2012 June Paper II
1. (b)
Explanation:
Normally, demand curve depicts the inverse relationship between price of a commodity and its demand. That is, demand increases as price decreases and vice versa. Therefore demand curve slopes downward to the right. Simply put, demand curve slopes downward.
2. (b)
Explanation:
Option (i) is incorrect because there are no restrictions on buyers and sellers in perfect competition. There is large number of buyers and sellers and they have perfect knowledge about market and technology respectively.
Option (ii) is correct as there is no restriction on the movement of goods in perfect competition.
Option (iii) is correct as there is no restriction on factors of production in perfect competition. They are perfectly mobile.
Thus, only option (ii) and (iii) are correct.
3. (c)
Explanation:
Assertion (A) is correct because according to the Law of Proportional Marginal Utility, a consumer attains maximum satisfaction when the ratio of marginal utility to price of various commodities is equal.
Reason (R) is correct as any change in the above condition (for example, change in price of any good) results in a disequilibrium.
4. (d)
Explanation:
(a) Survival – (iv) Primary objective
Survival is the main or primary objective of any business. A business can survive only if it earns sufficient profits to maintain its operations and expand.
(b) ROI – (i) Economic objective
Earning a reasonable return on investment (ROI) is the economic objective of a business. This ensures reasonable return for the investors.
(c) Growth – (ii) Natural urge
Growth or expansion is the natural urge or desire of any business. This increases the value of goodwill and leads to a strong position of the business in the market.
(d) Innovation – (iii) Business purpose
Innovation i.e. introducing something new (a new product, process, method, technology etc.) is considered the ultimate objective of a business. By innovation a business can face competition in a better way and increase its customer base by offering them something innovative.
5. (c)
Explanation:
(i) Sweezy’s kinked demand curve model – 1939
(ii) Neumann and Morgenstern Game Theory Model – 1944
(iii) Cournot’s Duopoly model – 1838
(iv) Baumol’s sales maximisation model – 1967
Therefore, the correct sequence of the order of evolution of these models/theories is:
(iii), (i), (ii), (iv)
2012 June Paper III
1. (b)
Explanation:
Assertion (A) is correct as Business Economics is a discipline that facilitates business decisions with the help of various models and theories which serves as tools in the decision making process.
Reason (R) is correct as business economics helps to analyse the problems and situations faced by a business organization.
2. (d)
Explanation:
Demand is determined at a particular price in a given period of time. It is also affected by the quantity available in the market or desired by individuals. Therefore, quantity, price as well as time form the elements of demand.
3. (b)
Explanation:
A firm attains equilibrium at an output level where its profit is maximized. According to the marginal approach, profit is maximized where:
i. MR = MC, and
ii. MC curve cuts MR curve from below i.e. MC curve is rising.
2012 December Paper II
1. (b)
Explanation:
Normative economics explains the moral, ethical or desirable condition. That is, it explains what should be.
Positive economics states the facts as they are. That is, it explains what is or the cause and effect of a phenomenon.
Microeconomics examines individuals units like an individual, a household, a firm or an industry. It studies the problems faced by an individual unit of the economy.
Macroeconomics examines all the individual units as a whole. It studies the problems faced by the entire economy.
2. (a)
Explanation:
Assertion (A) is true as Marginal Cost is the addition to the Total Cost when an additional unit of a good is produced while Differential Cost is the difference of cost in implementation of two alternatives. Thus, Marginal and Differential Costs are not same.
Reason (R) is false as a change in differential cost is the result of change in the costs of implementing different alternatives. It is not related to fixed costs.
3. (a)
Explanation:
First of all, an organization sets its Pricing Objectives whether it wants profit maximization or sales maximization.
Next, the organization considers its target segment, purchasing power of the target segment, market conditions, competition etc. to chalk out its Pricing Strategy. Two broad pricing strategies are: Penetration pricing and Price skimming.
After determining its strategy, the price is determined by adopting one of several Pricing Methods. A cost oriented method of determining price is Cost-plus method and a market oriented method of determining price is Perceived Value pricing.
Finally, Pricing Decision relate to setting of the price after considering Pricing Objectives, Pricing Strategies and Pricing Methods.
4. (b)
Explanation:
Some commodities like milk and electricity are used for multiple purposes. That is, these commodities have multiple uses. Demand for such commodities is called Composite Demand.
5. (d)
Explanation:
(a) Administered Price – (4) Fixed by government
Administered price is the price fixed by an authority rather than by the free market forces.
(b) Parity Price – (1) Landed Cost of Imports
Parity price is the price that seeks to equate the value of domestically produced goods with that of the imported goods. Tariff is levied on imported goods so that domestically produced goods can compete with the imported goods.
(c) Competitive Price – (2) Liberalised Economy
Competitive price is the price set by firms after considering price offered by the competitors. A liberalized economy allows the firms to freely adjust prices to face competition.
(d) Discriminating Price – (3) Public enterprises
Discriminating pricing is the practice of charging different price for different units/uses of a good or from different customers. Price discrimination requires a monopoly element and most of the public enterprises (like railways) enjoy monopoly. Thus, public enterprises practice price discrimination.
2012 December Paper III
1. (c)
Explanation:
Relationship between Average Cost (AC) and Marginal Cost (MC):
When AC curve is falling, MC curve lies below it i.e. MC < AC When AC curve is at its minimum point, MC curve intersects AC curve i.e. MC = AC When AC curve is rising, MC curve lies above it i.e. MC > AC
2. (c)
Explanation:
Paul Sweezy propounded the Kinked Demand Curve model to explain the condition of price rigidity in an Oligopolistic market structure.
3. (d)
Explanation:
Here, percentage change in price (ΔP) = 20% and percentage change in quantity (ΔQ) = 40%
Since, ΔP < ΔQ, the demand is highly elastic.
4. (a)
Explanation:
The demand for inferior goods is inversely related to the consumers’ income. Therefore, the income effect is negative.
Substitution effect is positive for all goods whether it is a normal good, a necessity, a luxury or inferior good. This is because demand for a good is positively related to the price of substitute.
Thus, income effect for an inferior good is negative while substitution effect is positive.
5. (b)
Explanation:
Under perfect competition, the demand curve (or Average Revenue (AR) curve) is horizontal or parallel to the x-axis. It is due to the fact, that a perfectly competitive firm has no control over the price of the good but it can sell any quantity at the price set by the industry. A perfectly competitive firm is price taker while industry is price maker.
2013 June Paper II
1. (a)
Explanation:
Assertion (A) is correct because utility is the characteristic of a good due to which it satisfies a want of customer.
Reason (R) is correct as utility is not related to ethics or morality. Alcohol has utility for the drunkards and cigarettes have utility for the smokers. Although both are not good for health and hence considered immoral, yet both of them possess utility.
2. (a) and (d)
Explanation:
(a) Contraction of demand – (ii) Demand curve remains the same
(a) Contraction of demand – (iii) Price change effect
Contraction of demand is reduction in quantity demanded caused by a change in price of the commodity (increase in price) and leads to a movement on the same demand curve i.e. demand curve remains the same.
(b) Decrease in demand – (i) Non-price change effect
(b) Decrease in demand – (iv) Shifts the demand curve
Decrease in demand is the reduction in demand caused by a change in factors other than price of the commodity viz. fall in the price of substitutes, rise in the price of complementary goods, fall in income of the consumers etc. And it results in a leftward shift in the demand curve.
(c) Increase in demand – (i) Non-price change effect
(c) Increase in demand – (iv) Shifts the demand curve
Increase in demand is the rise in demand caused by a change in factors other than price of the commodity viz. rise in the price of substitutes, fall in the price of complementary goods, increase in income of the consumers etc. And it results in a rightward shift in the demand curve.
(d) Expansion of demand – (ii) Demand curve remains the same
(d) Expansion of demand – (iii) Price change effect
Expansion of demand is increase in quantity demanded caused by a change in price of the commodity (decrease in price) and leads to a movement on the same demand curve i.e. demand curve remains the same.
3. (a)
Explanation:
Assertion (A) is correct as according to the Law of Variable Proportions (or Returns to a Factor) the marginal product first rises and then falls, reaches zero and finally becomes negative when variable factor is increased. Thus, marginal product diminishes beyond a point.
Reason (R) is also correct and provides right explanation to the Assertion (A). When variable factor is increased, the combination between fixed and variable factor gradually reaches the optimum level. As variable factor is increased upto the optimum level, marginal product increases. When variable factor is increased beyond the optimum level, marginal product starts to decline.
4. (c)
Explanation:
(a) Indifference Curve – (iv) Convex to the origin
Normally, indifference curves are convex to the origin as marginal rate of substitution is diminishing.
(b) Demand curve – (i) Slopes downward to the right
Generally, demand curve slopes downward to the right indicating the inverse relationship between price and demand.
(c) Perfect Competition – (ii) P = AR = MR = d
Since a firm is price taker under perfect competition, the shape of revenue curves are such that AR and MR curves are horizontal and coincide at the level of the prevailing price i.e. P = AR = MR. Also, AR curve and Demand curve depict the relationship between demand for a commodity and its price. Although, AR curve depicts the relationship from the seller’s point of view, Demand curve depicts the relationship from consumer’s point of view. Therefore, AR = d (demand). Hence, P = AR = MR = d.
(d) Price Leadership – (iii) Oligopoly
Price Leadership is a model to explain price and output determination under Oligopoly market situation.
5. (c)
Explanation:
The relationship between AR, MR and elasticity of demand (e) is given by:
When e = 1, i.e. MR = 0
2013 June Paper III
1. (b)
Explanation:
Assertion (A) is correct as markup pricing is one of the methods of price determination where markup is the profit as a percentage of the cost.
Reason (R) is correct as the expression for determining price under markup pricing is:
ATC + (m × ATC)
Here ATC = Average Total Cost and m is the profit percent
2. (a)
Explanation:
(a) Economic profit – (iii) Total Revenue – Total Cost
(b) Accounting profit – (i) Total Revenue – Explicit costs
Explicit Costs refer to cash payments made by the firms for factor and non-factor inputs, depreciation etc. Accounting costs include payments made to outsiders, the expenses incurred in acquiring an asset etc.
Implicit Cost or Opportunity cost of an input employed for production of goods is the value of next best opportunity available to it. Thus the opportunity cost of a factor producing a commodity X is the amount of another commodity Y that could have been produced by employing this factor in the production of Y.
Accounting Costs = Explicit costs, but
Economic costs = Explicit costs + Implicit Costs.
Therefore, Accounting profit = Total revenue – Explicit costs
And, Economic profit = Total revenue – (Explicit costs + Implicit costs) or Total revenue – Total cost
(c) Collusion/Cartel – (iv) Oligopoly
The concept of Collusion/cartel is used to explain the behavior of firms operating under oligopoly.
(d) Market – (ii) Buyers and Sellers exchanging
Market is a place where exchange between buyers and sellers takes place.
3. (d)
Explanation:
Cost includes all monetary items whether they are hired from the market or supplied by the owner. Opportunity costs like owner sacrificing the time he could spend with family and devoting it to work cannot be included in economic cost as it cannot be expressed in terms of money.
4. (d)
Explanation:
Demand is composed of elements like want or desire. It is the quantity desired by individuals and depends on price as well as time elements.
5. (c)
Explanation:
(a) Utilitarian Approach – (iii) U = f(x, y)
Alfred Marshall’s Utilitarian approach describes utility U as a function of quantities of commodities, say X, Y, consumed by an individual. This approach uses utility function to describe consumer behavior.
(b) Ordinal Approach – (i) Marginal Rate of Substitution
Hicks and Allen’s Ordinal approach describes consumer behavior with the help of Marginal Rate of Substitution.
(c) Price Consumption Curve – (ii) Budget line and Indifference curve
Price consumption curve traces the changes in consumer’s equilibrium that occurs due to change in price of commodity. Consumer’s equilibrium is determined using indifference curve and budget line.
(d) Consumer’s equilibrium – (iv) MRSXY = MRSYX
The consumer is in equilibrium when MRSXY = MRSYX.
6. (a)
Explanation:
Lerner’s Index is used to determine the monopoly power or market power of a firm. Market power is the ability to influence the price and setting up price higher than the marginal cost (MC). Higher the difference between price and MC, greater is the market power.
A Lerner’s index of zero indicates no control over the price, which occurs in perfect competition while a Lerner’s index of 1 indicates complete control over price.
7. (a)
Explanation:
(a) Perfect competition – (iv) Identical product
Under perfect competition, all the firms sell identical products
(b) Monopolistic competition – (iii) Product differentiation
Under monopolistic competition, the firms sell differentiated products.
(c) Oligopoly – (ii) Dominant strategy
Dominant Strategy is a concept in Game Theory to describe a strategy which is best or optimum for a firm, no matter what policy rivals adopt. Game theory is used to solve the problems faced by firms under oligopoly market structure.
(d) Discriminating Monopoly – (i) Different prices for the same product
A discriminating monopolist charges different prices to different customers for the same product.
2013 September Paper II
1. (c)
Explanation:
Cardinal utility analysis uses money as measuring rod to determine the value of utility of a product. Since a scale should not vary with changing conditions, it assumes marginal utility of money to be constant.
2. (c)
Explanation:
The properties of an indifference curve are:
i. It slopes downward to the right (i.e. it has negative slope)
ii. It is convex to the origin.
iii. Two indifference curves never intersect each other.
iv. A higher indifference curve represents higher level of satisfaction.
Clearly, ‘(c) Indifference curves necessarily have to be parallel’ is not the property of indifference curves.
3. (a)
Explanation:
A Increase in demand – 2. Rightward shift of the demand curve.
Increase or Decrease in demand are caused by factors other than price of the product itself, like income of consumer, price of related goods etc. So any change in other factors which results in increased demand causes a rightward shift in the demand curve.
B Contraction of demand – 1. Leftward movement along the demand curve.
Contraction of demand refers to decrease in quantity demanded due to rise in price of the product. Demand curve remains the same in this case and demand moves leftward on the same demand curve.
C Cross demand – 4. Demand of one commodity with changes in the prices of another related
commodity
Cross demand is the demand for a product caused due to change in price of related products (i.e. substitutes or complementary products)
D Joint demand – 3. Demand of more than one commodity to satisfy one specific want.
When two or more commodities are demanded together to satisfy a single want, their demand is referred to as Joint demand. Demand for complementary products like car and petrol is joint demand.
4. (c)
Explanation:
The first stage of Law of Variable Proportions ends where AP = MP. Thus, second stage begins at this point. AP is rising throughout the first stage, while MP first rises and then starts falling.
The second stage ends where MP = 0. AP and MP fall throughout the second stage. Therefore, when the second stage ends AP is falling. Third stage begins at the point where second stage ends.
MP is negative in the third stage while AP is still positive but is falling continuously.
5. (b)
Explanation:
Profit is maximum when MR = MC.
TR = 480 Q – 8 Q2 MR =
TC = 400 + 8 Q2 MC =
Now, MR = MC 480 – 16Q = 16Q 32Q = 480 Q = 480/32 = 15
2013 September Paper III
1. (c)
Explanation:
The relationship between AR, MR and elasticity of demand (e) is given by:
When e > 1, i.e. MR > 0 or MR is positive.
2. (c)
Explanation:
Price rigidity is a feature of an Oligopoly market as explained by Paul M. Sweezy in Kinked Demand Curve model.
3. (c)
Explanation:
In terms of cost, short-run optimum level of output is the quantity for which per unit production cost is minimum i.e. AC is minimum.
4. (d)
Explanation:
Opportunity cost of a resource is the amount that resource could have earned if it was diverted from its current use to its next best alternative.
2013 December Paper II
1. (c)
Explanation:
Business economics is application of tools (theory, laws and principles etc.) for taking business decisions and making policy by the managers. It is also called Managerial Economics.
2. (d)
Explanation:
(a) Cross elasticity is zero – (2) Two commodities are independent
Cross elasticity is the degree of responsiveness of demand due to a change in price of related goods.
Cross elasticity is positive for substitute goods and negative for complementary goods. It is zero when goods are not related to each other i.e. they are independent.
(b) Shut-down point – (1) Price = AVC
Figure A shows Average Cost (AC) and Average Variable Cost (AVC) curves. The rectangle under AC curve represents Total Cost (TC) and the rectangle under AVC shows Total Variable Cost (TVC). Thus, the rectangle formed between AC and AVC curve represents the difference between TC and TVC i.e. TC – TVC = TFC (Total Fixed Cost).
In figure B, Price = AC thus it covers TC. Since cost, in economics include implicit cost (which is the opportunity cost of owner owned resources), P = AC is the price at which firm earns normal profits.
In figure C, AC > Price > AVC; in this situation, the firm incurs losses as Price < AC and recovers TVC and only a part of TFC. If the firm decides to shut down it will incur losses equal to TFC but since firm is recovering a part of TFC, Loss < TFC. Hence the firm will continue its operations.
In figure D, Price = AVC; in this situation firm recovers only its variable cost. Thus, Loss = TFC. Firm will be in the same situation if it continues to operate or shut down temporarily. But if the price falls further and Price < AVC, the firm will prefer to shut down because in that situation Loss > TFC. Hence, P = AVC is the Shut-down Point.
(c) Slutsky theorem – (4) Substitution effect
Slutsky Theorem depicts the break up of price effect into income and substitution effect.
(d) Production Possibility Curve – (3) Transformation line
Since units of one product transform into those of the other product along a Production Possibility Curve, it is also called Transformation Curve or Transformation Line.
3. (b)
Explanation:
Assertion (A) is true as demand curve depicts the negative relationship between price of a good and its demand.
Reason (R) is false as Giffen Goods are an exception to the Law of Demand and their demand is positively related to their price.
4. (c)
Explanation:
According to the Law of Proportional Marginal Utilities, a consumer consuming two or more commodities is in equilibrium if the ratios of marginal utility and price of different goods are equal.
That is,
5. (a)
Explanation:
(a) Monopoly – (2) Homogeneous product’s price maker
A firm in a monopoly can influence the price of its product. Hence, it is a price maker.
(b) Monopolistic Competition – (3) Heterogeneous product
Under monopolistic competition, products offered by different firms are differentiated or heterogeneous.
(c) Perfect competition – (1) Price Taker
Firms under perfect competition have no control over the price of their product. They can sell any quantity of their output at the price fixed by the industry. Hence, they are price takers.
(d) Oligopoly – (4) Price Rigidity
Price rigidity is a characteristic of oligopoly as explained by Paul M. Sweezy in his Kinked Demand Curve model.
2013 December Paper III
1. (d)
Explanation:
(a) Multiple plants – (3) MR = MCT = MCA = MCB
A firm with multiple plants will first calculate total marginal cost (MCT = MCA+ MCB at each level of output). It will then decide profit maximizing level of output where MR = MCT. Finally, the total output will be distributed among different plants such that MCA = MCB = MCT.
(b) Cost-Plus pricing – (4) P = (1 + m)ATC
Under Cost-plus Pricing, a firm determines the price as ATC + m × ATC, where m is the markup or profit as a percentage of ATC.
(c) Multiple markets – (2) MRT = MC = MR1 = MR2
A firm operating in multiple markets will first calculate total marginal revenue (MRT¬ = MR1 + MR2 at each level of output). Then it will determine profit maximizing level of its output where MRT = MC. Finally, total output will be distributed among different markets such that MR1 = MR2 = MRT.
(d) Multiple products – (1) MRPT = MC = MRPx = MRPY
In case of a firm producing multiple products, it will first determine total marginal revenue product (MRPT = MRPX + MRPY at each level of output). Marginal revenue product is the additional revenue generated by employing an additional unit of resource. It will then determine profit maximizing level of its output where MRPT = MC. Then it will allocate the resource to the production of different products in such a way that MRPT = MRPX = MRPY.
2. (a)
Explanation:
The degree of responsiveness of demand for a commodity in response to a change in price of its related commodities is called Cross Price Elasticity or Cross Elasticity of demand.
3. (a)
Explanation:
Total Fixed Cost = Total Cost – Total Variable Cost = Rs.(260 – 60) = Rs.200
Since total fixed cost remains constant and does not vary with the level of output. Therefore, Total Fixed Cost = Rs.200 whether output is 100 units or 200 units.
4. (d)
Explanation:
Optimal input combination that minimizes the cost of production is attained where:
i. Isocost is tangent to the isoquant;
ii. MRTSLK = MRTSKL;
iii. Any deviation from this point leads to a lower level of output.
5. (d)
Explanation:
To put the rivals at a disadvantageous position, a firm under oligopoly can resort to false commitments and promises and even threats.
6. (b)
Explanation:
The Law of Demand operates only in case of normal goods out of the given options. Thus, this is not an exception to the law of demand. All others are exceptions to the law of demand.
2014 June Paper II
1. (c)
Explanation:
Demand curve is a straight line parallel to x-axis when there is no change in price (i.e. ΔP = 0).
And price elasticity of demand eP = . Therefore, when ΔP = 0, eP = ∞
2. (b)
Explanation:
Business economics is application of tools (theory, laws and principles etc.) for taking business decisions and making policy by the managers. It is also called Managerial Economics. Business economics integrates economic theory with business practices and studies the behavior of the firms.
Distribution theories of factor incomes viz. rent, interest, wages and profit are beyond the basic nature and scope of business economics.
3. (c)
Explanation:
Point of satiety is reached when the consumer obtains maximum satisfaction from consumption of a commodity. Satisfaction is expressed as utility under the Cardinal Utility Approach. TU is maximum when MU = 0.
4. (c)
Explanation:
Rectangular hyperbola is a curve such that every rectangle drawn under it has equal area. The area of a rectangle is the product of the length and breadth (i.e. the product of variable measured along the x-axis and y-axis) of the rectangle. Under the demand curve area of rectangle is the product of quantity (variable on x-axis) and price (variable on y-axis) which represents total expenditure.
Thus a rectangular hyperbola demand curve represents different price levels at which expenditure of the consumer remains constant. Hence a rectangular hyperbola demand curve represents unit elastic demand. It has unequal slope but equal elasticity (e = 1) at all points.
5. (a)
Explanation:
Assertion (A) is true Due to large number of firms selling identical product, firms in perfectly competitive market have no control over the price of the product. They take the price decided by industry as given. Hence, A perfectly competitive firm is not a price maker but is a price taker.
Reason (R) is also true. As explained above, the firms under perfect competition cannot set the price of their product but they can sell any amount of their product at the price set by the industry. Thus, the firm is interested in deciding the level of output only
6. (a)
Explanation:
(I) Skimming pricing – (b) A market having high price inelasticity
Skimming pricing refers to setting up a high price initially and gradually reducing it. This practice is successful only in a market where demand is highly inelastic. This means, a considerable change in price will lead to only a small change in quantity.
(II) Differential pricing – (c) A market having several segments differing prominently with regard to price elasticities of their demand.
Differential pricing refers to charging different prices to different segments of consumers. This practice is successful only when market can be divided into mutually exclusive segments with different price elasticities. For example, electricity distribution companies divide the electricity consumption market into residential and commercial and charges different prices to each segment.
(III) Penetrating pricing – (a) A market having high price elasticity
Penetrating pricing is the practice of charging low price initially to gain market share and gradually increasing it. This policy is adopted when operating in a market with elastic demand.
2014 June Paper III
1. (a)
Explanation:
(I) Excess of total revenue over total explicit cost – (c) Accounting profit
(II) total revenue equals total economic cost – (a) Normal Profit
(III) Excess of total revenue over total of explicit and implicit costs and a normal rate of return – (b) Economic Profit
Explicit Costs refer to cash payments made by the firms for factor and non-factor inputs, depreciation etc. Accounting costs include payments made to outsiders, the expenses incurred in acquiring an asset etc.
Implicit Cost or Opportunity cost of an input employed for production of goods is the value of next best opportunity available to it. Thus the opportunity cost of a factor producing a commodity X is the amount of another commodity Y that could have been produced by employing this factor in the production of Y.
Accounting Costs = Explicit costs, but
Economic costs = Explicit costs + Implicit Costs.
Therefore, Accounting profit = Total revenue – Explicit costs
And, Economic profit = Total revenue – (Explicit costs + Implicit costs) or Total revenue – Total cost
Also, when Total Revenue = Total Economic Costs then Economic Profit = 0. This situation is called a situation of Normal Profit as economic costs include the monetary measure owner’s sacrifice. The remuneration of owner or entrepreneur (here the money value of the sacrifice) is called profit. Therefore, economic costs always include an element of minimum profit. Thus, when Total revenue equals Total economic cost, the firm earns normal profit.
2. (a)
Explanation:
Assertion (A) is true because a monopolist can sell more of its output only by reducing the price. Therefore, a monopoly firm’s revenue curves i.e. AR and MR curves are downward sloping showing the negative relation between the price and quantity of output.
Reason (R) is also true. As explained above a monopolist has to reduce the price to increase the sale of his output. Thus, it does not simultaneously enjoy the freedom to determine both price and quantity to be sold according to its whims and fancy.
3. (d)
Explanation:
Figure A shows revenue curves under perfect competition while figure B shows revenue curves under imperfect competition.
In both situations profit is shown by shaded areas. To earn maximum profit (equal to the entire shaded area) the firm must produce OQ quantity of output. This is achieved when:
i. MR = MC; and
ii. MC curve cuts MR curve from below (or MC curve is rising)
4. (c)
Explanation:
(i) Dumping – (d) Discriminatory Monopoly
The practice of a firm to charge a higher price for its products in domestic market and a lower price in the foreign market is called Dumping. A monopoly adopting the policy of price discrimination practices dumping.
(ii) Kinked Revenue Curve – (b) Oligopoly firm
Kinked revenue curve (or Kinked demand curve) explains price rigidity faced by an oligopoly firm.
(iii) Horizontal straight line revenue curve – (c) Perfectively competitive firm
Horizontal straight line revenue curves (i.e. AR and MR curves) are a characteristic of Perfectly competitive firm.
(iv) Large number of buyers and sellers with differentiated products – (a) Monopolistic competitive firm
Two important features of a Monopolistic competitive firm are: Large number of buyers and sellers, and Differentiated products.
5. (c)
Explanation:
Penetrating pricing is the practice of charging low price initially to gain market share and gradually increasing it. This policy is adopted when operating in a market with highly elastic demand.
2014 December Paper II
1. (c)
Explanation:
(a) Income Effects, (b) Substitution Effects, and (d) Law of Diminishing Marginal Utility explain why Law of Demand operates and thus provide a reason for inverse relationship between variation in the price and quantity demanded.
On the other hand, (c) Future Expectations is an exception to the Law of Demand.
2. (b)
Explanation:
According to the Law of Proportional Marginal Utilities, a consumer consuming two or more commodities is in equilibrium if the ratios of marginal utility and price of different goods are equal.
That is,
3. (c)
Explanation:
Officially the answer key for this question is (c) i.e. (a)-(iii), (b)-(iv), (c)-(i), (d)-(ii).
But it should be (a)-(iv), (b)-(iii), (c)-(i), (d)-(ii). According to this answer:
(a) Zero Income Elasticity – (iv) Independent goods
When change in income leads to no change in demand, the goods are said to be independent of the level of income. Thus their income elasticity is zero.
(b) Unit Cross Elasticity – (iii) Indifferent goods
Unit cross elasticity (or cross elasticity = 1) of a good X is obtained when:
Percentage change in price of good Y = Percentage change in quantity of good X
Here the consumer is indifferent between the two goods. Thus the two goods are indifferent goods.
(c) Positive Cross Elasticity – (i) Substitute goods
Cross elasticity of a good X is positive when demand for good X is positively related to the price of good Y. Thus the two goods are substitutes.
(d) Negative Cross Elasticity – (ii) Complementary goods
Cross elasticity of a good X is negative when demand for good X is inversely related to the price of good Y. Thus the two goods are complementary.
4. (b)
Explanation:
Statement (A) is correct as isoquants are convex to the origin due to diminishing MRTS.
Marginal rate of technical substitution (MRTS) is the rate at which one factor (say Capital) is replaced by another (say Labour) without changing the level of output.
If quantity of capital is reduced its marginal productivity increases and therefore less and less quantity of capital needs to be substituted by labour to keep the level of output constant. As labour becomes relatively abundant and capital becomes relatively scarce, it becomes increasingly difficult for labour to replace capital. Thus, marginal rate of technical substitution diminishes and it gives isoquant its convex shape.
Statement (B) is incorrect because as convexity decreases and curve becomes less and less convex, it will be a straight line which depicts the relationship between substitute goods. In this case MRTS will become constant.
5. (d)
Explanation:
(a) Constant average cost over a range of output – (ii) Reserve Capacity
When average cost remains constant over a range of output, AC curve becomes horizontal. Thus, output increases without increasing the cost. This occurs when firm maintains a reserve capacity to meet the sudden rise in demand. In this way it is capable of increasing production without increasing the cost.
(b) Average cost becomes constant momentarily – (i) Economic capacity
Average cost becomes constant momentarily and then starts to rise. This happens when firm reaches its economic capacity or optimum capacity. Economic capacity is the level of output at which AC is minimum.
(c) Normal average cost is a U-shaped curve – (iv) Economies and Diseconomies
Normally AC is U-shaped. It falls continuously when firm enjoys economies of scale and rises when diseconomies of scale occur.
(d) Modern Long-run average cost is L-shaped – (iii) Production and Managerial cost effects
The Modern LAC curve is L-shaped indicating continuous and gradual decrease in Average Cost. This occurs when at a very large scale of production, managerial diseconomies are offset or balanced by production (or technical) economies.
2014 December Paper III
1. (c)
Explanation:
A Monopolist firm prefers to charge as high a price possible. This is possible only when demand for its product is inelastic. One reason for inelastic demand can be lack of close substitutes (i.e. lack of rival firms).
2. (a)
Explanation:
Assertion (A) is correct. In the short-run there is no entry or exit of the firms to or from the market. If existing firms are earning supernormal profits, new firms get attracted to the market in the long-run. This increases the supply of the product and consequently the price starts to fall. Finally, the price reaches a level where firms earn only normal profits.
Similarly, when firms are incurring losses, marginal firms leave the industry. This reduces supply of the product and consequently price begins to rise. Finally, the price rises to a level where firms earn only normal profits.
Reason (R) is also correct. The firms operate at minimum average cost at the level of normal profits. Since all the firms are selling identical products, there is absence of product differentiation. The selling costs are also absent due to absence of product differentiation.
3. (a)
Explanation:
Assertion (A) is correct. Differential pricing refers to charging different prices to different customers for the same product. For example: airlines offer huge discounts for booking tickets months in advance while charges higher price for tickets booked closer to the departure date. Thus, differential pricing structure is designed to accommodate the various categories of buyers.
Reason (R) is also correct. Differential pricing helps to bring in more customers, increase sales and revenue and help make the firm more competitive.
4. (b)
Explanation:
Cost-plus pricing is the practice of charging a price which includes a fixed percentage of profit. The price under cost-plus pricing is calculated as:
Price = AC + m × AC where AC = Average Cost and m = Percentage of Profit (or markup)
Product Tailoring refers to providing customized products to the customers. For example, a tailor stitches garments according to the specifications of the customer. Under this practice, the seller or service provider practices Cost-plus pricing.
Public Utility Pricing refers to pricing of products or services offered by the government to the general public, like postal service. Cost-plus pricing is adopted in this case too.
Refusal Pricing refers to offering a discounted price to a customer who had initially refused the previous offer of the firm. Here, again the firm adopts Cost-plus pricing.
Under monopoly, the firm does calculate the price of its product as a fixed profit percentage. It may charge higher profit to one customer and a lower profit to another. Since profit percentage is not fixed, it does not adopt cost-plus pricing.