Business Economics Important Questions

for B.com 5th semester

Unit 1
Explain the nature and scope of business economics.
Explain the characteristics of Business Economics.
Explain the features of Business Economics.
Explain the importance of Business Economics.
Explain the role of macro and microeconomics and differences between
Micro and Macro Economics.
Explain the law of diminishing marginal utility.
Explain the law of Equi marginal utility.
Unit 2
Explain the concept of demand, demand function and factors that
determine demand. (influencing demand)
Explain the different types of demand.
Explain the law of demand with exceptions.
Explain the elasticity of demand.
Explain the measurement of elasticity of demand.
Unit 3
Explain the law of supply and factors influencing supply.
Explain the market equilibrium.
Explain the theory of consumer behaviour (consumer surplus).
Explain the indifference curve analysis.
Unit 4
Explain the law of variable proportion.
Law of diminishing marginal returns to scale.
Short run production law.
Law of returns to scale.
Explain the long run production law.
Explain isoquants with its properties.
Explain the economies and diseconomies of scale.
Unit 5
Explain the different cost concepts.
Explain the short run cost curve and behaviour of total cost curves and
average cost curve.
Explain the long run cost curve and its features.
Explain the relationship between marginal cost and average cost.
Explain the relationship between marginal revenue and average revenue.
Explain break even analysis and its assumptions, uses and its limitations.
 UNIT – 1: Introduction
Q1) Explain the nature and scope of Business Economics?

OR

Explain the characteristics, Features, and Importance of Business

Economics.

Ans) Introduction:-

Business economics is related to economic activities which aim at

earning more of profits in the economy. Resources are limited and they
should be utilized to the maximum extent by business man for
maximum satisfaction.

Nature of Business Economics:

a) Demand Forecasting: - It is very important to know about the

demand for the continuous production process. Estimating future
demand for a particular product is called as demand forecasting.
Demand forecasting helps you to collect all the resources which
are required for future production.
b) Cost Analysis: - It is very important to analyse different costs
incurred by the business firms. Every firm desires to reduce cost
and increase the output. So that the firm enjoys more profits. At
time, it becomes difficult to estimate the cost of the future
production. But, with the help of business economics knowledge,
the cost of the future production can be estimated easily.
c) Profit Analysis: - The aim of every business firm is to earn
maximum profits in the long run which shows the success of the
business .But at times the business or the firm has to face
 uncertainty & risk in doing the business. So each firm has to make
innovative ideas in production & marketing process to achieve
more profits.

d) Capital Management: - Another important topic in business

economics is managing capital.It helps in planning , controlling
distribution of resources in the business effectively .Hence the top
level management has to make decision regarding capital which is
a difficult task.

e) Effective Use of Business Resources: -The study of BE is very

important in the utilization of resources. It helps to know the price
of raw material, the cost of output etc. Better utilization of
resources will help the firm to earn more profits.

f) Economic Policies for the Business Development: - The knowledge

of BE helps to make economic policies under macro level. The
economic policies are very important for the development of
trade & business in the country.

Scope of Business Economics: - The scope of BE is wide as it

considers the problems from all the areas of business. BE deals with
demand analysis, demand forecasting, production function, cost
analysis, inventory management, advertisement, pricing, resource
allocation etc.

Production Function - Factors of production are known as the inputs of

production department. They play an important role in production
process. So, Factors of production should be combined in such a way
where the cost should be less and output should be more, which helps
to get more profits. Hence production function helps the firm to make
different combination of factors to earn maximum profits.

Inventory Management – An Inventory refers to the stock of raw

materials. Inventory management is very important in production. If
the raw materials are purchased in higher quantity than required
then the capital gets blocked. On the other hand, if the stock is less.
Then the production will be effected.

Advertising – Producing the commodity is one thing and marketing is

another important thing. Advertising helps the consumers to know
about the new products. At the same time, it also helps business mass
to create market for his product. Hence it is an integral part of the
business firm.

Resource Allocation: - The main concern of the manager is allocation

(Distribution) of resources, he should be able to distribute the
resources in such a way that the cost should be less and output should
be more.

Pricing: - The main function of business firm is production and pricing.

The cost of production is always important while fixing the price of a
product. Complete knowledge about the pricing system is essential to
determine the price of the product.
Q2) Explain the Law of Diminishing Marginal Utility?
Ans) Introduction:-

H.H Goosen has introduced the law of diminishing marginal utility in the
year 1854.

Alfred Marshal redefined and popularized it. It is the first law of

consumption. It is based on the fact that Human wants are unlimited.
But a particular want can be satisfied. This law explains the behaviour of
the consumer in the practical life.

Definition:- “The additional benefit which a person derives from a given

increase of his stock of a thing, Diminishes with every increase in the
stock that he already has.”

Assumptions:

1) Rationality: - The consumer should be an optimistic, which means

having positive behaviour to seek maximum satisfaction.
2) Cardinal Measurement: - LDMU is based on cardinal measurement
of utility. It means utility is measured in terms of no’s
Ex:-1, 2, 3…etc
3) No time gap: - There should not be any gap between the
consumption of goods.
4) Constancy: - This law is applicable when there is no change in
income, tastes, habits, preferences of the consumer.
5) Marginal utility of Money: - It is assumed that marginal utility of
money should remain constant so that the consumer preference
will not change.
 6) Homogeneity: - It means the goods which are consumed should be
of similar quality, size, taste, colour etc..

Concept of utility:

1) Cardinal utility - The satisfaction which is measured in terms of no’s

called cardinal utility. Ex: - 1, 2,3,4,5…
2) Ordinal Utility - The satisfaction which is measured by grading or
ranking ex: - 1st 2nd 3rd….
3) Total Utility - The total satisfaction derived by consuming all the units
of commodities is called total utility .
4) Marginal Utility - The additional satisfaction derived by consuming
additional units of commodities is called marginal utility
MU (n) - TU (n) – TU (n- 1)

EXPLANATION OF THE LAW:

The Law states that as the consumer consumes more and more Units of
commodities, he gets less and less satisfaction from the additional units.
This law shows an inverse relationship between Stock of a commodity and
the marginal utility.
 From the above table, we get three conclusions. When one to three
apples are consumed, the TU is increasing at a diminishing rate. As TU is
increasing, MU is decreasing.

When fourth and fifth apples are consumed. TU becomes constant

and MU becomes zero. This is the situation where the consumer gets
maximum satisfaction.
When the sixth apple is consumed, TU decreases and MU becomes
negative.
Explanation of graph:
No of units is taken on X-axis, TU & MU are taken on Y-axis. This graph
explains
1) TU and MU
2) TU becomes max.MU=O
3) TU MU becomes –ve

Limitations:-

According to LDMU, as we go on consume more & more no of units,

The MU decreases but this is not true always. There are certain limitations
or criticisms or exceptions to the law.

1) Hobbies: In case of hobbies, this law of DMU is not applicable because

there is no end for the satisfaction, For instance, playing chess, cricket,
collecting stamps etc.
2) Misers: In the case of misers, the greed increases with every increase
in the additional money. Hence, MU will not diminish.
So, it is an exception to the law.
3) Drunkards: With every increase in the dose of liquor, his desire also
increases, hence MU will not decrease and it is not applicable to this
Law.
4) Durable goods: As we use the goods for a longer period of time the
measurement of utility is not possible.
5) Divisibility: It is not possible to divide all the commodities in to small
units. Hence we cannot measure MU in this case. So, this Law is not
applicable to individual goods.
 Q 3)Explain the Law of Equi – Marginal Utility?
Ans) Introduction: This is the second law in consumption given by H.H
Gossen in the year 1854. Later Alfred Marshall redefined it. The law of
EMU is based on consumer’s equilibrium.

Definition: - “ 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 should be rational person who seeks more

satisfaction.
2) Utility should be measured in cardinal terms.
3) MU of money should remain constant.
4) Prices of the goods should be constant.
5) Goods must be divisible and substitutable.
6) Utility derived from one commodity should be (Important)
independent from the other commodity

Explanation of Law:

The law of EMU explains consumer’s equilibrium. It refers to the

situation where the consumer gets maximum satisfaction with his
limited income from various goods and services. It is also called as law
of maximum satisfaction, the law of substitution, and law of EMU.

MU (A) MU (B) MU (C)

Consumer Equilibrium
 P (A) P (B) P (C)
MU = Marginal Utility
P = Price
A, B, C = Products

Illustration: This law can be explained by an example. When a person

has Rs.5/- how he spends it on two commodities A and B.

Price of the MU of A MU of B TU (A) TU (B)

Commodity
1 25 23 25 23
2 20 15 45 38
3 15 9 60 47
4 10 7 70 54
5 6 4 76 58

Explanation of Table:

When a consumer is spending Rs 5 on commodity ‘A’ and Rs 2 on

commodity B. Then his marginal utilities are equal. The utility derived
from commodity ‘A’ is 25+20+15=60 and the utility derived from
commodity ‘B’ is 23+15=38. The total utility derived from the both
commodities ‘A and ‘B is 60+38=98. This will be the maximum
satisfaction derived by the consumer from this limited income.
In the above graph, Money spent is taken on X-axis and MU of A and B
are taken on Y-axis MU of ‘A’ and ‘B’ are equal to 15.At this point the
consumer gets maximum satisfaction from his limited income. Hence it
is consumer equilibrium.
Limitations of Law:-
1) Law of EMU cannot be applied to indivisible and durable goods.
As it is not possible to calculate the MU.
2) Utility is a psychological concept and it is not possible to calculate
and compare the MU.
3) In the practical life, MU of money will never remain constant.
4) Ignorance of consumer about the market prices of different goods
etc. become limitation to the law.
5) If a person follows fashion, trend etc. in his spending then he will
not be able to spend his money wisely.
Q4) Explain the role of Micro Economics and Macro Economics?

Microeconomics and Macroeconomics are the two branches of modern

economics theory these two terms are first used by Ragnar Frisch of
University of Oslo to explain the economic theory in 1933.
Microeconomics
The word “Micro” is derived from the Greek word “Micros” which means
small. Microeconomics concentrates on individual economic units and its
behaviour.
According to professor Boulding Microeconomics is “the study of
particular firms, particular households, and particular individual, particular
commodities”. It mainly deals with the analysis of price determination and
resources allocation to specific uses according to left witch,
“Microeconomics is concerned with the economic activity is of such
economic units are consumers resources owners and business firms”.
Scope of Micro Economics
After the world have experienced A Great Depression of 1930 the theory
of value and distribution was given significance and the microeconomics
was referred to as the theory of prices the scope of microeconomics can
be understood from the following figure.

Macro Economics
The word macro is derived from Greek word macros it means large.
Macroeconomics concentrates on the behaviour of economic system as a
whole. It is the study of the aggregate so; it is also known as aggregative
economics.
According to Kenneth E. Boulding Macro Economics deals not with the
individual quantities as such but with aggregates of these quantities not
with the individual incomes but with the national incomes not with the
individual price but with the general price level not with individual outputs
but with the national output.

According to Gardner Ackley, “Macroeconomics deals with economic

affairs in the large”
Scope of macroeconomics
The study of Macroeconomics is necessary for understanding the working
of the economy Macroeconomics is also called as theory of income and
Employment. It is extremely helpful in assessing the general price level as
the macroeconomics concentrates on determining the problems of a
country's total income and its fluctuations. The scope of Economics can be
understood from the following
 UNIT – 2: Demand Analysis
Q1) Explain the Factors that determine demand?
Ans. The following are the factors that determine demand.

I) Price of a Commodity: - When price of the commodity

increase. The demand for that commodity decreases. When the
price of a commodity decreases, the demand for the commodity
increase. Hence, there exists indirect or inverse relationship.

II) Prices of Substitutes:- The related goods which give same level
of satisfaction is called substitute goods.
Ex: - Tea and Coffee.
The increase in the price of tea leads to increase in the demand
for coffee. Hence, there exists a direct relationship between the
price and demand.
III)Price of Complementary: - Car and petrol are the examples of
complementary goods. The fall in the price of petrol leads to
increase in the demand for cars and vice versa. Hence there exists
an inverse relationship.

III) Income of the Consumer: - Another important factor that

determines demand is the income of the consumer.
When income of the consumer increases, the demand for many
product increases. When income of the consumer decreases, the
demand for many products decreases. Hence there exists a direct
relationship.

IV) Changes in taste, Fashion, Preference: - When there is

change in taste fashion, preference of the consumer, there is also
change in demand according to their needs. Taste and preference,
fashions do not remain same forever.

IV) Changes in weather conditions: - Demand always changes

when the weather changes. At times, though the price remains
constant, the demand changes continuously.

VII) Changes in Population: - It is another factor that

determines demand. As the population increase demand also
increase for goods and services and vice versa.

VIII) Future Expectations {Speculation}: - The consumer always

expects that the price of a commodity will increase in future and
the present demand will be more. The reverse happens if a fall in
price is expected in the future.
IX) Advertisement: - The present market creates demand for
its products through advertisement. Advertisement helps in
bringing huge change in demand of a commodity / products.

X) Level of Taxation: - When there is high tax rate, the demand for
general goods will decrease. When the tax rate falls the demand
increases for these goods.

Q2) Explain the law of demand with limitations?

Ans) Introduction: - Law of demand is explained by Alfred

Marshall in the year 1890. It was taken from the book called
principles of economics. This law explains inverse relationship
between price and the demand.
Definition: - A rise in the price is followed by a fall in demand of
a commodity, as a fall in price is followed by rise in demand
keeping the other things constant.

Demand = want or desire + ability to pay + willingness to purchase

Assumptions:-
1. No change in income of the consumer.
2. No change in preference.
3. No change in prices of related goods.
4. No change in fashion, trends, taste etc.
 5. No change in government policies.
6. No change in weather conditions.
7. No future expectations.

Demand Function: - It explains the functional relationship between

price and the Factors that determine demand.

Formula: -

D (n) = f (p (n), p(y), p (z), M, W, A, T)

D (n) = Demand for the nth product
F = Functional relationship
P(n) = Price of nth product
P(y) = Price of substitutes product
P(z) = Price of complimentary product
M = Income, W = Weather
A = Advertisement, T= Taxation

Demand Schedule: -

It shows the relationship between different quantities of

commodity demand at various prices in a given period of time.

Imaginary Table

PRICE QUANTITY DEMAND

1 50
 2 40

3 30

4 20

5 10

From the above table, it is understood that as the price is increasing,

from Rs.1 to Rs.5, the demand decreases from 50 to 10. On the other
hand, if the price is decreasing from Rs.5 to Rs.1, then the demand is
increasing 10 to 50. Hence it shows inverse relationship between price
and the demand.
In the above graph, price is taken on X axis and quantity demand is
taken on Y axis.
DD is the demand curve which shows inverse relationship between
price and the demand.
Hence DD curve is sloping towards from left to right.

Exceptions or Limitations / Criticisms: -

 1. GIFFEN’S PARADOX:-
It was explained by British Economist called Sir Robert Giffen. In
this observation, the low paid laborers purchasing more bread,
though the price of bread was increasing. It is opposite to the law.

2. VEBLEN EFFECT OR SNOB DEAL:-

It was explained by Veblen. According to him, prestigious goods
like diamonds, expensive cars etc are purchased by the rich
people when the prices are high as they want to show their social
status in the society. It is opposite to the law.

3. Speculation:-
When the price of a commodity increases people expect that it
will increase more in the future and they purchase more and more
in present. Similarly, when they expect fall in price in the future
they postpone their purchases in the present. It is opposite to the
law.

Q3) why does the demand curve slopes downward from left to
right?
Ans) Introduction: - The demand curve generally slopes downwards
from left to right due to inverse relationship between price and
demand.
The following are the reasons for downward sloping demand curve
1) New Buyers: - The fall in the price attracts new buyers who
could not buy the products when the price was high. As there is
fall in the price the demand increases. Thus, the demand curve
slopes downward from left to right.
2) Old Buyers: - The fall in the price, encourages the old buyers to
buy more. So the demand will be more when the price is less.
Thus, the demand curve slopes downward from left to right.
3) Income Effect: - The fall in the price of a commodity brings
savings to the consumers. This savings is said to be extra
income. So when income increases demand also increases. This
is called income effect though, the demand curves slopes
downwards from left to right.
4) Substitution Effect: - When the price of a commodity falls it
becomes relatively cheaper than its substitutes. Normally the
people will substitutes cheaper goods over costly goods. Ex: Tea
& Coffee. Hence the demand curves slopes downward.
5) Multiple uses of commodity: - Some commodities which have
multiple uses are milk, electricity etc. If the prices of these
commodities fall, then the demand increases.

Q4) What is elasticity of demand? Explain the different types of

elasticity of demand.
Ans. Introduction: -
The concept of elasticity of demand measures the responsiveness of
demand of a commodity to change in the variables such as price,
income and substitutes.
The different types of elasticity of demand are
a) Price elasticity of demand
b) Income elasticity of demand
c) Cross elasticity of demand

Q5) Explain price elasticity of demand and its types.

Ans) Introduction: -
The concept of elasticity of demand measures the responsiveness of
demand of a commodity to change in the variables such as price,
income and substitutes.
a) Price elasticity of demand: It explains the percentage change in
price brings and percentage change in the demand. This concept
was explained by Alfred Marshall.

Formula = Proportionate or % change in demand

---------------------------------------------------------
Proportionate or % change in price

= Proportionate or % in demand
---------------------------------------------------------
Proportionate or % in price

1) Perfectly elastic demand (Ed is ∞): - As there is no change in the

price, the quantity demanded is infinite. It is called perfectly
elastic demand. The value of elasticity Ed is ∞. The demand curve
is parallel to x axis.
 y- axis
(ED=∞)

PRICE

X – axis
Q1 Q2 Q3 Q4 Q5
PRICE

2) Perfectly Inelastic demand(Ed is 0): - The percentage change in the

price does not bring any change in demand. It is called perfectly inelastic
demand. The value of elasticity Ed is zero (0). The demand curve is parallel
to y axis.
 3) Unitary elastic demand (Ed is 1) the percentage change in the
price brings the same percentage change in the demand. It is called
Unitary elastic demand. The value of Ed is 1. The demand curve is
called rectangular hyperbola.

4) Relatively elastic demand (Ed is > 1): The percentage change in the
price brings more percentage change in demand. It is called relatively
elastic demand. The value of Ed > 1. The demand curve is flatter.
5. Relatively Inelastic Demand (Ed<1):- The percentage
change in price brings less percentage change in demand.
The value of ED is less than 1
INCOME ELASTICITY OF DEMAND :

The income elasticity of demand is defined as the percentage change in

quantity demanded to the percentage change in income.

Income elasticity measures the responsiveness of demand to the

change in income.

Formula = % in demand (Q)

% in “M” (income).

Q = quantity demanded

M= income

Example: when a consumer’s income is ₨ 100, he will purchase 10 kgs

of rice.

When income increases to ₨ 120, he will purchase 12 kgs of rice.

Here, income elasticity of demand, explains the demand for rice to the
change in income.

Types of elasticity of demand: -

1. Unitary elasticity of demand: - The percentage change in the
income brings same percentage change in demand.

Formula: - % in M = % in qty DD
2. Relatively elastic demand (>1) : The percentage change in the
quantity demanded is more than the percentage change in income is
called income elasticity of demand greater than 1.

The goods are classified here are

Luxurious goods :- ex:- cars , LEDs

Percentage change in demand > percentage change in income.

3) Relatively inelastic demand (< 1):- the percentage change in
quantity demand is less than the percentage change in income is called
as income elasticity of demand.

The goods are classified into necessary goods like food grains.

% change in demand < % change in income.

4) Zero Income elasticity of demand: - the percentage change in the
income does not bring any change in the demand it is called as zero
income elasticity of demand. The goods here are salt, matchbox etc.
Income

Demanded

CROSS ELASTICITY OF DEMAND

The measure of responsiveness of the demand for a good towards the
change in the price of a related good is called cross elasticity of demand.
It is always measured in percentage terms. ... Related goods are of two
kinds, i.e. substitutes and complementary goods.

Formula: - % in demand for commodity ‘x’

% in price for commodity ‘y’

GOODS CLASSIFICATION
 1) Substitute Goods
2) Complementary Goods
3) Independent Goods

Substitute Goods

Substitute goods are two alternative goods that could be used for the
same purpose.

Complementary Goods
The complementary good has little to no value when consumed alone,
but when combined with another good or service, it adds to the overall
value of the offering.

pr
ic
e

Independent Goods
Independent goods are goods that have a zero cross elasticity of
demand. Changes in the price of one good will have no effect on the
demand for an independent good. Thus independent goods are neither
complements nor substitutes.

Q7) Explain the measurement of price elasticity of demand?

Ans: There are different methods for measuring price elasticity of
demand

1. Ratio Method
2. Total Outlay Method
 3. Point Method
4. Arc Method
(1) Ratio Method:- In this method elasticity is measured by
comparing change in the demand and change in the price. This
method is also known as “Percentage Method”.
Formula =
%Percentage change in Quantity demanded
% Percentage change in price
2) Total Outlay Method: - This method is also explained by Alfred
Marshall .
In this method, elasticity can be measured by comparing total
expenditure and change in the price. Under this method, elasticity
can be measured by taking three variables i.e.
T.E = P x Q
Total expenditure increases as the price falls.
Total expenditure decreases as the price increases.
1. Demand is said to be elastic. The value of Ed>1
2. The total expenditure remains same before and after change in
the price. Demand is said to be unitary. The value of Ed=1

3)T.E decreases as the price falls and it increases as the price increases.
Demand is said to be inelastic. The value of elasticity of demand is less
than < 1.
PRICE QUANTITY TOTAL NATURE OF ELASTICITY
DEMANDED EXPENDITURE
T=P*Q
9 40 360 Ed>1(Relatively Elastic
8 50 400 demand)
 7 60 420 Ed=1(Unitary demand)
6 70 420
5 80 400 Ed<1(Relatively inelastic
4 90 360 demand)

3) Point Method:-This method is called as geometric method. It is also

explained by Alfred Marshall. According to this method, the elasticity is
measured at different points on a straight line demand curve. The
following formula is used to measure the elasticity of demand.
Ed=lower segment of dd curve/upper segment of dd curve

The following diagram explains various elasticity of demand

through point method.

Let us assume that AE is the demand curve of 4cm, which is

divided into 5 points.

At point E Ed = LS/US= 0/4=0 Perfectly inelastic

demand
 At point D Ed = LS/US= Relatively
1/3=0.33<1 inelastic demand

At point C Ed = LS/US =2/2 =1 [Unitary Elastic

demand]

At point B Ed = LS/US =3/1 =3 [Relatively elastic

demand]

At point A Ed = LS/US [Perfectly elastic

=4/0=infinite demand]

4) Arc Method or Mathematical Method: The main drawback of the

point method is that it can be measured only when complete
information is given regarding the changes in the price and the
quantity demanded. But in the real life, it is not easy to get the
information about the minor changes in price and quantity. Hence
there will be certain gaps in the demand schedule and these gaps
can be studied with the help of arc method. Arc method studies a
portion of demand curve between two points. Under this method
elasticity is measured by taking the averages of price and the
demand
 UNIT 3: Supply Analysis

Q1): Explain Law of Supply and factors influencing supply?

Ans. Introduction: Supply means the various commodities which the

sellers are willing to sell at different prices in a given period of time. The
law of supply explains the direct relationship between the price and the
supply of a commodity.

Definition: - Other things remaining same, the supply of a commodity

rises with rise in the price and decreases with the fall in the price.

Factors that determine supply: -

(1) Cost of factors of production:- The cost of production for a

commodity depends upon various factors of production. If the
prices of factors rise, the cost also increases. A fall in the price of
factors will reduce the cost of production.
(2) State of Technology:-The supply of the commodity depends
upon the methods of production. Advanced technology helps in
increasing the productivity with low cost.
(3) Factors Outside the economic Sphere / Natural Calamities: -
Weather conditions, floods, earthquakes etc brings changes in
supply particularly in agricultural goods.
 (4) Tax : - A tax on a commodity or tax on factors of production
increases the cost of production.

Supply function: Supply function explains the functional relationship

between supply and price.

S(x) = F {P(x),P(y),P(f) ,W, T, t}

S[x] = Supply of commodity “x”

P(x) = Price of ‘X’ good.
P(y) = Prices of related goods.
P(f)= Prices of factors of production.
W = Weather conditions
T = Technology
t = government policy (tax)
Assumptions:

(1) They should not be any change in cost of production.

(2) No change in techniques of production
(3) Government polices like taxation, trade policies etc are to be
assumed constant.
(4) There should not be any change in transport cost.

(5) There should not be speculation of goods.

(6) The prices of the substitutes must be constant
Supply Schedule: It explains various quantity of commodities sold for
different prices in the market.
PRICE SUPPLY
10 100
20 200
30 300
40 400
50 500

From the above table, it is understood that when the price increases
from Rs 10 to Rs50, then the supply also increases from 100 units to
500 units. On the other hand when the price decreases from 50 to 10,
then supply also decreases from 500 to 100 units. Hence the price and
the quantity supplied shows the direct relationship.
 In the above graph, the quantity SS is taken on OX axis and the price is
taken on OY axis. SS is the supply curve which slopes upwards from left
to right due to the direct relationship.

Exceptions or Limitations:- A labour whose standard of living is low and

has fixed wants when wages increases by working for some more time
they feel happy . Higher wages increases the working hours. At same
point the worker feels satisfied with his wages and may not work for
more hours. Hence the backward sloping curve begins.
Q2) Explain the elasticity of supply?

ELASTICITY OF SUPPLY

Price elasticity of supply measures the responsiveness to the supply of

a good or service after a change in its market price. According to basic
economic theory, the supply of a good will increase when its price rises
and the supply of a good will decrease when its price decreases.
Formula: - % change in supply

% change in price
Types of Price Elasticity of Supply

1) Perfectly elastic Supply

2) Perfectly inelastic Supply
3) Unitary elastic supply
4) Relatively elastic supply
5) Relatively inelastic supply
Perfectly elastic Supply
It means that no change in price will result in an infinite amount of change in
quantity. Hence it is called Perfectly Elastic supply .SS is the supply curve
which is parallel to X axis.
ES = ∞

supplied
Perfectly inelastic Supply
There is no change in quantity supplied when the price changes. The
value of Es = 0. It is called perfectly in elastic supply. Here the SS curve is
parallel to Y axis.

QTY SUPPLIED
Unitary elastic supply
The percentage change in price leads to an equal percentage change in
quantity supplied. It is called unitary elastic supply.The value of Es =1
Relatively elastic supply
Refers to a condition when the proportionate change in the quantity
supplied is more than proportionate change in the price of a product.It
is called Relatively elastic supply .The value of ES = >1
Relatively inelastic supply
The percentage change in price brings less percentage change in supply. It
is called relatively inelastic supply.
The value of ES is< 1.
Q3.Explain the theory of Consumer Behaviour (consumer surplus)

INTRODUCTION:
The concept of consumer surplus was first formulated by Dupuit in 1844 to
measure social benefits of public goods such as canals, bridges, national
highways. Marshall further refined and popularized this in his ‘Principles of
Economics” published in 1890.

Thus, Marshall defines the consumer’s surplus in the following words: “excess of
the price which a consumer would be willing to pay rather than go without a
thing over that which he actually does pay is the economic measure of this
surplus satisfaction…. it may be called consumer’s surplus.”

ASSUMPTIONS
1) Cardinal measurement
2) Diminishing Marginal Utility
3) Marginal Utility remains Constant: It is assumed that marginal utility of money
should remain constant.
4) No Substitutes

MEASUREMENT OF CONSUMER SURPLUS

Consumer’s surplus = what a consumer is willing to pay minus what he actually
pays.
= Marginal utility – (Price x Number of units of a commodity purchased)
The concept of consumer surplus can be explained with the help of a table and a
graph.
 UNITS OF MARGINAL MARKET CONSUMER
COMMODITY UTILITY PRICE SURPLUS
=(Price
prepared to
pay – Actual
Market Price)
1 35 10 35 – 10 = 25

2 30 10 30 – 10 = 20

3 22 10 22 – 10 =12

4 10 10 10 -10 = 0
Total units = 4 Total utility = Total price = CS = 57
97 40

CS = Total utility – (Price *quantity)

CS = 97 - (10 * 4)
CS = 97 – (40)
CS = 97 – 40
CS = 57

Suppose for the first unit of the commodity the consumer is prepared to pay
Rs.10 this means that the first unit of the commodity is at least worth Rs.10
to him. In other words, he derives marginal utility equal to Rs.35
From the first unit.

For the second unit of the commodity, he is willing to pay Rs.10 and MU is 30
to him. This is in accordance with the law of diminishing marginal utility. Similarly,
the marginal utility of the third, fourth, units of the commodity
Fall to 22, and 10 respectively.

This shows that his marginal utility of the first three units is greater than the
market price which he actually pays for them. He will therefore obtain surplus or
net marginal benefit of Rs.25 (Rs.35 – 10) from the first unit, Rs.20 (= Rs.30-10)
from the second unit, Rs.12 from the third unit and from the fourth unit it is zero.
He thus obtains total consumer surplus or total net benefit equal to Rs.57

OP x OQ = OPEQ
OPEQ is the price which the consumer is paying.
PDE = Consumer surplus.
ODEQ is the price which is willing to pay.
ODEQ – OPEQ = Consumer Surplus

DD’ is the demand or marginal utility curve which is sloping downward, indicating
that as the consumer buys more units of the commodity falls, marginal utility of
the additional units of the commodity. As said above, marginal utility shows the
price which a person is willing to pay for the different units rather than go
without them. Quantity is shown on X Axis, Price and Marginal Utility is shown on
Y Axis.

Consumer surplus, also known as buyer’s surplus, is the economic measure of a

customer’s excess benefit. It is calculated by analysing the difference between the
consumer’s willingness to pay for a product and the actual price they pay, also
known as the equilibrium price. A surplus occurs when the consumer’s willingness
to pay for a product is greater than its market price.

Consumer surplus is based on the economic theory of marginal utility, which is

the additional satisfaction a person derives by consuming one more unit of a
product or service. The satisfaction varies by consumer, due to differences
in personal preferences. According to the theory, the more of a product a
consumer buys, the less willing he/she is to pay more for each additional unit due
to the diminishing marginal utility derived from the product.
 1
Q4. Explain Market Equilibrium

Equilibrium price:
In perfect competition, the price of a product is determined at a point at which
the demand and supply curve intersect with each other. This point is known
as equilibrium point as well as the price is known as equilibrium price.
In addition, at this point, the quantity demanded and supplied is called
Equilibrium quantity.

Equilibrium under Perfect Competition:

As discussed earlier, in perfect competition, the price of a product is determined
at a point at which the demand and supply curve intersect with each other. This
point is known as equilibrium point. At this point, the quantity demanded and
supplied is called equilibrium quantity.

PRICE Quantity Quantity Supplied

Demanded
1 50 10

40 20
2
3 30 30

4 20 40

5 10 50

At Rs 3/- the quantity demanded and quantity supplied are equal. Hence it is
called Market Equilibrium.
Q.5 Explain the indifference curve analysis

Introduction: The concept of indifference analyses is based on the concept of

ordinal utility. This concept is given by HICKS and ALLEN. It refers to various
combination two goods which gives same level of satisfaction the consumer.
Indifference curve is also known as Iso-utility curve or equal satisfaction curve. It
is also called weak ordering theory.
The indifference curve shows the combination of two goods with which a
consumer can get equal amount of satisfaction.
Assumptions:
The main assumption of indifference curves an as follows,

1. Two goods for consumption: Only two goods are used to consumed,

2. Divisible good: Goods for consumption can be divided into small units.

3 Constant Technique: Technique used is constant is known beforehand.

4. Possibility and Technical Substitution: The substitution between the two goods
is technically possible.

5. Efficient Combination: Under the given technique, goods for consumption can
be used with maximum efficiency.

Indifference curve schedule.

Let us suppose that there are two goods Apples and Mangoes . An indifference
curve schedule shows the different combination of these two inputs that yield the
same level of utility in all the cases.

(A) From the given table the combination A i.e. 1 Apple and 15 Mangoes
Will give 100 utils.
(B) Combination B i.e. 2 Apples & 11 Mangoes will give 100 utils.
(C) Combination C i.e. 3 Apples & 8 Mangoes will give 100 utils.
(D) Combination D i.e. 4 Apples & 6 Mangoes will give 100 utils.
(E) Combination E i.e. 5 Apples & 5 Mangoes will give 100 utils.

Hence all the combinations gives a consumer equal amount of total satisfaction.
So the consumers is indifferent between various combinations. That's why the
schedule is called as indifference schedule.
Combinations Apples Mangoes Utility MRTS

A 1 15 100 0

B 2 11 100 4:1

C 3 8 100 3:1

D 4 6 100 2:1

E 5 5 100 1:1
In the above graph Apples are taken on X axis and Mangoes on Y axis.
The IC is the indifference curve which is sloping downwards from left to right.
The different points or combination A,B,C,D,E of two goods gives equal
satisfaction in all the cases.
The consumer is indifferent as he can choose any of this point.

Properties of indifference curve

 Indifference curve is a downward sloping curve from left to right.

 It is convex to the origin because the marginal rate to substitution
diminishes as the good are substituted by one and other.
 An indifference curve cannot be constant.
 Two indifference curves cannot intersect with each other.
 Higher the indifference curve represents higher satisfaction.
 Lower the indifference curve represents lower satisfaction.
Indifference map

A set of indifference curves in the single graph is called indifference map.

IC 3 curve is the curve which gives the higher satisfaction.

IC 1 is the lower curve which represents the lower satisfaction

A set of indifference curve on map is called Indifference Map.

 Unit 4: - Production Analysis
Q1) Explain the concept of production and production function?

Ans) Introduction: - Production means not only creating a substance but

it refers to the creation of utilities in different ways. The utilities are
form utility, place utility, time utility and service utility.

1. Form utility: - It is created by changing the shape, colour, size of

the materials.
Ex: converting wood into chair or table.
2. Place utility: - By changing the place some goods acquire utility.
Ex: land on the seashore has no utility. Transport services are
related to creation of place utility by transporting goods from one
place to another.
3. Time utility: - Storing and preserving certain goods over a period
of time and releasing for sale at the time of scarcity creates time
utility.
Ex: Rice gets utility after 4 months of harvest season.
4. Service utility: - Utility created by rendering service is called
service utility. Ex: Doctors, lawyers etc.…
 Factors of production: -
Anything which helps in the production is called factors of
production. The production of a commodity involves large
number of factors but the four major factors are land, Labour,
capital and organization.
i. Land: - refers to all kinds of natural resources such as
fertility of soil, minerals, forests, water, etc.
 ii. Labour: - refers to the physical and mental efforts of a
human being.
iii. Capital: - refers to the man-made resources which are used
for purchasing capital assets, raw materials etc.….
iv. Organisation: - He is the person who coordinates all the
factors of production in a systematic way, organisation is
also called entrepreneur.
Production function: -
Production function is purely a technical concept. It shows
the transformation of input into output at any particular
time. It shows the physical relation between inputs used and
outputs purchased by the firm. The production function can
be expressed as: - Q = F {L, K, R, N, T}
Q = Output
F = Functional relationship
L = Labour
K = Capital
R = Raw material
N = Land
T = Technology
Here Q is dependent variable and L, K, R, N, T are
independent variable. Production function differs from firm
to firm. The production function is possible in short period
and long period.

Q2. Explain the law of variable proportion?

Ans: Introduction: This law is very important in production. It is stated
by Alfred Marshall. It is also called as “law of diminishing marginal
returns “. This law explains the behaviours of production function in
short period where only few factors are changed by keeping other
factors constant. Basically, this law is applicable in agriculture. The
factors which are changing are called variable factors such as Labour
and raw material. The factors which are not changing are called fixed
factors such as land and capital.

Definition: An issue in the amount of Labour and capital applied in the

cultivation of land, causes in general and less than proportionate
increase in the amount of output raised unless it happens to coincide
with an improvement art of agriculture.

Assumptions:

1. It is possible to change few factors by keeping other factors

constant to increase production.
2. All the variable factors should be same and related to short run.
3. The state of technology should be constant.
4. This law is operated especially in short run.
5. This law applies only to the field of production.
6. Labour should be efficient in knowledge, working.

Explanation of the Law:

The law can be explained by assuming land and capital to be fixed

factors of production. Here, the labour is assumed as variable factors
and they are increased in order to increase the production of a
commodity. Then variable and fixed factors are combined the
 proportion between the variable and the fixed factors will undergo
some changes it leads to law of variable proportion. This can be
explained with the help of a table.
Fixed (Labour) Total Average Marginal Stages
factor Variable product product product
factor
1 1 5 5 5 Stage I
1 2 12 6 7 Increasing
returns to scale
1 3 18 6 6 Stage II
1 4 20 5 2 Diminishing
returns to scale
1 5 20 4 0 Stage III
1 6 18 3 -2 Negative returns
to scale

Total Product (TP): It is the total output produced by total factors of

production.

Average Product (AP): it refers to the average product per unit of

variable factors.

AP= TP
No of units (Labour)
Marginal Product (MP): The addition made to the total by
producing an additional unit is called Marginal product.

MP = TP n – TP n-1

The production function has three stages by keeping other factors

constant, only Labour units are increased.
Increasing Returns (stage 1): in the beginning by increasing Labour
inputs, the change in the output is more than inputs. It is called
Increasing Returns Stage; at the third worker average product is equal
to marginal product.

AP=6, MP=6 AP=MP 6=6

At this point the first stage ends.

Diminishing Returns (stage 2): after certain period of time, the change
in inputs (Labour) brings less change in output. It is called Diminishing
Returns Stage. At the fifth Labour, the total product is constant and
marginal product is zero. Where TP=20, MP=0

The second stage ends.

Negative Returns (stage 3): Finally the production function enters into
the third stage of negative returns in which total products starts
diminishing and marginal products become negative.
Hence TP=18, MP=2

Graph
In the above graph variable factors (Labour) is taken on X-axis and total
product, average product is taken on Y-axis. TPC means Total Product
Curve, MPC means Marginal Product Curve, APC means Average
Product Curve. The first stage ends at the A where APC=MPC i.e.,
increasing returns stage. Second stage ends at the point B and C. Total
product is constant and MP is 0 i.e., diminishing returns stage. In the
third stage MP becomes negative and TP starts diminishing i.e.,
negative returns stage.

IMPORTANCE:

According to Alfred Marshall, the law is applicable to agriculture

only, but according to modern ec
onomist it is also applicable to industries mining, finishing, construction
of buildings etc.
Q3} Explain the Law of Returns to Scale?
Ans: INTRODUCTION: The law of returns to scale explains about the
inputs and outputs in the long period. It is possible to make adjustment
in all inputs in this period. This law explains the behaviours of
production functions in the long run. The change in all the inputs in the
long run with equal proportion will face those stages of production.

ASSUMPTIONS:

1) All the factors should be variable and homogenous

2) State of technology should remain same

1) Increasing Returns to Scale:

1)The increasing returns to scale arise when the given percentage of

increasing inputs leads to the greater percentage of outputs.

For example: If 10% increases in inputs of production leads to more

than 10% increase in output. It is called as increasing returns to scale.
This can be represented
ΔP > ΔF
P F

ΔP = % or proportionate change in output

ΔF = % or proportionate change in input

Reasons for Increasing Return s of Scale

1. Indivisibility of factors of production

2. Division of Labour
3. Specialization
4. Efficient Management

2)Constant Returns to Scale:

As the output is increasing further certain diseconomies enters into

production where the economics and diseconomies will be balanced
and leads to constant returns to scale.

If the inputs are increased by 10%

Formula: ΔP = ΔF

P F

ΔP = % or proportionate change in output

ΔF = % or proportionate change in input

F

3)Diminishing Returns to Scale:

When the firm goes on expanding its size of output after a certain
period more diseconomies appears and results in diminishing
returns to scale. If inputs increased by 10% the output will be less
than 10%

Formula: ΔP < ΔF

P F

• Reasons for Diminishing Returns to Scale:

• Inefficient management
• Lack of supervision
• Lack of proper coordination
• Higher factor prices
• Shortage of raw material
Combinations of inputs Total Marginal Returns
(Labour, capital) product product
1+10 9 9 Increasing returns to
2+20 20 11 scale (IRTS)

3+30 32 12
Constant returns to
4+40 44 12 scale (CRTS)
5+50 55 11 Diminishing returns
6+60 60 5 to scale (DRTS)

In the above table all the inputs i: e capital and Labour are changed in
equal proportion. Changes in outputs can be observed from total and
marginal product. In the beginning when the inputs are doubled the
marginal products are more than doubled. Such a change in outputs in
called increasing returns. But the 3rd and 4th input combination show
the increases outputs in same proportion. It the constant returns of
scale. Later similar change inputs of 5th and 6th combination shows
diminishing returns.
The above Graph inputs are taken on X-axis and marginal product is
taken on Y-axis. R – R1 shows increasing returns to scale and S – S1
shows diminishing returns to scale.

Q4) Explain Isoquants and its properties?

Ans) Introduction: - As in difference curve represents various ambitions

of two goods which gives equal level of satisfaction similarly isoquants.
Similarly, isoquants represent all the possible combinations of two
inputs which are capable of producing same amount

Of output isoquants represents equal qualities of output that is

why they are called as

Equal product curve or Iso product curve.

Iso-quants schedule: - the concept of iso-quants can be

understood by following table.

EQUAL PRODUCT COMBINATIONS

Combination Factor (x) Factor (y) MRTS: - Δy

Δx

A 1 20 -
B 2 15 4:1
C 3 11 3:1
D 4 8 2:1
E 5 7 1:1

EXPLAINATION: - The first combination A i.e., 1 unit of factor (x) and 20

unit of factor (y) Gives the output of 100 units,

Combination B 2x +15y will give the output of 100 units,

Combination C 3x + 11y will give the output of 100 units,

Combination D 4x + 8y gives the output of 100

Combination E 5x + 6y gives the output of 100 units, when all these

combinations are plotted on the graph is called Iso-quants curve. EX: -
equal product curve or the product curve.

In iso-quants, we specify the level of output by 100 units, but in the

case of indifference curve under consumer behaviour we cannot specify
the level of satisfaction.

ISO-QUANTS MAP: - Iso-quants map means a set of iso product curves

drawn in one graph.
  Properties of Iso-quants:

The properties of iso-quants are same as indifference curve of

consumer behaviour. The following are properties of iso-quants:

1) Iso-product curve is a downward sloping curve from left to right as

1 factor of y is reduced by increasing 1 factor of x in order to

maintain same output.

2) The marginal rate of substitution diminishes as the factors are

substituted by one another. So, it makes an iso-quant curve convex to

the origin.

3) An iso-quants curve cannot be constant.

4) Two iso-quants curve cannot intersect with each other suppose if
they intersect the point of intersection show common factor
combination for both the level of output which is unrealistic.

Q) Explain the Economies and Dis-economies of Scale.

Ans) The advantages of large-scale production are called economies of

scale. The economies are classified into internal and external
economics.

INTERNAL ECONOMIES: -

When a firm expands its size of output, only that firm enjoys some
advantages in production. These are called internal economies. They
are as follows:

1) TECHNICAL ECONOMIES- A large firm will be able to install large

capacity machinery. It also adopts latest technologies, own
workshops, division omnm f Labour, specialization etc., with the
help of these, the cost can be minimized with increased
production.
2) MANAGERIAL ECONOMIES- A big firm can appoint the right
person for the right place to manage the firm effectively. As a
result, the output will be more than the inputs.
3) MARKETING ECONOMIES- A large firm purchases various inputs in
bulk quantities at cheaper rates when compared to a small firm. It
can also get special transport, better quality goods, better concern
etc.It can sell its products in different markets easily by its
marketing department. Hence it enjoys more profits.
4) FINANCIAL ECONOMIES- A large firm can reduce its cost of
borrowings from banks and financial institutions due to its
 goodwill in money market. It can collect funds by selling its shares
and debentures in the capital market.
5) RISK-BEARING ECONOMIES- Generally large firms have a
production of different goods and services. Therefore, if there is
any loss in one type of goods it can be covered by the profits from
the other goods

EXTERNAL ECONOMIES- When the number of firms purchases the

same commodity in the particular area; it enjoys certain advantages
which are called external economies. They are as follows: -
1) Economies of Information- As the number of firms in an
industry expands, there is a possibility of increasing collective
and cooperative business.
2) Economies of Disintegration- When an industry grows, it
becomes possible to split up the process of production and can
be taken care by specialized firms.
3) Economies of bi-products- A Large industry can make use of
vast material by manufacturing bi products. Hence, it can make
money from the waste material as well.
DISECONOMIES [Disadvantages]
When there is an expansion of a firm beyond maximum limit of
the firm, then the firm faces dis-economies.
1.DIFFICULTIES IN MANAGEMENT- As a firm expands the
problems of the management increases. After that point,
the manager finds it difficult to control the production. The
entrepreneurs and the management will not be able to
maintain contact with each other and cannot keep all
departments in check. The problem of supervision becomes
difficult and increases the possibility of mistakes and
mismanagement.
2.DIFFICULTIES OF COORDINATION- The task of the
organization becomes more and more difficult with the
increase in the size of the firm. The management will face
problems while making decisions. It may therefore not find
enough time to check on individual problems. Decisions
taken in a hurry leads to inefficient management.
3.LABOUR ECONOMIES- Extreme division of labour with
growing scale of output results in lack of interest and
execution. The contact between the management and the
worker becomes less. Here, misunderstandings increase
which becomes a great hurdle for the firm.
4.SCARCITY OF FACTORS- Due to increase of firms in a
particular locality, each firm will find scarcity of factors.
Here, competition begins in purchasing Labour, raw
materials etc.
5.FINANCIAL DIFFICULTIES- A big firm needs huge capital
which cannot be obtained easily. Hence, the difficulty of
getting sufficient capital regularly stops further expansion of
the firm.
UNIT 5: Cost and Revenue Analysis
Q1) Explain the different types of cost concept?
Ans) Cost function: It explains the determinants of cost. The
determinants like price of the inputs, rate of output, the size the
and the rate of technology. It can be stated as

C [ F ] = [ F,O,P,T ]

C= cost

f= functional relationship

F= Factor input price

O= Rate of output

P= Size of the

T= States of technology

In short run, the cost function Explain cost, output relationship or the
behaviours of cost under given scale of output.

In the long run, the cost function Explain cost output relationship or the
behaviours of cost with a charging scale of output.

* Different types of Cost: -

1. Outlay cost: - It refers to the financial expenditure of the firm like
wages, interest cost of raw material, cost of machines etc. The
expenses are called as actual cost and they are record in the book of
accounts.

2. Opportunity cost: - It is not like the actual expenditure incurred by

the firm. Opportunity cost can be expressed in terms of profit from the
next best alternative.

For Example: - A business man can lend his money instead of investing
in the business and can earn interest. Hence this interest can be known
as opportunity cost which is not appeared in the bank of accounts.

3. Explicit Cost: -Money cost is the expenditure on various things. Cost

of raw material, Labour is required to produce the output. Explicit cost
refers to the actual money expenditure of the firm to buy the factor
which are required for produce the explicit cost are:

1. Expenses Increased on raw material.

2. Wages and salaries.

3. Power charges.

4. Rent of business premises.

5. Interest on capital.

6. Marketing and advertising expenses

Explicit cost is also called as out of pocket cost.

4. Implicit Cost: - Implicit cost are the payments which are not directly
paid by the firm. Implicit cost is:

1. Wages of Labour rendered by the businessman himself.

2. Interest on capital invested by the him.

3. Rent on land belonging to the owner of business.

4. Normal profit.

5. Fixed Cost: -It is also called as supplementary cost. Fixed factors are
not changeable and they remain constant over a period of time. Price
paid for fixed factors are called fixed cost. They are: -

1. Payment of cost on building.

2. Payment of interest on capital.
3. Insurance premium.
4. Depreciation and maintenance allowance.
5. Salary to the staff.
6. Payment of tax.
6. Variable Cost: -Variable cost is also called as prime cost, prices paid
for variable factors are called as variable cost.

It includes prices of raw material, wages of Labour, transportation

charges, fuel charges etc.

7. Incremental Cost: - It is the added cost to increase the level of

business activity by adding a new product, new machinery.

For Ex: - interest on additional capital borrowed is the incremental cost.

8. Sunk Cost: - The cost which are incurred will not be changed in the
business activity. The interest on the entire investment is called sunk
cost.

For Ex: - Fixed cost, salaries, loan payment are sunk costs.
9. Marginal Cost: - The additional cost added to the total cost in order
to produce one more unit of commodity. For Ex: - Output, TFC, TVC,
TC, AFC, AVC, AC, MC Schedule.

Q2) Explain the short run production cost curves and behaviour of
Total Cost and Average Cost.

Ans: - It can be classified into total cost and Average cost or unit cost.
a Total cost- In short run production, the total expenditure
made by the firm on fixed and variable factors is called total
cost. Hence, total cost is the sum of TFC+TVC.
b Total fixed cost- TFC is the total expenditure made on total
fixed factor inputs. TFC remains constant in short run. TFC are
rent, interest, capital and machinery.
c Total variable cost: - TVC is the expenditure made on total
variable inputs. TVC are like wages, raw materials,
transportation charges etc.

d Short Run Total Cost Schedule and the Graph

SCHEDULE: -
 Behaviour of the Total Cost Curve: -
1. TFC remains constant at all the levels of output. It is same even
the output is nil
2. TVC varies with output. It is nil when there is no output variable
cost are the direct cost for the output.
3. TP does not change in the same proportion. Initially it increases at
increasing rate later it increases with diminishing rate.

4. TC changes when there is change in the TVC. In the short run the
TC is depended on TVC.
• GRAPH: -

• The curve TFC is total fixed cost. It is a horizontal line parallel to x

axis showing constant feature of fixed cost at all the levels of
output.

• TVC means total variable cost. Initially, it rises then becomes steeper
showing a sharp rise in the total variable cost.

• TC means total cost: - TC is influenced by TVC when TVC becomes

steeper TC also becomes steeper.
• Short run average or Unit cost schedule and Graph

• Behaviour of average short run cost curves [unit cost curve]

• Average fixed cost = Total fixed cost/Output [AFC=TFC/Q]

• Average variable cost = Total variable cost/Output [AVC=TVC/Q]

• Average total cost = Average fixed cost + Average variable cost

[ATC=AFC+AVC]

• Marginal cost = TC n - TCn-1

Q3) Explain the characteristic of long run cost curve.

Ans: - Introduction: - long run period studies the long run production of
curve by changing all as the factor inputs. It can expand its production
capacity when there is change in demand for its product. In the same
way it can reduce production capacity if demand decreases for its
product. In long run only variable cost exists and there is no fixed cost
as in short run. Under long run relationship of the long run average cost
curve and long run marginal cost curve is studied. Long run consists of
all the possible short run situation to make actual output. Hence it
consists production planning for expansion of firm.
  Long run average cost curve: -

 Features: -
1. Tangent Curve: - Long run average cost curve is derived by
joining points of various short run average cost curves. LAC is drawn as
a tangent curve.

2. Envelope Curve: - The LAC curve is also known as an envelope

curve because it is the envelope group of average cost curves of short
run at different levels of output
3. Planning curve: - LAC curve is also known as long run planning
curve. As it helps business man to make decision regarding the
expansion of production. At OQ2 it is said to be maximum output as it

is minimum cost per unit. There is only one point on LAC curve where
SAC is tangent as well as both have the minimum point

4. Minimum cost combination: - LAC is tangent to different short

run average cost curve. The cost levels represent by LAC curve for
different levels of outputs is minimum cost combination of inputs by
the firm.

5. Flattered u shape: - The LAC curve is less u shape or it is in the

dish shape which means LAC curve in beginning slowly slopes
downwards and after reaching a point it gradually slopes upwards. The
behaviour LAC curve is same to the law of returns to scale. Decreasing
cost shows that the increasing returns constant cost shows constant
returns increasing cost shows decreasing returns.

Q4. Explain the relationship between Marginal revenue and Average revenue
under perfect market
Introduction
Perfect market is the market place where it deals with large number of buyers
and large number of sellers with homogeneous products. The price of the goods
in the perfect market is constant.
The revenue curves in the perfect market are equal the following table Explain
the relationship between average revenue and marginal revenue
QUANTITY PRICE TOTAL S AVERAGE S MARGINAL
SOLD REVENUE REVENUE = REVENUE(SMR)
TR/Q TR(n)-TR(n-1)
(SAR)

0 ---- 0 -----

1 100 100 100= 100/1 100

2 100 200 100=200/2 100

3 100 300 100=300/3 100

4 100 400 100=400/4 100

5 100 500 100=500/5 100

From the above table and graph it is understood that the relationship between
price, average revenue and marginal revenue is equal or constant in the perfect
market as price is constant average revenue is constant as price is constant the
additional goods sold will get the constant revenue hence marginal revenue is
also constant ,total revenue is increasing as the sales are increasing but with a
constant rate.

Q5. Explain the relationship between marginal cost and average cost
Introduction
The relationship between average cost and marginal cost is very important in
price theory the relationship between can be explained with the help of table and
the graph
Output (or) No. Total cost Average cost Marginal cost
of units

1 10 10 10
2 18 9 8
3 24 8 6
4 28 7 4
5 35 7 7
6 48 8 13
7 63 9 15
Both AC and MC are calculated from the Total cost
AC = TC/ Output (No. of units)
MC (n) = TC (n) – TC (n-1)

1. Both MC and AC curves are sloping downward. When AC curve is falling MC

curves lies below it.
2. When ac curve is rising, after the point of intersection, MC curve lies above
it.
3. MC reaches minimum and starts increasing through AC is still decreasing.
4. When AC is at minimum, MC cuts it from below when AC is increasing, MC is
also increasing faster than AC.
5. P is the Equilibrium point, When AC and MC are Equal.
6. OQ is the output which is called as Optimum Output. At point P, the
Quantity produced is Maximum.
 7. AC and MC curves are in U SHAPED
Q.6 Explain Break Even Analysis

A break-even analysis is an economic tool that is used to determine the cost

structure of a company or the number of units that need to be sold to cover the
cost. Break-even is a situation where a company neither makes a profit nor loss
but recovers all the money spent.The break-even analysis is used to examine the
relation between the fixed cost, variable cost, and revenue.

Importance of Break-Even Analysis

• Manages the size of units to be sold: With the help of break-even analysis,
the company or the owner comes to know how many units need to be sold
to cover the cost. The variable cost and the selling price of an individual
product and the total cost are required to know the break-even analysis.

• Monitors and controls cost: Companies profit margin can be affected by the
fixed and variable cost. Therefore, with break-even analysis, the
management can detect if any effects are changing the cost.

Components of Break-Even Analysis

• Fixed costs: These costs are also known as overhead costs. The fixed prices
include taxes, salaries, rents, depreciation cost, labor cost, interests, etc.

• Variable costs: These costs fluctuate and will decrease or increase according
to the volume of the production. These costs include packaging cost, cost of
raw material, fuel, and other materials related to production.

ASSUMPTIONS
1.All costs can be separated into fixed and variable components,

2. Fixed costs will remain constant at all volumes of output,

3. Variable costs will fluctuate in direct proportion to volume of output,

4. Selling price will remain constant

5. Productivity per worker will remain unchanged

Uses of Break-Even Analysis:

• (i) It helps in the determination of selling price which will give the desired
profits.

• (ii) It helps in the fixation of sales quantity to know the cost incurred.

• (iii) It helps in forecasting costs and profit as a result of change in volume.

• (v) It helps in making inter-firm comparison of profitability.

• (vi) It helps in determination of costs and revenue at various levels of

output.

• (vii) It is an aid in management decision-making.

Break-Even Analysis Formula

Break-even point = Fixed cost/Selling price – Variable cost
Example of Break Even Analysis:-
Company X sells a pen. The company first determined the fixed costs, which
include a lease, property tax, and salaries. They sum up to ₹1,575. The variable
cost linked with manufacturing one pen is ₹25 per unit. So, the pen is sold at a
premium price of ₹60.
Therefore, to determine the break-even point of Company X, the premium pen
will be:

Break-even point = Fixed cost/Selling Price – Variable cost

= ₹1,575/ (₹60 – ₹25)

= 1,575/35

= 45

= 45* 60 = 2700

Therefore, given the variable costs, fixed costs, and selling price of the pen,
company X would need to sell 45 units of pens to break-even.
In the above graph BEP is the point where the firm faces no profit no loss zone.

Initially TR is less and TC is more and the firm faces losses.

After BEP TR is more and TC is less and firm faces profits.

Limitations of Break-Even Analysis:

1. Break-even analysis is based on the assumption that all costs and expenses can
be clearly separated into fixed and variable components. In practice, however, it
may not be possible to achieve a clear-cut division of costs into fixed and variable
types.

2. It assumes that fixed costs remain constant at all levels of activity. It should be
noted that fixed costs tend to vary beyond a certain level of activity.

3. It assumes that variable costs vary proportionately with the volume of output.
In practice, they move, no doubt, in sympathy with volume of output, but not
necessarily in direct proportions..

4. The assumption that selling price remains unchanged gives a straight revenue
line which may not be true. Selling price of a product depends upon certain
factors like market demand and supply, competition etc., so it, too, hardly
remains constant.

5. It assumes that the business conditions may not change which is not true.

6. It assumes that production and sales quantities are equal and there will be no
change in opening and closing stock of finished product, these do not hold good
in practice.
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