Nepali Student in DUET, Dhaka, Bangladesh

1. DHAKA UNIVERSITY OF ENGINEERING AND TECHNOLOGY
GAZIPUR-1707, DHAKA
BANGLADESH
A Second Assignment on Hum-1103
ENGINEERING ECONOMICS
Submitted By :
Name: Bishnu Prasad Bhandari
Student ID: 191124
Department: B.SC. in Civil
Engineering
Submitted To:
Mamunur Rashid
Lecturer in Economics
DUET, Gazipur

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1. INTRODUCTION OF ECONOMICS
1.1. What do you mean by Economics? Why economics is important for nation
and Civil Engineering? Explain briefly.
Economics is a social science that deals with the production, distribution and
consumption of the goods and services. In other word, ‘Economics is the study
of how societies use scarce resources to produce valuable commodities and
distribute them among different people. Different scientists have defined to
economics by different ways. According to Dr. Alfred Marshall (founding father
of economics) Economics is the study of man’s action in the ordinary business of
life. Same way according to Adam Smith (modern father of economics)
Economics is an inquiry into the nature cause of the wealth and nation.
Economics studies the pattern of trade among nations and analyzes the impact of
trade barriers. It looks at growth in developing countries and proposes ways of
encourage the efficient use of resources. It also studies about how government
policies can be used to pursue important goals such as rapid economic growth,
efficient use of resources, full employment, price stability and fair distribution of
income. It studies the business cycle and examines how monetary policy can be
used to moderate the swing in unemployment and inflation. It also examines the
distribution of income and suggests ways that the poor can be helped without
harming the performance of the economy.
Engineering economics is a sub set of economics connected with the use and
application of economic principles in analysis of engineering decision. It focuses
on the decisions making process, it’s contact and environment. It is pragmatic by
nature, integrating economic theory with engineering practice.
Followings are the importance of studying economics for engineers.
It helps in making an effective manager and decision maker.
Dealing with a shortage of raw material.
Helping in taking decision in changing and uncertain business
world.
Helps to measure the cost and benefit of engineering project.
Helps in skillful evaluation of the projects.
Helps in distribute and utilize of resources in society.

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1.2. What do you mean by macroeconomics and microeconomics? Distinguish
between them.
Microeconomic
Microeconomics is a branch of economics that studies the behavior of
individuals and firms in making decisions regarding the allocation of scarce
resources and the interactions among these individuals and firms
Microeconomic examines small economic units the components of economy.
For example, Individuals, firms and industries.
Macroeconomic
Macroeconomics is a branch of economics dealing with the performance,
structure, behavior, and decision-making of an economy as a whole. For
example, using interest rates, taxes and government spending to regulate an
economy’s growth and stability. This includes regional, national, and global
economies.
Macroeconomic looks at aggregate. For example, national output, overall price
level, aggregate unemployment.
Microeconomics Macroeconomics
It studies the individual unit. It studies the two or large groups.
Laws related to marginal analysis are
included in it’s scope.
Problem related to whole economy
like employment, public finance,
national income are included in it’s
scope.
Deals with individual economic
variable.
Deals with aggregate economic
variable.
It’s analysis is simple. It is complex due to study of large
groups.
It is particularly focus on price
analysis.
It particularly focus on income
analysis.
It studies individual problems and it
is less important for comparative
study.
It studies the problems relating to
the economy and its importance is
growing.
Individuals, household, firms and
industries.
national output, overall price level,
aggregate unemployment.

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1.3. How do you define for scope of economy?
The scope of economics means the area of the economics study. It includes:
I. The subject matter of economics:
Economics studies man’s life and work, not the whole, but only one aspect of it
e.g it tells us how a man utilizes his limited resources (money & time, labor, raw
material) in order to fulfill his unlimited wants.
Economic Activity:
A farmer tilling his field, a worker is working in a factory, a doctor attending the
patients & so on, these activities are called Economic Activities.
II. Economics is a Social Science:
In society, a man produces what he does not consume & consumes what he does
not produce. So he has to buy a product which is not produced by him & sell his
excess production. This process is called an Exchange.
Things produced in factories with the help of labor, land, capital, &
entrepreneur. They all get a reward in the form of income (e.g. wages, rent,
interest, & profit). Economics studies how these incomes are determined. This
process is called Distribution:
· Macro Economics –
When we study how the level of country’s income & employment is determined,
at an aggregated level.
· Micro-Economic –
When economics is studied at individual level i.e. consumer’s behavior,
producer’s behavior, & price theory….
III. Economics, a Science or an Art?
A science is a systematized body of knowledge. Economics also many laws and
principles have been discovered & hence it is treated as a science. Economics
also guides the people to achieve aims, e.g. Removal poverty, so it is an art.
IV. Economics whether positive or normative science:
A positive science explains why and how of things and normative science
explains the right or wrong of the things. Economics is both, it not only tells us
why certain things happen, it also says whether it is right or wrong.

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1.4. Distinguish between needs, wants and demand?
1. Need
A need is something you have to have. We can’t survive without these things.
Example: people need air, water, food, clothing for shelter of survive.
Needs are basic human requirement. People also have strong needs for reaction,
education & entertainment. Marketer can’t create need.
2. Wants
A want is something you would like to have. It is not necessary but it would be
good thing to have. Example cell phone, bike, vegetable, Yoghurt etc.
Wants changes continuously and they are reshaped by our family, society.
3. Demand
Demand are wants for specific product backed by an ability to pay.
Example many people want a Mercedes car but only few are willing able to buy
at given price. Wants become demand when supported by purchasing power,
desire to get the things, wish to expense for this things.
1.5. Security and choice are the main basis of all economic problem?
Explain.
The Problem of Scarcity:
We live in a world of scarcity. People want and need variety of goods and
services. This applies equally to the poor and the rich people. It implies that
human wants are unlimited but the means to fulfil them are limited. At any one
time, only a limited amount of goods and services can be produced. This is
because the existing supplies of resources are extremely inadequate. These
resources are land, labor, capital and entrepreneurship.

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These factors of production or inputs are used in producing goods and services
that are called economic goods which have a piece. These facts explain scarcity
as the principal problem of every society and suggest the Law of Scarcity, The
law states that human wants are virtually unlimited and the resources available to
satisfy these wants are limited.
The Problem of Choice:
Since are live in a world of scarcity, a society can produce only a small portion
of goods and services that its people want. Therefore, scarcity of resources gives
rise to the fundamental economic problem of choice. As a society cannot produce
enough goods and services to satisfy all the wants of its people, it has to make
choices.
For instance, the more roads a country decided to construct the fever resources
will there be for building schools. So the problem of choice arises when there are
alternative ways of producing other goods. The sacrifice of the alternative (school
buildings) in the production of a good (roads) is called the opportunity cost.
There are a number of problems that can arise from choices that are made by
people, whether they are individuals, firms or government. Choices or
alternatives (or opportunity cost) are illustrated in terms of a production
possibility curve.
ADVERTISEMENTS:
A production possibility curve shows all possible combinations of two goods that
a society can produce within a specified time period whose resources are fully
and efficiently employed.
PP1 is the production possibility curve in Fig. 1 which shows the problem of
choice between two goods X and Y in a country. Good X is measured on the
horizontal axis and Good Y on the vertical axis. PP cue shows all combinations
of X and Y good that can be produced by the country with all its resources fully
and efficiently employed.
If the country chooses to produces more of X
good, it would have to sacrifice the production
of some quantity of Y good. The sacrifice of
some quantity of Y good is the opportunity cost
of producing some extra quantity of good X.
If the country chooses to produces more of X
good, it would have to sacrifice the production
of some quantity of Y good. The sacrifice of
some quantity of Y good is the opportunity cost
of producing some extra quantity of good X.

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The PP1 curve is downward sloping because to produce more of good X involves
producing less of Y good in a fully employed economy. Moving from point В to
D on the PP curve means that for producing XX, more quantity of good X, YY
quantity of good Y has to be sacrificed.
ADVERTISEMENTS:
Both point’s В and D represent efficient use of country’s resources. Point R which
is inside the bounder of PP curve implies inefficient use of resources. Point К
which is outside the boundary of PPX curve is an unattainable combination
because the country does not possess sufficient resources to produce two
combination of X and Y goods.
2. THE MARKET FORCES OF SUPPLY AND DEMAND
2.1. What are the factors that influence the shifting of the supply curve? Explain
them.
The supply curve shows how price affects quantity supplied, others things being
equal. These “other things” are non-price determinants of supply. Changes in
them shift S curve…The factors which affect the shifting of the supply curve.
1. Supply curve shifter: Input prices
A fall in input prices makes production more profitable at each output price.
So, firms supply a larger quantity at each price and S curve shifts to the right.
Example of the input price are wages, price of raw materials etc.
2. Supply curve Shifters: Sellers
An increase in the number of sellers increases the quantity supplied at each
price. Shift the S curve to the right.
3. Supply curve shifter: Technology
Technology determines how much inputs are required to produce a unit of output.
A cost saving technological improvement has same effect as a fall in input prices.
Shift the S curve to the right.

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4. Supply curve shifter: Expectations
Suppose a firm expects the price of the goods it sells to rise in the future.The
firm may reduce supply now, to save some of its inventory to sell later at the
higher price. This would shift the S- curve leftward.
5. Supply curve shifter: Monopolies
The monopolists may deliberately increase or decrease the supply as it suits
them. Thus exercise of monopolistic power brings about a change in supply.
6. Supply curve shifter: Transport improvement
Improvement in the means of transport reduces the cost and increase the
supply of the product. Thus conditions of supply change.
7. Supply curve shifter: Fiscal policy:
The fiscal policy of government also may affect the supply. For instance, a
higher import duty will restrict the supply and a lower duty will stimulate it.
There are some of the factors which bring about changes in the conditions of
supply and increase it or decrease it.
2.2 What is the law of demand and supply? what are the exceptions of law of
demand?
The law of demand states that quantity purchased varies inversely price. In other
word, the higher the price, the lower the quantity demanded.
The law of supply is the microeconomic law that states that, all others factors
being equal, as the price of a good or service increases, the quantity of goods or
services that supplies offer will increase, and vice versa.
Veblen’s effect
According to Veblen, there are certain goods that become more valuable as
their price increase. If a product is experience than its value and utility are
perceived to be more and hence the demand for that product increases. This
happens mostly with precious metals and stones such as gold, diamonds and
luxury cars
Giffen’s Paradox
Some special verities of inferior goods are terms as Giffen’s goods. Cheaper
verities of this category like bagra, cheaper vegetable like potato come under
this category. The Giffen paradox holds that demand strengthened with a rise
in price or weakened with a fall in price.
Fear of shortage
When serious shortages are anticipated by the people they purchase more
goods at present even though the current price is higher.
Fear of future rise in price
When the prices are rising household tend to purchase large quantities of
commodity out of apprehension that price may still grow up. When prices
are expected to fall further they wait to buy goods in future at still lower
prices. So quantity demand falls when prices are falling.

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Speculation
Speculation implies purchase or sale of an asset with the hope that it’s price
may rise or fall and make speculative profit. Normally, it is witnessed in the
stock exchanging market. People buy more share only when their prices
show a rising trend.
Emergencies
During emergency periods like war, famine, floods, cyclone, accidents etc.
people buy certain articles even through the prices are quite high.
Necessaries
Necessaries are those items which are purchased by consumers whatever
may be the price. Consumers would buy more necessaries in spite of their
higher price.
Ignorance
Sometimes may not be aware of prices prevailing in the market. A consumer
ignorance is another factor that at times includes him to purchase more
commodities at higher prices. This is specially so when consumer is hunted
by the phobia that a high price commodity is good in quality than a low priced
commodity.
2.3 Describe about economy system and different types of economy.
An economy is a system whereby goods are produced and exchanged. Without a
viable economy, a state will collapse. There are three main types of economies:
free market, command, and mixed. An economy may be defined as the state of a
country or region in terms of the production and consumption of goods and
services, and the supply of money.
A market economy (also called a free market economy, free enterprise economy)
is an economic system in which the production and distribution of goods and
services takes place through the mechanism of free markets guided by a free price
system. which are essentially capitalist economies, businesses and individuals
have the freedom to pursue their own economic interests, buying and selling
goods on a competitive market, which naturally determines a fair price for goods
and services.
On the other hand, a command economy (also known as planned economy) is an
economic system in which the state or government controls the factors of
production and makes all decisions about their use and about the distribution of
income. There is another type of economy, known as Mixed economy. Mixed
Economy is combination of free market and command economy. However, this
essay will analyze the main key difference between command and free market.
Mixed Economies
A Mixed Economy combines elements of free-market and command economies.
Even among free-market states, the government usually takes some action to
direct the economy. These moves are made for a variety of reasons; for example,

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some are designed to protect certain industries or help consumers. In economic
language, this means that most states have mixed economies.
Free- Market Economies:
Usually occur in democratic states. Individuals and businesses make their
own economic decisions
Command Economies:
Usually occur in communist or authoritarian states. The state’s central
government makes all the country’s economic decisions.
2.4What are the roles of the different types of banks to help in economy of the
nation? Describe differences between central bank and commercial bank?
The role of banks in economic development is to remove the deficiency of capital
by stimulating saving and investment. A sound banking system mobilizes the
small and scattered saving of the community and makes them available for
investment in productive enterprises. A well- functioning financial system is
fundamental to a modern economy and banks perform important functions for
society. They must therefore be secure. Banks should be able to lend money to
consumers and businesses in both upturns and downturns.
The central bank is a banker’s bank. It is normally part of or connected to the
government of the country and manage the country’s financial system. The
commercial bank refers to financial institutions that accepts deposits, offers
checking account services, makes varies loans and offers basic financial products.
It provides banking services to businessman, institutions etc.
DIFFERENCES:
CENTRAL BANK COMMERCIAL BANK
1. It is banker’s banks.
2. It is publicly owned institution.
3. It is the supreme monetary
authority of the country.
4. Central bank performs banking
functions for government.
5. It has authority of monopoly of
note issue.
6. Central bank is controller of credit
system in the country.
7. It is the leader of last resort. i.e. it
extends financial accommodation
to commercial banks in the time of
crisis.
1. It is the bankers to citizens.
2. It is publicly or privately owned institution.
3. These banks have no authority of monetary
of country just of own bank.
4. They perform to the public by accepting
government deposits and granting loans to
government.
5. They are not allowed to issue the notes.
6. They create credit for promotion of trade,
industry and economic growth as per the
directives of central bank.
7. They approach central bank for financial
assistance in the time of crisis.

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2.5 Why is Government Spending a Problem?
It needs to be understood that the government has no money of its own. If it
spends any money, it has to obtain this money from the people in one form
or another. There are three common ways that governments use to obtain
money from people. For instance, if a government spends $4 trillion and has
only $3 trillion it can obtain the balance in the following ways.
The first and the most obvious way is that the government introduces
more tax on its subjects. This can be directly attributed to the government
and hence is highly unpopular.
Some governments resort to borrowing money from the bond markets.
Now, it needs to be understood that there is only a finite amount of money
in the debt markets as well. If the government borrows more and more,
less is left for the private sector. Also, excessive government borrowing
tends to raise the interest rates making it unviable for the private sector
to raise money via this route. Hence, the economic effect is exactly the
same as taxation. Money leaves private hands and goes into the
government kitty.
Lastly, some governments resort to total dishonesty. They simply start
printing more currency. As the amount of currency in circulation
increases, the currency becomes less valuable. The effect of this is borne
by people who are left holding the currency.
It needs to be understood that almost all governments in the world are using
a combination of these three measures intermittently. Sometimes, they cut
taxes to increases borrowing. Other times they raise taxes to reduce debt.
Hence, in effect governments are going around in circles in order to avoid
facing the root issue, i.e. government spending.

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3. PRODUCTION POSSIBILITIES FRONTIERS
3.1 What do you mean by PPF describe the concept of Production possibility frontiers
PPF? Why production possibilities curve is concave? Give the appropriate reason.
Production possibility frontier is the graph which indicates the various production
possibilities of two commodities when resources are fixed. It is also called the
production possibility curve or product transformation curve.
Production possibility curve is called the opportunity cost curve as it is the curve which
shows the combinations of two goods and services that can be produced with fuller
utilization of a given amount of resources in the most efficient way and with a given
production technology. Scarcity: Production possibilities are bounded.
PPC is commonly drawn as concave to origin to represent increasing opportunity cost
with increased output of a good. Thus, MRT increases in absolute size as one moves
from the top left of the PPF to the bottom right of the PP

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3.2. Draw the production possibilities frontier, representing the economy's possible
production of milk and eggs. Now, show what will happen to the frontier or the
production point under each of the following circumstances. Use a separate graph to
illustrate each situation.
Production Possibility Curve:
Production Possibility Curve is a graphical illustration of the country's production
choices of two goods which the country can produce with the given amount of resource
endowment it has
The PPC for milk and eggs
Following is the PPC showing the production possibilities of Milk and Eggs.
A. Efficient Outcome:
The economy attains efficiency in production of
the goods when it produces along the PPC
curve. The points along the PPC curve
represents the maximum production
possibilities that an economy can undertake
with the given amount of resources. Hence in
the above figure point A in the PPC curve
represents an efficient production possibility of
eggs and milk.
PPC representing Efficient Outcome
B. Recession causes unemployment:
When the recession causes unemployment in
the economy, labor being a factor of production,
unemployment of labor leads to inefficient or
under utilisation of resources. Hence any point
within the PPC shows the inefficient level of
production. In the above figure point B shows
unemployment of labor in the economy
Unemployment of resources
C. Cows and Chickens reproduce
When cows and chicken reproduce, the cows
will be producing more quantity of milk and the
chickens will lay more eggs than before, at the
same amount of resources. This leads to
expansion in production possibility curve. As a
result of which the production possibility curve
of milk and eggs shifts outwards
Expansion of PPC due to reproduction

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D. Surgeon announces drinking water
prolongs life:
When the surgeon suggests drinking more water
prolongs life, people will start drinking more
water. If we consider milk and water to be
substitutes of each other, then demand of milk
will decrease and hence the production of the
milk will also decrease. As milk is produced
less, the economy is left with more amount of
resources to produce more eggs than before.
This change in the production preferences can
be seen from the above graph, where initially
the economy was producing at point A on the
PPC with M amount of milk and e amount of
eggs. As the production preference changes, the
economy shifts to point B, where M1 amount of
milk is produced and e1 amount of eggs are
produced.
The Production preference changes
E. Cows are infected with disease and
1/3 die
When the cows get infected and die, the
production of milk will be affected, as a
result the production of milk at all levels
will decline. This is shown by the inward
movement of the production possibility
curve along the Y axis. The PPC curve
moves from AB to A'B.
Decrease in milk production
F. Chickens are infected with disease.
1/2 die:
When the chickens are infected with disease,
and half of the chickens die, the production of
eggs will decrease. When the production of
eggs decreases, the PPC curve will shift inward
to the left along the X axis, showing the reduced
capacity for the production of eggs.
Decrease in production of eggs
G. Production increases, due to good
nutrition
When the production increases due to good
nutrition, the production of both milks and
eggs will increase. This will result in
outward shift in the PPC curve, as shown in
the above graph.
Outward shift in PPC due to increase in
production

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3.3. What does a production possibility frontier show us about a nation's
economy?
The PPF shows the point in which a country's economy is at its most efficient, producing
consumer goods and services by optimally allocating resources. It considers production
factors and determines the best combinations of goods.
It can be used to demonstrate the point that any nation's economy reaches its greatest level
of efficiency when it produces only what it is best qualified to produce and trades with
other nations for the rest of what it needs.
The PPF is also referred to as the production possibility curve or the transformation curve.
The production possibility frontier, usually abbreviated PPF, is used to describe the
production capacity of a country, or in some cases an individual business.
Usually we draw it in two dimensions for convenience, though in reality it should have
many dimensions, one for each product that could be produced.
Along the PPF, production capacity is fully utilized; it is not possible with current resources
and technology to produce any more. We can move along the PPF in each direction,
producing more of one good and less of another good.
We can also move inside the PPF, producing less of both goods; but this would mean
wasting our productive capacity, because we are capable of producing more than we are
actually producing.
The one thing we cannot do is move outside the PPF, producing more of both goods;
outside the PPF is a level of production we simply can't achieve. We’d like to if we could,
but right now we can’t.
The PPF is extremely important in describing a range of economic phenomena.
The PPF can be used to explain the concept of opportunity cost: Rather than measuring
costs in dollars which are rather arbitrary (and change with inflation), we can measure the
cost of producing one good in terms of not producing other goods. As you move along the
PPF to produce more X at the expense of less Y, the opportunity cost of X in terms of Y is
the slope dY/dX.
The PPF is often applied to international trade: Because different countries have PPFs of
different shapes, they can trade with one another to produce more efficiently than either
country could do alone, thus effectively expanding their consumption beyond their
individual PPF. (Put another way, the combined PPF of both countries is larger than the
PPF of each country alone.)
The PPF can also be used to describe inefficiency in production, unemployment, and the
business cycle. During a recession, the economy is producing below potential GDP because
people are unemployed. This means that we are below the PPF and could have more
economic output if we employed everyone and produced at full capacity.
Finally, the PPF can also describe changes in technology and overall economic growth. If
technology makes production of one good more efficient, the PPF will expand in the
direction of that good. If there is growth in the economy as a whole, the entire PPF will
expand outward.

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3.4. How to show economic growth by the production possibility curve?
Economic growth has two meanings:
Firstly, and most commonly, growth is defined as an increase in the output that an economy
produces over a period of time, the minimum being two consecutive quarters.
The second meaning of economic growth is an increase in what an economy can produce
if it is using all its scarce resources. An increase in an economy’s productive potential can
be shown by an outward shift in the economy’s production possibility frontier (PPF).
The simplest way to show economic growth is to bundle all goods into two basic
categories, consumer and capital goods. An outward shift of a PPF means that an economy has
increased its capacity to produce.
When using a PPF, growth is defined as an increase in
potential output over time, and illustrated by an outward
shift in the curve. An outward shift of a PPF means that an
economy has increased its capacity to produce all goods.
This can occur when the economy undertakes some or all of
the following:
Employs new technology
Employs a division of labor, allowing specialization
Employs new production methods
Increases its labor force
Discovers new raw materials
An inward shift of a PPF
A PPF will shift inwards when an economy has suffered a
loss or exhaustion of some of its scarce resources. This
reduces an economy’s productive potential
Resources run out
Failure to invest
Erosion of infrastructure
Natural disaster
Investment
If an economy chooses to produce more capital goods than
consumer goods, at point A in the diagram, then it will grow
by more than if it allocated more resources to consumer
goods, at point B.
Asymmetric growth
An economy can grow because of an increase in
productivity in one sector of the economy – this is
called asymmetric growth.
For example, an improvement in technology applied to
industry Y, such as motor vehicles, but not to X, such as
food production, would be illustrated by a shift of the PPF
from the Y-axis only.

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3.5. Explain how to extend a production possibilities curve.
Production Possibility Curve:
The representation of opportunity costs of alternatives available before the
economy, with the given endowment of resources can be shown through the
production possibility curve.
The production possibility curve is the locus of all the production possibilities
available with the economy which it is capable of producing with the given
amount of resources it has. The production possibility curve shows the efficient
level of production in the economy. The production possibility curve can be
extended or expanded by the following the ways:
1. Improvement in Technology:
When there is technological development in the country, the productivity of
the factors increases. This leads to greater production at all levels in the
economy, thus leading to a rightward extension or shift in the production
possibility curve.
2. Technical Progress:
When there is technical progress which leads to increases the factor's
efficiency to produce, then also the production possibility curve will shift to
the right.
3. Economic Growth:
When the economy undergoes high economic growth, the production
capabilities in the economy increases and with the given amount of resources
the economy becomes capable of producing greater outputs, leading to
extension of the PPC curve.

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4. ELASTICITY AND ITS APPLICATION
4.1. What are the income and cross-price elasticities of demand and how to
calculate them?
Income elasticity of demand (YLD) is defined as the responsiveness of demand when a
consumer’s income changes. It is defined as the ratio of the change in quality demanded over
the change in income. The higher the income elasticity, the more sensitive demand for a good
is to changes in income.
The income elasticity of demand measures the response of Qd to a change in consumer income.
Income elasticity of demand (YED) =
Percent change
Percent change in income
=
%∆ in Qd
%∆ in Y
An increase in income causes an increase in demand for a normal good.
Hence, for normal goods, income elasticity > 0.
For inferior goods, income elasticity < 0.
The income elasticity of demand measures how much quantity demanded responds to changes
in buyers’ incomes.
Cross elasticity of demand (XED) measures the percentage change in quantity demand for a
good after a change in the price of another. For example: if there is an increase in the price of
tea by 10% and the quantity demanded for coffee increase by 2%, then the cross elasticity of
demand =2/10.
The concept of cross elasticity of demand is of great importance in managerial decision making
for formulating proper price strategy. Multi-product firms often use this concept to measure
the effect of change in price of one product on the demand for other products.
Cross-price elasticity of demand (XED) =
Percent change in Qd for goood 1
Percent change in price og good 2
For substitutes, cross-price elasticity > 0
E.g., an increase in price of beef causes an increase in demand for chicken.
For complements, cross-price elasticity < 0
E.g. an increase in price of computers causes decrease in demand for software.
The cross-price elasticity of demand measures how much demand for one good responds to
changes in the price of another good.

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4.2. If the price of a commodity falls from Re.1.00 to 90p and this leads to an
increase in quantity demanded from 200 to 240, Calculate the price
elasticity of demand.
Elasticity of demand is equal to the percentage change of quantity
demanded divided by percentage change in price.
Price elasticity of demand is measured by using the formula:
4.3. What are the difference between price elasticity of demand and income
elasticity of demand?
The difference between price elasticity of demand and income elasticity of
demand is that Select one:
a. income elasticity measures the responsiveness of income to changes in supply
while price elasticity of demand measures the responsiveness of demand to a
change in price.
b. income elasticity refers to a horizontal shift of the demand curve while price
elasticity of demand refers to a movement along the demand curve.
c. income elasticity refers to the movement along the demand curve while price
elasticity refers to a horizontal shift of the demand curve.
d. income elasticity of demand examines how an individual's income changes
when prices change and the price elasticity of demand examines how quantity
demand changes when price changes.
Percentage change in Qs

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Income elasticity of demand =
percentage change in quantity demanded
percentage change in income
4.4. What is the price elasticity of supply? How is it related to the supply curve?
Price elasticity of supply measures the responsiveness to the supply of a good or
service after a change in its market price. According to basic economic theory,
the supply of a good will increase when its price rises. Conversely, the supply of
a good will decrease when its price decreases.
Time period of training: when a firm invests in capital the supply
is more elastic in its response to price increases. Factor mobility: when moving
resources into the industry is easier, the supply curve in more elastic. Reaction
of costs: if costs rise slowly it will stimulate an increase in quantity supplied
Income elasticity of Supply =
peentage change in Qs
percentage change in price
P
Q
Q1
P1
Q2
P2
SP rises
by 8%
Q rises by 16%

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Economists classify supply curves according to their elasticity.
The slope of the supply curve is closely related to price elasticity of supply.
4.5. What are the determinants of price elasticity?
The four factors that affect price elasticity of demand are
(1) availability of substitutes,
If consumers can substitute the good for other readily available goods that consumers
regard as similar, then the price elasticity of demand would be considered to be
elastic. If consumers are unable to substitute a good, the good would experience
inelastic demand.
(2) if the good is a luxury or a necessity,
The price elasticity of demand is lower if the good is something the consumer
needs, such as Insulin. The price elasticity of demand tends to be higher if its
a luxury good
(3) the proportion of income spent on the good,
The price elasticity of demand tends to be low when spending on a good is a small
proportion of their available income. Therefore, a change in the price of a good
exerts a very little impact on the consumer’s propensity to consume Marginal
Propensity to Consume The Marginal Propensity to Consume (MPC) refers to how
sensitive consumption in a given economy is to unitized changes in income levels.
MPC as a concept works similar to Price Elasticity, where novel insights can be
drawn by looking at the magnitude of change in consumption the good. Whereas,
when a good represents a large chunk of the consumer’s income, the consumer is
said to possess a more elastic demand
(4) how much time has elapsed since the time the price changed.
In the long term, consumers are more elastic over longer periods, which implies that
consumers with a more elastic demand in the long term.

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5. Interdependence and gains from trade
5.1. Why do people and nations choose to be economically interdependent?
Economic interdependence is when people rely on others to provide the goods
and services required for support.
People and nation choose economically interdependent for their lives or for
convenience. With economic interdependence comes economic growth. This
affiliation allows specialist industries to job and wage/salary increases and an
overall improvement to wealth and lifestyle. It can be seen that this reliance,
there is less inclination to go to war.
By compare of both countries before
trade and after trade in above graph,
it clearly shows that after the trade
both sides/both countries (USA &
Japan) gain the advantages. So
people and nations choose to be
economically interdependent.

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5.2. Show the Difference between Absolute Advantage and Comparative
Advantage
Absolute vs. Comparative Advantage: An Overview
The division and specialization of production in the global economy are shaped by two
key principles of capitalism, those of absolute advantage and comparative advantage.
While absolute advantage indicates which nation is best at producing a given good,
comparative advantage is an indication of which nation stands to lose the least by
choosing to produce one good versus another.
key takeaways
Absolute advantage is achieved when one producer is able to produce a competitive
product using fewer resources, or the same resources in less time.
Comparative advantage considers the opportunity cost when assessing the viability of
a product, accounting for alternative products.
Absolute Advantage
A nation or company is said to have an absolute advantage if it requires fewer
resources—generally raw materials, manpower, or time—to produce a given item. For
example, assume France and the United States both produce airplanes. In one month,
France can produce 14 planes while the U.S can churn out 45 of comparable quality.
This means it takes France 2.14 days to manufacture each plane versus the U.S. rate of
0.67 days.
In the above example, the U.S. has the absolute advantage because its ability to
produce high-quality products at a quicker rate than its competition indicates a more
efficient production model or more available and more talented labor.
While absolute advantage can be used to compare similar production, it does not take
into account the opportunity cost of choosing one product over another, possibly
more beneficial one.
Comparative Advantage
Comparative advantage is all about reducing the opportunity cost of a given
production strategy. The opportunity cost of producing a particular item is equal to the
potential benefit that could have been gained by choosing an alternative.It is also what
a business or country misses out on when choosing one option over another.
Assume that, utilizing the same amount of time and resources, China can produce
either 30 computers or 45 cellphones. The opportunity cost of manufacturing one
computer is 45/30, or 1.5 cellphones. Conversely, the opportunity cost of producing
one cellphone is 30/45, or 0.67 of a computer.

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5.3. what is comparative advantage in economics?
Comparative advantage is an economy's ability to produce a particular good or
service at a lower opportunity cost than its trading partners.
The law of comparative advantage describes how, under free trade, an agent
will produce more of and consume less of a good for which they have
a comparative advantage.
In an economic model, agents have a comparative advantage over others in
producing a particular good if they can produce that good at a lower
relative opportunity cost or autarky price, i.e. at a lower relative marginal
cost prior to trade. Comparative advantage describes the economic reality of the
work gains from trade for individuals, firms, or nations, which arise from
differences in their factor endowments or technological progress. (One should
not compare the monetary costs of production or even the resource costs (labor
needed per unit of output) of production. Instead, one must compare
the opportunity costs of producing goods across countries.
5.4. Does free trade make everyone better off? Explain How can trade make
everyone better off.
It's entirely true that free trade doesn't necessarily make absolutely everyone
better off than a system of more or less restricted trade. However, when you're
accounting for who does benefit it really is necessary to count everyone, not just
certain groups that you want to study the effects upon.
Trade Can Make Everyone Better Off because “Trade allows each person to
specialize at what he or she does best, whether it's farming, sewing, or home
building.” In the same way, nations can specialize in what they do best. In both
cases, people get a wider range of choices at lower prices.
People gain from their ability to trade with one another.
Competition results in gains from trading
Trade allows people to specialize in what they do best
from the trade of computers and wheat between japan and USA, we have
already found both countries are in in profit.

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6. The Cost Production
6.1. what is the production cost? Show the relationship between fixed cost and
variable cost with graph.
Production or product cost refer to the costs incurred by a business from
manufacturing a product or providing a service. Production costs can include a
variety of expenses such as labor, raw materials, consumable manufacturing
supplies and general overhead.
Fixed cost: A fixed cost is an expense that not change as production volume
increase or decrease within a relevant range. In other words, fixed coots are locked
in place as long as operation stay within a certain size. Fixed costs are less
controllable than variable cost because they aren’t based on volume or operation.
Some examples of fixed costs include rent, insurance, and property taxes. All of
these expenses are completely independent from production volume.
Variable cost: A variable cost is a corporate expense that changes in proportion to
production output. Variable costs increase or decrease depending on a company’s
production volume. They rise as production increase and fall as production
decrease. Examples of variable costs include the costs of raw materials and
packaging

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6.2. what are the basic element of production of cost?
The three elements of manufacturing costs are material, labor, and
manufacturing overhead. Material A distinction is made between direct materials
and indirect materials when the product is the relevant cost objective. Direct
materials are those which can be logically and readily identified with the product
A cost is composed of three elements – Material, Labor and Expenses. Each of these
three elements can be direct and indirect, i.e., direct materials and indirect
materials, direct labor and indirect labor, direct expenses and indirect expenses.
Materials:
“The material cost is the cost of commodities supplied to an undertaking”- I.C.M.A.
(i) Direct Materials Cost:
Direct material cost is “The cost of materials entering into and becoming
constituent elements of a product or saleable service”. Thus, materials which can
be identified with units of output or service are known as direct materials.
Cotton used in production of cloth, leather used in the case of production of leather
goods and lime in the production of chalk, etc., are the examples of direct materials.
Any materials purchased and used for a specific job are also direct materials.
(ii) Indirect Materials:
“Materials used for the product other than the direct materials are called indirect
materials. In other words, materials cost which cannot be identified with a specific
product, job, process is known as indirect material cost.
Small tools, stationery used in works, office stationery, advertising posters, and
materials used in maintenance of plant and machinery are a few examples of
indirect materials
Labor:
Labor is the remuneration paid for physical or mental effort expended in
production and distribution. “The labor cost is the cost of remuneration (wages,
salaries, commissions, bonus, etc.) of the employees of an undertaking” – I.C.M.A.
Expenses:
Expenditure other than material and labor is the third element of cost.
It is defined by I.C.M.A. as- “The cost of service provided to an undertaking and the
notional cost of the use of owned assets

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6.3. what are different types of cost that affects the cost of production?
1. Real Cost:
The term “real cost of production” refers to the physical quantities of various factors
used in producing a commodity.
In other-words—Real cost signifies the aggregate of real productive resources
absorbed in the production of a commodity or a service.
2. Opportunity Cost:
The opportunity cost is also known as ‘transfer cost’ or ‘alternate cost.
The utility of the study of opportunity cost lies in the theory of production. The factor
must be paid at least that price which they are able to obtain in the alternate use.
3. Money Cost:
‘Money Cost’ is the monetary expenditure on inputs of various kinds. It is that total
money expenses incurred by a firm in producing a commodity. They include wages and
salaries of labor cost of raw-material, expenditure on machines and equipment,
depreciation and obsolescence charges on machines building and other capital goods;
rent on building; interest on capital invested and borrowed, normal profits of business,
expenses on power, light, fuel, advertisement and transportation, insurance charges
and all types of taxes.
The money cost includes both:
(a) Implicit Costs
(b) Explicit Costs.
4. Production Costs:
Production costs have been called as the total amount of money spent in the
production of goods. They include the cost of raw materials and freight thereon, the
costs of manufacture, i.e., the wages of workers engaged in the manufacture of the
commodity and salaries of the manager and other office staff including those of peons
etc.
They also include and cover other overheads expenses like—rent, interest on capital,
taxes, insurance and other incidental expenses like—cost of repairs and replacements.
They include both prime costs and supplementary costs.
5. Selling Costs:
Selling costs are the costs of marketing, advertisement and salesmanship. These costs
are incurred to attract customers, expand market and capture more business and
retain the existing business. These costs are the essential costs of the competitive
economy.
6. Fixed and Variable Costs:

28. 27 | P a g e
Cost refer to the prices paid to the factors of production, we find prices paid to fixed
factors, and the prices paid to the variable factors which are termed as the fixed costs
and the variable costs respectively. Thus, the cost of production of a commodity is
composed of two types of costs, i.e., Fixed Costs Variable Costs and, also called Prime
and Supplementary Costs respectively.
7. Fixed Costs or Supplementary Costs:
Fixed Costs or Supplementary Costs are the amount spent by the firm on fixed inputs
in the short-run. Fixed costs are those costs which remain constant, irrespective of the
level of output. These costs remain unchanged even if the output of the firm is nil.
Fixed costs, therefore, are known as “Supplementary Costs” or “Overhead Costs”. Fixed
Costs, in the short-run, remain fixed because the firm does not change its size and the
amount of fixed factors employed.
8. Average and Marginal Cost:
We have examined earlier that what is the total cost i.e., Fixed Cost + Variable Cost
taken together is called Fixed Total Cost. Now, we are going to discuss what is Average
and Marginal Costs? Average Cost is also known as cost per unit. If total cost of
production is divided by the total number of units produced, we get the average cost
Marginal Cost is the cost of producing and additional unit of output. In other-words,
marginal cost is the addition made to the total cost by producing one more unit of
output.
6.4. What is marginal product? Is marginal product the same as marginal cost?
The marginal product of an input refers to the increase in total production that
results from the last unit of the input. For example, in finding out marginal
product of labor, we need to keep land, capital, technology, etc. constant to
filter out the change in output that results from change in labor.
The marginal product of an input, say labor, is defined as the extra output that
results from adding one unit of the input to the existing combination of
productive factors.
Marginal cost represents the total cost to produce one additional unit
of product or output. Marginal product is the extra output generated by one
additional unit of input, such as an additional worker that’s why marginal cost
and marginal product are not same.

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6.5. What are the economies of scale?
In microeconomics, economies of scale are the cost advantages that enterprises
obtain due to their scale of operation, with cost per unit of output decreasing with
increasing scale.
Types
There are two main types of economies of scale: internal and external. Internal
economies are controllable by management because they are internal to the
company. External economies depend upon external factors. These factors include
the industry, geographic location, or government.
Internal Economies of Scale
Internal economies result from a larger volume of production. You'll typically see
them in large organizations.
For example, large companies can buy in bulk. This economy lowers the cost per
unit of the materials they need to make their products. They can use the savings to
increase profits. Or they can pass the savings to consumers and compete on price.
There are five main types of internal economies of scale.
Technical
Monopsony power
Managerial
Financial
Network
External Economies of Scale
A company has external economies of scale if its size creates preferential
treatment. That most often occurs with governments.
For example, a state often reduces taxes to attract the companies that provide the
most jobs. Big real estate developers convince cities to build roads to support their
buildings. This government building saves developers from paying those costs.
Large companies can also take advantage of joint research with universities. This
partnership lowers research expenses for these companies
Diseconomies of Scale
Sometimes a company chases economies of scale so much that it becomes too
large. This overgrowth is called a diseconomy of scale. For example, it might take
longer to make decisions, making the company less flexible. Miscommunication
could occur, especially if the company becomes global. Acquiring new companies
could result in a clash of corporate cultures. This clash will slow progress if they
don't learn to manage cultural diversity.

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7.Consumer choice theory
7.1. How does the budget constraint represent the choices a consumer can
afford?
In a budget constraint, the quantity of one good is measured on the horizontal axis
and the quantity of the other good is measured on the vertical axis. The budget
constraint shows the various combinations of the two goods that the consumer
can afford. Plotting the budget constraint is a fairly simple process.
The budget constraint framework suggests that when income or price changes, a
range of responses are possible. When income rises, households will demand a
higher quantity of normal goods, but a lower quantity of inferior goods.
When the price of a good rises, households will typically demand less of that good
but whether they will demand a much lower quantity or only a slightly lower
quantity will depend in personal preferences. Also, a higher price for one good
can lead to more or less demand of the other good.
Budget constraint means the limit on the consumption bundles that a consumer
can afford
Example: Hurley divides his income between two goods, fish and mangos. A
“consumption bundle” is a particular combination of the goods. e,g, 40 fish and
300 mangos.
Hurley’s income: $1200
Prices: PF = $4 per fish, PM = $1 per mang

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7.2. How do indifference curves represent the consumer’s preferences?
Indifference curves map or graphically represent consumer preferences. The
slope of an indifference curve, the MRS, reflects the value placed on the
additional unit of a good in terms of the other goods the consumer would be
willing to give up
Consumer preferences can be measured by their satisfaction with a specific
item, compared to the opportunity cost of that item since whenever you buy
one item, you forfeit the opportunity to buy a competing item.
The preferences of individual consumers are not contained within the field of
economics.
indifference curves: shows consumption bundles that give the consumer the
same level of satisfaction
A, B, and all other bundles on I1 make Hurley equally happy – he is indifferent
between them. Then it shows following properties.

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7.3. What is the consumer choice theory?
The theory of consumer choice is the branch of microeconomics that relates
preferences to consumption expenditures and to consumer demand curves. As
the price of a good rises, consumers will substitute away from that good.
Choosing more of other alternatives.
In other word, Consumer choice refers to a theory in microeconomics that tries
to explain how people make a choice on which goods and services to consume.
According to the theory of consumer choice, people purchase goods and
services that they can afford. Economics assumes that people purchase goods
they can afford because money is a limited resource.
Based on consumer choice theory, people will consume more of a product when
they cost less because they can spend less money and gain more products.
When the cost of goods is high, consumers will consume less of the product.
Understanding this theory helps firms create products and services in high
demand because of their affordability, and thus managers need to understand
the theory of consumer choice.
7.4. Explain the income effect and substitution effect caused by price increase.
Price:
Price refers to the cost that an individual incurs for purchasing a particular good
or service. Some of the factors that affect a commodity's price include income
levels, demand, and supply. A price is said to be stable when the demand for
goods and services equals the supply.
Income effect refers to a concept that explains how the change of income level
impacts the demand for goods and services. The substitution effect relates to an
idea that describes how the increase in a commodity price leads to the rise in
demand for another substitute product.
The increase in the price of normal goods leads to a rise in demand for inferior
goods. Low-income earners mostly consume inferior goods, which are less
costly. When the cost of standard good increases, the consumer goes for
cheaper alternatives. Hence the rise in the price of ordinary goods leads to an
upsurge in the demand for inferior goods.

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When the price of goods increases and the income remains the same, the
demand for goods will decline. This is because the increase in the price of goods
makes consumers consume fewer goods and services since their income does
not allow them to purchase more goods.
7.5. What is consumer surplus?
Consumer surplus is an economic measurement to calculate the benefit (i.e.,
surplus) of what consumers are willing to pay for a good or service versus its
market price. The consumer surplus formula is based on an economic theory of
marginal utility. The theory explains that spending behavior varies with the
preferences of individuals. Since different people are willing to spend differently
on a given good or service, a surplus is created. This metric is used across a wide
range of corporate finance careers.
A long run is a period of time in which all factors of production and costs are
variable. In response to expected economic profits, firms can change
production levels. On other hand, the short run is the time horizon over which
factors of production are fixed, except for labor which remains variable

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8. Fiscal policy and monetary policy
8.1. Compare between fiscal policy and monetary policy. What are the main
objectives of fiscal policy in developing country?
Fiscal Policy: Fiscal policy refers to the use of government spending and tax
policies to influence economic conditions, especially macroeconomic
conditions, including aggregate demand for goods and services, employment,
inflation and economic growth.
Fiscal policy Monetary Policy
a. Change in government
spending and tax rates
a) Change in interest rates/money
supply
b. Set by government b) Set by a central bank
c. No specific target c) Target inflation
d. Side effect on government
budget/borrowing
d) Side effect on exchange rate
and housing market
e. Strong political dimension to
changing tax rates
e) Mostly independent from the
political process
f) Fiscal policy advised in very
deep recessions
f. Cuts in interest rates may not
work in liquidity tray
There are following objectives of fiscal policy in developing country….
Development by effective mobilization of resources
Effective allocation of financial resources
Reduction in inequalities of income and wealth
Price stability and control of inflation
Employment generation
Balanced regional development
Reducing the deficit in the balance of payment

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8.2. Describe the inflation? What are the causes of inflation?
Generally, inflation is a gradual, steady increase in the prices of goods and services. It refers
to a general increase in the prices of goods and services in the economy over time that
corresponds with a decrease in the value of money. Increase in public spending, hoarding, tax
reductions, price rise in international markets are the causes of inflation. These factors lead to
rising prices.
Primary Causes
In an economy, when the demand for a commodity exceeds its supply, then the excess demand
pushes the price up. On the other hand, when the factor prices increase, the cost of production
rises too. This leads to an increase in the price level as well.
Increase in Public Spending:
In any modern economy, Government spending is an important element of the total spending.
It is also an important determinant of aggregate demand.
Usually, in lesser developed economies, the Govt. spending increases which
invariably creates inflationary pressure on the economy.
Deficit Financing of Government Spending:
There are times when the spending of Government increases beyond what taxation can finance.
Therefore, in order to incur the extra expenditure, the Government resorts to deficit financing.
For example, it prints more money and spends it. This, in turn, adds to inflationary pressure.
Increased Velocity of Circulation:
In an economy, the total use of money = the money supply by the Government x the velocity
of circulation of money.
When an economy is going through a booming phase, people tend to spend money at a faster
rate increasing the velocity of circulation of money.
Population Growth:
As the population grows, it increases the total demand in the market. Further, excessive
demand creates inflation.
Hoarding:
Hoarders are people or entities who stockpile commodities and do not release them to the
market. Therefore, there is an artificially created demand excess in the economy. This also
leads to inflation.
Genuine Shortage:
It is possible that at certain times, the factors of production are short in supply. This affects
production. Therefore, supply is less than the demand, leading to an increase in prices and
inflation.

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Exports:
In an economy, the total production must fulfill the domestic as well as foreign demand. If it
fails to meet these demands, then exports create inflation in the domestic economy.
Trade Unions:
Trade union work in favor of the employees. As the prices increase, these unions demand an
increase in wages for workers. This invariably increases the cost of production and leads to a
further increase in prices.
Tax Reduction:
While taxes are known to increase with time, sometimes, Governments reduce taxes to gain
popularity among people. The people are happy because they have more money in their hands.
However, if the rate of production does not increase with a corresponding rate, then the excess
cash in hand leads to inflation.
The imposition of Indirect Taxes:
Taxes are the primary source of revenue for a Government. Sometimes, Governments impose
indirect taxes like excise duty, VAT, etc. on businesses.
As these indirect taxes increase the total cost for the manufacturers and/or sellers, they increase
the price of the product to have a minimal impact on their profits.
Price-rise in the International Markets:
Some products require to import commodities or factors of production from the international
markets like the United States. If these markets raise prices of these commodities or factors of
production, then the overall production cost in India increases too. This leads to inflation in
the domestic market.
Non-economic Reasons:
There are several non-economic factors which can cause inflation in an economy. For example,
if there is a flood, then crops are destroyed. This reduces the supply of agricultural products
leading to an increase in the prices of the commodities.
Investment in Gold, Real estate, stocks, mutual funds, and other assets are some of the ways to
deal with Inflation.
Types:
Demand-Pull Inflation, Cost-push inflation, Supply-side inflation Open Inflation, Repressed
Inflation, Hyper-Inflation, are the different types of inflation.
Open inflation – when the price level in an economy rises continuously
Repressed inflation – when the economy suffers from inflation without any apparent rise in
prices.

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8.3. What are the tools of fiscal policy? Which tool is important for fiscal policy?
spending or taxation.
Fiscal policy is therefore the use of government spending, taxation and transfer
payments to influence aggregate demand. These are the three tools inside
the fiscal policy.
The two main tools of fiscal policy are taxes and spending. Taxes influence the
economy by determining how much money the government has to spend in
certain areas and how much money individuals should spend. For example, if the
government is trying to spur spending among consumers, it can decrease taxes.
Spending cuts reduce the Federal government's need for more revenue. Reducing
government's role is going to allow businesses to borrow. This will generate
economic activity and in turn this will create jobs. More jobs result in more
taxable wages and increase the revenues to the Treasury. Expansion occurs, and
prices rise proportionally.
Raising taxes decreases the amount of money that can be spent on goods and
services. This reduces private sector hiring and increases the overall
unemployment.
There needs to be a balance. For and economy not to "overheat", real wages, less
taxes, needs to match overall growth in the gross domestic product (GDP). So
long as the economy is expanding at 3 to 4% inflation is manageable. When the
government adds money to the economy and crowds out private borrowing, then
you have classic inflation: too much money and not enough consumer demand.

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8.4. What is taxation? What are the purposes of taxation?
Taxation, imposition of compulsory levies on individuals or entities
by governments. Taxes are levied in almost every country of the world, primarily
to raise revenue for government expenditures, although they serve
other purposes as well.
Purposes Of Taxation
During the 19th century the prevalent idea was that taxes should serve mainly
to finance the government. In earlier times, and again today, governments have
utilized taxation for other than merely fiscal purposes. One useful way to view
the purpose of taxation, attributable to American economist Richard A.
Musgrave, is to distinguish between objectives of resource allocation, income
redistribution, and economic stability. (Economic growth or development and
international competitiveness are sometimes listed as separate goals, but they
can generally be subsumed under the other three.)
In the absence of a strong reason for interference, such as the need to
reduce pollution, the first objective, resource allocation, is furthered if tax
policy does not interfere with market-determined allocations. The second
objective, income redistribution, is meant to lessen inequalities in the
distribution of income and wealth. The objective of stabilization—implemented
through tax policy, government expenditure policy, monetary policy,
and debt management—is that of maintaining high employment
and price stability.
There are likely to be conflicts among these three objectives. For example,
resource allocation might require changes in the level or composition (or both)
of taxes, but those changes might bear heavily on low-income families—thus
upsetting redistributive goals. As another example, taxes that are highly
redistributive may conflict with the efficient allocation of resources required
to achieve the goal of economic neutrality.

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8.5. What is monetary policy? What are the objectives of Monetary Policy?
Monetary policy is the macroeconomic policy laid down by the central bank. It
involves management of money supply and interest rate and is the demand side
economic policy used by the government of a country to achieve
macroeconomic objectives like inflation, consumption, growth and liquidity.
Economic Growth
Price Stability
Controlled Expansion of Bank Credit
Promotion of Fixed Investment
Restriction of Inventories
Promotion of Exports and Food Procurement Operation
Desired Distribution of Credit
Equitable Distribution of Credit
To promote efficiency
Reducing the Rigidity

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9. National income and its concept
9.1. With the definition of national income describe the method of measuring
national income in detail.
National income is total amount of goods and services produced within the nation during the
given period say one year. It is the total of factor income i.e. wages, rent, profit, received by
factor of production. i.e. labor, capital, land and entrepreneurship of a nation. In other word,
national income means the value of goods and services produced by a country during a financial
year. Thus it is the net result of all economic activities of any country during a period of one
year and is valued in terms of money.
There are alternative ways to calculate the national income. Some methods are followings.
A. Census method or production method
It is also known as inventory or product method. In this method, the economy is classified into
convenient sectors like agricultural, industrial, direct services and foreign transaction sector
where international payments are considered.
• According to this method, Value of output is estimated
•Value of intermediate goods (input) is deducted from the value of output to obtain Gross Value
Added
Gross Value Added = Value of Output – Value of intermediate goods
Net Value Added = Gross Value Added – Depreciation
Limitations of Product Method
• Problem of Double Counting:
• unclear distinction between a final and an intermediate product.
• Not Applicable to Tertiary Sector:
• This method is useful only when output can be measured in physical terms
• Exclusion of Non Marketed Products
• E.g. outcome of hobby or self consumption
• Self consumption of Output
• Producer may consume a part of his production.
B. Income Method
• The net income received by all citizens of a country in a particular year, i.e. total of net rents,
net wages, net interest and net profits.
• It is the income earned by the factors of production of a country.
Process
• Economy is divided on basis of income groups, such as wage/salary earners, rent earners,
profit earners etc.
• Income of all the groups is added, including income from abroad and undistributed profits.
• Transfer payments made in the year are subtracted.
Formula:
•GNP = wages and salaries +rent +interest + Dividends +undistributed corporate profits +mixed
incomes + direct taxes + indirect taxes + depreciation + net income from abroad.

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Limitations
• Exclusion of non-monetary income: Ignores the non-monetized section of economic activities.
Economic activities that contribute to national income, but due to their non-monetary nature,
they go unrecorded. For e.g. a farmer and family working in their own field.
• Exclusion of Non Marketed Services: People undertake a particular activity that are difficult
to ascertain in money value. E.g. mother’s services to the family.
C. Expenditure method
• The total expenditure incurred by the society in a particular year is added together to get that
year’s national income.
Components of Expenditure:
✓ personal consumption expenditure
✓ net domestic investment
✓ government expenditure on goods and services, and
✓ net foreign investment
Limitations
• Ignores Barter System
• Ignores Own Consumption
• Affected by Inflation
D. Value Added Method
• In order to avoid double counting value added at each stage of production should be
calculated to arrive at GNP. The difference between the value of output and input at each stage
of production is called the value added. By summing such value added for all industries in the
economy, GNP can be found out.
9.2. What are the major difficulties in the measurement of national income in
developing country?
The following points are the major difficulties in the measurement of national income.
Difficulty 1. Prevalence of Non-Monetized Transactions:
There are certain transactions in India in which a considerable part of output does not
come into the market at all.
For example:
Agriculture in which a major part of output is consumed at the farm level itself. The
national income statistician, therefore, has to face the problem of finding a suitable
measure for this part of output.
Difficulty 2. Illiteracy: The majority of people in India are illiterate and they do not
keep any accounts about the production and sales of their products. Under the
circumstances the estimates of production and earned incomes are simply guess work.

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Difficulty 3. Occupational Specialization is Still Incomplete and Lacking:
There is the lack of occupational specialization in our country which makes the
calculation of national income by product method difficult. Besides the crop, farmers
are also engaged is supplementary occupations like—dairying, poultry, cloth-making
etc. But income from such productive activities is not included in the national income
estimates.
Difficulty 4. Lack of Availability of Adequate Statistical Data:
Adequate and correct production and cost data are not available in our country. For
estimating national income data on unearned incomes and on persons employed in the
service are not available. Moreover, data on consumption and investment expenditures
of the rural and urban population are not available for the estimation of national income.
Moreover, there is no machinery for the collection of data in the country.
Difficulty 5. Value of Inventory Changes:
The value of all inventory changes (i.e., changes in stock etc.) which may be either
positive or negative are added or subtracted from the current production of the firm.
Remember, if in the change in inventories and not total inventories for the year that are
taken into account in national income estimates.
Difficulty 6. The Calculation of Depreciation:
The calculation of depreciation on capital consumption presents another formidable
difficulty. There are no accepted standard rates of depreciation applicable to the various
categories of machine. Unless from the gross national income correct deductions are
made for depreciation the estimate of net national income is bound to go wrong.
Difficulty 7. Difficulty of Avoiding the Double Counting System:
The very important difficulty which a calculator has to face in measurement is the
difficulty of avoiding double counting.
For example:
If the value of the output of sugar and sugar cane are counted separately, the value of
the sugarcane utilized in the manufacture of sugar will have been counted twice, which
is not proper. This must be avoided for a correct measurement.
Difficulty 8. Difficulty of Expenditure Method:
The application of expenditure method in the calculation of national income has become
a difficult task and it is full of difficulties. Because in this method it is difficult to
estimate all personal as well as investment expenditures.

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9.3. What are the importance of national income analysis? Describe
briefly.
Importance 1. For the Economy:
National income data are of great importance for the economy of a country.
These days the national income data are regarded as accounts of the economy,
which are known as social accounts.
These refer to net national income and net national expenditure, which ultimately
equal each other Social accounts tell us how the aggregates of a nation’s income,
output and product result from the income of different individuals, products of
industries and transactions of international trade.
Their main constituents are inter-related and each particular account can be used
to verify the correctness of any other account Based very much on social
accounts, the national income data have the following importance.
Importance 2. National Policies:
National income data form the basis of national policies such as employment
policy because these figures enable us to know the direction in which the
industrial output, investment and savings’ etc. change, and proper measures can
be adopted to bring the economy to the right path.
Importance 3. Economic Planning:
In the present age of planning, the national data are of great importance. For
economic planning, it is essential that the data pertaining to a country’s gross
income, output, saving and consumption from different sources should be
available.
Without these, planning is not possible. Similarly, the economists propound
short-run as well long-run economic models or long-run investment models in
which the national income data are very widely used.
Importance 4. Economic Models:
Economists build short-run and long-run economic models in which the national
income data are widely used.
Importance 5. For Research:
The national income data are also made use of by the research scholars of
economics, they make use of the various data of the country’s input, output,

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income, saving, consumption, investment employment, etc., which are obtained
from social accounts.
Importance 6. Per-Capita Income:
National income data are significant for a country’s per capita income which
reflects the economic welfare of the country. The higher the per capita income,
the higher the economic welfare and vice versa.
Importance 7. Distribution of Income:
National income statistics enable us to know about the distribution of income in
the country. From the data pertaining to wages, rent, interest and profits we learn
of the disparities in the incomes of different sections of the society.
Similarly, the regional distribution of income is revealed it is only on the basis of
these that the government can adopt measures to remove the inequalities in
income distribution and to restore regional equilibrium. With a view to removing
these personal and regional disequilibria, the decisions to levy more taxes and
increase public expenditure also rest on national income statistics.
9.4. What items are included in Gross National Product (GDP)?
Thus GNP is the sum total of the following items:
(i) Wages and Salaries:
Under this head fall all forms of wages and salaries earned through productive activities
by workers and entrepreneurs. It includes all sums received or deposited during a year
by way of all types of contributions like overtime, commission, provident fund,
insurance, etc.
(ii) Rents:
Total rent includes the rents of land, shop, house, factory, etc. and the estimated rents
of all such assets as are used by the owners themselves.
(iii) Interest:
Under interest comes the income by way of interest received by the individual of a
country from different sources. To this is added, the estimated interest on that private
capital which is invested and not borrowed by the businessman in his personal business.
But the interest received on governmental loans has to be excluded, because it is a mere
transfer of national income.

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(iv) Dividends:
Dividends earned by the shareholders from companies are included in the GNP.
(v) Mixed incomes:
These include profits of unincorporated business, self-employed persons and
partnerships. They form part of GNP.
(vi) Undistributed corporate profits:
Profits which are not distributed by companies and are retained by them are included in
the GNP.
(vii) Mixed incomes:
These include profits of unincorporated business, self-employed persons and
partnerships. They form part of GNP
(viii) Direct taxes:
Taxes levied on individuals, corporations and other businesses are included in the GNP.
(ix) Indirect taxes:
The government levies a number of indirect taxes, like excise duties and sales tax.
These taxes are included in the prices of commodities. But revenue from these goes to
the government treasury and not to the factors of production. Therefore, the income
due to such taxes is added to the GNP.
(x) Depreciation:
Every corporation makes allowance for expenditure on wearing out and depreciation of
machines, plants and other capital equipment. Since this sum also is not a part of the
income received by the factors of production, it is, therefore, also included in the GNP.
(xi) Net income earned from Abroad:
This is the difference between the value of exports of goods and services and the value
of imports of goods and services. If this difference is positive, then it is added to the
GNP and if it is negative it is deducted from the GNP.
Thus GNP according to the Income Method = Wages and Salaries + Rents + Interest
+ Dividends + Undistributed Corporate Profits +Mixed Incomes +Direct Taxes+
Indirect Taxes+ Depreciation+ Net Income from abroad.

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9.5. What is the national income? Compare between GDP and GNP?
National income is the measure of the measure of the total market values of goods
and services (output) produce by an economy in a period of time (normally one
fiscal year).
COMPARISION
GDP GNP
This is an estimated value of the total
worth of a country’s production and
services within it’s boundary, by its
nationals and foreigners calculated over
the course on one year.
An estimated value of the total worth of
production and services, by citizens of a
country on its land or on foreign land,
calculated over the course on one year.
GDP = consumption + investment +
(government spending) + (exports –
imports)
GNP = GDP + NR (Net income inflow from
assets abroad or Net Income Receipts) – NP
(Ney payment outflow to foreign assets)
Uses in business, economic forecasting. Uses in business, economic forecasting.
To see the strength of a country’s local
economy.
To see how the nationals of a country are
doing economically.
Total value of products & services
produced within the territorial boundary
of a country.
Total value of goods and services
produced by all nationals of a country
(whether within or outside of the
country).
Local Scale International Scale
GDP highlights the strength of the
country’s economy
GNP highlights the residents’
contribution to the development of the
economy
Q.1. What is Budget? Explain the types of Budget.
Generally, Budget is a description of a financial plan or a periodic list of income & expenditure.
A government budget is an annual financial statement which outlines the estimated
government expenditure and expected government receipts or revenues for the forthcoming
fiscal year.
Depending on the feasibility of these estimates, Budgets are of three types –
Balanced budget
A government budget is said to be a balanced budget if the estimated government expenditure
is equal to expected government receipts in a particular financial year. Advocated by many
classical economists, this type of budget is based on the principle of “living within means.”
They believed the government’s expenditure should not exceed their revenue.
Though an ideal approach to achieve a balanced economy and maintain fiscal discipline, a
balanced budget does not ensure financial stability at times of economic depression or
deflation. Theoretically, it’s easy to balance the estimated expenditure and anticipated

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revenues but when it comes to practical implementation, such balance is hard to achieve.
Merits of a balanced budget
Ensures economic stability, if implemented successfully.
Ensures that the government refrains from imprudent expenditures.
Demerits of a balanced budget
Unviable at times of recession and does not offer any solution to problems such as
unemployment.
Inapplicable in less developed countries as it limits the scope of economic growth.
Restricts the government from spending on public welfare.
Surplus budget
A government budget is said to be a surplus budget if the expected government revenues exceed
the estimated government expenditure in a particular financial year. This means that the
government’s earnings from taxes levied are greater than the amount the government spends
on public welfare. A surplus budget denotes the financial affluence of a country. Such a
budget can be implemented at times of inflation to reduce aggregate demand.
Deficit budget
A government budget is said to be a deficit budget if the estimated government expenditure
exceeds the expected government revenue in a particular financial year. This type of budget is
best suited for developing economies, such as India. Especially helpful at times of recession,
a deficit budget helps generate additional demand and boost the rate of economic growth. Here,
the government incurs the excessive expenditure to improve the employment rate. This results
in an increase in demand for goods and services which helps in reviving the economy. The
government covers this amount through public borrowings (by issuing government bonds) or
by withdrawing from its accumulated reserve surplus.
Merits of a Deficit Budget
Helps in addressing public concerns such as unemployment at times of economic recession
Enables the government to spend on public welfare
Demerits of a Deficit Budget
Can encourage imprudent expenditures by the government.
Increases burden on the government by accumulating debts.
Q.2. How do you describe the cause of deflation?
Deflation:
When the overall price level decreases so that inflation rate becomes negative,
it is called deflation. It is the opposite of the often-encountered inflation.
Description: A reduction in money supply or credit availability is the reason
for deflation in most cases.

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Q.3. What do you mean by resources in economics explain briefly.
The resources of a society consist not only of the free gifts of nature such as land,
forests and minerals but also human capacity, both mental and physical and of all
sorts of man-made aids to further production, such as tools, machinery and
buildings.
The factors of production are resources that are the building blocks of the
economy; they are what people use to produce goods and services. Economists
divide the factors of production into four categories: land, labor, capital, and
entrepreneurship.
Land

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All those gifts of nature such as land, forest and minerals etc. commonly called
natural resources and known to economist as Land. Land is an economic
resource that includes all natural physical resources like gold, iron, silver, oil etc.
Some countries have very rich natural resources and by utilizing these resources
they enrich their economy to the peak
Labor
All human resources, mental and physical both inherited and acquired which
economist call Labor. The human input in the production or manufacturing
process is known as labor. Workers have different work capacity. The work
capacity of each worker is based on his own training, education and work
experience
Capital
All those man-made aids to further production such as tools, machinery and
factors which are used up in the process of making others goods and services
rather than being consumed for their own shake, which economist called Capital.
In economics, Capital is a term that means investment in the capital goods. So,
that can be used to manufacture other goods and services in future.
Entrepreneurship
This word is formed French word entrepreneur which means who undertakes
task. The Entrepreneur is person or individual who wants to supply the product
to the market, in order to make profit. Entrepreneurs usually invest their own
capital in their business. This financial capital is generally based on their savings
and they take risks linked to their investments. This risk-taking can be rewarded
by the profit of the business.
Q.4. What is iso-cost curve? Explain it graphically.
A curve showing the combinations of factor inputs that have constant market cost. If firms
are acting as price-takers in factor markets, the isocost curve is a straight line, whose slope
represents the relative prices of different factors' services.
These curves are also known as outlay lines, price lines, input-price lines, factor-cost lines,
constant-outlay lines, etc. Each iso-cost curve represents the different combinations of two

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inputs that a firm can buy for a given sum of money at the given price of each input.
Figure, 8 (A) shows three iso-cost curves AB, CD and EF, each represents a total outlay of 50,
75 and 100 respectively. The firm can hire ОС of capital or OD of labor with Rs.75. ОС is
2/3 of OD which means that the price of a unit of labor is 1 ½ times less than that of a unit of
capital. The line CD represents the price ratio of capital and labor.
Prices of factors remaining the same, if the total outlay is raised the iso-cost curve will shift
upward to the right as EF parallel to CD, and if the total outlay is reduced it will shift
downwards to the left as AB. The iso-costs are straight lines because factor prices remain the
same whatever the outlay of the firm on the two factors. The iso-cost curves represent the
locus of all combinations of the two input factors which result in the same total cost.
If the unit cost of labor (L) is w and the unit cost of capital (C) is r, then the total cost:
TC = wL + rC. The slope of the iso-cost line is the ratio of prices of labor and capital i e w/r.
or PL/РС where P is price.
Q.5. why economic problems arise in every country?
All societies face the economic problem, which is the problem of how to make the best use of
limited, or scarce, resources. The economic problem exists because, although the needs and
wants of people are endless, the resources available to satisfy needs and wants are limited
Some of the main reasons for the existence of economic problems are given below:
(i) Scarcity of Resources: Resources (i.e. land, labor, capital, etc.) are limited in relation to their
demand and economy cannot produce all what people want.
It is the basic reason for existence of economic problems in all economies. Scarcity is universal
and applies to all individuals, organizations and countries. There would have been no problem,
if resources were not scarce.
(ii) Unlimited Human Wants: Human wants are never ending, i.e. they can never be fully
satisfied. As soon as one want is satisfied, another new want emerges. Wants of the people are
unlimited and keep on multiplying and cannot be satisfied due to limited resources.

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Human wants also differ in priorities, i.e. all wants are not of equal intensity. For every
individual, some wants are more important and urgent as compared to others. Due to this
reason, people allocate their resources in order of preference to satisfy some of their wants. If
all human wants had been of equal importance, then it would have become impossible to make
choices.
(iii) Alternate Uses: Resources are not only scarce, but they can also be put to various uses. It
makes choice among resources more important.For example, petrol is used not only in vehicles,
but also for running machines, generators, etc. As a result, economy has to make choice
between the alternative uses of the given resources.
**** Q. Write short on utility and consumption. ***
I. Utility
Utility is a term in economics that refers to the total satisfaction received from
consuming a good or service. The economic utility of a good or service is important
to understand, because it directly influences the demand, and therefore price, of that
good or service.
Utility is defined as want-satisfying capacity of the commodity. For example, when a
person is hungry, bread has utility for him. It is a relative concept. eg. plough is useful
for a farmer but has no utility for a fisherman.
Types of Utility:
(1) Form Utility:
(2) Place Utility:
(3) Time Utility:
(4) Service Utility:
(5) Possession Utility:
(6) Knowledge Utility:
(7) Natural Utility:
II. Consumption
Consumption means using, buying or eating something. If we don't reduce our
energy consumption, we will run out of fuel. Conspicuous consumption is buying
something to show off. Consumption is related to the verb consume, which means to
eat, use, or buy.
Personal consumption expenditures are officially separated into three categories in the
National Income and Product Accounts: durable goods, nondurable goods, and services.
Durable goods are the tangible goods purchased by consumers that tend to last for more
than a year.