Answers to practice questions:

Unit I 4 Marks:-

Briefly write on the differences between normative economics and positive economics
=Normative economics involves making value judgments and recommending
what should be done in economics, often relying on ethical considerations and
personal values to guide policy prescriptions. In contrast, positive economics
focuses on objective analysis and describing economic phenomena as they are,
free from moral judgments or policy recommendations, relying on empirical data
and scientific methods to understand economic behavior and relationships.

write on the connection between Economics and HRM.

=Economics and Human Resource Management (HRM) are closely connected

disciplines within the broader field of business and organizational management.
Economics provides the foundational principles and analytical tools that help
HRM professionals make informed decisions and manage human capital
effectively. HRM involves the recruitment, selection, training, compensation, and
retention of employees, and these activities have direct economic implications
for organizations. Economics plays a crucial role in HRM by providing insights into
labor markets, supply and demand for specific skills, wage determination, and
the cost-benefit analysis of HR policies. Additionally, economic theories like
agency theory and human capital theory are often used to understand and
improve HR practices.

 Briefly write on the connection between Marketing and Managerial Economics 4

=Economics and managerial economics are intimately connected
disciplines that both deal with the allocation of scarce resources to
achieve specific objectives. Managerial economics is essentially the
application of economic principles and tools to solve business problems
and make decisions within a firm. It provides a bridge between the
broader economic theory and the practical decision-making needs of
managers. In this context, economics provides the theoretical foundation
and concepts, such as supply and demand, cost analysis, market
structures, and pricing theory, that managerial economics relies on to
analyze issues like pricing strategies, production optimization, resource
allocation, and risk assessment.

 Briefly write on the connection between Decision Making and Managerial Economics
4
= The connection between decision-making and managerial economics is
fundamental to the field. Managerial economics provides the analytical
tools and methodologies that aid decision-makers within organizations in
making rational, informed choices. It helps managers assess various
alternatives, analyze costs and benefits, and understand how different
factors, such as demand, competition, and resource constraints, impact
decision outcomes. In essence, managerial economics equips decision-
makers with the economic insights needed to optimize resource allocation,
set pricing strategies, determine production levels, assess investment
opportunities, and manage risks effectively.
 Briefly write on the connection between Mathematics and Statistics, and Managerial
Economics 4
= Mathematics and statistics play a crucial role in the field of managerial
economics. Mathematics provides the quantitative tools and techniques
for analyzing economic data, modeling relationships, and solving
optimization problems. Concepts from calculus, algebra, and linear
programming, for example, are used to derive cost functions, demand
curves, and profit-maximizing output levels. Statistics, on the other hand,
helps in collecting, summarizing, and interpreting data relevant to
managerial decision-making.
 Briefly write on the connection between Computer Applications and Managerial
Economics 4
=Computer applications are closely intertwined with managerial
economics, enhancing the decision-making process within organizations.
These applications enable the collection, storage, analysis, and
visualization of large volumes of economic data in real-time. They
facilitate complex calculations, simulations, and optimization models,
making it easier for managers to assess various scenarios, evaluate
market trends, and formulate strategies. Moreover, computer applications
allow for the automation of routine tasks, such as data entry and financial
analysis, freeing up time for managers to focus on more strategic aspects
of managerial economics.

 Briefly describe the role of managerial economics in the daily life of common people.
4
= Managerial economics may not have a direct impact on the daily life of
common people in the same way it does within businesses or
organizations. However, its principles indirectly influence various aspects
of everyday life. For instance, managerial economics helps firms make
pricing decisions, which can affect the cost of goods and services that
consumers purchase. It also plays a role in resource allocation and
production decisions, which can impact job availability and wage
levels. Additionally, government policies influenced by economic analysis,
such as taxation and regulations, can affect individuals' incomes,
expenses, and overall economic well-being

Briefly write on the connection between the improvement of products of a certain brand
and profit maximization. 7
=The connection between improving the products of a certain brand and
profit maximization is closely linked to customer satisfaction and market
competitiveness. When a brand invests in enhancing the quality, features,
or overall appeal of its products, it can achieve several benefits that
contribute to profit maximization:

1. Increased Customer Loyalty: High-quality and improved products

tend to satisfy customers more effectively. Satisfied customers are
more likely to become loyal to the brand, leading to repeat
purchases and long-term relationships.
2. Premium Pricing: Brands with superior products can often command
premium prices, which can result in higher profit margins.
Customers may be willing to pay more for products they perceive as
better in quality or value.
3. Market Expansion: Improved products can attract new customers
and expand the brand's market share. This growth in customer base
can lead to increased sales and revenue.
4. Competitive Advantage: In competitive markets, offering better
products can differentiate a brand from its rivals. This differentiation
can lead to a stronger market position, reduced price competition,
and higher profitability.
5. Reduced Costs: Over time, product improvements can lead to cost
efficiencies, such as reduced defects or maintenance expenses,
which can contribute to higher profits.
6. Positive Brand Image: Consistently enhancing product quality can
build a positive brand image, reinforcing customer trust and
goodwill.

2.Autumn is a festive season in India. This time the sweet products face high demand. As a
sweet maker, what would be your strategy to maximize short-run profit? 7
= To maximize short-run profit as a sweet maker during the festive season
in India, you can implement several strategies:

1. Product Mix: Focus on producing and promoting the most popular

and high-demand sweets traditionally associated with the autumn
festivals, such as Diwali and Navratri. Ensure you have a variety of
these traditional sweets like Gulab Jamun, Jalebi, Ladoo, and Barfi.
2. Efficient Production: Optimize your production processes to
minimize wastage and maximize output. Efficient production can
help reduce costs and increase profitability.
3. Pricing: Carefully set your prices to balance profit margins with
customer affordability. Consider offering special festive discounts or
bundled deals to attract more customers.
4. Marketing and Promotion: Invest in targeted marketing and
advertising campaigns to create awareness about your sweets.
Leverage social media, local events, and traditional marketing
channels to reach a wider audience.
 5. Seasonal Packaging: Create festive and attractive packaging for
your sweets to make them more appealing to customers and
suitable for gifting during the festivals.
6. Quality Control: Maintain strict quality control to ensure that your
sweets meet customer expectations. High-quality products can lead
to repeat business and positive word-of-mouth recommendations.
7. Inventory Management: Keep a close eye on your inventory levels to
avoid overstocking or understocking. You want to meet demand
without incurring unnecessary storage costs.
8. Staffing: Hire temporary staff or increase shifts during the peak
season to handle the higher production and sales volume efficiently.

Distinguish between short-run and long-run production functions with diagrams.10

= A short-run production function refers to that period of

time, in which the installation of new plant and machinery to
increase the production level is not possible. On the other hand,
the Long-run production function is one in which the firm
has got sufficient time to instal new machinery or capital
equipment, instead of increasing the labour units.
(1) Short Run Production Function:
 In the short run, the technical conditions of production are rigid so that the various
inputs used to produce a given outputs are in fixed proportions.
 However, in the short run, it is possible to increase the quantities of one input
while keeping the quantities of other inputs constant in order to have more output.
 This aspect of the production function is known as the Law of Variable Proportions.
 The short run production function in the case of two inputs, labour and capital
with capital as fixed and labour as the variable input can be expressed as Where K
refers to the fixed input.
Q=f(L,R)-
 This production function is depicted in Figure 1 where the slope of the curve shows
the marginal production of labor.
  A movements along the production function shows the increase in outputs as
labour increases, given the amount of capital employed K1�1 , If the amount of
capital increases to K2�2 , at a point of time, the production function Q = f (L, K1 )
shifts upwards to Q = f (L, K2 ), as shown in the figure.
 On the other hand, if labour is taken as a fixed input and capital as the variable
input, the production function takes the form,
Q=f(KL)�=�(��)

 This production function is depicted in Figure 2 where the slope of the curve
represents the marginal product of capital.

(2) Long Run Production Function:

 In the long run all inputs are variable. Production can be increased by changing
one or more of the inputs. The firm can changes its plants or scale of production.
 Equations (1) and (2) represent the long-run production function. Given the level of
technology, a combination of the quantities of labour and capital produces a
specified level of output.
 The long run production function is depicted in Figure 3 where the combination of
OK of capital and OL of labour produced 100Q.
 With the increase in inputs of capital and labour to and , the output increases to
200Q. The long run production function is shown in terms of an isoquant such as
100 Q.
 In the long run, it is possible for a firm to change all to change all inputs up or down
in accordance with its scale. This is known as returns to scale.
 The returns to scale are constant when output increases in the same proportion as
the increase in the quantities of inputs.
 The returns to scale are increasing when the increased in output is more than
proportional to the increase in inputs. They are decreasing if the increase in output
is less than proportional to the increase in inputs.
 Let us illustrate the case of constant returns to scale with the help of our
production function.
Q=(L,M,N,KT2)

 Given , if the quantities of all inputs L,M,N,K are increased n-fold the output Q also
increases n-fold. Then the production function becomes,

nQ=f(nL,nM,nN,nK)

 This is known as linear an homogeneous production function, or a homogeneous

function of the first degree. If the homogeneous function is of the kth degree, the
production function is,

nkQ=f(nL,nM,nN,nK)
  If k is equal to 1, it is a case of constant returns to scale; if it is greater than 1, it is a
case of increasing returns of scale; and if it is less than 1, it is a case of decreasing
returns to scale.

Our country is a thickly populated emerging economy. The size of the population matters
in matters of government policies. Suppose you have a business of making clay idols
which can be made manually or using dyes. The manual method turns out less number of
outputs in a day compared to the method of using dyes. In the upcoming Navratri festival,
the clay idol market is expecting a huge rush of buyers. You have the choice of recruiting
more manual laborers or recruiting relatively fewer number labourers having the skill of
operating dyes. So you have to state which choice you will exercise and the rationale
behind your decision. 7
= In the context of a clay idol manufacturing business in India, where the
upcoming Navratri festival is expected to bring a surge in demand, the
choice between recruiting more manual laborers or fewer skilled laborers
operating dyes depends on various factors. However, considering the
circumstances, it is generally advisable to opt for recruiting skilled
laborers operating dyes, and here's the rationale behind this decision:

1. Productivity and Output: Using dyes typically results in a higher

output per laborer compared to the manual method. This is crucial
when there is a surge in demand during festivals like Navratri.
Skilled laborers operating dyes can produce a greater number of
clay idols per day, which helps meet the increased market demand
efficiently.
2. Quality Control: Skilled laborers are more likely to produce
consistent and high-quality clay idols because the dye-operating
process allows for precision and uniformity. In contrast, manual
labor may result in variations in the final products, which can be a
concern when maintaining product quality is essential.
3. Time Efficiency: Dye-operated processes are generally faster than
manual labor. With limited time before the festival, it's crucial to
produce a sufficient quantity of clay idols to meet customer
demand. Skilled laborers can help achieve this more effectively.
4. Cost Considerations: While skilled labor may be paid higher
wages than unskilled labor, the higher productivity and efficiency
can often offset the increased labor costs. Additionally, it can reduce
wastage, which is common in manual processes.
5. Market Competition: During festivals, there can be intense
competition in the clay idol market. To stay competitive, a business
needs to offer a variety of options and meet customer demand
promptly. Using dyes and skilled labor can help the business
respond effectively to market dynamics.
6. Scalability: The use of dyes and skilled laborers allows for
scalability, which means the business can quickly adjust production
levels based on market demand. This flexibility is valuable during
festive seasons when demand can fluctuate significantly.
 7. Customer Satisfaction: Meeting customer demand with high-
quality products in a timely manner enhances customer satisfaction
and can lead to repeat business and positive word-of-mouth
referrals.

In summary, given the expected surge in demand during the Navratri

festival, the choice to recruit fewer skilled laborers operating dyes is a
prudent one. It allows for higher productivity, better quality control, time
efficiency, and flexibility to meet market demands effectively, ultimately
contributing to maximizing profits and customer satisfaction in the clay
idol business.

What is the connection between profit and wage? Describe how motivation for
skill-upgradation training as a tool is used in extracting more output or work
from employees in the matter of profit maximization of a business.
= The connection between profit and wages lies in the way businesses
manage their labor force, compensation policies, and employee
motivation. Wages, as a component of a company's cost structure,
directly impact profitability. To maximize profit, businesses often seek to
optimize the relationship between wages and employee productivity. Skill-
upgradation training can be a valuable tool in achieving this optimization.

Here's how motivation for skill-upgradation training can contribute to

extracting more output or work from employees and, in turn, profit
maximization:

1. Enhanced Productivity: Skill-upgradation training equips

employees with new knowledge and abilities, making them more
efficient and effective in their roles. When employees are better
skilled, they can produce more output in less time, contributing to
increased productivity.
2. Quality Improvement: Training can also lead to improved quality
of work. Employees with upgraded skills are less likely to make
errors or produce subpar products or services, reducing the costs
associated with defects, rework, and customer complaints.
3. Employee Engagement and Satisfaction: Investing in employee
development through training demonstrates that the company
values its workforce. This can boost morale, job satisfaction, and
overall engagement. Motivated and satisfied employees tend to be
more committed to their work and can be more productive.
4. Reduced Turnover: Employees who see opportunities for skill
development and career advancement within the company are less
likely to leave. Reducing employee turnover not only saves on
recruitment and training costs but also promotes stability and
continuity, which can benefit the bottom line.
5. Adaptation to Technological Changes: In a rapidly evolving
business environment, skill-upgradation training can help
employees stay current with the latest technologies and industry
 trends. This adaptability is crucial for remaining competitive and
profitable.
6. Competitive Advantage: Companies with a skilled and motivated
workforce are better positioned to outperform competitors. They
can offer superior products or services, respond to market changes
more quickly, and attract a loyal customer base.
7. Cost Control: While there is an initial investment in training, the
long-term benefits in terms of increased productivity and reduced
costs can outweigh the upfront expenses. Skilled employees are
often more cost-effective over time.
8. Innovation and Creativity: Skill-upgradation training can foster
innovation and creativity among employees. Workers with enhanced
skills are more likely to contribute ideas and solutions that can lead
to process improvements or new revenue streams.
9. Customization of Training: Tailoring training programs to address
specific skills gaps within the workforce allows businesses to align
training efforts with their particular needs and objectives, ensuring a
direct impact on productivity and profitability.

In summary, the connection between profit and wages involves optimizing

the productivity and performance of the workforce. Motivation for skill-
upgradation training serves as a strategic tool to enhance employee
capabilities, reduce costs, and improve overall profitability. When
employees are equipped with the skills and knowledge necessary to excel
in their roles, they can contribute significantly to a company's success by
producing more output, maintaining quality, and driving innovation.

A company is a bunch of legal contracts.” Support or refute this statement with

arguments and real-life examples. 10

The statement "A company is a bunch of legal contracts" is a simplified

but accurate way to describe the legal structure and framework that
underlies the existence and operations of a business entity. While it may
be somewhat reductionist, it is supported by several arguments and real-
life examples:

1. Legal Entity Formation: When a company is established, it is

typically registered as a legal entity, such as a corporation, limited
liability company (LLC), or partnership. These legal structures are
formalized through contracts and agreements that outline
ownership, governance, and operational guidelines. For instance,
the articles of incorporation or operating agreement are legally
binding documents that define the company's structure.
 2. Ownership Agreements: In many businesses, especially those
with multiple owners or shareholders, legal contracts such as
shareholder agreements or partnership agreements are crucial.
These contracts specify the rights and responsibilities of each
owner, the distribution of profits, and dispute resolution procedures.
They provide the legal framework for ownership.
3. Employment Contracts: Employment contracts between a
company and its employees outline the terms of employment,
including salary, benefits, job responsibilities, and termination
procedures. These contracts are legally binding and protect both the
company and the employee.
4. Vendor and Supplier Contracts: Businesses often enter into
contracts with vendors and suppliers for the procurement of goods
and services. These contracts specify the terms of payment,
delivery, quality standards, and other important terms that govern
the relationship.
5. Customer Contracts: Customer contracts, such as sales
agreements or service agreements, define the terms under which a
company provides products or services to its customers. These
contracts establish pricing, delivery schedules, warranties, and
other terms that protect both parties.
6. Lease Agreements: If a business operates from a physical
location, it typically enters into lease agreements for its premises.
These contracts specify rent, lease duration, maintenance
responsibilities, and other terms that legally bind both the lessor
and lessee.
7. Intellectual Property Contracts: Companies often create,
license, or protect intellectual property through contracts. For
example, licensing agreements specify how a company's trademark
or copyrighted material can be used by others, while non-disclosure
agreements (NDAs) protect sensitive information.
8. Financing Agreements: When a company seeks external
financing, it enters into contracts with lenders or investors. These
contracts outline the terms of the investment, interest rates,
repayment schedules, and other financial arrangements.

Real-life Example: Consider the case of a publicly traded company like

Apple Inc. Its existence and operations are governed by a complex web of
legal contracts, including its corporate charter, bylaws, contracts with
suppliers for components of its products, employment contracts for its
workforce, shareholder agreements, and contracts with consumers who
purchase its devices and services. These legal contracts define Apple's
structure, obligations, and relationships, and they underpin its ability to
operate and generate profit.

In conclusion, while a company is more than just a collection of legal

contracts, these contracts form the legal foundation and structure that
allow a business to function, define its relationships with various
stakeholders, and protect its interests. In this sense, the statement that "A
company is a bunch of legal contracts" is a valid way to emphasize the
importance of the legal framework within which businesses operate.

Describe how you can see a business from the viewpoint of legal contracts.7
Viewing a business from the viewpoint of legal contracts involves
recognizing the critical role that legal agreements and obligations play in
shaping the structure, operations, and relationships within the business.
Here's how you can see a business through the lens of legal contracts:

1. Formation and Structure: Begin by understanding the legal

contracts that establish the business entity itself. This includes
articles of incorporation, partnership agreements, operating
agreements, or any other foundational documents that define the
company's legal structure, ownership, and governance.
2. Ownership and Governance: Examine contracts related to
ownership, such as shareholder agreements or partnership
agreements. These contracts outline the rights and responsibilities
of owners, the allocation of profits and losses, and decision-making
processes. They define the corporate governance structure,
including the roles of directors and officers.
3. Employment and Labor Contracts: Explore employment
contracts that govern the relationship between the business and its
employees. These contracts detail compensation, benefits, job
responsibilities, non-compete agreements, and termination
procedures. They ensure that both the company and employees
understand their rights and obligations.
4. Vendor and Supplier Contracts: Analyze contracts with vendors
and suppliers, as they are critical for the procurement of goods and
services. These contracts specify terms such as pricing, delivery
schedules, quality standards, payment terms, and dispute resolution
mechanisms.
5. Customer Contracts: Review contracts with customers, which may
take the form of sales agreements, service contracts, or terms and
conditions. These contracts set out the terms under which the
company provides products or services, including pricing,
warranties, delivery expectations, and return policies.
6. Leases and Real Estate Contracts: Examine lease agreements if
the business operates from physical locations. These contracts
define rent, lease duration, maintenance responsibilities, and other
terms related to the use of real estate.
7. Intellectual Property Contracts: Understand contracts related to
intellectual property (IP), including licensing agreements, copyright,
trademark, or patent agreements. These contracts protect the
company's IP assets and specify how others can use or access them.
8. Financing Agreements: Scrutinize contracts associated with
financing, such as loan agreements, credit agreements, or investor
 contracts. These documents outline terms of investment, interest
rates, repayment schedules, and covenants imposed by lenders or
investors.
9. Regulatory and Compliance Contracts: Be aware of contracts
related to regulatory compliance. These may include agreements
with regulatory authorities, compliance with industry standards, or
contractual obligations to protect customer data and privacy.
10. Mergers and Acquisitions: In the case of mergers or
acquisitions, examine acquisition agreements, purchase
agreements, and due diligence reports. These contracts dictate the
terms of the transaction, including the purchase price, asset
transfers, and post-acquisition obligations.
11. Dispute Resolution and Liability Mitigation: Finally,
consider contracts that address dispute resolution mechanisms,
indemnification clauses, and liability limitations. These contracts
help manage legal risks and liabilities that the business may
encounter.

By analyzing a business from the viewpoint of legal contracts, you gain

insight into the legal obligations, rights, and relationships that shape its
daily operations and strategic decisions. This perspective helps ensure
compliance with the law, protect the business's interests, and manage
potential risks effectively.

In a matter of long-run profit maximization, suggest with logic some ways to minimize
indirect costs like transaction costs 7
= Minimizing indirect costs, such as transaction costs, in the pursuit of
long-run profit maximization involves optimizing business processes and
strategies to reduce the expenses associated with transactions. Here are
several ways to achieve this with logical reasoning:

1. Vertical Integration: Consider vertical integration, where a

company acquires or merges with suppliers or distributors. By
bringing parts of the supply chain in-house, you can reduce
transaction costs related to negotiations, contracts, and
coordination with external partners. For example, a manufacturer
might acquire a supplier to ensure a stable and cost-efficient supply
of essential materials.
2. Long-Term Contracts: Establish long-term contracts with
suppliers, customers, and other business partners. Long-term
commitments reduce the need for frequent negotiations and
transactions, leading to lower transaction costs over time. Moreover,
long-term relationships can foster trust and cooperation.
3. Electronic Procurement and Sales: Embrace e-commerce and
digital platforms for procurement and sales processes. These
technologies streamline transactions by automating order
 processing, invoicing, and payments. They also reduce paperwork
and administrative overhead, lowering transaction costs.
4. Standardization: Standardize products, processes, and contracts
whenever possible. Standardization simplifies transactions by
making terms and conditions more uniform and predictable. It
reduces the need for custom negotiations, legal reviews, and other
transaction-related activities.
5. Supplier Relationships: Build strong and collaborative
relationships with key suppliers. A cooperative supplier relationship
can lead to better terms, such as volume discounts, extended
payment terms, and lower prices. These benefits directly reduce
transaction costs associated with procurement.
6. Supplier Evaluation: Regularly evaluate and assess supplier
performance. By monitoring supplier quality, reliability, and
responsiveness, you can identify and address issues promptly,
reducing transaction costs related to dispute resolution and quality
control.
7. Technology Investments: Invest in technology solutions like
Enterprise Resource Planning (ERP) systems, which integrate
various business processes, including procurement, inventory
management, and finance. These systems can i

 Describe the role of property and property rights in business with real-life
examples. 10

= Property and property rights play a fundamental role in business by

providing a legal framework that defines ownership, control, and the
ability to use assets for productive purposes. These rights are essential for
the functioning of markets, the protection of investments, and the overall
growth of businesses. Here's an explanation of their role in business with
real-life examples:

1. Ownership and Investment Protection (2 marks):

 Property rights provide business owners with a legal claim to
their assets, ensuring that they can invest in and develop
these assets without fear of expropriation or unauthorized
use. This protection encourages entrepreneurs to invest time
and capital in their ventures.
 Real-life Example: Consider a small family-owned farm.
Property rights ensure that the family can own and cultivate
the land, make improvements, and plan for future generations
without the fear of someone else taking over the property.
2. Market Transactions and Trade (2 marks):
 Well-defined property rights facilitate trade and market
transactions. When individuals or businesses have confidence
 in their property rights, they are more likely to engage in
buying and selling activities.
 Real-life Example: Stock markets rely on clearly defined
property rights. When you purchase shares in a company, you
acquire property rights to a portion of that company's assets
and future profits, allowing for secondary market trading.
3. Collateral and Financing (2 marks):
 Property can be used as collateral to secure loans and
financing for business expansion. Lenders are willing to
provide credit when they have confidence in the borrower's
property rights and the enforceability of collateral.
 Real-life Example: Home mortgages are a common example.
Homeowners use their property as collateral to secure loans
for various purposes, including starting or expanding
businesses.
4. Innovation and Incentives (2 marks):
 Property rights incentivize innovation and the development of
new products and technologies. When individuals or
businesses have exclusive rights to the fruits of their
intellectual property or innovations, they are motivated to
invest in research and development.
 Real-life Example: Patents grant inventors exclusive rights to
their inventions for a specified period. This encourages
companies like pharmaceutical firms to invest heavily in
research to develop new drugs and treatments.
5. Environmental Conservation (2 marks):
 Property rights can also play a role in environmental
conservation. When individuals or entities have ownership or
usage rights over natural resources, they have incentives to
manage these resources sustainably to maximize their long-
term value.
 Real-life Example: The concept of "cap and trade" in
environmental policy allows businesses to buy and sell
emissions allowances. This market-based approach uses
property rights to incentivize companies to reduce emissions
efficiently.

• What is the producer equilibrium? Explain with a diagram. 10

= Producer’s equilibrium refers to the state in which a producer
earns his maximum profit or minimise its losses. According to MR-
MC approach, the producer is at equilibrium, when the Marginal
Revenue (MR) is equal to the Marginal Cost (MC) and Marginal Cost
curve must cut the Marginal Revenue curve from below.
Two conditions under this approach are:
(i) MR = MC
(ii) MC curve should cut the MR curve from below, or MC should be
rising.
MR is the addition to TR from the sale of one more unit of output and
MC is the addition to TC for increasing the production by one unit. In
order to maximise profits, firms compare its MR with its MC
As long as the addition to revenue is greater than the addition to
cost. It is profitable for a firm to continue producing more units of
output. In the diagram, output is shown on the X-axis and revenue
and cost on the Y-axis. The Marginal Cost (MC) curve is U-shaped
and P ~ MR = AR, is a horizontal line parallel to X-axis.
MC = MR at two points Rand K in the diagram, but profits are
maximised at point K, corresponding to O Q level of output. Between
O Q, and O Q levels of output, MR exceeds MC. Therefore, firm will
not stop at point R but will continue to produce to take advantage of
additional profit. Thus, equilibrium will be at point K, where both the
conditions are satisfied.
Situation beyond O Q level: MR < MC When output level is more
than O Q, MR < MC, which implies that firm is making a loss on its
last unit of output. Hence, in order to maximise profit, a rational
producer decreases output as long as MC > MR. Thus, the firm
moves towards producing O Q units of output.
  What is the long-run cost facing a producer? Show a
diagram. 4
= LRAC

| /\

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

| / \

|/ \

|------------------------------------> Output (Quantity)

  The LRAC curve slopes downward initially, indicating economies of
scale. This means that as a producer increases its output, the
average cost per unit of production decreases.
 At some point, the LRAC curve reaches its minimum point,
representing the optimal scale of production, where the producer
achieves the lowest possible average cost per unit.
 Beyond the optimal scale, the LRAC curve begins to slope upward,
indicating diseconomies of scale. This means that as a producer
further increases its output beyond the optimal scale, the average
cost per unit of production starts to rise due to inefficiencies, such
as coordination challenges and increased management complexity.
 The LRAC curve shows that in the long run, a producer can adjust its
production scale to minimize costs, but there is an optimal point
beyond which it becomes less efficient.

Unit 2
1. Define demand. 4
= Demand refers to the quantity of a good or service that consumers are willing
and able to purchase at various prices and within a specific period, all other
factors being equal. In other words, it represents the desire or need for a product
backed by the ability to pay for it. Demand is a fundamental concept in
economics and plays a central role in determining the price and quantity of
goods and services exchanged in a market. It is typically represented graphically
as a demand curve, which illustrates the relationship between price and the
quantity demanded, showing that as prices rise, the quantity demanded
generally decreases, and vice versa, assuming that all other factors remain
constant.

2. Write the demand function. 4

= The function of demand serves several important roles in economics
and market analysis:

1. Allocation of Resources: Demand helps allocate scarce resources

efficiently. It signals producers which goods and services are in
demand, allowing them to allocate resources toward the production
of those products to meet consumer needs.
2. Price Determination: Demand plays a critical role in price
determination. When demand is high relative to supply, prices tend
to rise, encouraging producers to supply more. Conversely, when
demand is low, prices may fall, prompting producers to reduce
supply or adjust their pricing strategies.
3. Consumer Behavior Analysis: The study of demand provides
insights into consumer behavior, preferences, and purchasing
patterns. Understanding these aspects helps businesses tailor their
 products, marketing strategies, and pricing to attract and retain
customers.
4. Market Forecasting: Demand analysis is essential for forecasting
market trends and predicting future consumer preferences.
Businesses, policymakers, and investors rely on demand data to
make informed decisions about production, investment, and trade.
5. Resource Allocation Efficiency: By responding to changes in
consumer demand, firms can allocate their resources more
efficiently, reducing wastage and improving economic

3. Describe how different factors affect demand. 7

= Several factors can influence and shift the demand for goods and
services in an economy. These factors are crucial for understanding how
changes in market conditions impact consumer behavior and,
consequently, the quantity of a product or service demanded. Here's an
overview of how different factors affect demand:

1. Price of the Product Itself (2 marks):

 The most fundamental factor affecting demand is the price of
the product. As the price of a product increases, all else being
equal, the quantity demanded typically decreases, and vice
versa. This relationship is represented by the law of demand.
2. Consumer Income (1 mark):
 Consumer income is a key determinant of demand. For most
goods, as consumers' income rises, they are generally willing
and able to purchase more of those goods. These goods are
known as normal goods. However, for inferior goods, as
income rises, demand may decrease because consumers
switch to higher-quality alternatives.
3. Prices of Related Goods (2 marks):
 The prices of related goods, specifically substitutes and
complements, can impact demand:
 Substitutes: An increase in the price of a substitute
product tends to lead to an increase in the demand for
the original product. For example, if the price of coffee
rises, the demand for tea may increase.
 Complements: An increase in the price of a complement
product can reduce the demand for the original product.
For instance, if the price of smartphones rises, the
demand for smartphone cases may decrease.
4. Consumer Tastes and Preferences (1 mark):
 Changes in consumer tastes and preferences can significantly
affect demand. Products that become fashionable or aligned
with consumer preferences often experience increased
demand, while those that fall out of favor may see decreased
demand.
5. Population and Demographics (1 mark):
 The size and composition of the population can influence

demand. An increase in the population can lead to higher
demand for goods and services, especially necessities like
food and housing. Demographic factors, such as age and
gender, can also affect preferences and demand for specific
products.
6. Consumer Expectations (1 mark):
 Consumer expectations about future prices, income, or
economic conditions can impact present demand. For
example, if consumers expect prices to rise in the future, they
may increase their current demand to stock up on goods at
lower prices.
7. Government Policies and Regulations (1 mark):
 Government actions, such as taxes, subsidies, trade policies,
and regulations, can influence demand. For instance,
subsidies on electric vehicles can increase their demand,
while taxes on sugary beverages may reduce demand.

4. Write the demand equation in y = c - mx form,

where c = 3, m = 2 in the price-quantity frame.
Write an economic interpretation of ‘m’. 4
= In the price-quantity frame, the demand equation in the form y = c -
mx, where c = 3 and m = 2, can be written as:

Quantity Demanded (y) = 3 - 2 * Price (x)

Economic Interpretation of 'm' (the coefficient of price, -2 in this case):

The coefficient 'm' (-2 in this context) represents the price elasticity of
demand. Price elasticity of demand measures the responsiveness of the
quantity demanded of a product to changes in its price. Here's the
economic interpretation of 'm' in this equation:

 When 'm' is negative, as in this case, it indicates that the good or

service is price-elastic. In other words, a percentage increase in the
price of the product will lead to a larger percentage decrease in the
quantity demanded, and vice versa. The demand for such a product
is sensitive to changes in price.
 In this specific equation, the value of 'm' being -2 means that for
every 1% increase in the price of the product, the quantity
demanded will decrease by 2%. Conversely, for every 1% decrease
in the price, the quantity demanded will increase by 2%.
 This interpretation implies that consumers are relatively responsive
to changes in the price of the product. For example, if the price of a
good like smartphones increases by 10%, the quantity demanded
 may decrease by approximately 20%, indicating that consumers are
sensitive to price changes in this market.

5. What is the law of demand? Illustrate with a

diagram. 4
= The law of demand is a fundamental concept in economics that describes
the inverse relationship between the price of a good or service and the
quantity demanded by consumers, all other factors being equal. In other
words, as the price of a product increases, the quantity demanded generally
decreases, and as the price decreases, the quantity demanded tends to
increase.

Illustrate demand-supply equilibrium with diagram 4

=
At any price below P, the quantity demanded is greater than the quantity
supplied. In such a situation, consumers would clamour for a product that
producers would not be willing to supply; a shortage would exist. In this
event, consumers would choose to pay a higher price in order to get the
product they want, while producers would be encouraged by a higher price
to bring more of the product onto the market.

The end result is a rise in price, to P, where supply and demand are in
balance. Similarly, if a price above P were chosen arbitrarily, the market
would be in surplus with too much supply relative to demand. If that were to
happen, producers would be willing to take a lower price in order to sell,
and consumers would be induced by lower prices to increase their
purchases. Only when the price falls would balance be restored.

Define price elasticity of demand (PED). Interpreted “PED < 1”. 7

=Price elasticity of demand (PED) measures the responsiveness of

demand after a change in price.
  Inelastic demand PED <1 – Perfectly inelastic PED =0
Goods which are inelastic tend to have some or all of the following
features:

1. They have few or no close substitutes, e.g. petrol,

cigarettes.
2. They are necessities, e.g. if you have a car, you need to
keep buying petrol, even if price of petrol increases
3. They are addictive, e.g. cigarettes.
4. They cost a small % of income or are bought infrequently.
  In the short term, demand is usually more inelastic
because it takes time to find alternatives
 If the price of chocolate increased demand would be
inelastic because there are no alternatives, however, if
the price of Mars increased there are close substitutes in
the form of other chocolate, therefore, demand will be
more elastic.

Define income elasticity of demand (IED). Interpreted “IED < 1

7marks
= Income elasticity of demand refers to the sensitivity of the quantity
demanded for a certain good to a change in the real income of consumers
who buy this good.

The formula for calculating income elasticity of demand is the percent

change in quantity demanded divided by the percent change in income.
With income elasticity of demand, you can tell if a particular good
represents a necessity or a luxury.
 If income elasticity of demand of a commodity is less than 1, it is a necessity good.
 If the elasticity of demand is greater than 1, it is a luxury good or a superior good.

Elastic chu liquidity tih nen thuhmun ang a ni.

What is cross elasticity of demand . When CED <1 7Marks.
 = The cross elasticity of demand is an economic concept that measures
the responsiveness in the quantity demanded of one good when the
price for another good changes. Also called cross-price elasticity of
demand, this measurement is calculated by taking the percentage
change in the quantity demanded of one good and dividing it by the
percentage change in the price of the other good.

What is inferior good? Explain with reference to IED 4 marks.

= An inferior good is a type of economic good or commodity for which the
quantity demanded increases as consumer incomes decrease, and it
decreases as consumer incomes rise. In other words, inferior goods have a
negative income elasticity of demand (IED). The concept of inferior goods
is related to changes in consumer preferences and behavior based on
their income levels.

Explanation with Reference to IED:

1. Negative IED: Income elasticity of demand (IED) measures the

responsiveness of the quantity demanded of a good to changes in
consumer income. When IED is negative, it indicates that as
consumer incomes increase, the quantity demanded of the good
decreases, and as consumer incomes decrease, the quantity
demanded increases. In other words, there is an inverse relationship
between income and the demand for the good.
2. Income and Inferior Goods: Inferior goods are typically
associated with lower income levels. When consumers have lower
incomes, they tend to purchase inferior goods because they are
more affordable or represent cost-effective choices. As their
incomes rise, consumers may shift their preferences to higher-
quality or more expensive alternatives, reducing their demand for
inferior goods.
3. Examples of Inferior Goods: Common examples of inferior goods
include generic or store-brand products, low-quality food items,
public transportation, and used or second-hand goods. These goods
are often chosen when consumers have limited budgets or lower
incomes but may be replaced with higher-quality or brand-name
alternatives when incomes increase.
4. Substitution Effect: The concept of inferior goods is related to the
substitution effect, which occurs when consumers switch from
inferior goods to superior goods as their incomes rise. This effect
reflects changing consumer preferences and the ability to afford
better-quality products.
The consumer’s equilibrium can be represented graphically as a point of
tangency where the indifference curve and the economic constraint meet.
Therefore, this equilibrium is obtained when the slope of the indifference
curve and the slope of the consumer’s budget line have the same level of
equality.

The above graph illustrates consumer equilibrium, where –

AB – Budget line

I, II, and III – Indifference curves. They are a portion of an individual’s

indifference map.

Given the limited income sources, a consumer cannot attain a position

beyond the budget line. R, E represent infinite numbers of attainable
bundles on AB, and T. These and the points on the budget line AB are
attainable with the limited income of the consumer.