Exams

QUESTION ONE

a) Discuss the scope and nature of economics.

Nature and Scope of Economics
While classical theorists offer a relatively narrower scope, neoclassical theorists suggest that economics has broad nature and scope.

Nature of Economics
It is divided into two fields with respect to nature – Science and Arts. Though divided into these two fields, it is considered a part of both.

Economics as an Art
Art is a field that dwells on the means of expression and application of any skills, whether creative, pragmatic, or emotional. Art exists all around us, and it takes a great mind to appreciate art. Like any other art form, economics requires a great deal of imagination; however, the imagination has to be in the context of reality and cannot be a fleeting idea.

Furthermore, economics is goal-oriented. It states the means to achieve an end; similar is the case with arts. For instance, Arts tells us the ‘how to’ part of anything. Economics also states theories that discuss the ‘how to’ part of an end goal. Therefore, arts and economics deal with the practical application of book-based knowledge. Both bring life to the theories.

Economics as a Science
Science determines the cause and effect relationship. It is quantifiable and uses a proven apparatus to predict the desired results. It is based on experimentation. Economics has all these qualities; it establishes a strong cause and effect relationship for the consumption of goods and services between demand and supply.

Moreover, it can be measured or quantified in graphs and charts and, more importantly, money. It uses its own methods to forecast the end result. Hence, economics is a science and can be of two types:

Positive: It is based on cause and effect relationship between variables and lays down the facts.
Normative: It is based on value judgements and is to do with ‘how’ things should be.
Hence, economics as a science deals with the theory and the principles; economics as an art deals with the application and execution.

Scope of Economics
Scope refers to the extent to which something deals with or the extent to which something is concerned. Consumption of goods and services is the most basic way to define its scope. However, in reality, the scope of economics is much more than the regular consumption of goods and services. It can be distinguished as follows:

Microeconomics
Micro refers to small; it is the study of individual units of consumption of goods and services as well as that of production and much more. It is concerned with one single household, office, industry or market.

Moreover, concepts such as product pricing and consumer or firm behaviour are a part of it. Various types of markets are also studied under this. Hence, the consumption of goods and services and the behaviour responsible for it is a part of microeconomics.

Macroeconomics
Macro means large; it is the study of the overall production and consumption of goods and services. It is concerned with national income, GDP, GNP or gross national product. Concepts such as macro-level business cycles, national budget, unemployment and money supply are a part of macroeconomics.

b) Distinguish between microeconomic and macroeconomics.

1. Microeconomics studies the particular segment of the economy, i.e. an individual, household, firm, or industry. It studies the issues of the economy at an individual level.

Macroeconomics studies the economy as a whole, that does not talk about a single unit rather it studies aggregate units, such as national income, general price level, total consumption, etc. It deals with broad economic issues.

2. Microeconomics focuses on individual economic units.

The focus of macroeconomics is on aggregate economic factors.

3. Microeconomics is used to solve operational or internal problems.

Macroeconomics, on the other hand, is concerned with environmental and external issues.

4. Demand and supply are the fundamental tools of microeconomics.

The primary tools of macroeconomics are aggregate demand and aggregate supply.

5. Microeconomics is concerned with a single product, business, household, industry, salaries, costs, and so on.

Macroeconomics is concerned with aggregates such as national income, production, market price, total consumption, total savings, total investment, and so on.

6. Microeconomics deals with concerns such as how the price of an item affects the amount sought and quantity provided, among other things.

Macroeconomics is concerned with significant economic concerns such as unemployment, monetary/ fiscal policy, poverty, international commerce, price inflation, deficit, and so on.

7. Microeconomics determines the price of a product as well as the prices of complementary and replacement products.

Macroeconomics aids in the maintenance of the overall price level as well as the resolution of important economic concerns such as inflation, deflation, disinflation, poverty, unemployment, and so on.

8. Microeconomics examines any economy from the ground up.

In contrast, macroeconomics has a top-down approach.

QUESTION THREE
a) Explain the Law of Equi-marginal Utility. Discuss it’s importance and limitations

Importance Of Law Of Equi Marginal Utility

1. Producer’s equilibrium : A wise producer combines different factors of production and substitutes one for the other to secure maximum profits. He continues his activity until the marginal returns from all factors equalized. For example, he may employ capital in stead of labor and labor instead of capital. He employs higher return factors in place of lower return factors. Then, only his cost of production will be Minimum. This may be expressed in the following equation

Marginal productivity of Goods A/Price of A =Marginal Productivity of goods B/Price Of B

2. Distribution : This law is also useful in the sphere of distribution. It determines the rewards to be paid to the different factors of production. A prudent producer continues to substitute one factor service for the other till the cost of employing each factor equals the marginal productivity of each factor.
3. Exchange : This law has importance in the determination of the prices of goods and services. In the case of substitutes, when the price of one goods increases the demand for the other goods increases. When the supply is limited, people like to purchase more quantity of a goods. Then its price increases. When the supply of a goods is greater than its demand, the price falls. As a result, people change their demand for the goods. This adjustment between scarcities and prices is possible due to the substitution of cheaper goods for costlier goods.
4. Public Finance : This law is also applicable in the sphere of Public Finance. Government imposes taxes in such a manner that the marginal sacrifice of each tax player is equal. Similarly in deciding about the projects and their total outlays, it implements only those projects which yield greater social marginal utility.
5. International Trade : This law is of Special importance in the domain of International Trade. This law helps the government in devising proper export and import policy for the promotion of economic development of the country. The government devises such a policy aiming at the export of lower marginal utility goods and import of higher marginal utility goods. It continues foreign trade till the marginal utilities from exports and imports become equal.
6. Planning : In Planning also this law has practical importance . Government follows this principle in allocating the scarce resources between different sectors. The plan objectives like social justice, economic progress, decentralization of industries, fair distribution of national income and wealth. removal of economic inequalities, eradication of unemployment, poverty etc. are achieved by the government through this law.
7. Distribution of Assets : This law is a boon to the speculators businessmen and entrepreneurs in acquiring the assets for different use. They compare the marginal returns and decide the distribution of assets. They substitute one asset for the other till their marginal returns are equalized.
8. Saving and expenditure : This law also plays an important role in determining the Proportion of savings and expenditure in one’s income. People save more income when marginal utility from savings is more than their expenditure. This involves substitution between savings and income.

The Main Limitations of the law of Equi-marginal Utility are mentioned below:

(1) Measurability of utility:
The law presupposes that the marginal utility of commodity can be measured by a consumer but utility is a subjective concept. There is no objective unit to measure it which differs from man to man and for the same consumer it differs from commodity to commodity.

(2) Irrationality by the consumer or ignorance of the consumer:
For application of this law the consumer has to calculate the marginal utilities of different commodities he wants to purchase and compare them. It is easier said than done. In real life the consumer does not behave so rationally.

The mind of the consumer is neither a calculating machine nor a computer while making purchase. Because of his ignorance he cannot make a rational calculation of marginal utilities of different commodities.

(3) Slave of customs and habits:
When a consumer purchases he becomes the victim of custom, habit and advertisement and is least concern about maximum satisfaction.

(4) Indivisible commodities:
In case of indivisible commodities the law is not applicable. The marginal utility of house cannot be compared with that of marginal utility of food.

(5) Not applicable to free goods:
In case of free goods one does not pay for these goods. Therefore, law is not applicable.

(6) Changes in prices:
If the prices of goods frequently change, the observance of the law may be difficult. This would complicate the process of comparing the marginal utilities of various goods.

(7) Marginal Utility of money does not remain constant:
The assumption of constant marginal utility of money is quite unrealistic

b) What do you mean by inferior goods and Giffen goods?

Inferior goods are goods whose quantity demanded decreases when the income of the consumer increases beyond a certain level and vice versa, are called inferior goods. In simple terms, the quantity demanded by consumers for such goods are indirectly related to the consumer’s income, and so the income elasticity of demand is negative.

Giffen goods are described as goods that show direct price-demand relationship, i.e. demand for good increases with an increase in the price, violating the law of demand. When the price of good falls, consumers do not purchase it more, as they seek better alternatives. It is due to the reason that income effect of higher price supersedes substitution effect. It includes those goods which consumers considers inferior and which occupy an essential place in consumer’s budget such as wheat, rice, etc.

QUESTION FOUR
a) What are indifference curves? Discuss properties of indifference curves.

An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility.

Properties of indifference curves

(i) Indifference curves are negatively-sloped or downward-sloping: An indifference curve slopes downwards from left to right. It shows that more of one commodity implies less of the other, so that the total satisfaction (at any point on the IC) remains constant.

(ii) Indifference curves are convex to the point of origin: An indifference curve will ordinarily be convex to the point of origin. This is because of diminishing marginal rate of substitution.

(iii) Higher indifference curve represents higher level of satisfaction: On an indifference map, a higher indifference curve represents those combinations which yield higher level of satisfaction than combinations on the lower indifference curves. The assumption of monotonic preferences of the consumer permits us to conclude that greater the consumption, higher must be the level of satisfaction.

(iv) Indifference curves never intersect one another: As each IC represents one level of satisfaction which remains constant, two different indifference curves can never cross or intersect each other.

b) Explain various methods of measuring national income.

The national income of a country can be measured by three alternative methods:
(i) Product Method
(ii) Income Method, and
(iii) Expenditure Method.

1. Product Method: In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process.

Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of value of goods.

To avoid the problem of double counting we can use the value-addition method in which not the whole value of a commodity but value-addition (i.e. value of final good value of intermediate good) at each stage of production is calculated and these are summed up to arrive at GDP. The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at market price can be converted into by methods discussed earlier.

2. Income Method:

Under this method, national income is measured as a flow of factor incomes. There are generally four factors of production labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.

Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor costs.

3. Expenditure Method:

In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure, gross capital formation (Government and private) and net exports (Export-Import).

Question 6
a) Define Monopoly? Describe salient feature of monopoly.

A monopoly is an economic market structure where a specific person or enterprise is the only supplier of a particular good.

Salient features of Monopoly

1. Single Seller: Under Monopoly, there is only one seller selling the product in the market. It means that the monopoly firm and the industry are the same in this form of market. As there is one seller, the monopolist has full control over the price and supply of the product. Whereas, the number of buyers in a Monopoly market is large, which means that no single buyer can influence the price of a product in the market.
2. No Close Substitutes: As there is a single seller selling the product under a monopoly market, there are no close substitutes for the same. Therefore, a monopoly firm has no fear of competition from other firms, either new or existing ones. For example, Indian Railways has no close substitute for transportation services. However, there are other distant services like metro, etc.
3. Price Discrimination: As a monopolist is a single seller in the market, he/she can charge different prices at the same time from a different set of consumers, which is also known as Price Discrimination.

Charging different prices from different consumers for the same product at the same time is known as Price Discrimination. The three types of Price Discrimination are Personal Price Discrimination, Place Price Discrimination, and Use Price Discrimination.

Personal Price Discrimination: When the seller charges different prices for the same product from different kinds of buyers, it is known as Personal Price Discrimination. For example, a doctor charges less from poor people and more from rich, railways charges less from senior citizens and more from young citizens.

Place Price Discrimination: When the seller charges a different price for the same product at different places, it is known as Place Price Discrimination. For example, the money charged for electricity in rural areas is less than the money charged per unit in urban areas.

Use Price Discrimination: When the seller charges a different price for the same product based on its uses, it is known as Use Price Discriminations. For example, electricity charges per unit for a commercial purpose is different from the charges per unit for residential purpose.

4. Restrictions on Entry and Exit: Under a Monopoly market, there are strong restrictions/barriers on the entry of new firms and exit of the existing firms. It means that a monopoly firm can earn abnormal losses and profits in the long run. One of the reasons behind the barriers may be legal restrictions, like licensing, patent rights, etc., or it might be due to the restrictions in the form of cartels created by the firms.
5. Price Maker: As there is only one seller under the monopoly market, and the firm and the industry are the same things, the seller has a complete control over the price of the product. Being a sole seller, the monopolist can influence the supply of goods in the market and can fix the price on their own.
   b) Explain the modern theory of profit.

c) Discuss the features of a good tax system.

A tax system is expected to be fair and non-discriminatory. For a tax system to meet these requirements, it must have the following attributes.

1. Neutral – A Neutral tax must be unbiased across economic activities, and not overly penalize work in favour of leisure, nor tax income used for saving and investment more heavily than income used for consumption.
2. Visibility – A very large segment of the population must be keenly aware that government costs money, government spending should be held to levels at which its benefits match its costs. This is a critical factor in most developing countries…
[20:35, 12/12/2022] Hez Khev: Question 6
a) Define Monopoly? Describe salient feature of monopoly.

b) Explain the modern theory of profit.

c) Discuss the features of a good tax system.

A tax system is expected to be fair and non-discriminatory. For a tax system to meet these requirements, it must have the following attributes.

1. Neutral – A Neutral tax must be unbiased across economic activities, and not overly penalize work in favour of leisure, nor tax income used for saving and investment more heavily than income used for consumption.
2. Visibility – A very large segment of the population must be keenly aware that government costs money, government spending should be held to levels at which its benefits match its costs. This is a critical factor in most developing countries…
[20:36, 12/12/2022] Hez Khev: Question 6
a) Define Monopoly? Describe salient feature of monopoly.

b) Explain the modern theory of profit.

Theories of Profit

There are various theories of profit which have been advanced from time to time regarding the nature of profit in a competitive economy. Almost all of them differ basically from one another and are inadequate to explain the actual role of profit in the operation of free economy. The most important theories are:
(i) Hawley’s Risk Bearing Theory of Profit.

(ii) Uncertainty Theory of Profit.

(iii) Rent Theory of Profit.

(iv) Marginal Productivity Theory of Profit.

(v) Dynamic Theory of Profit.

(vi) Monopoly Theory of Profit.

(1) #Hawley’s #Risk Bearing Theory of Profit:
Definition and Explanation:
This risk bearing theory of profit is associated with the name of F.B. Hawley. According to him:

“Profit is the reward of risk taking in a business. During the conduct of any business activity, all other factors of production, i.e., land, labor and capital have their guaranteed incomes from the entrepreneur. They are least concerned whether the entrepreneur makes profit or undergoes tosses”.

In a business activity, as we know, there are every chance at any moment in the variation of demand for the commodity produced, The demand may change due to changes in fashion, tastes, condition of trade, prices of substitutes, distribution of wealth, etc., or the project undertaken may prove to be a complete failure.

In all such cases, if the entrepreneur is not able to cover his total costs from the sale of the commodities, then it is he who ultimately bears the loss. So he must be compensated for undertaking such risks.

Thus, according to Hawley, profit is a payment or a reward for the assumption of risks by the entrepreneur. The ‘greater the risk, the higher must be the profits. It is because if the return on risky enterprise is at the same level as that obtained from the safe investment, then not a single entrepreneur will invest his capital in a risky enterprise.

Criticism:
Hawley’s risk theory of profit is criticized on the following grounds:

(i) According to Hawley, profit is a reward for bearing risks in a business. The modern economists believe that there is no doubt that profits contain some remuneration for risk-taking in a business but it is wrong to assume that profits are in their entirely due to the element of risk- The profits can I arise on account of better management, better supervision or they may I be due to the monopolistic position of the entrepreneur or they may be I due to sheer chance, etc., etc.

(ii) Another criticism levied by Carver is that profits arise not because risks I are borne but because the superior entrepreneurs are able to reduce the risks.

(iii) It is also pointed out that profits are never in proportion to the risk undertaken, it can. happen that in a more risky enterprise, the profits may be low and high in a less risky enterprise,

(iv) There are certain businesses where risks can be more or less accurately foreseen by statistical evidence, e.g. in insurance, the entrepreneurs who I run these businesses earn profits. This theory fails to explain as to how I the profits are earned in such business where the risks can be insured.

(2) #Uncertainty_Theory of Profit: Definition and Explanation:
According to Professor Knight:

“Profit is the reward for uncertainly-bearing and not of risk-taking in a business”.

According to him there are two kinds of risks which entrepreneur has to bear. Some risks are of such a nature that they can be anticipated to a fair degree of accuracy, e.g., the risk of death, accident, etc., and so can be insured in return for premium. The entrepreneur can include the payment made in the form of premium in the total cost of production, So such risks which can be calculated and insured should not entitle the entrepreneur to a profit. On the other hand, there are some risks which are unpredictable and unforeseen and so they are non-insurable.

For instance, if the demand for the product of at entrepreneur suddenly down due to changes in fashions, tastes, etc., then he may not be able to; cover his total costs of production. Such risks which are unforeseen and cannot be statistically measured are called by Knight, as uncertainty-bearing risks.

“Profits, according to him are the reward of uncertainty-bearing j rather than risk-taking which is insurable”.

Criticism:
(i) The total profits which an entrepreneur receives cannot be attributed solely to the element of uncertainty in a business. He performs other functions also such as coordinating, bargaining, and innovation in the business. So he must be paid for these services also.

(ii) It is not simply due to uncertainty-bearing that the supply of entrepreneur is restricted. There are other factors also which influence the supply the entrepreneur. For instance, lack of knowledge, lack of capital, opportunity, etc., do restrict the supply of an entrepreneur in a business.

(3) #Rent_Theory_of_Profit:
Definition and Explanation:
The Rent Theory of Profit is associated with the name of American economist, Francis A Walker. According to him:

“Profits are of the same genius as rent”.

The main points of Walker’s Theory of Profit can be summed up as such:

(i) Profit is rental in character. Just as superior grades of land earn more rent than the inferior grades of land, similarly superior entrepreneurs due to their exceptional ability or opportunity earn more profits than the inferior entrepreneurs.

(ii) As in the case of land, there is a no-rent or marginal land, so in the business also is a no-profit or marginal entrepreneur. The marginal entrepreneur is one whose ultimate receipts from the sale of the commodities just cover his total costs.

(iii) Just as rent is measured from the non-rent land, in the same way profits of the superior businessmen are calculated from the marginal entrepreneur.

(iv) The rent does not enter into price of agricultural production of the manufactured goods.

From all that we have said above, it can be concluded that profits are the reward of differential business ability.

Criticism:
The modern economist have discarded the Walker’s rent theory of profit on the following grounds:

(i) It simply provides a measure of profit. It does not throw light on the nature of profit which is of more importance.

(ii) Marshall is of the opinion that there is much difference between the rent of land and the entrepreneur’s profit. The rent of land can either be positive or zero, but in case of business, the total receipts from the sale of the product can fall short of total costs. So the entrepreneur may suffer losses and thus his profit may be in the negative. In the opinion of Marshall, the price of the commodity in the market is determined not by the cost of production of marginal firm but by the representative firm. Representative firm is that “which has a fairly long lease of life and has a fair degree of success, which is managed with normal ability and which has access to the normal economies of production”.

(iii) It is also pointed out that profit may not form a part of the cost of production of a commodity in the short period but in the long period if the business is to be continued, it must enter in the price of the product.

(iv) Profits do not arise simply because of the superior or exceptional ability of the entrepreneur, but they can also result due to chance gains or monopolistic position of the entrepreneur or they may be of the nature of the windfall income.

(4) #Marginal_Productivity Theory of Profit:
Definition and Explanation:
According to this theory:

“The earning of entrepreneur like the reward of other factors of production can be explained by the marginal productivity analysis”.

In the words of Champmon:

“The profit tend to be equal to the marginal social worth of the employers in exactly the same sense in which the labor gets his marginal net product from the employers. The marginal net product of an entrepreneur is the amount which the community is able to produce with his help over and above what it could produce without his help”.

Thus, we conclude that under conditions of perfect competition, the reward of the entrepreneur tends to be equal to the .marginal social worth of the employer. If the marginal productivity of the employer is high, the profit will also be high and the marginal net productivity is low, then profit will also be low.

Criticism:
One very important criticism levied on this theory is that the unit of factor, i.e., the enterprise is very large, if for finding out the marginal net productivity of the entrepreneur, we withdraw it from the business, then it will disorganize the entire productive organization. It, thus, becomes very difficult to ascertain the marginal net productivity of the labor.

(5) #Dynamic_Theory_of_Profit: Definition and Explanation:
In the world of reality, according to J.B. Clark:

“Profit arises only in a dynamic economy. An economy is said to be dynamic when there is a change in the population growth or a change in the method of production or a change in the consumers wants, etc., A society which is without these changes is called a static society. In a static society only monopoly profits continue to exist. All other economic profits are gradually eliminated by competition”.

In a dynamic society, an entrepreneur is always confronted with continuous unpredictable changes in demand for his product. The variation in demand may take place due to change in fashions, tastes, standard of living, distribution of income, population, new inventions, international repercussion and technological advances, etc. A prudent entrepreneur will always keep an eye on the future demand for his products. If he succeeds in increasing his sale by lowering the cost of production or by adoption of an innovation, then he can secure profits. Thus, we find, that profits are a reward, of progress, Schumpeter calls it the reward of innovation.

In a dynamic economy, if an entrepreneur produces a new thing and creates demand for his products, then he is likely to obtain big profits. But the profits of the entrepreneur cannot continue to exist for long period. The other entrepreneurs also adopt the innovation and produce similar products. As total output increases, the profits, gradually come down. Thus, we find that perpetual profits are the result of perpetual new successful innovations.

Criticism:
Prof, Knight has criticized the Clarkian Theory of profit on the ground that it is wrong to attribute all profits to dynamic changes. According to him, there are certain changes which are of a recurring and calculable nature. They can be anticipated and the output can be adjusted according to that. The profits do not arise on those regular changes but on those which are unforeseen or unpredictable. He thus observes that:

“It is not dynamic changes nor any changes as such which cause profits but he divergence of actual conditions from those which have been expected and on the basis of which business arrangements have been made”.

(6) #Monopoly_Theory of Profit:
Definition and Explanation:
There is no doubt that profits arise from dynamic changes, innovations and from making a correct estimate of future economic conditions. Another view point of profit is that monopolistic and monopolistic competition in the market also give rise to profits. The firms under monopoly or monopolistic competition have greater control over the price of the product. They are the price makers rather than the price takers. As such they raise prices by restricting the level of output and thus keep profit at higher level. Monopoly power, thus, is the basic sources of business profits.

Criticism:
This Kalocki’s theory of monopoly profits has also been criticized. It is said that monopoly is no doubt an important cause and source of monopoly profits but it does not replace other theories. Monopoly power only supplements other theories.

c) Discuss the features of a good tax system.

A tax system is expected to be fair and non-discriminatory. For a tax system to meet these requirements, it must have the following attributes.

1. Neutral – A Neutral tax must be unbiased across economic activities, and not overly penalize work in favour of leisure, nor tax income used for saving and investment more heavily than income used for consumption.
2. Visibility – A very large segment of the population must be keenly aware that government costs money, government spending should be held to levels at which its benefits match its costs. This is a critical factor in most developing countries where the citizenry believe that tax revenues are not being expeditiously administered.
3. Fairness – This is often stated as making the rich pay higher share of their income in taxes than the poor. There should be some amount of income exempt from tax to shelter the poorest citizens.
4. Simplicity – A tax system should be easy for the government to administer and enforce, and be easy and inexpensive for taxpayers to comply with. There should be clear definition of income and elimination of multiple layers of tax would create a system that is much simpler and easier to administer, enforce and comply with.
5. Convenience – A good tax system should be convenient in terms of time and mode of payment to the taxpayer.
6. Administrative Efficiency – The process of levying and collecting taxes must be administratively efficient, transparent and economical without any distortion.
7. Productive – A tax system should be such that brings in sufficient revenue to the Government. Since tax payment involves the outflow of money or money’s worth from the treasury of taxpayers, some Taxpayers have adopted many strategies to evade tax, tax evasion is defined as “the wilful attempt to defeat or circumvent the tax law in order to legally reduce one’s tax liability”. Tax evasion is punishable by both civil and criminal penalties.