Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition.

Ans :- Introduction
The degree to which a market or industry can be described as competitive depends in part on how many suppliers are seeking the demand of consumers and the ease with which new businesses can enter and exit a particular market in the long run. The spectrum of competition ranges from highly competitive markets where there are many sellers, each of whom has little or no control over the market price - to a situation of pure monopoly where a market or an industry is dominated by one single supplier who enjoys considerable discretion in setting prices, unless subject to some form of direct regulation by the government. In many sectors of the economy markets are best described by the term oligopoly - where a few producers dominate the majority of the market and the industry is highly concentrated. In a duopoly two firms dominate the market although there may be many smaller players in the industry. Competitive markets operate on the basis of a number of assumptions. When these assumptions are dropped - we move into the world of imperfect competition. These assumptions are discussed below Assumptions behind a Perfectly Competitive Market 1. Many suppliers each with an insignificant share of the market this means that each firm is too small relative to the overall market to affect price via a change in its own supply each individual firm is assumed to be a price taker 2. An identical output produced by each firm in other words, the market supplies homogeneous or standardised products that are perfect substitutes for each other. Consumers perceive the products to be identical 3. Consumers have perfect information about the prices all sellers in the market charge so if some firms decide to charge a price higher than the ruling market price, there will be a large substitution effect away from this firm 4. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology, other factor inputs) and improvements in production technologies achieved by one firm can spill-over to all the other suppliers in the market 5. There are assumed to be no barriers to entry & exit of firms in long run which means that the market is open to competition from new suppliers this affects the long run profits made by each firm in the industry. The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long term 6. No externalities in production and consumption so that there is no divergence between private and social costs and benefits Short Run Price and Output for the Competitive Industry and Firm In the short run the equilibrium market price is determined by the interaction between market demand and market supply. In the diagram shown above, price P1 is the market-clearing price and this price is then taken by each of the firms. Because the market price is constant for each unit sold, the AR curve also becomes the Marginal Revenue curve (MR). A firm maximises profits when

marginal revenue = marginal cost. In the diagram above, the profit-maximising output is Q1. The firm sells Q1 at price P1. The area shaded is the economic (supernormal profit) made in the short run because the ruling market price P1 is greater than average total cost.

Not all firms make supernormal profits in the short run. Their profits depend on the position of their short run cost curves. Some firms may be experiencing sub-normal profits because their average total costs exceed the current market price. Other firms may be making normal profits where total revenue equals total cost (i.e. they are at the break-even output). In the diagram below, the firm shown has high short run costs such that the ruling market price is below the average total cost curve. At the profit maximising level of output, the firm is making an economic loss (or sub-normal profits)

The Effects of a change in Market Demand In the diagram below there has been an increase in market demand (ceteris paribus). This causes an increase in market price and quantity traded. The firm's average revenue curve shifts up to AR2

(=MR2) and the profit maximising output expands to Q2. Notice that the MC curve is the firm's supply curve. Higher prices cause an expansion along the supply curve. Following the increase in demand, total profits have increased. An inward shift in market demand would have the opposite effect. Think also about the effect of a change in market supply - perhaps arising from a costreducing technological innovation available to all firms in a competitive market.

Q2. Give a brief description of

(a) Implicit and Explicit cost Explicit costs are those costs which are in the nature of contractual paymentsand are paid by an entrepreneur to the factors of production [excluding himself]in the form of rent, wages, interest and profits, utility expenses, and paymentsfor raw materials etc. They can be estimated and calculated exactly andrecorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cashoutlays and as such do not appear in the books of accounts. They are theearnings of owner employed resources. For example, the factor inputs owned bythe entrepreneur himself like capital can be utilized by him or can be supplied toothers for a contractual sum if he himself does not utilize them in the business.It is to be remembered that the total cost is a sum of both implicit and explicitcosts. (b) Actual and opportunity cost Actual costs are also called as outlay costs, absolute costs and acquisitioncosts. They are those costs that involve financial expenditures at some time andhence are recorded in the books of accounts. They are the actual expensesincurred for producing or acquiring a commodity or service by a firm. Forexample, wages paid to workers, expenses on raw materials, power, fuel andother types of inputs. They can be exactly calculated and accounted without anydifficulty.

Opportunity cost of a good or service is measured in terms of revenue whichcould have been earned by employing that good or service in some otheralternative uses. In other words, opportunity cost of anything is the cost of displaced alternatives or costs of sacrificed alternatives. It implies thatopportunity cost of anything is the alternative that has been foregone. Hence,they are also called as alternative costs. Opportunity cost represents onlysacrificed alternatives. Hence, they can never be exactly measured and recordedin the books of accounts.The knowledge of opportunity cost is of great importance to managementdecision. They help in taking a decision among alternatives. While taking adecision among several alternatives, a manager selects the best one which ismore profitable or beneficial by sacrificing other alternatives.

Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month,due to a rise of in the price to 22 rs per pen the supply of the firmincreases to 5000 pens. Find the elasticity of supply of the pens.
Ans :- Price elasticity of demand is a ratio of two pure numbers, the numerator isthe percentage change in the quantity demanded and the denominator isthe percentage change in price of the commodity. It is measured by thefollowing formula: Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantitydemanded = (5000 3000)/3000Percentage changed in price = (22 10) / 10 Ep = ((5000 3000)/3000) / ((22 10)/10) = 1.2

Q4. What is monetary policy? Explain the general objectives and instruments of monetary policy
Ans :- Meaning of Monetary Policy
The term monetary policy is also known as the 'credit policy' or called 'RBI's money management policy' in India. How much should be the supply of money in the economy? How much should be the ratio of interest? How much should be the viability of money? etc. Such questions are considered in the monetary policy. From the name itself it is understood that it is related to the demand and the supply of money.

Definition of Monetary Policy

Many economists have given various definitions of monetary policy. Some prominent definitions are as follows.

According to Prof. Harry Johnson, "A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy."

According to A.G. Hart, "A policy which influences the public stock of money substitute of public demand for such assets of both that is policy which influences public liquidity position is known as a monetary policy."

From both these definitions, it is clear that a monetary policy is related to the availability and cost of money supply in the economy in order to attain certain broad objectives. The Central Bank of a nation keeps control on the supply of money to attain the objectives of its monetary policy.

Objectives of Monetary Policy

The objectives of a monetary policy in India are similar to the objectives of its five year plans. In a nutshell planning in India aims at growth, stability and social justice. After the Keynesian revolution in economics, many people accepted significance of monetary policy in attaining following objectives. 1. 2. 3. 4. 5. 6. 7. Rapid Economic Growth Price Stability Exchange Rate Stability Balance of Payments (BOP) Equilibrium Full Employment Neutrality of Money Equal Income Distribution

These are the general objectives which every central bank of a nation tries to attain by employing certain tools (Instruments) of a monetary policy. In India, the RBI has always aimed at the controlled expansion of bank credit and money supply, with special attention to the seasonal needs of a credit. Let us now see objectives of monetary policy in detail :1. Rapid Economic Growth : It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be encouraged. This increased investment can speed up economic growth. Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability. 2. Price Stability : All the economics suffer from inflation and deflation. It can also be called as Price Instability. Both inflation are harmful to the economy. Thus, the monetary policy having an objective of price stability tries to keep the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is inflationary situation there should be a 'dear money policy'. 3. Exchange Rate Stability : Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. 4. Balance of Payments (BOP) Equilibrium : Many developing countries like India suffers from the Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved. 5. Full Employment : The concept of full employment was much discussed after Keynes's publication of the "General Theory" in 1936. It refers to absence of involuntary unemployment. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does not mean

that there is a Zero unemployment. In that senses the full employment is never full. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy. 6. Neutrality of Money : Economist such as Wicksted, Robertson have always considered money as a passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability. 7. Equal Income Distribution : Many economists used to justify the role of the fiscal policy is maintaining economic equality. However in resent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic equality. monetary policy can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society.

Q5. Explain in brief the relationship between TR, AR, and MR under different market condition.
Ans :- Total Average and Marginal Revenue
The revenue of a firm jointly with its costs ascertains profits. Now let us discuss the concepts of revenue. The term revenue denotes to the receipts obtained by a firm from the scale of definite quantities of a commodity at various prices. The revenue concept relates to total revenue, average revenue and marginal revenue. 1. Total Revenue It is the total sale proceeds of a firm by selling a commodity at a given price. If a firm sells 3 units of an article at $ 24, its total revenue is 3 x 24. Thus total revenue is price per unit proliferated by the number of nits sold, i.e. TR = P x Q, where TR is the total revenue, P the price and Q the quantity. Average Revenue It is the average receipts from the sale of certain units of the commodity. It is obtained by dividing the total revenue by the number of units sold. The average revenue of a firm is in fact the price of the commodity at each level of output since TR = P x Q, therefore, AR = TR / Q = P x Q / Q = P. Marginal Revenue MR In addition to total revenue as a result of a small hike in the sale of a firm. Algebraically it is the total revenue earned by selling N units of the commodity instead of N-1 i.e., MRn = TRn TRn-1.

2.

3.

Relation Between AR and MR Curves 1. Under Ideal Rivalry The average revenue curve is a horizontal straight line parallel to X axis and the marginal revenue curve coincides with it. This is since under ideal rivalry the number of firms selling an identical product is very huge. The price is determined the market forces of supply and demand so that only one price tends to prevail for the whole industry.

In market

price

OP.

Thus

the

demand

for

the diagram 1, each firm can sell as much it wishes at the the firms product becomes infinitely elastic.

In the diagram 2, since the demand curve is the firms average revenue curve, the shape of AR curve is horizontal to the X axis at price OP and the MR curve coincides with it. Any change in the demand and supply circumstances will change the market price of the product and consequently the horizontal AR curve of the firm. 2. Under Monopoly or Imperfect Competition, the average revenue curve is the downward inclining industry demand curve and its related marginal revenue curve lies below it. The marginal revenue is lower than the average revenue. Given the demand for his product the monopolist can increase his sales by lowering the price, marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue.

In the diagram 3, the MR curve falls below the AR curve and lie half a way on the perpendicular drawn from AR to Y axis. This relation will always exist amidst straight line downward sloping AR and MR curves. In diagram 4, AR curve is convex to the origin, the MR curve will cut any perpendicular from a point on the AR curve at more than half way to he Y axis. MR passes to the left of the mid point B on the

CA.

Alternatively, if the AR curve is concave to the origin, MR will cut the perpendicular at less than half way towards y axis, in the diagram 5, MR passes to the right of the mid point B on the CA. 3. Monopolistic Competition The relationship between AR and MR is the same as under monopoly. But there is an exclusion that the AR curve is more elastic and it is represented in the diagram 6. This is since products are close substitutes under monopolistic competition. The firm can hikes sales by a reduction in its price. Under Oligopoly The average and marginal revenue cures do not have a smooth downward slope under oligopoly. They acquire kinks. As the number of sellers under oligopoly is small, the effect a price cut or price hikes on the par of one seller will be followed by some changes in the behaviour of the other firms. If a seller raises the price of his product, the other seller will experience a fall in demand for his product.

4.

His average revenue curve is represented in the diagram 7 becomes elastic after K and its consequent MR curve rises discontinuously from a to b and then persists its course at the new higher level. Alternatively, if the oligopolistic seller reduces the price of his product, his rival also follows him in reducing the prices of their products so that he is not able to enhance his sales. His AR curve becomes less elastic from K

onwards and it is represented in the diagram 8. The consequent MR curve falls vertically from a to b and then slopes at a lower level. Importance of Revenue Costs The AR and MR curves form significant tool for economic analysis.

Profit Determinants The A curve is the price line for the producer in all market situations. By relating the AR curve to the AC curve of a firm, it can ascertain whether it is earning supernormal or normal profits or incurring losses. If the AR curve is tangent to the AC curve at the point of equilibrium, the firm earns normal profits. If the AR curve is above AC curve, it makes super normal profits. In case, AR curve is below the AC curve at the equilibrium point, the firm incurs losses.

Determination of Full capacity It can also be known from their relationship whether the firm is producing at is full capacity or under capacity. If the AR curve is tangent to the AC curve at its minimum point, under perfect rivalry, the firm produces its full capacity. Where it is not so, under monopolistic competition, the firm posses idle capacity.

Equilibrium Determination The MR curve when intersected by the MC curve determines the equilibrium position of the firm under all market conditions. Their point of intersection in fact determines price, output, and profit and loss of a firm.

Factor Pricing Determination The use of the average marginal revenue helps in determining factor prices. In factor pricing they are inverted U shaped and the average and marginal revenue curves become the average revenue productivity and marginal revenue productivity curves ARP and MRP, also they are useful device in describing the equilibrium of the firm under different market conditions.

Q6. What is a business cycle? Describe the different phases of a business cycle.
Ans :- Business Cycle:
The term business cycle refers to a wave like fluctuation in the overall level of economic activity particularly in national output, income, employment and prices that occur in a more or less regular time sequence. It is nothing but rhythmic fluctuations in the aggregate level of economic activity of a nation. Different writers have defined business cycles in different ways. According to Prof. Haberler: The business cycle in the general sense may be defined as an alternation of periods of prosperity and depression of good and bad trade. In the words of Prof. Gordon: Business cycles consists of recurring alternations of expansion and contraction in aggregate economic activity, the alternating movements in each direction being self- reinforcing and pervading virtually all parts of the economy. According to Keynes: A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, alternating with periods of bad trade characterized by falling prices and high unemployment percentages. Thus, one can notice a common feature in all these definitions, i.e., variations in the aggregate level of economic activities in different magnitudes.

Phases of a Business Cycle: A Business Cycle has Five Phases. They are as follows: 1. Depression, contraction or downswing It is the first phase of a trade cycle. It is a protracted period in which business activity is far below the normal level and is extremely low. According to Prof. Haberler depression is a state of affairs in which the real income consumed or volume of production per head and the rate of employment are falling and are sub-normal in the sense that there are idle resources and unused capacity, especially unused labor. During depression, all construction activities come to a more or less halting stage. Capital goods industries suffer more than consumer goods industries. Since costs are sticky and do not fall as rapidly as prices, the producers suffer heavy losses. Prices of agricultural goods fall rapidly than industrial goods. During this period purchasing power of money is very high but the general purchasing power of the community is very low. Thus, the aggregate level of economic activity reaches its rock bottom position. It is the stage of trough. The economy enters the phase of depression, as the process of depression is complete. It is also called, the period of slump. During this period, there is disorder, demoralization, dislocation and disturbances in the normal working of the economic system. Consequently, one can notice all-round pessimism, frustration and despair. The entire atmosphere is gloomy and hopes are less. It is a period of great suffering and hardship to the people. Thus, it is the worst and most fearful phase of the business cycle. 2. Recovery or revival Depression cannot last long, forever. After a period of depression, recovery starts. It is a period where in, economic activities receive stimulus and recover from the shocks. This is the lower turning point from depression to revival towards upswing. Depression carries with itself the seeds of its own recovery. After sometime, the rays of hope appear on the business horizon. Pessimism is slowly replaced by optimism. Recovery helps to restore the confidence of the business people and create a favorable climate for business ventures. As a result of these factors, business people take more risks and invest more. Low wages and low interest rates, low production costs, recovery in marginal efficiency of capital etc induce the business people to take up new ventures. In the early phase of the revival, there is considerable excess capacity in the economy so, the output increases without a proportionate increase in total costs. Repairs, renewals and replacement of plants take place. Increase in government expenditure stimulates the demand for consumption goods, which in its turn pushes up the demand for capital goods. Construction activity receives an impetus. As a result, the level of output, income, employment, wages, prices, profits, start rising. Rise in dividends induce the producers to float fresh investment proposals in the stock market. Recovery in stock market begins. Share prices go up. Optimistic expectations generate a favorable climate for new investment. Attracted by the profits, banks lend more money leading to a high level of investment. The upward trends in business give a sort of fillip to economic activity. Through multiplier and acceleration effects, the economy moves upward rapidly. It is to be noted that revival may be slow or fast, weak or strong; the wave of recovery once initiated begins to feed upon itself. Generally, the process of recovery once started takes the economy to the peak of prosperity. 3. Prosperity or Full-employment The recovery once started gathers momentum. The cumulative process of recovery continues till the economy reaches full employment. Full employment may be defined as a situation where in all available resources are fully employed at the current wage rate. Hence, achieving full employment has become the most important objective of all most all economies. Now, there is all round stability in output, wages, prices, income, etc. According to Prof. Haberler Prosperity is a state of affair in which the real income consumed, produced and the level of employment are high or rising and there are no idle resources or unemployed workers or very few of either. 4. Boom or Over full Employment or Inflation

The prosperity phase does not stop at full employment. It gives way to the emergence of a boom. It is a phase where in there will be an artificial and temporary prosperity in an economy. Business optimism stimulates further investment leading to rapid expansion in all spheres of business activities during the stage of full employment, unutilized capacity gradually disappears. Idle resources are fully employed. Hence, rise in investment can only mean increased pressure for the available men and materials. Factor inputs become scarce commanding higher remuneration. This leads to a rise in wages and prices. Production costs go up. Consequently, higher output is obtained only at a higher cost of production. Once full employment is reached, a further increase in the demand for factor inputs will lead to an increase in prices rather than an increase in output and income. Demand for Loanable funds increases leading to a rise in interest rates. Now there will be hectic economic activity. Soon a situation develops in which the number of jobs exceed the number of workers available in the market. Such a situation is known as overfull employment or hyper-employment. The boom carries with it the gems of its own destruction. The prosperity phase comes to an end when the forces favoring expansion becomes progressively weak. Bottlenecks begin to appear. Scarcity of factor inputs and rise in their prices disturb the cost calculations of the entrepreneurs. Now the entrepreneurs realize that they have over stepped the mark and become over cautious and their over-optimism paves the way for their pessimism. Thus, prosperity digs its own grave. Generally the failure of a company or a bank bursts the boom and ushers in a recession. 5. Recession A turn from prosperity to Depression The period of recession begins when the phase of prosperity ends. It is a period of time where in the aggregate level of economic activity starts declining. There is contraction or slowing down of business activities. After reaching the peak point, demand for goods decline. Over investment and production creates imbalance between supply and demand. Inventories of finished goods pile up. Future investment plans are given up. Orders placed for new equipments and raw materials and other inputs are cancelled. Replacement of worn out capital is postponed. The cancellation of orders for the inputs by the producers of consumer goods creates a chain reaction in the input market. Incomes of the factor inputs decline this creates demand recession. In order to get rid of their high inventories, and to clear off their bank obligations, producers reduce market prices. In anticipation of further fall in prices, consumers postpone their purchases. Production schedules by firms are curtailed and workers are laid-off. Banks curtail credit. Share prices decline and there will be slackness in stock and financial market. Consequently, there will be a decline in investment, employment, income and consumption. Liquidity preference suddenly develops. Multiplier and accelerator work in the reverse direction. Unemployment sets in the capital goods industries and with the passage of time, it spreads to other industries also. The process of recession is complete. The wave of pessimism gets transmitted to other sectors of the economy. The whole economic system thereby runs in to a crisis. Failure of some business creates panic among businessmen and their confidence is shaken. Business pessimism during this period is characterized by a feeling of hesitation, nervousness, doubt and fear. Prof. M. W. Lee remarks, A recession, once started, tends to build upon itself much as forest fire. Once under way, it tends to create its own drafts and find internal impetus to its destructive ability. Once the recession starts, it becomes almost difficult to stop the rot. It goes on gathering momentum and finally converts itself in to a full- fledged depression, which is the period of utmost suffering for businessmen. Thus, now we have a full description about a business cycle. A detailed study of the various phases of a business cycle is of paramount importance to the management. It helps the management to formulate various anti-cyclical measures to be taken up to check the adverse effects of a trade cycle and create the necessary conditions for ensuring stability in business.