RECOMENDACIONES FINALES

1. What is opportunity cost? Explain with the help of a numerical example. Or

What is opportunity cost? Explain with the help of an example.

Ans. Opportunity cost is the value of a factor in its next best alternative use. Example: If Mr. X has three

options of employment: A with ` 5,000 p.m., B with ` 6,000 p.m., C with ` 7,000 p.m. then Mr. X should be choosing the best option (C) of ` 7,000 p.m. and its opportunity cost would be ` 6,000 p.m.

2. Given price of a good, how does a consumer decide as to how much of that good to buy?

Ans. Given price of a good, consumer purchases that much of the commodity where rupee worth of

additional satisfaction MU P X X æ è çç ö ø

÷÷ from the consumption of a unit more of a good is equal to marginal utility of money (MU )_M for the consumer. So that, in a state of equilibrium:

MU P

X X

= MUM

3. Draw average variable cost, average total cost and marginal cost curves in a single diagram.

Ans. Fig. 1 shows average total cost (ATC), average

variable cost (AVC) and marginal cost (MC). All the three curves are U shaped. Also, MC curve must cut both ATC and AVC from their lowest points (A & B in the diagram).

4. An individual is both the owner and the manager of a shop taken on rent. Identify implicit cost and explicit cost from this information. Explain.

Ans. As a manager, the owner is rendering his own services. Managerial services are not hired from the

market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Rent paid of a shop is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market.

5. Explain the implication of large number of buyers in a perfectly competitive market. Or

Explain why are firms mutually interdependent in an oligopoly market.

Ans. The number of buyers of a commodity is very large under perfect competition. It is so large that by

varying his purchase, an individual buyer cannot affect total market demand for a commodity. Accordingly, an individual buyer cannot affect market price. He can buy any quantity at the existing price of the commodity. An individual buyer is a price taker.

Introductory Microeconomics 88 Economics–XII

ATC MC Output X O B A Q1 Q Y AVC Cost Figure 1

Or

In an oligopoly market, there is a small number of big firms. Accordingly, there is a high degree of mutual interdependence. Implying that, price and output policy of one firm has a significant impact on the price and output policy of the rival firms in the market. When one firm lowers its price, the rival firms may also lower the price. And, when one firm raises the price, the rival firms may not do so. It is because of this interdependence that it becomes very difficult to estimate change in firm’s sales caused by a change in price. Implying that a precise relationship between price and sales cannot be established. Or, that the firm’s demand curve cannot be drawn.

6. What is ‘marginal rate of transformation’? Explain with the help of an example. Or

Explain the concept of marginal rate of transformation with the help of an example.

Ans. Marginal rate of transformation is the rate at which output of Good-Y is to be sacrificed to produce a

unit more of Good-X when the given resources are fully and efficiently utilised in the production of goods X and Y, and the technology remains constant. It refers to the slope of PPC (production possibility curve). It is also called opportunity cost of producing a unit more of Good-X.

Example: Output of Y Output of X

10 10 7 11

When some resources are shifted from Use-Y to Use-X, there is a loss of output of 3 units of Y for a unit more of Good-X. MRT = D

D Y X =

3

1= 3. [Here, DY refers to loss of output of Good-Y and DX refers to gain of output of Good-X.]

7. A producer borrows money and opens a shop. The shop premises is owned by him. Identify the implicit and explicit costs from this information. Explain.

Ans. Imputed rent of owner’s self-owned shop is implicit cost because implicit costs are incurred on the

use of self-owned factors/inputs. Interest paid on the borrowed money is explicit cost because it is the expense incurred by the producer for borrowing money from the market.

8. State reasons why does an economic problem arise.

Ans. Economic problem is a problem related to the allocation of resources (or problem of choice). It arises

due to the following reasons:

(i) Unlimited Wants: Human wants are unlimited.

(ii) Limited or Scarce Means: Resources are scarce in relation to human wants.

(iii) Alternative Uses: Resources have alternative uses. Land, for example, may be used to produce

rice or wheat or it may be used for the construction of buildings.

9. A producer invests his own savings in starting a business and employs a manager to look after it. Identify implicit and explicit costs from this information. Explain.

Ans. Imputed interest of owner’s self-owned savings is implicit cost because implicit costs are incurred on

the use of self-owned factors/inputs. Salary paid to a manager to look after the business is explicit cost because it is the expense incurred by the producer for hiring the services of the manager from the market.

10. Define production possibilities curve. Explain why it is downward sloping from left to right. Ans. Production possibility curve (also called production possibility frontier) is a curve showing different

combinations of two goods, which can be produced with the given resources and technique of production. It is also assumed that the given resources are efficiently utilised. The production possibility curve slopes downward from left to right. This is because (owing to fuller and efficient utilisation of the given resources, as well as given technology) output of Good-X can be increased only by sacrificing some output of Good-Y.

11. A consumer consumes only two goods X and Y and is in equilibrium. Price of X falls. Explain the reaction of the consumer through the utility analysis.

Ans. In a situation of equilibrium in case of two commodities:

MU P X X = MU P Y Y When PX falls, MU P MU P X X Y Y

> . Implying that rupee worth of satisfaction is greater for X than Y. Accordingly, the consumer will start buying more of X in place of Y. When consumption of X increases, MUX must fall, while a cut in consumption of Y would mean a rise in MUY. Accordingly, MU

P

X X

will start falling while MU

P

Y Y

will start rising. The consumer will stop buying more of X (in place of Y) only when MU P X X = MU P Y Y .

Briefly, when PX falls, more of X will be purchased in place of Y.

12. Draw total variable cost, total cost, and total fixed cost curves in a single diagram.

Ans. Fig. 2 shows total cost (TC), total variable cost (TVC)

and total fixed cost (TFC). Total cost is the sum of total variable cost and total fixed cost. So TC curve is the vertical summation of TFC and TVC curves.

13. A producer starts a business by investing his own savings and hiring the labour. Identify implicit and explicit costs from this information. Explain.

Ans. Implicit costs are incurred on the use of self-owned factors/inputs. Accordingly, interest foregone by

the producer on account of the use of his own savings is the implicit cost of production. Explicit cost is incurred when inputs are hired/purchased from the market. Thus, cost of hiring labour (wages) is an explicit cost of production.

14. Explain the implications of large number of sellers in a perfectly competitive market. Or

Explain why there are only a few firms in an oligopoly market.

Ans. The number of sellers of a commodity is very large under perfect competition. The number of firms

selling a particular commodity is so large that an individual seller contributes only a small fragment to the market supply. Thus, any increase or decrease in supply by an individual firm hardly impacts the total market supply and consequently, an individual firm cannot impact price of the commodity.

Or

By definition, oligopoly is a form of the market in which there is a small number of big firms. Each firm is so big that it controls a significant segment of the market.

Example: Firms producing cars in India.

Why only a few firms? Because,

(i) Production requires huge capital investment, that deters the entry of new firms.

Introductory Microeconomics 90 Economics–XII

O Y X Output Cost (™) 1 2 3 4 5 6 7 8 TVC 80 70 60 50 40 30 20 10 TC TFC Figure 2

(ii) Technology used in production is so distinct that it is difficult for an ordinary firm to acquire it. (iii) The firms often form trusts and cartels, converting the market almost into a monopoly market,

which becomes impregnable for the small firms.

(iv) The firms often get patent rights for their products, and their branded products happen to achieve consumer’s loyalty over time. This keeps the new firms at bay.

(v) The firms happen to achieve control over strategic inputs, making it difficult for the new firms to enter the market.

(vi) Owing to their large scale production and economies of scale, the existing firms start incurring so much of advertisement expenditure that the entry of new firms virtually becomes impossible.

15. Explain the central problem of ‘how to produce’.

Ans. The problem of how to produce is a problem relating to choice of technology. It is a central problem

because no economy can ever escape it. Broadly, it is the problem of deciding input ratio of different factor inputs and efficient use of resources. There are two techniques of production: (i) Labour intensive technique in which labour is used more than capital, and (ii) Capital intensive technique in which capital is used more than labour. Optimum technology is the one that maximises productivity (output per unit of input) or minimises cost of production.

16. A farmer takes a farm on rent and carries on farming with the help of family members. Identify explicit and implicit costs from this information. Explain.

Ans. The farmer is using the services of his family members for farming. Farming services are not hired or

purchased from the market. So, these services involve an implicit cost. Because, working outside the family farm, the family members would have earned some wages. The wages foregone are the implicit costs. Rent paid of a farm taken on rent is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market.

17. A producer borrows money and starts a business. He himself looks after the business. Identify implicit and explicit costs from this information. Explain.

Or

A producer borrows money to start a business and looks after the business himself. Identify the implicit and explicit costs from this information. Explain.

Ans. As a manager, the owner is rendering his own services. Managerial services are not hired from the

market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Interest paid on borrowed money is explicit cost because it is the expense incurred by the producer for borrowing money from the market.

18. Explain, giving reason, why production possibilities curve is concave. Ans. PPC is concave to its origin because marginal opportunity cost D

D loss of Y gain of X æ è çç ö ø ÷÷ of shifting resources from commodity-Y to commodity-X tends to rise. And, marginal opportunity cost tends to rise because of the law of diminishing returns. When more and more resources are allocated to X, additional gain of output (per unit of input) tends to decrease; and as more and more resources are withdrawn from Y, additional loss of output tends to rise. Accordingly, the ratio D

D loss of Y gain of X æ è çç ö ø

÷÷ tends to rise. Implying a rise in the slope of PPC as more and more resources are shifted from Y to X. Rising slope of PPC means that PPC is concave to the origin.

19. A consumer consumes only two goods X and Y and is in equilibrium. Price of X rises. Explain the reaction of the consumer with the help of utility analysis.

Ans. Equilibrium condition in case of two commodities:

MU P X X = MU P Y Y

When PX rises, the ratio MU P X X falls and MU P X X < MU P Y X

. Since X becomes relatively expensive (than Y), the consumer will start consuming less of X and more of Y. As a consequence MU

P

X X

will start rising while MU

P

Y Y

will start falling. The adjustment process would continue till MU P X Y =MU P Y Y . Briefly, if PX

rises the consumer will react by buying less of X.

20. Draw supply curves showing price elasticity of supply equal to (i) zero, (ii) one, and (iii) infinity throughout. Ans.

21. Explain the implications of ‘homogeneous product’ in a perfectly competitive market. Or

Explain the implications of ‘differentiated product’ in monopolistic competition.

Ans. A product being perfectly homogeneous implies that all units of a commodity are identical in size,

quality, shape, colour, weight, etc. In a state of perfect competition, a perfectly homogeneous product is sold in the market. Since a large number of sellers sell a homogeneous product, there is a zero control over price. All sellers in the market have to sell the product at a uniform price. If ever an individual firm tries to charge higher price, it would lose all its buyers to a large number of other sellers in the market. A firm is simply a price taker.

Or

Product differentiation or differentiated product is a distinct feature of monopolistic competition. Though the number of firms is large but their product differs in colour, shape, brand, quality, durability, etc. It has two important implications:

(i) It allows a firm a partial control over price of its product, and

(ii) It causes high elasticity of demand for the firm’s product owing to the availability of a large number of close substitutes.

22. A producer starts a business by investing his own savings. He employs a manager to look after the business. Identify the explicit and implicit costs from this information. Explain.

Ans. Imputed interest of owner’s savings is implicit cost because implicit costs are incurred on the use of

factors/inputs. Salary paid to a manager to look after the business is explicit cost because it is the expense incurred by the producer for hiring the services of the manager from the market.

23. A producer takes a building on rent for carrying out business. He looks after the business himself. Identify the implicit and explicit costs from this information. Explain.

Ans. As the producer is carrying out the business himself, he is rendering his own services. Managerial

services are not hired from the market. So, they are implicit cost. Implicit costs are incurred on the use of self-owned factors/inputs. Rent paid of a building taken on rent is explicit cost because it is the expense incurred by the producer for purchasing the inputs from the market.

Introductory Microeconomics 92 Economics–XII

Y X S S P Q E = 1_s Q1 (b) O Quantity Price P1 Y X S P Q E = ¥_s Q1 S (c) O Quantity Price Y S P P1 S (a) O Quantity Price E = 0_s X Figure 3