MODULE 1: BASIC ECONOMIC PRINCIPLES

Central Economic Problems & Economy

What are the three central problems of an economy?

1. What to produce: Deciding which goods and services to produce and in what quantities
2. How to produce: Choosing the methods, techniques, and resources for production
3. For whom to produce: Determining how goods and services will be distributed among
people

What are the basic economic problems?

1. Scarcity of resources: Resources are limited (land, labor, capital)

2. Unlimited wants: Human desires and needs are endless
3. Allocation of resources: Need to decide how to use limited resources efficiently

Why does the problem of choice arise in an economy? The problem of choice arises because:

 Resources (land, labor, capital) are limited

 Human wants and needs are unlimited
 We must choose how to use resources to satisfy the most important needs first
 Every choice involves giving up something else (opportunity cost)

What are the determinants of supply?

1. Price of the good: Higher price → more supply

2. Cost of production: Lower costs → more supply
3. Technology: Better technology → more supply
4. Taxes and subsidies: Lower taxes/more subsidies → more supply
5. Future price expectations: Expected price rise → less current supply
6. Price of related goods: Higher prices of alternatives → more supply of this good
7. Number of sellers: More sellers → more supply
Production Possibility Curve (PPC)
What is a production possibility curve?

 A graph showing the maximum possible combinations of two goods an economy can
produce using all available resources efficiently
 Shows the trade-off between producing different goods
 Points on the curve represent full employment of resources
 Points inside the curve represent underutilization of resources
 Points outside the curve are unattainable with current resources

Explain underutilization of resources and full employment of resources using PPC:

 Underutilization of resources: Points inside the PPC curve (like point U) show the
economy is not using all available resources efficiently. This might be due to
unemployment, inefficient production methods, or unused capacity.
 Full employment of resources: Points exactly on the PPC curve (like points A, B, C)
show the economy is using all resources efficiently. Every point on the curve represents
different allocation of resources between the two goods.

Explain the concept of opportunity cost and its linkage with PPC:

 Opportunity cost is the value of the next best alternative forgone when making a choice
 On the PPC, opportunity cost is shown by the slope of the curve
 Moving from one point to another on the PPC shows the opportunity cost
 Example: If moving from point A (20 cars, 0 computers) to point B (15 cars, 10
computers), the opportunity cost of 10 computers is 5 cars
 Typically, PPC is concave (bowed outward) because opportunity costs increase as more
of one good is produced
Business Organizations
What is a Joint Stock Company? Discuss its advantages and disadvantages:

Advantages of Joint Stock Company:

1. Limited liability: Shareholders' liability limited to their investment

2. Large capital: Can raise huge amounts by selling shares to many people
3. Professional management: Hired experts run the company
4. Transferable shares: Easy to buy and sell ownership
5. Perpetual existence: Company continues even if shareholders change
6. Risk diversification: Spread among many shareholders

Disadvantages of Joint Stock Company:

1. Double taxation: Taxed on profits and again on dividends

2. Complex formation: Many legal formalities and documentation
3. Separation of ownership and control: Shareholders may have little control
4. Possibility of conflicts: Between shareholders and management
5. Excessive regulations: Subject to many government rules

Explain four types of firms in business field:

1. Sole Proprietorship:
o One owner who manages business
o Owner keeps all profits and bears all risk
o Simple to start, flexible, direct control
2. Partnership:
o Two or more people share ownership
o Partners share profits, losses, and management
o More capital than sole proprietorship
o Limited to 20 partners (usually)
3. Joint Stock Company:
o Owned by shareholders
 o Limited liability for owners
o Separate legal entity
o Professional management
4. Cooperative:
o Owned by members who are also users
o Democratic control (one member, one vote)
o Profits distributed based on use of services
o Focus on service rather than profit

Point out any three advantages of proprietorship:

1. Easy to form: Minimal legal formalities, quick to start

2. Direct control: Owner makes all decisions without consulting others
3. Flexibility: Can adapt quickly to market changes
4. All profits to owner: No sharing of profits with others
5. Privacy: Financial information remains private

Utility Theory

Define marginal utility:

 The additional satisfaction gained from consuming one more unit of a good
 Example: The satisfaction from drinking the second glass of water is the marginal utility
of the second glass

State the law of diminishing marginal utility and its assumptions:

Law of diminishing marginal utility: As more units of a good are consumed in a given time
period, the satisfaction (utility) from each additional unit decreases.

Assumptions:

1. Homogeneous units: All units of the good are identical

2. Continuous consumption: No time gap between consuming units
 3. Rational consumer: Consumer behaves rationally
4. Unchanged tastes: Consumer's preferences do not change
5. Independent goods: Utility of one good not affected by consumption of others

Explain the law of diminishing marginal utility with diagram:

The law states that as a consumer consumes more units of a good, the additional satisfaction
(marginal utility) from each extra unit falls.

Example:

 First ice cream: High satisfaction (MU=10)

 Second ice cream: Good but less satisfying (MU=8)
 Third ice cream: Even less satisfying (MU=5)
 Fourth ice cream: Little satisfaction (MU=2)
 Fifth ice cream: No additional satisfaction (MU=0)
 Sixth ice cream: Negative satisfaction (MU=-3)

Relations between marginal utility and total utility:

1. When TU increases, MU is positive: Each additional unit adds to total satisfaction

2. When TU is maximum, MU is zero: Additional unit adds nothing to total satisfaction
3. When TU decreases, MU is negative: Additional unit reduces total satisfaction

Demand and Supply

State the law of demand and explain with diagram and schedule:

Law of demand: As price of a good increases, quantity demanded decreases, and vice versa
(negative relationship between price and quantity demanded).

Demand Schedule Example:

Price (₹) Quantity Demanded (units)
5 100

4 200
3 300

2 400
1 500

Exceptions to law of demand:

1. Giffen goods: Inferior goods that are consumed more when price rises (e.g., staple foods
for poor)
2. Veblen goods: Luxury goods bought for status (e.g., designer clothes)
3. Emergency goods: Necessities like medicines bought regardless of price
4. Goods of ignorance: When quality is judged by price (e.g., perfumes)
5. Future expectations: If price is expected to rise further

State the law of supply and explain determinants of supply:

Law of supply: As price of a good increases, quantity supplied increases, and vice versa
(positive relationship between price and quantity supplied).

Determinants of supply:

1. Price of the good: Higher price → more supply

2. Cost of production: Higher costs → less supply
3. Technology: Better technology → more supply
4. Taxes & subsidies: Higher taxes → less supply; more subsidies → more supply
5. Price expectations: Expected future price rise → less current supply
6. Number of sellers: More sellers → more supply
7. Natural factors: Good weather for crops → more supply
What are the components of demand?

1. Income: Higher income → more demand (normal goods)

2. Price of related goods:
o Substitutes: Higher price of substitutes → more demand
o Complements: Higher price of complements → less demand
3. Tastes and preferences: Favorable taste → more demand
4. Population: Larger population → more demand
5. Future expectations: Expected future price rise → more current demand
6. Credit availability: Easy credit → more demand
7. Distribution of income: Even distribution → broader demand

Elasticity of Demand

Define price elasticity of demand:

 The percentage change in quantity demanded divided by the percentage change in price
 Ed = % Change in Quantity Demanded ÷ % Change in Price

What is inelastic demand?

 When percentage change in quantity demanded is less than percentage change in price
(Ed < 1)
 Example: 10% price increase causes only 5% quantity decrease
 Typically for necessities (salt, medicine)

What is cross elasticity of demand?

 The percentage change in quantity demanded of good A divided by percentage change in

price of good B
 Measures how demand for one good responds to price change of another good
 Positive for substitutes, negative for complements

Explain five degrees of elasticities of demand with diagrams:

 1. Perfectly inelastic (Ed = 0):
o Quantity demanded doesn't change at all with price changes
o Vertical demand curve
o Example: Insulin for diabetics
2. Inelastic (Ed < 1):
o Quantity demanded changes less than proportionately to price
o Steep demand curve
o Example: Basic food items
3. Unitary elastic (Ed = 1):
o Quantity demanded changes exactly proportionately to price
o Rectangular hyperbola
o Example: Mid-range clothing
4. Elastic (Ed > 1):
o Quantity demanded changes more than proportionately to price
o Gentle demand curve
o Example: Luxury items, entertainment
5. Perfectly elastic (Ed = ∞):
o Infinite response of quantity to any price change
o Horizontal demand curve
o Example: Perfect competition

Consumer and Producer Surplus

What is consumer surplus?

 The difference between what consumers are willing to pay for a good and what they
actually pay
 Represented by the area below the demand curve and above the price line
 Shows net benefit to consumers from market exchange

Define consumer surplus, producer surplus, social surplus and deadweight loss:
 1. Consumer surplus: Difference between what consumers are willing to pay and what
they actually pay
2. Producer surplus: Difference between what producers receive and their minimum
acceptable price (the supply curve shows minimum acceptable prices)
3. Social surplus: Sum of consumer surplus and producer surplus; represents total benefit to
society
4. Deadweight loss: Loss of economic efficiency when market equilibrium is not achieved;
typically shown as a triangle area

What happens to consumer and producer surplus when the sale of a good is taxed?

 Consumer surplus decreases: Consumers pay higher prices

 Producer surplus decreases: Producers receive lower prices
 Tax revenue is created: Goes to government
 Deadweight loss appears: Some mutually beneficial transactions don't happen because
of the tax
 The tax burden is shared between consumers and producers depending on elasticities

Deadweight Loss and Taxation

What is deadweight loss? How does it relate to taxation?

 Deadweight loss is the loss of economic efficiency when market equilibrium is not
achieved
 It represents lost utility that isn't transferred to anyone else in the economy
 With taxation, deadweight loss occurs because some trades that would be mutually
beneficial don't happen
 The more elastic demand and supply are, the larger the deadweight loss from taxation

Explanation of impact of tax on consumer and producer surplus:

1. Before tax: Market is at equilibrium with optimal social surplus

2. After tax:
o Market quantity decreases
 o Consumer price increases
o Producer price decreases
o Government collects tax revenue
o Consumer and producer surplus both decrease
o Part of the decrease goes to government as tax revenue
o Part of the decrease becomes deadweight loss

Diagrammatically explain deadweight loss of taxation:

 Triangle area represents deadweight loss

 Rectangle area represents tax revenue
 The burden of tax is shared between consumers and producers
 The more inelastic side bears more of the tax burden

Opportunity Cost

What is the economic significance of opportunity cost?

 Makes decision-making rational by comparing alternatives

 Helps in optimal allocation of scarce resources
 Shows the real cost of choices in terms of foregone alternatives
 Critical for businesses, individuals, and governments in resource allocation
 Reveals hidden costs not captured in accounting

Describe opportunity cost with an example:

 Definition: Value of the next best alternative foregone when making a choice
 Example: A student choosing to study medicine instead of engineering
o Direct cost: College fees, books for medicine
o Opportunity cost: Potential engineering salary during years of extra medical
training
  Example: A farmer using land to grow wheat instead of corn
o Opportunity cost is the value of corn that could have been produced

MODULE 2: PRODUCTION AND COST THEORY

Production Function

Describe production function:

 Mathematical relationship between inputs (factors of production) and maximum possible

output
 Shows how much output can be produced with different combinations of inputs
 Can be short-run (at least one input fixed) or long-run (all inputs variable)
 Example: Q = f(L, K) where Q is output, L is labor, K is capital

What is a production function? Explain long run production function and represent the
three returns to scales with isoquants:

Production function is the relationship between inputs and maximum possible output. In the long
run, all inputs are variable, so firms can adjust all factors of production.

Long-run production function and returns to scale:

1. Increasing returns to scale:

o Output increases more than proportionately to inputs
o Example: 100% increase in inputs → more than 100% increase in output
o Isoquants get closer together as output increases
o Due to specialization, better resource utilization
2. Constant returns to scale:
o Output increases exactly proportionately to inputs
o Example: 100% increase in inputs → 100% increase in output
o Isoquants equally spaced
o No economies or diseconomies of scale
3. Decreasing returns to scale:
 o Output increases less than proportionately to inputs
o Example: 100% increase in inputs → less than 100% increase in output
o Isoquants get farther apart as output increases
o Due to management problems, coordination issues

Law of Variable Proportions

Diagrammatically explain the law of variable proportions:

The law states that as more of a variable input is added to fixed inputs, total product initially
increases at an increasing rate, then at a decreasing rate, and finally declines.

Three stages of production:

1. Stage I:
o Total product (TP) increases at increasing rate
o Marginal product (MP) increases and is above average product (AP)
o AP increases
o Corresponds to increasing returns
2. Stage II:
o TP increases at decreasing rate
o MP decreases but remains positive
o AP decreases
o Most efficient stage, rational producer operates here
o Corresponds to diminishing returns
3. Stage III:
o TP decreases
o MP becomes negative
o AP continues to decrease
o Irrational to operate in this stage

Cost Concepts

Distinguish between explicit and implicit cost:

  Explicit cost: Actual money payments made by the firm
o Examples: Wages, rent, interest, raw materials
o Appear in accounting records
 Implicit cost: Value of self-owned resources used in production
o Examples: Owner's time, self-owned building, own capital
o Not actual cash payments
o Opportunity cost of using own resources
o Often ignored in accounting but important in economics

Distinguish between Fixed cost and variable cost:

 Fixed cost: Costs that don't change with output level

o Examples: Rent, insurance, equipment depreciation
o Must be paid even if production is zero
o Per unit fixed cost decreases as output increases
 Variable cost: Costs that change with output level
o Examples: Raw materials, direct labor, power
o Zero when production is zero
o Generally increases with output

Production decision: Should a firm continue production or shut down in the short run?

If AVC < P < AC: Continue production

 Explanation: Price covers variable costs and part of fixed costs

 Fixed costs must be paid whether producing or not
 Better to produce and cover some fixed costs than shut down
 Example: If AVC = ₹8, AC = ₹12, P = ₹10, continue production

If P < AVC: Shut down

 Explanation: Price doesn't even cover variable costs

 Losses would be greater if production continues
  Better to shut down and only incur fixed costs
 Example: If AVC = ₹8, AC = ₹12, P = ₹7, shut down

Break-Even Analysis

Define break-even point:

 The level of output where total revenue equals total cost

 The firm makes neither profit nor loss
 Formula: Break-even quantity = Fixed Cost ÷ (Price - Variable Cost per unit)
 Break-even revenue = Break-even quantity × Price

What is margin of safety? What happens when margin of safety is low?

 Margin of safety: Difference between actual sales and break-even sales

 Usually expressed as a percentage: (Actual sales - Break-even sales) ÷ Actual sales × 100
 When margin of safety is low:
o Higher risk of losses if sales drop
o Less cushion against adverse market conditions
o Business is more vulnerable to economic fluctuations
o Need close monitoring of costs and sales

Explain break-even analysis with a diagram:

The break-even chart shows:

 Fixed cost line (horizontal)

 Total cost line (sloped upward)
 Total revenue line (sloped upward from origin)
 Break-even point (intersection of total cost and total revenue)
 Profit area (above break-even point)
 Loss area (below break-even point)

Assumptions, uses and limitations of break-even analysis:

Assumptions:

1. All costs can be classified as fixed or variable

2. Fixed costs remain constant
3. Variable costs change proportionately with output
4. Selling price doesn't change with volume
5. Single product or constant sales mix
6. Technology and efficiency remain constant
7. No inventory changes

Uses:

1. Determining minimum sales volume needed

2. Setting prices
3. Making product decisions
4. Planning profit targets
5. Controlling costs
6. Evaluating effects of changes in costs or prices

Limitations:

1. Simplified assumptions may not hold in reality

2. Difficult to classify all costs as fixed or variable
3. Fixed costs may change with large output changes
4. Ignores economies of scale
5. May not work for multiple products
6. Ignores time value of money

Economies and Diseconomies

What are external economies? Identify types of external economies:

 External economies: Benefits to firms from factors outside their control

 Types:
 1. Concentration of industry: Related businesses in one area
2. Improved transportation: Better infrastructure reducing costs
3. Skilled labor pool: Availability of trained workers
4. Development of ancillary services: Support businesses
5. Information sharing: Knowledge spillovers between firms

Explain two reasons why internal diseconomies might occur:

1. Management problems: As firm grows, coordination becomes difficult, decision-

making slows down, communication challenges increase
2. Coordination issues: Harder to coordinate different departments, duplication of efforts,
bureaucracy increases

Other reasons include: 3. Control problems: Difficult to maintain quality standards 4. Labor
relations: Worker alienation, less motivation, labor disputes 5. Transportation costs: Moving
materials within large facilities becomes costly

Briefly explain any four types of internal economies from large scale production:

1. Technical economies:
o Better machinery utilization
o Specialization of machinery
o Linked production processes
o Advantages of large machines
2. Managerial economies:
o Specialization of management functions
o Use of computers and technology
o Scientific management techniques
o Professional expertise
3. Marketing economies:
o Bulk buying discounts
o Lower transportation costs per unit
o Better bargaining power
 o Specialized marketing department
4. Financial economies:
o Better access to capital markets
o Lower interest rates
o More financing options
o Ability to issue stocks and bonds
5. Risk-bearing economies:
o Diversification of products
o Spread risk across markets
o Research and development capabilities
o Weather market fluctuations better

Isoquants and Isocost Lines

What are isoquant curves? State their properties:

 Isoquant: A curve showing all combinations of inputs (like labor and capital) that
produce the same level of output

Properties of isoquants:

1. Downward sloping: Shows substitution between inputs

2. Convex to origin: Reflects diminishing marginal rate of technical substitution
3. Non-intersecting: Two isoquants can't cross (would be contradictory)
4. Higher isoquant = higher output: Isoquants further from origin represent higher output
levels
5. Never touch axes: Both inputs are essential (can't produce with zero of any input)

Illustrate expansion path using a diagram:

 Expansion path: A line connecting all optimal input combinations as output increases
 Shows how input proportions change as a firm expands
 Found by connecting the tangent points of isoquants with isocost lines
  For constant returns to scale with unchanging input prices, the expansion path is a
straight line from the origin

Technical Progress

What is labour augmenting technical progress?

 Technical progress that increases the productivity of labor

 Makes labor more efficient without changing the amount of capital
 Example: Better training, education, or work methods
 Sometimes called "Harrod-neutral" technical progress
 Results in more output from the same amount of labor

What is technical progress? Distinguish between embodied and disembodied technical

progress:

Technical progress: Improvements in technology that allow more output from the same inputs
or same output with fewer inputs

Embodied technical progress:

 Technical improvements incorporated in new machines or equipment

 Requires investment in new capital goods
 Example: New, more efficient machinery replacing old equipment
 Benefits realized only when new equipment is purchased and installed

Disembodied technical progress:

 Technical improvements that increase productivity without new investment

 Applied to existing production facilities
 Example: Better organization, improved management techniques, worker training
 Benefits can be realized without capital replacement

Explain the concept of technical progress. Which are the three types of technical progress:
Technical progress: Improvement in production methods that allows more output from same
inputs

Three types:

1. Neutral technical progress:

o Increases productivity of all factors equally
o Called "Hicks-neutral"
o Doesn't change optimal input mix
2. Labor-saving technical progress:
o Increases productivity of capital more than labor
o Reduces optimal labor-to-capital ratio
o Example: Automation
3. Capital-saving technical progress:
o Increases productivity of labor more than capital
o Increases optimal labor-to-capital ratio
o Example: Improved worker training

Producer's Equilibrium

With the help of a diagram, explain producer's equilibrium and expansion path:

Producer's equilibrium: The optimal combination of inputs that minimizes cost for a given
output level

Conditions for producer's equilibrium:

 MRTS (Marginal Rate of Technical Substitution) = Price ratio of inputs

 Slope of isoquant = Slope of isocost
 MPL/MPK = PL/PK (where MP is marginal product, P is price, L is labor, K is capital)

Expansion path: Shows optimal input combinations as output increases

 Connect tangent points of isoquants and isocost lines

  Shows how optimal input mix changes as firm expands
 If input prices are constant and returns to scale are constant, expansion path is a straight
line

Cost-Output Relationships

Discuss cost-output relationship in short-run and long-run:

Short-run cost-output relationship:

 Some inputs fixed (typically capital), some variable (typically labor)

 Fixed costs do not change with output
 Variable costs increase with output
 Total cost = TFC + TVC
 Average cost (AC) typically U-shaped due to:
o Spreading fixed costs over more units (decreasing average fixed cost)
o Law of diminishing returns affecting variable costs
 Marginal cost (MC) eventually increases due to diminishing returns
 MC cuts AVC and AC at their minimum points

Long-run cost-output relationship:

 All inputs variable, no fixed costs

 Firm can choose optimal plant size
 Long-run average cost (LRAC) curve is envelope of short-run average cost curves
 LRAC often U-shaped due to:
o Economies of scale at lower outputs (decreasing LRAC)
o Diseconomies of scale at higher outputs (increasing LRAC)
 Optimal scale of production at minimum LRAC

Draw a diagram and derive the three relations between MC and AVC:

The three relations between marginal cost (MC) and average variable cost (AVC):
1. When AVC falls, MC < AVC:
o If the cost of an additional unit is less than the average, it pulls the average down
o Example: If AVC is ₹10 and MC is ₹8, AVC will decrease
2. When AVC is minimum, MC = AVC:
o At the minimum point of AVC, MC equals AVC
o MC curve intersects AVC curve at its minimum point
3. When AVC rises, MC > AVC:
o If the cost of an additional unit is more than the average, it pulls the average up
o Example: If AVC is ₹10 and MC is ₹12, AVC will increase
 MODULE 3: MARKET STRUCTURES AND PRICING
Perfect Competition

Explain the conditions for profit maximization of a firm:

 Profit maximization occurs where MR = MC (Marginal Revenue = Marginal Cost)

 For maximizing profit, the firm produces up to the point where the revenue from the last
unit equals the cost of producing it
 Second-order condition: MC curve must cut MR curve from below
 In perfect competition, MR = Price, so profit maximization occurs where P = MC

Illustrate why the demand curve in perfect competition is perfectly elastic:

 In perfect competition, each firm is small relative to the market

 Each firm produces a homogeneous product identical to competitors
 Firms are price takers, accepting the market price
 If a firm raises price above market price, it loses all customers
 If a firm lowers price below market price, it needlessly reduces revenue
 Therefore, demand curve is horizontal (perfectly elastic) at the market price

Why is a firm under perfect competition called a price taker?

 Individual firm cannot influence the market price

 Each firm's output is too small compared to total market supply
 Product is homogeneous, so buyers have no reason to pay more than market price
 Perfect information means buyers know the market price
 The firm can sell any amount at the market price but nothing above it

What is perfect competition? What are the features of a perfectly competitive market?

Perfect competition: A market structure with many buyers and sellers, where no single
participant can influence the market price

Features:
 1. Many buyers and sellers: No market power for any individual participant
2. Homogeneous product: Identical products, no differentiation
3. Free entry and exit: No barriers to entering or leaving the market
4. Perfect information: All buyers and sellers have complete knowledge
5. Price takers: Firms accept the market price, cannot influence it
6. Perfect mobility of factors: Resources can move freely between different uses
7. Zero transaction costs: No costs of exchange beyond the price

Monopoly

Identify three distinctions between perfect competition and monopoly:

1. Number of sellers:
o Perfect competition: Many sellers
o Monopoly: Single seller
2. Price determination:
o Perfect competition: Price taker (accepts market price)
o Monopoly: Price maker (sets market price)
3. Barriers to entry:
o Perfect competition: No barriers to entry
o Monopoly: Strong barriers to entry

Other distinctions: 4. Product: Homogeneous in perfect competition, unique in monopoly 5.

Demand curve: Horizontal in perfect competition, downward sloping in monopoly 6. Price =
MC?: Yes in perfect competition, No in monopoly (P > MC) 7. Economic profit: Zero in long-
run perfect competition, possible in monopoly

Compare the market situation of monopoly and monopolistic competition:

Similarities:

1. Both face downward-sloping demand curves

2. Both can earn abnormal profits in short run
3. Both have price setting power (P > MC)
Differences:

Feature Monopoly Monopolistic Competition

Number of
Single seller Many sellers
sellers

Unique product, no close

Product Differentiated products
substitutes

Barriers to entry Strong barriers No significant barriers

Control over
Substantial Limited by substitutes
price

Normal profits only (like perfect

Long-run profits Can earn abnormal profits
competition)

Advertising Little need for advertising Heavy advertising to differentiate products

Examples Public utilities, patented drugs Restaurants, clothing brands

Monopolistic Competition

Elucidate the features of a monopolistic competition:

1. Large number of sellers: Many firms competing in the market

2. Product differentiation: Products similar but not identical (in quality, design, brand)
3. Free entry and exit: No significant barriers to entering or leaving the market
4. Some price setting power: Firms have limited control over price due to differentiation
5. Non-price competition: Advertising, packaging, service important
6. Imperfect information: Consumers may not know all alternatives
7. Examples: Restaurants, retail clothing, personal services

What are the characteristics of monopolistic competition, and how does it differ from
monopoly?

Characteristics of monopolistic competition:

 1. Many sellers
2. Differentiated products
3. Free entry and exit
4. Independent decision-making
5. Selling costs (advertising) important
6. Some control over price

Differences from monopoly:

Feature Monopolistic Competition Monopoly

Number of firms Many One

Product Differentiated Unique, no close substitutes

Entry barriers Low or none High

Price control Limited Substantial

Long-run profits Normal profits only Can maintain abnormal profits

Demand elasticity Relatively elastic Relatively inelastic

Examples Restaurants, clothing Public utilities, patented drugs

Explain equilibrium of a firm under monopolistic competition:

Short-run equilibrium:

 Profit maximization at MR = MC
 Can earn abnormal profits if P > AC
 Can incur losses if P < AC
 Will continue if P > AVC even with losses

Long-run equilibrium:

 Free entry eliminates abnormal profits

 New firms enter if existing firms earn abnormal profits
 Firms exit if incurring losses
  At equilibrium: P = AC (normal profits only)
 But unlike perfect competition: P > MC (excess capacity)
 Demand curve tangent to AC curve but not at minimum point

Oligopoly

What is collusive oligopoly?

 A market situation where a few firms in an oligopoly agree (formally or informally) to fix
prices, limit output, or share markets
 Forms of collusion:
o Cartel: Formal agreement (like OPEC)
o Price leadership: One firm sets price, others follow
o Tacit collusion: Informal understanding without explicit agreement
 Goal is to behave like a monopoly and maximize joint profits
 Often illegal in many countries under antitrust laws

Explain oligopolistic competition with its features:

Oligopoly: Market dominated by a few large firms where each firm must consider rivals'
reactions

Features:

1. Few sellers: Small number of large firms dominate

2. Interdependence: Each firm must consider rivals' reactions to its decisions
3. Barriers to entry: Significant obstacles for new firms
4. Homogeneous or differentiated products: Can be identical or slightly different
5. Non-price competition: Advertising, product quality important
6. Price rigidity: Prices tend to be stable (explained by kinked demand curve)
7. Examples: Automobiles, steel, telecommunications

What is oligopolistic market? How does the concept of a kinked demand curve explain
price stability in an oligopolistic market?
Oligopolistic market: A market dominated by a few large firms, each aware that their actions
affect others and will cause reactions.

Kinked demand curve explanation:

 The demand curve facing an oligopolist has a "kink" at the prevailing price
 If one firm raises price: Others won't follow, so demand is elastic (steep drop in quantity)
 If one firm lowers price: Others will follow to protect market share, so demand is
inelastic (small gain in quantity)
 Result: Price tends to be stable because:
o Price increases cause large loss in sales (not profitable)
o Price decreases cause price wars with little gain in quantity (not profitable)
 MR curve has a discontinuity (gap) at the kink
 Wide range of MC changes won't affect optimal price or quantity
 Explains why oligopoly prices tend to be "sticky" and change less frequently

Pricing Strategies

Explain cost-plus pricing:

 Setting price by adding a fixed percentage markup to the average cost

 Formula: Price = Average Cost + (Average Cost × Markup Percentage)
 Simple and widely used method
 Ensures costs are covered and target profit margin is achieved
 Common in retail, manufacturing, and services
 Example: If cost is ₹100 and markup is 20%, price = ₹120

What is price skimming?

 Setting a high initial price for a new product, then gradually lowering it over time
 Often used for innovative or unique products
 Captures high-willingness-to-pay customers first
 Helps recover R&D costs quickly
 Price reduced as competition increases or to reach more price-sensitive segments
  Examples: New electronics, pharmaceuticals, fashion items

What is penetration pricing?

 Setting a low initial price to gain market share quickly

 Aims to attract customers and establish brand loyalty
 Often used for products with elastic demand
 Can discourage new competitors from entering
 May increase long-term profits through high sales volume
 Examples: New streaming services, software products, fast food chains

What is pricing and what are the different methods used for pricing?

Pricing: Process of determining what a company will receive in exchange for its products or
services

Different pricing methods:

1. Cost-plus pricing: Cost + fixed percentage markup

2. Price skimming: High initial price, gradually lowered
3. Penetration pricing: Low initial price to gain market share
4. Product line pricing: Different prices for different products in the same line
5. Psychological pricing: Prices set to appeal psychologically (₹99 instead of ₹100)
6. Premium pricing: High price to suggest high quality
7. Economy pricing: Low price, minimal marketing costs
8. Bundle pricing: Package of products sold at a discount
9. Dynamic pricing: Changing prices based on demand or time
10. Geographical pricing: Different prices in different locations

Market Structures Comparison

Compare and differentiate between perfect competition, monopoly, and oligopoly:

 Feature Perfect Competition Monopoly Oligopoly

Number of firms Many small firms Single firm Few large firms

Unique, no close May be homogeneous or

Product Homogeneous
substitutes differentiated

Entry barriers None Very high Significant

Substantial (price
Price control None (price taker) Limited by interdependence
maker)

Horizontal (perfectly Downward sloping

Demand curve Kinked
elastic) (inelastic)

Profit Complex due to

Where P = MC Where MR = MC
maximization interdependence

Can earn abnormal

Long-run profits Normal profits only Can earn abnormal profits
profits

Allocatively
Efficiency Allocatively efficient Usually inefficient
inefficient

Automobiles,
Examples Agricultural products Public utilities
telecommunications

Define market structure:

 The organizational and other characteristics of a market that influence the behavior and
interaction of buyers and sellers
 Determined by number of firms, nature of product, entry conditions, information
availability
 Key types: perfect competition, monopolistic competition, oligopoly, monopoly
 Influences pricing decisions, output levels, efficiency, and consumer welfare

Non-Price Competition

What is non-price competition? Give examples:

  Competition between firms based on factors other than price
 Especially important in oligopoly and monopolistic competition
 Examples:
1. Advertising and promotion
2. Product quality improvements
3. Better customer service
4. Extended warranties
5. Attractive packaging
6. Convenient location
7. Loyalty programs and rewards

Which are the different types of Non-price competition under Oligopoly:

1. Advertising: Heavy spending to build brand image

2. Product differentiation: Creating unique features or designs
3. Sales promotion: Discounts, coupons, free samples
4. Better services: After-sales service, warranties
5. Product quality: Superior materials or engineering
6. Research and development: Creating improved products
7. Packaging: Attractive or convenient packaging
8. Location: Prime retail positions

List out any six non-price competition methods followed in oligopoly:

1. Advertising campaigns: Building brand recognition

2. Product innovation: Adding new features
3. Extended warranties: Offering longer protection
4. Free accessories: Bundling complementary items
5. After-sales service: Superior customer support
6. Loyalty programs: Rewards for repeat customers
7. Celebrity endorsements: Using famous personalities
8. Superior delivery: Faster or free shipping
 MODULE 4: NATIONAL INCOME AND MONETARY
POLICY
National Income Concepts

Differentiate between GDP and GNP:

 GDP (Gross Domestic Product):

o Total value of all final goods and services produced within a country's borders in
a specific time period
o Based on geographic boundary (domestic territory)
o Includes production by foreigners within the country
o Excludes earnings of citizens abroad
 GNP (Gross National Product):
o GDP + Net factor income from abroad
o Based on ownership (by country's citizens)
o Includes earnings of citizens abroad
o Excludes earnings of foreigners within the country
o Formula: GNP = GDP + Factor income earned by nationals abroad - Factor
income earned by foreigners in the domestic territory

How is GDP calculated? GDP can be calculated using three methods:

1. Expenditure Method: C + I + G + (X-M)

o C = Consumer spending
o I = Investment spending by businesses
o G = Government spending
o X = Exports
o M = Imports
2. Income Method: Sum of all factor incomes
o Wages and salaries
o Rent
o Interest
 o Profit
o Mixed income
3. Value Added Method: Sum of value added at each production stage
o Value added = Value of output - Value of intermediate inputs
o Avoids double counting

Distinguish between final goods and intermediate goods:

 Final goods:
o Products purchased for final use, not for resale or further processing
o Counted in GDP calculation
o Examples: Cars purchased by consumers, furniture for home use
 Intermediate goods:
o Products used in the production of other goods and services
o Not counted directly in GDP (to avoid double counting)
o Value included in final goods' prices
o Examples: Steel used in car manufacturing, flour used by bakeries

Explain the difference between stock and flow in national income with example:

 Stock: Economic variable measured at a specific point in time

o Examples: Wealth, assets, debt, inventory, population
o Like the amount of water in a tank at a moment
 Flow: Economic variable measured over a period of time
o Examples: Income, production, investment, consumption, depreciation
o Like the rate of water flowing into or out of a tank
 Example:
o Wealth (stock) vs. Income (flow)
o A person has ₹10 lakh in bank (stock) and earns ₹50,000 per month (flow)
National Income Calculation Methods
How is national income estimated according to the income method? The income method
calculates national income by summing all factor incomes:

1. Compensation of employees: Wages, salaries, benefits paid to workers

2. Rent: Income from lending property
3. Interest: Income from lending money
4. Profit: Corporate profits, dividends
5. Mixed income: Income of unincorporated enterprises (self-employed)

Adjustments made:

 Add: Taxes on production and imports

 Subtract: Subsidies
 Add: Consumption of fixed capital (depreciation) for GDP
 Subtract: Consumption of fixed capital for NDP

Explain the methods of national income calculation:

1. Income Method:
o Sum all factor incomes (wages, rent, interest, profit)
o Add taxes on products minus subsidies
o Add depreciation (for GDP)
o Advantage: Shows income distribution
o Challenge: Difficult to separate mixed income
2. Expenditure Method:
o Sum all final expenditures: C + I + G + (X-M)
o C = Consumer spending
o I = Investment spending
o G = Government spending
o X-M = Net exports
o Advantage: Shows composition of demand
 o Challenge: Difficult to differentiate final and intermediate goods
3. Value Added Method:
o Sum value added at each production stage
o Value added = Output value - Intermediate input value
o Calculated sector by sector
o Advantage: Shows sectoral contribution
o Challenge: Requires detailed production data

How is GDP estimated under expenditure method? GDP using expenditure method is
calculated as:

GDP = C + I + G + (X-M)

Where:

 C (Consumption): Household final consumption expenditure

o Durable goods (furniture, appliances)
o Non-durable goods (food, clothing)
o Services (education, healthcare)
 I (Investment): Gross domestic capital formation
o Fixed capital formation (machinery, buildings)
o Changes in inventories
o Excludes financial investments
 G (Government): Government final consumption expenditure
o Public services (defense, administration)
o Public goods (roads, bridges)
o Excludes transfer payments (pensions, subsidies)
 X-M (Net exports): Exports minus imports
o X = Exports of goods and services
o M = Imports of goods and services

Explain value added method: The value added method calculates GDP by summing the value
added at each stage of production:
  Value added = Value of output - Value of intermediate inputs used
 Prevents double counting in GDP calculation
 Calculated for each enterprise or industry, then summed

Process:

1. Identify all productive enterprises in the economy

2. Calculate gross output value for each
3. Calculate intermediate consumption value for each
4. Subtract intermediate consumption from gross output to get value added
5. Sum all value added across the economy

Example:

 Farmer sells wheat for ₹100

 Miller buys wheat, makes flour, sells for ₹150
 Baker buys flour, makes bread, sells for ₹250
 Value added: Farmer (₹100), Miller (₹50), Baker (₹100)
 Total value added = ₹250 (equals final product value)

Circular Flow of Income

Explain the circular flow of income in three sector and four sector model with a neat
diagram:

Three Sector Model includes:

1. Households: Supply factors of production, receive income, spend on goods and services
2. Firms: Use factors of production, produce goods and services, earn revenue
3. Government: Collects taxes, provides public goods, makes transfer payments

Flows:

 Households provide labor to firms and receive wages

 Firms provide goods to households and receive payment
  Government collects taxes from both
 Government provides goods, services and transfers

Four Sector Model adds: 4. Foreign sector: Other countries that engage in trade and financial
transactions

Additional flows:

 Exports: Goods and services sold to foreign countries

 Imports: Goods and services bought from foreign countries
 Foreign investment flows in both directions
 Foreign transfer payments and receipts

Leakages and injections:

 Leakages: Savings, taxes, imports

 Injections: Investment, government spending, exports
 Equilibrium when leakages = injections

Inflation

What is Inflation? Explain different types of inflation and its control measures:

Inflation: Persistent increase in the general price level of goods and services in an economy over
a period of time

Types of inflation:

1. Demand-pull inflation:
o Caused by excess aggregate demand relative to available supply
o "Too much money chasing too few goods"
o Causes: Increased consumer spending, government spending, investment, exports
o Graph shows rightward shift of aggregate demand curve
2. Cost-push inflation:
o Caused by increases in costs of production
 o Triggers include wage increases, raw material costs, indirect taxes
o Results in higher prices even with stable demand
o Graph shows leftward shift of aggregate supply curve

Control measures:

1. Monetary measures:
o Increase interest rates to reduce borrowing
o Reduce money supply through higher reserve requirements
o Open market operations (selling government securities)
o Credit rationing and control
2. Fiscal measures:
o Reduce government spending
o Increase taxes to reduce disposable income
o Reduce budget deficit
o Control public expenditure

Effectiveness comparison:

 Monetary policy works better for demand-pull inflation

 Supply-side policies needed for cost-push inflation
 Combination usually most effective
 Monetary policy can work faster but may hurt growth
 Fiscal policy can be more targeted but takes time to implement

How are monetary policy measures used to control inflation:

1. Increase bank rate: Central bank raises interest rate for lending to commercial banks
o Commercial banks raise interest rates for customers
o Higher rates discourage borrowing and spending
o Reduces money supply and aggregate demand
2. Increase Cash Reserve Ratio (CRR): Higher percentage of deposits banks must keep
with central bank
 o Reduces banks' lending capacity
o Less credit creation in economy
o Tightens money supply
3. Increase Statutory Liquidity Ratio (SLR): Higher percentage of deposits banks must
keep in liquid assets
o Further reduces lending capacity
o Controls credit expansion
4. Open Market Operations: Central bank sells government securities
o Buyers pay money to central bank
o Money moves from circulation to central bank
o Reduces money supply in economy
5. Credit rationing: Direct controls on bank lending
o Limits on loans for specific sectors
o Priorities for essential sectors

Explain cost push inflation with the help of a diagram. What are the effects of inflation on
production and distribution?

Cost-push inflation diagram: Shows aggregate supply curve shifting leftward due to increased
production costs, resulting in higher price level and lower output.

Effects on production:

1. Reduced output: Higher costs may force cutting production

2. Uncertainty: Makes planning difficult
3. Misallocation of resources: Investment decisions distorted
4. Lower quality: Firms may compromise quality to maintain profits
5. Production bottlenecks: Supply chain disruptions

Effects on distribution:

1. Fixed income groups suffer: Pensioners, salaried workers lose purchasing power
2. Creditors lose, debtors gain: Loans repaid in less valuable money
 3. Savers lose: Real value of savings erodes
4. Speculative gains: Asset holders may benefit
5. Wage-price spiral: Workers demand higher wages, increasing costs further
6. Income inequality: Different groups affected differently

Financial Markets

Distinguish between Money market and Capital market:

Money Market:

 Deals with short-term funds (up to one year)

 Instruments: Treasury bills, commercial paper, certificates of deposit
 Purpose: Managing liquidity, working capital needs
 Lower risk, lower return
 Participants: Banks, financial institutions, corporations
 Examples: Call money market, commercial paper market

Capital Market:

 Deals with long-term funds (more than one year)

 Instruments: Stocks, bonds, debentures
 Purpose: Long-term investment, capital formation
 Higher risk, higher potential return
 Participants: Individual investors, institutional investors, corporations
 Examples: Stock exchanges, bond markets

What is a Trading account?

 An account used for buying and selling securities in the stock market
 Linked to a bank account for fund transfers
 Required to trade in securities (stocks, bonds, derivatives)
 Operated through a broker or trading platform
 Shows transaction history, current holdings, profit/loss
  Usually linked to demat account for holding securities

What is government securities?

 Debt instruments issued by the government to finance public expenditure

 Considered safest investment (sovereign guarantee)
 Types include:
o Treasury Bills (short-term, up to 1 year)
o Government Bonds (long-term, 1-30 years)
o Dated Securities
 Features:
o Fixed interest rate (coupon)
o Regular interest payments
o Face value returned at maturity
o Highly liquid, tradable in secondary market

Monetary Policy

What is monetary policy? What are the monetary policy measures?

Monetary policy: The actions of a central bank to influence the money supply and interest rates
to achieve macroeconomic objectives (price stability, growth, employment)

Monetary policy measures:

1. Bank rate (Discount rate):

o Interest rate at which central bank lends to commercial banks
o Higher rate → tighter policy → less borrowing → less money supply
o Lower rate → expansionary policy → more borrowing → more money supply
2. Cash Reserve Ratio (CRR):
o Percentage of deposits banks must keep with central bank
o Higher CRR → less lending capacity → less money supply
o Lower CRR → more lending capacity → more money supply
3. Statutory Liquidity Ratio (SLR):
 o Percentage of deposits banks must invest in approved securities
o Higher SLR → less funds for lending → less money supply
o Lower SLR → more funds for lending → more money supply
4. Open Market Operations (OMO):
o Buying government securities → increases money supply
o Selling government securities → decreases money supply
o Direct way to add or remove money from circulation
5. Repo Rate and Reverse Repo Rate:
o Repo: Rate at which central bank lends short-term to banks
o Reverse Repo: Rate at which central bank borrows from banks
o Affects interbank lending rates and overall market rates

How does open market operation work to affect the money supply?

Open Market Operations (OMO): Buying or selling of government securities by the central
bank in the open market

When central bank buys securities:

1. Central bank purchases government securities from banks or public

2. Money flows from central bank to sellers
3. Banking system has more cash reserves
4. Banks can create more credit through loans
5. Money supply increases in economy
6. Interest rates tend to fall
7. Used during recession or low growth

When central bank sells securities:

1. Central bank sells government securities to banks or public

2. Money flows from buyers to central bank
3. Banking system has less cash reserves
4. Banks' credit creation capacity reduced
 5. Money supply decreases in economy
6. Interest rates tend to rise
7. Used during inflation or overheating economy

Stock Market

Write notes on NIFTY and SENSEX:

NIFTY:

 Full name: National Stock Exchange Fifty

 Stock index of National Stock Exchange (NSE)
 Represents 50 large, liquid Indian companies
 Well-diversified across sectors
 Free-float market capitalization weighted index
 Base value of 1000 (November 3, 1995)
 Managed by India Index Services and Products Ltd. (IISL)
 Widely used benchmark for funds and derivative products

SENSEX:

 Full name: Sensitive Index

 Stock index of Bombay Stock Exchange (BSE)
 Represents 30 large, liquid Indian companies
 Oldest stock index in India
 Free-float market capitalization weighted index
 Base value of 100 (1978-79)
 Widely tracked indicator of Indian stock market
 Often quoted in international financial media

Demat and Trading account:

Demat account:
  Electronic account to hold shares and securities
 Eliminates physical share certificates
 Reduces risks of theft, forgery, damage
 Faster transfers and settlements
 Maintained by depositories (NSDL, CDSL)
 Required for trading in Indian stock markets

Trading account:

 Used to buy and sell securities

 Linked to bank account and demat account
 Provided by stockbrokers
 Shows transaction history and current positions
 Functions like a bridge between bank and demat account
 Necessary for placing orders in the market

Bank Rate vs. CRR and SLR:

Bank Rate:

 Interest rate at which central bank lends to commercial banks

 For longer-term loans
 Signals central bank's monetary policy stance
 Affects commercial banks' lending rates
 Tool to control inflation and money supply

CRR (Cash Reserve Ratio):

 Percentage of net demand and time liabilities banks must keep with central bank
 Held as cash reserves with central bank
 Earns no interest (opportunity cost for banks)
 Direct control on money multiplier
 Quick impact on liquidity
SLR (Statutory Liquidity Ratio):

 Percentage of deposits banks must maintain in liquid assets

 Includes cash, gold, government securities
 Ensures bank solvency and liquidity
 Can be used to channel funds to government
 Controls credit expansion in economy
MODULE 5: INTERNATIONAL TRADE AND BALANCE
OF PAYMENTS
1. International Trade Basics

What is international trade? List out the advantages of foreign trade. (3 marks)

 Definition: Exchange of goods and services between countries

 Advantages:
1. Specialization - Countries produce what they're best at
2. Wider variety of goods - Access to products not available locally
3. Lower prices - Competition from imports reduces prices
4. Technology transfer - Advanced technology comes with trade
5. Better resource use - Resources used more efficiently
6. Larger markets - Companies can sell to bigger customer base

What is free trade? (3 marks)

 Trade without any barriers or restrictions

 No tariffs, quotas, or licenses needed
 Market forces decide what to trade
 Based on comparative advantage principle

What are the advantages of protectionism in international trade. (3 marks)

1. Protects infant industries - New industries get time to grow

2. Saves domestic jobs - Local workers keep employment
3. Anti-dumping - Prevents selling below cost by foreign companies
4. Strategic industries - Protects defense and essential industries
5. Diversification - Reduces dependence on few products

2. Trade Theories

Explain absolute advantage theory with the help of an example. (7 marks)

  Definition: Country produces goods using less resources than others
 Example:
o India needs 10 workers to make 1 car, USA needs 5 workers
o India needs 2 workers to make 100kg rice, USA needs 8 workers
o USA has absolute advantage in cars (needs fewer workers)
o India has absolute advantage in rice (needs fewer workers)
o So USA should make cars, India should grow rice - both benefit

Examine the comparative cost theory. Point out any two criticisms against this theory. (7
marks)

 Theory: Countries should produce goods with lower opportunity cost

 Works when no absolute advantage exists
 Example: Even if USA is better at both cars and rice, if India's opportunity cost for rice
is lower, India should produce rice
 Criticisms:
1. Assumes only labor costs matter - ignores capital and technology
2. Ignores transport costs - shipping might make trade unprofitable
3. Assumes perfect mobility - workers can't always switch jobs easily
4. No government intervention - real world has tariffs and quotas

Explain Heckscher-Ohlin theory. (3 marks)

 Countries export goods using their abundant factors

 Labor-rich countries export labor-intensive goods
 Capital-rich countries export capital-intensive goods
 Example: India (labor-rich) exports textiles, USA (capital-rich) exports machines

State and explain the Heckscher-Ohlin theory of international trade. (8 marks)

 Basic idea: Countries export what uses their abundant resources

 Two factors: Labor and Capital
 Example:
 o India has lots of labor but less capital
o USA has lots of capital but expensive labor
o India exports labor-intensive goods (textiles, handicrafts)
o USA exports capital-intensive goods (machinery, technology)
 Result: Both countries benefit from this trade pattern

3. Balance of Payments

What is balance of payments? List out its components. (3 marks)

 Definition: Record of all money flows between a country and rest of world
 Components:
1. Current Account - Trade in goods/services, income, transfers
2. Capital Account - Purchase/sale of assets
3. Financial Account - Investment flows
4. Errors and Omissions - Statistical discrepancies

What is BOP? (3 marks)

 Balance of Payments - systematic record of economic transactions

 Shows money coming in vs going out
 Must always balance (sum equals zero)
 Important for economic health monitoring

What is meant by BOP? What are the measures to correct disequilibrium in BOP? (7
marks)

 BOP: Complete record of international transactions

 Disequilibrium: When imports exceed exports (deficit)
 Correction measures:
1. Devaluation - Make currency cheaper
2. Import controls - Quotas and tariffs
3. Export promotion - Subsidies for exporters
4. Foreign loans - Borrow to cover deficit
 5. Deflation - Reduce domestic spending
6. Exchange controls - Limit foreign currency access

Point out any three items coming under unilateral transfers account. (3 marks)

1. Gifts and donations - Money sent without expecting return

2. Foreign aid - Help from other countries
3. Worker remittances - Money sent home by workers abroad
4. Pensions - Payments to retired people living abroad

4. Currency and Exchange Rates

What is devaluation? (3 marks)

 Government deliberately reduces value of its currency

 Makes exports cheaper and imports expensive
 Done to improve balance of payments
 Different from depreciation (market-driven fall)

Differentiate between devaluation and depreciation. (3 marks)

 Devaluation:
o Government decision
o Happens in fixed exchange rate system
o Deliberate policy action
 Depreciation:
o Market forces decide
o Happens in floating exchange rate system
o Natural market movement

What do you mean by devaluation? Explain the conditions for its success. (4 marks)

 Devaluation: Official reduction in currency value

 Success conditions:
 1. Elastic demand - Exports/imports respond to price changes
2. Spare capacity - Can produce more for export
3. Stable prices - Inflation doesn't eat up benefits
4. No retaliation - Other countries don't devalue too

5. Trade Barriers

Examine the tariff and non-tariff barriers to international trade. (4 marks)

 Tariff barriers:
o Import duties/taxes
o Makes imports expensive
o Government gets revenue
 Non-tariff barriers:
o Quotas - Limit on quantity
o Licenses - Permission needed
o Technical standards - Safety rules
o Subsidies - Help to local producers

What are tariff barriers? Explain its impact on the economy. (7 marks)

 Definition: Taxes on imported goods

 Types:
o Specific tariff - Fixed amount per unit
o Ad valorem - Percentage of value
 Economic impacts:
1. Higher prices for consumers
2. Protection for local industry
3. Government revenue
4. Less efficient resource use
5. Possible retaliation from other countries
6. Reduced consumer choice
What are types of non-tariff barriers? (4 marks)

1. Quotas - Maximum quantity allowed

2. Licenses - Need permission to import
3. Voluntary Export Restraints - Exporter limits quantity
4. Technical barriers - Product standards and regulations
5. Subsidies - Government support to local producers
6. Administrative delays - Slow customs procedures

6. Trade Policy

Differentiate between free trade and protectionism. List any six arguments in support of
protectionism (10 marks)

 Free Trade:
o No barriers to trade
o Market decides everything
o Based on comparative advantage
 Protectionism:
o Barriers to protect local industry
o Government controls trade
o Limits foreign competition

Arguments for protectionism:

1. Infant industry - New industries need time to grow

2. Employment - Protects local jobs
3. Dumping prevention - Stops unfair pricing
4. National security - Protects strategic industries
5. Revenue - Tariffs give government money
6. Balance of payments - Reduces imports

What is protection? State any five arguments in favour of protection. (7 marks)

  Protection: Government policies to help domestic industries
 Arguments:
1. Infant industry argument - Young industries can't compete initially
2. Anti-dumping - Prevents selling below cost
3. Employment protection - Saves local jobs
4. Strategic industries - Defense and essential goods
5. Diversification - Reduces dependence on few products

Explain any four measures to solve the problem of deficit in the balance of payments. (8
marks)

1. Devaluation/Depreciation:
o Makes exports cheaper
o Makes imports expensive
o Improves trade balance
2. Import restrictions:
o Tariffs raise import prices
o Quotas limit quantities
o Reduces import spending
3. Export promotion:
o Subsidies to exporters
o Tax benefits
o Better infrastructure
4. Deflation policy:
o Reduce domestic spending
o Lower imports naturally
o Control inflation

7. Marshall-Lerner Condition

What is Marshall-Lerner condition? (3 marks)

 Sum of price elasticities of exports and imports must exceed 1

 Only then will devaluation improve balance of payments
 Formula: |Ex| + |Em| > 1
 Where Ex = export elasticity, Em = import elasticity