Q-1] Inflation is a global Phenomenon which is associated with high

price causes decline in the value for money. It exists when the
amount of money in the country is in excess of the physical volume
of goods and services. Explain the reasons for this monetary
phenomenon.
a) Define Inflation
b) Causes for Inflation
A-1]
a) Define Inflation
Inflation is commonly understood as a situation of substantial and
rapid increase in the level of prices and consequent deterioration in the
value of money over a period of time. It refers to the average rise in
the general level of prices and fall in the value of money
Inflation is statistically measured in terms of percentage increase in the
price index, as a rate (percent) per unit of time- usually a year or a
month. The trend of price indices reveals the course of inflation in the
economy. Usually, the Wholesale Price Index (WPI) numbers are used
to measure inflation. Alternatively, the Consumer Price Index (CPI) or
the cost of living index can be adopted to measure the rate of inflation.
In order to measure the percentage rate of inflation, the following
formula can be used:
change price[t]
100
Percentage rate of inflation, P[t] =
Price[t1]
Change in price [t] = P [t] P [t-1].
Here, P = price level
[t], [t-1] = periods of calendar time in which the observations are
made.
b) Causes for Inflation
Demand rises much faster than supply. We can enumerate the following
reasons for increase in effective demand.
Increase in money supply Supply of money in circulation increases on
account of the following reasons: deficit financing by the government,
expansion in public expenditure, expansion in bank credit and
repayment of past debt by the government to the people, increase in
legal tender money and public borrowing.

Increase in disposable income Aggregate effective demand rises

when disposable income of the people increases. Disposable income
rises on account of the following reasons: reduction in the rates of
taxes, increase in national income while tax level remains constant,
and decline in the level of savings.

Increase in private consumption expenditure and investment

expenditure An increase in private expenditure both on consumption
and on investment leads to emergence of excess demand in an
economy. When business is prosperous, business expectations are
optimistic and prices are rising. More investments are made by private
entrepreneurs causing an increase in factor prices. When the income of
the factors rise, there is more expenditure on consumer goods.

Increase in exports An increase in the foreign demand for a countrys

exports reduces the stock of goods available for home consumption.
This creates shortages in the country leading to a rise in price level.

Existence of black money The existence of black money in a country

due to corruption, tax evasion, black-marketing, etc. increases the
aggregate demand. People spend such unaccounted money
extravagantly and create unnecessary demand for goods and services
thus causing inflation.

Increase in foreign exchange reserves This may increase on the

account of inflow of foreign money into the country. Foreign direct
investment may increase and non-resident deposits may also increase
due to the policy of the government.

Increase in population growth This creates an increase in demand for

many types of goods and services in a country.

High rates Higher rates of indirect taxes would lead to a rise in prices.

Q-2] Monopoly is the situation there exists a single control over the
market producing a commodity having no substitutes with no
possibilities for anyone to enter the industry to compete. In that
situation, they will not charge a uniform price for all the customers
in the market and also the pricing policy followed in that situation.
a) Define Monopoly
b) Features of Monopoly
c) Kinds of Price Discrimination
A-2]
a) Define Monopoly
Monopoly is that market form in which a single producer controls the whole
supply of a single commodity which has no close substitutes.
Monopoly may be defined, as a condition of production in which a single firm
has the power to fix the price of the commodity or the output of the

commodity. It is a situation there exists a single control over the market

producing a commodity having no substitutes with no possibilities for anyone
to enter the industry to compete.
b) Features of Monopoly
Anti-thesis of competition Absence of competition in the market
creates a situation of monopoly and hence, the seller faces no threat of
competition.

Existence of a single seller There will be only one seller in the market
who exercises single control over the market.

Absence of substitutes There are no close substitutes for the sellers

product with a strong cross elasticity of demand. Hence, buyers have
no alternatives.

Control over supply Seller will have complete control over output and
supply of the commodity.

Price maker The monopolist is the price maker and in taking decisions
on price fixation, he or she is independent. He or she can set the price
to the best of his or her advantage. Hence, the monopolist can either
charge a high price for all customers or adopt price discrimination
policy if there are different types of buyers.

Entry barriers Entry of new firms is difficult. Hence, monopolist will

not have direct competitors in the market.

Firm and industry is same There will be no difference between the

firm and an industry.

Nature of firm The monopoly firm may be a proprietary concern,

partnership concern, Joint Stock Company or a public utility which
pursues an independent price-output policy.

Existence of super normal profits There will be opportunities for

supernormal profits under monopoly, because market price is greater
than the cost of production.

c) Kinds of Price Discrimination

The policy of price discrimination refers to, the practice of a seller to charge
different prices for different customers for the same commodity, produced
under a single control without corresponding differences in cost.

Three kinds of price discrimination are commonly seen. It is as follows:

Discrimination of the first degree Under price discrimination of the
first degree, the producer exploits the consumers to the maximum
possible extent, by asking to pay the maximum he/she is prepared to
pay rather than go without the commodity. In this case, the monopolist
will not allow any consumers surplus to the consumer. This type of
price discrimination is called perfect discrimination.

Discrimination of the second degree In case of discrimination of the

second degree, the monopolist charges different prices for markets of
the same commodity, but not at a maximum possible rate but at a
lower rate. The monopolist will leave a certain amount of consumers
surplus with the consumers. This is done to keep the consumers
satisfied and prevent the entry of potential rivals. This method is
adopted by railway companies.

Discrimination of the third degree In case of discrimination of the

third degree, the markets are divided into many sub-markets or subgroups. The price charged in each case roughly depends on the ability
to pay of different subgroups in the market. This is the most common
type of discrimination followed by a monopolist.

Q-3] Define Fiscal Policy and the instruments of Fiscal policy.

a) Definition of Fiscal policy
b) Explanation of Instruments of Fiscal Policy
A-3]
a) Definition of Fiscal policy
The term fisc in English language means treasury, and the policy related
to treasury or government exchequer is known as fiscal policy.
Fiscal policy is a package of economic measures of the Government
regarding public expenditure, public revenue, public debt or public
borrowings. It concerns itself with the aggregate effects of government
expenditure and taxation on income, production and employment.
In short, it refers to the budgetary policy of the government.
b) Explanation of Instruments of Fiscal Policy
Instruments of fiscal policy include:
1. Public revenue: It refers to the income or receipts of public authorities.
It is classified into two parts - tax-revenue and non-tax revenue. Taxes are
the main source of revenue to a government. There are two types of taxes.
They are direct taxes such as personal and corporate income tax, property
tax, expenditure tax, and indirect taxes such as customs duties, excise

duties, sales tax (now called VAT). Administrative revenues are the biproducts of administrate functions of the government. They include fees,
license fees, price of public goods and services, fines, escheats and special
assessment.
2. Public expenditure policy: It refers to the expenditure incurred by the
public authorities like central, state and local governments. It is of two kinds:
development or plan expenditure and non-development or non- plan
expenditure. Plan expenditure includes income-generating projects like
development of basic industries, generation of electricity, development of
transport and communications and construction of dams. Non-plan
expenditure includes defense expenditure, subsidies, interest payments and
debt servicing changes.
3. Public debt or public borrowing policy: All loans taken by the
government constitutes public debt. It refers to the borrowings made by the
government to meet the ever-rising expenditure. It is of two types, internal
borrowings and external borrowings.
4. Deficit financing: It is an extraordinary technique of financing the
deficits in the budgets. It implies printing of fresh and new currency notes by
the government by running down the cash balances with the central bank.
The amount of new money printed by the government depends on the
absorption capacity of the economy.
5. Built in stabilizers or automatic stabilizers (BIS): The automatic or
built-in stabilizers imply automatic changes in tax collections and transfer
payments or public expenditure programmes so that it may reduce the
destabilizing effect on aggregate effective demand. When income expands,
automatic increase in taxes or reduction in transfer payments or government
expenditures will tend to moderate the rise in income. On the contrary, when
the income declines, tax falls automatically and transfers and government
expenditure will rise and thus built-in stabilizers cushion the fall in income
Q-4] Describe Cost-Output Relationship in brief.
a) Definition of cost-output relationship
b) Explanation of Cost-output relationship in short run and long run
in brief
A-4]
a) Definition of cost-output relationship
Cost and output are correlated. Cost-output relations play an important role
in almost all business decisions. It throws light on cost minimization or profit

maximization and optimization of output. The relation between the cost and
output is technically described as the cost function.
Mathematically speaking TC = f (Q) where TC = Total cost and Q stands for
output produced.
b) Explanation of Cost-output relationship in short run and long run
in brief
1) Cost-output relationship in short run
The cost concepts made use of in the cost behavior are Total cost, Average
cost, and Marginal cost.
Total cost is the actual money spent to produce a particular quantity of
output. Total Cost is the summation of Fixed Costs and Variable Costs.
TC=TFC+TVC
Up to a certain level of production Total Fixed Cost i.e., the cost of plant,
building, equipment etc, remains fixed. But the Total Variable Cost i.e., the
cost of labor, raw materials etc., vary with the variation in output. Average
cost is the total cost per unit. It can be found out as follows.
AC=TC/Q
The total of Average Fixed Cost (TFC/Q) keep coming down as the production
is increased and Average Variable Cost (TVC/Q) will remain constant at any
level of output.
Marginal Cost is the addition to the total cost due to the production of an
additional unit of product. It can be arrived at by dividing the change in total
cost by the change in total output.
In the short-run there will not be any change in Total Fixed Cost. Hence
change in total cost implies change in Total Variable Cost only.
2) Cost-output relationship in long run
Long run is a period, during which all inputs are variable including the one,
which are fixes in the short-run. In the long run a firm can change its output
according to its demand. Over a long period, the size of the plant can be
changed, unwanted buildings can be sold staff can be increased or reduced.
The long run enables the firms to expand and scale of their operation by
bringing or purchasing larger quantities of all the inputs. Thus in the long run
all factors become variable.
The long-run cost-output relations therefore imply the relationship between
the total cost and the total output. In the long-run cost-output relationship is
influenced by the law of returns to scale.
In the long run a firm has a number of alternatives in regards to the scale of
operations. For each scale of production or plant size, the firm has an
appropriate short-run average cost curves. The short-run average cost (SAC)

curve applies to only one plant whereas the long-run average cost (LAC)
curve takes in to consideration many plants.
Q-5] Discuss the practical application of Price elasticity and Income
elasticity of demand.
a) Practical application of price elasticity
b) Practical application of Income elasticity
A-5]
a) Practical application of price elasticity
Firms give a lot of importance to PED while setting prices for their products. A
firm will be more willing to increase the price of a product which has a more
inelastic demand because it will lead to an overall increase in their revenue.
With an increase in price of the product, the demand will not fall in the same
proportion and this end up in more revenue for the firm. On the other hand a
firm seeking to increase its revenue and having elastic demand for its
product should not increase its prices because it will lead to a fall in their
revenue. As the price increase there will be a more than proportionate fall in
sales, thus pulling down the overall revenue of the firm.

Elasticity of Demand: - " Elasticity of demand is the rate at which the

quantity demanded changes with a change in price."
In other words we can say that elasticity of demand is the relationship
between the proportionate change in price and the proportionate change in
quantity demanded.
FORMULA: ED = Proportionate change in quantity demanded/Proportionate
change in price.
This concept has a great practical importance in the sphere of government
finance and in the commerce and trade due to the following reasons:

1. IMPORTANCE FOR FINANCE MINISTER: - Before imposing the taxes

finance minister has to keep in view the elasticity of demand of various
goods. If the demand is inelastic, he can increases the tax and thus can
collect large revenue.
2. IMPORTANCE FOR THE MONOPOLIST: - If the monopolist finds that the
demand for his product is inelastic, he will fix the price at a higher level,
otherwise he will lower the price.
3. FIXATION OF WAGES: - If a demand of labour is inelastic, it is easy to
rise their wages otherwise not.
4. INTERNATIONAL TRADE: - If the demand of commodity is inelastic then
heavy duties can be imposed on its import heavy duties can be imposed on
its import and export.
5. IMPORTANCE FOR THE PRODUCER: - Producer will study elasticity of
demand before fixing the price of his commodities. Secondly, If the demand
for a commodity is inelastic the producer will spend a large amount on
advertisement for increasing the sale.
6. RATE OF FOREIGN EXCHANGE: - The rate of foreign exchange is also
considered on the elasticity of exports and imports of the country.
7. TERMS OF TRADE: - The terms of trade between two countries are based
on the elasticity of demand of the traded goods.
8. IMPORTANCE FOR THE BUSINESSMAN: - When the demand of good is
elastic , businessman increase his sale by lowing the price. If the demand is
elastic then he fixes high prices.
9. JOINT PRODUCT COST PROBLEM: - Sometimes it is very difficult to
know the separate cost of each factor of joint products. Here elasticity of
demand becomes very helpful in determining the cost of each factor of
production.
10. IMPORTANCE FOR COMMUNICATION INDUSTRY: - The concept of
elasticity is practically used in fixing the rates and fares of transfer of goods.

11. LAW OF INCREASING RETURN AND DEMAND: - When small industry

is working under the law of increasing return, its demand should be elastic.
So it will lower the price and increase the sale.
b) Practical application of Income elasticity
Income elasticity of demand may be defined as the ratio or proportionate
change in the quantity demanded of a commodity to a given proportion
change in the income. In short, it indicates the extent to which demand
changes with a variation in consumers income. Thefollowing formula helps
to measure the income elasticity (Ey).
Or
Where
Ey is income elasticity of demand
D is change in demand
D is original demand
Y is change in income
Y is original income
Example
Original demand=400 units Original income= 4000 units
New demand =700 units New income= 6000 units
Change in demand= 700-400= 300 units change in income=60004000=2000
Hence Ey=300/2000*4000/400=1.5
Generally speaking Ey is positive. This is because there is a direct
relationship between income and demand, i.e. higher the income; higher
would be the demand and vice versa. On the basis of the numerical value of
the co-efficient, Ey is classified as greater than one, less than one, equal to
one, equal to zero and negative. The concept of ey helps us in classifying
commodities in to different categories.
1. When
2. When
etc)
3. When
4. When
5. When

Ey is positive, the commodity is normal (used in day-to-day life)

Ey is negative, the commodity is inferior. ( for example jowar, beedi
Ey is positive and greater than one, the commodity is luxury.
Ey is positive but less than one, the commodity is essential.
Ey is zero, the commodity is neutral. E.g. salt, match box etc.

Practical application of income elasticity of demand

1. Helps in determining the rate of growth of the firm.
If the growth rate of the economy and income growth of the people is
reasonable

forecasted, in that case it is possible predict expected increase in the sales of

a firm and vice versa.
2. Helps in the demand forecasting of a firm.
It can be in estimating future demand provided the rate of increase in
income and Ey for the products are known. Thus, it helps in demand
forecasting activities of a firm.
3. Helps in production planning and marketing.
The knowledge of Ey is essential for production planning, formulating
marketing
strategy, deciding advertising expenditures and nature of distribution
channel etc in the long run.
4. Helps in ensuring stability in production.
Proper estimation of different degrees of income elasticity of demand for
different types of product helps in avoiding over-production or underproduction of a firm. One should know whether rise or fall in income is
permanent or temporary.
5. Helps in estimating construction of houses.
The rate of growth in incomes of people also helps in housing programs in a
country.
Thus it helps a lot in managerial decisions of a firm.
Q-6] Discuss the scope of managerial economics.
a) Definition of Managerial Economics
b) Scope of Managerial Economics
A-6]
a) Definition of Managerial Economics
Managerial economics is a discipline which deals with the application of
economic theory to business management. It deals with the use of economic
concepts and principles of business decision making. Formerly it was known
as Business Economics but the term has now been discarded in favour of
Managerial Economics.
Managerial Economics may be defined as the study of economic theories,
logic and methodology which are generally applied to seek solution to the
practical problems of business. Managerial Economics is thus constituted of
that part of economic knowledge or economic theories which is used as a
tool of analysing business problems for rational business decisions.
Managerial Economics is often called as Business Economics or Economic for
Firms.

b) Scope of Managerial Economics

The scope of managerial economics is not yet clearly laid out because it is a
developing
science. Even then the following fields may be said to
generally fall under Managerial Economics:
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
These divisions of business economics constitute its subject matter.
Recently, managerial economists have started making increased use of
Operation Research methods like Linear programming, inventory models,
Games theory, queuing up theory etc., have also come to be regarded as
part of Managerial Economics.
1.Demand Analysis and Forecasting: A business firm is an economic
organization which is engaged in transforming productive resources into
goods that are to be sold in the market. A major part of managerial decision
making depends on accurate estimates of demand. A forecast of future sales
serves as a guide to management for preparing production schedules and
employing resources. It will help management to maintain or strengthen its
market position and profit base. Demand analysis also identifies a number of
other factors influencing the demand for a product. Demand analysis and
forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis: A firms profitability depends much on its
cost of production. A wise manager would prepare cost estimates of a range
of output, identify the factors causing are cause variations in cost estimates
and choose the cost-minimising output level, taking also into consideration
the degree of uncertainty in production and cost calculations. Production
processes are under the charge of engineers but the business manager is
supposed to carry out the production function analysis in order to avoid
wastages of materials and time. Sound pricing practices depend much on
cost control. The main topics discussed under cost and production analysis
are: Cost concepts, cost-output relationships, Economics and Diseconomies
of scale and cost control.
3.Pricing decisions, policies and practices: Pricing is a very important area
of Managerial Economics. In fact, price is the genesis of the revenue of a firm
ad as such the success of a business firm largely depends on the correctness
of the price decisions taken by it. The important aspects dealt with this area

are: Price determination in various market forms, pricing methods,

differential pricing, product-line pricing and price forecasting.
4.Profit management: Business firms are generally organized for earning
profit and in the long period, it is profit which provides the chief measure of
success of a firm. Economics tells us that profits are the reward for
uncertainty bearing and risk taking. A successful business manager is one
who can form more or less correct estimates of costs and revenues likely to
accrue to the firm at different levels of output. The more successful a
manager is in reducing uncertainty, the higher are the profits earned by him.
In fact, profit-planning and profit measurement constitute the most
challenging area of Managerial Economics.
5.Capital management: The problems relating to firms capital investments
are perhaps the most complex and troublesome. Capital management
implies planning and control of capital expenditure because it involves a
large sum and moreover the problems in disposing the capital assets off are
so complex that they require considerable time and labour. The main topics
dealt with under capital management are cost of capital, rate of return and
selection of projects.