CHAPTER 3

DEMAND ANALYSIS
I. Answer the following in about 40 lines each: 2 pages
Que 1 What is Demand function? What are the factors that determine the demand for
a good?
Ans 1 Demand function is a mathematical expression showing the relationship
between the quantity demanded of a commodity and the factors that determine
it. It can be expressed in the form of a function as given below:
Dx=f(Px,Ps,Pc,Y,T)
Where Dx=demand for good X, Px= price of good X, Ps= price of substitutes, Pc=
price of complementaries, Y =income of the consumer, T =taste of the consumer
and f= functional relationship that determines the quantity demanded with
respect to changes in its determinants.
DETERMINANTS OF DEMAND
There are a number of factors that determine the demand for a good. The
following are some of the important factors that determine demand:
1 PRICE OF THE COMMODITY: The demand for a commodity is inversely related to
its price. If the price of a commodity decreases its demand will increase and vice
versa.
2 PRICES OF SUBSTITUES AND COMPLEMENTARIES: Demand is also influenced by
the change in the prices of related goods.
3 INCOME OF THE CONSUMER: An increase in the income of a consumer leads to
an increase in his purchasing power or quantity demanded.
4 TASTES AND PREFERENCES: Taste vary from person to person. Taste do not
remain same forever.
5 POPULATION: A change in the size of a population will affect the demand for
certain goods.
6 TECHNOLOGICAL CHANGES: New discoveries enter the market.
7 CHANGE IN WEATHER: Demand for a commodity may change due to a change in
climatic conditions.
8 STATE OF BUSINESS: During the period of prosperity demand for a commodity
will expand and during depression demand will contract.

Que 2 Explain the law of demand and examine its exceptions.

Ans 2 Law of demand explains the relationship between price and the quantity
demanded for a commodity. Demand varies with the price; in other words, if the
price is low demand will be high and if the price is high demand is low.
1 INDIVDUAL DEMAND SCHEDULE
An individual demand schedule is a list of various quantities of a commodity
purchased at different prices by a single consumer in the market.

2. MARKET DEMAND SCHEDULE

In a market, there exist a number of consumers who purchase various quantities
of a commodity at the corresponding prices.
EXCEPTIONS
1. GIFFEN’S PARADOX: Sir Robert Giffen (1837-1910) observed that poor
people will demand more of inferior goods, if their prices rise. People spent
higher portion of their income on bread, substituting bread for meat. Goods
of this type are known as GIFFEN GOODS.
2. VEBLEN EFFECT (Prestigious goods): Thorstein Veblen (1857-1929) pointed
out that some gods like diamond, precious stones, etc. which are demanded
by rich people and if prices of these goods fall poor people can also buy and
rich people will stop buying these goods as these do not have special status.
3. SPECULATION: If the prices of the commodities are expected to increase still
further in future, the consumer will buy more of it now.
Que 3 Explain the concept of income and cross demand with suitable
diagrams.
Ans 3 INCOME DEMAND
Income demand explains the relationship between various level of consumer’s
income and various quantities of good and services demanded assuming other
factors remaining constant. Other factors here include price of the good, price
of related good, taste, preference etc. The functional relationship between
income and quantity demanded is shown in the following; Dx=f(Y).
Where Dx= demand for good x, Y= income of the consumer and f= function.
INCOME DEMAND FOR SUPERIOR l NORMAL GOODS
In case of superior or normal goods, quantity demanded increases when there
is an increase in the income of the consumers.
INCOME DEMAND FOR INFERIOR GOODS
Quantity demanded of inferior goods decreases with the increase in the income
of the consumers.
CROSS DEMAND
Cross demand refers to the relationship between any two goods which are
either complementary to each other or substitute for each other. The
functional relationship between the price of a commodity, say Y and the
quantity demanded for another commodity, say X is called cross demand.
SUBSTITUTE GOODS
Substitute goods are those goods which satisfy the same want. For example,
tea and coffee etc.
 COMPLEMENTARY GOODS
Complementary goods are those goods which satisfy the want jointly.

II. Answer the following questions in about 20 lines each: 1 page

Que 1 Illustrate the reason for negative sloping demand curve.
Ans 1 Following are the main reasons for existence of negative slope of demand
curve.
1 LAW OF DIMINSHING MARGINAL UTILITY: According to this law, if an individual
consumes more of a particular good, the utility that the consumer gets from
additional units will diminish.
2 INCOME EFFECT: The real income of a consumer will rise due to a fall in the price
of a commodity, being other things remaining constant.
3 SUBSTITUTION EFFECT: Being the prices of the substitutes remaining constant,
when the price of a commodity falls, it becomes relatively cheaper and is
substituted for other goods.
4 MULTIPLE USES OF A COMMODITY: There are some commodities which have
multiple uses like milk, coal and electricity. If the prices of these goods fall, there
will be greater demand for these goods rather than those which are restricted to a
particular use.
5 OLD AND NEW BUYERS: If the price of a good falls, the real income of the old
buyers will increase. As a consequence of this, the demand for the good may
increase. New buyers who were unable to buy the good at a higher price, will be
able to buy it after a fall in its price.

Que 2 what is price elasticity of demand?

Ans 2 Elasticity of demand means the percentage change in quantity demanded in
response to the percentage change in one of the variables on which demand
depends. These variables are the price of the commodity, price of related goods,
income of the consumer, tastes and preferences of the consumer etc. The
percentage change in quantity demanded divided by the percentage change in any
one of the variables on which demand depends denotes ELASTICITY OF DEMAND.
Elasticity of demand changes from person to person, place to place, time to time
and one commodity to another. For instance, rice, salt, vegetables etc. do not
show any significant change in the quantity demanded even after a rise in the
price of these goods, similarly, there will be a greater change in the quantity
demanded of refrigerators, air coolers etc. with a small fall in their prices.
Price elasticity of demand is the responsiveness of quantity demanded of a good to
a change in the price of that commodity.

Que 3 What are the basic determinants of price elasticity of demand?

Ans 3 Following are some of the important factors on which elasticity of demand
for a commodity depends.
1 NATURE OF THE COMMODITY: In case of necessaries, the elasticity of demand
will be inelastic. EX, rice, pulses, sugar and salt. Though the prices of these
necessaries change, the quantity demanded remains the same.
2 AVAILABILITY OF CLOSE SUBSTITUES: Prices of substitutes influence the demand
for a commodity up to a certain extent.
3 MULTIPLE USES OF THE COMMODITY: The more the possible use of commodity
the greater will be its price elasticity and vice versa.
4 PROPORTION OF INCOME SPENT: If the proportion of income spent on a
particular commodity is very small, demand for it will tend to be inelastic.
5 PRICE LEVEL: If the price of a good is too high or too low, then the elasticity of
demand for these goods will be inelastic.

Que 4 Point out the importance of price elasticity of demand.

Ans 4 There are several uses of price elasticity of demand both for business and
government and some of the places where price elasticity of demand is useful;
1 MONOPOLY MARKET: If the demand for a product has different elasticities in
different markets, the producer can fix different prices in different markets.
2 GOVERNMENT: The commodities of some industries have inelastic demand. Such
industries are declared as ‘public utilities’.
3 INTERNATIONAL TRADE: The trade between two countries is possibly only by
taking into consideration the mutual elasticities of demand for each other’s
products. ‘Terms of Trade’ implies the rate at which one unit of domestic
commodity will exchange for unit of a foreign commodity.
4 MINISTRY OF FINANCE: The government imposes taxes for revenue. While
imposing taxes on commodities, the finance minister selects different goods based
on their price elasticities.
5 MANAGEMENT: If the demand for workers is inelastic, the demand of trade
unions to raise wages will be fruitful.

Que 5 Describe the income and cross elasticities of demand.

Ans 5 INCOME ELASTICITY OF DEMAND
Income elasticity of demand shows the degree of responsiveness of quantity
demanded of a commodity to a change (increase or decrease) in the income of the
consumer, other things remaining constant. Other factors here include price of the
good, price of related goods, tastes, preferences, etc. The functional relationship
between income and quantity demanded may be inverse or direct depending on
the nature of the commodity.
CROSS ELASTICITY OF DEMAND
Cross elasticity of demand refers to the change (increase or decrease) in the
quantity demanded of a good in response to the change (increase or decrease) in
the price of its related goods, other things remaining constant. There are certain
goods whose demand depends not only on their price but also on the prices of
related goods.

III. Answer the following questions in about 5 lines each:

Que 1 Prepare individual demand schedule.

Que 2 What are the types of price elasticity of demand?

Ans 2 Following are the types of price elasticity of demand;
1. Perfectly elastic demand
2. Perfectly inelastic demand
3. Unitary elastic demand
4. Relatively elastic demand
5. Relatively inelastic demand

Que 3 What is perfectly elastic demand?

Ans 3 Perfectly elastic demand is also called as infinite elastic demand. If a small
change in price causes an infinite change in quantity demanded, it is known as
perfectly elastic demand.
Que 4 What is perfectly inelastic demand?
Ans 4 Perfectly inelastic demand is also known as zero elastic demand. In this case,
change in price does not any influence on the quantity demanded. The demand is
non-responsive to change in price.

Que 5 What is unitary elastic demand?

Ans 5 It refers to a situation where a given percentage change in price is
accompanied by an equal percentage in the quantity demanded. Such elasticity of
demand is said to be unitary elasticity of demand.

Que 6 What is relatively elastic demand?

Ans 6 It refers to a given situation where a small percentage change in the price of
a commodity is accompanied by a greater percentage change in its quantity
demanded.
Que 7 What is relatively inelastic demand?
Ans 7 It refers to a situation where a greater percentage change of the commodity
is accompanied by a small percentage change in its quantity demanded.

CHAPTER 4
PRODUCTION ANALYSIS
I. Answer the following questions in about 40 lines each; 2 pages
Que 1 Critically examine the law of variable proportions.
Ans 1 LAW OF VARIBLE PROPORTIONS
In short run, some factors of production can be varied while some factors of
production cannot be varied. The former are called the variable factors (labour,
raw materials etc.) and the latter are called the fixed factors (land, capital,
organization etc.).
The law states that when increasing number of units of a variable factor is
applied to fixed factors, total output first increases at an increasing rate, then
diminishing rate and eventually decreases. This law is also known as ‘Law of
diminishing returns’.
ASSUMPTIONS OF THE LAW
1. The law specifically operates in the short run.
2. The techniques of production remain constant.
3. Labour factor alone is variable and all other factors of production are
constant.
4. All units of variable factors are homogeneous.
5. The product is measured in physical quantity.
EXPLANATION OF THE LAW

TOTAL PRODUCT: It is the total output produced by all factors of production

combined together.
AVERAGE PRODUCT: It refers to the total product per unit of variable factor,
labour.
MARGINAL PRODUCT: The addition made to the total product by employing
additional unit of a variable factor.
Que 2 Explain the law of return to scale.
Ans 2 The law of returns to scale is concerned with the production function
in the long run. The law of returns to scale studies the behaviour of output
in response to change in scale of inputs. The three outputs are;
1 Increasing returns to scale
2 Constant return to scale
3 decreasing return to scale
ASSUMPTIONS
1. All inputs except entrepreneurship are variable.
2. State of technology remains the same.
3. There is perfect competition in the market.
4. Production is measured in physical quantities.
5. A worker works with the given tools and implements.

EXPLANATION OF THE LAW OF RETURNS TO SCALE

CAUSES OF INCREASING AND DIMINSHING RETURNS
I. CAUSES OF INCREASING RETURNS: In the process of production, some
factors are to be used as a whole. For example; machinery, management
etc. cannot be divided into small units.
II. CAUSES OF DIMISHING RETURNS: As the firm expands its size, it
experiences certain economies up to a certain level of output.

Que 3 Describe the internal and external economies.

Ans 3 INTERNAL ECONOMIES
Internal economies accrue to the firm itself when it expands its output or
enlarges its scale of production. Internal economies are classified as economies
of technical, managerial, marketing, financial, welfare, risk bearing and
research.
1 TECHNICAL ECONOMIES: These will arise to a firm for the use of better
machines and production techniques. Large firms will have more resources at
their disposal. Therefore, these firms can install the most suitable machinery.
2 MANAGERIAL ECONOMIES: A large firm can benefit by specializing its
managerial departments. Each department is under the charge of an expert.
3 MARKETING ECONOMIES: As scale of a firm increases, internal
economies accrue to the firms due to the large scale purchases and sales.
4 FINANCIAL ECONOMIES: A large firm will be able to procure cheap and
timely finance easily because of its good reputation and large assets.
5 ECONOMIES OF WELFARE: Large firms employ a large number of
workers. Firms will provide welfare facilities t their workers.
EXTERNAL ECONOMIES
External economies are external to a firm which accrue to each member firm
when the output of the industry increase as a result of the expansion of the
industry as a whole.
1 ECONOMIES OF CONCENTRATION: When an industry is concentrated
in a particular area, its firms reap some common economies. These are-
availability of skilled labour, transport, communication, banks, insurance
companies, etc.
2 ECONOMIES OF INFORMATION: An industry will be in a better position
than a firm to setup research laboratories because of its large resources.
3 ECONOMIES OF WELFARE: As compared to a firm, an industry is in a
more advantageous position to provide welfare facilities to the workers.
4 ECONOMIES OF SPECIALISATION: When an industry grows, it becomes
possible to split up the processes which are taken over by specialist firms.

Que 4 Explain short-run costs of a firm with suitable graphs and

illustrations.
Ans 4 In short run, the costs faced by a firm can be classified in to two types
such as fixed and variable costs.
1 FIXED COSTS AND VARIABLE COSTS
The fixed costs of a firm are those costs that do not vary but fixed with the
change in output. It is due to this, the value of fixed costs is always positive
even if production activity does not take place or it is zero. Alfred Marshall
called these costs as ‘supplementary costs’ or ‘overhead costs’. Variable costs
are those costs which change with the change in the volume of output.
Marshall called these costs as ‘prime costs’.
2 NATURE OF SHORTRUN COSTS AND COST CURVES
Short run is a period of time within which the firm can vary its output by
varying only variable factors of production. Therefore, short run cost structure
of a firm reveals fixed costs and variable costs. Their related concepts are total
fixed cost (TFC), total variable cost (TVC), total cost (TC), average cost (AC), and
marginal cost (MC). TC=TFC+TVC.

Que 5 Write an essay on revenue analysis.

Ans 5 REVENUE ANALYSIS
The purpose of revenue analysis is to explain the determination of price
under different market situations. Supply of goods depends upon their cost
of production. In any market, price is determined by the interaction of
demand and supply of goods.
CONCEPTS OF REVENUE
The amount of money that the firm receives from the sale of certain
quantities of a goods at various prices is called revenue. In other words, the
total sale proceeds of a firm are known as revenue. There are three types of
revenue concepts. They are: a) total revenue, b) average revenue and c)
marginal revenue.
A) TOTAL REVENUE: Total income received by the firm from the sale of
certain quantity of output at a given price is called total revenue.
B) AVERAGE REVENUE: Average revenue is the revenue per unit of
goods sold. It is computed by dividing the total revenue by the number of
units of a good sold.
C) MARGINAL REVENUE: It is the net addition to the total revenue by
selling additional unit of the good i.e., the revenue which would be
earned by selling an additional unit of the good.
AR AND MR CURVES UNDER PERFECT COMPETITION
Under perfect competition, there exist a large number of buyers and
large number of sellers. The sellers under this competition offer
homogeneous products and, therefore neither seller nor buyer have any
control on the price of the product.
Demand curve for the product of a firm itself is the firms average
revenue curve. In this case, total revenue(TR), average revenue(AR) and
marginal revenue(MR) of a perfectly competitive form are analyzed here.
 II. Answer the following questions in about 20 lines each; 1 page
Que 1 Describe the main features of factors of production, namely, land
and labour.
Ans 1 Main features of land are:
1. Land is a free gift of nature.
2. The supply of land is limited.
3. Land is immovable.
4. Land has some original indestructible powers.
5. Land provides infinite variation of degree of fertility. One piece of land
may produce more and the other less.
6. Land cannot produce anything by itself. It does not yield any result
unless human efforts are employed.
7. Continuous use of land with the combination of other factors of
production leads to the diminishing returns.
Main features of labour are;
1. Labour is inseparable from the labourer itself.
2. Labour is highly perishable.
3. Labour has less mobility.
4. Labour has a weak bargaining power.
5. Labour power differs from labourer to labourer. Therefore, labour
may be classified as
a) Unskilled labour
 b) Semi-skilled labour
c) Skilled labour
6. Initially the supply curve of labour is upward sloping and at higher
level of wages it is backward bending.

Que 2 What are the merits and demerits of division of labour?

Ans 2 The following are the merits of division of labour:
a) Increase in productivity of labour and production.
b) Inventions and discoveries are facilitated.
c) Saving in time.
d) Mechanization is possible.
e) Diversity of employment.
f) Increase in dexterity and skills.
g) Right man in the right place.
h) Large scale of production is possible.
The following are the demerits of labour:
a) Leads to monotony
b) Retards human development.
c) Loss of skill.
d) Possibility of unemployment.
e) Hindrance to mobility of labourers.

Que 3 Write a note on capital.

Ans 3 CAPITAL(K)
Capital is nothing but a ‘produced factor of production’. Generally, money is
treated as capital. Money spent on plant and machinery, tools, raw materials,
buildings, etc. is called as capital. The supply of capital changes. Capital has
mobility.
CHARACTERISTICS OF CAPITAL:
1.REAL CAPITAL AND HUMAN CAPITAL: Real capital refers to goods such as
buildings, plant, machinery etc. Human capital refers to human skills and ability.
2.INDIVIDUAL CAPITAL AND SOCIAL CAPITAL: Individual capital is the personal
property whereas social capital is what belongs to the community as a whole.
3.FIXED CAPITAL AND VARIBLE CAPITAL: Expenditure incurred on machinery and
buildings in the production process is called as fixed capital. Amount spent on
purchase of raw materials, daily wages to labour, etc. is called variable capital.
4.TANGIBLE CAPITAL AND INTANGIBLE CAPITAL: Tangible capital may be perceived
by senses where an intangible capital is in the form of certain benefits and rights.
Eg, good will, patent rights, etc.

Que 4 What is supply? Explain the determinants of supply.

Ans 4 Supply means the amount offered for sale at a given price. We may define
supply as a schedule of the amounts of a good that would be offered for sale at all
possible prices at any one instant of time, or during any one period of time.
DETERMINANTS OF SUPPLY:
1.PRICE OF A GOOD: Price of a good is more important and this price determines
the profit of the firm.
2.PRICE OF ITS RELATED GOODS: Goods comprise substitutes and
complementaries. Any change in the prices of these goods exerts influence on
production of the good in consideration.
3.PRICES OF FACTORS OF PRODUCTION: Increase in the prices of factors of
production would lead to an increase in the cost of production. As a result, supply
of the commodity may decline.
4.STATE OF TECHNOLOGY: New and improved methods of production, inventions
and innovations help to save factors, costs and time.
5. GOALS OF PRODUCER AND OTHER DETERMINANTS: Goals of producer, means of
transport and communication and natural factors etc will equally influence the
supply of a commodity.
Que 5 Discuss about the changes in supply.
Ans 5 INCREASE IN SUPPLY AND DECREASE IN SUPPLY
Assuming the price of the commodity remains the same, the supply curve shifts
right side or left side as per the changes in other determinants. In the given figure,
quantity supplied is shown on OX axis and price on OY axis. Assuming price of the
commodity remains same, the supply curve shifts to right, S1S1, as the supply
increases due to change in other determinants. As a result, more quantity of
supply (OQ1) is offered at old price, OP; or old quantity, OQ is offered at lower
price, OP1. In contrast, when supply decreases the supply curve shifts to left as
S2S2S due to change in other determinants and as a result, quantity supplied will
be reduced to OQ2.

Que 6 Discuss the types of cost.

Ans 6 Broadly, costs can be classified into three types, namely, 1. Money costs, 2.
Real costs and 3. Opportunity costs.
1.MONEY COSTS: The money spent by a firm in the process of production of its
output is money cost. These costs would be in the form of rent on buildings, wages
and salaries paid to labour, interest on capital, etc. These costs are further divided
in implicit and explicit costs.
2.REAL COSTS: According to Alfred Marshall, the efforts and sacrifices made by the
owners of the factors of production in the process of production activity are the
real costs. The money costs and real costs do not correspond with each other.
3.OPPORTUNITY COSTS: It is also called alternative cost or economic cost.
Opportunity cost is next best alternative use of factors of production. In other
words, opportunity costs are nothing but next best alternative foregone by a
factor.

Que 7 Explain the relationship between average cost and marginal

cost.
Ans 7 In the short run analysis of the firm, average cost (AC) or short run average
cost (SAC) and marginal cost (MC) or short run marginal cost(SMC) are more
important than total costs. Marginal cost determines the exact level of output of a
firm.
Average cost(AC) is the sum of average variable cost (AVC) and average fixed cost
(AFC). It is total cost divided by the number of units produced. In short, cost per
unit is known as average cost (AC). AC= TC/Q+TVC/Q=AFC+AVC. Marginal cost
(MC) is the addition made to the total cost by the production of additional unit of
output. It is to be noted that both AC and MC curves will have ‘U’ shape implying
three phases i.e., decreasing, minimum (constant) and increasing.

Que 8 Explain diagrammatically the nature of average revenue and

marginal revenue under perfect competition and monopoly.
Ans 8 AR AND MR CURVES UNDER PERFECT COMPETITION
The above is in the case of perfect competition.
Industry decides the price. Firm is the price taker.
AR=MR.
AR AND MR CURVES UNDER MONOPOLY
Under monopoly, there is a single seller. The commodity offered by a monopolist
may be or may not be homogeneous. The product has no close substitutes. The
cross elasticity of demand is very low. Monopolist can control price and output of
the commodity, but he can’t determine both simultaneously.

III. Answer the following questions in about 5 lines each

Que 1 Define the production function.
Ans 1 It represents the physical relationship between the inputs and the output. It
shows the transformation of inputs in to output at a particular time period.
Production function can be expressed mathematically as follows; Qx=f (N, L, K, O,
T).

Que 2 Explain the concept of average product and marginal product.

Ans 2 AVERAGE PRODUCT (AP):
It refers to the total product per unit of the variable factor, labour.
AP=TP/L
MARGINAL PRODUCT(MP):
The addition made to the total product by employing additional unit of a variable
factor.
MP=TP/L

Que 3 Explain the classification of factors of production.

Ans 3 Following are the factors of production:
1. Land
2. Labour
3. Capital
4. Organization/ Enterprise
5. Technology

Que 4 Explain technical economies.

Ans 4 These will arise to a firm from the use of better machines and production
techniques. Large firms will have more resources at their disposal. Therefore,
these firms can install the most suitable machinery. As a result, production
increases and average cost of production falls.

Que 5 What is capital accumulation?

Ans 5 Capital formation denotes increase in the stock of real capital in a country. In
other words, capital formation involves making of more capital goods such as
machines, tools, transport equipment etc which are used for further production of
goods. Saving and investment are essential for capital formation.

Que 6 Define supply function.

Ans 6 The supply function explains the relationship between the determinants of
supply or a commodity and the supply of that commodity. Supply function can be
written as: Qx = f( Px, Pr, Pf, T, Gf, Gp),where Qx = quantity of good X supplied, Px
= price of good X, Pr = price of related goods, Pf= price of factors of production, T =
technology, Gf= goal of the firm, Gp= government policy, f= functional
relationship.

Que 7 Define law of supply

Ans 7 The law of supply explains the relationship between price of a commodity
and its quantity supplied. As per the law of supply, ‘’other things remaining the
same, as the price of a commodity increases its quantity supplied increases and
vice versa’’.