TVC at all levels of output.
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The short-run total cost schedule of a firm (hypothetical data)
Units of Units of labour Total TFC TVC TC

capital (variable product
(Rs) (Rs) (Rs)
factor)
(fixed factor) (TP)
(4) (5) (6)
(2)
(1) (3)
4 0 0 100 -- 100
4 1 2 100 10 110
4 2 5 100 20 120
4 3 10 100 30 130
4 4 15 100 40 140
4 5 18 100 50 150
4 6 20 100 60 160
4 7 21 100 70 170
Table 10.1
Behavior of Total Costs:

Examining costs schedules in table 10.1, we may observe the following interesting points about the
behavior of various total costs:
• TFC remains constant at all levels of output. It is the same even when the output is nil. Fixed costs
are thus independent of output.
• TVC varies with the output. It is nil when there is no output variable costs are thus direct cost of
the output.
• TVC does not change in the same proportion. Initially it is the increasing at a decreasing rate, but
after a point, it increases at an increasing rate. This is due to the operation of the law of variable
proportion or non-proportional output. which suggest that initial to obtain a given amount a output
relatively, variation in factors are needed in less proportion, but after a point when the diminishing
phase operates, variable factor, are to be employed in a greater proportion to increase the same ‘level’
of output.
• TC varies in the same proportion as the TVC. Thus, in the short period the changes in total cost
are entirely due to changes in the total variable costs as fixed costs. The other component of total cost,
remain constant.
21
The TFC curve is horizontal indicating constant total fixed cost at each output level. The TVC curve
rises at a decreasing rate up to a point and at an increasing rate thereafter. It reflects the operation of
the law of diminishing returns. TC is drawn by vertical adding up of TFC and TVC.
THE RELATIONSHIP BETWEEN MARGINAL COST AND AVERAGE COST
Focusing their attention on average and marginal costs data, economists have observed a unique
relationship between the two as follows:
• When AC is minimum, the MC is equal to AC. Thus, MC curve must intersect at the minimum
point of ATC curve.
• When AC is falling, MC is also falling initially, after a point MC may start rising but AC continues
to fall. However, AC is greater than MC (AC>MC). Hence, ultimately at a point both costs will be
equal. Thus, when AC and MC are failing, MC curve lies below the AC curve.
• Once MC is equal to AC, Then as the output increases AC will start rising and MC continues to
rise further but now MC will be greater than AC. Therefore, when both the costs are raising, MC curve
will always lie above the AC curve.
The above stated relationship is easy to see through geometry of AC and MC curves, as shown in the
figure.
It can be seen that:
 Initially, both MC and AC curves are sloping downward. When AC curve is falling, MC curve
lies below it.
 When AC curve is rising, after the point of intersection, MC curve lies above it.
22
It follows thus, that when MC is less than AC, it exerts a down ward pull on the AC curve. When MC
is more than AC it exerts an up word pull on the AC curve. Consequently, MC must equal AC, while
AC is at the minimum. Hence, MC curve interests at the lowest point of AC curve. It may be recalled
that MC curve also intersects the lowest point of AVC curve. Thus, it is a significant mathematical
property of MC curve that i8t always cuts both the AVC and ATC curves at their minimum points.
The figure thus, MC curve crosses the AC curve at point P. at this point P, for OQ level of output the
average cost is PQ which is the minimum.
The MC curve intersects the AC curve at its minimum point from below.
It should be noted that no such relationship can ever be traced between the MC curve and the AFC
curve simply because by definition, the MC curve is independent.
Further, the area underlying the MC curve is equal to the total variable cost of a given output.
In fact, the point on each average cost curve measures the average cost but the area underlying them
denote total costs as under:
 Total area underlying the AFC curve measures the cost total fixed cost.
 The area underlying the AVC curve measures the total variable cost.
 The area underlying the MC curve measures the total marginal cost.
 The area underlying the ATC curve measures the total cost.
Finally, the MC curve is important because it is the cost concept relevant to rational decision making.
It has greater significance in determining the equilibrium of the firm. In fact, the increasing MC due to
diminishing returns sets a limit to the expansion of a firm during the period. Further, it is the MC curve
which acts on the supply curve of the firm.
From the above discussion of cost behavior, we may conclude that short-run average cost curves (AVC,
ATC and MC curves) are U-shaped, except the AFC curve, which is an asymptotic and down ward
sloping curve.
23
Module- 4
1. What is Price Discrimination?(3 M) (June 2015)
Price discrimination refers to the practice of a seller of selling the same good at different prices to
different buyers. A seller makes price discrimination between different buyers when it is both
possible and profitable for him to do so. Price discrimination is not a very common phenomenon.
It is very difficult to charge different prices for the identical good from different customers.
Frequently, the product is slightly differentiated to successfully practice price discrimination.
In the words of Mrs. John Robinson “The act of selling the same article, produced under single
control at different prices to different buyers is known as price discrimination”. Also Prof. Stigler
defines Price discrimination as “the sales of technically similar products at prices which are not
proportional to marginal cost” As per this definition, a seller is indulging in price discrimination
when is charging different prices from different buyers for the different varieties of the same good
if the differences in prices are not the same as or proportional to the differences in the cost of
producing them. For Example, If the manufacturer of a mobile of a given variety sells at Rs.
10.000/- to one buyer and at Rs. 11,000/- to another buyer, (Specific Model) he is practicing price
discrimination.
2. What is Price Skimming and Price Penetration?(3 M) (Dec. 2014)
Price skimming
Price skimming is a product pricing strategy by which a firm charges the highest initial price that
customers will pay. As the demand of the first customers is satisfied, the firm lowers the price to
attract another, more price-sensitive segment.
The causes for the adoption are:

1) Heavy expenditure on a new product
2) Absence of competition at the initial stage
3) Demand is relatively less elastic
4) Suitable for luxurious products
5) Early recovery of initial investment
6) Attracting the consumers of high income group
7) Earning high rate of profit at the initial stage
Price Penetration
A marketing strategy used by firms to attract customers to a new product or service. Penetration
pricing is the practice of offering a low price for a new product or service during its initial offering
in order to attract customers away from competitors. The reasoning behind this marketing strategy
is that customers will buy and become aware of the new product due to its lower price in the
marketplace relative to rivals.
Penetration pricing can be a successful marketing strategy when applied correctly. It can often
increase both market share and sales volume. Additionally, the high sales volume can also lead
to lower production costs and higher inventory turnover, both of which are positive for any firm
with fixed overhead. The chief disadvantage, however, is that the increase in sales volume may
24
not necessarily lead to a profit if prices are kept too low. As well, if the price is only an
introductory campaign, customers may leave the brand once prices begin to rise to levels more in
line with rivals.
The causes for the adopting are:

1) Low cost of production of a need product
2) Economies of a large scale production
3) Low expenditure on research advertisement and sales promotion programme
4) Enter and expand the market
5) Suitable when the demand for a product is relatively elastic
6) Discouraging competition
7) Attracting consumers of low income group
8) Discouraging government intervention
9) Earning maximum profit through maximum sales.
3. What is Oligopoly? Explain its features. (7 M) (Dec. 2014)

Oligopoly refers to the market structures where a few sellers are (more than to but not too many)
in a given line of production. Fellner defines oligopoly as “competition among the few.” In an
oligopolistic market, firms may be producing either a homogeneous product or may have product
differentiation in a given line of production, the oligopoly model fits well in such industries as
automobile, manufacturing of electrical appliances, etc., in our country.
Following are the distinguishing of an oligopolistic market:
• There are a few sellers supplying either homogeneous products or differentiated products.
• Firms have a high degree of interdependence in their business policies in fixing price and
determining output
• Firms under oligopoly have always the fear of retaliation by rivals
• Competition is of a unique type in an oligopolistic market. Here, each oligopolistic faces
competition, and has to wage a constant struggle against his rivals
• Advertising and selling costs have strategic importance to oligopolistic firms.
4. What are the features of perfect competition? Explain how price is determined under
perfect competition in the short run? (10 M) (Dec. 2014)
Perfect Competition is a market structure where there is a perfect degree of competition and single
price prevails. The concept of Perfect Competition was introduced by Dr. Alfred Marshall. Nothing
is 100% perfect in this world. So, this states that perfect competition is only a theoretical possibility
and it does not exist in reality.
A perfect market is one where there is perfect competition. This is a model market. According to
Boulding, “the competitive market may be defend as a large number of buyers and sellers all
engaged in the purchase and sale of identically similar commodity, who are in close contact with
one another and who buy and sell freely among themselves”.
Main Features of Perfect Competition
The following are the characteristics or main features of perfect competition:-
1. Many Sellers
In this market, there are many sellers who form total of market supply. Individually, seller is a firm
and collectively, it is an industry. In perfect competition, price of commodity is decided by market
25
forces of demand and supply. i.e. by buyers and sellers collectively. Here, no individual seller is in
a position to change the price by controlling supply. Because individual seller's individual supply
is a very small part of total supply. So, if that seller alone raises the price, his product will become
costlier than other and automatically, he will be out of market. Hence, that seller has to accept the
price which is decided by market forces of demand and supply. This ensures single price in the
market and in this way, seller becomes price taker and not price maker.
2. Many Buyers
Individual buyer cannot control the price by changing or controlling the demand. Because
individual buyer's individual demand is a very small part of total demand or market demand. Every
buyer has to accept the price decided by market forces of demand and supply. In this way, all buyers
are price takers and not price makers. This also ensures existence of single price in market.
3. Homogenous Product
In this case, all sellers produce homogeneous i.e. perfectly identical products. All products are
perfectly same in terms of size, shape, taste, colour, ingredients, quality, trade marks etc. This
ensures the existence of single price in the market.
4. Zero Advertisement Cost
Since all products are identical in features like quality, taste, design etc., there is no scope for
product differentiation. So advertisement cost is nil.
5. Free Entry and Exit
There are no restrictions on entry and exit of firms. This feature ensures existence of normal profit
in perfect competition. When profit is more, new firms enter the market and this leads to
competition. Entry of new firms competing with each other results into increase in supply and fall
in price. So, this reduces profit from abnormal to normal level.
When profit is low (below normal level), some firms may exit the market. This leads to fall in
supply. So remaining firms raise their prices and their profits go up. So again this ensures normal
level of profit.
6. Perfect Knowledge
On the front of both, buyers and sellers, perfect knowledge regarding market and pricing conditions
is expected. So, no buyer will pay price higher than market price and no seller will charge lower
price than market price.
7. Perfect Mobility of Factors
This feature is essential to keep supply at par with demand. If all factors are easily mobile
(moveable) from one line of production to another, then it becomes easy to adjust supply as per
demand.
Whenever demand is more additional factors should be moved into industry to increase supply and
vice versa. In this way, with the help of stable demand and supply, we can maintain single price in
the Market.
8. No Government Intervention
Since market has been controlled by the forces of demand and supply, there is no government
intervention in the form of taxes, subsidies, licensing policy, control over the supply of raw
materials, etc.
9. No Transport Cost
It is assumed that buyers and sellers are close to market, so there is no transport cost. This ensures
existence of single price in market.
26
5. Explain with the help of ‘Kinked Demand Curve’. (7 M) (June 2015)

Kinked Demand Curve Theory of Oligopoly Price
An important point involved in kinked demand curve is that it accounts for the kinked average revenue
curve to the oligopoly firm. The kinked average revenue curve, in turn, implies a discontinuous marginal
revenue curve MA-BR. Thus, the kinky marginal revenue curve explains the phenomenon of price in the
theory of oligopoly prices.
Because of discontinuous marginal revenue curve (MR), there is no change in equilibrium output, even
though marginal cost changes hence, there is price rigidity. OP does not change.
It is observed that quite often in oligopolistic markets, once a general price level is reached whether
by collusion or by price leadership or through some formal agreement, it tends to remain unchanged over a
period of time. This price rigidity is on account of conditions of price interdependence explained by the
kinky demand curve. Discontinuity of the oligopoly firm’s marginal revenue curve at the point of
equilibrium price, the price-output combination at the kink tends to remain unchanged even though
marginal cost may change.
27
It can be seen that the firm’s marginal cost curve can fluctuate between MC1 and MC2 within the range of
the gap in the MR curve. Without disturbing the equilibrium price and output position of the firm. Hence,
the price remains at the same level OP, and output OQ, despite change in the marginal costs.
6. Explain the price and output determination under monopolistic competition. (10 M) (June
2015)
PRICE DETERMINATION UNDER MONOPOLISTIC COMPETITION:
Under monopolistic competition, the firm will be in equilibrium position when marginal revenue
is equal to marginal cost. So long the marginal revenue is greater than marginal cost, the seller will
find it profitable to expand his output, and if the MR is less than MC, it is obvious he will reduce
his output where the MR is equal to MC. In short run, therefore, the firm will be in equilibrium
when it is maximising profits, i.e., when MR = MC.
(a) Short Run Equilibrium: Short run equilibrium is illustrated in the following diagram:
Diagram: Monopolistic Competition Short Run Equilibrium
In the above diagram, the short run average cost is MT and short run average revenue is MP. Since
the AR curve is above the AC curve, therefore, the profit is shown as PT. PT is the supernormal
profit per unit of output. Total supernormal profit will be measured by multiplying the supernormal
profit to the total output, i.e. PT × OM or PTT’P’ as shown in figure (a). The firm may also incur
losses in the short run if it is facing AR curve below the AC curve. In figure (b) MP is less than
MT and TP is the loss per unit of output. Total loss will be measured by multiplying loss per unit
of output to the total output, i.e., TP × OM or TPP’T’.
(b) Long Run Equilibrium: Under monopolistic competition, the supernormal profit in the long run
is disappeared as new firms are entered into the industry. As the new firms are entered into the
industry, the demand curve or AR curve will shift to the left, and therefore, the supernormal profit
will be competed away and the firms will be earning normal profits. If in the short run firms are
suffering from losses, then in the long run some firms will leave the industry so that remaining
firms are earning normal profits.
The AR curve in the long run will be more elastic, since a large number of substitutes will be
available in the long run. Therefore, in the long run, equilibrium is established when firms are
28
earning only normal profits. Now profits are normal only when AR = AC. It is further illustrated
in the following diagram:
29
Module- 5
1. Mention the three methods of measuring the National Income?(3 M) (June 2015)
Or
What are the different methods of measuring National Income? What are the difficulties in
measuring GDP? (10 M) (Dec. 2014)
Methods of Measurement of National Income

1. Product Method:
In this method, national income is measured as a flow of goods and services. We calculate money
value of all final goods and services produced in an economy during a year. Final goods here refer
to those goods which are directly consumed and not used in further production process.
Goods which are further used in production process are called intermediate goods. In the value of
final goods, value of intermediate goods is already included therefore we do not count value of
intermediate goods in national income otherwise there will be double counting of value of goods.
To avoid the problem of double counting we can use the value-addition method in which not the
whole value of a commodity but value-addition (i.e. value of final good value of intermediate
good) at each stage of production is calculated and these are summed up to arrive at GDP.
The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at
market price can be converted into by methods discussed earlier.
2. Income Method:
Under this method, national income is measured as a flow of factor incomes. There are generally
four factors of production labour, capital, land and entrepreneurship. Labour gets wages and
salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.
Besides, there are some self-employed persons who employ their own labour and capital such as
doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these
factor incomes is called NDP at factor costs.
3. Expenditure Method:
In this method, national income is measured as a flow of expenditure. GDP is sum-total of private
consumption expenditure. Government consumption expenditure, gross capital formation
(Government and private) and net exports (Export-Import).
Difficulties in Measurement of National Income
30
There are many difficulties when it comes to measuring national income, however these can be
grouped into conceptual difficulties and practical difficulties.
Conceptual Difficulties
 Inclusion of Services: There has been some debate about whether to include services in the
counting of national income, and if it counts as output. Marxian economists are of the belief
that services should be excluded from national income, most other economists though are
in agreement that services should be included.
 Identifying Intermediate Goods: The basic concept of national income is to only include
final goods, intermediate goods are never included, but in reality it is very hard to draw a
clear cut line as to what intermediate goods are. Many goods can be justified as
intermediate as well as final goods depending on their use.
 Identifying Factor Incomes: Separating factor incomes and non factor incomes is also a
huge problem. Factor incomes are those paid in exchange for factor services like wages,
rent, interest etc. Non factor are sale of shares selling old cars property etc., but these are
made to look like factor incomes and hence are mistakenly included in national income.
 Services of Housewives and other similar services: National income includes those goods
and services for which payment has been made, but there are scores of jobs, for which
money as such is not paid, also there are jobs which people do themselves like maintain
the gardens etc., so if they hired someone else to do this for them, then national income
would increase, the argument then is why are these acts not accounted for now, but the
bigger issue would be how to keep a track of these activities and include them in national
income.
Practical Difficulties
 Unreported Illegal Income: Sometimes, people don't provide all the right information about
their incomes to evade taxes so this obviously causes disparities in the counting of national
income.
 Non Monetized Sector: In many developing nations, there is this issue that goods and
services are traded through barter, i.e. without any money. Such goods and services should
be included in accounting of national income, but the absence of data makes this inclusion
difficult.
Precautions for Value added approach •
There are certain precautions which are to be taken to avoid miscalculation of national income
using this method. These in brief are:
31
(i)Problem of double counting: When we add up the value of output of various sectors, we should
be careful to avoid double counting. This pitfall can be avoided by either counting the final value
of the output or by including the extra value that each firm adds to an item.
(ii) Value addition in particular year: While calculating national income, the values of goods added
in the particular year in question are added up. The values which had previously been added to the
stocks of raw material and goods have to be ignored. GDP thus includes only those goods and
services that are newly produced within the current period.
(iii) Stock appreciation: Stock appreciation, if any, must be deducted from value added. This is
necessary as there is no real increase in output
- (iv) Production for self consumption. The production of goods for self consumption should be
counted While measuring national income. In this method, the production of goods for self
consumption should be valued at the prevailing market prices.
Precautions in Expenditure Method
While estimating national income through expenditure method, the following precautions should
be taken.
(i) The expenditure on second hand goods should not be included as they do not contribute to
the current year’s production of goods.
(ii) Similarly, expenditure on purchase of old shares and bonds is not included as these also do
not represent expenditure on currently produced goods and services.
(iii) Expenditure on transfer payments by government such as unemployment benefit, old age
pensions, interest on public debt should also not be included because no productive service is
rendered in exchange by recipients of these payments.
Precautions in Income Method
While estimating national income through income method, the following precautions should be
undertaken.
(i) Transfer payments such as gifts, donations, scholarships, indirect taxes should not be
included in the estimation of national income.
(ii) Illegal money earned through smuggling and gambling should not be included.
(iii) Windfall gains such as -prizes won, lotteries etc. is not be included in the estimation of
national income.
32
(iv) Receipts from the sale of financial assets such as shares, bonds should not be included in
measuring national income as they are not related to generation of income in the current year
production of goods.
2. What do you understand by the term GDP?(3 M) (Dec. 2014)

The Gross Domestic product is one of the primary indicators used to guage the health of a country’s
economy. It represents the total value of all the goods and services produced over a specific time
period – you can think of it as the size of the economy. The monetary value of all the finished goods
and services produced within a country's borders in a specific time period, though GDP is usually
calculated on an annual basis. It includes all of private and public consumption, government
outlays, investments and exports less imports that occur within a defined territory.
GDP = C + G + I + NX
where:
"C" is equal to all private consumption, or consumer spending, in a nation's economy"G" is the sum
of government spending"I" is the sum of all the country's businesses spending on capital"NX" is
the nation's total net exports, calculated as total exports minus total imports. (NX = Exports -
Imports)
Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the
year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the
last year.
Measuring GDP is complicated (which is why we leave it to the economists), but at its most basic,
the calculation can be done in one of two ways: either by adding up what everyone earned in a year
(income approach), or by adding up what everyone spent (expenditure method). Logically, both
measures should arrive at roughly the same total.
As one can imagine, economic production and growth, what GDP represents, has a large impact on
nearly everyone within that economy. For example, when the economy is healthy, you will typically
see low unemployment and wage increases as businesses demand labor to meet the growing
economy. A significant change in GDP, whether up or down, usually has a significant effect on the
stock market. It's not hard to understand why: a bad economy usually means lower profits for
companies, which in turn means lower stock prices. Investors really worry about negative GDP
growth, which is one of the factors economists use to determine whether an economy is in a
recession.
What is Business Cycle? Explain different phases of business cycle. (7 M) (Dec. 2014)
Or
Discuss the various phases of Business cycle. (7 M) (June 2015)
Concept Of Business Cycle: A Business Cycle can be defined as wavelike fluctuations of business
activity characterized by recurring phases of expansion and contraction in periods varying from
three to four years. Business cycle are a type of fluctuations found in the aggregate economic
activity of nations that organize their work mainly in business enterprises- Mitchell. A cycle
consists of expansions occurring at about the same time in many economic activities followed by
similarly general recessions, contractions and revivals which merge with the expansion phase of
the next cycle. This sequence of change is recurrent but not periodic.
33
Phases of Business Cycle:
According to Burns & Mitchell, every business cycle has the critical mark off points of peak and
trough, From trough to peak there is the expansion phase and from peak to trough the contraction
phase. The turning points characterized the other two stages.
Revival/Expansion/Recession/Contraction
Burns & Mitchell phases of Business Cycle: Peak – Trough - Beginning of Recession -
Beginning of Revival.
Joseph Schumpeter does not agree with Burns and Mitchell on the phases of business cycle; peak
and trough cannot be regarded as the critical mark off points. According to him, the critical mark-
off points are “neigbour hoods of equilibrium the upper half of the business cycle from A to B is divided
into two parts : 1) PROSPERITY / EXPANSION 2) RECESSION. The lower half of the business
cycle from B to C similarly consists of two parts namely : 3) DEPRESSION 4) RECOVERY /
STAGFLATION
1) Prosperity / expansion: this phase is also called as upswing . The prosperity or expansion stage
begins from an equilibrium position under the stimulus of certain forces. This forces create
expectations of rising profits. Wage disbursements increase rapidly, demand for consumption of
goods also grows rapidly. The demand for raw materials leads to larger employment in other
industries, as does the demand for consumption goods when workers spend their additional
earnings received from the entrepreneurs. If this position from which the expansion phase began
was one of less than full employment of resources, the increased demand for both consumption
goods and raw materials, would be satisfied by rapid increase in their supply. The marked feature
of prosperity is expansion in bank deposits and supply of currency, this leads to price rise.
Distortions of price relations: price do not rise uniformly during the prosperity phase. Gradually
wholesale prices rise more than retail prices. These distortions of the cost structure in every
prosperity phase increase the margin of profit. Expansion reaching its heights: the rising profit
and prevailing optimism about its continuance boost up the stock prices of stock exchange
securities. Entrepreneurs, observing that their profits are growing rapidly, make further
investments. The end of expansion: during the prosperity phase, expansion itself gradually brings
into play a series of forces which ultimately lead to the beginning of recession. The most important
of these factors is the gradual rise of costs relatively to prices.
Recession: The phase of recession, which is a turning period, is relatively shorter. In this period
while the forces of expansion is weekend, the forces that make for contraction get strengthened.
Recession phase is normally characterized by :- liquidation of stock market strains in banking
system; liquidation of bank loans; fall in prices; sharp reduction in demand for capital equipment;
abandoning of relatively new projects; slow fall in consumer goods; sharp decrease in capital
goods demand. Collapse in marginal efficiency of capital
34
Depression / contraction: Recession ultimately merges into depression which is the phase of
relatively low economic activity. When an economy moves from recession to depression, there is
a notable fall in production of goods and services and in employment. The least affected sectors
are Agricultural Activities in terms of both output & employment and Retail Business is also little
affected. The most affected sectors are manufacturing, mining and construction. The worst
affected industries are those which produce machines, tools, plants, equipments and steel. During
depression there is a substantial reduction in the incomes of the people and thus the demand for
consumer goods also declines. It has been observed that during depression when incomes of most
of the households drastically fall, they make substantial reduction in durable goods. In this phase
the general price level falls despite the reduction in output of goods and services.
Recovery/stagflation: The recovery stage is gradual. It starts when the prices stop falling. At this
stage marginal efficiency of capital starts recovering. The firms begin making investment to
replace depreciated equipment. With business prospects improving, some firms opt for large
investments. Along with restoration of normal price relations, there is correction of distortions in
cost-price relations. Another sign of beginning of recovery is revival of stock exchange activities
manifested in the rising prices of securities. The upward movement of the prices of the securities
is taken to be a good indicator of the recovery of the profits. The cumulative process in the business
cycle builds up and the phase of recovery tends to move on into the phase of prosperity. The cycle
at this stage is ready to repeat itself.
3. Discuss in detail the impact of economic environment on the business. (10 M) (June 2015)
35
 GDP
GDP is the measure upon which we value every single product and service that is available to us.
If GDP is going down, then that means the economy is shrinking, which in turn creates falling
house prices and job cuts. If GDP is rising, then that means the economy is expanding, which
creates more wealth and more new jobs. A limitation with GDP is that it gives us information
about what has already happened, and is not good for finding information about the road ahead.
Business Cycle
The business cycle is the sequence of a slump, recovery, boom and recession. It is the regular
patterns of up and downs in the economy. We record this in a cyclical movement of economic
growth categorized by recovery, boom, recession and slump. It is measured by changes in GDP
from one quarter to the next.
Employment
Unemployment varies with the level of economic activity. In early 2004 there was plenty of
employment in the UK, so employment figures were low. Now in 2011 there are fewer jobs and
high unemployment. Employers were reporting skill shortages in a number of areas. One cause
36
of unemployment may be downswings in the trade cycle i.e. periods of recession. People also
argue that new technology generates new products, new services and therefore new jobs. Fewer
workers may be required in some production processes where specific tasks are taken over, but
rising productivity boosts incomes and the demand for new jobs in the economy as a whole.
Interest Rates
A rate that is charged or paid for the use of money.
Recession
During this period, interest rates tend to fall during the months of recession to stimulate
the economy by offering cheap rates at which to borrow money. People are therefore
encouraged to spend money rather than save, as saving will give them a poor return on
their money, and so that the economy will grow.
Growth
In times of growth, interest rates tend to rise thus encouraging people to save money rather
than spend. Because the interest rate is higher, then people get more for their money if
they choose to save.
Inflation Rates
Represents the general increase in prices. Inflation is a sustained increase in the average price
level of a country. The rate of inflation is measured by the annual percentage change in the level
of prices. For example a small company borrows capital from a bank to buy new assets for their
business, and in return the lender receives interest at an interest rate for deferring the use of funds
and instead lending it to the borrower. Interest rates are normally expressed as a percentage of
the principal for a period of one year.
Stability
There are basic economic factors in terms of economic growth, and the problems it faces. There
are problems no matter where in the world we live. Decisions have to be made on how the types
of goods and services are to be produced. Is farming and agriculture a good market, or is the
money in housing and education? Consideration also has to be taken into account, such as how
these goods and services should be produced. By people (labour intensive), or hi-tech methods
that cost a lot of money to run. And finally, who should get the goods and/or services that the
business produces? Does everyone get an equal share?
The ways in which a business chooses to answer these questions will dictate the economy in
which we live. If the economy produces a fairly constant output in terms of goods and services,
then provided the prices of those goods and services are affordable to those who use them, then
we will have a stable economy.
The problems occur however when the economy becomes unstable, when goods and services are
in short supply, or that the prices become so high that people can no longer afford them. The fact
that unemployment is rising can mean that the production and supply of goods begins to decrease
37
and the amount of money to purchase the goods available decreases too, mostly to do with the
reduction in wages.
Therefore instability in the economy can lead to a huge shortage of goods and services. In
countries of extreme poverty this could even mean food and medicines. The loss of jobs and
income is also a factor, so if there were goods and services people could not afford to buy them.
Stability is determined by consumer confidence. If consumers are not confident, then the
economy develops a slump.
38
Module- 6
1. What is Globalization?(3 M) (June 2015) (Dec. 2014)
Globalization is the process by which the world is becoming increasingly interconnected as a result of
massively increased trade and cultural exchange. Globalization has increased the production of goods
and services. The biggest companies are no longer national firms but multinational corporations with
subsidiaries in many countries. Globalization is a process of interaction and integration among the
people, companies, and governments of different nations, a process driven by international
trade and investment and aided by information technology. This process has effects on the environment,
on culture, on political systems, on economic development and prosperity, and on human physical well-
being in societies around the world.
Globalization has been taking place for hundreds of years, but has speeded up enormously over the last
half-century.
Globalization has resulted in:
 Increased international trade

 A company operating in more than one country
 Greater dependence on the global economy
 Freer movement of capital, goods, and services
 Recognition of companies such as McDonalds and Starbucks in LEDCs
Although globalization is probably helping to create more wealth in developing countries - it is not
helping to close the gap between the world's poorest countries and the worlds richest.
2. What is meant by disinvestment? Explain its merits and demerits. (7 M) (Dec. 2014)
Advantages of Disinvestment:
 Increase in efficiency
 Professional Management
 Increase in Competition
 Reduction in Public sector Sick units
 More Opportunities for Privatization
 Reduction of burden on Government
 Improvement in Marketing and Technology
 Reduction of Industrial Disputes
Disadvantages of Disinvestment:
The drawbacks of disinvestments of PSUs, with particular reference to disinvestments of huge profit
making and dividend paying PSUs are under as follows:
 The dividend payout by PSUs is highest in the year 2002. Besides
disinvestment proceeds, the government has profited handsomely from high dividends in the year
2002. The quantum of dividend received (excluding from banks) is worth more than Rs.3380
Crores for the year ending March 2002
39
 There would be Chances of ASSETS STRIPPING of profit-making

PSUs
 Selling of the huge profit making and dividend paying PSUs would
result in killing a Goat for one time best meal once only, rather than
feeding it well and getting Precious milk for years.
 Disinvestment of oil PSUs particularly when war clouds are moving around IRAQ a major supplier
of oil products to the world at large, would proved to be a hazardous decision.
 Selling profit-making PSUs would be equivalent losing regular source of income to the
Government.
 Contraction of Public Sector
 Increase in Private Sector Investment Plans
 Uneconomic Price Policy
 Increase in Unemployment
 Wasteful Expenses
 Increase in Regional imbalance
 Ignores weaker sections
 Ignores Enterprises of National Importance.
 Exploitation of Poor nations.
3. What is meant by Privatization? What are the rationale for privatization and
disinvestment? What are the criticisms for disinvestment? (10 M) (Dec. 2014)
The transfer of ownership, property or business from the government to the private sector is termed
privatization.
Definition: The transfer of ownership, property or business from the government to the private
sector is termed privatization. The government ceases to be the owner of the entity or business.
The process in which a publicly-traded company is taken over by a few people is also called
privatization. The stock of the company is no longer traded in the stock market and the general
public is barred from holding stake in such a company. The company gives up the name 'limited'
and starts using 'private limited' in its last name.
Rationale for Privatization and Disinvestment :
 Disintegration of Socialist Economy
 Inefficient public sector
 Uneconomic pricing policy
 Experience of New Industrial Nation
 To avail benefits of Capitalism
 To solve the financial crisis of the government
 For promoting Industrial Growth
 For promoting Globalization.
 It is believed that the private ownership leads to better use of resources and their more
efficient allocation.
 The proliferation of market based economy resulted in the fact that State could no longer
meet the growing demands of the economy. It was believed that the government can deliver
better results when it responds according to the market driven forces.
40
 Globalization and WTO commitments need quick restructuring of the Public Sector
Undertakings. If they are not able to adapt to this, they would not be able to survive. Public
enterprises, because of the nature of their ownership, can restructure slowly and hence the
logic of privatization gets stronger. Besides, techniques are now available to control public
monopolies by regulation/competition, and investment of public money to ensure
protection of consumer interests is no longer a convincing argument.
Demerits/Criticism of Disinvestment:
1. The amount raised through disinvestment from 1991-2001 was Rs. 2051 crores per year
which is too meagre. Further, the way money released by disinvestment is being used,
remaining undisclosed.
2. The loss of PSU’s is rising. It was 9305 crore in 1998 and 10060 crore in 2000.
3. This is welcome but disinvestment of profit making public sector units will rob the
government of good returns. Further, if department of disinvestment wants to get away
with commercial risks, why should it retain equity in disinvested PSU’s, e.g. Balco (49%),
Modern Foods (26%) etc.
4. The growth in social sector is not in any way hindered by non-availability of manpower.
5. This is true but only when the govt, ensures that the market system regulates and
disciplines privatized firms taking care of public’s interest.
6. Privatization programme is generally not been affected through the public sales of
shares. Earlier, sale of shares (1991-96) attracted the employees to a limited extent and was
not friendly to small investors and employees.
7. In most cases, shares of disinvested PSU’s are by and large in the hands of institutions
with little floating stock. The present policy of privatization through the strategic partner
route would also not achieve these objectives.
8. Hindustan Lever has categorically stated that it has no plans for any capital infusion in
Modern food industries acquired by it in January, 2002. The supporter of disinvestment
had thought that tax payer’s money would be saved through private sector investment.
9. No monopoly is good. Only fair and full competition can bring relief to consumers.
4. Write a note on ‘New Industrial Policy of 1991’. (7 M) (June 2015)

A major shift in the industrial policy was made by the Congress (I) Government led by Mr. P.B.
Narasimha Rao on July 24, 1991.
The main aim of this policy was to unshackle the country's indus-trial economy from the cobwebs
of unnecessary bureaucratic control, introduce liberalization with a view to integrate the Indian
economy with the world economy, to remove restrictions on direct foreign investment and also to
free the domestic entrepre-neur from the restrictions of MRTP Act. Besides, the policy aims to shed
41
the load of the public enterprises which have shown a very low rate of return or are incurring losses
over the years. The salient features of this policy are as follows:
1. Except some specified industries (security and strategic concerns, social reasons, environmen-tal
issues, hazardous projects and articles of elitist consumption) industrial licensing would be
abol-ished.
2. Foreign investment would be encouraged in high priority areas up to a limit of 51 per cent equity.
3. Government will encourage foreign trad-ing companies to assist Indian exporters in export
activities.
4. With a view to injecting the desired level of technological dynamism in Indian industry, the
gov-ernment will provide automatic approval for tech-nology agreements related to high priority
indus-tries.
5. Relaxation of MRTP Act (Monopolies and Restrictive Practices Act) which has almost been
rendered non-functional.
6. Dilution of foreign exchange regulation act (FERA) making rupee fully convertible on trade
account.
7. Disinvestment of Public Sector Units' shares.
8. Closing of such public sector units which are incurring heavy losses.
9. Abolition of C.C.I, and wealth tax on shares.
10. General reduction in customs duties.
11. Provide strength to those public sector enterprises which fall in reserved areas of operation or
in high priority areas.
12. Constitution of special boards to negoti-ate with foreign firms for large investments in the
development of industries and import of technol-ogy-
Critique of the New Industrial Policy
The keynote of the new industrial policy includes liberalisation and globalisation of the economy.
Liberalisation means deregularisation of the industrial sector by cutting down to the minimum
administrative interference in its operation so as to allow free competition between market forces.
Similarly globalization means making the Indian economy an integral part of the world economy
by breaking down to the maximum feasible the barriers to move-ment of goods, services, capital
and technology between India and the rest of the world.
42
The new Industrial Policy fulfils a long-felt demand of the industry to remove licensing for all
industries except 18 industries (coal, petroleum, sugar, motor cars, cigarettes, hazardous chemicals,
pharmaceuticals and luxury items).
It proposes to remove the limit of assets fixed for MRTP Companies and dominant undertakings.
Hence business houses intending to float new com-panies or undertake expansion will not be
required to seek clearance from the MRTP Commission. This step will enable MRTP Companies
to establish new undertakings, and effect plans of expansions, merg-ers, amalgamations and
takeovers without prior gov-ernment approval. They shall have the right to ap-pointment of
directors.
The new Industrial Policy goes all out to woo foreign capital. It provides 51% foreign equity in
high priority industries and may raise the limit to 100% in case the entire output is exported.
This runs counter to the Nehruvian Model. Experts fear that this over-enthusiasm to wlecome
foreign capital and to give free hand to multination-als will be detrimental for indigenous industries
more so house-hold and small scale industries. This may lead to economic and political crisis in
future. It is also alleged that the Policy has been framed at the instance of the IMF and is going to
protect the interests of developed Western countries at the cost of national interests. Critics also
argue that once foreign capital is permitted free entry the distinction between high and low priority
industries will disap-pear and all lines of production will have to be opened to facilitate foreign
investment. This may create Brazil or Mexico like economic crisis.
By opening the gates of the Indian economy wide to the multinationals, the self-reliance aspect has
been completely ignored. These multinationals with slightest of inconvenience may shift their
op-erations elsewhere leaving the economy in the lurch.
Since multinational and private entrepreneurs would prefer most favourable locations for their
industries it would further intensify spatial disparity in economic development. This fact has been
well collaborated by the letters of intent so far approved.
While selling out public sector shares and companies to private investors the Government is not
only ignoring the interests of the employees but is transferring the assets at throw away prices.
These public sector companies could have been handed over to the working class or autonomous
organizations to manage their affairs independently.
In the absence of MRTP safeguard private companies may develop monopolistic outlook and may
indulge in unfair trade practices.
There is also a risk of growing consumerism rather than strengthening the sinews of the economy.
Foreign investors may prefer to invest in low priority consumer sector instead of going for high
priority sector.
With the state yielding to the private enter-prise the social objectives of equity with growth and
protecting the interests of the down trodden and semi-skilled labourers would be thrown to the
winds. This will be against the cherished goals of our Constitution and may create socio-economic
dispar-ity and tension.
43
5. Briefly explain the advantages and disadvantages from WTO to India. (10 M) (June 2015)
The WTO is a body designed to promote free trade through organizing trade negotiations and act
as an independent arbiter in settling trade disputes. To some extent the WTO has been successful
in promoting greater free trade
Free trade has many advantages, such as:
1. Lower prices for consumers. Removing tariffs enables us to buy cheaper imports
2. Free trade encourages greater competitiveness. Firms face a higher incentive to cut costs. For
example, a domestic monopoly may now face competition from foreign firms.
3. Law of comparative advantage states that free trade will enable an increase in economic welfare.
This is because countries can specialise in producing goods where they have a lower opportunity
cost.
4. Economies of scale. By encouraging free trade, firms can specialise and produce a higher quantity.
This enables more economies of scale, this is important for industries with high fixed costs, such
as car and aeroplane manufacture.
5. Free trade can help increase global economic growth.
Disadvantages of WTO
1. However, the WTO has often been criticized for ignoring the plight of the developing world.
2. It is argued the benefits of free trade accrue mostly to the developed world.
3. Free trade may prevent developing economies develop their infant industries. For example, if a
developing economy was trying to diversify their economy to develop a new manufacturing
industry, they may be unable to do it without some tariff protection.
44
6. Mention the instruments of Fiscal Policy?(3 M) (June 2015)

 Taxation
 Public Borrowing
 Forced savings or Deficit Financing
 Public Expenditure
7. What is meant by Fiscal Policy?(3 M) (Dec. 2014)

Fiscal policy is the government’s schedule for spending and tax implementation to influence the
economy for the year. Government introduces fiscal policy every year to cope with problem faced
by its economy and for the betterment of society. The fiscal policy is concerned with the raising of
government revenue and incurring of government expenditure. To generate revenue and to incur
expenditure, the government frames a policy called budgetary policy or fiscal policy.
“Fiscal policy refers to the policy of the government as regards taxation, public borrowings and
public expenditure with specific objectives in view. These objectives are to produce desirable effect
and avoid undesirable effect on the national income, production, employment, and general price
level.”
8. Explain the salient features of Union Budget 2014-15 which affects ordinary citizens. (7 M)
(Dec. 2014)
The Union budget is presented each year on the last working day of February by the finance
minister of India in parliament. In the article 112 of the Indian constitution Union budget
of India is referred to as the Annual Financial Statement of Government of India.
The process of bill presentation is initiated by the means of the financial bill and the
appropriation bill has to be passed by the house before it comes into effect from April 1
every year. The first day of April marks the beginning of India's financial year.
In the following table some salient features of the budget presented today and the interim
budget 2014-15 (vote-on-account since the budget had been placed before the House by
the previous UPA government) have been listed to give readers an idea about the changes
which have taken place over the course of the last two years :
Budget 2014-15 Budget 2015-16

It was presented on July 10, 2014 by Finance It was presented on February 28, 2015 by
Minister Arun Jaitely Arun Jaitely
Income tax exemption limit was raised last This year total exemption of up to Rs
year by 50,000 to Rs 2.5 lakh and for senior 4,44,200 can be achieved as stated by the
citizens to Rs 3 lakh Finance Minister.
Exemption limit for investment in financial Additional 2% surcharge for the super rich
instruments under 80C raised to Rs 1.5 lakh with income of more than 1 crore.
from Rs 1 lakh.
Investment limit in PPF raised to Rs 1.5 lakh Service Tax increased to 14% from the
from Rs 1 lakh. current 12.36%. Wealth Tax has been
45
abolished. 100% exemption for contribution

to Swachch Bharat apart from CSR.
Deduction limit on interest on loan for self- DEFENCE :
occupied house was raised to Rs 2 lakh from Rs 2,46,726 crore allocated for Defence, the
Rs 1.5 lakh. primary focus of this budget is on "Make in
India" for quick manufacturing of Defence
equipment.
Committee to look into all fresh tax demands AGRICULTURE
for indirect transfer of assets in wake of Rs 25, 000 crore for Rural Infrastructure
retrospective tax amendments of 2012. Development Bank.
To support Micro Irrigation Programme Rs
5,300 crore are separately assigned.
Farmers credit- target of 8.5 lakh crore.
Fiscal deficit target was retained at 4.1% of INFRASTRUCTURE :
GDP for current fiscal and 3.6% in FY 16. Rs 70, 000 crores to the Infrastructure sector.
Tax free bonds for projects in rail road and
irrigation.
Purchasing Power Parity (PPP) model for
infrastructure development to be revitalised
and govt will bear majority of the risk.
Rs 150 crore was allocated for increasing Rs 150 crore allocated this time for research
safety of women in large cities. and development. NITI to be established and
involvement of entrepreneurs, researchers to
foster scientific innovations.
LCD, LED, TV became cheaper last year. The government has also proposed to set up 5
ultra mega power projects, each of 4,000
MW.
The prices of Cigarettes, pan masala, The prices of Cigarettes have been increased
tobacco, aerated drinks were raised last year. again this year. whereas prices of footwear
have been decreased.
Government last year projected revenue WELFARE SCHEMES :
generation from taxes of Rs 9.77 lakh crore. 50, 000 toilets will be constructed under the
Swacch Bharat Abhiyan. Two new programs
will be introduced - GST and JAM Trinity.
GST will be implemented by April 2016
Rs 2,037 crore was set aside last year for Mudra Bank refinance micro finance orgs. to
integrated Ganga conservation. The mission encourage first generation SC/ST
was named as "Namami Ganga." entrepreneurs.
Kisan Vikas patra was promised to be It has also been projected by the Finance
reintroduced, national savings certificate with Minister that the government will ensure
insurance cover to be launched Housing for all by the year 2020.
FDI limit to be hiked at 49 pc in defence, Up gradation of 80, 000 secondary and senior
insurance. secondary schools.
46
Disinvestment target fixed at Rs 58,425 crore DBT will be further be expanded from 1
crore to10.3 crore.10.3 crore.
Gross borrowings were pegged at Rs 6 lakh In the Atal Bihari Pension Yojana,
crore in 2013-14. government will contribute 50% of the
premium limited to Rs 1000 a year.
Contours of GST was finalised last fiscal; A new scheme for physical aids and assisted
govt assured to look into DTC proposal. living devices for people aged over 80.
Pt Madan Mohan Malviya New Teachers Government to use 9000 crore rupees
Training Program was launched with a sum unclaimed funds in PPF/EPF for senior
of Rs 500 crore. citizens fund.
It was also declared that the govt will provide Rs 5000 crore additional allocation for
Rs 500 crore for the rehabilitation of MGNREGA. The government will create a
displaced Kashmiri citizens. universal security system for all Indians.
It was declared that 5 IIM's will be opened in IIM's will be opened in Jammu and Kashmir
HP, Punjab, Bihar, Odisha and Rajasthan. and Andhra Pradesh, Indian Institute of
Mines (IMS) situated in Dhanbad will be
upgraded to IIT.
It was also declared that 5 more IIT's in It was announced that a new IIT in Karnataka
Jammu, Chhattisgarh, Goa, Andhra Pradesh will be established.
and Kerala.
Four more AIIMS like institutions to come This year AIIMS like institutions to be
up in AP, West Bengal, Vidarbha in opened in Jammu and Kashmir, Punjab,
Maharashtra and Poorvanchal in UP Tamil Naidu, Himachal Pradesh, Bihar and
Assam.
Digital India program was promised to be RENEWABLE ENERGY

launched last year to ensure broadband Rs 75 crore for electric cars production.
connectivity at village level. Renewable energy target for 2022 : 100K
MW in solar; 60K MW in wind; 10K MW in
biomass and 5K MW in small hydro.
National Rural Internet and Technology TOURISM

Mission for services in villages and schools, Development schemes for churches and
training in IT skills proposed. convents in old goa; Hampi, Elephanta caves,
Forests of Rajasthan, Leh Palace, Varanasi,
Jallianwala Bagh, Qutb Shahi tombs at
Hyderabad to be under the new tourism
scheme.
Rs 100 crore scheme to support 600 new and There will also be VISA on arrival for 150
existing community radio stations. countries.
47
Rs 100 crore were announced for metro It was also described in the budget report
projects in Lucknow and Ahmedabad. 2015-16 that the credibility of the Indian
economy has been re-established in the last
nine months.The last nine months have seen
a turn around, making India one of the
fastest growing economies in the World with
a real GDP growth expected to be around
7.4%
Govt's plan expenditure pegged at Rs 5.75 Three Key achievements :
lakh crore and non plan at Rs 12.19 lakh 1. Financial inclusion- 12.5 crores families
crore financially mainstreamed in 100 days.
2. Transparent Coal block auctions to
augment resources of the States.
3. Swacch Bharat is not only a program to
improve hygiene but has also become a
movement to regenerate India.
Rs 4,000 crore to increase flow of cheaper Game Changing reforms :
credit for affordable housing to urban - Goods and Service Tax (GST)
poors/FWS/LIG segment migrants - Jan Dhan, Aadhar and Mobile (JAM) for
direct benefit transfer
Set aside Rs 11,200 crore for PSU banks Inflation has declined a structural shift has
capitalization, government in favour of been observed, CPI Inflation projected at 5%
consolidation of PSU banks ; the objective is by the end of the year, consequently, easing
to make banks more accountable and of monetary policy.
transparent
Rs 7,060 crore were separately allocated for GDP growth in 2015-16 is projected to be
setting up 100 smart cities between 8 to 8.5%.
9. Explain the various tools of credit used by RBI. (10 M) (Dec. 2014)
Or
Discuss the various credit control tools used by Central Bank of our country in order to
regulate credit in the economy. (10 M) (June 2015)
The government through the reserve bank of India employs the monetary policy as an instrument
of achieving the objectives of general economic policy. The main objectives of the monetary policy
are as follows:
 Regulation of monetary growth and maintenance of price stability
 Ensuring adequate expansion of credit
 Assist economic growth
 Encourage flow of credit into priority and neglected sectors
 Strengthening of the banking system of the country
The quantitative or general measures influence the total volume of the credit while the
qualitative measures influence the selective or particular use of credit.
Reserve Bank of India has the power to influence the volume of credit created by banks in
India. The banking regulation act 1949 says that the Reserve Bank of India can ask any
48
particular bank (or even all the banks i.e. banking system of the country) to not to lend to
particular groups/ persons.
Apart from this RBI is armed with weapons to control the money market in India. For example
each bank has to get a license from RBI to do banking business in India and this license is
always subject to cancellation by RBI provided the bank does not fulfill the requirements
stipulated by RBI. Each scheduled bank needs to send a weekly report to RBI which shows its
assets and liabilities.
The quantitative measures of credit control are :
I. Bank Rate Policy: The bank rate is the Official interest rate at which RBI rediscounts the
approved bills held by commercial banks. For controlling the credit, inflation and money
supply, RBI will increase the Bank Rate. Current Bank Rate is 6%.
II. Open Market Operations: OMO The Open market Operations refer to direct sales and
purchase of securities and bills in the open market by Reserve bank of India. The aim is to
control volume of credit.
III. Cash Reserve Ratio: Cash reserve ratio refers to that portion of total deposits in
commercial Bank which it has to keep with RBI as cash reserves. The current Cash reserve
Ratio is 6%.
IV. Statutory Liquidity Ratio: It refers to that portion of deposits with the banks which it has
to keep with itself as liquid assets(Gold, approved govt. securities etc.) . the current SLR
is 25%. If RBI wishes to control credit and discourage credit it would increase CRR &
SLR.
Qualitative measures: Qualitative credit is used by the RBI for selective purposes. Some
of them are
 Margin requirements: This refers to difference between the securities offered
and amount borrowed by the banks. Marginal Requirement of loan can be
increased or decreased to control the flow of credit for e.g. – a person mortgages
his property worth Rs. 1, 00,000 against loan. The bank will give loan of Rs.
80,000 only. The marginal requirement here is 20%. In case the flow of credit has
to be increased, the marginal requirement will be lowered.
 Consumer Credit Regulation: This refers to issuing rules regarding down
payments and maximum maturities of installment credit for purchase of goods.
 Guidelines: RBI issues oral, written statements, appeals, guidelines, and
warnings etc. to the banks.
 Rationing of credit: The RBI controls the Credit granted / allocated by
commercial banks. Rationing of credit is a method by which the Central Bank
seeks to limit the maximum amount of loans and advances and, also in certain
cases, fix ceiling for specific categories of loans and advances.
 Moral Suasion: psychological means and informal means of selective credit
control. Moral suasion and credit monitoring arrangement are other methods of
credit control. The policy of moral suasion will succeed only if the Central Bank
is strong enough to influence the commercial banks.
 Direct Action: This step is taken by the RBI against banks that don’t fulfill
conditions and requirements. RBI may refuse to rediscount their papers or may
give excess credits or charge a penal rate of interest over and above the Bank rate,
for credit demanded beyond a limit.
10. Explain the role and functions of RBI. (7 M) (June 2015)

Role of RBI in Economic Development:
49
 Development of Banking System

 Development of Financial Institutions
 Development of Backward areas
 Economic Stability
 Economic Growth
 Proper Interest rate structure
 Controlling Inflation
 Monitoring Financial System
Main Functions
1.Monetary Authority:
 Formulates, implements and monitors the monetary policy.
 Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.
2.Regulator and supervisor of the financial system:
 Prescribes broad parameters of banking operations within which the country's banking and financial
system functions.
 Objective: maintain public confidence in the system, protect depositors' interest and provide cost-
effective banking services to the public.
3.Manager of Foreign Exchange
 Manages the Foreign Exchange Management Act, 1999.
 Objective: to facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.
4.Issuer of currency:
 Issues and exchanges or destroys currency and coins not fit for circulation.
 Objective: to give the public adequate quantity of supplies of currency notes and coins and in good
quality.
5.Developmental role
 Performs a wide range of promotional functions to support national objectives.
6.Related Functions
 Banker to the Government: performs merchant banking function for the central and the state
governments; also acts as their banker.
 Banker to banks: maintains banking accounts of all scheduled banks.
11. What is Fiscal Policy? What are its Components? (5 M) (June 2015)
Fiscal policy involves the decisions that a government makes regarding collection of revenue
through taxation and about spending the revenue. It is often contrasted with monetary policy , in
which a central bank (RBI in India, the Federal Reserve in the United States) sets interest rates and
determines the level of money supply. Fiscal policy and monetary policy can have dramatic effects
on the economy.
INSTRUMENTS OF FISCAL POLICY

1. Taxation
Taxation is the most important source of public revenue of both development and developing
countries. On account of this reason, the governments of developing countries are trrying to
increase the proportions of national income collected in taxes from 10 to 15 percent to 30 to 40
percent levels reached in developed countries like USA, UK, France, Germany etc.
50
Tax revenue is usually considered under two headings: direct taxes on individuals and firms, and
indirect (commodity) taxes on goods and services. Direct taxes includes taxes on personal income,
corporate income tax, taxes on property and wealth.
Indirect or commodity taxes include sales tax, excise duty and customs duties (import and export).
While developed countries depend on direct taxes more for their tax revenue, developing countries
depend more on the indirect taxes.
2. Public Borrowing
The second most important source of public revenue is public borrowing; it is different from
taxation, since all borrowing from public must be repaid.
Repayment will require the raising of resources in future when the time comes. On account of this
obligation of repayment it is customary to regard public borrowing as merely an exercise of ‘fund
raising’ for government while taxation is ‘income proper’.
The government can raise public debt either in the form of voluntary loan or in the form of
compulsory loan. Voluntary loan is secured by the government by issue of various types of bills
and securities in the money market. In compulsory loan, bonds are issued by government for
periods ranging between five to ten years having tax free interest payment.
3. Forced savings or Deficit Financing
Deficit financing has become an important tool of financing government expenditure. In simple
terms it means the way the gap between excess of government expenditure over its receipts is
financed. However the concept of deficit financing is interpreted in different ways in the western
countries and in India.
In the western countries whenever the public expenditure is greater than its revenue receipts, it is
financed through public borrowing or creation of new money. Whenever there is deficit in the
current account, its financing becomes deficit financing. Even public borrowing is a way of deficit
financing.
In the modern sense public borrowings to finance excess of public expenditure over revenue is
included in the capital account of the budget. After including these borrowings in the capital
account, there may still be a deficit in the budget. The method adopted by the government to finance
this overall budget deficit in the current and capital account together is known as deficit financing.
India adopts deficit financing of this type.
The Planning Commission in India defines deficit financing as "the direct addition to gross national
expenditure through budget deficits whether the deficits are on revenue or capital accounts".
In Developing countries like India, deficit financing is identical to printing more currency and
putting it into circulation.
4. Public Expenditure
After the Second World War, many underdeveloped countries embarked upon ambitious programs
of economic development. As private sector does not have either the willingness or the resources
to invest in infrastructure such as the laying of railway tracks, power generation, development in
communication etc. Therefore, the responsibility of building up the infrastructure of the economy
and large capital goods industries has be borne by the government.
In the modern day world, the state has also to fulfill social obligation like provision of cheap or
free public health service, education, cheap housing facility etc. therefore additional expenditure
have to be incurred towards the provision of these facilities. Many developed countries provided
monetary assistance to unemployment persons. This is known as unemployment compensation.
Pensions to senior citizens are also provided.
12. Distinguish between Direct and Indirect Taxes. (5 M) (June 2015)

 Direct taxes are those which are levied on the individual or taxpayer directly while indirect taxes
are those which are levied on the individual indirectly which imply that they are raised from
intermediary and not directly from individuals.
51
 Direct taxes are raised in the form of income tax while indirect taxes are raised in the form on
excise duty, sales and service tax.
 While direct tax results in lower disposable income which in turn affect the saving and investment
of an individual whereas indirect taxes leads to rise in price of products and services which in turn
affects the consumption pattern of consumers across the country.
 While direct taxes are easily identifiable and higher income groups are taxed at higher rate which
is justifiable as you pay according to your means and thus they tend to reduce inequality of income
while indirect taxes are uniform for all individuals and it does no separate rich from poor which
makes those unjustifiable for poor people.
 While an individual can adjust his or her income tax by investing into various tax exempt
investments and therefore it results in reduced direct taxes whereas indirect taxes have to be paid
and there quantum cannot be reduced.
 Chances of tax evasion are more under direct taxes than it is under indirect tax structure.
 Direct tax does not lead to higher inflation but since indirect tax results in higher price for products
it leads to higher inflation and therefore they put inflationary pressure on the economy of a country.
Governments across the world seldom use any of them rather they use a mix which can result in proper
redistribution of income without affecting the growth and inflation of a country too much.
13. Explain briefly the reasons for Fiscal Deficit. (5 M) (June 2015)
DEFINITION of 'Fiscal Deficit'
When a government's total expenditures exceed the revenue that it generates (excluding money
from borrowings). Deficit differs from debt, which is an accumulation of yearly deficits.
Causes of Fiscal Deficit
 Increase in Subsidies: The government has been providing subsidies on a number of items such as
fertilizers, exports, food items, etc. This has resulted in a fiscal imbalance. The major subsidies
provided by the Central Government of India has increased over the years resulting in fiscal
imbalance.
 Payment of Interest: One of the major components of government expenditure is the interest
payment both on domestic loans and foreign loans. The government debt has increased
considerably over the years. This has resulted in increased interest burden on the government.
 Defence Expenditure: The defence expenditure is increasing over the years. The government has
limited scope to reduce defence budget due to security problems across the Indian borders.
 Poor Performance of Public Sector: The poor performance of public sector has also resulted in
fiscal imbalance. The poor performance of public sector is due to various reasons such as political
interference, inefficiency and corruption of management, low labour efficiency, lack of
professionalism, surplus staff, etc. Due to poor performance of public sector, the Government gets
low revenue by way of dividend from public sector units.
 Tax Evasion: Indian tax system is made up of complex procedures with numerous exemptions.
Corruptions is rampant at all levels, which leads to the fiscal imbalance.
 Weak Revenue Mobilisation: While increase in government expenditure has been the major cause
of fiscal imbalance, inadequate rise in revenue receipts also contributed to fiscal imbalance. The
revenue receipts of the centre, consisting of tax revenue, net of state's share and non-tax revenue,
has increased at slower rate than that of growth in expenditure.
 Excessive Govt. borrowings
The Indian Context:
52
India recorded a Government Budget deficit equal to 4.50 percent of the country's Gross Domestic
Product in the fiscal year 2013/2014. Government Budget in India averaged -3.87 Percent of GDP
from 1991 until 2014, reaching an all-time high of -2.04 Percent of GDP in 1997 and a record low
of -7.80 Percent of GDP in 2009. Government Budget in India is reported by the Ministry of
Finance, Government of India.
India’s fiscal deficit in the first two months of the fiscal year 2014-15 (April-May) touched 45.6%
of the full-year target of Rs.5.3 trillion, a six-year high, because of high non-Plan expenditure and
low revenue receipts. In 2013-14, during the same period, fiscal deficit stood at 33.3% of the full-
year target.
53

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Economics for Managers 16MBA12

Question Papers and Solutions

1. What is Cross Elasticity of Demand?(3 M) (June 2016)

3. Explain the Baumol’s Sales revenue maximization? (7 M) (Dec. 2014)

Y Axis measures the annual profit rate- ROI

X Axis measures the size of sales.

Ep =Percentage change in Quantity demanded

Where Ep = Price Elasticity

Types of Price Elasticity

2. Income Elasticity of Demand

ratio of percentage change in quantity demanded due to percentage change in income of

Ey =Percentage change in Quantity demanded

Where Ey = Income Elasticity

Types of Income Elasticity

Advertising elasticity of demand= Proportionate change in sales

Illustration: Practical Application

6. Briefly explain the scope of Managerial economics. (10 M June 2015)

2. Explain the Law of Variable proportions. (10 M) (Dec. 2016)

The product curve

Explanation of the stages

3. Briefly explain the properties of Iso-quant curves? ?(7 M) (June 2015)

Forms of internal Economies

Forms of External Economies:

DISECONOMIES AS LIMITS TO LARGE-SCALE PRODUCTION

 Target Sales volume = TFC- Target Profit

 It is useful in arriving at make or buy decision.

Importance of the concept of opportunity cost

4. Define Total , Average and marginal Cost?(3 M) (Dec. 2014)

Average Total Costs (ATC):

In the short-run, since TC = TFC + TVC

Thus, TC = TFC + TVC

The data are based on the following assumptions:

 Labour and capital are the two factor inputs.

The short-run total cost schedule of a firm (hypothetical data)

Units of Units of labour Total TFC TVC TC

Behavior of Total Costs:

The causes for the adoption are:

The causes for the adopting are:

3. What is Oligopoly? Explain its features. (7 M) (Dec. 2014)

5. Explain with the help of ‘Kinked Demand Curve’. (7 M) (June 2015)

Diagram: Monopolistic Competition Short Run Equilibrium

Methods of Measurement of National Income

Difficulties in Measurement of National Income

Precautions for Value added approach •

Precautions in Expenditure Method

Precautions in Income Method

2. What do you understand by the term GDP?(3 M) (Dec. 2014)

Phases of Business Cycle:

 Increased international trade

 There would be Chances of ASSETS STRIPPING of profit-making

4. Write a note on ‘New Industrial Policy of 1991’. (7 M) (June 2015)

7. Disinvestment of Public Sector Units' shares.

9. Abolition of C.C.I, and wealth tax on shares.

10. General reduction in customs duties.

Critique of the New Industrial Policy

Free trade has many advantages, such as:

6. Mention the instruments of Fiscal Policy?(3 M) (June 2015)

7. What is meant by Fiscal Policy?(3 M) (Dec. 2014)