BATCH

2024-25

CITY ACADEMY
LAW COLLEGE
B.A.LL.B. (Integrated) Five Years Degree Course
(First Year)
SEMESTER-I

ECONOMICS I
 SYLLABUS
 PREVIOUS YEAR QUESTIONS
NOTES
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 UNIT I

SYLLABUS :

Introduction of Economics

i. Nature and Significance of Economics

ii. Micro and Macro Economics, Positive and Normative Economics
iii. Economic theory of democracy
iv. Economics and Law
v. Basic Concepts: Equilibrium, Marginal Utility, Opportunity Cost, Black Money,
Price, Direct and Indirect Taxes

PREVIOUS YEAR QUESTIONS :

1. Economics is defined in variety of ways . Discuss scarcity definition of economics.(2023)

2. Critically examine the views of Marshall and regarding the nature and scope of
economics.(2015,2016)
3. Critically examine the view’s of Robbins regarding definition nature and scope of
economics. Do you think that Robbins views are superior than Marshall in dealing the
nature and scope of Economics. (2017)
Or
Give a comparative analysis of the definition of Economics given by Marshall and
Robbins . (2022)
4. Differentiate between micro and macro economics . Discuss the scope and limitations of
micro and macro economics (2018 , 2021)
5. Explain the following :
A) Positive and Normative Economics
B) Black Money (2021)
6. A)Economics is concerned with material welfare of human being (2019)
B)Economics is science concerned with problem of choice(2019)
7. Explain relationship between economics and law? (2015, 2016, 2019)
8. Write an Essay on Economics and Law (2017, 2018)
9. Write short notes on the following :
a) Total Utility and Marginal Utility
b) Positive and Normative Economics (2023)
10. Differentiate between direct and Indirect tax . Explain the merits and demerits of
direct taxes and indirect taxes . (2023)

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Short notes

1. Wealth (2015)

2. Opportunity Cost (2015)

3. Material Welfare(2015)

4. Black Money (2016)

5. opportunity Cost (2016)

6. Micro and Macro Economics (2016)

7. Difference between Direct and Indirect Tax(2016)

8. Opportunity Cost (2017)

9. stable and unstable equilibrium(2017,2018)

10. Static and dynamic equilibrium(2018)

11. Positive economics(2018)

12. Problem of choice(2018)

13. Concept of equilibrium (2019)

14. Micro and macroeconomics (2019)

15. Opportunity cost (2019)

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 LECTURE 1

a. Economics is defined in variety of ways . Discuss scarcity definition of economics.(2023)

b. Critically examine the views of Marshall and regarding the nature and scope of
economics.(2015,2016)
c. Critically examine the view’s of Robbins regarding definition nature and scope of economics.
Do you think that Robbins views are superior than Marshall in dealing the nature and scope of
Economics. (2017)
Or
Give a comparative analysis of the definition of Economics given by Marshall and Robbins .
(2022)
d. 1. Economics is concerned with material welfare of human being (2019)
2. Economics is science concerned with problem of choice(2019)

What is Economics?
The term ‘Economics’ is derived from two words of Greek language, namely, Oikos (household) and
Nemein (to manage), meaning thereby household management. Earlier, it used to be called as
Political Economy. In fact, Indian scholar and philosopher, Chanakya (Kautilya) in his famous book
‘Arth-Shastra’ has examined both kinds of activities, i.e. economics and political. Greek philosopher
Aristotle had used the term economics to mean the management of ‘family and the state’. Dr.
Marshall was the first to use the term ‘economics’ in 1890 in his famous work “Principles of
Economics”. Economics is barely 200 year old. Adam Smith, the Founder of Modern Economics,
shaped the form in which we study Economy today. His famous book “An Inquiry into the Nature
and Causes of Wealth of Nations”, published in 1776, is still acclaimed even today. Till the end of 18th
and the mid of the 19th century (1776 – 1850), several great Economists like Ricardo, Malthus, J. B.
Say, etc., had fully supported the thoughts of Adam Smith. These economists are known as classical
economists. From the middle of 19th century to the first three decades of the 20th century (1850-
1930) economists like Menger, Walras, Cournot, Marshal, Pigou, etc., had made significant
contributions to the development of the study of Economics. In 1933, Prof. Ragnar Frisch, a
famous economist of Oslo University, Norway, divided the study of economics into two parts:

(i) Micro Economics, and

(ii) Macro Economics

Economics is a popular, useful and significant social science. It involves economic activities of men.
Economic activities are those activities, which are concerned with the efficient use money and other
such scarce means. These means are used to satisfy the wants of the man. In short, Economics is the
study of those activities of human beings, which are concerned, with the satisfaction of man’s
unlimited wants by utilizing the usually limited resources.

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  Wealth Centred Definition of Economics

Adam Smith was a Scottish philosopher , widely considered as the first modern economist. Smith
defined economics as “an inquiry into the nature and causes of the wealth of nations .in
1776 ”

According to classical Economists like Adam Smith, J. B. Saw, Walker, J. S. Mill, etc.; Economics is a
subject that studies nature of wealth and its production, consumption, exchange and distribution,
etc.

WEALTH - CENTERED DEFINITIONS OF ECONOMICS:

Adam Smith:

“Economics is an enquiry into the nature and cause of wealth of nations.”

J. B. Saw:

“Economics is the science which deals with wealth.”

Walker:

“Economics is the body of knowledge which relates to wealth.”

Senior:

“The subject treated by political economics is not happiness but wealth.”

J. S. Mill:

“Economics is the practical science of production of wealth.”

Economics had not developed as an independent and important study before the publication in 1776
of the famous book of Adam Smith titled “An Inquiry into the Nature and Causes of Wealth
of Nations”.

Main Features of Adam Smith‘s definition

Economics is a study of Wealth only: According to these definitions, Economics confines itself to the
study of wealth. These Economists give primary place to the study of wealth and secondary to the study of
man. According to Adam Smith, the purpose of economics is to increase the wealth of nation. Economics
includes the consumption, production, exchange and distribution of wealth.

Nature of Meaning of Wealth: The term ‘wealth’ in these definitions is used to signify those material
goods, which are scarce. Material goods are those goods, which can be seen and touched and include: cloth,
furniture, book, gold, silver, etc. Non-material goods or services are those, which cannot be seen or touched.
For example, the services of a professor, lawyer, doctor, dancer, clerk, peon, etc., are not considered as
wealth and so remained outside the scope of the study of economics for a long time. Causes of Wealth:
According to these wealth definitions Economics seeks to investigate the causes that lead to increase of
wealth. There are two ways of increasing wealth: a) By increasing the supply of goods through large-scale
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production, b) By increasing the demand for goods through extension of market

Economic Man: The supporters and followers of wealth-related definition of Economics have imagined
such a man who is fully aware of his self interest and who makes persistent efforts to achieve this selfish ends
to the maximum. Such a man is called economic man.

Criticism of Smith’s Definition

This definition was criticized by so many philosophers they are Carlyle, Ruskin, Walrus, and Dickens
and others.

1. The wealth-centric definition of economics limited its scope as a subject and was seen as narrow and
inaccurate. Smith’s definition forced the subject to ignore all non-wealth aspects of human existence.
2. The Smithian definition over-emphasized the material aspects of well-being and ignored the non-
material aspects. It was assumed that human beings acted as rational economic agents who
mindlessly strived to maximize their own well-being.
3. The Smithian definition prevents the subject from exploring the concept of resource scarcity. The
allocation and use of scarce resources are seen as a central topic of analysis in modern economics.

 Welfare Centred Definition of Economics

British economist Alfred Marshall defined economics as the study of man in the ordinary business of life.
Marshall argued that the subject was both the study of wealth and the study of mankind. He believed it was
not a natural science such as physics or chemistry, but rather a social science.

Welfare Oriented Definition Was Given By Prof. Marshall in His Famous Book “Principles of
Economics” In 1890.

MATERIAL-CENTERED DEFINITIONS OF ECONOMICS:

Main material-related definitions of Economics are as follows:
In the words of Marshall:

“Economics is a study of mankind in the ordinary business of life; it examines that part of individual and
social action which is most closely connected with the attainment and with the use of material requisites of
well being”.

According to Canan:

“The aim of political economy is the explanation of the general causes on which the material welfare of
human beings depends.”

In the words of Beveridge:

“Economics is the study of the general methods which men use to meet their material needs.”

According to Pennon:

“Economics is the science of material welfare”

In the words of Pigou:

“Economics is the study of economics welfare as part of the social welfare process.”

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Main Features of Welfare Oriented Definition :
Importance to the study of Man: These definitions have accorded more importance to the study of man
than to wealth. Wealth is merely a means to satisfy wants of man.

Study of Social Man: In Economics, one studies the economic activities of men and the society. Individual
and collective activities of men and society are studied in Economics.

Ordinary Business of Life: By ‘ordinary business of life’, Marshall means those economic activities of a
man, which are mostly concerned with wealth getting and wealth spending.

Study of Real Man: Economics does not study any economic or selfish man. It studies the real man who
possesses several virtues, believes in social welfare and is influenced by economic and non-economic motives.

Material Requisites: Economics studies those activities of the man, which are closely connected with the
material requisites of well-being. Material goods are those, which can be seen and touched, for instance,
book, chair, pen etc.

Welfare: Economics studies those material means, which promote human welfare. Economics is concerned
with man’s material well-being. It is most closely connected with the attainment and the use of the material
requisites of well-being.

Classificatory: These definitions are considered to be classificatory as they have divided the economic
activities of the man into two classes, this is, ordinary and extra-ordinary; welfare and non- welfare;
material and non-material; social and individual etc.

Money is the measure of material welfare: According to Pigou, material or economic welfare is that
part of social welfare which can be measured directly or indirectly with the measuring rod of money.

Criticism of Marshall’s Definition

1. The Marshallian definition, like the Smithian definition, ignored the problem of scarce resources,
which possess unlimited potential uses.
2. Marshall’s definition restricted economics as a subject to only analyze the material aspects of human
welfare. Non-material aspects of welfare were ignored. Critics of the Marshallian definition asserted
that it was difficult to separate material and non-material aspects of welfare.
3. The Marshallian definition does not provide a clear link between the acquisition of wealth and
welfare. Marshall’s critics claimed that it left the subject in a state of perpetual confusion. For
instance, there are plenty of activities that might generate wealth but that can reduce human welfare.

 Scarcity Centered Definition of Economics

Austrian economists Menger and Petter, and English economist Stigle had given scarcity-related definitions
of Economics but it was examined in detail by Prof. Robbins in his book “An Essay on the Nature and
Significance of Economic Science”, published in 1932.

Scarcity-Centered Definitions of Economics:

According to Lord Robbins:

“Economics is a science that studies human behaviour as a relationship between ends and scarce means
which have alternative uses.”

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In the words of Scitovosky:

“Economics is a science concerned with the administration of scarce resources.”

According to Stonier and Hague:

“Economics is fundamentally a study of scarcity and the problems which scarcity gives rise.”

In the words of Harvey:

“Economics is the study of how men allocate their limited resources to provide for their wants.”

Main Features of Scarcity Oriented Definition :

Unlimited Wants or Ends: By ‘ends’ Lord Robbins means ‘wants’ in Economics. We study those wants of
man, which are concerned with goods and services. These are called economic wants. There is no limit to
these wants. As one want is satisfied, immediately another want crops up. This chain of wants is endless.
That is why it is said that wants are unlimited. They can be satisfied one by one, but to satisfy all them at one
time is not possible. Economics is concerned with the satisfaction of economics wants irrespective of their
being virtuous or otherwise.

Limited or Scarce Means: Most of the means of satisfying economic wants are scarce. Means of satisfying
economic wants may be material goods or non-material services. The term scarce is used in a relative sense
here. Those means are scarce whose demand is more than the supply.

Alternative Uses of Means: The third main reason that causes economic problems is that the scarce
means have alternative uses. Milk we know, is a mean. It can be used for preparing butter, curd, cheese etc.
Milk being scarce, if more of, it is used for preparing cheese, less will be available for making curd and
butter.

Wants differ in urgency: Man has several wants, but at any given time one of these wants may be more
urgent and important than other wants. A person wants medicine, milk, and fruit for his sick child. But he
will go in for medicine first; thereafter he will buy milk and fruit.

Choice-Related Problems: It is clear from the definitions of Economics given by Lord Robbins that when
all the four characteristics of human life; namely- a) unlimited wants, b) scarce means, c) alternative uses of
means, and d) different urgency of wants: become operative, there arises the problem of choice. One has to
make a choice as to which want be satisfied first and by which means.

Criticism of Robbin’s Definition

1. Robbin’s definition of economics transformed the subject from a normative social science into a
positive science with an undue emphasis on individual choice. His definition prevented the subject
from analyzing topics such as social choice and social interaction theory, which are important topics
within the modern microeconomic theory.
2. Robbin’s definition prevented it from analyzing macroeconomic concepts such as national income
and aggregate supply and demand. Instead, economics was merely used to analyze the action of
individuals, using stylized mathematical models.

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  Growth Oriented Definition of Economics

The modern definition, attributed to the 20th-century economist, Paul Samuelson, builds upon the
definitions of the past and defines the subject as a social science. According to Samuelson, “Economics is the
study of how people and society choose, with or without the use of money, to employ scarce productive
resources which could have alternative uses, to produce various commodities over time and distribute them
for consumption now and in the future among various persons and groups of society.”

The growth oriented definition of Economics was given by Prof. Samuelson in his famous book “The
foundation of economic analysis” in 1947

In the words of noble prize winner Prof. Samuelson:

“Economics is the study of how people and society end up choosing with or without the use of money, to
employ scarce productive resources that could have alternative uses, it produces various commodities over
time and distributes them for consumption, now or in the future, among various persons and groups in
society. It analyses costs and benefits of improving patterns of resource allocation.”

According to Benham:

“Economics is the study of the factors affecting employment and standard of living.”

C. E. Ferguson has defined Economics in these terms:

“Economics is the study of the economic allocation of scarce physical and human means (resources) among
competing ends, an allocation that achieves stipulated objectives by way of optimizing or maximizing.”

According to Lipsey and Steiner:

“Economics, broadly defined concerns

(i) the ways in which According society uses its resources and distributes the fruits of
production to individuals and groups in the society,
(ii) the way in which production and distraction change over time and
(iii) the efficiencies of economics system.”

Main Features of Growth-oriented Definition :

Economics Resources: These definitions underline the point that Economics is the study of economic
resources. These economic resources refer to natural, human and physical resources, which satisfy human
wants but are scarce and have alternative uses. These resources are obtained on payment of price or by
making some sacrifice.

Efficient Allocation of Resources: Choice making is the main problem in Economics. Efficient allocation
and use are the chief objectives of choice making.

Full Utilization of Resources: According to growth-oriented definitions, Economics is not concerned with
resources only but also with their full use and utilization.

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Increase in Resources: These definitions also underline the fact that the objective of Economics is to
increase the quantum and productivity of resources in future. This results in an increase in the growth rate of
economy, more employment and higher standards of living.

From the above definitions and Picking up the term ‘wealth’ from the definition of Adam Smith, ‘welfare’ from
that of Marshall, ‘scarcity’ from that of Robbins and ‘economic growth’ from that of Samuelson, an
acceptable definition of Economics can be constructed in these words:

‘Economics is a subject that studies those activities of man which are concerned with
the maximum satisfaction of wants or with the promotion of welfare and economic
growth by the efficient consumption, production and exchange of scarce means
having alternative uses’

Nature of Economics

There is a great controversy among the economists regarding the nature of economics, whether the
subject ‘economics’ is considered as science or an art.

If it is a science, then either positive science or normative science.

 Economics as a Science:

Before we start discussing whether economics is science or not, it becomes necessary to have a clear
idea about science. Science is a systematic study of knowledge and fact which develops the
correlation-ship between cause and effect. Science is not only the collection of facts, according to
Prof. Poincare, in reality, all the facts must be systematically collected, classified and analyzed.

There are following characteristics of any science subject, such as;

(i) It is based on systematic study of knowledge or facts;

(ii) It develops correlation-ship between cause and effect;

(iii) All the laws are universally accepted

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(iv) All the laws are tested and based on experiments;

(v) It can make future predictions;

(vi) It has a scale of measurement.

On the basis of all these characteristics, Prof. Robbins, Prof Jordon, Prof. Robertson etc. claimed
economics as one of the subject of science like physics, chemistry etc. According to all these
economists, ‘economics’ has also several characteristics similar to other science subjects.

(i) Economics is also a systematic study of knowledge and facts. All the theories and facts related
with both micro and macro economics are systematically collected, classified and analyzed.

(ii) Economics deals with the correlation-ship between cause and effect. For example, supply is a
positive function of price, i.e., change in price is cause but change in supply is effect.

(iii) All the laws in economics are also universally accepted, like, law of demand, law of supply, law
of diminishing marginal utility etc.

(iv) Theories and laws of economics are based on experiments, like, mixed economy to is an
experimental outcome between capitalist and socialist economies.

(v) Economics has a scale of measurement. According to Prof. Marshall, ‘money’ is used as the
measuring rod in economics. However, according to Prof. A.K. Sen, Human Development Index
(HDI) is used to measure economic development of a country.

However, the most important question is whether economics is a positive science or a normative
science? Positive science deals with all the real things or activities. It gives the solution what is?
What was? What will be? It deals with all the practical things. For example, poverty and
unemployment are the biggest problems in India. The life expectancy of birth in India is gradually
rising. All these above statements are known as positive statements. These statements are all
concerned with real facts and information.

On the contrary, normative science deals with what ought to be? What ought to have happened?
Normative science offers suggestions to the problems. The statements dealing with these suggestions
are coming under normative statements. These statements give the ideas about both good and bad
effects of any particular problem or policy. For example, illiteracy is a curse for Indian economy.
The backwardness of Indian economy is due to ‘population explosion’.

Now an important question arises whether economics is a positive science or a normative science?
The economists like Prof. Senior (classical economist) and Prof. Robbins, Prof. Freight-men (modern
economists) claimed that economics is a positive science. However, Prof. Pigou (classical

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economist). Prof. Marshall (neoclassical economist) etc. are of opinion that economics is a
normative science.

 Economics and Positive Science:

The following statements can ensure economics as a positive science, such as;
(i) Logically based:
The ideas of economics are based on absolute logical clarifications and moreover, it develops
relationship between cause and effect.

(ii) Labour Specialisation:

Labour law is an important topic of economics. It is based on the law of specialisation of labour
Economists must concern with the causes and effects of labour-division.

(iii) Not Neutral:

Economics is not a neutral between positive and normative sciences. According to most economists,
economics is merely positive science rather than normative science.

 Economics and Normative Science:

The following statements can ensure economics as a normative science, such as,

(i) Emotional View:

A rational human being has not only logical view but also has sentimental attachments and
emotional views regarding any activity. These emotional attachments are all coming under
normative statements. Hence, economics is a normative science.

(ii) Welfare Activity:

Economics is a science of human welfare, All the economic forwarded their theories for the
development of human standard of living Hence, all the economic statements have their respective
normative views.

(iii) Economic Planning:

Economic planning is one of the main instruments of economic development. Several economists
have given their personal views for the successful implementation of economic plan. Hence,
economics is coming under normative science.

All these lead us to the conclusion that ‘Economics’ is both positive and normative science. It does not
only tell us why certain things happen however, it also gives idea whether it is right thing to
happen.
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  Economics as an Art:
According to Т.К. Mehta, ‘Knowledge is science, action is art.’ According to Pigou, Marshall etc.,
economics is also considered as an art. In other way, art is the practical application of knowledge
for achieving particular goals. Science gives us principles of any discipline however, art turns all
these principles into reality. Therefore, considering the activities in economics, it can claimed as an
art also, because it gives guidance to the solutions of all the economic problems.

Therefore, from all the above discussions we can conclude that economics is neither a science nor an
art only. However, it is a golden combination of both. According to Cossa, science and art are
complementary to each other. Hence, economics is considered as both a science as well as an art.

Significance of Economics
Economics is concerned with helping individuals and society decide on the optimal allocation of our
limited resources.
The fundamental problem of economics is said to be scarcity - the idea that wants (demand) is
greater than the resources we have. The economy faces choices on

 What to produce? - Is it worth spending more on health care?

 How to produce? - Should we leave it to market forces or implement government
regulations.
 For whom to produce? - How should we distribute resources, should we place higher
income tax on the wealthiest in society?
How to manage the macro economy?
Both inflation and mass unemployment can be devastating for society. Economists argue that both
can be avoided through careful economic policies. For example:
 Policies to reduce unemployment
 Policies to reduce inflation
If economics can contribute to reducing unemployment, then it can make a significant improvement
to economic welfare. For example, the mass unemployment of the 1930's great depression led to
political instability and the rise of extremist political parties across Europe.

However, the problem is that economists may often disagree on the best solution to these challenges.
For example, at the start of the great depression in 1930, leading economists in the UK Treasury
suggested that the UK needed to balance the budget; i.e. higher taxes, lower unemployment benefits.
But, this made the recession deeper and led to a fall in demand.

It was in the great depression that John Maynard Keynes developed his general theory of
Employment, Income and Money. He argued that classical economics had the wrong approach for
dealing with depressions. Keynes argued that the economy needed expansionary fiscal policy. -
higher borrowing and government spending.

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Overcoming Market Failure

It is considered that free markets offer a better solution than a planned economy (Communist)
However, free markets invariably lead to problems such as
 The over production of negative externalities (e.g. pollution/congestion)
 The underproduction of goods with positive externalities (e.g. education, health care, public
transport).
 Non-provision of Public Goods - (national defence, law and order)
An economist can suggest policies to overcome these types of market failures. For example
 Tax negative externalities
 Subsidise public services like health care and education.
The importance of economics is that we can examine whether society is better off through
government intervention to influence changes in the provision of certain goods.

Some topical issues economists are concerned with

 Carbon Tax - should we implement a carbon tax to reduce global warming?
 Should we tax fatty foods?
Efficiency
Another area where economists have a role to play is in improving efficiency. For example
economists may suggest supply side policies to improve the efficiency of an economy.
Individual Economics
Economics is also important for an individual. For example, every decision we take involves an
opportunity cost - which is more valuable working overtime or having more leisure time?
In recent years, behavioural economics has looked at the diverse range of factors that influence
people's decisions. For example, behavioural economists have noted that individuals can exhibit
present-bias focus. This means placing excess importance on the current time period and making
decisions our future self may regret. This includes over-consumption of demerit goods like alcohol
and tobacco and failure to save for a pension.
Efficiency v Equity
In classical economics, we often focus on maximising income and profit. However, this is a limited
use of economics. Economics is also concerned with maximising overall economic welfare (how
happy are people). Therefore economics will help offer choices between increasing output and
reducing inequality.

 Efficiency v equality
 GDP and Happiness

Economics of daily living

In recent years, economists such as Gary Becker have widened the scope of economics to include
everyday issues, such as crime, family and education and explained these social issues from an
economic perspective. Becker places emphasis on the theory of rational choice. The idea that

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individuals weigh up costs and benefits.

Significance of Economics

 First and foremost, the most important advantage of economics is helping the society decide
and formulate the ways for the optimal allocation of its limited and scarce resources.
 Economics provides us the mechanism and analytical techniques to optimise the utilisation of
the available resources and reduce wastages.
 Optimum utilisation of the ‘Opportunity cost’ is another principle in which the scarce
resources are utilised efficiently after calculating and checking the opportunity cost.
Minimising the opportunity cost gives maximum profits. The use of this principle by
governments in budget allocations results in better growth rates for a nation.
 The stability of an economy is a must for any country or society to survive in the long run.
The adoption of sound economic practices in a society can only ensure that the economy is
stable and growing at the same time.
 Economics is equally important for the economical growth of individuals. A person may not
need the knowledge and understanding of the theoretical side of economics, but he definitely
needs to understand the basic economic practices that he must follow to save himself from
going broke or bankrupt and to enjoy a healthy and wealthy life. Also, understanding of at
least the basic economics helps maximising the profit.
 Economists can advise governments on how to manage the economy and avoid inflation and
unemployment through well devised economic policies.
 Economists can also be of great help to the society by suggesting certain policies to the
governments to overcome the market failures caused due to various factors such as under or
over-production.

Conclusion
Economics is important for many areas of society. It can help improve living standards and make
society a better place. Economics is like science in that it can be used to improve living standards
and also to make things worse. It partly depends on the priorities of society and what we consider
most important.

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 LECTURE 2

a. Differentiate between micro and macro economics . Discuss the scope and limitations
of micro and macro economics (2018 , 2021)
b. Explain Positive and Normative Economics (2021)

MICRO AND MACRO ECONOMICS

 Microeconomics
Microeconomics is the study of decisions made by people and businesses regarding the allocation of
resources, and prices at which they trade goods and services. It considers taxes, regulations and
government legislation.

Microeconomics focuses on supply and demand and other forces that determine price levels in the
economy. It takes a bottom-up approach to analyzing the economy. In other words, microeconomics
tries to understand human choices, decisions and the allocation of resources.

Having said that, microeconomics does not try to answer or explain what forces should take place
in a market. Rather, it tries to explain what happens when there are changes in certain conditions.

For example, microeconomics examines how a company could maximize its production and
capacity so that it could lower prices and better compete. A lot of microeconomic information can be
gleaned from company financial statements.

Microeconomics involves several key principles, including (but not limited to):

 Demand, Supply and Equilibrium: Prices are determined by the law of supply and
demand. In a perfectly competitive market, suppliers offer the same price demanded by
consumers. This creates economic equilibrium.
 Production Theory: This principle is the study of how goods and services are created or
manufactured.
 Costs of Production: According to this theory, the price of goods or services is determined
by the cost of the resources used during production.
 Labor Economics: This principle looks at workers and employers, and tries to understand
patterns of wages, employment and income.

The rules in microeconomics flow from a set of compatible laws and theorems, rather than
beginning with empirical study.

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  Scope of Microeconomics:

In micro economics the following problems and theories are discussed:

1. Price Theory

According to Prof. Robbins, human wants are unlimited but the resources to satisfy them are
limited. Therefore, we face the problem of choice in wants and economy in means. This problem is
solved by the price mechanism automatically. In other words, prices of all goods are determined by
the equilibrium of demand and supply. So, demand and supply are discussed in micro economics.

Each economic system has to make the decisions regarding what is to produced, how it is to be
produced and how the resources to be allocated amongst the different competing uses. Such all,
under capitalism, is performed with the help “Price Mechanism” i.e., those goods will be produced by
the producers which maximize their profits; those techniques will be adopted which minimize their
cost of production and the resources will be allocated in those uses where the resource command
higher prices etc. Thus, in the micro economics, we deal with the problem of production,
consumption, distribution and resource allocation.

2. Theory of Consumer Behaviour and Demand

In this part, consumer’s behaviour is studied. It is examined how he satisfies his multiple ends with
his scarce means e.g., why consumers purchase goods and which factors influence their decisions. In
other words, theory of utility, concepts of demand and elasticity of demand are studied in it.

As everyone has to face the problem of multiplicity of wants and limited money income. In such
state of affairs, it is the desire of each consumer to maximize his satisfaction, when so happens the
consumer is said to be in equilibrium. Much the micro economics deals with the problem of
equilibrium.

In order to describe consumer equilibrium basically we have two school of thoughts-Classical and
Neo-classical. The classical economists presented the “Utility Approach” or “Cardinal
Approach”, while the Neo-classical economists presented”. Indifference Curve Approach” or
“Ordinal Approach”. In addition to these two approaches Professor Paul. A. Samuelson has also
presented a theory of consumer behaviour which is known as “Revealed Preference Theory”.

After having discussed the theories of “Satisfaction Maximization” the demand behaviour of a
consumer with respect to a particular commodity is also considered in micro economic theory.

3. Theory of Production Behaviour

In capitalism factories are in private ownership. Therefore, quantity of production of goods is

decided by different firms individually. Every firm tries to get equilibrium or maximize its profit.
For this purpose, a firm tries to find optimum combination of factors. Each student of Economics is
well aware of with the four factors of production like land, labor, capital and entrepreneur.

These factors are responsible for production activities. According to classical economists, in short
run, the production depends upon the units of labor only while the capital etc. is kept fixed, In such
state of affairs the total production increases at different rates. This phenomenon is known as “Law
of Variable Proportions” in micro economic theory.

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4. Theory of firm Behaviour:

Like a consumer, the firm also wants to attain equilibrium. While the equilibrium of the firm is
attached with “Minimization of Costs” or “Maximization of Output”. Both these situations are also
known as “Optimum Factor Combination of a firm”, Thus to describe firm’s equilibrium or
“optimum factor combination”, we have two approaches in micro economics (1) Classical’s Marginal
Productivity theory (2 Neo-Classical’s “Isoquant – Iso Cot Approach”.

5. Theory of Costs and Revenues:

In micro economics we study different types of costs of production. The analysis of costs of
production may be from short run point of view as well as from long run point of view. In this
context the traditional and modem approaches are adopted. Moreover, different types of revenues
arc also considered in microeconomics.

6. Theory of Market Structure and Behaviour:

The types of market like Perfect Competition, Monopoly, Duopoly and Monopolistic Competition are
of greater significance for the readers of micro economics. Accordingly, here it is analyzed that how
the firms under different market conditions make decisions regarding the determination of price
and output.

7. Theory of Income Distribution:

The national income of a country is the result of joint efforts of land, labor, capital and
organization. Accordingly, the national income, has to be distributed amongst these factors. OR it is
to be seen that how the factor prices like wages will determined in the competitive and nor
competitive markets. Thus, for this purpose we have the classical and neo classical theories in
microeconomics.

8. Theory of Welfare Economics:

In the present time, social as well as economic welfare has attained greater importance.
Accordingly, the economists have to devise those measures and criteria which are aimed at creating
efficiency and optimality in the economic system. Therefore, in microeconomics, we study different
techniques which bring welfare to the people.

9. Economics of Uncertainty:

Most of the traditional or classical economics is based upon certainty, i.e., the economic agents do
not have to face risk while making decisions. But in the present time the element of risk has attained
a lot of importance. Accordingly, economic theories are also being devised on the basis of
uncertainty. Therefore, in microeconomics, we also study the economics of uncertainty.

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  Uses / Importance / Advantages of Microeconomics:
We can realize the importance of the study of micro economics from the following points.

1. Utility Maximization:

It teaches us to purchase the required products in most suitable quantities so that the total utility
obtained is maximized. Hence, Micro economic analysis explains us the optimum use of our income
and by virtue of it enables us to avoid the wastage of hard-earned income.

2. Resource Allocation:

By the study of micro economics we come to know how millions of consumers and producers
allocate their consumption and production resources in an attempt to achieve their optimum level.

3. Income Distribution:

By the distribution theories we learn the determination of rewards to factors of production in the
form of rent, interest, wages and profit by which distribution of wealth takes place. Unequal
distribution of income will lead to unequal distribution of wealth. It will then consequently provoke
reaction to achieve fair and relatively equal distribution of income/wealth in a society.

4. Price Determination:

The study of micro economics is highly helpful in understanding the determination of relative prices
for the productive services rendered by different factors of production.

5. Optimization:

It also helps entrepreneurs to achieve optimum production point with their budget constraint. By
this, they can maximize their profit or at least they will minimize their losses.

6. Welfare Policies:

It also helps to frame economic policies aimed at achieving public welfare e.g. tax exemption for the
poor, determination of rewards according to qualification and productive capabilities, minimum
wage laws etc.

7. Guidance for Consumers:

It enables the consumers to allocate their 1ncome on different goods in such a way that total utility
is maximized; thus, helping them to avoid the wastage of resources.

8. Guidance for Producers:

It enables entrepreneurs to achieve the optimum combination of factors of production and thereby it
enables them to maximize their profit: or at least minimize their losses. When the rewards of factors
of production are determined in accordance with their marginal productivity, the chances of their
exploitation are minimized. Thus, it enables labourers as well to achieve suitable rewards for their
productive services.

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9. Coordination Between Small Units of Economy:

It also provides guidance for small segments of an economy to bear them well coordinated with
each other. Moreover, the study of micro economics is essential to achieve the best outcome of macro
policies.

10. Working of Economy:

Microeconomics provides idea about working of the economy. It tells us about behaviour of
consumer or firm. All such consumers and firms are part of the whole economy.

11. Predictions:

Microeconomics is based on certain predictions. There are certain conditions that become basis of
predictions. It explains that if some event happens then what. will be the result. If demand goes up
the prices will go up.

12. Economic Policies:

Microeconomics is used to formulate policies. it tells us effect of government policies on allocation of

resources. The people can oppose new taxes. The government can adjust its policies through
reaction of individuals.

13. Basis of Welfare Economics:

Microeconomics is the basis of welfare economics. The individual firms and organisations pay taxes
to the government. They can check whether the government has used that money for welfare of the
people.

14. Management Decisions:

Business decisions re made with the help of microeconomics. The analysis of demand and cost is
essential. The management can use facts and figures to arrive at most suitable decision.

15. Basis of Whole Economy:

Microeconomics is the basis of whole economy. Microeconomics studies small and individual units
of the economy which later on becomes a base to study the economy as a whole.

16. Solves Problems of Firms:

Microeconomics is helpful in solving the problems of individual firms. The working of firm is
examined to know the real problem. The solution is made to handle such problem.

 Disadvantages / Limitations of Microeconomics:

Following are the demerits of micro economic analysis and policies related to it.

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1. Free Market Economy:

Microeconomics is based on the idea of free market economy. In fact, there Is no free market
economy after great depression of 1930.

2. Study of Parts:

Microeconomics is concerned with study of parts but not the whole. In terms of individual terms, it
is impossible to describe large and complex universe of facts like economic system.

3. Misleading for Analysis:

Microeconomics is inadequate and misleading for analysis of economic problems. The principles
relating to an individual household cannot be applied to the whole. economic system.

4. Full Employment:

Microeconomics assumes that there is full employment. There is no full employment at all times in
this world. Full employment is an exception in practical life.

5. Economic Instability:

When every single firm it allowed to operate freely in an open economy, it would naturally go for
self-interest; even at the cost of national interest. Thus, it would disrupt the cohesion between
different productive units which will ultimately force the economy to move into depression. A free
enterprise economy is therefore an unstable economy i.e. the economy which keep: on fluctuating
with boom: and depressions.

6. Exploitation of Consumers:

Inspite of proper guidance for the consumers the real-life situation reveals that they are exploited.
This happens with the rising rate of inflation iii an economy. With the pace of inflation, on one hand,
wealth keeps on concentrating in a few hands while, on the other hand, consumers are deprived of
their purchasing power. The natural inequality of income distribution in a free enterprise economy
leads to exploitation of consumers.

7. Exploitation of Labourers:

Entrepreneurs exploit their labourers by keeping their wage rate low or even lower than their
marginal productivity. This happens in three ways:

(i) By forcing labourers to work for more hours than required under labour laws.

(ii) By installing automatic and computerized plants to increase the marginal productivity of labour
which is not followed by increase in their wage rate.

(iii) By setting up production units in remote areas to employ labour at notoriously low wage rate.

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8. Absence of Large-Scale Production:

Micro economic analysis encourages setting up of small units for growth of economy. This could
possibly be achieved more efficiently by initiating and encouraging large scale production.

9. Unrealistic Assumptions:

Micro economics is based on unrealistic assumptions, especially in case of full employment

assumption which does not exist practically. Even behaviour of one individual cannot be generalised
as the behaviour of all.

10. Inadequate Data:

Micro economics is based on the information dealing with individual behaviour, individual
customers. Hence, it is difficult to get correct information. So, because of incorrect data Micro
Economics may provide inaccurate results.

 Macroeconomics
Macroeconomics, on the other hand, studies the behavior of a country and how its policies impact
the economy as a whole. It analyzes entire industries and economies, rather than individuals or
specific companies, which is why it's a top-down approach. It tries to answer questions such as,
"What should the rate of inflation be?" or "What stimulates economic growth?"

Macroeconomics examines economy-wide phenomena such as gross domestic product (GDP) and
how it is affected by changes in unemployment, national income, rates of growth and price levels.

Macroeconomics analyzes how an increase or decrease in net exports impacts a nation's capital
account, or how gross domestic product (GDP) is impacted by the unemployment rate.

Macroeconomics focuses on aggregates and econometric correlations, which is why governments

and their agencies rely on macroeconomics to formulate economic and fiscal policy. Investors who
buy interest-rate sensitive securities should keep a close eye on monetary and fiscal policy. Outside a
few meaningful and measurable impacts, macroeconomics doesn't offer much for specific
investments.

John Maynard Keynes is often credited as the founder of macroeconomics, as he initiated the use of
monetary aggregates to study broad phenomena. Some economists dispute his theories, while many
Keynesians disagree on how to interpret his work

 Scope of Macroeconomics:

From the above discussion we find that macroeconomics has the following scope.

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1.Theory of National Income:

In macroeconomics we study ‘NI’; its different concepts and its measurement.

2. Theory of NI Determination:

The major part of macroeconomics deals with the theory of NI determination. Accordingly, in
macroeconomics, we study classical and Keynesian theories of national income and employment.

3. Theory of NI Fluctuations:

In capitalist economies, the economic activities are never alike. Sometimes there is a brisk in
economic life, while on the other occasions, the business activities are sluggish. Such fluctuations in
economic life of a country are known as trade cycles. Why there are such fluctuations? In this
context we study a lot of theories, particularly, “Samuelson’s Multiplier-Accelerator” interaction is
of great importance for the readers of macroeconomics.

4. Theory of Consumption and Savings:

In macroeconomics, AD plays an important role. The AD has an important component which is

Consumption (C). The consumption has a counterpart which is Saving (S). How people behave
regarding consumption expenditures and savings? In this connection, starting from Keynes
consumption function, we have a lot of consumption theories like Dusenberry’s Relative Income
Theory”, ” Friedman’s Permanent Income Theory” and “Modigliani’s Life Cycle Income Theory “.

5. Theory of Money:

In an economy ‘money’ plays an important role. What will be the effects of changes in supply of
money on the economy? What are inflation and deflation? What causes the inflation. What is
demand pull and cost push inflation? What a Phillips curve shows? In this respect we study a lot of
theories in macroeconomics.

6. Theory of Economic Stabilization:

As told earlier that in capitalist economies, inflation, unemployment, unequal income distribution,
misallocation of resources, deficit in BOP and budget deficits are the routine problems. Therefore, to
remove them or for the sake of economic stabilization, government has to intervene with the help of
” Fiscal and Monetary Policies”. The role of such policies will be analyzed in macroeconomics.

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7. Theory of Growth:

The Keynes model of income and employment just deals with static and comparative static
situations. But in addition to this model, we have a lot of dynamic growth models in
macroeconomics where we study the growth path of the economy; effect of change in population on
the level of NI: the effect of change in technology on the level of NI, etc.

 Importance of Macro Economics:

We can realize the importance of the study of macroeconomics from the following points.

1. Working of Economy:

Macroeconomics is helpful to understand working of economy. Economic system is complicated.

Many interdependent-economic factors affect the economy. Microeconomics cannot provide clear
picture of whole economy.

2. Making Economic Policies:

Macroeconomics is used to make economic policies. There is need facts and figures abut national
income, total employment, total investment, total saving and general price level. Macroeconomics
can provide statistics about such variables.

3. Solves Economic Problems:

An economy can face problems like overproduction, unemployment, and rising price level. The
government can solve its problems with the help of macroeconomics.

4. Studies Trade Cycles:

The capitalistic economies can face problem of trade cycles or ups and downs, in business activities.
Such problems upset the proper working of economy. Macroeconomics provides solution to
overcome difficulties of trade cycles.

5. Widens Scope of Microeconomics:

The laws of microeconomics are framed with the help of macroeconomics. The law of diminishing
marginal utility is derived from analysis of aggregate behaviour of people.

6. Changes in Price Level:

Macroeconomics deals with the problems of changes in price level. There may be inflation, deflation,
or stagflation. The changes in price level create disturbance for proper working of economy.

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7. Study of National Income:

The study of national income explains various problems of economy. National income of any
Country can show its economic conditions. The population control program or defense program
depend upon national income. Macroeconomics is used to calculate national income.

8. Behaviour of Individual Firms:

Microeconomics studies behaviour of individual firms. Demand for a product depends upon total of
such product in the economy. The causes for decrease in total demand are analyzed to note decrease
in demand of a product.

 Limitations:

1. Dependence on Individual Units:

Macroeconomics deals with aggregates and such aggregates are taken from individuals. The results
of aggregates may be different from individual. What is good for individual may not be good for the
economy. The saving for a person is good but it is bad for whole economy. There is decrease in
national income due to saving of society. Thus, decisions for economy on the basis of individual
behaviour are wrong.

2. Statistical Difficulties:

The measurement of macroeconomic problems involves statistical difficulties. These problems relate
to aggregation of microeconomic variables. When microeconomic variables relate to dissimilar
individual units the aggregates of such variable provide wrong results.

3. Indiscriminate Use is Bad:

Indiscriminate use of macroeconomics for analysis of problems is bad. The measures suggested to
control general price level may to be useful in controlling prices of individual products.

4. Aggregate Variables May Be Useless:

The aggregate variables relating to an economic system may not provide significant results. The
national income of any country may be divided by population provides per head income. An
Increase in national income does not means that income of every individual has gone up.

5. Aggregates Are Not Similar:

Macroeconomics considers that aggregates are similar without checking their internal structure.
Average wages are calculated with the help of total wages of all workers. The wages of one sector
may increase while that of other may decreases but average will remain the same and aggregates
may differ.

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 Microeconomics Macroeconomics
Meaning
Microeconomics is the branch of Economics that is related Macroeconomics is the branch of Economics that
to the study of individual, household and firm’s behaviour deals with the study of the behaviour and
in decision making and allocation of the resources. It performance of the economy in total. The most
comprises markets of goods and services and deals with important factors studied in macroeconomics involve
economic issues. gross domestic product (GDP), unemployment,
inflation and growth rate etc.
Area of study
Microeconomics studies the particular market segment of Macroeconomics studies the whole economy, that
the economy covers several market segments
Deals with
Microeconomics deals with various issues like demand,
supply, factor pricing, product pricing, economic welfare, Macroeconomics deals with various issues like
production, consumption, and more. national income, distribution, employment,
general price level, money, and more.

Business Application
It is applied to internal issues. It is applied to environmental and external issues.

Scope
It covers several issues like demand, supply, factor It covers several issues like distribution, national
pricing, product pricing, economic welfare, production, income, employment, money, general price level, and
consumption, and more. more.
Significance

It perpetuates firmness in the broad price

It is useful in regulating the prices of a level, and solves the major issues of the
product alongside the prices of factors of economy like deflation, inflation, rising prices
production (labour, land, entrepreneur, (reflation), unemployment, and poverty as a
capital, and more) within the economy. whole.

Limitations

It has been scrutinised that the misconception

It is based on impractical presuppositions, i.e., in of composition’ incorporates, which sometimes
microeconomics, it is presumed that there is full fails to prove accurate because it is feasible
employment in the community, which is not at all that what is true for aggregate
feasible. (comprehensive) may not be true for
individuals as well.

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 POSITIVE AND NORMATIVE ECONOMICS
Economics is a science as well as art. But which type of science is a big question here, i.e. positive or
normative? Positive economics is related to the analysis which is limited to cause and effect
relationship. On the other hand, normative economics aims at examining real economic events
from the moral and ethical point of view. It is used to judge whether the economic events are
desirable or not.

While Positive economics is based on facts about the economy. Normative economics is value
judgment based. Most of the people think that the statements which are commonly accepted are a
fact but in reality, they are valued. By, understanding the difference between positive and
normative economics, you will learn about how the economy operates and to which extent the policy
makers are taking correct decisions.

BASIS FOR POSITIVE ECONOMICS NORMATIVE ECONOMICS

COMPARISON

Meaning A branch of economics A branch of economics based on

based on data and facts is values, opinions and judgement is
positive economics. normative economics.

Nature Descriptive Prescriptive

What it does? Analyses cause and effect Passes value judgement.

relationship.

Perspective Objective Subjective

Study of What actually is What ought to be

Testing Statements can be tested Statements cannot be tested.

using scientific methods.

Economic issues It clearly describes It provides solution for the

economic issue. economic issue, based on value.

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 LECTURE 3

a. What is economic theory of democracy ?

Economic Theory of Democracy

An Economic Theory of Democracy is a political science treatise written by Anthony Downs ,

published in 1957 . The book set forth a model with precise conditions under which economic theory
could be applied to non-market political decision-making .

 Anthony Downs is an American economist specializing in public policy and public

administration .

Anthony Downs claimed that significant elements of political life could be explained in terms of
voter self-interest .

The downs paradox of voting basically asks if it is rational to not to vote . Down’s paradox
challenges the claim that it is rational for a self interested individual to vote for the purpose of
changing an election . As someone self interested and rational will not take action for which the cost
of voting outweighs the benefits .

Anthony Downs starts from his basic model : in a world of perfect information each voter would
compare his expected utility of having a party A in government with the expected utility of having
party B in the government . This utility differential would determine each voter’s choice at the ballot
box .

And these informations are based on the policies formulated by various parties competing in the
elections . These parties announce to carry out those policies in case they acquire office .

Nature of Parties :
 2 or more parties compete in periodic elections for control of governing
 The winning party will gain control until the next election
 Losing party never attempt to prevent the winners from taking office , nor do winners use the
powers of office to vitiate the ability of losers to compete in the next election
 All sane , law abiding adults who are governed are citizens , and every citizen has one and
only one vote in each election

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 Axioms :

Each political party is a team of men who seek

office solely in order to enjoy the income ,
prestige and power that go with running the
government

The winning party has complete control over the

governments action until the next election . There are
no votes of confidence between elections either by a
legislature or by electorate . Nor are any of it's
orders registered sabotaged by bureaucracy

The only limit on government's power is that the

incumbent party cannot in any way restrict the
political freedom of opposition

i.e., in democracy the government always acts so

as to maximise the number of votes it will recieve
. In effect ,it is an entrepreneur selling policies
for votes instead of products for money .

Now we will discuss about RENT SEEKING WHICH ACTS AS AN AID TO POLITICAL
PARTIES FOR MAXIMISING THEIR NUMBER OF VOTES

RENT SEEKING

Rent-seeking is a concept in economics that states that an individual or an entity seeks to increase
their own wealth without creating any benefits or wealth to the society.

Rent-seeking activities aim to obtain financial gains and benefits through the manipulation of the
distribution of economic resources. Economists view such activities as detrimental to the economy
and society. The practice reduces economic efficiency through the inefficient allocation of resources.

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Also, it commonly leads to other damaging consequences, including a rise in income inequality, lost
government revenues, and a decrease in competition.

Rent-seeking doesn’t tend to increase productivity in the economy. On the other hand, it can be an
easier alternative to production for the purpose of obtaining financial benefits. The practice can be
especially favorable during economic slowdowns or recessions when companies cannot easily
increase production.

Also, it is commonly viewed that rent-seeking activities discourage innovation. Instead of

developing new innovative methods for revenue generation, companies may rely on the practice to
increase their own wealth.

The concept of rent-seeking was developed by American economist Gordon Tullock in 1967.
However, the term was offered by another economist, Anne Krueger.

THE TULLOCK PARADOX

The corrupt politicians utilize their bureaucratic power to engage in rent-seeking activities. In order
to gain certain benefits, the rent-seekers may bribe politicians. However, G. Tullock determined that
there is a significant difference between the cost of rent-seeking (bribery) and the gains from this
practice. This paradox is called the Tullock Paradox.

The Tullock Paradox states that rent-seekers generally obtain large financial and economic gains at
an enormously small cost. This cost-benefit discrepancy stems from several possible explanations:

 In democratic states, there is somewhat more transparency for voters to monitor the
behavior of the politicians. Therefore, if a politician is corrupt and takes a bribe, it may be
discovered, and voters can penalize the corrupt politicians by not reelecting them, or he may
be criminally charged.
 Another force that determines the costs for rent-seekers is whether there is competition
among politicians. If there are different politicians that can ensure the delivery of certain
benefits to rent-seekers, then the competing politicians will push down the cost of rent-
seeking.

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 LECTURE 4

a. Write an Essay on Economics and Law (2017, 2018)

ECONOMICS AND LAW

The law and the economy interact in many ways. Whereas private law assists individuals and groups who
are willing to enter into agreements in a free market, public law seeks to correct the outcomes of a free
market system by means of economic and social regulation. Economists themselves should be informed
about the legal environment in which economic activities must be conducted, while lawyers should be aware
of the economic effects of current legal rules and the expected outcome under a different legal regime. Law
& Economics meshes together two of society’s fundamental social constructs into one subject, allowing a
multi-faceted study of significant problems which exist in each subject.

What can Law & Economics do?

Law & Economics, with its positive economic analysis, seeks to explain the behaviour of legislators,
prosecutors, judges, and bureaucrats. The model of rational choice, which underlies much of modern
economics, proved to be very useful for explaining (and predicting) how people act under various legal
constraints. This positive analysis informs the normative branch of the discipline about possible outcomes. If
effects of divergent legal rules and institutions are known, the normative analyst will be able to discern
efficient rules from those that are inefficient and formulate reform proposals to increase the efficiency of the
law. Also, Law & Economics has the ability to improve the quality of the legal system. In the last decades, an
impressive literature has developed, showing the strength of both positive and normative economic analysis
in various areas of law.

History of Law & Economics

Law & Economics began its synthesis as a discipline through the theories of the Chicago School, and received
guidance and influence from such pioneers as Guido Calabresi and Nobel Prize winners Ronald Coase and
Gary Becker. Richard Posner’s book ‘Economic Analysis of Law’(1972) became one of the classics of the
discipline. Recently, other methods have moved to the fore, including the Property Rights approach, the
Austrian School and the Neo-Institutionalist approach. Finally, the Public Choice School, with Nobel Prize
winner James Buchanan as an outstanding author, focuses more specifically on the political context of the
law-making process.

Positive and normative law and economics

Economic analysis of law is usually divided into two subfields: positive and normative

Positive law and economics

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'Positive law and economics' uses economic analysis to predict the effects of various legal rules. So, for
example, a positive economic analysis of tort law would predict the effects of a strict liability rule as opposed
to the effects of a negligence rule. Positive law and economics has also at times supported to explain the
development of legal rules, for example the common law of torts, in terms of their economic efficiency.
Normative law and economics
Normative law and economics goes one step further and makes policy recommendations based on the
economic consequences of various policies. The key concept for normative economic analysis is efficiency, in
particular, allocative efficiency.
A common concept of efficiency used by law and economics scholars is Pareto efficiency. A legal rule is
Pareto efficient if it could not be changed so as to make one person better off without making another
person worse off. A weaker conception of efficiency is Kaldor–Hicks efficiency. A legal rule is Kaldor–Hicks
efficient if it could be made Pareto efficient by some parties compensating others as to offset their loss.
Nonetheless, the possibility of a clear distinction between positive and normative analysis has been
questioned by Guido Calabresi who, in his book on "The future of Law and Economics" (2016: 21-22),
believes that there is an "actual - and unavoidable - existence of value judgments underlying much economic
analysis"
Uri Weiss proposed this alternative: "It is common in law and economics to search for the law that will lead
to the optimal outcome, providing the maximum size 'pie,' and to think about maximizing happiness instead
of minimizing pain. We prefer another approach: We do not try to identify games that will lead to the
optimal result but to prevent games in which it is in the best interests of the players to come to an unjust
result"

Importance of economics in law

1. Economic laws are the statement of cause and effect
By this statement, we meant that science as well as law is concerned with the cause and effect
relationship that means it focuses on the relationship between one thing which is affecting another
thing, for example, the relationship between the substitute and the complementary goods.

2. Economics helps in better interaction with human behavior

The primary objective of the law is to video from the infringement from his basic rights which
means the law is rotated towards human behavior and has to build a proper and better interaction
with the humans to provide the settlements for their disputes arising out of the economic factors in
the economy. Therefore, we can easily say that economics helps in better interaction with human
behavior.

3. Regulation of various bodies needs a better understanding of Economics

Every aspect of the economy like cash flow, demand, supply, utility, etc. Therefore, proper
enactments related to these concepts need a basic understanding of economics. Moreover, the
regulation of various bodies governing these concepts needs proper law constituting them. For
example – RBI, LIC, SEBI, etc.

4. Economics helps in understanding the negative externalities in various law

subjects
A negative externality is a cost that is suffered by a third party as a consequence of an economic
transaction. In a transaction, the producer and consumer are the first and second parties, and third
parties include any individual, organisation, property owner, or resource that is indirectly affected.

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Externalities are also referred to as spillover effects, and a negative externality is also referred to as
an ‘external cost’.

5. Economics helps in understanding tax laws

Economics helps in understanding tax laws directly or indirectly economics helps in understanding
various concepts of tax laws. For example, the economics of taxation pocket on the problems
concerned with the levying of taxes. As we know Economics deal with the issues of the economy alike
law is concerned with the issues related to the society.

6. Economic help in understanding the company law

Company Law or we can say business law, in other words, is concerned with the corporate sector
which includes various terms and definitions which early man can’t understand without
understanding the concept of Economics. Therefore we can say that company law can be
understood to the people having a piece of basic knowledge regarding economics.

7. Economics helps in understanding consumer protection law

Economic directly or indirectly helping the understanding of consumer protection that is covered
under the Consumer Protection Act which is enacted for the protection of consumers and
encroachment of their rights as a consumer of the goods and services. Therefore, the basic
understanding of Economic helps in understanding Consumer Protection laws.

8. Laws related to the limited resources can only be understood by having a basic
knowledge of Economics.

As we know India is a diverse country having very limited resources for example water, petroleum
and many others. For that purpose, to conserve these resources proper rules and regulations are to
be introduced in various legislation or promulgations to sustainable development. For example,
Water (prevention and control of pollution) act of 1974 have been enacted

9. Concept of uncertainty and expectations taught by economics in law

As we know economics to deal with unlimited wants and limited resources thus comprises greater
expectations. And for the accomplishment of these expectations wants, normally people used to do
unfair means to attain it. For that purpose, proper legislation is to be made in the law itself which
reflects the significance of economics in lawmaking.

10. Economics act as a critical examination of lawmaking

There is no doubt that economics deals with each and every sector of the economy. Therefore, for the
enactment of necessary legislation, we have to consider the parameters of economics. Economics
exam board critical examination for the present situation of the economy which helps in enactment
of various promulgations related to the economy.

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 LECTURE 5

a. Explain the following :

1. Black money . (2021)
2. Total Utility and Marginal Utility (2023)
b. Differentiate between direct and Indirect tax . Explain the merits and demerits
of direct taxes and indirect taxes . (2023)

Basic Concepts

EQUILIBRIUM :
Economic equilibrium is a condition or state in which economic forces are balanced. In effect, economic variables
remain unchanged from their equilibrium values in the absence of external influences. Economic equilibrium is
also referred to as market equilibrium.

Economic equilibrium is the combination of economic variables (usually price and quantity) toward which
normal economic processes, such as supply and demand, drive the economy. The term economic equilibrium
can also be applied to any number of variables such as interest rates or aggregate consumption spending. The
point of equilibrium represents a theoretical state of rest where all economic transactions that “should” occur,
given the initial state of all relevant economic variables, have taken place.

KEY TAKEAWAYS

 Economic equilibrium is a condition where market forces are balanced, a concept borrowed from physical
sciences, where observable physical forces can balance each other.
 The incentives faced by buyers and sellers in a market, communicated through current prices and
quantities drive them to offer higher or lower prices and quantities that move the economy toward
equilibrium.
 Economic equilibrium is a theoretical construct only. The market never actually reach equilibrium,
though it is constantly moving toward equilibrium.

Types of equilibrium :

 Stable , Unstable & Neutral Equilibrium :

There are three types of equilibrium, namely stable , neutral and unstable equilibrium. Prof. Schumpeter
explains the three positions with a simple illustration of a ball placed in three different states. According to
Schumpeter, “A ball that rests at the bottom of a bowl illustrates the first case; a ball that rests on a billiard
table, the second case, and a ball that is perched on the top of an inverted bowl, the third case.”

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In figure 1(a), the ball is comfort at the base of the bowl. It remains in stable equilibrium. If interfered, the ball is
going to rest at its original position again. In figure 1(b), the ball is located on a billiard table. It shows neutral
equilibrium. If perturbed, the ball is going to find its balance at another new position. In figure 1(c), the ball is
stabilized on top of the upturned bowl. It is basically in unstable equilibrium. If interrupted, the ball will
certainly move down either side of the bowl and fails to get back to its original position.

(a) Stable Equilibrium: There is stable equilibrium, when the object concerned, after having been disturbed,
tends to resume its original position. Thus, in the case of a stable equilibrium, there is a tendency for the
object to revert to the old position.

In figure 2, DD represents a negatively sloped demand curve and SS denotes a positively sloped supply curve.
The equilibrium occurs at point E. At this point, the supply and demand are in balance; the equilibrium price
OP and the equilibrium quantity OQ are determined. It is a classical example of stable equilibrium in
economics.

What happens at prices above equilibrium level?

Let us assume that the market price is OP1. At this price, P1B is the quantity supplied while the quantity
demanded is only P1A. Hence, quantity supplied is more than the quantity demanded. The surplus quantity in
the market is to the extent of AB. This creates a downward pressure on price. The downward pressure applies
until the price reaches the equilibrium level at which the quantity supplied equals the quantity demanded.
What happens at prices below equilibrium level?
In the diagram, let us consider the price OP2. At this price level, the quantity supplied is less than the quantity
demanded. CE1 denotes the volume of shortage of commodity. Due to this excess demand, an upward pressure
on the price applies. This upward pressure pushes up the price to the equilibrium level at which the quantity
supplied equals the quantity demanded.

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(b) Unstable Equilibrium: On the other hand, the equilibrium is unstable when a slight disturbance evokes
further disturbance, so that the original position is never restored. In this case, there is a tendency for the
object to assume newer and newer positions once there is departure from the original position.
In supply and demand analysis, unstable equilibrium can occur at two occasions: (1) when there is a
negatively sloped supply curve and (2) when there is a positively sloped demand curve.
1. Negatively Sloped Supply Curve
Unstable equilibrium occurs when there are negatively sloped demand curve, which is normal and a
negatively sloped supply curve, which is a rare and exceptional case. This negatively sloping supply curve
is possible when both increasing production and decreasing costs occur simultaneously due to various
internal and external economies of scale enjoyed by the firm.

In figure 3, the point E represents equilibrium. OP is the equilibrium price and OM is the equilibrium
quantity. If the price goes above the equilibrium price, the quantity demanded is more than the quantity
supplied. Because of this excess demand, price goes up further and moves away from equilibrium.
Similarly, at prices below equilibrium, quantity supplied is more than quantity demanded. Due to excess
supply, price goes down further and continues to move away from the equilibrium. In both the cases, there
is no possibility for the price to move towards equilibrium. Hence, E represents an unstable equilibrium
position.

2. Positively Sloped Demand Curve

A second scenario of unstable equilibrium exists while the supply curve is usual and demand curve is
positively sloping. Such a demand curve is applicable in the event of ‘giffen goods’. In the instance of
giffen goods, demand goes up while the price of the commodity rises and vice versa.

In figure 4, the rare demand curve intersects the regular supply curve at E, which establishes the
equilibrium price at OP and the equilibrium quantity at OM. A rise in price above OP causes an
excessive amount of demand oversupply. This excess demand over supply provokes another great increase
in the price. A reduction in price below OP contributes to excess supply over demand. This excess supply
over demand triggers a further decrease in the price. Hence, E in the above diagram is in unstable
equilibrium since there is no chance for the original equilibrium to be restored.

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 (c) Neutral Equilibrium: It is neutral equilibrium when the disturbing forces neither bring it back to the original
position nor do they drive it further away from it. It rests where it has been moved. Thus, in the case of a neutral
equilibrium, the object assumes once for all a new position after the original position is disturbed.
The situation of neutral equilibrium crops up when demand and supply curves go together in a range of prices
or in a range of quantities. The Neutral equilibrium is finely detailed in the following diagram:

In figure 5(a), demand curve DD and supply curve SS correspond over a range of prices between OP to OP1.
OP is the original equilibrium price and OM is the quantity. When the price goes down from OP to OP1, the
equilibrium quantity OM stays unchanged. The market is in neutral equilibrium in the EE1 range of prices.

Similarly, the demand curve DD and supply curve SS coincide over the range of output from M to M1 as
shown in figure 5(b). A change in demand or supply within the MM1 range of output has no influence to
modify the equilibrium price level. Hence, the equilibrium price is neutral to changes in demand for or supply of
commodities within the range of MM1.

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  Partial and General Equilibrium :

What is Partial Equilibrium Analysis?

Partial equilibrium is just the technical terms for demand and supply analysis. Partial equilibrium models
consider only one market at a time, ignoring potential interactions across markets. It is strictly valid only
under some limited circumstances (certain restrictions on demand and the assumption that the sector in
question is small relative to the economic system as a whole), which may not always hold in practice, but
may be reasonable approximations. These types of models allow us to predict changes in key economic
variables of interest, including prices, the volume of trade, revenue, and measures of economic efficiency.

What Is General Equilibrium Theory?

General equilibrium theory, or Walrasian general equilibrium, attempts to explain the functioning of the
macroeconomy as a whole, rather than as collections of individual market phenomena.

The theory was first developed by the French economist Leon Walras in the late 19th century. It stands in
contrast with partial equilibrium theory, or Marshallian partial equilibrium, which only analyzes specific
markets or sectors.

KEY TAKEAWAYS

 General equilibrium analyzes the economy as a whole, rather than analyzing single markets like with
partial equilibrium analysis.
 General equilibrium shows how supply and demand interact and tend toward a balance in an economy
of multiple markets working at once.
 The balance of competing levels of supply and demand in different markets ultimately creates a price
equilibrium.
 French economist Leon Walras introduced and developed the theory in the late 19th century.

Partial Equilibrium General Equilibrium

Micro economics uses partial equilibrium analysis Macro economics uses general equilibrium. It is not based on
based on the assumption, other things remaining any` assumption.
constant.
Partial equilibrium studies the equilibrium of a It deals with the equilibrium position of the economy as a whole.
consumer, a firm, an industry or a market.
It deals with one or two variables at a time. So it is a It deals with all the variables of the economic system
simple method. It is independent. simultaneously. So it is sophisticated. There is interdependence
between variables.
Partial Equilibrium is regarded as a worm's eye- General Equilibrium is a bird's eye-view.
view.

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  STATIC AND DYNAMIC EQUILIBRIUM

Static economics studies only a particular point of equilibrium. But dynamic economics also studies the
process by which equilibrium is achieved. As a result, there may be equilibrium or may be disequilibrium.
Therefore, static analysis is a study of equilibrium only whereas dynamic analysis studies both equilibrium and
disequilibrium.

MARGINAL UTILITY :
Marginal utility refers to the additional benefit derived from consuming one more unit of a specific
good or service. Consuming units can result in positive, negative, or zero marginal utility. Utility is
not constant, and for every additional unit consumed, often the consumer experiences what
economists refer to as the diminishing marginal utility, where each additional unit adds less and
less marginal utility.

Summary

 Marginal utility is the extra benefit derived from consuming one more unit of a specific good
or service.
 The main types of marginal utility include positive marginal utility, zero
marginal utility, and negative marginal utility.
 Consumers often experience higher marginal utility when marginal cost is
lower.

 MARGINAL UTILITY TABLE

No. of units (cups) Total utility (TU) Marginal utility (MU)

1 30 utils 30 utils
2 55 utils 25 utils
3 75 utils 20 utils
4 85 utils 10 utils
5 92 utils 7 utils
6 95 utils 3 utils
7 95 utils 0 util
8 90 -5 utils

We can see that both TU and MU began from the same point. However, as consumption increased,
total utility continued increasing, whereas, the marginal utility kept declining in line.
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On the 7th unit, when total utility is at its peak (95 utils), the marginal utility was zero therefore,
implying that any additional cup of coffee from that point would result in negative MU or
dissatisfaction. A rational consumer would stop his/her consumption at the 7 th unit.
Thus, from the above discussion, we can encapsulate the relationship between TU and MU as noted
below –
 Marginal utility falls when total utility rises
 MU = 0 when total utility is maximum
From a consumer’s perspective, marginal utility can be aligned with the cost of consuming a
commodity. For instance, if marginal utility cost of a commodity is Rs.20 and MU derived from it is
more than 20 utils (assuming Re.1 = 1 utils), then such individuals will continue his/her
consumption until marginal utility of that commodity equals its price. It is also known as the
consumer’s equilibrium.

 MARGINAL UTILITY CURVE

Relationship between TU and MU:

1. TU increases with an increase in consumption of a commodity as long as MU is positive. In this phase,
TU increases but a diminishing rate as MU from each successive unit tends to diminish.
2. When TU reaches its maximum, MU becomes zero. TU stops rising at this stage. This point is known as
point of satiety.
3. When consumption is increased beyond the point of satiety, TU starts falling as MU becomes negative.

OPPORTUNITY COST :

Opportunity cost is the value of what you lose when choosing between two or more options. When
you decide, you feel that the choice you've made will have better results for you regardless of what
you lose by making it. As an investor, opportunity cost means that your investment choices will
always have immediate and future losses or gains.

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While opportunity cost is not an exact measure, one way to quantify this cost might be to estimate
the future value that you opted not to receive and compare it with the value of the choice you made
instead.
Comparing these measures in hindsight will make them appear more concrete, but keep in mind
that such an estimation is only a theoretical difference.
On a basic level, this is a common-sense concept that economists and investors like to explore. For
example, what would have happened if Walt Disney had never started animating?
He might have gone on to do something equally successful, or you may not have ever heard his
name. Opportunity cost is the proverbial fork in the road, with dollar signs on each path—the key is,
there is something to gain and lose in each direction. You make an informed decision by estimating
the losses for each decision.
 Alternative definition: Opportunity cost is the loss you take to make a gain, or the loss of
one gain for another gain.

BLACK MONEY :
Black money is a term used in common parlance to refer to money that is not fully legitimate in the
hands of the owner. This could be for two possible reasons.

 First is that the money may have been generated through illegitimate activities not
permissible under the law, like crime, drug trade, terrorism, and corruption, all of which are
punishable under the legal framework of the state.
 Second and perhaps more likely reason is that the wealth may have been generated and
accumulated by failing to comply with the tax requirements.

There have been several estimates regarding the extent of black money economy also called as
parallel economy. Some of the estimates suggest it to be as high as up to fifty to hundred percent.

Although black money in India is decades old problem, it has become real threat post liberalization.
Illegal activities such as crime and corruption, non-compliance with taxation requirements, complex
procedural regulations, cultural and social practices, globalization along with weak institutional,
policy, legal and implementation structures have further augmented the black money economy.

 Causes of Black Money :

1. Unrealistic Tax Laws and Tax Frauds

2. Different Rates of Excise Duty
3. Control Policy
4. Quota System
5. Scarcity, 6. Inflation
7. Elections in a Democratic System and Political Funding
8. Real Estate Transaction
9. Privatisation
10. Agricultural Income

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 PRICE :
Price, the amount of money that has to be paid to acquire a given product. Insofar as the
amount people are prepared to pay for a product represents its value, price is also a measure of
value.

It follows from the definition just stated that prices perform an economic function of major
significance. So long as they are not artificially controlled, prices provide an economic
mechanism by which goods and services are distributed among the large number of people
desiring them. They also act as indicators of the strength of demand for different products and
enable producers to respond accordingly. This system is known as the price mechanism and is
based on the principle that only by allowing prices to move freely will the supply of any given
commodity match demand. If supply is excessive, prices will be low and production will be
reduced; this will cause prices to rise until there is a balance of demand and supply. In the same
way, if supply is inadequate, prices will be high, leading to an increase in production that in turn
will lead to a reduction in prices until both supply and demand are in equilibrium.

 Factor cost:
It is the total cost of all the factors of production consumed or used in producing a good or
service.
 Basic price:
Basic price is the amount receivable by the producer from the purchaser for a unit of a good or
service produced as output minus any tax payable, plus any subsidy receivable, on that unit as a
consequence of its production or sale.
 Market price:
Market price is the price at which a product is sold in the market. It includes the cost of
production in the form of wages, rent, interest, input prices, profit, etc. It also includes the taxes
imposed by the government and the subsidies provided by the government for the producers.
Market price = Basic price + Product taxes – Product subsidy
Or
Market Price = Factor cost + Net indirect taxes
Where,
Net indirect taxes = Indirect taxes – Subsidy

DIRECT AND INDIRECT TAXES :

Tax is a mandatory fee imposed upon individuals or corporations by the Central and the State
Government to help build the economy of a country by meeting various public expenses.
Taxes are broadly divided into two categories- Direct and Indirect taxes.

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What is Direct Tax?
It is a tax levied directly on a taxpayer who pays it to the Government and cannot pass it on to
someone else.
What are the direct taxes imposed in India?
Some of the important direct taxes imposed in India are mentioned below:
 Income Tax- It is imposed on an individual who falls under the different tax brackets based
on their earning or revenue and they have to file an income tax return every year after
which they will either need to pay the tax or be eligible for a tax refund.
 Estate Tax– Also known as Inheritance tax, it is raised on an estate or the total value of
money and property that an individual has left behind after their death.
 Wealth Tax– Wealth tax is imposed on the value of the property that a person possesses.
However, both Estate and Wealth taxes are now abolished.

 What is Indirect Tax?

It is a tax levied by the Government on goods and services and not on the income, profit or
revenue of an individual and it can be shifted from one taxpayer to another.
Earlier, an indirect tax meant paying more than the actual price of a product bought or a
service acquired. And there was a myriad of indirect taxes imposed on taxpayers.
Goods and Service Tax (GST) is one of the existing indirect tax levied in India. It has subsumed
many indirect tax laws.
Let’s discuss a few indirect taxes that were earlier imposed in India:
 Customs Duty- It is an Import duty levied on goods coming from outside the country,
ultimately paid for by consumers and retailers in India.
 Central Excise Duty– This tax was payable by the manufacturers who would then shift
the tax burden to retailers and wholesalers.
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 Service Tax– It was imposed on the gross or aggregate amount charged by the service
provider on the recipient.
 Sales Tax– This tax was paid by the retailer, who would then shifts the tax burden to
customers by charging sales tax on goods and service.
 Value Added Tax (VAT)– It was collected on the value of goods or services that were
added at each stage of their manufacture or distribution and then finally passed on to the
customer.

 Comparison of Direct and Indirect Taxes

There are different implications of direct and indirect taxes on the country. However, both types of
taxes are important for the government as taxes include the major part of revenue for the
government.

Direct Taxes Indirect Taxes

It is levied on income It is levied on product or services.
and activities
conducted.

The burden of tax The burden of tax shifted for indirect taxes.
cannot be shifted in case
of direct tax.

It is paid directly by It is paid by one person but he recovers the

person concerned. same from another person i.e. person who
actually bear the tax ultimate consumer.

It is paid after the It is paid before goods/service reaches the

income reaches in the taxpayer.
hands of the taxpayer

Tax collection is Tax collection is relatively easier.

difficult.

Example Income tax, Example GST, excise duty custom duty sale
wealth tax etc. tax service tax

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 UNIT II

SYLLABUS :

Demand and Supply

I. Law of Demand and Supply
II. Elasticity of Demand and its Application
III. Law of Diminishing Marginal Utility and Equi-Marginal utility
IV. Indifference curve Analysis-Assumptions and Consumer’s Equilibrium.
V. Consumer’s Surplus
PREVIOUS YEAR QUESTIONS
1) What is demand explain its various factors affecting law of demand how we can
measure elasticity of demand also explain application of demand in economics?
2) What is law of demand write the meaning and assumptions?
3) Discuss Law of Demand . Why demand curve slopes downward to the right? (2023)
4) What do you mean by supply? What are the factors that influence it ? Discuss in detail
increase in supply and expansion of supply . (2021 )
5) Discuss the various methods of measuring Elasticity of Demand . (2022)
6) Differentiate between price elasticity of demand and cross elasticity of demand. Explain
the proportionate change method and point method to measure the price elasticity of
demand. (2015,2016,2017)
or
Discuss the concept of Elasticity . Explain the various types of Price , Income and Cross
elasticities of demand with the help of diagrams . (2021)
7) Define Price Elasticity of Demand . What are the factors that influence the Price Elasticity
of Demand ? (2022)
8) Explain following
a. Types of price elasticity of demand (5*2) (2019)
b. Proportionate change method to measure elasticity of demand
9) Explain law of equi-marginal utility with the help of table and graph (2018 , 2021,2023)
10) Explain following (5*2) (2019)
a. Law of equi marginal utility
b. Explain properties of indifference curve
11) What do you mean by Marginal Rate of Substitution ? Explain consumer equilibrium
with the help of Indifference Curve . (2022)
Short Notes
1. Relationship between Marginal utility and Total utility (2015,2016,2018)
2. Consumers’ surplus
3. Reasons responsible for working of the law of demand (2011)
4. Law of diminishing marginal utility (2017)
5. Law of Equi-marginal utility (2016,2017)
6. Cross elasticity of demand
7. Marginal rate of substitution (2018)

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 Lecture 1
a. What is law of demand write the meaning and assumptions?
b. Discuss Law of Demand . Why demand curve slopes downward to the right?
(2023)
c. What do you mean by supply? What are the factors that influence it ? Discuss in
detail increase in supply and expansion of supply . (2021 )

Law of Demand and Supply

 Meaning and Definition of Demand

According to Benham: “The demand for anything, at a given price, is the amount of it, which
will be bought per unit of time, at that price.”

According to Bobber: “By demand we mean the various quantities of a given commodity or
service which consumers would buy in one market in a given period of time at various prices.”

Requisites:

a. Desire for specific commodity.

b. Sufficient resources to purchase the desired commodity.

c. Willingness to spend the resources.

d. Availability of the commodity at

(i) Certain price (ii) Certain place (iii) Certain time

Demand drives economic growth. Businesses want to increase demand so they can improve
profits. Governments and central banks boost demand to end recessions. They slow it during the
expansion phase of the business cycle to combat inflation. If you offer any paid services, then you
are trying to raise demand for them.
So what drives demand? In the real world, a potentially infinite number of factors impact each
consumer's decision to buy something. In economics, however, the equation is simplified to highlight
the five primary determinants of individual demand and a sixth for aggregate demand.

 The Five Determinants of Demand :

1. The price of the good or service.
2. The income of buyers.
3. The prices of related goods or services—either complementary and purchased along with a
particular item, or substitutes and bought instead of a product.
4. The tastes or preferences of consumers will drive demand.

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 5. Consumer expectations. Most often, this refers to whether a consumer believes prices for the
product will rise or fall in the future.

For aggregate demand, the number of buyers in the market is the sixth determinant.

 Demand Equation or Function

 Types of demand

As a business, you need to understand the different types of demand to be able to best anticipate
how much product you need. Demand characteristics provide a picture of how well the industry is
thriving and offers ideas as to where new service can be introduced. The following list details seven
types of demand in economics:

1. Joint demand
2. Composite demand
3. Short-run and long-run demand
4. Price demand
5. Income demand
6. Competitive demand
7. Direct and derived demand
8. Cross Demand

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1. Joint demand
Joint demand is the demand for complementary products and services. These can be products that
are accessories for others or that people commonly purchase together. For example, cereal and milk
or peanut butter and jelly. The two are linked but demand for one is not necessarily dependent on
the demand for the other.

2. Composite demand

Composite demand happens when there are multiple uses for a single product. For example, corn
can be used as animal feed, ethanol and food in its whole form. The rise in demand for any of these
products leads to a shortage in supply for the others. This shortage can lead to a rise in price.

3. Short-run and long-run demand

Short-run demand refers to how people will immediately react to price changes while elements are
fixed. For example, if the demand for a product drastically decreases and a manufacturer has high
overhead costs, they have no choice but to absorb the profits lost. Over time, or in the long run,
companies have a chance to adjust to the new situation by decreasing labor or increasing price and
supplies.

4. Price demand

Price demand relates to the amount a consumer is willing to spend on a product at a given price.
Businesses use this information to determine at what price point a new product should enter the
market. Consumers will buy items based on their perception of that product's value. Price elasticity
refers to how the demand will change with fluctuations in price.

5. Income demand
As consumers make more income, quantity demand increases. This means people will buy more
overall when they earn more income. Tastes and expectations also change with an increase in
income, reducing the size of one market and increasing the size of another. Consumers will often buy
a product or service because it is what they can afford but may deem lower quality. The demand for
those lower-quality products will decrease as income increases.

NORMAL GOODS INFERIOR GOODS

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6. Competitive demand

Competitive demand occurs when there are alternative services or products a customer can choose
from. From a business's perspective, they can use fluctuations in the price of their competitors to
determine how their own will sell. An example of this is between name-brand and store-brand
medicine. If a consumer prefers a name brand but it is out of stock or the price increases
significantly, the store brand will see a rise in sales.

7. Direct and derived demand

Direct demand is the demand for a final good. Food, clothing and cell phones are an example of this.
Also called autonomous demand, it's independent of the demand for other products.

Derived demand is the demand for a product that comes from the usage of others. For example, the
demand for pencils will result in the demand for wood, graphite, paint and eraser materials. In this
example, the demand for wood is dependent on the demand for its uses.

Derived demand is also known as producers demand and indirect demand .

Derived demand is similar to joint demand because of its connection to other products. It is different
from joint demand because it is dependent on the final product to generate a need. Without the need
for those end products, there is no demand for the intermediate product.

8. Cross Demand

It refers to the demand for different quantities of a commodity or service whose demand depends
not only on its own price but also the price of other related goods and services. For example, tea and
coffee are considered to be the substitutes of each other. Thus, when the price tea increases, people
switch to coffee. Consequently, the demand for coffee increases. Thus, it can be said that tea and
coffee have cross demand .

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  Law of Demand
Demand for a commodity is related to price per unit of time. It is the experience of every
consumer that when the prices of the commodities fall, they are tempted to purchase more.
Commodities and when the prices rise, the quantity demanded decreases.

Statement of the Law

Some well-known statements of the law of demand are as under
According to Prof. Samuelson:
“The law of demand states that people will buy more at lower prices and buy less at higher prices,
other things remaining the same”.
E. Miller writes:
“Other things remaining the same, the quantity demanded of a commodity will be smaller at higher
market prices and larger at lower market prices”.
“Other things remaining the same, the quantity demanded increases with every fall in the price and
decreases with every rise in the price”.
In simple we can say that when the price of a commodity rises, people buy less of that commodity
and when the price falls, people buy more of it ceteris paribus (other things remaining the same).
Or we can say that the quantity varies inversely with its price. There is no doubt that demand
responds to price in the reverse direction but it has got no uniform relation between them.
If the price of a commodity falls by 1%, it is not necessary that may also increase by 1%. The demand
can increase by 1%, 2%, 10%, 15%, as the situation demands.
The functional relationship between demanded and the price of the commodity can be expressed in
simple mathematical language as under:

Formula For Law of Demand

Qdx = f (Px, M, Po, T,……….)
Here
Qdx = A quantity demanded of commodity x.
f = A function of independent variables contained within the parenthesis.
Px = Price of commodity x.
Po = Price of the other commodities.
T = Taste of the household.
The bar on the top of M, Po, and T means that they are kept constant. The demand function can also
be symbolized as under:
Qdx = f (Px) ceteris paribus
Ceteris Paribus. In economics, the term is used as a shorthand for indicating the effect of one
economic variable on another, holding constant all other variables that may affect the second
variable.

Schedule of Law of Demand

The demand schedule of an individual for a commodity is a List or table of the different amounts of
the commodity that are purchased from the market at different prices per unit of time. An individual
demand schedule for good say shirts are presented in the table below:

Individual Demand Schedule for Shirts:

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 (In Rupees )
Price per shirt 100 80 60 40 20 10
Quantity demanded per 5 7 10 15 20 30
year Qdx

According to this demand schedule, an individual buys 5 shirts at ₹ 100 per shirt and 30 shirts at
₹10 per shirt in a year.

Law of Demand Curve/Diagram

Demand curve is a graphic representation of the demand schedule.

According to Lipsey:
“This curve, which shows the relation between the price of a commodity and the amount of that
commodity the consumer wishes to purchase is called demand curve”.
It is a graphical representation of the demand schedule.
In the figure (4.1), the quantity. demanded of shirts in plotted on horizontal axis OX and “price is
measured on vertical axis OY. Each price-quantity combination is plotted as a point on this graph. If
we join the price-quantity points a, b, c, d, e, and f, we get the individual demand curve for shirts.
The DD/ demand curve slopes downward from left to right. It has a negative slope showing that the
two variables price and quantity work in opposite direction. When the price of a goods rises, the
quantity demanded decreases and when its price decreases, quantity demanded increases, ceteris
paribus.

Assumptions of Law of Demand:

According to Prof. Stigler and Boulding:
There are three main assumptions of the Law:

(i) There should not be any change in the tastes of the consumers for goods (T).
(ii) The purchasing power of the typical consumer must remain constant (M).
(iii) The price of all other commodities should not vary (Po).

Example of Law of Demand

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If there is a change, in the above and other assumptions, the law may not hold true. For example,
according to the law of demand, other things being equal quantity demanded increases with a fall in
price and diminishes with a rise to price.
Now let us suppose that price of tea comes down from ₹ 40 per pound to ₹ 20 per pound. The
demand for tea may not increase, because there has taken place a change in the taste of consumers
or the price of coffee has fallen down as compared to tea or the purchasing power of the consumers
has decreased, etc., etc.
From this, we find that demand responds to price inversely only if other thing remains constant.
Otherwise, the chances are that the quantity demanded may not increase with a fall in price or vice-
versa.
Demand, thus, is a negative relationship between price and quantity.

In the words of Bilas:

“Other things being equal, the quantity demanded per unit of time will be greater, lower the price,
and smaller, higher the price”.

Limitations/Exceptions of Law of Demand

Though as a rule when the prices of normal goods rise, the demand them decreases but there may be
a few cases where the law may not operate.

(1) Prestige goods: There are certain commodities like a diamond, sports cars etc., which are
purchased as a mark of distinction in society. If the price of these goods rises, the demand for them
may increase instead of falling.

(2) Price expectations: If people expect a further rise in the price of a particular commodity, they
may buy more in spite of a rise in price. The violation of the law, in this case, is only temporary.

(3) Ignorance of the consumer: If the consumer is ignorant about the rise in the price of goods,
he may buy more at a higher price.

(4) Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are
inferior in comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its
price increases, the demand also increases. And this feature is what makes it an exception to the law of
demand. The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in
the Irish diet. During the potato famine, when the price of potatoes increased, people spent less on
luxury foods such as meat and bought more potatoes to stick to their diet. So as the price of potatoes
increased, so did the demand, which is a complete reversal of the law of demand.

(5) Veblen Goods

The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept
that is named after the economist Thorstein Veblen, who introduced the theory of
“conspicuous consumption“. According to Veblen, there are certain goods that become more valuable
as their price increases. If a product is expensive, then its value and utility are perceived to be more,
and hence the demand for that product increases. And this happens mostly with precious metals and
stones such as gold and diamonds and luxury cars such as Rolls-Royce. As the price of these goods
increases, their demand also increases because these products then become a status symbol.

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Importance of Law of Demand:
(i) Determination of price
The study of the law of demand is helpful for a trader to fix the price of a commodity. He knows how
much demand will fall by an increase in price to a particular level and how much it will rise by a
decrease in the price of the commodity. The schedule of market demand can provide the information
about total market demand at different prices. It helps the management in deciding whether how
much increase or decrease in the price of the commodity is desirable.

(ii) Importance to Finance Minister

The study of this law is of great advantage to the finance minister. If by raising the tax the price
increases to such an extent that the demand is reduced considerably. And then it is of no use to raise
the tax because revenue will almost remain the same. The tax will be levied at a higher rate only on
those goods whose demand is not likely to fall substantially with the increase in price.

(iii) Importance to the Farmers

Goods or bad crop affects the economic condition of the farmers. If a goods crop fails to increase the
demand, the price of the crop will fall heavily. The farmer will have no advantage of the good crop
and vice-versa.

 Law of Supply

The law of supply is a basic principle in economics that asserts that, assuming all else being
constant, an increase in the price of goods will result in a corresponding direct increase in the
supply thereof. The law works similarly with a decrease in prices.

The law of supply depicts the producer’s behavior when the price of a good rises or falls. With a
rise in price, the tendency is to increase supply because there is now more profit to be earned. On
the other hand, when prices fall, producers tend to decrease production due to the reduced
economic opportunity for profit.

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Factors that affect supply :

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 Lecture 2

a. What is demand explain its various factors affecting law of demand how we can
measure elasticity of demand also explain application of demand in economics?
b. Discuss the various methods of measuring Elasticity of Demand . (2022)
c. Differentiate between price elasticity of demand and cross elasticity of demand.
Explain the proportionate change method and point method to measure the
price elasticity of demand. (2015,2016,2017)
or
d. Discuss the concept of Elasticity . Explain the various types of Price , Income and
Cross elasticities of demand with the help of diagrams . (2021)
e. Define Price Elasticity of Demand . What are the factors that influence the Price
Elasticity of Demand ? (2022)
f. Explain following
i. Types of price elasticity of demand (5*2) (2019)
ii. Proportionate change method to measure elasticity of demand

Elasticity of Demand and its Application

Scenario:

You design websites for local businesses.

You charge ₹2000 per website and currently sell 12 websites per month.

Your costs are rising (including the opportunity cost of your time), so you consider raising the price
to ₹2500.

The law of demand says that you won’t sell as many websites if you raise your price. How many
fewer websites? How much will your revenue fall, or might it increase?

These questions can be answered by using the concept of elasticity, which measures how much one
variable responds to changes in another variable.

In other words, elasticity measure how much buyers and sellers respond to changes in market
conditions .

Elasticity is a concept in economics that talks about the effect of change in one economic variable
on the other.

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Elasticity of Demand, on the other hand, specifically measures the effect of change in an
economic variable on the quantity demanded of a product. There are several factors that affect the
quantity demanded for a product such as the income levels of people, price of the product, price of
other products in the segment, and various others.

Elasticity of Demand

Elasticity of Demand, or Demand Elasticity, is the measure of change in quantity demanded

of a product in response to a change in any of the market variables, like price, income
etc. It measures the shift in demand when other economic factors change.

In other words, the elasticity of demand is the percentage change in quantity demanded
divided by the percentage change in another economic variable.

The demand for a commodity is affected by different economic variables:

1. Price of the commodity

2. Price of related commodities
3. Income level of consumers

“The elasticity (or responsiveness) of demand in a market is great or small according as the amount
demanded increases much or little for a given fall in price, and diminishes much or little for a given rise
in price”.
– Alfred Marshall, British Economist

 Types of Elasticity of Demand

On the basis of different factors affecting the quantity demanded for a product, elasticity of demand
is categorized into mainly three categories: Price Elasticity of Demand (PED), Cross
Elasticity of Demand (XED), and Income Elasticity of Demand (YED).

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1. Price Elasticity of Demand (PED)
Any change in the price of a commodity, whether it’s a decrease or increase, affects the quantity
demanded for a product. For example, when there is a rise in the prices of ceiling fans, the quantity
demanded goes down.
This measure of responsiveness of quantity demanded when there is a change in price is termed as
the Price Elasticity of Demand (PED).

The mathematical formula given to calculate the Price Elasticity of Demand is:

PED = Percentage Change in Quantity Demanded /Percentage Change in Price

The result obtained from this formula determines the intensity of the effect of price change on the
quantity demanded for a commodity.

2. Income Elasticity of Demand (YED)

The income levels of consumers play an important role in the quantity demanded for a product. This
can be understood by looking at the difference in goods sold in the rural markets versus the goods
sold in metro cities.
The Income Elasticity of Demand, also represented by YED, refers to the sensitivity of quantity
demanded for a certain good to a change in real income (the income earned by an individual after
accounting for inflation) of the consumers who buy this good, keeping all other things constant.

The formula given to calculate the Income Elasticity of Demand is given as:

YED = % Change in Quantity Demanded% / Change in Income

The result obtained from this formula helps to determine whether a good is a necessity good or a
luxury good.

3. Cross Elasticity of Demand (XED)

In a market where there is an oligopoly, multiple players compete. Thus, the quantity demanded for
a product does not only depend on itself but rather, there is an effect even when prices of other
goods change.
Cross Elasticity of Demand, also represented as XED, is an economic concept that measures the
sensitiveness of quantity demanded of one good (X) when there is a change in the price of another
good (Y), and that’s why it is also referred to as Cross-Price Elasticity of Demand.

The formula given to calculate the Cross Elasticity of Demand is given as:
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XED = Percentage Change in Quantity Demanded for one good (X) / Percentage Change in Price of
another Good (Y))
The result obtained for a substitute good would always come out to be positive as whenever there is
a rise in the price of a good, the demand for its substitute rises. Whereas, the result will be negative
for a complementary good.

These three types of Elasticity of Demand measure the sensitivity of quantity demanded to a change
in the price of the good, income of consumers buying the good, and the price of another good.

 Variety of Demand Curves

Rule of thumb:

The flatter the curve, the bigger the elasticity. The steeper the curve, the smaller the elasticity.

Five different classifications of Demand curves :

 Perfectly elastic Demand
 Perfectly inelastic Demand
 Highly Inelastic Demand
 Unitary elastic Demand
 Relatively Inelastic Demand

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 A. Perfectly Elastic Demand
Ed = ∞
Demand Curve = Horizontol
When there is a sharp rise or fall due to a change in the price of the commodity, it is said to be
perfectly elastic demand.
In perfectly elastic demand, even a small rise in price can result in a fall in demand of the good to
zero, whereas a small decline in the price can increase the demand to infinity.
However, perfectly elastic demand is a total theoretical concept and doesn’t find a real application,
unless the market is perfectly competitive and the product is homogenous.
The degree of elasticity of demand helps to define the slope and shape of the demand curve.
Therefore, we can determine the elasticity of demand by looking at the slope of the demand curve.
A Flatter curve will represent a higher elastic demand. Thus, the slope of the demand curve for a
perfectly elastic demand is horizontal.

B. Perfectly inelastic Demand

Ed = 0
Demand Curve = Vertical
A perfectly inelastic demand is the one in which there is no change measured against a price
change.
Like perfectly elastic demand, the concept of perfectly inelastic is also a theoretical concept and
doesn’t find a practical application. However, the demand for necessity goods can be the closest
example of perfectly inelastic demand.
The numerical value obtained from the PED formula comes out as zero for a perfectly inelastic
demand.
The demand curve for a perfectly inelastic demand is a vertical line i.e. the slope of the curve is zero.

C. Highly Elastic Demand

Ed >1
Demand Curve = Flatter
Relatively elastic demand refers to the demand when the proportionate change in the demand is
greater than the proportionate change in the price of the good. The numerical value of relatively
elastic demand ranges between one to infinity.
In relatively elastic demand, if the price of a good increases by 25% then the demand for the product
will necessarily fall by more than 25%.

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Unlike the aforementioned types of demand, relatively elastic demand has a practical application as
many goods respond in the same manner when there is a price change.
The demand curve of relatively elastic demand is gradually sloping.

D. Unitary elastic Demand

Ed = 1
Demand Curve = Rectangular Hyperbola
When the proportionate change in the quantity demanded for a product is equal to the
proportionate change in the price of the commodity, it is said to be unitary elastic demand.
The numerical value for unitary elastic demand is equal to 1. The demand curve for unitary elastic
demand is represented as a rectangular hyperbola.

E. Relatively Inelastic Demand

Ed < 1
Demand Curve = Steeper
In a relatively inelastic demand, the proportionate change in the quantity demanded for a product
is always less than the proportionate change in the price.
For example, if the price of a good goes down by 10%, the proportionate change in its demand will
not go beyond 9.9..%, if it reaches 10% then it would be called unitary elastic demand.
The numerical value of relatively inelastic demand always comes out as less than 1 and the demand
curve is rapidly sloping for such type of demand.

 Methods of Measuring Price Elasticity of Demand

There are basically four ways by which we can measure price elasticity of demand. These methods
are

1. Percentage method
2. Total outlay method
3. Point method
4. Arc method

 Percentage Method
Percentage method is one of the commonly used approaches of measuring price elasticity of demand
under which price elasticity is measured in terms of rate of percentage change in quantity
demanded to percentage change in price.

According to this method, price elasticity of demand can be mathematically expressed as

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For an example: When the price of a commodity was Rs 10 per unit, its demand in the market was 50 units
per day. When the price of the commodity fell to Rs 8, the demand rose to 60 units. Here, price elasticity of
demand can be calculated as

Unlike price elasticity of supply, price elasticity of demand is always a negative number because quantity
demanded and price of the commodity share inverse relationship. This means, higher the price, lower will be
the demand, and lower the price, higher be the demand of the commodity.

 Total Outlay Method

Total outlay method, also known as total expenditure method of measuring price elasticity of
demand was developed by Professor Alfred Marshall . According to this method, price elasticity
of demand can be measured by comparing total expenditure on a commodity before and after the
price change.

While comparing the expenditure, we may get one of three outcomes. They are

Elasticity of demand will be greater than unity (Ep > 1)

When total expenditure increases with fall in price and decreases with rise in price , the value of PED will be
greater than 1. Here, rise in price and total outlay or expenditure move in opposite direction , i.e.,
inverse relationship between price and total expenditure .

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Elasticity of demand will be equal to unity (Ep = 1)
When total expenditure on commodity remains unchanged in response to change in price of the
commodity, the value of PED will be equal to 1.

Elasticity of demand will be less than unity (Ep < 1)

When total expenditure decreases with fall in price and increases with rise in price, the value of PED will be
less than 1. Here, price of commodity and total outlay move in same direction.

Total Price
Quantity outlay or elasticity
Cases Price (P) demanded expenditure of demand
(Q) (E = PXQ) (PED)

I 6 1 6 PED > 1
5 2 10
II 4 3 12 PED = 1
3 4 12
III 2 5 10 PED < 1
1 6 6

When the information from the above table is plotted in the graph, we get graph like the one shown
below.

Total Expenditure

In the graph, total outlay or expenditure is measured on the X-axis while price is measured on the Y-
axis. In the figure, the movement from point A to point B shows elastic demand as we can see that
total expenditure has increased with fall in price.

The movement from point B to point C shows unitary elastic demand as total expenditure has
remained unchanged with the change in price. Similarly, the movement from point C to point D
shows inelastic demand as total expenditure as well as price has decreased.

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Total outlay method of measuring price elasticity of demand does not provide us exact numerical
measurement of elasticity of demand but only indicates if the demand is elastic, inelastic or unitary
in nature. Therefore, this method has limited scope.

 Point Method
The point method of measuring price elasticity of demand was also devised by Prof. Alfred
Marshall . This method is used to measure the price elasticity of demand at any given point in the
curve.

According to this method, elasticity of demand will be different on each point of a demand curve.
Thus, this method is applied when there is small change in price and quantity demanded of the
commodity.

According to this method, price elasticity of demand (PED) is mathematically expressed as

 Arc Method/ Average Method/Mid-Point Method :

One of the problems with the price elasticity of demand formula is that it gives different values
depending on whether price rises or falls. If you were to use different start and end points in our
example above—that is, if you assume the price increased from ₹8 to ₹10—and the quantity
demanded decreased from 60 to 40 units , the Ped will be:

 Percentage change in quantity demanded = (40 – 60) / 60 = -0.33

 Percentage change in price = (10 – 8) / 8 = 0.25
 PEd = -0.33 / 0.25 = 1.32, which is much different from 2.5

To eliminate this problem, the arc elasticity can be used. Arc elasticity measures elasticity at the
midpoint between two selected points on the demand curve by using a midpoint between the two
points. The arc elasticity of demand can be calculated as:

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 Let’s calculate the arc elasticity following the example presented above:

 Midpoint Qd = (Qd1 + Qd2) / 2 = (40 + 60) / 2 = 50

 Midpoint Price = (P1 + P 2) / 2 = (10 + 8) / 2 = 9
 Percentage change in qty demanded = (60 – 40) / 50 = 0.4
 Percentage change in price = (8 – 10) / 9 = -0.22
 Arc Ed = 0.4 / -0.22 = 1.82

When you use arc elasticities you do not need to worry about which point is the starting point and
which point is the ending point since the arc elasticity gives the same value for elasticity whether
prices rise or fall. Therefore, the arc elasticity is more useful than the price elasticity when there is
a considerable change in price.

 Application of Elasticity of Demand

1. Effects of Changes in Price Upon Demand:
The concept is very useful to study the reactions of the demand for a commodity to the changes in its
price. If the demand is elastic, a small change in the price brings about a considerable change in the
quantity demanded, but in the case of inelastic demand this consequential change in demand is
relatively small. So, the concept is relevant to the decisions relating to business pricing and profits.

Thus, the fixing of price of a commodity is crucially based on the elasticity of demand of the
commodity. As Bates and Parkinson put it: “When costs are rising, it is tempting to pass on the cost
increases by increasing price to the consumer, and if demand for the product is relatively inelastic,
this measure may well succeed; and when, as for example in the case of rail transport, there are
many substitutes and the demand is relatively elastic, increasing prices may well lead to a reduction
of total revenue rather than an increase.”

2. Effects of Changes in Price on Revenue:

The concept enables us to determine the condition of equilibrium of a firm. And a profit-maximising
firm reaches equilibrium when revenue = marginal cost.

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And, the value assumed by MR depends on price elasticity of demand:
MR = P (1 – 1/Ep) where Ep is coefficient of price elasticity.

Thus, we could easily assert from this relationship that

(i) When Ep = 1 (unit elasticity of demand),

MR = AR x (1 -1) = 0. It means that a change in price will not affect total revenue.

(ii) When Ep → α (perfectly elastic demand),

MR = AR x (1 – 0) = AR, as under perfect competition.

So, a firm may raise the price of its product(s) if demand is inelastic, in which case sales and profits
would not be affected. In case of a commodity with elastic demand, a reduction in price alone can
raise the sales volume and, consequently, profit.

3. Monopoly Pricing:
The concept is useful in monopoly price- decisions. The monopolist, being the sole supplier of a
particular commodity, can raise price but cannot affect demand pattern of consumers. So, in fixing
the price the monopolist will have, of necessity, to take note of the elasticity of demand for his
product. He will fix the price at a low level when the demand is elastic and at a high level when it is
inelastic.

Moreover, a profit-maximising monopolist will always operate on the elastic part of his demand
curve or his average revenue curve. Neither too high nor too low a price may enable him to realise
his objective: profit maximisation. What will be the profit- maximising price will be dictated by
elasticity of demand; and it will enable the monopolist to know exactly at what price sales proceeds
or total revenue will be the highest.

4. Price Discrimination:
In perfect competition, the same price is charged from all the buyers. But, the downward slope of the
demand curve of the monopolist gives scope for price discrimination. Price discrimination refers to
the practice of charging different prices for the same product from different buyers at the same
time. It can be profitably practised only when price elasticity of demand differs from market to
market or from one segment of the market to another.

5. Wage Bargaining by Trade Unions:

The bargaining power of the trade unions in raising the wages of a group of labour in a particular
industry also depends, among other things, on the elasticity of demand for their services to the
employer. A trade union usually succeeds in raising wages when the demand for the services of
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labour to the employer is inelastic: because, in such a case the employer cannot easily dispense with
their services. On the other hand, it may not succeed when demand for labour is elastic.

6. Importance in Taxation:
Furthermore, the concept is a useful tool in taxation. A finance minister is to consider the elasticity
of demand of the different commodities for the purpose of taxation. If he pushes commodity tax
(excise duty) rates up too much the consequent increase in price may make the total tax yield even
lower than before. On the other hand, a small tax reduction may result in an increase in the tax
yield.

Firstly, the total expenditure by the consumers will determine the size of the tax yield. And, the total
expenditure is the measure of elasticity of demand. If, however, the government simply wishes to
discourage the consumption of a commodity which happens to have a highly inelastic demand—e.g.,
in case of cigarettes — the imposition of a tax may have very little effect on demand and tax
collections may rise.

So, before imposing a tax or raising the existing rate of a tax, the government will have to consider
the elasticity of demand of the commodity concerned. It can get more revenue from the taxes
imposed on commodities with inelastic demand (like sugar, clothes, kerosene oil, etc.) than what is
possible from the taxation of those with elastic demand (like refrigerators, motor cars, steel
furniture’s, etc.). It so happens because in the former case taxes may raise their prices but their
demand and sales will not fall very much; but, in the latter case taxes, by raising the prices, reduce
the demand and sales considerably.

7. Importance in Determining the Incidence of Taxation:

The concept of the elasticity of demand, along with that of supply, is used to determine the shifting
and incidence of a tax. When a tax is imposed on a commodity of inelastic demand, the seller can
generally transfer the burden of the tax upon the consumers by raising the price, and so the
incidence of tax falls upon the buyers.

But, in the case of a tax on a commodity with elastic demand, such a shifting of tax is not an easy
task. Similarly, in the case of import and export duties on commodities the inelasticity of demand
can be used to determine the incidence of such duties.

8. Price Determination of Joint-cost Products:

Again, in the case of the joint-cost products (e.g., cotton fibre and cotton seeds) where the cost of
each cannot be separately determined, the criterion of demand elasticity is applied in determining
their individual prices.

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 Lecture 3

a. Explain law of equi-marginal utility with the help of table and graph (2018 ,
2021,2023)

 LAW OF DIMINISHING MARGINAL UTILITY

Introduction

Hermann Heinrich Gossen, a German economist, is the first to explain the law of diminishing
marginal utility based on general observations of human behavior which was proposed in 1854 .
Because of this reason, the law is further termed as ‘Gossen’s first law’.

What does the law state?

The law of diminishing marginal utility states that the utility derived from each successive unit of a
commodity diminishes. To put it simply, even the most beautiful place of the world or the sweetest
music can make you feel bored after certain stage. The law further states that when an individual
consumes more of a commodity the total utility increases at a decreasing rate. However, after
certain stage, the total utility also starts decreasing and the marginal utility becomes negative (See
Table). This means that the individual does not need the commodity further.

Law of Satiable Wants

As you understand, an individual’s want for a particular commodity gets satiated when he or she
consumes more and more of it. After certain stage, the individual is not willing to consume the
commodity anymore. Because of this reason, the law of diminishing marginal utility is also known
as the law of satiable wants.

Assumptions of the Law of Diminishing Marginal Utility

The law of diminishing marginal utility is based on the following explicit assumptions:

Homogeneity

Each unit of the commodity under consideration is identical in all aspects such as quality, taste,
color, size and so on.

Reasonability

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Each unit of commodity under consideration must be same and standard. For example, 100 ml of
coffee, 200 grams of apple and so on.

Constancy

The law of diminishing marginal utility assumes that consumer’s consumption pattern, tastes,
preferences, income, and price of the commodity and its substitutes are constant during the process
of consumption.

Continuity

The law further assumes that consumption is a continuous process and there is no room for any
time gap.

Rationality

Finally, for the law to hold well, the consumer must be a rational economic man. In addition, the
law assumes that the consumer’s mental condition remains normal during the process of
consumption.

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Edward wishes to choose the combination that will provide her with the greatest utility,
which is the term economists use to describe a person’s level of satisfaction or happiness with his
choices.

Edward can measure her own utility with something called utils – a subjective measure of the
satisfaction gained from consumption. The table shows how Edward's utility is connected with her
consumption of burgers.

The first column of the table shows the quantity of burgers consumed.

The second column shows the total utility, or total amount of satisfaction, that Annabel
receives from consuming that number of burgers.

The most common pattern of total utility, as shown here, is that consuming additional goods leads
to greater total utility, but at a decreasing rate.

The third column shows marginal utility, which is the additional utility provided by one
additional unit of consumption.

1200

1050 1050
1000 1000
900 900
800
750
UTILITY ( SATISFACTION )

600
550

400
300
250 250
200 200
100
50
0 1 2 3 4 5 6 7
0 8
1 2 3 4 5 6 7 8
-150
-200

-400
UNITS

TOTAL UTILITY MARGINAL UTILITY

Relationship between Total Utility & Marginal Utility

1. TU increases with an increase in consumption of a commodity as long as MU is positive. In this
phase, TU increases but a diminishing rate as MU from each successive unit tends to diminish.
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 2. When TU reaches its maximum, MU becomes zero. TU stops rising at this stage. This point is
known as a point of satiety.
3. When consumption is increased beyond the point of satiety, TU starts falling as MU becomes
negative.

 LAW OF EQUI- MARGINAL UTILITY

The idea of equi-marginal principle was first mentioned by H.H.Gossen (1810-1858) of

Germany. Hence it is called Gossen's second Law. Alfred Marshall made significant refinements of
this law in his 'Principles of Economics'.

The law of equi-marginal utility explains the behaviour of a consumer when he consumers more
than one commodity. Wants are unlimited but the income which is available to the consumers to
satisfy all his wants is limited. This law explains how the consumer spends his limited income on
various commodities to get maximum satisfaction. The law of equi-marginal utility is also known as
the law of substitution or the law of maximum satisfaction or the principle of
proportionality between prices and marginal utility.

 Definition
In the words of Prof. Marshall, 'If a person has a thing which can be put to several uses, he will
distribute it among these uses in such a way that it has the same marginal utility in all'.

 Assumptions
1. The consumer is rational so he wants to get maximum satisfaction.
2. The utility of each commodity is measurable.
3. The marginal utility of money remains constant.
4. The income of the consumer is given.
5. The prices of the commodities are given.
6. The law is based on the law of diminishing marginal utility.

In simple words, a consumer will derive maximum satisfaction when:

MARGINAL UTILITY RESPECTIVE PRICES THE MARGINAL

DERIVED FROM OF THOSE = UTILITY OF MONEY
CONSUMING : COMMODITIES INCOME OF THE
VARIOUS COMMODITIES CONSUMER

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So , The law states that a consumer should spend his limited income on different commodities in such a
way that the last rupee spent on each commodity yield him equal marginal utility in order to get
maximum satisfaction.

Suppose there are different commodities like A, B, …, N. A consumer will get the maximum satisfaction
in the case of equilibrium i.e.,

MUA / PA = MUB / PB = … = MUN / PN = MUM

Where MU’s are the marginal utilities for the commodities and P’s are the prices of the commodities.

Example :

UNITS OF MU of A Ratio = MU of B Ratio = MU of C Ratio =

COMMODITY MUA/PA MUB/PB MUC/PC

1 24 12 30 10 32 8

2 20 10 24 8 24 6

3 16 8 18 6 16 4

4 12 6 12 4 8 2

5 8 4 6 2 0 0

Where,
Price of A =2, Price of B = 3, Price of C = 4

Suppose, the consumer’s income is Rs. 25, he would spend the amount in order to get maximum
satisfaction. As per the law, the consumer would get maximum total satisfaction when:
MUA/PA = MUB/PB = MUC/PC = MUM

In the schedule there are three points of equi-marginal utility (i.e. 8, 6 & 4)
1. When the ratio is equal to 8, it means that the consumer will buy 3 units of A, 2 units of B and I
unit of C. in this case, the total expenditure will be:
A=3x2=6
B=2x3=6
C= 1x4=4
16 (i.e. < 25)

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2. When the ratio is equal to 4, it means that the consumer will buy 5 units of A, 4 units of B and 3
units of C. In this case, the total expenditure will be :
A = 5 x 2 = 10
B = 4 x 3 = 12
C = 3 x 4 = 12
34 (i.e. > 25)

3. When the ratio is equal to 6, it means that the consumer will buy 4 units of A, 3 units of B and 2
units of C. In this case, the total expenditure will be :
A=4x2=8
B=3x3=9
C=2x4=8
25 (=consumer’s income)

Therefore, the consumer will get maximum satisfaction when :

MUA/PA = MUB/PB = MUC/PC = MUM

i.e. 12/2 = 18/3 = 24/4 = 6

The following table shows the consumer’s allocation towards various commodities and the total
utility derived from the given income:

Commodity No. of Units Total Spend Total Utility

A 4 8 (4 x 2 ) 72
(24 + 20 + 16 + 12)
B 3 9 (3 x 3 ) 72
( 30 +24 + 18 )
C 2 8 (2 x 4 ) 56
( 32 + 24 )
25 200

Graphical Representation:
The above principle can also be illustrated in terms of a figure. We have drawn marginal utility
curves for goods X and Y in Fig 2.12(a) and (b).

Here we use marginal utility and price. Marginal utility per rupee spent on good X = MU X/PX, and
that of Y = MUY/PY. The MUX/PX curve has been shown in Fig. 2.12(a) while the MU Y/PY curve has
been shown in Fig. 2.12(b). We have not drawn negative portion of the marginal utility curves.

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Now, by superimposing Fig. 2.12(b) on Fig. 2.12(a), we get Fig. 2.13 in which we measure available
income—00’—of the consumer on the horizontal axis.

As we move rightwards from ‘O’, amount spent on X increases and, as we move leftwards from ‘O’,
amount spent on Y increases. How does our consumer allocate his total income in buying both goods
X and Y is described by equalizing per rupee spent on both?
Our consumer maximizes his total utility by spending OD amount on good X and O’D amount on
good Y. By purchasing this combination, the consumer equalizes marginal utilities per rupee spent
on X and Y at point E (i.e., MUX/PX = MUY/PY = ED). No other combination will give greater
satisfaction.
If our consumer spends OC on good X and O’C on good Y then MU X/PX will exceed MUY/ PY by the
distance AB. This will induce the consumer to buy more of X and less of Y. As a result, MUX/PX will
fall, while MUY/PY will rise until equality is restored at point E. Similarly, if the consumer spends
OH on X and O’H on Y then MUX/PX< MUY/PY. Now, the consumer will buy more of Y and less of X.
This substitution between X and Y will continue until MUX/PX= MUY/PY. Therefore, the consumer
can derive maximum satisfaction only when marginal utility per rupee spent on good X is the same
as the marginal utility per rupee spent on another good Y. When this condition is met, the consumer
does not find any interest in changing his expenditure pattern.
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 Lecture 4

a. Explain properties of indifference curve . (5) (2019)

b. What do you mean by Marginal Rate of Substitution ? Explain consumer
equilibrium with the help of Indifference Curve . (2022)

 INDIFFERENCE CURVE ANALYSIS – ASSUMPTIONS AND

CONSUMER’S EQUILIBRIUM

What is Indifference Curve?

Indifference curve can be defined as the locus of points each representing a different combination of
two good, which yield the same level of utility and satisfaction to a consumer.

Therefore, the consumer is indifferent to any combination of two commodities if he/she has to make
a choice between them. This is because an individual consumes a variety of goods over time and
realises that one good can be substituted with another without compromising on the satisfaction
level.

When these combinations are plotted on the graph, the resulting curve is called indifference curve.
This curve is also called the iso-utility curve or equal utility curve.

History

The theory of indifference curves was developed by Irish Born British economist Francis Ysidro
Edgeworth , who explained in his 1881 book the mathematics needed for their drawing; later
on, Vilfredo Pareto
( Italian Economist ) was the first author to actually draw these curves, in his 1906 book i.e.,
Manual of Political Economy. While the father of Indifference curve is Sir John Richard Hicks
and Sir Roy George Douglas Allen in paper ‘A Reconsideration of Theory of Value’. Later, in
1939 J.R.Hicks in his book “ Value and Capital” gave a final shape to this “Indifference Curve
Analysis”.

Indifference Curve Analysis

Let us learn the indifference curve through a schedule. Assume that a consumer consumes two
commodities X and Y and makes five combinations for the two commodities a, b, c, d, and e, which is
shown in Table 1:

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 COMBINATION UNITS OF UNITS OF
COMMODITY X COMMODITY Y
A 3 25
B 5 15
C 9 8
D 17 4
E 30 2

When the indifference schedule for X and Y is plotted on a graph, a curve is obtained, which is
shown in Figure 1.

Figure 1: Indifference Curve Analysis

On the indifference curve (IC), there can be several other points in between the points a, b, c, d, and
e, which would yield the same level of satisfaction to the consumer. Therefore, the consumer remains
indifferent towards any combinations of two substitutes yielding the same level of satisfaction.

Assumptions

Theories of economics cannot survive without assumptions and indifference curve analysis is no
different. The following are the assumptions of indifference curve analysis:

a. Rationality

The theory of indifference curve studies consumer behavior. In order to derive a plausible
conclusion, the consumer under consideration must be a rational human being. For example, there
are two commodities called ‘A’ and ‘B’. Now the consumer must be able to say which commodity he
prefers. The answer must be a definite. For instance – ‘I prefer A to B’ or ‘I prefer B to A’ or ‘I prefer
both equally’. Technically, this assumption is known as completeness or trichotomy assumption.
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 b. Consistency and Transtivity

Another important assumption is consistency. It means that the consumer must be consistent in his
preferences. For example, let us consider three different commodities called ‘A’, ‘B’ and ‘C’.
Transtivity means if the consumer prefers A to B and B to C, obviously, he must prefer A to C. In this
case, he must not be in a position to prefer C to A since this decision becomes self-contradictory.

Symbolically,

If A > B, and B >C, then A > C.

c. More Goods to Less / Positive Utility

The indifference curve analysis assumes that consumer always prefers more goods to less. Suppose
there are two bundles of commodities – ‘A’ and ‘B’. If bundle A has more goods than bundle B, then
the consumer prefers bundle A to B.

d. Ordinal Utility
Ordinal utility explains that the satisfaction level after consuming any goods or services cannot be
scaled in numbers. However, these things can be arranged in the order of preference.

e. Scale of Preference
This theory is also based on scale of preference. A rational consumer usually prefers the
combination of goods which gives him maximum level of satisfaction. Thus, the consumer can
arrange goods and their combination in order of their satisfaction. Such an arrangement of
combination of goods in the order of level of satisfaction is called the “Scale of Preference”.

Indifference Map
An Indifference Map is a set of Indifference Curves. It depicts the complete picture of a consumer’s
preferences. The following diagram showing an indifference map consisting of three curves:

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 We know that a consumer is indifferent among the combinations lying on the same indifference curve.
However, it is important to note that he prefers the combinations on the higher indifference curves to
those on the lower ones.

This is because a higher indifference curve implies a higher level of satisfaction. Therefore, all
combinations on IC1 offer the same satisfaction, but all combinations on IC2 give greater satisfaction
than those on IC1.

Indifference Curve Properties

The indifference curve (IC) has certain definite properties or characteristics, which are as follows:

1. Indifference Curves are negatively sloped

2. Higher Indifference Curve represents a higher satisfaction level
3. Indifference Curves are convex to the origin
4. Indifference Curves do not intersect
5. Indifference Curves need not to be parallel to each other

Indifference Curves are negatively sloped or Indifference Curves are Downward

Sloping from Left to Right
The indifference curves are sloped downwards to the right. The reason for the negative slope is that
as a consumer increases the consumption of commodity X, he/ she sacrifices some units of
commodity Y in order to maintain the same level of satisfaction.

Higher IC represents a higher satisfaction level

A higher IC lying above and to the right of another IC implies a higher level of satisfaction and vice
versa. In simple words, the combination of commodities on the higher IC is preferred by a consumer
to the combination that lies on a lower IC.

Indifference Curves are convex to the origin

ICs are curved inwards; thus they are convex to the origin. This implies that as the consumer
continues to substitute commodity X for commodity Y, MRS of X for Y diminishes along the IC.

Indifference Curves do not intersect

This can be explained by considering a hypothetical situation where two indifference curves
intersect. The point of intersection would then imply that a combination of commodities on the
higher curve would offer the same level of satisfaction as that on the lower indifference curve, which
violates the basic assumption of ICs.

Indifference Curves need not to be parallel to each other

Indifference curves are not necessarily parallel to each other. Though they are falling, negatively
inclined to the right, yet the rate of fall will not be the same for all indifference curves. In other
words, the diminishing marginal rate of substitution between the two goods is essentially not the
same in the case of all indifference schedules.

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 What Is the Marginal Rate of Substitution (MRS)?

In economics, the marginal rate of substitution (MRS) is the amount of a good that a consumer is
willing to consume compared to another good, as long as the new good is equally satisfying. MRS
is used in indifference theory to analyze consumer behavior.

 The marginal rate of substitution is the willingness of a consumer to replace one good for
another good, as long as the new good is equally satisfying.
 The marginal rate of substitution is the slope of the indifference curve at any given point
along the curve and displays a frontier of utility for each combination of "good X" and "good
Y."
 When the law of diminishing MRS is in effect, the MRS forms a downward, negative sloping,
convex curve showing more consumption of one good in place of another.

Calculation of MRS:

Marginal Rate of Substitution Formula

X: Represents the substitute

Y: Existing or current resource getting replaced

Marginal Rate of Substitute Formula = △Y/△X

where,
△ Y Change in Good Y
△ X Change in Good X

The MRS formula shows that when the number of substitutes grows in the subsequent phases and
the number of current resources decreases, the MRS falls.

MRS representation in terms of marginal utility

MRSxy = -MUx/MUy
Where ,
MUx = Marginal Utility of X commodity
MUy = Marginal Utility of y commodity

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Limitations
The main limitation of this theory is that it correlates to only two products at a time. Thus, for
instance, we can calculate the MRS of good A for good B, good A for good C, and good B for good C,
but it cannot portray a combination of A, B and C.

To get the result, you would need to calculate the MRS three times by discovering how:

Item A relates to item B.

Item A relates to item C.
Item B is related to item C.

Example
A basic understanding of the MRS helps retailers make efficient product assortment and attain
target sales.

Customer A went to a confectionery store with a high product mix to purchase baked goodies. He
planned to buy 13 pieces of pastries and one cupcake. However, he ended up buying more of the
cupcake since he couldn’t find the necessary number of pastries. The customer replaced desired
option with another one because it was out of stock at the moment of the purchase.

MRS = Change in Pastries/Change in Cupcake

= Δy/ Δx

= slope of the indifference curve

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 ● Bundle A contains thirteen pieces of pastries and one cupcake.
● Bundle B contains nine pastries and two cupcakes. Sacrifices four pastries for an additional
cupcake.
● Bundle C contains seven pastries and three cupcakes. Sacrifices two pastries for an additional
cupcake.
● Bundle D contains six pastries and four cupcakes. Sacrifices one pack of pastries for an
additional cupcake.

Bundles A, B, C, and D all give the same level of enjoyment. Thus, we may also deduce that in the
beginning, the customer was ready to make concessions and substitute a greater quantity of
pastries with the cupcake.

We can observe that the number of pastries replaced reduces in the following combinations. As such,
this example shows that the marginal rate of substitution is diminishing.

Budget Line
The budget line, also known as the budget constraint, price line, consumption possibility line ,
exhibits all the combinations of two commodities that a customer can manage to afford at the
provided market prices and within the particular earning degree.
The budget line is a graphical delineation of all possible combinations of the two commodities that
can be bought with provided income and cost so that the price of each of these combinations is
equivalent to the monetary earnings of the customer.
It is important to keep in mind that the slope of the budget line is equivalent to the ratio of the cost of
two commodities. The slope of the budget constraint possesses distinctive importance.
In other words, the slope of the budget line can be described as a straight line that bends
downwards and includes all the potential combinations of the two commodities which a customer
can purchase at market value by assigning his/her entire salary. The concept of the budget line is
different from the Indifference curve, though both are necessary for consumer equilibrium.
The two basic elements of a budget line are as follows:

 The consumer’s purchasing power (his/her income)

 The market value of both the products
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 Example of a Budget Line
Radha has ₹50 to buy a biscuit. She has a few options to allocate her income so that she receives
maximum utility from a limited salary.

Budget schedule
Combination Cream Plain biscuit Budget
biscuit (@ ₹5 per allocation
(@ ₹10 per packet)
packet)
A 0 10 10 × 0 + 5 ×
10 = 50
B 1 8 10 × 1 + 5 ×
8 = 50
C 2 6 10 × 2 + 5 ×
6 = 50
D 3 4 10 × 3 + 5 ×
4 = 50
E 4 2 10 × 4 + 5 ×
2 = 50
F 5 0 10 5 + 5
×0=
50

To get an appropriate budget line, the budget schedule given can be outlined on a graph.

The budget set indicates that the combinations of the two commodities are placed within the
affordability margin of a consumer.

 Features of Budget Line

Some of the properties of the budget line are as follows:
 Negative slope: If the line is downward, it shows a reverse correlation between the two
products.
 Straight line: It indicates a continuous market rate of exchange in individual combinations.
 Real income line: It denotes the income and the spending size of a customer.
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  Tangent to indifference curve: It is the point when the indifference curve meets the
budget line. This point is known as the consumer’s equilibrium.

 Assumptions of a Budget Line

The budget line is mostly based on the assumption and not reality. However, to get clear and precise
results and summary, the economist considers the following points in terms of a budget line:
 Two commodities: The economist assumes that the customers spend their income to
purchase only two products.
 Income of the customers: The income of the customer is limited, and it is designated to
buy only two products.
 Market price: The cost of each commodity is known to the customer.
 Expense is similar to income: It is assumed that the customer spends and consumes the
whole income.

 Shifts in Budget Line

We all know that, whatever purchases are made by the consumers, are based on two main factors –
Consumer’s income and Prices of goods. So, these two factors decide the consumption limits of
the consumer. Hence, if there is a change in any one of these determinants, it may result in the
change of the budget line. Come let us understand the effect of change in these two factors:

 Change in Income

 Increase in income

Suppose there is an increase in the income of the consumer, however, the prices remain
unchanged. So, it is quite obvious that the consumer’s capacity to buy the goods will increase
and so he will be able to buy more quantity of the same commodity. Consequently, the budget
line shifts rightward.

 Decrease in Income

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Suppose there is a decrease in the income of the consumer, and, the prices remains unchanged. So,
this will decrease the consumer’s capacity to buy the two goods. Therefore, as per his new budget
constraint, he will demand less quantity of the two commodities. This will shift the budget line
leftward.

 Change in Prices of Goods

 Change in the price of good X

Suppose the price of good X falls, but the price of good Y and the consumer’s income is the
same. Resultantly, the consumer will be able to buy more units of good X. This will shift the
line to the right. However, if there is a rise in the price of good X, the consumer will have to
forego some units of good X. This will shift the slope on the left side.

 Change in the price of good Y

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 Suppose the price of good Y falls, but there is no change in the price of good X and the income
of the consumer. As a result of which the consumer will be able to buy more units of
commodity Y. This will shift the price line to the right. However, if there is an increase in the
price of good Y, the consumer will have to forego some units of good Y. Hence, the slope will
shift left.

What is Consumer Equilibrium?

Consumer’s Equilibrium in Indifference Curve Analysis is defined as a situation when the consumer
maximizes his satisfaction, spending his given income across different goods with the given prices.
Here, the indifference curve and budget line are used to determine the consumer equilibrium point.
Indifference curve analysis helps to find out how the consumer spends his limited income on the
combination of different goods to get maximum satisfaction.
In other words, consumer equilibrium refers to a situation in which a consumer with given income
and given prices purchases a combination of goods and services which gives him maximum
satisfaction and he is not willing to make any change in it.

Assumptions :

1. The money income of the consumer is given and is constant.

2. The two goods, on which income is spent, are a substitute for each other.
3. The consumer is rational and always tries to maximize his satisfaction.
4. The prices of goods are constant.
5. The consumer is aware of the prices prevailing in the market for all goods.
6. He can spend his income in small quantities.
7. There is perfect competition in the market.
8. The commodities are divisible.
9. The consumer is fully aware of the indifference map.

Conditions of Consumer Equilibrium:

The consumer’s equilibrium under indifference curve analysis is found at the tangent between the
budget line and a convex indifference curve. To find out the consumer equilibrium, the following
conditions must be satisfied :

1. Price or Budget line should be tangent to an Indifference curve.

2. Indifference curve must be convex to the origin.

1. Price or Budget line should be tangent to an indifference curve:

In the words of Watson,

“When the consumer is in equilibrium, his highest attainable indifference curve is tangent to price line.”

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 The price line tangent to an indifference curve

In fig, AB is the budget or price line, and IC1, IC2 and IC3 are indifference curves. A consumer can buy any of
the combinations whether C, D, and E of chocolates Kitkat and DairyMilk, shown on budget line AB. He can’t
buy any combination on IC3 as it is beyond the budget line AB. But, he can buy those combinations which are
not only on the budget line AB but also coincide with the highest indifference curve which is IC 2 here.
Out of the combinations C, D and E, the consumer will be at equilibrium at the combination D. Because, at
this point, the budget line AB is tangent to the highest indifference curve IC 2. No doubt, he can afford the
combinations C and E as well but these will not give him the maximum satisfaction as these combinations
belong to the lower indifference curve IC1.
It means, that the consumer’s equilibrium point is the point of tangency of the budget line and indifference
curve. At point D, the slope of the indifference curve and budget line coincides. Here,
The slope of the indifference curve is indicative of the marginal rate of substitution of commodity-1 for
commodity-2 (MRSXY).
The slope of the budget line is indicative of the ratio of the price of commodity-1(P1) and the price of
commodity -2(P2).

At equilibrium:
Slope of indifference curve= = Slope of Budget Line
Or
MRS XY = PX/PY

In short, the first condition of the consumer’s equilibrium is that the budget or price line should be tangent to
the indifference curve. It means that the price ratio of commodity-1 and commodity-2 should be equal to the
marginal rate of substitution of commodity-1 for commodity-2.

2. Indifference curve must be convex to the origin:

The other condition of equilibrium is that at the point of equilibrium, the indifference curve should be convex
to the point of origin. It means, that the marginal rate of substitution of commodity-1 for commodity-2 should
be diminishing.
If at the point of equilibrium, the indifference curve is concave and not convex to the origin, then it will not be
a position of permanent equilibrium.

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Graphical Representation:

Indifference curve convex to the origin

In fig, AB is the price line and IC is the indifference curve. At point ‘E’, price line AB is tangent to an
indifference curve. Thus, at point E, the marginal rate of substitution and price ratio of KitKat and Dairy
Milk are equal. But, at point E, the marginal rate of substitution is increasing instead of diminishing.
Therefore, E is not a permanent equilibrium point. In other words, at point E, the indifference curve IS
concave to its point of origin ‘O’ and it violates the second condition of the equilibrium.
By moving to the right or left of point E, a consumer can reach a higher indifference curve. So, equilibrium
will not be permanent at point E. Therefore, A consumer will be in permanent equilibrium when at the point
of tangency of the indifference curve and price line, the indifference curve is convex to the point of origin. As
in fig, the consumer is in equilibrium at point E1 on the IC1 curve. At the point E1, price line AB is tangent to
the IC1 curve which is convex to the point of origin

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 Lecture 5

a. Explain consumer surplus using cardinal and ordinal approach .

CONSUMER SURPLUS
Meaning of Consumer's Surplus

consumer surplus, also called social surplus and consumer’s surplus, in economics, the
difference between the price a consumer pays for an item and the price he would be willing to pay
rather than do without it. As first developed by Jules Dupuit, French civil engineer and economist,
in 1844 and popularized by British economist Alfred Marshall, the concept depended on the
assumption that degrees of consumer satisfaction (utility) are measurable.

Consumer’s surplus is also known as buyer’s surplus. Prof. Boulding named it ‘Buyer’s surplus’.
Let us look at an example to understand the concept of consumer’s surplus. Suppose there is a
commodity called ‘X’ in the market. You would like to buy commodity X, as you deem that the
commodity is very useful. The important point here is that the commodity X does not have
alternatives. When it comes to price of the commodity, you are willing to pay ₹10. However, when
you inquire in the market, the seller says that the price of the commodity is ₹5. Therefore, the
difference between what you are willing to pay and the actual price (₹10 - ₹5 = ₹5 in our example)
is called consumer’s surplus.

You are willing to pay ₹10 for the commodity because you feel that the commodity is worth ₹10. It
implies that the total utility derived from the commodity is equal to ₹10. However, you are able to
buy the commodity for ₹5.

Therefore,

consumer’s surplus = total utility – market price

Hence, you could recognize consumer’s surplus in commodities that are highly useful and low
priced.

Definition of consumer’s surplus

Prof. Samuelson defines consumer’s surplus as “The gap between the total utility of a good and its
total market value is called consumer’s surplus.” In the words of Hicks, “Consumer’s surplus is the
difference between the marginal valuation of a unit and the price which is actually paid for it.”

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 Assumptions of Consumer's Surplus Theory

The following assumptions base the theory of consumer’s surplus or buyer’s surplus:

1. Utility as a measurable entity

The theory of consumer’s surplus assumes that utility can be measured. Marshall in his cardinal
utility theory has assumed that utility is a measurable entity. He claims that utility can be measured
in cardinal numbers (1, 2, 3…). The imaginary unit to measure utility is known as ‘util’. For instance,
the utility derived from a banana is 15 utils, the utility derived from an apple is 10 utils, and so on.

2. No alternative commodities available

The second important assumption is that the commodity under consideration does not have
substitutes.

3. Ceteris paribus

This assumption means that the customer’s income, tastes, preferences and fashion remain
unchanged during the analysis.

4. Marginal utility of money is constant

The theory of consumer’s surplus further assumes that the utility derived from the money stock in
the hands of the customer is constant. Any change in the quantity of money that is in the hands of
customer does not affect the marginal utility derived from it. This assumption is necessary because
without it, money cannot perform as a measuring rod.

5. Concept of diminishing marginal utility

The theory of consumer’s surplus is based on the law of diminishing marginal utility. The law of
diminishing marginal utility claims that as you consumer more of a commodity, the marginal utility
derived from it decreases eventually.

6. Independent marginal utility

This assumption means that marginal utility derived from the commodity under consideration is
not influenced by the marginal utilities derived from other commodities. For instance, we are
analyzing consumer’s surplus for oranges. Though an apple is a fruit, the utility derived from it does
not affect the utility derived from oranges.

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 Measurement of consumer's surplus: The law of diminishing
marginal utility approach
The law of diminishing marginal utility is the basis for the concept of consumer’s surplus. The law of
diminishing marginal utility states that as you consume a particular commodity more and more,
the utility derived from it keeps on decreasing. For a particular commodity, there exists only one
price in a market. For instance, you buy 10 coconuts. The price of a coconut in the market is ₹10.
You pay the same price for all the units you buy. You pay ₹10 for the first coconut. Obviously, you do
not pay ₹20 for the second. At the same time, the utility you derive from each coconut may differ.
According to Alfred Marshall,
Consumer’s Surplus = Total Utility – (Price × Quantity)
Symbolically,
C.S = TU – (P × Q)
Since,
TU = ∑MU,
C.S = ∑MU – (P × Q)
Where,
TU = Total Utility
MU = Marginal Utility
P = Price
Q = Quantity
∑ (Sigma) indicates the sum total.

Table 1

Units of Marginal Market Consumer's Surplus

Commodity Utility Price
(Imaginary (cents)
price)
1 50 10 40
2 40 10 30
3 30 10 20
4 20 10 10
5 10 10 0
Total = 5 TU = 150 Total = Total 100
units 50

Thus, consumer’s surplus = TU – (P × Q) = 150 – (10 × 5) = 150 – 50 = 100.

The following diagram supports the measurement in a better manner:

Consumer's surplus for a market

The above example shows how to measure consumer’s surplus for an individual. Similarly, you
could measure consumer’s surplus for an entire market (group of individual consumers) with the
help of market demand curve and market price line.

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In figure 2, DD represents market demand curve. It shows the price that the market is willing to pay
for the successive units of a commodity. The market offers lower prices for the successive units of the
commodity because of the law of diminishing marginal utility. PB denotes market price line. PB is
horizontal, which implies that the market price is same for all units of the commodity. The point E
represents equilibrium position, where market demand curve intersects market price line. OQ
represents the quantity of the commodity that the market purchases given the equilibrium position.

In figure 2, ODEQ represents the money the market is ready to spend for OQ units of commodity.

However, OPEQ is the actual amount spent by the market to acquire OQ units of commodity.

Hence, DPE is consumer’s surplus for the market.

Summation of Consumer’s Surplus

Summation of consumer’s surplus gives consumers’ surplus. Consumer’s surplus refers to the
surplus enjoyed by an individual consumer. On the other hand, consumers’ surplus refers to surplus
enjoyed by the society as a whole. Note that consumers’ surplus is different from the consumer’s
surplus for a market (explained above). While analyzing consumer’s surplus for a market, we
consider market demand curve and market price line. However, in consumers’ surplus, we add the
consumer’s surplus enjoyed by all the consumers individually. Marshall claims that in this way, we
can measure the total surplus enjoyed by the society as a whole. However, we need to assume that
there are no differences in income, preferences, taste, fashion etc.

Market Price and Consumer's Surplus

There is an inverse relationship between market price and consumer’s surplus. An inverse
relationship means that a decline in market price increases consumer’s surplus and vice-versa.

J.R. Hicks’ Method of Measuring Consumer’s Surplus

Prof. J.R. Hicks and R.G.D. Allen have introduced indifference curve approach to measure
consumer’s surplus. Prof. J.R. Hicks and R.G.D. Allen are unable to accept the assumptions
suggested by Marshall in his version of measuring consumer’s surplus. According to these
economists, the assumptions are impracticable and unrealistic.
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According to Prof. J.R. Hicks and R.G.D. Allen,

1. Marginal utility of money is not constant. If the stock of money decreases, the marginal utility
of money will increase.
2. Utility is not a measurable entity but subject in nature. Hence, it cannot be measured in
cardinal numbers.
3. Utility derived from a unit of a commodity is not independent. Instead, utility is related to
previous units consumed.

In figure 4, horizontal axis measures commodity A and vertical axis measures money income.

Assume that the consumer does not know the price of commodity A. This means that there is no
price line or budget line to optimize his consumption. Therefore, he is on the combination S on
indifference curve IC1. At point S, the consumer has ON quantity of commodity A and SN amount of
money. This implies that the consumer has spent FS amount of money on ON quantity of commodity
A.

Now assume that the consumer knows the price of commodity A. Hence, he can draw his price line
or budget line (ML). With the price line (ML), the consumer realizes that he can shift to a higher
indifference curve (IC2). Therefore, the new moves to the new equilibrium (point C), where the price
line ML is tangent to the indifference curve IC2. At point C, the consumer has ON quantity of
commodity A and NC amount of money. This implies that the consumer has spent FC amount of
money on ON quantity of commodity A. Now the consumer has to spend only FC amount of money
instead of FS to purchase ON quantity of commodity A. Therefore, CS is the consumer’s surplus.

The Hicks’ version of measuring consumer’s surplus attains results without Marshall’s
doubtful assumption. Hence, Hicks’ version is considered to be superior to that of Marshall’s .

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 UNIT III

SYLLABUS :

Market Structure :

i. Classification of Markets
ii. Revenue and Cost Curves
iii. Price and Output Under Perfect Competition and Monopoly
iv. Cartels and Dumping
v. Anti-Monopoly Laws

Previous Year Questions

a. Distinguish between short run and long run cost curves . Why is long-run average cost
curve also termed as envelope curve ? (2023)
b. Discuss the various concepts of cost of a firm during the short period. (2015)
c. Discuss firms Equilibrium under monopoly competition.
Or
What do you understand by monopoly? How is price determined under conditions of
monopoly ? (2012, 2014,2015,2023)
d. Explain characteristics of perfect market competition also explain short- and long-term
equilibrium in market (2018)

Or

What do you mean by equilibrium of a firm discuss the equilibrium of a firm under the
perfect competition (2019)

Or

List the assumptions of perfectly competitive market . How price and output is
determined in long run under perfect competition ? (2021)

e. By bringing about differences between monopoly and perfect competition , list the
assumptions of a perfectly competitive market . How is output determined under perfect
competition in shortrun ? (2022)
f. A. Write the comments on AR and MC curve

B. AR and MR curve (2018)

7. Discuss in detail Cartelisation . (2021 )

8. Write briefly on the following a) Dumping (2019) b) Discriminating monopoly

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 9. What is Dumping ? Discuss its types and objectives . What are the anti-dumping
measures available with government ? (2022)

10. Discuss in detail the important features of the Competition Act,2002 . (2023)

Short notes

1.Price discrimination (2015)

or
Essential condition for price discrimination (2016)

2. Relationship between marginal and average cost (2015, 2018, 2019)

3. Long Run Average Cost Curve (2016, 2018)

4. Average revenue and marginal revenue in an imperfect competitive market (2016)

5. Revenue curve of firm under imperfect competition (2019)

6. Dumping (2016, 2017, 2018)

7. Cartel (2017, 2019)

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 LECTURE 1

a. What is market ? what are the features of market ? How market is classified in
different categories ?

CLASSIFICATION OF MARKETS

The word market originates from the Latin word ‘maracatus’. It is a market where diverse commodities
are bought and sold at specific retail prices. Marketing is a sub-concept that is directly related to the
activities of the players present within a market environment. In Economics, marketing is referred to as
a strategy which is implemented to boost the sales of a product that is listed in a defined market.
However, with the introduction of the internet, the entire marketing meaning has changed significantly.
The modern-day meaning of marketing is directly correlated to the concept of digital marketing.
Advertisement and research are the two most fundamental pillars of marketing and must be considered
by sellers to boost their overall sales potential.

 In ordinary language, a market refers to a place where the buyers and sellers of a commodity gather
and strike bargains.
 In economics, however, the term “Market” refers to a market for a commodity. E.g. Cloth market;
furniture market; etc.
According to Chapman, “the term market refers not necessarily to a place and always to a commodity
and buyers and sellers who are in direct competition with one another”.
 According to the French economist Cournot, “Market is not any particular place in which things are
bought and sold, but the whole of any region in which buyers and sellers are in such free intercourse
with each other that the prices of the same goods tend to equality easily and quickly”.

The above mentioned definitions reveals the following features of a market:

1. A region. A market does not refer to a fixed place. It covers a region, which may be a town, state,
country or even world.
2. Existence of buyers and sellers. Market refers to the network of potential buyers and sellers who
may be at different places.
3. Existence of commodity or service. The exchange transactions between the buyers and sellers can
take place only when there is a commodity or service to buy and sell.
4. Bargaining for a price between potential buyers and sellers.
5. Knowledge about market conditions. Buyers and sellers are aware of the prices offered or
accepted by other buyers and sellers through any means of communication.
6. One price for a commodity or service at a given time.

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 CLASSIFICATION OF MARKETS

• Local Market
• Regional Market
GEOGRA
• National Market
PHICAL
• International Market
AREA

• Perfect Market
COMPET • Imperfect Market
ITION

• Agricultural Market
• Bullion Market
NATUR • Stock Market
E OF • Consumer Market
GOODS

• Wholesale Market
VOLUM • Retail Market
E OF • Industrial Market
EXCHAN
GE

• Good Market
ARTICL
• Service Market
ES OF
TRADE

• Very Short
TIME • Short
PERIOD • Long

• Regulated
REGULA • Unregulated
TION

• Spot Market
TRANSA • Forward Market
CTION

Classification of Market on the basis of :

A. GEOGRAPHICAL AREA
 Local Market
A local market for a product exists when buyers and sellers of commodity carry on business in a
particular locality or village or area where the demand and supply conditions are influenced by local
conditions only. E.g. Perishable goods like milk and vegetables and bulky articles like bricks and stones.

 National Market
When commodities are demanded and supplied throughout the country, there is national market e.g.
wheat, rice or cotton
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  Regional Market
Commodities that are demanded and supplied over a region have regional market.

 International Market
When demand and supply conditions are influenced at the global level, we have international market. e.g.
gold, silver, cell phone etc.

B. COMPETITION

On the basis of competition, markets are classified as perfect market and imperfect market. In a
perfect market, buyers and sellers are fully aware about the prices of products prevailing in the market.

Therefore, the price of a product is same all over the market. On the other hand, in an imperfect market,
the price of a product is different all over the market as buyers and sellers do not have any information
regarding prices of products.

C. NATURE OF GOODS

 Agricultural Markets
agricultural markets are "perfectly competitive," meaning (ideally) that a homogeneous product is
produced by and for many sellers and buyers, who are well informed about prices. The market is
characterized by free entry and exit, with producers obligated to be price takers.

 Bullion Markets
A bullion market is a market through which buyers and sellers trade gold and silver . There are
various bullion markets dotted around the world, although the London Bullion Market is known as
the primary global market trading platform for gold and silver.

 Stock Markets
The stock market broadly refers to the collection of exchanges and other venues where the buying,
selling, and issuance of shares of publicly held companies take place. Such financial activities are
conducted through institutionalized formal exchanges (whether physical or electronic) or via over-
the-counter (OTC) marketplaces that operate under a defined set of regulations.

 Consumer Market
A consumer market is a market when individuals purchase products or services for their own
personal use, as opposed to buying it to sell themselves. Consumer markets consist primarily of
products that people use as part of their everyday lives. Anytime someone purchases a product for
their own use, they become part of the consumer market. The market typically is divided into four
different categories: food, beverages, transportation and retail.

D. VOLUME OF EXCHANGE

 Retail Market

The market for the sale of goods or services to consumers rather than producers or intermediaries. For exam
ple, a retail clothing store sells to people who will (most likely) wear the clothes. It does not include the sale of
the clothes to other stores who will resell them.

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  Wholesale Market

The market for the sale of goods to a retailer. That is, a wholesaler receives large quantities of goods from a
manufacturer and distributes them to stores, where they are sold to consumers. A wholesaler is generally abl
e to extract a better price from the manufacturer because it buys so many good relative to an individual retail
er.

 Industrial Market

The industrial market (also called the producer market or business market) is the set of all individuals and
organizations that acquire goods and services that enter into the production of other products or services
that are sold, rented, or supplied to others. The major types of industries making up the industrial market
(business market) are agriculture, forestry, and fisheries; mining; manufacturing; construction and
transportation; communication and public utilities; banking, finance, and insurance; and services.

E. ARTICLES OF TRADE

 Good Market
The product market is the place where supply and demand of final goods interact with each other.
Companies act as suppliers and offer their products to potential customers at prices that are set
following the dynamics of the laws of supply and demand. Governments and other entities normally
step in to oversee the market’s activities, and depending on the degree of regulation they impose, the
market might be catalogued from free to restricted.

 Service Market
The service market is the place where supply and demand of services interact with each other.

F. TIME PERIOD

 Very Short Period

Very short period refers to the type of competitive market in which the supply of commodities cannot be
changed at all. So in a very short period, the market supply is perfectly inelastic. The price of the
commodity depends on the demand for the product alone. The perishable commodities like flowers are the
best example.

 Short-period
Short period refers to that period in which supply can be adjusted to a limited extent by varying the
variable factors alone. The short period supply curve is relatively elastic. The short period price is
determined by the interaction of the short-run supply and demand curves.

 Long Period
Long period is the time period during which the supply conditions are fully able to meet the new demand
conditions. In the long run, all (both fixed as well as variable) factors are variable. Thus the supply curve
in the long run is perfectly elastic. Therefore, it is the demand that influences price in the long period.

G. REGULATION

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  Regulated Market: In such a market there is some oversight by appropriate government
authorities. This is to ensure there are no unfair trade practices in the market. Such markets may refer
to a product or even a group of products. For example, the stock market is a highly regulated market.

 Unregulated Market: This is an absolutely free market. There is no oversight or regulation, the
market forces decide everything

H. TRANSACTION
 Spot Market: This is where spot transactions occur, that is the money is paid immediately. There is
no system of credit

 Future Market: This is where the transactions are credit transactions. There is a promise to pay the
consideration sometime in the future.

 Perfect Competition
Definition: Perfect competition describes a market structure where competition is at its greatest
possible level. To make it more clear, a market which exhibits the following characteristics in its
structure is said to show perfect competition:

1. Large number of buyers and sellers

2. Homogenous product is produced by every firm
3. Free entry and exit of firms
4. Zero advertising cost
5. Consumers have perfect knowledge about the market and are well aware of any changes in the
market. Consumers indulge in rational decision making.
6. All the factors of production, viz. labour, capital, etc, have perfect mobility in the market and are
not hindered by any market factors or market forces.
7. No government intervention
8. No transportation costs
9. Each firm earns normal profits and no firms can earn super-normal profits.
10. Every firm is a price taker. It takes the price as decided by the forces of demand and supply. No
firm can influence the price of the product.

Description:
Ideally, perfect competition is a hypothetical situation which cannot possibly exist in a market.
However, perfect competition is used as a base to compare with other forms of market structure. No
industry exhibits perfect competition in India.

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  Imperfect Competition

Imperfect competition is a competitive market environment where there are many vendors. But in
comparison to the perfect competitive market scenario, they sell heterogeneous (dissimilar)
products in competitive markets which are, as the name suggests, imperfect.

Characteristics & Causes

Imperfect competition is true competition in the world. Some of the manufacturers and sellers are
doing it today to gain surplus profits. In this scenario, the seller takes advantage of the privilege of
influencing the price to gain more money.

If a retailer sells a non-identical product on the market, he will increase the prices and earn profits.
High profits allow other sellers to enter the market, and sellers who suffer losses can leave the
market very quickly.

Imperfect markets do not meet the stringent standards of a hypothetical, perfectly, or purely
competitive market. They are characterized by competition for market share, high entry and exit
barriers, various products and services, and a small number of purchasers and sellers.

Conditions that lead to imperfect competition include:

1. A limited flow of cost and price information

2. Monopoly control of some suppliers
3. Collusion of sellers to keep prices high
4. Maintain discrimination by sellers among buyers based on the buying power

Forms of Imperfect Competition

Imperfect competition is, in economic theory, a form of market structure that demonstrates some
but not all features of competitive markets.

Types of imperfect competition include:

 Monopolistic competition: This is a situation in which many firms compete with slightly different
goods. The costs of production are above what perfectly competitive companies can achieve, but
society benefits from the distinction of the products.

 Monopoly : A corporation that has no competition in its business. A monopoly company produces
less production, has higher costs, and sells its product at a price higher than the price if it were limited
by competition. Such adverse outcomes create oversight by the government in general.

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 The most extreme condition of imperfect competition exists when the market for a particular good or
service is a monopoly, one in which there is a sole supplier. A supplier that has a monopoly on the
provision of a good or service essentially has complete control over prices.

Because it has no competition from other suppliers, the sole supplier can essentially set the price of its
goods or services at any level it desires. Monopolies often charge prices that provide them with
significantly higher profit margins than most companies operate with.

 Oligopoly : This is a market with only a few firms. They form a cartel to reduce production and
boost profits in the way a monopoly does .

In an oligopoly, there are several – but a small, limited number – of suppliers. The market for cell phone
service in the United States is an example of an oligopoly, as it is essentially controlled by just a handful of
suppliers. The small number of suppliers, which limits buying choices for consumers, provides the suppliers
with substantial, although not complete, control over pricing.

 Duopoly : A duopoly is a market structure in which there are only two suppliers. Although
duopolies are somewhat more competitive than monopolies, the level of competition is still far from
perfect, as the two suppliers still have significant control of marketplace prices.

An example of a duopoly exists in the United Kingdom’s detergent market, where Procter & Gamble
(NYSE: PG) and Unilever (NYSE: UL) are virtually the only suppliers. The two suppliers in a duopoly
often collude in price setting.

 Monopsony: A single-buyer market and many sellers.

A rare form of imperfect competition is a monopsony. A monopsony is a single buyer, rather than any
supplier, who has great control over market prices. Government entities often enjoy a monopsony
position.

For example, the central government in any country is usually the sole buyer of certain military
equipment. There may be multiple manufacturers selling such goods, but all the sellers are basically at
the mercy of whatever price the government is willing to pay for the goods.

 Oligopsony : A market with few buyers and many sellers.

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 LECTURE 2

a. Distinguish between short run and long run cost curves . Why is long-run
average cost curve also termed as envelope curve ? (2023)
b. Discuss the various concepts of cost of a firm during the short period. (2015)

REVENUE AND COST CURVES

REVENUE

Revenue is the income a firm retains from selling its products once it has paid indirect tax,
such as VAT. Revenue provides the income which a firm needs to enable it to cover its costs
of production, and from which it can derive a profit. Profit can be distributed to the owners,
or shareholders, or retained in the business to purchase new capital assets or upgrade the
firm’s technology.

Revenue is measured in three ways:

Total revenue
Total revenue (TR), is the total flow of income to a firm from selling a given quantity of
output at a given price, less tax going to the government. The value of TR is found by
multiplying price of the product by the quantity sold.

Average revenue
Average revenue (AR), is revenue per unit, and is found by dividing TR by the quantity sold,
Q. AR is equivalent to the price of the product, where P x Q/Q = P, hence AR is also price.

Marginal revenue
Marginal revenue (MR) is the revenue generated from selling one extra unit of a good or
service. It can be found by finding the change in TR following an increase in output of one
unit. MR can be both positive and negative.

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  Revenue schedule

A revenue schedule
shows the Price Quantity Demanded Total Revenue Marginal Revenue amount of
revenue generated
by a firm at different
10 1 10 -
prices.

9
2 18 8

8 3 24 6

7 4 28 4

6 5 30 2

5 6 30 0

4 7 28 -2

3 8 24 -4

2 9 18 -6

1 10 10 -8

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 Revenue curves

Total revenue
Initially, as output increases total revenue (TR) also increases, but at a decreasing rate. It
eventually reaches a maximum and then decreases with further output.

Less competition in a given market is likely to lead to higher prices and the possibility of
higher super-normal profits.

Average revenue
However, as output increases the average revenue (AR) curve slopes downwards. The AR
curve is also the firm’s demand curve.

Marginal revenue
The marginal revenue (MR) curve also slopes downwards, but at twice the rate of AR. This
means that when MR is 0, TR will be at its maximum. Increases in output beyond the point
where MR = 0 will lead to a negative MR.

COST

Opportunity Cost

Economists like to say every choice has a cost. That cost is called an opportunity cost.
In economics, cost isn’t just about money; it is about lost opportunities. For example, if
you chose to go to soccer practice, you lose the opportunity to hang out with your
friends. Hanging out with your friends is your opportunity cost. Opportunity cost is the
value of the best alternative not chosen.
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Here is another example, let’s say your friend offers to buy you lunch. You could eat a
hamburger, salad, sandwich, or burrito (these are all of your alternatives). You decide
to get the burrito. The burrito is your choice (the best alternative). Your opportunity
cost is the second best choice available or what you would have gotten if the burrito
wasn’t available. If that was the hamburger, then the hamburger is your opportunity
cost for choosing the burrito.

 Explicit Cost vs Implicit Cost:

There are two types of cost that total the opportunity cost for a choice.

Explicit cost is the cost most people think about when they hear the word cost. Explicit cost is
the money paid when a choice is made. If I choose to go to the movies with my friend, the
price of the ticket, popcorn, and soda would be the explicit cost of going to the movie.

Implicit cost is the value of lost opportunities (lost income most often in AP) as the result of a
choice. If I took the night off work to go to the movies with my friend, the implicit cost would
be the money I could have earned that night had I worked.

Opportunity cost is the explicit costs and implicit costs added together.

Calculating Opportunity Cost:

Many times on an exam you will see questions that require you to calculate
opportunity cost. The key to answering these questions is to focus on the cost of the
choice. If someone loses the opportunity to earn money (implicit cost), that is part of
the opportunity cost. If someone chooses to spend money (explicit cost), that money
could be used to purchase other goods and services so the spent money is part of the
opportunity cost as well. Add the value of the next best alternatives (the opportunities
that would have been chosen had the choice not been available) and you have the
total opportunity cost. If you miss work to go to a movie, your opportunity cost is the
money you would have earned if you went to work plus the money spent to go to the
movie.

Note:

In economics classes, the terms opportunity cost and cost are often used
interchangeably. So when you hear cost, it is the implicit and explicit costs added
together.

Fixed Costs:

These are costs for a firm which do not change with the quantity produced (they remain
fixed). Rent, loan payments, insurance, etc will generally be the same whether a firm
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produces zero units of output or ten thousand. On a
graph, FC are a horizontal line (indicating the same
dollar amount for every quantity). A firm will operate
as long as losses are less than fixed costs. Otherwise
the firm will temporarily shut down. That is because
fixed costs are “sunk costs” meaning they are already
lost.

Variable Costs:

These are the costs which change with the quantity

produced. Labor, electricity, and raw materials are all
examples of variable costs because as more units are produced more money will be spent on
labor, electricity, and raw materials. If total revenue is greater than total variable costs, the
firm will operate and their losses will be less than fixed costs. If total revenue is less than total
variable costs, the firm will temporarily shut down.

Total Costs:
Variable Costs plus Fixed Costs give you Total Costs. On a graph the TC curve is the same
shape as the VC. The distance between the two curves is equal to the value of the Fixed costs.

Marginal Cost:
Marginal cost is the change in total cost divided by the change in quantity (MC = ∆TC/∆Q).
Usually the change in quantity is just 1 so MC is the cost associated with producing just one
more unit of output. The marginal cost curve intersects the ATC and AVC at their minimum
points. That relationship is because as long as the cost of producing one more unit of output
(MC) is less than the current average the average will fall. Also, as long as the cost of
producing one more unit of output is higher than the current average, the average will rise.
The Marginal Cost curve looks like the Nike swoosh. At low quantities, the marginal cost
curve is downward sloping. That is due to specialization that causes increasing marginal
returns. The quantity where the marginal cost curve is at its minimum is where diminishing
marginal returns sets in. Diminishing marginal returns causes marginal costs to rise at
higher quantities.

Average Fixed Costs:

Add up all of the fixed costs for a firm and divide by the quantity produced (AFC = FC/Q).
Continually decreases. Rarely drawn because the distance between the ATC and AVC will be
equal to the AFC at that quantity. Average fixed costs continually decrease as output
increases.

Average Variable Costs:

Add up all of the variable costs for a firm and divide by the quantity produced (AVC = VC/Q).
Decreases until it intersects the MC then increases. Looks like a smirk. Firms shut down
(temporarily) when price falls below the minimum point on the AVC.

Average Total Costs:

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Variable costs added to Fixed costs, then divided by Quantity gives you the Average Total
Costs (ATC=TC/Q). It decreases until it intersects the MC then increases. Looks like a smile.
The ATC tends to be a flipped average product curve. Producing the quantity where the
ATC is at its minimum is productively efficient.

Shifting Cost Curves:

Changing a variable cost like per unit taxes or subsidies, labor costs or raw material costs will
shift the ATC, AVC, and MC upward if it is a cost increase or downward if it is a cost
decrease.

Changing a fixed cost like lump sum taxes or subsidies, rent payments, or insurance
payments, will only shift the ATC upward if it is a cost increase or downward if it is a cost
decrease.

Short-run Average Total Cost (SRATC) vs Long-run Average Total Cost

(LRATC):
When a business first opens, it will have a short-run average total cost curve for various
quantities it can produce. In the short run only variable costs can be changed; fixed costs
cannot. The firm can only change the rate of production by changing the amount of raw
materials, labor, etc. it utilizes in the production process. In the long run, all costs (fixed and
variable) can change. The firm can expand capacity, by purchasing more machinery or
building a new factory. That change gives the firm a new short-run average total cost curve
at greater quantities. As the firm continues to grow each new capacity creates a new short-
run average total cost curve at a higher quantity. Each possible SRATC gives way to a long-
run average total cost curve which shows average costs for all quantities the firm can
produce in the long run at every possible capacity.

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Economies of scale:
When the long-run average total cost curve is downward sloping, higher quantities have a
lower average cost. This occurs for many firms as they expand and get more efficient
allowing them to minimize average costs. This is called economies of scale.

Many businesses will eventually reach a point where continuing to expand leads to the
creation of inefficient bureaucracies, etc. which increase average costs. When this occurs, the
long-run average total cost curve will be upward sloping. That is called diseconomies of scale.
Between the downward sloping and upward sloping portions of the long run average total
cost curve there is often a flat portion where the firm is experiencing neither economies of
scale or diseconomies of scale. This area is called constant returns to scale. Here, as the
business expands production capacity, the long run average costs do not change.

Returns to scale:
One of the reasons for economies of scale is that small firms can often increase resources
used by a small amount while increasing output much more. This is called increasing returns
to scale. Some firms may increase output at the same rate as they increase resources. That is

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called constant returns to scale. Other firms may increase output at a smaller rate as they
increase resources. This is called decreasing returns to scale.
The easiest way to figure out if a firm is experiencing increasing, decreasing or constant
returns to scale is to double all inputs and see what happens to output. If output also doubles,
the firm is experiencing constant returns to scale. If output more than doubles, it is
experiencing increasing returns to scale. If output less than doubles, it is experiencing
decreasing returns to scale.

Cost Curve Math

It is important to realize the shapes of all the cost curves come from a typical firm’s actual
costs. The basic formulas were shown above but your next exam might make things a little
trickier. Below is a chart with all costs for a fictitious firm. We will use the numbers in the
chart to examine different ways to find the different costs.

Ways to find fixed cost

1. Total cost for making a quantity of zero: The total cost in the example above is 20 so
the fixed cost is 20
2. Difference between total cost and variable cost: At the quantity of 1, the total cost is 30
and the variable cost is 10; so, the difference is 20 (30-10).
3. Difference between average total cost and average variable cost times the quantity: At
the quantity of 2, the average total cost is 17.5 and the average variable cost is 7.5.
The difference it 10. 10 x 2 = 20, so the fixed cost is 20.
4. Find average fixed cost times quantity: At the quantity of 4 the average fixed cost is 5.
Since 4 x 5 = 20, the fixed cost is 20.
Ways to find marginal cost
1. The change in variable cost for producing one more unit: The variable cost for a
quantity of 2 is 15 and the variable cost for 3 is 25. So, the marginal cost for the 3rd
unit produced is 10.
2. The change in total cost for one more unit: The total cost for a quantity of 4 is 45 and
the total cost for 5 is 60. So, the marginal cost for the 5th unit produced is 15.

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 3. The multiply the average variable cost by the quantity to find variable cost. Then, find
the change in the variable cost for producing one more unit. At the quantity of 4, the
average variable cost is 10, so the variable cost is 40 (10 x 4 = 40). At the quantity of 5,
the average variable cost is 12 so the variable cost is 60 (12 x 5 = 60). The change in
variable cost for the 5th unit produced is 20 (60-40).
Ways to find variable cost
1. Add all the marginal cost up to that unit: So, if you are trying to find the variable cost
for the 6th unit, you would add the marginal cost for all previous units produced. The
marginal cost for all 6 units is 10, 5, 10, 15, 20 and 25. Add all those up and you get a
variable cost of 85.
2. Total cost minus fixed cost: At a quantity of 1, the total cost is 30 and the fixed cost is
20. So, the variable cost is 10 (30-20).
3. Average variable cost times quantity. At the quantity of 2, the average variable cost is
7.5. Since 2 x 7.5 = 15, the variable cost for a quantity of 2 is 15.
4. Find the difference between the average total cost times the quantity and the average
fixed costs times the quantity: At the quantity of 4, the average total cost is 15 and the
average fixed cost is 5. Since 4 x 15 = 60 and 4 x 5 = 20, the total cost is 60 and the
fixed cost is 20. The difference (the variable cost) is 40 (60-20)
5. Find average variable cost times quantity: At the quantity of 5, the average variable
cost is 12. Since 5 x 12 = 60, the variable cost is 60.
Ways to find the total cost
1. Add the fixed cost and variable cost together: The first unit produced has a fixed cost of
20 and a variable cost of 10. So the total cost of one unit is 30 (20+10).
2. Add the fixed cost and the marginal cost of each unit produced thus far: At a quantity
of 2, the fixed cost is 20. The marginal cost for the first unit is 10 and the second unit is
5. Since 20+10+5=35, the total cost of 2 units is 35
3. Add average variable cost times quantity and average fixed cost times quantity
together: At the quantity of 5, the average variable cost is 12 and the average fixed
cost is 4. Since 5 x 12 = 60 and 5 x 4 = 20, the total cost for 5 units is 80 (60+20).
4. Find average total cost times quantity: At 6 units, the average total cost is 17.5. Since 6
x 17.5 = 105, the average total cost for 6 units is 105.
Ways to find average variable cost
1. Find variable cost (using any method above) and divide by quantity: At the quantity of
2, the variable cost is 15. Since 15/2 = 7.5, the average variable cost for 2 units is 7.5.
2. Difference between average total cost and average fixed cost: At the quantity of 3, the
average total cost is 15 and the average fixed cost is 6.67. Since 15 – 6.67 = 8.33.
Ways to find average total cost
1. Find total cost (using any method above) and divide by quantity: At the quantity of 3,
the total cost is 45. Since 45/3 = 15, the average total cost for 3 units is 15.
2. Add average variable cost and average fixed cost: At the quantity of 4, the average
variable cost is 10 and the average fixed 5. Since 10 + 5 = 15, the average total cost for
4 units is 15.
Ways to find average fixed cost
1. Find fixed cost (using any method above) and divide by quantity: At the quantity of 5,
the fixed cost is 20. Since 20/5 = 4 the average fixed cost for 5 units is 4.
2. Difference between average total cost and average variable cost: At the quantity of 6,
the average total cost is 17.5 and the average variable cost is 14.17. Since 17.5 – 14.17
= 3.33, the average fixed cost for 6 units is 3.33.

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 LECTURE 3

a. Explain characteristics of perfect market competition also explain short- and long-
term equilibrium in market (2018)
Or
What do you mean by equilibrium of a firm discuss the equilibrium of a firm
under the perfect competition (2019)
Or
List the assumptions of perfectly competitive market . How price and output is
determined in long run under perfect competition ? (2021)
b. Discuss firms Equilibrium under monopoly competition.
Or
What do you understand by monopoly? How is price determined under conditions
of monopoly ? (2012, 2014,2015,2023)
c. By bringing about differences between monopoly and perfect competition , list the
assumptions of a perfectly competitive market . How is output determined under
perfect competition in shortrun ? (2022)

Price and output determination under perfect competition

 Short-run Equilibrium of firm and industry

Short-run refers to that time period in which a firm can not change the fixed factors of
production. Therefore, a firm cannot change its production process and there may be
abnormal profit, normal profit or even loss depending on the firm's revenue and cost. The
profit and loss also depends upon the nature of AC and AR, which can be presented as
follows:-
1. If AR=AC, the firm receives a normal profit.
2. If AR> AC, the firm receives abnormal profit.
3. If AR< AC, the firm bears the loss.

The profit and loss depend also on the nature of MR and MC and the following
conditions must be fulfilled in order to obtain equilibrium in the perfect competition market:
1. Market supply must be equal to market demand.
2. MC must be equal to MR.
3. MC must cut MR from below.

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The short-run equilibrium of the firm and industry under perfect competition can be
explained by the help of the following diagrams:-

In the above figures, we can see the equilibrium price determination in the industry in the
first figure. In the second, third, and fourth figures, the conditions of equilibrium in three
different firms are shown under perfect competition, in the short run. There are three
possibilities which are as follows:-

1. Abnormal profit (supernormal or excess profit):-

The second figure shows the abnormal profit earned by the firm. The firm earns an
abnormal profit when AR is greater than AC. In this figure, E is the equilibrium point because
here MR and MC are equal and MC is intersecting MR from below. So, OQ is the equilibrium
quantity. The firm is earning abnormal profit equal to the shaded rectangular area. The
firm's average cost of production is ‘OC’.

2. Normal profit:-
In the third figure, the firm is in equilibrium at point E. Because at this point MC is
intersecting MR from below. The equilibrium output is OQ. The firm is earning just a normal
profit because AR and AC are equal at this level of output. It is that profit which is just
sufficient to run the business.

3. Loss:-
In the fourth figure, the firm is in equilibrium at point E because, at this point, both necessary
and sufficient conditions are fulfilled. The equilibrium output determined by the firm is OQ.
At this output, AC is greater than AR. So, the firm is bearing loss equal to the shaded area.

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  A firm’s Long-run equilibrium under Perfect Competition

Long-term is the period in which the firm can vary all of its inputs. There are no fixed costs and
therefore, the AFC or Average Fixed Cost curve vanishes. Also, the Average Cost (AC) curve
represents the Average Total Cost (ATC) curve. Further, since the firm can vary all its inputs, it
can close own and leave the industry.

We know that in the long-run, the AC curve which is formed by its short-run AC curves is also U-
shaped. This means that up to a certain limit, the firm experiences increasing returns and the
AC curve slopes downwards.

A phase of constant returns follows in which the AC curve neither rises nor falls. Subsequently,
diminishing returns to scale phase starts in which the AC curve slopes upwards.

In the long-run, new firms can also enter the industry. This is the free entry and exit feature
which has two implications:

1. There is no compulsion on the firm to operate under losses and it can leave the industry.

2. No firm can earn super-normal profits. This is because when a firm earns super-normal
profits, it attracts new firms to the industry. This leads to an increase in the supply which
results in lowering the prices and normalizing of profits.

The figure above describes the determination of long-run equilibrium under perfect
competition. As you can see, the output is measured along the X-axis and the costs along the Y-
axis. Also, the firm is a price-taker.

Further, its AR curve runs parallel to the X-axis and the MR curve coincides with it.
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In order to determine the equilibrium of the firm, we will consider three alternative prices that
the firm receives from the industry:

Price #1
The price in the market is below the optimum cost of the firm (OP 0). From this cost, we get a
corresponding average revenue of AR0 and Marginal Revenue of MR0. As you can see in the
figure, MR0 cuts the LMC curve at two points – E and E0.

However, none of these points is the long-run equilibrium of the firm. At point ‘E’, the LMC curve
cuts the MR0 curve from above while at point E0, it cuts the curve from below. But, since AR0 <
LAC, the firm incurs losses.

Price #2
The price of the firm’s product is more than the optimum cost or the least possible average
cost of the firm. In such cases, the firm is not in a state of stable equilibrium. If this price is
OP2 with the average revenue curve AR2 and the marginal revenue curve MR2, then we can see
that

 The LMC curve intersects the MR2 curve from below at point E2

 AR2 > LAC

This means that the firm is enjoying super-normal profits. However, this attracts new firms to
the industry which increases the supply and the price falls until no firm can earn super-normal
profits.

Price #3
The price of the firm’s product is equal to its optimum cost of production. If this price is OP1
with the average revenue curve AR1 and the marginal revenue curve MR1, then we can see
that

 The MR1 curve cuts the LMC curve from below at the lowest point E1

 AR1 = LAC
Therefore, the firm neither incurs a loss nor earn a super-normal profit. Therefore, there is no
incentive for the existing firms to leave the market or new ones to join it. Also, the
corresponding equilibrium output is OM1.

Hence, we can note that in long-run equilibrium, the firm produces an optimum output at the
lowest possible average cost. Therefore, the firm operates under constant returns to scale. Also,
we have

 MC = AC

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  MC = MR

 AC = AR
Therefore, we have AC = AR = MC = MR.

Go through this link for further reference :

https://kullabs.com/class-12/economics-1/theory-of-price-and-output-determination/price-and-
output-determination-under-perfect-competion

Price and output determination under Monopoly

 Price and output determination under monopoly in Short-run:

Short-run refers to that period in which a monopolist cannot change the fixed factors.
However, the monopolist is free in determining price due to lack of competition. A monopolist
has control over the market supply. So, he/ she is the price maker. His/ her price and output
determination is motivated by profit as well as sales maximization. Therefore, he/ she will
adjust the output in such a way that the marginal cost and marginal revenue are equal.

In short run equilibrium whether the firm makes an abnormal profit, normal profit or loss, it
depends on the level of AC and AR which can be shown as follows:-
1. If AR=AC, the firm receives a normal profit.
2. If AR> AC, the firm receives abnormal profit.
3. If AR< AC, the firm bears the loss.

The following conditions must be fulfilled in order to attain equilibrium under monopoly:-

1. MR must be equal to MC
2. MC must intersect MR from below.

The equilibrium position of a monopoly firm can be graphically presented as follows:-

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In the above figures, the three different possibilities of profit and loss situation in the short
run under monopoly firm are shown. These possibilities are explained as follows:-

1. Abnormal profit:-
In the first figure, we see that the equilibrium point is 'E' when MC cuts MR from below. The
equilibrium level of output is determined at OQ. The level of revenue earned is OP and the
cost incurred is OC. Since Revenue is greater than cost, the firm earns abnormal profit equal
to the shaded area (ABPC).

2. Loss:-
In the second figure, point E is the equilibrium point where MC intersects MR from below. The
equilibrium level of output is OQ. The cost incurred is OC and the revenue earned is OP. Since
cost is higher than revenue, the firm bears loss equal to the shaded area (ABCP).

3. Normal profit:-
In the third figure, we can see that the equilibrium point is at 'E' where the conditions for
equilibrium are fulfilled. The equilibrium level of output is OQ. The revenue and cost are at
the same level (OP). The firm earns just a normal profit to sustain its business in this case.

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 LECTURE 4
a. Discuss in detail Cartelisation . (2021 )
b. Write briefly on the following a) Dumping (2019)
c. What is Dumping ? Discuss its types and objectives . What are the anti-dumping
measures available with government ? (2022)

CARTEL AND DUMPING

Cartel

 What is Cartel ?

A cartel is an organization created from a formal agreement between a group of producers

of a good or service to regulate supply in order to regulate or manipulate prices. In other
words, a cartel is a collection of otherwise independent businesses or countries that act
together as if they were a single producer and thus can fix prices for the goods they produce
and the services they render, without competition.

KEY TAKEAWAYS

 A cartel is a collection of independent businesses or organizations that collude in

order to manipulate the price of a product or service.
 Cartels are competitors in the same industry and seek to reduce that competition by
controlling the price in agreement with one another.
 Tactics used by cartels include reduction of supply, price-fixing, collusive bidding, and
market carving.
 In the majority of regions, cartels are considered illegal and promoters of anti-
competitive practices.
 The actions of cartels hurt consumers primarily through increased prices and lack of
transparency.

 Purpose

 These are formed to protect the self-interest of a group of producers. The producers
work in a group to regulate the prices of commodities.
 Through this, the producers can easily raise the prices by observing the demand-supply
ratio for the goods.
 This member can decide jointly to restrict the supply in the market.
 They can also decide to provide entry barriers to their market.

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  How does it Work?

It all starts with a company which operates in an oligopoly market. Oligopoly market is an
extended form of monopoly wherein only a few sets of companies operate in a standardised
manner (like the telecom sector). The competitors in the oligopolistic market have the
capacity to downturn the entire market up to the cost of production, thereby vanishing the
profits of other competitors. This event provides other competitors to unite & become market
leaders for the said product & thus few such companies consolidate to become one.
Another way for consolidation is to form an undisclosed cartel for leading the prices in the
industry. In their selfish interest, the members will never agree for a price reduction.
Members usually agree to restrict the supply to maintain high prices. However, some member
may cheat & supply more to grab more margins at higher prevailing prices. Competitors who
are not part of the cartel may distort the market by offering a significant reduction in the
prices for said goods. In such a case, customers will move towards the new competitor.

 Cartel Examples

Example #1

We can consider the example of legalised cartel famous over the globe, namely,
the Organisation of Petroleum Exporting Countries (OPEC). 14 oil-producing countries form
OPEC cartel over the globe, whose objective is to stabilise the oil market in the countries.
Their objective is to sell oil at reasonable prices to consuming countries.

Example #2

The European Commission has imposed a whopping fine of 750 Million Euros on 11-group of
companies who participated in illegal cartel for gas-insulated switchgear projects. The group
created public utility companies as well as consumers. The Commission collected evidence
through documentation available easily. The member units prepared sham bids to
manipulate the tenders. However, Swiss-based ABB did not attract the fine since it was the
whistleblower & has supported the Commission in providing sufficient evidence to unfold the
Cartel.

 Types of Cartels

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1 – Price Cartels – They fix the minimum prices as per their demand-supply ratio. Members
cannot sale the products below such prices.

2 – Term Cartels – They agree on the terms of business on a standard basis. Each member is
obliged to follow the terms of trade. Terms of trade can be delivery-mode, delivery-locations,
delivery-time, terms of payment, charging of interest in case of delay, etc.

3 – Customer Assignment Cartels – Specific customers are assigned to each member. Thus,
all customers are divided amongst the members to ensure appropriate flow of revenue. Each
member shall maintain the dignity of allocation & should not grab customers of other
members.

4 – Quota Cartels – Quota means the quantum of supply. Such type of collaboration offer to
restrict the supply, which in turn upscales the prices in the market. Ever member much
produce only up to quantum allocated to it & should not exceed the limit.

5 – Zonal Cartels – They allocate the geographical locations of the country, to each member
in the cartel. Members should ensure to operate on their specific territory.

6 – Syndicate Cartels – Here, few members unit to sell jointly & reduce the cost of
production. Such cartels intend to achieve the economies of scale.

7 – Super Cartels – These are high-level international collaborations. Cartels of the domestic
country agree with cartels of the foreign country.

 How Cartels Causes Inefficiencies in the Market?

Cartels may be formed for fixing the prices, quantum, or terms of trade or for allocating the
trade zones or for achieving the economies of scale. The extra revenue earned by the
member is not due to additional efforts of producers or due to extra production supplies.
Rather such agreements make the producers inefficient in the long run.

From the consumer’s perspective, they are concerned with only the prices to be paid for a
specific product. Formation of cartels affects their balance disposable income. Since the
supplies are restricted through agreement, the production capacities of large-scale producers
are underutilised to the said extent. The large-scale producers could have produced more &
dumped excess production in the foreign market. However, super cartels restrict such excess
export of goods in the short-term.

Thus, slowly & steadily economies of scale get reduced, which becomes one of the causes of
rising in inflation.

 Effects

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 It has been found that the prices of commodities increase significantly due to price
manipulations by Cartels. International cartels have more impact on such price
increases. However, these are backed by the limitation of a few members who do not follow
the agreed price and supply at lower than the said price. This exposes the cost of production
to the consumers. Such member may also beyond the upper cap of supply limit.
 Cartels do not last long. The average duration can be assumed to be between 5 to 8 years
approximately. On the other hand, some cartels are required by Government of various
countries to safeguard the sovereignty. In such a case, no legal repercussions can be imposed
for any price manipulation or any sort of issue.

 When it’s Powerful?

This is usually powerful when the country’s sovereignty is at stake. In such a case, these are
not questioned about the prices they charge or the supplies of production. This is also
powerful when one of the members in the cartel has complete control over the market & is
dominant in nature.

Also, high entry barriers are another reason for powerful cartels. The reason is that less
number of competitors drives the market prices & it is not under the control of the demand-
supply ratio.

 Advantages

 It provides monopoly-type power to the member units.

 Products can be sold at higher margins, which maximises the gross profits.
 The cost of advertising is reduced and the product is easily known to the customers.
 No effect of the business cycle on the individual players.
 Production efficiency can be easily managed as per supply constraints.
 Reasonable margin is assured for each member in the cartel.
 Big savings are achieved on economies of scale.

 Disadvantages

 Individual monopolies affect the disposable income of customers.

 Its create inefficiencies in the market, which may affect the quality of the end product.
 It may or may have full regulation over the member, which provides instability to other
members.
 There is no motivation to increase the efficiency in the market & thus, prices of product
stay at a high cost.
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  Demand will fluctuate as per the needs of customers & other economies of scale. This
cannot regulate demand.
 The individual members are not able to scale up their operations.

Dumping

 What is Dumping?

Dumping in the financial world occurs when a company or a country exports its products at a
price lower than its domestic price. Exporters dump to compete with the producers and sellers
in the importing country.

Definition

 Dumping is a situation of International price discrimination, where the price of a

product when sold to the importing country is less than the price of the same product
when sold in the market of the exporting country.
 Dumping, in its legal sense, means export of goods by a country to another country at
a price lower than its normal value

Summary

 Dumping enables consumers in the importing country to obtain access to goods at

an affordable price. However, it can also destroy the local market of the importing
country, which can result in layoffs and the closure of businesses.
 The WTO and EU regulate dumping by putting tariffs and taxes on trading
partners. Sufficient proof must be provided that dumping has happened.
 Dumping can also take place in the exporter’s home market. If the product can be
priced at a higher cost abroad, the company can sell at a lower price at home.

 Objectives of Dumping

 To Find a Place in the Foreign Market : Due to perfect competition in the foreign
market he lowers the price of his commodity in comparison to the other competitors
so that the demand for his commonly may increase
 To Sell Surplus Commodity : When there is excessive production of a monopolist’s
commodity and he is not able to sell in the domestic market, he wants to sell the
surplus at a very low price in the foreign market. But it happens occasionally
 Expansion of Industry : The cost of production of his commodity is reduced and by
selling more quantity of his commodity at a lower price in the foreign & Domestic
market, he earns larger profit.
 New Trade Relations : He sells his commodity at a low price in the foreign market,
thereby establishing new market relations with those countries
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  How Dumping Takes Place

It may seem that the dumping company may lose a lot of money by charging a lower price.
However, it is not the case in real life, as the dumping company is not losing money.

The majority of multinational companies (MNC) practice international price differentiation.

They price a certain item depending on what each nation’s customer can afford. For example,
Tide detergent in China is sold for less than one-fifth of the U.S. price. However, if a
particular country is willing to pay more for a product, the MNC will price the product at a
higher cost.

 Types of Dumping

Below are the four types of dumping in international trade:

1. Sporadic dumping

Companies dump excess unsold inventories to avoid price wars in the home market and
preserve their competitive position. They can either dump by destroying excess supplies or
export them to a foreign market where the products are not sold.

2. Predatory dumping

Unlike sporadic dumping, which is occasional, predatory dumping is permanent. It involves

the sale of goods in a foreign market at a price lower than the home market. Predatory
dumping is done to gain access to the foreign market and eliminate competition. It creates
a monopoly in the market.

3. Persistent dumping

When a country consistently sells products at a lower price in the foreign market than the
local prices, it is called persistent dumping. It happens when there is a constant demand for
the product in the foreign market.

4. Reverse dumping

Reverse dumping happens when the demand for the product in the foreign market is less
elastic. It means that price changes do not impact demand. Therefore, the company can
charge a higher price in the foreign market and a lower price in the local market.

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  Advantages of Dumping

 Consumers in the importer’s country can gain access to products at lower prices.
 Exporters receive subsidies from their government to sell at lower prices abroad.
 The exporter’s country can generate employment and become industry leaders.

 Disadvantages of Dumping

 The debt of the exporter’s country will increase due to subsidies provided to sell at
lower prices abroad.
 Dumping is expensive, and it will take the exporters years to sell at a lower price and
put competitors out of business.
 The target company can retaliate and cause a trade war.

The World Trade Organization’s and the European Union’s Fight against Dumping

The World Trade Organization (WTO) and the European Union (EU) continuously take measures to
discourage countries from dumping by imposing tariffs and taxes.

 The WTO’s Role

Member countries of the WTO lay down principles during the negotiation of the General Agreement
on Trade and Tariff (GATT), where they agree not to dump and enforce tariffs on each other.

According to the WTO, if a country wants to put an anti-dumping tariff on a trading partner, then
that country needs to prove the occurrence of the dumping and its impact on the local market.

They also need to show that the dumped price is much lower than the exporter’s domestic price. The
disputing country should also determine the normal price before the anti-dumping tariff is in place.

 The EU’s Role

Like the WTO, the European Union also enforces anti-dumping measures through its economic arm –
the European Commission (EC). If a member country accuses a trading partner of dumping, the EC
needs to find that dumping has caused material harm to the complainant.

Before imposing the duties, the EC must find that the dumping has caused material harm to the local
market. It also needs to ensure that the anti-dumping duties do not violate the best interests of the EU.

If found guilty, the exporter can agree to sell at a minimum price, and duties can be imposed if the EU
rejects the price offered by the exporter.
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 LECTURE 5

a. Discuss in detail the important features of the Competition Act,2002 . (2023)

Anti-Monopoly Laws

 Introduction :
India got its independence in 1947, however, the Indian economic system was
suffering at the time, most importantly the two major contributors to the revenue of
the country were, agriculture and industrial sector, service sectors were nowhere to
be seen. Therefore, the government felt the need to be liberal in its approach towards
the service and the industrial sector for them to grow exponentially. However, this
approach from the government served them no good as the industrialists were quick
to spot the loophole and exploit it, by indulging in unfair, restrictive, and monopolistic
trade practices. As a result, the government had to formulate the Monopolies and
Restrictive Trade Practices Act, 1969 (MRTP Act) for the regulation of such activities,
however, it was later repealed, and the Competition Act, 2002 came into force in
2009 for regulating restrictive and monopolistic trade practices.

 Anti-monopoly laws : a lookout in the existing structure

The MRTP Act, 1969 was outdated because the main focus of the Act was to curb
monopolies and not promote competition in India. Importantly, the Act aimed to
protect the consumer from exploitation. However, the Act in place just lost its essence
and made it more difficult for industrialists rather than making it easier for the
customers. Therefore the government set up the Raghavan Committee to suggest a
suitable legislative framework and that is how the Competition Act, 2002 was
formulated.

Interestingly, the Act was passed in 2002 and was assented by the President in 2003,
however, the Act did not come into force until 2009. This was because the government
wanted this Act to not have any major deficiencies like the earlier one. Therefore, even
though the Competition Act had been passed, all the proceedings for seven years were
still functioning under the old MRTP Act. Once the Competition Act was amended in
2007 the government was confident to repeal the old Act and bring in the new one.

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  Competition Commission of India (CCI)
Competition Commission of India is the regulator of competition under the
Competition Act, 2002 in the Indian market. This commission comprises members
and a chairperson. There cannot be less than 2 and more than 6 members and all of
them are appointed by a selection committee by the Centre. The goal for the
formation of the commission was to accomplish the objectives of the Act, moreover,
imposing fines and granting relief in certain cases. After approaching the CCI, if the
parties feel the right sentence has not been pronounced, the appellate body is
the Competition Appellate Tribunal (COMPAT).

 The objective and the scope

The main objectives of the Competition Act are herein laid down below:

 The Act prevents activities that have an adverse effect on competition.

 To protect the interest of the consumer.
 To promote and sustain competition in the Indian market.
 To ensure freedom of trade to all the participants in the market.

There are two types of agreements that the parties can enter into:

 Horizontal agreement
Horizontal agreements are agreements in which the enterprises engaging in the same
activity (competitors) enter into an agreement. For example, if Samsung agrees with
Nokia then that is a Horizontal agreement. However, these agreements don’t need to
be entered by two companies. If the producers, wholesalers, and retailers dealing
with a similar product enter into an agreement, that will also fall within the ambit of
horizontal agreement.

These types of agreements are always on the radar of the CCI because in such an
agreement the Commission can suo moto cognizance if they find the agreement
having an adverse effect on competition, the CCI does not hold back in imposing
heavy penalties on the organization part of such agreements. For example, in 2012
the CCI imposed a hefty penalty of 6200 cr on 11 leading cement companies for price
cartelization.

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  Vertical agreement
Vertical agreements are the exact opposite, these agreements are between two entities
at a different level of the manufacturing and distribution process (Non-competitor).
For example, Tata Motor enters an agreement with CEAT Tyres for the supply of tires
for their cars, then it is a vertical agreement. Therefore, it will not be out of place to
state here that these agreements are formed between the companies within the supply
chain of the industry.

Importantly, these agreements are more liberal than the horizontal ones because
there can be an agreement between the retailer and the distributor to help the
business scale. For example, Dominos, Raymond, etc. ask their distributors to only
sell the products that they produce but if these agreements have an adverse effect on
competition then CCI can hold them liable as well. However, in these cases, the
liability lies on the complainant to prove the same.

Anti-Competitive agreement

Anti-Competitive agreements are those agreements that have an appreciable adverse

effect on competition (AAEC). The formation of a cartel is an example of such an
agreement. In simple words, a cartel is an association of producers or manufacturers
with the sole aim of restricting competition and maintaining the prices high.
Determining factors for AAEC are:

 Creation of a barrier for a new entrant.

 Driving existing competition in the market.
 Foreclosure of competition by hindering entry.
 Benefits to the customer in the long run.
 Improvement in production or distribution of goods/services.
 Promotion of technical, scientific, and economic development by the means of
production or distribution of goods/ services.

Whenever any organization enters into a contract these indicators are looked into
carefully for maintaining a healthy and competitive environment to do business, at
the same time looking after the needs of the customers. However, in the case

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of Competition Commission of India v. Co-Ordination Committee of Artists and
Technicians of W. B. Film and Television, 2017, the Supreme Court held that, if an
agreement falls into any of the categories for horizontal agreements under Section
3(3) of the Act, it is per se treated as adversely affecting competition and would be
void. There is no requirement of proof as to whether it has caused an appreciable
adverse effect on competition (AAEC).

 Abuse of dominant position

A dominant position can be said to be a position of strength in the industry, in a way
that they can influence the consumer to use their products/services instead of their
competitors. Interestingly, in the Indian market, it is not wrong to hold a dominant
position, however, its abuse is prohibited.

Under this, the enterprises cannot enter into any agreement which demonstrates
clear abuse of its dominant position. For example, Conditional sale or purchase and
predatory pricing.

Illustration: If A has a dominant position in its industry then if A asks B (a

distributor) to buy a new product X if they want their Y product (Which is the best
seller), or if A decides to sell its product lower than its cost of production so that its
competitors can no longer sustain in the market. These two instances are clear cases
of abuse of the dominant position.

Factors that determine the dominant position of an enterprise in an

industry:

 Market capitalization.
 Economic advantages over the competitors.
 Dependence of consumer.
 Vertical integration.
 Market Structure and size.

The case of the T-series was a classic example in this regard, it is a known fact that T-
series has a crystalline dominant position in the music industry, therefore abusing its
power T-series asked all the radio stations to only play their songs. However, HT
media, a competitor, complained about the same and CCI asked T-series to stop this
monopolistic behavior.

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  Combinations
The acquisition, amalgamation, or merger between two or more enterprises is known
as a combination under the Act. There is a very strong reason to regulate such
activities by the enterprises because combinations in some cases create a monopoly in
an industry which makes it very tough for the other competitors to enter the market.
For example, if A and B have a market capitalization of 40% and 35% respectively
and they both decide to merge then a monopoly will be created in that industry as the
two biggest players have merged.

There are three types of combinations:

1. Horizontal Combination (occurs when two enterprises in the same industry

combine).
2. Vertical Combination (Occurs when one enterprise combines with another
enterprise that makes raw material for their industry).
3. Conglomerate Combination (occurs when two enterprises of the different
industries combine).

In order to combine with other companies above the threshold, a proposal should be
made to CCI via an application and after examining this combination the CCI will
announce its result within 150 days an extension of 30 days can be requested. In case
of no response or approval, the companies can effectively combine and if the proposal
is not approved then the parties are not satisfied with the decision then they can
appeal to the COMPAT, and the final appeal lies with the Supreme Court.

The threshold for Combination:

Asset Turnover

Enterprise-
India > INR 2000 CR OR >INR 6000 CR
level

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 > USD 1 Bn with at >USD 3 Bn with at
Worldwide least INR 1000 CR in least INR 3000 CR in
India India

Group level India > INR 8000 CR OR > INR 24000 CR

> USD 4 Bn with at > USD 12 Bn with at

Worldwide least INR 1000 CR in least INR 3000 CR in
India India

 The achievements associated with the anti-monopoly laws

 Increased competition in the Indian market.

 Removes barriers for trade in the market.
 The formation of CCI has provided a forum for complaints and disputes
regarding the competition.
 Prohibits the formation of Anti-competitive agreements.
 Companies can no longer abuse their dominant position in the market.
 Regulating the operations, mergers, amalgamations, and acquisitions of the
enterprises, so that big companies do not form a monopoly in the market.
 Abolition of formation of cartels and inducing predatory pricing.
 One-stop solution for all the problems concerning the competition in India.
 Increased India’s ranking in the ease of doing business index.

 Need for amendments

 The Competition Act, 2002 is not aligned with the antitrust laws of other top
countries. Therefore, India should take cues from them and implement them
in the Indian market.
 All the businesses around the world are changing, earlier there was only
physical business but now with the whole internet revolution globally as well
as in India, there is a need for laws regulating the business online.
 Moreover, there should be a specific provision for regulating the use of big
data in e-commerce.

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  Provisions should regulate the use of customer’s data, where and how it is
being used.
 Amendments with regards to the holding of ‘dominant position’ in the
market, because holding a dominant position is not seen as a problem but the
abuse of the position is a problem.
 These competition regulation bodies are present in metropolitan cities and
there is no trace of their existence in rural areas. To resolve this, the
government in the Amendment of 2020 asked the National Company Law
Tribunal (NCLT) and the National Company Law Appellate
Tribunal (NCLAT) to handle competition cases as well. However, the
government should set up regulatory bodies specifically operating in the
competition cases across the countries for more effective results.

 Conclusion
The Competition Act, 2002 is a revolutionary Act because after the enactment of this
Act businesses got the right to compete in the Indian market. This legislation by the
centre promotes fair competition and regulates all the anti-competitive actions by
firms and enterprises. This Act curbs three major issues in the Indian market, anti-
competitive agreements, abuse of dominant positions, and regulation on the
combination. Though this legislation is revolutionary, there are still some
amendments that need to be enacted for the better functioning of the Act and so that
this Act is at par with international practices.

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 UNIT IV

SYLLABUS :

Factor Pricing :

i. Theory of Wages
ii. Exploitation of Labour
iii. Rent: Ricardian and Modern Theory
iv. Interest: Liquidity Preference theory
v. Risk and Uncertainty theory of Profit
vi. Land Reform

Previous Year Questions

1. Critically examine the Liquidity Preference theory of interest .(2011, 2014,2022)

Or

Explains Keyne’s Liquidity Preference Theory . (2021)

2. Explain the Ricardian Theory of Rent . (2023)

3. Rent is surplus critically examine Ricardo’s theory of rent. (2011, 2014, 2016)
Or

Explain modern theory of rent ? How it is differ from Ricardo’s theory of rent. (2017, 2018)

4. Critically examine marginal productivity theory of wages. (2015, 2016 , 2021)

5. “Rent is a reward for specificity of a factor of production.”In the light of above statement ,
explain the modern theory of Rent . (2022)

6. Explain modern theory of wages (2019)

7. Describe land reform in India. (2018,2023)

Or

The efforts towards land reforms in India have been slow . Discuss the reasons for the poor
progress of land reforms in India . (2021)

8. Discuss the motives of liquidity preference (2019)

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9. Explain the following –

a) Rent is differential surplus (2019)

b) Rent is that part of the factor’s income which is access of its transfer earning. (2019)

Short Question

1. Liquidity preference (2011)

2. Insurable and uninsurable insurance (2011)

3. Uncertainty theory of profit(2014)

4. Objective of land reform (2014)

5. Liquidity Trap (2015, 2016, 2019)

6. Scarcity Rent (2015, 2016)

7. Theory of profit (2016)

Or

Uncertainty theory of profit (2014)

8. Describe theory of wages (2018)

9. Insurable and uninsurable insurance (2011)

Other Questions :
I. India’s phenomenal growth trajectory is an outcome of myriad of reforms , one
such being goods and services tax . Discuss .(2022)
II. Discuss the shapes of total and average cost curves in the short run with the help of
Law of Varaible Proportions .(2022)

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 LECTURE 1

a. Critically examine marginal productivity theory of wages. (2015, 2016 , 2021)

b. Explain modern theory of wages (2019)

THEORY OF WAGES

 Introduction
The economic stature has been through various theories before it could become what it is
now. Theories play a very important part as they realise again and again what all has been
analysed until now and what were the reasons that a particular theory is not followed in the
present. Wages and productivity are a very basic and crucial part of Economics. They provide
the very core structure of economic policies and a framework for establishing economic
stability. There have been different theories regarding the relation between wages and
productivity and their impact on the industries. With the change in time, the theories have
evolved and have taken a form of more stabilised nature than others.

 Wages
Wages are understood as monetary payment for any service or labour. Under Indian law,
wages are defined in The Minimum Wages Act, 1948. Section 2 (4) of the Act defines wages
as ‘all remuneration which is made by monetary mode for a work done under an
employment’. This Section provides for certain exceptions as well such as wages won’t include
household supplies, travelling allowances, the contribution made to PPF etc. The wages are
determined by the demand and supply in the market for labour like other prices.

 Productivity
Productivity is defined as a mode to measure the efficiency of the products that have been
used and the output they are giving in the economy. It is the ratio of the output volume to the
input volume of the unit. It is regarded as very important in establishing economic growth
and competitiveness in the economy of the country. The utilisation of the input processes and
assuring that the output received is maximum determines the productivity of the unit.

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  Theories of Wages

 Subsistence Theory of Wages

This theory is also known as the Iron Law of Wages or the Brazen law of Wages. First,
formulated by the Physiocrats, it was later developed by a German economist Ferdinand
Lasalle. The father of Economics Adam Smith has also mentioned such theory in his book
‘An Inquiry into the nature and causes of The Wealth of Nations’, where he states that wages
which are to be paid to workers should be enough so that they can live and support their
family. David Ricardo is considered as one of the best exponents of this theory and his
contributions helped in developing this theory. Under the Theory of Exploitation, Karl
Marx also made it as a basis. The theory states that wages that are provided to a labourer
should be a payment that is just sufficient to satisfy the necessities of life. It determines that
there is a subsistence level of payment which should be followed and the wages should be
given according to the same, without exceeding such limit. It was held by its proponents that
in a case where the wages are lower than the given subsistence level, there will be a fall in
labour supply due to decline in population and it will lead to a rise in wages which will also
lead to a decline in supply. Moreover, if the wages are higher than the subsistence level, the
labour supply will increase which eventually will lead to lower wages. Thus, this theory
stressed upon the maintenance of a subsistence level so that wages remain fixed at such a
level and there is no eventual situation of higher or lower wages.

David Ricardo explains two assumptions which have been taken in this theory- first is that
the food production is subject to the Law of Diminishing Returns and second that
population increases at a faster rate.

However, this theory could not hold any stand in a practical sense. There were many
loopholes in this theory which made it nearly impossible to acknowledge for a longer period
of time. In the industrial sector of a country, there are not just one but many types of
employment and thus even the wages deem to be different for such different employments.
This theory does not consider the same and is based on uniformity of wages all over the
industry which is not practical. Criticism has also been laid down that this theory only takes
into consideration the supply of the market and ignores the demand which is crucial because
supply depends on demand in a market and even in case of wages, the demand can make a
huge difference in the supply. This theory is also criticised because it is based purely on
the Malthusian Theory of Population which does not really apply every time. An assumption
has been taken that the increase in wages will result in an increase in the population of the
country, which might not be true for many developed countries. In developed countries such
a rise in wages results in an increase in the standard of living and thus this theory does not
apply in every situation. Furthermore, it is also criticised that this theory only holds true for a
long period of time, but does not give any particulars or results in a short time or in a year.
This makes it difficult to analyse the theory especially on an industrial level, where such
calculations become very important.

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  Standard of living Theory of Wages
It came in the late 19th century and refined the Subsistence Theory of Wages. It related the
wages of the workers to the standard of living and stated that wages should be determined by
the standard of living of the workers and not by the subsistence margin. This theory seemed
to have refined the previous theory, but it holds no good, as the dependency on the standard
of living could vary from person to person and it could not be regarded as a strong grid to
measure wages. It also focussed only on the supply part and did not consider the demand in
the market. The Standard of living of a worker could change from time to time and
moreover, this theory was impractical and very indirect because the workers could not get
high wages just because they had a high standard of living. The output in productivity should
also be there to increase such wages.

 Wage Fund Theory of Wages

This theory’s biggest criticism came from the Trade Unions in the industries. The theory was
propounded by Adam Smith and popularized by John Stuart Mill . This theory stated
that Wages are depended upon the proportion between the population and the capital. A part
of the capital is kept aside for the sole purpose of wages and the determinant is the
population to calculate the wages. Population under this theory means the labourers or
working class and the theorists asserted that competition in the market is affected by these
two factors- capital and population. Under this theory, the capital which was called the wage-
fund was kept constant as it was stated that if the wage fund is used for wages given to
workers it would affect the decrease in the capital of production equipment or goods and
ultimately decrease in wages as well. Thus, wages-fund is kept constant, and so, if the wages
are to be increased it results in a decline in population and if the population is increased, then
the wages will decrease. There is an inverse relationship between the two.

The theory is given a mathematical dimension- “Wages= Wage fund/ population”.

This theory was seen as an attack and dysfunctioning of the trade union in the industries. As
trade unions do not have any control over the population in the industry, it is impossible for
them to raise wages without reducing the number of workers. Thus, it binds them under the
decision of the Industry which was a huge blow to the whole purpose of a trade union. This is
not the only issue with this theory. The wages-fund, which is supposed to remain constant, is
not defined under this theory. And thus, what constitutes the whole capital is not defined.
Further, the quality of workers has been compromised, as it takes a relation between wages
and population without realising that the quality of workers as well the quality of work can
get affected if wages are raised. It also assumed that wages can only increase if there are
profits, however, in the case of increasing returns, both wages and profits will increase. This
theory took supply and demand in its ambit but it has failed in determining the wage rate
and thus compromising the freedom and bargaining power of trade unions.

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  Surplus- Value Theory of Wages

Karl Marx propounded this theory. He deviated from the Subsistence Theory of Wages and
stated that the wages are drawn to a subsistence level not because of the population but
because of the unemployed labourers. He stated that for capitalists, the workers are a mere
instrument in gaining capital, and in case, where a labourer is working for extra productivity,
there is a surplus-value that is generated and it adds to the capital of the industry which goes
back to the owner. Marx in his theory has attacked the capitalists and he has drawn the
negative aspects of industries which derives the workers to work more than they are paid for.
It states a situation where even overtime is not paid to the workers and the extra productivity
is used by the owners of such industry to increase their capital.

 Bargaining Theory of Wages

This theory explains that wages depend upon the bargaining power of the workers. John
Davidson in his book ‘The Bargain Theory of Wages’ propounded this theory and stated
that there are various factors which influence the wages in a bargain of the workers and
producers. Under this theory, the more the worker is able to work, the more he gets paid. This
works in small industries like labour for carrying goods through lorry or other transport or
daily wage workers or workers employed for a specific period of time.

 Residual Claimant Theory of Wages

Propounded by Prof. Francis Amasa Walker, this theory states that the wages of a worker
are equal to the product minus rent, profit and interest. Thus, rent, interest and profits are
understood as not a part of wages and after subtracting such determinants from the capital
of productivity given the wages should be given to the workers. This theory came with a lot of
flaws as there was no way that the wages could be fixed after the production has started as
they are fixed before starting the production in an industry. Therefore, in such a case the
residual claimant will be the entrepreneur and not the labourer. Furthermore, subtracting
profits and rent will not change the fact that the capital of landlords and entrepreneurs are
not fixed and thus it is futile to do so. Criticism has been made that this theory ignores the
aspect of supply of workers as well as the trade unions.

 Marginal Productivity Theory of Wages

It is regarded as the most satisfactory theory among all others. Von Thunen first stated this
theory and then it was developed by John Bates Clark, Phillips Henry Wicksteed and Léon
Walrus. The theory states that the wages of a worker are dependent upon the productivity of
the worker. It states that as an employer goes on employing labour, according to the Law of
Diminishing Marginal Utility, the marginal product will fall and thus the labour is employed
up to a level where wages is equal to a marginal level. Prof. S.E. Thomas states that due to
the competition that prevails among the labour force, a wage rate is determined which is
equal to the marginal product so that the wages provided are up to mark with the employed
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workers. This theory is most practical and provides that an employer can only employ
workers up to a mark where he is able to pay the wages for productivity. Thus, productivity is
given importance. Moreover, it is in compliance with the other factors of the market like
supply and demand.

This theory is applied with an assumption that all factors such as the mobility of workers,
Perfect Competition, technology are constant. This is one of the factors which derives criticism
in this theory.it is not homogenous in nature and with the change in circumstances it might
not work at all, which makes it practically insufficient. It deals with the marginal productivity
which may be affected because of the low wages that are being given.

 Conclusion
There are other different theories as well which provide for various analyses and structure of
wages. The Marginal productivity theory has been the closest to a satisfactory theory of
wages. It has its own criticism but the feature that it directly relates to the productivity of the
worker makes it stand out. The industries have been working quite in the same mechanism in
many places, however, it is difficult to achieve the objective due to the challenges mentioned
above. But still, in a market, this theory is simpler and provides a better mechanism than the
others. There are other theories such as supply and demand theory as well which is purely
based on the supply and demand in the market and the employment and wages of the
workers according to it.

 Modern Theory of Wages

Modern theory of wages regards wages as a price of labour and all other prices
determined by the usual supply and demand analysis. According to this approach, wages
are determined by the interaction of market forces of demand and supply.

 Demand for Labour:

The demand for labour comes from the entrepreneurs as it is used for the production of
goods and services. Thus, the demand for labour depends upon the productivity of labour
i.e., the higher the productivity of labour, the greater will be the demand for it from
employers. Thus, demand for labour depends upon the marginal productivity of labour;
since the marginal productivity of labour will slope downwards after a stage, the demand
curve of labour will also slope downward.

Factors Affecting the Demand for Labour:

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1. Technological Changes:
Technological changes influence the marginal productivity of labour. Therefore, these
changes also influence the demand for labour.

2. Derived Demand:
Demand for labour is a derived demand. It means that demand for labour depends upon
the demand for goods and services which it produces. If at any given time the demand for
a particular commodity produced by the labour is high, it is natural that the demand for
labour shall also be high. Hence, the greater is the consumer demand for the product, the
higher will be the demand for the labour to produce that commodity.

3. Proportion of Labour:
The demand for labour also depends upon the proportion in which labour is mixed with
other factors of production. When a small amount of labour is engaged in the production
of a product, the demand for that type of labour is inelastic. For instance, the demand for
labour for operating automatic machines or latest machines in large scale factories is
inelastic.

4. Cost of other Factors:

The demand for labour depends upon the cost of other factors of production which can be
used as substitute for labour. If substitute factors are costly, the entrepreneur will
naturally substitute labour in place of costly factor.

In such a case the demand for labour will be high. If the prices of substitute factors which
can be used in place of labour have declined, the substitute factor will be used in place of
labour. Hence, the demand for labour will decline.

This can be shown with the help of Fig. 3:

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In Fig. 3 number of labourers has been measured on OX-axis and the wage rate on Y-axis.
DD is the industry’s demand curve. It slopes downward from left to right indicating that
when wages are low, demand for labourers increases and when the wage rate tends to
increase, demand for labour decreases.

 Supply of Labour:

Supply of labour in an economy depends upon both economic as well as non-economic

factors. Economic factors influencing the supply of labour comprises of existing
employment, desire to increase monetary income, bargaining power of the labourers, size
of population, income distribution etc. while the non-economic factors consist of family
affection, social conditions, domestic environment etc.

Psychological factors also affect the supply of labour. It is only due to the psychological
factors that a worker decides how much time he should devote to work and how much to
leisure. Moreover, the supply of labour also depends on the elasticity.

The supply of labour for a firm is perfectly elastic, so, the firm at current wages can
employ as many workers as it wishes. On the contrary the nature of supply of labour for
an industry is not infinitely elastic. Thus, it cannot employ more and more labourers at the
current wage rate. The industry can do so by attracting labourers from other industries by
offering them higher wages. Following diagram clears this point more vividly.

In Fig. 4 hours supplied has been taken on X-axis and wages on Y-axis. SS is the backward
bending supply curve. OW relates to the initial wage rate. When the wage rate is OW’, the
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hours supplied are OX1. The maximum working hours are OX at wage rate OW. Now
suppose the wage rate increases to OW”, in that case hours supplied will decrease to OX 1.
Thus, we may conclude that like other factors of production, supply curve of labour is also
upward sloping from left to right.

Factors Affecting Supply :

1. Size of Population:
The supply of labour depends upon several factors. In the first place, the supply at any
given time depends upon the number of labourers in the country. This, in itself is a result
of the size of population and that proportion of this population which is called working
population.

The size of population is determined by the difference in birth rate and the death rate.
The proportion of total population which is called working population depends upon
occupational distribution, level of technical advancement, conservation and mobility of
labour.

2. Efficiency of Labour:
The supply of labour does not merely depend upon the size of population. It also depends
upon the efficiency of labour. Efficiency depends upon several factors like hours of
working, service and working conditions, wage rates, economic incentives and other
conditions that have a bearing upon the working ability of labour.

3. Mobility of Labour:
The supply of labour also depends upon the mobility of labour. If the labour is less mobile
either because the means of transport are not developed or there is conservatism among
the labourers, or because there are climatic, language or traditional hindrances, then it
follows that supply of labour shall be highly limited.

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 LECTURE 2

a. What is exploitation of labour ? What are the upcoming labour legislation in

India ? What are the types of exploitation ?
b. Explain Karl Marx Exploitation of labour .

EXPLOITATION OF LABOUR

Forced labour and human trafficking for labour exploitation are pervasive issues in India .
Forced labour and debt bomdage are common practice across the primary , secondary and
tertiary economic sectors in India , with widely reported cases in a significant number of
industries , including brick kilns , carpet weaving , embroidery , textile and and garment
manufacturing , mining manual scavenging and agriculture . Some Bangladeshi and Nepali
migrants are also subjected to forced labour in India through recruitment fraud and debt
bondage .
Indian workers also migrate for work abroad , primarily to the Gulf , Europe and North
America . These workers often pay exorbitant recruitment fees , and are particularly vulnerable
to a wide range of exploitative labour practices , including contract substitution , withholding
of documents , non-payment of withholding of wages , and exhausting working hours and are
often subjected to varying degrees of deception and coercion . In some cases , this exploitation
amounts to human trafficking for labour exploitation , forced labour and slavery .

 Forced labour, debt bondage and social vulnerability

Bonded labour is defined in the Bonded Labour System (Abolition) Act of 1976 as a system
of forced or partly forced labour under which a debtor accepts an advance of cash or in-kind in
exchange for a pledge of his or any family member’s or other dependant’s labour or service to, or
for the benefit of, the creditor. The agreement can be oral or in writing, may be of a fixed
duration of time or not, and with or without wages paid. Debt bondage denies individuals the
right to choose their employer or to negotiate the terms of their contract. Workers are forced
work until they repay a debt that is constantly manipulated and augmented through the
imposition of interests, penalties and deductions, and they cannot work for other employers in
the interim.
Bonded labour is deeply entrenched in India’s socio-economic structure. More than a mere
economic model for the organisation of labour, debt bondage is an exploitative practice
reinforced through coercion and custom. Moreover, evidence suggests that members of
marginalised castes and tribes, religious minorities, refugees and migrant workers are
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disproportionately affected by debt bondage. The social and economic marginalisation of these
communities in India, coupled with the limited ability for people to move out of these groups,
renders members of these groups particularly vulnerable to severe labour exploitation,
including trafficking and forced labour. Despite a number of steps taken by the government in
this regard, much higher degrees of poverty and illiteracy remain among these communities
than in the general population. Additionally, members of these groups often lack viable
livelihood opportunities and access to credit and financial services, resulting in a culture of
constant indebtedness. While laws do exist to protect these communities, enforcement remains
weak.
The practice of debt bondage persists predominantly in the informal and unregulated sectors,
which are estimated to employ around 94% of the workforce in India. The absence or lack of
implementation of labour standards in these sectors creates severe power imbalances in
employer-worker relationships and exacerbates workers’ vulnerability to exploitation.
Furthermore, due to the chronic underpayment of minimum wages in low-skilled and semi-skilled
work, large portions of the labour force have to resort to debt bondage in order to meet basic
consumption needs, comply with social rituals, or deal with medical emergencies.
Under India’s federal structure, the implementation of the 1976 Act is the responsibility of state
governments. However, the National Human Rights
Commission has documented numerous instances of state authorities’ failure to effectively
implement measures to address the issue. Moreover, according to Anti-Slavery International, while
large numbers of Vigilance Committees have been set up throughout India with the purpose of
identifying and supporting bonded labourers, these are generally inactive and ineffective in
practice.

 Criminal liability

The legal Framework against bonded labour is provided in the Bonded Labour System
(Abolition) Act , 1976 and is supported by labour legislation such as the Contract Labour Act of
1970, the Inter-State Migrant Workmen Act and the Minimum Wages Act. The Act formally
abolished debt bondage and declared all customs, traditions, contract or agreement by virtue of
which a person is required to provide bonded labour void . The act also prohibits bonded labour ,
provides for individual and corporate criminal liability and prescribe a penalty of up to three
years of imprisonment and a 2000 rupees fine for the act of advancing a bonded debt ,
extracting bonded labour or compelling a person to provide bonded labour. However , despite
the prohibition, debt bondage is widespread in India partly due to the fact that the prosecution
rate for these crimes remain extremely low and in the event of conviction , imprisonment
penalties are highly hardly ever imposed.

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Section 370 of the Indian Penal Code was introduced in mid-2013. This section prohibits
trafficking for the purpose of physical and sexual exploitation, and defines exploitation to
include:
 sexual exploitation,
 slavery or practices similar to slavery,
 servitude, and
 the forced removal of organs.

Surprisingly, the provision does not make an explicit reference to forced labour and debt
bondage. However, according to research by the Freedom Fund and the Thomson Reuters
Foundation, most legal experts believe that servitude and ‘practices similar to slavery’ would
include situations of bonded and forced labour where a person does not have freedom of
employment and is made to work. Importantly, this provision does not require movement of a
person, for as soon as one person recruits or receives another for the purpose of exploitation,
trafficking is established.

Section 370 also makes direct reference to government officials’ involvement in human
trafficking, prescribing sentences of up to life imprisonment. Section 166A of the Penal Code also
holds police responsible for delays in registering a First Information Report after a victim makes
a complaint, and punishes inaction with six months’ to two years’ imprisonment. However,
according to the 2015 US Trafficking in Persons Report, the numerous incidents reported in the
Indian press, and instances of inaction by police and prosecutors indicate serious issues with
the application of the anti-trafficking legal framework by law enforcement, inconsistent
application of the law across jurisdictions, corruption, and a lack of awareness or capacity in
some parts of the country. Furthermore, victims face other obstacles to access justice, including the
inability to travel to court, social stigma and intimidation, and significant delays in trials.
Under the Child Labour Act 1986 children under the age of 14 are prohibited from working in certain
industries including domestic work, working in roadside restaurants, working in mines, factories
and in other industries. The Juvenile Justice Act 2000 also criminalises the exploitation of juvenile or
child workers, including procuring a juvenile for the purpose of hazardous employment, keeping
him or her in debt bondage, or withholding or using his or her earnings. Moreover, where a
victim of child labour is rescued, the Court may suspend or cancel the business license of the relevant
business and may order to seal the premises until back wages are paid to the victims or court fines are
paid. A conviction is not required.

 Labour protections

The labour legislation in India is complex, with over 40 central legal mechanisms segmented by
industry or type of work, including a variety of Acts regarding work in factories, plantations
and construction work. The legislation addresses issues such as maximum working hours,
minimum wage, health and safety, and working conditions.

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However, it is estimated over 90% of workers in India work in the informal economy, and are
therefore vulnerable to exploitation in an informal and unregulated environment.

In forced labour cases, labour officials who attend the rescue are meant to ensure that withheld
wages of the labourer are paid. Generally, these are calculated on the day and a claim is initiated
by the labour officials under the Minimum Wages Act.

 UPCOMING LABOUR LEGISLATION IN INDIA

The Indian Parliament combined 25 labour laws into three codes, i.e., the Social Security
Code, the Code on Industrial Relations and the Code on Occupational Safety, Health and
Working Conditions. The Code on Wages, enacted in 2019, also amalgamated four
relevant labour laws.

The Four new Labour Codes were supposed to be effective from 01 April 2021 however
considering the rise in COVID cases and the potential impact of the new Codes on per
employee costs for enterprises, the Government has delayed implementation of new Codes
to a future date. The Central and State Governments have yet to notify the rules. The
new legal provisions will be effective only, once notified.

 Types of exploitation

It is common for many victims of trafficking to have suffered multiple forms of exploitation,
often at the same time. For example, some victims of domestic servitude may also be subjected to
sexual exploitation – either from the outset or at certain physical development stages of
the child’s life. The following details various types of exploitation victims of trafficking might
suffer.

 Domestic servitude

Domestic servitude involves carrying out household chores and often caring for the children of
that household. Since the work takes place behind closed doors and the domestic worker often
lives in the home, the exploitation is usually hidden. Victims can work long hours with no rest
days and have their finances controlled by the employer. Victims have been forced to sleep on
the floor and are often denied contact with their family. One of our clients suffered from
permanent damage to her lungs because she was forbidden from seeking medical treatment for
tuberculosis. It is common for domestic workers to suffer from physical, sexual and emotional
abuse as well.

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Children make up a quarter of the reported number of victims of domestic servitude. They are
often be held in private fostering arrangements, which may or may not be with a member of
their extended family. They are usually kept away from school and health services. There are
also cases where traffickers from West Africa corrupt traditional belief systems to control their
victims, who believe they will be punished or killed by the spirits of the deceased for
disobedience. These traffickers are notoriously difficult to prosecute due to the victim’s
overwhelming fear of these spirits.

 Forced labour

Forced labour can take many forms because it involves someone working against their will
because of threats or inability to leave. There are certain industries, however, such as restaurant
work, agricultural and construction, that are more common for this type of exploitation. The
work involves long hours and hazardous conditions. Victims are often housed together in poor
and cramped living conditions. Three quarters of forced labour victims are male. Like with
domestic servitude and other forms of exploitation, physical, sexual and emotional abuse are
often present.

 Sex exploitation

Young people are particularly vulnerable to sexual exploitation, and both boys and girls are
trafficked for this reason. Sexual exploitation can be the form of exploitation, such as through
prostitution or pornography, or it can be a means of control such as with sexual servitude or
other forced sexual services. Sexual exploitation can exist in private homes, brothels, massage
parlours, or nightclubs. It often involves the receipt of ‘gifts’, which can include for example,
money, affection, or accommodation, in exchange for performing sexual activities. Sexual
activities can also be used as punishment. Violence and intimidation are often involved which
increases the young person’s vulnerability and inability to escape the situation of exploitation.
It is more common for sexual exploitation of children to take place with other forms of
exploitation (i.e. forced labour) than for it to occur in isolation.

 Enforced criminality

Exploitation of a young person can take the form of forcing them to do criminal acts, such as
pickpocketing, ATM theft, DVD selling, cannabis cultivation, and drug trafficking. Four out of
five of those exploited through cannabis cultivation are children and most are from Vietnam.
This enforced criminal activity is often led by organised gangs. Being forced to conduct criminal
activity stops victims from seeking help for fear of being arrested. Enforced criminality can also
involve other forms of exploitation and often victims are locked away in homes. Exploitation can
be due to debt bondage, which is when the employer forces the victim to pay off a debt or loan
which is often inflated and nearly impossible to escape.

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Many children are arrested and charged for cultivating drugs when found in cannabis factories
or when found to be shoplifting or pickpocketing when in fact these children may have been
trafficked. For more on this see our Criminal law section. In such circumstances, it is important
to refer the child to a criminal solicitor.

 Benefit fraud

This type of exploitation is on the increase and involves the trafficker claiming state benefits in
the victim’s name. The money is then withheld from the victim and kept by the trafficker. The
victims tend to be younger, under 12, because younger children are harder to identify and
eligible for benefits for longer. The victim might also have several false identities. There is
evidence that children exploited for housing benefits were moved between different addresses,
often in different local authorities and under the care of different adults, which raises a number
of safeguarding concerns.

 Exceptions to the “forced labour” definition

Article 2(2) of Convention No. 29 describes five situations, which constitute exceptions to the
“forced labour” definition under certain conditions (See General Survey on Forced Labour,
ILO Committee of Experts, 2007 ):

 Compulsory military service.

 Normal civic obligations.
 Prison labour (under certain conditions).
 Work in emergency, situations (such as war, calamity or threatened calamity e.g. fire,
flood, famine, earthquake).
 Minor communal services (within the community).

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 KARL MARX EXPLOITATION OF LABOUR

 Marxism Definition
Marxism is a social, economic, and political doctrine developed by German philosophers Karl
Marx and Friedrich Engels in 1848 to describe the class struggle between capitalists and
laborers. It analyzes in-depth causes and effects of capitalism and advocates for a social
revolution to replace it with communism.
A capitalist economy focuses on accumulating capital while influencing the working class,
productivity, and socioeconomic advancement. Marx criticized this system for plundering
resources and instilling a feeling of hatred among laborers against business owners. Marxist
class conflict and Marxian economics are the fundamentals of Marxism, explaining power
imbalances, class struggle, and social transformation.

 Marxism is a social, economic, and political theory that examines the causes and
effects of capitalism and promotes communism as an alternative.
 Karl Marx and Friedrich Engels, two German philosophers, proposed this theory in
1848 to explain the class conflict between capitalists (Bourgeois) and laborers
(Proletariat).
 This theory suggests that the growing struggles between the social classes will
eventually culminate in a revolution led by the proletariat, overturning the bourgeois
and seizing control of the economy.
 Marx argued that class conflicts might have considerably more societal consequences
than the theory predicts. However, due to increased competition, consumption,
demand and supply, and wages, the globe has witnessed a revolution in the industry.
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  How Does Marxism Theory Work?

Marxism theory works on the single objective of eliminating the social class order. Capitalism,
according to Marx, leads to exploitation and alienation of workers, resulting in the class
struggle. He also proposed that once capitalists lose their economic and political power, laborers
will seize the means of production.

Marx argued for creating a society in which there is no distinction between people based on
their social class or status, nor any discrimination of any kind. Instead, every citizen
collaborates to achieve a common goal and prosperity.

Marx analyzed atrocities, sufferings, and agonies of the working class. As a result, he theorized
that because capitalism favors private business owners and the wealthy section of society, it
will inevitably result in the working class becoming poorer and poorer. He, thus, proposed that
a capitalistic society consists of two class types – the Bourgeois (private business owners) and
Proletariat (laborers).

1. Bourgeoisie – These are capitalists who own the majority of wealth and control means of
production, such as facilities, equipment, materials, etc., and the proletariat. They are
economically and politically powerful enough to influence legislation and property rights and
thus exploit workers.
2. Proletariat – These are laborers who convert raw materials into marketable commodities.
However, they have no control over the means of production. They also face exploitation in the
form of fewer wages and unemployment during the recession, so they become revolutionary.

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  Marxism Theory Explained In Points

The Marxism theory is an excellent example of how economies work in which the bourgeoisie
and the proletariat will always exist. It is well-known yet disputed because Marx believed the
conflict between the two could have a far-reaching impact on society than the theory suggests.

Marx truly believed that one day the working class would bring a revolution and end
capitalism. However, it is not the case with the modern world. The following are the main
points of the theory:

 The bourgeoisie oppress the proletariat by paying them the lowest possible wages
 The proletariat rebel against the capitalist economy, which supports inequality
 It frees the working class from social and income inequality with revolution
 Demolition of social status and profit-driven thinking by introducing equality in society
 It replaces capitalism with communism

Marxism Examples

Let us look at the following Marxism examples to understand the concept better:

Example #1

Assume there are two persons, one from a business family and the other from the working class.
While it seems impossible for them to be friends as they come from different social classes, a
friendship between them would lead to conflicts.

A loss in business or of materialistic possessions may not bother the capitalist acquaintance, but
it can derail the ambitions of a working-class individual. On the other hand, it could mean a
matter of survival for the working-class friend.

The bourgeoisie friend will always look at matters through the capitalist philosophy. But the
proletariat friend will always see things differently. It is where the Marxism ideology comes
into play. Marx suggested that Marxism is not merely the relationship between the working
class and capitalists but the never-ending conflict of thoughts, actions, struggles, and successes.

Example #2

Contrary to what analysts believed that the Communist Party of China promotes a modern
capitalist society, President Xi Jinping stressed embracing the Marxism philosophy. Currently,

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when income and consumption disparities are rising across the country, Xi emphasized the
idea of adopting the theories of Marx as a “spiritual pursuit” and “way of life.” He also added
that as the largest self-declared socialist nation, China experienced tremendous growth and
success by sticking to socialism. It, thus, shows his belief that the philosophy of Marx is still
relevant to modern China.

 Marxism vs Communism vs Socialism vs Capitalism

 Marxism

This philosophy ardently supports communism and believes in a social and economic revolution
ignited through the perpetual sufferings of the working class. Due to exploitation in the
capitalist system, proletarians will overthrow capitalists and seize control of the economy and
the means of production.

 Communism

In this type of economic system, the community owns and controls the means of production,
such as factories, lands, and services. It, thus, eliminates private ownership and establishes a
society in which there is no class division but equality. Its best example is when Chinese
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Communist leader Mao Zedong took over the control of China in 1949. He formed a communist
country and named it the People’s Republic of China. It is something that the Marxism ideology
aims to achieve.

 Socialism

While it may sound similar to communism, the former differs from the latter in that all
individuals in society own the means of production. So, the idea of public or collective
ownership is the main characteristic of socialism. On the other hand, in communism, the state
owns all the properties and services communally without any single owner. A socialist economy
exists in many European countries like Denmark, Sweden, Iceland, etc. One can also find traces
of the Marxism philosophy in this type of economy.

 Capitalism

The capitalist economy is a system where private corporations dominatingly own and control
means of production. They also have the freedom to determine supply and demand to
maximize profit. It also establishes a legal framework that safeguards the freedom to own and
transfer private property.
Hong Kong, Switzerland, and Singapore are examples of a capitalist economy. These countries
passionately work toward economic dynamism by opening the door of their markets to global
business and restructuring their fiscal policies. The Marxism ideology, originating from
working-class conflicts and deteriorating relationships, stands against this arrangement.

 Criticism

The Marxism philosophy has received many criticisms for its anti-capitalist ideology. Marx
feared capitalism would fail due to intense competition and low-quality output, or the working
class would dissipate it once and for all. It would eventually result in the emergence of
monopolies, a supply-demand imbalance, job losses, and depression. But it has not happened
over the years.

On the contrary, the world has witnessed a revolution in industrialization due to increasing
competition, consumption, demand and supply, and wages. However, one cannot deny that
class antagonism has always been there and grown in intensity through time, alongside
industrialization and technological innovation.

Another criticism of the Marxism theory is that many socialists and historians believe a
proletarian revolution does not always bring social order.

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  EXTRA NOTES

What is labour exploitation?

Within the field of Human Trafficking and Modern Slavery

prevention, labour exploitation refers to situations where people are coerced to work for little or
no remuneration, often under threat of punishment. There are a number of means through
which a person can be coerced, including:

 Use of violence or intimidation

 Accumulated debt
 Retention of identity papers
 Threat of exposure to immigration authorities

All types of labour, within every industry, are susceptible to labour exploitation. It is a
worldwide problem whose scope and scale is sometimes difficult to wrap your head around.
Here are some key facts and figures from the International Labour Organization (ILO):

 There are an estimated 40.3 million people trapped in modern slavery around the world
at any given time. Of this 40.3 million, 24.9 million people are estimated to be within
situations of forced labour.
 Out of the 24.9 million people trapped in forced labour, 16 million people are exploited
within the private sector. This includes in fields such as domestic work, construction, and
agriculture.
 8 million of this 24.9 million are persons suffering forced sexual exploitation.
 Around 4 million of this 24.9 million are in situations of forced labour imposed by state
authorities.
 Women and girls are disproportionately affected by forced labour, accounting for 99% of
the victims in the commercial sex industry, and 58% in other sectors.

These figures make for pretty bleak reading, and it can often leave us feeling powerless in the
face of such widespread exploitation. But we are not powerless, we believe that through our
collective action we can shine a light on this exploitation and work to prevent it from
happening. So, what can you do about it?

What can you do to help prevent labour exploitation?

1. Educate Yourself
The first step you can take is to educate yourself about the issue, so that you can spot the signs
of labour exploitation. By spotting the signs, you can help change the course of an individual’s
future.

Someone may be being exploited for labour if they:

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  show signs of psychological or physical abuse. They appear frightened, withdrawn
or confused.
 have restricted movement on leaving or entering the premises. They are highly likely to
be accompanied.
 are forced to stay in accommodation provided by the employer, which can be
overcrowded. In some cases those exploited sleep at the site of their exploitation (car
washes/factories).
 claim to not know personal details.
 do not have control or access to their passport or other legal documents.
 lack the necessary protective equipment or suitable clothing.
 they are grouped together with workers of a similar nationality/age/gender and appear to
have a representative by whom they are ‘coached.’

Remember: Spotting one of these signs may not mean that someone is being exploited
or trafficked but seeing one should be a reason to be suspicious. The more signs you see, the
more likely that this person is being controlled, exploited, and trafficked. Be sure to visit
our #SpotTheSigns resources for industry specific indicators in multiple languages.

2. Report anything you deem suspicious

If you suspect that someone is being coerced or exploited, or you are yourself a victim of human
trafficking, call your nearest local authorities or support organisation.

You can anonymously report your suspicions to Crimestoppers. Equally, if you do not think
there is immediate danger but have seen something that doesn’t look right you can report
anonymously and confidentially via The STOP APP – which can also help us build a picture of
what exploitation looks like globally.

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 LECTURE 3

a. Explain the Ricardian Theory of Rent . (2023)

b. Rent is surplus critically examine Ricardo’s theory of rent. (2011, 2014, 2016)
Or
c. Explain modern theory of rent ? How it is differ from Ricardo’s theory of rent.
(2017, 2018)
d. “Rent is a reward for specificity of a factor of production.”In the light of above
statement , explain the modern theory of Rent . (2022)
e. Explain the following –
a. Rent is differential surplus (2019)
b. Rent is that part of the factor’s income which is access of its transfer earning.
(2019)

Rent : Ricardian and Modern Theories

Rent :
In simple words, ‘ rent’ is used as a part of the produce which is paid to the owner of land for the use
of his goods and services.

But, in economics, rent has been differently defined from time to time.

Thus rent refers only to make payments for factors of production which are in imperfectly elastic
supply. For instance, it is the price paid for the use of land.

Definition of Rent:

The concept of rent has been defined as follows:

“Rent is that portion of the produce of earth which is paid to landlord for the use of original and
indestructible powers of the soil.” -Ricardo

“Rent is the income derived from the ownership of land and other free gifts of Nature.” He further
called it ‘Quasi Rent’ which arises on the manmade equipment’s and machines in the short period
and tend to disappear in the long run. – Marshall
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“Rent is the price paid for the use of land.” –Prof. Carver

Economic rent is also termed as surplus as it is received by landlord without any effort. Prof.
Bounding termed it as “Economic Surplus.” Moreover, modern economists comprising of Mrs. Joan
Robinson, Boulding etc. opined that part of the income of each factor can be rent.

Income alone received by land cannot be rent. It is so because different factors have different uses.
As such, each factor will be used for that purpose in which its income is maximum. Opportunity cost
of a factor for its use in the work yielding maximum income is the price of output that the factor
concerned can earn by working in next alternative use.

Definition of Economic Rent:

The definitions of economic rent can be grouped into two parts as:

 Classical Definitions:
“Economic rent is the payment for the use of scarce natural resources”. – Jacob Oser

“Economic rent is that portion of a landlord’s income which is attributable to his ownership of
land.” – Anatol Murad

 Modern Definitions:
“Economic Rent may be defined as any payment to a factor of production which is in excess of the
minimum amount necessary to keep the factor in its present occupation.” – Boulding

“Rent is the difference between actual payment to a factor and its supply price or transfer earnings.”
– Hibdon

 Types of Rent:

The main types of rent are as under:

1. Economic Rent:
Economic rent refers to the payment made for the use of land alone. But in economics the term rent
is used in the sense of economic rent. In the words of Ricardo and other classical economists,
economic rent refers to the payment for the use of land alone It is also called Economic Surplus
because it emerges without any effort on the part of landlord. Prof. Boulding termed it “Economic
Surplus”.

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2. Gross Rent:
Gross rent is the rent which is paid for the services of land and the capital invested on it.

Gross rent consists of:

(1) Economic rent. It refers to payment made for the use of land.

(2) Interest on capital invested for improvement of land.

(3) Reward for risk taken by landlord in investing his capital.

3. Scarcity Rent:
Scarcity rent refers to the price paid for the use of the homogeneous land when its supply is limited
in relation to demand. If all land is homogeneous but demand for land exceeds its supply, the entire
land will earn economic rent by virtue of its scarcity. In this way, rent will arise when supply of
land is inelastic. Prof. Ricardo opined that land was beneficial but it was also scarce. Productivity of
land was indicative of the generosity of nature but its total supply remaining more or less fixed
symbolized niggardliness of nature.

4. Differential Rent:
Differential rent refers to the rent which arises due to the differences in the fertility of land. In every
country, there exists a variety of land. Some lands are more fertile and some are less fertile. When
the farmer’s are compelled to cultivate less fertile land the owners of more fertile land get relatively
more production. This surplus which arises due to difference in fertility of land is called the
differential rent. This type of rent arises under extensive cultivation. According to Ricardo, “In order
to increase production on same type of land, more units of labour and capital are employed.”

5. Contract Rent:
Contract rent refers to that rent which is agreed upon between the landowner and the user of the
land. On the basis of some contract, which may be verbal or written, contract rent may be more or
less than the economic rent.

Ricardian Theory of Rent :

David Ricardo, a classical economist developed a theory in 1817 to explain the origin and
nature of economic rent. Rent is the payment made to landlord for the use of land. Ricardo
was of the view that rent is paid for the fertility of land.

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According to David Ricardo, rent is portion of produce of earth paid to the landlord for the
use of original and indestructible power of soil. It means the rent is paid by the user to the
owner of land. It is paid for the use of fertility of soil. Fertility of soil is naturally determined
and not changeable. Rent is directly proportional to fertility of soil. However, the least
fertile land used for cultivation has no rent. The land is called marginal land.

 Assumptions
 Rent arises only from land
 Land is used for agricultural (maize) production
 Agricultural production starts from the most fertile land and expands to the least
fertile land
 Supply of land is limited and fixed by nature. It can’t be created and destroyed
 Fertility differs from place to place and rent is directly related to fertility

According to David Ricardo, the people firstly choose most fertile land for cultivation. If
such type of land is already occupied they expand production to the less fertile land. Rent
arises only due to scarcity of land. It can be explained with the help of table and figure as
following

Type of land Harvesting (per acre) Rent (per acre)

A 100 tons 100-40=60 tons
B 80 tons 80-40=40 tons
C 60 tons 60-40=20 tons
D 40 tons 40-40=0 tons

Let there be an island inhabited with 4 types of land A,B,C and D. the harvesting per acre
from the types of land are 100, 80, 60 and 40 tons respectively, if 1st group of people go to
the island, they choose type a land. Since the land isn’t occupied by other people they obtain
it free of cost. If 2nd group of people go to the land and find type A land already occupied
they either choose type B land free of cost of hire the Type A land paying 20 tons per acre
rent. If 3rd group of people go to the land and find type A land and type B already occupied
they either choose type C land free of cost of hire the Type B land paying 20 tons per acre
rent or type A land paying 40 tons per acre rent. If 4th group of people go to the land and
find type A land and type B and type C land already occupied they either choose type D land
free of cost of hire the Type C land paying 20 tons per acre rent or type B land paying 40
tons per acre rent or type A land paying 60 tons per acre rent. In this way, rent goes on
increasing with the expansion of agricultural production from most fertile land top least

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 fertile land.

Highest Rent = On Grade I land i.e. Most superior piece of land

Marginal land = Grade V land where Amount spend and Value of Output is Equal i.e. ZERO
RENT

The important point to be noted about the classical (Ricardian) theory of rent is that rent
does not form a part of the cost of production. As seen above, rent on land is the earnings
over and above the cost of production. As rent does not enter into cost of production, it
therefore does not determine price.

Price of corn (or produce of the land) must be equal to the minimum average cost of
production of the marginal land, but the marginal land earns no rent. It is thus clear that in
Ricardian Theory, rent is not price determining. In fact, in this theory rent is price
determined, that is, it is price of corn which determines rent, and not other way around. To
quote Ricardo, “Corn is not high because a rent is paid, but a rent is paid because corn is
high.”

 Criticisms

1. There is no original and indestructible power of land.

2. Fertility changes from time to time. Fertility can be increased by using fertilizers and
irrigation too.
3. Cultivation is not always started from most fertile land. Land is chosen with respect to
location, physical facilities and so on.
4. Rent is determined by supply and demand of land too not only by fertility.

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 5. Rent arises from all factors of production.
6. Land is used for trade, manufacture, recreation, animal husbandry too.
7. Supply of land is not limited from the standpoint of the farmer.
8. There must exist production cost if land is considered from the stand point of an
individual farmer instead of from the stand point of the society.
9. The assumption that land has no alternative use other than production of corn is
unrealistic.
10. Ricardian order of cultivation( first grade land, then second grade land and so on)
may not be feasible in all cases.
11. Ricardian concept of marginal land is not seen in real world.
12. This theory is applicable only in the case of land but according to modern economists
there is rent component in all factor incomes if the supply is limited.
13. According to Ricardo rent is not included in the price of corn. But it is not always true.

Modern Theory of Rent :

Modern theory of rent is an amplified and modified version of Ricardian theory of Rent. It
was first of all discussed by J.S. Mill and after that developed by economists like Jevons ,
Pareto , Marshall , Joan Robinson etc.

According to modern theory, economic rent is a surplus which is not peculiar to land alone.
It can be a part of income of labour, capital, entrepreneur.

According to modern version rent is a surplus which arises due to difference between actual
earning and transfer earning.

That is:
Rent = Actual Earning-Transfer Earning.

 What is Transfer Earning?

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In this universe, each factor of production has varied uses. When we transfer one factor
from one use to another, we have to sacrifice the income earned by it from its earlier use.
Sacrifice of earning is called transfer earning.

Basically, the concept of transfer earning in economics is introduced by Prof. Benham.

According to him, “The amount of money which any particular unit could earn in its best
paid alternative use is sometimes called its transfer earnings.” A similar idea was developed
by Pigou. Different economists consider transfer earnings as that amount of money which
any particular unit could cam in its best paid alternative use.

Thus, what a person, piece of land or capital can earn in the next best alternative use is
known as transfer earnings. Thus, according to Mrs. Robinson, “The price which is
necessary to retain a given unit of three factors in a certain industry may be called its
transfer earning.”

Suppose a piece of land can cam Rs. 100/- when it is used for producing wheat and the same
amount if it is used for cotton. There is no extra earning because there are no transfer
earnings. If, however, the same piece of land could cam Rs. 60 when put to the use of cotton.

Its transfer earning would be Rs. 40 and the extra gain of Rs. 40 which is surplus could be
called Rent. So, according to this theory, we can define rent as a payment of excess of the
transfer earnings. In the words of Benham, “In general the excess of what any unit gets over
its transfer earnings is of the nature of rent.” In the above example, true rent is Rs. 10 and
transfer earning Rs. 40.

 Modern Definitions of Rent:

“Rent is a payment in excess of transfer earning.” Stonier and Hague

“The essence of the conception of rent is the conception of a surplus earned by a particular
part of a factor of production over and above the minimum sum necessary to induce it to do
its work”. Mrs. Joan Robinson

 Features of Modern Theory of Rent:

The major features of the modern theory of rent are as under:

1. Rent can be a part of the income of all factors of production.

2. Amount of rent depends upon the difference between actual earning and transfer earning.
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3. Rent arises when supply of the factor is either perfectly inelastic or less elastic.

Why Rent Arises:

According to modern theory, rent arises due to scarcity of land. Supply of other factors like
labour, capital etc. can also be scare in relation to demand. Therefore, income earned by
these factors in excess of their minimum income is called economic rent.

Prof. Wieser divided factors of production into two parts viz.; specific factors and non-
specific factors.

Specific Factors:
These factors refer to those factors which have only one use. For example, a farm used for
growing wheat alone. Such factors have no mobility.

Non-Specific Factors:
These factors are those which have mobility and can be put to different uses. It is only due to
the reason that specific factors cannot be put to another use. Specificity of factors is the main
cause of the emergence of rent. It is so because specific factors cannot be put to any other
use. So, its opportunity cost is zero. In other words, its transfer earning is zero. So its entire
actual earning in the existing use is rent.

 Determination of Rent:

Modern economists studied the determination of rent in two forms as:

1. Rent of Land

2. General concept of Rent.

Determination of Rent of Land or Scarcity Theory of Rent:

Modern economists opined that rent arises due to scarcity of land. Scarcity of land means
that demand for land exceeds its supply. Rent will be determined at a point where demand
for land is equal to its supply.

Demand for Land:

Land has derived demand. It means that demand for land depends on the demand for
agricultural products. If demand for food grains increases, demands for land will also
increase and vice-versa. Moreover, demand for land is influenced by its marginal
productivity. It means as more and more land is used its MP1 goes on diminishing.
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Supply of Land:
Supply of land is fixed. Its supply is perfectly inelastic. It means, increase in the price of land
will not evoke any increase in its supply.

In Fig. 5 units of land have been measured on X-axis and rent on Y-axis. SS is the supply
curve of land which is parallel to Y-axis indicating that the supply of land remains fixed.
Rent will be determined at a point where the demand and supply of land are equal to each
other.

Initially DD is the demand curve which intersects the supply curve at point E. At this point,
equilibrium rent OR is determined. Now, if the population rises which gives boost to the
demand for food, the demand curve shifts to D’D’ and the equilibrium will be at point E’ and
the rent will rise to the extent of OR’.

Similarly, if the demand curve shifts to D” D” and labour /capital the new equilibrium point
will be E” and the rent will fall to OR”.

Rent as the Difference between Actual Earnings and Transfer Earnings:

According to modern economists rent is the difference between actual earning and transfer
earning. Rent can be a part of income of factors of production. But, these factors will earn
rent only when their supply is less than perfectly elastic.

Thus, from elasticity point of view, there are three possibilities, i.e.:
1. Supply of factors of production is perfectly elastic.

2. Supply of factors of production is perfectly inelastic.

3. Supply of factors of production is less than perfectly elastic.

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(i) When Supply is Perfectly Elastic:
When change in demand at existing rate is followed by corresponding change in supply,
then the supply is said to be perfectly elastic i.e. such a factor is not scarce. At the existing
rate, any amount of that factor is available. Therefore, its actual earning and transfer
earning will be equal.

Actual Earning = Transfer Earning Rent

= Actual Earning – Transfer Earning = Zero

X axis – factors of production

In Fig 6 the supply curve of the factor of production is represented by SS which is horizontal
straight line. It means all factors are available at price OS. DD is the demand curve.

The demand and supply curves intersect each other at point E. ON is the quantity of the
factor used and price is OS. The total earnings are OSEN.

Since, transfer earnings are equal to actual earnings i.e. OSEN, there is no surplus and,
thus, no rent. If this firm does not pay the price, the factor units will be shifted to other uses
and earn there as much, because present earnings equates the transfer earnings. In this
way, we may conclude that if the supply is perfectly elastic, then there exists no surplus and
hence no economic rent.

(ii) When the Supply is Inelastic:

Inelastic supply of a factor indicates that any increase or decrease in demand is not followed
by the supply. In such a case, transfer earnings will be zero and the difference between
actual earning and transfer earning will be equal to actual earning. Therefore, all the actual
earnings will be called rent.

Rent = Actual Earning (Since Transfer Earning is zero)

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In Figure 7, SS is perfectly inelastic supply curve of land which indicates that if price of land
falls to zero even then supply remains OS. It means the transfer earnings of land are zero.

DD is the demand curve. As both the demand and supply curves intersect each other at point
E, price OP is determined. Since transfer earnings are zero, the total earnings (OSEP)
represent the economic rent.

(iii) When the Supply is Less than Perfectly Elastic:

Less than perfectly elastic supply means that the transfer earnings of all the factor units are
not equal. Mrs. Joan Robinson used the concept of ‘Transfer Earnings’ to explain the amount
of rent earned by a factor unit in a particular use. She defines transfer earnings as the price
which is necessary to retain a given unit of a factor in a certain industry.

This can be shown with the help of the following table 2:

The above table shows that when demand for labourer is 20, their transfer earning and
actual earnings are equal. Therefore, Rs. 20 is the minimum wage rate below which there
will be no supply of labour. Now, if demand for labourer increases to 35 but supply does not
increase to the same ratio, wage rate will rise. As a result actual earning of labourer will
rise to 25 while transfer earning will be Rs. 20 per labourer. Similarly, if the demand for
labourer increases to 40 but supply does not rise, wage rate of labourer will further rise.
Actual earning will go upto Rs. 30 per labourer. Thus, every labourer will earn rent equal to
Rs. 10.

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In Fig. 8 labour has been measured on X-axis and price on Y-axis. SS is the somewhat elastic
but not perfectly elastic supply curve indicating that what quantity of the factor will be
available at various prices. The transfer earning of X1 unit of factor is AK1 while the
price is OK.
Thus the surplus or rent is AL. In the same fashion, the other unit earns surplus or rent.
The transfer earnings of each factor units are less than the price. All units except the last unit
Kg are earning profits which are more than their transfer earnings i.e. they are earning
economic rent. The total earnings are OK6E’ K and the transfer earnings are OK6E’S.
If we take away the transfer earnings, we get KE’S as surplus or rent.

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 LECTURE 4

a. Describe land reform in India. (2018,2023)

Land Reforms
 Pre Independence

 Under the British Raj, the farmers did not have the ownership of the lands they
cultivated, the landlordship of the land lied with the Zamindars, Jagirdars etc.
 Several important issues confronted the government and stood as a challenge in
front of independent India.

 Land was concentrated in the hands of a few and there was a proliferation of
intermediaries who had no vested interest in self-cultivation.

 Leasing out land was a common practice.

 The tenancy contracts were expropriative in nature and tenant exploitation
was almost everywhere.
 Land records were in extremely bad shape giving rise to a mass of litigation.
 One problem of agriculture was that the land was fragmented into very small
parts l for commercial farming.

 It resulted in inefficient use of soil, capital, and labour in the form of

boundary lands and boundary disputes.

 Post Independence
 A committee, under the Chairmanship of J. C. Kumarappan was appointed to
look into the problem of land. The Kumarappa Committee's report recommended
comprehensive agrarian reform measures.
 The Land Reforms of the independent India had four components:

1. The Abolition of the Intermediaries

2. Tenancy Reforms
3. Fixing Ceilings on Landholdings
4. Consolidation of Landholdings.
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 These were taken in phases because of the need to establish a political will for
their wider acceptance of these reforms.

 Abolition of the Intermediaries

 Abolition of the zamindari system:

The first important legislation was the abolition of the zamindari system, which
removed the layer of intermediaries who stood between the cultivators and the state.
 The reform was relatively the most effective than the other reforms, for in most
areas it succeeded in taking away the superior rights of the zamindars over the
land and weakening their economic and political power.

o The reform was made to strengthen the actual landholders, the cultivators.

 Advantages:
The abolition of intermediaries made almost 2 crore tenants the owners of the
land they cultivated.

o The abolition of intermediaries has led to the end of a parasite class. More
lands have been brought to government possession for distribution to
landless farmers.
o A considerable area of cultivable waste land and private forests belonging to
the intermediaries has been vested in the State.
o The legal abolition brought the cultivators in direct contact with the
government.

 Disadvantages:
However, zamindari abolition did not wipe out landlordism or the tenancy or
sharecropping systems, which continued in many areas. It only removed the top
layer of landlords in the multi-layered agrarian structure.

o It has led to large-scale eviction. Large-scale eviction, in turn, has given rise
to several problems – social, economic, administrative and legal.

 Issues:
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 While the states of J&K and West Bengal legalised the abolition, in other states,
intermediaries were allowed to retain possession of lands under their personal
cultivation without limit being set.

o Besides, in some states, the law applied only to tenant interests like sairati
mahals etc. and not to agricultural holdings.

 Therefore, many large intermediaries continued to exist even after the

formal abolition of zamindari.
o It led to large-scale eviction which in turn gave rise to several socio-economic
and administrative problems.

 Tenancy Reforms

 After passing the Zamindari Abolition Acts, the next major problem was of
tenancy regulation.

o The rent paid by the tenants during the pre-independence period was
exorbitant; between 35% and 75% of gross produce throughout India.
 Tenancy reforms introduced to regulate rent, provide security of
tenure and confer ownership to tenants.

o With the enactment of legislation (early 1950s) for regulating the rent
payable by the cultivators, fair rent was fixed at 20% to 25% of the gross
produce level in all the states except Punjab, Haryana, Jammu and Kashmir,
Tamil Nadu, and some parts of Andhra Pradesh.
 The reform attempted either to outlaw tenancy altogether or to regulate rents to
give some security to the tenants.
 In West Bengal and Kerala, there was a radical restructuring of the agrarian
structure that gave land rights to the tenants.

 Issues :
In most of the states, these laws were never implemented very effectively. Despite
repeated emphasis in the plan documents, some states could not pass legislation
to confer rights of ownership to tenants.

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 o Few states in India have completely abolished tenancy while others states
have given clearly spelt out rights to recognized tenants and sharecroppers.
o Although the reforms reduced the areas under tenancy, they led to only a
small percentage of tenants acquiring ownership rights.

 Ceilings on Landholdings
 The third major category of land reform laws were the Land Ceiling Acts. In
simpler terms, the ceilings on landholdings referred to legally stipulating the
maximum size beyond which no individual farmer or farm household
could hold any land. The imposition of such a ceiling was to deter the
concentration of land in the hands of a few.
 In 1942 the Kumarappan Committee recommended the maximum size of
lands a landlord can retain. It was three times the economic holding i.e. sufficient
livelihood for a family.
 By 1961-62, all the state governments had passed the land ceiling acts. But the
ceiling limits varied from state to state. To bring uniformity across states, a new
land ceiling policy was evolved in 1971.

o In 1972, national guidelines were issued with ceiling limits varying from
region to region, depending on the kind of land, its productivity, and other
such factors.
o It was 10-18 acres for best land, 18-27 acres for second class land and for the
rest with 27-54 acres of land with a slightly higher limit in the hill and desert
areas.
 With the help of these reforms, the state was supposed to identify and take
possession of surplus land (above the ceiling limit) held by each household, and
redistribute it to landless families and households in other specified categories,
such as SCs and STs.

 Issues:
In most of the states these acts proved to be toothless. There were many loopholes
and other strategies through which most landowners were able to escape from
having their surplus land taken over by the state.

o While some very large estates were broken up, in most cases landowners
managed to divide the land among relatives and others, including servants,
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 in so-called ‘benami transfers’ – which allowed them to keep control over
the land.
o In some places, some rich farmers actually divorced their wives (but
continued to live with them) in order to avoid the provisions of the Land
Ceiling Act, which allowed a separate share for unmarried women but not for
wives.

 Consolidation of Landholdings

 Consolidation referred to reorganization/redistribution of fragmented lands

into one plot.

o The growing population and less work opportunities in non- agricultural

sectors, increased pressure on the land, leading to an increasing trend of
fragmentation of the landholdings.
o This fragmentation of land made the irrigation management tasks and
personal supervision of the land plots very difficult.
 This led to the introduction of landholdings consolidation.

o Under this act, If a farmer had a few plots of land in the village, those lands
were consolidated into one bigger piece of land which was done by either
purchasing or exchanging the land.
 Almost all states except Tamil Nadu, Kerala, Manipur, Nagaland, Tripura and
parts of Andhra Pradesh enacted laws for consolidation of Holdings.
 In Punjab and Haryana, there was compulsory consolidation of the lands,
whereas in other states law provided for consolidation on voluntary basis; if the
majority of the landowners agreed.

 Advantages:
It prevented the endless subdivision and fragmentation of land Holdings.

o It saved the time and labour of the farmers spent in irrigating and cultivating
lands at different places.
o The reform also brought down the cost of cultivation and reduced litigation
among farmers as well.

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 Result:
 Due to lack of adequate political and administrative support the progress made
in terms of consolidation of holding was not very satisfactory except in Punjab,
Haryana and western Uttar Pradesh where the task of consolidation was
accomplished.

o However, in these states there was a need for re-consolidation due to

subsequent fragmentation of land under the population pressure.
 Need of re-consolidation:
The average holding size in 1970-71 was 2.28 hectares (Ha), which has come down
to 1.08 Ha in 2015-16.
 While Nagaland has the largest average farm size, Punjab and Haryana rank
second and third in the list respectively.

o The holdings are much smaller in densely populated states like Bihar, West
Bengal and Kerala.
 The multiple subdivisions across generations have reduced even the sub divisions
to a very small size.

The Bhoodan and Gramdan Movements

 Vinoba Bhave, a disciple of Mahatma Gandhi, noticed the problems faced by

the landless harijans in Pochampalli, Telangana.
 He led the movements in an attempt to bring about a “non-violent revolution” in
India’s land reforms programme.

o The movements were about urging the landed classes to voluntarily surrender a part
of their land to the landless giving it the name- Bhoodan Movement.

 It began in 1951.
 In response to the appeal by Vinoba Bhave, some land owning class agreed to voluntary
donation of their some part of land.

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 The Central and State governments had provided the necessary assistance to Vinoba
Bhave.
 Later, the Bhoodan gave way to the Gramdan movement which began in 1952.

o The objective of the Gramdan movement was to persuade landowners and leaseholders
in each village to renounce their land rights and all the lands would become the
property of a village association for an egalitarian redistribution and joint
cultivation.
 Under this movement, a village was declared as Gramdan when at least 75% of
its residents with 51% of the land signified their approval in writing for
Gramdan.
o The first village to come under Gramdan was Magroth, Haripur, Uttar Pradesh.

Successes of the Movement:

 The movement was the first post independence movement that sought to bring social
transformation through a movement and not through government legislation.
 It created a moral ambience that put pressure on the big landlords.
 It also stimulated the political activity among the peasants and landless, providing a fertile
ground for political propaganda to organise peasants.

Drawbacks:

 The land donated was mostly those which were unfertile or under litigation as a result
although large areas of land was collected but little was distributed among the landless.
 Gramdan movement was started in villages where class differentiation had not emerged,
there was little difference in landholdings ownership, mainly in tribal areas.

o But it was not successful in areas where there was disparity in landholdings.
 Further, the movement failed to realize its revolutionary potential.

Result:

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 The movements received widespread political patronage.

o The movements reached their peak around 1969.

o Several state governments passed laws aimed at Gramdan and Bhoodan.
 But after 1969 Gramdan and Bhoodan lost its importance due to the shift from being a
purely voluntary movement to a government supported programme.

o In 1967, after the withdrawal of Vinoba Bhave from the movement, it lost its mass
base.

 Way Forward
 It has now been argued by the NITI Aayog and some sections of industry that
land leasing should be adopted on a large scale to enable landholders with
unviable holdings to lease out land for investment, thereby enabling greater
income and employment generation in rural areas.
 This cause would be facilitated by the consolidation of landholdings.
 Modern land reforms measures such as land record digitisation must be
accomplished at the earliest.

 Conclusion
 The pace of implementation of land reform measures has been slow. The objective
of social justice has, however, been achieved to a considerable degree.
 Land reform has a great role in the rural agrarian economy that is dominated by
land and agriculture. New and innovative land reform measures should be
adopted with new vigour to eradicate rural poverty.

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 LECTURE 5

a. Discuss the motives of liquidity preference (2019)

b. Critically examine the Liquidity Preference theory of interest .(2011, 2014,2022)
Or
c. Explains Keyne’s Liquidity Preference Theory . (2021)

Keynes’ Liquidity Preference Theory of Interest

or

The Monetary Theory of Interest

Keynes propounded the Liquidity Preference Theory of Interest in his famous book, “The
General Theory of Employment, Interest and Money” in 1936 .

According to Keynes, interest is purely a monetary phenomenon because the rate of interest
is calculated in terms of money. To him, “interest is the reward for parting with liquidity for
a specified period of time”.

 Meaning of Liquidity Preference

Liquidity preference means the preference of the people to hold wealth in the form of liquid
cash rather than in other non-liquid assets like bonds, securities, bills of exchange, land,
building, gold etc.
“Liquidity Preference is the preference to have an amount of cash rather than of
claims against others”.
-Meyer

John Maynard Keynes' liquidity preference theory concentrates on the demand and supply
for money as the interest rate determinants. According to his proposition that interest rate is
the price paid for borrowed money, people will rather keep cash with themselves than invest
cash in assets. Hence, people have a preference for liquid cash. People also intend to save a
percentage of their income. The amount that will be held in the form of cash and the amount
that will be spent depends on liquidity preference. People will prefer to hold cash since it is
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the most liquid asset and the reward for parting with liquidity is interest, whose rate
according to Keynes' is determined by the economic demand and supply of money.

Here are some important things to know about liquidity preference :

 The Liquidity preference theory which was developed by John Maynard Keynes states
that the interest rate is the price for money.
 This shows the relationship between the interest rate and the quantity of money the
public wishes to hold.
 According to Keynes, the demand for liquidity is determined by three motives which
are, transactional motives, precautionary motives and speculative motives.
 The theory suggests that cash is the most accepted liquid asset and more liquid
investments are easily cashed in for their full value.
 It proposes that people will rather keep cash with themselves than invest cash in
assets.
 When higher interest rates are offered, investors give up liquidity in exchange for
higher rates.

 Demand for money:

Liquidity preference means the desire of the public to hold cash. According to Keynes, there
are three motives behind the desire of the public to hold liquid cash: (1) the transaction
motive, (2) the precautionary motive, and (3) the speculative motive.

Motives of Demand for Money

According to Keynes, there are three motives for liquidity preference. They are:

Motives

Transactionary Precautionary Speculative

Motive Motive Motive

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1. The Transaction Motive
The transactions motive relates to the demand for money or the need of cash for the current
transactions of individual and business exchanges. Individuals hold cash in order to bridge
the gap between the receipt of income and its expenditure. This is called the income motive.
The businessmen also need to hold ready cash in order to meet their current needs like
payments for raw materials, transport, wages etc. This is called the business motive.

2. The Precautionary Motive

Precautionary motive for holding money refers to the desire to hold cash balances for
unforeseen contingencies. Individuals hold some cash to provide for illness, accidents,
unemployment and other unforeseen contingencies. Similarly, businessmen keep cash in
reserve to tide over unfavourable conditions or to gain from unexpected deals.
Keynes holds that the transaction and precautionary motives are relatively interest
inelastic, but are highly income elastic. The amount of money held under these two motives
(M1) is a function (L1) of the level of income (Y) and is expressed as M1 = L1 (Y)

3. The Speculative Motive

The speculative motive relates to the desire to hold one’s resources in liquid form to take
advantage of future changes in the rate of interest or bond prices. Bond prices and the rate
of interest are inversely related to each other. If bond prices are expected to rise, i.e., the rate
of interest is expected to fall, people will buy bonds to sell when the price later actually rises.
If, however, bond prices are expected to fall, i.e., the rate of interest is expected to rise,
people will sell bonds to avoid losses.
According to Keynes, the higher the rate of interest, the lower the speculative demand for
money, and lower the rate of interest, the higher the speculative demand for money.
Algebraically, Keynes expressed the speculative demand for money as
M2 = L2 (r)
Where, L2 is the speculative demand for money, and
r is the rate of interest.
Geometrically, it is a smooth curve which slopes downward from left to right.
Now, if the total liquid money is denoted by M, the transactions plus precautionary motives
by M1 and the speculative motive by M2, then
M = M1 + M2. Since M1 = L1 (Y) and M2 = L2 (r), the total liquidity preference function is
expressed as M = L (Y, r).

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  Supply of Money:
The supply of money refers to the total quantity of money in the country. Though the supply
of money is a function of the rate of interest to a certain degree, yet it is considered to be
fixed by the monetary authorities. Hence the supply curve of money is taken as perfectly
inelastic represented by a vertical straight line.

Determination of the Rate of Interest:

Like the price of any product, the rate of interest is determined at the level where the demand for
money equals the supply of money. In the following figure, the vertical line QM represents the
supply of money and L the total demand for money curve. Both the curve intersect at E2 where the
equilibrium rate of interest OR is established.

If there is any deviation from this equilibrium position an adjustment will take place
through the rate of interest, and equilibrium E2 will be re-established.
At the point E1 the supply of money OM is greater than the demand for money OM1.
Consequently, the rate of interest will start declining from OR1 till the equilibrium rate of
interest OR is reached. Similarly at OR2 level of interest rate, the demand for money OM2 is
greater than the supply of money OM. As a result, the rate of interest OR2 will start rising till
it reaches the equilibrium rate OR.
It may be noted that, if the supply of money is increased by the monetary authorities, but the
liquidity preference curve L remains the same, the rate of interest will fall. If the demand for
money increases and the liquidity preference curve sifts upward, given the supply of money,
the rate of interest will rise.

Equilibrium between Demand and Supply of Money

The equilibrium between liquidity preference and demand for money determine the rate of interest.
In short -run, the supply of money is assumed to be constant ( Rs. 200).

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LP is the liquidity preference Curve (demand curve). M2 M2 shows the supply curve of money to
satisfy speculative motive. Both curves intersect at the point E, which is the equilibrium point.
Hence, the rate of interest is 2.5. If liquidity preference increases from LP to L1P1 the supply of
money remains constant, the rate of interest would increase from OI to OI1. Numerical examples
given above can also be used for better understanding. Total demand for money=Mt+Mp+Ms
=0.125Y+0.125Y+(450- 100i).

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 Total supply of money= Rs. 200. Mt and Mp are influenced by Y. Hence for the sake of easy
understanding, Ms alone can be considered Demand for money=supply of money at equilibrium
point:450-100i=200;450 - 200=100i;250=100i; i=250/100=2.5.This is equilibrium interest In
reality, interest rate is also influenced by national income and commodity sector
equilibrium.However, they are not included here for making the understanding easier.

Suppose LP remains constant. If the supply of money is OM 2, the interest is OI2 and if the supply of
money is reduced from OM2 to OM3, the interest would increase from OI2 to OI3. If the supply of
money is increased from OM2 to OM4, the interest would decrease from OI2 to OI4.

 Criticisms

Keynes theory of interest has been criticized on the following grounds:

1. It has been pointed out that the rate of interest is not purely a monetary phenomenon.
Real forces like productivity of capital and thriftiness or saving by the people also play an
important role in the determination of the rate of interest.
2. Liquidity preference is not the only factor governing the rate of interest. There are several
other factors which influence the rate of interest by affecting the demand for and supply of
investible funds.
3. The liquidity preference theory does not explain the existence of different rates of interest
prevailing in the market at the same time.
4. Keynes ignores saving or waiting as a means or source of investible fund. To part with
liquidity without there being any saving is meaningless.
5. The Keynesian theory only explains interest in the short-run. It gives no clue to the rates
of interest in the long run.
6. Keynes theory of interest, like the classical and loanable funds theories, is indeterminate.
We cannot know how much money will be available for the speculative demand for money
unless we know how much the transaction demand for money is.

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 LECTURE 6

a. Explain theories of profit .

Theories of Profit

 Definition:

Profit is the financial benefit realized from the business activity when the revenues
generated exceeds the costs and expenses incurred in the operation of such activities.
Simply, the total cost deducted from total revenue yields profit.

The profits of the organization depend on the successful management of business operations,
i.e. how well an entrepreneur manages the risks and uncertainties of the firm. Although the
profits are directly linked to the entrepreneur and his functions, several economists have
given their varied views on origin, nature and role of profit. Till date, there is no complete
consensus among the economists with respect to the true nature and origin of profit. Due to
this, several theories of profit came into existence.

Theories of Profit

1 • Walker's Theory of Profit

2 • Clark's Dynamic Theory of Profit

3 • Hawley's Risk Theory of Profit

4 • Knight's Theory of Profit

5 • Schumpeter's Innovation Theory of Profit

6 • Monopoly Power as Source of Profit

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The main reason behind the formation of so many profit theories is the confusion among
the economists arising due to lack of agreement between them regarding the true and
proper function of the entrepreneur. Some believed that the function of an entrepreneur
is to coordinate and organize the factors of production, others have described the role of
the entrepreneur as a risk bearer, while some considered profits as a non-functional
income.

 Walker’s Theory of Profit

Definition:

Walker’s Theory of Profit, also called as a Rent Theory of profit was propounded by
F.A. Walker, who believed that profit is regarded as a rent of differential ability that an
entrepreneur may possess over the others.

Walker’s theory of profit works on the same principle as that of land rent, which is the
difference between the yields of least and most effective fertile lands. Likewise, the profit is
the rent of least and most efficient entrepreneurs. Generally, the least efficient worker tries
hard to cover only the cost of production while the efficient worker earns extra for his
differential abilities. Thus, the rent theory of profit posits that the profit of an entrepreneur
depends on a degree to which his abilities are exceptionally different or unique over the
others

The walker’s theory of profit is based on the assumption that a state of perfect
competition prevails, wherein all the firms are presumed to attain the same managerial
ability. Each firm would draw wages for management ability, which in the Walker’s view do
not form a part of the pure profit. The wages of management are regarded as ordinary
wages. Thus, under the perfect completion scenario, there will be no pure profit and each
firm will earn the management wages, known as normal profit.

The walker’s theory of profit is mainly criticized due to its inability to explain the nature
of profit. It provides only the measure of profits and not its real nature, which is of utmost
importance. The assumption that profits arise due to the differential ability of an
entrepreneur does not always stand true. The rise in the profits could also be due to the
entrepreneur’s monopoly in the market.

 Clark’s Dynamic Theory of Profit

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Definition:

Clark’s Dynamic Theory of Profit was propounded by J.B. Clark, who believed that
profits arise in the dynamic economy and not in the static economy.

The static economy is one in which the things do not change significantly or remains
unchanged. Such as, the population and capital remain stationary, goods continue to be
homogeneous, production process remains unchanged, and the factors of production enjoy
freedom but does not move because the marginal product in each industry remains the
same. Also, there is no uncertainty and risk.

On the contrary, the dynamic economy is characterized by the generic changes such as an
increase in population, improvement in production techniques, change and increase in the
consumer demands, changes in the organizational forms, increase in capital. The major
function of an entrepreneur is to work in a dynamic economy to take the advantage of these
changes and promote his business, reduce costs, and expand sales.

Clark believed that those entrepreneurs who successfully takes the advantage of these
changes in the dynamic economy make the pure profit, which is in addition to the normal
profit. Pure profits are short lived because, in the long run, the competitors imitate the
changes initiated by the leader. As a result, the demand for the factors of production
increases, thereby increasing the factor prices and the overall cost of production. On the
other hand, with an increase in the output, the price of a product declines for a given level of
demand as a result of which the pure profits disappears.

Thus, according to Clark, the profit is an elusive amount which can be grasped, but
cannot be held by an entrepreneur as it slips through the fingers and bestows itself to all the
society members. Clark’s dynamic theory of profit should not be misinterpreted as, the
profits in the dynamic economy remain for a short period of time and then disappears
forever. But, however, generic changes take place frequently, and the manager or
entrepreneur through his foresight must capitalize on it and continue to make a profit in
excess of the normal profit.

It can be concluded that Clark’s dynamic theory of profit is based on a notion

that emergence, disappearance, and re-emergence of profits is a continuous
process.

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  Hawley’s Risk Theory of Profit

Definition:

Hawley’s Risk Theory of Profit was propounded by F.B. Hawley, who believed that
those who have the risk taking ability in the dynamic production have a sound claim on the
reward, called as profit. Simply, profit is the price that society pays to assume the
business risk.

The risk in business may arise due to several factors, Viz. Obsolescence of a product, non-
availability of crucial materials, sudden fall in the prices, introduction of a better substitute
by the competitor, risk due to war, fire or any other natural calamity.

Hawley’s risk theory of profit is based on the notion that the businessman would expect
adequate compensation in excess of the actuarial value, i.e., premium on calculable
risk, for assuming the risk. Every entrepreneur strives to gain in excess of wages of the
management for bearing the business risk.

The major reason behind the Hawley’s opinion that profit should be maintained over and
above the actuarial risk is that the assumption of risk is annoying; it leads to trouble,
anxiety, and disutilities among the businessman of several kinds. Thus, assuming risk
grants entrepreneur a claim to a reward above the actuarial business risk.

According to Hawley, the profit consists of two parts: One representing the
compensation for the actuarial loss suffered due to several classes of risks assumed by the
entrepreneur; Second part represents the inducement to bear the consequences due to the
exposure to risk in the entrepreneurial adventures.

Hawley’s risk theory of profit is based on the assumption that profits arise from the factor
ownership, as long as the ownership involves risk. Hawley believed that an entrepreneur
must assume risks to qualify for the additional rewards (profit). On the contrary, if he
avoids the risk by insuring against it, then he would cease to be an entrepreneur and would
not be entitled to profits. Thus, it can be concluded that it is the uninsured risk from which
the profit arises and until the product is sold an entrepreneur’s amount of reward cannot be
determined. Hence, in Hawley’s opinion, the profit is a residue and therefore his theory is
also called a

Thus, it can be concluded that it is the uninsured risk from which the profit arises and until
the product is sold an entrepreneur’s amount of reward cannot be determined. Hence, in
Hawley’s opinion, the profit is a residue and therefore his theory is also called a Residual
Theory of Profit.

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  Knight’s Theory of Profit

Definition:

The Knight’s Theory of Profit was proposed by Frank. H. Knight in 1893 , who believed
profit as a reward for uncertainty-bearing, not to risk bearing. Simply, profit is the residual
return to the entrepreneur for bearing the uncertainty in business.

Knight had made a clear distinction between the risk and uncertainty. The risk can be
classified as a calculable and non-calculable risk. The calculable risks are those whose
probability of occurrence can be anticipated through a statistical data. Such as risks due to
the fire, theft, or accident are calculable and hence can be insured in exchange for a
premium. Such amount of premium can be added to the total cost of production.

While the non-calculable risks are those whose probability of occurrence cannot be
determined. Such as the strategies of a competitor cannot be accurately assessed as well as
the cost of eliminating the completion cannot be precisely calculated. Thus, the risk element
of such events is not insurable. This incalculable area of risk is the uncertainty.

Due to the uncertainty of events, the decision-making becomes a crucial function of an

entrepreneur or manager. If the decisions prove to be correct by the subsequent events, an
entrepreneur makes a profit and vice-versa. Thus, the Knight’s theory of profit is based on
the premise that profit arises out of the decisions made under the conditions of uncertainty.

Knight believes that profit might arise out of the decisions made concerning the state of the
market, such as decisions with respect to increasing the degree of monopoly in the market,
decisions regarding holding stocks that might result in the windfall gains, decisions taken to
introduce new product and technique, etc.

The major criticism of the knight’s theory of profit is, the total profit of an entrepreneur
cannot be completely attributed to uncertainty alone. There are several functions that also
contribute to the total profit such as innovation, bargaining, coordination of business
activities, etc.

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  Innovation Theory of Profit

Definition:

The Innovation Theory of Profit was proposed by Joseph. A. Schumpeter, who believed
that an entrepreneur can earn economic profits by introducing successful innovations.

In other words, innovation theory of profit posits that the main function of an entrepreneur
is to introduce innovations and the profit in the form of reward is given for his performance.
According to Schumpeter, innovation refers to any new policy that an entrepreneur
undertakes to reduce the overall cost of production or increase the demand for his
products.

Thus, innovation can be classified into two categories; The first category includes all those
activities which reduce the overall cost of production such as the introduction of a new
method or technique of production, the introduction of new machinery, innovative methods
of organizing the industry, etc.

The second category of innovation includes all such activities which increase the demand
for a product. Such as the introduction of a new commodity or new quality goods, the
emergence or opening of a new market, finding new sources of raw material, a new variety
or a design of the product, etc.

The innovation theory of profit posits that the entrepreneur gains profit if his
innovation is successful either in reducing the overall cost of production or increasing the
demand for his product. Often, the profits earned are for a shorter duration as the
competitors imitate the innovation, thereby ceasing the innovation to be new or novice.
Earlier, the entrepreneur was enjoying a monopoly position in the market as innovation
was confined to himself and was earning larger profits. But after some time, with the others
imitating the innovation, the profits started disappearing.

An entrepreneur can earn larger profits for a longer duration if the law allows him to
patent his innovation. Such as a design of a product is patented to discourage others to
imitate it. Over the time, the supply of factors remaining the same, the factor prices tend to
rise as a result of which the cost of production also increases. On the other hand, with the
firms adopting innovations the supply of good sand services increases and their prices fall.
Thus, on one hand the output per unit cost increases while on the other hand the per
unit revenue decreases.

There is a point of time when the difference between the costs and receipts gets disappear.
Thus, the profit in excess of the normal profit disappears. This innovation process continues
and also the profits continue to appear or disappear.

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  Monopoly Power as Source of Profit

Definition:

Another source of a pure profit (over and above the normal profit) is said to be a
Monopoly, characterized by a single seller without any close substitute. Monopoly Theory of
Profit posit that the firms enjoying the monopoly power restricts the output and charge
higher prices for its products and services, than under perfect completion.

So far, all the theories of profit have been propounded on the premise of perfect competition.
But theoretically, the perfect market condition is perceived as a non-existent or very rare
phenomena. Thus, an extreme to the perfect competition is the monopoly market structure
wherein the firms under monopoly can decide on the level of output and can charge a higher
price for its products.

Monopoly in the market may arise due to the following factors:

 Economies of scale, i.e. the cost decreases with the increase in production.
 Mergers and takeovers
 Ownership of unique materials
 Legal sanction or protection
According to the monopoly theory of profit, an entrepreneur can earn a pure profit,
also called as a monopoly profit and can maintain it for a longer time period by
using his monopoly powers. These powers are:

1. Power to control the supply and price of products.

2. Power to prevent the entry of a new competitor into the market by price cutting.
3. In certain situations, a monopoly power to control or regulate certain input markets.
Thus, a firm under monopoly can use any of these powers to earn a pure profit. Thus,
monopoly serve as an important source to make a pure profit. It is important to note
that, monopoly too is a rare phenomenon. The Monopolies exists, especially in the
government sectors such as production and supply of water, electricity, energy, etc. or come
under the existence by the government sanction and are under the control and regulation of
the government.

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Important :

Uncertainty Bearing Theory Of Profit:-

The uncertainty-bearing theory of profit was propounded by the American
economist Prof. F. H. Knight in his book risk, uncertainty, and profit, published in
1921 A. D. This theory is an improvement over Hawley's risk theory of profit. Prof. Knight
has focused and explained the uncertainty and distinguished it from risk. According to him,
the risk is a situation in which the statistical probability of an outcome can be determined
and can be minimized or reduced to naught (zero). According to Knight, profit is the reward
of bearing uncertainties which are not insurable but the risk can be insured.

Professor Knight has distinguished between insurable risk and uninsurable uncertainties as
follows:-

1. Insurable risk:-
The risks which are predictable and can be insured against on payment of an insurance
premium are known as risks. E.g.:- Risks of a factory caught fire, theft or accident, etc. The
insurable risk will not give any reward to an entrepreneur.

2. Uninsurable uncertainties:-
The risks which are unpredictable or uninsurable are known as uncertainties. E.g. :-
Reduction in demand, change in government policies, increase in competition, etc. An
entrepreneur bears these uncertainties and gets a reward in return which is called profit.
The risks which cannot be predicted are explained as follows:-

a. Uncertainty in market condition:-

The change in demand and supply conditions in the market lead the entrepreneur to
uncertainty.

b. Competitive uncertainty:-
When new firms enter the market, it increases competition among themselves and the profit
of existing firm will become uncertain.

c. Innovation:-
Due to the introduction of new technology, machines and capital goods need to be replaced
before they become obsolete. Thus, the uncertainties of entrepreneur increases due to
innovations.
d. Economic policies:-

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Economic policies can be classified into microeconomic policy and macroeconomic policy.
Because of the change in these policies, the entrepreneurs may get windfall gains or suffer
losses.
e. Business cycle:-
The business cycle also called the trade cycle is a common feature of a capitalist economy. It
refers to the fluctuation in the economic activity which changes aggregate demand and
aggregate supply. Consequently, business uncertainties of the entrepreneur grow.

Criticisms of the uncertainty-bearing theory of profit:-

1. No profit despite uncertainty-bearing:-

Critics pointed out that sometimes an entrepreneur earns no profit even after taking
uncertainties.

2. Incomplete theory:-
Profit is not the reward for bearing uncertainties. According to critics, other causes like
coordinating, bargaining, etc. also give profits. So, it is an incomplete theory of profit.

3. Not applicable in case of a joint stock company:-

The shareholders of joint stock companies who are entitled to a profit, do not perform any
functions of an entrepreneur.

4. Unable to explain monopoly profit:-

This theory does not suit well to expose the phenomenon of monopoly profit, where there is
very less uncertainty involved in a monopoly business.

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