UNIT I

ECONOMY
& CENTRAL
PROBLEMS OF
AN ECONOMY

Q.1 Define an economy.

Ans.

An economy is a system in

which and by which people get a

living

to

satisfy

their

wants

through the process of production,

distribution and exchange.

Q.2 Define an economic

problem.
Ans. The problem of choice
arising from the use of
limited
means
to
the
satisfaction of various ends
(wants) is known as an
economic problem.

Q.3Why does an economic

Ans. An economic
arises due to the
problem
ariseproblem
?

following reasons :i. Human wants are unlimited and

recurring in nature :
Human wants are endless i.e. they are
unlimited as we satisfy a want many more crop
up. This goes endlessly in the economy. Also
as we fulfill one particular want, at a particular
time it again recurs.
ii. Different priorities :
All human wants are not equally important,
they differ in intensity and urgency, this fact
enables a man to arrange his wants in order of

iii. Limited resources/Means :

An economy requires resources (land, labour,
capital, etc.) to produce goods and services.
Unfortunately, resources are limited in relation
to their demand. If economys resources were
as unlimited as wants there would have been
no need to make choices. Scarcity is the root
cause of economic problem.
iv. Means have alternate uses :
Resources are not only limited but can be put
to alternative uses. Same resource can be
used for different purposes. For eg :- A plot of
land can be used for farming, for play-ground
or for constructing dewelling units. A resource
once used for a purpose cannot be used for

Q.4 Explain the central problems of an

economy.
Ans. Following are the central problems of an
economy :i.What to produce ?
ii.How to produce ?
iii.For whom to produce ?
The above problems are called central problems
because they are common to all types of economics,
these problems can be explained as follows :-

i.

What to produce ?

Ans. A major problem before a

country is to decide what

commodities
should
be
produced and in what quantities
with the limited resources at her
command. There are many
types of goods that a country
needs. Hence it has to make a

ii. How to produce ?

Ans. This problem deals with the manner in
which goods and services should be produced,
its concerned with the choice of technique of
production, this problem arises because there is
more than one possible way in which goods and
services can be produced the problem deals
with deciding between labour intensive
technique and capital intensive technique of
production. Therefore most efficient technique
is to be selected. Most efficient technique is the
one which uses least amount of scarce
resources.

iii. For whom to produce ?

Ans. This problem deals with the
distribution of national income, it tries to
answer the problem of distribution of
national
income
among
various
individuals and factors of production. An
economy faces a problem of how the
income generated in the form of rent,
wages, interest and profit be distributed
among different factors of production or
how the income generated be distributed
among different individuals constituting
the society.

Q.5What is production possibility

curve or
production possibility
frontier?
Ans. A curve which shows all possible combinations of two goods that
an economy can produce with full utilization of given resources and state
of technology is known as production possibility curve or production
possibility Frontier.
It is also called as transformation curve.
Production possibility

Good X

Good Y

15

14

12

F
5
0
Assumptions:
i.The amount of resources in the economy is fixed.
ii.The technology is given and unchanged.
iii.The resources are efficient and fully employed
iv.All resources are not equally efficient or uniformly
efficient in production of all goods.

Q.6 Explain the terms opportunity

cost and marginal opportunity cost.
Ans. Opportunity Cost:
The opportunity cost for a commodity is the amount of
other commodity that has been forgone in order to
produce the first. In other words, it is the cost of
forgone alternative or the cost of next best alternative.
Marginal opportunity cost:
Marginal opportunity cost for a commodity is the
amount of other good which has to be given up in
order to produce an additional unit of the given
commodity.
In terms of Marginal Rate of Transformation (MRT) it is
defined as a ratio of no. of units of a good sacrificed to
produce an additional unit of the other good in a two

Q.7 Why
the
shape
of
production
Ans. PPC is concave
the
origin because
of increasing
possibility
curve tois
concave
to the
origin?

marginal opportunity cost, as more and more of a good

is produced factors producing it become marginally less
and less productive and hence we sacrifice more and
more quantity of the former good in order to increase
the production of the given good by one unit. This
happens due to our assumption that all resources are
not uniformly efficient in production. It means most
resources in the beginning are equally efficient but as
we go on producing more and more of a given
commodity, we may find it difficult to have equally
efficient resource, and then there is no option but to
transfer only the less and less efficient resource for
production of a given commodity. Therefore, in order to
produce each additional unit of good X we have to
sacrifice resources engaged in the production of good Y

Q.8Show economic growth, fuller

utilization
of resources and
underutilization
of
resources
with the
help of production
possibility curve.

Q.9Distinguish between:
Ans.
a) Market Economy and Planned
Economy
b) Positive Economics and
Normative Economics
c) Micro Economics and Macro
Economics

a)

Market Economy

Planned Economy

1 Market economics are 1 These are those economics

those
in
which in which the course of
economic activities are economic
activities
is
left to the free play of decided by some central
the market forces.
authority.
2 There is no interference 2 A central authority decides
by the govt. regarding the overall basket of goods
what to produce how to and services that people can
produce or how much to consume.
consume.
3 It is a free economy.

3 It is not a free economy.

b)

Positive Economics

Normative Economics

The positive statements 1 Normative

economics
or
describe what was, what is
statements describe what
and what would be under
ought to be. Its objective is to
given circumstances. We
determine the norms and aims.
can find out the degree of
truth in such statements.

These statements do not 2 These statements pronounce

pass any value judgement
value judgement.
(or issue of debate)

A positive statement does 3 A normative statement offer

not offer any suggestions
suggestions to solve the
about facts.
problem.

c)

Micro Economics

Macro Economics

Micro
economics
studies 1 Macro economics studies economic
economic
relationships
or
relationships or economic problems
economic problems at the level
at the level of the economy as a
of an individual, an individual
whole.
firm, an individual household
or an individual consumer.

It is basically concerned with 2 It is basically concerned with

determination of output and
determination of aggregate output
price for an individual firm or
and general price level in the
industry.
economy as a whole.

Study
of
microeconomics 3 Study of macroeconomics assumes
assumes that macro variables
that micro variables remain constant
remain constant eg. it is
eg. it is assumed that distribution of
assumed that aggregate output
income remains constant when we
is given while we are studying
are studying the level of output in the
determination of output and
economy.
price of an individual form or

UNIT IV
FORMS
OF
MARKET

Q.1Define the term Market.

Ans. Market refers to a structure in which
buyers and sellers negotiate over the exchange
of a well defined commodity and remain in close
contact with each other.
Economists have classified market into different
forms on the basis of different degrees of
competition like:
1) Perfect Competition
1)Monopoly
2)Monopolistic/imperfect competition.
3)Oligopoly

Q.2Define Perfect Competition

and explain its features.
Ans. Perfect Competition is a market situation in
which there are large no. of buyers and sellers,
firms sell a homogenous (identical) product and
there is free entry and exit of the firms in the
market.
Features:
1)
Large no. of buyers and sellers.
There are a large no. of buyers and sellers of the
commodity in the market, each buyer and seller
is too small in relation to the market such that it
cannot have any perceptible influence (visibly

Homogenous
product:
2)

Products sold in the market are

homogenous
i.e.
they
are
identical in all respects like
quality, colour, size, weight etc.
As a result a buyer cannot
distinguish between the outputs
of one firm with that of another

3) Perfect Mobility:
There is perfect mobility of
factors of production both
geographically (one place to
other) and occupationally (from
one job to other). The factors
are free to enter an industry if
considered profitable and leave
the industry when remuneration
(return) is inadequate.

4) Perfect Knowledge:
There is complete and perfect
knowledge on the part of buyers
and sellers. They

are

fully

aware of the prices and cost

prevailing in different parts of
the market.

5)
Perfectly Elastic AR and Marginal Revenue
MR Curves:
In perfect competition, a firm can sell any amount of
output at a given market piece, it means firms
additional revenue (MR) from sale of every additional
unit of the commodity will be just equal to the market
price (Average Revenue).
Hence AR and MR become equal (AR = MR)

6)

Firms are price takers:

Each firm is so small compared to
the market, that no single firm can
influence the market price thus
homogenous product and existence
of large no. of firms in this form of
market induce the firms to keep the
same price for their product. Every
firm accepts the market price
determined by the whole industry and
therefore it is a price taker and not

Q.3 Explain the meaning and features of

monopoly.

Ans. Monopoly refers to that form of market

wherein there is a single firm producing a
commodity for which there is no close
substitutes.
Features:
1) Single producer:
There is a single firm producing the commodity
in the market in such a market form there is no
difference between the firm and the industry.

2)
No close substitutes:
The necessary condition for
monopoly to exist is that there
should be no close substitutes
of the commodity in the market.
The cross elasticity of demand
for the output of the firm, the
price of every other
firms
product is zero.

3) Barriers to the entry:

The

entry

in

the

industry

is

completely prohibited or made

impossible legally or mutually. If
new firms are admitted into the
industry,

the

breaks down.

monopoly

itself

4) Independent price
Monopolist firm can adopt independent price
policy:
policy, i.e. it can increase or decrease price of a
commodity as it likes.
Monopoly firm has a
downward sloping average revenue curve. The
slope of the AR curve clearly indicates that a
monopoly firm sells more at a lower price and is a
price maker.

5)

Price Discrimination:

It

is

possible

under

the

conditions of monopoly it implies

that a monopolist firm can sell its
product at different prices to
different customers.

6) Downward sloping AR and MR

curves:
A monopoly firm is like an industry and faces a
downward sloping demand curve for its product
i.e. it has to lower its price to sell more. The
marginal revenue curve remains below the AR
curve as MR < AR.

Q.4 Define and explain the features of

monopolistic/imperfect competition.

Ans. It refers to a market situation in which

there are many firms which sell closely related
but differentiated products.
It has following features:
1)
Many Sellers:
There is large no. of firms producing the
commodity and supplying it in the market. Each
firm supplies a small percentage of total supply
of the product. As a result firms are in a position
to marginally influence the price of their
products due to their brand names.

2)

Product Differentiation:

Each firm produces a unique brand of

the same product which can be
differentiated from brands of other
firms. Products are not the same but
are closely similar to each other.
They can be differentiated on the
basis of brand names, colour, quality,
quantity, shape etc. The aim of the
firm is to win over customers by

3) Free entry and exit of

firms:
New firms can enter the market if
found
profitable.
Similarly
inefficient firms already operating
in the market are free to quit the
market if they incur losses. Every
firm is free to enter into the
industry and come out of the
industry as and when it wishes.

4)

Selling Cost:

Selling cost are the expenses

which are incurred for promoting
sales or for inducing customers to
buy the product of a particular
brand. This cost involves cost of
advertisement, free sampling,
salaries of salesmen etc.

5) Influence of Price:
Each firm has an influence on the
price of the commodity, as every
firm has the monopoly over the
production of its product. It is
free to determine the price of its
commodity on the basis of degree
of consumers preference for its
product and extent of competition

6)

AR and MR Curves:

AR and MR curves in monopolistic competition

are downward sloping because more units of a
product can be sold by reducing price. MR curve
is below the AR curve because increase in AR
implies decrease in MR.

Q.5 Define Oligopoly and explain its

features.
Ans. It is a form of the market in which there are
a few big sellers of a commodity and a large
number
of buyers.
There is a severe
competition in the market.
Features:
1)
A Few Firms:
A few firms, but large in size, dominate the
market
for a commodity. Each firm commands
a significant share of the market.
2)
Large Number of Buyers:
There a large number of buyers of a
commodity. The number is so large that no

3) High Degree of Interdependence:

There is a high degree of interdependence
between the firms.
Price and output
policy of one firm significantly impacts the
price and output policy of one firm
significantly impacts the price and output
policy of the rival firms in the market.
4) Barriers:
There are various barriers to the entry of
new firms.
These barriers are almost
similar to those under monopoly. Entry of
new firms is extremely difficult.

5) Not Possible to Determine Firms

Demand:
It is not possible to determine
firms demand curve under oligopoly.
Simply because it is not possible to
predict change in price. When a firm
lowers its price, demand for its
product may not increase, because
the rival firms may also lower the
price.
6) Formation of Cartels:
With a view to avoid competition,
firms may form a cartel. It is a

Q.6What happens to profit in

long run when
there is free
entry
and
exit? of entry or exit feature
Ans.The
freedom
implies that no firm can earn above
normal profits in the long run. It means
each firm earns just the normal profit. It
happens so because the existing firms
which are earning above normal profits
face competition with the new firms.
New firms enter the industry and
increase the supply. Consequently, price
comes down and above normal profits
go away.

Q.7What happens to loss in long

run when there is free entry and
exit in the market?
Ans.The feature of freedom of entry and
exit implies in the long run no firm incurs
loss. It means that each firm earns just
normal profit. This happens because the
existing firms which are incurring losses,
some of them will leave the industry.
Consequently, supply will decrease,
prices will go up and losses will be wiped
out. Thus, ultimately firms will earn just
normal profit in the long run and there

Q.8Distinguish between:
Ans.
a) Perfect Competition and
Monopoly
b) Perfect Competition and
Monopolistic Competition
c)Monopoly and Monopolistic
Competition

a)

Perfect Competition

Monopoly

There are large nos. of firms in the 1

market and no single firm can
influence the market price.

There is only one firm in the market and has the

power to influence the market price.

A firm cannot adopt independent 2

price policy; it is price taker and not
a price maker.

A monopolist firm can have independent price

policy, it is a price maker.

There is full freedom of entry and 3

exit of the firms in the long run.
Hence a firm can get only normal
profits in the long run.

There is restriction on the entry of firms hence a

firm can earn supernormal profit even in long
run.

Price discrimination is not possible 4

i.e. a firm charges same price from
all customers.

Price discrimination is possible. A firm charges

different prices from different customers.

AR MR curves are one and the 5

same and parallel to x-axis.

AR MR curves are downward slopping. MR

curve always remains below AR curve.

b)

Perfect Competition

Monopolistic Competition

Large no. of buyers and sellers

They produce homogeneous 2 They produce differentiated product

product

They have perfect knowledge 3 They have imperfect knowledge of

of market conditions
market conditions

They have perfect mobility

AR MR curves are parallel to 5 MR curves is below the below AR curve.

x-axis.

1 Many sellers and buyers

4 They have imperfect mobility

c)
1

Monopoly
Monopolistic Competition
Large no of sellers and buyers 1 Large no. of sellers and buyers are there.
are not there. Only one seller
but large no. of buyers.

Homogeneous or differentiated 2 Product

is
product.
differentiated.

Selling cost is not required.

3 Selling costs are very significant.

Entry of firms is not possible.

4 Entry of firms are not possible with

absolute freedom.

Full control over price.

5 Partial control over price.

closely

related

but

Q.9
Explain Number
the
basis
of
Market
Ans.1)
of Buyers
and
Classification.
Sellers:
When
there is a large number
of buyers and sellers of homogeneous
commodity, it is a situation of perfect
competition.
When there is a large number of buyers
and sellers but the commodity is not
homogeneous, it is a situation of
monopolistic competition.
When there is one seller but a large

2) Nature of Commodity:
It is a perfectly competitive market;
commodity should be homogeneous,
while in monopolistic competition,
the

commodity

differentiated.
product

may

homogeneous.

is

always

In monopoly, the
or

may

not

be

3) Degree of Price Control:

Perfect competition is said to exist
when the producer has no control
over

price.

monopolist

In
has

full

contrast,

the

control

over

price. Monopolistic competition has

partial control over price.

4) Knowledge of the Market:

In case of perfect competition,

buyers

and

perfect

knowledge

market.
market,

sellers

have
of

the

In other forms of
there

knowledge.

is

imperfect

5) Mobility of Factors:

Perfect mobility of the factors

is

another

competition.
essential

unique

It is not an

feature

forms of market.

of

other

PRICE
DETERMINATI
ON UNDER
PERFECT
COMPETITION

Q.1 Define Equilibrium, Equilibrium

Price and Equilibrium Quantity.

Ans. Equilibrium:
It is a state from where there is no net
tendency to move, it means that at the point of
equilibrium forces that determined it are
balanced.
Equilibrium Price:
The price at which market demand is equal to
market supply is called Equilibrium Price.
Equilibrium Quantity:
The quantity demanded and supplied at
Equilibrium Price is called Equilibrium Quantity.

Q.2 How
is
Equilibrium
Price
determined
under
perfect
competition?
Ans. Equilibrium price is determined by the
interaction of the forces of market demand and
market supply under perfect competition. It is
determined at the point where market supply
equals market demand.

In the above diagram we observe that when

market price is more than the equilibrium price,
supply becomes greater than the demand. It
creates the situation of excess supply.

As a result, there is competition among sellers

and the price starts declining. This continues till
market price becomes equal to equilibrium price.
Similarly, when market price is less than the
equilibrium price, demand becomes greater than
supply.
It creates the situation of excess
demand. As a result competition among buyers
price starts rising till it becomes equal to
equilibrium price.
In this manner, equilibrium price is determined at
a point where there is no tendency for demand

Q.3 Draw proper diagrams to show the

effect of change in demand on equilibrium
price and
equilibrium quantity when
supply (remains
constant) curve is
given.
Ans. i)
demand

When supply curve is given and

increases:

ii)
When supply curve is given and
demand decreases.

Q.4 Show the effect of change in supply, when

the demand curve is given (on equilibrium
price and equilibrium quantity)
Ans. i) When demand curve is given and supply
increases.

ii)
When demand curve is given and
supply decreases.

Q.5
Show the effect on equilibrium
price and
equilibrium quantity when
both demand and supply decrease
simultaneously.
Ans. There are three conditions when both
demand and supply decrease simultaneously.
i)
When demand decreases in a greater
proportion then the decrease in supply.

ii)
When decrease in supply is greater
than decrease in demand.

iii) When decrease in demand is equal to

the decrease in supply

Q.6 Show the effect on equilibrium price

when both demand and supply increase
simultaneously.
Ans. i)
When the demand increases in a
greater
proportion than the increase
in supply.

ii)
When the supply increases in a
greater proportion than the increase in
demand.

iii)
When the demand and supply
increases in the same proportion

ii)
When demand decreases in greater
proportion than increase in demand.

iii) When demand decreases and supply

increases in equal proportion.

Q.8
Show the effect on equilibrium
price when
demand increases and
supply decreases.
Ans.
i)
Demand increases in a greater
proportion than decrease in supply.

ii)
Demand increases in smaller
proportion as
compared to decrease in
supply.

iii)
Demand increases and
decreases in same proportion.

supply

Q.9
Show the effect on equilibrium
price when
demand changes.
Ans. 1. * Supply is perfectly elastic.
2. * Supply is perfectly inelastic.

*When demand changes and supply is

perfectly inelastic.

Q.10
Show the effect on equilibrium
price when
supply changes and demand
is either:
Ans. 1. * perfectly elastic
* perfectly inelastic

2)
Qty. remains const. with se in
supply price ses and with ses in
supply price ses.

Thank
You !