Assignment Code: BCOG-171/TMA/2022-23

Course Code: BCOG-171

Assignment Name: Principles of Micro Economics

Year: 2022-2023

Verification Status: Verified by Professor

Maximum Marks: 100

Note: Attempt all the questions.

Section-A

(This section contains five questions of 10 marks each)

Q.1) Explain the main determinants of demand of a commodity in the market. Distinguish between an Inferior good (commodity) and a Giffen good. (10)

Ans) The main determinants of demand of a commodity in the market are as follows:

Size of the Population: The likelihood that a commodity will be in higher demand increases with population size, all other things being equal. The population's size is influenced by a wide range of different variables. Birth and death rates play a significant role in determining a nation's population growth. In the past, birth rates have tended to rise faster than death rates. However, the population increase rate is accounted for by these two causes. Emigration and immigration have a small impact on population. This might be substantial in a small country, but in a large one like India (1380 million people in 2020), the impact of emigration and immigration is negligible.

Income Distribution: It is a little challenging to express the concept. In layman's words, it illustrates how poorer and higher income groups of people are distributed within the National Income (the factor income of the citizens of an economy over a year). Let's use an example to illustrate how it works. Assume for the purposes of situation A that the poorest 10% of the population receives only 2% of the nation's income, while the richest 10% of the population receives 6%. In contrast to situation B, where the richest 10% of the population receive 30% of the national revenue, this condition is described as having a very unequal distribution of income. In situation B, the poorest 10% of the population account for 9% of the national income.

The differences between an Inferior good (commodity) and a Giffen goods are as follows:

Giffen commodities are particular varieties of inferior goods, which makes them quite comparable to inferior goods in general. Both of these product categories are specific product categories that customers regard differently as market prices and income levels vary because they do not follow the general demand patterns outlined in economics. Giffen goods are products whose demand will decline when prices drop because consumers are less likely to buy more of them even when prices are low since they will instead look for better alternatives or spend their money on other things. People will spend less on subpar products as their income grows since they can now afford to buy more expensive, higher-quality alternatives.

These two ideas initially appear to be the same since they do not follow the same basic consumption patterns. As a result, when market prices and income levels fluctuate, consumers treat these items differently, despite the fact that they are distinct as was already mentioned. Giffen products are an example of inferior goods, thus they all fall under that category, but it is impossible to go the other way.

Q.2) Explain the Law of Supply. Point out its exceptions. (10)

Ans) If other factors that affect supply do not change, a higher price would result in greater profits. A producer will therefore be more inclined to supply if he anticipates receiving a better price for his goods. Similar to this, a producer will supply less if he anticipates receiving a lower price for his goods. Therefore, we see a direct correlation between a commodity's price and its supply. The "Law of Supply" refers to this direct correlation between a product's price and supply.

According to the law, if all other factors affecting supply stay constant, the quantity supplied of an item per unit of time increases as its price rises and vice versa. The only condition under which the law of supply is valid is that all other variables stay unchanged. In this direct relationship between price and supply of a good or service, the alteration in supply is brought about by the alteration in price, making the former the cause and the latter the result. The same idea can be expressed differently by noting that supply is treated as a dependent variable while price is treated as an independent variable. It is crucial to realise that while the statement "Supply rise leads to price rise" is untrue, the statement "Price rise leads to supply rise" is correct.

Exceptions to the Law of Supply

In general, the law of supply shows a relationship between the quantity supplied and the price. The law of supply has a few exceptions. Below are a few of the exceptions:

Non-maximisation of Profits: In some circumstances, the business may not be aiming to maximise profits. In that instance, even if prices remain unchanged, the quantity supplied may rise. For instance, if the company wishes to maximise sales while maintaining the same pricing, it may prefer to increase sales in order to boost overall revenue. The company may occasionally want to maximise revenues over the long term, while pursuing other objectives in the short term. Similar to this, if a company controls multiple businesses, it may want to maximise the profitability of each business collectively, making it possible for the law of supply to not apply to every product produced.

Factors other than Price not Remaining Constant: The rule of supply was established under the presumption that variables other than the commodity's price would not change. In practise, we see that things like the product's pricing may not always stay the same. For instance, if the prices of other commodities tend to rise, the amount of a commodity offered at a given price may decrease. Even though the price of a commodity does not change, a change in the state of technology may result in a change in the quantity supplied.

Q.3) Explain the concept of consumer's surplus. What are its limitations? (10)

Ans) The difference between the price a customer is willing to pay for a good and the price he actually pays for it is known as the consumer's surplus. The excess can be calculated in either monetary or utility terms. The measurement is expressed earlier in terms of utility units.

By Marshall, the idea of consumer surplus was first introduced. As you can see above, every consumer must purchase the same amount of a good or service for which its marginal value (i.e., the utility obtained from the final unit of the good or service) and price become equal. You would recall that the law of diminishing marginal utility applies to all commodities. The marginal usefulness of a commodity decreases when more is purchased by the consumer. The utility derived from intra-marginal (or earlier) units of a good is therefore different from the benefit derived from the marginal (or last) unit, which is equal to the price paid for it. It is more than the cost. The implication is that while the utility derived from the most recent unit is fully paid for by the consumer, the value derived from prior units is only partially paid for. The remaining functionality is provided without charge to the user.

The limitations of consumer's surplus are as follows:

1. Because it is challenging to calculate the marginal utility of various units of a good consumed by an individual, the consumer's surplus cannot be calculated with precision.

2. The marginal utility of the prior units are endlessly enormous in the case of necessities. The consumer surplus is always unlimited in such a scenario.

3. The availability of replacements has an impact on the surplus generated by a commodity for the consumer.

4. The utility scale of items that are used for their prestige value cannot be determined by a straightforward rule.

5. Because the marginal utility of money varies as purchases are made and the consumer's stock of money decreases, the consumer's surplus cannot be expressed in terms of money.

6. Only if it is assumed that utility may be valued in terms of money or another way, can the idea be accepted.

Consumer surplus is more than just a theoretical concept. It has a lot of practical importance despite the fact that it is challenging to quantify precisely and that trying to apply it to the entire market presents many challenges. For instance, the government is aware that needs increase consumer excess. As a result, they ought to charge amenities rather than necessity. Additionally, they ought to refrain from taxing the goods that make up a larger amount of the budgets of the poor. Similar to this, businesspeople might demand higher prices for goods that are in "strong" demand—that is, for which consumers are willing to pay more than they otherwise would.

Q.4) What is full-cost pricing principle? How does it lead to a higher than optimum production? (10)

Ans) Whatever the short-term surpluses of the monopolistic rival, they will eventually be eliminated. This occurs because surpluses draw in additional businesses because there is no barrier to new businesses entering the market. His demand-price curve also slopes downward as total output increases until the price is equal to the average cost of production. Assuming that there won't be any surpluses, the provider sets his price from the beginning to be exactly equal to the average cost of production. This is often referred to as the full-cost pricing approach.

Full cost pricing is a process in which a company determines the price of a product using its direct expenses per unit of output along with a markup to account for overhead costs and profits. The full-cost pricing approach has a clear advantage. In contrast to the alternative way of aligning marginal cost to marginal revenue, the producer achieves a higher production.

The mark-up pricing concept is another name for the full-cost pricing tenet. However theoretically amazing the marginal cost-marginal revenue equality principle may appear to a producer; it may not always be practical to put it into practise. For him, the task of determining marginal revenue and marginal cost under actual market conditions and attempting to match them may be too challenging and time-consuming. He would rather make a rough estimate of his usual cost and add to it however much, in his opinion, is necessary to ensure that he will receive the necessary recompense for his investment. The price he would prefer to charge is this increased amount. Because of this, the idea is also referred to as a mark-up pricing principle.

Full-cost pricing results in production that is greater than ideal. Now, if a producer engages in full-cost pricing in an environment of monopolistic competition, his output may exceed the ideal output. Naturally, there would be no opportunity to maximise excess as there is when marginal cost and marginal revenue are equal under full-cost pricing. There is potential for producing abnormal profits, at least in the short term. If there are producers who are motivated to maximise their earnings, then in their case equilibrium will occur before the point of maximum output. If that were the case, idleness and resource waste would be inevitable.

The fact that price is not equal to marginal cost of production in monopolistic competition is another characteristic of inefficient production about which there is no debate. When price is not equal to marginal cost, a suboptimal distribution of resources occurs, as we have discussed in the context of monopoly. In light of the fact that a monopolistic competitor's price is never equal to its marginal cost but is instead above it, the allocation efficiency of this kind of market is therefore never optimal.

Q.5) Explain the marginal productivity theory of distribution. Also state its assumptions. Why is the marginal productivity theory not considered a satisfactory theory of distribution? (10)

Ans) According to the marginal productivity theory, which J.B. Clark and others established, the reward for each of the four production elements depends on how productive its marginal income is. The firm that employs the factor of production and the industry to which the firm belongs are both regarded as being in equilibrium when compensation for a factor equals both marginal and average revenue productivity as well as marginal factor price.

Assumptions of the Marginal Productivity Theory

1. The factor markets are thought to be dominated by perfect competition. Let's say that the factor of production we are thinking about is labour. It is considered that there are so many buyers and sellers in the labour market that no one of them can have a significant impact on the pay rate alone. Furthermore, it is believed that labour is both homogeneous and mobile.

2. It is expected that the good generated by the relevant factor of production would sell in a market with perfect competition.

3. The theory makes the supposition that different production elements can be blended in various ratios during manufacturing. This indicates that production can be conducted by altering the quantity of one factor of production while maintaining the quantities of the other factors of production.

4. According to the law of changing proportions, production occurs, which suggests that the law of decreasing returns is what governs the ultimate stage.

5. All factor units must be employed since the theory bases its predictions on the economy having full employment. As a result, it implies that no factor units will be willing to perform for any pay or incentive that is less than the going rate in the market.

The marginal productivity theory falls short in its attempt to explain distribution. These are the reasons it has drawn criticism:

Factors of Production are not always Divisible: Only when a production element should be dividable or variable in tiny quantities can the marginal productivity of a production factor be evaluated. In reality, though, it's not always feasible. Therefore, it is typically quite difficult to measure the marginal productivity of capital equipment.

Factor Proportions in most Modern Industries are not Variable: Producers believe that certain factor ratios are immutable. In this case, it is impossible to gauge a factor's marginal production.

Marginal Productivity of Capital and Enterprise is not Measurable: Capital takes on the shape of capital equipment during the production process, and this equipment contains technology that is crucial to the productivity of labour. Because of how complicated this situation is, it is impossible to assess the estimated capital's marginal productivity. The money's lender gains additional interest. Due to the inability to properly identify its units, the enterprise problem is still more challenging to solve.

Unrealistic Assumptions: In the actual world, imperfect competition predominates, and employers may choose to hire production elements for a wage that is less than the marginal productivity. In a capitalist society that experiences levels of employment that are less than full, this forms the basis of exploitation.

The Marginal Productivity Theory does not explain Distribution: The marginal productivity theory first explains why an element of production is in demand before acknowledging that a factor of production's reward depends on both its supply and demand. Knowing the factor price, the company uses a factor until its compensation equals its marginal revenue productivity.

Section-B

(This section contains five short questions of 6 marks each)

Q.6) Distinguish between positive and normative economics. Which one should be preferred and why? (6)

Ans) The differences between positive and normative economics and which one should be preferred is mentioned below:

Positive economics only focuses on articulating economic principles and outlining reality. Theoretical presumptions or documented facts can both be used to develop the economic laws. In either case, they only inform us of what is. They make no determination as to whether the results of the economic analysis are desirable or call for revision. Contrarily, normative economics acknowledges that no economy is ever perfect. Its performance's results can constantly be enhanced. Finding an economy with numerous issues that need rapid care is extremely common. Such issues can be connected to price changes, employment, a lack of particular inputs, income, and wealth disparities, and more. In normative economics, the information learned is applied to enhance how the economy functions. Improvement goals are established, and the policy actions necessary to attain the goals are developed. Therefore, normative economics is focused on what should be. It is economics in application.

Economics research bears fruit or is employed as a creative tool to accomplish certain objectives. By definition, normative economics entails making value judgments, or judging what is right and desirable vs wrong and should be avoided. The inability to consistently come to consensus on a set of objectives is a special issue for normative economics. Therefore, each economist may suggest a different set of corrective actions depending on his preferences. Additionally, while in normative economics we employ them to achieve predetermined goals, in positive economics we stop at their derivation. The justification for normative economics is that since we care about our material well-being, we should seek to better both our circumstances and the way the economy functions. So, we shouldn't study economics only for the purpose of studying it. We should apply economics to real-world problems instead, hence normative economics is preferred over positive economics.

Q.7) Explain the attainment of equilibrium position by a consumer with the help of an indifference curve. (6)

Ans) Indifference curves technique can be used for measuring consumer's surplus also. This is done in the figure below.

In a demand curve, the quantity desired is measured along the X-axis and the price per unit of the commodity is measured along the Y-axis. The demand curve can be derived from the price consumption curve. Let the consumer have an OA income, and let AB provide his budget price range. According to the equilibrium position P, the consumer purchases OM of X1 for a price AC and keeps the remaining balance OC for himself. Now imagine an indifference curve showing all X and Y pairs that are equally useful to the pair zero of X plus OA of Y. The figure shows an indifference curve with the label "I." According to the diagram, Zero of X plus OA of Y has the same utility for the consumer as OM of X plus PM1 of Y. In other words, the customer is willing to pay AD for OM of X rather than forego it. But in reality, he merely pays AC. As a result, AD - AC = CD gives the difference between what he is willing to spend and what he actually pays. This is the consumer surplus calculated in terms of money (or in terms of commodity Y).

Q.8) What is backward bending supply curve? Explain with an example. (6)

Ans) An illustration of this condition, when real wages rise above a certain point, is a backward-bending labour supply curve. Real wage growth will have an impact on both income and substitution. We are aware of the income impact, which asserts that greater wages allow people to make their desired income with fewer hours of work. Therefore, it is simpler to earn enough money by working fewer hours if wages rise. They enjoy replacing leisure to further boost their revenue. We are aware that a higher income makes labour more alluring than leisure, according to the substitution effect. As a result, because work pays more, supply rises in proportion to rising earnings.

Leisure time will take the place of paid job time as salaries rise. As a result, there will be less labour available for sale and a consequent fall in the labour supply. The "labour-leisure" trade-off is something that wage-earning people must deal with because it involves the balance between the time spent doing work that pays a wage and the pleasure-producing unpaid time that enables participation in "leisure" activities and the use of time for essential self-maintenance tasks like entertainment and sleep. This suggests that the labour supply curve has a positive slope. However, the backward-bending labour supply curve happens when a higher income incentivizes employees to take advantage of more unpaid time and work fewer hours.

For instance, a person who is eager to spend time engaging in leisure activities while yet having minimal needs for goods and services. He might want to earn Rs. 30,000 annually and then optimise his free time after that. In this instance, the income effect takes over once wages surpass Rs. 30,000. With increased wages, he can now afford to take more time off from work. Similar to how a person will do well in satisfying his desire for goods and services but have little interest in leisure activities due to the substitution effect. The ability to earn more money and purchase more items increases the incentive to labour longer hours when wages rise.

Q.9) Explain the nature of Average Revenue Curve and Marginal Revenue Curve of a firm under Oligopoly. (6)

Ans) A demand curve is also a buyer's pricing curve since it reveals both the quantities of a commodity that buyers are willing to want and the prices at which they wish to do so. The demand curve can also be referred to as the buyers' price curve and the supplier's average revenue curve since the buyer's price is the average revenue for the supplier. As a result, in a market with perfect competition, the average revenue curve is horizontal. The price, or average revenue, stays the same with an increase in supply, and marginal revenue will match average revenue. The average revenue curve can therefore be seen as indicating marginal revenue at various levels of quantity sold in a perfect competitive environment.

A demand curve where increased supply is followed by lower revenue on average and lower supply is accompanied by higher revenue on average. This is achievable because all market participants agree to maintain their respective market shares by selling more at lower prices and fewer at higher prices. Nobody enjoys using force to drive others away. As a result, the average and marginal revenue curves of a typical corporation will be downward sloping. The marginal revenue curve in this case is discontinuous, it should be emphasised. If the demand curve is kinked, the average and marginal revenue curves are both sloping downward but have peculiar forms.

Q.10) Discuss the concept of quasi-rent. How does it differ from the concept of economic rent? (6)

Ans) Marshall introduced the idea of quasi-rent for the first time in his well-known book Principles of Economics. According to him, the supply of production inputs like capital equipment might be inelastic in the near term, which allows them to earn more than their supply prices. This surplus is undoubtedly rent in nature. Marshall, though, preferred to refer to it as quasi-rent since he could distinguish clearly between land and other elements of production, particularly capital goods, and structures.

In both short and long time frames, the supply of land remains constant. Even over a lengthy period of time, man cannot increase its supply through skill or effort. Capital equipment, however, is an exception to this. Although its supply may be inelastic in the short term, it can always be raised over the long term. Marshall believed that equipment, structures, and skilled labour could only generate an excess over their supply prices in the near term. Over time, as these components' supplies rise in response to rising demand, the surplus is eventually erased. Marshall argued that no factor of production can generate quasi-rent over the long term.

According on whether the availability of a resource is permanently or temporarily insensitive to the amount of compensation paid for its usage, this payment is referred to as "economic rent" or "quasi-rent" in economic theory.

Section-C

(This section contains four short questions of 5 marks each)

Q.11) ‘Scarcity is the mother of every economic system.’ Explain. (5)

Ans) One of the most fundamental economic issues we deal with is scarcity, or the lack of resources. Because we live in a society with boundless demands even if resources are scarce, we encounter scarcity. We must thus make a decision. We have to compromise. We must deploy resources effectively. Because resources are finite and cannot satiate our insatiable wants, we must take such actions.

Economics as a science would not exist without scarcity.

Economics is the study of how products and services are made, distributed, and consumed. Studying such acts would be fairly dull if society did not have to make decisions on what to create, distribute, and consume. To meet people's limitless wants and requirements, society would produce, distribute, and consume an infinite amount of everything. Everything would be free, and everyone would have what they wanted. We all see, however, that this is untrue. Economists research the choices and trade-offs society makes in response to scarcity. Because of this, scarcity is the foundation of all economic systems.

Q.12) What are the properties of an Isoquant? (5)

Ans) The properties of an Isoquant are as follows:

1. An isoquant has a negative slope or slopes downward from left to right. This is the case because when one input is raised, the quantity of the other input must be decreased in order to maintain a constant total output.

2. There can be no intersection of two isoquants. If they do, it means that at the moment of contact, a specific pairing of two inputs will result in two distinct output levels. But this is totally ridiculous. How is it possible for the same input combination to result in two output levels with the same production methods?

3. The origin is convex for an isoquant. Because of the diminishing marginal rate of technical replacement, isoquants are convex. The law of diminishing marginal returns is also implied by an isoquant's convexity. The fact that many variables in the manufacturing of a good are imperfect substitutes for one another leads to the declining marginal rate of technological substitution. Normally, an isoquant is convex at the origin.

Q.13) Distinguish between primary and intermediate inputs. (5)

Ans) The differences between primary and intermediate inputs are as follows:

The laws of production or broad generalisations about the relationships between inputs and outputs make up the theory of production. Therefore, the subject matter of the theory of production is the broad description of the physical interactions between inputs and outputs. The term "inputs" refers to everything involved in creating tangible commodities or services. Some inputs are made up of commodities and services that are now being produced by other economic producers. Intermediary inputs are what they are known as.

Primary inputs, such as land, labour, capital, and enterprise, make up the other inputs. Primary inputs are also known as production factors. Consider a carpenter who makes chairs as an example. The carpenter's labour, the workshop, the tools he used, and the initiative he took to make chairs are instances of main inputs. The wood, nails, cane, and polish that he used are examples of intermediate inputs.

Q.14) Critically examine the Law of Equimarginal Utility. (5)

Ans) Law of Equimarginal Utility explains the relation between the consumption of two or more products and what combination of consumption these products will give optimum satisfaction.

Law of Equimarginal Utility

This law is founded on the idea that you should make the most of your limited resources. It shows how a consumer behaves when he consumes multiple commodities. According to the law, a customer should allocate his limited funds among a variety of goods so that, in order to maximise happiness, the last rupee spent on each good will provide him with equal marginal utility.

Assumptions of the Law

1. There is no change in the price of the goods or services.

2. The consumer has a fixed income.

3. The marginal utility of money is constant.

4. A consumer has perfect knowledge of utility.

5. Consumer tries to have maximum satisfaction.

6. The utility is measurable in cardinal terms.

7. There are substitutes for goods.

8. A consumer has many wants.

Importance of the Law

1. The area of production benefits from this law. A producer works to maximise profit despite having limited resources.

2. This law is beneficial in the area of trade. A variety of things are exchanged, including wealth, trade, imports, and exports.

3. The field of public finance is appropriate.

4. Workers can use the law to schedule their time between work and rest.

5. In both saving and spending situations, it is helpful.

6. In the event of a price increase, it is wise to explore for alternatives.