Micro Economics Solved Question Paper 2020 (December), Dibrugarh University B.Com 1st Sem CBCS Pattern

The figures in the margin indicate full marks for the questions

1. Answer the following as directed:                      1×8=8

(a) Cross elasticity of demand between tea and coffee is

• Positive.

• Negative.

• Zero.

• Infinite.  (Choose the correct answer)

(b) “Supply is a ________ function of price of the commodity.” (Positive/negative) Which is correct?

(c) Which of the following is not a property of indifference curve?

• Convex to the origin.

• Downward sloping from right to left.

• Does not​​ cut each other.

• None of the above.  (Choose the correct answer)

(d) The concept of fixed cost of production is concerned with

• Short run.

• Long run.

• Both short run and long run. (Choose the correct answer)

(e) Write the meaning of opportunity cost.

Ans: The​​ opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity.

(f) Mention any one objective of a business firm.

Ans: Wealth Maximization

(g) What is the most important condition of equilibrium of a firm?

Ans: MC=MR

(h) Why is the demand (average revenue) curve of a monopolist downward sloping?

Ans: Since a monopolist is the single supplier of a particular product, he has to reduce the price to increase sales. This leads to a downward sloping demand curve.

2. Write short notes on the following (any four):                 4×4=16

a) Point elasticity of demand.

Ans: Point elasticity of demand is a measure used in economics to quantify the responsiveness of quantity demanded to a change in price at a specific point on a demand curve. It provides insight into the percentage change in quantity demanded relative to a percentage change in price.

Mathematically, the point elasticity of demand (Ep) is calculated using the following formula:

Ep = (%ΔQ / %ΔP) * (P / Q)

Where:

%ΔQ represents the percentage change in quantity demanded

%ΔP represents the percentage change in price

P represents the initial price at the point of measurement

Q represents the initial quantity demanded at​​ the point of measurement

The point elasticity of demand can be interpreted as follows:

If Ep > 1: The demand is considered elastic. A percentage change in price leads to a larger percentage change in quantity demanded. Consumers are highly responsive to price changes, indicating that the good or service is price-sensitive.

If Ep < 1: The demand is considered inelastic. A percentage change in price results in a smaller percentage change in quantity demanded. Consumers are relatively less responsive to price​​ changes, indicating that the good or service is less price-sensitive.

If Ep = 1: The demand is considered unitary elastic. A percentage change in price leads to an equal percentage change in quantity demanded. The proportionate change in price and quantity​​ demanded is the same, resulting in constant total revenue for the seller.

The point elasticity of demand is useful for understanding consumer behaviour and making pricing decisions. It helps firms determine how changes in price will impact their revenue and profitability. Additionally, it provides insights into the competitiveness of the market and the sensitivity of consumers to price fluctuations.

b) Income consumption curve.

Ans: The income consumption curve is a graphical representation that illustrates the relationship between changes in income and the quantity of goods and services consumed by an individual. It is typically drawn for a specific good while holding the prices of other goods constant.

To construct an income consumption curve, various levels of income are plotted on the horizontal axis, and the corresponding quantity of the good consumed is plotted on the vertical axis. The resulting curve connects these points.

The income consumption curve generally exhibits an upward slope, indicating that as income increases, the quantity of the good consumed also increases. However, the shape of the curve depends on the type of good being analyzed (normal or inferior) and the income elasticity of demand for that good.

For normal goods, the income consumption curve is upward-sloping but can exhibit different degrees of steepness. The steeper the curve, the higher the income elasticity of demand, indicating that the good is more responsive to changes in income.

For inferior goods, the income consumption curve is downward-sloping, reflecting the negative income elasticity of demand. As income increases, individuals consume less of the inferior good and shift towards substitutes, resulting in a decrease in quantity demanded.

c) Social cost and private cost of​​ production.

Ans: Social Cost of Production: The social cost of production extends beyond the private costs and incorporates the external costs or negative externalities imposed on society as a result of production activities. These costs are not directly​​ accounted for or borne by the producer but are instead borne by third parties or society as a whole.

Negative externalities can arise in various forms, such as pollution, environmental degradation, congestion, health effects, or depletion of natural resources. For example, a manufacturing plant emitting pollutants that harm the surrounding community creates a social cost beyond the private cost borne by the firm.

The social cost reflects the full cost to society, including both private costs and the external costs imposed on others. It is important to consider social costs to capture the broader impact of production activities on society's well-being and to ensure efficient resource allocation.

Private Cost of Production: The private cost of production refers to the expenses incurred by a firm or producer in the process of producing goods or services. It includes all the explicit costs, such as wages, raw materials, rent, utilities, and other inputs that are directly accounted for in the firm's accounting records.

Private costs are internal to the firm and affect its profitability and decision-making. They are the costs that the firm considers when determining its optimal level of production and pricing strategy. Private costs are typically borne by the producer and are reflected in the supply curve of a firm.

d) Social cost of monopoly.

Ans: A monopoly is a market structure characterized by a single firm with exclusive control over the production and supply of a good or service. The social cost of a monopoly refers to the negative consequences and inefficiencies that arise from its existence. These costs stem from several factors.

Firstly, monopolies often result in higher prices compared to competitive markets. With limited or no competition, monopolistic firms can set prices at a level that maximizes their profits but harms consumer welfare. This reduces purchasing power and leads to a decrease in overall economic welfare.

Secondly, monopolies tend to produce less output than would occur under competitive conditions. By restricting supply, monopolistic firms can maintain higher prices. This reduction in output limits consumer choices and results in an inefficient allocation of resources.

Thirdly, monopolies can lead to an inefficient allocation of resources within the economy. With limited competitive pressure, monopolistic firms may not have the same incentives to allocate resources efficiently or invest in research and development. This can impede innovation and slow technological progress.

e) Characteristics​​ of Isoquants.

Ans:​​ Properties or Features of Isoquant

The following are the important properties of isoquants:

1. Isoquant is downward sloping to the right. This means that if more of one factor is used less of the other is needed for producing the same​​ output.

2. A higher isoquant represents larger output.

3. No isoquants intersect or touch each other. If so it will mean that there will be a common point on the two curves. This further means that same amount of labour and capital can produce the two levels of output which is meaningless.​​ 

4. Isoquants need not be parallel to each other. It so happens because the rate of substitution in different isoquant schedules need not necessarily is equal. Usually they are found different and therefore, isoquants may​​ not be parallel.

5. Isoquant is convex to the origin. This implies that the slope of the isoquant diminishes from left to right along the curve. This is because of the operation of the principle of diminishing marginal rate of technical substitution.

f) Average revenue and marginal revenue curves under monopolistic competition.

Ans: In monopolistic competition, where firms have some control over prices, the average revenue (AR) curve represents the average amount of money a firm receives for each unit of its product sold. It slopes downward because the firm needs to lower prices to sell more products and attract customers, but it can't raise prices significantly due to competition.

The marginal revenue (MR) curve shows the additional revenue a firm earns by​​ selling one more unit of its product. In monopolistic competition, the MR curve lies below the AR curve. This is because when the firm lowers the price to sell more units, the extra revenue it gains from the additional sales is less than the revenue lost​​ from the price reduction.

Understanding these curves helps firms make decisions about pricing and production levels in monopolistic competition. They need to consider the trade-off between attracting customers by lowering prices and the impact on their overall revenue.

3. What is elasticity of demand? Mention different types of elasticity of demand. Explain any one method of measuring price elasticity of demand with the help of numerical example.       2+3+6=11

Ans:​​ Elasticity of Demand Meaning and Definition

The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it​​ explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.

Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.

According to E.K. Estham, “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price”.

According to Muyers “Elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve”.​​ 

According to A.K. Cairncross “The elasticity of demand for a commodity it is the rate at which quantity bought changes as the price changes.”

Types of Elasticity of Demand

These are three types of elasticity

1. Price elasticity

2. Income elasticity – It is of three types.

a) Zero income elasticity

b) Negative income elasticity

c) Positive income elasticity

3. Cross elasticity – It is of two types.

a) Advertisement elasticity and​​ 

b)​​ Elasticity of price expectation.

1. Price Elasticity (EP):

Price elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a commodity in response to change in its price i.e. it measures how much a change in price of a good affects demand for that good, all other factors remaining constant. It is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.

EP= Proportionate change in quantity demanded/ Proportionate change in price

2. Income elasticity (EY):​​ 

Income elasticity of demand measures how much a change in income affects demand for that commodity if the price and other factors remain constant.

EY= Proportionate change in quantity demanded/ Proportionate change in income

A product with an income elasticity of more than one will experience a growth in demand that is higher than growth in consumer’s income. Luxury goods tend to have relatively high income elasticity. Low quality goods have negative income elasticity, as people stop buying them when they can afford to.

There are three types of income elasticity:​​ 

a) Zero income elasticity: Here a change in income will have no effect of quantity demanded. For example: - salt, matches, cigarettes.

b) Negative income elasticity:​​ Here an increase in income leads to a decrease in quantity demanded. This happens in inferior goods.

c) Positive income elasticity: In this an increase in income will leads to an increase in quantity demanded. For most goods income elasticity is positive.

3. Cross elasticity (ED):​​ 

This measures the change in demand for a commodity due to change in price of another commodity.

ED= Percentage change in quantity demanded of commodity A/ Percentage change in price of commodity B

If the goods having substitutes​​ the cross elasticity is positive i.e. an increase in the price of X will result in an increase in sales of Y. If the goods are complementary and increase in the price of one commodity will depress the demand for the other. So cross elasticity will be negative. If the goods are unrelated cross elasticity will be zero. Because however much the price of one commodity increased demand for the other will not be affected by that increase. There exist another two types of cross elasticity viz.​​ 

Measurement of Elasticity of Demand

Elasticity of demand can be measured through three popular methods. These methods are:

1. Percentage method or Arithmetic method

2. Total Outlay method

3. Graphic method or point method.

4. ARC Method

5. Revenue Method

1. Percentage​​ method:​​ 

According to this method elasticity is estimated by dividing the percentage change in amount demanded by the percentage change in price of the commodity.​​ 

Ep = [Percentage change in demand / Percentage change in price]

In this method, three values​​ of ‘Ep’ can be obtained. Viz., Ep = 1, Ep > 1, Ep < 1.

If 5% change in price leads to exactly 5% change in demand, i.e. percentage change in demand is equal to percentage change in price, Ep = 1, it is a case of unit elasticity.

If percentage change in demand is greater than percentage change in price, Ep > 1, it means the demand is​​ Relatively elastic.

If percentage change in demand is less than that in price, Ep < 1, meaning thereby the demand is​​ Relatively Inelastic.

Or

What is an indifference curve? Explain the main properties of an indifference curve.         3+8=11

Ans: Meaning of Indifference Curve:​​ An indifference curve is a curve which shows different combinations of two commodities yielding equal satisfaction to the consumer. It means all the points located on an indifference curve represent such combinations of two commodities as yield equal satisfaction to the consumer. Since the combination represented by each point on the indifference curve yields equal satisfaction, a consumer becomes indifferent about their choice. In other words, he gives equal importance to all the combinations on a given indifference curve.​​ 

According to H.L. Varian:​​ ‘An indifference curve represents all combinations of two commodities that provided the same level of satisfaction to a person. That person is therefore indifference among the combinations represented by the points on the curve”.​​ 

Properties of Indifference Curves:

The following are the main properties of indifference curves:

(1)​​ An indifference Curve Slopes Downwards from Left to the Right:​​ An indifference curve slopes downwards from left to right, or that, its slope is negative. This property is based on the assumption that if a consumer uses more quantity of one good he will use less quantity of the other, then​​ only he will have equal satisfaction from their different combinations. This property can be explained with the help of following diagram:

(2)​​ Convex to the Point of Origin:​​ An indifference curve will ordinarily be convex (bowed inward) to the point of​​ origin. Convexity of the curve means that it bows inward to the origin. The slope of the indifference curve is called the marginal rate of substitution because it indicates the rate at which the consumer is willing to substitute one good for the other. This property can be explained with the help of following diagram:

(3)​​ Two Indifference Curves Never or Intersect each other:​​ Each indifference curve represents different levels of satisfaction, so they do not intersect or touch each other. This property can be explained with the help of following diagram.​​ 

In this figure two indifference curves IC and IC, have been shown intersecting each other at point A, but it is not possible. Point A and C on indifference curve IC, represent combinations yielding equal satisfaction, that is, satisfaction from ‘A’ combination = satisfaction from ‘C’ Likewise, point ‘A’ and ‘B’ on indifference curve IC, represents combinations yielding equal satisfaction, that is, satisfaction from ‘A’ combination = satisfaction from ‘B’​​ combination. It implies that satisfaction from ‘B’ combination is equal to satisfaction from ‘C’ combination; but it is not possible because in ‘B’ combination quantity of oranges is more than ‘C’ combination, although quantity of applies in both combinations is equal.​​ 

(4)​​ Higher Indifference Curve Indicates Higher Satisfaction:​​ In indifference map, higher indifference curve represents those combinations which yield more satisfaction than the combinations on the lower indifference curve. This property is​​ illustrated in the following figure:

In this figure IC2 is higher and IC1 is lower indifference curve. Point B on IC2 represents more units of apples than point A on IC1 curve, although in both combinations quantity of oranges is the same. Hence point B​​ on IC2 will give more satisfaction than point A on IC1.​​ 

(5)​​ Indifference Curve touches neither X-axis nor Y-axis:​​ It is assumed in the indifference curve analysis that a consumer buys combinations of different quantities of two goods. Hence an indifference curve touches neither OX-axis nor OY-axis. In case an indifference curve touches either axis it means that the consumer wants only one commodity and his demand for the second commodity is zero. An indifference curve may touch OY-axis if it represents money instead of a commodity, as shown in the following figure:

In the above figure, IC touches OY-axis at point ‘M’. It means the consumer has in his possession OM quantity of money and does not want any unit of apples. At point ‘N’ consumer likes to have​​ a combination of OQ quantity of apples and OP units of money. This combination will yield him same satisfaction as by keeping OM units of money.​​ 

(6)​​ Indifference Curves need not be parallel to each other:​​ Indifference curves may or may not be parallel to each other. It all depends on the marginal rate of substitution of two curves shown in the indifference map. If marginal rate of substitution as indicated by two curves diminishes at the same rate, then these curves (IC and IC) will be parallel to each other, otherwise they will not be parallel as IC and IC.​​ 

4. Explain with the help of numerical example the law of variable proportion. In which stage a rational producer fixes his output?     8+3=11

Ans: Law of Variable Proportion Meaning

The law of variable proportion is one of the fundamental laws of economics. It is also known as the 'Law of Diminishing Marginal Returns' or the 'Law of Diminishing Marginal Productivity.' This Law of variable proportion shows the input-output relationship or production function with one variable factor, i.e., a factor, which can be changed, while other factors of production are kept constant.​​ 

In short-period when the output of a good is sought to be increased by way of additional application of the variable factor, law of​​ variable proportions comes into operation. When the number of one factor is increased while all other factors remain constant, then the proportion between the factors is altered. On account of change in the proportion of factors there will also be a change in total output at different rates. In economics, this tendency is called Law of Variable Proportions. The law states that as the proportion of factors is changed, the total production at first increases more than proportionately, then equi-proportionately and finally less than proportionately.​​ 

According to Samuelson, “The law states than an increase in some inputs relative to other fixed input will, in a given state of technology, cause total output to increase, but after a point the extra output resulting from the same addition of extra inputs is likely to become less and less.”

Law of Variable Proportion Assumptions

The law of variable proportions functions is based on following assumptions:​​ 

1. Constant technology:​​ The technology is assumed to be constant because technological changes will result into rise of marginal and average product.​​ 

2. Short-run:​​ The law operates in the short-run because it is a well-known fact that some factors are fixed and others are variable. In the long-run, all factors are​​ variable.​​ 

3. Homogeneous input:​​ The variable input employed is homogeneous or identical in amount and quality.​​ 

4. Use of varying amount of variable factor:​​ It is possible to use various amounts of a variable factor on the fixed factors of production.​​ ​​ 

5. No Change in price:​​ The law can be stated in terms of costs only if the prices of variable inputs as well as prices of output remain constant.

Explanation of the Law of Variable Proportion with the help of an example

Law of variable proportion can be explained with the help of following table and diagram:​​ 

Explanation:​​ 

From the above Table and Diagrams drawn on the assumption that production obeys the law of variable proportions, one can easily understand three​​ stages of production. These are elucidated in the following table:​​ 

Three Stages of Production

Or

Write the meaning of ‘optimal combination’ of factor of production. Explain the equilibrium of a firm with the help of isoquant and isocost lines. (Write both output maximization and cost minimization.)  3+8=11

Ans:​​ Producer’s Equilibrium or Optimum Combi­nation of Factors or Least Cost Combination

The producer’s equilibrium refers to the situation in which a producer maximizes his profits. In other words, the producer is producing given amount of output with least cost combination of factors. The least cost combination of factors also called optimum combination of the factor or input. Optimum combination is that combination at which either:

a) The output derived from a given level of inputs is maximum OR

b) The cost of producing a given output is minimum.​​ 

For producer’s equilibrium or optimum combination, it must fulfill following two conditions as:

(i) At the point of equilibrium the iso-cost line must be tangent to isoquant curve.

(ii) At point of tangency i.e., iso-quant curve must be convex to the​​ origin or MRTSLk must be falling.

The iso-cost line gives information regarding factor prices and financial resources of the firm.

With a given outlay and prices of two factors, the firm obtains least cost combination of factors, when the iso-cost line becomes tangent to an iso-product curve. Let us explain it with the following Fig. 15.

In Figure 15, P1L1 iso-cost line has become tangent to iso-product curve (representing 500 units of output) at point E. At this point, the slope of the iso-cost line is equal to the iso-product curve. The slope of the iso- product curve represents MRTS of labour for capital. The slope of the iso-cost line represents the price ratio of the two factors.

Slope of Iso-quant curve = Slope of Iso-cost curve

MRTSLk = – ∆L/∆L = MPL/MPK = PL/PK

[where ∆K → change in capital, ∆L → change in labour, MPL → Marginal Physical Product of Labour, MPk – Marginal Physical Product of capital, PL Price of Labour, and PK → Price of capital, MRTSLK =Marginal Rate of Technical Substitution of labour and capital.]

The firm employs OM units of labour and ON units of capital. The producing firm is in equilibrium. It obtains least cost combination of the two factors to produce 5 00 units of the commodity. The points such as H, K, R and S lie on higher​​ iso-cost lines. They require a larger outlay, which is beyond the financial resources of the firm.

5. Define normal price. Diagrammatically explain how normal price is determined. Why does a firm under perfect competition make only normal profit in the long run?      2+6+3=11

Ans: Long-run price is also known as long-run normal price or simply normal price. Long-run price or normal price is determined by long-run equilibrium between demand and supply when the supply conditions have fully adjusted themselves to the given demand conditions.

Marshall says, “Normal or natural value of a commodity is that which economic forces, would tend to bring about in the long run”. Given the demand, a price will tend to prevail in the long run when supply has fully adjusted and that price is known as long run price or normal price. It is worth noting that normal price of a good is not the same thing as the average price of the good.

Normal price is the price to which actual prices tend to reach in the long run, while the average price is the arithmetical average of all actual prices over a period of time. Moreover, it should be borne in mind that long-run normal price may never be actually achieved. There will usually be a change in either the demand or supply conditions underlying the long-run equilibrium before it is actually achieved. The long run like tomorrow never comes.

Long-run Equilibrium of the Firm:

In the long-run, it is possible to make more adjustments than in the short-run. The firm can adjust its plant capacity and scale of operations to the changed circumstances. Therefore, all costs are vari­able. Firms must earn only normal profits. In case the price is above the long-run AC curve firms will be earning supernormal profits.

Attracted by them, new firms will enter the industry and supernormal profits will be competed away. If the price is below the LAC curve firms will be incurring losses. As a result, some of the firms will leave the industry so that no firm earns more than normal profits. Thus “in the long-run firms are in equilibrium when they have adjusted their​​ plant so as to produce at the mini­mum point of their long-run AC curve, which is tangent (at this point) to the demand (AR) curve defined by the market price” so that they earn normal profits.

It’s​​ Assumptions:​​ This analysis is based on the following assumptions:

• Firms are free to enter into or leave the industry.

• All firms are of equal efficiency.

• All factors are homogeneous. They can be obtained at constant and uniform prices.

• Cost curves of firms​​ are uniform.

• The plants of firm: are equal having given technology.

• All firms have perfect knowledge about price and output.

Determination:

Given these assumptions, each firm of the industry will be in the equilibrium in the following two conditions.

(1) In equilibrium, its short-run marginal cost (SMC) must equal to its long-run marginal cost (LMC) as well as its short-run average cost (SAC) and its long-run average cost (LAC) and both should be equal to MR=AR=P. Thus the first equilibrium condition is:​​ 

SMC = LMC = MR = AR = P = SAC = LAC at its minimum point, and

(2) LMC curve must cut MR curve from below.

Both these conditions of equilibrium are satisfied at point E in Figure 3 where SMC and LMC curves cut from below SAC and LAC curves at their minimum point E and SMC and LMC curves cut AR = MR curve from below. All curves meet at this point E and the firm produces OQ optimum quantity and sell it at OP price.

Since we assume equal costs of all the firms of industry, all firms will be in equilibrium m the long-run. At OP price a firm will have neither a tendency to leave nor enter the industry and all firms will earn normal profit.

Or

Illustrate the effects of taxes and subsidies on demand and supply under perfect competition.    6+5=11

Ans: Effects of taxes and subsidies on demand and supply under perfect competition

Taxes and subsidies have distinct effects on the demand and supply curves in a perfectly competitive market. Let's explore the impact of taxes and subsidies separately:

A. Effects of Taxes:​​ When a tax is imposed on a good or service in a perfectly competitive market, it affects both the demand and supply sides:

1. Demand Side: The tax increases the price paid by consumers. As a result, the demand curve shifts downward and to the left. This is​​ because consumers are willing to purchase fewer units of the good at the higher price due to the increased cost of consumption.

2. Supply Side: The tax also affects producers. The tax adds to the cost of production for firms, reducing their profitability.​​ Consequently, the supply curve shifts upward and to the left. Producers are willing to supply fewer units of the good at the given price to offset the increased production cost.

The combined effect of the tax is a decrease in both the equilibrium quantity​​ and consumer surplus. The burden of the tax is shared between consumers (in the form of higher prices) and producers (in the form of reduced profits). The reduction in quantity traded and the distortion in the market caused by the tax lead to a deadweight​​ loss, representing an efficiency loss in the economy.

B. Effects of Subsidies: A subsidy is a payment or support provided to producers that lowers their production costs. The effects of subsidies on demand and supply in a perfectly competitive market are​​ as follows:

1. Demand Side: The subsidy lowers the price paid by consumers. As a result, the demand curve shifts downward and to the right. Consumers are willing to purchase more units of the good at the lower price due to the increased affordability.

2. Supply Side: The subsidy benefits producers by reducing their production costs. This encourages suppliers to increase their output and supply more units of the good at the given price. The supply curve shifts downward and to the right as a result.

The combined effect of the subsidy is an increase in both the equilibrium quantity and consumer surplus. The subsidy effectively lowers the price consumers pay and increases the quantity supplied by producers. This leads to a more efficient allocation of resources​​ and an increase in overall welfare.

6. Discuss the main features of monopoly market. Explain with diagram how the equilibrium price and output are determined under monopoly in the short run.         4+7=11

Ans:​​ Features of Monopoly:​​ The various features of​​ Monopoly are:

1. Single Seller and large number of buyers:​​ Under monopoly, there is a single seller selling the product. As a result, the monopoly firm and industry is one and the same thing and monopolist has full control over the supply and price of the​​ product.

2. No Close Substitutes:​​ The product produced by a monopolist has no close substitutes. So, the monopoly firm has no fear of competition from new or existing products. For example, there is no close substitute of electricity services.

3. Restrictions on Entry and Exit:​​ There exist strong barriers to entry of new firms and exit of existing firms. As a result, a monopoly firm can earn abnormal profits and losses in the long run. These barriers may be due to legal restrictions like licensing or patent rights or due to restrictions created by firms in the form of cartel.

4. Price Discrimination:​​ A monopolist may charge different prices for his product from different sets of consumers at the same time. It is known as ‘Price Discrimination’.

5. Price Maker:​​ In case of monopoly, firm and industry is one and the same thing. So, firm has complete control over the industry output. As a result, monopolist is a price-maker and fixes its own price.

6. Monopoly is also an industry:​​ Under monopoly situation, there​​ is only one firm. There is no difference between the study of a firm and industry.

Price and output determination under monopoly in Short-run: 

Short-run refers to that period in which a monopolist cannot change the fixed factors. However, the monopolist​​ is free in determining price due to lack of competition. A monopolist has control over the market supply. So, he/ she is the price maker. His/ her price and output determination is motivated by profit as well as sales maximization. Therefore, he/ she will​​ adjust the output in such a way that the marginal cost and marginal revenue are equal.

In short run equilibrium whether the firm makes an abnormal profit, normal profit or loss, it depends on the level of AC and AR which can be shown as follows:

1. If AR=AC, the firm receives a normal profit.

2. If AR> AC, the firm receives abnormal profit.

3. If AR< AC, the firm bears the loss.

The following conditions must be fulfilled in order to attain equilibrium under monopoly:
a) MR must be equal to MC

b) MC must intersect MR from below.

The equilibrium position of a monopoly firm can be graphically presented as follows:

In the above figures, the three different possibilities of profit and loss situation in the short run under monopoly firm are shown. These​​ possibilities are explained as follows:

1. Abnormal profit:​​ In the first figure, we see that the equilibrium point is 'E' when MC cuts MR from below. The equilibrium level of output is determined at OQ. The level of revenue earned is OP and the cost incurred is OC. Since Revenue is greater than cost, the firm earns abnormal profit equal to the shaded area (ABPC).

2. Loss:​​ In the second figure, point E is the equilibrium point where MC intersects MR from below. The equilibrium level of output is OQ. The cost​​ incurred is OC and the revenue earned is OP. Since cost is higher than revenue, the firm bears loss equal to the shaded area (ABCP).

3. Normal profit:​​ In the third figure, we can see that the equilibrium point is at 'E' where the conditions for equilibrium are fulfilled. The equilibrium level of output is OQ. The revenue and cost are at the same level (OP). The firm earns just a normal profit to sustain its business in this case.

Or

What is price discrimination? Discuss with diagram how price and output​​ are determined under discriminating monopoly.        3+8=11

Ans: Price discrimination means the practice of selling the same commodity at different prices to different buyers. Under monopoly the producer usually restricts output and sells it at a higher price, thereby making maximum profit. If the monopolist charges different prices from different customers for the same commodity, it is called price discrimination or discriminating monopoly. The idea is to get from each customer whatever profits could be squeezed out of him depending on his ability to pay and intensity of demand. When a seller charges Rs.20 for a commodity from a customer A and Rs.22 for the same commodity from customer B, he is practicing price discrimination. Joan Robinson defines price discrimination as, “the act of selling the same article produce under a single control at different prices”. Price discrimination may also be defined as, “the sale of technically similar products at prices which are not proportional to marginal cost”.

Pricing under discriminating monopoly:​​ 

Under simple monopoly the producer will charge the equilibrium price on the basis of total output and the marginal revenue and marginal cost will decide the equilibrium of the monopoly firm. ​​ In order to discrimination prices, the entire market will be divided into sub-markets on the basis of the elasticity of demand for the product. Only if the elasticity of demand is different, price discrimination will be profitable. After dividing the market, the producer has to decide​​ the supply for each submarket. Here the decision of output for each sub – market depends on the equilibrium​​ condition of each sub-market with the total cost condition and the revenue curves of the sub-market. The monopolist should decide two things on the​​ basis of his cost and revenue curves.

• how much the total output should produce

• How the total output should be shared between the sub-markets and what prices should be charged in each of his sub-market.

For sake of simplicity, we shall take that a monopolist device his market, into sub-markets A and B and finds the AR curve different in these two. The following diagram illustrates the revenue curves of the two sub-markets A and B and the aggregate situation in the entire market under his control.

The sub-market A given on the extreme left AR, is the demand curve or the average revenue curve of the market. In sub-market B it is the demand curve or the average revenue curve of the market. Note that the elasticity of demand in these two sub-markets are different. In sub-market The demand curve shows inelastic in nature and in sub-market B the curve shows the elastic in nature. The two sub-markets respective marginal revenue curves are shown as MR1​​ and MR2 .which lie below the average revenue curve of the respective sub-market. The figure on the extreme rite shows the total market where the aggregate conditions of the revenue curves are shown. The total average revenue curves of the two sub-markets have been shown in the total market as AAR. Similarly, the aggregate of the two marginal revenue curves of the sub-markets has been shown as AMR. According to the figure AR1​​ + AR2​​ = AAR. MR1+MR2=AMR combined at various levels of output. Since the output is under single control the marginal cost curve in the aggregate figure. MC in the total market shows the marginal cost for the entire production. The level of production is determined at the point where MR=MC. In the total market the aggregate MR curve cuts the MC curve at E and the total output is determine at OM for the two sub-markets. How much of OM goes to each of these markets is found out by drawing from E a line parallel to X-axis. This line indicating marginal cost of output cuts the marginal revenue curves of the sub-markets at E2​​ and E1. at the point E1​​ the marginal revenue of the sub-market A and the marginal cost of production are equal. So the equilibrium condition in sub-market A lies at E1​​ where the quantity of commodity should be OM1. Similarly, the equilibrium point in sub-market B lies at the point E2​​ where the marginal cost level meets the marginal revenue level of that sub-market. The corresponding quantity of the commodity in sub-market B is OM2.​​ 

Therefore, quantity OM will be sold in sub-market A and quantity OM2​​ in the sub-market B. At the​​ equilibrium point E1​​ in sub-market The price of the commodity will be P1M1​​ as at the level of equilibrium output the average revenue is P1M1. In submarket B, at the equilibrium output the average revenue P2​​ M2. So, the price of the commodity in that sub-market will be P2M2.

Thus the monopolist producing OM quantities in sub-market A at a price​​ P1M1. He will sell OM2​​ quantity in sub-market B at a price P2M2. in the figure price is higher in sub-market A and lower in B. It has discriminated the two and​​ charges different prices for the same commodity.

7. What is meant by product differentiation? Explain with the help of diagram the ‘individual equilibrium’ and ‘group equilibrium’ under monopolistic competition.  4+8=12

Ans:​​ Equilibrium of the individual firm in the short period:​​ The monopolistic competitive firm will come to equilibrium on the same principle of equalizing MR and MC. ​​ Each firm will choose that price that price and output where it will be maximizing its profit. ​​ The following diagram shows​​ the equilibrium of the individual firm in short period.

The short period marginal cost and average cost curves are shown as SMC and SAC. ​​ The sloping down average revenue and marginal revenue curves are shown as AR and MR. ​​ The equilibrium point is E where MR equals MC. ​​ The equilibrium output is OM and the price is fixed OP. ​​ The difference between average cost and average revenue is RQ. ​​ The output is OM. ​​ So, the supernormal profit for the firm is shown by the rectangle PQRS. ​​ The firm by producing OM​​ units of its commodity and selling it at a price of OP per unit realizes the maximum profit in the short run. Firms may also incur loss also which can be indicated in the following diagram.

With the revenue curves and cost curves the firm comes to equilibrium at E1​​ where MR equals MC. ​​ At this point the firm is making the minimum loss P1Q1R1S1​​ shown by the shaded rectangle. ​​ The price is P1.  ​​​​ The firm incurs loss in the short run because average cost is high than average revenue.

The different firms in monopolistic competition may be making either abnormal profits or losses in the short period depending on their costs and revenue curves. ​​ The price of the commodity of the different firms will be different because the firm adopt individual price policy. ​​ Based on consumer preferences of the product of the firm and the cost of production each firm will be fixing its price which may be different from the price of other firms. ​​ Old and long standing firms with established customers and goodwill will find high​​ price advantageous. ​​ The technique of production due to long experience may result in the cost position very comfortable. ​​ So, established firms will be making abnormal profits in the short period. ​​ Newly started firms may have to fix the price at a lower​​ possible level to establish themselves. ​​ The profit may not be very high. ​​ It may even result in loss at the initial stages. ​​ Thus in monopolistic​​ competition firms may be making abnormal profit, normal profit or loss in the short period. ​​ Firms making losses will keep the loss out at minimum and try to cover the average variable cost.

Individual Firm’s Equilibrium in Long Run

In the preceding sections, we have discussed that in the short run, firms can earn supernormal profits. However, in the long run, there is a gradual decrease in the profits of the firms. This is because in the long run, several new firms enter the market due to freedom of entry.​​ 

When these new firms start production the market supply would increase and the price would fall. This would​​ automatically increase the level of competition in the market. Consequently, AR curve shifts from right to left and supernormal profits are eliminated. The firms will be able to earn normal profits only.​​ 

In the long run, the AR curve is more elastic than​​ that of in the short run. This is because of an increase in the number of substitute products in the long-run. The long-run equilibrium of monopolistically competitive firms is achieved when average revenue is equal to average cost. In such a case, the firms receive normal profits.​​ 

Shows the long-run equilibrium position under monopolistic competition.

In Fig. 3.5, P is the point at which AR curve touches the average cost curve (LAC) as a tangent. P is regarded as the equilibrium point at which the price level is MP (which is also equal to OP) and output is OM.​​ 

In the present case average cost is equal to average revenue that is MP. Therefore, in long run, the profit is normal. In the short run, equilibrium is attained when marginal revenue is equal to​​ marginal cost. However, in the long run, both the conditions (MR = MC and AR = AC) must hold to attain equilibrium.​​ 

Group equilibrium in the long period

Group equilibrium means price-output adjustment of a number of firms, instead of an individual firm, whose products are close substitutes. The different firms in a group adopt independent price-output policies because of their monopolistic position with reference to the peculiarity of the product. Where it should be remembered that product is a close substitute of other firms. In the short run when firms make huge profit, the tendency will be for the new producers to enter the field. But the difficulty of finding out the group equilibrium arises out of diversity of conditions of various firms constituting the group. Each firm in its own way carters the specific tastes and preferences of the group consumers. So, each firm will have different demand curves and cost curves depending on their efficiency

Chamberlin solved the difficulty by making some heroic assumption of uniformity to arrive at the long run equilibrium of the group.

• • The firms competing in the group are producing more or less similar products

  • The firms competing have equal share of the market demand which means that the shape of the AR curve will​​ be the same for all

  • All firms have equal efficiency in production and therefore the cost curve are similar and

  • The numbers of firms are fairly large and each firm regards itself as independent in the group. This assumption of chamberlain actually boils down to the conditions of the perfect competition with minor differences.​​ 

The abnormal profit earn in short period will attract new comers to the group. The new comers will fix lower prices than the prices charged by the existing firms. This will compel the​​ existing firms to reduce the prices. As a result of such a keen competition, price will fall. Consequently, the AR curve will shift to a lower position. The AC curve will shift to a higher position due to increased demand on factors of production. This distance between AR and AC will be narrowed down and the abnormal profits will be removed. Ultimately the firms will earn only normal profits. The group equilibrium in the long run under monopolistic competition is shown below.

LPAR and LPMR indicate the long period average and marginal revenues. LPMC and LP AC show the long period marginal and average cost curves. The point E is the equilibrium where marginal revenue equals marginal cost and the output is OM. At the equilibrium output the average revenue or​​ the price of the price is OP. the figure shows that the firm produces OM units and sells it at a price of OP per unit making only normal profit. The figure shows that the average curve just touches the AC curve at the point of equilibrium output. So average cost equals average revenue. The firm is not making any abnormal profit but only normal profit. Over a long period of time, under monopolistic competition, every firm will earn only normal profit. This situation is exactly similar to the perfect competition, long run equilibrium. The main difference is that in perfect competition the AR is horizontal touching to the average cost curve at the lowest point showing that the average cost is the minimum cost and the prices also minimum. But in monopolistic competition the average revenue curve is sloping down. It touches the average cost curve not at the minim point but at the falling side (point K in the figure). So long as the shape of the average cost curve is ‘U’ shaped, the long period equilibrium of a firm producing under monopolistic competition will necessarily result in smaller output than in the perfect competition.

Since all the firms are producing on no-profit no-loss condition (Normal Profit) there will be no tendency for the new firms to enter nor​​ existing firms to go out. The group has come to equilibrium.​​ 

Thus by Chamberlin’s method we can arrive at the group equilibrium in the long run in the monopolistic competition.

Or

Point out the main characteristics of oligopoly. Explain the price and output determination process under price leadership in oligopoly.          4+8=12

Ans:​​ “Oligopoly” is a term derived from two Greek words “Oligos” meaning a few “pollein” meaning to sell. Thus Oligopoly refers to that form of imperfect competition where there​​ will be only few sellers producing either a homogenous product which are close substitutes but not perfect substitutes or similar products.

There are only few sellers of a product under oligopoly due to which actions taken by any individual seller have a​​ significant impact on other sellers. There is a personalized competition under oligopoly. All firms act as rivals of each other. The most important feature of oligopolistic market is interdependence in decision making.​​ 

Oligopoly Examples: Perfect example​​ of Oligopoly in India is Indian Telecom Industry. In telecom industry, there are only few sellers for example Reliance Jio, Airtel, BSNL, IDEA etc. All these act as rivals of each other. Also when one company increases or decreases tariff charges, this is​​ also followed by other companies

Oligopoly Features

Following are the features of oligopoly which distinguish it from other market structures:

1. Few Number of Sellers:​​ Under Oligopoly, there are only few sellers producing either a homogenous product which​​ are close substitutes but not perfect substitutes or similar products.

2. Interdependence of firms:​​ The most striking feature of Oligopoly market is the interdependence of the firms operating in similar industry. Since the products of oligopolist are close substitute, the price and output decisions of one will surely affect the other firm’s pricing and output decision. The oligopolist has to take into account the actions and reactions of his rivals while deciding his price and output policies.​​ 

3. Price rigidity:​​ Another important feature of oligopoly with product differentiation is price rigidity. The price will be kept unchanged because any change in price by one oligopolist invites retaliation and counter- action from others. So, the oligopolist normally​​ sticks to one price because they do not want to enter into price competition. If an oligopolist reduces his price, his rivals will also do so and therefore, it is not advantageous for the oligopolist to reduce the price.

4. Indeterminate demand curve:​​ This feature is a natural outcome of the first feature. No firm in Oligopoly can forecast the nature and position of the demand curve with certainty. The firm cannot estimate the sales when it decides to reduce the price of its product. Hence the demand curve under oligopoly is indeterminate.

Price Leadership under Oligopoly

Price leadership is a feature of oligopolistic situation. One firm assumes the role of a leader and fixes the price of a product or the entire industry. Price leadership can be seen when most or all of the firms in an industry decide to sell their product at a price fixed by one among them. The other firms in the industry follow this price.​​ 

These price followers simply accept the price fixed by the price leader and adjust their output to this price. The price leader may be the biggest firm in the industry or it may be a firm with the lowest cost of production. Its leadership may be established as a result of price-war in which it emerges as the winner. Independent pricing by each firm in​​ the industry is rarely seen in the oligopolistic situation. Instead there will be some agreement among the various firms with regard to the price that is to be charged.​​ 

The agreement among these rival firms may be formal or informal. There may be a formal agreement among the various firms to follow the price fixed by a leader chosen from among them. Or there may be only an informal understanding among themselves.

Determination of Profit-maximizing price by Price Leader

The price and output decisions are illustrated in the above figure. Here it is assumed that there are only two firms A and B and firm A has a lower cost of production than B. These two firms are producing homogeneous products and are having equal share in the market.​​ 

Thus these firms face the same demand curve which will be half of the total market demand curve. DD is the demand curve facing each firm which is half of the total demand curve for the product. MR is the marginal revenue curve of each firm. MC, is the marginal cost curve of firm​​ A and MC2 is the marginal cost curve of the firm B.

As the firm A has a lower cost of production than the firm B, MC, is drawn below MC2. If the price is fixed independently each firm will fix a price at which MC=MR. Then price of A would have been OP and B would have been OP.​​ 

But in the oligopolistic market the firm B cannot make maximum profit by fixing the price as OP, the firm B is to fix its price as OP, the price the low cost firm A has fixed. Firm B can sell its product only if it accepts its price as OP, the lower price. While A makes maximum profit, B is to be satisfied with a lower profit. Thus firm A is price leader and firm B has to follow it.

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