Applied Agribusiness Economics - Questions & Answers, 2nd Semester

Applied Agribusiness Economics (MAE 523) Internal Assessment
1
Prepared by: Basudev Sharma M.Sc.Ag. (ABM), 2nd
Semester
Purbanchal University
HIMALAYAN COLLEGE OF AGRICULTURAL
SCIENCE AND TECHNOLOGY (HICAST)
KATHMANDU, NEPAL
Course: Applied Agribusiness Economics (MAE 523) Program: MSc Agriculture (Agribusiness Management)
Assignment Prepared by: Basudev Sharma, M.Sc.Ag. (Agribusiness Management), 2nd
Semester, 3rd
Batch
Assignment Submitted to: Nanu Jha, Adjunct Professor, HICAST, Kathmandu, Nepal
GROUP A: LONG ANSWER QUESTIONS
Q.1. Explain the term "Equilibrium". How price is determined under perfect and imperfect
market, monopoly, monopolistic and oligopoly markets.
Answer:
Demand is the quantity of a good or service consumers are willing and able to buy at a
given price in a given time period and supply is the quantity of a product that a producer is
willing and able to supply onto the market at a given price in a given time period. An
inverse relationship exists between price & quantity demanded. As price rises quantity
demanded falls and as price falls quantity demanded rises. A direct relationship exists
between price & quantity supplied. As price falls, quantity supplied falls and as price rise,
quantity supplied rises.
Equilibrium is a point where the demand
and the supply intersect with each other.
Equilibrium in market is where the market
price has reached to a level at which
quantity demanded is equal to quantity
supplied. The price at which quantity
demanded and quantity supplied is
equilibrium price. The quantity at which
equilibrium arises is equilibrium quantity.
If something happens to disrupt that
equilibrium (e.g. an increase in demand or a decrease in supply) then the forces of demand
and supply respond (and price changes) until a new equilibrium is established. Let's look

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briefly at how the market equilibrium point is established using basic supply and demand
analysis. The demand for and supply of fresh vegetables in a local market is shown in the
table below:
Price (Rs/kg) Demand-1 (kg) Supply-1 (kg) Demand-2 (kg) Supply-2 (kg)
40 200 500 250 750
35 250 450 325 700
30 300 400 400 650
25 350 350 425 600
20 400 300 550 550
15 450 250 675 500
10 500 200 800 450
Perfect Competition:
Perfect competition refers to a market situation where there are a large number of buyers
and sellers dealing in homogenous products. Moreover, under perfect competition, there
are no legal, social, or technological barriers on the entry or exit of organizations.
In perfect competition, sellers and
buyers are fully aware about the current
market price of a product. Therefore,
none of them sell or buy at a higher rate.
As a result, the same price prevails in the
market under perfect competition. Under
perfect competition, the buyers and
sellers cannot influence the market price
by increasing or decreasing their
purchases or output, respectively. The
market price of products in perfect competition is determined by the industry. In perfect
competition, the price of a product is determined at a point at which the demand and supply
curve intersect each other. This point is known as equilibrium point. At this point, the
quantity demanded and supplied is called equilibrium quantity.
Imperfect Competition:
Imperfect competition is a competitive market situation where there are many sellers, but
they are selling heterogeneous (dissimilar) goods as opposed to the perfect competitive
market scenario. Imperfect competition is the real world competition. Today some of the

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industries and sellers follow it to earn surplus profits. In this market scenario, the seller
enjoys the luxury of influencing the price in order to earn more profits. There are four types
of imperfect markets:
a) Monopoly (only one seller)
b) Oligopoly (few sellers of goods)
c) Monopolistic competition (many sellers with highly differentiated product) and,
d) Monopsony (only one buyer of a product)
Monopoly Market:
Monopoly refers to a market structure in which there is a single producer or seller that has a
control on the entire market. This single seller deals in the products that have no close
substitutes and has a direct demand, supply, and prices of a product. Therefore, in
monopoly, there is no distinction between an
one organization constitutes the whole
industry.
A monopoly market is in equilibrium when it
produces that much amount of output which
yields maximum total profit. In this market
price of the product is determination at the
point of MR equal to MC and MC cut MR
from below.
Monopolistic competition:
Monopolistic competition refers to the market situation in which many producers produce
goods which are close substitutes of one
another. Two important distinguishing
features of monopolistic competition are: (a)
Product differentiation, and (b) Existence of
many firms supplying the market.
Under monopolistic competition, the firm will
be in equilibrium position when marginal
revenue is equal to marginal cost. So long the

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marginal revenue is greater than marginal cost, the seller will find it profitable to expand
his output, and if the MR is less than MC, it is obvious he will reduce his output where the
MR is equal to MC. In short run, therefore, the firm will be in equilibrium when it is
maximizing profits, i.e., when MR = MC.
Oligopoly Market:
Oligopoly is that market situation in which the number of firms is small but each firm in
the industry takes into consideration the reaction of the rival firms in the formulation of
price policy. The number of firms in the industry may be two or more than two but not
more than 20. Oligopoly differs from monopoly and monopolistic competition in this that
in monopoly, there is a single seller; in monopolistic competition, there is quite a larger
number of them; and in oligopoly, there are only a small number of sellers. The
oligopolistic industries are classified in a number of ways:
(a) Duopoly: If there are two giant firms in an industry it is called duopoly. Duopoly is
further classified as below:
i. Perfect or Pure Duopoly: If the duopolists in an industry are producing
identical products it is called perfect or pure duopoly.
ii. Imperfect or Impure Duopoly: If the duopolists in an industry are producing
differentiated products it is called imperfect or impure duopoly.
(b) Oligopoly: If there are more than two firms
in an industry and each firm takes
consideration the reactions of the rival firms
in formulating its own price policy it is called
oligopoly. Oligopoly is further classified as
below:
i. Perfect or Pure Oligopoly: If the
oligopolists in an industry are
producing identical products it is
called perfect or pure oligopoly.
ii. Imperfect or Impure Oligopoly: If the oligopolists in an industry are
producing differentiated products it is called imperfect or impure oligopoly.

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Price determination under oligopoly:
(a) If an industry is composed of few firms each selling identical or homogenous products
and having powerful influence on the total market, the price and output policy of each
is likely to affect the other appreciably, therefore they will try to promote collusion.
(b) In case there is product differentiation, an oligopolist can raise or lower his price
without any fear of losing customers or of immediate reactions from his rivals.
However, keen rivalry among them may create condition of monopolistic competition.
Monopsony Market:
It is a market structure where only one buyer interacts with many sellers of a particular
product. A monopsony is a market condition similar to a monopoly except that a large
buyer, not a seller, controls a large proportion
of the market and drives prices down. It is the
case of a single buyer who is not in
competition with any other buyers for the
output which he seeks to purchase, and as a
situation in which entry into the market by
other buyers is impossible.
The analysis of monopsony pricing is similar
to that under monopoly pricing. Just as a
monopolist is able to influence the price of the product by the amount he offers for sale,
similarly the monopolist is able to influence the supply price of his purchases by the
amount he buys.
Source:
 https://www.investopedia.com/articles/personal-finance/101014/10-characteristics-
successful-entrepreneurs.asp
 http://www.economicsdiscussion.net/price/price-and-output-determination-under-perfect-
competition/4092
 http://www.economicsdiscussion.net/price/price-determination-under-imperfect-
competition-explain-with-diagram/1735
 https://www.cengage.com/economics/tomlinson/lecture/8435.pdf
 https://sites.google.com/site/maeconomicsku/home/monopolistic-competition
 http://economicsconcepts.com/price_and_output_determination_under_oligopoly.htm
 https://sites.google.com/site/maeconomicsku/home/oligopoly

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Q. 2. Describe the demand function and elasticity of demand. How does a producer forecast
demand his products to sell in the market?
Answer:
Demand refers to the quantity of a commodity or a service that people are willing to buy at
a certain price during a certain time interval. It can be termed as a desire with the
„willingness‟ and „ability‟ to pay for a commodity. All other things remaining unchanged,
the quantity demanded of a good increase when its price decreases and vice versa.
Demand function is an algebraic expression that shows the functional relationship between
the demand for a commodity and its various determinants affecting it. This includes income
and price along with other determining factors.
The demand function relates price and quantity. It tells how many units of a good will be
purchased at different prices. In general, at higher prices, less will be purchased. Thus, the
graphical representation of the demand function (often referred to as the demand curve) has
a negative slope.
Types of Demand Function
Based on whether the demand function is in relation to an individual consumer or to all
consumers in the market, the demand function cab be categorized as, Individual Demand
Function and Market Demand Function.
Individual Demand Function: It refers to the functional relationship between demand
made by an individual consumer and the factors affecting the individual demand. It shows
how demand made by an individual in the market is related to its determinants.
Mathematically, individual demand function can be expressed as,
Dx= f (Px, Pr, Y, T, F)
Where,
Dx= Demand for commodity x;
Px= Price of the given commodity x;
Pr= Price of related goods;
Y= Income of the individual consumer;
T= Tastes and preferences;
F= Expectation of change in price in the future.

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Market Demand Function: It refers to the functional relationship between market demand
and the factors affecting market demand. Market demand is affected by all the factors that
affect an individual demand. In addition to this, it is also affected by size and composition
of population, season and weather conditions, and distribution of income. Mathematically,
market demand function can be expressed as,
Dx= f (Px, Pr, Y, T, F, Po, S, D)
Where,
Dx= Demand for commodity x;
Px= Price of the given commodity x;
Pr= Price of related goods;
Y= Income of the individual consumer;
T= Tastes and preferences;
F= Expectation of change in price in the future;
Po= Size and composition of population;
S= Season and weather;
D= Distribution of income.
Elasticity of Demand:
Elasticity of demand is the degree to which demand for a good or service varies with its
price. Normally, sales increase with drop in prices and decrease with rise in prices. It refers
to how sensitive the demand for a good is to changes in other economic variables, such as
the prices and consumer income. Demand elasticity is
calculated by taking the percent change in quantity of
a good demanded and dividing it by a percent change
in another economic variable. Higher demand
elasticity for a particular economic variable means
that consumers are more responsive to changes in this
variable, such as price or income.
Types of elasticity of demand:
1. Perfectly Elastic Demand: When a small change in price of a product causes a major
change in its demand, it is said to be perfectly elastic demand. In perfectly elastic

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demand, a small rise in price results in fall in demand to zero, while a small fall in price
causes increase in demand to infinity. Here, the demand is perfectly elastic or ep = ∞.
2. Perfectly Inelastic Demand: A perfectly inelastic demand is one when there is no
change produced in the demand of a product
with change in its price. The numerical value
for perfectly inelastic demand is zero (ep=0).
3. Relatively Elastic Demand: Relatively elastic
demand refers to the demand when the
proportionate change produced in demand is
greater than the proportionate change in price
of a product. The numerical value of relatively
elastic demand ranges between one to infinity.
Mathematically, relatively elastic demand is known as more than unit elastic demand
(ep>1). For example, if the price of a product increases by 20% and the demand of the
product decreases by 25%, then the demand would be relatively elastic.
4. Relatively Inelastic Demand: Relatively inelastic demand is one when the percentage
change produced in demand is less than the percentage change in the price of a product.
For example, if the price of a product increases by 30% and the demand for the product
decreases only by 10%, then the demand would be called relatively inelastic. The
numerical value of relatively elastic demand ranges between zero to one (ep<1).
5. Unitary Elastic Demand: When the proportionate change in demand produces the
same change in the price of the product, the demand is referred as unitary elastic
demand. The numerical value for unitary elastic demand is equal to one (ep=1).
Factors Affecting the Elasticity of Demand of a Commodity
1. Nature of commodity: Elasticity of demand of a commodity is influenced by its nature.
A commodity for a person may be a necessity, a comfort or a luxury. i. When a
commodity is a necessity like food grains, vegetables, medicines, etc., its demand is
generally inelastic as it is required for human survival and its demand does not fluctuate
much with change in price. ii. When a commodity is a comfort like fan, refrigerator, etc.,
its demand is generally elastic as consumer can postpone its consumption. iii. When a
commodity is a luxury like AC, DVD player, etc., its demand is generally more elastic

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as compared to demand for comforts. iv. The term „luxury‟ is a relative term as any item
(like AC), may be a luxury for a poor person but a necessity for a rich person.
2. Availability of substitutes: Demand for a commodity with large number of substitutes
will be more elastic. The reason is that even a small rise in its prices will induce the
buyers to go for its substitutes. For example, a rise in the price of Pepsi encourages
buyers to buy Coke and vice-versa. Thus, availability of close substitutes makes the
demand sensitive to change in the prices. On the other hand, commodities with few or
no substitutes like wheat and salt have less price elasticity of demand.
3. Income Level: Elasticity of demand for any commodity is generally less for higher
income level groups in comparison to people with low incomes. It happens because rich
people are not influenced much by changes in the price of goods. But, poor people are
highly affected by increase or decrease in the price of goods. As a result, demand for
lower income group is highly elastic.
4. Level of price: Level of price also affects the price elasticity of demand. Costly goods
like laptop, Plasma TV, etc. have highly elastic demand as their demand is very sensitive
to changes in their prices. However, demand for inexpensive goods like needle, match
box, etc. is inelastic as change in prices of such goods do not change their demand by a
considerable amount.
5. Postponement of Consumption: Commodities like biscuits, soft drinks, etc. whose
demand is not urgent, have highly elastic demand as their consumption can be postponed
in case of an increase in their prices. However, commodities with urgent demand like
life saving drugs, have inelastic demand because of their immediate requirement.
6. Number of Uses: If the commodity under consideration has several uses, then its
demand will be elastic. When price of such a commodity increases, then it is generally
put to only more urgent uses and, as a result, its demand falls. When the prices fall, then
it is used for satisfying even less urgent needs and demand rises. For example, electricity
is a multiple-use commodity. Fall in its price will result in substantial increase in its
demand, particularly in those uses (like AC, Heat convector, etc.), where it was not
employed formerly due to its high price. On the other hand, a commodity with no or few
alternative uses has less elastic demand.

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7. Share in Total Expenditure: Proportion of consumer‟s income that is spent on a
particular commodity also influences the elasticity of demand for it. Greater the
proportion of income spent on the commodity, more is the elasticity of demand for it and
vice-versa. Demand for goods like salt, needle, soap, match box, etc. tends to be
inelastic as consumers spend a small proportion of their income on such goods. When
prices of such goods change, consumers continue to purchase almost the same quantity
of these goods. However, if the proportion of income spent on a commodity is large,
then demand for such a commodity will be elastic.
8. Time Period: Price elasticity of demand is always related to a period of time. It can be a
day, a week, a month, a year or a period of several years. Elasticity of demand varies
directly with the time period. Demand is generally inelastic in the short period. It
happens because consumers find it difficult to change their habits, in the short period, in
order to respond to a change in the price of the given commodity. However, demand is
more elastic in long run as it is comparatively easier to shift to other substitutes, if the
price of the given commodity rises.
9. Habits: Commodities, which have become habitual necessities for the consumers, have
less elastic demand. It happens because such a commodity becomes a necessity for the
consumer and he continues to purchase it even if its price rises. Alcohol, tobacco,
cigarettes, etc. are some examples of habit forming commodities.
Methods of forecasting demand of the products:
Demand Forecasting is a systematic and scientific estimation of future demand for a
product. Simply, estimating the sales proceeds or demand for a product in the future is
called as demand forecasting. The following points highlight the top seven methods of
demand forecasting. They are:
1. Survey of Buyer’s Intentions: This is direct method of estimating demand of customers
as to what they intend to buy for the forthcoming time—usually a year. By this the
burden of forecasting goes to the buyer. This method is useful for the producers who
produce goods in bulk. Still their estimates should not entirely depend upon it. This
method does not hold good for household consumers because of their inability to foresee
their choice when they see the alternatives. Besides the household consumers there are

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many which make this method costly and impracticable. It does not expose and measure
the variables under management control.
2. Collective Opinion or Sales Force Composite Method: Under this method, the
salesmen are nearest persons to the customers and are able to judge, their minds and
market. They better understand the reactions of the customers to the firms products and
their sales trends. The estimates of the different salesmen are collected and estimates
sales are predicted. These estimates are revised from time to time with changes in sales
price, product, designs, and publicity programs, expected changes in competition,
purchasing power, income distribu-tion, employment and population.
3. Trend Projection: In this method a trend line can be filled through the series in visual
or statistical way by the method of least squares. The analyst can make a plausible
algebraic relation—may it be linear, a quadratic or logarithmic between sales on one
hand and independent variable time on the other. The trend line is then projected into the
future for purpose of extrapolation. This time series is expressed by the equation:
O = TSCI, where, O = observed data, T = a secular tend, S = a seasonal factor,
C = cyclical element, I = an irregular movement.
4. Executive Judgment Method: Under this method opinions are sought from the
executives of different discipline i.e., marketing, finance, production etc. and estimates
for future demands are made. Thus, this is a process of combining, averaging or
evaluating in some other way the opinions and views of the top executives. The forecasts
can be made speedily by analyzing the opinions and views of top executives. The
technique is quite easy and simple.
5. Economic Indicators: This method has its base for demand forecasting on few
economic indicators.
(a) Construction contracts: For demand towards building materials sanctioned for Cement.
(b) Personal Income: Towards demand of consumer goods.
(c) Agricultural Income: Towards demand of agricultural imports instruments, fertilizers,
manner etc.
(d) Automobiles Registration: Towards demand of car parts and petrol.

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6. Controlled Experiments: Under this method, an effort is made to ascertain separately
certain determinants of demand which can be maintained, e.g., price, advertising etc. and
conducting the experiment, assuming etc., and conducting the experiment, assuming that
the other factors remain constant. Thus, the effect of demand determinants like price,
advertisement packing etc., on sales can be assessed by either varying them over
different markets or by varying them over different time periods in the same market.
7. Expert’s Opinions: Under this method expert‟s opinions are sought from specialists in
the field, outside the organizations or the organization collects opinions from such
specialists; views of expert‟s published in the newspaper and journals for the trade,
wholesalers and distributors for the company‟s products, agencies and professional
experts. These opinions and views are analyzed and deductions are made therefrom to
arrive at the figure of demand forecasts.
Demand forecasting methods can be summarized as:
Source:
 https://www.businesstopia.net/economics/macro/concept-demand-function-types
 https://www.slideshare.net/Mayu015/ppt-micro-economics
 http://www.economicsdiscussion.net/elasticity-of-demand/5-types-of-price-elasticity-of-
demand-explained/3509
 http://www.yourarticlelibrary.com/economics/9-major-factors-which-affects-the-
elasticity-of-demand-of-a-commodity-economics/8946
 http://www.economicsdiscussion.net/demand-forecasting/methods-demand-
forecasting/top-7-methods-of-demand-forecasting-managerial-economics/13493
Source: https://businessjargons.com/methods-of-demand-forecasting.html

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Q.3. Describe the uncertainty, and explain the types of precautions are taken by a farmer to
adjust his production and resource use to meet uncertainty.
Answer:
Uncertainty has been called "an unintelligible expression without a straightforward
description" It is the lack of certainty, a state of limited knowledge where it is impossible to
exactly describe the existing state, a future outcome, or more than one possible outcome. It
is the situation where the current state of knowledge is such that (i) the order or nature of
things is unknown, (ii) the consequences, extent, or magnitude of circumstances,
conditions, or events is unpredictable, and (iii) credible probabilities to possible outcomes
cannot be assigned.
Uncertainty connotes in everyday language in three different directions, relating to the
external world, to knowledge, and to the mind, respectively. A common usage of
“uncertainty” and “uncertain” is the one that relates to our mind and our emotions,
intentions and actions. Hence, we may say that we are uncertain about what to do or feel
insecure in English, but also unsure, perhaps bordering to feeling anxious, afraid or
helpless.
Different types of precautions can be taken by a farmer to adjust his production and
resource use to meet uncertainty. The following points highlight the measures to be
adopted by farmers to deal with uncertainty in a farm enterprise. The measures are:
1. Diversification: Diversification means that the farmer carries on several farm
enterprises simultaneously in order to avoid the dangers of having all his eggs in one
basket. This implies that even in a situation where transformation ratio and price-ratio
expectations clearly dictate specialization in a single product, the farmer, as a
precaution against uncertainty, does not do so and instead, diversifies his production by
producing several products. By such diversification, the farmer hopes to reduce the
variation in his aggregate income because, generally, yield and prices of all products do
not vary in the same direction simultaneously. If the return from one product is low, the
return from another product might be high enough to compensate for the loss.
2. Flexibility: As an alternative or supplement to diversification, the farmer may use the
technique of flexibility for minimizing the impact of uncertainty on his earnings.

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Flexibility means that the farming system is so arranged that farmer can without much
cost, move out from one enterprise into another if economic conditions make this shift
desirable. With flexible techniques, it should be possible for the farmer to switch over
resources, say from beef enterprise to milk enterprise. Flexibility, as heady says, is the
avoidance of rigid production methods‟. And in case of a multi-product enterprise, it
also means avoidance of a rigid production pattern.
3. Liquidity: Apart from compromises in the designs of farm buildings and equipment,
flexibility may require that the farmer holds a greater proportion of his assets in liquid
from that he would if he did not care for flexibility. With liquid resources the farmer
can take advantage of passing favorable opportunity such as highly remunerative price
rise by purchasing additional resources. Another advantage of liquidity is the ability it
provides to the farmer to face unforeseen contingencies such as continued crop failure
and market slumps. The farmer who has liquid reserves can withstand such
contingencies better than his neighbor with less liquid resources.
4. Capital Rationing: It is a general term which means a restricted flow of capital to an
enterprise even when the return to it is quite high. This condition is characteristic of
agriculture in a large number of countries. It has often been observed that while the
marginal return to labour in agriculture is below that in the rest of the economy, the
marginal return to capital is higher so that a more efficient allocation of resources
would be achieved if labour were to move out of agriculture and capital to move in
until the marginal product of each factor become equal in each sector of the economy.
5. Contract Farming: It involves contractual agreements in money terms between the
farmer, manufacturing firms and input suppliers. Such agreements guarantee the farmer
a certain price for a given grade of a product at given time. By this agreement, the
farmer not only can mitigate the inherent price and income uncertainties of the
traditional marketing system but also establishes useful links with manufacturing firms
and input suppliers.
6. Choice of Reliable Enterprise: Farmers know that yield from certain enterprises is
more stable than from others. For example, yield variation of pigs and poultry, is

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generally thought to be less than that of sheep and beef cattle. Again cereal yield is
generally less variable than the yield from root crops.
7. Adoption of Innovative Techniques: Again uncertainty is avoided by the farmer by
continuing to stick to the traditional crops rather than the crops involving new
innovations even if these may be more remunerative. Innovations in the activities
involving biological element have more uncertainty around than and are consequently
slow to be adopted. In fact, one will not be wrong if one says that keenness to avoid
uncertainty is one reason for the slow rate of technological progress in agriculture as
compared with that in industry.
8. Discounting for Risk: This implies that the farmer produces less than the optimum
output level on average in order to reduce losses in unfavorable seasons. Smaller
production will reduce the losses if the situation turns out to be unfavorable. However,
this may not be considered to be a suitable method of meeting uncertainty. Arguments
against this method are the same as those advanced against capital rationing.
9. Maintaining Reserves: This is another form of flexibility. Maintenance of extra
multipurpose equipment and labour force larger than what is normally necessary, to
meet some types of uncertainty e.g., floods, etc., may be helpful. Maintenance of food
reserves may also be helpful at times.
10. Guaranteed Agricultural Prices: This measure involves enactment of legislation
giving the farmer more or less precise guarantees of the price level or the minimum
price he may expect some time ahead. These prices generally lie within certain fixed
percentages of the, „parity prices‟ i.e., the prices ensuring some sort of harmony with
the prices of the industrial products; and their actual level varies with the estimated in
the coming year.
11. Buffer Stock Scheme: Like the guaranteed price scheme, the Buffer stock scheme is
also aimed (generally) at removing price uncertainty. In this method, the buffer stock
authority (which is ordinarily government agency) purchase stocks of agricultural
commodities in years of bumper crops and unloads them into the market in years of
crop shortages with a view to raising price in times of glut and lowering them in times
of scarcity. An essential condition for the smooth and efficient functioning of the buffer

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stock scheme is that the buffer stock authority most be able to maintain a balance
between its purchases and sales over a period. This would largely depend on the levels
of ceiling and floor prices at which the buffer stock authority starts releasing and
purchasing stock respectively.
12. Crop Insurance: By means of crop insurance, the farmer can insure himself against
certain chance occurrences such as loss due to poor weather, insect infestations and
disease. The farmer insures a small known cost, the insurance premium, and there by
transfer the risk of much larger losses to the crop insurance agency.
Source:
 https://en.wikipedia.org/wiki/Uncertainty
 http://www.economicsdiscussion.net/india/farming/top-12-measures-to-deal-with-
uncertainty-farm-enterprise/21429
 https://www.etikkom.no/globalassets/documents/publikasjoner-som-pdf/risk-and-
uncertainty-2009.pdf
Q.4. What is elasticity of production? How is it measured? What does a production function
indicate with Ep=1, less than 1, and more than 1?
Answer:
The elasticity of production, also called output elasticity, is the percentage change in the
production of a good by a firm, divided the percentage change in an input used for the
production of that good, for example, labor or capital. The elasticity of production shows
the responsiveness of the output when there is a change in one input. It is defined as the
proportional change in the product, divided the proportional change in the quantity of an
input. Mathematically it is expressed as, Ep = ΔP/P ÷ ΔI/I
Ep = Since % is common,
Ep = ÷ or, X/Y * ∆Y/∆X
Where Ep = Elasticity of Production
Y = Output and X = Input
Expressed in another way: By definition, Y/X = AP, and ∆Y/∆X = MP, then Ep = MP/AP
%∆ in Output (Y)
%∆ in Input (X)
∆Y
∆X
Y
X

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For example, if a factory employs 10 people, and produces 100 chairs per day. If the
number of people employed in the factory increases to 12, that is, a 20% increase, and the
number of chairs produced per day increases to 110 (that is, a 10% increase), the elasticity
of production: Ep = ΔQ/Q ÷ ΔL/L = 10/100 ÷ 2/10 = 0.1 ÷ 0.2 = 0.5
If the production function contains only one input, the elasticity of production measures the
degree of returns to scale. In this case, if the elasticity of production is 1, the production has
constant return to scale, at that point. If the elasticity of production is greater than one, the
production has increasing returns to scale at that point. If the elasticity of production is less
than one, the production has decreasing returns to scale at that point.
In simple words, production function refers to the functional relationship between the
quantity of a good produced (output) and factors of production (inputs). The production
function is purely a technical relation which connects factor inputs and output.
Production function means the functional relationship between inputs and outputs in the
process of production. It is a technical relation which connects factors inputs used in the
production function and the level of outputs. Mathematical representation of the production
relationship is as: Q = f (K, L, La) where Output (Q) is dependent upon the amount of
Capital (K), Land (L) and Labour (La) used.
Three Stages of Production Function:
Stage I: In this stage AP is increasing so MP>AP. All the product curves are increasing.
Stage I stops where AP reaches its
maximum at point X. MP peaks and then
declines at point Y and beyond, so the
law of diminishing returns begins to
manifest at this stage.
Stage II: It starts where the AP of the
input begins to decline. TP still continues
to increase, although at a decreasing rate,
and in fact reaches a maximum. MP is continuously declining and reaches zero at point N2,
as additional labor inputs are employed.
XY

18
Semester
Stage III: It starts where the MP has turned negative. In this stage all product curves are
decreasing and total output starts falling even as the input is increased.
Elasticity of production (Ep) is greater than 1 is stage I, but greater than 0 is stage II, and
negative in stage III of the production function.
Source:
 https://www.econowiki.com/en/elasticity-of-production
 https://www.slideshare.net/TejKiran2/production-function-31851979
 http://www.economicsdiscussion.net/production-function/production-function-meaning-
definitions-and-features/6892
Q.5. If 10% of rice crop was destroyed by a blast disease attack, and subsequently, 20% of the
remainder by a spell of drought disaster. A farmer harvested the yield was found to be 2000
quintals. What yield would have been obtained had there been no disaster (disease attack
and drought)?
Answer:
Given,
Rice crop destroy by a blast = 10%
Again crop losses by drought = 20%
Harvested yield after disaster = 2000 quintals
Suppose if no disaster farmer could be able to harvest = X quintals
Since crop destroy by a blast = X * 10% = 0.1X quintals
After blast destroyed crop remains = X - 0.1X = 0.9X quintals
Again crop loss by drought = 0.9X * 20% = 0.18X quintals
Final crop harvested after drought = 0.9X - 0.18X = 0.72X
From the situation given above we can write an equation as,
0.72X quintals = 2000 quintals
or, X = 2000/0.72 quintals
Therefore, X = 2777.78 quintals
If no disaster farmer can obtained about 2777.78 quintals of rice

19
Semester
GROUP B: WRITE SHORT NOTE ON:
a. Economic models:
Answer:
In economics, a model is a theoretical construct representing economic processes by a set
of variables and a set of logical and/or quantitative relationships between them. The
economic model is a simplified, often mathematical, framework designed to illustrate
complex processes. An economic model is a mathematical or logical statement of
economic theory. It is a method of analysis which presents an over-simplification of the
real world. Economic Models can set up with diagrams, words, equation form, etc.
Types of Economic Models
 Physical Models: These are sculptures, photographs or visual representation of
certain aspects of a system.
 Analog Models: These models are one set of properties represent the other set
which the system under study possesses.
 Symbolic Models: In these models the inter-relationships are expressed through
mathematical symbols.
Types of Symbolic Models
 Quantitative Models: These are based on statistical data. e.g. Binomial, Poisson
and Normal Distribution.
 Allocation Models: These are used for finding a solution for optimizing a given
objective. e.g. Linear Programming, Break-Even Analysis, etc.
 Scheduling Models: These are used for determining an optimum sequence for
performing certain operations. e.g. PERT, CPM, etc.
 Waiting Line Models: These represent the random arrival of customers at any
point of service. e.g. Big Mart, Fresh House, Subhiksha, etc.
 Simulation Models: These are of two types one is Monte Carlo Technique and
another is Systems Simulations. Monte Carlo Technique uses Random numbers;
Whereas Systems Simulations uses Historical numbers.
 Inventory Models: These models help in optimizing inventory levels. e.g.
E.O.Q., ABC Analysis.
Source:
 https://www.slideshare.net/nileshshouche1/economic-model-2?from_action=save
 https://en.wikipedia.org/wiki/Economic_model

20
Semester
b. Prime cost and supplement cost:
Answer:
Prime cost refers to a manufactured product's costs, which are calculated to ensure the
best profit margin for a company. The prime cost calculates the use of raw materials and
direct labor. Prime cost is the direct cost of manufacturing an item for sale. Businesses
use prime cost as a way of measuring the total cost of the production inputs needed to
create a given output. By analyzing its prime costs, a company can determine how much
it must charge for its finished product in order to make a profit. By lowering its prime
costs, a company can increase its profit and/or undercut its competitors' prices.
A prime cost is an expenditure that directly relates to the production of finished goods. In
other words, these expenses are directly incurred to create finished goods. Prime costs
consist of direct materials and direct labor. Direct materials include all tangible
components of a product. For example, direct materials include raw materials, supplies,
and any other component that becomes part of the finished product. A rim would be
considered a direct material in a bicycle. Direct labor includes the wages paid to
employees who produce finished products. These employees can be welders, machinists,
painters, or any other person who directly contributes to the production of a product.
Supplementary cost is the general cost of an undertaking as a whole including
administration, interest, taxes, general maintenance, depreciation, and obsolescence -
distinguished from prime cost. Supplementary cost is also called fixed cost.
The distinction between prime costs (variable costs) and supplementary costs (fixed
costs) is, however, not always significant. In fact, the difference between supplementary
and prime costs is meaningful and relevant only in the short period. In the long run, all
costs are prime because all factors of production become adjustable in the long run. In the
short period, only those costs are prime which are incurred on the factors which are
adjustable in the short period.
In the short run, however, the distinction between prime and supplementary costs is very
significant because it influences the average cost behavior of the product of the firm.
Thus, it has a significant bearing on the theory of firm. In specific terms, the significance
of making this distinction between fixed and variable costs is that in the short period a

21
Semester
firm must cover at least its variable or prime costs if it is to continue in production. Even
if a firm is closed down, it will have to incur fixed or supplementary costs. The firm will
suffer no great loss in continuing production, if it can cover at least its variable costs
under the prevailing price.
Source:
 https://www.investopedia.com/terms/p/prime-cost.asp
 https://www.myaccountingcourse.com/accounting-dictionary/prime-costs
 https://www.slideshare.net/SunilSingh23/cost-of-production-1-
16760228?from_action=save
c. Support price:
Answer:
In economics, a price support may be either a subsidy or a price control, both with the
intended effect of keeping the market price of a good higher than the competitive
equilibrium level. In the case of a price control, a price support is the minimum legal
price a seller may charge, typically placed above equilibrium. It is the support of certain
price levels at or above market values by the government.
A price support scheme can also be an agreement set in order by the government, where
the government agrees to purchase the surplus of at a minimum price. For example, if a
price floor were set in place for agricultural wheat commodities, the government would
be forced to purchase the resulting surplus from the wheat farmers (thereby subsidizing
the farmers) and store or otherwise dispose of it. It is an artificial (non free-market)
minimum-price supported by a government to protect vulnerable but crucial producers
(such as farmers) from wild fluctuations in the commodity prices.
Price supports especially for non-perishable commodity have been practiced by almost all
the responsible government. This programme helps to maintain the price at the levels
generally accepted by the producers. As price support for perishable commodity such as
eggs, vegetables etc have been very expensive over time. A rational government has to be
very cautious during formulating and adoption of a particular price stabilizing
programme. However minimum supports programme that help keep the purchasing
power more or less constant and necessary for encouraging the production.

22
Semester
Price supports are similar to price floors in that, when binding, they cause a market to
maintain a price above that which would exist in free-market equilibrium. Unlike price
floors, however, price supports don‟t operate by simply mandating a minimum price.
Instead, a government implements a price support by telling producers in an industry that
it will buy output from them at a specified price that is higher than the free-market
equilibrium price.
In a free market without any price support, the market equilibrium price would be P*, the
market quantity sold would be Q*, and all of the output would be purchased by regular
consumers. If a price support is put in place- let‟s, for example, say that the government
agrees to purchase output at price P*PS- the market price would be P*PS, the quantity
produced (and equilibrium quantity sold) would be Q*PS, and the amount purchased by
regular consumers would be QD. This means, of course, that the government purchases
the surplus, which quantitatively is the amount Q*PS-QD.
The amount that the government spends on the price support is equal to the size of the
surplus (Q*PS-QD) times the agreed-upon price of the output (P*PS), so expenditure can be
represented as the area of a rectangle with width Q*PS-QD and height P*PS. Overall, the
total surplus generated by the market (i.e. the total amount of value created for society)
decreases from A+B+C+D+E to A+B+C-F-H-I when the price support is put in place,
meaning that the price support generates a deadweight loss of D+E+F+H+I.
Source:
 https://en.wikipedia.org/wiki/Price_support
 https://www.thoughtco.com/introduction-to-price-supports-4082777

23
Semester
d. Paradigm:
Answer:
Paradigm is the way we perceive, understand and interpret the world. A paradigm is like
a map in our head. We assume that the way we “see” things is the way they really are or
the way they should be. A paradigm shift is a way of looking at something differently.
We are stepping “outside the box”. When we make a paradigm shift we can see, think,
feel and behave differently. Example: Ptolemy thought the earth was the center of the
universe. Copernicus believed the sun was the center of the universe. (a paradigm shift
occurred).
A paradigm is a self-consistent set of ideas and beliefs which acts as a filter, influencing
how we perceive and make sense of the world. The term was first used by Thomas Kuhn
in “the structure of scientific revolutions” (1962) to describe the the impact of change
within the ruling theory of science when fundamental assumptions changed. Kuhn argued
that the history of science is not a linear and continuous assimilation of facts but rather a
number of revolutions in which new paradigms or new ways of seeing the world, entirely
replace the old.
A paradigm is a constellation of concepts, values, perceptions and practices shared by a
community, which forms a particular vision of reality that is the basis of the way a
community organizes itself. (Fritjof Capra 1997:6).
A paradigm at the heart of a culture can influence perception and meaning: if we believe
that there is a culture of entitlement, we will hear and remember words that support that
frame. In addition, the prevailing paradigm encourages certain types of behavior. If
everyone believes there is a blame culture, it is likely that people will behave in blaming
ways. In this way, the paradigm becomes a self-fulfilling prophecy, a sort of filter which
helps make life manageable and gives us a sense of stability in a changing world.
Source:
 https://www.slideshare.net/tagcblog/what-is-a-paradigm-ppt-presentation
 https://storytelling.co.za/paradigms-and-change/

Applied Agribusiness Economics - Questions & Answers, 2nd Semester

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