Q1 ANS

What is present value analysis? How do you calculate present

value example

What Is Present Value (PV)? 

Present value (PV) is the current value of a future sum of money or stream
of cash flows given a specified rate of return. Future cash flows are
discounted at the discount rate, and the higher the discount rate, the lower the
present value of the future cash flows. Determining the appropriate discount
rate is the key to properly valuing future cash flows, whether they
be earnings or debt obligations.

Understanding Present Value (PV) 

Present value is the concept that states an amount of money today is worth
more than that same amount in the future. In other words, money received in
the future is not worth as much as an equal amount received today.

Inflation and Purchasing Power 

Inflation is the process in which prices of goods and services rise over time. If
you receive money today, you can buy goods at today's prices. Presumably,
inflation will cause the price of goods to rise in the future, which would lower
the purchasing power of your money.

Discount Rate for Finding Present Value 

The discount rate is the investment rate of return that is applied to the present value
calculation. In other words, the discount rate would be the forgone rate of return if an investor
chose to accept an amount in the future versus the same amount today. The discount rate that
is chosen for the present value calculation is highly subjective because it's the expected rate
of return you'd receive if you had invested today's dollars for a period of time.

In many cases, a risk-free rate of return is determined and used as the discount rate, which is
often called the hurdle rate. The rate represents the rate of return that the investment or
project would need to earn in order to be worth pursuing. A U.S. Treasury bond rate is often
used as the risk-free rate because Treasuries are backed by the U.S. government. So, for
example, if a two-year Treasury paid 2% interest or yield, the investment would need to at
least earn more than 2% to justify the risk.

The discount rate is the sum of the time value and a relevant interest rate that mathematically
increases future value in nominal or absolute terms. Conversely, the discount rate is used to
work out future value in terms of present value, allowing a lender to settle on the fair amount
of any future earnings or obligations in relation to the present value of the capital. The word
"discount" refers to future value being discounted to present value.

The calculation of discounted or present value is extremely important in many financial

calculations. For example, net present value, bond yields, and pension obligations all rely on
discounted or present value. Learning how to use a financial calculator to make present value
calculations can help you decide whether you should accept such offers as a cash rebate, 0%
financing on the purchase of a car, or pay points on a mortgage.

PV Formula and Calculation 

Present Value=FV(1+r)where:FV=Future Valuer=Rate of returnn=Number o
f periodsPresent Value=(1+r)nFVwhere:FV=Future Valuer=Rate of retur
nn=Number of periods
1. Input the future amount that you expect to receive in the numerator of the formula.
2. Determine the interest rate that you expect to receive between now and the future
and plug the rate as a decimal in place of "r" in the denominator.
3. Input the time period as the exponent "n" in the denominator. So, if you want to
calculate the present value of an amount you expect to receive in three years, you
would plug the number three in for "n" in the denominator.
4. There are a number of online calculators, including this present value calculator.

Q2 ANS
What kinds of questions can marketers use consumer
behavior research to answer? Explain it with Examples

How to analyse consumer behavior by asking these 12 simple

questions?
Analysing consumer behavior is difficult because there are many factors
which influence consumer’s behavior. However, if you ask these 12 basic
questions, then the going can be easy. These 12 questions will help you
build a consumer profile, and will also determine the different types of
customers which buy your product and the influences which make them
buy.
1) Who buys your products and services? – Is it male, female, children,
poor, rich or exactly what would be the type of customer who will buy your
product. First get an idea of the ideal customer you would like to target.

2) Who makes the decision to buy the product? – Many a times, the
purchase may be made by someone but the decision is not theirs. For
example – an office may buy good looking interiors for themselves but the
decision for these interiors was made by the architect or the interior
designer.

3) Who influences the decision to buy the product? – The best example
of influencers are children. A dad may buy the product on the decision of
the mom, but the main influencer is the child who wants a specific thing or
a specific toy. Hence, toy companies always advertise on children’s TV
channels to make them their influencers.

4) How is the purchase decision made? – With the above children’s

example, the child goes to his mother and asks a particular toy. The mom
then communicates to dad or buys it herself. Thus, the process is that the
influencer influences the decision maker, and then the purchase is made.
This orderly fashion of making the purchase decision should be known to
the marketer.

5) Why does the customer buy? – What are the customer’s needs due to

which he is buying the product? In the above case, the mother is buying a
toy for her child. In the example of interior designers making decisions, the
client wants a beautiful office. So each customer is buying a product for
different reasons and you can analyse consumer behavior on the basis of
WHY they are buying that product.

6) Why is the consumer preferring one brand over another? – The best

analysis of consumer behavior is when we analyse their decision making.
Many consumers have their own brand preferences. If you analyse why the
customer is preferring one brand over another, you will find many features
and characteristics which the customer prefers and hence he is inclined
towards one brand more than the other.
7) Where do customers go to buy the brand? – Are they buying the
product online, or are they buying through a convinience store? In fact, are
the customers taking quotations from 10 different suppliers and then
choosing a single one? What is the manner in which the customer is buying
a brand, tells a lot about how far the customer is ready to go to buy the
brand. This aspect of consumer behavior will be different for each customer
and give insight for consumer behavior analysis.

8) When do customers buy a product? – In the above two examples, the
client is buying new interior design equipments for his office because he is
building his new office. Similarly, the mom is buying a toy for her child may
be because its his birthday, or may be because the child is really pestering
her after seeing the AD on TV. So these are the stimulus due to which the
customer has decided to buy the product. You need to know whether the
stimulus is seasonal, is it external or internal.

9) What is the product’s perception? – Is the product perceived as

a value for money product or is it perceived as premium? In fact, the
product can face a problem if it is neither VFM nor premium, because this
means that the product does not have a clear target audience. The
perception of the product plays a major role in generating word of
mouth and you want a positive perception for your product so that the
customer recommends your product to someone else.

10) What social factors influences the purchase decision?

– Many people have never been able to understand why people buy
an Audi or a BMW. But most of these people belong to a conservative
mindset. On the other hand, ask a high net worth individual to buy a
common toyota car and he will scoff at you. He has to maintain his “Social
standards”. Similarly, if you ask the conservative one to buy street clothes
instead of buying branded clothes, he will scoff at you too. Social factors
are a major factor in influencing consumer behavior and they are important
to analyse consumer behavior as well.
 3 What's the Difference between Income Effect and Substitution Effect? Explain it

Ans- income Effect is a result of the change in the real income due to the
change in the price of a commodity.
substitution effect arises due to change in the consumption pattern of a
substitute good, resulting from a change in the relative prices of goods.
BASIS FOR
INCOME SUBSTITUTION
COMPARISO
EFFECT EFFECT
N

Meaning Income effect Substitution effect

refers to the means an effect
change in the due to the change
demand of a in price of a good
commodity or service, leading
caused by the consumer to
change in replace higher
consumer's priced items with
real income. lower prices ones.

Reflected by Movement Movement along

along income- price-consumption
consumption curve
curve

Effect of Income being Relative price

freed up. changes.

Expresses Impact of rise Change in quantity

or fall in demanded of a
purchasing good due to
power on change in prices.
consumption.

Rise in price of a Reduces As alternative

good disposable goods are
income, which comparatively
in turn cheaper and so
decrease customers will
quantity switch to other
demanded. goods.

Fall in price of a Increases real Will make it

good spending cheaper than its
 BASIS FOR
INCOME SUBSTITUTION
COMPARISO
EFFECT EFFECT
N

power of a substitutes, which

consumer, that will attract more
allows customers and
customers to result in higher
buy more, with demand
the given
budget.

4 Explain how to find the consumer equilibrium using indifference curves and a budget
constraint.

Ans- Consumer equilibrium refers to a situation, in which a consumer derives

maximum satisfaction, with no intention to change it and subject to given prices and
his given income. The point of maximum satisfaction is achieved by studying
indifference map and budget line together.

On an indifference map, higher indifference curve represents a higher level of

satisfaction than any lower indifference curve. So, a consumer always tries to remain
at the highest possible indifference curve, subject to his budget constraint.

Conditions of Consumer’s Equilibrium:

The consumer’s equilibrium under the indifference curve theory must meet the
following two conditions:

(i) MRSXY = Ratio of prices or PX/PY

Let the two goods be X and Y. The first condition for consumer’s equilibrium is that

MRSXY = PX/PY
a. If MRSXY > PX/PY, it means that the consumer is willing to pay more for X than the
price prevailing in the market. As a result, the consumer buys more of X. As a result,
MRS falls till it becomes equal to the ratio of prices and the equilibrium is
established.
b. If MRSXY < PX/PY, it means that the consumer is willing to pay less for X than the
price prevailing in the market. It induces the consumer to buys less of X and more of
Y. As a result, MRS rises till it becomes equal to the ratio of prices and the
equilibrium is established.
(ii) MRS continuously falls:
The second condition for consumer’s equilibrium is that MRS must be diminishing at
the point of equilibrium, i.e. the indifference curve must be convex to the origin at
the point of equilibrium. Unless MRS continuously falls, the equilibrium cannot be
established.

Thus, both the conditions need to be fulfilled for a consumer to be in equilibrium.

Let us now understand this with the help of a diagram:

In Fig. 2.12, IC1, IC2 and IC3 are the three indifference curves and AB is the budget
line. With the constraint of budget line, the highest indifference curve, which a
consumer can reach, is IC2. The budget line is tangent to indifference curve IC2 at
point ‘E’. This is the point of consumer equilibrium, where the consumer purchases
OM quantity of commodity ‘X’ and ON quantity of commodity ‘Y.
All other points on the budget line to the left or right of point ‘E’ will lie on lower
indifference curves and thus indicate a lower level of satisfaction. As budget line can
be tangent to one and only one indifference curve, consumer maximizes his
satisfaction at point E, when both the conditions of consumer’s equilibrium are
satisfied:

(i) MRS = Ratio of prices or PX/PY:

At tangency point E, the absolute value of the slope of the indifference curve (MRS
between X and Y) and that of the budget line (price ratio) are same. Equilibrium
cannot be established at any other point as MRSXY > PX/PY at all points to the left of
point E and MRSXY < PX/PY at all points to the right of point E. So, equilibrium is
established at point E, when MRSXY = PX/PY.
(ii) MRS continuously falls:
The second condition is also satisfied at point E as MRS is diminishing at point E, i.e.
IC2 is convex to the origin at point E.
5.What is monopoly market and explain short run and long run market
equilibrium with diagrams.

A monopoly describes a market situation where one company owns all the
market share and can control prices and output. A pure monopoly rarely
occurs, but there are instances where companies own a large portion of the
market share, and ant-trust laws apply.

The diagram for a monopoly is generally considered to be the same in the

short run as well as the long run.
 Profit maximisation occurs where MR=MC. Therefore the equilibrium is
at Qm, Pm. (point M)
 This diagram shows how a monopoly is able to make supernormal
profits because the price (AR) is greater than AC.
 Usually, supernormal profit attracts new firms to enter the market, but
there are barriers to entry in monopoly, and this enables the monopoly
to keep supernormal profits

Difference between monopoly and competitive markets in the long-run

In the short run, firms in competitive markets and monopolies could make
supernormal profit.
However, there is one major difference.
 In monopolies, there are barriers to entry – which prevent new firms
from entering the market
 In competitive markets barriers to entry and low – so new firms can
enter the market causing lower profit.
 Therefore, in the long-run in competitive markets, prices will fall and
profits will fall.
 However in the long-run in monopoly prices and profits can remain high.
Efficiency and monopoly
 Monopolies set a price greater than MC which is allocatively inefficient.
 By producing at Qm, the monopoly is productively inefficient (not lowest
point on AC curve)
 With less competition, a monopoly has fewer incentives to cut costs and
therefore will be x-inefficient.
Welfare loss to society
 In a competitive market, the output will be at Pc and Qc. (point C)
 In a monopoly, the output will be QM and PM – causing a fall in
consumer surplus.
 Monopoly also causes a fall in producer surplus (less is sold). But, some
of the consumer surplus is captured by firms (from setting higher price).
 The blue triangle shows the net loss of consumer and producer surplus
to society.
 Long run average costs in monopoly

It is assumed monopolies have a degree of economies of scale, which

enables them to benefit from lower long-run average costs.
In a competitive market, firms may produce quantity Q2 and have average
costs of AC2. A monopoly can produce more and have lower average costs.
This enables efficiency of scale.

6.Explain the lexicographic orderings by consumers, explained with the help

of suitable diagrams.
Lexicographic Orderings by Consumers (With Diagram)
The indifference curves (ICs) would be negatively sloped, i.e., they would be
sloping downward towards right like the curves given in Fig. 6.2. Axiom of
continuity of preferences ensures that the ICs really exist.

However, a consumer may order his commodity

combinations in such a way that would preclude the existence of ICs. Suppose
that the consumer craves so much for a certain good, X, that he would prefer
any combination that would have more of X, whatever may be the quantity of
the other good, Y, in the bundle.
But if any two combinations contained equal amounts of X, then he would
prefer the bundle with more of Y. This kind of ordering has been shown in Fig.
6.5.
In this figure, all combinations to the right of V contain more of good X. Hence
all points to y the right of V are preferred to V and all points to the left of V are
inferior to V. Also, for the combinations with a given amount of good X as of
point V, those lying to the north of V (like U), would be preferred to V, and
those lying to the south of V (like W), would be inferior to the combination V.

7} Explain a collusive oligopoly with example.

Oligopoly can either be collusive or non-collusive. Collusive oligopoly is a market situation

wherein the firms cooperate with each other in determining price or output or both. A non-
collusive oligopoly refers to a market situation where the firms compete with each other rather
than cooperating.

Collusive Oligopoly

Sometimes, firms may try to remove uncertainty related to acting independently and enter
into price agreements with each other. This is collusion. Collusion is either formal or informal. It
can take the form of cartel or price leadership.

1)A cartel is an association of independent firms within the same industry which follow the
common policies relating to price, output, sale, profit maximization, and the distribution of
products.
2)Price leadership is based on informed collusion. Under price leadership, one firm is a large or
dominant firm and acts as the price leader who fixes the price for the products while the other
firms allow it.

EXAMPLE: Asda and Sainsbury’s colluded with Dairy suppliers, Dairy Crest and Wiseman
Dairies to increase the price of milk, cheese and other dairy products in supermarkets

8] What is Cost? Draw the AC, AVC, AFC AND MC curves?

Cost is the monetary value of goods and services that producers and consumers purchase.
There are 2 type of cost short run cost and long run cost.
1)The Short-run Cost is the cost which has short-term implications in the production
process, i.e. these are used over a short range of output. These are the cost incurred once
and cannot be used again and again, such as payment of wages, cost of raw materials, etc.
2)Long-run average total cost (LRATC) is a business metric that represents the average cost
per unit of output over the long run, where all inputs are considered to be variable and the
scale of production is changeable
LRAC = TC/q
 Short-run Cost type:
1] Average cost:
The Average Cost is the per unit cost of production obtained by dividing the total cost (TC)
by the total output (Q).
The average total cost is the sum of the average variable cost and the average fixed costs.

ATC = AFC + AVC

In other words, it is the total cost divided by the number of units produced.

ATC (Average Total Cost) = Total Cost / quantity

2] Average variable cost:

Average variable cost is the total variable cost divided by the number of units produced. Hence,
if TVC is the total fixed cost and Q is the number of units produced, then

AVC = TVC/Q

3] Average fixed cost:

The average fixed cost is the total fixed cost divided by the number of units produced. Hence, if
TFC is the total fixed cost and Q is the number of units produced, then

AFC=TFC/Q
4] marginal cost
Marginal cost is the addition made to the cost of production by producing an additional unit of
the output. In simpler words, it is the total cost of producing t units instead of t-1 units.
MCn = TCn – TCn-1
The diagram below shows the AFC, AVC, ATC, and Marginal Costs (MC) curves:

9. Identify some of exceptional cases on law of demand and Explain with

diagram.
What are the Exceptions to the Law of Demand?
In an economy, the chief determinants of the market conditions are demand
and supply factors. In the competitive markets, the price range of the product
keeps fluctuating as long as Demand and supply aren't equalled. This situation
is equilibrium. There are specific exceptions to the law of Demand that we will
explore now. In economics, the law of Demand is true to the lines for most
cases. However, some significant exceptions are there. For instance, even if the
Price for Cigarettes goes up, its Demand won't reduce. The exceptions to the
law of demand typically suit the Giffen commodities, Veblen and essential
goods. Let us have a look at these exceptions in detail now.
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Law of Demand
Law of Demand states that when the price of a product increases, its demand
decreases and vice versa, keeping all other factors constant. Say a buyer may
get a dozen fruits at Rs.80. If the price hikes up to Rs.90, he can limit the
purchase to half a dozen. Therefore, the law of Demand in economics pictures
an inverse relationship between the Price and quantity of a particular product
or service. Now, we will get into what are the exceptions to the law of
Demand?

Exceptions to the Law of Demand

1. Veblen Goods
The theory of Veblen goods belongs to the next category of exceptions to the
law of Demand. Thorstein Veblen was the one to highlight this concept. Veblen
goods are the ones whose demand increases with their Price. They become
more valuable with their price rise. These are the goods people consider to be
more useful with an increase in Price. Like a high priced gold necklace, it's
more desirable to the customer than the one with lower costs. A cell phone
model with high cost has more demand in the market. These insights indicate
exceptions to the law of Demand with examples.
Veblen's concept suits the best in the case of most popular celebrities. Like,
they go for a high range of cosmetics or jewellery to maintain their status. It is
a total exception to the law of Demand. 

2. Price Change Exception

The issue of price change in the market is another exception to the law of
Demand. There might be a situation when the Price of a product or service
increases and is subjected to future growth. So, the customers may buy more
of it to avoid further cost increment. Eventually, there are times when the
Price of a product is about to decrease. Consumers may temporarily stop the
purchase to avail of the future benefits of price decrement.
Recently, there has been a massive rise in the price of onions. People were
buying it more due to the worry of the further cost increase. 

3. Necessary Goods
Let us understand what are the exceptions to the law of demand in case of
necessary items. The Demand for essential goods stays intact even if there’s a
price rise. People can’t stop purchasing the products of regular necessities. For
example, if the cost of salt increases, consumers won't end affording it. It is a
complete opposite to the law of Demand in economics.

4. Luxury Goods
A significant exception to the law is Demand for luxury goods. In such cases,
even if the price increases, the consumer won't stop consumption. Cigarettes
and alcohol typically come in this category.

5. Income Change
The change in income of a consumer or a family also determines the Demand
for a particular product. If a family's income increases, they may choose to buy
a specific product in more quantity, no matter the Price. Again, if the family's
income decreases, they can select to reduce product consumption to an
extent. It opposes the law of Demand. 
 10.What is the difference between change in demand and shift in demand?

Comparison Chart
BASIS FOR MOVEMENT IN DEMAND
SHIFT IN DEMAND CURVE
COMPARISON CURVE

Meaning Movement in the demand The shift in the demand curve is

curve is when the commodity
experience change in both
the quantity demanded and
price, causing the curve to
move in a specific direction.
when, the price of the
commodity remains constant,
but there is a change in quantity
demanded due to some other
factors, causing the curve to
shift to a particular side.

Curve

What is it? Change along the curve. Change in the position of the
curve.

Determinant Price Non-price

Indicates Change in Quantity Change in Demand

Demanded

Result Demand Curve will move Demand Curve will shift

upward or downward. rightward or leftward.

Definition of Shift in Demand Curve

A shift in the demand curve displays changes in demand at each possible price,
owing to change in one or more non-price determinants such as the price of
related goods, income, taste & preferences and expectations of the consumer.
Whenever there is a shift in the demand curve, there is a shift in the
equilibrium point also. The demand curve shifts in any of the two sides:
 Rightward Shift: It represents an increase in demand, due to the
favourable change in non-price variables, at the same price.
  Leftward Shift: This is an indicator of a decrease in demand when the
price remains constant but owing to unfavourable changes in
determinants other than price.

11.Why long run average cost curve will be called as envelop Curve?
Explain with diagram.
The curve long run average cost curve (LRAC) takes the scallop shape, which is why
it is called an envelope curve. As the long run average cost curve is derived from the
short run average cost curves.

And it is known that all inputs are variable, thus the firm can have a number of

alternative plant sizes and levels of output that it wishes.For such every alternative

level the firm may have separate SRAC’s. Joining the slopes of all the average cost

curves derives the LRAC curve. As shown in the following figure, the slopes of the

short-run average cost curves leads to the attainment of LRAC which is a scallop

shaped which is why it is called the envelope curve.

We can observe from the above figure that although many SRAC curves exit

however, only one point of the small arc of each short run cost curve will lie on the

long run average cost function.

Which makes the LRAC a smooth U-shaped curve, which reflects the laws of returns

to scale.

According to which the cost per unit of production decreases as plant size increase’s

due to the economies of scale, which the larger plant size makes possible.

It is in accordance with the long run average cost curve is the long run marginal cost

curve.

The LRMC intersects the LRAC at its minimum point, which also happens to be the

minimum point of the short run average cost curve. It is at this point that the

following relationship is derived:

SRAC = SRMC when LRAC = LRMC and it is because of the fact that LRAC reflects

the laws of returns to scale and the LRMC reflects the long run cost resulting from

the production of the last unit of output which does not make the LRMC a U-shaped

or scallop shaped.

Q12) Compare and contrast the marginal utility approach with the indifference
curve approach in understanding consumer behaviour.

Utility Analysis:-
In Utility Analysis,  consumer Equilibrium refers to a situation where a consumer is
getting maximum satisfaction by spending his income across different goods. At this
situation, the consumer does not tend to change his expenditure pattern.
In other words, A consumer is in equilibrium when he allocates his limited income
across different commodities to maximize his satisfaction or utility. Any change in the
allocation of income will lead to a fall in total satisfaction to the consumer.
Indifference Curve Analysis:-
In Indifference Curve Analysis, Consumer’s Equilibrium is defined as a situation
when the consumer maximizes his satisfaction, spending his given income across
different goods with the given prices. Here, the indifference curve and budget line
are used to determine the consumer equilibrium point. Indifference curve analysis
helps to find out how the consumer spends his limited income on the combination of
different goods to get maximum satisfaction.
In other words, consumer’s equilibrium refers to a situation in which a consumer with
given income and given prices purchases a combination of goods and services
which gives him maximum satisfaction and he is not willing to make any change in it.

Conclusion:
Both these analyses prescribe almost identical conditions for consumer’s equilibrium
yet indifference curve analysis helps a consumer reach consumer’s equilibrium
without any unrealistic assumptions. Thus, indifference curve analysis is superior to
the utility analysis.
Q13. Discuss the role of time element in the determination of price and output under
perfect competition with the help suitable diagrams

Role of time element in determination of price are given below:

Time plays an important role in the theory of volume, i.e., price determination because
supply and demand conditions are affected by time.

Price during the short-period can be higher or lower than the cost of production, but in the
long-period price will have a tendency to be equal to the cost of production

The relative importance of supply on demand in the determination of price depends upon
the time given to supply to adjust itself to demand.

To study the relative importance of supply or demand in price determination, Prof. Marshall
has divided time element-into three categories:

(a) Very short period or market period.

(b) Short period.

(c) Long period.

Now we shall discuss the price determinant in different period.

(a) Very short period (determination of market price):

Market period is a time period which is too short to increase production of the commodity
in response to an increase in demand. In this period the supply cannot be more than existing
stock of the commodity.

The supply of perishable goods is perfectly inelastic during market period. But non-
perishable goods (durable goods) can be stored.

Therefore, the supply curve of non-perishable goods above reserve price has a positive
scope at first but becomes perfectly inelastic after some price level.

The reserve price y depends upon-(i) cost of storing, (ii) future expected price, (iii) future
cost of production, and (iv) seller’s need for cash we will discuss the determination of
market price by taking a perishable commodity and determination of market price is
illustrated.

DD is the original demand curve and SS the market period supply curve. The demand curve
DD (perfectly inelastic) cuts the supply curve SS at point E. Point E, is the equilibrium point
and equilibrium price is determined at OP, level.
Increase in demand shifts the demand curve to D,D and the price also increased to OP,.
Decrease in demand shifts the demand curve downward to D2D2 and the price too falls to OP
It is, thus, clear that in market period price fluctuates with change in demand conditions.

(b) Price determination is short period:

In the short period fixed factors of production remain unchanged, i.e., productive capacity
remains unchanged.

However, in the short period supply can be affected by changing the quantity of variable
factors.

In other words, during the short period supply can be increased to some extent only by an
intensive use of the existing productive capacity.

Therefore, the supply curve in the short-run slopes positively, but the supply curve is less
elastic. Determination of price in the short-run is illustrated.

SS is the market period supply curve and SRS is short-run supply curve. The original demand
curve DD cuts both the supply curves at E, point and thus OP, price is determined.

Increase in demand shifts the demand curve upward to the right to D,D,. Now with the
increase in demand the market price (in market period) rises at once to OP 3 because supply
remains fixed. But in the short-run supply increases. Therefore, in the short-run price will
cuts the SRS curve. If demand decreases opposite will happen.

(c) Price determination in long period (Normal Price):

In the long period there is enough time for the supply to adjust fully to the changes in
demand.

In the long period all factors are variable. Present firms can increase on decrease the size of
their plants (productive capacity).

The new firms can enter the industry and old firms can leave the market. Therefore, long-
period supply curve has a positive slope and is more elastic than short period supply curve.

The shape of supply curve of the industry depends upon the nature of the laws of returns
applicable to the industry. Price determination in the long period is illustrated.

DD is the original demand curve and LS is the long period supply curve of the industry.
Demand curve DD and supply curve LS both intersect each other at E point and OP price is
determined.
This price will be equal to minimum average cost (AC) of production because in the long
period firms under perfect competition can only earn normal profits. Suppose these are
permanent increase in demand.

With the increase in demand, the demand curve shifts to D1,D1. As a result of increase in
demand the price in the market period and short period will rise.

Due to increase in price present firms will earn above normal profit. Therefore, new firms
will enter into market in the long period.

As a result of it supply will increase in the long period. In the long period price will be
determined at OP1, level because at this price demand curve D1 D 2 cuts the LS curve at
E2 point.

Price OP1, is greater than previous price OP1, because the industry is an increasing cost
industry. This new higher price will also be equal to minimum average cost of production.

Q14. What are the diseconomies of scale? Explain with illustrations

Diseconomies of Scale

Diseconomies of scale happen when a company or business grows so large that the costs
per unit increase. It takes place when economies of scale no longer function for a firm. With
this principle, rather than experiencing continued decreasing costs and increasing output, a
firm sees an increase in costs when output is increased.

The diagram below illustrates a diseconomy of scale. At point Q*, this firm is producing at
the point of lowest average unit cost. If the firm produces more or less output, then the
average cost per unit will be higher. To the left of Q*, the firm can reap the benefit of
economies of scale to decrease average costs by producing more. To the right of Q*, the
firm experiences diseconomies of scale and an increasing average unit cost.
Special Considerations

Diseconomies of scale specifically come about due to several reasons, but all can be broadly
categorized as internal or external. Internal diseconomies of scale can arise from technical
issues of production or organizational issues within the structure of a firm or industry.

External diseconomies of scale can arise due to constraints imposed by the environment
within which a firm or industry operates. Essentially, diseconomies of scale are the result of
the growing pains of a company after it's already realized the cost-reducing benefits of
economies of scale.

The first is a situation of overcrowding, where employees and machines get in each other's
way, lowering operational efficiencies. The second situation arises when there is a higher
level of operational waste, due to a lack of proper coordination. The third reason for
diseconomies of scale happens when there is a mismatch in the optimum level of outputs
within different operations.

Types of Diseconomies of Scale

Internal diseconomies of scale involve either technical constraints on the production
process that the firm uses or organizational issues that increase costs or waste resources
without any change to the physical production process.

Technical Diseconomies of Scale

Technical diseconomies of scale involve physical limits on handling and combining inputs
and goods in process. These can include overcrowding and mismatches between the
feasible scale or speed of different inputs and processes.

An overcrowding effect within an organization is often the leading cause of diseconomies of

scale. This happens when a company grows too quickly, thinking that it can achieve
economies of scale in perpetuity. If, for example, a company can reduce the per-unit cost of
its product each time it adds a machine to its warehouse, it might think that maxing out the
number of machines is a great way to reduce costs.However, if it takes one person to
operate a machine, and 50 machines are added to the warehouse, there is a good chance
that these 50 additional employees will get in each other's way and make it harder to
produce the same level of output per hour. This increases costs and decreases output.

Sometimes, diseconomies of scale happen within an organization when a company's plant

cannot produce the same quantity of output as another related plant. For example, if a
product is made up of two components, gadget A and gadget B, diseconomies of scale might
occur if gadget B is produced at a slower rate than gadget A. This forces the company to
slow the production rate of gadget A, increasing its per-unit cost.

Organizational Diseconomies of Scale

Organizational diseconomies of scale can happen for many reasons, but overall, they arise
because of the difficulties of managing a larger workforce. Several problems can be
identified with diseconomies of scale.

First, communication becomes less effective. As a business expands, communication

between different departments becomes more difficult. Employees may not have explicit
instructions or expectations from management. In some instances, written communication
becomes more prevalent over face-to-face meetings, which can lead to less feedback.

Another drawback to diseconomies of scale is motivation. Larger businesses can isolate

employees and make them feel less appreciated, which can result in a drop in productivity. 

External Diseconomies of Scale

External diseconomies of scale can result from constraints of economic resources or other
constraints imposed on a firm or industry by the external environment within which it
operates. Typically, these include capacity constraints on common resources and public
goods or increasing input costs due to price inelasticity of supply for inputs.

External capacity constraints can arise when a common pool resource or local public good
cannot sustain the demands placed on it by increased production. Congestion on public
highways and other transportation needed to ship a firm's products is an example of this
type of diseconomy of scale.

As output increases, the logistical costs of transporting goods to distant markets can
increase enough to offset any economies of scale. A similar example is the depletion of a
critical natural resource below its ability to reproduce itself in a tragedy of the
commons scenario. As the resource becomes ever more scarce and ultimately runs out, the
cost to obtain it increases dramatically.

Price inelasticity of supply for key inputs traded on a market is a related cause of
diseconomies of scale. In this case, if a firm attempts to increase output, it will need to
purchase more inputs, but price inelastic inputs will mean rapidly increasing input costs out
of proportion to the increase in the amount of output realized
17 Explain about consumer behaviour in Preference ordering -- Feasible set --
Consumption decision
Ans: Consumer behavior is the study of how individual customers, groups or
organizations select, buy, use, and dispose ideas, goods, and services to satisfy
their needs and wants. It refers to the actions of the consumers in the marketplace
and the underlying motives for those actions.
Marketers expect that by understanding what causes the consumers to buy
particular goods and services, they will be able to determine—which products are
needed in the marketplace, which are obsolete, and how best to present the goods
to the consumers
The study of consumer behavior assumes that the consumers are actors in the
marketplace. The perspective of role theory assumes that consumers play various
roles in the marketplace. Starting from the information provider, from the user to the
payer and to the disposer, consumers play these roles in the decision process.

“Consumer behavior is the actions and the decision processes of people who
purchase goods and services for personal consumption” – according to Engel,
Blackwell, and Mansard,
Consumer buying behavior refers to the study of customers and how they
behave while deciding to buy a product that satisfies their needs. It is a study of
the actions of the consumers that drive them to buy and use certain products.
Consumption Decisions in the Short Run and the Long Run

Economists distinguish short-run decisions from long-run decisions. A consumer decision

is considered short run when her consumption will occur soon enough to be constrained by
existing household assets, personal commitments, and know-how. Given sufficient time to
remove these constraints, the consumer can change her consumption patterns and make
additional improvements in the utility of consumption. Decisions affecting consumption
far enough into the future so that any such adjustments can be made are called long-
run decisions. Elasticities of demand in the short run can differ substantially from
elasticities in the long run. Long-run price elasticities for a product are generally of higher
magnitude than their short-run counterparts because the consumer has sufficient time to
change consumption styles.

18 Graphically explain the economy’s production possibility curve in terms of

economic growth.

The production possibility curve represents graphically alternative production possibilities

open to an economy.

The productive resources of the community can be used for the production of various
alternative goods.

But since they are scarce, a choice has to be made between the alternative goods that can
be produced. In other words, the economy has to choose which goods to produce and in
what quantities. If it is decided to produce more of certain goods, the production of certain
other goods has to be curtailed.
It all available resources are employed for the production of wheat, 15,000 quintals of it can
be produced. If, on the other hand, all available resources are utilized for the production of
cotton, 5000 quintals are produced. These are the two extremes represented by A and F and
in between them are the situations represented by B, C, D and E. At B, the economy can
produce 14,000 quintals of wheat and 1000 quintals of cotton.

At C the production possibilities are 12,000 quintals of wheat and 200u quintals of cotton, as
we move from A to F, we give up some units of wheat for some units of cotton For instance,
moving from A to B, we sacrifice 1000 quintals of wheat to produce 1000 quintals of cotton,
and so on. As we move from A to F, we sacrifice increasing amounts of cotton.

The following diagram (21.2) illustrates the production possibilities set out in the above table.

In this diagram AF is the production possibility curve, also called or the production possibility
frontier, which shows the various combinations of the two goods which the economy can
produce with a given amount of resources. The production possibility curve is also called
transformation curve, because when we move from one position to another, we are really
transforming one good into another by shifting resources from one use to another.
 19. Explain various types of price elasticity of
demand with the help of diagrams.

The degree to which demand responds to price changes is not always the same.
A product's demand can be elastic or inelastic, based on the rate of change in demand in
relation to a product's price change.
Elastic demand occurs when the demand response is larger with a modest proportional
change in price. Inelastic demand, on the other hand, occurs when there is comparatively less
change in demand with a higher rise in price.

Let us discuss the different types of price elasticity of demand 

1. Perfectly Elastic Demand:

It is considered to be completely elastic demand when a little change in the price of a product
produces a large change in its demand. In the case of fully elastic demand, a slight increase
in price produces a drop in demand to zero, whereas a small decrease in price generates an
increase in demand to infinite. In this situation, the demand is completely elastic, or ep = 00.
The degree of demand elasticity influences the form and slope of a demand curve. As a result,
the slope of the demand curve may be used to calculate demand elasticity. The greater the
elasticity of demand, the flatter the slope of the demand curve.
In perfectly elastic demand, the demand curve is represented as a horizontal
straight line,
According to Figure, at price OP, demand is unlimited; nevertheless, a little increase in price results
in a drop in demand to zero. Figure can alternatively be taken to mean that at price P, customers are
willing to buy as much of the product as they desire. A little price increase, on the other hand, might
discourage people from purchasing the goods.

However, fully elastic demand is a theoretical idea that cannot be used in practise. It can, however,
be used in situations such as a completely competitive market and homogeneous items. In such
circumstances, the demand for an organization's product is considered to be fully elastic.

2. Perfectly Inelastic Demand:

A completely inelastic demand occurs when there is no change in a product's demand in response to
a price adjustment. The numerical value for perfectly inelastic demand (ep=0) is zero.
In case of perfectly inelastic demand, demand curve is represented as a straight vertical
line

Figure shows that the price shift from OP1 to OP2 and OP2 to OP3 does not indicate a change in a
product's demand (OQ). For every price value, demand remains constant. Perfectly inelastic demand
is a theoretical idea that cannot be used in practise. However, in the case of necessary products such
as salt, demand does not vary in response to price changes. As a result, demand for critical products
is completely inelastic.

3. Relatively Elastic Demand:

Relatively elastic demand occurs when the proportional change in demand exceeds the
corresponding change in price of a product. Relatively elastic demand has a numerical value ranging
from one to infinity.

More than unit elastic demand (ep>1) is the mathematical definition of moderately elastic demand.
For example, if the price of a product rises by 20% but demand falls by 25%, the demand will be
relatively elastic.

The demand curve of relatively elastic demand is gradually sloping

It can be interpreted from Figure that the proportionate change in demand from OQ1 to OQ2
is relatively larger than the proportionate change in price from OP1 to OP2. Relatively elastic
demand has a practical application as demand for many of products respond in the same
manner with respect to change in their prices.
For example, the cost of a specific brand of cold drink rises from Rs. 30  to Rs. 40. In such a situation,
customers may opt for a different brand of cold beverage. However, some customers continue to
use the same brand. As a result, a minor change in price results in a bigger change in product
demand.

4. Relatively Inelastic Demand:

When the percentage change in demand is smaller than the percentage change in the price of a
product, the demand is said to be relatively inelastic. For example, if the price of a product rises by
30% yet demand falls by only 10%, the demand is said to be relatively inelastic. The numerical value
of moderately elastic demand (ep1) varies from zero to one. Marshall defines somewhat inelastic
demand as elasticity less than one.
The demand curve of relatively inelastic demand is rapidly sloping.

It can be interpreted from Figure that the proportionate change in demand from OQ1
to OQ2 is relatively smaller than the proportionate change in price from OP1 to OP2.
Relatively inelastic demand has a practical application as demand for many of
products respond in the same manner with respect to change in their prices.

5. Unitary Elastic Demand:

When a proportional change in demand results in the same change in the price of a product,
the demand is said to be unitary elastic. Unitary elastic demand has a numerical value of one
(ep=1).

The demand curve for unitary elastic demand is represented as a rectangular

hyperbola.

From Figure it can be interpreted that change in price OP1 to OP2 produces the same change
in demand from OQ1 to OQ2. Therefore, the demand is unitary elastic.

The different types of price elasticity of demand are

summarized
 20. Describe the two conditions necessary for
attaining equilibrium for a firm in the short run.
Short-Run Equilibrium of the Firm:

The short run is a span of time during which a firm's output can be varied by altering the
variable variables of production in order to maximise profits or incur minimum losses. The
number of businesses in the industry is set since neither current nor new firms may depart.

Its Conditions:
When a company is in equilibrium, it earns the most profit as the difference between its total
revenue and total cost. It must meet two requirements in order to do so: (1) MC = MR, and
(2) at the moment of equality, the MC curve must cut the MR curve from below and then
climb higher.
The market forces of demand and supply determine the price at which each business sells its
output. Each company will be able to sell as much as it wants at that price. However, owing
to competition, it will be unable to sell at a greater price than the market price. As a result, at
that price, the firm's demand curve will be horizontal, and P = AR = MR for the firm.

1. Marginal Revenue and Marginal Cost Approach:

The firm's short-run equilibrium may be explained using both marginal analysis and
total cost-total revenue analysis. First, we do a marginal analysis under similar cost
conditions.

This analysis is based on the following assumptions:

1. All firms in an industry use homogeneous factors of production.

2. Their costs are equal. Therefore, all cost curves are uniform.

3. They use homogeneous plants so that their SAC curves are equal.

4. All firms are of equal efficiency.

5. All firms sell their products at the same price determined by demand and supply of the
industry so that the price of each firm is equal to AR = MR.

Determination of Equilibrium:

Given these assumptions, suppose that price OP in the competitive market for the product of
all the firms in the industry is determined by the equality of demand curve D and the supply
curve S at point E in Figure 1 (A) so that their average revenue curve (AR) coincides with the
marginal revenue curve (MR). At this price, each firm is in equilibrium at point L in Panel
(B) of the figure where (i) SMC equals MR and AR, and (ii) the SMC curve cuts the MR curve
from below. Each firm would be producing OQ output and earning normal profits at the
maximum average total costs QL. A firm earns normal profits when the MR curve is tangent
to the SAC curve at its minimum point.

 If the price is higher than these minimum average total costs, each firm will be
earning supernormal profits. Suppose the price rises to OP2 where the SMC curve cuts
the new marginal revenue curve MR2 (=AR2) from below at point A which now
becomes the equilibrium point. In this situation, each firm produces OQ 2 output and
earns supernormal profits equal to the area of the rectangle P2 ABC.
 If the price falls below OP1 the firm would make a loss because the SAC would be higher than
the price. In the short-run, it would continue to produce and sell OQ 1 output at OP1 price so
long as it covers its AVC. S is thus the shut-down point at which the firm is incurring the
maximum loss equal to SK per unit of output. If the price falls below OP 1 the firm will close
down because it would fail to cover even the minimum average variable cost. OP 1 is thus the
shut-down price.
 We may conclude from the above discussion that in the short-run each firm may be making
either supernormal profits, or normal profits or losses depending upon the price of the
product.
2. Total Cost Revenue Analysis:
The firm's short-run equilibrium can also be demonstrated using total cost and total
revenue curves. The firm's profits can be maximised at the level of output when the
gap between total revenue and total cost is the greatest.
Starting from O, the total revenue curve is an upward sloping straight line. This is
because, under perfect competition, the company sells little or big amounts of its
product at a constant price. Total revenue will be 0 if the company generates nothing.
The greater the output, the greater the rise in overall revenue. As a result, the TR
curve is linear and slopes upward.
The firm's earnings will be maximised at the level of output where the difference
between the TR curve and the TC curve is greatest. It is the geometric level at which
 the slope of a tangent applied to the total expense curve matches the slope of the total
revenue curve.

TP measures the highest amount of profit at OQ production. Profits of the company

decrease when outputs are lower or bigger than OQ between A and B locations.
Because the TC curve is above the TR curve, the firm's losses are the greatest if it
generates OQ1 output. Profits are nil in the first quarter. A similar issue exists in Q2.

Since the marginal revenue equals the slope of the total revenue curve and the
marginal cost equals the slope of the tangent to the total cost curve, it follows that where the
slopes of the total cost and revenue curves are equal as at P and T, the marginal cost equals
the marginal revenue.
The explanation of the equilibrium of the firm by using total cost-revenue curves does not
throw more light than is provided by the marginal cost-marginal revenue analysis. It is useful only in
the case of certain marginal decisions where the total cost curve is also linear over a certain range of
output.

21. Discuss the conditions of price discrimination under monopoly.

In monopoly, there is a single seller of a product called monopolist.
The monopolist has control over pricing, demand, and supply
decisions, thus, sets prices in a way, so that maximum profit can be
earned.

The monopolist often charges different prices from different

consumers for the same product. This practice of charging different
prices for identical product is called price discrimination.

According to Robinson, “Price discrimination is charging different

prices for the same product or same price for the differentiated
product.”
There are three types of price discrimination, which are
shown in Figure-13:

i. Personal:
Refers to price discrimination when different prices are charged
from different individuals. The different prices are charged
according to the level of income of consumers as well as their
willingness to purchase a product. For example, a doctor charges
different fees from poor and rich patients.

ii. Geographical:
Refers to price discrimination when the monopolist charges
different prices at different places for the same product. This type of
discrimination is also called dumping.

iii. On the basis of use:

Occurs when different prices are charged according to the use of a
product. For instance, an electricity supply board charges lower
rates for domestic consumption of electricity and higher rates for
commercial consumption.

Figure-14 shows the degrees of price discrimination:

i. First-degree Price Discrimination:

Refers to a price discrimination in which a monopolist charges the
maximum price that each buyer is willing to pay. This is also known
as perfect price discrimination as it involves maximum exploitation
of consumers. In this, consumers fail to enjoy any consumer
surplus. First degree is practiced by lawyers and doctors.
ii. Second-degree Price Discrimination:
Refers to a price discrimination in which buyers are divided into
different groups and different prices are charged from these groups
depending upon what they are willing to pay. Railways and airlines
practice this type of price discrimination.

iii. Third-degree Price Discrimination:

Refers to a price discrimination in which the monopolist divides the
entire market into submarkets and different prices are charged in
each submarket. Therefore, third-degree price discrimination is also
termed as market segmentation.

Necessary Conditions for Price Discrimination:

Price discrimination implies charging different prices for identical
goods.

It is possible under the following conditions:

i. Existence of Monopoly:
Implies that a supplier can discriminate prices only when there is
monopoly. The degree of the price discrimination depends upon the
degree of monopoly in the market.

ii. Separate Market:

Implies that there must be two or more markets that can be easily
separated for discriminating prices. The buyer of one market cannot
move to another market and goods sold in one market cannot be
resold in another market.

iii. No Contact between Buyers:

iv. Different Elasticity of Demand:
23. What are the diseconomies of scale? Explain with illustrations

Diseconomies of scale happen when a company or business grows so large that the
costs per unit increase. It takes place when economies of scale no longer function for
a firm. With this principle, rather than experiencing continued decreasing costs and
increasing output, a firm sees an increase in costs when output is increased.

The diagram below illustrates a diseconomy of scale. At point Q*, this firm is
producing at the point of lowest average unit cost. If the firm produces more or less
output, then the average cost per unit will be higher. To the left of Q*, the firm can
reap the benefit of economies of scale to decrease average costs by producing more.
To the right of Q*, the firm experiences diseconomies of scale and an increasing
average unit cost.
Types of Diseconomies of Scale
Internal diseconomies of scale involve either technical constraints on the production process
that the firm uses or organizational issues that increase costs or waste resources without any
change to the physical production process.

1. Technical Diseconomies of Scale

Technical diseconomies of scale involve physical limits on handling and combining inputs
and goods in process. These can include overcrowding and mismatches between the feasible
scale or speed of different inputs and processes.

2. Organizational Diseconomies of Scale

Organizational diseconomies of scale can happen for many reasons, but overall, they arise
because of the difficulties of managing a larger workforce. Several problems can be identified
with diseconomies of scale.

3. External Diseconomies of Scale

External diseconomies of scale can result from constraints of economic resources or other
constraints imposed on a firm or industry by the external environment within which it
operates. Typically, these include capacity constraints on common resources and public
goods or increasing input costs due to price inelasticity of supply for inputs.
22. Explain the innovation theory of profit.
The Innovation Theory of Profit was proposed by Joseph. A. Schumpeter, who
believed that an entrepreneur could earn economic profits by introducing successful
innovations.

In other words, innovation theory of profit posits that the main function of an
entrepreneur is to introduce innovations and the profit in the form of reward is given
for his performance.

According to Schumpeter, innovation refers to any new policy that an entrepreneur

undertakes to reduce the overall cost of production or increase the demand for his products.

Thus, innovation can be classified into two categories;

 The first category includes all those activities which reduce the overall cost of
production such as the introduction of a new method or technique of production,
the introduction of new machinery, innovative methods of organizing the industry,
etc.

 The second category of innovation includes all such activities which increase the
demand for a product, such as the introduction of a new commodity or new quality
goods, the emergence or opening of a new market, finding new sources of raw
material, a new variety or a design of the product, etc.
The innovation theory of profit posits that the entrepreneur gains profit if his innovation is
successful either in reducing the overall cost of production or increasing the demand for his
product.

An entrepreneur can earn larger profits for a longer duration if the law allows him to patent his
innovation. Such as a design of a product is patented to discourage others to imitate it. Over the
time, the supply of factors remaining the same, the factor prices tend to rise as a result of which the
cost of production also increases. On the other hand, with the firms adopting innovations the supply
of good sand services increases and their prices fall. Thus, on one hand the output per unit cost
increases while on the other hand the per unit revenue decreases.

There is a point of time when the difference between the costs and receipts gets disappear. Thus,
the profit in excess of the normal profit disappears. This innovation process continues and also the
profits continue to appear or disappear.