Section-A
Long Answer Questions. (Answer in about 500
words each) 2X20=40
Q.N.1. Distinguish (with graphical
illustration) between price elasticity of Demand and cross elasticity of
demand. How can you measure the elasticity of demand? Explain with example how
the concept of elasticity of demand is useful for an industry in its decision
making process?
Ans:
Difference between Price and Cross
Elasticity of Demand
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2. What are the advantages of International trade?
Explain Heckscher-Ohlin’s (version) approach of international trade.
Ans: International
trade and Its advantages
International trade refers to the exchange of goods
and services between one country or region and another. It is also sometimes
known as “inter-regional” or “foreign” trade. Briefly, trade between one nation
and another is called “international” trade, and trade within the territory
(political boundary) of a nation “internal” trade.
Advantages of International Trade:
(1) Optimum Allocation: International
specialisation and geographical division of labour leads to the optimum
allocation of world’s resources, making it possible to make the most efficient
use of them.
(2) Gains of Specialisation: Each trading country gains when the total output increases as a
result of division of labour and specialisation. These gains are in the form of
more aggregate production, larger number of varieties and greater diversity of
qualities of goods that become available for consumption in each country as a
result of international trade.
(3) Enhanced Wealth: Increase
in the exchangeable value of possessions, means of enjoyment and wealth of each
trading country.
(4) Larger Output: Enlargement
of world’s aggregate output.
(5) Welfare Contour: Increase
in the world’s prosperity and economic welfare of each trading nation.
(6) Cultural Values: Cultural
exchange and ties among different countries develop when they enter into mutual
trading.
(7) Better International Politics: International trade relations help in harmonising international
political relations.
Heckscher-Ohlin’s (version) approach of international
trade
The
Modern Theory of international trade has been advocated by Bertil Ohlin. Ohlin
has drawn his ideas from Heckscher's General Equilibrium Analysis. Hence it is
also known as Heckscher Ohlin (HO) Theory. According to Bertil Ohlin, trade
arises due to the differences in the relative prices of different goods in
different countries. The difference in commodity price is due to the difference
in factor prices (i.e. costs). Factor prices differ because endowments (i.e.
capital and labour) differ in countries. Hence, trade occurs because different
countries have different factor endowments. The Heckscher Ohlin theorem states
that countries which are rich in labour will export labour intensive goods and
countries which are rich in capital will export capital intensive goods.
Assumptions
of Heckscher Ohlin's H-O Theory
Heckscher-Ohlin's
theory explains the modern approach to international trade on the basis of
following assumptions :
1.
There are two countries involved.
2.
Each country has two factors (labour and capital).
3.
Each country produce two commodities or goods
(labour intensive and capital intensive).
4.
There is perfect competition in both commodity and
factor markets.
5.
All production functions are homogeneous of the
first degree i.e. production function is subject to constant returns to scale.
6.
Factors are freely mobile within a country but
immobile between countries.
7.
Two countries differ in factor supply.
8.
Each commodity differs in factor intensity.
9.
There are no transportation costs.
Given
these assumption, Ohlin's thesis contends that a country export goods which use
relatively a greater proportion of its abundant and cheap factor. While same
country import goods whose production requires the intensive use of the
nation's relatively scarce and expensive factor.
In
the two countries, two commodities & two factor model, implies that the
capital rich country will export capital intensive commodity and the labour
rich country will export labour intensive commodity. But the concept of country
being rich in one factor or other is not very clear. Economists quite often
define factor abundance in terms of factor prices. Ohlin himself has followed
this approach. Alternatively factor abundance can be defined in physical terms.
In this case, physical amounts of capital & Labour are to be compared.
Section-B
Medium Answer Questions. (Answer in about 250 words each)
4X12=48
Q.N.3. What do you mean by ‘National
Income’? Explain how production flow, income flow and expenditure flow in an
economy are related to each other?
Ans: National income is an uncertain
term which is used interchangeably with national dividend, national output and
national expenditure. On this basis, national income has been defined in a
number of ways. In common parlance, national income means the total value of
goods and services produced annually in a country. In other words, the total
amount of income accruing to a country from economic activities in a year’s
time is known as national income. It includes payments made to all resources in
the form of wages, interest, rent and profits.
According to Marshall: “The labour and capital of a
country acting on its natural resources produce annually a certain net
aggregate of commodities, material and immaterial including services of all
kinds. This is the true net annual income or revenue of the country or national
dividend.”
Relationship between production flow,
income flow and expenditure flow
There
are four main sectors or groups of participants in an economy: the households, firms, government and foreign sector. Moreover, there are two main sets of markets in an
economy: the markets for goods and services (simply called goods markets) and the markets
for the various factors of production (the factor markets). These sectors
and markets are interrelated through the processes of production, income and
spending. For example, households sell their factors of production on the
factor markets and then use their income to purchase goods and services on the
goods markets. Firms, on the other hand, purchase factors of production on the
factor markets and then combine these factors to produce goods and services
which are then sold on the goods markets. Government extracts income from
households and firms through taxation and purchase goods, services and factors
of production in the goods and factor markets. As far as the foreign sector is
concerned, part of the domestic production is exported to other countries,
while other goods and services are imported to satisfy domestic needs.
This can be understood with the help of the following diagram
Q.N.4. Distinction between law of returns
and returns to scale
Ans:
The law of diminishing returns only applies in the Short Run, when only one
factor of production is variable and can be increased. The other factors of
production are fixed. Thus as the variable factor of production is increased
the marginal product of that factor will rise at first, but will at some point
begin to fall.
Returns to scale can only occur when no factors of
production are fixed. If the quantities of all of the factors of production are
increased, then output will also increase. However, the amount by which output
rises can either be proportionately more than the amount that the factors of
production were increased by, proportionately less, or the same. These cases
are called increasing returns to scale, decreasing returns to scale, or
constant returns to scale.
Reasons for operation of the law of
diminishing return:
(i) Inelasticity (fixity) supply of some
factors: It is the fixity of the supply of land which sets the
law of diminishing return in motion. In short period some factors are fixed and
given. When other variable factors are combined with this factor in increasing
proportions, this fixed factor is distribute on the units of variable factors.
After an ideal combination the proportion of variable factors to fixed factors
become high. That is why diminishing return occurs.
(ii) Imperfect substitutes: According
to Mrs. Joan Robinson the factors of production are imperfect substitute for
one another. Capital can be substituted for labour to some extent but cannot do
perfectly. If these factors were perfect substitutes for one another, the
returns would not diminish. The greater the imperfection in substitution of one
factor for another, the faster shall be the fall in marginal return.
(iii) Optimum Proportion: Factors
are combined in a proportion which is given. No other combination will be more
efficient than this. If this proportion is disturbed, the efficiency of factors
will fall giving rise to diminishing returns.
Q.N.5. (a) State the relationship between Average Cost
and Marginal Cost.
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(b) From a given cost function: TC = 60 + 0.5q + 0.3q2
Find out Fixed Cost, Average Variable Cost and Marginal
Cost
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Q.N.6. What is propensity to consume (MPC)?
Explain with example and diagram how MPC influences the multiplier?
Ans: Marginal
Propensity to Consume: The Marginal Propensity to Consume is
defined as the proportion of the aggregate raise in pay that is utilised on the
consumption of goods and services opposing to the amount being saved. It can
also be defined as Induced Consumption as this shows the consumption of
goods and services due to increase in disposable incomes. The Marginal Propensity to Consume
(MPC) is expressed mathematically as:
MPC = dC / dY
Where dC = Change in Consumption
dY = Change in Disposable Income
The Multiplier & the Marginal
Propensity
In economics, the multiplier effect refers to the idea
that an initial spending rise can lead to an even greater increase in national
income. In other words, an initial change in aggregate demand can cause a
further change in aggregate output for the economy. The
multiplier effect is a tool used by governments to restimulate aggregate
demand. The size of the multiplier depends on the marginal
propensity to consume. The relation between the Marginal
Propensity and the Multiplier may be given as: Multiplier = 1 / (1 - MPC) = 1 / MPS
With increasing MPC (i.e. : decreasing MPS),
the value of the multiplier increases as
because themultiplier is equal to the
reciprocal of the Marginal Propensity to Save.
The greater the Marginal Propensity to Save,
the smaller will be the multiplier. The Greater the
Marginal Propensity to Consume, the larger would be the multiplier.
It gives the idea that every rupee spend, creates more than one rupee in
the economic activity.The effect of MPC on multiplier
can be understood with the help of the following diagram:
Section-C
Short Answer Questions. (Answer in about
100 words each) 2x6=12
7. Distinguish between any four of the
followings:
i. Inferior goods and Giffen goods
Ans: An inferior good is a good the demand for
which decreases as income increases. Inferior goods have a negative income
elasticity of demand. The income effect is negative, but is outweighed by a
positive substitution effect. Therefore as prices increase, demand falls, and
vice versa.
A Giffen good is a good
where the income effect is so negative as to completely outweigh the
substitution effect. As prices increase, demand increases, and vice versa. This
means that Giffen goods would have a positive price elasticity of demand. The
main idea here is that Giffen goods are essential and have no close
substitutes, so as their price increases, disposable income is switched away
from other goods and towards the Giffen good.
ii. Economic law and economic theory
Ans: Only four questions are
required
iii. Multiplier and Accelerator
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iv. Perfect Competition and Monopolistic Competition
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v. External Economies and Internal Economies
Ans: Internal economies of scale
arise when firms increase their scale of production. Hence, they incur lower
average costs of production, either through specialization or other factors.
When average costs fall, giving the price of the good to be constant, profit
margins of these firms will be increased. Thus, the individual firm benefits
from internal economies of scale.
External
economies of scale arise when all firms in an industry experience decreasing
average costs of production, which can be due to economies of concentration, information
and disintegration. Unlike internal economies of scale, external economies of
scales independent on the size of the individual firms in the industry as both
small and large firms benefit from it.
8. Explain any four of the followings:
i. Crowding-out Effect
Ans: Crowding out is
a situation where personal consumption of goods and services and investments by
business are reduced because of increases in government spending and deficit
financing sucking up available financial resources and raising interest rates.
Crowding out creates some problems for economy. First, an expansionary fiscal
policy means that the government is using financial resources that are now
longer available for use by individuals and businesses. Additionally, if the
government is competing for goods and services along with individuals and
business, it may result in increased prices because of the increase in demand.
ii. Real Cash Balances
Ans: Only four questions are
required
iii. Investment Multiplier
Ans: Only four questions are
required
iv. Economic Welfare
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v. Personal Disposable Income
vi. Stagflation
vii. Positive Economics
Ans: Only four questions are
required
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