1 MICRO ECONOMICS ECONOMICS Uses of scare resources in order to get maximum satisfaction is said to be Economics. OR An Economics is a mechanism that allocates scare resources among competing uses. SCARCITY Scarcity is defined as we looking for more as the resources available now. Economics arise when we have following things. 1. What 2. How 3. Whom What goods and services will produce and what quantity to produce. How will be various good and services be produce. for Whom will the various goods and services be produce. Distribution of Economics benefit depends on the distribution of income and wealth. Economics has two type. A. Decision Maker. B. Coordination Mechanism. Any Person or organization of person that make choices are deals in decision market. Decision Maker fall in to three groups. i. House ii. Firms iii. Government Economy is change country to country. Advance countries go for capital but some have limitation of qualified labour. OPPORTUNITY COST Economist use the term opportunity cost of emphasis that making choice in the fact of Scarcity implies a cost OR We go for best in order to forgone other upon them. Economics other divided into two parts. 1. Micro Economics 2. Macro Economics Micro Economics Micro Economics deals with single, individual or a particular firm, consumer or producer. Macro Economics Macro Economics deals as whole or over all performance of economy like national income. According to the Adam Smith Economics is the study of wealth and according to him wealth is for man but not man is for wealth. According to Robbins
Economics
Nov 22, 2014
Economics for B.com part I
ecomomics for bechlors in commerce part one
economic analysis for bcom part one
ecomomics for bechlors in commerce part one
economic analysis for bcom part one
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MICRO ECONOMICSECONOMICSUses of scare resources in order to get maximum satisfaction is said to be Economics.
ORAn Economics is a mechanism that allocates scare resources among competing uses.
SCARCITYScarcity is defined as we looking for more as the resources available now.
Economics arise when we have following things.
1. What
2. How
3. Whom
What goods and services will produce and what quantity to produce.
How will be various good and services be produce.
for Whom will the various goods and services be produce.
Distribution of Economics benefit depends on the distribution of income and wealth.
Economics has two type.
A. Decision Maker.
B. Coordination Mechanism.
Any Person or organization of person that make choices are deals in decision market.
Decision Maker fall in to three groups.
i. House
ii. Firms
iii. Government
Economy is change country to country. Advance countries go for capital but some have limitation of qualified labour.
OPPORTUNITY COSTEconomist use the term opportunity cost of emphasis that making choice in the fact of Scarcity implies a cost OR We
go for best in order to forgone other upon them.
Economics other divided into two parts.
1. Micro Economics
2. Macro Economics
Micro EconomicsMicro Economics deals with single, individual or a particular firm, consumer or producer.
Macro EconomicsMacro Economics deals as whole or over all performance of economy like national income.
According to the Adam SmithEconomics is the study of wealth and according to him wealth is for man but not man is for wealth.
According to RobbinsEconomics is the study of human behaviors as a relation between ends and scare moons which have alternate uses.
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CONSUMER1. To get the maximum satisfaction from producer (House Hold Sector) supplier of loan.
2. They are lender of loan. They purchases their bonds.
PRODUCER1. To get profit from consumer pockets. (Business Sector) Desire to borrowed the loan.
2. Demand the loan. They print new loan to borrow the loan.
DemandThe Theory of Demand | The Meaning of DemandDemand in economics means a desire to possess a good supported by willingness and ability to pay for it. like for
example if we have a desire to certain commodity, but we do not have the adequate means to pay for it, it will simply
be a wish, a desire or a want and not demand.
Demand is effective desire which is backed by willingness and ability to pay for a commodity in order to obtain it.
Characteristics of Demand in economics
1. Willingness and ability to pay.
2. Demand is always at a price.
3. Demand is always per unit of time.
The Law of DemandThe law of demand states that people will buy more at lower prices and by less at higher price, other thing meaning
the same.
When a price of a commodity increase quantity demanded is decreases and as the price decreases quantity
demanded increases keeping other things constant.
Functionally Demand is defined as
Qd(x) = F(Px, M, Po, T, ….)
Px = Price of commodity
M = Money Income of the household
Po = Price of other commodities
T = Taste of household
Assumption of the LawThere are three main assumption of the law.
1. No change in the taste of Consumer (T)
2. Purchasing power must remain constant (M)
3. Price of all commodities remain constant (Po)
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Exceptions to the Law of DemandThis law may be not valid for few cases like
1. Prestige Goods Some luxuries items are purchases as a mark of destination in Society. If the Price of these goods
rises, the demand for them increases instead of falling.
2. Price Expectation If peoples expect rise in the price in future they may be violet this law.
3. Giffen Goods If the price of Giffen goods falls, its demand also falls. There is the price effect in case of giffen
goods.
The Individual’s Demand For a CommodityThe individuals demand for a commodity is the amount of commodity which the consumer is willing to purchase at
any given price over a specified period of time.
Demand ScheduleThe Demand Schedule of a individual for a commodity is list or table of the different amounts of the commodity that
are purchased in the market at different price per unit time.
Individual Demand Schedule for Trouser
Price per Trouser (P) | 800 | 600 | 500 | 450 | 400
Quantity Demand (Q) | 006 | 010 | 016 | 020 | 030
‘Demand CurveDemand Curve shows the relation between the price of a commodity and the amount of that commodity that
consumer wishes to purchase.
The Market Demand for a CommodityThe Market demand for a Commodity is obtained by adding up the total quantity demanded at various prices by the
entire individual over a specified period of time in the Market.
Market Demand SchedulePrice per (KG) …..Demand of the Buyers
RS. ………………. A | B | C | D | Total
20 ………………… 3 | 4 | 5 | 6 | 18
18 ………………… 4 | 5 | 6 | 7 | 22
16 ………………… 5 | 6 | 7 | 8 | 26
14 ………………… 6 | 7 | 8 | 9 | 30
12 ………………… 7 | 8 | 9 | 10 | 34
10 ……………….. 6 | 7 | 10 | 11 | 38
Market Demand CurveMarket demand Curve is also very sloped like individual demand curve.
By analyzing the demand curve we note that when price fall the demand for the goods increase therefore the demand
curve slopes from left to right
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1. Law of diminishing marginal utility.
2. New Buyers.
3. Increase in Real Income.
4. Substitution Set.
1. Law of Diminishing Marginal Utility
The Law of demand is bases on the law of diminishing marginal utility. According to which, when a consumer
purchase more units of a commodity, its marginal utility declines. The consumer therefore will purchase more units of
that commodity only if its price falls.
2. New Buyers
When the prices of a commodity falls those peoples also become capable to purchase who were not able before. The
Demand increase due to entry of new buyers in the market and so demand curve slopes from left to right.
3. Increase in Real Income
Due to fall in price people purchasing power increases for that good so due to which demand curve is slopes
rightward.
4. Substitution Set
Suppose two substitutes commodity like tea and coffee and if the price of one commodity is decrease then people felt
that other is expensive so they bye cheapest one.
If price of coffee decrease than tea seems to be expensive so people go for coffee.
Movement of Shifting Of Demand CurveThere are two ways to show demand curve
1. Movement along the demand curve.
2. Shifting of demand curve.
1. Movement along the Demand Curve
If only change in price of commodity and keeping other factors remain constant (Income etc) than we more along
demand curve it is technically called extension and contraction in demand.
Extension ====> Increase in Demand
Contraction ====> Decrease in Demand
2. Shifting of Demand Curve
Demand Curve shift upward or downward due to change in demand, due to change in one or more factors other than
price.
If there is increase in demand than curve moves upward.
If there is decrease in demand curve moves downward.
The Theory of Supply It is the amount of a commodity that seller are able and willing to offer for sale at different prices per unit of time.
ORSupply is a Schedule of the amount of a good that would be offered for sale at all possible prices at any period of
time.
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SupplyIt refers to that quality of the commodity which is actually brought into the market for sale at given price per unit of
time.
StockStock means that total quantity of a commodity which exists in market but cannot be offered for sale at a short notice.
The Law of Supply Keeping other factor constant If the price of a commodity rises, seller supply more goods while if the price decreases
than they will supply less keeping other factor constant.
It is formed that the direct relation between quantity and supply and we can easily understand by supply schedule
and supply curve.
From the Supply curve and Schedule we observed that the supply curve is positively sloped means that is direct
relation between price and supply of the commodity.
The Supply function can also be explained it.
Qxs = f(Px, Tech, Si, Fn, X, …..)
Where
Qxs = Quantity Supplied by commodity of x by the producer.
Px = Price of commodity X
Tech = Technology
Si = Supplies of Import……………… These are constant fact of production.
Fn = Feaditer of machine
X = Taxes / Subsidies
We can say supply is a function of
Qxs = f(Px)
Movement / Shift In SupplyAccording to the law of Supply that If the price increases supply increases so we can say that change in price curve
change in Quantity Supply so movement along the curve happen at different price level while keeping other factor
remain constant or we can say that there is movement along the curve is only price change and other factors remain
constant.
When price is Pi Supplier offer Qi quality for sale while when price increases to P2 the offer Q2 which slow there is
movement along the curve shift in Supply curve.
Where Ss = Actual Supply Curve
When price level Decrease due to other factors (Tech, Si, Fn, X, ….) the Actual Supply curve (Ss) shift upward to the
left (Ss)
When price level increase due to other factor (Tech, Si, Fn, X, ….) the Actual Supply curve (Ss) Shift downward to
the right (S2S2)
Non-Price Factor which can shift in Supply. These factors are
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1. Change in Factor Prize
The rise or fall in supply may take place due changes in cost of production. If the input prizes which is used for
making the commodity increases the cost of production.
2. Change in Technique
If there is improvement in technology then it will come reduction in cost of production.
3. Improvement in the Means of Transport
If there is improvement in communication in transport then if leads to minimize the cost of production.
4. Political Changes
The increase or decrease in supply also occurs due to political changes. If there is war in between two country then it
will decrease the Supply.
5. Taxation
If Government received heavy taxes on the Import of a commodity then the Supplies of these goods is reduced at
each price.
6. Future Rate
If firm expect higher price the future they produce in large scale.
Elasticity of DemandThe Law of Demand Indicates the direction of change in the quantity demanded of a result of change in price.
Economists here ease and measure the responsiveness of quantity demanded to a change in price by the concept of
elasticity of demand.
Elasticity of demand shows the expansion and contraction in demand with respect to change in price.
Price Elasticity of DemandPrice Elasticity of demand response the expansion or contraction in demand is response to change in price.
Mathematically
Ep = Proportionate change in quantity demand / Proportionate change in price
Ep = D f/q / Dp/p
Degree Of Price Elasticity Of DemandDegree of elasticity of demand falls into five categories.
1. Perfectly elastic demand
2. Perfectly Inelastic demand
3. Unitary elasticity
4. Relatively elastic demand
5. Relatively Inelastic demand
1. Perfectly Elastic Demand
A demand is properly elastic demand when amount demanded of a good at the ruling price is infinite. Imperfectly
elastic demand when ruling price fall the consumer by much good while when price level increase the consumer
leave the use of product or says demand is equal to zero.
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2. Perfectly Inelastic Demand
Perfectly Inelastic demand shows that there is no change in demand is response to change in prize. It refers the
elasticity of demand is equal to zero.
3. Unitary Elasticity of Demand
Such demand in which percentage change in price is equal to percentage change in quantity we said the demand is
unitary elastic.
4. Relatively Elastic Demand
Relatively elastic demand shows the percentage change in quantity demanded is higher is response to percentage
change in price like suppose the 10% change in price leads the 20% change in quantity then.
5. Relatively Inelastic Demand
Relatively Inelastic shows that % change in quantity is less in response to % change in prize.
When, Ed < 1, we said relatively inelastic demand.
Measurement of Prize Elasticity of DemandThere are three methods of measuring elasticity of demand.
1. Revenue Method
2. Proportional Method
3. Graphic Method
1. Revenue Method
According to this method elasticity of demand can be measured from the change in the total revenue of the firm as
the increase or decrease the prices of the goods. Elasticity is expressed in three ways.
A. Unit elastic demand
B. Elastic demand
C. In elastic demand
A. Unit Elastic Demand
When the increase or decrease in the price of goods leads to firm total revenue remain the same we said this is Unit
Elastic Demand.
B.Elastic Demand
A Negatively r/s small changes in price of the good and the total revenue of the firm. When a firms lowers the price its
total revenue rises and when it increase the price of a good its total revenue falls.
C. Inelastic Demand
In case of inelastic demand a relation exist between change in price of a good and the total revenue of the firm. When
a firm raise the price of a good its total revenue goes up and when its lower the prize the total revenue of the firm
goes down.
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Price of Per Dozens (Rs) P | Quantity Demanded Q | Total Revenue TR = PxQ | Elasticity
1.50 …………………………… 3 ……………………… 4.50 …………………. > 1
1.25 …………………………… 4 ……………………… 5.00
1.00 …………………………… 5 ……………………… 5.00 …………………. = 1
0.75 …………………………… 6 ……………………… 4.50
0.60 …………………………… 7 ……………………… 4.20 …………………. < 1
0.50 …………………………… 8 ……………………… 4.00
2. The Proportional Method Or Percentage Method
This method relates to point elasticity we compare the % change in price with the % change in demand. The elasticity
of demand is the ratio of % change in quantity demanded of a product to the % change in price.
Elasticity of Demand = Proportionate change in demand / Proportionate change in price
Elasticity of Demand always Negative but we taken positive value between we noted fallen price in followed by rise in
demand means demand is always Negatively Sloped.
3. Geometric Measurement of Elasticity OR The Point Method.
The price elasticity of demand ca also be measured at any point on the demand curve. It is noted that demand is
unitary at mid point of demand curve the total revenue is maximum at this point. Any point above unitary point shows
elasticity is greater than 1 (means price relation in this point leads to an increase in the total revenue.
Any point below midpoint below midpoint shows elastic is less than 1 means price relation in these point lead to
reduction in the total revenue.
Point elasticity of demandThe point elasticity refers to elasticity of demand at a point of demand curve. The change in price and resultant
changed in demand are very small.
We use are of demand curve to measure elasticity when price changed are big we use the average of the two prices.
Are elasticity is a measure of the measure responsiveness to price changes exhibited by a demand curve over same
finite stretch the curve.
Where,
PM is an arc which measures elasticity over a certain range of prices and quantities. We noted from the fig. that
elasticity is difference of different point.
Now suppose at point P on the demand.
These results show that the point method of measuring elasticity at two Points on a demand curve gives different
elasticity Coefficient.
In order to avoid this problem, we use an average of the two values is calculated on the basis of following formula
Q1 – Q2/Q1 + Q2 divided P1-P2/P1+P2
This result is more satisfactory then the two different elasticity coefficient arrived at by the point elasticity Method.
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The closer the two points P and M are the more accurate will be the measure of elasticity on the basis of are
elasticity.
Are elasticity is the elasticity of mid-point of P and M
Types of ElasticityThe demand depends upon various factors such as the price of a commodity, the money income of consumer the
prices of related good the taste of the people etc.
The elasticity of Demand measures responsiveness of quantity demanded to a change in any one of the above
factors by keeping other factors constant.
There are three major types of elasticity.
1. Price elasticity
2. Income elasticity
3. Cross elasticity
1. Price Elasticity of Demand.
If measures the responsiveness of demand to small changes in price.
Mathematically
Ep = Proportionate change in quantity demand / Proportionate change in Price
2. Income Elasticity
It measures the changes in Demand due to change in income.
Mathematically
Income Elasticity = Proportionate change in Quantity Demand / Proportionate Changes in Income
Measurement of Income Elasticity
Its measure in same way as price elasticity measure.
For Example: If the income of a consumer increases by 5% the prices of all other goods remain constant, the
purchase of the consumer for good X increases by 10%.
3. Cross Elasticity of Demand
It measures a change in price of one good causes a change in demand for another.
ORChange in price of substitutes goods result change in Demand for the goods.
Cross Elasticity of Substitutes
When such goods who are substitute to each other. Like Tea and Coffee, Butter & Jam etc. An increase in the price
of one good result the increase in quantity demands for other.
Factors Determining Elasticity of DemandThere are several factors which determine the elasticity of demand.
1. For Necessary the Demand is Inelastic Or Less Elastic
For necessities of life demand do not effect much as response to change in price like (Salt, Wheat etc)
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2. Demand for Luxuries is Elastic
When the price falls consumer buy more & when price rise no one will purchase. These are the luxuries of life. Like
we have to purchase a Flat in Clifton buy a Car like BMW etc.
3. Demand for Substitutes is also elastic
when the price of one commodity increase demand for its substitutes increase.
4. Demand for Goods having Several Uses is Elastic
Coal is such a good Which is cheap and use for several purpose so demand for it is elastic.
5. Elasticity also depends on the Price Levels
If the price is either too high or low the demand will be less elastic.
6. Has If and Fashion
The demand for those goods which are habitually consumed or which are in fashion is elastic.
7. Future Expectation about Price Changer
If people think that price level include in future demand for it increases.
ConclusionAs we analyze these condition and sort that elasticity do not depend on a particular thing if changer time to time and
place to place.
Elasticity of SupplyPrice elasticity of supply is a measure of the degree to which the quantity supplied in the responds to changes in
price.
Mathematically
Es = % change in Quantity supplied / % change in price.
Elasticity of supply represents the extent of change in supply in response to a change in price.
If the amount supplies rise as compete to rise in price supply said to be elastic.
If the amount supplies rise but not must as compose to rise in price than supply is said to Inelastic.
Categories of Price Elasticity of SupplyThere are five degrees of price elasticity of Supply.
1. Infinitely elastic or perfectly elastic.
2. Elastic
3. Unitary elastic
4. Inelastic
5. Perfectly inelastic
1. Perfectly Inelastic
In Perfectly elastic supply amount supplied at the ruling price is infinite.
2. Elastic Supply
When the % change in the amount of a good Supplied is greater than % change in price we said supply is elastic.
3. Unitary Elasticity
When the % change in the quantity supplied is exactly equal to % change in price than elasticity of supply is unitary.
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4. Inelastic Supply
When % change in amount supplied less than % change in price supply is said to be Inelastic.
5. Perfectly Inelastic Supply
When there is no change in amount supplied in response to change in price we said supply is perfectly inelastic.
Measurement of Elasticity of SupplyLike demand, elasticity of Supply has three types.
1. Equal to unity
2. Greater than unity
3. Less than unity
1. Equal to Unity
If % change in quantity supplied is equal to % change in price elasticity is equal to 1 or unity.
2. Greater than unity
If % change in quantity supplied is great than % change in price, elasticity will be great than unity
3. Less than Unity
If the % change in amount supplied is less than % change in price than supply elasticity will be less than unity.
Qs. What do you understand by Market Equilibrium?A price you which both buyer and seller agree is called Market Price.
As we know the consumer want cheaper price for the commodity and seller want higher price. But at a price for which
both consumer and seller agree is said to be Equilibrium in the market.
E —-> Shows market Equilibrium.
Po —> is the Equilibrium price for which both consumer and seller agree. Consumer agrees to buy at this price and
seller agrees for sale at this price.
Qo —-> is the quantity demanded by consumer at this price and quantity supplied by the supplies.
Simply we define market Equilibrium at that both consumer and producer are satisfy for a fixed price.
Qs. Show the effects of change in Demand and Equilibrium Market?Find we assume that there is no change in supply schedule.
Now we analyze the effect of changes in demand or Equilibrium considering following type of Supply curve.
1. Relatively Elastic Supply
2. Relatively Inelastic Supply
3. Perfectly Elastic Supply
4. Perfectly Inelastic Supply
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1. Relatively Elastic Supply
E ——> Initial Equilibrium Pt in the market.
Po —–> Initial Equilibrium Pt for which both consumer and produce agreed.
DD —–> Initial Demand Curve.
Now Suppose demand Increase then DD will shift upward to the right D,D then as the market demand Increase in
result producer increase the price and also increase the quality then new Equilibrium Point i.e E.
D,D, ——> Shows Increase in Demand
E’ ———> New Equilibrium Pt achieve when demand increases
Pi ——–> New Price when Demand increase.
Qi ——–> Quantity Supplied at E’
As we see that due to elastic supply curve the Extension in supply is higher than % Extension in price.
Similarly, If demand curve shift downward to the left due to decrease in demand Equilibrium Pt achieve E.
Where
E ——-> Eq Pt when demand decreases
P2 ——–> Price at new Eq Pt E
Q2 ——–> Quantity Supply at new Eq.Pt E
The contraction in supply is greater in response to % change in price.
2. Relatively Inelastic Supply
In Inelastic Supply the % change in price is higher than % change in supply due to increase in demand.
ORContraction or Extension in supply is less than the % change in price.
3. Perfectly Elastic Supply
When increase in demand in perfectly elastic supply there is no effect on price but quantity supply is increase from
QQo to QQ1 and new Eq Pt are is E when demand decrease quantity supply decreases QQo to QQ2.
4. Perfectly Inelastic Supply
In Perfectly Inelastic Supply there is no effect on quantity supplied on change in demand but if increase from DD to
D2D2 the price increased from Po to P2 if demand decrease the price decrease P1.
Qs. Analyze the shifts in supply on Market Equilibrium?ORWhat effect of shift in Supply on Market Equilibrium?First we suppose the demand curve is constant and only change in supply take place.
Now we always analyze the effect of shift in supply an Market Equilibrium on demand curve.
1. Elastic demand curve.
2. Inelastic demand curve.
3. Perfectly elastic demand curve.
4. Perfectly inelastic demand curve.
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1. Elastic Demand Curve
When supply increase from SS to S1S1 the Equilibrium point shift to E’ and new price and quantity demanded
achieve when supply decreases from SS to S2S2 Eq Pt E shift to E and price increases to P2 when quantity
demanded decreases to Q2.
Inelastic demand % change in quantity demand is increase or decrease is higher is response to % change in price.
2. Inelastic Demand Curve
Inelastic demand curve % change in quantity demanded is less than % change in price as result of shift in supply
curve.
3. Perfectly Elastic Demand Curve
There is no change in price in perfectly elastic demand curve in response to change in supply.
4. Perfectly Inelastic Demand Curve
If supply increase in the Market in perfectly inelastic demand. Supply increased than the quantity required in the
market. So the price decreases in order to get new Eq Pt E’ but quantity demand remain constant.
Qs. Discuss the effect of shift in both supply and demand on Equilibrium Market.As the demand (DD) increase to (D1D1) the new Eq Pt E’ achieve with supply (SS1) but if supply also increase from
SS to S1S1 then new Eq Pt achieve. Where both new demand and supply curve intersect each other E and new
price P2 will be set for quantity Q2.
When supply is greater than the rise in demand. If supply is higher than demand the price automatically be
decreases.
If DD shift to DD1 and SS shift to S1S1 the intersect point of D1D1 and S1S1 shows now Eq Pt and we see the price
decreases as result.
Increase in Demand and Decrease in SupplyIf demand increase to DD1 from DD and supply decrease from SS to S1S1 then new Eq Pt achieve E’ where both
new demand and supply intersect out after and we see price is higher in this case price increase from P0 to P1.
s. Distinguish between internal economics and external economics how do they arise?Scale of production means size of plant, the number of plants and the technique of production adopted by the
producer
Scale of production are
1. Small Scale Production
2. Large Scale Production
Economics of large scale production can be grouped as
A. Internal Economics
B. External Economics
A. Internal Economics
The Internal Economics arise within a firm as a result of its own expansion, independent of the size and expention of
the industry.
OR
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Internal economics are those economics in production those reduction in cost which occur by firm itself when it
expand its output or enlarge the scale of production
Internal Economics have following types.
1. Technical Economics
2. Risk-Bearing Economics
3. Managerial Economics
4. Commercial Economics
5. Financial Economics
1. Technical Economics
It arise when production is carted on a large scale, a firm can afford to install up-to-date and costly machines and
have its own repairing arrangements. As result cost percent is decrease due to large scale of production from the
new set up. Like for e.g. embroidery machine.
2. Risk-Bearing Economics
Some of huge firms take the big risk on manufacturing by taking the supply on credit. These are said risk bearing
Economics.
These Economics make the average cost curve a downward sloping curve as the level of output increased.
B. External Economics
As a result of expansion in industry size as whole the member of firm get benefits these are said to be external
economics. Some types of external economics are
1. Economics of Concentration
2. Economics of Information
3. Economics of Disintegration
1. Economics of Concentration
These are the advantages of local industry when a firm have skilled worker they got better transport and other
benefits. Those firms get these Economics.
2. Economics of Information
Publication of Technical Journals and Central research Institute will the engagement of all firm make Economics of
Information.
3. Economics of Disintegration
When an Industry grow it split there some process to Specialized department like for e.g. A number of cotton mills
located in a particular area may have also the benefits of making plant.
Short RunShort Run is a period of time in which the quantities of some inputs are fixed and they can be varied.
Long RunLong Run is a period of time in which the quantities of all inputs can be worried.
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Qs. What are production functions? How does it help in the understanding of producer equilibrium?It refers to a allow of input’s resulting in a flow of output over a period of time, leaving prices a side. It shows the
maximum amount of output can be produced from a given set of input in existing state of technology the output
change when input quantity changed.
Factors Effecting Production FunctionIt depends on
A. Quantity of resources used.
B. State of Technical Knowledge.
C. Possible Process.
D. Size of the Firms.
E. Nature of Firm’s organization.
F. Relative prices of the Factors of Production.
As these factors change production function also change Production plant size can be change in Long run but not in
Short run.
X = f (a,b,c,d,…..)
Where
X = output per unit time
a,b,c,d = are input used for making goods.
In order to understand production function we have few things in mind.
i. There is a technical relationship the input or output of product without considering price factor.
ii. Combination of factor of production gives output. Output increases as the factor of production organized in a good
number.
iii. Productivity depends on the nature of technology used, like labour, intensive firm depend on their quantity of
labour.
A change in technology will can shift to another production function.
According to Cubb Dougler production function
Q = KLaC
Where
Q —-> Quantity Manufactured
L —-> Labour Employed
K and a —-> lue constants and (a < 1) C —-> Capital Used.
ConclusionThe study of the theory of production is the study of production function itself. It helps to understand the law of
proportion where keeping on a factor of production we increase the other factors.
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Qs. State and explain the law of variable proportion Illustrate diagrammaticallyORDiscuss the law of variable proportion and explain the conditions of its applicability.Law of Variable ProportionsIf we know that the outputs depends on the quantity and quantity of the factors of production. So in order to increase
output we must have to change some factor production, keeping other factor constant. The law of variable proportion
studies the effect of output of variation in factor proportion.
As the proportion of one factor is combination of one factor increased after a point find the marginal and then the
average product of that factor will diminish.
ORAn Increase in some inputs relative to other comparatively fixed inputs will cause outputs to increase but after a point
the extra output relating from the some addition of input will become less and less.
Assumptioni. Technology remains constant other wise marginal and the average curve will get diminish.
ii. Only one point is variable while other being be constant.
iii. It assumes a short run. In between long run all inputs can be changed.
Stage 1
As we see that from 1 to 4 workers work on 40 acres gives the higher output and Marginal product increase.
Stage 2
We see when increase the number of worker from 5 to 8 the total product increase but marginal product remain
same.
Stage 3
After increasing more work we see still total product increased but marginal product decrease.
ConclusionSo if analyze if we increase more worker we got increase in TP and MP but as we increase so much worker TP may
be increase and MP decline and it is fact so many worker spoil the good or made the quantity difference.
Qs. Write notes on Laws of Diminishing Returns?Law of Diminishing ReturnsDiminishing Returns occur in all when labour input increases.
There is a change in output as we increase any one variable factor keeping offers constant.
Returns to ScaleA change in scale occurs when there is an equal % change in the use of all firms input. If we increase 1 worker and
one machine for knitting sweater from 4 workers and 1 machine, we double scale of production.
There are three types of possible cases.
1. Constant returns to scale.
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2. Increasing returns to scale.
3. Decreasing returns to scale.
1. Constant Returns to Scale.
Constant returns to scale occur when the % increase in firms output is equal to the % increase in its inputs. It means
when a firm doubles all its input its output exactly double.
2. Increasing Returns to Scale OR Economics of Scale.
Increasing return to scales occur when the % increases in output exceeds the % increase in output. It means when a
firm doubles its input the output will be move then up double. Economics of scale occur in production process, where
increased output gets by a firm to by use more productive technology.
3. Decreasing Returns To Scale OR Diseconomics of Scale.
When the % increases in output is less than % increase in inputs then we say Decreasing Return to Scale occur. It
means when a firm double its input and output increases 50% it means diseconomics of scale are present.
Example
Suppose a knitting firm with one worker and 1 knitting machine gives 4 sweaters.
If he doubles the firm’s input to 2 knitting machine and 2 workers and they gives 15 sweaters a day. we said
increasing return to scale or Economics of scale.
If the increase 4 knitting machine and 4 workers and then gives 25 sweaters a day, it means decreasing to
return to scale of diseconomics of scale.
Qs. What do you understand by Perfect Competition? State and Explain the essential conditions or Characteristics of Perfect Competition?Perfect CompetitionA market is a set of condition in which buyers and sellers exist involves to exchange goods.
A market is said to be perfect competition of following characteristics exist in the market.
1. Large number of buyers and sellers.
2. Homogenous products.
3. Free entry on exit.
4. Perfect Knowledge.
5. Absence of Transport.
6. Perfect Mobility of the factor of production.
Prices are fixed in the market due to large no sellers. If any one low their price all have must to low their price but if
any high their price will alone himself and consumer do not go to him.
Qs. Distinguish between Perfect and Imperfect Competition.Perfect Competition
If in any market the large number of seller and buyers free entry and exist in the market, Homogenous product, the
market is called Perfect Competition Market.
Imperfect Competition
It is different then perfect competition market in this market
the number of sellers are few
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the product are not homogenous
Same price do not exist in the market.
MonopolyCharacteristics of monopoly market.
Single Seller
Price Discrimination
Homogenous Product
No entry of New Seller
Monopolistic CompetitionMonopolistic competition exist when following characteristic found.
Many Seller
Free entry in the market
Prize change to capacity of seller
Differentiate Product.
OligopolyFollowing are the Characteristics of Oligopoly.
Few sellers (may be three, four etc).
Homogenous product (Cement).
Free entry in the Market.
In Oligopoly market only 2 sellers in the market and Homogenous product with price differentiate.
Qs. Explain with the help of diagram a Firm’s Equilibrium condition in short runs under perfect competition.ORWhat do you understand by Firm’s Equilibrium? What are the conditions of this equilibrium?ORA firm is in equilibrium where its marginal revenue is equal to its marginal cost. Explain.A firm is at equilibrium when there marginal cost (MC) is equal to Marginal revenue (MR). At this point they are not
able to change there level of output. At equilibrium position firm gets maximum profit.
Firm’s Equilibrium in the Short Run under Perfect CompetitionAs we see that under perfect competition demand curve is perfectly elastic due to fixed price. The firm’s changes the
variable factors in order evaluates extra cost incurred on producing extra unit (MC) and also looking for the scale of
extra unit of production (MR)
MC curve must cut MR curve from below:
These conditions shows the firms maximum profits or minimum losses, but they do not shows firms absolute profit
and loss position.
In short run under perfect competition there are three possibilities.
A. When a firm is making super normal profits in the short run.
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B. The firm making just normal profits in short run.
C. The firms incurring losses in the short run but does not close down.
D. A firm minimizes losses by shutting down.
1. Profit Maximizing Position
In short run when market price exceeds the short run average total cost (SATC) the firms got maximum profit.
Under Perfect Competition firms can not be able to influence the price that is why effect price takes. Therefore AR or
demand curve and MR would coincide with each other under perfect competition.
OP —-> Price Prevailing in the market.
PD —-> Both AR and MR curve.
MC —-> Marginal cost curve.
Firms get maximum profit where MC cuts MR (<= MR = MC) and MC cuts the MR from below.
Now we see that MC cuts MR at two points T and R. Where at T, MC cuts from the above so it is not our equilibrium
point while at R,MC cuts from the above so that is our equilibrium position. Hence,
MC = MR = Price
Where,
OP —-> Market Price
R —–> Firms equal point
Where MR = MC
ON —-> Quantity produce at eq.
The inter section of MR and MR, set the quantity of good the firm will produces.
OPRN —-> The total revenue at equal position.
OKMN —-> The total cost of producing ON at eq.
KPRM —-> The firm earning super normal profit.
2. Zero Profit of a Firm
In short run a firm may be making zero profit are economic profit.
OP —-> Market Price
PD —-> AR and MR curve
R —–> Break even Point
at Break even Point (R)
MR = MC = ATC
OPRM —-> Revenue and cost of the firm
At break even firm get economic profit mean zero profit at this point firms suffer in the market.
3. Loss Minimizing Case
The firm in short run is minimizing losses if the market price is smaller than ATC but large than AVC.
OP —-> Market Price
N —–> Firms eq. point where MR = MC
OPNK —-> Total Revenue
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OTSK —-> Total Cost
PTSN —-> Firm is suffering a net loss equal to shaded area.
4. Short-Run Shut Down
In short run price takes firm minimizes losses by closing it down if the market price is smaller than AVC.
Where,
OP —-> Market Price
Z —–> Eq.Pt where MR = MC
OK —-> Output produced by firm at Z
OPZK —-> Total Revenue
OTFK —-> Total cost
PTFZ —-> The firm suffering net loss of total fixed cost.
If price is falls below Z, firm is minimize it losses or better to closing down in short run.
Qs. Examine the Equilibrium of a firm under perfect competition in the long run.ORExplain why a firm earns maximum profit when MR = MCORWhat is perfect competition? Show how in a perfectly competition equilibrium the price of a commodity is equal it its marginal and average cost of production.Firms Equilibrium in the Long RunThe long run is a period during which firms can be able to change there fixed cost as well as variable cost.
In long run there is a possibility of entry of new sellers.
In this regard the long run refers to a situation where free and full scope for adjustment has been allowed to
economics forces.
In long run all cost are variable
AC and MC curves makes the decision for output.
Under Perfect Competition a firm is in equilibrium when price is equal to MC and AC.
If P> AC firm will get supernormal profit, so there is a chance of entry of new firm in this case due to extra
ordinary profit.
Due to entry of new firm output increase so price will be decline untills all firms earning normal profit.
There are two conditions must have to satisfy under perfect competition long run equilibrium.
Price = Marginal Cost
Price = Average cost.
I.e. P = MC = AC
Where,
R —-> Shows firms equilibrium in long run at Price P —-> MR = AR = P
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M —-> Best level of Output at equilibrium
OPRM —-> Total Revenue
At price P, there is no tendency for the new firms to enter or leave the industry.
If Price increase from P to P1 the firm will get more than normal profits and new firms attract due to higher price. So
price will go down again. Similarly of price goes down so due to which firms get loss and some of them quit from the
market there for supply decreases and therefore price rise up to P.again.
Qs. What do you mean by equilibrium of an industry? State and explain the condition of this equilibrium under perfect competition.ORCan a firm earn more than normal profit in the long run? Explain.Meaning of Equilibrium of IndustryAn industry is said to be equilibrium when there is no tendency for its output to increase or decrease. This equilibrium
helps to determine price. In equilibrium there is no tendency to entry or exit of the firm
Conditions of Equilibrium A industry is in equilibrium if they satisfied with two conditions.
1. All firms in the industry should be in equilibrium. A firm gives output at which where MC = MR and MC curve cuts
MR curve from below.
2. Whole industry in equilibrium means there is no tendency for the firm’s entry or exit. It occurs when all firms get
normal profits which are enough to stay in the market.
An industry will be earning normal profit if the price (AR) is equal to average cost (AC) if P > AC firms get super
normal profits, so the new firm offered in the industry.
If P < AC, the profit is less than normal profit so many be some firm leaves the industry.
So we get two necessary condition for equilibrium in the industry.
i MR = MC and
ii AR = AC
Equilibrium in short run is really possible in industry but in long run they should have to achieve equilibrium.
Hence, only in long run, industry affair equilibrium because all factors of production have full scope for adjustment.
Qs. What are the salient features of perfect competition? How is price determined under perfect competition?ORExplain the term “Equilibrium”. How prices are determined under perfect competition?Cost of production is very important for determining price.
The demand of all consumers and supply of all firms together determines the prices.
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In perfect competition market their is importance of force of demand (MU) and the force of supply (i.e. lost of
production)
Equilibrium PriceAs we know demand curve is normally slopes downward to the law of demand if price decreases demand increases
or if prices increases demand decreases. While the supply curve is normally sloped means supplier supply more at
higher price.
Equilibrium occurs in the market when demand and supply are equal.
Equilibrium not occurs, suddenly it takes some time and up and downs in price. From equilibrium of price falls the
quantity demanded increases but supply falls. Similarly of price rise the demand decrease and supply increase.
We analyze that price is determine in the market when market is in equilibrium means demand and supply are equal.
Equilibrium of price charges when demand or supply change.
Thus we analyze that factors like cost of production incomes of the consumers and size of the population take point in
determining price they all shows by supply and demand.
Qs. What is Monopoly? Explain how prices are determined under Monopoly?A market is which a single producer exist. Who control whole market and making bearers for the entry of new firm
and there is no close substitute of its commodity.
We said there is Monopoly in the market if we see following characteristics.
1. Single Producer
2. Homogenous product
3. Price Discrimination
4. No entry of new producer or say bearer in the market
So in this regard we can say monopoly is price market and he can charge higher price. But if he fix the higher price
may be his amount sold is lesser so in order to increase consumer he should have to decline the price. That is why
monopoly firm change two prices by making price discrimination.
Price Output Determination under MonopolyIn Monopoly the demand curve AR is downward sloped shows that as mono output sold MR decreases. Which is
always less than AR curve.
A firm is in maximum level of profit or in equilibrium. When MR = MC
Similarly, Monopoly firm get equilibrium when there MR = MC and they set there price when MR = MC.
E —-> Equilibrium point where MR = MC
OP —-> Price set by Monopoly firm when MR = MC and the point at which they set at P’ in AR
OQ —-> output produced at equilibrium
OPP’M —-> Total revenue
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OTLM —-> Total cost
Profit = OPP’M – OTLM = TPP’L
Monopoly Price and Elasticity of DemandA very important point about equilibrium of monopolist is that the equilibrium of monopolist will always lie at that
level of output where the elasticity of demand for his product is greater than one.
As we see that MC = O the price set at which Ed is unity.
MC is increase the price set at the point where Ed > 1.
Qs. Explain how the equilibrium of firm is determined under monopoly?As we knows that under perfect competition firm demand curve is perfectly elastic. But in Monopoly demand curve is
downward sloped therefore MR is smaller than AR.
In Perfect Competitive market equilibrium exist when MR = MC = AR but under monopoly for equilibrium MC = MR <
AR price.
Equilibrium is MR = MC < AR shows Monopoly charges higher prices and less output. In short run under Monopoly
there are three possible cases.
1. Super Normal Profit.
2. Zero Profit.
3. Losses
Qs. What is a Discriminating Monopoly? Under What conditions is price discrimination possible, profitable and socially describe?ORWrite Short note on price discriminating?Price DiscriminationWhen Monopoly firms gives different prices for different types of market this is known as price discrimination. Like for
example KESC charges two prices for same good one for commercial use and second for home KESC. Some time
monopoly firm make their product differentiate for different market. These differences may be special, wrapper,
packing etc.
Conditions of Price DiscriminationThere are three main condition on which monopolist discriminates prices.
A. When consumer have certain preferences or prejudice mean get higher from upper classes. Price discrimination
also occur if one consumer do not known that other consumer pay less than him.
When the nature of the good is such as make it possible for monopolist to change different prices like hair cut price
are different in different areas.
When consumers are separated by distance or tariff barriers, the monopolist can charge different prices. Example
(DO your self).
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Condition Making Price Discrimination Possible and ProfitableThe elasticity of demand in different market must be different monopolist divide these buyer into two categories in two
different market. T
There should be complete agreement among the sellers. Discrimination is possible when goods are sold on special
orders because than the purchaser cannot know what is being charged from others
Qs. Explain how prices are determined in the case of discriminatory monopoly.ORWhat is prices discrimination explain how a discriminating monopolist reaches equilibrium?Price Determing Under Price DiscriminatingIn discriminating monopoly different prices are charged for the commodity while in simple monopoly single price
charged for whole output.
So it should have to decide how much output will produced to discriminate the monopoly price. Monopoly firms divide
his market in sub-market we know suppose they divide the market is two types is market A and B.
We see that market B has elastic demand curve than market A.
Where AR1, AR2 —-> are Average Revenue of Market A and B.
MR1 and MR2 —-> are Marginal Revenue of Market A and B
Hence for the discriminating monopolist to be in equilibrium following condition must be satisfied. Marginal cost of
total output combined revenue marginal MR1 in MR + A = MR2 in MKT B
= CMR
The Cardinal Utility Analysis of Consumer BehaviorThe Theory of consumer behavior can be explained with basic approaches.
1. The Cardinal Approach
2. The Ordinal approach
Cardinal believes that utility can be measured. While Ordinal believes that utility is not measurable.
The Theory of Consumer BehaviorProblem of choice arises when we have limitation to some thing. We try to satisfy the most urgent wants for and less
urgent afterward.
We can say that a consumer when faced with limited means and unlimited wants consciously or unconsciously
utilities his resources in such a manner that he at the highest level of satisfaction.
This is consumer equilibrium point.
A point from where consumer is not like to change his decision unless the price of the commodities or his income
changes.
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Utility AnalysisMeaning of utilities
The power of a commodity to satisfy a human want is called its utility. For Example Clothes have a utility for us
because we can wear it.
Utility analysis based on cardinal measurement of utility. The main assumptions are
A. Cardinal Measurement of utility
B. Independent utilities
C. Marginal Utility of money remain constant
D. Introspection method
A. Cardinal Measurement of Utility
Utility is measured and quantifiable entity. The utility of goods expressed in cardinal numbers tell us a great deal
about the preference of the consumer like (10 Units, 20 Units)
B. Independent Utilities
According to the cardinal school the utility is a function of the quantity of those goods and of that good alone. It does
not depend at all upon the quantity consumed of that good.
C. Marginal Utility of Money Remain Constant
The marginal utility of money with the purchase remains constant but as the more of its purchased or consumed the
marginal utility of commodity diminishes.
D. Introspection Method
The Cardinal’s school assumes that the behavior marginal utility in the mind of another person can be self
observation.
Total Utility (TU) And Marginal Utility (MU)This is the sum total of the units of utility which can derives from consumption of all the units of commodity during a
specified period of time.
TU = F(x1, x2, x3, …….xn) Where x1, x2, x3, …..xn) quantities of goods.
MU = Change in TU that results from adding one units change in consumption of commodity per unit of time.
Law of Diminishing Marginal UtilityThis law describes a familiar and fundamental tendency of human behavior.
The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase
in the stocks that he already has.
ORThe Marginal utility of a commodity diminishes as the consumer gets larger quantities of it.
This law based upon two facts
1. Total wants of a man are unlimited but each single want can be satisfied. As a man gets more and more of a
commodity, the desire of his want for that good goes on falling. A point is reached when consumer no longer want
any more units of that good.
2. Different goods are not perfect substitutes for each other in the satisfaction of various particular wants. As such
marginal utility will decline as the consumer gets additional units of a specific good.
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Explanation of the LawSuppose a man is very thirsty. He goes to market and buy a glass of sweet water. The glass of water gives him
immense pleasure or say first glass of water is great utility for him. If he takes second glass utility is than first one.
And if he increases the glass of water will reach at the stage where he feel negative increase or say utility is declined.
Simply we say in a given span of time the more use of product the lesser will be the utility.
Assumption of the lawAssumption of law of diminishing utility are:
1. Rational behavior of consumer
2. Constant marginal utility of money
3. Diminishing marginal utility
4. Utility is additive
5. Consumption to be continuous
6. Suitable quantity of a commodity
7. Characteristics of the consumer does not change
8. No change of fashion, customer, tastes
9. No change in the price of commodity
Consumer Surplus ConceptThe theory of consumer surplus is also based on the law of diminishing marginal utility. A consumer while purchasing
the commodity compares the utility of the commodity with that of the price which he has to pay. In most of the cases
he is willing to pay more than what be actually to pay. The excess of the price which he would be willing to pay rather
than to go without the thing over that which he actually does pay is the economic measure of this surplus satisfaction.
Qs. How Equilibrium of a firm is determined under monopolistic competition. Explain?Why in this condition the demand curve facing firms is more elastic than under monopoly?ORDistinguish between monopoly and monopolistic competition and explain why the demand curve under monopolistic competition. Discuss the equilibrium a firm under conditions of monopolistic competition.Monopolistic Competition is a market situation in which there are relatively large number of small firms which produce
or sell similar but not identified commodities to the customers. It is different than perfect and monopoly market
therefore refer as imperfect market. (e.g. soal market, tooth paste market)
Characteristics of Monopolistic CompetitionThe main characteristics of monopolistic competition are
1. Large number of seller
2. Differentiable goods
3. Advertisement and propaganda
4. Nature of demand curve
5. Freedom of entry and exit of the firms
If we found these conditions in any market we simply say it is imperfect market or monopolistic market.
Price-Output Determination Under Monopolistic Competition
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In perfect competition demand curve is perfectly elastic due to large number of sellers and homogeneous good. While
in monopoly the demand curve is downward sloped and which is relative in elastic due to single sellers.
But in Monopolistic competition these is large number of sellers but goods are differentiate. So they can make there
sell more by advertising and make them self. Prominent but not able to change much higher price due large number
of seller. i.e. Why the demand curve is downward sloped in Monopolistic market and relatively elastic.
Firm’s Equilibrium Price and OutputIn short run monopolist firm may get super normal profit or may be in losses.
Equilibrium Price and Output In Long run under Monopolistic CompetitionIn Monopolistic market all firm shows no profit and no loss in order to avoid the entry of new seller. If they show profit
in long run new seller may losses.
Qs. What is Oligopoly? What are the causes of oligopoly? How do price and output determined oligopoly?OligopolyOligopoly is the market in which there are a few or small number of firms an industry and they produce the major
share of the market.
Characteristics of Oligopoly are
1. Few or small number of seller (may be 4,3,2)
2. Homogenous good (like cement)
3. Bearer to entry.
Causes of OligopolyDue to some causes oligopoly are
1. Economics of Scale
If some firm have potential of improved technology and getting economics of its production than other who use old
techniques to suffer in the market and may exit so many firms left due to economics of scale.
2. Barrier to Entry
Some firms have control over the raw material used in production or they get ownership for the raw material so there
is a bearer created for new firms.
MergerIf few firms merge with each other.
Mutual InterdependenceFirms watch each other price and mutually decide or set the prices.
Price and Output Determination Under OligopolyThere is not a single theory which exactly explains the pricing and output divisions under oligopoly.
The reason for that are:
1. Goods Produced may not be standardized
2. Oligopoly firms sometime mutually fire there price but some times at independently.
3. There is some bearer to entry of new firm which is impossible some times.
Qs. Differentiate between Laws of Return and Laws of return to scale.
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Laws of ReturnWhen we generally talk about change in input and as result or in return output will also change we deal in Laws of
Return. There are few laws of returns
1. Law of variable proportion
2. Law of Constant return
3. law of Increasing return
4. Law of Diminishing return
5. Law of cost
1. Law of Variable Proportion
As we change the variable factor of production and keeping the factors constant than first average and marginal
output will increase but after more addition of that factor marginal output will tries to decline and we rich at the stage
where marginal output is at maximum while marginal output is equal to zero and further increase in output cost a
negative impact (marginal output will negative)
2. Law of Constant Return
When the percentage output is equal to percentage change return to output is called constant marginal return.
3. Law of Increasing Return
When the percentage change in input is less than percentage change in return to output is called increasing marginal
return.
4. Law of Diminishing Return
When the percentage change in input is greater than percentage change in return to output is called diminishing
marginal return.
5. Law of Cost
If we increase the cost of production output will may increased and if we decrease the cost of production output will
may decreased.
Laws of Return to ScaleWhen we consider only our change of scale (means change all factor of production) and got a return as an output.
These are called Return to Scale. There are three laws of return to scale:
1. Constant return to scale
2. Increasing return to scale
3. Decreasing return to scale
1. Constant Return to Scales
When we double our scale of input and as result or in return scale of output will also be exaclty double then we said
we got a Constant Return to Scale.
For Example: Suppose we increase one labour and on knitting machine from one labour and one knitting it means we
double our scale of production while in return output goes to four from two means we got a constant return to scale
because
scale of input = scale of output.
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2. Increasing Return to Scale
If we double our scale of input and as result or in return output will be more than double that is called increasing
return to scale. Due to increase in scale of output from got economics to scale.
Suppose we increase two labour and two knitting machine from two labour and two knitting it means we double our
scale of input as in return output goes to 10 from 4 means we got on increasing return to scale because
Scale of Input < Scale of Output
3. Decreasing Return to Scale
When we double our scale of input and as result or in return we got increase in output less than double and that is
called decreasing return to scale.
Due to less that double scale of output our cost will increase and that is called diseconomics to scale.
For Example Suppose we increase Z labour and Z knitting machine from 2 labour and 2 knitting. It means we double
our scale of input as in return output goes to T from A means we got on decreasing return to scale.
Qs. Define Indifference Curve?ORExplain the main characteristics or properties of Indifference CurveORWhat are the consumption of Indifference Curve? Give their propertiesThe concept of ordinal utility implies that a consumer is able to compare the different level of satisfaction. He can
judge satisfaction derived from a good or a combination of these is equal to greater than or less than another we can
simply say.
He is in position to rank his preferences the difference curve analysis is based upon what is called preference
indifference hypothesis. The consumer is assumed to be in a position to indicate his preference or indifference
between various combinations of goods.
Suppose we go in the market to purchase A,B,C, and D and we like A more than B that is said we prefer or
indifference A to B similarly if we prefer C and D than we indifference C to D.
Utility derived by the combination of these goods rather in this combination we prefer A to B or B to A.
Now consider a consumer who wants to buy apples and mangoes. He does not purchase them as bizarrely.
If he likes mangoes than apples than he prefer mangoes to apples or if he like apples than mangoes he will prefer
apples to mangoes.
The consumer obtains as much total satisfaction (total utility) from 11 apples and one mango and from 8 apples and 2
mangoes and other combinations. But that satisfaction is same in a combination.
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Properties of Indifference CurveWe note the few properties of indifference curve.
1. An Indifference Curve Slopes downwards to the right
It is because when consumer decides to have more units of one of the two goods he will reduce the number of the
units of the other goods. If he will remain on the same indifference curve than his level of satisfaction remain same.
If we see that preference of mangoes increase which shows indifference curve sloping downwards from left to right.
As our hypothesis that consumer is at the same level of satisfaction because he is on the same indifference curve.
Now if we see at point A, B, C we see from A to B consumer increase quantity of both good which is not possible so
indifference curve never be sloped upward to right.
Indifference Curve is always sloped. Which show prefer of consumer at one good to another.
2. Two Indifference Curve never cut Each Other
Our hypothesis is that consumer is at same level of satisfaction that is IC, Now suppose two Indifference curve
intersect each other.
As we see that Point A is at higher Indifference Curve IC2 which shown he get higher satisfaction. Similarly at point
he is cut lower Indifference Curve IC1 which shows he get less satisfaction point he get same same satisfaction of
IC1 and IC2 which is practically not possible because our hypothesis is that consumer get same level of satisfaction.
It is proved that Indifference curve never intersect each other.
Indifference Curve are convex to the originConvexity means we use more and more of good X and Y less and less of good Y. The marginal rate of substitution
of x for y goods falls.
As we see that the marginal rate of substitution (MRS) of many for apples falls while the MRS of mangoes for apples
remains constant and MRS of mangoes for apples increase which is not happen in general.
Hence it is proved that Indifference Curve is convex to the origin.
Qs. Write short notes on Marginal Rate of SubstitutionORWhat is Marginal Rate of Substitutions? Explain the Law of Diminishing Marginal Rate of Substitution?Marginal rate of Substitution (MRS) shows how much of one commodity is substituted for how much of another MRS
is an important tool of indifference curve.
As we see that when our consumer has 15 apples and no mangoes he will prepared to forgot 4 apples for 1 mango
and yet remain at the same level of satisfaction.
In his second combination he will be prepared to accept 4 apples for the loss, may be defined as the amount of
apples that is sacrificed for obtaining one mango or it may also be defined as the amount for the loss of one mango
so that he may remain at the same level of satisfaction.
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In Hick’s Word
We may define Marginal rate of Substitution of X for Y as the quantity of Y. Which would just componsate the
consumer for the loss of the marginal unit of X.
It’s a common observation that as we come to have more and more of one good, we shall be prepared to foryo less
and less of the other. It is simply says that MRS of good X for good Y will falls as we have more of x and less of Y
which we see clearly in other combination and get ratios (3 : 1, 2 : 1, 1 : 1)
Consumer Equilibrium Qs. How Consumer reaches equilibrium?ORExplain how a consumer can maximize his total satisfaction out of his limited resources.ORAnalyze the equilibrium of a consumer spending a given amount of money income on two commodities with a fixed price ratioORExplain the law of diminishing marginal rate of SubstitutionORShow that a consumer is in equilibrium when the MRS between two commodities becomes equal to their price ratioThe Consumer is said to be in equilibrium when he affairs the maximum possible satisfaction from his purchases
given the prices in the market and amount of money he has for making purchase for consumer equilibrium position
we have to consider following assumption.
Our consumer indifference map or scale of preference remains same throughout the analysis.
Price of goods in the market is give and constant.
He has a given and constant amount of money to spend on the goods and if he does not spend it on one goods be
must spend it on the other.
Each of the goods is homogenous and divisible. The consumer acts rationally means he tries to maximize his
satisfaction.
His income and the relative prices of the two goods for purchasing so equilibrium must on same at same point.
Price Income line AM contains all the possible opportunities of combining the two goods that are opportunities to our
hypothetical consumer that why this line also called price opportunity line.
At point P consumer reaches at equilibrium at this point he buy OP of mangoes and OH of apples. Point p lies in Il3
which shows consumption highest indifference curve he can’t go more. Any point other than P gives less satisfaction
to consumer. Thus at point P
So the necessary conditions for equilibrium are
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Price line must be tangent to indifference curve.
Indifference must be convex to origin.
EconomicsAllocations of scar resources in order to get maximum satisfaction is called economics.
Economics is further divide into two parts.
1. Micro Economics
2. Macro Economics
Micro deals with individual single or particular consumer, producer, firm, industry or
Market.
While Macro deals with as whole like National income, employment level etc.
Micro Economics is called Price Theory and Macro Economics is called Income theory.
Price theory explains the composition or allocation of total production.
Qs. Income theory explain the level of total production and why the level of totalproduction and why the level rises and falls.Micro EconomicsIn economics micro means single, individual or particular. Micro Economics means deals with single, Individual or
particular consumer produces or Market etc. In conducting economics analysis, micro economics approach is on
micro basis, generally an assumption of full employment in the economy as whole is made.
Importance of Micro EconomicsMicro Economics has both theoretical and practical importance. From the theoretical point of view it explain the
function of a free intense economics it tells as how consumer and producer take the decision for million of goods and
services to consume and produce. It tells us how goods and services distributed among them. It explains the
determination of the relative prices of various goods and services. For Practical importance micro economics
helps in the formulation of economics policies calculated to promote efficiency in production and welfare of the
masses.
In Professor Lerner’s words
Micro Economics theory facilities the understanding of what would be a hopelessly complicated confusion of billions
of facts by constructing simplified model of behaviors.
Limitation of Micro EconomicsMicro Economics has same limitations.
A. It cannot give an idea of the functioning of the economy as whole.
B. It assume fall employment which is rare phenomena, it is therefore, an unrealistic
assumption.
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Macro Economics and the Theory of Income and EmploymentMacro Economics deals as whole such as National Income employment, saving investment, total consumption, price
level.
Macro Economics deals also with how an economy grows. It determines the chief economic development and the
various stages and process of economics growth. Study of macro economics is very important to get proper view of
an economy.
Limitation of Macro AnalysisIf has limitation of its own:
A. Individual is ignored altogether.
B. The Macro analysis over looks individuals difference for instance the price level may be
stable but the prices of food grains may have gone up.
C. While speaking of the aggregate it is also essential to remember the nature compound and
structure of the components.
Need for Integrating Macro and Micro EconomicsMicro and Macro Economics can’t give adequate way to analysis the working of the economics system. So if we wish
to get solutions of our main economics solution we should have to integrate the two approaches. We apply proper
Integration of the Micro and Macro approaches because there are few macro problems which have no micro
elements involved and few micro problems that are without macro aspects.
ConclusionThus if proves that subject matter of economics includes price theory (or micro economics), income and employment
theory (macro economics) and growth theory.
Simply we can say economics is a study of economics system under which men work and live.
National IncomeAccording the can economist Colin Clark
The national income for any period consists of the money value of the goods and services becoming available for
consumption during that period.
According to Pigou.
National Income is that part of the objective income of the community including income derived from abroad which
can be measured in money.
Thus,
National Income is the aggregate factor income (i.e. earnings of labour and property) which aries from the current
production of goods and services by the nation’s economy.
The concept of national income has three interpretations:
1. Receipt Total
2. An expectative Total
3. A Total Value of Production over the course of one year.
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The various concepts of national income are given below.
A. Gross National Product (GNP)
B. Net National Product (NNP)
C. Personal Income (PI)
D. Disposable Income
E. National Income at factor Cost
Gross National Product (GNP)According to Camsell
GNP is defined as the total value of all final goods and services produced in a country in one year.
We can say that GNP represents the total market value of all final goods and services produced by factors of
production located with in nation’s border during a year.
Problem in Measuring (GNP)In calculating GNP we have some problems.
1. Stress on final output
The value of only those good are added in GNP which are in their final stage of production and are available for
consumption for e.g.
Table made of wood is the final product while w and is primary good.
2. Value added method.
In order to avoid pitfall of double or multiple counting is to calculate only the added value of a particular commodity at
its every stage of production. (Suppose the price of your note book is 20Rs, but this includes the cost of paper,
printing and sending GNP will be same in both case but if we include again the cost of paper and sending etc it will
double.
3. Non-Productive Transactions are excluded from GNP
We should excluded non-productive transaction like a student got money from his father.
4. Other Transactions
There are few other transactions which are not included in GNP. For example A person working in their own house
holds without any payment through the market.
Using the expenditure approach the main components of GNP are as under.
i. Consumption Expenditure. (C)
All goods and services bought by house holds are grouped together consumption.
ii. Gross Private Investment. (I)
This includes investment expenditure by firms or sole properties on capital goods.
iii. Government Expenditure. (G)
Government Expenditure on durable and non-durable goods and services is include.
iv. Net exports
Difference between export and import (X-M)
Mathematically GNP Can be Defined as
GNP = C + I + G + (X-M)
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B. Net National Product (NNP)
Net National product or national income at market prices is the net market money value of all the final goods and
services produced in a country during a year GNP at market price depreciation = NNP at market price
Mathematically
NNP = C + G + (Net I) + (X-M)
OR
NNP = GNP – Depreciation
Depreciation means value of goods deceive years by year Desorption of the machinery is named as depreciation.
C.National Income at Factor Cost
National Income (NI) or National Income at factor cost is the aggregate earnings of the four factor of production
(Land, Labour, Capital and Organization) which arise from the current production of goods and services by nation’s
economy.
The major component of NI are
1. Compensation of employees (wages, salaries, commission etc)
2. Proprietor’s income
3. Net income from rentals and royalties.
4. Net interest (excess of interest payments of domestic business system over its interest receipt and net interest
received from abroad)
D. Personal Income (PI)
Personal income is the sum total of all incomes actually received by all individuals or house holds during a year. IF
consists of wages, salaries, Interest and rent etc by all household.
Mathematically,
PI = NI – (corporate profits, social security, tax corporate taxes) + transfer payment.
Transfer Payment, A payment for which no productive service is made like old age pension, social security payment
etc.
E. Disposable Personal Income (DPI)
DPI is the amount which is left for the individuals after paying the taxes to a government.i.e.
DPI = Personal Income – Personal Taxes
OR
DPI = Consumption + Saving.
Qs. What are the different methods of measuring National Income or Gross National Product (GNP)? Point out the difficulties facing the measurements of GNP?Method of Measuring National IncomeProduction of goods and services give rise to income and income gives rise to demand for goods and services.
Demand gives rise to expenditure and expenditure give rise to further production of goods. Thus there is a certain
flow of product income and expenditure.
National Income can be measured by three ways.
1. Product Method (value added method)
2. Income Method
3. Expenditure Method
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1. Product Method (Value Added Method)
Product method is also called value added method or national income at market price method, Which is measure in
two ways.
i. Final Product approach.
ii. Value added approach
i. Final Product Approach
If represents the flow of production or value of all final goods over a one year with in the country.
ii. Value Added Approach
Under this method the economy is divided into different sectors such as Agriculture, manufacturing, commerce,
transport, banking etc. So the GNP is measured by adding net value at each stage.
Precautions
The precautions to be avoided are
1. Excluding non market goods and services like father teaching his sons.
2. Depreciation allowances to be set. Depreciation is subtracted from GNP.
3. Deduction of indirect taxes, Govt Charges, which is on commodity for sale.
2. Income Method
It measures the total payments made to house holds in the production of final goods and services during a year. GNP
is the sum of following types of income.
i. Rental Income earned by individuals for the use of their real state such as land, building, royalties received from
copyrights etc.
ii. Wages include income of employees.
iii. Net Interest get from business.
iv. Profit get by the firm.
v. Depreciation as a cost of production.
vi. Indirect business taxes.
Precautions
We do not include such thing which have no meanings like father giving his son money for education but we include a
labour wages in GNP.
3. Expenditure Method
In this method GNP is measured as total spending on final goods and services produced within a country during a
year. The spendings are
i. Consumption Expenditure (C)
The households spend their income on consumer durables such as Car, furniture.
ii. Non-Durable Goods
Such as foods, clothing and services.
iii. Investment (I)
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iv. Government Expenditure (G)
Net Export (X-M)
So GNP is
GNP = G + I + G + (X-M)
Precautions
1. Final expenditure only includes not intermediate expenditure.
2. Property Income received from abroad should be included in GNP.
Difficulties in the Measurement of National IncomeThese difficulties are,
1. Non-Availability of statistical material For some services it is difficult to know the exact amount recieved like
tutors, income services given in spare time. These are difficult to find out so not include in GNP.
2. The Danger of Double counting The cost of the commodity is likely to counted twice or multiple of it is not taken
carefully.
3. Difficulty in assessing the depreciation allowance, accidental damages, repair and replacement charges. It
needs higher level of Judgment to assist depreciation allowance.
4. Non-Market Service Like tuition centre, exclude from GNP.
5. HousingRent of House —-> Include in GNP
Purchase of House —-> Exclude from GNP
6. Transfer earning exclude from GNP like relief allowance, pensions.
7. Self Consumed Production Like we use other or friends goods.
8. Income from foreign firms (foreign firms invest in the country)
Problems of Measurement Under-Developed CountriesThe national income under developed countries like Pakistan cannot be measured accurately due to.
i. Self consumed bartered consumption. Some transaction which is not include money like exchange of goods.
(Agriculture) are not add in National Income.
ii. No systematic accounts maintained.
iii. No occupational Classification
iv. Unreliable data.
Qs. Define Circular flow of income in a two sector economy. What factors influence the size of National Income.Circular Flow of Income In a Two Sector EconomyWe suppose that there are only two sectors in the economy.
A. House Hold
B. Business Sector
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i. The business sector hire the factors of production owned by the household sectors and it is the sole producer of
goods and services in the economy.
ii. House hold sector are buyer and purchase from Business sector.
iii. Business Sectors sells entire output to house hold sector.
iv. There are no saving and investment in the economy.
v. House hold earn income from Business sector.
vi. Business sector earn income from house hold sector.
vii. The economy is closed economy means no international trade.
viii. No inter-action of Government.
Determinants of National IncomeThere are many factors which influence the size of national income.
1. The stock of factors of Production
GNP depends on quantity and quantity of the country’s stock of production. The factors of production are land, labour
capital and organization.
2. Labour
Size of national income depends on quantity and quantity of labour in the country.
3. Capital
Its very important that how much capital is on for a firm if firm is large and capital is less than GNP is decline.
4. State of Technical Knowledge
Its technology and technical workers are good, than national income increase.
5. Political Stability
GNP increases if a country has political stability.
Qs What are the main causes of inequalities of income? Suggest measures to reduce inequality?ORWhat are the main causes of inequality of income in a modern society? Discuss role of taxation policy in reducing this inequality?Inequality of Income DistributionA country must have to ensure that its income evenly distributed not only increase. Inequality of income is main
feature of capitalist economics. The socialist countries like communist china have established system whose aim is to
reduce inequalities of incomes.
Causes of InequalityCauses of inequality of income are
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1. Inheritance
Some person born with a silver spoon and they got lots of money and property after death of their parents. While
some are born in poor family and they got burden of payback of his parents after death so this system of inheritance
causes inequality.
2. System of Private Property
Under this system a person is free to earn, free to save and free to own property. First a man earns and acquires
property and then his property starts earnings (Rent from house)
3. Difference in Natural Qualities
Some peoples are gifted than other so they do work hardened efficiently than other and makes the inequality.
4. Difference In Acquired Talents
A child may born intelligent but if he is not lucky enough to receive proper education then his ability remain
undeveloped.
5. Family Influence
Here in Pakistan and India family contacts make a lot of difference to what people earn. Unskilled person got a good
job from the contacts of relative, friends and other.
6. Luck and Opportunity
Some people luckily got good chance and they avail it.
Measures to Reduce InequalityIn order to reduce inequality of income we have some suggestions.
1. Fixing Minimum Wages
Fixing minimum wages will level up the incomes from below.
2. Social Security
By giving social security person get large benefits whose income low. These are free education, free medical,
pension, insurance etc.
3. Equality of Opportunity
Some thing may be to done to eliminate the family influence in the matter of choice of profession (example Govt give
scholarship)
4. Steeply Graded Income Tax
By including taxes way may prevent some extent from rich persons. These taxes are super taxes, excess profit tax,
and capital gain tax.
5. High Taxes on luxuries
Govt may put high taxes on luxuries of life which poor person can’t be afford.
6. Sleep Death Duty, Succession Taxes and Estates Duty
Government should have to impose taxes on generation to switching of estate.
ConclusionWe can reduce inequality but cannot remove.
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Qs. What is Consumption function? How is it determined?ORExplain the term “Prosperity to consume” Bring out the functional between Consumption and Income.ORDistinguish between average propensity to consume and marginal prosperity to consume and show that A. MPC < 1 B. MPC declines as income rises and C. Propensity to consume is generally stable.In the Keynession System, employment depends on effective demand which in the form of consumption demand and
investment demand. If demand increases for consumption of commodity the investment increase and so employment
level increase. A high propensity to consume is favorable to employment.
MeaningConsumption function is also called propensity to consume. Consumption means amount spent on consumption at a
given level of income. Consumption function or propensity to consume means the whole of schedule showing
consumption expenditure at various level of income.
Factors Influence ConsumptionThese factors are
1. The real income of the individual.
2. His Past savings.
3. Rate of interest.
Income plays a major role in order to influence consumption function. Past saving is very small and for specific
purpose like contributions to social security (Pension etc). Rate of interest encourage some people to save more & to
earn a higher rate of interest.
Average and Marginal Propensity to ConsumerThe r/s between income and consumption is measured by the average and marginal propensity to consume.
APC = C / Y [Where C --> Consumption and Y --> Income]
APC is the ratio of consumption and income where
MPC = /\ C / /\Y
MPC is the rate of change in consumption to the change in income.
The normal r/s between income and consumption is such that income rises, consumption also rises, but by less than
the rise in come.
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Qs. Examine the meaning, working and importance of the multiplier in keynession theory of income and employmentORWhat is “Marginal Propensity to Consume”? Show how multiplier depends on the magnitude of the MPC.MPC shows r/s between a given rise in investing and the resulting change in income. Suppose we invest 100Rs, so
we expect more than that as additional income. We spend some amount from additional income and save the rest
income. Additional spending depends on their MPC. Now we suppose MPC is 3/4. Then they will spend 75 Rs and
save 25 Rs. If the MPC is stable the series of consecutive expenditure becomes.
/\(income) Y = 100 + 100 x (3/4) + 100 x (3/4)2 + 100 x (3/4)3
=> /\Y = 100 [1 + (3/4) + (3/4)2 + (3/4)3 + ......]
We see that an initial primary investment of 100 Rs gives rise to an increase of 40 Rs in the National Income. The
investment Multiplier measures the r/s between an increase in income caused by a primary increase in investment
Investment Multiplier = /\Y / /\I
In our case,
Multiplier = 400/100 = 4
Multiplier is given by the following formula
Multiplier = I / I – MPC
If MPC = 4/5 than Multiplier is 5
If MPC = 9/10 than Multiplier is 10 But
If MPC = 1 than Multiplier is infinite this shows a little increase of investment will load automatically a full
employment.
If MPC = 0 than Multiplier = 1 shows increase in investment is equal to increase in total income.
Limitation of the Multiplier ConceptThe factors which tend to reduce multiplying effect are called “Leakage”. The various limitations of multiplier are
1. MPC Not Constant
MPC is assumed constant in keyness concept of multiplier so that mps will necessarily be constant. Keyness ignores
the possibility of leakage. In dynamic economy MPC or MPS never be constant.
2. Debit Cancellation
If people use a part of new increment in income to repay their bad debts instead of spending on further consumption.
3. Purchase of Old Stock and Securities
If new income is spent on buying on buying old stock, shares and securities, consumption will be less and multiplies
in respect will be low.
4. Net Imports
If import is greater than export than it means outflow of funds to foreign countries.
5. Price Inflation
If the price of goods increase mpc will automatically increase.
Instead of all above problem, Multiplier has very importance in economics and for economics policy. It plays a vital
role as an instrument of income.
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Qs. Distinguish between autonomous and introduced investment on what factors investment depend?ORWhat is meant by “Investment”? and what do you understand by introduce to invest. Discuss the factors which govern the inducement to invest in a capitalist economy.In the keynessian system employment depends upon effective demand. Effective demand should be constitute of
investment and consumption. Investment mean addition to stock of capital to the nation’s like building of new
factories, new machines etc.
Autonomous and Induced InvestmentAutonomous Investment is done by Govt. for promoting peoples welfares as under plan developed. Induced
investment is made by the people as a result of change in income level or consumption.
Concept of Marginal Efficiency of Capital (MEC)It has very importance in macro economics. Whenever an enterprise makes a certain investment in his business, he
first looks into the marginal efficiency of capital. What return he is going to obtain from the given investment.
MEC is the expected rate of profit of a new capital asset.
Lets suppose, we invest 10,000 Rs on purchase of new machine. The net return of this machine is expected to Rs.
1000 per annum, The MEC will be
1000/10000 x 100 = 10%
Show the ratio of expected annual return.
Factors On Which Investment Depends.Investment depends on
1. MEC
2. Rate of Interest
1. MEC
The MEC is the expected annual rate of return on an additional unit of a capital good.
According to Keyness
The MEC is the rate of discount which makes the present value of the prospective field from the Capital asset equal
to its supply price.
2. Rate of Interest
As the investment increases the rate of interest also increase so MEC decline.
Factors Effecting MECMEC is influenced by short run as well as long run factors. These are
A. Short Run Factors
i. Demand for the Product.
ii. Liquid Assets.
iii. Sudden changes in income.
iv. Current rate of investment.
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B. Long Run Factors
i. Rate of Growth of Population
ii. Technological Development
iii. Rate of Taxes.
Qs. What is “Effective Demand”? How it influence the determination of level of employment and income in an economy? DiscussORExplain the Keynessian Theory of Income and Employment.According to Keynessian employment is a function of income, the greater the level of national income, greater the
volume of employment keeping other factors constant in short run.
i.e. Capital, Technology, Quality of Labour are constant.
So in the absence of changes in these constant the total output of goods and services cannot be expanded without
increasing employment. The level of both income and employment depends on the Aggregate Demand and
Aggregate Supply. The intersection of Aggregate Demand curve and Aggregate supply curve shows equilibrium level
of income and employment.
Keynessian emphasis on Aggregate Demand (AD) which is depends upon the total expenditure of the consumer on
consumption goods and of enterprise on investment goods. Consumption depends upon the size of the consumer
income and propensity to consume investment demand is determined by the MPC and the rate of interest. It depends
upon fixture expectations of enterprise regarding the future yields from the goods.
Investment Demand = Distance between C and C + I
C + I —> Aggregate Demands
E —> Shows the Equilibrium level of income and employment
OY —> level of income at Equilibrium point E.
Equilibrium Not Necessary at Full EmploymentIt is clear that this equilibrium E between AS and AD may not be achieved at full employment and income. The
equilibrium will established at full employment income only when investment demand is sufficiently large to fill the
saving gap between the income and consumption correspondence to full employment.
Qs. When Aggregate Demand equals Aggregate Supply or Saving equals the investment equilibrium level of national income is determined? Prove.OREquilibrium level of national income is determined by the intersection of savings and investment schedules. DiscussEquilibrium level of income and employment is established at that level at which AD = AS. It has also been seen that
AD = AS when the investment spending is equal to then amount savings.
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If Income Investment < Saving
It means AD would not be sufficient to take the AS of output of the market so bringing reduction in output income and
employment at level in which investment spending.
If Given Level of Income Intended Investment < Intended Savings
The enterprise will not be able to sell the entire output at given prices. So they intend to reduce output so the level of
income and employment will reduced.
Qs. According to Keyness, Saving-Investment Equality is a basic condition of equilibrium. DiscussORAre savings and investment in an economy always equal? If not how cans this condition be brought aboutORWhat do you mean by saving and Investment?InvestmentAccording to Keyness Theory,
Investment means not addition to the stock of capital goods like machinery, equipment, factories etc.
It also includes Inventories that why Investment term is different from Capital.
SavingSaving means that amount which a man saves out of income after his expenditure so, saving means the income
which is not consumed.
Saving and Investment EqualityA controversial question always in mind that is Saving and Investment are equal? According to Keyness
No, but it only possible when it reaches its equilibrium position.
According to Keyness
The national Income is derived from the production and Scale of A. Consumer’s good and B. Investment goods.
I.e. Income = Consumption + Investment
=> Y = C + I …… i
Another look at income is
Income = Consumption + Saving
Y = C + S …… ii
So,
By comparing these two eq. we get
C + S = C + I
=> SC saving > I (investment)
Are Savings and Investment Always EqualAccording to Keyness Economics,
They must be always equal But we got that is not happen always.
By realizing all of there we get realized or actual saving and investment always equal but intended or expected
savings and investment may differ. But it also equal at equilibrium level of income.
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Islamic Economic SystemCapitalism, Communism and Mixed Economics system has purely a materialistic approach in which human social life
has no importance. But in Islamic System
The followers of Islam are required to lead a material life in such way that it becomes a source of happiness and
respect of others in this world for making secure himself for next world.
Islamic Economic System consist of institutions, organizations and the social values by which natural, human and
man made resources are used to produce, exchange, redistribute and consume wealth. Use Goods and services
under the guiding principles of Islam to achieve “FALAH” in this world and also the world there after.
Salient Features of Islamic SystemMain characteristics of Economic System of Islam are.
1. The Concept of Private Property
2. Consumption of wealth
3. Production of wealth
4. Distribution of wealth
5. The concept of Zakat
6. Interest free Economy
7. Economic Growth
8. Responsibilities of the Government.
1. The Concept of Private Property
Basic Principles in Islam for Consumption or Investment of private property are
Concept of “HALAL” and “HARAM” for earning or in production and consumption of wealth.
A property cannot be used against public interest.
Show much as you have something.
Real/money Capital cannot be used for gain.
Payment of Zakat is compulsory.
2. Consumption of Wealth
In Islamic System uses of luxuries are not allowed because it against the concept of “TAQWA” should have
distinguished between “HALAL” and “HARAM”.”BUKHAL” and “ISRAF” are to be avoided.
3. Production of Wealth
Price mechanism plays a key role in carrying out the production process in an Islamic Society. As Price system
results in the expectations of workers and consumers the Govt. Interferences with the price mechanism to over come
the problem. These things are not allowed in Islamic System.
Production of drugs, gambling, lottery, music, dance etc.
Lending and borrowing on interest
Black marketing, Smuggling etc.
4. Distribution of Wealth
Islamic Economics System favours fair (not equal) distribution of wealth in the sense that it should not be confined to
any particular section of the society. For fair distribution of wealth Islam gives following steps
“BUKHAL” and “ISRAF” are to be avoided.
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Payment of Zakat
Interest not allowed
Monopoly of Private firm not allowed
Earning from Black Market.
5. The Concept of Zakat
Zakat is a major source of revenue the government in an Islamic state. It levy on all goods and money or on wealth if
have to pay yearly on the month of RAJAB or RAMADAN.
6. Interest free Economy
The whole financial system the bank structure in particular is run on the basis “SHARAKAT” and “MUZARABAT” in
Islamic state. Therefore, Islamic economics is an interest free economy.
7. Responsibility of the Government
Responsibility of the Islamic Government are
1. Should Check non Islamic activity like gambling, smuggling, black marketing etc.
2. Should secure poor people by giving them necessity of life i.e. food, clothing, health etc.
3. Should provide equal employment opportunity.
4. Social and Economic Security is required to guarantee by the Govt.
ConclusionAn Islamic Setup provides a graceful economic and social life. it distribute the wealth in all family.
Qs. Explain the importance of Zakat in the process of Distribution of wealth in Islamic State?The Concept of ZakatZakat has two meanings in Arabic
i. That which purifies
ii. That which causes growth.
i. That Which Purifies
This indicates that Zakat purifies the human soul by keeping a person away from illegal source of earning, eliminating
the love for materialism and overcoming the sense of pride for being wealthy.
ii. That Which Causes Growth
This means that ALLAH protected the wealth from which Zakat had been paid and in the way the peace of mind of
the person who pay Zakat.
In economics technically Zakat defined as
Zakat is a “transfer payment” which Sahib-e-Nisab muslim pay to poor by given rate after completion of one year on
the considered nisab.
Assessment of Zakat1. Sahib-e-Nisab Muslim
A muslim who owns and keeps his/her possession at least 7 1/2 total gold of 52 1/2 total silver or cash money to the
equivalents value is considered a Sahib-e-Nisab Muslim.
2. Exposed and Unexposed Wealth
Zakat is paid from two types wealth i.e. exposed (e.g. Salary and Merchandise) and Unexposed (e.g. gold, silver,
cash money etc)
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3. The Rate of Zakat
If paid on atleast 7 1/2 total golds or 52 1/2 total silver or the equivalents value of cash, goods, salary etc.
i. The rate of Zakat is 2 1/2 of total value of (cash, goods, salary, building etc)
ii. The rate of Zakat is 10% for the Agricultural Produce of land. This should be given on every cropping
Beneficiaries of ZakatBeneficiaries of Zakat are
1. The Poor. Those people who are below than Sahib-e-Nisab.
2. The Needy. They are the people who are unable to earn their living e.g. handicapped disabled, unemployees
person.
3.The Converts. Those who convert to Islam have right to get Zakat.(this type has been excluded by the Ulama)
4. The Debtors. Those who heavily indebted can get zakat to repay their debts.
5. Mujahideen. Zakat can also be given to Mujahideen.
It is clear that Zakat is a source of financial assistance to the poor and needy to become economically independent.
Economic Significance / Importance of Zakat1. Fair Distribution of Wealth
Islam does not permit that the wealth is distributed in few hands. Therefore people have to pay 2 1/2 % Zakat to poor.
2. Elimination of Class Conflict
Zakat makes the poor obliged and thus the problem of class conflict does not arise at all.
3. Economic Stability
Zakat promotes the velocity of Calculation of money due to which aggregate demand for goods and services
increases. This determines the lives of investment, income and employment on stable footing. Hence an Islamic
economy is always stable.
4. Social Security
Zakat fund not only covers the poor and the disabled but it also provides social security to the unemployed who may
later on prove to be valuable assets of the nation.
5. Discouragement of Anti-Social Activities
Zakat which is paid from (rizq-e-halal) stop muslims from anti social activities like smuggling etc.
6. Social Welfare
Hospitals, schools, and handicrafts for the poor can be constructed by making use of the zakat fund.
7. Self Reliance
Zakat enables peoples to take care of each others needs.
8. Control of Crimes
The Major causes of crimes particularly the poverty of people. This can be overcome by paying Zakat regularly. Zakat
decrease the crime rate.
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Qs. In what respect Islamic Economic System is superior to Capitalism and Socialism. Discuss?ORDiscuss the basic principles of Islamic Economic System and and compare it with Capitalism?Comparison of Islamic Economic System with other Economic SystemIslamic Economic System possesses the character of both capitalism and socialism and it is free from their evils.
Following are the comparison of Islamic state with others.
1. Distinguishing Characteristics
Capitalist says “Economic Freedom” to producers and Consumers.
Communism says Economic Equality achieved through state ownership of the means of production.
The distinguish characteristics of an Islamic System is “Economic and Social Justice” so that every body gets his /
her due.
2. The Concept of Private Property
In a Capitalist system unlimited liberty and right of ownership for private property is given which has resulted in the
capitalist exploitation of workers. Islam allows the right of private ownership and freedom of enterprise in limited
capitalism but not leave the property for the long period.
3. Consumption of Wealth
In Capitalism any thing can be consumed while a communist society only consumer goods and services which are
allowed to be produced in the country. In Islamic Country only “HALAL” are allowed to be produced and consumed
“HARAM” goods and services are not allowed to be produced and consumed.
4. Production of Wealth
Capitalism motive is only profit they produced goods for only profit. In communist society central plan authority made
decision what to produce and how much to produce. But in Islamic System only have to produce “HALAL” goods and
“HARAM” goods like alcohol drink, drug etc are not allowed.
5. Distribution of Wealth
In Capitalism concentration of wealth is goes on few hand due to unlimited right of ownership and free competition. In
communism system dicta for ship is created due to concept of private property. In Islamic System, Due to “ZAKAT”
and “SADQAT” automatically wealth transfer to poor from rich.
6. The Role of Interest
The interest made brings equal between saving and investment to promote, capital formation in a capitalist society. In
communism, interest does not pay any role for saving and investment. In the Islamic system interest based economic
activities are strictly banned. Hence interest is not a source of capital formation in an Islamic.
ConclusionWe conclude that Capitalist and communist are materialistic in nature and they only looking for to satisfy the material
wants of the people. But Islamic economic system provides a fine blend of materialism and spiritualism.
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