Friday, February 06, 2015

IGNOU SOLVED ASSIGNMENT: EEC - 11 (2014 - 2015)

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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