UNIT - 3

1. Explain the short run production function (Law of variable Proposition) Discuss the long run
Production with an Example Discuss the different short run costs and shape of cost.

A. Short Run Production Function and Law of Variable Proportions:

Short Run Production Function:

The short run refers to a period where at least one factor of production (like labour) is fixed while others (like
raw materials) are variable. In the short run, a firm can increase its output only by increasing the variable inputs.
The relationship between inputs (like labour) and outputs (goods or services) is depicted through the short run
production function.

Law of Variable Proportions:

This law describes the relationship between input factors and output when one input is varied while others are
held constant. Initially, as more of the variable input is added to the fixed input, the marginal product of the
variable input increases. However, beyond a certain point, the marginal product of the variable input begins to
decrease due to factors like diminishing returns or inefficient resource allocation.

Long Run Production and Example:

Long Run Production:

In the long run, all inputs are variable. Firms have the flexibility to adjust all factors of production to optimize
their output. There are no fixed constraints like factory size or equipment. This allows for greater flexibility and
adjustments to achieve optimal production levels.

Example:

Consider a bakery. In the short run, the bakery might increase its output by hiring more bakers (variable input)
while keeping the oven capacity and space fixed. However, in the long run, the bakery could expand its
production by adding more ovens, increasing floor space, hiring additional staff, and even relocating to a larger
premise if necessary.

Different Short Run Costs and Shape of Cost:

Short Run Costs:

1. Fixed Costs (FC): Costs that do not vary with the level of output in the short run. Examples include rent,
insurance, etc.

2. Variable Costs (VC): Costs that change with the level of output. Examples include raw materials, labor, etc.

3. Total Costs (TC): Sum of fixed and variable costs (TC = FC + VC).

4. Average Fixed Cost (AFC): FC divided by the quantity of output.

5. Average Variable Cost (AVC): VC divided by the quantity of output.

6. Average Total Cost (ATC): TC divided by the quantity of output (ATC = AFC + AVC).

7. Marginal Cost (MC): The change in total cost due to producing one more unit of output.
Shape of Cost Curves:

- Average Fixed Cost (AFC): It continuously decreases as output increases because the fixed cost is spread
over a larger quantity.

- Average Variable Cost (AVC): Initially decreases due to economies of scale, but then starts increasing due to
diminishing returns.

- Average Total Cost (ATC): Usually follows the shape of AVC, but if the increase in AFC outweighs the
decrease in AVC, it rises continuously.

- Marginal Cost (MC): Initially decreases due to economies of scale, then starts increasing due to diminishing
returns, intersecting AVC and ATC at their minimum points.

Understanding these cost curves helps firms make production decisions based on the most cost-effective output
level.

2. Curves with table. Why does long run average cost U shaped with diagram?

A. The Long Run Average Cost (LRAC) curve typically showcases a U-shaped pattern due to economies and
diseconomies of scale. Let's break it down with a table and a diagram to understand the U-shaped nature of the
LRAC curve.

Table Illustrating LRAC and Corresponding Output Levels:

Output Level Total Cost (TC) Average Total Cost (ATC)

1. 500 1000
2. 1000 750
3. 1500 600
4. 2000 500
5. 2500 460
6. 3000 450
7. 3500 485
8. 5000 800
9. 5500 1000

LRAC Curve Diagram:

The LRAC curve depicts the minimum average cost possible for various levels of output when the firm can
adjust all inputs. It shows how the cost per unit changes as the scale of production changes.
 1200
1000
800
600
Y-Values
400
200
0
0 2000 4000 6000

- Initially, the LRAC curve slopes downward due to economies of scale. This occurs when increasing
production leads to cost savings per unit due to factors like specialization, efficient use of resources, etc. Hence,
as production increases, the average cost decreases.

- At the bottom of the U-shape, the LRAC reaches its minimum point, representing the optimal scale of
production where the firm enjoys maximum efficiency and economies of scale.

- Beyond this point, the LRAC curve starts to slope upward due to diseconomies of scale. This happens when
the firm becomes too large or inefficient, leading to increased average costs per unit as production further
increases. Factors like coordination issues, bureaucracy, or inefficiencies in management might contribute to
this increase in costs.

Why LRAC is U-shaped:

1. Economies of Scale: Initially, as output increases, the firm benefits from specialization, bulk purchasing, and
efficient use of resources, leading to lower average costs.

2. Optimal Scale: At a certain point, the firm reaches its optimal scale where it experiences the lowest possible
average costs per unit due to maximum efficiency.

3. Diseconomies of Scale: Beyond the optimal scale, the firm faces inefficiencies and increased costs due to
complexities arising from increased size or operations.

This U-shaped LRAC curve illustrates how firms experience cost changes with different levels of production in
the long run.

3. What is break Even point? Describe the features/characteristics of perfect competition, Monopoly and
Monopolistic competition. Enumerate the price and output determination in short and long run under
Monopoly.

A. Break-Even Point:

The break-even point refers to the level of output or sales at which total revenue equals total costs, resulting in
neither profit nor loss. It's the point where a business covers all its expenses but doesn't make any additional
profit. The formula to calculate the break-even point in units is:

Break-Even Point (in units) = Fixed Costs / Selling Price per Unit−Variable Cost per Unit

This point helps businesses understand the minimum level of sales required to cover costs and can be a crucial
metric for decision-making, especially in setting sales targets or pricing strategies.
Characteristics of Market Structures:

1. Perfect Competition:

- Many buyers and sellers.

- Homogeneous or identical products.

- Perfect information available to all participants.

- Easy entry and exit from the market.

- Firms are price takers (they cannot influence the market price).

2. Monopoly:

- Single seller dominating the market.

- No close substitutes for the product.

- Significant barriers to entry, preventing other firms from entering the market.

- The monopolist is a price maker (has significant control over setting the price).

3. Monopolistic Competition:

- Many sellers offering differentiated products (slightly varied).

- Some control over pricing due to product differentiation.

- Relatively easy entry and exit.

- Firms have a degree of control over their prices but are still influenced by competitors.

Price and Output Determination in Monopoly:

Short Run:

- The monopolist chooses the output level where marginal revenue (MR) equals marginal cost (MC) to
maximize profits.

- The price is determined by the demand curve at the quantity where MR = MC. The monopolist then reads off
the price from the demand curve at this quantity.

Long Run:

- In the long run, a monopolist can continue to earn economic profits since barriers to entry prevent other firms
from entering the market and competing.

- However, if there are no barriers or new technology, other firms might enter, reducing the monopolist's market
power and profits.

Summary:

- In a monopoly, the firm has control over price and quantity in the short run due to barriers to entry, setting
both at levels that maximize profit.

- In the long run, a monopolist can sustain economic profits unless new competitors enter the market.
4. Explain the price and output determination in short and long run under Monopolistic competition

A. In monopolistic competition, firms operate in a market structure that combines elements of both monopoly
and perfect competition. Let's break down the price and output determination in the short and long run under
monopolistic competition.

Short Run:

Price Determination:

- Firms in monopolistic competition have some control over the price their products are a bit different from
others.

- Each firm faces a downward-sloping demand curve because its product is somewhat different.

- They can set prices higher than marginal cost in the short run, similar to a monopoly, due to their apparent
difference.

Output Determination:

- Firms produce at a point where marginal cost (MC) equals marginal revenue (MR) to maximize profits.

- However, they might not produce at the minimum point of average cost (like in perfect competition) due to
product differentiation and the ability to charge higher prices.

Long Run:

Price and Output Determination:

- In the long run, If companies in this setup are making good profits, it attracts more companies to join in,
offering similar but slightly different products.

- As new firms enter, existing firms' demand decreases as consumers have more choices.

- Increased competition leads to a decrease in demand for existing firms' products, reducing their market share.

- Firms that were earning economic profits now face a decrease in demand and profits, pushing them to adjust
prices and output to regain customers.

Resultant Equilibrium:

- In the long run Over time, firms end up producing where their prices cover their average costs but not
necessarily at the lowest cost point (like in perfect competition).

- The outcome involves firms earning normal profits, as their products are slightly differentiated from others in
the market.

Summary:

In short, in monopolistic competition, firms have some control over pricing due to product differentiation.
However, in the long run, competition erodes some of that power as new firms enter the market. Firms adjust
output and pricing to achieve equilibrium, where they earn normal profits and produce at levels where prices
cover average costs.
5. What is Oligopoly and its characteristics?

A. Oligopoly refers to a market structure characterized by a small number of large firms dominating the
industry. These firms have a significant share of the market and their actions influence prices and other market
factors. Here are the key characteristics of oligopoly:

Characteristics of Oligopoly:

1. Few Large Firms:

- The market is dominated by a small number of firms. They have a substantial market share, and their actions
significantly impact the industry.

2. Interdependence:

- Actions of one firm directly affect the others. Any change in price, output, or strategy by one firm can lead to
reactions from competitors. Firms are highly aware and responsive to each other's decisions.

3. Barriers to Entry:

- Significant barriers, such as high start-up costs, technology, or government regulations, limit the entry of
new firms into the market. This helps existing firms maintain their positions.

4. Product Differentiation or Homogeneous Products:

- Oligopolistic firms may sell either differentiated products (like automobiles) or homogenous products (like
steel). Differentiated products create some level of market power for firms.

5. Non-Price Competition:

- Firms often compete through means other than price, like advertising, product differentiation, quality,
branding, or customer service. This helps firms maintain their market positions without engaging in price wars.

6. Price Rigidity:

- Prices tend to be relatively stable in the oligopoly market due to the interdependence among firms. Changes
in prices might lead to retaliation from competitors, so firms often avoid aggressive price changes.

7. Collusion and Cartels:

- Oligopolistic firms might collude to control prices or output levels. Cartels, where firms formally agree to
cooperate, are examples of this behaviour. However, such agreements can be illegal and are often subject to
regulation.

8. Game Theory:

- Firms in oligopoly often use game theory to anticipate and react to the strategies of their competitors. This
helps them make decisions considering the potential reactions of other firms.

9. Examples:

- Industries like automobile manufacturing, telecommunications, oil, and aircraft are often cited as examples
of oligopoly due to the presence of a few dominant firms.

Oligopolies create a complex competitive landscape where firms must strategize not just based on their own
costs and demands but also by considering the reactions and strategies of their competitors. This
interdependence among firms sets oligopolistic markets apart from other market structures.
UNIT – 4

1. What is national income accounting? What are the types of national income concepts? (GDP, GNP,
NDP, NNP and others)

A. National income accounting is a system used to measure the economic performance of a country. It quantifies
the total value of goods and services produced within a country's borders over a specific period, providing a
snapshot of the nation's economic health. Various concepts are used in national income accounting to capture
different aspects of economic activity:

Types of National Income Concepts:

1. Gross Domestic Product (GDP):

- GDP measures the total value of all final goods and services produced within a country's borders in a given
time, regardless of who owns the production factors. It includes consumption, investments, government
spending, and net exports (exports minus imports).

2. Gross National Product (GNP):

- GNP measures the total value of all final goods and services produced by a country's residents, whether
within the country's borders or abroad. It includes the GDP plus net income earned from foreign investments
minus income earned by foreign residents within the country.

3. Net Domestic Product (NDP):

- NDP measures the value of a nation's economic output after depreciation of capital is subtracted. It considers
the wear and tear on capital goods during the production process.

4. Net National Product (NNP):

- NNP measures the total value of goods and services produced by a country's residents after accounting for
depreciation and any income earned from abroad minus the income earned by foreign residents within the
country.

5. National Income (NI):

- National income is the total income earned by citizens and businesses of a country, including wages, profits,
rent, and interest. It is derived from GDP by subtracting indirect taxes and adding subsidies.

6. Disposable Income:

- Disposable income is the amount of money individuals or households have available to spend or save after
paying taxes and receiving government transfers.

7. Per-Capita Income:

- Per capita income is calculated by dividing the total national income of a country by its population. It
provides an average income per person in the country.

These concepts help economists and policymakers understand and analyse various aspects of a country's
economic performance, such as production, income generation, distribution, and overall economic growth.
2. Different approaches/methods to measures national income.

A. There are three primary approaches or methods used to measure national income:

1. Production Approach (Output Method):

Gross Domestic Product (GDP) is primarily calculated using the production approach. This method adds up
the value of all goods and services produced within a country's borders in a given time period.

- Value Added Method: This approach sums up the value added at each stage of production. It avoids double-
counting by considering only the value added at each stage of production, rather than the total value of the final
product.

2. Income Approach:

This method calculates national income by summing up all incomes earned in the production of goods and
services within a country's borders over a specific period. It includes:

- Wages and Salaries: Income earned by labour.

- Profits: Income earned by businesses.

- Rent: Income from land or property.

- Interest: Income from financial assets.

- Taxes and Subsidies: Adjustments for taxes and subsidies to arrive at the net income.

3. Expenditure Approach:

This method calculates national income by summing up total expenditures in an economy. It is represented by
the equation:

{GDP} = {Consumption} + {Investment} + {Government Spending} + {Net Exports}

- Consumption: Expenditure by households on goods and services.

- Investment: Expenditure on capital goods, such as machinery and buildings.

- Government Spending: Expenditure by the government on goods and services.

- Net Exports: Exports minus imports.

These three approaches should ideally yield the same value for national income when measured accurately.
However, due to various statistical discrepancies, different approaches might yield slightly different results.
Combining these approaches provides a comprehensive view of a country's economic activity and national
income.
3. What is inflation? Measurement of inflation?

A. Inflation refers to the sustained increase in the general price level of goods and services in an economy over a
period of time. When inflation occurs, each unit of currency buys fewer goods and services than it did before.
It's commonly measured as an annual percentage change in the Consumer Price Index (CPI) or the Producer
Price Index (PPI).

Measurement of Inflation:

1. Consumer Price Index (CPI):

- The CPI measures the average change over time in the prices paid by urban consumers for a basket of goods
and services.

- It tracks the prices of items like food, housing, transportation, clothing, and other goods and services that
consumers typically buy.

2. Producer Price Index (PPI):

- The PPI measures the average change over time in the selling prices received by domestic producers for their
goods and services.

- It tracks the prices of goods at various stages of production before they reach the final consumer.

3. GDP Deflator:

- The GDP deflator is a broader measure that reflects price changes in all goods and services included in the
Gross Domestic Product (GDP).

- It measures the average price level of all goods and services included in GDP, providing an overall inflation
measure.

Calculation of Inflation Rate:

The inflation rate is calculated by comparing price changes between two periods using the following formula:

Inflation Rate =

For example, if the CPI in the current year is 120 and the CPI in the previous year was 110:

{Inflation Rate} = = ( ) = 9.09%

A positive inflation rate indicates prices are rising, while a negative rate denotes deflation (a decrease in the
general price level).
Inflation can have various impacts on an economy, affecting purchasing power, savings, investments, and
interest rates. Central banks often set inflation targets and use financial policy tools to manage inflation within a
certain range to maintain economic stability and growth.

4. What are the different types of inflation?

A. Inflation can be categorized into various types based on the causes, magnitude, and duration of price
increases. Here are some of the common types of inflation:

1. Demand-Pull Inflation:

This occurs when aggregate demand in an economy exceeds aggregate supply. It usually happens during periods
of robust economic growth, increased consumer spending, or when there's excessive money supply. Demand-
pull inflation leads to an increase in prices due to high demand for goods and services.

2. Cost-Push Inflation:

Cost-push inflation arises from increased production costs, such as rising wages, raw material prices, or higher
taxes. When businesses face higher production costs, they often pass these increases on to consumers through
higher prices, causing inflation

3. Built-In Inflation (Wage-Price Spiral):

Built-in inflation occurs when inflation expectations become ingrained in an economy's structure. For instance,
if workers expect prices to rise, they demand higher wages. When businesses pay higher wages, they increase
prices to cover the increased costs, leading to a cycle of wage-price increases.

4. Structural Inflation:

This type of inflation results from fundamental changes in an economy's structure, such as shifts in supply and
demand, changes in technology, or shifts in demographics. It may take a long time to correct because it's rooted
in deep structural changes.

5. Hyperinflation:

Hyperinflation is an extremely high and typically accelerating inflation rate, often exceeding 50% per month. It
erodes the value of a currency rapidly, leading to a loss of confidence in the currency and disrupting economic
stability.

6. Open or Creeping Inflation:

Open or creeping inflation is a moderate and relatively steady rise in the general price level. It's usually slow
and doesn't immediately disrupt economic activities, allowing businesses and consumers to adjust to price
changes gradually.

7. Disinflation:
Disinflation refers to a decrease in the rate of inflation. It means that prices are still rising, but at a slower rate
than before. It's not a decrease in prices (deflation) but a slowdown in the rate of price increases.

Understanding the types of inflation helps economists and policymakers implement appropriate measures to
manage and mitigate its effects on the economy. Each type of inflation may require different policy responses to
maintain economic stability and control price increases.

5. What are the various types of unemployment?

A. Sure, here are the different types of unemployment explained in simpler terms:

1. Frictional unemployment (Looking for a Better Job): This type of unemployment is temporary and occurs
when individuals are in between jobs. It's often considered voluntary as workers take time to search for better
opportunities or transition between careers. This is called frictional unemployment

2. Structural unemployment (Skills Don't Match Jobs): When the skills people have don't match what
employers need, it's called structural unemployment. This happens when certain jobs or industries change, and
leading to long-term unemployment for some workers that fits their skills.

3. Cyclical unemployment (Economic Ups and Downs): It occurs during economic downturns or recessions
when overall demand for goods and services decreases, leading to layoffs and job losses.

(OR)

When the economy is not doing well, companies might cut jobs, leading to cyclical unemployment. It's like a
roller coaster tied to how well the economy is doing.

4. Seasonal unemployment (Seasonal Jobs): Some jobs are only available at certain times of the year, like
farm work in harvest seasons, tourism, retail, or construction. When these jobs aren't available, it's seasonal
unemployment.

5. Underemployment (Not Using Skills Fully): Sometimes, people have jobs but aren't using all their skills or
are working part-time when they want full-time work. That's called underemployment. This includes individuals
who are overqualified for their jobs or are working in positions below their skill level.

6. Hidden or disguised unemployment (People Working, but Not Adding Much): This happens when people
are working but not really making a big impact on the economy, like doing jobs that don't produce much. It's
called hidden or disguised unemployment. (For instance, in some cases, individuals might be employed in jobs
that are not productive or are engaged in subsistence farming or informal sector work, which might not be
accounted for in official employment statistics.)
Each type of unemployment happens for different reasons, and understanding them helps figure out how to help
people find work and keep the economy healthy.