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Thursday,January12,2012

ECONOMICSNOTESB.COMPART1(PUNJAB
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ECONOMIC
S
Q#1:Criticallyexaminethedefinitionofeconomics
givenbyAlfredMarshall?
Or
Economicsisthestudyofcausesofmaterialwellbeing
Discussandcriticizetheconcept
Introduction:
ThewordeconomicshasbeenderivedfromLatinwordOIKONOMOSandtherearethree
differentconceptsaboutthedefinitionofeconomics.

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HOLLYWO
OD
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*WALLPAPER
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ERS*_*
Theworstwax
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Classical

TheArtof
Extreme
Sleeping!

Neoclassical

joke

Modern

LAWYERS

AccordingtoMarshall.
Economics is the study of mankind in the ordinary business of life it examines that part of
individualsandsocialactionswhicharemostcloselyconnectedwiththeattainmentandwiththe
useofmaterialrequisitesofwellbeing.
MainpointsofMarshall:
FollowingarethemainpointsofMarshallsdefinition.
Ordinarybusinessoflife:
Ineconomicsordinarybusinessoflifeisstudied.
Primaryimportancetowellbeing:
In economics primary importance is given to human wellbeing and secondary
importancetowealth.
SocialScience:
AccordingtoMarshallEconomicsisasocialscienceanditisnotthescienceofwealth

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JamesBond
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worth...
the10
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only.

VOLCANO

Activitiesofmaterialwellbeing:
Ineconomicstheactivitiesofmaterialwellbeingarediscussedonly.

MeritsofMarshallsDefinition
FollowingarethemeritsofMarshallsdefinition:
Ordinarybusinessoflife:
Marshallsdefinitionisnotrelatedwiththetendenciesofaparticularcommunityonly.In
fact it discusses the general behaviour of ordinary people this thing makes the subject
importantforacommonman.
Nochargeofselfishness:
AsMarshallhasgivenprimaryimportancetohumanwellbeingandsecondarytowealth,
thereforethechargesofselfishnesscannotbeleveledagainsthisdefinition.
Subjectboundaries:
By discussing only the activities of material wellbeing in economics Marshall has given
boundariesofthesubjectandhehasnotmadethesubjectlimitlesslikethedefinitionof
economicsgivenbyclassicaleconomist.
Correspondstomoderneconomicstendencies:
In the modern age planning in every sector is made for the sake of welfare and
wellbeing.similaryMarshallhasalsogivenimportancetowelfareandwellbeing,therefore
hisdefinitioniscorrespondstomoderneconomicstendencies.
Socialscience:
Marshallhasnotdiscussedeconomicsintermsofwealthonlyhetreatseconomicsasa
socialscience.
Primaryimportancetowellbeing:
Marshall has not given total importance to wealth, he has given primary importance to
wellbeingandsecondarytowealthaswealthisjustmeansandnottheends.

DemeritsofMarshallsDefinition
Doesnotcoveralleconomicproblems:
Marshallhasjustdiscussedthemattersofmaterialwelbeingandhehasneglectedalotofother
activitieswhichmustbebroughtunderdiscussedineconomicswhichdonotcausematerialwell
being.
Welfareisavagueconcept:
Welfareisavagueconceptbecauseitdifferperson,timetotime,placetoplaceandneedto
need.
WelfareisUnmeasurable:
Welfareisthestateofmindwhichcannotbemeasurednumericallytherefore,thewholesubject
cannotdependuponunmeasurableconcept.
Servicesneglected:
Marshallhasneglectedallnonmaterialservicesoflawyers,teachers,doctors,etc.
Isolatedpeopleneglected:
Marshall has also neglected the activities of those people who lead isolated lives like baggers,
peoplelivinginjungle.

whypeople
leavetheir
parents
allthatglitter
isnotgold
TRUELOVE
STORIES
TheTrainSet
This
definitelyis
amustsee
Rainbow
Dreamland
HomeSweet
Home
Life
is...unpredi
ctable!
HERICHEST
PEOPLE
OFTHE
WOLRD
20089
FAMOUS
PERSONA
LITYOF
THE
WORLD
INVENTIONS
OFTHE
WORLD
HOLLYWOOD
,BOLLYWO
OD
MOVIES&
DRAMAS
DAILY
QURAN&
HADITH
http://www.blo
gger.com/
ECONOMICS
OF
PAKISTAN
NOTES
B.COM
PART
1(PUNJAB
UN...
AUDITING
B.COM
PARTII
PUNJAB
UNIVERSIT
YLAHORE
PA...
MONEY
,BANKING
&FINANCE
NOTES
B.COM
PUNJAB
UNIVER...
NASANEW
DISCOVER
IES
SHAKIRA
ALBUMS
POPMUSIC

Unnecessaryclassification:

POPMUSIC

Practically nobody classified consumption of wealth into wellbeing and non wellbeing groups,
thereforeMarshallsdefinitionisimpractical.

Pisces
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2012

Conclusion

Aquarius
Horoscope
2012

Though Marshalls definition is better than the definition given by classical economists, but
because of some demerits, his definition may not be treated as the best definition of economics
thedefinitionofeconomicsgivenbythesomemoderneconomistslikeKeynes,Samuelson, etc,
maybetreatedascomprehensivelyinfollowingwords.

Capricorn
Horoscope
2012

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Sagittarius
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Economics is a social science which is concerned with the proper use and allocation of
resourcesfortheachievementandmaintenanceofgrowthwithstabilityandefficiency.
Q#2:Economicsisthescienceofscarcityandchoice,discussedand

criticizetheconcept?
Therearethreedifferentconceptsaboutthedefinitionofeconomics:
1.Classical
2.NeoClassical
3.Modern

2012
Scorpio
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2012
Libra
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2012
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Robbinsisamongmoderneconomists.Inhisbook,THENATUREANDSIGNIFICANCEOF
ECONOMICSSCIENCE(1932),hehasdefinedeconomicsasascienceofscarcityandchoice.

Contraband
(2012)

FollowersoftheRobbins:

Shakira's
Biography

HisfollowersareStiggler,Eastham,Keynes,Samuelsonandetc.

RIHANNA

RobbinsDefinition:

ARIES
HOROSCO
PE2012

Economicsisthesciencewhichstudieshumanbehaviorasarelationshipbetweenends
(multipledesires)andscarcemeanswhichhavealternativeuses.

Taurus
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2012

MainPointsoftheRobbinsDefinition:

Gemini
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2012

FollowingarethemainpointsofRobbinsdefinition.

RobbinssDefinition:
Economicsisthesciencewhichstudieshumanbehaviorasarelationshipbetweenends
(multipledesires)andscarcemeanswhichhavealternativeuses.

Cancer
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2012
RedTails
(2012)

MainpointstheRobbinssDefinition:

Supernatural
(2005TV
Series)

FollowingarethemainspointsofRobbinsdefinition

Haywire
(2011)

MultipleDesires:
Humandesiresaremultipleandthesedesiresarechangingwiththepassageoftime.
DifferenceofImportance:
Alldesiresarenotequallyimportant,somearemoreimportantandsomearelessimportant.
LimitedResources:
Tosatisfyhumanwantsresourcesarequitelimited.

Beautyand
theBeast
(1991)
Sherlock
Holmes:A
Gameof
Shadows
(2011)
TheDevil
Inside
(2012)
TheDevil
Inside
(2012)

Alternativeuses:
Limitedresourcescanbeappliedalternatively.

MeritsofRobbinsdefinition
WidenedScope:
Robbinshasdiscussedineconomicsallthemattersofscarcityandchoice,eithertheycause
materialwellbeingordontcausematerialwellbeing.Inthiswayhehaswidenedthescopeof
economicsascompareditMarshall.
UniversalApplication:
Aseveryonefacestheproblemofscarcityandchoice,therefore,thedefinitionofeconomics
givenbyRobbinssisuniversallyapplicable.
NoChargeofselfishness:
Thechargeofselfishnesscannotbeleveledagainstthedefinitionofeconomicsgivenby
Robbinssbecausehehasnotdefinedeconomicsasascienceofwealth.
NonMaterialServicesAlsoIncluded:

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(2011)
roadtooscar
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NIGHAM
SINGER
RIHANNA
SHAKIRA
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MUSIC
Cancer
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2012
ECONOMICS
NOTES
B.COM
PART
1(PUNJAB
UNIVERSIT
YLAH...

Robbinshasalsogivenimportanceinthesubjecttononmaterialservicesliketheservicesof
doctors,teacher,lawyers,etc.

Gemini
Horoscope
2012

IsolatedPeopleNotNeglected:

NEWS
UPDATES

Robbinshasalsodiscussedineconomicstheactivitiesofthosepeoplewhoarenotrelatedtothe
societyandleadtheirlivesinisolatedways.

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SONGS

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Factordecreasingwelfarenotneglected:

SHAKIRA
HISTORY

Robbinshasalsodiscussedintheeconomicsantiwelfareactivitiesliketheuseofcigrattes,
narcotics,drugsetc.

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MOVIES
2012

DemeritsoftheDefinition

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Horoscope
2012

ModerneconomistslikeKeynesSamuelson,etchavecriticizedthedefinitionofeconomicsgiven
byProfessorRobbinsbyusingfollowingpoints.

ARIES
HOROSCO
PE2012

SocialScience:

BEAUTYOF
THE
KIRESTAN

AccordingtoRobbins,economicsisapositivesciencelikePhysics,Chemistrybutinfactpositive
science deals with nonliving matters, while economics is concerned with the behaviour of living
humanbeingstherefore,economicsisasocialscienceandnotapositivescience.
Notatheoryvalueonly:

Followers

Robbins has reduced economics merely to a theory value and he has neglected its practical
aspect.

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Welfareismissing:

Members(3)

Jointhissite

In the definition of Robbins welfare is quite missing because Robbins has totally neglected the
aspectofwelfareandwellbeing.
Toomuchwidenedthescope:
According to Robbins all human activities which are related with the problem of scarcity and
choice, are treated as economics activities, but infact all the activities of scarcity and choice
cannotbetreatedaseconomicactivities.

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Colorless:
The definition of economics given by Robbins has made the subject quite colorless because a
commonmangetsnothingoutofit.
Selfcontradictory:
Being an economist Robbins himself could not remain neutral then, how can he expect from an
ordinarypersontoremainneutral.
Normativeaspectneglected:
There are two main branches of science but he has discussed only positive aspect whereas
normativehasbeenneglected.
Planningisneglected:
PlanningisanimportantpartofeconomicsbutRobbinshastotallyneglectedplanning.
Macroaspectisneglected:
MicroandMacroaretwomainbranchesofeconomicsbutRobbinshasneglectedmacroaspect
oftheeconomics.
Analyticalconceptonly:
Hehasstressedtowardsneutralanalysisofhumanbehaviourwhilehehasneglecteditspractical
aspect.

Conclusion
Though Marshalls definition is better than the definition given by classical economists, but
because of some demerits, his definition may not be treated as the best definition of economics
thedefinitionofeconomicsgivenbythesomemoderneconomistslikeKeynes,Samuelson, etc,
maybetreatedascomprehensivelyinfollowingwords.
Economicsisasocialsciencewhichisconcernwiththeproperuseandallocationofresources
fortheachievementandmaintenanceofgrowthwithstabilityandefficiency

Q#3:Givethecomparisonofthedefinitions
givenbyMarshallandRobbins?
Before giving the comparison of the definition of economics given by Marshall and Robbins.
Observethedefinitionsofeconomicsgivenbybotheconomists.
AccordingtoMarshall:
Economics is the study of mankind in the ordinary business of life it examines that part of

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individualsandsocialactionswhicharemostcloselyconnectedwiththeattainmentandwiththe
useofmaterialrequisitesofwellbeing.
AccordingtoRobbins:
Economics is the science which studies human behavior as a relationship between ends
(multipledesires)andscarcemeanswhichhavealternativeuses.
If we study the above definitions of economics given by Marshall and Robbins we may give the
followingcomparisons.

Marshall

Robbins

Marshall gave his view in his book principle


ofEconomics(1890).

Robbinsgavehisviewinhisbook the nature


and significance of economics science
(1932).

1.NeoClassical:
Marshall is among neo classical economists
and his definition is treated as neoclassical
definition.

1.Modern:
Robbinsisamongmoderneconomistsandhis
definitionistreatedasmoderndefinition.

2.SocialScience:

2.NeutralScience:

AccordingtoMarshall.

AccordingtoRobbins

Economicsisasocialscience

Economics is a positive science in which


humanbehaviourisstudiedneutrally.

3.LimitedScope:
Marshall has given quite limited scope of
economics because he has included in
economicsonlytheactivitiesofmaterial well
being.
4.ClassificatoryConcept
Marshall has classified the consumption of
wealth into wellbeing and non wellbeing
groups and he has discussed in economic
onlyfirstgroupwhilehehasneglectedsecond
group. So Marshall has given the
classificatoryconcept.
5.NormativeScience:
Marshallhastreatedeconomicsasa
normativescience,asitdealswiththe
activitiesofmaterialwellbeing.
6.VagueConcept:
Welfareisavagueconceptwhichdiffersfrom
persontoperson,placetoplace,timetotime
andneedtoneed.
7.UsefulSubject:
Marshallhasgivenimportancetowelfareand
wellbeing,whichhasmadethesubjectquite
useful.
8.CorrespondstomodernEconomic
Tendencies:

3.Widenedscope:
Robbins has widened scope of economics as
compared to Marshall because all the
activities of scarcity and choice have been
discussed by him either they cause material
wellbeingornot.
4.Analyticalconcept:
Robbinshasnotclassifiedtheconsumption of
wealth into wellbeing and non wellbeing
groups,ratherhehasstressedtowardsneutral
analysis of human behaviour, therefore his
conceptmaybecalledanalyticalconcept.
5.PositiveScience:
Robbins treated economics as a positive
science, like physics, chemistry and we are
forbiddentopassourjudgment while studying
humanbehaviour.
6.BasedonReality:
Everyindividualfacestheproblem of scarcity
and choice, therefore the definition of
economics given by Robbins is closer to
realityofhumanlife.
7.ColorlessSubject:
Robbins definition has made it colorless and
complexed because a common man gets
nothingoutofit.

In the modern age planning in every sector is


made for the sake of welfare and wellbeing,
similarly Marshall has also given importance
to the welfare and wellbeing, therefore his
definition corresponds to modern economics
tendencies.

8. Does not Corresponds to modern


EconomicsTendencies:

9.IsolatedPeopleNeglected:

9.IsolatedpeoplealsoDiscussed:

Marshallhasneglectedtheactivitiesof
isolatedpeoplewhoarecutawayfrom
society.

Robbins has discussed even the activities of


these people who are cut away from society
in other words he has not neglected isolated
people.

10.NonMaterialservicesneglected:
Marshallhasneglectednonmaterialservices

Robbins has totally neglected welfare and


wellbeing therefore his definition does not
correspondtomoderneconomicstendencies.

10.Nonmaterialservicesnotneglected:

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liketheservicesofdoctors,teachers,
lawyers,etc.

Robbins has not neglected nonmaterial


services like the services of doctors,
teachers, and lawyers. He has given
importancetotheseservicesineconomics.

Conclusion
Though Marshalls definition is better than the definition given by classical economists, but
because of some demerits, his definition may not be treated as the best definition of economics
thedefinitionofeconomicsgivenbythesomemoderneconomistslikeKeynes,Samuelson, etc,
maybetreatedascomprehensivelyinfollowingwords.
Economics is a social science which is concerned with the proper use and allocation of
resourcesfortheachievementandmaintenanceofgrowthwithstabilityandefficiency.

Q#4:definelawofdiminishingmarginalutilitywiththehelpof
scheduleanddiagram?
Or
Whatisthefirstlawofconsumptionbycardinalapproach?
Introduction:
Thelawofdiminishingmarginalutilityisthefundamentallawofconsumptionifwealthindicating
cardinalmeasurementofutility.Differenteconomistshavedefineditindifferentwordsprominent
ofthemareMarshall,JevonsandGossen
Definitions:
AccordingtoMarshall:
Theadditionalbenefitswhichapersonderivesfromanincreaseinthestockofathing,
diminisheswitheveryincreaseinthestockthathealreadyhas.
Simpledefinition:
Ifotherthingsdonotchangeandaconsumercontinuouslyappliesunitsofacommodity,then
marginalutilitycontinuetodecrease.

Explanationthroughtable:
UnitsofApples

TotalUtility

MarginalUtility

TU

MU

30

30

50

20

60

10

60

50

10

Diagram:

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Explanation:
Accordingtoabovescheduleanddiagramasaconsumerisapplyingunitofapplescontinuously,
itmarginalutilitydecreasing.Atfourthunitithasbecomezeroafterthatithasbecomenegative.
ThisdecreasingtendencyofmarginalutilityisrepresentingthelawofDiminishingMarginalUtility.
Assumption:
Followingaretheassumptionofthelaw.
Continuoususe:
Inthislawitisassumedthataconsumerappliesunitsofacommoditycontinuouslywithoutand
gap.
Samequality:
Itisalsoassumedthatthequalityofeverysuccessiveunitmustbesame.
Samesize:
Itisalsoassumedthatthesizeofalltheunitsmustbesame.
Reasonablesize:
Itisassumedthatthereisareasonablesizeofunits.Thesizeofunitshouldneitherbeverybig
norverysmall.
Nochangeinincome:
Itisalsoassumedthatduringtheapplicationofeachnextunitofcommodity,theincomeofthe
consumermustbesame.
Nochangeintaste:
Itisalsoassumedthattheconsumeristhenormalperson,hedoesnotlikeordislikea
commodityextraordinary.

Exceptionofthelaw
Followingaretheexceptionofthelaw.
Desireofmoney:
Thislawisnotapplicableforthedesireofmoneyasthedesiremoneyincreasewiththeincrease
ofthequantityofmoney.
Utilityofknowledge:
Thislawisnotapplicableforknowledgebecausetheutilityofknowledgedoesnotdecreaseby
theincreaseofknowledge.
UseofNarcotics:
Thislawisnotapplicablefornarcoticsalsoaseachnextunitofnarcoticsdoesnotprovidelesser
utilitytoaconsumer.
Hobby:
Thislawisnotapplicableforhobbiesalsobecauseapersondoesnotfeellesserutilityofevery
nextunitincaseofhobby.
Fashion:
Thislawisnotapplicableforfashionbecausepeoplebecomemoreandmorecrazyoffashion,
whentheygetinvolvedinfashion.

Practicalimportanceofthelaw
Followingarethepracticalimportanceofthelawofdiminishingmarginalutility.
Baseofthelawofdemand:
Thislawprovidesbaseforthelawofdemandbecauseaconsumeralwayscomparestheutilityof
thecommoditywiththepriceofthatcommodityandtakesrationaldecision.
Importanceforcustomer:
Knowingthediminishingtendencyofmarginalutilityarationalconsumerappliesunitsofmoney
ondifferentcommoditiesverycarefullyandhetriestomaximizetotalutility.
Consumersurplus:

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Aconsumermayhavemaximumsurplusbyapplyingunitsofmoneyonacommodityrationally,
bykeepinghiseyesondiminishingtendencyofmarginalutility.
Q#5:State&explaintheLawofEquimarginalutilityalsogiveitsexceptionsandpractical
importance.?

Introduction:
ThelawofEquimarginalutilityisthesecondfundamentallawofconsumptionofwealthgivenby
NeoclassicalEconomists.DifferentEconomistshavedefineditindifferentwordsProminentof
themareMarshallandLipsy.
AccordingtotheLipsy:
Thehouseholdmaximizingtheutility,willsoallocatetheexpenditurebetweencommoditiesthat
theutilityoflastpennyspentoneachitembecomeequal.
AccordingtoLaw:
Ifunitsofmoneyareappliedondifferentcommoditiesinsuchawaythatmarginalutilityofeach
itembecomeequal,thentotalmaximizes.
Example:
Supposeaconsumerwantstoapplyfiveunitsofmoneyonmangoesandapplestomaximize
totalutility.Healsoknowsmarginalutilityofbothcommoditiesasshowninthefollowing
schedule.
Schedule:
UnitsofMoney

MarginalUtilityofMangoes

MarginalUtilityofApples

30

25

25

20

20

15

15

10

10

Accordingtotheaboveschedule,ifaconsumerappliesthreeunitsofmoneyonmangoesandtwo
unitsonapples,thenthemarginalutilityofbothcommoditiesbecomesequal,thereforetotalutility
maximizesas:
30+25+20+25+20=120max
Ifconsumerappliestwounitsofmoneyonmangoesandthreeonapples,thenmarginalutilityof
bothbecomeunequal,thereforetotalutilitydoesnotremainmaximum
30+25+25+20+15=115notmaximum
Diagram:

Accordingtotheabovediagramandschedule.Ifthreeunitsofmoneyareappliedonmangoes
andtwoonapples,thenmarginalutilityofbothbecomesequalandtotalutilitymaximum.Butif
thirdisremovedfrommangoesandappliedonapplesthenMUofbothbecomeunequal.

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Therefore,TUcannotremainmaximum,asthelossofutilitywillbegreaterthenthegainofutility
asshowninthediagram.
EquationofConsumerEquilibrium:
RealizingtheimportanceofpricesNeoClassiceconomistshavegiventhefollowingequationfor
consumerequilibrium
ConsumerEquilibrium=MUa/Pa=MUb/Pb==MUn/Pn
C.E=12/4=24/8==60/20
C.E=3=3==3
ASSUMPTIONS:
LimitedUnitsOfMoney:
Thelawassumesthattheconsumerapplieslimitedunitsofmoney.
Rationality:
Thelawalsoassumesthattheconsumerbehavesrationallytomaximizehissatisfaction.
DivisibleGoods:
Inthelawitisassumedthatthethingswhichaconsumerconsumesaredivisibleintosmallunits
likesugar,salt.
DiminishingMarginalUtility:
Asaconsumerappliesmoreandmoreunitsofacommodity,itsmarginalutilitydecreases.
ConstantPrice:
Thelawassumesthatthepriceofthecommoditiesremainconstanteithertheconsumerbuys
lesserquantityorgreaterofthecommodity.
ChoiceToUse:
Consumerhasthechoicetousemorethanonecommodities.
LIMITATIONS:
MeasurementOfUtility:
Utilityismentalstate,whichcannotbemeasurednumericallytherefore,itisdifficulttoequalize
marginalutilityofdifferentcommoditiesnumerically.
IndivisibleGoods:
Thelawisalsonotapplicableforthosegoods,whichareindivisibleliketubelight,fan,shoeetc.
CustomandFashion:
Sometimes,peoplepurchasegoodsjustforfashionorcustomanddonotcaretomaximizetotal
utility.
SmallPurchase:
Mostlythelawholdsonlyinthebigpurchasewhileitisnotapplicableinsmallpurchasebecause
wedonotcareforsmallpurchases.
IgnoranceofConsumer:
Sometimesaconsumercannotbebenefitedfromthelawduetoignoranceofprices,substitutes
andqualityofgoods.
DurableGoods:
Thelawisalsonotapplicablefortheuseofdurablegoodsbecauseitisnotpossibletofindtheir
exactutility.
PRACTICALAPPLICATION:
Thelawofsubstitutionistheothernameofthelawofequimarginalutility.Itisapplicableto
variouseconomicproblems.
ImportanceforConsumers:
Thelawisimportantforconsumersbecausebyapplyingthislawaconsumertriestoequalize
marginalutilityforthemaximizationoftotalutility.
ImportanceforProducers:
Thelawofsubstitutionisalsohelpfulforproducers,asbyapplyingthislawthemaximumoutput

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byusingtheirlimitedresources.
ImportanceforFinanceMinister:
Thelawishelpfulforfinanceministertocollectrequiredrevenuethroughtaxeswithminimum
disturbance.
WelfareoftheState:
Thelawofsubstitutionisalsohelpfulforthegovernmenttoprovidemaximumwelfaretoits
citizensbyapplyingitsincomeindifferentsectorsaccordingtotheirrelativeimportanceandtheir
shareinproductivity.

Q#6:DefineDemand,ExplaintheLawofDemandwiththehelp
ofscheduleanddiagram?
Demand:
In the ordinary language, the desire of a commodity is considered as demand but in economics
onlythatdesireofcommodityisconsideredasdemandwhichisbackedbypurchasingpower.
Demand=Desire+PurchasingPower
Asdemandiseffectedbypricetherefore,wemaydefinedemandinfollowingwords:
Definition:
Different amounts of a commodity which a consumer is willing to purchase at various
levelofprice
LawofDemand:
Thelawofdemandinfactshowsthenegativerelationshipbetweenpriceandquantitydemanded
Definition:
Ifotherthingsdonotchangethenthedemandofagooddecreaseswitheveryincreasein
itspriceandthedemandofagoodincreaseswiththedecreaseinitsprice.
Itmaybeexplainedwiththehelpoffollowingscheduleanddiagram.
SCHEDULE:

PRICE

QTYDEMAND

30

20

10

DIAGRAM:

4
Price

2
D

O102030X

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Quantitydemanded
Explanation:
Accordingtoabovescheduleanddiagram,withtheincreasesinprice,demandisdecreasingand
withthedecreaseinpricedemandisincreasing,whichisrepresentingthelawofdemand.

Assumptions:
Followingaretheassumptionsofthelawofdemand:
1.Nochangeinincome:
Inthelawofdemand,itisassumedthattheincomeoftheconsumershouldremainconstant
becausethechangeinincomeoftheconsumermayalsoeffectthedemandofcommodity.
2.NoChangeinpopulation:
Inthelawofdemanditisalsoassumedthatthepopulationshouldremainconstant,asthe
demandofacommoditymaychangeduetochangeinpopulation.
3.NochangeinBuyerstaste:
Itisalsoassumedthatthebuyerstasteshouldremainconstant,asthechangeintastemayalso
effectthedemand,positivelyornegatively.
4.Nochangeinfashion:
Itisalsoassumedthatthereshouldbenochangeinfashion.
5.Nochangeinpriceofsubstitutes:
Inthelawofdemanditisalsoassumedthatpricesofsubstitutesshouldremainconstant,asit
mayeffectthedemand.
6.NochangeinLawandorders:
Inthelawofdemanditisalsoassumedthatthereshouldbenochangeinlawandordersituation.
7.Nochangeinquantityofmoney:
Inthelawofdemanditisalsoassumedthatquantityofmoneyshouldremainconstant.

Exceptions/Limitations:
1.GiffensGoods:
ThelawofdemandisnotapplicableforGiffensgoodsbecausethedemandforGiffensgoods
decreasesastheirpricedecreases,inthissituationpeoplecanhavechoicetousebetterthing.
2.Lifesavingdrugs:
Thelawofdemandisnotapplicablefortheconsumptionoflifesavingdrugs.
3.PrestigiousGoods:
Thelawofdemandisnotapplicablefortheuseofprestigiousgoodslikediamond.
4.Veryhighpricesproducts:
Itisalsoobservedthatthelawofdemandisnotapplicableforhighpricesproducts,becausethe
demandforthoseproductsdoesnotchange,astheirpricechanges.
5.Acuteshortage:
Thelawofdemandisnotapplicable,incaseofacuteshortageofcommoditiesorduetothe
situationofwar,whichdisturbspeaceandsecurity.

Q#7:defineelasticityofdemandandalsodiscuss
methodsofmeasurementofelasticityofdemand?
Introduction
Theconceptofelasticityofdemandwasgivenbyneoclassicaleconomists.Differenteconomist
havedefineditindifferentwords.ProminentofthemareMarshall,StonierandHagueetc.
Definition:
AccordingtoStonierandHague.
Elasticity of demand is a technical term used by economists to describe the degree of
responsivenessofdemandforagoodtoachangeinitsprice.

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Simpledefinition:
ThedegreeofresponsivenessofdemandofagoodduetochangeinitspriceiscalledElasticity
ofDemand.
Somegoodshavemoreelasticdemandwhilesomeotherhavelesselasticdemand.

MethodsofmeasurementArcElasticity
1.TotalExpenditureMethod:
(i)Negativerelationshipbetweenpriceandtotalexpenditureindicatesmoreelastic.(Ed>1)
PRICE

QUANTITY
DEMANDED

TOTAL
EXPENDITURE

12

Theabovescheduleisshowingnegativerelationshipbetweenpriceandtotalexpenditurewhichis
representingmoreelasticdemand.

Intheabovediagramhorizontaltendencyofdemandcurveisrepresentingmoreelasticdemand.
(ii)Positiverelationshipbetweenpriceandtotalexpenditureindicateslesselasticdemand.(Ed<1).
PRICE

QUANTITY
DEMANDED

TOTAL
EXPENDITURE

Theabovescheduleisshowingpositiverelationshipbetweenpriceandtotalexpenditurewhichis
representinglesselasticdemand

Intheabovediagramverticaltendencyofdemandcurveisrepresentinglesselasticdemand.
(iii)Ifthepricechangesbutthetotalexpenditureremainsamethenelasticityofdemandbecome
equaltounity.(Ed=1)
PRICE

QUANTITY
DEMANDED

TOTAL
EXPENDITURE

Theabovescheduleisshowingthatpriceischangingbuttotalexpenditureremainssame,which

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indicatesthatelasticityofdemandisequaltounity.

Theabovediagramisalsorepresentingelasticityofdemandisequaltoone.

2.FormulaMethod:
Prof.Altenhasgivenfollowingformulaforthemeasurementofelasticity.

Example:

PRICE

QTYDEMAND

Po4

Qo2

P12

Q13

=1/5*6/2=3/5<1
Demandislesselastic

MeasurementofPointElasticity
3.Percentagemethod:
Prof.Flexhasgivenfollowingformulaforthemeasurementofelasticityofdemand.

Ed=
Percentagechangeindemand
PercentagechangeinPrice
EXAMPLE:
Suppose10%changeinpriceofacommodityresult20%changeinitsdemand.
Ed=20%/10%
2>1
Demandismoreelastic.

4.FormulaMethod:
Elasticofdemandbetweentwocloserpointismeasuredwiththehelpoffollowingformula.
Ed=q/p*p/q

PRICE

QTYDEMAND

3.7

2.8

Here:P=4q=2

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P=0.3q=0.8
Ed=q/p*p/q
=0.8/0.3*4/2=16/3=5.3>1moreelastic
Demandismoreelastic.

GeometricalMethod:
Elasticityofdemandataparticularpointismeasuredwiththehelpofgeometricalmethod.
EdatpointE=LowerSegment/Uppersegment

ExplaintheconceptsofArcElasticityofdemandandPoint
Elasticityofdemand?alsogivemethodoftheirmeasurement?

ArcElasticityofdemand
TheelasticityofdemandbetweentwodistinctpointsexistingonademandcurveiscalledArc
elasticityofdemand

PointElasticityofdemand
TwocloserpointsexistingonademandcurveisalsoknownasPointelasticityofdemand.

DefineIncomeElasticityofdemand(EY)andCrosselasticityof
demand(Ec).Andalsodiscusstheirmethodsofmeasurement?

IncomeElasticityofDemand
Thedegreeofresponsivenessofdemandofagoodduetochangeinincomeofconsumeris
calledIncomeElasticityofDemand.
Formula:
Ey=q/y*y/q
Example:
Y

Qd

100

10

180

15

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Y=100q=10
Y=80q=5
Puttingthevalue
Ey=5/80*100/10=5/8<1
DemandisLessElastic.

CrossElasticityofDemand(Ec)
Thedegreeofresponsivenessofdemandofagood(a)duetochangeinpriceofsomeothergood
(b).
Formula:
Ec=qa/Pb*Pb/qa
Example:
Pb

Qa

10

16

12

Qa=7qa=5
Pb=6Pb=10
Puttingthevalues
7/6*10/5=70/30=2.3>1
DemandismoreElastic

LAWOFRETURNS
Q#8:Stateandexplainthelawofincreasingreturnwiththe
helpofscheduleanddiagramandalsogiveitsapplicationin
industrialsector?
INTRODUCTION:
Ineconomicactivitiesthecourseofproductionusuallypassesthroughthreedifferentstages,new
classiceconomistshavedefinedordiscussedthesestagesintheformofthreedifferentlaws.
1.LawofincreasingReturns
2.LawofDiminishingReturns
3.LawofConstantReturns

LAWOFINCREASINGRETURNS:
Differenteconomistshavedefinedthelawofincreasingreturnsindifferentwords.Butprominent
ofthemareBenham,Champan&Marshall.
STATEMENT:
Intheprocessofproductionifmoreandmoreunitsareappliedofvariablefactorskeepingother
factorsconstant,atfirstmarginalproductionincrease(becauseofimprovementinthecombination
ofvariablefactors).Thisincreasingtendencyofmarginalproductionperunitofvariablefactoris
knownasLawofIncreasingReturns.

Explanationwiththehelpofscheduleanddiagram:
TheLawofIncreasingreturnsmaybeexplainedwiththehelpoffollowingschedule&diagram.
SCHEDULE:
Unitsoffixed
factors

Unitsofvariable
factors

Totalproduction

Marginalproduction

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5acres

10

10

5acres

30

20

5acres

60

30

5acres

90

30

5acres

110

20

5acres

120

10

DIAGRAM:

Accordingtotheaboveschedule&diagram,thefirstthreeunitsMarginalProductionIncreases
whichisrepresentingLawofIncreasingReturns.
ASSUMPTIONS:
1.Atleastonefactorofproductionshouldbekeptfixed/constant.
2.Atleastonefactorofproductionshouldbekeptvariable.
3.Alltheunitsofvariablefactorareassumedhomogenous.
4.Methodsofproductionshouldbesame.
5.Thereisshortperiodunderconsideration.
6.Equalrewardshouldbegivestoeachunitofvariablefactor.
7.Thereshouldbeequalworkingperiodforeachunitofvariablefactor.
8.Thereisscopeofimprovementinthecombinationoffactor.
APPLICATION:
Accordingtoneoclassicaleconomists,thelawofincreasingreturnismostlyapplicablein
industrialsector.Followingarethemainreasonsforitsapplicationinindustrialsector.
1.Industrialproductionistakenincoveredplaces.
2.Itiseasiertosuperviseindustrialproduction.
3.Industrialproductionismostlydurableinnature.
4.Industrialproductionisquitecertaininnature.
5.Industrialproductionisnotmucheffectednegativelybynaturalclimates.
6.Itiseasierandcheaperindustrialproduction.
7.Somespecificnaturaltimeisnotrequiredforindustrialproduction.(Itdoesnotgrowbutis
obtained).
8.Therebargainingpowerisstrongforindustrialgoods.
CONCLUSION:
Accordingtosamemoderneconomistsinfactincreasing,Diminishingandconstantreturnsare
differentphasesofuniversalLawofvariableproduction.
Asontheapplicationofmoreandmoreunitsofvariablefactor,iftheCombinationgetimproved,
marginalproductionincreases.
Ontheotherhand,iftheCombinationgetsdefective,marginalproductiondecreaseeitherthe
sectorisindustrialoritisagriculture.

Q#9:StateandexplainthelawofDiminishingReturnswiththe
helpofscheduleanddiagramandalsogiveitsapplication?
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INTRODUCTION:
Ineconomicactivitiesthecourseofproductionusuallypassesthroughthreedifferentstages,new
classiceconomistshavedefinedordiscussedthesestagesintheformofthreedifferentlaws.
1.LawofincreasingReturns
2.LawofDiminishingReturns
3.LawofConstantReturns

LAWOFDIMINISHINGRETURNS:
Differenteconomistshavedefinedthelawofincreasingreturnsindifferentwords.Butprominent
ofthemareBenham,Champan&Marshall.
DEFINITION:
Intheprocessofproductionifmoreandmoreunitsareappliedofvariablefactorskeepingother
factorconstantatfirstmarginalproductionincreaseafterreachingtoamaximumpointitremains
constantforsometimes.Ifstillmoreandmoreunitsareappliedtheirmarginalproductiontendsto
declinebecauseofappearanceofdefectiveCombinationoffactorsthisdiminishingtendencyof
marginalproductionperunitofvariablefactorisknownasLawofDiminishingReturns.

Explanationwiththehelpofscheduleanddiagram:
TheLawofdiminishingreturnsmaybeexplainedwiththehelpofscheduleofdiagram.
Schedule:
Unitsoffixed
factors

Unitsofvariable
factors

Totalproduction

Marginalproduction

5acres

10

10

5acres

30

20

5acres

60

30

5acres

90

30

5acres

110

20

5acres

120

10

Diagram:

Accordingtotheabovescheduleanddiagramintheunitsfrom4thtoonwardsmarginalproduction
isdecreasingwhichisrepresentingtheLawofDiminishingReturns.
ASSUMPTIONS:
Atleastonefactorofproductionshouldbekeptfixed/constant.
Atleastonefactorofproductionshouldbekeptvariable.
Alltheunitsofvariablefactorareassumedhomogenous.
Methodsofproductionshouldbesame.
Thereisshortperiodoftimeunderconsideration.

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Equalrewardshouldbegivestoeachunitofvariablefactor.
Thereshouldbeequalworkingperiodforeachunitofvariablefactor.
DefectiveCombinationoffactorhasbeenobtained.
APPLICATION:
AccordingtoneoclassicaleconomiststhelawofDiminishingReturnsismostlyapplicableto
agriculturalsector.
Followingarethemaincausesofitsapplicationinagriculturesector.
1.Agricultureproductionistakeninunsafeandopenfields.
2.Itisdifferenttosuperviseagriculturalproduction.
3.Agriculturalproductionismostlyfoundperishableinnature.
4.Itisdifficultandcostlyagricultureproduction.
5.Therebargainingpowerisquiteuncertain.
6.Agricultureproductionisverymucheffectednegativelybynaturalclimates.
7.Specifictimeperiodisrequiredtogrowagricultureproduction.
CONCLUSION:
Accordingtosamemoderneconomistsinfactincreasing,Diminishingandconstantreturnsare
differentphasesofuniversalLawofvariableproduction.
Asontheapplicationofmoreandmoreunitsofvariablefactor,iftheCombinationgetimproved,
marginalproductionincreases.
Ontheotherhand,iftheCombinationgetdefective,marginalproductiondecreaseeitherthe
sectorisindustrialoritisagriculture.

Q#10:Stateandexplainthelawofreturnswiththehelpof
scheduleanddiagramandalsogiveitsapplication?
INTRODUCTION:
Ineconomicactivitiesthecourseofproductionusuallypassesthroughthreedifferentstages,new
classiceconomistshavedefinedordiscussedthesestagesintheformofthreedifferentlaws.
1.LawofincreasingReturns
2.LawofDiminishingReturns
3.LawofConstantReturns

LAWOFRETURNS:
Differenteconomistshavedefinedthelawofreturnsindifferentwords.Butprominentofthemare
Benham,Champan&Marshall.
DEFINITION:
Inthecourseofproductionifmoreandmoreunitsareappliedofvariablefactorskeepingother
factorconstantatfirstmarginalproductionincreasebecauseofimprovementinthecombinationof
variablefactorsafterreachingtoamaximumpointitremainsconstantbecauseofoptimum
combinationofvariablefactors.Ifstillmoreunitsareappliedthenmarginalproductiontendsto
declinebecauseofappearanceofdefectiveCombinationoffactors.Theincreasingtendency
showslawofincreasingreturn,constanttendencyshowslawofconstantreturnandthe
diminishingtendencyofmarginalproductionshowLawofDiminishingReturns.

Explanationwiththehelpofscheduleanddiagram:
TheLawofreturnsmaybeexplainedwiththehelpofscheduleofdiagram.
Schedule:
Unitsoffixed
factors

Unitsofvariable
factors

Totalproduction

Marginalproduction

5acres

10

10

5acres

30

20

5acres

60

30

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5acres

90

30

5acres

110

20

5acres

120

10

Diagram:

Accordingtotheabovescheduleanddiagraminfirstthreeunitsmarginalproductionincreasing
whichshowlawofincreasingreturnfrom3rdto4thunitsmarginalproductionremainconstant
whichshowslawofconstantreturnandfromunit4thtoonwardmarginalproductiondecreases
whichisrepresentingtheLawofDiminishingReturns.
ASSUMPTIONS:
Atleastonefactorofproductionshouldbekeptfixed/constant.
Atleastonefactorofproductionshouldbekeptvariable.
Alltheunitsofvariablefactorareassumedhomogenous.
Methodsofproductionshouldbesame.
Thereisshortperiodoftimeunderconsideration.
Equalrewardshouldbegivestoeachunitofvariablefactor.
Thereshouldbeequalworkingperiodforeachunitofvariablefactor.
Thereisascopeofimprovementinthecombinationofvariablefactor.
APPLICATION:
Accordingtoneoclassicaleconomiststhelawofincreasingreturnisapplicabletoindustrysector.
Lawofdecreasingreturnapplicableonagriculturesectorandlawofconstantreturnisapplicable
onbothsectors.
CONCLUSION:
Accordingtosamemoderneconomistsinfactincreasing,Diminishingandconstantreturnsare
differentphasesofuniversalLawofvariableproduction.
Asontheapplicationofmoreandmoreunitsofvariablefactor,iftheCombinationgetimproved,
marginalproductionincreases.
Ontheotherhand,iftheCombinationgetsdefective,marginalproductiondecreaseeitherthe
sectorisindustrialoritisagriculture.
Q#11:StateandexplaintheLawofVariableProportionwiththehelpofscheduleand
diagram?
Accordingtomoderneconomistsincreasing,constantandDiminishingReturnsareinfactdifferent
phasesofUniversallawofVariableproportion.Itiscalleduniversalbecauseitisuniversally
applicableineachsectoroftheeconomyeitherindustrialoragricultural.
DifferenteconomistshavedefinedthelawofVariableproportionindifferentwords.ButProminent
ofthemareSimuelson&Ryan.DEFINITION:
InthecourseofproductionifmoreandmoreunitsareappliedofaVariablefactor,keepingother
factorConstant.Atfirstmarginalproductionincreasesbecauseofimprovementinthe
Combinationofvariablefactors.Afterreachingtoamaximumpointitbeginstodeclinebecauseof
appearanceofdefectiveCombinationoffactorsevenafterbecomingzeroandbecomesnegative.
ThistendencyofvariationinmarginalproductionisknownasLawofVariableProportion.

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ACCORDINGTOSIMUELSON:
Anincreaseinsome(Variable)input(factors)relativetoothercomparativelyfixedininputwill
Causeoutputtoincreasebutafterapointtheextraoutputresultingfromthesomeadditionof
inputwillbecomelessandless.
Itmaybeexplainedwiththehelpofscheduleanddiagram.
SCHEDULE:
UNITSOF
FIXED
FACTOR

UNITSOF
VARIABLE
FACTOR

TOTAL
PRODUCTION

AVERAGE
PRODUCTION

MARGINAL
PRODUCTION

5acres

10

10

10

5acres

30

15

20

5acres

60

20

30

5acres

80

20

20

5acres

90

18

10

5acres

90

15

5acres

80

11.4

10

ASSUMPTIONS:
Atleastonefactorofproductionshouldbekeptfixed/constant.
Atleastonefactorofproductionshouldbekeptvariable.
Alltheunitsofvariablefactorareassumedhomogenous.
Methodsofproductionshouldbesame.
Thereisshortperiodoftimeunderconsideration.
Equalrewardshouldbegivestoeachunitofvariablefactor.
Thereshouldbeequalworkingperiodforeachunitofvariablefactor.
Thereisscopeofimprovementinthecombinationoffactor.
EXPLATION:
ThelawofVariableProportionmaybeexplainedinthreedifferentstagesasdescribedbelow.

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1STSTAGE:
Inthe1STstagemarginalproductionincreaseswhiletotalproductionincreasebyincreasing
production.Averageproductionalsoincreasesbylesserproportionascomparetoincreasein
marginalproduction.
2NDSTAGE:
Inthe2ndstagemarginalproductiondecreasesbutitremainpositive.Itthisstagetotalproduction
increasesbydecreasesproportion.MarginalproductionintersectstotheAverageproductionat
thehighestpointofAverageproduction.
3rdSTAGE:
ThisstagemarginalproductionbecomesnegativewhilebothtotalproductionandAverage
productionusetodecreasebutremainpositive.

FIRMS
Q#:12:DefinePerfectCompetitionandexplainHowpriceandoutputisdeterminedundera
perfectcompetition?
OR
Q#:Explainequilibriumofafirmunderperfectcompetition?

PerfectCompetition:
Itisamarketsituationinwhichalargeno.ofsmallfirmsproducehomogeneousgoodsandsell
theirproductsinthemarketatsameprice.Thereisfreeentryandexitoffirmsinmarket.The
priceisdeterminedinmarketwithequilibriumofdemandandsupplyofthatcommodityinmarket.
Everyfirmispricetakerandnotpricemaker.Thetransportationcostisalmostzero,whichdoes
notaffectthemarketprice.

Characteristics:
Thereislargeno.ofbuyersinthemarket.
Thereislargeno.ofsellersinthemarket.
Thereisfreeentryandexitinthemarketforfirms.
Samepriceofacommodityprevailsinthe
Thepriceisdeterminedinmarketwithequilibriumofdemandandsupplyofthat
commodityinmarket.
Everyfirmispricetakerandnotpricemaker
Thetransportationcostisalmostzero,whichdoesnotaffectthemarketprice
Nofirmcanaffectmarketpricebyitsindividualbehavior.

Determinationofprice:
Incaseofperfectcompetitionpriceofcommodityisdeterminedinmarketwithequilibriumof
demandandsupplyofcommodityinmarket.

Asthepriceremainssametherefore,
Price=AR=MR

Determinationofoutput:
Followingarethetwodifferentmethodsfordeterminingoutputinperfectcompetition

Totalcostandtotalrevenuemethod:
Theoutputatwhichthereismaximumdifferencebetweentotalcostandtotalrevenuewillbethe
bestoutputasshownbelow.

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AccordingtotheabovediagramOQisthebestoutputbecauseitgivesmaximumdifference
betweenTR&TC.

Marginalcostandmarginalrevenuemethod:
Accordingtothismethodfollowingaretheconditionsofequilibrium.
MC=MR
MCshouldcutMRfrombelow.

AccordingtoabovediagrampointEfulfillsbothconditionsthereforeOQistheoutput.

CasesofshortrunEquilibrium:
Therearefourcasesofshortrunequilibrium
Supernormalprofit(AR>ACorTR>TC)
NormalProfit(AR=ACorTR=TC)
Lossminimizing(AR
Shutdownpoint(AR

Supernormalprofit(AR>ACorTR>TC):
AtthatequilibriumofafirmearnssupernormalprofitwhereAR>AC&TR>TC
Itmaybeexplainedwiththehelpoffollowingdiagram.

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=EQAC=E1Q AR>AC
TR=OPEQTC=OP1E1Q TR>TC
Thereforesupernormalprofit=PEE1P1asshownbyshadedareainthediagram.

NormalProfit(AR=AC&TR=TC):
Atthatequilibriumafirmearnsnormalprofit.Itmaybeexplainedwiththehelpofdiagram.

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Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=EQAC=EQ AR=AC
TR=OPEQTC=OPEQ TR=TC

Lossminimizing(AR
Atthispointafirmsuffersminimumlossitmaybeexplainedwiththehelpoffollowingdiagram.

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=EQAC=E1Q AR<AC
TR=OPEQTC=OP1E1Q TR<TC
Thereforeminimumloss=PEE1P1asshownbyshadedareainthediagram.

Shutdownpoint(AR
Atthisequilibriumafirmfoundatshutdownpoint.Itmaybeexplainedwiththehelpoffollowing
diagram.

Accordingtotheabovediagram,
AR=EQAC=E1Q AR<AC
TR=OPEQTC=OP1E1Q TR<TC
Thereforefirmisatshutdownpoint,theloss=PEE1P1asshownbyshadedareainthediagram.

LongrunEquilibrium:
Overalongperiodoftimenumberoffirms,sizeoffirmsandmethodofproductioncanbe
changed,thereforeeveryfirmcanearnonlynormalprofit.Itmaybeexplainedwiththehelpof
diagram.

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Accordingtotheabovediagram,
LAR=EQLAC=EQ LAR=LAC

LTR=OPEQLTC=OPEQ LTR=LTC

Q#13:Definemonopolyexplainhowpriceandoutputis
determinedundermonopoly?
Monopolyisamarketsituationinwhichthereisasingleproducerorsellerofacommodityin
marketthereisnoclosesubstitutionofthatcommodityinthemarket.Nootherfirmisallowedto
enterintothemarket.Thefirmispricemakernotapricetaker.

Characteristics:
Thereisasingleproducerorsellerinmarket
Thereisnoclosesubstitutioninmarket.
Thereisnocompetitioninthemarket.
Nootherfirmisallowedtoenterintothemarket.
Thefirmrepresentssindustryinthemarket.
Thefirmispricemakernotapricetaker.

DeterminationofOutput:
Followingarethedifferentmethodsofoutput.
1.TRandTCmethod
2.MCandMRmethod.

TRandTCmethod:

Theoutputatwhichthereismaximumdifferencebetweentotalcostandtotalrevenuewillbethe
bestoutput.SoOQisthebestoutput.

Marginalcostandmarginalrevenuemethod:
Accordingtothismethodfollowingaretheconditionsofequilibrium.
MC=MR
MCshouldcutMRfrombelow.

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AccordingtoabovediagrampointEfulfillsbothconditionsthereforeOQistheoutput.

Determinationofprice:
AverageRevenue(AR)representsprice,therefore,accordingtopreviousdiagramatOQisoutput.
AR=E1QorPrice=E!Q
Therefore,E1QwillbethepriceorOP1willbetheprice

Casesofshortrunequilibrium:
Followingarethedifferentshortrunequilibriumcases.
Supernormalprofit
Normalprofit
Lossminimizing.

Supernormalprofit:
Atthatequilibriumafirmearnssupernormalprofit
WhereAR>ACORTR>TCwhichisshowninthefollowingdiagram.

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=E1QAC=E2Q AR>AC
TR=OP1E1QTC=OP2E2Q TR>TC
Thereforesupernormalprofit=P1E1E2P2asshownbyshadedareainthediagram.

Normalprofit:
Afirmearnsnormalprofitattheequilibriumwhere
AR=ACandTR=TC,itmaybeexplainedwiththehelpofdiagram

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint

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AR=E1QAC=E1Q AR=AC
TR=OP1E1QTC=O1PE1Q TR=TC
Thereforefirmisearningnormalprofit.

Lossminimizing:
AfirmsuffersminimumlossatthatequilibriumwhereAR

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=E2QAC=E1Q AR<AC
TR=OP2E2QTC=OP1E1Q TR<TC
Thereforeminimumloss=P1E1E2P2asshownbyshadedareainthediagram.

Longrunequilibrium:
Incaseofmonopolyoveraperiodoflongtimeafirmmostlyearnssupernormalprofit.Itmaybe
explainedwiththehelpoffollowingdiagram.

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
LAR=E1QLAC=E2Q LAR>LAC
LTR=OP1E1QLTC=OP2E2Q LTR>LTC
Thereforesupernormalprofit=P1E1E2P2asshownbyshadedareainthediagram.

Q#14:Definemonopolisticcompetitionandalsoexplain
equilibriumofafirmundermonopolisticcompetition?
MonopolisticCompetition:
Monopolisticcompetitionisamarketsituationinwhichrelativelylargenumbersofsmallfirms
producesandsellaproductwiththeiridentity.
Infact,monopolisticcompetitionisablendofmonopolyandperfectcompetition

Characteristics:
Followingarethemaincharacteristicsofmonopolisticcompetition.
Relativelylargenumberofsmallfirms
Productdifferentiation
Relativelyeasierentryandexitoffirm
Rollofadvertisement&publicity
Stiffcompetition
Relativelylessercontrolonprice

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Relativelymoreelasticdemand.

DeterminationofOutput:
Followingarethedifferentmethodsofoutput.
3.TRandTCmethod
4.MCandMRmethod.

TRandTCmethod:

Theoutputatwhichthereismaximumdifferencebetweentotalcostandtotalrevenuewillbethe
bestoutput.SoOQisthebestoutput.

Marginalcostandmarginalrevenuemethod:
Accordingtothismethodfollowingaretheconditionsofequilibrium.
MC=MR
MCshouldcutMRfrombelow.

AccordingtoabovediagrampointEfulfillsbothconditionsthereforeOQistheoutput.

Determinationofprice:
AverageRevenue(AR)representspricetherefore,accordingtopreviousdiagramatOQisoutput.
AR=E1QorPrice=E!Q
Therefore,E1QwillbethepriceorOP1willbetheprice

Casesofshortrunequilibrium:
Followingarethedifferentshortrunequilibriumcases.
Supernormalprofit
Normalprofit
Lossminimizing.

Supernormalprofit:
Atthatequilibriumafirmearnssupernormalprofit
WhereAR>ACORTR>TCwhichisshowninthefollowingdiagram.

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Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=E1QAC=E2Q AR>AC
TR=OP1E1QTC=OP2E2Q TR>TC
Thereforesupernormalprofit=P1E1E2P2asshownbyshadedareainthediagram.

Normalprofit:
Afirmearnsnormalprofitattheequilibriumwhere
AR=ACandTR=TC,itmaybeexplainedwiththehelpofdiagram

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=E1QAC=E1Q AR=AC
TR=OP1E1QTC=O1PE1Q TR=TC
Thereforefirmisearningnormalprofit.

Lossminimizing:
AfirmsuffersminimumlossatthatequilibriumwhereAR

Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
AR=E2QAC=E1Q AR<AC
TR=OP2E2QTC=OP1E1Q TR<TC
Thereforeminimumloss=P1E1E2P2asshownbyshadedareainthediagram.

Longrunequilibrium:
Incaseofmonopolyoveraperiodoflongtimeafirmmostlyearnssupernormalprofit.Itmaybe
explainedwiththehelpoffollowingdiagram.

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Accordingtotheabovediagram,EistheequilibriumpointthereforeOQisthebestoutput.At
thispoint
LAR=E1QLAC=E2Q LAR>LAC
LTR=OP1E1QLTC=OP2E2Q LTR>LTC
Thereforesupernormalprofit=P1E1E2P2asshownbyshadedareainthediagram.

Q#15:Criticallyexaminemarginalproductivitytheoryof
distribution.?
OR
Criticallyexaminemarginalproductivitytheoryofpricingoffactors?
Introduction:
Classical,neoclassicalandmoderneconomistshavegivendifferenttheoriesaboutpricingof
factorsthetheorygivenbyneoclassicaleconomistsisgenerallyknownasmarginalproductivity
theoryofdistribution.Differenteconomistshavedefineditindifferentworks,Prominentofthem
areMarshall,Jevons,Clarketc.
Definition:
Therewardisgiventoeachunitoffactorsaccordingtomarginalproductivityoffactors,therefore
greaterrewardisgiventoeachunitofthatfactorwhichgivesgreatermarginalproductionandless
rewardisgiventoeachunitofthefactorwhichgiveslessmarginalproductivity.
Realizingthisfact,Neoclassicaleconomistshavegivenforpricingoffactors.
Equation:
MPPa/Pa=MPPb/Pb=...........MPPn/Pn
SupposepriceisRs10kg
5kg/Rs50=10kg/Rs100=............18kg/Rs180
1/10=1/10=................1/10
Schedule:
Thetheorymaybeexplainedwiththehelpoffollowingschedule.
Unitsof
Labor

MPPKg

Price/Rs
PerKg

MRPRs

Wages

10

10

100

60

10

90

60

10

80

60

10

70

60

10

60

60

10

50

60

Rs

Table:

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Accordingtotheabovescheduleanddiagramasmoreandmoreunitsoflaborarebeingapplied,
thenmarginalproductionisdecreasing.IffiveunitsoflaborareappliedtheMPis6kgtherefore
Rs60willbegiventoeachunitoflabor.

Assumption:
Followingaretheassumptionsofthetheory.
HomogeneousUnits:
Itistheassumedthatalltheunitsofvariablefactor(Labor)arehomogeneous.
FactorsareSubstitutable:
Itisalsoassumedthatdifferentfactorcanbesubstitutedtoeachother.
PerfectCompetition:
Itisalsoassumedthatthereisperfectcompetitioninfactorsmarket.
MobilityofFactors:
Itisassumedthatfactorsofproductionare,perfectlymobileormovableinotherwords,theycan
beappliedfortheproductionofoncommodityortheotherone.
DiminishingReturns:
Thetheoryassumesthatmarginalproductiondecreasesifmoreandmoreunitsoffactorsare
applied.
ElasticSupplyofFactors:
Thetheoryassumesthatthesupplyoffactorsisperfectlyelastic.

Criticism:
Followingarethemaincriticismagainstmarginalproductivitytheory.
UnrealisticAssumptions:
Assumptionsofthistheoryarequiteunrealistic.
NoHomogeneous:
Thetheoryassumeshomogeneousunitsoffactorsbutpracticallyalltheunitsofafactorcannot
behomogeneous.
NoPerfectSubstitutes:
Tosomeextentthefactorsaresubstitutablebuttheyarenotperfectsubstitutetoeachother.
NoPerfectMobility:
Tosomeextentmobilityoffactorispossiblebuttheyarenotperfectlymovable.
NoPerfectCompetition:
Perfectcompetitionispracticallyfoundnowhereintheworld.

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OnlyDiminishingReturns:
Thetheoryhasjustdiscussedthetendencyofdiminishingreturnsandithasneglectedincreasing
andconstanttendencymarginalproductionwhileisunwisetoneglectit.
Independence:
Accordingtomarginalproductivitytheory,itistherewardwhichdependsuponthemarginal
productivitybutmoderneconomistsbelievethatmarginalproductionandrewardbothare
independentinotherwordsbothdependsuponeachother.
StaticTheory:
Itisastatictheorywhichisnotapplicableinthisdynamicage.

Q#16:CriticallyexamineKeynesiantheoryofinterest?
Or
Criticallyexaminetheliquiditypreferencetheoryof
interest?
Introduction:
Interestistherewardwhichispaidagainsttheservicesofcapital.Differenteconomisthavegiven
differenttheoriesofinterest.Keynesisamongmoderneconomist,thetheorygivenbyhimis
generallyknownas
Keynesiantheoryofinterestorliquiditypreferencetheoryofinterest.
Keynestheory:
AccordingtoKeynes:
Interestistherewardforpartingwiththeliquidityofmoneyforaspecificperiodoftimeandthe
rateofinterestisdeterminedwiththeequilibriumofdemandandsupplyofmoney.
Demandofmoney:
Peoplewanttokeepsomemoneywiththemfortransactionmotive,businessmotive,
precautionarymotiveandspeculativemotive.Itisknownasdemandofmoney.
Transactionalmotive:
Peoplewanttokeepsomemoneywiththemincashformtomeettheirdailyneedslikepurchase
ofvegetables,meatandbread.
Businessmotive:
Individualandfirmsalsokeepsomemoneywiththeminliquidformfortheirbusinessneedlike
thepurchaseofrawmaterial,paymentofwages,bills.
Precautionarymotive:
Somemoneyisalsokeptbypeopletofacethesituationofemergencylikeaccident,breakdown
ofmachinery,businessslumpetc.
Speculativemotive:
Somemoneyisalsokeptbypeopleforspeculativemotiveforpurchaseofshares,bonds,
securities.

Relationshipbetweenrateofinterestanddemandof
money
AccordingtoKeynesthedemandofmoneyforspeculativemotiveisnegativelyrelatedwiththe
rateofinterest.

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Supplyofmoney:
Thesupplyofmoneydependsuponmetallicreserves,monetarypolicyandbankingsystemofthe
country.InhistheoryKeyneshasassumedshortperiodoftimeandhebelievesthatincaseof
shortperiodthesupplyofmoneyremainsinelastic.

Determinationofrateofinterest
AccordingtoKeynes
Therateofinterestisdeterminedwiththeequilibriumofdemandandsupplyofmoneyasshown
inthefollowingscheduleanddiagram.
RateofInterest

DemandofMoney

SupplyofMoney

5%

60

40

10%

50

40

15%

40

40

20%

30

40

25%

20

40

Accordingtotheaboveschedule&diagramat15%rateofinterestdemandandsupplyofmoney
areequal.Thereforethisrateofinterestwillbedeterminedinthemarket.

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Effectonrateofinterestofchangeindemandof
money

Accordingtotheabovediagram,increaseindemandofmoneyresultincreaseinrateofinterest
anddecreaseindemandofmoneyresultdecreaseinrateofinterest.

Effectonrateofinterestofchangeinsupplyof
money

Accordingtotheabovediagramincreaseinsupplyofmoneyresultdecreaseinrateofinterest
anddecreaseinsupplyofmoneyresultincreaseinrateofinterest.

Criticism:
1.Keyneshasassumedshortperiodoftimeandhehasdiscussednothingaboutlongperiod.
2.Keyneshasnotgivencleanpictureaboutsupplyofmoneyassometimesheincludes
creditmoneyinsupplyofmoneyandsometimeshedoesnotincludeitinsupplyof
money.
3.Keyneshasgivenimportancetodemandandsupplyofmoneybuthehasneglectedthe
forceswhichworkbehindsaving
4.AccordingtosomemoderneconomistlikeHick,HansomlikeKeyneshastriedtoputold
wineinnewbottle.

Q#17:CriticallyExaminesRecardianTheoryofRentOr
Criticallyexamineclassicaltheoryofrent?
Introduction:
Rentistherewardwhichispaidagainsttheservicesofland,differenteconomistshavegiven
differenttheoriesofrent.
Ricardoisamongclassicaleconomists,thetheorygivenbyhimisgenerallyknownasRecardian
TheoryofRent.

Definition:
AccordingtoRicardo
Rentisthatpartofproductionofland,whichispaidtothelandlordagainsttheuseoftheoriginal
andindestructiblepowerofthesoil.Asthefertilityofdifferentgradesoflandisdifferent,therefore
thedifferenceofproductionofalandwiththeproductionofmarginallandistreatedastherentof
thatland.

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Example:
Ricardohasexplainedhistheorybygivingtheexampleofanewlypopulatedcountryhavingfour
gradesoflandA,B,CandlandD.whileAlandismostfertileandlandDisleastfertile.Atfirst
peoplewillcultivatelandA.withtheincreaseinpopulationtheywillbringunderthecultivation
landB,CandthenlandDaccordingtotheincreasingtendencyofpopulationandprice.IflandD
justcoversitscostthenitwillbetreatedasmarginallandandnorentwillbechargeonland
D.Therentofothergradesoflandwillbedeterminedbycomparingtheirproductionwiththe
productionofmarginalland,asshowninfollowingschedule.

Schedule:
Marginalproductionandgradesofland.
UnitsofInput(Lab
&Capital)

LandA

LandB

LandC

LandD

3515

3010

255

20

3010

255

255

20

Rent

20

MarginalLand

20

30

15

NoRent

Formula:
Totalproductionofland=(MP*Units)
RentoflandA=35+30+25+20(20*4)
=11080
=30
Similarly,wecancalculaterentofeachgradeofland.

Accordingtotheabovediagram,theshadedareaisrepresentingtherentofdifferentgradesof
land.
Assumptions:
FollowingarethemainassumptionofRicardiantheory.
Differenceoffertility:
Differentlandshavedifferentfertility,somearemorefertileandsomearelessfertile.
Perfectcompetition:
Thistheoryisbasedontheassumptionofperfectcompetition.

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NoRentLand:
Thelandwhichjustcoversitscostofcultivationiscalledasnorentland(MarginalLand).
Knowledgeoffertility:
Ricardoassumesthatpeopleknow,whichlandismorefertileandwhichislessfertile.
Originalandindestructiblequality:
Itisassumedthatfertilitypoweroflandisoriginalandindestructible.
Agradelandfirst:
ItisassumedthatfarmersprefertouseAgradelandfirst.
Diminishingreturns:
Itisalsoassumedthatmarginalproductiondecreasesasmoreandmoreunitsareapplied.
Criticism:
Maincauseofrent:
AccordingtoRicardo
Causeofrentisthedifferenceofproductivityofsoil,whileaccordingtothemoderneconomists
maincauseofrentisthescarcityofthesoil.
Noperfectcompetition:
Thetheoryassumesperfectcompetition,butperfectcompetitionisfoundnowhereintheworld.
Nomarginalland:
Ricardohasgiventheconceptofmarginallandbutpracticallyitisfoundnowhereintheworld.
Noperfectknowledgeoffertility:
Farmersaremostlyawareofthefertilityofthesoilalittlebitbutperfectknowledgeaboutfertility
isnotpossible.
Nooriginalandindestructiblepower:
Accordingtomoderneconomists,thereisnooriginalandindestructiblepowerofthesoil.The
fertilitymayincreaseordecreasetimetotime.
Agradelandisnotpreferred:
ItiswrongtoassumethatAgradelandiscultivatedfirst.Inthemodernworldthelandnearestto
themarketiscultivatedfirstinsteadofAgradeland.
Increasing&Constantreturnhavebeenignored:
Ricardohasdiscussedthediminishingtendencyofmarginalproductionwhilehehasignored
increasingandconstanttendenciesofmarginalproduction.
Rentisapartofcost:
Ricardohasnotincludedrentinthecostofproductionbutinrealsense,rentisapartofcostand
itcannotbeseparated.
Roleofhumanstruggleinfertility:
HumanstruggleplaysanimportantroleinthefertilitybutRicardohasignoredit.
Noneedtoseparatetheory:
Accordingtomoderneconomists,demandandsupplytheoryissufficienttodeterminedrentand
thereisnoneedofseparatetheoryforthedeterminationofrent.
Q#18:DefineNationalIncome,Discussmethodsofitsmeasurementandalsostatethe
problemsofmeasurementofN.I.
Ans:Introduction:
DifferenteconomistshavedefinednationalincomeindifferentwordsprominentofthemareAlfred
Marshall,Pigou,Fisher,Campbell,Kuznat,SamuelsonandAckley.
AccordingtoCampbell:
Totalmarketvalueofallfinalgoodsandservicesproducedinacountryduringoneyeariscalled
NationalIncome.
AccordingtoAckley:NationalIncomeisnothingmorethanthesumofallindividualincomes.

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AccordingtoSamuelson:
Itistheloosenamewegiveforthemoneymeasureoftheoverallannualflowofthegoodsand
servicesinaneconomy.
ConceptofNationalIncome:
FollowingaretheconceptsofNationalIncome,GNP,NNP,GDP,NDP,NI,PI,andDPI.
Methodsofmeasurement:
Thefollowingarethemethodsofmeasurement
1.Productivemethod
2.Incomemethod.
3.Expendituremethod.
Productmethod:
Accordingtothismethodnationalincomecanbemeasuredbysummingupthetotalmarketvalue
ofallfinalgoodsandservicesproducedinacountry.
Itmaybeexplainedwiththehelpoffollowingexample.

Number

Netvaluein
(billionRs.)

Sector

Agriculture

60

Manufacturing

40

Smallenterprises

20

Transport&communication

30

Commerce&trade

10

Mining

20

Services

50
230

Precautions:
Toavoiddoublecountingonlyfinalorfinishedgoodsareincluded.Finalgoodsarethosewhich
arepurchasedbyconsumersforfinaluse.Depreciationcostisnotincluded.
Incomemethod:Nationalincomecanalsobemeasuredbytakingthesumoftotalincomeofall
thefactorsofproductionofacountryduringoneyear.
Example:
Sourcesofincome

(BillionRs.)

Wagesoflabor

80

Rentofland

50

Interestofcapital

20

Profitoforganizations

40

Corporateprofit(JSC)

10

IndirectTax

30
230

Precautions:
Transferpayment:Transferpaymentsarenotincludedinnationalincomelike
zakat,charity,pensionetc.
Incomefromillegalsources:Incomefromillegalsourcesisalsonotincludedlike
incomefromtheftorbribery.
Depreciationcost:Depreciationcostalsonotincludedinnationalincome.
Totalexpendituremethod:

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Nationalincomecanbemeasuredbytakingthesumoftotalexpenditures,whichareincurred,in
acountryduringoneyear.
Example:

NatureorheadofExpenditure

Amount
(BillionRs.)

Privateconsumptionexpenditure

60

Privateinvestmentexpenditure

50

Govt.productiveexpenditure

40

Govt.nonproductiveexpenditure

30

Exportsurplusie(XM)

50(9040)
230

Income=Y=C+I+G+(XM)
Y=60+50+(40+30)+(9040)
Y=230
Precautions:
Expendituresshouldbecountedonce.
Theexpenditureonthepurchaseofsecondhandgoodsshouldnotinclude.
DifficultiesinmeasurementofNationalIncome:
Followingarethedifficultiesofnationalincomediscussasunder:
Unpaidservices
Bartersystems
Foreignfirms
Inadequatestatisticaldata
Lackoftrainedstaff
Habitofkeepingnoaccount
Morethanonejob.
Cottageindustry
Noncooperationofpeople
Taxevasion(escapefromtax)

Q#19DefineNationalIncome,Alsogiveconceptsof
NationalIncome?
Introduction:
DifferenteconomistshavedefinednationalincomeindifferentwordsprominentofthemareAlfred
Marshall,Pigou,Fisher,Campbell,Kuznat,SamuelsonandAckley.
AccordingtoCampbell:
Totalmarketvalueofallfinalgoodsandservicesproducedinacountryduringoneyeariscalled
NationalIncome.
AccordingtoAckley:
NationalIncomeisnothingmorethanthesumofallindividualincomes.
AccordingtoSamuelson:
Itistheloosenamewegiveforthemoneymeasureoftheoverallannualflowofthegoodsand
servicesinaneconomy.
ConceptofNationalIncome:
FollowingaretheconceptsofNationalIncome,GNP,NNP,GDP,NDP,NI,PI,andDPI.
GrossDomesticProduct(GDP):
GDPisthemarketvalueofallfinalgoodandservicesproducedwithinthegeographical
boundariesofacountryduringoneyear.InGDPforeignremittancearenotincluded,howeverthe
incomesofforeignfirmsmustbeincludedforexampleBATAisaforeignfirm,itsproductionand

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incomeinPakistanwillbeincludedintheGDPofPakistan,thoughaportionofprofitistaken
abroadbythefirm.

GDP=GNPForeignremittance+Incomeof
foreignfirms
Example:(forallconceptsofnationalincome)
(Suppose)
GrossNationalProductGNP400M.$
GrossDomesticProductGDP320
Incomeofforeignfirms(takenabroad)40
Foreignremittance120
Depreciationcost30
Indirecttaxes50
Govt.subsidies10
Transferincomes70
Corporateprofit60
Undistributedprofit20
Socialsecuritycontribution15
Personaltaxes55

GDP=GNPForeignremittance+Incomeofforeignfirms
400120+40

GDP=320M.$
NetDomesticProduct(NDP):
Ifthedepreciationexpenditurearedeductedfromgrossdomesticproduct,thenwegetNet
DomesticProduct.

NDP=GDPDepreciationcost
NDP=32030
=290
GrossNationalProduct(GNP):
ItisthewidertermofnationalincomeascomparedtoGDP.
GNPofacountryforaparticularyearisthesumofthemarketvalueofallfinalgoodsand
servicesproducedfrotheconsumptionandinvestmentpurposeofthatcountry.
InGNPforeignremittancesarealsoincludedwhileincomeofforeignfirmstakenabroadisnot
included.
GNP=GDP+foreignremittancesincomeofforeignfirmstakenabroad
GNP=320+12040
GNP=400
NetNationalProduct:
IfdepreciationexpenditurearedeductedfromGNPthenwegetNNP.
NNP=GNPDepreciationcost
NNP+40030
NNP=370M
NationalIncome:
TotalincomeinfactisnotdistributedamongthefactorsasaportionistakenbytheGovt.inthe
formoftaxeswhilesometimesGovtgivessubsidies.

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IfGovttaxesaredeductedandGovtsubsidesareincludedinNNPthenwegetNI.
NI=NNPGovtTaxes+GovtSubsides
NI=37050+10
NI=330
PersonalIncome:
Personalincomereferstotheaggregateofallincomesactuallyreceivedbyallfactorsof
productionintheformofwage,rent,interest,profit.Transferincomesalsoincludedinpersonal
income,howevercorporateprofit,undistributedprofitandsocialsecuritycontributionisnot
includedinpersonalincome.
P.I=N.I+TranferIncomes(corporateprofit+undistributedprofit+sscontribution)
P.I=330+70(60+20+15)
P.I=305
Disposablepersonalincome(DPI):
Ifpersonaltaxesaredeductedfrompersonalincomethenweget(DPI).Infactitistheamount
whichpeoplecandisposeoffaslike.
DPI=P.IPersonaltaxes
DPI=30555
DPI=250
Q#20:DefineNationalIncome.ExplaintheCircularFlowofnationalIncomewiththehelp
ofdiagram.
Introduction:
DifferenteconomistshavedefinednationalincomeindifferentwordsprominentofthemareAlfred
Marshall,Pigou,Fisher,Campbell,Kuznat,SamuelsonandAckley.
AccordingtoCampbell:Totalmarketvalueofallfinalgoodsandservicesproducedinacountry
duringoneyeariscalledNationalIncome.
AccordingtoAckley:NationalIncomeisnothingmorethanthesumofallindividualincomes.
ConceptofNationalIncome:
FollowingaretheconceptsofNationalIncome,GNP,NNP,GDP,NDP,NI,PI,andDPI.
Methodsofmeasurement:
Thefollowingarethemethodsofmeasurement
Productivemethod
Incomemethod.
Expendituremethod.
CircularFlow:
IfweobservetheNationalIncome,wecametoknowthatN.I.circulatesbetweentwosectorsin
differentforms.Thesesectorsare(i)household.(ii)Firms.ThecirculationofNationalIncome
betweenthesetwosectorsiscalledcircularflowofnationalincome.
CircularflowofN.I.maybeexplainedwiththehelpoffollowingdiagram.
ServicesofGoods
Upperhalf
Services

HouseholdFirms

Reward

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Lowerhalf
PricesofGoods
ThediagramshowsthatononesideNationalIncomemovesfromHouseholdtowardsfirmsinthe
formoftheirservices.Ontheothersideinreturnitmovesfromfirmstowardhouseholdinthe
formofrewardsoffactorsasshownbyinnercircleintheabovediagram.
Theproductionmadebythefirmsisofferedforsaletofactors(household)inreturnhouseholdgive
priceofgoodstofirmsasshownbytheoutercircleoftheintheabovediagram.
Thismovementofnationalincomefromhouseholdtofirmsandfromfirmstohouseholdin
differentformsisknownascircularflowofnationalincome.
TheabovediagramshowstwotypesofflowofNationalIncome.
(i)Realflow.
(ii)MonetaryFlow.

RealFlow:
Upperhalfofdiagramisshowingrealflowofgoodsandservicesfromonesectortoother.

MonetaryFlow:Thelowerhalfofthediagramisshowingmonetaryflowofnational
incomeintheformofrewardoffactorsandpriceofgoods.

Q#21:Definetax.Discussvariouscannotoftaxation?
TAX:
Taxisacompulsorycontributionleviedbythestateonitsindividualstomeetthedevelopment
andnondevelopmentexpenditures.
Taxiscompulsorycontributionbythepeopletothepublictreasurytomeetthegeneral
expenditureofthegovernment.
CannonsofTaxation:
Thequalitiesthatagoodtaxshouldpossessaredescribedascannonsoftaxation.AdamSmith
hasstatedfourcannonsoftaxationontheadministrativesideofpublicfinance.Accordingtohim,
agoodtaxisonewhichcontains
1.Thecannonofequality
2.Thecannonofcertainly
3.Thecannonofconvenience
4.Thecannonofeconomy
1.Thecannonequality:
Thisisthemostimportantprincipaloftaxation.Itmeansthatthereshouldbejustice.Theburden
oftaxshouldbeequaloneverytaxpayer.Equalburdendoesnotmeanthattheamountofthis
taxisequal.Itmeansthatthereshouldbeequalsacrificeandeveryoneshouldpaytaxaccording
tohisability.Richshouldpaymorethanthepoor.
2.Thecannonofcertainty:
Thiscannonimpliesthatthetaxwhicheachindividualisboundtopayshouldbecertainandnot
arbitrary.Thetimeofpayment,themodeofpayment,theamounttobepaidshouldclearsothat
hemayadjusthisexpendituresaccordingly.
3.Thecannonofconvenience:
Accordingtothiscanon,thereshouldbeappropriatetimingsoftaxcollection.Methodofrecording
paymentsshouldalsobeeasyandconvenienttothetaxpayers.Forexample,ifthetaxcanbe
paidthroughcheque,itwillbeconvenient.Ifthetaxpayerhastogotoanofficemanytimes,itwill
beinconvenient.
4.Thecannonofeconomy:
Ifthecostofcollectionofataxissmall,itiscalledeconomical.Ifthereisataxinwhich
taxpayershavetolargeamountsbutonlyasmallamountgoestothegovernmenttreasurydueto
heavysalariesofstaff,thentaxisnoteconomical.Thecostoftaxcollectionshouldbethe
minimum.
Otherscannonsoftaxation:
5.Cannonofproductivity:

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Thecannonofproductivityimpliesthatataxshouldbringsufficientrevenuetothegovernment.A
fewtaxesbringinglargerevenuearebetterthanmanytaxeseachbringingverysmallsum.
6.CannonofElasticity:
Cannonofelasticitystatesthattheamountcollectedshouldincreaseordecreaseaccordingto
theneedsofthegovernment.InPakistan,incometaxandcustomdutyareelasticbecausealittle
increaseintheirratescanbringinlargeamountofadditionalrevenue.
7.CannonofSimplicity:
Thetaxstructureshouldbesimplesothatthepeoplecaneasilyknownwhohastopaythetax
andhowmuch.Thetaxpayershouldbeabletocalculatetheamountoftaxandpayit
conveniently.
8.CannonofDiversity:
Asingletaxisnotdesirable.Thereshouldbevarioustypesoftaxes,othatallclassesofpeople
havetopaysomeamount.Inthisway,allpeoplecancontributetothestaterevenue.
9.HarmlessforEconomicsIncentives:
Thenatureandrateoftaxshouldbesuchthatitdoesnothavebadeffectsonpeoplesincentives
foreconomicefforts.

10.CannonofUniformity:Thetaxsystemshouldbeuniformandnotarbitrary.Forexample,if
peopleofLahorehavetopayhigherrateofincometaxthenthepeopleofothermajorcities,the
taxwillnotbeuniform.
Q#10(a)Stateandexplainthelawsofcostwiththehelpofscheduleanddiagram?
INTRODUCTION:
Ineconomicactivitiesthecourseofproductionusuallypassesthroughthreedifferentstages,new
classiceconomistshavedefinedordiscussedthesestagesintheformofthreedifferentlaws.
1.LawofincreasingReturnsorDiminishingcost
2.LawofDiminishingReturnsorincreasingcost
3.LawofConstantReturnsorconstantcost

LAWOFCOST:
Differenteconomistshavedefinedthelawofcostindifferentwords.Butprominentofthemare
Hanson,StainleyBenham,Champan&Marshall.
DEFINITION:
Inthecourseofproductionifmoreandmoreunitsareappliedofvariablefactorskeepingother
factorconstantatfirstmarginalcostdecreasesbecauseofimprovementinthecombinationof
variablefactorsafterreachingtoamaximumpointitremainsconstantbecauseofoptimum
combinationofvariablefactors.Ifstillmoreunitsareappliedthenmarginalcosttendstodecline
becauseofappearanceofdefectiveCombinationoffactors.Thisdiminishingtendencyofmarginal
costrepresentlawofdiminishingcost,constanttendencyshowslawofconstantcostandthe
increasingtendencyofmarginalcostshowsLawofincreasingcost.

Explanationwiththehelpofscheduleanddiagram:
TheLawofreturnsmaybeexplainedwiththehelpofscheduleofdiagram.
Schedule:
Unitsof
fixed
factors

Unitsof
variable
factors

Total
production

Marginal
production

Marginal
cost

Reward/unitsof
variablefactor

5acres

10

10

100/10=10

100

5acres

30

20

100/20=5

5acres

60

30

100/30=3.3

5acres

90

30

3.3

5acres

110

20

5acres

120

10

10

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Diagram:

Accordingtotheabovescheduleanddiagraminfirstthreeunitsmarginalcostisdecreasing
whichshowlawofdecreasingcostin3rd&4thunitsmarginalcostremainconstantwhich
showslawofconstantcostandfromunit4thtoonwardmarginalcostisincreasingwhichis
representingtheLawofincreasingcost.
ASSUMPTIONS:
Atleastonefactorofproductionshouldbekeptfixed/constant.
Atleastonefactorofproductionshouldbekeptvariable.
Alltheunitsofvariablefactorareassumedhomogenous.
Methodsofproductionshouldbesame.
Thereisshortperiodoftimeunderconsideration.
Equalrewardshouldbegivestoeachunitofvariablefactor.
Thereshouldbeequalworkingperiodforeachunitofvariablefactor.
Thereisascopeofimprovementinthecombinationofvariablefactor.
APPLICATION:
Accordingtoneoclassicaleconomiststhelawofdecreasingcostisapplicabletoindustrysector.
Lawofincreasingcostismostlyapplicablefortheproductionofthosegoodsinwhichboth
industryandagriculturesectorareusedlikesugar,carpet&textileindustry.
CONCLUSION:
Accordingtosamemoderneconomistsinfactincreasing,Diminishingandconstantreturnsare
differentphasesofuniversalLawofvariableproduction.
Asontheapplicationofmoreandmoreunitsofvariablefactor,iftheCombinationgetimproved,
marginalproductionincreases.
Ontheotherhand,iftheCombinationgetsdefective,marginalproductiondecreaseeitherthe
sectorisindustrialoritisagriculture.
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3 comments

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Top comments

S.M.Ghufran Basit 1 year ago (edited) - Shared publicly

Really
a Great & appreciable work.Make sure that diagrams are visible.
Keynesian theory of Income & Employment & the other Area of Macro are
also needed to be more informative.
Looking forward for the inclusion.
Best Regards.
1 Reply

M Sarmad Rafiq 1 year ago - Shared publicly

Great
job. Very useful for students But diagrams are not visible. Kindly make
sure there visibility
1 Reply

Imran G 1 year ago - Shared publicly


good work man but diagrams are not visible plz make sure visibility
1 Reply

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