Q1. What do the following signify?
1. Movement from one point on the PPC to another
2. Movement from a point within the frontier to the curve
3. Outward shift in PPC
Answer:
The Production Possibility Curve (PPC) is a graphical representation of
various combinations of two goods that an economy can produce using all
its resources efficiently, given the current level of technology.
1.
Movement from one point to another on the PPC indicates a
reallocation of resources from one good to another. This movement
shows that the economy has decided to produce more of one good at
the expense of the other, reflecting the concept of opportunity cost.
For example, moving from point A to B on a PPC might mean producing
more butter and fewer guns.
2. Movement from a point inside the PPC to a point on the curve signifies
a gain in efficiency. Initially, the economy was not utilizing its resources
fully—possibly due to unemployment or underutilization of capital.
Moving to a point on the curve means that resources are now being
used to their full productive capacity, without any change in resource
availability or technology.
3. An outward shift in the PPC represents economic growth. This could be
due to an increase in resources (like more labor or capital) or
improvement in technology. For example, the development of new
machinery can increase production capacity, allowing more of both
goods to be produced.
Each of these movements represents fundamental economic concepts—
scarcity, efficiency, choice, and growth—and are useful for understanding
how economies make decisions and respond to changes in available
resources or technology.
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Q2. “Economics is a science of choice-making.” Explain.
Answer:
Economics is often referred to as the science of choice-making because it
studies how individuals, firms, and societies allocate limited resources to
satisfy unlimited wants. Scarcity is the central problem—resources like
land, labor, and capital are finite, while human desires are infinite. This
imbalance forces people and economies to make choices about what to
produce, how to produce, and for whom to produce.
These choices are not random but are made by weighing costs and
benefits. This is where the concept of opportunity cost comes in—the cost
of the next best alternative foregone when a decision is made. For
example, if the government decides to spend more on military defense, it
may have to cut spending on healthcare or education.
Economics provides analytical tools and models to help make rational
decisions. Consumers must choose how to allocate income among goods
and services; producers must decide what combination of inputs to use;
governments must prioritize spending areas based on social welfare. These
decisions involve trade-offs.
Moreover, economics applies scientific methods like data collection,
statistical analysis, and modeling. Though human behavior is involved,
economics uses logical reasoning to study how choices are made under
constraints, making it both a social science and a science of decision-
making.
In conclusion, economics is rightly called the science of choice-making, as
it revolves around how to best utilize scarce resources to achieve
maximum satisfaction or output, whether at the individual, firm, or
societal level.
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Q3. Distinguish between:
a) Static and Dynamic Analysis
Answer:
Static analysis studies economic variables at a particular point in time. It
assumes that all other factors remain constant, making it a timeless
snapshot of the economy. It is used to analyze short-run equilibrium
situations such as demand-supply balance, price determination, and
marginal analysis.
Dynamic analysis, on the other hand, studies variables over time. It
considers time lags, trends, and adjustments. For example, how capital
accumulation today affects GDP in the future is a dynamic study. It is
essential for analyzing growth, inflation, investment, and business cycles.
b) Microeconomics and Macroeconomics
Answer:
Microeconomics focuses on individual economic units like consumers,
firms, and industries. It studies demand and supply, price mechanisms,
and market structures. Example: Why does the price of onions rise?
Macroeconomics deals with aggregate economic variables like national
income, inflation, employment, and fiscal policy. It analyzes the overall
functioning of the economy. Example: What causes unemployment or
inflation?
Micro helps understand individual behavior, while macro gives a bigger
picture of the economy. Both are interdependent and essential for
economic analysis.
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Q4. Explain the effect of tax using demand and supply:
Given:
Qd = 150,000 – 3P
Qs = 7P
Find equilibrium and impact of a ₹5,000/unit tax.
Step 1: Find Equilibrium Price (P) and Quantity (Q)
Set Qd = Qs:
150,000 – 3P = 7P
⇒ 150,000 = 10P
⇒ P = ₹15,000
Now Q = 7P = 7×15,000 = 105,000 units
Step 2: With Tax (T = ₹5,000)
Effective supply price = P – Tax
So:
Qd = 150,000 – 3P
Qs = 7(P – 5,000)
Set Qd = Qs:
150,000 – 3P = 7(P – 5,000)
150,000 – 3P = 7P – 35,000
⇒ 185,000 = 10P
⇒ P = ₹18,500
Q = 150,000 – 3×18,500 = 150,000 – 55,500 = 94,500 units
Result:
Price rises for consumers (from ₹15,000 to ₹18,500)
Quantity drops (from 105,000 to 94,500)
Consumers bear higher prices
Government earns tax revenue = ₹5,000 × 94,500 = ₹47.25 crore
Creates deadweight loss: reduction in consumer & producer surplus
not recovered by tax.
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Q5. Given SL = 10W and DL = 600 – 10W, find equilibrium wage and
employment. Analyze ₹40 wage floor.
Step 1: Equilibrium (where DL = SL)
DL = 600 – 10W
SL = 10W
Set DL = SL:
600 – 10W = 10W
600 = 20W
W = ₹30 (equilibrium wage)
Now, Q = 10W = 10 × 30 = 300 units of labor
Step 2: Impact of Wage Floor (W = ₹40)
At W = ₹40:
DL = 600 – 10×40 = 200
SL = 10×40 = 400
Excess Supply: 400 – 200 = 200 units of unemployment
Analysis:
A minimum wage above equilibrium creates surplus labor (unemployment).
Firms hire less due to higher cost, while more workers are willing to work. While
the intention is to protect laborers, the actual result is job loss for low-skilled
workers.
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Q6. Given TR = 100Q – 2Q², find elasticity when MR = 20
Step 1: Marginal Revenue (MR)
TR = 100Q – 2Q²
MR = d(TR)/dQ = 100 – 4Q
Given MR = 20:
100 – 4Q = 20
⇒ Q = 20
Step 2: Price (P)
TR = P × Q
P = TR / Q = (100×20 – 2×20²) / 20
P = (2000 – 800) / 20 = 60
Step 3: Elasticity (Ep)
Ep = MR / (MR – P) = 20 / (20 – 60) = 20 / (–40) = –0.5
Since |Ep| < 1, demand is inelastic. A decrease in price will reduce total
revenue.
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Q7. Explain the kinked demand curve and its limitations.
Answer:
The kinked demand curve model is used to explain price rigidity in an oligopoly
market.
The demand curve has a kink at the prevailing market price:
Above the kink, demand is elastic: if a firm raises price, rivals don’t follow,
so it loses customers.
Below the kink, demand is inelastic: if it lowers price, others follow, and all
lose revenue.
This creates a gap in the marginal revenue (MR) curve, leading to price stability,
as firms avoid changing prices.
Limitations:
1.
Doesn’t explain price rise: Model only justifies price rigidity, not price
increases.
2. No explanation of original price: It doesn’t explain how the current price
was set.
3. Ignores product differentiation and advertising, both key in oligopolies.
4. Assumes only two reactions: Other firms may react differently to price
changes.
Despite this, it helps understand non-collusive oligopoly behavior.
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Q8. Define excess capacity and link it to monopolistic competition.
Answer:
Excess capacity refers to a situation where firms don’t produce at minimum
average cost. They operate below optimal scale.
In monopolistic competition, due to product differentiation:
Firms face downward sloping demand curves
They reach long-run equilibrium when AR = AC, but not at minimum AC
This causes excess capacity—firms could produce more at lower cost, but
don’t due to insufficient demand for their specific product.
It leads to welfare loss and inefficiency, but provides variety to consumers.
