Question Paper code: 632301

B.E/B.TECH DEGREE EXAMINATIONS, MAY 2025

Third Semester
CW3301- FUNDAMENTALS OF ECONOMICS
(Common to B.E Computer Science and Engineering/B.Tech Artificial Intelligence and Data Science)

END SEMESTER EXAMINATION APR/MAY-25

PART-A-(10X2=20 Marks)

1. How is the market demand curve obtained?

The market demand curve is obtained by horizontally summing the individual demand
curves of all consumers in the market. At each price level, the total quantity demanded is
calculated by adding the quantities demanded by all buyers. This gives the market demand at
different prices, which is then plotted to form the market demand curve.

2. Outline the elasticity of demand.

Elasticity of Demand refers to the degree of responsiveness of quantity demanded of a good

to a change in its price, income, or the price of related goods.
It includes: Price Elasticity, Income Elasticity, Cross Elasticity

3. Does the marginal utility theory impact demand?

Marginal Utility Theory states that as a consumer consumes more units of a good,
the additional satisfaction (marginal utility) from each extra unit decreases.
This decline in utility leads to a decrease in willingness to pay, which affects
demand. Hence, demand falls as price remains the same or increases, following
the law of demand.

4. What is consumers' surplus?

Consumer Surplus is the difference between the maximum price a consumer is
willing to pay for a good and the actual price they pay.
It represents the extra benefit or satisfaction gained by consumers in a transaction.

5. What are the assumptions of a perfectly competitive market?

 There are a large number of buyers and sellers.
 All firms sell identical (homogeneous) products.
 Firms can freely enter and exit the market.
 Buyers and sellers have perfect knowledge of the market.

6. Outline the production function.

The production function shows the relationship between inputs (like labor and capital) and the
output of goods or services.
It is usually expressed as:
Q = f(L, K)
Where:
Q = Output L = Labor input K = Capital input

7. Illustrate Gross National Product (GNP).

 Gross National Product (GNP) is the total market value of all final goods and services
produced by the nationals of a country during a given period (usually one year), including
income earned abroad.
Formula: GNP = GDP + Net income from abroad
(Net income from abroad = Income earned by citizens abroad – Income earned by foreigners
domestically)
Example: If India’s GDP is ₹200 lakh crores, and Indian citizens earn ₹10 lakh crores from
abroad while foreigners earn ₹5 lakh crores within India:
GNP = 200 + (10 – 5) = ₹205 lakh crores
8. What is Bank credit creation multiplier?
The credit creation multiplier shows how much total credit (loans) the banking system can
create with a given amount of initial deposit.
To inject realism and accuracy in the projections of demand of credit banks now prepare a
quarterly credit and held discussion with their borrowers from various sectors.
9. How does issue of money market instruments impact inflation?
Issuing money market instruments (like Treasury bills, commercial papers) reduces excess
liquidity in the economy, thereby controlling inflation by limiting spending and credit.
10. How do price and wage rigidities affect the economy?
When prices and wages do not change quickly, it can cause problems like job loss, slow
recovery of the economy, and poor use of resources during tough times.

Part B-(5 X 13 =65 Marks)

11. a) Explain the differences between microeconomics and macroeconomics and their
respective focuses and methodologies.

Parameter Microeconomics Macroeconomics

Economic Individual units such as a Aggregate units such as national
Unit consumer, a firm, or an industry income, total employment, overall
price level
Scope Deals with individual markets Deals with economy-wide issues like
and prices of goods and services inflation, unemployment, economic
growth
Central Allocation of limited resources Determination of income, output,
Problem among competing wants employment, and general price level
Main Tools Demand and supply, marginal National income accounting, IS-LM
utility, cost and revenue analysis model, AD-AS model, fiscal and
monetary policy
Use Helpful in pricing decisions, Useful in policy formulation, economic
resource allocation, production planning, and national budgeting
planning
Equilibrium Partial equilibrium (in a single General equilibrium (in the entire
Analysis market) economy)
Determinants Consumer behavior, firm Aggregate demand, aggregate supply,
production, market structure government spending, investment, etc.
Limitation It is based on unrealistic It has been analysed that ‘fallacy of
approach, i.e.in micro economics composition’ involves, which
it is assumed that there is a full sometimes doesn’t proves true because
employment in the society which it is possible that what is true for
is not at all possible aggregate may not be true for
individuals
Approach Bottom-up (analyzes small parts to
 understand the whole) Top-down (analyzes the economy as a
whole to infer individual impact)
Examples Individual income, individual National income, national savings,
savings, price determination of a general price level, aggregate demand,
commodity, individual firm’s aggregate supply, poverty,
output, consumer equilibrium unemployment, etc.,

(OR)
b) State and explain the any FIVE determinants of demand and supply.

Determinants of Demand:
1. Price of the Good: The price of a product is one of the most important factors influencing
demand. According to the law of demand, when the price of a good rises, the quantity
demanded generally falls, and when the price falls, the quantity demanded increases,
assuming other factors remain constant.
2. Income of the Consumer: A change in the income level of consumers affects their
purchasing power. As income increases, the demand for normal goods tends to rise.
Conversely, for inferior goods (like low-cost or low-quality products), demand may fall as
consumers shift to better alternatives.
3. Prices of Related Goods: The demand for a good is influenced by the price of related goods.
If the price of a substitute good (like tea for coffee) increases, the demand for the original
good (coffee) may rise. On the other hand, if the price of a complementary good (like petrol
for cars) increases, the demand for the related good (cars) may decrease.
4. Tastes and Preferences: Changes in consumer tastes, trends, and preferences play a major
role in determining demand. If a product becomes fashionable or is promoted effectively,
consumer preference may increase, leading to higher demand.
5. Future Expectations: If consumers expect that prices will rise in the future, they may
purchase more now, leading to an increase in current demand. Similarly, if they expect prices
to fall or income to decrease, they may reduce current purchases.
Determinants of Supply:
1. Price of the Good: As the price of a product increases, producers are more willing to supply
more of it because higher prices can lead to higher profits. This is the basic principle of
the law of supply.
2. Cost of Production: If the cost of inputs like labour, raw materials, or energy increases, the
overall cost of producing a good also rises. Higher production costs may reduce supply
because it becomes less profitable to produce the same quantity of goods.
3. Technology: Technological advancements can lead to more efficient production processes.
Improved technology can lower production costs and increase output, leading to an increase
in supply.
4. Government Policies: Taxes and subsidies significantly impact supply. If the government
imposes higher taxes on a product, the cost of supplying it increases, reducing supply. On the
other hand, subsidies lower production costs and encourage producers to supply more.
5. Expectations of Future Prices: If producers expect the price of a good to rise in the future,
they may reduce current supply and wait to sell later at a higher price. This results in a
temporary decrease in current supply.

12. a) Examine the effects of price ceilings and price floors on the market equilibrium.

Price Ceiling (Maximum Price)

A price ceiling is a government-imposed maximum limit on the price of a good or service to
make it affordable, usually below the equilibrium price.
 Effects:
 Shortage: At the lower price, demand increases but supply decreases, leading to excess
demand (shortage).
 Black markets: Sellers may charge illegal higher prices.
 Reduced quality: Producers may reduce the quality or quantity of the product to save costs.
 Example: Rent control in cities like New York.

Price Floor (Minimum Price)

A price floor is a government-imposed minimum price set above the equilibrium price, often
used to protect producers.
Effects:
 Surplus: At the higher price, supply increases but demand decreases, leading to excess
supply (surplus).
 Wasted resources: Unsold goods may be stored, wasted, or destroyed.
 Government purchases: Government may have to buy excess supply, causing budget
burden.
 Example: Minimum wage laws or agricultural price supports.

OR
b) Identify the effects of a price change on a consumer's behavior, including the income and
substitution effects.
A change in the price of a good affects consumer behavior in two main ways: through the income
effect and the substitution effect.
1. Substitution Effect
 When the price of a good falls, it becomes relatively cheaper compared to other goods.
 As a result, the consumer tends to substitute the cheaper good for relatively more expensive
alternatives.
 Example: If the price of tea decreases, consumers may buy more tea instead of coffee.
Effect: Consumers switch to the cheaper good.

2. Income Effect
 A price drop increases the real income (purchasing power) of the consumer, even if their
money income stays the same.
 This allows them to buy more goods, including the one that became cheaper.
 The effect depends on whether the good is normal (more is bought as income rises) or
 inferior (less is bought as income rises).
Effect: The consumer feels richer and may consume more.

13. a) Analyze the concept of total, average, and marginal costs and their graphical
representation.

Total Cost (TC):

Definition:
Total cost is the overall expenditure incurred by a firm in the production of a given level of
output. It includes fixed costs (TFC) and variable costs (TVC).
TC=TFC+TVC
Behavior:
 Fixed cost remains constant regardless of output.
 Variable cost increases with output.
 Thus, total cost increases with output.

Average Cost (AC):

Definition:
Average cost is the cost per unit of output.
AC=TC/Q=TFC+TVC/Q=AFC+AVC
Where:
 AFC = Average Fixed Cost = TFC / Q
 AVC = Average Variable Cost = TVC / Q
Behavior:
 AFC always decreases with output.
 AVC initially falls and then rises due to the law of variable proportions.
 AC is U-shaped because of the combined effect of AFC and AVC.

Marginal Cost (MC):

Definition:
Marginal cost is the addition to total cost when one more unit of output is produced.
MC= ΔTC/ ΔQ
Behavior:
 Initially decreases due to increasing returns (more efficiency).
 Then increases due to diminishing returns.
 Hence, MC curve is U-shaped.

(OR)
b) Elucidate the concept of monopolistic competition, including the conditions for equilibrium and the
graphical representation.

Concept of Monopolistic Competition

Monopolistic competition is a market structure that blends characteristics of both perfect
competition and monopoly. It is common in real-world markets, particularly in retail and service
industries.
Key Features:
 Many sellers and buyers: A large number of firms compete in the market.
 Product differentiation: Each firm offers a product that is slightly different from others (e.g.,
branding, quality, packaging).
 Freedom of entry and exit: Firms can freely enter or leave the market.
 Some price control: Due to product differentiation, each firm has a limited degree of market
power.
 Non-price competition: Firms often compete through advertising, packaging, customer
service, etc.

Equilibrium Conditions
A. Short-Run Equilibrium
In the short run, a monopolistically competitive firm behaves like a monopolist.
 The firm maximizes profit where MR = MC (Marginal Revenue = Marginal Cost).
 The demand curve is downward sloping, so AR > MR.
 The firm may earn supernormal profit, normal profit, or loss depending on cost and
revenue.

B. Long-Run Equilibrium
In the long run, due to free entry and exit, firms make only normal profit.
Conditions:
 MR = MC: Profit-maximizing condition.
 AR = AC: No supernormal profit due to entry of new firms.
 Excess capacity: The firm does not produce at the minimum point of the AC curve.
14. a) Identify the basic Keynesian model of determining income, taking into account the
Keynesian multiplier notion.

The Keynesian model, developed by John Maynard Keynes, explains how national income
(output) is determined by the level of aggregate demand in the economy, particularly in the
short run when there is unemployment and unused capacity.
1. Aggregate Demand (AD):
Total spending in the economy, represented as:
AD=C+I+G+(X−M)
C: Consumption
I: Investment
G: Government expenditure
X: Exports
M: Imports
2. Aggregate Supply (AS):
Total output produced by firms, determined by the level of employment and
productive capacity.
3. Consumption Function:
C=a+bY
a: Autonomous consumption (independent of income)
b: Marginal propensity to consume (MPC)
Y: National income
4. Equilibrium Condition:
The economy is in equilibrium when:
AD=AS(or)Y=C+I+G+(X−M)

Keynesian Multiplier Effect:

The multiplier shows how an initial increase in spending leads to a larger increase in
national income.
Multiplier (k) = 1/1−MPC
For example, if MPC = 0.8, then:
k=1/1−0.8=5
This means an initial investment of ₹100 crores increases income by ₹500 crores.
So, the total increase in income from an increase in investment is:
ΔY=k⋅ΔI
Assumptions of the Basic Keynesian Model:
 Prices and wages are sticky or fixed in the short run.
 There is unused capacity and unemployment in the economy.
 Investment is autonomous (not dependent on income).
 Output adjusts to meet demand (not the price level).

Implications of the Keynesian Model

1. Demand-driven economy: Income and output are determined by aggregate demand,
not by supply.
2. Active government role: Fiscal policy (like government spending) can increase
income during recessions.
3. Multiplier effect: Small increases in autonomous spending can lead to larger
increases in income.

In the Keynesian model, income is determined by the level of aggregate demand. If AD

increases, output and income rise. In times of recession or unemployment, boosting AD
through government spending can raise income and employment.
(OR)

b) Apply how the transaction demand, cautious demand, and speculative demand all affect the
need for money.

The demand for money arises from different motives, as explained in Keynesian
economics. These motives—transaction demand, precautionary (or cautious)
demand, and speculative demand—each reflect why individuals and businesses
choose to hold money rather than invest or spend it immediately. Here's how each
affects the need for money:

1. Transaction Demand for Money

 Meaning: This is the demand for money to carry out everyday transactions
like buying goods and services.
 Reason: Money is needed as a medium of exchange to meet routine
expenses.
 Influence on Money Demand:
o Positively related to income: As income or business activity
increases, transaction demand rises.
o Example: A salaried worker needs money to pay rent, bills, and
groceries.

2. Precautionary (Cautious) Demand for Money

 Meaning: Money held for unexpected expenses or emergencies.
 Reason: To be financially secure in case of uncertainty, such as medical
emergencies or sudden repairs.
 Influence on Money Demand:
o Also rises with income, as people set aside a portion of their
earnings.
o Uncertainty in the economy (e.g., inflation, job insecurity)
increases this demand.
o Example: A household keeps some savings liquid in case of job loss.
3. Speculative Demand for Money
 Meaning: Money held to take advantage of future investment
opportunities or avoid losses from holding financial assets.
 Reason: People prefer to hold cash when they expect interest rates to rise
(which lowers bond prices).
  Influence on Money Demand:
o Inversely related to interest rates:
 If interest rates are low, people hold more money,
expecting rates to rise later.
 If interest rates are high, people prefer to invest in bonds
instead of holding cash.
o Example: An investor holds cash now, expecting bond prices to fall
(and interest rates to rise).

Combined Effect:
Together, these three motives determine the total demand for money:
Total Demand for Money=Transaction Demand + Precautionary (Cautious) Demand +
Speculative Demand
Higher income → more transaction and precautionary demand.
Lower interest rates → higher speculative demand.
Economic uncertainty → increases precautionary and speculative demand.

15. a) What are various monetary policy measures that can be undertaken by the government?
Explain how this impact the economy.

Monetary policy refers to the actions undertaken by a nation's central bank (in India, the
Reserve Bank of India - RBI) to control the money supply, interest rates, and availability of
credit in the economy. The main goal is to maintain price stability, control inflation, promote
economic growth, and ensure financial stability.

1. Bank Rate
The rate at which RBI gives loans to banks.
High bank rate = costlier loans → less borrowing → inflation falls.
Low bank rate = cheaper loans → more borrowing → growth increases.
2. Repo Rate
Short-term loan rate from RBI to banks.
Lower repo rate = more money with banks → cheaper loans for people and
businesses.
Higher repo rate = less money in the market → controls inflation.
3.Reverse Repo Rate – In Short
It is the interest rate at which RBI borrows money from banks.
High rate → Banks keep more money with RBI → Less lending → Inflation falls
Low rate → Banks lend more to people → More spending → Growth rises
4. Cash Reserve Ratio (CRR)
% of money banks must keep with RBI.
High CRR = banks have less money to give as loans → money supply reduces.
Low CRR = more money available → boosts spending and investment.
5. Statutory Liquidity Ratio (SLR)
% of deposits banks must keep in safe assets (like gold or govt. bonds).
High SLR = less money for loans → slows economy.
Low SLR = more money for loans → boosts economy.

(OR)

b) Describe the differences between voluntary and involuntary unemployment, as well as its causes
and effects.

Voluntary Unemployment Involuntary Unemployment

Definition A situation where individuals A situation where individuals are
choose not to work, even though willing and able to work at the
suitable jobs are available. prevailing wage but cannot find
employment.
Choice Based on the person’s own Not a matter of personal choice; caused
Factor choice. by external factors.
Worker's The person decides not to work, The person is actively looking for
Attitude often temporarily. work, but jobs are not available.
Availability Jobs are available, but the Jobs are not available for the person’s
of Jobs individual refuses to take them. skill or in the economy.
Wage Refuses to work at the current Wants to work at the current wage
Acceptance wage rate. rate, but there is no opportunity.
Example A person quitting to travel or A worker laid off due to economic
waiting for a better job slowdown

Causes of Voluntary Unemployment

1. Job dissatisfaction
2. Low wages
3. Better opportunities expected
4. Personal reasons (e.g., study, health, family)

Causes of Involuntary Unemployment

1. Economic downturn/recession
2. Technological changes reducing labor demand
3. Rigid labor laws or minimum wage
4. Mismatch of skills (structural unemployment)

Effects of Unemployment
Effect Type Description
Economic Loss of national income, reduced consumer spending, lower tax
revenues
Social Increased poverty, crime, social unrest
Psychological Loss of self-esteem, depression, mental stress

Part C (1 X 15=15 Marks)

16. a. A government imposes a price ceiling of $80 per unit on a product that is currently selling
at $100 per unit. The demand curve for the product is downward-sloping, and the supply
curve is upward-sloping.
Using a diagram, illustrate the effect of the price ceiling on the market. Calculate the shortage
or surplus that results from the price ceiling.

Step 1: Understand the Market Situation

Equilibrium Price (Pe) = $100
The government sets a price ceiling = $80
Demand curve = downward-sloping
Supply curve = upward-sloping

Step 2: Know What a Price Ceiling Means

A price ceiling is the maximum legal price that can be charged.
When the ceiling is below the equilibrium price, it is called a binding ceiling,
causing a shortage.
 Consumers want to buy more at the lower price, but producers supply less.
Step 3: Draw the Supply and Demand Diagram
Label the axes:
o Y-axis → Price
o X-axis → Quantity
Plot the curves:
o Draw a downward-sloping demand curve (D)
o Draw an upward-sloping supply curve (S)
Mark the equilibrium point:
o At Price = $100, the intersection of supply and demand is Equilibrium
Quantity (Qe)
Draw the price ceiling line:
o A horizontal line at $80, below the equilibrium price
Label the new quantities:
o At $80, move:
 Rightward on the demand curve → get Qd (Quantity Demanded)
 Leftward on the supply curve → get Qs (Quantity Supplied)
Step 4: Assume Supply and Demand Equations (if required for calculation)
To calculate shortage, assume linear functions:
Let:
 Demand equation: Qd=200−P
 Supply equation: Qs=−40+1.4P
Step 5: Find Equilibrium (Optional Verification)
At P = 100:
Qd=200−100 =100
Qs=−40+1.4(100) =−40+140=100
Equilibrium quantity = 100 units
Step 6: Apply the Price Ceiling ($80) to Equations
At P = 80:
 Qd=200−80
=120
Qs=−40+1.4(80)
=−40+112=72
Step 7: Calculate the Shortage
Shortage=Qd−Qs
=120−72
=48 units
Step 8: Interpret the Results
At $80, consumers demand 120 units, but producers supply only 72 units
So, the market faces a shortage of 48 units
This may lead to:
o Long queues
o Rationing
o Black markets
Final Result:
 Price ceiling = $80 (binding) * Shortage = 48 units * Cause: Quantity demanded >
Quantity supplied at ceiling price

Price
 (Or )
b) A company produces a product in a monopolistic market. The company's demand curve is
downward-sloping, and the company's marginal revenue (MR) curve intersects the marginal cost
(MC) curve at a quantity of 50 units. Calculate the company's profit-maximizing quantity and price,
and explain why the company will produce at this level.
Problem Summary:
 Market: Monopoly
 Demand curve: Downward-sloping
 MR (Marginal Revenue) = MC (Marginal Cost) at Q = 50 units
 Find profit-maximizing quantity and price and explain why the company produces at this
level
Solution:
Step 1: Understand the Rule for Monopoly Profit Maximization
A monopolist maximizes profit at the quantity where:
MR = MC
At this point:
 Producing more would cost more than it earns (MC > MR)
 Producing less means losing out on potential profit (MR > MC)
Step 2: Use Given Data
We are told:
 MR = MC at Q = 50 units
So, the profit-maximizing quantity is: Q=50 units
Step 3: Find the Price at That Quantity
A monopolist uses the demand curve to find the price consumers are willing to pay for 50 units.
Assume a linear demand curve (or use one if provided). For example, say:
P=200−2Q
At Q=50Q = 50:
P=200−2(50)=200−100=P=$100
Step 4: Calculate Total Revenue (TR), Total Cost (TC), and Profit (Optional)
If cost function is available, e.g.,
Let MC = 20 (constant), then:
TC=MC×Q=20×50=1000
TR=P×Q=100×50=5000
Profit=TR−TC=5000−1000=$4000
Step 5: Economic Explanation – Why Produce at MR = MC?
 Producing where MR = MC ensures that the last unit produced adds as much to revenue as
it adds to cost.
 If MR > MC, the firm should increase output to gain more profit.
 If MR < MC, the firm should reduce output to avoid loss.
 Thus, Q = 50 units is the optimal (profit-maximizing) level.
Final Answer:
 Profit-maximizing quantity = 50 units
 Price at that quantity = $100 (depends on demand curve)
 Explanation: Firm maximizes profit by producing where MR = MC