Principle of economics

Q1. What do you mean by law of demand? explain the determinants of demand.

The law of demand is a fundamental principle of economics that states that at a higher price, consumers
will demand a lower quantity of a good1. This is because consumers use the first units of a good they
purchase to serve their most urgent needs first, then they use each additional unit of the good to serve
successively lower-valued ends1. This is also known as the law of diminishing marginal utility1.

The determinants of demand are the factors that influence how much consumers are willing and able to
buy a good at a given price. Some of the main determinants of demand are:

 Income: The amount of money consumers earn affects their purchasing power and their demand for
normal goods and inferior goods. Normal goods are goods whose demand increases as income
increases, such as cars, clothes, or vacations. Inferior goods are goods whose demand decreases as
income increases, such as cheap food, used clothing, or public transportation 2.
 Preferences: The tastes and preferences of consumers affect their demand for different goods.
Preferences can be influenced by factors such as advertising, trends, habits, or beliefs. For example, if
consumers develop a preference for organic food, they will demand more organic food and less
conventional food at the same price2.
 Prices of related goods: The demand for a good can also depend on the prices of other goods that are
either substitutes or complements. Substitutes are goods that can be used in place of each other, such as
tea and coffee. Complements are goods that are used together, such as bread and butter. If the price of a
substitute increases, the demand for the original good will increase, and vice versa. If the price of a
complement increases, the demand for the original good will decrease, and vice versa 2.
 Number of buyers: The size and composition of the market also affect the demand for a good. If there
are more buyers in the market, or if the buyers have different characteristics that make them more
likely to buy a good, the demand for that good will increase2.
 Expectations: The expectations of consumers about future prices, incomes, or availability of a good can
also influence their current demand. For example, if consumers expect the price of a good to increase in
the future, they may buy more of it now to avoid paying a higher price later2.

Q2. What do you mean by law of supply? Explain the determinants of law of supply.

Ans:- The law of supply is a fundamental principle of economic theory that states that, keeping other factors
constant, an increase in price results in an increase in quantity supplied³. In other words, there is a direct
relationship between price and quantity: quantities respond in the same direction as price changes³. This is
because suppliers will try to maximize their profits by producing and selling more units of a good or service
when the price is high¹.

The determinants of supply are the factors that influence how much suppliers are willing and able to
produce and sell a good or service at a given price. Some of the main determinants of supply are:

1. **Costs of production**: The costs of production include the expenses incurred by suppliers to
obtain theinputs and resources needed to produce a good or service, such as labor, materials,
machinery, rent, taxes, etc. If the costs of production increase, the suppliers will have lower
profits and will be less willing to supply the same quantity at the same price. Conversely, if the
 costs of production decrease, the suppliers will have higher profits and will be more willing to
supply more quantity at the same price².
2. **Technology**: The technology refers to the methods and techniques used by suppliers to
produce a good or service more efficiently and effectively. If the technology improves, the
suppliers will be able to produce more output with the same or fewer inputs, which lowers their
costs of production and increases their profits. Therefore, they will be more willing to supply
more quantity at the same price. On the other hand, if the technology deteriorates, the suppliers
will face higher costs of production and lower profits, which will reduce their willingness to
supply at the same price².
3. **Prices of related goods**: The prices of related goods can also affect the supply of a good or
service. Related goods can be either substitutes or complements in production. Substitutes in
production are goods that can be produced using the same resources, such as wheat and corn.
Complements in production are goods that are produced together, such as leather and meat. If
the price of a substitute in production increases, the suppliers will have an incentive to switch
their resources to produce more of that good and less of the original good. If the price of a
complement in production increases, the suppliers will have an incentive to produce more of
both goods together².
4. **Number of sellers**: The number and size of sellers in the market also affect the supply of a
good or service. If there are more sellers in the market, or if the sellers have larger capacities to
produce, the supply of that good or service will increase. Conversely, if there are fewer sellers in
the market, or if the sellers have smaller capacities to produce, the supply of that good or
service will decrease².
5. **Expectations**: The expectations of suppliers about future prices, costs, demand, or
availability of a good or service can also influence their current supply. For example, if suppliers
expect the price of a good or service to increase in the future, they may withhold some of their
current supply to sell it later at a higher price. Alternatively, if suppliers expect the price of a
good or service to decrease in the future, they may increase their current supply to sell it now
before it loses value².

Q3. What is price elasticity of demand ? explain different types of price elasticity of demand .

Ans:- Price elasticity of demand is a measure of how sensitive the quantity demanded of a good or service is
to its price1. It is computed as the percentage change in quantity demanded divided by the percentage
change in price2. Price elasticity of demand shows how consumers respond to price changes in terms of their
buying decisions.

There are different types of price elasticity of demand, depending on the magnitude and direction of the
response. They are:

 Perfectly elastic demand: This occurs when the quantity demanded drops to zero when the price increases
by any amount, or when the quantity demanded becomes infinite when the price decreases by any amount.
This means that consumers are extremely sensitive to price changes and will only buy the good or service at
a single price. The demand curve for a perfectly elastic demand is horizontal2.
 Elastic demand: This occurs when the percentage change in quantity demanded is greater than the
percentage change in price. This means that consumers are relatively sensitive to price changes and will buy
more or less of the good or service depending on the direction of the price change. The demand curve for an
elastic demand is downward sloping and relatively flat2.
 Unit elastic demand: This occurs when the percentage change in quantity demanded is equal to the
percentage change in price. This means that consumers are proportionally responsive to price changes and
will buy the same percentage more or less of the good or service depending on the direction of the price
change. The demand curve for a unit elastic demand is downward sloping and has a slope of -12.
 Inelastic demand: This occurs when the percentage change in quantity demanded is less than the
percentage change in price. This means that consumers are relatively insensitive to price changes and will
buy almost the same amount of the good or service regardless of the direction of the price change. The
demand curve for an inelastic demand is downward sloping and relatively steep2

 Perfectly inelastic demand: This occurs when the quantity demanded does not change at all when
the price changes by any amount. This means that consumers are completely insensitive to price
changes and will buy a fixed amount of the good or service no matter what the price is. The demand
curve for a perfectly inelastic demand is vertical2.

.Q4. explain determinants of price elasticity of demand.

Ans:- The determinants of price elasticity of demand are the factors that affect how responsive
consumers are to changes in the price of a good or service. Some of the main determinants of price
elasticity of demand are:

1. **Availability of substitutes**: The availability of substitutes refers to how easy it is for consumers
to switch from one good or service to another that satisfies the same need or want. The more
substitutes available, the more elastic the demand for a good or service will be, because consumers
can easily choose a cheaper alternative when the price goes up. The fewer substitutes available, the
more inelastic the demand for a good or service will be, because consumers have fewer options and
may have to buy it regardless of the price¹.
2. **Proportion of income spent**: The proportion of income spent refers to how much a good or
service costs relative to the consumer's income. The higher the proportion of income spent, the
more elastic the demand for a good or service will be, because consumers will be more sensitive to
price changes and will adjust their consumption accordingly. The lower the proportion of income
spent, the more inelastic the demand for a good or service will be, because consumers will be less
affected by price changes and will maintain their consumption¹.
3. **Number of uses**: The number of uses refers to how versatile a good or service is in satisfying
different needs or wants. The more uses a good or service has, the more elastic the demand for it
will be, because consumers can adjust their consumption of different uses depending on the price.
The fewer uses a good or service has, the more inelastic the demand for it will be, because
consumers have less flexibility in their consumption patterns².
4. **Complementarity between goods**: Complementarity between goods refers to how closely
related two goods or services are in terms of consumption. Complementary goods or services are
those that are used together, such as bread and butter, or cars and gasoline. The more
complementary two goods or services are, the more elastic the demand for one will be with respect
to the price of the other, because consumers will reduce their demand for both when one becomes
more expensive. The less complementary two goods or services are, the more inelastic the demand
for one will be with respect to the price of the other, because consumers will not change their
demand for one much when the other changes in price².
5. **Time and elasticity**: Time and elasticity refers to how the duration of a price change affects the
consumer's response. The longer a price change lasts, the more elastic the demand for a good or
service will be, because consumers will have more time to adjust their behavior and find
alternatives. The shorter a price change lasts, the more inelastic the demand for a good or service
will be, because consumers will have less time to react and may not change their behavior much².
 Q5. Indifference curve ? discuss the properties of indifference curve.

Ans:- An indifference curve is a graphical representation of different combinations of two goods that
provide the same level of satisfaction or utility to a consumer. It shows the consumer’s preferences and
trade-offs between the two goods. An indifference curve is also called an iso-utility curve because it depicts
equal utility12.

Some of the properties of an indifference curve are13:

 Downward sloping: An indifference curve slopes downward from left to right, indicating that as the quantity
of one good increases, the quantity of another good must decrease to maintain the same level of utility. This
reflects the assumption that both goods are desirable and have positive marginal utility.
 Convex to the origin: An indifference curve is convex to the origin or bowed inward, indicating that as the
quantity of one good increases, the consumer is willing to give up less and less of another good to maintain
the same level of utility. This reflects the assumption of diminishing marginal rate of substitution (MRS),
which means that the consumer’s willingness to substitute one good for another decreases as he moves
along the indifference curve.
 Never intersect: Two indifference curves can never intersect or cross each other, because that would imply
that the consumer has inconsistent preferences. If two indifference curves intersect, it means that there are
two points on different curves that provide the same level of utility, which contradicts the definition of an
indifference curve.
 Higher curve implies higher utility: A higher indifference curve represents a higher level of utility than a
lower indifference curve, because it contains more of both goods or more preferred combinations of goods.
The consumer always prefers to be on a higher indifference curve than a lower one.
 Do not touch the axes: An indifference curve cannot touch either axis, because that would imply that the
consumer gets zero utility from one good, which contradicts the assumption that both goods are desirable
and have positive marginal utility.

Q6. What is income effect? Explain the types of income effect.

Ans:- The income effect is the change in the quantity demanded of a good or service due to a change in the
consumer’s real income or purchasing power. Real income is the income adjusted for inflation or changes in
prices. The income effect occurs when the price of a good changes, which affects the consumer’s budget
constraint and hence the amount of goods he can afford to buy12.

The income effect can be classified into three types based on the relationship between the good in question
and income3:

 Negative income effect: It is negative in those cases where the good is inferior, meaning that its demand
decreases as income increases. This income effect occurs when the price of an inferior good falls, which
increases the consumer’s real income and makes him buy less of the inferior good and more of other normal
goods. For example, if the price of potatoes falls, a consumer may buy less potatoes and more meat,
because potatoes are an inferior good and meat is a normal good.
 Null income effect: It occurs in those cases where the good is neutral, meaning that its demand does not
depend on income. This income effect occurs when the price of a neutral good changes, which does not
affect the consumer’s real income or his demand for the good. For example, if the price of salt changes, a
consumer may not change his consumption of salt, because salt is a neutral good and its demand is relatively
constant.
 Positive income effect: It is positive in those cases where the good is normal, meaning that its demand
increases as income increases. This income effect occurs when the price of a normal good falls, which
increases the consumer’s real income and makes him buy more of the normal good. For example, if the price
of pizza falls, a consumer may buy more pizza, because pizza is a normal good and its demand increases with
income.

Q7. What is substitution effect? Discuss Hicks-Allen approach of substitution effect.

Ans:- The substitution effect is the change in the quantity demanded of a good or service due to a change in
its relative price, holding the consumer’s utility or satisfaction constant. The substitution effect occurs when
the price of a good changes, which affects the consumer’s budget constraint and hence the trade-off
between the two goods. The substitution effect captures the consumer’s tendency to substitute a cheaper
good for a more expensive good, keeping the same level of utility12.

The Hicks-Allen approach of substitution effect is one of the methods to isolate the substitution effect from
the income effect. It was developed by John Hicks and Roy Allen, who proposed to measure the substitution
effect by keeping the consumer on the same indifference curve before and after the price change. This
means that the consumer’s utility or satisfaction is unchanged, and only the relative prices of the goods
affect his choice23.

The Hicks-Allen approach of substitution effect can be illustrated by the following figure:

(DIAGRAM NAHI MILA MUJHE BAAD ME SEND KAR DUNGI) 

n this figure, X and Y are two goods, and AB is the initial budget line when the price of X is P x . The
consumer’s initial equilibrium is at point E 1 , where he consumes X 1 units of X and Y 1 units of Y, and
attains utility level U 1 . Suppose that the price of X falls to P x ’ , which shifts the budget line to AC. The
consumer’s new equilibrium is at point E 2 , where he consumes X 2 units of X and Y 2 units of Y, and attains
a higher utility level U 2 .

The total change in quantity demanded of X due to the price change is X 2 - X 1 , which can be decomposed
into two effects: substitution effect and income effect. The substitution effect is measured by moving along
the same indifference curve U 1 from E 1 to E 0 , where it is tangent to a hypothetical budget line AD that
has the same slope as AC but passes through E 1 . This means that the consumer’s real income or purchasing
power is adjusted such that he can just afford his initial bundle E 1 at the new prices. The substitution effect
is then X 0 - X 1 , which shows how much more X the consumer buys when its relative price falls, keeping his
utility constant. The income effect is measured by moving from E 0 to E 2 along the new budget line AC. The
income effect is then X 2 - X 0 , which shows how much more X the consumer buys when his real income
increases due to the price fall, keeping his relative prices constant.

The Hicks-Allen approach of substitution effect has some advantages and disadvantages over other
methods, such as:
 It is consistent with the ordinal utility theory, which assumes that consumers can rank their preferences but
not measure them in cardinal terms.
 It allows for negative or zero income effects for normal goods, which may be more realistic than positive
income effects assumed by other methods.
 It does not depend on whether the good is normal or inferior, as it always shows a positive substitution
effect for a price fall.
 However, it involves a hypothetical budget line that may not be observable or feasible in reality.
 It also involves a constant utility assumption that may not be valid for large price changes.

Q8. Explain the law of variable proportion .

Ans:- The law of variable proportion is an economic law that describes the relationship between one
variable factor of production and the output, keeping other factors of production constant. The law states
that as the quantity of a variable factor increases, the total product initially increases at an increasing rate,
then increases at a decreasing rate, and eventually starts to decline12.

The law of variable proportion can be divided into three stages:

 Stage I: In this stage, both TP and MP increase at an increasing rate. This means that as more units of X are
employed, Y increases more than proportionately. This stage reflects increasing returns to scale or increasing
returns to a factor. This stage occurs because of the underutilization of the fixed factors (such as land or
capital) and the specialization and division of labor among the variable factors. In this stage, both MP and AP
are rising and MP is above AP.
 Stage II: In this stage, TP increases at a decreasing rate and reaches its maximum point. This means that as
more units of X are employed, Y increases less than proportionately. This stage reflects diminishing returns
to scale or diminishing returns to a factor. This stage occurs because of the optimal utilization of the fixed
factors and the diminishing marginal productivity of the variable factors. In this stage, MP is falling and
reaches zero at the end. AP is also falling but remains positive. MP cuts AP at its maximum point.
 Stage III: In this stage, TP starts to decline and becomes negative. This means that as more units of X
are employed, Y decreases. This stage reflects negative returns to scale or negative returns to a
factor. This stage occurs because of the overutilization of the fixed factors and the negative marginal
productivity of the variable factors. In this stage, both MP and AP are negative and MP is below AP.

The law of variable proportion has some implications for production and cost analysis. The law implies that
there is an optimum combination of factors that maximizes output and minimizes cost. The optimum
combination occurs at the end of stage I or the beginning of stage II, where MP is equal to AP and both are
at their maximum levels23.

Q10. Explain producers equilibrium .

Ans:-
A producer is said to be in equilibrium when it is producing a level of output at which his profit is maximum.
Profits are defined as the difference between total revenue (TR) and total cost (TC).
Thus, Profit = TR - TC. Profits will be maximum when the difference between total revenue and total cost is
maximum. The difference between total revenue and total cost is maximum at the level of output where the
slope of TR curve = slope of TC curve. The diagram illustrates the equilibrium of a firm using TR and TC
curves.
In the diagram, TR represents total revenue curve and TC represents total cost curve. PP is the profit curve
which is derived from the difference between TR and TC curve. A producer gets the maximum profits when
he produces OQ units of output. If he produces OQ1 units, he earns P1Q1 as profit which is less than PQ and
in case of OQ2 units, he earns only P2Q2 as profit. This too is less than the maximum profit (PQ).

Q11. Discuss why long run cost curve are ‘ U’ shaped?

Ans:- The long run average cost curve takes a U shape to illustrate how average cost initially decreases due to
economies of scale while the firm experiences increasing returns to scale. Then it exhibits constant returns as the
firm operates at its optimal size. Lastly if the firm tries to expand more than its optimal point, due to diseconomies of
scale while the firm experiences decreasing returns to scale and average cost increases.

OR

the long-run average cost curve as having an approximately U-shape. It is generally believed by economists
that the long-run average cost curve is normally U shaped, that is, the long-run average cost curve first
declines as output is increased and then beyond a certain point it rises.
above the U-shape of the short-run average cost curve is explained with the law of variable proportions.
But the shape of the long-run average cost curve depends upon the returns to scale. Since in the long run all
inputs including the capital equipment can be altered, the relevant concept governing the shape of this long-
run average cost curve is that of returns to scale
Returns to scale increase with the initial increases in output and after remaining constant for a while, the
returns to scale decrease. It is because of the increasing returns to scale in the beginning that the long-run
average cost of production falls as output is increased and, likewise, it is because of the decreasing returns
to scale that the long-run average cost of production rises beyond a certain point.

Q12. What do you mean by economies of scale. Explain the factors responsible
for economies of scale

Ans:- Economies of scale are cost advantages reaped by companies when production becomes efficient.
Companies can achieve economies of scale by increasing production and lowering costs. This happens
because costs are spread over a larger number of goods. Costs can be both fixed and variable.

KEY TAKEAWAYS
  Economies of scale are cost advantages companies experience when production becomes efficient,
as costs can be spread over a larger amount of goods.
 A business's size is related to whether it can achieve an economy of scale—larger companies will
have more cost savings and higher production levels.
 Economies of scale can be both internal and external. Internal economies are caused by factors
within a single company while external factors affect the entire industry.

Factors responsible for economies of scale are:-

 Technical: large-scale machines or production processes that increase productivity

 Purchasing: discounts on cost due to purchasing in bulk
 Managerial: employing specialists to oversee and improve different parts of the production process
 Risk-Bearing: spreading risks out across multiple investors
 Financial: higher creditworthiness, which increases access to capital and more favorable interest
rates
 Marketing: more advertising power spread out across a larger market, as well as a position in the
market to negotiate

Q13. What do you mean by diseconomies of scale? Explain the factors responsible for
diseconomies of scale.

Ans:- Diseconomies of scale are the disadvantages or inefficiencies that arise when a firm or an industry
expands its scale of production or operation beyond an optimal level. Diseconomies of scale cause the
average cost per unit to increase as output increases, which reduces the profitability and competitiveness of
the firm or the industry12.

Diseconomies of scale can be classified into two types: internal and external. Internal diseconomies of scale
are the factors that are related to the management, organization, or technology of the firm itself. External
diseconomies of scale are the factors that are related to the market conditions, resource availability, or
government policies that affect the industry as a whole23.

Some of the factors that can cause diseconomies of scale are1 :

 Poor communication: As a firm grows larger, it becomes more difficult to communicate effectively and
efficiently among different departments, divisions, or branches. This can lead to confusion, duplication,
delays, errors, or conflicts that reduce productivity and quality.
 Coordination problems: As a firm grows larger, it becomes more complex and bureaucratic, requiring more
layers of hierarchy and supervision. This can increase the administrative costs and reduce the flexibility and
responsiveness of the firm to changing customer needs or market conditions.
 Alienation and motivation issues: As a firm grows larger, it may lose its sense of identity and culture, making
the employees feel less valued and involved. This can reduce their morale, loyalty, creativity, and motivation,
leading to higher turnover and lower performance.
 Technical constraints: As a firm grows larger, it may face physical or technical limitations in its
production process, such as diminishing returns to scale, congestion, bottlenecks, or breakdowns.
This can increase the marginal cost and reduce the marginal product of each unit of output.
 Resource scarcity: As an industry grows larger, it may face increasing competition for scarce
resources, such as land, labor, capital, raw materials, or energy. This can increase the input prices
and reduce the output quality or quantity.
  Market saturation: As an industry grows larger, it may face decreasing demand for its products or
services due to market saturation, changing consumer preferences, or emergence of substitutes.
This can reduce the sales volume and revenue of each firm in the industry.
 Government intervention: As an industry grows larger, it may face increasing regulation or taxation
from the government due to environmental, social, or political concerns. This can increase the
compliance costs and reduce the profitability of each firm in the industry.

Q14. what do you mean by perfectly competitive market & explain its features.

Ans:- Perfect Competition

This type of market structure refers to the market that consists of a large number of buyers and also a large
number of sellers. No individual seller is able to influence the price of an existing product in the market. All
sellers in a perfect competition produce homogenous outputs, i.e. the outputs of all the sellers are similar to
each other and the products are uniformly priced.
Features of Perfectly Competitive Market
1) A large number of buyers and sellers
There exist a large number of buyers and sellers in a perfectly competitive market. The number of sellers is
so large that no individual firm owns the control over the market price of a commodity.
Due to the large number of sellers in the market, there exists a perfect and free competition. A firm acts as a
price taker while the price is determined by the ‘invisible hands of market’, i.e. by ‘demand for’ and ‘supply
of’ goods. Thus, we can conclude that under perfectly competitive market, an individual firm is a price taker
and not a price maker.
2) Homogenous products
All the firms in a perfectly competitive market produce homogeneous products. This implies that the output
of each firm is perfect substitute to others’ output in terms of quantity, quality, colour, size, features, etc.
This indicates that the buyers are indifferent to the output of different firms. Due to the homogenous nature
of products, existence of uniform price is guaranteed.
3) Free exit and entry of firms
In the long run there is free entry and exit of firms. However, in the short run some fixed factors obstruct the
free entry and exit of firms. This ensures that all the firms in the long-run earn normal profit or zero
economic profit that measures the opportunity cost of the firms either to continue production or to shut
down. If there are abnormal profits, new firms will enter the market and if there are abnormal losses, a few
existing firms will exit the market.
4) Perfect knowledge among buyers and sellers
Both buyers and sellers are fully aware of the market conditions, such as price of a product at different
places. The sellers are also aware of the prices at which the buyers are willing to buy the product. The
implication of this feature is that if any individual firm is charging higher (or lower) price for a homogeneous
product, the buyers will shift their purchase to other firms (or shift their purchase from the firm to other
firms selling at lower price).
5) No transport costs
This feature means that all the firms have equal access to the market. The goods are produced and sold
locally. Therefore, there is no cost of transporting the product from one part of the market to other.
6) Perfect mobility of factors of production
There exists geographically and occupationally perfect mobility of factors of production. This implies that the
factors of production can move from one place to other and can move from one job to another.
7) No promotional and selling costs
There are no advertisements and promotional costs incurred by the firms. The selling costs under perfectly
competitive market are zero.

Q15. Explain the condition of equilibrium of the firm in the short run and long run.

Ans:- The condition of equilibrium of the firm in the short run and long run depends on the market structure
and the cost and revenue curves of the firm. I will assume that you are asking about a firm under perfect
competition, which is a market structure where there are many buyers and sellers, homogeneous products,
free entry and exit, and perfect information.

In the short run, a firm under perfect competition is in equilibrium when it maximizes its profit (or minimizes
its loss) by producing a level of output where marginal revenue (MR) equals marginal cost (MC) and MC is
rising at the point of equality12. This means that the firm produces an additional unit of output only if it adds
more to its revenue than to its cost. The price at which the firm sells its output is determined by the market
demand and supply, and is equal to its average revenue (AR) and marginal revenue (MR).

In this figure, the firm’s equilibrium output is OQ where MR = MC and MC cuts MR from below. The firm’s
equilibrium price is OP which is equal to its AR and MR. The firm’s total revenue is OQ x OP which is the area
of rectangle OQRP. The firm’s total cost is OQ x QC which is the area under the short-run average cost (SAC)
curve up to OQ. The firm’s profit is TR - TC which is the area of rectangle PQRC. This is a case of supernormal
profit because TR > TC and SAC < AR at OQ.
However, in the long run, a firm under perfect competition cannot earn supernormal profit because of free
entry and exit of firms. If there are supernormal profits in the short run, more firms will enter the market
until the profits are competed away. Conversely, if there are losses in the short run, some firms will exit the
market until the losses are eliminated. In the long run, a firm under perfect competition is in equilibrium
when it produces at the minimum point of its long-run average cost (LAC) curve where long-run marginal
cost (LMC) equals short-run marginal cost (SMC) and both are equal to price (P), average revenue (AR) and
marginal revenue (MR)1. This means that the firm produces at the lowest possible cost and earns only
normal profit which is included in its cost. The firm’s long-run equilibrium can be shown graphically as
follows:

In this figure, the firm’s equilibrium output is OQ where LMC = SMC = MR = AR = P. The firm’s equilibrium
price is OP which is equal to its AR, MR, LMC and SMC. The firm’s total revenue is OQ x OP which is the area
of rectangle OQRP. The firm’s total cost is OQ x QL which is the area under the LAC curve up to OQ. The
firm’s profit is TR - TC which is zero because TR = TC and LAC = AR at OQ. This is a case of normal
profit because there is no economic surplus or loss for the firm.

Q16. What is monopoly? Discuss the features of monopoly market situation.

Ans:- A monopoly is a market structure where there is only one seller of a product that has no close
substitutes. The seller faces the entire market demand and has the power to set the price of the
product. A monopoly can arise due to various reasons, such as legal barriers, patents, natural
resources, economies of scale, or network effects.

Some of the features of a monopoly market situation are:-

A monopoly is a market structure where there is only one seller of a product that has no close substitutes.
The seller faces the entire market demand and has the power to set the price of the product. A monopoly
can arise due to various reasons, such as legal barriers, patents, natural resources, economies of scale, or
network effects.

Some of the features of a monopoly market situation are12:

 Single seller and several buyers: There is only one firm that produces and sells the product in the market.
The firm is the industry and has no competitors. However, there are many buyers who purchase the product
from the monopolist.
 No close substitutes: The product that the monopolist sells has no close substitutes available in the market.
This means that the cross-elasticity of demand between the monopolist’s product and other products is very
low or zero. The buyers have no alternative but to buy from the monopolist if they want to consume the
product.
 Strong barriers to entry: There are significant obstacles that prevent new firms from entering the market
and competing with the monopolist. These barriers can be legal, such as patents, licenses, or regulations;
technological, such as high fixed costs or superior know-how; or natural, such as exclusive access to a scarce
resource or a geographic location.
 Price maker: The monopolist has the ability to influence the price of the product by adjusting its output
level. The monopolist faces a downward-sloping demand curve for its product, which means that it can sell
more only by lowering the price. The monopolist chooses the output and price combination that maximizes
its profit, subject to the demand and cost conditions. The monopolist’s price is higher than its marginal cost,
which implies that it earns a positive economic profit in the long run.

Q17. Explain short run and and long run equilibrium n monopolistic market condition.

Ans:- The short run and long run equilibrium of a firm in a monopolistic market can be explained as follows:

In the short run, a firm in a monopolistic market is in equilibrium when it maximizes its profit (or minimizes
its loss) by producing a level of output where marginal revenue (MR) equals marginal cost (MC) and MC is
rising at the point of equality1. This means that the firm produces an additional unit of output only if it adds
more to its revenue than to its cost. The firm’s short-run equilibrium can be shown graphically :-

In this figure, the firm’s equilibrium output is Q where MR = MC and MC cuts MR from below. The firm’s
equilibrium price is P which is determined by its downward-sloping demand curve (D) at Q. The firm’s total
revenue is Q x P which is the area of rectangle OQRP. The firm’s total cost is Q x AC which is the area under
the average cost (AC) curve up to Q. The firm’s profit is TR - TC which is the area of rectangle PRCA. This is a
case of supernormal profit because TR > TC and AC < AR at Q.

In the long run, a firm in a monopolistic market cannot earn supernormal profit because of free entry and
exit of firms. If there are supernormal profits in the short run, more firms will enter the market until the
 profits are competed away. Conversely, if there are losses in the short run, some firms will exit the market
until the losses are eliminated. In the long run, a firm in a monopolistic market is in equilibrium when it
produces at the minimum point of its average cost (AC) curve where marginal cost (MC) equals marginal
revenue (MR)1. This means that the firm produces at the lowest possible cost and earns only normal profit
which is included in its cost. The firm’s long-run equilibrium can be shown graphically as follows:

In this figure, the firm’s equilibrium output is Q where MC = MR and AC = AR. The firm’s equilibrium price is
P which is determined by its downward-sloping demand curve (D) at Q. The firm’s total revenue is Q x P
which is the area of rectangle OQRP. The firm’s total cost is Q x AC which is equal to TR. The firm’s profit is
TR - TC which is zero because TR = TC and AC = AR at Q. This is a case of normal profit because there is no
economic surplus or loss for the firm.

Q18. Differentiate between perfect competition and monopoly.

Ans:- Perfect competition and monopoly are two extreme forms of market structures that have different
characteristics and implications for consumers and producers. Some of the main differences between
perfect competition and monopoly are123:

 Number of sellers and buyers: In perfect competition, there are many sellers and buyers of a homogeneous
product, which means that no one seller or buyer can influence the market price or output. In monopoly,
there is only one seller of a unique product, which means that the seller has full control over the market
price and output.
 Product differentiation: In perfect competition, the products are standardized, homogeneous, and identical,
which means that consumers have no preference for any particular seller’s product. In monopoly, the
products are not standardized, and there can also be substitutes for the product, which means that
consumers may have different preferences for the seller’s product or its alternatives.
 Barriers to entry and exit: In perfect competition, there are no barriers to entry or exit in the market, which
means that new firms can enter or exit the market freely in response to profit opportunities. In monopoly,
there are high barriers to entry or exit in the market, which means that new firms cannot enter or exit the
market easily due to legal, technological, natural, or strategic reasons.
 Price and output determination: In perfect competition, the firms are price takers, which means that they
accept the market price determined by the interaction of demand and supply. The firms produce at the level
where their marginal cost equals their marginal revenue, which also equals the market price. In monopoly,
the firm is a price maker, which means that it sets the market price by choosing its output level. The firm
produces at the level where its marginal cost equals its marginal revenue, which is lower than the market
price.
 Profitability: In perfect competition, the firms earn zero economic profit in the long run, which means that
they earn only normal profit that covers their opportunity cost. This is because any positive or negative
economic profit in the short run will attract entry or exit of firms until economic profit is eliminated. In
monopoly, the firm can earn positive economic profit in both the short run and the long run, which means
that it earns more than normal profit. This is because the high barriers to entry prevent entry of new firms
even when there is economic profit.
 Efficiency: In perfect competition, the market outcome is allocatively and productively efficient, which
means that it maximizes social welfare and minimizes cost. This is because at equilibrium, the price equals
both marginal cost and marginal benefit, and also equals average cost. In monopoly, the market outcome is
allocatively and productively inefficient, which means that it reduces social welfare and increases cost. This
is because at equilibrium, the price exceeds both marginal cost and marginal benefit, and also exceeds
average cost.