ME SAMPLE QTNS ANSWERS Q1. The Cobb-Douglas Production function is given by the following equation: Mention whether it will be increasing returns to scale, or constant returns to scale, or decreasing returns to scale for the following values of a and b. a) a=0.52, b=2.29 b) a=1.56, b=1.34 c) a=2.55, b=1.26 Ans: Q2. There are a few products whose income elasticity of demand is negative. What is the term used to describe such products? Explain with examples of such products, Ans: The products whose income elasticity of demand is negative are known as inferior goods. Income elasticity of demand is negative when people have lower incomes, and when people have lower incomes, they tend to buy inferior goods. E.g.: Bus service is preferred to air service when the income of a person decreases. Thus, bus service is an inferior good, food like pizza, hamburger is cheap thus they are preferred to nutritious food when the income is low thus, they are also known as inferior goods. Q3. Mention whether the cross-elasticity of demand will be positive and negative for the following combinations of products justifying your answers: a) Pen and Refill b) Bread and butter c) Train tickets and Bus tickets d) Two-wheeler sales and financing services Ans: Cross elasticity of demand: It is defined as the percentage change in quantity demand for a good after change in price of another good. Positive cross elasticity: Cross elasticity of demand is positive for substitute goods because the demand of one good increase when the price of substitute good decreases. Negative cross elasticity: Cross elasticity of demand is negative for complementary goods because the demand of one good decrease when the price of complementary good increases. 1. Pen and refill: Cross elasticity of demand will be negative because they are complementary goods and the demand for refill decreases with increase in price of pen. 2. Bread and butter: Cross elasticity of demand will be negative because they are complementary goods and the demand for butter decreases with increase in price of bread. 3. Train tickets and bus ticket: Cross elasticity of demand will be positive because they are substitute goods and the demand for train tickets will increase with increase in the price of bus tickets. 4. Two-wheeler sales and financing services: Cross elasticity of demand will be negative because they are complementary goods and the demand for financing services will decrease with increase in price of two Q4. Explain how the two measures mentioned below can help the economy in the times of COVID19 pandemic situation. a. Cut tax and people spend more b. Raising Government Spending Ans: The two measures cut tax and raising government expenditure is a part expansionary fiscal policy a. Cut tax and people spend more Reduction in tax rate increases disposable income of people. Because reduction in tax rate increase after tax reward for workers and after-tax returns from investment. Tax cut will boost consumption and investment in economy. Higher after-tax reward encourages labours to increase their working hours. Tax cut will increase labour supply and production. It raises output level in economy. Thereby aggregate demand will raise in economy b. Raising in government spending The government should borrow from the private sector from surplus private saving sector savings and increase spending to kickstart economy. By stimulating economy, government can encourage private sector to start investing and spending again. It can eliminate the crowding out of private investment as a result of rise in government spending. It increases consumption and investment. Building of public work schemes has the effect of creating effective demand and it leads utilization of idle resources back into the circular flow. It will increase private investment in economy. Thereby production and labour demand will increase with higher wages. As a result, employment, output and income will rise The two measures mentioned above can help the economy to boost aggregate demand in time of COVID-19 Pandemic Q5. Explain why the long-term Phillips curve is a straight vertical line, while the short-term curve is downward sloping? Ans: In short run, Phillips curve shows that there exists a negative relationship between inflation and unemployment rate. As inflation falls, unemployment rises and vice versa. When unemployment falls or more people get jobs, they get more money in their hands which raise their spending on goods and raise aggregate demand in the economy. A rise in aggregate demand raise price level and turns out to be inflation. In long run, producers have hired enough labour which makes unemployment to at its natural rate. It says that inflation rate and unemployment do not have relation while at a specific unemployment rate, inflation rate changes. Q6. Complete the following Table: a. Units of Average Product (AP) Marginal Product (MP) Labour (Units) (Units) 1 - 20 2 18 - 3 - 18 4 20 - 5 22 - 6 26 - b. Units of AFC (Rs) MC (Rs) TC (Rs) 1 - - - 2 - 10 82 3 20 8 - 4 - - 99 5 12 10 - Labour Ans: APn = π»π·π πΈπ TPn = APn* Qn MPn = βπ»π· βπΈ = TPn - TPn-1 Units of Average Product (AP) Marginal Product (MP) Total Product Labour (Q) (Units) (Units) 1 20 20 20/1 = 20 2 18 16 (36-20) 18*2 = 36 3 18 (54/3) 18 36+18= 54 4 20 26 (80-54) 20*4 = 80 5 22 30 (110-80) 22* 5 = 110 6 26 46 (156-110) 26*6 = 156 Units of AFC (Rs) MC (Rs) TC (Rs) TFC 1 60 - 92 (10+82) 60 2 30 (60/2) 10 82 60 3 20 8 90 (82+8) 60 4 15 (60/15) 9 (99-90) 99 60 5 12 10 109 (10+99) 60 Labour (Q) TFC = AFC * Q AFC = TFC / Q MC = TCn - TCn-1 Q7. Mention any one industry which is witnessing monopolistic competition in India, explaining your answer with the right arguments, facts and judgements. Ans: Restaurants are best example of monopolistic competitive industry in India. Because it is a blending of perfect competition and monopoly. There are many restaurants in the industry. Their products are highly differentiated by its style trend, brand name, quality, salesman ship, advertisement etc. Different types and varieties of foods products are being offered by restaurant industry in India. There will be an effort of non-price competition among restaurants to increase sales and capture market demand through production and selling expenses Another example, Telecom industry is an excellent example of monopolistic competition with just three players operating in it at the end of year 2020 with a minor player also to the mix. The sector which started as dominated by only government players Bharat Sanchar Nigam Limited (BSNL) and Mahan agar Telecom Nigam Limited (MTNL) underwent a transformation after the mobile phone revolution of 1990's. Number of players increased which at one point of time had around 20 players operating in different telecom circles. However rising cost of spectrum purchase led to gradual whittling down of the players after 2010's. Arrival of Reliance Jio and cost of 4G spectrum purchase led to further erosion of competition in 2016 with only four players remaining. At present Jio is the leading player with 33.6% market share of the subscribers followed by Bharti Airtel and Vodafone Idea or Vi with 28% each. BSNL holds 10% market share which is more of low end of the market with Average Revenue Per User (ARPU) being the lowest. At present the focus of the industry is raising ARPU’s with possibility of Vi exiting the industry due to litigation related huge debts and BSNL turning moribund due to lack of government support is also a possibility. Corruption allegations had led to the government ordering investigation into various players in the 2G spectrum allocation which in turn led to price of spectrum waves being priced too high leaving it out of reach of many players. BSNL for its part has not been able to bid or implement 4G till date in its network leading to the same being outdated and subscribers avoiding it. Dominant line of thinking is that the sector will turn int a duopoly with only Reliance Jio and Bharti Airtel remaining in future. Q8. Demand for a particular product is given by D= 15-2P where P is the selling price of the product. What would be the single price of the product for revenue maximization? If the product is sold at two different prices of Rs. 7 and Rs, 11 to two different customer segments, what will happen to the revenues? Explain the mathematical working with conceptual reasoning. Also mention what phenomenon does this represent in the context of consumer surplus. Ans: Demand function: D = 15–2P Here D represents quantity (Q). For revenue maximization: D = 15 – 2P By rearranging, P = (15 – D )/2………….. Price function TR = P × D = (15D – D^2)/2 TR would be the maximum if its derivative is 0. Derivative of TR = ½*(d/dD) [15D – D^2] 0 = (15 – 2D)/2 Hence by solving, D = 7.5 This is to be placed in the price function in order to get price. P = (15 – 7.5) / 2………….. Price function = 3.75 Answer: the single price is Rs.3.75. Maximum revenue = P × D = 3.75 × 7.5 = Rs.28.125 Different prices: Given, prices are Rs.7 and Rs.11 to two different customer segments. This is called price discrimination and it happens in airline business, electricity supply, etc. This pricing strategy increases revenues compared to the single pricing strategy (as above). How it works: as per the single pricing strategy, the market price is Rs.3.75. At this price the demanders of Rs.11 price and Rs.7 price could be available If there is price discrimination, the price range would be high, which is now Rs.7 to Rs.11. The firm can able to tap larger market, which increases more revenue earnings. Regarding the consumer surplus (CS): Price discrimination reduces CS. This is so because by this pricing system the firm captures the maximum willingness-to-pay of consumers. The firm creates different customer segments based on their maximum willingness to pay. Therefore, CS reduces. Q9. Why is a higher than normal GDP growth rate accompanied by rise in inflation and fall in unemployment? Ans: In an economy when GDP is higher than normal growth it is accompanied by rise in inflation and fall in unemployment because increase in aggregate demand in the economy leads to higher GDP growth and fall in unemployment and rise in inflation. This phenomenon is explained by Phillips curve by A.W. Phillips. Phillips curve is a downward sloping straight line, where we measure unemployment on the horizontal axis and inflation rate on the vertical axis. It is a graph which shows inverse relationship between unemployment and rate of inflation in an economy. As demand increase in an economy, prices increase and it leads to increase in inflation which further decreases unemployment rate due to their negative relationship Q10. Explain the relationship between short run production function and the long run production function. why are they so different from each other? Ans: A short run production function is one which requires very less time to be set up and begin production process. Revenue can be generated from the factors of production without much delay. The output can be increased in case of short run production function whereas long run production function requires considerable time to be set up and involves and output to be generated. At least one factor of production is variable in short run whereas in long run none of the factors are variable. Impact of scale of production is limited in case of short run production while it is significant in case of long run. The fundamental difference between the two is the impact of factors of production. In case of short run production function, the variable factor of production changes and leads to major impact with production rising manifold. Whereas in case of long run production function there is no major impact of variable factor of production in final output. Number of barriers exist for entry in case of short run production function whereas in case of long run function the firms are free to enter and exit the industry. In case of time function the impact of factors of production can be changed in short run function. Whereas in case of long the factors cannot be changed fast. Factor ratio changes in short run function but does not in case of long run function. Law of variable proportion operates in short run function whereas in law of returns to scale operates in case of long run function. Q11. Explain with the reason and graph, the price elasticity of demand in case of a) perfect competition vis-à-vis the monopoly b) Monopolistic vis-à-vis the Monopoly? Ans: A) In a perfect competition market, since all goods are perfectly substitute in the market. So, the price is given in the market. They are price takers. Hence the price elasticity or the demand curve is perfectly elastic, that is, it is a straight horizontal line on price-quantity plane, whereas, in monopoly market the demand curve is downward sloping on price-quantity plane because of the fact that they have a market power and they can increase price of a good without losing their customers. B) In a monopolistic market, the firms have relatively low degree of market power so in short run the demand curve is downward sloping but as it approaches in long run it becomes highly elastic, that is, it becomes sensitive to price changes, whereas, in monopoly market firms have a market power and the demand curve is always downward sloping on price-quantity plane. (Graphs Pending) Q12.Explain how does price discrimination result in increase of revenues and reduction of consumer surplus in Airlines Industry? Ans: Price discrimination is a technique used by sellers to extract the maximum price possible from buyers, which has the obvious and direct implications of increasing the revenue and profit received by the seller. This is accomplished by transferring consumer surplus from buyers to sellers Price discrimination benefits businesses through higher revenues and profits. A discriminating monopoly is extracting consumer surplus and turning it intosupernormal profit/ producer surplus. Price discrimination can take one of three forms (or degrees): ο· First-Degree Price Discrimination: Also termed perfect price discrimination, this form exists when a seller is able to sell each quantity of a good for the highest possible price that buyers are willing and able to pay. In other words, ALL consumer surplus is transferred from buyers to the seller. ο· Second-Degree Price Discrimination: Also termed block pricing, this form occurs when a seller charges different prices for different quantities of a good. Such discrimination is possible because the different quantities are purchased by different types of buyers with different demand elasticities. Block pricing of electricity, in which electricity prices depend on the amount used, is the most common example. The key is that regular households tend to use very little electricity compared to retail stores, which uses less compared to large manufacturing firms. ο· Third-Degree Price Discrimination: This is the most common of price discrimination. It occurs when the seller is able to separate buyers based on an easily identifiable characteristic, such as age, location, gender, and ethnic group. Senior citizen discounts are a common example. Higher gasoline prices near highways versus inside cities is another. Some ways that real world airlines discriminate price are as follows: Time of buying ticket. There is no hard and fast rule, but if you buy a ticket several months in advance it tends to be cheaper. If demand for the particular flight is high, then the airline starts putting up the price of that flight. It means that the remaining tickets will only be bought by people willing to pay a higher price (inelastic demand). If a particular flight is not selling very well, the airline will do the opposite and reduce price. This lower price attracts more people who are sensitive to prices and ensures that the flight will fill up. Ideally, the airline would like to fill up the plane with passengers paying the most they are willing to pay. There is no point in selling very cheap tickets and having the flight sold out many weeks in advance. You may have had experience of looking for airline ticket and seeing a flight for £200. The next day, you return to buy ticket, but see it has gone up to £220. This is very annoying, but is due to price discrimination. The airline will reserve a certain number of economy tickets at a low price (to attract early customers more sensitive to price. But, if the tickets for flight are selling well, it can afford to charge higher prices for the remaining few tickets. The airline is trying to capture as much consumer surplus as possible) Unsocial hours cheaper. Because some flight times are less popular, these flights will tend to be cheaper. For example, if you take a weekend break. Most people would prefer to come back late on Sunday. These late Sunday flights tend to be more expensive than early morning Sunday flights. Paying extra for seats with more leg room. In economy class, Virgin offered a seat with 3 inches of extra leg room for £30. At 185cm, I jumped at offer. To me, it is a good £30 investment. It was quite popular with nearly 40% of seats in economy now being taken up with extra leg room seats. It’s not quite price discrimination because it’s a slightly different product, but the airline is able to charge higher prices to those consumers with slightly more inelastic demand. In addition to the 3 inches of extra leg room, you could go to the other extreme and pay £15,000 for a first class airfare. Interestingly, you can only buy these extra leg room seats shortly before the flight. I wonder if this is to discourage people from avoiding business and just buying a cheap upgrade to economy? When you travel. Travelling at peak times will be much more expensive. One good example is travelling during the week. I was once looking at airfares from London to New York in October. From Monday to Friday, the cheapest fare was over £1,000 – I was shocked at the cost. But, when I changed the date to Saturday to Saturday, the price fell to £350. The reason is that the customers travelling Monday to Friday are businessmen. Their demand tends to be more inelastic (because it is paid by company expenses). If you are more flexible and willing to travel at the weekend, you are more sensitive to price and have a more elastic demand. Airfares also vary depending on the time of the year. During peak summer holidays, airfares are more expensive. Parents have more inelastic demand because they can’t go on holiday during term time. Charging for extras. Ryanair has become expert at charging for extras like check in luggage. It means consumers who are less sensitive to price, may – pay to enter plane early, pay to have a check in bag. See: Ryanair Airmiles. Airmiles isn’t really price discrimination, but it is a way of rewarding loyal consumers. The more times you travel with a particular airline, the more airmiles you get, and thus you get a discount for frequent flying. Q13. Look at the indifference curves shown below and justify the properties of Indifference curve with reasons. Ans: a) The point A and the point C lies on the same indifference curve representing that the consumer will get same level of utility. The bundles that the consumer consuming at point C and A are different, but he will be getting same level of utility at both the points. On the other hand, the consumer will get higher utility at point F because the point F lies on the higher indifference curve. And we know that higher indifference curve gives higher level of satisfaction. b) The indifference curve is derived using the utility derived from the two goods. If we are concerned with the goods that give utility to the consumer than the Indifference curve cannot slope positively. But, if the consumer is consuming the goods anyone of which give him disutility, then the indifference curve will be sloping upward. Y Good Y ο 1C 0 Good X ο X Here, we can see that the suppose the consumption of X is giving him the disutility. So, the consumption of X will reduce the Total utility. But along the indifference curve the consumer will get same level of total utility, so he will consume Good Y so that the total utility increases and the constant level of utility is maintained. c) The indifference curves are convex to the origin because of the diminishing marginal rate of substitution. That means for each successive unit of X the consumer give up less and less of Y. This idea is the reflation of the law of diminishing marginal utility. Let’s understand with a help of a diagram: Good Y ο Y 6 3 1 0 1C 1 2 3 Good X ο Here, supposes the consumer is at the bundle (1,6). Now, the consumer has move to consuming X=2. At this level of X, the consumer if consume Y=3, thus, the consumer is willing to give up 3 units of Y for 1 unit of X. If the consumer wants to consume more of X (X's MU is declining) he will not be willing to give up the Y as much as before. So, he will give up 2 units of Y. Because the MU of X is declining and the consumer is willing to give up (pay) less and less for X. That’s why the Indifference curve is convex to the origin. X Q14. The Regression Output mentioned below was obtained while trying to estimate the demand for the roses as a function of the three predictor variables. Answer the questions that follow: a) Mention the three predictor variables. b) What is the regression equation for predicting the demand of the roses? c) How reliable is the model in predicting the demand for the roses? Justify your answer. d) Do the three predictor variables have statistically significant influence on the demand for roses? Justify your answer. e) What does the sign of each of the coefficient in the regression line indicate? Relate with the f) theory learnt in the classroom and justify the signs.
