Explore topic-wise InterviewSolutions in Current Affairs.

Correct option: (b) negative

Correct option: (d) zero

Option : (3) Both (A) and (R) are True and (R) is the correct explanation of (A).

Cross elasticity.

1. Perfectly inelastic

2. Total Expenditure 

3. Relatively elastic 

4. Point I Geometric method 

5. Complementary goods

Option : (3) Both (A) and (R) are True and (R) is the correct explanation of (A)

Correct option: (c) rectangular hyperbola

Importance of Concept of Elasticity of Demand:

1. To a Producer : It helps the producer to decide the price for his product. If the demand for his product is relatively inelastic, he will fix higher price and vice versa.

2. To Government : In order to raise additional revenue by means of new taxes like excise duties on commodities Govt, has to keep in mind the elasticity of demand for a commodity. So a high tax can be imposed on commodities like petrol or cigarettes, the demand for which is relatively inelastic.

3. In International Trade : If the foreign demand for exportable products of a country is relatively elastic, its export will rise much after a slight reduction in their prices. But if foreign demand is relatively inelastic, the exporters can raise their prices without much fall in exports.

4. Trade Union : Knowledge of elasticity of demand can help the trade union in wage bargaining. They can ask the employees to pay higher wages to the workers by changing the price policy of their product. If the demand for the product produced by them is inelastic then the trade unionist may suggest the employer to raise the price, so as to earn higher profit. Which then can be used to pay higher wages.

5. Public Utility Services : It is the Government who takes the decision to distribute certain essential goods and services, which have inelastic demand. For eg. Indian Railways, bank service, water supply, etc. If such services are left to private sector they will exploit the consumers by charging high prices.

6. Devaluation : Devaluation measure is adopted by the government to promote exports and correct deficit in the balance of payment. Devaluation makes our goods cheaper in the foreign market. However, devaluation is successful only if exports have elastic demand.

7. Factor Pricing: It is helpful in determining the prices of various factors of production like rent for land, wages or salary for labour, interest for capital, etc.

(a) Positive Cross Elasticity (Substitutes) 

(b) Negative Cross Elasticity (Complementary) 

(c) Zero Cross Elasticity (Unrelated goods)

(a) Positive Cross Elasticity : Positive cross elasticity of demand takes place in the case of substitute such as tea and coffee, pepsi and coke. If the price of coffee rises it will lead to an increase in the demand for tea. Similarly a fall in price of coffee will cause a decrease in demand for tea. Thus price and demand move in the same direction in case of substitute.

(b) Negative Cross Elasticity : Negative cross elasticity takes place in the case of complementary goods. It takes place when a change in the price of (petrol) one complementary good brings about a change in demand for (car) another commodity in the opposite direction. 

For e.g. a rise in petrol prices may lead to fall in demand for car and vice-versa.

(c) Zero Cross Elasticity: Zero cross elasticity of demand takes place in case of unrelated goods. For instance a rise or fall in price of car may not affect the demand for books.

In international trade, the concept of elasticity of demand plays an important role. This concept proves helpful in determining the norms that would prove beneficial for international trade. For instance, based on the elasticity of the commodities that are exported, the country can decide on the price that is to be charged. For exports that have inelastic demand, higher price can be charged. Similarly, the concept can be used to formulate export and import policies in a better manner.

In international trade, the concept of elasticity of demand plays an important role. This concept proves helpful in determining the norms that would prove beneficial for international trade. For instance, based on the elasticity of the commodities that are exported, the country can decide on the price that is to be charged. For exports that have inelastic demand, higher price can be charged. Similarly, the concept can be used to formulate export and import policies in a better manner.

The concept of Price Elasticity was developed by great neo-classical economist Dr. Alfred Marshall in the year 1890.

According to Dr. Alfred Marshall, “The elasticity or responsiveness of demand in a market is great or small, according to the amount demanded which increases much or little for a given fall in price, and diminishes much or little for a given rise in price. ” Elasticity of demand in fact refers to the degree of responsiveness of the quantity demanded of a commodity to change in the variable on which demand depends.

(i) Internal Economies: The internal economies (advantages of large scale production) arise within the firm when it increases its scale production by increasing all inputs. The major internal economies are as follows:

• Technical economies – benefits from capital equipment i.e., machines 
• Managerial economies – reduction in managerial expenses 
• Marketing economies – can manage bulk orders of supply 
• Financial economies – can easily raise finance/loan. 
• Risk bearing economies – can face ups and downs in business. 
• Transport and storage economies – development of transport and warehouse of its own.

(ii) External Economies: These are the benefits which a firm gets when the entire industry is expanded. They accrue to all the firms as a result of expansion in the output of whole industry and they are not dependent on the output level of individual firms. The firms get these economies from outside because of expansion of the industry. The major external economies are as follows: 

•  Low cost of raw materials and capital equipments.
• Technological economies-use of latest techniques of production. 
• Development of skilled labour – trained labour for higher productivity. . 
• Growth of ancillary industry – small scale industries to supply spare parts and use of by-products. 
• Development of Transportation, communication and marketing facilities.

(iii) Diseconomies and Decreasing Returns to scale: The decreasing returns in the production process operate mainly because of diseconomies of large scale production. The firm faces lots of difficulties in managing these roadblocks. When the size of the firm is expanded, its management and supervision becomes, complicated. There are many disadvantages of large scale production which area also known as dis-economies of scale.

There are two types of diseconomies viz., Internal Diseconomies and External Diseconomies of scale. 

(a) Internal Diseconomies: These are the disadvantages.which a firm faces due to expansion of its scale of production. 

They are: 

• Lack of proper coordination among different departments of production process. 
• Lack of control on inputs. 
• Deterioration in communication between various departments. 
• Lack of identification of errors committed.

(b) External Diseconomies: These are the disadvantages which the firms have to face due to expansion in the industry as whole. 

They are: 

•  Increased pressure on transportation – increase in cost of transport.
• Increase in pollution – rise in social cost. 
• Shortage of capital-banks hesitate to finance. 
• The factors of production becoming costly. 
• Increase in business risk and marketing problems.

It is the cost of the next best alternative product which is measured in terms of revenue earned by the factor when it is employed in other alternative jobs.

In other words it is the cost of displaced alternative. While calculating opportunity cost the profit earned from the best alternative employment sacrificed is taken into consideration. The concept of opportunity cost was popularized by an American writer -Prof.Heberlour.

When the Short run Average Variable Cost (SAVC) is decreasing, the Short run Marginal Cost (SMC) also should decrease and when SAVC increases, the SMC should also increase but more than SAVC. Hence, the SMC curve has to cut SAVC from below at the minimum point.

In the long run, we have three types of costs viz.., Total cost, Long run average cost, and Long run marginal cost.

Also known as decreasing returns to scale, operates when output increases in a smaller proportion for an increase in all inputs. Here, the Total Product increases in a decreasing rate. For example, if a producer increases all inputs by 20%, the total product may increase by 15% only.

The four major short run costs are as follows: 

1. Fixed Cost 

2. Variable Cost 

3. Total Cost 

4. Average Cost.

When the output increases in a greater proportion than the increase in inputs it is called as Increasing Returns. When a firm expands, increasing returns to scale are obtained in the beginning. Here the Total Product increases at increasing rate, For example, if there is 20% increase in inputs, the output increases by 30%.

The three laws of Variable Proportions are as follows: 

1. The law of Increasing Returns.

 2. The law of Diminishing Returns. 

3. The Law of Negative Returns.

Prof. Alfred Marshall introduced the concept of Real cost.

For an increase in the output, AC and MC fall initially then reach a minimum value and later rise with the rise in output. The change in MC is greater than that in AC.

In the beginning, AC falls due to the more influence of of AFC and later rises under the influence of AVC with an increase in output. This makes AC to become U shaped.

MC falls as output increases in the beginning. It starts rising after a certain level of output. This happens because of the influence of the law of variable proportions. The fact that Marginal Product rises first, reaches maximum and then declines ensures that the Marginal Cost curve of a firm declines first, reaches minimum and then rises and becomes U shaped.

Calculation of Marginal product: 

4 Labour – 70 Units of ‘x’ 

5 Labour- 75 Units of ‘x’ 

MP = TPn -TP_n-1 , where TP_n= 75, TP_n-1=70 

= 75 – 70 = 5

 units of product. 

So, MP = 5 

Calculation of Average Product (AP): AP 

= TP/Input(Labour) 4 Labour – 70 Units of ‘x’ 

AP = 70/4 =17.5 with 4 labourers and capital 

5 Labour- 75 Units of ‘x’ 

AP = 75/5 = 15 with 5 labourers and capital.

Cost of production refers to the expenses incurred by the producer to produce various goods and services. It includes all those expenditures incurred by a firm or industry to manufacture their products.

It is the cost per unit of output produced. It is obtained by dividing total cost by the total output produced, i.e. AC = TC/output.

These are the costs which are incurred on fixed factors of production. The amount of expenditure.spent on fixed factors is unaltered in the short run.

It is an additional cost incurred to produce an additional output. In other words it is the net additions to the total cost when one more unit of output is produced. MC = TC_n – T_Cn-1,

An Iso-quant is a curve on which the various combinations of labour and capital show the same level of output. It also refers to the locus of all possible combinations of two inputs (Labour and Capital) which result in the same output level.

The Marginal Product refers to additional unit of output produced with help of additional factor input.

The process of determination of price of goods and services through market forces viz., demand and supply is called ‘Price Mechanism’.

There are four essential requirements for existence of a market, they are as follows; 

•  Existence of goods and services. 
• Existence of buyers and sellers. 
• Existence of Price 
• A place – region, a country or means of exchange – internet/telephone.

The equilibrium price is that level of price which is determined at the point where the demand and supply intersect (i.e., when supply and demand become equal).

Equilibrium refers to a position of rest. It is a position from which the producer or a firm has no tendency to move or change.

The supply in economics refers to the quantity of a product which the sellers or producers offer for sale at a particular level of price and particular period of time.

i. One seller and large number of buyers: Monopoly is said to exist when there is only one seller of a product. A monopolist may be the only person, a few partners or in the form of joint stock company. The demand for the monopolist is the market demand. In simple monopoly the number of buyers is assumed to be large. No single buyer can influence the price by his individual actions.

ii. No close substitute: The second condition of monopoly is that there should not be any close substitute of the product sold by the monopolist. If it is not so, the monopolist cannot charge a price according to his own desire. So he cannot be a price maker. That means, monopoly cannot exist when there is competition.

iii. Restriction on the entry of new firms: In a monopoly market, there is a strict barrier on the entry of new firms. Monopolist faces no competition. For example, in India, production of atomic energy is to be done only by Government. The private entrepreneurs are restricted from entering that market.

iv. Nature of Demand Curve: The aggregate demand of all buyers of the product of a monopolist is the demand of monopolist. We also know that the demand curve of an individual slopes downward from left to right. Since the demand curve of a monopolist is the summation of the demand curves of all the buyer of the product sold by the monopolist, demand curve of a monopolist slopes downward, it means that a monopolist can sell more of his output only at a lower price. On the contrary, if he raises the price of this product, his sales will be reduced.

v. No difference between Firm and Industry: The existence of single seller of one product rules out or eliminates the difference between the firm and the industry. The monopolist is a firm as well as an industry.

vi. Price Maker: The monopolist is a price maker which means that he sets price for his own goods agd services without any external pressure. His fixation of price is not influenced by any other factors which do not fall in his purview.

vii. Perfect knowledge: In monopoly market, the monopolists will be having perfect knowledge about the market conditions. So, they have control over the price and the quantities supplied. They also know about the demand in the market.

viii. Price discrimination or Uniform price: As the monopolist has complete control over the market supply, he can charge either different prices or uniform prices for different groups of consumers.

The main features of monopolistic competition are as follows: 

(a) Large number of buyers and sellers: The number of sellers in the monopolistic competition is large but when compared to perfect competition it is less. Every firm decides its own price and quantities to be produced. The number of buyers is also large.

(b) Product differentiation: Product differentiation is the main feature of monopolistic competition. Product differentiation means, the products in monopolistic competition are different in quality, size, shape, colour, packaging, odour etc. So, the products sold in this market are not heterogenous.

(c) Existence of selling costs: Selling costs are the unique feature of monopolistic competition. Selling costs are those costs which are incurred by the producer on marketing of products. The selling costs include advertisement, salesmanship, publicity, attracting packaging etc. The intention of incurring selling costs is to attract the consumers.

(d) Free entry and exit: There is no restriction on entry of new firms and exit of old firms. The product differentiation attracts new firms into the industry.

(e) Downward sloping demand curve: The demand curve in a monopolistic competition which, represents Average Revenue line, slopes downwards. Here, a single firm cannot control the entire market supply. A reduction in price leads to increase in demand and increase in Average Revenue and rise in price leads to fall in demand and decrease in Average Revenue.

(f) Price Maker: As the products produced by each firm is differentiated in brand, shape, size, package, quality etc., the firms in monopolistic competition fix their own price. Therefore, every firm enjoys monopoly power on its own product.

The demand curve of monopolistic competitive firm is more elastic than monopoly market because of the presence of close substitutes in monopolistic competition. In monopoly market there are no close substitutes.

Duopoly is the market situation where there are only two sellers or firms in the market. Example – Private firm and public firm.

Prof.E.H.Chamberlin popularized the concept of monopolistic competition.

The mercantalists traced Macro economics first.

Macro-economics refers to the study of aggregates covering the entire economy, such as General price, General employment, National Income, Inflation etc.

Price rigidity the important feature of oligopoly market. Here, price rigidity implies that prices are difficult to change. If any firm increases the price of its product to earn more profit, the other firms may not follow the same. As other firms do not follow, the firm which has increased the price loses its customers. On the other hand, if a firm reduces its price, the rival firms also reduce their price. This leads to price war and consequently, there will be increase in market demand and the firms do not get expected level of profit. So, the oligopolists not change their prices due to the fear of rivals reaction.Reasons for Price Rigidity (Price Stability) 

There are many reasons for price rigidity in oligopoly market, they are as follows:

• Individual sellers in oligopoly market know that there may be price war. 
• The firms want to avoid any involvement in unnecessary insecurity and uncertainity. 
• The firms may stick to the present price level to prevent new firms from entering the 
• The firms may prefer non-price competition rather than price war. 
• It is the kinked demand curve analysis which is responsible for price rigidity in oligopolistic markets.

It is also seen that, if a stable price has been set through agreement or collusion, no seller would like to disturb it, for fear of unleashing a price war and thus engulfing himself into an era of uncertainty and insecurity.

In monopoly market, the monopolist may incur losses in the short run. The firm incurs loss when its Total cost is greater than Total revenue.

When price (Average Revenue) is equal to the minimum of Average Cost curve, we get normal profit.

When Price is greater than minimum point of Average Cost curve, we get abnormal profit.

Profit is the difference between Total Revenue and Total Cost. When Total Revenue is greater than Total cost, we get profit.

Advertisement costs, publicity costs, packaging costs etc.

It means that the prices are difficult to change. It is one of the features of Oligopoly market in which the prices do not move according to the changes in demand.

The importance and the need for introducing a macro outlook of an economy are given below:

1. There is a need to understand the functioning of the economy at the aggregate level to evolve suitable strategies and to solve the basic problems prevailing in an economy. 

2. Understanding the future problems, needs and challenges of an economy as a whole is important to evolve precautionary measures. 

3. Macro economics provides ample opportunities to use scientific investigation to understand the reality.

4. Macro economics helps to make meaningful comparison and analysis of economic indicators. 

5. Macro economics helps for better prediction about future and to formulate suitable policies to avoid economic crises, for which Nobel Prize in Economic Sciences is awarded.