Economics Past Questions Compilation (2013 June - 2022 June)

COMPILED BY KISAN JOSHI,
CA ASPIRANTS-ICAN
CHAPTERWISE COMPILATION OF Fundamental of Economics (CAP I)
[2009 June -2022 June]
Compiled by Kisan Joshi,

kisanjoshi001@gmail.com
CA ASPIRANTS-ICAN
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Chapter-1
Introduction to Microeconomics
1. Distinguish between micro and macroeconomics. (5Marks) (2013 JUNE)

Answer:
Micro economics is the study of individual economic units where as macro is the study of all the
units combined together or economy as a whole. Micro & macro economics are interdependent or
complementary to each other. However, there are some differences between them which can be
explained as follows.
i) Micro economics studies the individual units of the economy such as individual income, price of
the commodity, and output of the firm demand & supply of a commodity. But macro economics
deals aggregate variables such as national income, national saving, level of employment, etc.
ii) Micro economics covers various aspects like allocation of resources, theories of economic
welfare. Macro economics covers various aspects like income & employment theories, theories of
economic growth, theories of general price level and modern theories of distribution.
iii)Microeconomics is based on the assumption of full employment of resources. Hence, it takes total
employment, total output, and total expenditure as given. Macro economics does not assume full
employment. Hence it regards the variables like total employment, total output etc as flexible.
iv)Micro economics studies the equilibrium process by using partial equilibrium analysis. It analyzes
only the micro laws such as law of demand, law of supply, which are valid only under the ―ceteris
paribus‖ assumption. But macro economics uses general equilibrium analysis for the study of the
economy as a whole. It examined how the general price level is determined and how there sources
are allocated at the level of economic system as a whole.
v) Micro economics is based on price mechanism which is operated by the forces of market demand
and market supply. Equilibrium price and output is determined by the interaction of demand and
supply. It is also called price theory. On the other hand, national income, output and employment
are the basis of macro economics. These factors are determined by aggregate demand and aggregate
supply. It is also called theory of income and employment.
vi)Micro economics studies the equilibrium at a particular point of time; it does not explain the time
factor. So, micro economics is regarded as the static analysis. But macro economics is based on time
lag, rate of change, and expected value of variables so macro economics is regarded as dynamic
analysis.
vii) The study of micro economics is not of much help to solve the important present day problems
such as decline in national income, hyper inflation, wide spread unemployment and so on. On the
other hand, macro economics studies the causes, effects and possible measures for the solution of
these problems.
2. Explain the scope of microeconomics. (3 Marks) (2013 DEC)

Answer:
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Scope of microeconomics can be explained with the help of following points

• Allocation of Resources: -
Microeconomics assumes that total quantity of resources is given and it seeks to explain how they
are allocated in production of various goods and services. Therefore, microeconomics studies the
allocation of resources and determines what to produce? How to produce? And for whom to
produce?
• Theory of product pricing: -

Microeconomics studies the process of price determination of goods and services in different market
structure. The market can be perfect competition, monopoly, monopolistic and oligopoly. The
theory of product pricing is also known as the theory of the firm. The subject matter of theory of
product pricing is theory of demand and theory of production and cost.
• Theory of demand:
Goods are produced for consumer. Microeconomics studies the consumer behavior. It studies law
of demand, elasticity of demand, law of diminishing marginal utility, consumer’s surplus, and
indifference curve, revealed preference theory and so on.
• Theory of production and cost:

One of the important scopes of microeconomics is production and cost theory. It includes law of
variable proportion, law of return to scale, least cost combination of inputs, different concepts of
cost, linear programming and so on.
• Theory of factor pricing:

The theory of factor pricing is another scope of microeconomics. It is also called as theory of
distribution. Microeconomics studies about the determination of price of factor of production, i.e.
land, labour, capital and organization. The rewards for these factors are called rent, wages, interest
and profits.
• Theory of economic welfare:

The theory of economic welfare is also known as welfare economics. The theory of economic
welfare refers to the economic efficiency of factors of production in the line of production,
consumption, distribution and exchange. The important function of welfare economics is to define
and analyze the law of economic efficiency which is the main scope or subject matter of
microeconomics.
3. Economics is science of wealth. Discuss. (3) (2014 JUNE)
Answer:
Earlier economists (known as the classical economists) like Adam Smith and his distinguished
followers J.S. Mill, F.A. Walker, J.B. Say, David Ricardo, etc. treated economics as a science of
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wealth. Adam Smith universally regarded as the Father of Economics, defined economics as a
science, dealing mainly with the question of how wealth was produced and distributed. The
emphasis on wealth reveals itself in the very title of Smith’s book. “The great objective of the
political economy of every country”, wrote Smith, “is to increase the riches and power of that
country”. Adam Smith, therefore, thought of economics as an inquiry into the nature and causes of
the wealth of Nations. In short, economics is a science of wealth.
The disciples of Adam Smith continued to stress the role of economics as the study of wealth.
According to J.B. Say, “Economics is the study of the laws which govern wealth.” Prof. Walker
supported Adam Smith’s definition by saying, “Economics is that body of knowledge which relates
ot wealth”. J.S. Mill wrote, “Economics investigates into the nature of wealth and laws of production
and distribution.” Thus economics was considered as a science of wealth. The main points in the
definitions are:
a) Economics is the study of wealth only; it deals with consumption, production, exchange and
distribution of wealth.
b) Only such material commodities, as constitute wealth are scarce and useful. Non-material
things like services and free goods are not included in wealth.
c) Economics is only concerned with the activities, of the economic man not of the non- economic
man.
d) The source of the wealth of a nation is the laborer whose productivity would be increased
through the division of labour.
e) The ultimate goal of human beings is to earn wealth, because wealth is only the means for
satisfying human wants.
f) This definition laid stress on the existence of the free capitalist economy.
g) Classicists gave the key or first place to wealth and secondary place for the man in the
study of economics. In other words, the subject matter of economics as wealth.
4. What are the basic differences between micro and macroeconomics? (3) (2014 DEC)
Answer:
The main points of difference between them are as follows :

1. Literalmeaning: The term micro-economics was derived from the Greek word ‘mikros’ meaning
small. Likewise, the term macro-economics was also derived from the Greek word ‘makros’ meaning
large.
2. Studyof aggregate variables: Micro-economics is the study of individual units like individual
demand , individual supply , individual income etc. But macro –economics includes the study of the
aggregate variables such as aggregate demand, aggregate supply, national income etc.
3. Partialand general equilibrium analysis: Micro- economics studies the individual equilibrium
process by using partial equilibrium analysis. On the other hand macro-economics uses general
equilibrium analysis for the study of the economic behavior of the economy as a whole.
4. Scopeof micro and macroeconomics: Micro-economics covers the areas such as the pricing of
products, pricing of factors of production, theories of economic welfare and so on. Whereas macro
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economics covers the area such as theories of income and employment, theories of money and price
level, theories of economic growth and so on.
5. Assumption of full employment: Micro-economics assumes full employment of all factors
including labour. But macroeconomics doesn’t assume full employment.
5. Describe the scope of microeconomics.(3) (2015 DEC)
Answer:
Micro economics deals chiefly with the choice and decision-making behavior of households, firms and
industries and the relationship between prices and quantities of individual goods and services. The scope
of microeconomics can be explained with the help of following components:
(i) Theory of Demand: Under this head, microeconomics studies concepts and theories like demand
function, elasticity of demand, etc. related to consumer’s behavior.
(ii) Theory of production: Under this head, microeconomics studies concepts and theories of
production like production function, cost function, etc related to producer’s behavior.
(iii) Theory of pricing: Under this head, microeconomics studies the process and basis of
determining price of product and impacts under different market structures.
(iv) Theory of economic welfare, microeconomics also studies the theories related to economic
welfare.
(v) Theory of factor Pricing: Microeconomics also deals with determination of prices of factor
of production such as rent, interest, wage, profit etc.
6. Define micro and macroeconomics. Explain any four differences between them.(3)(2016 DEC)
Answer:
Microeconomics is a branch of economics that studies the nature, relationship and behavior of individual
households and firms in making decisions on the allocation of limited resources. Whereas
Macroeconomics is a branch of economics that studies the nature, relationship and behavior of such
aggregate quantities and averages as national income, total consumption, savings, investment, total
employment, general price level and so on.
The main differences of Microeconomics and macroeconomics can be stated as following:
a) Difference in origin and development: Microeconomics was originated form Greek word
‘MIKROS’ which means small and initiated by Classical economists. Whereas macroeconomics was
originated form Greek word ‘MAKROS’ means large and Initiated by J.M.Keynes.
b) Difference in Objective of study: The objective of Microeconomics is optimum allocation of
resources, whereas the objective of macroeconomics is full employment and growth of
resources.
c) Difference in Methodology of study: Microeconomic study is based on partial equilibrium
analysis. Whereas Macroeconomic study is based on general equilibrium analysis.
d)Difference in scope of study: Microeconomics has limited scope and includes individual consumer,
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producer, firm, industry etc. as its subject matter. Whereas Macroeconomics has broad scope and
includes National income,aggregate employment, Price level etc. as its subject matter.
Even though there are many differences between Microeconomics and macroeconomics but in fact
they are like two sides of a same street and interdependent with each other rather than different.
7. How is the microeconomics useful for efficient allocation of resources?(3)(2017 JUNE)

Answer:
An efficient allocation of resources is defined as a desirable situation where our scarce resources are
used to produce particular types of goods and services that best maximise the overall satisfaction of
society‟s needs and wants, wellbeing or living standards (both in the short and long terms). An efficient
allocation of resources occurs when we produce the goods and services that people value most highly.
Resources are allocated efficiently when it is not possible to produce more of a good or service without
giving up some other good or service that is valued more highly. In this situation marginal benefit and
marginal cost of the production are equal.
The study of microeconomics helps in understanding that how a firm or an industry etc can
maximize its production efficiency and the profit by appropriate allocation and utilization of
resources at its disposal. Theory of production in microeconomics explains that a producer allocates
resources efficiently when:
MPK/ PK = MPL /PL, where MPK is marginal product of capital, MPL = is marginal product of labour
PK = price for use of capital and PL = price for use of labour
Similarly, microeconomics also concerns how a consumer allocates resources to maximize

satisfaction. Theory of consumer's behaviour in microeconomics explains that a consumer allocates
resources efficiently when:
MUA/ PA = MUB/ PB = ……………………………….= MUN/ PN, where MU = marginal utility, P= price,
A,B,…..N are the goods and services that a consumer consumes
Resources are efficiently allocated by competitive markets through market mechanism or price
mechanism. In competitive market, price is determined by demand and supply, and the price decides
the basic economic issues like: What to produce? How to produce? For whom to produce? Demand
and supply are the fundamental analyzing tools of microeconomics.
8. Explain the definition of economics given by Alfred Marshall.(3)(2017 DEC)

Answer:
After the wealth definition of economics by Adam Smith in 1776 AD, one of the forefathers of neo-
classical thought Alfred Marshall had given one of the popular definitions of economics in 1890 AD.
According to Alfred Marshall, “on the one side economics is the study of wealth; and on the other, and
more important side, it is the study of mankind”.
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In his definition, Marshall reverted the priority of economics as given by Adam smith. He gave first
priority to human beings and second priority to the wealth. Wealth is only the means to fulfil the human
wants but the role of human beings is more important in the society than the role of wealth. He defined
economics as social science for the first time. The main features of welfare definition of economics given
by Alfred Marshall are as follows:
1.Primary concern on mankind
2.Stress on material welfare
3.Economics as social science
h) Microeconomics concerns about the optimum allocation of resources rather than full employment
and growth of resources. Justify the statement with proper example. 3 (June 2018)
Answer:
Microeconomics is a branch of economics which deals with the relationship between the small or
individual variables such as individual consumer, household, firm, industry etc. it also helps in making
decisions on the allocation of available limited resources. Microeconomics can also be defined as the
worm’s eye view analysis of microeconomic variables.
One of the goals of microeconomics is to analyze market mechanisms that establish relative prices
amongst goods and services and allocation of limited resources amongst many alternative uses.
Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes
the theoretical conditions needed for perfect competition.
The main objective of microeconomics is to study principles, problems and policies related to optimal
allocation of resources. Microeconomics don’t deal with the growth of resources rather allocates the
available limited resources to its best use. As for example, when the consumer has limited budget to spend
on various goods and maximize the utility in such case microeconomics can be the useful tool to solve
that problem. Similarly, if the producer has limited cost to employ inputs used in the production process
microeconomics teaches in optimal employment of inputs as well.
i) "Economics is the science that explains the efficient use of scarce resources."Explain. 3 (2018DEC)
Answer:
The fundamental economic problem facing all societies is that of scarcity. Scarcity is the
condition in which our wants (for goods and services) are greater than the limited resources
(land, labor, capital, and entrepreneurship) available to satisfy those wants.
Wants are unlimited. When one economic want is satisfied another want appears. But our
means or resources of fulfilling such wants are limited. Thus, scarcity arises due to the
imbalance between unlimited wants and limited resource.
As scarcity exists everywhere and for all economic units from individuals to government,
all are forced to make choices. People have to make choices because of scarcity. Because
our unlimited wants are greater than our limited resources, some wants must go unsatisfied.
Efficient use of resources is the situation in which every resource is optimally allocated by
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minimizing waste. As the resources have alternative uses, right choice for use of resources
helps for its efficient use. If people make right choice, it makes their life comfortable
otherwise their life will be hard. The efficient use of resource is related to what to produce,
how to produce, how much to produce and how to distribute to its people.
Economics is the subject that gives tools and techniques for efficient use of resources.
Consumers, producers and government can use the economic theories for best use of them.
So, economics is the science that explains the efficient use of scarce resources.
Economist Lionel Robbins rightly stated “Economics is the science which studies human
behavior as a relationship between ends and scarce means which have alternative uses”.
11. Define microeconomics. How the microeconomics is useful in economy? (5 marks) (2019DEC)
Answer:
Microeconomics is the study of economic action and behavior of individual units or small units of
individual units like consumer, firm or factor owner. It explains small components of national
economy and explains their equilibrium position and interrelationship among those components. It is
the study of how individuals and firms make themselves as well off as possible in the world of scarcity
and consequences of those individual decisions for market and entire economy. Microeconomics
analyzes the price of a specific product, the number of workers employed by a single firm, the revenue
or income of a particular firm or household, or the expenditures of a specific firm, government entity,
or family.
The managers use the microeconomic theories for best managerial decisions. It is helpful to study
consumer's behavior, to study input and output relationship, to forecast demand for future,
organizational design, product selection, product pricing, product promotion, worker hiring and
training and investment and financing decision.
The microeconomics is useful as:
i. To understand the operation of an economy
Microeconomics explains the nature of the interrelationships between microeconomic variables
and provides us the knowledge of the working of complex economic system. In other words, it
explains the conditions of efficiency in both consumption and production, i.e. efficiency of
exchange and production. In short, it studies price mechanism and provides tools to verify the
working system of an economy.
ii. To provide tools for economic policies
Microeconomics helps to formulate economic policies to the government on the proper allocation
of resources. It also helps in pricing of certain public utilities like postal service, railways, water
supply, electricity, etc. in order to promote mass welfare. Similarly, microeconomics helps policy
makers to apply relevant microeconomic theories in explaining the problems, analyze the
implications of alternative policies and select one which seems to be most appropriate.
iii. To examine the conditions of economic welfare
Microeconomic theories provide the base for the formulation of propositions that maximize social
welfare. In other words, it consists of the study of welfare economics. Welfare economics is related
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to the maximization of social welfare (i.e. efficiency of production and exchange) which is
possible only under perfect competition. It reveals how under imperfect competition there is a
misallocation of resources (money, men and material) and how the output obtained is always less
than the optimum. Therefore, it also suggests means to correcting the inefficient allocation of
resources and eliminating inefficiency.
iv. Efficient Utilization of Resources
Microeconomics helps for optimum utilization of resources of consumer and producer. It provides
the law of substitution by which a consumer will maximize his satisfaction, where the ratio of
marginal utilities of goods is equal to the ratio of their prices.
v. Useful in International Trade
The study of microeconomics enables us to estimate gains from international trade and the
determination of the foreign exchange rate. It is the microeconomics that helps to analyze the
relative elasticity of demand for each other’s product and also to determine the gains from
international trade. Similarly, the rate of foreign exchange in a free market is determined by the
demand for and supply of foreign currency.
vi. Useful in Business Decision-Making
Price theory can be applied to solve certain managerial problems continually faced by business
enterprises. Another name of price theory in the service of business executives is known as
managerial economics. It helps business to achieve maximum production with the given amount
of resources. With the help of microeconomics, business firms can make decisions in demand
analysis, cost analysis and methods of calculating prices. Thus, microeconomics is helpful in
business decision making in following sectors:
 To study consumer's behavior
 To study input and output relationship
 To forecast demand for future
 Organizational design
 Product selection
 Product pricing
 Product promotion
 Worker hiring and training
 Investment and financing, etc.
12. State the welfare definition of economics provided by Alfred Marshall? 3 marks (2020 Dec.)
Answer:
The leader of the neo-classical period Alfred Marshall provided the material welfaredefinition of
economics in his book "Principles of Economics" published in 1890. According to him, "Economics
is a study of mankind in the ordinary business of life. It examines that part of individual and social
action which is most closely connected with the attainment and use of material requisites of well-
being."
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Main features
1. Study of mankind
2. Normative Science
3. Social Science
4. Study of Material activities
13. Differentiate between microeconomics and macroeconomics. 3 marks (2021 December)
Answer:
Bases Microeconomics Macroeconomics
Definition Microeconomics studies the Macroeconomics studies the behavior

behavior of individual economic of the whole economy.
units like individual producer,
individual consumers, etc.
Basis Demand and supply of a particular Aggregate demand and aggregate

factor or commodity are the main supply of a whole economy are the
basis of microeconomics. main basis of macroeconomics.
Main focus It is focused on price determination It is focused on determination of level

and allocation of resources through of income and employment. So, it is
price mechanism. So, it is also also called Theory of income and
called Price Theory. employment.
Subject Theory of product pricing, factor Theory of income and employment,

matter pricing, resource allocation and general price level, economic growth
economic welfare are the major and distribution are the major subject
subject matters of matters of macroeconomics.
microeconomics.
14. “Micro economics has a great significance in business decision”. Give three reasons. 3 Marks (2021 December)
Answers: With the help of micro economics, business firms can make decisions in demand analysis, cost analysis
and methods of calculating prices. They are explained below:
A. Optimal Resource Allocation. Business firms have limited or scarce economic resources by which they are
facing the problem of optimization, i.e. Output or profit maximization or cost minimization. Hence, they
will have to make optimum allocation of resources to achieve their goals. Micro economics also helps to the
business firms to select highly efficient and least cost production technique.
B. Basis for Prediction. Microeconomic theories establish cause and effect relationships between two or
more economic events. It also provides the basis for predicting the future course of economics.
Microeconomics theories are of great importance in the planning of the future course of economic activities
alone by individuals, business firms and the government. For example, micro economics states that the fall of
the demand for a product comes out with the fall of the price. This type of prediction indicates the future trend
of price. Such predictions help the policy-makers formulate polices regarding prices of commodities.
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C. Linear Programming. Micro economics provides the technique of linear programming by which a
producer takes a number of important decisions. He knows which factor is available in abundance and whose
supply is scarce in quantity. This knowledge helps a farmer or an entrepreneur to mix the factors of
production in an optimum manner and can increase his income. Linear programming also investigates the best
possible production process among the alternative production processes to attain maximum income.
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Chapter-2
Demand and Supply Analysis
1. Define price elasticity of demand. Explain various uses of price elasticity of demand in
business decision. (3+7=10) (2013
JUNE)
Answer:
a) Price elasticity of demand indicates the degree of responsiveness of quantity demanded of a good
to a change in its price, other factors such as income, taste & preference of the consumers, prices of
related commodities that determine demand, are held constant. In other words price elasticity of
demand is defined as the ratio of percentage or proportionate change in quantity demanded to a
percentage change in price. Thus,
Ep=
Ep=
Symbolically,
Where,
Q=quantity of commodity P=price of commodity
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Chapter wise Compilation of Past Questions Answer of Economics for CAP I
CA FINAL (CAPIII)
The various uses of price elasticity of demand in business decision making can be explained as
follows:
i) Product pricing
With the knowledge of price elasticity of demand, the producer will be able to increase or
decrease the price of commodities. If the demand for commodities is elastic, it is desirable to
reduce the price and will lead to an increase in sales of the commodities .On the other hand, if
the demand is inelastic; it is desirable to increase the price.
ii) Pricing factor of production
The concept of price elasticity of demand is also useful to determine the price of factor of
production. If the demands for factor of production are inelastic, the producers are prepared to
pay more prices for these factors. Similarly, they are ready to pay low price for elastic factors
of production.
iii)Pricing of joint product
Some goods are produced jointly due to some reasons, such as meat and wool production jointly
from sheep farming with same investment etc. It is difficult to separate the cost of production of
these goods. In such a situation, the price is determined on the basis of elasticity of demand.
High price charges to inelastic product and low price to highly elastic product.
iv)Demand Forecasting
The concept of elasticity of demand is useful to the firm in demand forecasting. The firm can
make necessary arrangement of raw materials, inventory, personnel and finance for
production on the basis of expected change in demand.
v) Trade union
The concept of price elasticity of demand is useful to trade union in wage bargaining. Trade
union will be able to get their wage high if the demand for their service is inelastic.
2. Explain the law of diminishing marginal utility. What are its exceptions? (8+2=10)(2013
JUNE)
Answer:
The law of diminishing marginal utility was propounded by H. Gossen in 1854 AD and
further restated by Alfred Marshall. The law of diminishing marginal utility describes a
familiar and fundamental tendency of human behavior. The law of diminishing marginal
utility states that: ―As a consumer consumes more and more units of a specific commodity,
the utility from the successive units goes on diminishing‖.
According to Marshall, ―The additional benefit which a person derives from an increase of his
stock of a thing diminishes with every increase in the stock that already has‖.
The law of diminishing marginal utility is based upon three facts. First, total wants of a man are
unlimited but each single want can be satisfied at a time. As a man gets more and more units of
a commodity, the desire of his for that good goes on falling. A point is reached when the
consumer no longer wants any more units of that good. Secondly, different goods are not perfect
substitutes for each other in the satisfaction of various particular wants. As such the marginal
utility will decline as the consumer gets additional units of a specific good. Thirdly, the
marginal utility of money is constant given the consumer‘s wealth.
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Explanation of the law :

This law can be explained by taking a very simple example. Suppose, a man is very thirsty. He
goes to the market and buys one glass of sweet water. The glass of water gives him immense
pleasure or we say the first glass of water has great utility for him. If he takes second glass of
water after that, the utility will be less than that of the first one. It is because the edge of his thirst
has been blunted to a great extent. If he drinks third glass of water, the utility of the third glass
will be less than that of second and so on.
It can be more cleared with the help of following schedule and diagram.
Units Total Utility Marginal Utility

1st glass 20 20
2nd glass 32 12
3rd glass 40 8
4th glass 42 2
5th glass 42 0
6th glass 39 -3
In the figure, along OX we measure units of a commodity consumed and along OY is shown the
marginal utility derived from them. The marginal utility of the first glass of water is called initial
utility. It is equal to 20 units. The MU of the 5th glass of water is zero. It is called satiety point.
The MU of the 6th glass of water is negative (-3). The MU curve here lies below the OX axis.
The utility curve MM/ falls left from left down to the right showing that the marginal utility of
the success units of glasses of water is falling.
The law is based on following assumptions:

i) Rationality
ii) Consumption units must be homogeneous and reasonable
iii) MU of money remains constant
iv) continuous consumption
The main exceptions of the law are:
1. This law does not apply to rare things or curious things like old coins, rare paintings, diamonds,
stamps etc. It is because the consumer has to sactrifice more time, money and effort to collect
these things. Thus, MU from each successive unit goes on increasing.
2. When a consumer consumes a commodity for the first time, he may get and increasing
marginal utility, for long time. This may be the case with a man who has seen the television for
the first time in his life.
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3. Marshall assumed that the marginal utility of money remains constant or does not go on falling,
it goes on increasing if and extra unit of money is spent.
4. Persons who have a craze for books, music or poetry, may obtain more or more utility by the
successive units of those things.
5. If a person is habituated to use alcohol or other intoxicants, then the utility from the commodity
may increase because of the change in his mental condition due to the use of alcohol or
intoxicants.
3. Explain the concept of cross elasticity of demand with its types. (5) (2013 JUNE)
Answer:
Cross elasticity of demand can be defined as the degree of responsiveness or sensitivity of

quantity demanded of the commodity towards price of related goods. In other words, cross
elasticity of demand measures the relative effect on quantity demanded of the commodity with
change in price of related goods.
Mathematically, cross elasticity of demand can be stated as,
exy = % change in quantitydemandedfor x good
% change in price of y good
There are three types of cross elasticity of demand. They can be explained as following:
Py ec=0 (
ec >0
ec<0
Qx
i) Positive cross elasticity of demand:

If two goods X and Y are substitutes, increase in price of one commodity also increases the
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quantity demanded of another commodity in the market. In this case, value of cross elasticity
will be positive. As for example: increase in price of coke also increases demand of pepsi in the
market.
ii) Negative cross elasticity if demand:
If two goods X and Y are complements, increase in price of one commodity decreases the
quantity demanded of another commodity in the market. In this case, value of cross elasticity
will be negative. As for example: increase in price of car decreases demand of petrol in the
market.
iii)Zero cross elasticity of demand:
If two goods X and Y are non-related, change in price of one commodity doesn‘t show any effect
on the quantity demanded on the commodity. It is the case of zero cross elasticity of demand.
As for example: change in price of cement will not affect quantity demanded of books in the
market.
4. What are the determinants of demand? Explain any two. (3) (2013 DEC)
Answer:
Demand always relates to price and other determinants of demand at a period of time. Demand
for a commodity is defined as the quantity of that commodity which a consumer is willing and
able to purchase at given price of that commodity for a specified period of time.
The main determinants of demand are: Price of a commodity, Income of the consumer, Price
of related goods, Taste and fashion of The consumer, Advertisement expenditure, Size of
population, taxation policy, money supply, climate and weather, state of business, conventions
etc
i. Price of a commodity: Other things being equal, demand for a commodity varies inversely
with price of same commodity. In other words, when price of a commodity increases, demand
for that commodity decreases and vice versa. It is due to the operation of law of diminishing
marginal utility, income effect, substitution effect, etc.
ii.Income of the consumer: The relationship between income and demand can be established
as follows:
A) Normal goods: Other thing being equal, when income increases, demand for normal goods
also increases and vice versa. It implies that demand for normal goods varies positively with
income.
B) Inferior goods: Other things being equal, when income increases, demand for inferior good
decreases and vice versa. It implies that demand for inferior good varies inversely with income.
5. Discuss about Law of Diminishing Marginal Utility. (5) (2014 JUNE)
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CA FINAL (CAPIII)
Answer:
The law of diminishing marginal utility was first developed by German economist H.H.
Gossen. So this law is also known as the first law of Gossen. But later, Alfred Marshall
furnished this law in an analytical way.
Statement:-
According to the law of diminishing marginal utility, marginal utility of a commodity diminishes
as an individual consumes more units of a commodity. In other words, as a consumer consumes
more units of a commodity, the extra satisfaction or marginal utility that he derives from an extra
unit of the commodity goes on falling.
According to Marshall- “The additional benefit which a person derives from a given increase of
his stock of a thing diminishes with every increase in the stock that he already has.”
Initially, in the process of consuming only marginal utility declines and not the total utility. The
total utility goes on increasing at a decreasing rate and becomes maximum at a certain point
where marginal utility becomes zero. If the consumer consumes mote unit beyond this point, he
will get disutility or dissatisfaction. In this situation total utility also begins to decline.
The law of diminishing marginal utility describes a familiar and fundamental tendency of human
nature. This law in based on the following assumptions:
1) Rationality: - The consumer is assumed to be rational through the experiment.
2) Homogeneity: - All units of the commodity should be equal in size and quality.
3) Continuity: - The commodity must be consumed continuously. That is, units are consumed
one after another without any interval of time.
4) Constancy: - There should not be any change in income, taste, preferences or fashion of
commodity.
5) Cardinal measurement of utility: - Utility can be numerically expressed by the consumer.
This law can be explained through table and figure.

Units of Commodity Total Utility (TU) Marginal Utility (MU)
1 20 20
2 35 15
3 45 10
4 50 5
5 50 0
6 45 -5
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CA FINAL (CAPIII)
In above table, if consumer continuously consumes 1st, 2nd, 3rd, 4th and 5th units of commodity
marginal utility goes on falling ie, 20, 15, 10, 5 and 0 utils of respectably. If he again
consumes 6th unit of commodity, marginal Utility becomes negative and total Utility also
decrease.
In the above diagram, the units of commodity and the marginal utility are measured on X-axis
and Y-axis respectively. According to the diagram, UU1 is the marginal utility curve which is
formed by the summation of different points (which refers the relation between units of
commodity and their marginal utilities) A, B, C, D, E, F respectively. It slopes downwards, left
to right, indicating that when the consumer consumes more, or more units, of the same
commodity, the marginal utility obtained from each successive unit goes on diminishing and
also becomes negative as shown in the figure.
A point lying on the UU1 curve reflects the initial utility which is more. Point E refers to the
point of satiety or full satisfaction of the consumer because at this point MU is equal to zero.
Point F refers to the condition of disutility because at this point MU is negative
6. Define indifference curve. (3) (2014 JUNE)
Answer:
The Indifference Curve analysis is developed to overcome the defects of marginal utility
analysis or cardinal approach. An indifference curve represents satisfaction of a consumer from
two commodities. It is drawn on the assumption that for all possible points on an indifference
curve, the total utility remains the same. An indifference curve represents preference of the
consumer between two commodities. On the basis of consumer's scale of preference, we can
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CA FINAL (CAPIII)
draw indifference curves. An indifference curve represents satisfaction of a consumer from two
commodities. It is drawn on the assumption that for all possible points on an indifference curve,
the total utility remains the same. An indifference curve represents preference of the consumer
between two commodities.
We can explain indifference curve with an example of apple and orange. Let us suppose that if a
consumer wants to buy some units of apples and oranges. The consumer does not make purchases of
the amount of these commodities arbitrarily. He knows it well that one combination of apples and
oranges gives him as much satisfaction as another combination of less apples and more oranges or
another combination of more apples and less oranges. Thus the consumer will have combination of
apples and oranges in his mind. All the combination yields same satisfaction to the consumer. So the
consumer will be indifferent to choose any combination from the various combinations. We can
further explain it with the help of following indifference schedule.
Indifference schedule
Combination Apples Oranges
1 15 1
2 11 2
3 8 3
4 6 4
5 5 5
In the table given above, the consumer is assumed to be purchasing combination of apples and
oranges. He tells us that he is indifferent between the 5 combinations given above. When we show
these combinations on a graph showing apples in one axis and orange on another axis we obtain a
curve. This curve is called indifference curve. An indifference curve is the locus of all the points
representing various combinations of two commodities giving the same satisfaction to the consumer.
Y
Y Commodity
IC
OX
X Commodity
In the above diagram, IC is the indifference curve showing the various combinations of the two
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CA FINAL (CAPIII)
commodities which give the consumer equal satisfaction. An indifference curve may therefore be
defined as the locus of the various combinations of two commodities, which yield the same total
satisfaction to the consumer. The curve is also called as the iso-utility curve or a curve of equal utility.
It is not necessary that there should be only one combination of two commodities. There might be
versions combinations of two commodities representing greater and lesser satisfactions than the
previous one. In this case there will be numbers of indifference curve. If there will be numerous of
indifference curve then there will be called as indifference map.
7. Why does the law of demand operate? Explain. (5) (2014 DEC)
Answer:
The causes responsible are as follows:
(I) Income Effect: When the price of the commodity falls, consumer’s purchasing power
increases. That is, with the same money income, they are able to purchase more goods
when the priceof the commodity falls.
(II) Substitution effect: when the price of the commodity falls, it becomes relatively cheaper
than other commodity in the market. This induces the consumer to substitute the
commodity whose price has fallen for other commodity which has now become relatively
dearer. As a result of this substitution effect, the quantity demanded of the commodity,
whose price has fallen, rises.
(III) Law of diminishing marginal utility: According to the law of diminishing marginal
utility, as consumer consumes more and more unit of a commodity, the utility obtained
from the additional unit known as marginal utility goes on declining. Thus, consumer
consumes more when the price falls.
(IV) Affordable for new consumer: When the price of a commodity is relatively high, only
few consumerscan effort to buy. When the price of a commodity falls, more consumers
would start buying it because some ofthose whopreviously could not afford tobuyit may
now afford to buy it.
(V) Multiple uses: There are some commodities which can be put into several uses. When
the price of a commodity increases, the consumers reduce the use use of this commodity.
Hence purchase is reduced.
8. Define cross elasticity of demand. What are its types? (3) (2014 DEC)
Answer:
Other things being equal, cross elasticity is the ratio of the percentage change in the
quantity demanded for one commodity with the percentage change in the price of another
related commodity. In other words, it measures the degree of responsiveness of the
quantity demanded for x good to the change in the price of y good. It is connected with
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CA FINAL (CAPIII)
substitutes and complements.

exy = % change in quantitydemandedfor x good
% change in price of y good %
Cross elasticity is of three types:

1. Positive Cross Elasticity of Demand (exy = +ve)
If the quantity demanded for one commodity, say X good, varies positively with the price of
another commodity, say Y good, cross elasticity will be positive. It is connected with
substitutes.
2. Negative Cross Elasticity of Demand (exy = –ve)
If the quantity demanded for one commodity, say X good, varies inversely with the price of
another commodity, say Y good, cross elasticity will be negative. It is connected with
complements.
3. Zero Cross Elasticity of Demand (exy = 0)
If there is no any response in quantity demanded for one commodity, say X good, due to
the change in price of another commodity, say Y good, cross elasticity will be zero. It is
connected with non-related goods.
9. Define cardinal and ordinal measurement of utility. (3) (2014 DEC)
Answer:
Cardinal and Ordinal utility analysis
Consumer's behaviour can be explained by two methods (i) Cardinal approach or marginal utility
analysis (ii) Ordinal approach or indifference curve analysis. Cardinal analysis is also known by the
name of Marshallian utility analysis whereas ordinal approach is known by the name of Hicks and
Allen approach. The term cardinal and ordinal have been borrowed from mathematics. The numbers
1,2,3,4 etc. are cardinal numbers. A person can express the satisfaction derived from the consumption
of a commodity in quantitative terms. He can say, for instant, that for him the first unit of the commodity
has utility equal to 10, the second unit 8, and so on. The cardinal number 2, for example is twice the
size of number 1. In this case utility is measured in imaginary units. In contrast, the number 1st, 2nd,
3rd, 4th etc. are ordinal numbers. The ordinal numbers are ranked or ordered. It is not possible to know,
from the ranking list, the actual size relation of the numbers. The 2nd numbers might not be twice as
big as the 1st number. The ordinal numbers 1st, 2nd, 3rd, and 4th could be 10, 15, 35, 50 and 20, 40,
50 and 60. According to ordinal approach, since utility is a subjective phenomenon it cannot be
measured quantitatively. We can only say that the utility derived from different units gave more, less
or equal situation. The ordinal concept permits us to say only that the consumer prefers an apple to an
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CA FINAL (CAPIII)
orange, but it does not indicate by how much. Marshall is in cardinal approach and he explained
consumer's behaviour with the help of cardinal measurement of utility whereas modern economist like
Hicks and Allen, have supported the ordinal approach and replaced the utility analysis by the
indifference curve analysis.
10. Explain the law of supply. (3)(2015 DEC)
Answer:
Law of supply states that quantity supplied of a commodity varies positively with price of
same commodity, other things being equal. It implies that when price of a commodity
increases, quantity supplied of same commodity also increases and vice versa. In other
words, it shows the direction of change in quantity supplied due to change price of same
commodity.
Based on given figure, SS1 is the supply curve. It slopes upwards to the right. This slope
indicates that quantity supplied of a commodity varies positively with price of same
commodity.
11. Define supply. Explain the two cases under shift in supply with the help of schedule and diagram.
(5) (2016 JUNE)
Answer: Please write as per teacher's instruction.
12. Define price elasticity of demand. Explain any four uses of price elasticity of demand in
business decision making. (5) (2016 DEC)
Answer:
Price elasticity of demand refers to the degree of responsiveness or sensitivity of

quantity demanded of a commodity towards price of the commodity. In other
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CA FINAL (CAPIII)
words, price elasticity of demand measures the relative effect on quantity demanded
of a commodity due to change in its price.
Mathematically, it can be expressed as,
Price elasticity of demand has enormous uses in business decision making, in fact: price
elasticity of demand is one of the main tool of business decision making. The main four uses
of price elasticity of demand in business decision making are as follows:
1. Determination of Price of the Product:
Price elasticity of demand helps in determination of price of the product. If the product is
highly elastic higher price will reduce demand of the product significantly. Hence, price of
highly product should be lower in the market and price of less elastic product will be higher
since it will not decrease demand significantly.
2. Demand Forecasting :
Price elasticity of demand is useful in forecasting the future demand of the product with the
expected price of the market in future. If the coefficient of elasticity of a product is known, we
can predict/forecast the future demand as per the expected price of future.
3. Analysis of Market :
Price elasticity can also be useful to analyze the market whether the market is highly
competitive, normal or monopolistic. If substitute goods are available, the market will be highly
elastic and competitive. Similarly, if there is no any substitute good, the market will be inelastic
and monopolistic.
4. Determination Business Strategies:
To determine any business successful strategy, the businessperson should have complete
knowledge about the market, rivalry, future demand etc. Price elasticity of demand helps the
businessmen to know about such things and make appropriate business strategy and business
planning.
In conclusion, Price elasticity of demand is the measurement of sensitivity of change in price
of the commodity to the quantity demanded of the product. It is one of the major tool to make
the business decisions like pricing, demand forecasting, market analysis, strategy formulation
etc.
13. Explain the types of demand function. (3) (2016 DEC)
Answer:
Demand function indicates the relationship between demand for a product as dependent
variable and its determinants as a independent variables.
Demand function is of two types.

Single variable or short run demand. dx = f(Px) and multivariable or Long run demand
function dx = f( Px,
py, Y, P, Ex …)
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CA FINAL (CAPIII)
Linear Demand Function

A demand function is said to be linear when the slope of demand curve remains constant
throughout its length.
Mathematically, it is
written as Dx = a – b Px
Where,
Dx = demand for a commodity, a= autonomous demand, b = slope of demand
curve, Px = Price of a commodity
Geometrically, linear demand function is shown by straight line- demand curve, as below
Non-Linear Demand Function

A demand function is said to be non-linear or curvilinear when the slope of the demand curve (∆P/∆D)
changes all along the curve. Power function is one of the example of non- linear demend function as
And Where, a, b and c are all greater than zero.
Geometrically, non- linear demand function is shown in following figure.
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CA FINAL (CAPIII)
14. How is equilibrium price determined under perfectly competitive market? (5)(2017 JUNE)
Answer
Perfect competition market is the market structure where market demand and market supply
interact each other without any restriction and determine equilibrium price in the market.
Equilibrium means that the forces of supply and demand are “in balance” and there is no reason
for price or quantity to change, ceteris paribus. Market attains equilibrium when:
Market demand = Market supply
In this situation the price that consumers want to pay equals to the price that a producer wants
to charge.
According to law of demand, consumers want to buy more quantity of a good at low price but
according to law of supply, producers want to sell more quantity of the good at high price.
Finally, both consumers and producers agree to buy and sale equilibrium quantity at the
equilibrium price.
This can be explained by following table:
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CA FINAL (CAPIII)
Pric Market Marke Shortage Pressure on

e deman t / Surplus Price
(Rs) d supply
2 50 10 Shortage Rising
4 40 20 Shortage Rising
6 30 30 Equilibriu No change
m
8 20 40 Surplus Falling
10 10 50 Surplus Falling
As shown in table, when price of the commodity is Rs. 2, market demand is 50 units but market
supply is only 10 units. Due to greater demand than supply, there is shortage of the commodity.
As a result price increases to Rs. 4. At this price, market demand is 40 units and supply is 20
units and there is still shortage of the good. Due to shortage price further increases to Rs. 6.
At price Rs. 6 market demand and market supply are equal to each other i.e. 30 units. So, this
price is called equilibrium price. If price further increases, then demand decreases to 20 units
whereas supply increases to 40 units. This results excess supply than demand and the price
goes downward.
Therefore, price Rs. 6 is the market clearing price because this equates demand and supply.
10
Such equilibrium price determination process can also be shown in the following figure.D
S
SPurH
pluZs
In the Figure quantity of the commodity and price are measured on X and Y axis respectively.
DD is the demand curve which slopes downward. It indicates negative price quantity
relationship. SS is the supply curve which slopes upward. It indicates positive relationship
between price and quantity supplied. Point E is the equilibrium point where quantity demanded
is equal to quantity supplied. Thus, equality between demand and supply curve determines the
equilibrium price OP and equilibrium quantity OQ.
At price higher than equilibrium, there is an excess supply. Such excess supply will be cleared
when price falls to the equilibrium level. Likewise, at price lower than equilibrium, there is an
excess demand. Such situation of shortage increases price to the equilibrium level
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CA FINAL (CAPIII)
15. Discuss the concept of income elasticity of demand. (3) (2017 JUNE)
Answer: Please refer to previously asked same questions.
16. Define demand. Explain concept of extension and contraction in demand with the help of
suitable example and diagram. (1+4=5)(2017 DEC)
Answer:
Demand for a commodity is defined as a schedule of quantity demanded of that commodity which
a consumer is willing and able to purchase at various prices for a given period of time. It shows
the relationship between determinants of demand (basically price) and quantity demanded of a
commodity.
Demand of a commodity changes with change in its determinants. When price of a commodity
changes, the quantity demanded of a commodity changes due to which the consumer‟s equilibrium
will shift either upwards or downwards within the same demand curve which is called as movement
along the demand curve. There are two cases under movement along the demand curve; extension
in demand and contraction in demand. They can be explained as following.
a. Extension in demand: when price of a commodity decreases, quantity demanded of the commodity
increases due to which the consumer‟s equilibrium will shift downwards within the same demand
curve. It is called as extension in demand.
b. Contraction in demand: when price of a commodity increases, quantity demanded of the
commodity decreases due to which the consumer‟s equilibrium will shift upwards within the
same demand curve. It is called as contraction in demand.
The concepts of extension and contraction in demand can be explained with the help of
following example via schedule and diagram.
Combination Price of Quantity Remarks

Potato demanded
(Rs.Per Kg) of Potato (Kg)
A 20 4
B 40 2 Contraction
C 30 3 Extension
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CA FINAL (CAPIII)
B
Price (Rs)
4
Extension
Contraction
3 C
2 A
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CA FINAL (CAPIII)
In the above diagram, the consumer has shifted from A to B due to increase in price of potato from
Rs. 20 per kg to Rs 40 per kg, which is contraction in demand. When price of potato decreases from
Rs 40 to Rs 30 per kg, point has shifted from B to C, it is extension in demand.
17. What is supply? Explain the extension in supply with the help of appropriate example.
(1+2=3)(2018 JUNE)
Answer:
Supply can be defined as the quantity of a commodity which the seller is ready to sell and buyer are
also ready to purchase at given price and given period of time. In fact, supply is a part of stock with
given price and time. As we know, there exists direct relationship between price and quantity
supplied of a commodity. It means when price of the commodity increases, quantity supplied of the
commodity also increases. Due to which, suppliers equilibrium point will move upwards within the
same supply curve. It is called as extension in supply. It can be explained with the help of following
example.
Let us suppose the price of apple, initially the price of apple was Rs. 150 per Kg. at which the supply
was 5 Kg which is described by point A in the following diagram. When price of the commodity
increases to Rs. 160 per Kg. quantity supplied of apple increases to 8 Kg which is described by point
B on the diagram. Here with increase in price of apple by Rs. 10 Per Kg. the equilibrium point move
upward within the same supply curve which is extension in supply.
Point Price (Per Kg) Quantity Supplied (Kg)
A 150 2 Kg
B 160 4 Kg
Price (Rs)
160 B
150 Extension in supply

O
Quantity Supplied (kg)

1
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CA FINAL (CAPIII)
18. "Utility derived from consumption of additional unit of a commodity diminishes at every
additional unit of consumption of the commodity." Elaborate by using numerical table. 3
(2018 JUNE)
Answer:
Other things remaining the same when a consumer consumes additional unit of a commodity,
utility obtained from every additional unit of commodity decreases. In other words, if consumer
consumes more and more unit of same commodity marginal utility obtained from that commodity
decreases. This law of consumer's behaviour is known as law of diminishing marginal utility.
When consumer consumes more units of a commodity at the same time consumer reaches to the
point of satisfaction. In this situation, marginal utility obtained from that commodity is zero. If the
consumer consumes more unit of a commodity than this level, consumer obtains negative marginal
utility. This is explained with the help of following table:
Units of a Total Marginal

commodity utility utility
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
When a consumer consumes 1st unit of a commodity, he obtains 10 of total and marginal
utility. Again if he consumes 2nd unit, he gets 18 total utility but marginal utility
decreases to 8. Similarly, if he consumes successive unit up to 5th unit, total utility
increases continuously but marginal utility decreases. Total utility becomes maximum
when the consumer consumes 6th unit of the commodity but marginal utility at this unit
is zero. When a consumer consumes 7th unit he gets negative marginal utility and total
utility decreases to 28.
19. Define price elasticity of demand. How is price elasticity of demand measured by point
method?(1+4=5)
(2018 DEC)
Answer:
price elasticity of demand (Ep) is the responsiveness of change in quantity demanded
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CA FINAL (CAPIII)
due to change in price of a commodity. It is the ratio of percentage change in quantity
demanded for a commodity to the percentage change in its price, other things
remaining the same.
Percentage change in quantity demanded for a

=
commodity Ep Percentage change in price of a
commodity
Q P
P Q
Where, P = change in price, Q = change in quantity demanded, P = initial price, Q
= initial quantity demanded
Point Method
In the point method, the price elasticity can be measured at the different points of linear
and non-linear demand curves. It is mainly used when there is very small change in
price and quantity demanded. Elasticity at any point is the ratio of the lower segment
of straight line to the upper segment.
Lower segment of demand
=
curve EP Upper segment of
demand curve
Point Elasticity of Demand on a Linear Demand Curve
The point elasticity of demand on a linear demand curve is different at different
points of the demand curve which are shown in the figure below:
 B (Ep = ∞)
Price
 E (Ep > 1)
 C (Ep = 1)
 D (Ep < 1)
A(Ep = 0)

Quantity
X
In figure, AB represents a linear demand curve. Let us suppose C is the middle point
of the demand curve. Based on the above formula we can compute price elasticity of
demand at different points of linear demand curve as follows:
E
CA (C) Lower segment
1
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CA FINAL (CAPIII)
(∵AC = CB)
P Upper segment CB
Lower segment EA
E (E) > 1 (∵ EA > EB)
P Upper segment EB
Lower segment 0
E (A) 0
P Upper segment AB
Lower segment
E (D)
DA < 1 (∵DA< DB)
P Upper segment DB
Lower segment BA
EP (B) = Upper segment =0 = ∞
Point Elasticity of Demand on a Non-Linear Demand Curve

If the price demand curve be non-linear instead of a straight
line, then the price elasticity of demand at a point of it
can be
measured by drawing a tangent line to that point.
To measure price elasticity of demand at point P, AB tangent line is drawn at point P. Then,
Lower segment PB
E (P) 1
P Upper segment PA
Similarly, to measure price elasticity of demand at point Q, CD tangent line is drawn at

point Q. Then,
E Lower segment QD
(Q) 1
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CA FINAL (CAPIII)
P Upper segment QC
20. State and explain the law of diminishing marginal utility. 3 (2018 DEC)
Answer:
According to the law of diminishing marginal utility when a rational consumer

consumes the homogeneous units of the commodity continuously, the additional
satisfaction attained by the consumer form each extra unit of consumption goes on
diminishing. This theory was propounded by German economist H.H. Gossen in 1854
AD. It was further developed and popularized by Alfred Marshal.
This law can be explained with the help of the following simple example. Suppose, a
man is very hungry. He goes to the market and buys one apple. The apple gives him
immense pleasure or we say the first apple has great utility for him. If he takes second
apple after that, the utility will be less than that of the first one. It is because the edge of
his hunger has been blunted to a great extent. If he eats third apple, the utility of the
third apple will be less than that of second and so on.
Units of Apple Total Utility Marginal Utility

1st 20 20
2nd 35 15
3rd 45 10
4th 50 5
5th 50 0
6th 45 -5
Graphically,
20
Marginal Utility
15
10
O MU
1 2 3 4 5 6
-5 Units of apple
33
COMPILED BY
KISAN JOSHI,
CA
FINAL (CAPIII)
In the Diagram, The marginal utility of the first unit of apple is 20 utils. The MU of
each extra unit of apple is reducing and becomes zero at the 5th unit of apple and MU
of the 6th unit of apple is negative (-5). The MU curve here lies below the OX axis.
The utility curve MU falls left from left down to the right showing that the marginal
utility of the successive units of apple is falling.
21. Illustrate cross elasticity of demand with its types.(3 marks) (2019 DEC)
Answer:
Meaning of Cross Elasticity of Demand

Cross elasticity is defined as the proportionate (percentage) change in quantity
demanded of one good (say X) due to proportionate (percentage) change in price
of another good (say Y). It is related to two goods which have some relation
between them.
If X and Y are two goods, then
Proportionate change in quantity of X % QX
ec= =
Proportionate change in price of Y % PY
Symbolically,
QX
QX ∆𝑄𝑥 PY
e= =
c PY ∆𝑃𝑦 QX
PY 
Where,
COMPILED BY KISAN
JOSHI,
CA FINAL
(CAPIII)
ec = Cross elasticity
ΔQX = Change in quantity of X ΔPY =
Change in price of Y
PY = Original price of Y QX =
Original quantity of X
Types of Cross Elasticity of Demand
 Positive Cross Elasticity (ec > 0)
If change in price of Y and quantity of X move in same direction, ec is said to be
positive, i.e. increase price of y brings increase in quantity of X, vice versa.
PY QX
PY QX
If two goods X and Y are substitutes, ec is said to be positive. Coke and Pepsi can
be taken as substitutes.
 Negative Cross Elasticity (ec < 0)
It change in price of Y and quantity demand of X move in the opposite direction,
ec is said to be negative; i.e. If Py increases, demand of X decreases, vice versa.
PY QX
PY QX
If two goods X and Y are complements, ec is said to be negative. Mobile set and
sim card can be taken as complementary goods.
 Zero Cross Elasticity (ec=0)
If change in price of Y leads to no change in quantity of X, ec is said to be zero.
If two goods X and Y are independent, ec will be zero. Book and seed for a
farmer or a student can be independent or unrelated goods.
The various types or degrees of cross elasticity can be shown by the following
combined figure:
Y
eC = 0 eC > 0
Price of Y
eC < 0
X
O
Quantity of X
COMPILED BY KISAN
JOSHI,
CA FINAL
(CAPIII)
22.What do you mean by shift in supply curve? Explain any four factors that shift the supply
curve.(1+2 =3)(2019 DEC)
Answer:
If the entire supply curve shifts from one position to another due to change in non- price
determinants, it is known as shift in supply curve or change in supply. In other words, if
supply curve shifts from one position to another due to change in other determinants of
supply except the price of the commodity, we call it shift in supply.
The factors that cause shift in supply curve can be explained below:
1. Technology
If there is technological advancement, production cost will be lower so that
firms can supply more output which causes a rightward shift in supply curve.
On the other hand, if the state of technology declines, production cost will be
higher so that firms are able to supply less output such that the supply curve
shifts leftward.
2. Prices of Resources
If prices of resources or inputs are higher, firms supply less output due to
increase in cost of production causing leftward shift in the supply curve. On
the other hand, if their prices are low, they can supply more output due to
decrease in cost of production causing rightward shift in supply curve.
3. Tax and Subsidy
If producers are imposed heavy tax, their cost of production increases so that
they can supply less output and vice-versa. On the other hand, provision of
subsidy helps to reduce cost so that producers can supply more output.
4. Future Expectations
If future price of the product is expected to rise, producers will supply less
output at present. On the other hand, if future price of the product is expected
to fall, producers will be willing to supply more output at present.
COMPILED BY KISAN
JOSHI,
CA FINAL
(CAPIII)
23. State and explain the law of supply. What are the causes of its exceptions? (2+3=5 marks)
(2020 Dec.)
Answer:
The law of supply reflects the general tendency of the sellers in offering their stock of a
commodity for sale in relation to the varying prices. It describes seller’s supply behavior under
given conditions. It has been observed that usually sellers are willing to supply more with a rise
in prices. Other things remaining unchanged, the supply of a commodity rises, i.e., expands
with a rise in its price and falls, i.e., contracts with a fallin its price. In other-words, it can be
said that “Higher the price higher the supply and lower the price lower the supply.” There is
direct relationship between price and supply.
S = f(P)
Where,
S = Quantity supplied
P = Price
Thus, the law suggests that supply varies directly with the change in price. So, a larger
amount is supplied at a higher price than at a lower price in the market.
Explanation of the Law:
This law can be explained with the help of a supply schedule as well as by a supply curve
based on imaginary figures and data.
Hypothetical Supply Schedule
PX (in Rs.) SX
1 5
2 10
3 15
4 20
5 25
Supply schedule reflects the law of supply in the sense that higher the price of X, higher will
be the supply of it.
Supply Curve
The graphical presentation of supply schedule is known as supply curve. If we plot the above
COMPILED BY KISAN
JOSHI,
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(CAPIII)
hypothetical supply schedule in graph, we are able to derive supply curve as follows:
COMPILED BY KISAN
JOSHI,
CA FINAL
(CAPIII)
Y
S1
5
3
Price
2 S
X
O
5 10 15 20 25 Quantity
Supply curve (SS1) is upward sloping exhibiting law of supply. As price

increases, quantity supplied of X goes on increasing. For example, when price
increases from Re.1 to Rs.2, the quantity supplied of the commodity X
increases from 5 to 10 units. Similarly, when price increases from Rs.2 to
Rs.3, the quantity supplied increases to 15 units. This implies that there is
positive relationship between price and quantity supplied of a commodity.
Exception of the law of supply
It refers to negative relationship between price and quantity supplied. The
causes of exception of law of supply are:
a. Commodities out of fashion
b. Auction sale
c. Seasonal goods
d. Stock clearance sale
e. Perishable goods
f. Change in government policy, etc.
CA FINAL (CAPIII)
24. Define perfect competition market. How output is determined under it in short run
withsuitable diagrams. (1+4=5 marks) 2021 December
Answer:
a) Perfect competition is a type of market structure in which there are large number of
buyers and sellers dealing with homogeneous product at a same price. This is the market
where buyers and sellers have perfect knowledge of a market.
In the short run some factors of production are fixed and some factors of production are
variable. Due to the shortage of time, producer cannot change fixed factors of production.
Under perfect competition market, Industry is a group of firms where price of the
commodity is determined with the interaction between market demand and market
supply. The price and output corresponding to the intersection of the demand and supply
curve are called equilibrium price and output. Accepting the price determined by industry
the firm determines the output to determine the equilibrium output in the short run, the
firm should fulfill two condition such as (a). MC= MR (b). MC must cut MR form below
In short run, firm may earn profit or normal profit or losses depend on the efficiency of
the firm and level of average cost. Π=(AR-AC) output. There are three cases of profit
under AR-AC approach, which are:
1. If AR> AC ---------- Super Normal Profit
2. If AR= AC --------- Normal profit
3. If AR< AC ---------- Loss
Graphically
Y Y Y Y
AR<AC Loss
D
S If AR= AC nor profit
If AR>AC profit MC
MC AC
MC A
E AC AC C
E
E1 P 2
P P P E
AR= MR
C A AR= MR 3
AR= MR
S
D
O Q XO X XO X
Q O Q Q
Output industry
1 2 3
Output firm A Output firm B Output firm C
CA FINAL (CAPIII)
In order to determine the output level of each firm, price is taken from the industryrepresented by P- line which is
also equal to MR and AR under perfect competition (i.e.,AR=MR= p). In figure b, MC intersects MR at points A and
E1 where MC=MR and MCcuts MR form below. Thus point E is the equilibrium point and it gives profit
maximization level of output Q1. The E1Q1 line intersects AC curve at point A. Point A is horizontally joined with Y-
axis at point C. Where the total revenue area is OPE 1Q1 and total cost area is OCAQ1 and area CPE1A is profit.
In figure C, both condition of equilibrium is fulfilled at point E2. Where the total revenuearea is OPE2Q2 and total
cost area is also same as the total revenue where the firm has neither profit nor loss i.e., normal profit.
In figure D, the both condition of equilibrium are fulfilled at point E 3 where the total revenue area is OPE3Q3 and
total cost area is OCAQ3 where TC is excess than TR thus there is loss represented by the area PCAE3.
In this way the firm may get excess profit, loss or normal profit in short run.
25. Explain the concept of the law of diminishing marginal utility. 3 marks 2021 June
Answer
The law of diminishing marginal utility was introduced by German economist Herman Heinrich Gossen
in 1854. Hence it is also named as First Law of Gossen. But it was Alfred Marshall who popularized this
law through his well-known book 'Principles of Economics' published in 1890. According to this law,
"The additional benefit which a person derives from a given increase of his stock of a thing diminishes
with every increase in the stock that he already has."
This law states that initially total utility increases at a decreasing rate, reaches its maximum point and
finally it decreases at various units of consumption of a particular commodity. This implies that marginal
utility diminishes at each successive unit of consumption of a commodity. It is because of the fact
that the more we have of a commodity, the less we want to have more of it. The popular proverb in
connection tothis law is that familiarity breeds contempt.
Tabular and Graphical presentation of the law
Units of X MUX
1 10
2 8
3 6
4 4
5 2
6 0
7 –2
41
CA FINAL (CAPIII)
MUX
12
10
0 1 2 3 4 5 6 7 8 9 10 Units of X
MUX
–2
From above table and figure, when the consumer increases the units of consumption of commodity X,
marginal utility (MUX) is observed to be diminishing. The MUX has three parts: (i) when the units of
consumption are increased up to 6 units, MUX is diminishing but positive, (ii) at 6th unit of consumption,
MUX is zero which implies that the consumer has reached the saturation point, (iii) after 6th unit of
consumption, MUX is diminishing.
26. Explain the concept of individual and market demand curves with the help of table and diagram.
3 Marks (2022 June)
Answer(Hint)
Individual Demand Market Demand

The consumer equilibrium condition determines the quantity of each good the individual consumer will demand. As the example
above illustrates, the individual consumer's demand for a particular good—call it good X—will satisfy the law of demand and can
therefore be depicted by a downward‐sloping individual demand curve. The individual consumer, however, is only one of many
participants in the market for good X. The market demand curve for good X includes the quantities of good X demanded
by all participants in the market for good X. The market demand curve is found by taking the horizontal summation of all
individual demand curves. For example, suppose that there were just two consumers in the market for good X, Consumer 1 and
Consumer 2. These two consumers have different individual demand curves corresponding to their different preferences for
good X. The two individual demand curves are depicted in Figure, along with the market demand curve for good X.
42
CA FINAL (CAPIII)
(Make a table showing - For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2
demands 1 unit; so, the market demand is 2 + 1 = 3 units of good X and so on)
The market demand curve for good X is found by summing together the quantities that both consumers demand at each
price. For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2 demands 1 unit; so, the market
demand is 2 + 1 = 3 units of good X. In more general settings, where there are more than two consumers in the market for
some good, the same principle continues to apply; the market demand curve would be the horizontal summation of all the
market participants' individual demand curves.
27. Define income elasticity of demand. Calculate income elasticity of demand for milk by using average method in
following income demand schedule and explain the nature of milk
Income of consumers Quantity demanded for
milk(liters )
40,000 30
60,000 40
Answer:
Other things being equal,income elasticity is the ratio of the percentage change in quantity demanded of a
good with the percentage change in price. In other words, it measures the degree of responsiveness of the
quantity demanded of a commodity to changes in the income of the consumers.It is connected with normal
goods and inferior goods.Thus.
% Change in quantity demanded

eY = ————————————————————
% Change in Income of the consumer
Change in quantity demanded/Initial Quantity Demanded
43
CA FINAL (CAPIII)
eY = ————————————————————
Change in Income/Initial Income
Now,
Initial income (Y1 ) = 40,000
Final income (Y2) =60,000
Initial demand (Q1 )=30
Final demand (Q2 ) 40
Now Income elasticity
Δ quantity demand / (Q1 + Q2 )
eY = —————————————
Δ Income /(Y1 + Y2 )
10/ (30 + 40 )
= —————————————
20,000 / (40,000+ 60,000 )
10/70
= ——————————
20,000/1,00,000
=0.71
Since the income elasticity is 0.71 Milk is a normal good
44
CA FINAL (CAPIII)
Chapter-3
Production Theory
1. Explain the production function. 5Marks (2013 JUNE)
Answer:
Production process involves the use of various inputs or factor services to produce output.
Production function refers to the functional relationship between the quantity of a good
produced (output) and factors of production (inputs).
According to A. Koutsoyianis, ―The production function is purely a technical relation which
connects factor inputs and output.‖ In short, it is a schedule indicating the amount of the output
obtained from different combination of inputs, given the state of technology and in a given
period of time.
Based on time, the production function is of two types. They are:
i) Short run production function (or Single variable production function):
Short run production function refers to the functional relationship between the units of variable
factors and the output. In short run production function, we study the effect of change in the
quantity of one variable input on the output, by keeping all other inputs constant. Algebraically,
it is written as:
Q = f(Nvf)
where
Q = Output
f = Function
Nvf = Quantity of variable factors
= Constant capacity of other inputs like machine
It is also called single variable production function or production function with one variable
input.
ii) Long run (or Multi-variable) production function:

Long run production function refers to the functional relationship between the quantities of all
inputs and output. In long run production function, we study the effect on output with the
variation of all inputs, say, land, labour, capital and entrepreneur. Therefore, it is also termed
‗multi-variable production function‘. Algebraically, it is expressed as:
Q = f(W, L, K, M, T)
where, Q = Output, f = function, W = Land, L = Labour, K = Capital, M =
Management, T = Technology
Long run production function also be depicted as production function with two variable
inputs, i.e., Q = f(L, K)
where , Q = output, f = function, L = labour, K = capital.
45
CA FINAL (CAPIII)
2. Explain production possibility curve. (3) (2013 DEC)

Answer:
Production possibility curve (PPC) in economics is a graph that shows different possible
combinations of inputs for different level of production in the limited resources during a certain
time. This curve is concave from the origin. This approach represents a number of economic
concepts, such as scarcity of resources, opportunity cost (or marginal rate of
transformation), productive efficiency, allocation efficiency, and economies of scale.
This curve shows all possible combinations of two goods that can be produced simultaneously
during a given time period, ceteris paribus. When we have to increase the quantity of one good
produced, production of the other good must be sacrificed. Or it has to sacrifice its less urgent
needs to select most urgent or essential needs.
Let us take two products, rice & wheat. If production of wheat gets priority over the production
of rice, resources should be diverted towards the production of wheat.
A
B
C
P
D
Rice E
Q
F
0 Wheat X
46
CA FINAL (CAPIII)
Any production possibility curve above it represents higher level production and needs more
resources. Similarly, any production possibility curve below it shows lower level production,
which needs lesser amount of resources.
In the above Diagram P lies beyond the production possibility curve. In order to produce this
combination, the economy requires more resources than are available and therefore this is
impossible. The economy may decide to produce at point Q, but at this combination the
available resources would remain under-utilized. Therefore, it has no option rather than to
choose any one of the combination from A to F falling within the production possibility curve.
3. Explain the laws of returns to scale. 3Marks (2013 DEC)
Answer:
The law of returns to scale explains how the proportional increase in all the inputs affects
the total output as its various levels. When a firm increases all its inputs proportionally,
there are three possibilities, which are described as below.
i. Increasing returns to scale: When the increase in output is more than proportionate to the
given increase in the qualities of all factor-inputs, it is termed as increasing returns to scale.
ii. Constant returns to scale: The constant returns to scale means that if all factor inputs are
varied at a certain percentage rate, output will change by the same rate.
iii. Diminishing returns to scale: When the increase in output is less than proportionate to the
given increase in the quantities of all factor inputs, it is termed as diminishing returns to
scale.
4. Briefly explain the stage of diminishing return under law of variable proportion. 3Marks (2014
June)
Answer:
Law of variable proportion is the new name for the law of diminishing return. The economists
like Marshall, Benham, Samuelson, John Robinsion etc have contributed to the development
to this law. This law indicates the short run production function. This law indicates the
production with one factor variable while other factors of production are kept constant. This
law indicates that continuous change in the proportion of the factors of production change the
production first at increasing rate, and then it changes takes place at diminishing rate.
There are three stages of law of variable proportion
j) Stage of increasing return
k) Stage of diminishing return
l) Stage of negative return
Stage of diminishing return is the second stage of law of variable proportion and
“what we think, we Become-Buddha”

CA FINAL (CAPIII)
this is explain with the help of the following production schedule and diagram:
Units of TP AP MP Stage
variable
factor
1 10 10.0 -
2 24 12.0 14 I Stage
3 39 13.0 15
4 52 13.0 13
5 61 12.2 9
6 66 11.0 5 II Stage
7 66 9.4 0
8 64 8.0 -2 III
Stage
In the diminishing return stage, the total product (TP) continues to increase
in diminishing rate. Both AP and MP are decline. This stage ends when MP is zero. The total
product is maximum and this can be indicated by above schedule and diagram. In this stage the
variable factor is more as compare to fixed factor and so production will be decreased. In this stage
the fixed factor is over utilized and become inadequate to the variable factor. The variable factor
cannot substitute to the fixed factor so the diminishing return operates. The stage of diminishing
operates because of the indivisibility of the fixed factor.
5. Explain the economic stage of law of returns. (3)

(2014 DEC)

CA FINAL (CAPIII)
Answer:
There are three stages of law of returns. Among them 2nd stage i.e. stage of diminishing returns
is economic stage. This is the most important stage in the production function. In this stage, as
more of the variable input is added to the fixed input, the total product (TP) continues to
increase at a diminishing rate and reaches to maximum i.e.MP will be zero. Here both the
marginal product (MP) and average product( AP) of the variable factor will diminishing but
are positive. The diminishing rate of MP will be greater than diminishing rate of AP i.e. AP >
MP ≥ O. This stage occurs when the fixed factor becomes inadequate relative to the quantity
of the variable factor.
6. Explain the laws of returns to scale. (5) (2015

DEC)
Answer:
Returns to scale reveals the total effect on output with proportionate variations
in all inputs. It explains three effects on output. They are explained below:
1. Increasing Returns to Scale (IRS). If the percentage or proportionate increase in
output is greater than the percentage or proportionate change in input, it is the law of
increasing returns to scale in operation.
When increasing returns to scale occur, the successive iso-quants will lie at decreasingly smaller

CA FINAL (CAPIII)
distances along a straight line ray OP1 through the origin. In Fig., the various iso- quants IQ1, IQ2
and IQ3 are drawn, which successively represent 100, 200, 300 units of the output. It will be seen
that distances between the successive iso-quants decrease as we expand the output by increasing the
scale. Thus, increasing returns to scale occur since
L1 L2 L3
L1L2
OA AB BC , which means that equal increases in output are

OK KK KK
1 12 23
obtained by smaller and smaller increments in the input.
2. Constant Returns to Scale (CRS). If the percentage or proportionate increase in output
equals the percentage or proportionate increase in inputs, it is the law of constant returns
to scale in operation.

CA FINAL (CAPIII)
When constant returns to scale occur, the successive iso-quants will lie at the same
distances along a straight line ray OP2 through the origin. In Fig., IQ2 and IQ3 are iso-
quants which represent the total output of 100, 200 and 300 units. Constant returns to
scale are indicated by the equal distance between the iso-quants along the scale line.
Thus, constant returns to scale
L1 L2 L3
L1L2
occur
since OA AB BC which means that both inputs and output
O KK KK
K
1 12 23
are increased in the same proportion.
3. Decreasing Returns to Scale (DRS). If the percentage or proportionate increase in
output is less than the percentage or proportionate increase in inputs, it is the law of
decreasing returns to scale in operation.

CA FINAL (CAPIII)
When decreasing returns to scale occur, the successive iso-quants will lie at
increasingly greater distances along a straight line ray OP3 through the origin. In Fig.,
successively
L1 L2 L3
L1L2
decreasing returns to scale occur

since OA AB BC . It means that
OK KK KK
1 12 23

CA FINAL (CAPIII)
more and more of inputs (labour and capital) are required to obtain equal increments in the
output.
7. Define production function. State the difference between short run

production function and long run production function. (3)
(2016 JUNE)
Answer:
The functional or technical relationship between units of inputs and output is called as production
function.
Mathematically,
Q= f (Ld, L, K, O)
Where, Q= output produced
Ld = Land L= Labor K=Capital O= Organization
In economics, short run refers to the time period in which only variable factors can be
changed keeping fixed factors as constant. Short run production function can be defined as the
functional relationship between quantity of output produced and units of variable factors used in
production process.
Mathematically, Q= f(Nvf)
Where, Q=Output Nvf= number of variable factors of production.
In short run, the producer can only change one factor keeping others as constant therefore short
run production function can also be termed as single variable production function. Law of variable
proportions is the example of short run production function.
Long run is that time period in which all the factors are variable. Long run production function
can be defined as the functional relationship between quantity of output produced and units of all
inputs used in production process. Since, it reveals the composite effect of all the inputs to output
it is also called as multi-variable production function. The law of returns to scale, Cobb-Douglas
production function etc. are the examples of long run production function.
Mathematically, Q = f(Ld, L, K, O) or Q= f(L,K)
Where, Q= Output Ld= land L= Labor K= Capital, O=Organization
8. Explain the relationship between average productivity (AP) and marginal

Productivity (MP) with the help of schedule and diagram. (3)
(2016 DEC)
Answer:
Average productivity (AP) refers to the production per unit of labour received by the
producer by employing certain number of labour in its production process.

CA FINAL (CAPIII)
Mathematically, where, TP = Total product, N = units of labour
Marginal Productivity (MP) refers to the additional output received by the producer by
employing one additional unit of labor in it’s production process. In other words, it is the
ratio between change in total product (∆TP) and the change in units of labour (∆N).
Mathematically, or,

CA FINAL (CAPIII)
Where, ∆TP = change in Total product, ∆N = change in units of labour

th
TPn = Total product of n unit of labour TPn-1 = Total product of (n-1)th unit of
labour
The relationship between AP and MP can be explained with the help of following schedule
and diagram.
Units of labor TP AP MP
10 10 10
2 30 15 20
3 60 20 30
4 80 20 20
5 90 18 10
6 90 15 0
7 80 11.4 -10
40 50
30
20
10
AP
Units of labor
O 1 2 3 4 5 6 7
-10
MP

CA FINAL (CAPIII)
From the above diagram it is clear that at first unit of labour, AP and MP both will be
AP, MP
equal. After this both will increase but MP increases by higher rate than that of AP. Both
reaches their respective maximum points at 3 units and MP starts to fall but AP remains
constant for a while. MP intersects at the highest point of AP and diminishes sharply. AP
will never be zero or negative but MP can also be zero as well as negative.
Hence in conclusion, we can be say that initially AP and MP start from same point, rate
of increase in MP is higher than that of AP, both reaches to their respective maximum
points and MP starts to fall before AP. MP intersects AP at its highest point, after which
MP will be less than AP. MP can be zero as well as negative but AP will never be zero or
negative.
9. Explain the law of increasing returns to scale with its causes. (3) (2017
JUNE)
Answer:
Law of returns to scale explains the effect of change in units of all the factors of production (scale)
to total output. A change in scale refers to the situation where all the factors of production are
changed in same proportion. There are three returns to scale; increasing returns to scale, constant
returns to scale and decreasing returns to scale.
Increasing returns to scale can be defined as a situation when increase in all factors of
production leads to more proportionate increase in output. As for example, when the factors of
production are doubled, output will be more than doubled. Law of increasing returns to scale can
be explained with the
help of following table and diagram. IR
IQ
Units of capital
Units of Units of Output IQ

labor capital
1 10 K IQ
1
2 2 25 3
30 Units
3 45 K2
3 10 units 20 Units
K1
O L1 L2 L3
Unit of Labor

CA FINAL (CAPIII)
The above table describes that with addition of one extra unit of both units of labor and capital,
output is increased in higher proportion. Similarly in the given diagram, initially to produce 10
units of output (in IQ1) OL1 units of labor and OK1 units of capital are employed. To increase
output from 10 units to 20 units Ol2 units of labor and OK2 units of capital are employed. But the
increment in factors proportion is
PHZ P.T.O.

CA FINAL (CAPIII)
less than the increment in output (OL1>L1L2 and OK1>K1K2). Hence, there is operation of
law of increasing returns to scale.
The main causes of operation of increasing returns are:
1. Dimensional relations
2. Greater specialization at work
3. Indivisibilities etc.
10. Explain the law of variable proportion. (5) (2017 DEC)

Answer:
The law of variable proportion explains the short run production relationship of a variable input
and output, keeping fixed factors constant. When more and more units of variable inputs are
employed, output shows three different the production behaviours in three stages:
Stage I: Stage of Increasing Returns

In this stage, total product (TP) increases at increasing rate to point of inflection and just starts
to increase at decreasing rate. Marginal Product (MP) increases, reaches to maximum point
and just starts to decrease. Average product (AP) increases throughout this stage and reaches
to maximum at point where AP equals to MP. In this stage MP is greater than AP.
Situation of increasing returns occurs due to higher utilization of capacity of fixed factor and
specialization in use of variable factors.
Stage II: Stage of Decreasing Returns
In this stage, TP continues to increase at a diminishing rate until it reaches its maximum point.
MP continues to decrease and becomes zero and AP decreases. In this stage AP is greater than
MP.
Situation of decreasing returns occurs due to limited of capacity of fixed factor and limitation
in specialization variable factor.
Stage III: Stage of Negative Returns
In this stage TP decreases and MP becomes negative. The AP decreases continuously.
Situation of negative returns occurs due to overcrowded variable factors.
Law of variable proportion can be explained with the help of following hypothetical table
where labour is the variable factor and land is the fixed factor.
Land (in Units Stage
acre) TP AP MP
of of
labou return
r

CA FINAL (CAPIII)
5 0 0 0 –
5 1 10 10 10
5 2 30 15 20 Increasing
5 3 60 20 30
5 4 80 20 20
5 5 90 18 10
Diminishing
5 6 90 15 0
5 7 80 11.4 –10 Negative
In above table, input output relation up to use of fourth units of labour shows the stage first.
Use of fifth and sixth unit of labour shows the second stage and use of seventh unit of labour
shows the third stage.
The law of variable proportions can be explained with the help of following figure.
Y
TP, AP, MP

C
B Third stage
First  Second
stage Point of stage TP
inflection
AP
L0 L
2
L X
1
Labo
O ur

CA ASPIRANTS-ICAN
MP
In above figure, input output relation up to use of L1 units of labour shows the stage first. Use of
labour from L1 to L2 shows the second stage and use of labour after L2 shows the third stage.
11. Describe production function. (3) (2017 DEC)

Answer:
The production function describes the technical relationship between inputs and outputs in physical
terms. It shows how and to what extent output changes with variations in input during a specified
period of time. The word function in Mathematics means the relationship that exists between one
dependent variable and many independent variables.
Like demand, production function refers to a period of time. It shows the maximum amount of output
that can be produced from a given set of inputs in the existing state of technology. The output will
change when the quantity of any input is changed.
A production function may take the form of a schedule or table, a graphed line or curve, an algebraic
equation or of a mathematical model. But each of these forms of a production function can be
converted into the other forms. Algebraically production function can be written as:
Q = f (Ld, L, K, O, ….)
Where,
Q stands for quantity of output Ld
stands for quantity of land L stands
for quantity of labour K stands for
quantity of capital
O stands for quantity of organization
Here, quantity of output is dependent variable because it depends upon different factors of
production. Factors of production are independent variables.
In real life, production function is generally very complex because it includes a wide range of inputs.
The inputs have different importance in different production. Land is the most important factor in
agriculture but not in industry. For simplicity and convenience, if we assume that there are only capital
and labour as factors of production, then in that case, the production function can be written as:
Q = f (K, L)
Here,
Q stands for quantity of output K
stands for quantity of capital L
stands for quantity of labour
We explained that two inputs could be changed while other factors remain the same. Sometimes it
may happen that only one input can be changed while other factors have to keep constant. In this case
the production function may be written as:
Q = f (L)
Here only labour is considered as variable factors of production. This will be the case of short run.
Short run refers to a period during which supply of certain factors of production is supposed to be
inelastic. But long run is a period of time during which supply of all the factors of production is

CA ASPIRANTS-ICAN
assumed to be elastic.
12. Explain the concept of short run and long run production functions. (3) (2018 JUNE)
Answer:
There are generally two types of production function: Short-run and Long-run production
functions.
i. Short-run Production Function
A production function in which some factors are fixed and some factors are variable is
known as short-run production function. A short-run production function can be expressed
as:
—
Q = f( K , L)
Where,
—
K = Fixed factor capital
L = Variable factor labour
The ‘Law of variable proportions' deals with the nature of short-run production function.
ii. Long-run Production Function
Long run production function implies a production function with all factors variable, i.e.
Q = f(K, L)
Where,
K and L both are variable inputs
The ‘Law of returns to scale' deals with the nature of long-run production function.
The distinction between short-run and long-run production functions is related to the capacity
of the firm to change inputs. It is not related to the calendar date.
13. What is meant by returns to scale? Why do increasing returns to scale occur? 3 (2018 DEC)
Answer:
Returns toof Scale is the effect in the level of output as a result of change in all inputs
by same ratio. Increasing returns to scale refers to the case when all factors are increased
in a given proportion, the output increases at a greater proportion. Thus, if labor and capital
are increased by 10%, the output rises by more than 10%. Likewise, if labour and capital
are doubled, the output more than doubles.
There are three degrees of returns to
scale IRS
DRS
LRS

CA ASPIRANTS-ICAN
Indivisibilities of some inputs, particularly machinery, management, marketing skills, etc.,

thereby increasing their use.
ii)
Greater specialization of labor, machinery and management resulting in the increase in
productivity of inputs leading to increasing returns to scale.
iii)
Dimensional relations, i.e. when labor and capital are doubled, the output is more than
doubled over same level of output.
14. Why does a rational producer produce second stage of law of variable proportion? Why not in
first or third stage?(3 marks) (2019 DEC)
Answer:
A rational producer will always choose to operate production process in the second stage, i.e. the
stage of diminishing returns. It is because (i) fixed resources are utilized at full capacity (ii) it is
possible to recover the cost incurred on such resources (iii) a producer satisfies his goal – output
maximization. In other words, the total product becomes maximum (or maximum and constant
and marginal product becomes zero). It can be concluded that a rational producer seeks his
production in that stage where the total product is maximum (or marginal product is zero with
maximum and constant total product).
A rational producer would not like to operate stage ‘I’. It is because the average product of the
variable input is increasing throughout this stage. Similarly, fixed resources are not fully utilized
and it is not possible to recover cost incurred on such factors in stage ‘I’. It is not beneficial to
operate this stage. MP of the variable factor is negative or TP is decreasing. Thus, it is obvious
that the rational producer will not like to operate production process in stage I and stage III.
15. Explain the concept and causes of constant returns to scale. 3 marks (2020 Dec.)
Answer:
Constant returns to scale is said to occur if the percentage increase in production is equal tothe
percentage increase in inputs. For example, if the increase in inputs by 10% leads to the increase
in output by 10%, it is the case of Constant Returns to Scale.
Table
Labou Capita Outpu
r l t
1 1 100
2 2 200

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This case can be presented by the following figure:
R(Scale Line)
L4
L3 c
L2 b IQ3(300)
L
IQ1(100)
In the figure, four iso-quants IQ1, IQ2, IQ3 and IQ4 are drawn and they show units of output
equal to 100, 200, 300 and 400 units respectively. Each successive iso-quant lies at equal
distance to each other such that ab = bc = cd which implies that in order to increase output
by same quantity (i.e. by 100 units), inputs are increased by same units as previous i.e. K1K2
= K2K3 = K3K4 and L1L2 = L2L3 = L3L4 representing constant returns to scale.
The main causes of constant returns to scale are explained below:
i. Limitation of the economies of scale
When the economies of scale are exhausted and diseconomies are yet to start, there may
be a brief phase of constant returns to scale.
ii. Divisibility of inputs
Constant returns to scale may occur in certain productive activities where the factors of
production are perfectly divisible. For example, we can double the output by setting up
two plants (factories) which use the same quantity and same type of workers, capital
equipment, raw materials and other inputs.
16. State and explain the law of variable proportion with the help of suitableillustration? (1+4=5 marks) 2021
June
Answer:
The law exhibits the short-run production functions in which one factor varies while others are fixed.
According to law, when we obtain extra output on applying an extra unit of the input, then this output is
either equal to or less than the output that we obtain fromthe previous unit. It examines the effect on
output with the change in only one variable input by keeping all other inputs fixed.
The Law of Variable Proportions concerns itself with the way the output changes when we increase the
number of a variable factor. It explains the effect on change in output with the change in units of one
variable input. Hence, it refers to the effect of the changing factor-ratio on the output. In other words, the law
exhibits the relationship between the unitsof a variable factor and the amount of output in the short-term. This
is assuming that all otherfactors are constant. This relationship is also called returns to a variable factor.
The law states that keeping other factors constant, when you increase the variable factor, then the total
product initially increases at an increases rate, then increases at a diminishing rate, and eventually starts
declining.

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The law is based on the following assumptions:
i. Short run analysis

ii. Given technology
iii. Units of variable inputs are homogeneous and perfectly divisible
iv. Possibility of combining fixed and variable inputs in different units etc.
We can explain the law with the help of following illustration:
In this example, the land is the fixed factor and labour is the variable factor. The table shows the different
amounts of output when you apply different units of labour to one acre of landwhich needs fixing.
The following diagram explains the law of variable proportions. In order to make a simplepresentation, we
draw a Total Physical Product (TPP) curve and a Marginal Physical Product (MPP) curve as smooth
curves against the variable input (labour).
The law has three stages as explained below:
1. Stage I – The TPP increases at an increasing rate and the MPP increases too. The MPP increases with an
increase in the units of the variable factor. Therefore, it is also called the stage of increasing returns. In this
example, the Stage I of the law runs up to three units of labour (between the points O and L).
2. Stage II – The TPP continues to increase but at a diminishing rate. However, the increase is positive. Further,
the MPP decreases with an increase in the number of units of the variable factor. Hence, it is called the stage

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of diminishing returns. In this example, Stage II runs between four to six units of labour (between the points L
and M). This stage reaches a point where TPP is maximum (18 in the above example) and MPP becomes zero
(point R).
3. Stage III – Now, the TPP starts declining, MPP decreases and becomes negative. Therefore, it is called the stage
of negative returns. In this example, Stage III runs between seven to eightunits of labour (from the point M
onwards).
17. Explain the features of capital. 3 marks (2021 December)

Answers:
In general, money or wealth is known as capital. But in economics, capital refers to that part of wealth which is used
for the further generation of wealth. The capital is explainedas physical capital and financial capital.
Capital has following features:
1. Man-made Factor
Capital is the man made factor of production. So, it is also known as derived factor of production. It helps for
further production of goods and services. Buildings, machines, means of transport, etc. are the examples of
capital that are made by man.
2. Passive Factor
Capital is a passive factor of production. Without the use of labor, it becomes useless. Even automatic machine
needs the help of human to work.
3. Mobile Factor
Capital is mobile factor of production as compared to labor and land. Capital has the quality of durability,
divisibility and portability. So, it can be moved from one placeto another place and used for production purposes.
4. Elastic
Capital is elastic in nature. As it is a manmade factor, its supply can be increased or decreased as per the need.
5. Depreciable
Capital is the man made physical good. So, after using it up to a particular time period, its efficiency may decrease.
Hence, there should be periodic maintenance of capital as well as replacement of parts of capital. Thus, capital
is depreciable factor of production.
18. Define the average product and the marginal product. Explain the relation between the average product and the marginal product.
5 Marks (2022 June)
Answer(Hints):
The marginal cost of production is the change in total production cost that comes from making or producing one additional
unit. Marginal cost (MC) is calculated by taking the change in total cost between two levels of output and dividing by the change
in output. The marginal cost curve is upward-sloping.
Average cost includes fixed costs, like those necessary for production, that remain the same no matter the output. Average
cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced (the output Q): It has strong
implication to how firms will choose to price their commodities.

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Relationship between Marginal Product and Average Product
The marginal product curve crosses the average product curve at the maximum of the average product curve.
Marginal product focuses on the changes between production totals and the quantity of resources. Average product shows
output at a specific level of input. The peak of the average product curve is the point at which the marginal product curve and
average product curve intersect. For the points below (to the left of) this point, the marginal product of the extra input is higher
than the average product. For example, if adding another worker increases output by more than the average product of the total
labor force, then the marginal product of the new worker will raise the average product amount. Thus, the average product
curve must be below the marginal product curve. Similarly, if the new worker adds less product than the average product
amount, the average product curve will be above the marginal product curve (for all points to the right of the point of
intersection of the two curves). At the point of intersection, the additional worker produces the same as the average product of
the total workforce; there will be no change. The marginal product curve may fall to zero, showing that an additional worker
will have no impact on production; for example, if there is no more space left to work in, or if machines are working at 100%
capacity and all raw materials have been used up.
The marginal product (MP) curve crosses the average product (AP) curve at the point where the average product curve is at a
maximum.
OR, In other words,

Average Cost (AC) is defined as the total cost divided by level of output, i.e.,
AC = TC
Q
Marginal cost (MC) is defined as the change in TC due to change in level of output, i.e.
MC = TC
Q 
We can present both AC and MC in the following figure.
AC, MC

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
Minimum point of AC

With the help of the figure above, we can derive the following relationships between AC and MC:
a. Both AC and MC are derived from same sources Total Cost (TC) and level of output (Q) with the difference that MC needs
change in TC and Q.
b. Both are U-shaped due to law of variable proportions.
c. When AC falls, MC also falls but rapidly. Thus to the left of minimum point of AC, AC > MC.
d. When AC increases, MC also increases but rapidly. To the right of minimum point of AC, AC < MC.
e. MC always cuts AC at its minimum point. At minimum point of AC i.e. at a, AC = MC.
19. What is the average and marginal costs? Illustrate their relationship.
Answer:
Average Cost(AC) is defined as the total cost divided by level of output, i.e.
AC = TC/Q
Marginal cost(MC) is defined as the change in TC due to change in level of output, i.e.
MC= ΔTC/ΔQ
With the help of the figure above, we can derive the following relationships between AC and MC:
a) Both AC and MC are derived from same sources Total Cost(TC)and level of output(Q)with the difference that
MC needs change in TC and Q.
b) Both are U-shaped due to law of variable proportions.
c)When AC falls, MC also falls but rapidly. Thus to the left of minimum point of AC, AC>MC.
d) When AC increases, MC also increases but rapidly. To the right of minimum point of AC, AC<MC.
e) MC always cuts AC at its minimum point. AL minimum point of AC i.e.at a, AC=MC.

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Chapter-4
Cost and Revenue
1. Define economic and accounting costs. What is the basic difference between them? (4+1=5) (2013 JUNE)
Answer:
Cost of production refers to the expenditure made by the producer in various factors of production
which directly or indirectly contribute the production process. It mainly depends on two factors:
price of inputs and level of output. Since, price of inputs are exogenously determined, cost of
production mainly depends on the level of output. Hence, cost function expresses the functional
relationship between cost of production and level of output.
Mathematically, C = f(Q)
Accounting cost refers to the monetary payments made on various external factors contributing
the production of goods and services. It includes all the costs which can be presented in the
accounting book by an accountant. Accounting cost only consists explicit cost.
Accounting cost = explicit cost = money cost
Economic cost includes all type of monetary as well as non-monetary payments made by the
producer to the various factors of production contributing the production process. It includes both
explicit as well as implicit cost.
Economic cost = explicit cost + implicit cost
= money cost + (imputed cost + normal profit)
The basic difference between accounting cost and economic cost is that, accounting cost only
includes explicit of money cost in it whereas, economic cost includes both explicit or money cost
as well as implicit cost (sum total of imputed cost and normal profit) in it.
2. Explain the derivation of short run average cost curve. (5) (2013 DEC)
Answer:
Cost means the amount of money which is spent to produce certain commodity. Cost occupies important
place in economics especially in the field of production. The producer produces the commodity by
employing various factors of production. So, he has to pay some money to various factors of
production. The total sum of money which a producer has to pay for various factors of production is
cost of production.

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Cost of production is a function of the volume of output produced. Total cost is made up of two
components. Some of the inputs are fixed and indivisible. Their aggregate cost remains constant and,
hence, goes on falling in an average proportion as output increases. Other factors of production are
variables and go on increasing with the level of output produced. Hence, the variable cost of
production continuously increases but in different proportions. The behavior of the total cost of
production is a mixture of these two influences. Like the law of returns, there are similar laws for
cost behavior. The cost behaves exactly in an opposite manner as compared to the behavior of the
returns or the output.
Short Run Average Cost: The short run average cost can be derived by adding AFC and AVC. So,
it is necessary to know what are AFC and AVC.
AFC: Average fixed cost is the total fixed cost divided by output. That means AFC can be derived
dividing TFC by the total output. i.e. TFC/Q
Y AVC
Cost
Output
AFC
Output X
TFC cannot change in short run whatever be the output. But AFC diminishes with every
increase of output. It diminishes in the same proportion as the output is increased. The shape
of AFC will be rectangular hyperbola. AFC falls steeply in the beginning and tends to touch
the horizontal axis, but it never succeeds in doing so. That means AFC cannot be zero but
goes on diminishing.
TVC
AVC: Average variable cost can be derived by dividing total variable cost byAVC
output. i.e.
Cost

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CA FINAL (CAPIII)
AVC decreases first and it increases with every increase in output. It decreases in the
beginning up to a certain point and then starts rising sharply after that point. The average
variable cost becomes lowest when it will be nearest to the X axis. After that point AVC
increases. Now, we can get average cost with the help of AFC and AVC.
Units of T T T A A A
output F V C F V C
C C C C
1 30 10 40 30 10 40
2 30 18 48 15 9 24
3 30 24 54 10 8 18
4 30 32 62 7.5 8 15.5
5 30 50 80 6 10 16
6 30 72 102 5 12 17
From the above table, it becomes clear that the average cost is the sum of average fixed cost
and average variable cost. In the above table, there are 7 columns. As we know the short run
AC is the summation of AFC and AVC it goes on increasing with every increase in output.
When output is 1 unit it is 30 + 10 = 40. As the output increases to 2 units it becomes 48 units
because of the increase in production. After that it begins to increase and becomes 17 at 6th units
of production The average cost goes on decreasing at first and becomes minimum which is 15.5
it becomes at the output of 4th unit and it increases when output increases. It is clear from the
table that the average fixed cost decreases continuously as the output increases. From the above
table, it is clear that the average cost decreases first becomes minimum and begins to increase
with every increase in output.
The short run average cost curve can be explained with the help of following diagram.
Y AC
AVC
Cost
AFC
O
X
Output
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In the diagram, AFC is the Average Fixed cost and AVC is the Average variable cost. AC is the
Average Cost curve. The AC is derived by the vertical summation of AFC and AVC curves.
The AC curve decreases first, becomes minimum and begins to increase. So, the shape of AC
will be, as the English Alphabet U. AFC tends to touch the X axis but it can never touch it.
Similarly, AC also tends to touch the AVC but it can never touch it.
3. Distinguish between economic cost and accounting cost. (3) (2014 JUNE)
Answer:
When an accountant evaluates the financial position of a business, he takes only monetary expenses
incurred on factor services owned by outsiders, except the producer, in calculation. Thus, it consists only
of explicit costs.
Economic costs are the aggregate of explicit costs and implicit costs (i.e. imputed costs and normal profit).
These costs include both actual monetary expenditure on inputs which are purchased or hired and imputed
value of the inputs ( e.g. land, labour and capital) owned and provided by the entrepreneur including
normal profit.
Accounting cost = Explicit cost (or money cost) Economic
cost = Explicit costs + Implicit cost
Or, Economic cost = Accounting cost + (Imputed cost + Normal profit)
4. Explain how short run total cost curve is derived. (3)(2014 DEC)
Answer:
Short run is the period where there will be fixed and variable cost. So the total costs can be obtained by
adding total fixed cost and total variable cost. The total fixed cost remains constant whatever be the
level of output. The TFC, therefore, is a horizontal straight line or will be parallel to X axis. It means
that TFC will be there if output is zero. The TVC cost increases as the output increases. The TVC curve
rises upward starting from the point of origin.Which means that when output is zero, the cost also
becomes zero. We can explain short run total cost curve with the help of the following diagram.
CA FINAL (CAPIII)
TC
Y
TVC
Cost
O TFC
Output
In the figure total fixed cost (TFC) remains the same whatever is the product. The total cost curve
(TC) is upward sloping. Total cost curve is the summation of TFC and total variable cost (TVC).
TVC curve goes on increasing as the output is increased. When the production is Zero in that case
also there will be OP amount of TFC. So TC curve starts from point P. But the TVC starts from
origin. This is because if the production is zero it will also be zero.
5. Define economic and accounting costs. What is the basic difference between them?(2+1=3)(2015
DEC)
Answer:
Cost of production refers to the expenditure made by the producer in various factors of production
which directly or indirectly contribute the production process. It mainly depends on two factors: price of
inputs and level of output. Since, price of inputs are exogenously determined, cost of production mainly
depends on the level of output.
Hence, cost function expresses the functional relationship between cost of production and
level of output.
Mathematically, C = f(Q)
Accounting cost refers to the monetary payments made on various external factors
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contributing the production of goods and services. It includes all the costs which can be
presented in the accounting by an accountant. Accounting cost only consist explicit cost.
Accounting cost = explicit cost = money cost
Economic cost includes all type of monetary as well as non-monetary payments made by the
producer to the various factors of production contributing the production process. It includes
both explicit as well as implicit cost.
Economic cost = explicit cost + implicit cost
= money cost + imputed cost + normal profit
The basic difference between accounting cost and economic cost is that, accounting cost only
includes explicit of money cost in it whereas, economic cost includes both explicit or money
cost as well as implicit cost ( sum total of imputed cost and normal profit) in it.
6. Define LAC. Why is it U-shaped? (3)(2016 JUNE)
Answer:
LAC is a locus representing minimum cost points of the plants that can be operated in short run. It
means LAC is derived by joining various minimum SACs of producing various levels of output. It
is called tangent curve, envelope curve, planning curve and so on. It is less pronounced than SACs,
because the firm will have better chance of getting profit with change of factors of production.
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Due to the application of laws of returns to scale in longrun production function and
presence of economies and diseconomies of scale, LAC is U- shaped.
When IRS operates, LAC falls, when DRS operates LAC rise and when CRS operates, LAC
reaches at its minimum and constant.
7. Explain the relationship between Average Revenue (AR) and Marginal Revenue (MR) in perfect
competition market with the help of schedule and diagram. (3) (2016 DEC)
Answer:
Perfect competition is a type of market structure in which large number of buyers and sellers will be
dealing with homogeneous product and there is free entry and exit of firms in an industry. There is large
number of firms in an industry. All the firms are very small in size in comparison to industry which can’t
influence price as well as output of the whole industry. Hence, price of the product will be determined
by the industry with the help of market demand and market supply and all the firms will follow that price.
It means all the firms are price takers not the price makers in perfect competition market and price of the
product remains constant.
Total Revenue (TR) refers to the sum total of income received by the producer by
selling all the available units of his product in given period of time.
Mathematically, TR = P X Q where, P = price per unit, Q = total quantity sold.
Average Revenue (AR) refers to the income/revenue per unit of output. It is the ratio
between TR and total Quantity sold. It is always equal to price.
Mathematically,
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JOSHI,
CA FINAL (CAPIII)
Marginal revenue (MR) refers to the addition made to total revenue with sale of one
additional unit of the product in the market. In other words, it is the difference between
total revenue of last unit sale and total revenue of second last unit of sale.
Mathematically,
The relationship between TR, AR and MR in perfect competition market can be

explained with the help of following schedule and diagram.
Price TR AR MR
Quantity
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
Revenue
TR
50
40
30
AR /MR
1 2 3 4 5 Quantity
From the above diagram it is clear that TR curve in perfect competition market is a straight line
starting from origin. It increases in same rate as quantity increases. AR and MR both curves will
coincide with each other and parallel to X-axis. In conclusion, TR had direct relationship with
quantity and AR and MR both are independent of quantity.
COMPILED KISAN
JOSHI,
CA FINAL (CAPIII)
8. Explain the behavior of short run total cost curves.(3)(2017 JUNE)
Answer- Write as per Teachers Instruction.
9. Define marginal cost. Prove that marginal cost is independent of fixed cost algebraically.(3
2017 Dec.)
Answer
Marginal cost can be defined as the additional cost incurred in producing one extra unit of output.
It can also be defined as the ratio of change in total cost and change in units of output (normally
one).
Mathematically,
Where, = change in total cost, = change in quantity of output
Marginal cost is independent of fixed cost or it only depends on variable factors only. It
can be proved algebraically as following.
We know that,
The above expression shows that, marginal cost only depends on total variable cost (TVC)
or it is independent of fixed cost. OR
MC = TCn - TCn-1
= TFCn + TVCn - ( TFCn-1 + TVCn-1
= TVCn - TVCn-1
10. Define average and marginal costs. Illustrate their relationship. (3) (2018 JUNE)
Answer:
Average Cost (AC) is defined as the total cost divided by level of

output, i.e.,
TC
AC = Q
Marginal cost (MC) is defined as the change in TC due to change in level of
output, i.e.
TC
MC =
Q
AC, MC
COMPILED KISAN
JOSHI,
CA FINAL (CAPIII)

Minimum
 point of AC
With the help of the figure above, we can derive the following relationships
between AC and MC:
a. Both AC and MC are derived from same sources Total Cost (TC) and level
of output (Q) with the difference that MC needs change in TC and Q.
b. Both are U-shaped due to law of variable proportions.
c. When AC falls, MC also falls but rapidly. Thus to the left of minimum point
of AC, AC > MC.
d. When AC increases, MC also increases but rapidly. To the right of
minimum point of AC, AC < MC.
e. MC always cuts AC at its minimum point. At minimum point of AC i.e. at a, AC
= MC.
11. Define revenue. Explain the average and marginal revenue curves in perfect
competition.(1+4=5) (2018 DEC)
Answer:
Revenue is the income received by seller by selling given level of output. The profit of a firm
depends primarily upon the revenue and the cost of the firm. The firm earns more profit ifhe
can sell his product in excess of the cost of production. The revenue of a firm can be
obtained by multiplying the total units of sales by its price.
In prefect competition the price of the commodity will be the same in all over the market. If a
seller increases the price of the commodity, he has to give up his consumer. Similarly, if he
decreases the price, then he has to give up his profit. So the seller neither increases the price
nor decreases the price. In this case, the AR and MR will coincide with each other. That means
the AR and MR will be the same. We can further explain it with the help of the following table.
Demand and Revenue Schedule of a Firm
Price per No. of Total Average Marginal
Quantit Quantity Revenu Revenu Revenu
y (Rs.) sold e (Rs.) e (Rs.) e (Rs.)
120 1 120 120 120
120 2 240 120 120
120 3 360 120 120
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JOSHI,
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120 4 480 120 120
120 5 600 120 120
120 6 720 120 120
As the above Revenue Schedule shows, the firm has accepted the price of Rs. 120 per quintal
determined by the industry. The demand curve of the firm is perfectly elastic, since the firm can
sell a larger or a smaller quantity at this price of Rs. 120 per quintal.
The above schedule has been expressed by the alongside diagram. In the diagram, DD curve is
the average as well as the marginal curve of the firm. Under perfect competition, the average
revenue curve will coincide with the marginal revenue curve. In the upper portion of the
diagram, TR is the total revenue curve which goes on increasing with every increase in output.
12. Explain
The Institute average
of Chartered revenue
Accountants of and marginal revenue under monopoly and
Nepal imperfect competition with suitable diagram.(3 marks) (2019 DEC)
Answer
Average revenue and marginal revenue under monopoly and imperfect competition
A monopoly is a market structure characterized by a single seller, selling a unique
product in the market. In a monopoly market, the seller faces no competition, as the
firm is the sole seller of goods with no close substitute. Thus, the seller being a sole
seller has full control over the supply of the commodity. A monopolist is a price maker
and it is he who determines the price of his product based on the law of demand.
Therefore, the seller can sell more units of the output only at lower prices.
Similarly, the imperfect competition is a form of market in which firms produce
differentiated products with close substitutes. Firms under imperfect competition have
absolute right to produce and sell identical or differentiated product. Other firms are
prevented by laws from producing and selling such goods. This gives a firm monopoly
power over production, pricing and sale. Therefore, all firms have full control over the
supply of their commodity, and they follow the law of demand in pricing the product.
Hence, revenues under imperfect competition follow the trends of revenues under
monopoly.
In monopoly market, there is an inverse relationship between output and price. Hence,
the total revenue increases at first then starts to decrease. But, both average and marginal
revenue fall continuously. However, the decreasing rate of marginal revenue is greater
than average revenue.
Table 1.1: Revenue Schedule
Sales Quantity Price Revenue (Rs.)

(Kg) Q (Rs.) TR (=PQ) AR =TR/Q MR= ∆TR/∆Q
P
1 10 10 10 10
2 9 18 9 8
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JOSHI,
CA FINAL (CAPIII)
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
TR
AR
MR X
Above table and figure shows TR increases as output increases then starts to decreases.
Similarly as output increases both MR and AR decreases. MR may be negative.
15. Explain the relationship between average revenue, marginal revenue and total revenue under
monopoly. (2020 Dec.) 3 marks
Answer:
Under monopoly, there is negative relationship between price and quantity of output sold by
the firm. In other words, if the firm wants to sell more output, it charges lower price and if
less output is to be sold, it charges higher price. Due to negative relationship between price
and quantity, the total revenue (TR) increases at a decreasing rate initially, reaches to its
maximum point and finally it starts falling. If output is not sold (i.e. Q = 0), TR = 0 so that
the TR curve starts from origin. The average revenue (AR) and the marginal revenue (MR)
curves are downward sloping straight lines such that AR > MR at each level of output sold
by the firm.
COMPILED KISAN
JOSHI,
CA FINAL (CAPIII)
Tabular presentation
TR TR
Output (Q) Price (P) TR = P*Q AR = MR =
Q Q
0 7 0 - -
1 6 6 6 6
2 5 10 5 4
3 4 12 4 2
4 3 12 3 0
5 2 10 2 -2
6 1 6 1 -4
Graphical Presentation
TR, AR, MR
14
12
10
0 Q
-2
-4
In the figure, the TR, AR and MR curves are drawn on the basis of the above table. The
TR curve is upward sloping concave curve up to 4th unit of output implying that TR
increases at a decreasing rate. At 4th unit of output sold by the firm, it is maximum and
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after 4th unit of output, it falls. The AR and MR curves are downward sloping straight lines because
the relationship between price and quantity is negative as shown in the table. At each level of output,
AR lies above MR. At 4th unit of output, MR is equal to zero. To the left of this output, it is positive
and to the right of this output, it is negative.
16. Explain scarcity in economics. 3 marks (2021 June)
Answer:
It is the basic issue of economics which initiates all the economics problems. Scarcity ineconomics refers
to the gap between unlimited wants and limited resources. It is a situation of lack of resources to fulfill the
wants. Situation of excess of demand over supply is scarcity. Scarcity gives rise to the problem of choice.
Due to scarcity of resources people have to choice between them. Scarcity is the reason of value of goods.
The goods which are scarcer are of high value and vice versa. People can create scarcity through various
ways. So, scarcity is the foundation of the other problem of economics. According to Robbins economics is
the "science of scarcity".
17. Write the concept of monopolistic competition. Explain its any three features. (1+2=3 marks) (2021 June)
Answer:
Monopolistic competition is a blend of monopoly and perfect competition. It is a market structure

characterized by large number of sellers (firms) selling differentiated products which are close substitutes
to each other, and there is free entry and exit of firms. It has following features:
i. Large number of buyers and sellers
There are large number of firms but not as large as under perfect competition. That means each firm
can control its price-output policy to some extent. It is assumed that any price-output policy of a firm
will not get reaction from other firms that means each firm follows the independent price policy. If a
firm reduces its price, the gains in sales will be slightly spread over many of its rivals so that the extent
to which eachof the rival firms suffers will be very small. Thus, these rival firms will have no reasonto
react.
ii. Free entry and exit of firms
Like perfect competition, under monopolistic competition also, the firms can enter orexit freely. The
firms will enter when the existing firms are making super-normal
profits. With the entry of new firms, the supply would increase which would reduce the price and hence
the existing firms will be left only with normal profits. Similarly, if the existing firms are sustaining
losses, some of the marginal firms will exit. It willreduce the supply due to which price would rise and
the existing firms will be left only with normal profit.
iii. Product differentiation
Another feature of the monopolistic competition is the product differentiation. Product differentiation
refers to a situation when the buyers of the product differentiate the product with other. Basically, the
products of different firms are not altogether different; they are slightly different from others. Although
each firm producing differentiated product has the monopoly of its own product, yet he has to face the
competition. This product differentiation may be real or imaginary. Real differences are like design,
material used, skill etc. whereas imaginary differences arethrough advertising, trademark and so on.
iv. Selling cost

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Another feature of the monopolistic competition is that every firm tries to promote its product by
different types of expenditures. Advertisement is the most important constituent of the selling cost
which affects demand as well as cost of the product. The main purpose of the monopolist is to earn
maximum profits; therefore, he adjuststhis type of expenditure accordingly.
18. Is monopoly market always harmful to society? 3 marks (2021 June)

Answers:
Monopoly is the market structure in which a firm is the only supplier or the producer of a particular good
or service to its large number of buyers. The producer supplies the product which has no close substitutes.
A monopolist is a person or business entity that has significant market power, that is, the power to determine
the price more than marginalcost of the good. Monopolies have an incentive to under-produce and can
generate unwarranted economic profits. As a result, price is high and output is less in society.
Nevertheless, it is important to recognize that monopoly is not always as socially harmful as sometimes
indicated. Some economists consistently argue that monopoly power is required to generate dynamic
efficiency, that is, technological progressiveness. This is because high profit levels boost investment in
research and development (R&D) and innovation. If some of these profits are invested in new technology,
costs are reduced via process innovation. Similarly, ‘natural’ monopolies can benefit from economies of
scale.All these make the monopolist’s supply curve to the right of the competitive industry supply curve.
The result is lower price and higher output in long run. Moreover, monopolist may induce to keep low price
because consumer can give up consumption and start to consume remote substitutes. Similarly, monopolist
does not want to attract government attention by charging high price. Hence, a monopoly firm charges low
priceand produce optimum output even if it has monopoly power due to above reasons.
19. Define average and marginal cost and explain their relationship. (1+2=3 marks) (2021 December)
Answer:
20. Average Cost (AC) is the cost required for producing one unit output. It can be defined as the total cost divided by
level of output, i.e.,
TC
AC = Q
Marginal cost (MC) is the cost for producing additional unit of the commodity. It isdefined as the change in total
cost due to change in level of output, i.e.
TC
MC =
Q 
We can present both AC and MC in the following figure and explain their relationship.
AC, MC
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MC AC
a

 Minimum
point of AC
O
With the help of the figure above, we can derive the following relationships between ACand MC:
i. Both AC and MC are derived from same sources Total Cost (TC) and level of output
(Q) with the difference that MC needs change in TC and Q.
ii. When AC falls, MC also falls but rapidly. Thus, to the left of minimum point of AC, AC > MC.
iii. When AC increases, MC also increases but rapidly. Thus, to the right of minimum point of AC, AC < MC.
iv. MC always cuts AC at its minimum point. At minimum point of AC i.e. at a, AC = MC.
v. The minimum point of MC always comes before the minimum of AC. It means whenAC is decreasing MC may
increase but when MC is decreasing AC can’t increase.
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Chapter-5
Market Forms
1.Explain how price and output are determined under monopolistic market in the long run. (10)
(2013 JUNE)
ANSWER:
The concept of monopolistic competition has been introduced by American economist E.H.
Chamberlin in1933.Monopolistic competition is a market situation in which there are many
sellers of a particular product, but each seller sells somewhat differentiated product, which are
close substitute of one another. Each firm has monopoly on their product and also has their own
price and output policy.
The main characteristics of monopolistic competition are listed below. i) Many sellers ii)
Differentiated product with close substitutes iii) Free entry and exit of firms iv) Negative sloping
demand curve vi) Imperfect knowledge about market.
Job of Firm
Under monopolistic competition, firm has following three jobs.
(i) To determine level of output - To determine profit maximizing level of output
firm has to fulfill following conditions:
(a) MC=MR
(b) Slope of MC>slope of MR
(ii) To determine price- Firm determines price of its product on the basis of law of
demand (i.e., more sale, low price and vice versa)
(iii) To formulate sales strategy-In order to participate non-price competition, each
firm has to formulate sales strategies, i.e., either informative sales strategy or
promotional sales strategy.
Long period is a period at which firm can adjust market supply according to change in market
demand due to availability of sufficient time to vary units of all inputs.
In long run, firm obtains only normal profit. It is due to the condition of free entry and exit of firms.
Due to market imperfections, all firms operate their plant only at sub-optimal capacity.
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Normal Profit
The firm is in equilibrium at point E where both the conditions are

fulfilled i.e. MC = MR & MC cuts MR from below.
Level of output = OQ
Equilibrium price=OP
Per unit cost (AC) = OP (=QT)
Per unit revenue (AR) = OP (=QT)
AR = AC = normal profit
OP=OP
TR= PQ = OP x OQ = Area of OPTQ
TC = CQ = OP x OQ = Area of OPTQ
Area of TR (OPTQ) = Area of TC (OPTQ)
Thus the firm obtains normal profit.
2. What are the characteristics of perfect competition? (5)

(2013JUNE)
Answer:
The main characteristics of perfect market are as follows:

i) Large number of buyers and sellers. There are a large number of
buyers and sellers who compete with each other and their number is
so large that no buyer or seller is in a position to influence the demand
or supply in the market.
ii) Product homogeneity with perfect substitutes. The output of each firm
in the market is homogeneous, identical or perfectly standardized. The
homogeneity of the product refers not only to the physical
characteristics of the commodity such as color, size, trademark, taste
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etc. but also to the environmental factors such as location of the seller,
sales strategy etc. This means that the products of various firms are
indistinguishable from each other, i.e. they are perfect substitutes for
one another.
iii) Free entry and exit of firm. Every firm is free to enter the market or to
go out of it. Entry or exit may take time but firms have freedom of
movement in and out of the industry.
iv) Perfect knowledge. It is assumed that all sellers and buyers have
complete knowledge of the condition of the market. This knowledge
refers not only to the prevailing conditions in the current period but in
all future periods as well. Information is free and costless. Under these
conditions, uncertainty about future development in the market is
ruled out.
v) Perfect mobility of factors of production. The factors of production are
free to move from one firm to another throughout the economy.
vi) No government regulation. There is no government regulation (i.e.
tariffs, subsidies, rationing of output and demand), and taxing and so
on are ruled out.
vii) Absence of transport cost. There is no transport (taking the product
from one point of the market to the other) cost. Thus, the price of the
product is not affected by the cost of transportation.
3. What are the characteristics of perfect competition? Explain any two.

(3)(2013 DEC)
Answer:
Perfect competition is that market structure in which there are large

numbers of sellers and buyers of homogeneous product, there are perfect
substitutes of its product and there is free entry and exit of the firm into
the industry.
The main characteristics are: large number of buyers and sellers,
Product homogeneity, free entry and exit of the firms, Perfect mobility
of factors of production, Perfect knowledge, No govt. regulation,
Absence of transport cost and Profit maximization
Large number of buyers and sellers: The industry or market includes
a large number of firms (and buyers), so that each individual firm,
however large, supplies only a small part if the total quantity offered in
the market. The buyers are also numerous so that no monopolistic power
can affect the working of the market. Under these conditions each firm
alone cannot affect the price in the market by changing its output.
Product homogeneity: The industry is defined as a group of firms
producing a homogenous product. The technical characteristics of the
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product as well as the services associated with its sale and delivery are
identical. There is no way in which buyer can differentiate firms, and will
have some discretion in setting its price. This is not possible in perfect
competition.
4. How are the price and output determined under monopoly in the long run?
(5) (2014 JUNE)
Answer:
Monopoly is the form of market structure for a commodity in which there
is only one seller of the commodity. The monopolist has no close
substitutes and there are strong barrier to entry into the industry. As a result
seller has full control over the supply of the commodity. Thus he is the price
maker.
Benham: “A monopolist is literally a single seller and monopoly power is based
entirely on control over the supply”
In reality pure monopoly is a myth which is found rarely in the real world. In the real
world, only imperfect monopoly can be found where the monopolist has to face
substitutes. For example, Nepal Electricity Authority may be called imperfect
monopolist since it has to face competition of distance substitutes like kerosene,
petrol, gas, candle, solar etc. in different use.
There is no difference between the firm and industry in monopoly.
In the long run, there is sufficiently long time available to the firm to adjust its output
to the changing demand. The firm can adjust its output to the changed demand not
only by varying the variable factors but also by changing the fixed factor such as plant
and machinery etc.
In the long run also the monopolist is in equilibrium at a point where its marginal
revenue (MR) is equal to its marginal cost (MC) and MC curve cuts the MR curve
from below. In the short run, monopolist can earn super normal profits, normal profits
or losses. Therefore the monopolist price is greater than, equal to or less than the
average cost in the short run. But in the long run the monopolist price would be higher
than the average cost because in the long run, the greater possibilities is that
monopolist can earn super normal profit. Because there is no possibility of entry of
new firms into the industry. Therefore in the long run the monopolist price is not less
than the average cost (AC). If the monopolist price is less than AC in the long run the
firm would prefer to close down its business and to leave the market rather than suffer
financial losses. Therefore in the long run the monopolists earn super normal profit
but in the rare case he can earn the normal profit.
It is to be noted that the size of the plant and the degree of its utilization of a particular
size of plant of a monopolist depends fully on market demand. Monopolist may reach
optimum scale (minimum point of LAC) or remains at sub-optimal scale (falling part
of LAC) or may cross optimum scale (beyond minimum point of LAC) according to
market condition. There is no certainty to reach optimum scale in the long run in
monopoly as in perfect competition. In general, the monopolist produces less then
optimum output.
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In this figure, OY axis measures revenue and cost and OX axis measures
output. E is the equilibrium point where the two conditions i.e. (a) MR is
equal to MC and (b) MC curve also cuts the MR curve from below, are
fulfilled. OP is the equilibrium price.
Here, TR = Area OPQM TC = Area OSRM
Total profit = TR – TC
Total profit = Area OPQM – Area OSRM
Total profit = Area PQRS
Thus the monopolist firm maximizes the profit at OM level of output. OM is
the equilibrium output and OP is the equilibrium price at E point. The
monopolist operates his plant at a sub optimal capacity and it is indicated by
point R where the falling part of AC cuts the MQ vertical line. Thus, the
portion RS of the plant is unused capacity.
5. Explain the causes responsible for raising monopoly.

(3)
(2014 DEC)
Answer:
The main cause leads to monopoly are the following:
1. Strategic Raw Material. A firm owning or controlling a raw material, which
is essential in the production process, can prohibit the creations of rival firms.
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In other words, a firm may acquire monopoly because of its single right or
control over the key sources of raw material, which are used to produce articles
such as diamond, graphite etc. Such monopoly is called raw material monopoly
or natural monopoly.
2. Patent Rights. Patent rights are granted by the government to a firm to produce
a commodity of specified quality and character or to use a specified technique
of production. Such monopolies are called patent monopolies.
3. Limit Pricing Policy. A monopoly firm may adopt the limit pricing policy
which may be combined with other policies such as heavy advertising or
continuous product differentiation, which renders entry unattractive. This is the
case of monopoly established by creating barriers to new competitors.
4. Legal Restrictions. Most of the public monopolies in the public utility sector
such as power supply, electronic communication media and postal services are
government monopolies that are created by the government law. The objective
of this policy is to work for public welfare.
5. Optimum Scale of Plant. If a monopoly firm is established at optimal scale of
resources, it becomes almost impossible for new firms to enter the industry and
survive. Monopolies existing on account of this factor are known as natural
monopolies. Thus may emerge from the technical condition of efficiency.
6. Explain the three features of monopolistic competition. 3 (2015 DEC)

Answer:
Features of Monopolistic Competition
1. A large number of sellers:- The number of sellers are sufficiently large that there
is no feeling of material interdependence among them. Each firm acts independently
without caring for any effect, which its action may have upon those of its
competitors.
2. Differentiated products:- The large number of buyers have preference for the
product of the particular seller. Different sellers may have differentiated products for
creating preference for their product in the minds of the buyers.
3. Free entry:- Under monopolistic competition, the new firms may enter into the
industry freely. They can enter and exit out of the industry and can produce the
products which are close substitutes with other products.
7. Explain any four features of perfect competition. 3 Marks (2016 JUNE)
Answer:
Perfect competition is a form of market in which there will be large number of

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buyers and sellers. The product of the different producer will be homogenous.
A firm can't affect the price by its individual efforts. A perfect competition
market is characterized by the following features:
1. Large numbers of buyers and sellers:- The first condition of perfect
competition is large number of buyers and sellers. The market must have such
a large number of sellers that no seller is able to dominate in market. Similarly,
there should be large number of buyers.
2. Homogenous Product:- under this market the firms or sellers must sell
homogenous goods. There shouldn't be any differentiation of products in
quality, variety, colour, design, packing or other selling conditions of the
product.
3. Free entry and exist for firms:- Under perfect competition there is
absolutely no restriction on the entry of new firms in the industry or the exit of
the firms in the industry who want to leave it.
4. Perfect mobility of factors of production:- All factors of production should
freely move from one firm to another. If labour of the same type moves from a
low paid occupation to a highly paid occupation, the price of labour i.e. the
wage rate will be similar in all the occupation or firms.
5. Perfect knowledge:- Another condition of perfect competition is that both
sellers and buyers must have perfect knowledge about the market conditions.
Seller must know the prices of the commodity, which is prevailing in the
market similarly the buyers must know the price being charged by different
sellers.
6. Absence of transportation cost:- Price of the product should not be affected
by the cost of transportation cost. In other words, the market price charged by
sellers should not be different due to the presence of transportation cost.
8. Define monopoly. Why a monopoly firm always obtains supernormal/excess profit in

long run? 3 Marks (2016 June)
Answer:
Monopoly is a type of market Structure in which single seller and large number of
buyers are dealing with the product which has no substitutes. There is
restriction/barriers to entry of new firms in the industry without government
regulation.
The main characteristics of monopoly market are as follows:

1. Single seller large number of buyers
2. No close substitutes
3. Barriers to entry of new firms
4. Firm is same as industry
5. Firm itself is price maker
6. Negatively sloped demand curve etc.
20
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The firm operating in monopoly market always obtains excess profit in long run due
10
to the following reasons.
a) Monopoly firm has sufficient time to replace all the inefficient factors of
production in long run by efficient ones which creates favorable condition to obtain
profit.
b) Since, there are barriers to entry of new firms industries. There is no fear of
competition being the firm as single in the market.
The firm itself is price maker. So, the firm determines the price in such a way that
it could earn excess profit.
9. Define oligopoly. State any four distinct characteristics of oligopoly. (3) (2016 DEC)
Answer:
Oligopoly is a type of market structure under imperfect competition market. It falls

between two extreme market structures, perfect competition and monopoly. Oligopoly
occurs when a few firms dominate the market for a good or service. This implies that
when there are a small number of competing firms, their marketing decisions exhibit
strong mutual interdependence. By mutual interdependence we mean that a firm's action
say of setting the price has a noticeable effect on its rival firms and they are likely to
react in the some way. Each firm considers the possible reaction of rivals to its price
and product development decisions. The examples of Oligopoly market in Nepal are
soft drinks industries, Airlines companies, Universities etc.
There are some distinct features of oligopoly market structure in comparison
to other type of market structures which can be explained as following:
1. Interdependence in Decision Making: In oligopoly, all firms under an industry are
interdependent in decision making. Since, behavior of one firm will affect another; they
observe the behavior of their opponents and make decisions accordingly.
2. High Advertising and selling cost: Oligopolistic firms give higher
importance to advertising and selling costs. They want to increase the sales not by
changing the price but by other means such as advertising and selling costs and
marketing techniques.
3. Group Behavior: We can observe the Mass behavior rather than individual behavior in
oligopoly market structure. Since, one firm don’t want to take risk with individual
decision making in the industry. They decide in group regarding the price, output,
Quality etc.
4. Indeterminate Demand curve: Since oligopolistic firms are interdependent with each
other, they do not know their demand curve. They can anticipate their demand curve if
they know the expected behavior of other firms of the industry but when the behavior
of other firms change demand curve will also change. Hence, the demand curve of an
oligopolistic firm is indeterminate.
In conclusion, Oligopoly is a type of realistic market structure within imperfect market

structure. It has some distinct and realistic characteristics such as Interdependency,
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group behavior, High advertising cost, unknown demand curve etc.

10. Define monopoly. Explain the equilibrium of a monopoly firm in long run.(3) (2017 JUNE)
Answer:
Monopoly is a type of market structure in which single seller and large number
of buyers are dealing with a product with no close substitutes. There is restriction
to entry of new firms and the firm is same as industry. The main features of
monopoly market are as follows:
a) Single Seller large number of buyers
b) No close substitutes of the product
c) Restriction to entry of new firms
d) Firm is same as industry
e) Firm itself is a price maker
f) Negatively sloped demand curve etc.
In long run, monopoly firm always obtains excess or abnormal profit because in
one hand monopoly firm will have no fear of competition due to restriction to
entry of new firms on the other hand the firm itself is a price maker. Hence, it
determines the price in such a way that the firm will be able to obtain excess
profit. It can be explained in the following diagram.
Follow the Teachers Instruction for further answers.
11. Despite of being large number of firms in an industry, no price war takes place
in perfect competition market. Justify the statement with proper reasons along with
salient features of perfect competition market. (3) (2017 DEC)
Answer:
Perfect competition is a type of market structure in which large number of buyers

and sellers are dealing with the homogeneous products and there is free entry and
exit of firms in the industry. Industry is composed of large number of firms, each
individual firms are very small in size in comparison to the industry which can‟t
influence the price as well as output of whole industry. Industry determines the price
of the product on the basis of market demand and supply and all the firms follow that
price. Therefore all the firms in perfect competition market are price takers not the
price makers. Since, the firms produce homogeneous products and follow the same
price as determined by the industry; no price war takes place in perfect competition
market.
The salient features of perfect competition market are as follows:

1. Large number of buyers and sellers
2. Homogeneous products
3. Free entry and exit of firms
4. Perfect mobility of factors of production
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5. Perfect knowledge of the product
12. Define monopolistic competition. Explain how price and output are
determined under it in the short-run with suitable diagrammatic illustration.
(1+4=5) (2018 JUNE)
Answers:
Monopolistic competition is a blend of monopoly and perfect
competition. It is a market structure characterized by large number of
sellers (firms) selling differentiated products which are close substitutes
to each other, and there is free entry and exit of firms.
The price and output determination under monopolistic

competition in the short run can be presented below:
In the short run equilibrium, there arises three cases:
a. Abnormal profit (AR > AC)
b. Normal profit (AR = AC)
c. Losses (AR < AC)
The fact that a firm is in (short–run) equilibrium does not
necessarily mean that it makes abnormal (excess) profits. Whether
a firm makes abnormal profit or losses depends on the level of AC
in the short-run equilibrium. Thus, it is important to analyze the
above mentioned 3 cases as per the level of AC.
Graphical Analysis
Pe COMPILED BY KISAN JOSHI,
Pe
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AR (=D) AR (=D)
AR (=D)
MR MR MR
Output
Abnormal Profit Loss Normal Profit
(AR>AC) (AR=AC)
1. (AR<AC)
In the given figures, we have drawn downward sloping AR (=D) and MR curves.
At
e, the firm is in equilibrium as the two conditions for equilibrium
are met. In case of abnormal profits, Average Cost (AC) curve lies
below AR curve at A so that AR > AC, and the shaded region
PeABC is abnormal profit enjoyed by the firm which is shown by
the first figure. In case of losses, AC curve lies above the AR curve
at A so that AR < AC, and the shaded region PeABC is the loss
faced by the firm shown by the second figure. In case of normal
profit, average cost curve (AC) is tangent to AR curve at A so that
AR = AC. It is shown by the third figure. Thus we can conclude
that it is the level of AC that forces a firm to bear losses or enjoy
abnormal profit or just stay with normal profits at equilibrium. In
this way, a firm is in equilibrium with price Pe and output Qe as
shown by the figures.
13. How monopoly firm attains equilibrium in long-run? Explain graphically.

3(2018 DEC)
Answer: please refer to your note for best answer.
14. What is monopoly? Explain how price and output are determined under it in
the short- run with suitable diagrammatic illustration. (1+4= 5 marks)( 2019
DEC)
Answer:
The word ‘monopoly’ has been derived from two Greek words ‘monos’
meaning ‘single’ and 'pollein’ meaning ‘seller’. Thus, monopoly implies
the situation of single seller.
Monopoly is a market structure characterized by a single seller (firm)

selling the goods that has no close substitutes and there is strong barrier
to entry into the industry. In other words, monopoly is a market situation
under which a firm has complete control over the supply of its output. A
monopolist is like a king without crown.
The equilibrium of a monopoly firm occurs under the two conditions. It
means in monopoly market output is determined where the following two
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conditions are satisfied:

vii. MC = MR
viii. MC must cut MR from below. i.e., Slope of MC > Slope of MR.
AR corresponding to that equilibrium output will be equilibrium price
determined.
In short-run, the firm may be in three conditions:
a. Abnormal profit (AR >AC)
c. Losses (AR< AC)
The fact that a firm is in (short–run) equilibrium does not necessarily
mean that it makes abnormal (excess) profits. Whether a firm makes
abnormal profit or losses depends on the level of AC in the short-run
equilibrium. Thus, it is important to analyze the above mentioned 3
cases as per the level of AC.
Graphical Analysis
C,R,P C,R,P C,R,P
MC MC
AC
AC
B
MC C
Pe A
A
A Pe
Pe AC
B e
C
e
e
AR (=D) AR (=D)
AR (=D)
MR
MR MR
O Qe Output O Qe Output O Qe Output
Abnormal Profit Normal Profit
Loss
(AR>AC) (AR<AC) (AR=AC)
In the given figures, we have drawn downward sloping AR (=D) and

MR curves. At e, the monopolist is in equilibrium as the two
conditions for equilibrium are met. In case of abnormal profits,
Average Cost (AC) curve lies below AR curve at A so that AR > AC,
and the shaded region PeABC is abnormal profit enjoyed by the firm
which is shown by the first figure. In case of losses, AC curve lies
above the AR curve at A so that AR < AC, and the shaded region
PeABC is the loss faced by the firm shown by the second figure. In
case of normal profit, average cost curve (AC) is tangent to AR curve
at A so that AR = AC. It is shown by the third figure.Thus, we can
conclude that it is the level of AC that forces a firm to bear losses or
enjoy abnormal profit or just stay with normal profits at equilibrium.
In this way at equilibrium, firm produces Qe amount of goods at the
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price Pe. A firm in monopoly bears losses in rare conditions only, i.e.
at times of depression and initial stage of production.
15. Define monopolistic competition. Explain how price and output are
determined under it in the short-run with suitable diagrammatic
illustration. (1+4=5 marks) (2020 Dec.)
Answer:
Monopolistic competition is a blend of monopoly and perfect
competition. It is a market structure characterized by large number of
buyers and sellers (firms) sellingdifferentiated products which are close
substitutes to each other, and there is free entry and exit of firms.
Monopolistic firms determine output when MC=MR and MC cutsMR
from below.
The price and output determination under monopolistic competition in
the short run canbe presented below:
In the short run equilibrium, there arises three cases:
a. Abnormal profit (AR > AC)
c. Losses (AR < AC)
The fact that a firm is in (short–run) equilibrium does not necessarily
mean that it makes abnormal (excess) profits. Whether a firm makes
abnormal profit or losses depends on the level of AC in the short-run
equilibrium. Thus, it is important to analyze
the above mentioned 3 cases as per the level of AC.
Graphical Analysis
Pe
Pe
In the given figures, we have drawn downward sloping AR (=D) and MR

curves. At e, the firm is in equilibrium as the two conditions for
equilibrium are met. In case of abnormal profits, Average Cost (AC)
curve lies below AR curve at A so that AR > AC, and the shaded region
PeABC is abnormal profit enjoyed by the firm which is shown bythe first
figure. In case of losses, AC curve lies above the AR curve at A so that
AR < AC, and the shaded region PeABC is the loss faced by the firm
shown by the second figure. In case of normal profit, average cost curve
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(AC) is tangent to AR curve at A so that AR = AC. It is shown by the
third figure. Thus we can conclude that it is the level of AC that forces a
firm to bear losses or enjoy abnormal profit or just stay with normal
profits at equilibrium. In this way, a firm is in equilibrium with price P e
and output Qe as shown by the figures.
15. Define supply curve. Illustrate a firm's supply curve and market supply curve. (1+4=5 marks) 2021
December
Solution:
a) Supply curve is the graphical representation of relationship between price and quantity
supplied. The supply curve slopes upward showing positive relationship between price
and quantity supplied. When price increases, quantity supplied also increases, vice versa.
A firm's Supply Curve and its Derivation
Firm's supply is the quantity offered for sale by an individual firm. It can be derived with
the help of a firm's supply schedule. A Firm's supply schedule is a table that shows
various amounts of a commodity that a producer wants to supply at different prices in a
market.
A hypothetical supply schedule of an individual seller is given below.
Price (Rs.) Quantity supplied (Units)
2 1
4 2
6 3
According to the table, when price of a commodity is Rs. 2 per unit, quantity supplied is
1 unit. When price rises to Rs. 4, quantity supplied increases to 2 units. If price further
increases to Rs. 6, quantity supplied also rises to 3 units. Thus, firm's supply schedule
shows the quantity supplied of a commodity at various prices by a single supplier. It
shows the positive relationship between price and quantity supplied.
If the price quantity combinations of the schedule are presented in a graph and they are
joined, a firm's supply curve is derived as shown in figure below
S
Price
8
c
6
b
4 a
2 S
O X
1 2 3 4
Quantity supplied
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In the Figure, quantity supplied and price are measured on X and Y axis respectively.
Points a, b, c and d in the figure show the different price quantity combinations. By
joining these points, we derive an upward sloping supply curve. Thus, a firm's supply
curve shows the positive relationship between price and quantity supplied.
Market Supply Curve and its Derivation
Market supply curve is the horizontal sum of individual firm's supply curve. Market
supply curve is derived with the help of market supply schedule. The table showing
the supply of whole market for a commodity at different prices is known as market
supply schedule. It is an aggregate of the quantity supplied by all the individual firms
in the market.
Following represents market supply schedule assuming that there are only two
producers say A and B.
Individual Firm's Supply Total Market
Price (Rs.) (Units) Supply
A B A+B
2 1 2 3
4 2 3 5
6 3 4 7
When price of the commodity is Rs. 2 quantity supplied by producer A and B is 1 and
2 units respectively. By adding up quantity supplied by producer A and B we get total
market supply i.e. 3 units (1 + 2 = 3). When price increases to Rs. 4 then market supply
also increases to 5 units. Likewise, when price further increases to Rs. 6 then market
supply also increases to 7 units. Thus, market supply schedule shows the positive
price-quantity relationship.
Market supply curve can be derived by plotting the market supply schedule into a
graph which is shown in the figure below:
Y
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Price
SA
SB
6 SM
0 X
1 2 3 4 5 6 7
Quantity supplied
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In figure, price and quantity supplied are measured on Y and X axis respectively. Curve SA and SB are the
supply curve of two different firms. SM is the market supply curve which is the horizontal sum of SA and SB.
Upward slopping market supply curveshows the positive relationship between the price and quantity supplied in
market. When price is Rs. 4 then market supply is 3 units. When price increases to Rs. 4 then market supply also
increases to 5 units. Likewise, when price further increases to Rs. 6 then market supply also increases to 7 units.
It means higher the price, higher will be the quantity supplied of a commodity and vice-versa.
16. Define average cost. Why it is ‘U’ shaped in the short run? (1+2=3 marks) (2021 June)
Answer:
Average cost is the per unit cost of production. In the short run it is the sum of average fixed and
variable cost. It is also called average total cost.
AC = STC/Q
AC= TFC + TVC/Q
AC = AFC + AVC= ATC
The nature of short period Average Cost Curve is ‘U’ shaped. It is determined by Average Fixed Costs
and Average Variable Costs. In the beginning, they are decreasing as the level of output increases. So,
Average Costs fall more sharply due to the combined effectof the declining average fixed and Average
Variable Costs.
This results from the use of indivisible factors and the reaping of internal economies of labour,
technical, managerial, marketing etc. The Average Cost will continue to fall till they reach the
minimum point which is the optimum point level of output. Once the optimum level of output is
reached, Average Costs starts rising as more are produced beyond this level.
The rise in Average Variable Cost is more than offset by the small fall in Average FixedCosts and
hence the Average Costs rises quickly. This is due to the change of economies into dis-economies. This
gives the short-run as well as long-run Average Cost Curves of the firm is ‘U’ shaped.
The nature ‘U’ shaped short-run Average Cost curve can be attributed to the law of variable
proportions. This law tells that when the quantity of one variable factor is changed while keeping the
quantities of other factors fixed, the total output increases with an increasing rate and then declines
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with more than proportionate.
17. Define oligopoly market. Mention its four features? (2+1 =3 marks) (2021 December)
Answers:
Oligopoly is a market structure in which there are few firms producing homogeneous or differentiated
products; there all the firms will be interdependent. Oligopoly market are market dominated by a small number
of suppliers; few firms will rule over the market. In Nepal, industries producing instant noodles, telecom service
providers, etc. face oligopolistic market situation.
Features of Oligopoly
 Few Numbers of Sellers.
 Homogeneous or differentiated products
 Interdependence in decision making
 Some barriers to entry but not impossible
 Huge advertisement and promotional cost
 Non-price competition and selling cost
 Indeterminate price and output
 Imperfect knowledge about the market
 Realization of economies of scale, etc.
18. Define perfect competition Market. Mention its four features. 3 Marks (2022 June)
Answer:
Perfect competition is that market structure in which there are a large number of sellers and buyers of
homogeneous products and products are perfect substituted of each other. It is a market structure characterized
by a complete absence of rivalry among individual firms. In other words, it is a form of market in which there
are a large number of buyers and sellers. Sellers sell homogeneous goods with perfect substitutes. Firms
produce only a small portion of the total output produced by the whole industry. An industry is a group of
different firms producing the same product. A single firm cannot affect the price by its individual efforts. It is
only a price taker.
Characteristics (or Conditions) of Perfect Competition

1.Large Number of Buyers and Sellers. There are a large numher of buyers and sellers who compete with
each other and their number is so large that no buyer or seller is in a position to infuence the demand or supply
in the market.
2.Product Homogeneity with Perfect Substitutes. The output of each firm in the market is homogeneous,
identical or perfectly standardised. The homogeneity of the product refers not only to the physical
characteristics of the commodity such as colour, size, trademark. taste etc. but also to the environmental factors
such as location of the seller, sales strategy etc. This means that the products of various firms are
indistinguishable from each other, i.e. They are perfect substitutes for one another.
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3.Free Entry and Exit of firm. Every firm is free to enter the market or to go out of it. Entry or exit may take
time but firms have freedom of movement in and out of the industry.
4.Perfect Knowledge. It is assumed that all sellers and buyers have complete knowledge of the condition of the
market. This knowledge refers not only to the prevailing conditions in the current period but in all future periods
as well. Information is free and castless. Under these conditions, uncertainty about future development in the
market is ruled out.
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Chapter-6
International Trade
1. What are the roles of foreign trade in economic development of Nepal? Explain any two. (3)
(2013 DEC)
Answer:
The foreign trade is of special significance to both developed as well as developing countries. The
foreign exchange can be earned from foreign trade, which can be spent on the import of machinery
and equipments. This helps to accelerate the pace of economic growth.
The roles of foreign trade in economic development of Nepal are: benefit of technological progress,
availability of raw materials, Expansion of market, increase in employment opportunities,
benefit of specialization, increase in public revenue etc.
 Benefit of technological progress:- The less developed countries (LDCs) like Nepal are
technologically backward. There is rapid technological progress in developed countries. Hence,
the goods like machinery and equipments for industrial, electrical, transport and communication
projects can be imported through foreign trade. The technical know- how, managerial skill is
exchanged through foreign trade.
 Availability of raw materials:- The geographical position of different countries is not
Uniform. All countries are not rich in all types of raw materials. The countries can import raw
materials for foreign countries. The developed countries also import significant volume of raw
materials from foreign countries.
2. Define Balance of payment and Balance of trade. ((2014 JUNE)

Answer:
BOP is the systematic record of all economic transactions. It includes not only visible items but
also invisible items such as shipping, banking, insurance services, interest, gifts, etc. All the
countries are either to make payments to others or to receive from others. BOP is thus, a statement
of payments and receipts. Kindleberger defines BOP as, “a systematic record of all economic
transactions between the residents of the reporting country and the residents of foreign countries
during a given period of time.”
m) It is a systematic record of all economic transactions between one country and the rest of the
world.
n) It includes all transactions, visible as well as invisible.
o) It relates to a period of time. Generally, it is an annual statement.
p) It adopts a double entry book-keeping system. It has two sides: credit side and debit side.
Receipts are recorded on the credit side and payments on the debit side.
q) When receipts are equal to payments, BOP is in equilibrium; when receipts are greater than
payments, there is surplus in BOP; when payments are greater than receipts, there if deficit in BOP.
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r) In the accounting sense, total credits and debits in the BOP statement always balance each
other.
But balance of trade is only a major component of balance of payment. It is represented in the trade
and merchandise account section of the current account in the balance of payment. However,
balance of payment includes, apart from balance of trade or merchandise account, the invisible
account. Therefore. We can say that since balance of trade is only a partial study of the total
economic transaction in international trade, it has it has a little analytical significance. It is the
balance of payment, which provides a complete record of international economic transactions and
has a great analytical and economic significance.
3. "International trade is the Heart of Open Economy" explain the statement with the help of
advantages of international trade in case of developing countries like Nepal. (5)
(2015DEC)
Answer:
Trade between or among the countries of the world across borders is called as international
trade or foreign trade. With the flow of globalization after 1980’s the volume as well as role of
foreign trade is increasing. Specially in case of developing countries like Nepal, where labor
intensive production technique prevails and due to lack of capital and other supplementary
factors of production. It is not possible to produce all the goods and services which they
consume and they import goods and services from foreign countries. On the other hand when
they produce goods even by importing raw materials they have very small market to sell those
goods and services to sell. For which they seek foreign market to sell those products and earn
more profit. Hence, for developing countries like Nepal, international trade plays very
important role in development of the economy as heart plays the main role in operation of
human life.
The main advantages of international trade in case of developing countries like Nepal
are as follows:
1. Consumption of quality goods at cheaper price:
Import of goods from foreign country in high volume decrease the price of products in domestic
market. Hence, the people of developing countries will be able to consume the quality
products at cheaper price.
2. Preservation of consumer’s sovereignty:
Foreign trade provides the choice to the consumers to consume what they want no matter the
product is produced in domestic country or foreign country. It preserves the consumer’s
sovereignty.
3. Export promotion and source of foreign currency reserve:
Foreign trade provides access to export goods and services to international market which helps
to earn foreign currency and improve standard of living of developing countries.
4. Increase in government revenue:
Increase in export and import of goods and services increases export and import taxes to
increase government revenue.
5. Increase in productivity of domestic industries:
Competition created by foreign trade also increases the productivity of domestic industries as
people choose the superior than inferior. If they produce the inferior, they will exit from the
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market.
6. Improvement in relationship between countries:
Foreign trade not only increases the trade volume but also improves the relationship
between/among countries of the world through the transfer of goods, services, technology
and social/cultural norms and values etc.
7. Helps in internal crisis:
If internal production system faces any crisis, foreign trade helps to supply goods and services
from international market to fulfill demand of goods and services of domestic people.
With the help of those various benefits of international trade in case of developing countries.
It can be justified that foreign trade is the main basis of development in case of developing
countries like Nepal in this age of globalization.
4. Explain any three problems of international trade.(3) (2016JUNE)

Answer:
The main Problems of international trade are as follows:
1. Geographical Location: Nepal is a land locked country surrounded by India in three sides
and by China in one side i.e., north. Due to over dependence on India Nepal's foreign trade is
hindered. It is very difficult to trade freely with overseas countries.
2. Concentrated on limited goods: Nepal's export is limited only to on few goods. The main
items of Nepal's are primary products while the imports are finished goods and machineries.
This results to the increase in imports and decrease in exports. Nowadays Nepal's main items
are carpets and exports readymade garments. Their exports are also in declining trend.
3. Low quality goods: The goods produced in Nepal are of inferior quality. There are
complaints that even the quality of carpets and garments are deteriorating. The goods produced
also involve high cost. Thus, Nepalese products of low quality involving high cost cannot
compete in international market with foreign products.
5. Describe the problems of foreign trade in Nepal . (3)(2016 DEC)

Answer:
Foreign trade or international trade refers to the exchange of goods and services from
domestic economy to the rest of the world. In other words, it is the trade between two
countries of the world. Most of the countries of the world have been able to take advantage
from the foreign trade. Foreign trade is being one of the important base for economic
development of a country but Nepal is not being able to take advantage from foreign trade
even in this age of globalization.
Analyzing the current situation of foreign trade, Nepal’s trade is mostly concentrated
with India. About 60% trade with India and only 40% with the rest of the world. With
increase in volume of international trade, trade deficit is also increasing rapidly. Due to high
trade deficit, balance of trade also being negative. The main problems of foreign trade in
Nepal are as follows:
a. Odd geographical location: Being Nepal a landlocked country, trade with other countries
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than India is very difficult. Even trade with neighbor country china is also very difficult due
to geographical location. It is one of the major causes of high trade dependency with India.
b. Low production of goods and services: To export goods and services, excess of supply over
domestic demand of goods and services is necessary.
c. Obsolete Technology of Production: Due to primitive production technique, cost of
production of Nepalese products is higher than other countries and Nepal can’t compete with
other countries in terms of price and quality as well.
d. One sided foreign trade: Nepal’s foreign trade is mostly concentrated with India. About
60% of the total trade is with India and rest 40% with other countries. It is also one of the
major problems of Nepalese foreign trade.
e. Limited goods to export: Nepal is producing only limited products that can be exported to
other countries. In fact, those products are also produced by India as well. Therefore,
potentiality of exporting goods from Nepal is being limited.
Due to above stated problems of Nepalese economy, Nepal is not being able to take
advantages from foreign trade and converted as dependent import based economy.
6. What is international trade? Explain its advantages and disadvantages. (5) (2017 JUNE)
Answer:
Trade between or among the countries of the world across borders is called as international trade
or foreign trade. With the flow of globalization after 1980‟s the volume as well as role of foreign
trade is increasing. Specially in case of developing countries like Nepal, where labor intensive
production technique prevails and due to lack of capital and other supplementary factors of
production. It is not possible to produce all the goods and services which they consume and they
import goods and services from foreign countries. On the other hand when they produce goods
even by importing raw materials they have very small market to sell those goods and services to
sell. For which they seek foreign market to sell those products and earn more profit. Hence, for
developing countries like Nepal, international trade plays very important role in development of
the economy as heart plays the main role in operation of human life.
The main advantages of international trade in case of developing countries like Nepal are as
follows:
1. Consumption of quality goods at cheaper price:
Import of goods from foreign country in high volume decrease the price of products in
domestic market. Hence, the people of developing countries will be able to consume the
quality products at cheaper price.
2. Preservation of consumer’s sovereignty:
Foreign trade provides the choice to the consumers to consume what they want no matter the
product is produced in domestic country or foreign country. It preserves the consumer’s
sovereignty.
3. Export promotion and source of foreign currency reserve:
Foreign trade provides access to export goods and services to international market which
helps to earn foreign currency and improve standard of living of developing countries.
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4. Increase in government revenue:
Increase in export and import of goods and services increases export and import taxes to
increase government revenue.
5. Increase in productivity of domestic industries:
Competition created by foreign trade also increases the productivity of domestic industries as
people choose the superior than inferior. If they produce the inferior, they will exit from the
market.
Apart from those above stated points international trade also helps in improvement in
relationship between countries and helps in internal crisis. But it has also some disadvantages;
main disadvantages of international trade can be stated as follows:
1. Increases Dependency: international trade increases the dependency of a nation on foreign
goods. Domestic products cannot compete with the cheaper foreign goods and the country
will be import based.
2. Un-utilization of Natural Resources: when the country start to import by discouraging the
domestic industries, the natural resources and raw materials of the domestic country will be
un-utilized.
3. Loss of Foreign Currency: in case of Import based country like Nepal, import pushes out
the foreign currency for goods and services from the domestic country.
4. Creates difficulties in abnormal relationship between the countries: when two trading
countries face the problem of conflict, war, border seal etc. it will stop export-import and
there may be scarcity of goods and services across the countries.
5. Change in consumption habit of the People: international trade may change the
consumption habit of domestic people since they will be intended to absorb the foreign habit
of eating, clothing and others.
7. Define protectionism policy. State any four arguments in favor of protection policy.(1+2=3)(2017
DEC)
Answer:
Protectionism refers to the policy of the government designed to control the import of foreign goods
and services or made them expensive by imposing tariff barriers or non-tariff restrictions.
Protectionism encourages the domestic industries by allowing subsidies, investment allowance, tax-
rebate etc. Since, the import of foreign goods is restricted, the domestic industries will be protected.
The main four arguments in favour of protectionism policy are as follows:

1. Protectionism helps to protect the infant cottage and small scale industries.
2. Protectionism helps in diversification of the industries within the country.
3. Protectionism policy helps in expansion of employment and income.
4. Protectionism policy helps in making the terms of trade more favourable to the country
by controlling trade deficit.

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8. Define BOP. Explain any four items of current account of BOP. 3 (2018 JUNE)
Answer:
Balance of payment (BOP) is a summary statement of systematic record of all
economic transactions between one country and the rest of the world. It includes all
transactions, visible as well as invisible items. A balance of payments statement
consists of two components: (a) current account and (b) capital account.
Current Account
The current account of the balance of payments statement relates to real and short term
transactions which are concerned with actual transfer of goods and services. It contains
receipts and payments on account of exports of visible and invisible items.
The current account of the balance of payments includes the following items: (Consider
any four)
 Merchandise. Exports and imports of goods from the visible account have a dominant
position in the current account of balance of payments. Exports are entered in the credit
side and imports are entered in debit side.
 Travel. Travel is an invisible item in the balance of payments. Travel may be for
reasons of business, education, health, international conventions or pleasures.
Expenditure by the foreign tourists in our country forms the credit item and the
expenditure by our tourists abroad constitutes the debit item in our balance of
payments.
 Transportation. International transportation of goods is another invisible transaction.
It includes warehousing (while in transit) and other transit expenses. Use of domestic
transport services by the foreigners is the credit item and the use of foreign transport
services by domestic traders is the debit item.
 Insurance. Insurance premium and payments of claims is also an invisible transaction
in a country's balance of payments account. Insurance policies sold to foreigners are a
credit item and the insurance policies purchased by domestic users from the foreigners
purchased are a debit item.
 Investment Income. Another invisible item in the current account of the balance of
payment is the investment income which includes interest, capital, dividends and
profits.
 Government Transactions. Government transactions refer to the expenditure incurred
by a government for the upkeep of its organizations abroad (e.g., payment of salaries
to the ambassadors, high commissioners, etc.). Such amounts received by a
government from abroad constitute the credit item and made to the foreign
governments form the debt item.
9. Distinguish between balance of trade (BOT) and balance of payments (BOP). 3(2018 DEC)
Answer:
Balance of Trade (BOT)

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Balance of trade refers to systematic records (import and export) of goods of a
country in a year. Difference between export and import amount of a country during
a year is called balance of trade. It includes the money value of visible goods
(material goods) only. It indicates following three types of trade situations of a
country.
If, Export = Import: Balanced trade or equilibrium balance
of trade Export > Import: Surplus or favourable BOT
Export < Import: Deficit or unfavourable BOT
Balance of Payments (BOP)
An economic indicator that shows the summary statement of receipts and payments
of a country with the rest of the world during a year is called balance of payments.
It shows the difference between receipts and payments of a country during a year. It
includes the money value of visible as well as invisible items (services, foreign
loans, gifts, etc.). It indicates following three types of payment situation of a country.
So, the balance of payments is a systematic record of all economic transactions
between one country and the rest of the world.
If, Receipts = Payments: Equilibrium BOP
Receipts > Payments: Favourable BOP or Surplus
BOP Receipts < Payments: Unfavourable BOP or
Deficit BOP
10. What are the advantages of international trade? (3 marks) (2019 DEC)
Answer:
There are various advantages of international trade. Some of them are as follows:
 To utilize the natural resources: International trade helps the economy to utilize its natural
resources. For example, Nepal is rich in natural resources and by utilizing it, Nepal can
exports the goods based on natural resources like hydropower.
 Advantages of large scale production: In international trade, a country can produce goods
for itself as well as for foreign countries; means more production and this helps to get the
advantages of large scale production.
 Exchange of technical knowledge: Basically underdeveloped countries have lack of
technical knowledge and international trade facilitates to import it from developed
countries.
 Increase in efficiency: The producer attempts to produce variety of goods, better quality
of goods at the minimum possible cost that increases in efficiency.
 Enhance the cooperation and understanding: In international trade, different people of
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different countries come into the contact to trade which helps to enhance the cooperation and
understanding.
Donations and Gifts. Donations, gifts, etc. received by a country from abroad are the
credit item and sent to the foreign countries are the debit item in the balance of
payments account. Donations and gifts are 'unilateral transfers' or 'unrequited
payments' because nothing is given in return for them.
Miscellaneous. Miscellaneous invisible items include expenditure incurred on services
like advertisement, commissions, film rental, patent fees, royalties, subscriptions to the
periodicals, membership fees, etc. Such payments received by a country from abroad
are a credit item and made by a country to foreign countries are a debt item.
11. Explain the any four components of current account of balance of payment. 3 marks (2020 Dec.)
Answer:
Balance of payment (BOP) is the systematic records of international transaction covering all
transactions including material goods, services and finance and capital. It shows the difference
between receipts and payments of a country during a year. Three major accounts are practiced in
BOP: current account, capital account, and financial account
Current Account: The account that keeps the record of both tangible and intangible items.
Tangible items include goods while the intangible items are services and income. It has following
components:(Any Four Only)
1. Merchandise
Exports and imports of goods from the visible account have a dominant position inthe
current account of balance of payments. Exports constitute the credit side and imports the debit
side.
2. Travel
Travel is an invisible item in the balance of payments. Travel may be for reasons of business,
education, health, international conventions or pleasures. Expenditure bythe foreign tourists
in our country forms the credit item and the expenditure by our tourists abroad constitutes the
debit item in our balance of payments.
3. Transportation
International transportation of goods is another invisible transaction. It includes warehousing
(while in transit) and other transit expenses. Use of domestic transport services by the
foreigners is the credit item and the use of foreign transport services by domestic traders is
the debit item.
4. Insurance
Insurance premium and payments of claims is also an invisible transaction in a country's
balance of payments account. Insurance policies sold to foreigners are a credit item and the
insurance policies purchased by domestic users from the foreigners purchased are a debit item.
5. Investment Income
Another invisible item in the current account of the balance of payment is the investment
income which includes interest, capital, dividends and profits.
6. Government Transactions
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Government transactions refer to the expenditure incurred by a government for the upkeep of
its organizations abroad (e.g., payment of salaries to the ambassadors, high commissioners,
etc.). Such amounts received by a government from abroad constitutethe credit item and made
to the foreign governments form the debt item.
7. Donations and Gifts
Donations, gifts, etc. received by a country from abroad are the credit item and sent tothe
foreign countries are the debit item in the balance of payments account. Donations
and gifts are 'unilateral transfers' or 'unrequited payments' because nothing is given in return
for them.
8. Miscellaneous
Miscellaneous invisible items include expenditure incurred on services like advertisement,
commissions, film rental, patent fees, royalties, subscriptions to the periodicals, membership
fees, etc. Such payments received by a country from abroad are a credit item and made by a
country to foreign countries are a debit item.
12. Explain any four major problems of international trade for countries like Nepal. 3 marks (2020
Dec.)
Answer:
At present Nepal is a member of WTO and integrated to global economy. But, Nepal is unable to take
advantage from globalization. The trend of Nepalese foreign trade shows that the foreign trade
deficit is growing every year. The main problems of international trade for countries like Nepal
are presented below:
i. Landlocked Country
Nepal is a landlocked country. It is surrounded at three sides by India and remaining by China.
Nepal gets transit facility available to landlocked countries. But transit facility is very weak
and it has increased the transportation cost. Due to this reason, there is limited trade with
overseas.
ii. Lack of Trade Diversification
In Nepal, there is no policy of trade diversification regarding country-wise and commodity
wise. There are few commodities such as readymade garments, carpet, handicraft, etc.
exported by Nepal and there are limited countries such as India, Germany, and USA etc. where
the limited goods are exported.
iii. Low Quality of Goods
There is high cost of production and low quality of goods produced in Nepal. This is because
most of the Nepalese Industries use primitive technology, unskilled labor,and inferior raw
materials. So, Nepalese goods are inferior which can't compete with foreign goods in
international market.
iv. Lack of Industrialization
Due to the internal conflict and poverty, there is slow development of manufacturing
industries. There is limited export oriented industries in the country. So, there is less export in
comparison to import.
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Chapter-7
Nepalese Economy
1. What are the problems of Nepalese agriculture? Explain. (5) (2013 DEC)
Answer:
Agriculture is the main stay of Nepalese economy. Hence, it has been accorded top most priority in
almost all economic plans of Nepal, but despite various efforts made, the agriculture production
and productivity is low. The major problems of agriculture are as follows:
i. Traditional technology: Technology adopted in Nepalese agriculture is traditional. High yielding

varieties and improved seeds, chemical fertilizers, improved tools and implements, crop rational
practices and water delivery systems have not been adopted to an adequate extent. Agriculture
productivity can be substantially increased if these devices are extended. Because of the lack of
pesticides and plant protection systems, it is estimated that about 22 percent of edible food grain
production is destroyed by various kinds of pests and insects every year.
ii.Inadequate irrigation facility: Irrigation is the life blood of agriculture. But the irrigation facilities
are inadequate in Nepal. Nepal's agriculture is still largely dependent on monsoon, which is
uncertain. Only 42% of cultivated land has irrigation facilities. Hence, it is rightly said Nepal's
agriculture is a gamble on monsoon.
iii. Lack of agricultural credit: Nepalese farmers are still largely dependent on village money
Lenders. Interest rates are as high as 50% to 300% in various forms are quite common in traditions
credit. Only about 21% credit comes from institutional sources.
iv. Lack of marketing and storage facility: The rural areas lack marketing facility due to the
absence of road facility. The farmers are compelled to sell their products, cheaply to local
shopkeepers and rich farmers. There is no guarantee of receiving reasonable price. Similarly, the
farmers are compelled to sell the products at low price during the harvesting season due to the lack
of storage facility.
v. Defective land tenure system: In Nepal there is dual ownership on land. One class of people
cultivates the land; the other class reaps the benefits without any labour. The tenancy right of the
farmers is not still secure. The rent charged by land owners is high. Small size of land holdings is
another defect. Hence, the farmers do not have any enthusiasm to increase production.
vi. Lack of agricultural research: Cropping pattern suitable to ecological conditions should be
adopted. The findings of foreign agricultural research are unsuitable for Nepal. But Nepal lacks the
adequate agricultural research related to cropping productivity suitability of crops, technology, etc.
The agricultural research and extension is not based on general farmers' need.
2. What are the main three importances of cottage and small scale industry for the development
of the country? Explain. (3) (2014 JUNE)
Answer:
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There is a great Importance of cottage and small scale industry in a country like Nepal where
most of the peoples are not well educated and more employed. There is lack of technical
efficiency, capital and other essential elements of production. The importance of cottage and
small scale industry in a country is needed also for the economic development as well as the
mobilization of local skill and resources. The importance of cottage and small scale industry in
a country for the economic development of the country can be illustrated as follows:
1. Increase in the opportunities of employment

Most of the Nepalese are engage in the agriculture. They are not busy all the seasons in the
agriculture activities. They are only busy for 4/5 months in the agriculture sector and are leisure
for rest months. There is a great importance of cottage and small scale industry to provide the
employment for the unemployed and partially employed manpower.
2. Utilization of local resources
The cottage and small scale industries are based on local raw materials. Such raw materials are
scattered all over the country. With the establishment of cottage and small scale industries, the
raw materials are utilized otherwise they are unutilized or wasted. As a result income of the
people is increased along the increase in employment opportunities.
3. Easy to establish (low capital)

There is less difficulty to establish cottage and small scale industry in comparison to large-
scale industries. Neither a large amount of investment needed nor the high technical knowledge
and foreign raw material is needed to establish such industry. As all the essential things are
available in local and domestic market it is easy to establish such industries.
3. State and explain the prospects of tourism industry in Nepal.(5)(2014 DEC)
Answer:
Nepal abounds in tourism prospects in all spheres, historical or cultural, hills or forests, wildlife,
or springs, or fairs, festival or people. For the tourists Nepal has three special attractions: snow-
capped mountains, natural vegetation and repertoir ancient monuments. Nepal is compared with
Switzerland of Europe. The prospects of tourism are as follows:
1. Natural Beauty. Nepal is full of natural beauty. The tourists are attracted by world’s top
summits like Mt. Everest (world’s highest), Kanchanjunga, Annapurna, Machhapuchhre etc. It has
fascinating rivers, water falls and lakes. It has a variety of flora and fauna. The mountain regions of
the country are like natural parks. Nepal is rich in terms of natural resource and bio- diversity.
Chitwan forests are famous for unicorn (one-horned) rhinos.
2. Ancient Art and Architecture. Nepal is a country of temples. Every temple is a specimen of
architecture. Durbar Squares of Kathmandu, Bhaktapur and Patan, which are famous for their arts
and architectures, are places of attraction for the tourists. Important places of pilgrimage like
Muktinath, Gosainkunda, Pashupatinath, Swayambhu, etc. are here. Most of the Nepal’s ancient
monuments are recorded on the world heritage lists.
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3. Religious
Places. Nepal is the only Hindu kingdom in the world. It is a holy place for the Hindus as
well as Buddhists. Ramjanaki (Janakpur), Pashupati (Kathmandu) and Krishna mandir (Patan) are
Hindu temples. Lumbini is the birthplace of Lord Buddha. All these attract the Hindus and Buddhists
and even the people of other religions across the world.
4. CulturalVariety. Nepal is a multi-ethnic nation with over sixty different ethnic groups living
various parts of the country. Each ethnic group has its own culture. Tourists enjoy cultural varieties.
Nepalese people regard guests are as gods. They are very courteous and hospitable to the visitors.
5. Climatic
Variety. Nepal has different climates the difference depending on topography altitude.
Therefore tourists from different countries can choose the climate they like most. If they prefer a
warm climate in winter, they can visit the southern plains (Terai). If they prefer a cold climate in
summer, they can visit the mountains. Temperate climates can be enjoyed in the Hills.
6. Birthplace
of Brave Persons. Nepal is the birthplace of world famous Gurkhas and Sherpas (tigers
of mountains). It is also the birthplace of great thinker Lord Buddha.
4. Explain any three importance of medium and large scale industry in Nepal. 3 (2015 DEC)
Answer:
The main importance of MLSI are explained below.
1. Rapid Economic Growth. Productivity in MLSI is higher than that in any other
sector of the economy. The development of MLSI can increase the economic growth rate of
Nepal. Because MLSI accelerates economic growth, it increase the annual national income.
2. Resource Utilization. Nepal is rich in natural resources. Therefore, MLSI should
use them. Nepal’s limestone deposits came to be used only after the establishment of large-
scale cement industries. Similarly, other mineral deposits and water and forest resources
could be utilized for upgrading MLSI.
3. Sectoral Balance. Nepal’s economy is dependent by an large on agriculture. About
65.58% of the total Nepal’s population is engaged in this occupation. This position shows
the state of sectoral imbalance in Nepal. It is necessary to divert some of the population to
the non-agricultural sector. MLSI help in the sectoral balance of economy by developing
transport, communication, electricity, banking, insurance, trade and commerce.
5. State the traditional sources of agri-finance in Nepal. 3 (2015 DEC)

Answer:
The main sources of traditional (or non-institutional) agricultural finance are moneylenders,
landlords, traders and private borrowings.
a. Moneylenders and Landlords. From the very beginning, moneylenders the main
suppliers of short-term and long-terms credits to Nepalese farmers. They provide loans
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to the farmers for productive as well as unproductive purposes. Their loan advancement
process is flexible and the loan has fixed repayment. The moneylenders are somewhat
flexible about the execution of documents and the security to be obtained. Their loan is
also available readily to those persons whom the lender knows closely. However, the
loan obtained from the moneylender is not enough to meet the demands for credit of
modern agriculture.
b. Traders and Private Borrowings. Another agency, which provides short-term credits
to farmers is the traders. They provide loans to the farmers for productive purposes
before the harvest is ready on the condition that they (the farmers) will sell their produce
to them at pre-determined prices, which are usually very low, compared to prevalent
market prices at the time of harvest. This type of loan assumes greater significance in
the case of food grains like paddy, wheat and cash crops like cotton, jute, tobacco,
cardamom and sugarcane.
6. Introduce Nepalese agriculture. Explain its importance in economic development of Nepal.(5)(2016

JUNE)
Answer:
Agriculture is the primary sector of the Nepalese economy. More than 50% people of Nepal
regard agriculture as the major occupation for their survival. Major portion of Nepal’s export
trade depends on agriculture. Even though the contribution of agriculture sector in GDP is
decreasing but agriculture is main source of survival of the country. Agriculture sector includes
cash crops, food crops, horticulture and floriculture, forestry, fisheries etc.
Due to various problems like small size of land holdings, lack of irrigation facilities,
absence of industrialized farming, primitive farming practice, and subsistence farming etc.
productivity as well as contribution of agriculture sector in National GDP is not satisfactory
despite of major portion of population involve in this sector.
The main importance of agriculture in economic development of Nepal are explained below.
1. Agriculture is the main source of industrial raw materials such as furniture, paper and paper
related products, textiles, handicrafts, medicine etc. Nepal can achieve high growth through
development of those sectors only.
2. Agriculture is the main basis of employment opportunities. A country can develop only by
creating employment opportunities. It can not only help to increase the volume of GDP but also
help to achieve growth.
3. Agriculture is the main basis of foreign trade. Most of the exportable items of Nepal are
agriculture based. Export helps to earn foreign currency and increase in national income through
which Nepal can shift from less developed economy to developing economy.
4. Increase in living standard of rural people. Generally, due to lack of other opportunities rural
people’s main source of income is from agriculture. Hence, Agriculture can help to increase
living standard of rural people and balanced growth of the economy.
5. Main source of National income and sectoral development. Since, agriculture is the main
occupation of majority people of Nepal. Agriculture contributes to national income and sectoral
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development of the economy.
From above stated points it is clear that agriculture plays very important role in development
and growth of the country.
7. Explain any three uses of microeconomics in business decision making. (3) (2016 JUNE)
Answer:
Micro economics is a branch of economics that studies the nature, relationship and behavior of
individual households and firms in making decisions on the allocation of limited resources.
Microeconomics examines how these decisions and behaviors affect the supply and demand for goods
and services, which determines prices, and how prices, in turn, determine the quantity supplied and
quantity demanded of goods and services.
Microeconomics has enormous uses in business decision making. Main three uses of
microeconomics in business decision making can be explained as following:
1. Microeconomics can help in optimum allocation of resources: As we know the resources used
in business are limited. To earn more profit by the business organization the resources should
be allocated in optimum way. It can be understood from microeconomic point of view.
7. Microeconomics helps in Pricing of product as well as factors through interaction of demand
2.
and supply. It is also another main use of microeconomics in business decision making.
8. Microeconomics helps in increasing efficiency of factors of production. Efficiency refers to
.
the relationship between scarce resources and output. Each business organization want
to achieve efficient situation for this we need microeconomic study.
8. Evaluate the role of cottage and small scale industry in Nepal. (5) (2016 DEC)
Answer:
Cottage and small scale industries are the foundations of sustainable economic development
and self development economy. So the government has been giving emphasis on
establishment, development, and expansion of cottage and small scale industries that
contribute to the economic development by creating self-employment and employment
through entrepreneurship and skill development at local levels.
Role of cottage and small scale industries are as follows:
1. Increase employment opportunities
Country like Nepal having capital-scarce and labour surplus economy can generate more
employment opportunities by encouraging local people and private sectors to establish such
industries. Establishment of such industries can help to solve the problem of under
employment, disguised unemployment and seasonal employment.
2. Utilization of local resources
These industries are based on local raw materials. So, proper utilization of locally available raw
materials like bamboo, herbs, animal skins, stone, etc. can increase the level of production of
essential goods in the society.
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3. Decrease in level of poverty
Establishment and expansion of such industries generate more employment opportunities among
low income group people. They also become the subsidiary source of income of such people.
Thus, such industries help to raise the economic status of poor people and support for
decreasing level of poverty.
4. Source of foreign currency earning
Handmade carpet, handicrafts, Nepali paper products, woolen shawl (pashmina), metal products
are some of the examples of goods exported by Nepal in foreign market. By increasing
efficiency of cottage and small industries production of such products can be increased level
of foreign currency earning can be increased by exporting such goods.
5. Protect local art and culture
Products of cottage and small scale industries are based on local art, culture and skill. So,
operation of these industries and supply of products of these industries inside and outside the
country helps to preserve traditional art, skill and culture of a country.
6. Basis of large scale industries
These industries are the basis of large scale industries. Development of such industries
increases income and purchasing power of people, enhances managerial skill and efficiency of
entrepreneurs, increases market demand of industrial products, etc. These are the symptoms of
establishment and expansion of large scale industries.
7. Balanced development
Cottage and small scale industries are mostly established to meet local demand and are
dispersed all over the country. Thus, they support to reduce regional disparity. Hence, these
industries help to make balance between rural and urban area.
Development of cottage and small scale industries is essential for the development of less
developed country like Nepal. So far, a total of 270,988 cottage and small scale industries are
registered across the country. But, due to various problems like lack of capital, lack of
protection policy, lack of skilled manpower, lack of rural infrastructures, traditional technology,
limited market, intermediary exploitation these industries are not found flourished all over the
country. Those which are in existence are in bad condition.
9. Describe the salient features of Nepalese economy. (3) (2017 JUNE)

Answer:
Nepal is a least developed country of south Asia. It is rich in natural resources and beauty but
remained as least developed due to underutilization of those resources. Agriculture sector is
being the main source of employment along with the main contributor to the Gross Domestic
Product (GDP). Due to lack of manufacturing industries and other employment opportunities,
the trend of foreign migration for employment is increasing which in turn increasing the
inflow of remittances in the country and in the process of converting the country from agro-
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based economy to remittance-based economy.
The salient Features of Nepalese economy are as follows:
1. Dominance of Agriculture Sector: Nepalese economy is dominated by agriculture sector
since more than one third of population depend on agriculture and about one third of the GDP
is contributed by agriculture sector.
2. Dualistic Economy: Nepalese economy has dualistic character, in one part there is rural
subsistence economy with traditional way of living and on the other there is urban modern
economy with modern way of living.
3. Underutilization of natural resources: Nepal is rich in natural resources such as water,
minerals etc. but none of them have exploited and utilized properly to develop the economy.
4. Unequal distribution of income and wealth: there is huge gap in income and wealth of rich
and poor group of people. Almost 90 percent of total income goes to the 10% of the people,
which is even widening the gap between rich and poor.
5. Import Based Economy: due to lack of infrastructure development and industrial
development, Nepal is being import based economy. Most of the consumer goods are imported
from India and other countries in the world. Which is creating adverse effect on balance of
trade of the country.
Apart from those above stated features, Nepal has low productivity of factors of production,
high population growth rate, high potential for tourism etc.
10. Explain any four role of tourism sector in economic development of Nepal. (3)(2017 DEC)
Answer:
Tourism industry includes the whole business activities of providing facilities for tourists like
hotel/lodge, tourist service management offices, travel agencies, trekking agents, rafting and many
more services relate to tourists. Tourism is one of the main prospectus sector of Nepal for
development because tourists are attracted to the country because of its natural beauty, unique
culture, cultural heritages etc.
The main role of tourism sector in economic development of Nepal are as follows:
1. Tourism can be the main source of public as well as private income.
2. Tourism is the one of the major sources of foreign currency earnings.
3. Tourism industry helps in development of cottage/handicraft industries.
4. Tourism helps in expansion and development of rural infrastructures.
5. Tourism sector also helps to correct unfavourable balance of trade.
1) Increase in income:
From tourism industry government collects taxes. In addition Private sector creates employment
opportunity that gives income to general people also.
2) Source of foreign currency.
Tourists from foreign countries bring currency of their country and spend in Nepal that increases
earning of foreign currency in country.
3) Development of cottage industry:
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Tourist want to buy the production of cottage industry to bring souvenir with them that helps to
develop cottage industry.
4) Development of rural infrastructure:
Tourist visits rural area of country that makes government to develop rural infrastructure.
11. Explain the major problems of agriculture sector development in Nepal.(5) (2018 JUNE)
Answers:
Agriculture sector is the dominant sector of Nepal since it contributes the majority of
the gross domestic product of the economy. Even though, more than 60 percent of the
population of Nepal are involved in agricultural sector but the contribution of this
sector in national income is not satisfactory because agriculture sector of Nepal is
facing many problems.
The main problems of Nepalese agriculture sector can be explained as following:

1. lack of industrial farming:
Nepalese agricultural system is following subsistence farming system. Farmers
produce crops for their self-consumption rather than sale and generate income. Due
to which they are producing all those commodities whether their productivity is
satisfactory or not.
2. lack of agriculture research:
It is one of the main problems of Nepalese agriculture sector. Due to lack of research
on agricultural productivity and fitness, the productivity of the agricultural is very
low. The farmers don’t know about the product which is best fit in their soil and
environment.
3. lack of technical education:
Even though Nepal is called as agro-based economy, but the technical education
agriculture sector is not supporting it. The farmers have no knowledge about the
modern technologies and process of farming.
4. lack of appropriate policy:
Since, government of Nepal had adopted agriculture policy to support and develop
agricultural sector, but the policy itself is not being able to produce the result as
desired. It is because the policy is not consistent with the current features, problems
and their measures to solve those problems.
5. Lack of agricultural subsidy:
Lack of agricultural finance is one of the major hurdles of Nepalese agriculture
sector. Most of the Nepalese farmers are poor, they can’t invest money in fertilizers
and modern agricultural equipment. Therefore the government should provide
subsidy to the farmers in such activities.
If those problems of Nepalese agriculture sector are solved, it surely increases the
productivity of the sector which in turn increases the contribution in the national income
and employment generation in the economy along with increases in export of
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agricultural goods.
13. Explain the importance of cottage and small scale industry in Nepal (any five points).3
(2018 DEC)
Answer:
Cottage and small scale industries are the foundations of sustainable economic
development and process toward self-reliant development of an economy. So, the
Government of Nepal has been giving emphasis on establishment, development, and
expansion of cottage and small scale industries that contribute to the economic
development by generating production and creating self-employment and employment
through entrepreneurship and skill development at local levels.
Importance of cottage and small scale industries is as follows (any five):
Utilization of local resources and increase in output
Such industries are based on local raw materials. So, proper utilization of locally
available raw materials like bomboo, herbs, animal skins, stone, etc. can increase the
level of production of essential goods in the society.
Increase in employment opportunities
Country like Nepal having capital-scarce and labor-surplus economy can generate more
employment opportunities by encouraging local people and private sector to establish
such industries. Establishment of such industries can help to solve the problem of under-
employment, disguised unemployment and seasonal unemployment.
Decrease in poverty level
Establishment and expansion of such industries generate more employment
opportunities among low-income people. They also become the subsidiary source of
income of such people. Thus, these industries help to raise the economic status of poor
people and assist in decreasing the level of poverty.
Source of foreign currency earning
Handmade carpets, handicrafts, Nepali paper products, woolen shawl (Pashmina), metal
products are some of the examples of goods exported by Nepal in foreign market. By
increasing efficiency of cottage and small industries, production as well as export of
such products can be increased. This helps in reducing Nepal's trade deficit and also
increasing the level of nation's foreign exchange reserve.
Protect local art and culture
Products of cottage and small scale industries are based on local art, culture and skill.
So, operation of these industries and supply of products of these industries inside and
outside the country contribute to preserve traditional art, skill and culture of the country.
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Basis of large scale industries
These industries are the basis of large scale industries. Development of such industries
increases income and purchasing power of people, enhances managerial skill and
efficiency of entrepreneurs, increases market demand of industrial products, etc. Thus,
these industries provide the basis for the establishment and expansion of large scale
industries.
Balanced development
Cottage and small scale industries are mostly established to meet local demand and are
dispersed all over the country. Thus, they support to reduce regional disparity and promote
balance between rural and urban areas.
13. What is the role of tourism industry in economic development of Nepal?(3 marks) (2019 DEC)
Answer:
In today’s scenario, the tourism industry has evolved as one of the largest economic sectors of
the world and the industry has helped many countries to achieve economic prosperity as the
tourism industry helps in employment generation, fosters ancillary industries, etc. which
would ultimately drive the economic development.
In Nepal’s context, the role of tourism industry in economic development are as follows:
1. Sources of foreign exchange
As the exports of Nepal is very limited and the country needs a large sum of foreign
exchange to finance its import bills, therefore the tourism industry is very crucial for the
earning of foreign exchange. Today’s Nepal receives a major chunk of foreign exchange
from workers’ remittance and if and only if we can harness the potential of tourism industry
in Nepal, the given opportunity to collect foreign exchange is immense.
2. Increase in employment
The tourism industry helps to generate both direct as well as indirect employment. In
Nepal, many people are engaged in hotels, lodges, travel agencies, adventure sports, etc.
Overall, the increase in employment increases the people’s income which in turns helps
the demand in economy driving the economic activities.
3. Effect of Development Infrastructure
The spending of tourist in Nepal is an income of the recipient which in turn is either spent
or saved. Overall the income for tourism industry would goes in development of
communication, transportation, accommodation, etc. which would largely contribute
toward building physical infrastructures of the country.
4. Cultural Exchange
The beauty of tourism industry is that it involves a cultural exchanges and enrichment of
both the counter parties, and it can have an impact of changing a life style of the people of
the country as well. During their visits, the tourist learns from us and we also learn from
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them as well about the cultures, good practices, etc.
5. Development of cottage industry
The Nepalese handicrafts is very popular among the tourists thus the boom in tourism
industry would be a boon to the country. As the increased demand for such
handicraft would help to expand the cottage industries in various parts of the country which
would lead into more employment generation and income.
6. Increase in Government Revenue
As the Nepal has a huge potential for the tourism industry and if the Government is able to
create a conducive environment for the industry, the Government can generate huge
amount of revenue in the form of tax, fee, royalty, etc.
20. Highlights the features of Nepalese economy. 3 marks (2020 Dec.)

Answer:
Nepal is a small and landlocked economy surrounded by emerging economies of the world India
and China. It is a developing country. So, the features of Nepalese economy are similar to the
features of developing countries. Some of the features of Nepalese economy are as follows:
a. High dependence on agriculture
Agriculture is the primary sector of Nepalese economy. It has highest contribution in the Gross
Domestic Product of Nepal. Still more than 65percent people are depending on agriculture. It
is the basis of employment, source of export, industrialization, etc.
b. Remittance based economy
More than forty lakhs Nepalese people are working in different part of the world. They send
their income in Nepal in terms of remittance. It has around twenty five percent share in GDP.
There is great contribution of remittance in overall socio- economic transformation of the
country.
c. Dualistic economy
Nepalese economy has dualistic in nature i.e. one side urban and another rural. There is modernization with
existence of primitive economy.
d. Unutilized and underutilized natural resources
Nepal occupies huge potentiality of water, forest, mineral and human resources. They are
underutilized and unutilized. The rate of unemployment is increasing, shortage of energy,
increasing barren land, etc. in the country.
e. Extreme poverty
Still, eighteen percent people of the country are living below the poverty line. It is widespread in
the rural and remote areas. The problem is concentrated towards marginalized group of the society.
Government has given main focus on poverty alleviation in the country in its national plans and
policies. It is the main challenge of Nepalese economy.
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21. Describe the importance and problem of manufacturing industry in Nepal. (2.5+2.5=5 marks) 2021 June
Answers:
Importance of manufacturing industries of Nepal are as follows:
1. Rapid economic growth
Economic growth implies the increase in real GDP of an economy. Increase in industrial
production increases economic growth rapidly because the productivity thissector is higher than
other sector of the economy. Historical data of developed countries like American countries,
European countries, Japan etc. shows that these countries achieved rapid economic growth only
after industrial revolution in these countries.
2. Alleviation of Poverty and Unemployment
About two third of people are dependent in agriculture and a majority of agriculture sector of
Nepal are either underemployed or disguised unemployed. In this scenario development of
industrial sector can absorb the surplus labor of agriculture sectorbecause industrial sector
creates mass number of employment. Mass unemployed people get employment opportunity, their
income increases. They are able to get enough food, education and health facilities etc. which
helps to reduce poverty.
3. Resource utilization
Industrial sector needs a lot of human resources, natural resources and capital resources. In
developing country like Nepal, though we are deficient in capital resources, we are rich in human
resources and natural resources. Development of industrial sector helps to use these resources
properly. Unutilized water resources, forest resources, mineral resources and human resources can
be used efficiently by industrial sector. For example: Nepal's limestone deposits came to be used
only afterthe establishment of large-scale cement industries.
4. Balanced development
Balanced development implies the equal development of all economic sectors like agriculture,
industrial sector and service sector. Development of industrial sector pulls all other sectors up.
Let's see how other sectors of an economy are also developed in industrial area. Industries need
banking and insurance services so financial institutions are established there. Population increases
because of theworkers and their families. As a result demand for school, shops, healthcare services
are developed. Industrial sector produces modern tools, chemical fertilizers and pesticides, which
increase agricultural productivity and it is demands the agricultural products as raw materials
which leads to the development and modernization of the agriculture sector. Thus all other sectors
also develop along with industry.
5. Capital formation
Capital formation is very important for development. Acute deficiency of capital is the main
problem economy. Industrial sector stimulates capital formation. In large scale industries, the
surplus is very high. By using external and internal economies, industry can get higher profit.
These profits can be reinvested for expansion and development. In addition, industrial
development expands capital market which opens investment opportunities of shares and bonds.
6. Increase in public revenue
The development of industrial sector helps to increase public revenue. Government receives
revenue from the industries in form of customs duty, excise duty, value- added tax, income tax
etc.
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Problems of manufacturing industries are as follows:
1. Financial difficulties
Availability of capital is a precondition for the development of industrial sector. The capital
formation rate is low in Nepal so invest in industrial sector is difficult. Moreover, Nepalese
investors do not have adequate investment capability.
2. Lack of basic infrastructures
Basic infrastructures like industrial zone, transportation, communication, electricity are
prerequisite for industrial sector development. In Nepal such infrastructures are inadequate in both
quantity and quality. There are not sufficient industrial zones, poorroads transportation, inadequate
and expensive electricity. All these increases cost ofproduction of industrial sector.
3. Limited market
Industrial sector produce goods in large quantities. So the market for these goods should be large
too. But the markets for industry products are very limited. India is apotential market for Nepalese
goods. But India seems to be more interested in exporting its goods to Nepal than in importing
Nepalese products. Nepalese people are poor and their purchasing power is very low. This also
does not provide market for Nepalese goods.
4. Lack of raw materials
The industrial sector of Nepal does not get raw materials regularly. The raw materials available
within the country are of low quality and also are not available in adequate quantities. Raw
materials have to be imported from abroad many of which are expensive. One has to go through
official formalities such as obtaining licenses and permits, which are time-consuming. Sometimes
industries remain closed for want ofthe supply of raw materials.
5. Absence of entrepreneurial class
Efficient and skilled entrepreneurs or managers are required for managing industrial sector. There
are very few entrepreneurs in Nepal who can conceive, promote, implement and take risks. The
government also does not encourage entrepreneurs.
6. Less competitiveness
Competitive capacity of Nepalese industrial sector is very less due to high cost of production.
Nepalese industrial product cannot compete in international market. So foreign goods are cheaper
than Nepalese goods as a result industries are not established in Nepal.
22. Explain the concept of balance of trade and balance of payments.3 mark (2021 June)
Answers:
Balance of trade refers to the export and import of visible items, i.e., material goods. It is the difference
between the value of visible exports and imports. Visible items are thoseitems which are recorded in
the custom office. For example, material goods which are exported and imported are recorded in the
custom office. Balance of trade is also knownas merchandise account of exports and imports.
Under Balance of Trade, the following three cases can occur:
v. X = M: Balanced BOT
vi. X > M: Surplus BOT
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vii. X< M: Deficit BOT Where,
X = Exports of visible goodsM = Imports
of visible goodsBOT = Balance of trade
Balance of Payments
Balance of payments is a systematic record of all economic transactions: visible as well as invisible,
in a period, between one country and the rest of the world. It shows the relationship between one
country's total payments to all other countries and its total receipts from them. Thus, Balance of
payments is a statement of payments and receipts on international transactions. Payments and receipts
on international account are of threekinds: (a) the visible balance of trade; (b) the invisible items; and
(c) capital transfers.
A balance of payments statement consists of three parts: (i) current account
(ii) capital account and (iii) financial account or foreign exchange reserve account.
23. Distinguish between balance of trade and balance of payments. 3 marks (2021 December)
Answers:
Balance of trade records the variability of imports and exports made by a country during one year. When a
country achieves an equal status in terms of imports and exports, then this situation is regarded as trade
equilibrium. However, if the former surpasses the latter,then it creates a trade deficit, which is not a favorable
situation for a country. On the otherhand, if export value exceeds that of imports, then it creates a trade surplus,
which puts an economy in a favorable situation.
The balance of payment combines every private and public investment to find out the money inflow and outflow
in an economy over a specific period. The ideal status of balance of payment should be zero, which indicates
that the money coming into the country is equal to the money going out of the country. However, this situation
is highlyunlikely. Therefore, if it is negative, then it means deficit, and if positive, it means a surplus.
Following are the major differences between the balance of trade and balance of payment:
i. Concept
Balance of trade is a statement which records a country’s imports and exports of goods with other countries
during a period generally one year. Whereas balance of payment records all the economic transactions
performed by a country within the period.
ii. Records
A major difference between balance of payments and balance of trade is regarding with the records they
keep. Balance of trade only records the physical items. On the other hand, balance of payment records
physical items along with non-physical items.
iii. Capital transfers
The capital transfer is another significant difference between balance of trade and balance of payment.
Capital transfers are only included in a balance of payment. It records all capital receipts and payments.
iv. Final result
Balance of trade can be positive, negative and balanced. However, balance ofpayments shall always
be balanced.
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v. Component
Another factor that distinguishes between the balance of trade and balance of payment is that balance of
trade is a major part of a balance of payment. It is a component of a BOP’s capital account section.
Every country in the world keeps a record of its economic activities which reflect the actual condition of the
particular economy. However, balance of trade only reveals a partial picture, whereas balance of payment reveals
the complete picture of the economy.
24. Explain any three problems for industrialization in Nepal. 3 marks (2021 December)
Answers:
Industrialization is very essential for the overall economic development of the country. It helps to achieve
various national objectives such as economic growth, employment generation, resource utilization, income
generation etc. But in Nepal, the rate of industrialization is very slow. There are various problems. They are
discussed below:
i. Insufficient capital
For the establishment of medium and large-scale industries huge amount of capital isrequired which is very
difficult to be formed in the context of Nepal. So, lack of capital is the problem of medium and large-scale
industries.
ii. Lack of infrastructures
Infrastructures such as transportation, communication and electricity are the most essential elements for the
industries. In our country basic infrastructures are insufficient.
iii. Lack of human resource
Generally, modern industries need skilled manpower for handling the business but there is a situation of
shortage of skilled manpower and problem of brain drain in our country. So, there is scarcity of skilled
manpower.
iv. Lack of competitiveness
Most of the Nepalese industrial products are of low quality. Such, low-quality products pose difficulty to
complete in both domestic and international market. Cartelling is the major problem of Nepalese market to
enhance competition.
v. Small Market
The domestic market for Nepalese industrial products is very limited due to low purchasing power of the
people and comparatively small population size. There is lack of transport and communication facilities to
sell the commodity throughout the country. There is difficulty for market access.
25. Explain the problems of agriculture development in Nepal and suggest remedies for them.
Answers:
Agriculture sector is the dominant sector of Nepal since it contributes the majority of the gross domestic product of the
economy. Even though, more than 60 percent of the population of Nepal are involved in agricultural sector but the contribution
of this sector in national income is not satisfactory because agriculture sector of Nepal is facing many problems.
CA ASPIRANTS-ICAN
The main problems of Nepalese agriculture sector & their remedies are explained as following:
1. lack of industrial farming:
Nepalese agricultural system is following subsistence farming system. Farmers produce crops for their self-
consumption rather than sale and generate income. Due to which they are producing all those commodities whether
their productivity is satisfactory or not.
Providing farmers with modern farm machines and simple farm equipments is another powerful solution to her
problems of food and agriculture in the state. This is highly very important because the local farmers there are still,
helplessly making use of only cutlass and hoe. Another Great Step toward mechanization of agriculture is to
provide stable water and electricity supplies in the Farming Areas
2. lack of agriculture research:

It is one of the main problems of Nepalese agriculture sector. Due to lack of research on agricultural productivity
and fitness, the productivity of the agricultural is very low. The farmers don’t know about the product which is
best fit in their soil and environment.
Effort shall be made from individual and government level in order to do some research about the agricultural
crops and their proper way of farming.
3. lack of technical education:
Even though Nepal is called as agro-based economy, but the technical education agriculture sector is not supporting it. The
farmers have no knowledge about the modern technologies and process of farming. Efforts should be made to ensure that
rural and urban dwellers get free or very affordable basic education. These will make it easier for them to learn about highly
developed farming practices that improve efficiency. Also, continuous learning, via agriculture extension services, and
training seminars, is vital for farmers in the agricultural sector to ensure that they are currently deploying the best practices
on their farms and agribusiness.
4. lack of appropriate policy:

Since, government of Nepal had adopted agriculture policy to support and develop agricultural sector, but the
policy itself is not being able to produce the result as desired. It is because the policy is not consistent with the
current features, problems and their measures to solve those problems.
Appropriate policies & rules shall be made to uplift the position of farmers and encourage more people to be
engaged in farming.
5. Lack of agricultural subsidy:

Lack of agricultural finance is one of the major hurdles of Nepalese agriculture sector. Most of the Nepalese
farmers are poor, they can’t invest money in fertilizers and modern agricultural equipment. Therefore, the
government should provide subsidy to the farmers in such activities.
If those problems of Nepalese agriculture sector are solved, it surely increases the productivity of the sector which
in turn increases the contribution in the national income and employment generation in the economy along with
increases in export of agricultural goods.
Agricultural funds really need to be made available for these farmers as this is still part of the most effective
solutions to the nation's food and agricultural development. Another plus to funding is to provide these farmers
with hybrid seeds and simple agricultural machines at subsidized rates.
CA ASPIRANTS-ICAN
“THANK YOU”
“I WISH YOU ALL THE BEST FOR YOUR EXAM”.
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Economics Past Questions Compilation (2013 June - 2022 June)

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COMPILED BY KISAN JOSHI,

CHAPTERWISE COMPILATION OF Fundamental of Economics (CAP I)

[2009 June -2022 June]

Compiled by Kisan Joshi,

Follow @CA Aspirants - ICAN on:

YouTube- https://www.youtube.com/c/CAAspirantsICAN Tik Tok: https://vt.tiktok.com/ZSdWDFrPM/

1. Distinguish between micro and macroeconomics. (5Marks) (2013 JUNE)

2. Explain the scope of microeconomics. (3 Marks) (2013 DEC)

Scope of microeconomics can be explained with the help of following points

• Theory of product pricing: -

• Theory of production and cost:

• Theory of factor pricing:

• Theory of economic welfare:

3. Economics is science of wealth. Discuss. (3) (2014 JUNE)

The main points of difference between them are as follows :

5. Describe the scope of microeconomics.(3) (2015 DEC)

7. How is the microeconomics useful for efficient allocation of resources?(3)(2017 JUNE)

Similarly, microeconomics also concerns how a consumer allocates resources to maximize

8. Explain the definition of economics given by Alfred Marshall.(3)(2017 DEC)

Definition Microeconomics studies the Macroeconomics studies the behavior

Basis Demand and supply of a particular Aggregate demand and aggregate

Main focus It is focused on price determination It is focused on determination of level

Subject Theory of product pricing, factor Theory of income and employment,

Q=quantity of commodity P=price of commodity

Explanation of the law :

Units Total Utility Marginal Utility

The law is based on following assumptions:

Cross elasticity of demand can be defined as the degree of responsiveness or sensitivity of

exy = % change in quantitydemandedfor x good

% change in price of y good

i) Positive cross elasticity of demand:

5. Discuss about Law of Diminishing Marginal Utility. (5) (2014 JUNE)

This law can be explained through table and figure.

6. Define indifference curve. (3) (2014 JUNE)

substitutes and complements.

% change in price of y good %

Cross elasticity is of three types:

9. Define cardinal and ordinal measurement of utility. (3) (2014 DEC)

10. Explain the law of supply. (3)(2015 DEC)

Answer: Please write as per teacher's instruction.

Price elasticity of demand refers to the degree of responsiveness or sensitivity of

Mathematically, it can be expressed as,

Demand function is of two types.

Linear Demand Function

Non-Linear Demand Function

And Where, a, b and c are all greater than zero.

Geometrically, non- linear demand function is shown in following figure.

Pric Market Marke Shortage Pressure on

Combination Price of Quantity Remarks

150 Extension in supply

Quantity Supplied (kg)

Units of a Total Marginal

price elasticity of demand (Ep) is the responsiveness of change in quantity demanded

Percentage change in quantity demanded for a

Point Elasticity of Demand on a Non-Linear Demand Curve

Similarly, to measure price elasticity of demand at point Q, CD tangent line is drawn at

According to the law of diminishing marginal utility when a rational consumer

Units of Apple Total Utility Marginal Utility

Meaning of Cross Elasticity of Demand

Supply curve (SS1) is upward sloping exhibiting law of supply. As price

COMPILED BY KISAN JOSHI,

Individual Demand Market Demand

% Change in quantity demanded