ヽ

‐‐由‐ ‐菫‐‐■_■ ■■■_■ 口■■‐■ ｀

/・ 「 T甲 ・・ ￨・
・
17・ 、
■

￨ ￨
￨ ￨
￨ ￨
￨ ￨
￨ ￨
￨ ￨
￨ ￨
日 ￨
￨ ￨
￨
￨
UNIVERSITY OF CALiCU丁 ￨
￨

￨ ￨
￨ SC=00LOF plsTANCEEbucATION ￨
￨
￨
￨ ￨
￨ ￨
￨
STUDY MATER:ALS ￨
￨ ￨
￨ ￨
￨ ￨
￨ ￨
￨ ￨
￨
￨
￨
M.A.ECONOMICs ￨
￨
￨

￨ ￨
(PreViOus) ￨
￨
￨ ￨
￨ ￨
￨ 2000 AdmissiOn onwards ￨
￨:
￨
蝙 ￨
￨
￨

￨
￨ 目
、
．¨

￨ ￨
  ︼︲

￨ ￨
￨
口∩りＯη製蟄望ヽむ卜飩つ０

￨
￨ ￨
目 Paper I ￨
￨ ￨
￨ ￨
￨
icro Economic Theory ￨
￨
￨
:
￨ ￨ ͡

■ ￨
｀し●
甲 ‐ り■ 璽 ‐ 暉 ■ 軍 璽 口 ■ ■ ‐ ■ ■ ■ ■ ■ ■ ■ ■ ■ ‐ど L聖 巴 ど ′
==“
 2

MODJi,J;I}''1..

CONCEPTUAL BASIS

GENERAL METHODOLOGY OF ECONOMIC ANALYSIS

The tool kit of cconomic
N{ethodology ref'ers to scientillc approach to study a problem'
aualysis has rrndergone a intlrked change, becarise it is essential
to acquire a sense o1' how
economic analysis becomes adiusted to the changing problems
of our times and the naturc of
o1'techniclttes' Economics
atlalysis is inf'luenced by the growth of information antl improvement
The Lrse of
is a scientific stutly and its-s1ant is obviottsly on logic and scientilic methods' the
llnalysis. For example'
mathemtrtics has become indispensabte in the tool box of econornic
techniques like Linear Programnring, lnput output analysis,
came Theory iind ruodel building
etc. al'e based on mathematical calcttlations'
approtrches, stiitiu, dyrtamic
The diff'ererlt methods of economic anlll,sis iuclude mic[i,t-mzrcro
and compitriitive static ?rnalysis, decluctive antl inductive methods
atttl p0sitiVe rttttl norntative
explorative, cxperittle nttrl,
appr.oaclies. Apart fi.orn these, the mode of researclr tnay be descriptive,
evAlnzttive,,."diagnostii: and prognostic.'Ihe apptoticlt is descriptive
il'ctripltrtsis is lard on
classitjcation anil ryririysis; lvniic the diagnostic approach ettdeavors
lo see ihc causc ol the
pt'oblem'
probierl, the prognostii approac| tries to predict tlto cgttrse' o1'the

GENERAL AND SPECIAL METHODOLOGY

collccpttltilisation
General methodology is conccrnetl with relations betwecu obscrvation,
of procedure in special lields
and judgernent. But ,pe"iat methoclology is concerned with rules
tor special methods' Itt
of'e^quiry; differelces between various lields, special sitttations calling
Formal logic is
both of these cases we can i<tentify the use o1 lormal logic or indtrctive logi:.
pure logic which is known as deductive or analytical logic.. But inductive
logic is pclpuiarly
ftlrmer is concerned witlt
knorvn as applied logic or ernpirical logic or even material logic' The
valid i,ferrir"., base,l on st;dy of objective relations betweetl pr:opositions,
ol deals rvith
valid ge neralisations
i'rpliczrtio,s or even a priori. on the other hand the iatter is concerned with
iurd dells with llltilef ialtl'utlt
based on study of r,veiglts ol evidence to tesl irnpressions, opinions
and probabilitY.

LOGY AND GRAPHY

-graphl' rllcill)s
A-logy is difl'erenr li.orrr a -glaphy. A.-lrr!}/ is a thcot'clieul s1'sttrtti $'ltiic a
is that studies lit'e'
clrrrr.ving or writilg. There irre biology and biography; the lornter
the sc:ience

the lirtter is a desc:ription ol person's life. There ?rre ethnology and

ethnograph! I the former is the
sciencethat stlldies races customs and habits. In all such cotnbinzrtions
rvith particular obiects,
the logies are systems ol theories anil the graphies are ilescriptions.
If rnethodology is the scieuqe
tltit siudies the principles of validation rind reicction of scientilic propositions: and ir a word
should be needed for itre tlescription of a method or methods employed
in a ptrrticular research
project, that word could possibly be nlethodology'

ROLE AND SIGNIFICANCE OF ASSUMPTIONS

postr"rlatcs is a
Atter selecting a probler-n for analysis specificzition of the assumptions or
r'vhrjse existence
very important step, Assumptions i[rply a condition or i] state o1 an organistu
can o1ly be <Jeducted lrom observable pheno[lel1on, rather thirtr by direct observatioll.

Assumptiprls serve several purposes in scientific irnalysis. They determinc the scope
and

dimensions of the study ancl also specily the f aclors.to be taken.as corlstiurt.
They arc cssentially
. Lrse as t!-re pr.elrise on which hypotheses zrre built. The assumptions
whicir at'e generally made in
,economic studies n-ray bc bioadly classif ied as under'
 _l

I' Resource and Techttological assumptions: Assumptions ol tl.is category pertain to (a) rhe
sttpply beliavior of tlte inputs (b) Le lationship betwecn the inputs; and (c) relarionship bcrween
input anri output.
2. Instittitional Assurnptions: Thcse assuurptions pertain to (a) the niitlrrc of socio-econornic
slstem; and (b) natut't' ttl'competition in the market, i.e. whether perfecl compctitiorl,
monopoly or itny othcr. kind o1'uttu.kct s^tr.ucture .

3' Mtltivatitlnal Assuttrptitllts: Assuntllrions rc-uarding thc mol.ivcs behind [hc ccttr.ronric activitics
conslittltc motivationiti itsstttlptions. 'fhese ?irc mostl), nraximisatiol ur ntininrisati.n
ol'
some econornic r;ariable s rtr objectivc l,unction.
Assutnptions are mostlv unlealistic in the sense that they may not be statisticztlll,
r,eriliable.
But making assulllptiot'ts, be they appear: to be unrealistic, is indispensiblc in de<iuctive
approach.
For, tut economic systenr is an extremely complex rnechanisrn and a meaninglul
ecolonic
generalisation is not possible uttless the phenorlenon selected for
stlrdy is re rlucetl to a meaningl,ul
size. The pllrpose is served bv assun-riug awily the firctors, causing compiic:ations.

VALUE JUDGEMENTS AND IDEOLOGY

It sltould be noled tltitl noririitrtive cconorlics involves value .ir-rdgerlents or ',vhat simpiy
known as values. 81'r'aitrc.jr-rclgetlcnts or values wc understand the conceptions
o1,the people
abo-ttt what is^ right tlr rvhitl. is n'ron-s. T'hese conceptiorls are based
on the ethical, pqlitical,
phiiosophical altd re ligioLrs bclicls ol'tltc people antl are nol based or1
ilny scicntil-ic logic ,r lar,r,.
Pro1" Robbirts opittcd that it is unscicntillc to includc the vaiue.iuclgcnrelts
in ttre ccrr.ro*ic
analysis' But lt.taltl' well'arc econornists tlo uol ail.est this vicw. As a lrattcr
ol'fact 11dnlr yi11l
issues concerning ecottotttic welf'are alisin-q 1i'orn productive
eflicieucy irnd distributive.juslice
necessarily invr:lr,c value .j Lrdgculcrtts.

PROBLEM
Two distinct t)/pes of conl'usir)n iue 1requentiy rnet with respect to the lwin
cgncepts of
value Judgement and ideology: one is thc total reduction o1'vtrlue jutlgements
to ideology and
vice versa, that is, the beliel'that thcse two r:oncepts iue comple.tetl) ,1,irorryrr,,o,rs;
fhe second is
the conlusiott o1 the t'ilt'iotts meaning and inrplications of each concept
taken separately.
CONEPTIONAL VARIATION
According to Holna KatoLrsiatt value.judgenrcnts rc1'er to conscior.rs and piecerletrl
ob.jectivr:
nol]lls or sr-rbjcctive (moral) prcdilcctions (plelerences). For exarnple, that
io cra6icate povcr-ty
there should bc il tnorc cvcn tfistribuiion o1'iucolne; or that thelc shoull
be mure political f'r.e edtlrrr
enjtlyed b1'the public. on thc olhcr ltuncl, ideolorv ret'ers to an LrnconseitlLrs,
or scmicouscieus
and total rvorld vierv. Et'cn il'ideoit;g,v is assunred (as it is done by
sorne) to be a wholly c'nsci.us
btrt total vision. it coLrld not he I'educcrl - zrs concept - to a nrere value
.judgernent. It ruay be
argtted that valtre' jltclgemc-ttts are practir:al uranil'estations of total icleologrcal
co,rmitments:
Although men with difl'cre nt - allegcii or proltssed - ideolo-iries sometipres
share the same value
iudgements. But in any crtsc, it rloes not follow that these ior',..pt, can be reducetl to a sincle
czrtegory either lor analytical or lbr pracdcal purpose.

VALUE JUDGEMENTS IN SCIENCE

It is ttecessary to discard onc (implicit or explicit; clairn; nalnely that a scientist
rrs slrch,
does not beal any responsibilitl, Ibr his objectiv. itot...nts;
and that hc would be fi.ee to.jutige
their consequence only as iitt ordinary member ol tlie public. It is possible
for. any idet to be
eutirely valtte free evctt lltottgh it ntay have been forme<I by
dilect observation. There is no
lLndatnental clilt'erencc bcttvt'ctt Iratut'ilI and social sciences
in this regarii. It is both possible anri
desirable lbr screnli"^ts to bc t-"onsciousl\, honesl. Ethical neutrality
ir ,.. lrr,f m.r.r..
"i.rrirsi.rr,
 4

is itsclf a moral pOsition.

vALUE JUDGEMENTSIN E90NOMIC SC:ENO暉

Thc gencrtt c8ё haS bCe,Sttted and economic sciencc in no cxCoptiOn to it.All ccOnOmic
dua1 6conOmiζ ts ctt and sh6uld be
idё aslike all scientific ideas,aFe Vttue in■ pregnated,Indi宙
consciouζ lyhOnestinproppsing orasSessi,gttiV?ntheO五
es.No EcOnomistCtt be mor』 y ncutrd
to economic isste,for indiffcrence itSelf iS a moraljudgcmellt.

lDEOLOGY

菅賓脚 肌鶏 酬 器 鶴 棚 艇I磁瀧 鮮 l驚‖

轟器 eま

Ld」 mp許 山d∞ Ⅲお

H山 む
∝ rirl∬
l魁 思 霊
t留
胤FF'i雛
“ 壼 :ゝ

f淵 辮 Wぽ 邸 淵常
apllic江 10ns ttd Conclusions,At its most gcnc

奎辮 辮鰈朧1激
ri胤
ざ ry.

HiSTOR:CAL BACKGROUNo OFIDiEOLOGY

ふ 服 繋協 棚 盤 ユ :営 麟 篤 富 1忠 皇 fl」 T:鯖 春 織 illi篤 ::躙

St cnを わle us to SCrttch
and tllc word ofessence(rea■ ty).Thereforo Ompiricttkllowledge can ttbё
the surfκ e or reality.

Paradoxically tlle term ideo10gy was inventediat thc tllrn of thc 19 th ccnttlry to denote the

11譜 ‖
翼:鴨朧l賓累:ぼ酬 li鮪 羅 1織 点
識:ぶ ::釉 l躍 滅盤 l舗 :ll朧
∞ d dd山 」釧 Sm町 鰤 鴫 血e

露 蹴 :∬ 慧 :僕 濯 鮪 雷獄 l躍 棚 霜
NIIarx stood Hege1 0n his hё ad.Hc aLtaCked on thC ViCW thtt idcas alonc deterlllined thc
Onlllcnt, lnstit,tions in inlluCncing
coursc of evcnts, and he Staltcd the rolo of natural cnvi■

躍選
器驚 静
幣魔:群 認:::導撚li鵬 肝 :壼
肥樹
跳l;'忠鳥鵠 猟 ∬ :澪 ::l

lDEOLOGY:lN ECONOMiC SCIENCE

lё Vancc oftllc concCpt of idc910gy'0,CO'OllllC'C191CC
I Tttequcstlo■ 16w iS;whati,th9 r。
md itS CCVe10pmellti l
l.Relelance Ofldeo10gy as littited ConsCibusness:The niturc,the lcvCl of technology
n tlle scope ind discoVery tt cЖ h
md the Soじ 10_institutiOnd iamework bOth diκ Ct ttd COiStr減

路:￨:識 :現猶:冨
l澪

:tttI[T:::機11:i器 盤
漱糧l管:¶ ;躍 詰 1:￡ 11『 :
isation.So thCy inVCStigatcd thc dctcrlllination()f

盟乳胤;lⅧ
電器:Ⅷlfr‖ i緊 ζ
ld slow growth.Thercforc they concentratcd On a
ns;there can bc no dOubtthat some 6fthc Succcss
lonment.Contcmporary
ofthe marginalistmetlloo wお dtCtOthiS generttsocialandeconomiCen宙
lic and dynalluc
Nc6claζ sical and Kё シ nesian cc6nonlists payed aL16at attCntiOnto lnacro econOl■
p■ oblel■ lゎ r Slmiltt envllonmcntal К aSOnS.

孟 漁 胤忠 鵠 譜願∬1∬鳳 およ
串 :llim橋 半:=罵
 ヽ

present. The sub.ject on u,hich fbeling luns particularly high and accusatiou and collnter accusatiotl
arc trequently made. This concept is celtainly helpfirl in a generzil analysis o1'wlty we think iind
do as rvc do. But it is cxLrcnrcly dil'ficult to apply in particular. For. unless iI pet'sou's ideological
commitnrents rrre sell'prlrl'csscd it would bc almost irnpossiblc to prove. It is usually a witstc ol'
time to cliticise zitheoly rnainly along ideological lincs - in any casc therc llre mol'e eif'ective and
less arbitrary methods.
On the lbregoing pages w'e \,vere exarnining the concepts ol Value.judgements attd ideology
as explained by Mtirk Blaug and Maurice Dobb. It appetirs that their arquments are biised or1 the
assumption that truth is relative. Therelbre they even go to the extcnt to sriying that it is impossible
tbr any idea to be entiroly value lree. But if truth is assumed to be absolute (really it is so) value
judgements can not be subiective. There will be a clear difl'erence between what is right and
what is wrong with universal application.

HYPOTHESIS AND THEORY

A hypothesis urtry be an idea, generaliszition or imagination which is subiect to furthcr
verification test. Htrving selected a problem the researcher stzrrts looking at some conjectural
statements o1'thc relations between two or ntore variables. These statemeuts or explanittions irre
tentative as they are to be testcd for detcrmining the level of validity. Hypothcsis and proble nt
have certain similar- 1'eatures. Both invcllve direct investigirtions and enable the researcher 1o
dccluce specific empirical maniltstations and advance scientilic kuorvledge by conl'irming or
nLrll il'ying t hc thcor'-r,.

A tentative solution to a problem is called hypothesis. McGuigan (1969) has

suggested
dellned a hypothesis as a testable statelnent of potentizrl relationship between two or nrore
variables. Hypothesis need not be an absolute truth. A hypothesis is usually ft'amed on one or
more fbllowing sources:
l) Facts established by previous invcstigations in the relirled iirea.
'2) Through ilre investigator's expe[iences and observations and
3) Thror"rgh the investigator's reasoning insight and logiczrl derivations li'om a theory.
The following are the criteria to fl'zrme tr good hypothesis:
1) The hypothesis shoLrld be an inlequate answel'to the specitic problerl that clenrands uur arlswer'.

2) It should hzlr,e il logical sirnplicity.

3) It should be expressed in a quiutiflable lour or be susceptible to convcuieut qualilic;ltiort.
4\ It must be verifiable and
5) [t must be stated in sucli rr wiry ns to allorv it to be reluted.
THEORY
Theory is deflned as systematically organised knowledge applicable to a relatively wide
variety of circumstlnccs e specially a system of assumptions, acceptable principles and rules o1'
procedure devised to analyse, predict or otherwise expiain a specilied set of phenomenzr. They
ctrn be put into practice on cxperimental basis and observations can be made and inferences can
be drawn.
Any scientific investigation consists of four steps: (a) the assembly of lacts, (b) lonnatictn ol'
abstract hypothesis or general explanation of the behavior of f)rcts, (c) the inter'fcrences yielded
by thc hypothesis to deternrine the behavior of the lacts in specilic cases and (d) the tcst ol'
iulct'cnces witlt rclcrcncc to il uew set ol lacts in order to determine u,hethcr the inltr:cnces arc
col'l'e c[ ()l' 11ot.
 As such economic theory is a set of hypotheses and preclictions ?lbout economic phentlmena.
At the final stage the theory must tre tested against the facts. Granted that thc logic is corl'ect the
criterion of'a good theory is that it should be a successfirl pre diction.

. ROLE OFTHEORY
Goode and Hatt, two renownetl authorities in nrethodology oI behavitlural sciences suggestetl
that theory has various roles to be perlbrmed. They ure girrcu bclorv.
I ) Theory as orientation: A nrajor luuction ol'thc theorelicirlsvstenr is thut it nalruws th.'r'angc
o1'fircts to be studied. Theory helps in ilefining what kind of tucts alc relcvant fol study.
2) Theory as conceptualisation and classification: Theory provides collceplLlal sltucturcs attd
relationships with other concepis Icading 1o thc vurious syslcn) ol'couccptualisalirltts antl
classil'ications.
3) Theory in summarising: This role of theory leads to concisely summarisation of r,vhat is
already known about the object of study. Tliese sumrnaries may bc divided two simple
categolics: (a) empirical generalisation; and (b) systems of rclationsliips hctrvee n propositions.
4) Theory predicts facts: The prediction of facts is arlothel' role o1'theory rvhich has sevcral
lacts. The most obvious is the extrapolation li'om the knowu lo thc unkur'lr.r,n. Iu an carly
scientific investigatiou, there remained l bcliel'that such f itc:tors ciruscd sLrch piitte rn zind othcr
tactors canscd other pattcrns
5) Theory points to gaps: Since theory surrmarises thc knowrr f ircts and predicts facts i,vhich
have not yet been observed, it must also point to ilreirs rvhic:h hAve not yct explored. r

DIFFERENCES BETWEEN HYPOTHESIS AND THEORY

A hypothesis is rlillerenl lr'otn a thetlry iri nrirul'rvlrys.'['hc irnportanL dilhrences are giveu
belorv:
I ) A hypothesis i-s a tenttrtive statement zrbollt any phenourenon like charactelistics or nature
and behzrvior of any ec,onomic aserlt.s, relationships tu1rol1g economic varinbles or agents etc. put to
testing its validity subsequently. Ori the othel hand a theory is a lrl,pothesis tested lor it.s validity
and accepted as true under the given assllmptiolls, Thus a hypothesis is te stable stateme nt r.vhich is
f.ound true.

2)
A hypotheses is cxpectcti to be tnre relativel), lbr u sholt pcliod ol'tirnc: hut a llteoly is
expected to be true fbr pretty long period ol'tin-le.
Therelbre a hypotheses in due course be come s ii theoly it' it survivcs o\/e r a long pe liod o1'time
after varieties of tests, Mtury of the pl'esent theorics of consuilers hchiivior' $'!-rc originally called
hypotheses. Exaniples are Sirmuclson's Reveale<l Pref'elence l-l1,pothcscs, Neunraun - Mor_uenstens
I{ypothesisn and Friedman - Savagc Hypothcses. these hypothcses arc no\\r trcated as theorics of
consume[ behaviour. The reason is thitt they coulcl survir,r] varietics ol'tcsls.

MODEL BUILDING
'Ihe term econonric model is defined as a theoretical enr,irorlr)lcnt assuurcri by an econrlnrist
who wishes to work the irnplications of a theory in pr:ecisely knorvn conditions. A nrodel is then a
complete system of nrathematicirl ecluations and the systern rrray he as hroad or as llrlrrow as the
problem being studie<J.
 ﹁′
Complete set of Stnrcturiil Equirtionq

Definitional Equations Behavioural Equations

Systems Variables Riurdom Variabl

Endosenous Var

1. DEFINITIONAL AND BEHAVIORAL EOUATIONS

A rrrodcl is a systetu ol'.struc'trrrlrlr'(plations. Thcv lrlc cirllctl sln-rclr.rral crlr-r:.rlittus bccauie thcy
show the ba.sic stntctLu'e ol a give n econoLnic systcnr. In
-qcne
lal tl-rs stu.rcrural e quatitns are classilied
into two types: dellnitiolrul and bu'havioriil cquations.
(a) Detlnitional equations are identities or truisms. They contain neither causal statements nor
descriptions of dccision making. For e.xlniple, income is equal to corlsLlmption plus saving.
(b) Behavioural ecluations iis the name inrplies describc the behaviour of individuals or groups in
the ecottomy stich as householiis, enterprises etc. The behavioural valiables are economic
magniludes that lrA\/ itssurrre dil'l'erent valtres such as pt'icc, output etc.

2. SYSTEMATIC AND HANDOM VARIABLES

Systematic variitblcs ilre those to r,vhich detinite values can be assigned with certainty and
which are related to prices and qr"rantities of il commoiiill,sold. Randonr variahles arc those whose
vitlues depend on chauce or pLobability. They do uot lirllow anl, specilicd pat- tcrn or shor.v auy
prcdic:tablc rcialionship to otlre r variables. Randunr variablcs ars somctiurcs callcd cltance variablcs
or raltdom et'rors. TheY arc crr()rs in thc scnse thirt whcu we colnc to apply the modcl to eurpilical
dati; rvc lloticc lhat our s1'stematic re liitiimships do not hold cxac:tly good be cause thcy arc clror ilr
nteasLlrement.

3. EXOGENOUS VARIABLES AND ENDOGENOUS VARIABLES

Thc exogenous r,ulirrblcs are n()t cxplainetl by the rnodel but rather they iire detelnrined by
factors outside the model. I'liey ale not inf'luenced by the endogenous variables. Another way ol'
expressing this is that the virlues clf exogenons val'iables are assuuled to l're known and taken as
given fbr the purpose of model. In a sirnple national inconre urodel we mry assuure that invcstutent
is exogenous and tltttt consumption and income are endogenous. Investntent is indeterminate in
this model and il may be dependent on some other varjables. In short, exogenous variables alc
independcnt and endogcrlolls viiriables arc. depe.ndent variahles in a s1,sleu.

TYPES OF ECONOMIC MODELS

Economic tnodels at'e broadly clltssil'icd into trvo types. The fl'st ty,pe include ntodels thzrl irre
designed to pl'ovide insiglrt int() pr'()pr'rtics ol'irctual or hypothelical econontic svsLem but \,\,hosc
pitrameters could not be cstilnated ll'om e mpirical data.'fechnology ol'irn econonty is described as
an exanpJe firr this.

The secontt type include urodels whose parametels coukl conccivably be estiruatcd ii'orl
empirical data and u,llich coulti bc usecl as a-basis lbi clecision rlrilking: Such a lrio<iel nay provide
valtrable. insighr also. Thc relationship betrn,een national incorne and the sales of 11 linr can be
taken as tn exarnple lor this. .

Econornists construct Lheoretical nurclels fhiil ctrrrespond tcl thc real wot'ld probletn. Thc snccess
 8

of the model largely depends on the skill of the model builder. But if the model is not applicable to
the real world, it is the most useless thing in the world. It will be a rriodel of nothing.

EVALUATION AND RESEARCH

Evalnation and research are both scientific rllethods of conductillg study ot ztccumulittion of
systeniatic knowledge. Both of them deal with behavioural phenomellzi. They tire interdependent
anil are very much inlluenced by each other, Both of thern employ scientilic niethods witlt varying
dcgrccs.

MEANING OF EVALUATION
Evalualicln in context of the word value, rrczuls judgement o1'sotnethitt-u on thc basis ol' its
givcn objectives.In other words evaluation is an assessntcnl o[ appraisal o1'the valuc oL wtlt'th ul'a
pro.ject or rr pl'ogt'amme. Evaluation is made generaiiy to gallge the succcss or othel'wise, assess
elle ctiverress of the progr?rmmes or it may help author to suggest points l'or further iinprovement.

MEANING OF RESEARCH
Reselrch is scientific undertaking which by nleans o1 logical and systematised r-nethods, aims
to discover, new facts or verify old ftrcts, and to analyse their sequences, iutcrrelationships, caustrl
explanations and the natural laws which govern them.
Gap for research arises only if one is able to identily the dilference between knowledge about
a truth and the truth itself. Thetelbre all researches are attempts niade to deepen tlie existing
knowletlge about truth. There are cases in which knowledge is r,r,idened by identil'ying
irrten'e lalionships by doing researclr.

The diffbrences betwecn evaluation:rncl research miry be sumrnat'ised iis ftlllows:

Evaluatiort Reseeu'ch

1 Evaluation is based 1. Research is based olt hypothesis

on bench-mark suruey. lnd is thcorctical.
2. Evaluation goes on without hypoflresis.2. Tests the hypothesis and evolves a theory.
3. Somewhat loose from scientifii view, 3. Mostly scientillc ilt ttature.
4. It is carried out on professional basis. 4. In research, thirst for knowledge is the
,i biggest inccrrtivc.
５

Curative in nature 5. Discovering or itiventing l)iltLlre.

６

Motivtttive force is to improve our 6. Motivtttion is to trrrive iit tt-uth or

orvn effot'ts. to tlevelop a the ory.

In brief evaluation a positive study and it is curative in nature but rcsearch is both positive and
luorrnative study and discovering or inventive in nature.

USE OF DATA
Data serve as basis for study trnd'antrlysis.'They are the most relevzrnt material a reseatcher
gets in the trbrm of facts,, figurbs and information. In the behavioral colttext the data come llom thc
tiuing stuff zurd they may;6e revelations of laction; attitutle, values opini:on and vatjous fonns ot
socio psychological interactiqn processes. These arc termed as qualitative data, while an.other
category of data ftag ip, numerical data also can bqderived from the qualitative tacts on the basis of
neasurqment 1gc\pigugs and,thus it doeq inyolye a socio psyclrologisal f}ame of ref'ercnce. Data
invo1vefactsindeve1opingatheor.y'].i''.l,l:'li'.
Theory and data are in constant interaction and therefbre developtnent of one results in the
development of other. Science actually depends upon a continuous stimulation of data by theory
and theory by data.
 9
1) Data Initiall Many atime, historical incide-nces, srories,
ad }reorr: unanticipated analogous
straregic, data provide imiortan,
new theories rhat come through
ir..* ,r,a*r;. il;;;A;ilffi;;;r*'orr.rop or initiate
keen obsemations of fias and their.o*inirr-interplay.
2) Data Lead to the Rejection and
Reformutation of Exilsting or* r**
theory
n-tust be able to ad.iusl
with eacir othr,,
or thei. rejection is imperative.
il;y
d;;;dilrformutatiorr of.thetretical "ro
orientation
ctllltitlttOUS pfOCeSS.
.J;;"iffiffi;'"d';il.
rhis process ;f - --*'Euuvu qrrr rElr;utlull
Illay I together an<r is

3 )
Data Redetine and clarify Theory:
New dat'a, that flt the theory, will always
and claritv the theory because' rederine
thev nrolidg
the concept formation leads to ioimutation
*iorn , inffior, orrhri,.;;;iurrirutior. obviously
r,ypotr,"li"Lo
obtained data reiect the hypothesis, "r renog anJcrarifyor., ,rrr."lire.t.o, anarysed and
then it does
a continues process ano thi retormutation the existing thbory. This is erlso
of theory wil f,uo ro the discovery of
new facts.
Thus it is clear that the scientists
orher, and rheir concern is to see dara
must rcalise that theory and data
oo, *, .".n
i, it Lo.y *i ii*rr
,, oo.. "OO.rrOl,

STATISTICAL TESTING
TIre data collected through census
or sampre surueys may contain some
sampling en'ors and non-sampling emors. Ther:e arc
errors. rne errors wrri.i'uri* ore
part of the population m.o,ril.,lur. to selection of unrepresentative
of investigati6ns i, asking questions
kno.ws ;;il;il; Non-sampling erom include biases
a'd irr r=.oiJin'g rh;;r*;". They also occur.s
due ro inaccurate
inlbrmation given bv,.rfor,t.nt,
The-v must be nrade rcriarbre by
Brrb;{;;ilfiil#;l datathei,eliabiliry must be assured.
urininrising tie r*rpi; ilTnon-ranrpting
enors.

wc have seen that a hypothesis is a supposition

made as basis for reasoning. Au scientific
theories are tested for setti,g up
a trypotrrJi; duin,,,i;ilf-aobservation. If
clearlv inconsistent the hvpotioir
around the statement of hypothesis
ir i.iuur.;ii;",.#ffifd;;;il, obierved facrs are
,r.nred rogicarry
with whicrr tr* art",iuv o, *uy not confirm.
i^ statisticar
.,,.,lli,Iirl'"H*f* test are
""*;;;;;;;;ffi;;r".esis; and (2)

This is a very usefu] tgol in testing

the significance of difl'erence. In its
hvpothesis assefis thattherc is notrue-difl';;;";]ffi;-r**"."0 simplest form the ,ull
mauer under consideration and that the population in the particurar.
whatever little differenJeiounO is accidental.or
chance oi tlue to ditl'eience in ,rrr
ru*prir u;;ry;iil'yp.itrris ii den'red by theattributable to
symbol Ho.
(2) Alternative Hypothesis
This hypothesis specifies those values
that the.researcher believes to hold
that the sanple data leads to accept,m* true, and, 1e hopes
ivpffiffi;..ti..". The alternative hypothesis may
HI ffi $'^--H"
r an ge o r varues *tt"r,nir
"it -' : d;lffi :;r'#"il:,H::,u,',1:, r*oo ric ar y
In order to distinguish between these
two types of hypotheses let us take the
psvcltologist who wishes to test case of a
100 might estabrish the fblrowing
whether or not u.rrtin .i*, ;i;;il;;;;;
re higher than ffi;
nula,io utt"rnutire t ypot-.iir.
Ho = lr = 100 (null hypothesis)
Ha= fr>I00 ( alternative hypothesis)
or' il'he is interested in testing the difference
between the mean Ie of two groups, .he
 two groups have equal
索零,黙メ:搬
螢
tttL胤
幣み 織誡 not equal rn
‖思 m器予 ,- [n: * 0t

HO=P■ 1陣 〒0(nun)yl° ■esお )

Ha=pl_m≠ 0(altemttiVe hypothesis)

STATISTICAL TESTING METHODS considerable

Since in many of the problerns
it makes necessary to take a small size sample'
with problems of s,rall samples'
a*ention has been palJ in'oeueloping ,uitutrri.rts tbr dealing
t'neory ot r"Jr samples is ttrat of
Sir williarn Gosser turd R'A'
The greatest contribuiion to tt e the pen name 'student'' He
gtrve his test
Fisher. Sir, Gosser published his discoveryl;it,#der ate based on
't-test' arld Fisher gu,, *ottler test known as 'z;test'' These tests
popularly known as
t' distribution and'z' distribution'

STUDENT'S T-DISTRIBUTION

t=…
distribution the quantity't' is defined
as
According to the '1' S

rvhere X = llletfl of the samPle

which sample hiu been drawn'
lneall of the parent population from
Fr= in the sample'
s = The standard deviation of
the sample n = number of observation

Tlret-clllvehasamode,coirrcidingwitlrthenretrnandatt=0.[t.issyrlrnrctricalatrdliketlte
either side of the mean'
uorural curve extontis to inf inity of

Z-TEST
Prot.Fislrerlrasgiverramethod.oftestingthesignificanceofcortelatiottcoel]icic.ntmsnrall z and thtrt is
io this metrrod ur. .o"ni-.i.nt ot=ror'ralation is trairsfou,ed into
sampres. According
gir"n bv Fisher is used to test (r) whether
hypothetical
why trris is ctr*ed z_test. Trre sttrtistic,
values-of coneclion differ significantly'
value, or (2) wrretheri;. ';r,*pr.
t-test is
dittbrs significantry fiom zero, the
on the otrrer l.ra,d tor testi,g whether corrcration
prcl'erable.

t'T:Li::'::JI;:" g1'::::lT or popuration, is norrnar rn orcrer

conducted onry when.the
pruametric tests. But chi-square test
is ,, non-pur,.rnetric test which is
r.vords these two tests ru.e Thougrr.non-pzuamet'ic
co*ducted when itis impossibleto
or.u*.-no*aldisuibution otpopulation.
c^me to be widelv r"rsed'
in the r9 th centuri:j;;;; ;;iy atter
rq+s itris resr
trreory was rleveroped
-hi-tquott
iri. o,rron,age of test arc the followitlg'
of popultuiou tlisrributitr, '
i.e. they can b0 used with any type
(i) These tests are distr.ibution - free,
itnd
and handie than parantetric tests;
(ii) They are tlsirally cornputati<rnally.eirsier to understttnd
(iii)Tlreycanbeusedwitlrdittbfenttypesollneasurementsthatprohibittlreuseofparanretric
lests.
Hower,eritdoesnotmealchi-sqrraretestgivesmaximumteriaurl-r;11'0,]itisoneofthe d as 1]
arrd most widely rrs-ed test in satistical
wor* Tlre Greek letter X nn,].*':' firstrr.se
simplest
Trre quantity trre nlagnitude of the disc'cpancy
b,v Kar1 pearson rn trre year 1gQO xzdescribeq
between theory iitid observation'
 ￢

11

hお dcnned tt χ
'=颯 E
Wher Oreた Is t9中 e obServed iequencies ttd ,
E Iettt tO the ё
xpected iequcncics ald '
Σ reた ぉto the sulll tOtal・

:島ntil』 f::ill:::::￨￨::ll::ll::[:
1::￨:l:lnill]1:[Itirilii(llif:llllhiidill[1・
・ :Cギ C」 江
「 Cd湘 uさ 0∫ 2ぉ b%価
χ 血
cぬ Ы c

i驚 蔦1鷺職ill轟轟謙轟1聰 li

UESTI.NS
Essay rype
1' Bring out the rore and signitica,ce of assurnption
in economic dreory.
2' buildi,g? How do build a,
vou economic rnoder with behaviourar
Xl:f'rt#'el and systeriratic

Medium Type
l' what are value judgentents? what is thei. relevance
in econo,ric scierc:c ./
2. Distinguish between evaluation and research.
3. What are data? How clo the1, leacl to rejection
and lefiu'mulatjon oJ' the existing
theol.y.?
Short Type
l. What is a hypothesis?
2. Bring out the advantages of Chi_square testing
3 ' what is the diflbrence
between a hypotrresis ;urd a theor:y?
4. Detine ideology..

!￨.:

:;1
い                       。    ヽ ．

',■
 メ ￢書 ‐ _￨´ :■ ■
12

Ⅳ10DUIノ E II

THEORY OF CONSUMER IEHAV10UR

REVEALED pREFERENCE THEORY
Thc theOry Of COnsuふ ёi Choice deals Witll lhe determinallts Of demand.AcCOrdiig lo thC
orthc collll■ 10dity,otherS
liditional thcoryヴ dCmandthe cOnSumCrchoiCe is dCt8rmincd bypricё
tl・

鷺 滞 1需 器 I∬ 1嗽 ‖
1催 :l鳳 ま ギ洲育富i鵬 lW撚
:燎
l又 聡
:l霊 :∬ ￨∬

紐 拠選器胤
遺 器Ti職 軍1盤 聡脚 濃1繰 IIよ

躙
:幌

焉
1器

Ⅷ
e.TLrc arC

掛
■
O祖 buy With his inc61■

m聯棚響冊淵 織盤卵鍔 1鰍脚 胤

be ttleto cOmpare uility Ofぬ 10'S baSkets of g?OdS WhiCllhё
l職
tll b6 expК SSed in‐ termS of nulllbers.

釉
宙 ets of色
【
菫 ∬ 赳
6odsれ COiding tO the Sttitfaction tlltt CXh bundlC given him・
nLie dittrentbundlCS Ofg00dS The m灘
HC
n

ふ ust beお t to de“

rmi¨ hiS Ordor of pie,rence tt°
Oidinal lltility theoHeS arё
tllc illdiffercnC,CurVesapprOachandrCVealcdllelCIil穐 II∫ 電￨:￨:II

lilM胤 ∬ :鼎 激電 I慇:l棄 凝器 Lttl;:

棋
∝
1肌 Otllesis Only.

ぷ
腹
:灘

…
:よ

剛蝋
lics in 1938.ThiS

謝柵
edcd prctrencc into,COn()l・
P油 lA.SalniClSOl intrOduccd the concOpt,ヤ

朧淵i露難
I榊融∫
he reVO温 ed prcた rellCC
じ

lcir rcstiiCtivC aSSumpt10nS.HOWCVCr,thCrc arc a

■
fcW aSsul■ p■ Ons“ r tlliS'hジ
pOtlleSiS too:

ASSUMPT10NS er江 lonality,in thtt he preた

IS bundlCS 9f
l: R“ ″θ αIり Onsumer isお mmcd tO bella↓
・26ods
%Am豫 恒面m m
“
tlltt incllld6 morё qumtttS.
'Th'こ
1 2.Cわ ″ζ
おra4り :TⅢ
器 青箭 lttι 誡 電ll響y
which bundle B V:酬
棚
able.
`olller situaton in whiCh A is dSO a Va五
Situm° n A is grttЮ rthtt B ttd B iS grcttcrthan C,
3.■ ■■,friッ リ「 Ifin tty laltiCul年
thё n C Wi■ never be gretter,hal A. l quitc
C叩 お 10 01eXpresttng hiS W■
4.S″・θ4gθ「 F・
j′
tgr.Since consu面 eris a humtt being heヽ
`θ :ChdCC Witllollt thC help of mOncy Or any OthCr
n・ eely.SO he Can icvcd mゞ lstalCC.
circumstanCC.ゝ 江an is tSSumed tO bC dOminant ovCr the Circul■

PREFERENCE HYPOTHESiS AND STRONG ORDERING

I sa血 uels6n has uSCd pretie“ e hypO"esis aS the bttiS Of hiS theory Of denland.AccOrding to
,it meanS lillltt hc cOnsidCrs d1 0thCr
tllis c611cept w“ n a COnsumer chOOSes,cOmbination本 S
ed to be intriOrtO A=Thus ChOiCe reve』
血crnativeじ 01hbillttil五
s"hich he couldヽ Ne purchお
prefeFenCe. ￨・ ‐‐
・

およ蹴 織 点麟 獣
認 淵 賢
H電 ち鴫::鳳器lTH誡
賓 :瀧 1織
a島
ふ
y赫 呻b耐 訛 l出璃欝:1晶 胤 鷲
ll喘 ∬∬ l鳳二I滞 脱鷺習 さnc6 and
G.If A is ChOscn iti
Thc prettК nCё iS rcVealcd,by stron3 0rdering.ThC COnSulller is not ili a strltC Of indiff61・
 13

＞ Ｏｏ０ ０ Ｎ

Fig 2 1
E0 1
D° ￨●
F

Good X

he does not need any dominant factorto persuadg him for taking decision: Thus the budget
line has
only a passive role for revealing the prefelence. Thus under strong ordering relation ofindiflbt.ense
between various altemative combiuations is lrled out.

DERIVATION OF THE DEMAND CURVE

Assume that the comunret has the budget line AB in Fig. 2.2. anrt chooses the collection ol'
goods denoted by point Z. Thus he revealed his preference- Suppose thirt rhe price
ofx falls so that
new budget line f'acing the consume t is AC. We can show that the new combination will include
a
lar-rer quantity of X.

Fig 2 2

X, X, B X3Bi C cood XX
Good x

Firstly, we nt*e a compensating variation of the income, which consists in the r.e<Juction o/
ittcorue so that the consr.uner has just enough incone to enabie him to continuc purchasing
Z if lre
rvishes so. The corrlpens:iting variation is shown inFig2.2 by a par.allel line passing through
Z.
Since the courbinatior Z is still available to hiur, the cousumer will not choosc any buMle tq
rhc
lcli of Z on the segmellt ArZ, because his choice would be inconsistent, uiven lhat in the original
siluation all the combinations of ArZ were revealed infbrior to the substitution eflecl is
zero) or hc
p
will choose a combination on the segment zB'. Such as which includes a larger quantiry ol X
(namely X2). Secondly, if we remove the imagiruuy reduction in income
all allow thJconsumer to
move onthe new budget line AC, he will choose a combination
{Such as N) to the righi ofW if tlrc
commodity X is normal with a positive income effect. The new revealed equilibriuni, posiqion (N)
incl,des a larger quantity of X (i.e. X3) resulting form the fall in its price. Thus the reveared
pteference axjom and the inrplied consistency choice'open i diiect
way to tlre derivation of the
demand curved. As price talls, more of it is purihased. Thirs the Marshallian inverse price -
demalrl
rclationship is obttrincd withotrt any introspective malysis. Sanruleson calls this demand
thcorelr
as the fundamental theorem or conpensatiol theor.y.
 l4
DERIVATION OF INDIFFERENCES CURVES
even without.getting
Indifference curves ciu:l be derived from revealed prefetence hypothesis
preferences. The hypothesis pernits
information about the consumer's tastes and ranking his Ys.t9
various market prices provided that (a) his
,r. ,n"-i^Aiff"r"rce map by observing his behavioi at
choice its consistent,(b) his tastes are-independent of his choice over time and do not change, and
i"iii""orru*tr is rationalein, Pareto sense, i'e he prefer more goods to less'

IGNORANOE
zoNE

10NORANCE
20NE

O 'annd X u

Assume that the initial budget liDe of rhe consumer is AB in

Fig' 2'3' And he chooses tJre
it denote infedor combinadons of
combination Z. All the other poiits on the budget line and below
Z.IfwedrawperpendicularsthroughZ,CZmdZD,allthecombinationsontheselines'andinthe
area defined by t-hem to the right 6, are preferred to Z because
they contain more quantity of at
least one commodity. combinations of goods in the remaining area below
cZD and the above tl.Ie
still not ordered. HowevJ' we may rank them lElative to z by adopting the
lbllowing
truJget tine are
procedure.
ン つ０〇〇

. I'
LeI the price of S fall so rhar the new budget line RS passes through Z. The consumer will
choose either v or a point right of v on that the consumef chooses
V. using the transitivity
rtlie'oi'iginal siduatibn.'V is gteater than Z i the new
we iind Z is greair than' V'in
"..tr.rti""
;;;Jc;iil; r pvet i, gleaTer thun V. we nray iepeii this plbcetlure dy drawing budgetinierior lines below
"igrtoranle zorie" dtat arc to Z'
7.,r-J O"iiri* g,iia.ralty ati tt e .ombinations ot: the'lowir'
that the
;;ih.ly;ffik att ttre comUinatiorns of ihe upper ''ign5rarlcd iohb". For eidniplewillasdume either stay at
price of increases and the new budget, liner KL.: passes thmugh:Z'.The consu.41e[
Z or choose a point such as U on KL. Using the rationality assumption we find MU is greater than
gradually
U. From the revealed principle u is greater than z. Repeating this plocedure we may
range
naffow down the "ignorance zone" until we locate the indiffercnce curve within as naITOw a
 15

Fig 2.5

as pOssible.Hence the revealed axiOtt perIIutts us tO derive the indif予

0「 Jle consumcFin vど iOus じrencc curve frolll thc bchavi()1・
lal・ ket situatiOns.

The cmv教 iy ofぬ eh“ 峰κ

e clrve mり be eshbIShed∬
“
Lctus Кdraw the O」 ginaibudgetsituttiOn.we ObsOrve thatthe i
i棚 ∴];き 綿選 ¶性 I堪
犠ⅧI蠍 お掘:躙鑑 ざ 黒T詭鳳蝋蹴wT家品 掘l臨
山 ∫
鵬よ守1∫ :思T:需:筵 TTFtti鷲 甘 T,:f,edり 'n∝ lЮ
c呼 .号 Iぎ

CR:T:cAL EVALUAT10N .
κnCe.90い

h…品
a ttorc6■ 五b面 。n Ю tteぬ cOry Ordemma.。
Jiぶ 躍 淵 Ж m寓 庶
hc

灘欄翼 警
d tO del.i…

I欄
Lo consulller analysis,it uses

l鸞 瘍 器¶鵬 l蹴跳唸lT驚 霊 ・
￨

1灘 脳 ‖ Iよ 1き
etc,ca,bc sed tO constl■
indcx nvmberOrcOst oflivinL.
lct in
. 密‰蠍 椒珈 拙
e reヤ ealelpreferencethざ OFCnl Sutters fronl c,■
ildei説 I「 1:電 lVelupeH:rily'■ ain dC■ ごiclldes ・
・

h山 駐鵬1慰癬現
:臨
ald COntl,ッ t6■aこ 徳.The c6h
diSplり aた eling Of di餞 enc(

・
)l・

l inlnlё dateineighbou山 00d。

緻棚躙螂 理譴
言脚爾
f'a興 ?11'9 eXPlⅢ
pCdiⅢ t19 1isht 9fthiS analysis.￨￨

listilctiOn betwCen thc incOlllc l

tc anttysis wili nOt tell lis how
to substitutiOn effect.It shOuld i
丼 om the ihcOme e価 cct.Thc
lil・
 t鏃
艇庶 認胤 器:F淵 ‰TΨ l淵 ∬‖鷲
11織 腫器:喘 :∬ :Tお

潔卜
1ぶ
照脚 薇 i麒 輔 灘鎧舗騨捕
盤聰 酬ぜ淵 熙 rve_￨ ‐
:鷲 :諾 l“

c6nsuicrisが ⅢmCdnOttO be

iざ :躙 :lilli 器蹴
鷲 現 器露
:織 l為 Inark,ti
thatcOnsuinCrwhOSO
C° n粘 ζ
istじ ncy postulalC・
1111∫ l::Ii‖ II:ll「 :IIIё cO轟

‖
Ii view ofthe 16ove dじ ficiencies and linlita壼
ons,itiS10ubti::lflξ

温詰
l需 魔
鷲 Ю
織1潔霜認盤l鵬 ∬蹂IsⅢ ∝ ∝
ぬ“回岬¨ lllll::l軍 ll:I:「 1誠

伍eo五 es irnishedby MttSh』 and HiCkS・

QUEST:ONS
Essay rype renCe meOre興 .

l.Explain md illus,Ⅲ the,品

axioms u五 lerlyittg 9eded pleお
にぶ1狙 illdittrcttc
,prOCeedsЮ ■19平 征sl江ⅢⅢhW,fdemi五 d ind車
2.Dis∞
"h6w
culve針 SttnttЮ
Om the revё alod prefe"nce theOrenl.
“
S力 οr answertype iOllship with° ut
IsQ rcll■
l. HOw does Smuison deriVe MarShlユ lan pri,9 1 demand invじ
introspectivlmaly,iS?
theorel■l?
2.Give theimpⅢ 江iOns ofiL■ 01轟 ∝ Zo"in,veⅢ d,pretrence
S iS,upe● Orto the emicr meorics Of demmd?
3.W,y dQ yoり ,響 1"i鮨 nce curvc mdy●
“

■
回 釧
ヽⅢⅢ り
赫赫Ⅲ価ぬ H:CKS REV:S10N OF DEMAND THEORY

離手i霧騨轟
HⅢ
an。
l.eason6d dじ rivaion of de面
l::,1lil[鸞
lofbgiC,
褒 ￨
‐

` FEATunES OFTHE甲 二

肌織肥
v:,FD THEORY
revi“ dtheoγ Of d叩 血 :They are」 vcn bebWi
distincttaturι sわ ■
品

‐
, Thtt arじ s6me

絲重:i量轟輔識諄纂響奮
2節
IT瀾
0血 伊impo■ 血 勢 Юben“ Ⅲ 岬 H“ Wh9F螺
肝 拙 路ゞ 乱 ｀:

1熙脚 雛
琴恐躙 蠍
“

d ittdittrenCe curVes,
Of h“ 娩
"ncemore
representilg curves_He
th4n'WOttand。
COmm6ditieS:iSじ
じondly,he wall
“
 17
ln addition to these disadvantages he abrdoned indif'lerence
'tssumption cur.ves rlue to the trdvantage
ot clarity of preference hypothesis in the iew theory.

PREFERENCE HYPOTHESIS AND LOGIC OF ORDERING

Hicks essumes preference hypothesis as a principle which govenrs
the behaviour of a custo^rer.
According to him "the ideal consumer ohoosei that altemative,
out ofthe various altematives open
to him which he most preferc, or lanks most highly. In
one set of market conditions he make some
choice, in others other choices, but the choice-s he
makes always express the sune order.ing an<l
rnus1, thereforc, be consistent witrr one another"
trris
market situation chooses the nrost prefefied combination
st.t".rrt irlprirr"tiut ,rr" .ri"rr"r. r,.;r*,
and he will choose diftbrent cornuinutio,
in dillbrent martet situatiofl; but this choicesin diffblent
market situations will be consistent with
eash other. In his earlier approach arso the demand
theory was based on pref'er.en". t ypotir.rr, t rt
therc he exprcssed the givel scale ofprelbrence
at oncein the tbrm a set of in<Jillbrence cur.ves.
STORING AND WEAK ORDERINGS

. An otdeling is said to be strong in a set if each item has a place of its own in the order. and each
item could then be given a number'. Here man's treedom
rurd ability to exprcss his choice is
recognised. He is competent to take decisions.

A set of items .is weakly ordered if the items are crusteled into gr.oups
.. but none of thc irems
orHicks, iA wcak oroering conri.ts ot-
within a group can be put a head r)rrhe olhels. In the wolds
a djvision into groups, in whicrr ..o,1ucnces
of gr.oups is srrongry ordered, but in which ther.e is no
ordering within the groups,'.
Indiflbrence curves can be cited as examples ofweak
orderiug, because aI points on which are
equally desi.able md he,ce occupy same price in the
order. on ihe other hand, ,"r.Jp."i.r"r".
approach implied strong ordering since it assumes
that the choice ofcombination reveals consumeni
prclbrcnce for it alr other artemadve conbinations
open to him. choice can rcvele pi"r.:""r.. t",
a combination onry if au the arternative combi'ationi
ue strongly ordered. weak
that the consumer chooses a position and rciects -i.rrs ^pri.-
others op.n to lrirn, then the rejected p"ri,i"l.",r
rejects others open to him then the reiected positions
,rcd noi u. inferjor to the position actuiuly
chosen but may have been indifrbre,ce to ii, Hence
under weak ordering, actual choice rails to
rcveal prefercnce.

HICKS' CRITICISM OF THE LOGIC OF STRONG ORDERING

AccordiDg to Hicks, whele thechoice is betwecn
any good which is rvailable is discl.ete units
and nroney which is finaly divisible, the possibility
ot"equatty desir.ed combinations nrusr be
acc'epted a strong ordering has, therelbre, to
be given up. wny the str.ong ordering hypothesis is
のＣ”﹁総さ０︺

valid when the choice is between,roney which is n.t

finally divisible uoa i., ,.pr."i.*.J .r-,r,. v
axis .nd the commodity X which is iniperfectry =
aivrsiute and is rcprcsented on the x - axis is
illustmted in Fig' 2.1. This is because money, memured
or y-axis is taken to be fi,ally divisible,
the ellbctive alternative will no ronger be.rcprcsented
uy square corners. They wilr appezu. i, the
ヽ２添Ｕ 目出

diagram as a series of parallel lines (or strips)

a,,rro*rln iigi.f

COMMODITY Fig 2 1
 18
alternative canrl()t bc stron5til'
Ail points ou the str.ips will be er crive arternatives trut
such
rrrll s, .lt'
.l.ticr.ecr unless the wh.ie o1.o.e stripe
was pret'e'red to the whorc .f lhc ucxt slripe.
hrid tir
preler an adtJitio,al trnit o1'X r'vhetcv:l th':
r,i,hich mealls thirt the cListol-ller wor.rld or*uyt cattrlol bc
or the stipes
quir. *tr.,r,i.Thus tt e ct'tective alternatives appearing
pay lirr it. But this is
ale two altetlative P and Q on a given
stlipe u'hich tIIe stlt]h
stl.on-qly ordered. Agnifr, sllppose thete
that P is pref'erred,o n o, *o*t .1. stripe,
*t it, n it-pretened to Q' Given thut' we,can alrvays l'inti
aircrnati'cs
a poi,t between
p and e which is indiff'ere,t to R. I; is thus e'ident that when various
of thctn'
be a relation Of indillerence betu'ee n
sotue
appezrr as a series of ,tri-par, there can

THE LOGIC OF WEAK ORDERING ^ r.I:,

AfterrejectingtheStrongorderinghypothesis,prof'Hicksproceedstoesttrblislrthccllsi-.ltll.
In the wortls of prof. Hicks, "rl rrrc corsurrlr'rf's
scalc rr1
acloption of the weak or.dering hypothesis. (rc'e'al ) tirat r\
ni' o pu,tituiar positio, A docs not show
pref'erence is weakly order, then his choice thcrc is ,rr
or on the triangle; ail that is srr.rvrr is that
is preterred to any rejected position within posirio, rriav
re,jected i, piel,erred to a'i.iri, perf'ectry possibre thar s.nre rciected
positio, *r.,i.i.,
oit-ne .ejected posiliorl is thc. ir,lallcr
tll'cltrt'rcc'
h.] inditterent to A; tr.,. .rroi.. ol A instead

THE DIRECT CONSISTENCY TEST

Pr.tl[.HicksbylollorvingSittlrrrelsolltLssumescoltsistencyofcltoiccbclrar,ittitt.trtttlrCpill.trri
prices .t g.rds utitl liis
remai,s unchanged whcn
t'e idear cons,mer whose scare o1 pret'erences the cottsistcncY
l-:orlsumer''s demand Hicks applics
inoome vary. So i, brder to derive to*, ,tuout p'ol'' t{icks call t'is
his prelcrence approach.
test wrrich hirs been appried by Sam.rsonin
Test. Tlie. vario*s ctrses i. rvhicrr consistc^cf
'evealed is.i,ducd
consistency test as ure oir-ericonsistency
are given below:
lines lie whoily outsidc tlte other ' as iu
Fig
1. It is conceivable that one of the two price-income
2.2.Whereaslieswhollyoutsidcuu.tnthiscascofpointBlieswitirintlretrilrrglciroa.

Commodity X

vcak ordel・ ings 11l tlic B

ThcrcfOrc,in thc A sitll々 ltiOn,A is preferrcd tp B under strong and、
rc tlle consumCrs chOicc of A in tlie situtitiOn is ЧuitC COnSiStcl)1
situation,A is not Ⅳ ail力 lc.ThCrcね
witll his ChoiCe of B in the sitllatlon.
,thcn thc tW(ン
2.Secondly,i10ne OfthC pricc-11lCon16 1ihcs doel nOt llc Wh01ly OutsidC tllc Othel・
/ing arc thC fOtlr pOSSibic Casesi
、
vill intel・ sCCt With CaCh Othcr at sollle pOint.Thcn thC f9110ヽ
ttO thC Cr6ss(単 g2.3)in thiS CtlsC,the chOiCC Or 13
a)BOth the selectCd p6sitiOns A and B lie lel‐
Cnccゃ rÅ 6vcr t in dlc A situmi()n
in thё Bふ ituition is quite conSiStCnt ttith thё prcた 1・

POsi16n B lies within thc trim31c aOa,md thelebre tllc chOiCe 01:A in thC A situation sh()WS
ordCringS Btu il thc B SituanOn
consunlclls pretrence fOr A oVer B,both under strOng and wc■
 19

Commoclity X Comrnodity X

A is not iivailable, and therefbre the choice ol B in the B sittitrtion is quite consistent with the
choice of A in the A situation.

b) Similarly when A alttl B are taken on

the right side ol'rhe cross ris shown in Fig.2.4.
sittlltliotl' A B is not avitilable anri in the two in the
situations B A is not aviiilable a,tl thus r,e
nladc itt t'he twtt situations iu'e cousistenl, choices
whether it is stron-u or weak or.der.inr u,hich
is acloptcil.
c) In this case tlic Iwo chosen positions A
arid B lie on cit]rerside of thc cross as shown
2'5' Flerc also tlte choiccs rnade iir both the in Fiu
r,r,cak o'derin_q which is adopted.
sirnzrrions are consisrenl,
rrL' whcrhcr i,
rrrrurrtur rL ir;l;.';;ilr,;
r)

Commodity X Commodity X

d) The two selected positions A zin<i B in

thc twcl situations lie side the cross in
case there is inconsistency' Iu the A Fig. 2.6. In tiris
situation when A is chosen B lies within
therelbre A is revaled to be prel'e'red the triangie aoa,
to B. But in the B situation when A is also
withi, the triangle bob, positio. B is chosen rtrther available a*d lies
than Am showing cousu,ler.,s preterence
over A' Thus' in this casc o,1e time of B
the consumer pretbrs A to B and iu angther
'tt
Hence choice is quite inconsisrenr; he pref-er.s B to A.
bottr under *;;k-;;;;;ur, srroug or<jc,riug.
It is evident from the above analysis that we reach "*
the same conclusion in all cases fi.o,r
direct consistency test whether we acicipt the
strong or weak ordering hypothesis.
strotlg otderi,g vield the stune result Th.ugh the we ak and
in ..go,i ,o ur.
th.t sal,e result will not occlrr when we prbcled
.o,"i;;;il;i.r;;;:i,;;ij'i'J .c,re,r,hcr.r,
besides goorl X and the contposite
ro g.**ii*, i..., *rr.n wc t.ke rrore comm.ditie s
co,,rodity -or.y allow the price oI m.rc tr.r,,
vary' But as lo*g as we limil our a,alysis one goocl t.
to the de,rani to,. u ,ingr. .orr;;;,;;;;cacir the sanre
 20
we assume strong or weak
in respect of the presence or absence of consistency whether
conclusion
ordering.

DERIVATION OF LAW OF DEMAND

Hickshtusderivedthedownwar.dslopingdetnandonthebasisofwetrktlrderingolconsumer.s de,r.,ded of
choice. The law of dernand says-that
* pr.-i.E olt ,, "on *odity decreases, the qutrntity
ctranflt'o*tut'-r'u1.t1o kind of eftects on the demand for a
rharcommodity increases. The prtce accounts for the law
eft'ect a,d it is the ltrtter wrrich
com,rodity, viz, income eff.ect and substitiiion separating
problem, therefbre .".""rirr.o i1 rleriving the demand curve is of
of demand. The first ha^s been sought by
effects of the pJce chaoge. Sorutions to this problem
income and substitu,i*or
Hicks tlrrough hi s #.;fi ;;il;;;; i;;#ffiil ;Js amuers onr s " co st di rrere,ce meth od"
METHOD
THE COMPENSAT]NG VARIATION
Hickshirsuseddiagramtoshowtheeflbotsofchange!lrir:eofXonthequantitycletrranded M and the horizontal
axis measurcs the composite commodity
of it, as shown inFig.z.1 .Vdrtical t"*:le' the consumer
soppor" g1ri, ur9 nric.11.of T *9
M'
axis msasures the commodity X. Td]l:
other things remaini,g the stune'
scr
position e orirr. hne Ma. No* ;;,,,. ilce of X
crrooses f'all, positio. on trris line will be
t'at the new oppor.r,,ity rine is Ma. si*. the consistency theory' Therefote position B on Ma
rrau ries outside Ma, any
from
pref'erred to position A on ma: it tbllows the sr'rbstitution
rrre preierence for B over A is aciou.tecl fbr by
is prererred to positio, .A o, Ma. compensiiting
price ori. i, I"irt. income eflbct be now removed by
and inconre eftects of the r,alr suppose
f1ne, Ct, pt*rrtr with inco,re eflbct removed'
variartion method by drawi,g a lo-M^u'
Hicks' is indifferent to A'
position as selectedl;hi;h alcording to
Σ メ″
う。Ｅ Ｅ 。０ 。″

Fig 2.7
一∽。。Ｅ ００

o Commodity
CommoditY X

to bc iniJillbrent to Ar'
A has the properlies thtrt .uc'ecluired
Now it can be show. that position reast lor lwil
variation ii,e cb must intersect Mu, ^t
For A to be inditferent to Ar for compensating
[easons.

a)IfitlieswhollyoutsidetlrelineMa,AwillbepreferredtoAl,trtrd
b)IfitlieswhollyirrsideMa,Awotrldbeprefer.redtoAlAlter:ratively,posil'iorrsAarrdAlcan
at the cross' and A (oI A)
if (i) Aand A1 both lie outside the cresol (ii) A (oL At) lies
be i,diffbrent consuurptio, of X tends tct
rie atthe cross. In all these c^ses, the
ries o,tside thd cross and (iii) both
result of a 1a11 i, price of X' Tliis
is wlizit law oI der,and stlys'
increase between A a,d Ar, aS tr

COST DIFFERENCE METHOD

temovitlg tlte incotne
consuner's hcoure lbr the pulpose of
The cost rlifl-erence rnethod reduces purchase conrbinati.* A o1'
of tall i' the price, so that it leaves the consumers.iusr aure td
eftect ol ltis ctlnsttmption at
the dittere,.. b.t*..'", the ctlsts
goods. consumer's incc,me is thus ,",tu..Juf have Lo pitss
price. The llcw oppoilLurity rine cb. the'elir.c
positio, A at the ord price an6 at trre new
 2\
through new oppoftunity line. CL. I , rs;ition A has the properties needed tbr deriving the law of ciemand.

Σ メＬ ＯЭ Σ Σ Ｏｏ  Ｏ
Ш卜一
Fig 2-B

∽ＯαΣ αＯ

- Commodity X

Position A is an intermediate position. Since position A lies trt the cross. A cannot be to the leli
of Ar because it will, in that position infiinges the consistency test. Tlerefbre the possibilities that
remain are (i) that A is to the left of At, and (ii) A and A1 coinside. In either case, the consurnption
of X tends to increase as a result of faIl in the pdce, of X, given the consumer's income. It shows
that undel this hypothesis too, the substirution effect of a fall in price of X tends to increase its
cousumption. This is what is required to derive the demand curue.
There is a distinct advantage for cost differcnce nrethod over the compensating var.iation method.
While urder compensating variation method, measgring the magnitude of chapge in i,come is
quite a problem, under the cost difference method measuring cost diflbrence raisei no problem
at
all as its income elfeot is quite easy to handle. However, Hicksadheres to the compensating vadzition
method by arguing that in the higher rcalnts, demand theory has more applicatings of substittrtion
elfect than income efl'ect.

INFERIOR GOODS GIFFEN GOODS AND LAW OF DEMAND

According to the law of demand the quantity has a negative conelartion with changes in p.ice
and positive correlafion with rise in incotne. But in the case of inferior goocls the consumption
decrcases with the rise in income, lbr they are rcplaced by the superior substitutes at higher levels
oI income. Sirnilarly, when the price of such goods decreasestheir coruumption again tlecrcases
Technically speaking. The income eff'ect is negative in cases of in1erior goods. The income elTect
is not only negative but also it outweighs the substitutions effect.
The inf'erior goods.fbr which there is direct price-demand relationship are known as Gift'en
goods' Thus Giffen goods, which are exceptions to the Mamhallial law of deprand can
occur when
the tbllowing three conditions are f'ulfilled

1) The commodity must be inf'erjor gootl with a negative income elasticity of significant size.

Fig 2.9

Commodity X (Giffen good)

 22

ii) The substitution el'lcct. rttust bc smll!.

iii)'the proportiorl ol'incotrte spctlt Lrpon int'erior goocl nltrsl be lalgc.
'fhe Gill'er good case is demonstrated in tig 2.9 where the position ts lic to left or original
position A indicating that there is decrease in demand olthe good X as a result in price.

APPRAISAL
l. J.R. Hicks in lis Revision o1 Demand tlieory basetl on weak logical orclcring uses the
methodology of preference hypothesis and abandons indiff'erence cllrues. Besides the
innovtitions of logic of ordering he coneots tlie mistakes ol indiltbrence cllrve analysis, ttamely,
continually zind maximising behavious on tlte part of the consumer.
2. By basing his thcory on weak ordering which recognises the possibility of indiff'erpncc in
cousLrmer's scale of plelbrenceHickretainsthemerits of indilfbrencecurves ittltis ttewtheory.

3. Evel by aban<loning the unrealislic assumptions of iridill'erence curve trnalysis Hicks in his
levised tlieory splits thc price efI''ect income and sr"rbstitution el'fects and so it could itccount for
Giff'en's paradox wliich revealed pref'erence tlieory could not'
.1. Fr-rrther', by separating sr.rhstitution ell''ect liom iucome elfect with the weak ordct'ing approach,
Hicks has been able to explain complementary and slrbstitllte goods in his genertlised versiott
ol dcnrand thcory.
But l}om the view point of pragmatists, an impoffiuit questiotl wllic:h nlay be asked is; Do thc
discoveries made by Hicks in his new theory of demand' make any siguilicant contributioll itt
regard to its applicability to the practicril problems of r:eallil'e ? In answer to this question, Machlup's
t.emalks ile wofth mentioning, "By pragmatic tests,..... we shall hardly be :rble to claim any
impofttrnce fbr Hicks discoveries. They will in no wily eftect ally l'ecommendzUiolr of tlte past"'
But all scholarly and theoretical worts should not be, and cannot bc, ttlways iudged, accepted ol'
re.jected simply on thc basis of its appliczrbility test. Hicks deserves credit for inlproving tlic
theoretical content of his demand theory and also fbr keeping the interest alive in thc thcory ol'
consumer behaviour.

OUESTIONS

Essay type
l. Critically examine Hicks Revision of Demand Theory
2. E.xaminc how far Hicks has been able to tlerivr-' theory ol'demand basc<i ou weak ordering and
prel'crence hypothesis.

Medium type
l. What do yon know about Hicks' logic of ordering and prel'erence hypotlresis?
2. Give a briel accoullt of the direct cotlsistency test of Hir:ks.

Short Type
L Distinguish between strong and weak ordedngs of consumers.
2. Horv did Hicks atttrck the strong ordering of Sarnuelson/
3. What is thc logic of rveiik ordering in den.rand theoly?
4. Can you explain Cil't'cu's paridox u,ith Hicks't'evision o1'Detuattd thcoryl

NEUMANN - MORGENSTERN HYPOTHESIS

In thc post wilr pcliorl there has been firrthcr devclopmcnt in utility theory. These ntotlern
 ,23
devcioptnents in utility theory analyses corlsumel's behavioul when as indivirjual has 1o choose
among risky and uttcertain alternatives. In this l'especr lll credit goes to Von Neumann ancl
It4otgcstern tvho in thc cottt'se of tlreir r,vork.on Game Theory provided a carr1ilal Lltility lleasllre
fbl'ilre rankitls of Situarions involvinq probabilitics, that is, l'isky ancl uncerttrin situations. This
ntodcnl Lttilit)'theory or analysis is also sometimes knorvn as Bcluoulliap utilirl,theor.1,afier Daniel
Bst'llriulli, thc iStll cenLury Srviss nrathemilticiau w'ho got intcrcsteiJ in thc prJblem knsq,n as,,St.
Petersburg P.rrildox turcl pror,icled hypothcsis lor resolving this palirtlox.

ST. PETERBURG PAHADOX

∽∩Ｚく∽⊃○ エト Ｚ一ШΣ ００Ｚ一

Fig 3.1

o 'i*"oi,? ,* iiorrlo*o.3l rrr'3., " 24

X

St.Pctelshuig paradox rel'crs to the pr.oblenr why people are unwilling to make bets at bettur
tltan -50--50 otlds whctt tlieir inalhematical expectation.s of winning money in a par-ticuliu.type
ol'
gatltblc, ilrc gl'eilter Lhart the ntolley they bct. The gaure in St. Petersburg paiatl.x
is one that
|i:qltit'es the lcrsslng of a coin LIntil it firlls heads up, then payltlent equal t6 2x is macle
rvhe rc x is tle
iiittnbcr ol'tintes, tossing is done to a head. Bemoulli provitled a convincing explanati.n oI'the,
-cet
siiid bchal'iottr ol'rationll inclividual. Lrntler lisky and uncertain situations an indivirtual takcs
tlecisions on the basis of expeuted utility rather thtrn expected rnoney value . He ltrr1ler
contendecl
thilt l)lal'gillal utility ol'tnr)ney to the individual declines tis he has morc of it. The gr.apliic
illustration
-tir:cn itr Fig.3.1 will r-nake clear Bertroudli's scllution to the paraclox.In the g,upl f-axis mcasurcs
tlLliitttil.y of money (in thousaucl of rupees) and on he Y-a-xis marginal utility
of moncy is measureiJ.
Stippose an iltdividual has Rs.20,000/- iurci he ellters into a bet il even otlcls (i.e.,
50-50 orlds). If he
vr,ins thc het, money witl him will rise to Rs.2l If
,000/-. as a lesult of ln increase in money with
iiirll thc expe(rted tllarginitl utility of extra one thousand rupees to lrinr rvhich is depicted by
tlre
ri-'i:tanglc CDFE is less than the extra miu'qinal utility ol the previous oue thotisald (i.c.
20t1
ihousand) tllpees r,r'hich is rneilsur.ed b1,the re(:tiugle ABCD. In othcr wortls, the gain
in utility in
t asc ol'his l'inuint the bct is lc.ss than the Ioss ol area the same in tcrms
oJ' r,r,rr.y o,r,,runt (i.c. Rs.
i"0(x)) 'fhus givcn the tnitrginal utility o1'tttoney. expected Ioss of rrtility hln thc tSousands
i'lrpecs illvolvcd irt l.lte bet, it rllionai individual will.. therelble, not
make a bet with -50-50 odiis
N-M METHOD OF MEASURING UTILITY
ivlakilg ttsc ol'Be rrtottlli's idca that under risky anrl uncertain prospccts as in berti.g
, ga,rbling
:tnd purchasing lottery tickets etc., zl rational inclividuzrl will go by the
expected utility rather than
expected mone)i valuc. The choices by an individual under risky and urrcertain
situirtion depel<l
on thc N-M utility index (i.e cxpected numericerl utilities) and its behtrviour
wjth the chanses in
nolrey iucome.

ASSUMPTIONS
This rncthod is based on the following assumptions.
( i) It is assttnred tliat the individual possesses zr scale of pref'erences thrt is quite comprehensi,e
and cornplete.
 24

(ii) The ildiviudul cal always say whether he pref'ers one even to another or hc is indilf'ercnt
between the two.
(iii) It is llso assurned thm the individual's choices are consistcnt.

The first step is to state the numerical probabilities of uncertain everts ot'acq-triring adtlitional
money. Suppose sornebody purchirses a lottery ticket. Its l'irst plize is Rs. -5,000 aud supptlse
he will -cet
solrebotly purchases a totteiyilcket. Its first prize is Rs. 5,000 atrtl sttppose if he losses
Thc probability ot his winning
a consolation prices of Rs. l0 Further sllppose the odcls are 60:40 ie.
(genertrlly callcd
is 0.6 and the probability o1'his losing O.+. Witt this the expected lnoney vaiue
foL probability of
he standard actuaritil evaluation) of lottery ticket is p(w) +1-p) F, wherc o stands
winning and w the rnonetary amount of the first prize and (l-p) the probability of his losing
an d

therelbre of getting the sonsolation pdze of monetaty value of the ticket'

=0.6(5,000) +(0.a) 10
=3,000 +4
=3,004
The expected utility of the above lottery ticket is
p.U (w) +(l-p) U(F) where U(w) is the expected utility ol the tirst prizc artd U(F) the Lrtility ol'
thc consolation prize. The expected utility ol'the lottery tir:ket is
0.6 x U (Rs.5,000) + 0.4 x U (Rs.l0)
Now let us attribute ar.bitltrrily the utility of Rs.5000/- as 500 util and ol' Rs. l0/- be I Lrtil.
With
this expecte<l utility of the above lottery ticket = 0'6 x 500 util + 0.4 util
= 300 utils + 0'4 utii
= 300.4 uti1s.
I1the above example let us ask individutrl x as to with liow muclt sure sum of money and the
the
above 'lottery ticket *itl, tlr. given prize and probabilities he would be indiff'elent. Suppose
i,dividual reveals that he is indiff'erent between Rs.3,000/ - itnd the lottery ticket. Then in this casc
the certailly equivalent is Rs.3,000/-. Therefore utility of Rs.3,000/ is equal to the expected
utility
qi the lottery ricket. i.e., 300.4 urils. Thus for the individural utility index ol Rs.3,000/- is 300.4
utils.
Hence amount Rs.l0l Rs'5,0001 Rs.3,000/-
Utility l uti1 500 utils 30():4 utils

Likewヽ e,by using tlle"oVe prOcedЧ Кutility index ofother sums ofllloncy cν be Calctllttcdi
v a curvC,
n this way a serics Of N― M utility indiccs can be calculatcd which can be used to a dra、
【

CONSTRUCT:ON OF OTILITV iNDEX

utilit,轟 dex Oan be¨ lsⅢⅢ Ld ly C,lCJttillg■ 9 ce■ 減llty eq.lliv諷 ■ tS alldilldr respcOtive
lltilitiOs, ′ i l .` ￨ : ` .￨ }‐ ￨ ヽ :
suppOse aper"ル Xe,teお lintO a ga面 blelwhiChiiay enablじ hi興 Юttlrn OFRs.10,000/

謂蹴F‖耀鷺[淵翼鮒憮 蒲瞥よT籠潔‖ 職鷺:!瀾%il縄

"get a
l「
gain will be expκ ssed as Outils.The prouわ ility of winning the ganlble is O.5 ands,the probability
is thc ce■ 洒nty
oflosing is ttso O.5。 MI.XInderquestioning giveS tllC info岬 面 on thtt Rs.4,000/―
C.J維
I馬 言
懲 「l:繕 I聰 祥
lIF思 1淵》 『温扁翠瀧il置;:嘉晩 .】 lily
utility nunlbers are substituted in the equation tlle iestllt is O.5x l()utiヽ +().5 x Utils=U
(Rs,4,000/‐ )ThuS Rs.4,0()0/― has 5 utils.
 25
To get morenumbers, the sameprocedure is repeated tbrothergambles.
Take one fbrRs.l0,0fi)/
p of winning 0'7 and p of losing is 0.3. ui. x says
. there thar thi certainty equivalent of this one
is Rs.6,000/- because of the more favourable probabiliries.
The calculated ;tihiy ,r nrr,6o6l-
utils' Two more gambles will give two mor. uiility numbers. one
iri
is Rs.zo,oool- ti,r, u p of winping
of 0.33 and a cefiainty equivarlent of Rs.4,000/
For Rs.20,000/- the nuntber is l5 utils. The last gamble for
Rs.35,000/- hius a p of wilning of
0.33 and certainty equivalent of Rs.6,000. For Rs.35O00/-
the index is 2l utils. Tire gambles and
theil results are given in the tbllowing table.

Utility Celtainity Equivalents

5 Utils Rs.4,000
7 Utils Rs:6,000
10 Utils Rs.10,000
15 Utils Rs.20,o00
21 Utils
Rs.35,000

Based on the above table the utility index curve can be constructed. Take the utils on the y_
axis and the certainty equivalents on X_axis. All the points are joined with a smooth cul.ves irs
shown in the lig 3.1
Ｙ   ２
。

15
のヨ ト つ

１
。  
 

Fig 3.1
５

THOUSANDS OF RUPEES

The total utility curve'in Fi-u.3.1 rises at a diminishing rate.It is because

the marginal utility ol.
money din-rinishes' Tlie Neummn Morcgenstern method,
therefbrc, yields meiLsures ol'cirdinal
utility' either conceptually or as the outcoires of actual tixperiments.
Their cartJintrl is not, h.wever,
iclentical with the older Neo-classical c'ardinirl
utility. Tile present method does nor nreasurc rlre
strength of f'eelings toward goods and seruices.
All that NM method can do is to illumirare the
actions ol' a persons making choices in the face
of risk. But bt-"penii;'* ,r.* orssibilities ot. ':
measLrrement, Neuntann and Morgenstern have given new Jrengttr to the older i,r.u
Cardial Utility. orfr.o;tlili
CRITICTSM
The linitations of Neumann-Morgenstern hypothesis
arc given below as criticism:
(i) The N-M utility intlex is only a theoretical concept
measuring utility. It provicles a basi,s
indexing the expected utility revels under rn..,ruin *rr
conditions.
 26
illt:'rt'"
(ii), It does not fileasure the interisity of introspectirre satisfacrion or plcasure ',r'tr*'dctti;rit'l
good lheorv'
which does not explain tlie intensity of demanrl. can not clairn 1o hc
btlt
(iii)In Neo-classical studies utility actual md :rbsoluterleasurelncnt 01'strcngltil o1'1euliii5':
here it is used in an opeiatiotial'sense'
ploviding a basis ft.ri'
utility serves al.rseful pLlrpos9 b1'
The Neuma*n-Morgenstem measure of
iu'olved, in s;pitc of
ratiorJitrin6rrg *JprZoi.iion, particularly where uncertainty'anc risk ilre
the fact that there is arr arbitaries in the method of computing;
utility in'Jex'

OUESTIONS ,

Essay Typd
L critictrlly explain Neuurann-Morgenstern hypothesis as a theory ol'demittlii inVoiYirlr: I isk'
2. H0w dcl you construcl ulility irrdex'? Erarline the behaviour of rl corlsuulel' rn tht titirt'kct rvilli
tlie help of'a utilitY index.

Medium TYPe
1. Briefly explain St.'Petetsburg paradox'
2. What are the a.ssumptions of Neumlrnn-Morgenitern Hypothesis:f
3. How do you construct utility index?

Short Type
L. What do you meaD by certainty equivalent'?
2. Point out some limitations of Neumann-lt{ofgenstern h,vpothesis'

THE FRIEDMAN口 SAVAGE HYPOTHESIS

『
‖崎織Iiば ∬
Iり :出 席i∬
(器
露 llⅧ k盤 盤ピ
‖ヽ II‖11∴ ボ
1嵩 l艇 ;ア ::『

1徽憾 鸞 撤 脚 IIざ
撻様 鱗 幾Fll鱗
姜
灘
avoid risk alld ofindulging in ganbling ald■ lcrc 灘 器∬i点 蹴蟹品1柵 ‖
F淋 1
dcpicted in ig 4.1 .
γ l L
﹂０ ＞トコ 一

＞ ШＺ Ｏ Σ
卜⊃ コく Ｚ一０ 匡＜ Σ

Fio 4_1

Y:
 27
MU is the Marginal utility of Inoney alrd it is a roller - coaster
cur1,e ha'inu lhl,ec sesrn.nts
indicating fioni lelt_ to. right, dirninishi,g niargiral utility
or ,rron.y io.";r; il;.r LM r,vliic:h is
to income level o1', the segment MN which
is upto income level y,y, an<i the segrucnt NH whiclr 'p is
inconre higher than Yr. In the first segment marginal
utility of money dirnishcs i. the scc.^d rhc
mar-einal Lltility incleases iurd in the third
again the marginal utility diminishes. An inciividrurl at
ittcome level A would be induced to buy insu'ance rhc
and thereby avoid risk since thc paymenr u1.
insuremce premium is srnall as compared
with the loss of utility he would sufl'er. rvithout insuranc:es
'tl'ith such an income intlividual will be unrvilling
to take tirt. in a gar-nble or riskl, i,r,csr,re .ts since
the gain in utility tbrrn any income will be
snialler tliiur the loss of utility f)onr it. At tlrc iuconle l*vcl
oB r'vhich is rrliddlc inconle'se-qnlent IvIN the money incomc is
increasing. l{cr.c lhc i,di'iduli bu,s
lo{tcry tickets, indui-uc in ganlbling or undertake iisky
invcstr}lcnts sincc thc grrin ip utilitv h..,r r_-xna
lllollc)/ will bc tnuch gtcatct'tllan the loss clf utilityiiom
thc srnall paymculs lgr, lrttur.-\,tiukct (il.
0'om equal molietary loss itt a gamblc. At y,
incoure level the marginal urility agaill dcclinr]s.
result ol'this he will be unwilling to tirke risft except As a
at very tlvourable odds .

APPLICATIONS
The applications o1'Friedmiul - Savage hypothesis
are fbuntl infields ol'prod*ctior, tiistr.ibution
and excha,ge, particurarly when the <recisions
ale taken rationary.
(i) Inn rationai decisiott, the probabilities of ;^ucceSS and
failure are .joned rvilh the i,dcr
utility' An enttept'eneur is encout'aged to go iihea<l with '1,
an investment or.pro.iL'ct il'thc cxpccted
-sain in utiiity excee<is the expected ross; decri,es if it is vice versa.
(ii) There are clil''ferent classes of people in a .society. Anrong them
ricir ard po6r. ciasscs 5ar..e
diminishing utility lbr money income. on the 'other
hand the middle class IrrLve i*cr.easinLr
utility fbr mone1, income. The dcher.cla.ss buy insurance;
the rniddle .f rs t r-r'i,,;;,;, ;;iril:
in ganibling or unclet'takes Iisky investments. The poor
which involve less risk.
r -r-- ,1"
p."pr. -'' pr*i,r,r.",,r,\,
t'-" (jorrlro(lirics

(iii) whcn ncw dur,ble coluttrodities likc ceme,t,

asbest.s ctc., al'e iutroiitrccd int. thc rrurket thc
rich and poor classes with not buy thern. on
the other hancJ they will buy thc tr.,tljti.,iLI itc*rs.
The items of the ne\'v companies ale avoided
mainly because of the risk involr,.cil: but tlrc
middle class people will truy them if they are
cheap.
(iv) Even new collstllner item when introduced
into the rnarket the shop-kcepers/r.cprescntalives
can move them very ezrsily among the middle
class people
(v) Salesmen have to spend more time to push
their costly corrunodities to tlre rich customers;
even then their attempts will be in vain. on
the other hani they can easily seil suclr c,,u,odities
to the middle class customers.
Friednian and Savzrge think that the curve or:
muginal utility of money incrure indicates the
behaviour of people in difrblent socioeconomic groups.
of course, they ailmit tlat there ar.e nrany
dillb'ences anlong- tltc-pe'sons within the same
socioeconouric gro,ps s<l,re have grcat pre lcr.c^ce
lor. garnblin_q the others unwilling to take any
risk at all.

THE MARKOWITZ HIPOTHESIS

Neumann-Molegenstelr hypothesis suggests
that thc marginal utility ol,luoncl' djnriuishcs for
all people and therefbrc thev are u,wiliing t-o
,rar<e riii;.;;;;:T;; ilil;'-';;i.,,*. hy,p.thcsis
nrakes the conclusion that very rich an<l
very poor people have dirninishing mar.ginal
therefbre they tefrain florn lail bets and utility rurd
only tlre niido'le class people have i,creasing ruargi,al
utility fbr money income and they alone enter into
bets. Even though these are the clainx u,e
a widespread practice of garnbling among rlnd
the people all over the rvorld. I\4ore ovcr, why sonre.
irrespective of theirclass prelt'to make
ciroices.,rd.r r.,y iirtv sitrrar.iors such as i, ;r gamble
raco pttt'chasing of commodities of new or
compiuries '/ Arc tlrese peopie irrational aucl
thouglrrlcss,/
 2lt
questiolls'
prof.essor Markrvitz gives nrore retisonable explanation for these

Changes in the relative tevel of money in'come 1

hypothesis ASSLlme tltat mu'ginal
Neumanna-Mofegenstern hypothesis and Friedman-savage
on the oiher hand, Mnrkorvitz has tried
ut,ity of money oepe'n,ts o, the-absolute revel of income. devizrtions liout
and also deluge in garnbling' He ttrkcs
ro explain why most people buy insurance According
the auitude of trre people towzuds risk'
the prese,t income ortne inoividual as determining
to Markowitz hypothesis, with smalr increases
ii in"ome increa-ses but large inc'czrses in incot,e
the other ha,d with s,rall decrcascs in incotnc
yield di,ri,ishi*g *;rgr;^i uriti y of money. On yield
increrues but large dect'cases in i,come
from the pr€sent level *a'ginal utility oi'-roor-,.y
diminishing marginal utility or money'

ILLUSTRATION OF THE HYPOTHESIS

N,Iarkorvitz hypothesis is ilustratetJ in Fig.
4.2i,which trrc curve N4U or'nrargi,al utilitl',ol'
MU rrtrs threc in,ectio* points. A B a'd c .nd
,ro,ey incoure is shorvn. The mar.gi,al ut,ity"curve
two int'lection points and th.cc sc.gnlcnts in
N{u
l'.ur. segureuis BC, cH, BA tirld AL u, u-ooi,..t As thc
iorn ligurc 4.2 is the prcsent rc'cr .r'irc.rr-rc.

・
curve ol Friedman _ Savagc hypothesis.

■
yo to y2, ,iargi,J ,t,ity of money incrcascs along BC. Hou'e'er'

´
person,s incorne increases iorm
y2 yicld tliminishing mirginat utility of money. on the othcr haud' stnall

・
increases in incomc
yo to yieti incr.Jasing marginalutility ot *roney b*t rugc decreases
decreases in money i,rco*re fro,r
ittinconte,thatis,totlreieflofYlbrirrgabor'rtditninishirrgrrrargirralutilityoltuotrey.
Y
﹂０ントコ一
ШＥ００Ｚ一＞ШＺＯ
卜⊃ コくＺ一
０，匡くΣ

MONEY INCOME
of
to Martowitz, yield risirlg urzrr-einirl utility
Small incretrses in mo.ey income, accorrling
yieldlirnl,ishing-rnargi,al utility o llloney' Therefo.e
money; but large increases in money income take risks in'olving
srrrati tai,. bets butwin be rcluctant to
the individuar will be willing to accept marginar utiiity ol'
smarl decreases in income yieid risi,g
lzirge amounl of money. Similarry, si,ce
otilitv, the indivirl,al wilr be cagcr t. i*su'c
agai*sr
money trnd ltrrge ones diminishing margirrui
lisks in spite of heavy losses. ._.. _r ,.-1
siroitiosrer; but will inrlulge in very high The
rt^owitz hypothesis has a great it'tlpotlttnce
Iir the theory of constr-mer behaviour it e ivk pcoplc
people with a sliglit increase in their ittcome
will tlakc pttt'chtrse of flsky itcnrs' Brlt the
is becausc
tliought to pulchase such risky itcnts' This
having increase in incorne will have second is 1ltc
havc risiirg'rarginirl tttilitY.l'ttt,uey r^'herc
the peoplc having small incretrsc in i*cor'e
ltave diminishirtg nlargirlirl trtilitl' ol' lltottcl''
pcople having Iarger increase in money iucotne
ヽ 

QUESTIONS
・

Essay Type
evn the widespread p ractice o1'garnbling aln()llg dil'ie r:ertt
'^"':f '' r"'nnthpcic explain
I . How diles Markowitz hypothesis
. classe.s of PeoPle ?
●    ヽ

.2.Howdoyotrl.eltrteFreiedman-Sirvagehypothesiswitlrtlretlreorytll.oonsunrct.sbelravior"rr.l
 29
Very short type
I . What is the practical importance ol Markowitz
hypothesis.l
2. What do you merns by r.oller. _ coastel curve ?
3. Why do 1,ou say thrt a consrrmer in market is like a gambler,l

RECENT DEVELOPMENTS IN THE THEORY OF MARKET

DEMAND
(i) The Pragmatic Approach to Demand Anatysis
Many u'riters have criticiscd lhe practical uselulncss ol earlicr tlteorios
ol dentand. l\,losl ol
lhcln ale lhcoletically intprcssive bLtl uonc ol lhcrl could expldn
the corriplexilics ol lhc r.eal'
tu',r'ld sit,ation This nccessitatcd sorne practicar app.oach
io thc thcor.y ,,r c,nsunrcr.s trcha'i.Lrr.
ErerrboJr ilcacpts tltc tirrrLllrrrrCntll Juu 0l {g111n,i (|n tntsl irnd
lr) )trriilled dCt)lirnd I.Un(]tl,,nj
directly lln lhc basis ttl tttarkcl dilta with()ul Icfe[encc to thc
Il]cory ol ulility and thc bchar irrrrr rit
indiVidual collsulller. Dctnancj is cxprcssed as a rrulliyirrilte
1unction is elstirnatctl wilh
cctlttotttclric nletltods. Such rlerland llrtctions reler to lhc nrarket
beliaviour ol cr)lrsur]lcm. 'urr,rrrs
ll is lo
the behaviottts of itll cottsrttlrcrs it.s a gl oup, and no1
to the belraviour of s iDgle individuals - It is also
to be noted thal in Dost cascs the demanti lunctiols [efe[ to a group ol' corlmodities, namcly,
denrand tbr' lbod, consumcr. durables, etc.

There ale dit'llculties which arise in estimating demaud

lurotions. Iu6cx nunrber.s arc uscd to
agglegate tlie delltand ol individuals and their commodities.
But tlierc arc problcnrs in thc st,tisrical
estilnatiolls oldelnaDd llnctions. The most important
of these dilllcullies alrsc lirnr t hc sinrullaue.Lrs
change o1'all the detelminants Suclt a change nrakes it
extrcrncly riillicult tg asscss thc inllucncc
ol cach individual laotor scparately. of coulse thele arc now
many sophisticate6 lcchuiques to
eslitralc the variables deruaud lunctions.

CONSTANT ELASTICITY DEMAND FUNCTIONS

The con.slanl claslicity l1'pc ol denrancl fiulctions has bccu
. wulcJy usetl 5v e,c.,.nrcrrici:rrs
anrl ils lirnction is givcn hcktrv:

Qx = h .pxr'r.p r.yr .c.-

Whcle Q,, = euantity tlemanded of comrnodity
Px = Price of X
Y0 = Consumer's aggr.cgatc income
c'*, = A tl.end lactol. lbl. tilstes
br =
pr.ice elasticity ol'dentand

b: = Cr.oss clasticity of tlcmand

br = Incontc elasticity o[ derrand
b,' = Zclo hrurogcneity rlcnoting no rnoney illusion
Thc telnl cttnstanl clcsicitv ilcntand lirnction is due
to the lact thal in this Ji)nrr lhe clasticitir.s
,)l LlCnlilnd lrte iNstrttretl l,r ti,rt::rr errl;q1.,a,.
The ildvocalcs ol plaglll:rtic approach exprcss the
deniand lrncliol) ill a way to irrcorpolale lhc
assulnption of 'no monc1, illusion' postulatcd by the
tr.aditl0nal lheory of thc consurncr.. Tt ay a.l.,
the denland as a honrogcnons .lrnction of dcgr.ee "*f
zero. This trrx been cfrected b1, irt,"a,oi,,!',.",,r
income and rclative prices in the functions, tliat is

Qx=件
)Ы 件半皓)"
 30

where p is general pr.ice inclex. tn this lirrmuliuion it is obvious that

if
priccs ttttd ittctttltc
quantiiy demanded ol'x will nol chattgc'
change by the sal.rle proporlion, lbr exalnple 5 perceut, the
ol'the r.elative priccs atid rcal
bcc,use -s pcrcent rvill appear in both the numerator and denontinator
ir]come, and'theilce will cancel ou1. The nerv quantity demanded
will be the same as the initial onc:
tlilre is no money illusion in tlre behaviour of the consumel'.
DYNAMIC VERSIONS OF DEMAND FUNCTION

i) Distributed' Lag Model

litttctions in cl1'natllrc
A rccent development in demand studies is the expression of demiud
the quantity denianded and ol'iucolltc
form. Dynarriic dcmand ltnctions inclutles lagged values o1 genc.ally
as separate i,tluencing the demanJin ury particlllar period. It expresses the
'aritrbles
curlent pgrctrtrsing decisions are inf]uenced by past behaviour'
lccepletl itlea tftat
-fhe behaviour depcnds ()l) past leve ls
most common assunrptiou ol'this urodel is that cutrent
tlurahle, past purchase cottstittttc it stock
ol'inconre and past levels o1'demantl.If the comm0dity is
purcltascs ol'sucl.t dulablc' Il'thc
.l't5is col]rnrotlity wlrich clcarly afl'ects the current (and lutr"rre)
past pulchases elect a habit which is uccFri'ccl
conrnrodity is non _ durablc (c.g. tclbacco, [ood, etc.)
the level ol' pttt'chases ill plcvit)tls
hv bu,ving a*d consnming theiorumodity in the pasL, so that
Incorporatitlg the ittl}'rcnce ol'past
per.iorls influcnce tlic currcnt (antl tutule) pattelns of demand.
l'unction is a way for reudering it dynarlric'
decisions and decisions and experiences inthe demantl
past behaviour af'tects the present is
Another usual assuntption conceuring the way in which
have greater inccluence on present
tliat the more recent ol' past levels of income or demand
people are nlore inlluenced by
collsumptioll patterns than the more relnote ones. For extunple'
rive or ten years ago. Functi.rrs
their i,come in the last yetrr than by the income they earnecl
vtrriablcs a'e called distributed - lag
incrudi*g ltigged values oI demand, of income or any other
nrodr'ls.

ii) Linear expenditure Systems (t'E S'

'ilet)
individuatl ctlmntodities' Srrclt
L.E.S. models cleal rvith gl.oups of commodities rather than
These models are ol'gtcat intcrest in aggrcgiltc
grorrps, rvheri addccl, yiclcl rutirl cor-rsumer expenditure.
constttnptitttt lunctiotl' ouc
cc...urctric ,roclcls where they proved deiirable diaggregatiott o1'tltc irr 1954
,t rhc carliesr LES .r'dcls was sllggcsted by R. Stone ol'canrbridge urliversitf
1'htts
which demand llnctiotts itlc dclivcd
svsrc*r rvas tu*uulatctl ou 1he lrirsis ot'a utitity lunction,li'om
subiect to a budget constrainl ln tltis
in rhe uor.nral lv^y 5y maxinrisation ol'ttre uiitity I'unctions
r.ospcct rhe approachot LES is the same as that of
rnodels based on indift'crence cllrves. Hotl'ever
groups of oommodities betweu'n wlticlt no
LES tlilfcrs in such a way tllat they are applied to
is basically designed f or handling
substitution is possible, wliile the inclil'ference curves approtrch

Fig 5.1

:NDiFFERENCE MAP FOR COMPLEMENTARY G00DS

 31
c()li)iir('(liiics which iue sllhtililutcs. TI]e vr'ry nol.ion of indilf'erence curve is
the substitutcs. They
vtrrY luliioil of inclifl'ercllce cLli've is tlrc srrhstitutability ot'the
c:ommodities concegrecl. In tricr the
intliflet'cnccs nlilp of a LES rvoulcl appeilr'as in Fig.
-5.1 . implying the norr-substitntability ol'
groups 01'1hc suttt ttf tlie utilities clerived fronr tJre various group,
ot'coniniodities. For example, let
tls ttssulne that all the corntutldities bought by the consumers are grouped
in live categories:
A Friud and bevorages
B Clothlns

I) i{.rirsc.hold opcriition expenses

I i
Scr viccs (transport. cetellainnicnis, ctc.)
'I'hc total utility is
I u,
,ll Ir = U,., +LT.r,+U,r;r-Ft,;,r_,,*U,e
,

AdrliLiYrlf irnplics tlritt l"lte utilitics of'tlte various

-cloLrps are inrlependent. Lhat r.s r5ar ther.c is
ito po-<sitriiitl'o1'strbstitutitlr orcomplernentar:ilybetwe"nilre'Erolrps
A, B, C, D apd E.
hi I-ES tl'tc corttmodities bought by the consumels ale grouped in broarJ
categories. so as they
;rru cr)rllpzlliltle rvith tl:i: ailditivity
]rostuiate of ttre utiiity lunr:tion. Thris each g,rJup rnust include
all substitrites aild r-oliplettletrts. tn this r.vay substitutes betleen groups
is rulecl Jut, but strhstinrtion
cilti oc!:l'lf tvil-ltitt each gtottp. The. consumers buy some minimum quantity
fi.om each group,
irrespe&iVe of prices. T'ite rrtinimurn quantities are called 'subsi.stence
quantities, because tSey are
the tuittintultl t'equirentcttfs l't;r keeping the consumer alive. . The income
left after expenditure on
tllc mjniirluill (luantitics co\/crcd is allocated among the vadous gl.oups
on the basis of pr.ices.
The int:ome. ol the cL)usunicr.is therefbre split into two pafis: (1
) ttre,stibs^istence inconte,,
whidl is sptnt firrthe acquisilion ol the minimurn quantities of tir. various corlmodities.
antl (ii)
the $upcll.lillllei iiry incontc'', the income teft afier the rnininrum expenditure.
h'liixitnisation of the constrained utiliry function yields the fbllou,ing
demand functjgl.s:
gt .=
-vt I h1(Y-: PrYr )

pl
Where, q I = quenlify dernanded o1'group I
v ! =, nrininrum cluantity of group 1

bl = lnarginal budget share

y1 = conSLl[1er's total income
p = price index of group 1

)' = snbsistence income

12-P,Y,) = supelrunleraty income
The rlenlancl funclion mity be written in a sliglrtly tliffelent
tbnn p,c1, = yi pr + b, ( ),- rpryr)
ttr F'rpendittlrc on ill'ollp I = subsistence expenditure + supernumerary
cxpenditure.
[:r'Otn thii; iiri'm itis t'as)'l() say wh1, the coelficients b, ale nrarginal budger
shales, It is c]car.
is tlie pairrial riclivrrrive.ol' rhe c.xpendirure nn g,.*p with r.espect
:]:::i ?",
Ill('()t)tc.
tti tlre ,rp;,;;,;r;;;;
.

Thcrc arc '.'iirioLrs \/Lllsj()us or trre rilieal' cxpenditure model, rJepending

on ,n. ,orol ot'uiitity
l'unction. \/itttot-ts '*'tit.n; iLssLurre a tlifl'elcnt t'c,rni of lhe u,ir,,y r.rr"tion
and he,cethey,tlerive:r
 32

dil f erent fbrmulation and tlemand f'unctions.

OUESTIONS

Essay tyPe
trom distribtrtcd
Examihe the constant elasticity demand t'unctions and show lrow it is tlil'I'erent
leg models of demand.

Medium type
, l. What is the significance of pragmatic approach to demand analysis ?
Z. Explain linear.expenditure systems in contrast with the indifl'erence cule analysis'
Short type
l. what do you mean by 'subsistence quantities and subsistence income''l
2. Brietly explain the term supemumerary income in the context ol'denland function'
3. Why do you say dynanlic version ol'demancl f'unction is a distributed lag model'l

)
 33
MODULE‐ III

THEORY OF PRODUCT:ON
The concept of productirln lunction plays an important role in the neocltissical
t5eory ol. value
and distribution. The conoept of production is rlelined as an activity
which changes a ggs6 ir.rl-cl
difl'erent goods. Production is sairJ to have taken place if consumem pr:ef'er
the new quantity, new
lbrm or the new distribution, to the old. So a productive activity rnay be
deti;; as o1e wSiclr
increases "the degree of compliance between the quantity, fi'om
and distribution of commodities
and given preference pattern,'.

THE PRODUCTION FUNCTION

The productio[ t'unction is apurely technical rclation which
connects lirctor inputs and outputs.
lt describes the laws of proportion, that is, the transformation of factor
inputs in to pioducts (outputs)
at any particular time period. The production function leprcsents
the technology ol,a firm, an
industry or of the economy as a whole. The production I'unction includes all the tectinicatty ef6cienr
methods of production.
A methotl of production is a combination of lactor inpirts required lbr the pr.otlucti6l
of ope
unit ol output.

FORM OF THE PRODUCTION FUNCTION

A simple
specification of a production fuurction could be
e = I,(K,L) where e is the output ind
K and L the amount of capital a,d labo,r used in the production process.
More generally, the t-unction could be expressed es
e = O (Vr,V2, V.,...Vn) where e ref.ers tr_r
the output and Vl,V2,V3....Vn to the inputs urd o to the functionaf
outputs.
relation between t11g il;;;;
lMPL:CIT ASSUMPTIoNS
Therc are several illlpoltant assulllptions which are implicit in the concept of production
functiOn,Thcy arc fol10willg.

(l) The inputs and outputs ile non_negative.

(2) Only the key indepenrlent variable considered adequate to explain the
changes in outpul are
incorporated in the function.
ＯＣ”ЧりＮヽもお蟄Ｘ肖︶

(3) Valious processes availuble to prcduce any given good

.rccluire lhe strme atl)oul.ll ol. raw naterials.

('l) The production flnction is singie valuerr and continuous
i.e. For every combinatio' of services, there is o,ly maximurn
outpLrt.
(5) The production fLnctiott is a technical concept which would
口お

be valid only on the assumption

that inputs and outputs are measurable in physical terms.
(6) The production function ,describes the vadous efllcient production
possibilities available to a
I'i rttt.

(7) The production function is based on an assunlption

thzit the technology is givel.

COBB. DOUGLAS PRODUCTION FUNCTTON

It is an empirical production fiurction which was suggested
by paul. H. Douglas, and Economisl
and C' w' Cobb, a Mathematician' The cobb - Dougtaiplo<luction
lunction Jrves its ipp.r.taricc
t<l Dougla^s observatiott ol'cettain characte[istics
in a uo.t,r,rr(,r,,rt ol,clata anall,sed. probubly thc
bcst ktttlwn prrlduction I'ttnclion in Econontics is
the Cohh - Dougla^s llnction which takes lhc lirrrrr
 34

corlst:ult ltld ct and alc pos il iYc

e = AaobF where e is autp,t, a & b tire inputs, A is a positivc B

fiactions.
So rn e irnp o rto nt .fe o t t u' e s o.f tlt i s .ftutc tio n u r e :

(1) Beinginalong-linearfbr.rr,itissirlpletohandle.(Inloglrithmiclirrn,thel'ttnctiortrslouQ
=logA+o"loga+ Bkrgb)
(2) Oticn thc lunctiott is tlsed in thc lilrtlr Q = Aab' tn tltis casc cx,{- F = I i.c' thc 1uttctioil sllorvs
collslttllt 1tl ettclt inPut.
(3) The lunction yields di[linishing retlrl'lls to eacli input.

(4) u and B show the output elasticity coetficient for inputs

chiurge in otttput oVCr it
,a,
alld
,b,.
The outpnt elasticity is defined as the ratio ol the relative
relative change in an inPut.
(5),cr, zurd'B, slrow the relative distribtrtive Shiues of inputs'il, and'b'

CES PRODUCTION FUNCTION

class o1'funcl.iou kttor'r't.t irs the LlEs
Anclther widely used empiriczil protluction lunction is the
of Substitution) production function. Thc fortn of lhis ltrnction
is
(Constant Elasticity
q = y [kc - q + (t+k) N-q) -vlQ
Whcre y, k, q antl v are parallleters (1'>0: 0<kcl, cl>-l ) and
L arrd N rcpt'csettl tr'r'o itlpttts

Tlte importtrnt propertiet oJ tttis'Jitnction ore:

()
(l) ttisalineariy,honrogeneousI'trnctirlr-ri.c.,r,vhenIantlkarcitrct'eascrlb1'rrl-l'.lti'thcoutprrl
will be increased bY m-lold.
(2) It shows constant returlls to scale'
alone'
(3) Average product ol either input depends on the input ration
(4) Marginal product to eithcr input depends upon the input ratio alone'
input antJ its cot'respondirtg nrarginal
(5) Euler's thereom holds, i.c. The sum ol the products'of e:rch
protluct. will be equal to the total product'

THE FIXED COEFFICIENT PRODUCTION FUNCTION

prttclltctitlti
production function may lirkc severai l'0rms. one of thcr-n is lixed coelTicient
fixcd prilpotli.tts'
lunctio^. In this casc; the luciors ol'protlttction are used in dcli,itc
a fixed n1urher wttrkers may be reqr,riretl to
produce a irnit / rttlils tll'tlte ptrrdttct
For instance,
Y

/
″′ 300 units of output
コく卜一
Ｌく０

100 units of outPut

 35

ｄ
ａ
ｎ
this proportion cannot be varied by substituting one fac..rr lor
thc othcr lactors. i.e. in

ｈ
ｉ
ｔ

ｓ
production function the technical coefflcient oi production
is fixed.
The flxed coefficient pt.oduction can be illustrated by
the above diagram. Here the capital
labour rali()lt is fixed as 2:3

TECHNOLOGTCAL PROGRESS AND THE PRODUCTION

FUNCTION
As knowledge of new and more efficient methods of production
becomes available,
technology changes. Further more new inventions
may result in the increase ol,the elliciency ol-
all rlethods of productitln. At the same time some techniques
may beconre ineflicient and dropour
t'om the production. These changes in technology .onriit.,te 'technological
pro-sress,.
Graphically the etf'ect of innovation in processes is shown
with an upu,ard slrili 9l,t5c prr:duction
isoquant Fig 3 (ii)' This shitis shows that tile same
outpllt may be produced by less f.ctor inputs or
more output may be obtained with the same inputs

Fis 3.1 (i)

. Hicks has distinguished three types clf technical progress, depending on its cllect on t.hc r.zi{e .l
sr:bstitutiitn of tiie f'actors o1, produciion.

o x
Fig. 3.2 (ii)

CAPITAL - DEEPENING TECHNICAL PROGRESS

Technical pl'ogress is capital - rleepening (or
capital - using ) il, alo,g ;r line on whicjr t'e K/
L ratiois constallt, tlie MRS LK increas.rl Tn. iinplies
,trn, ,..rrnical progress increases thc
marginal product of capital by mole than
the marginaiproduct of labour. The slope
ot the s,itiinir
alons anv givett radiris. rrre cafita - deepe,ing
:i,'"TTilH:T?iT'steep r".r;i.;r;;,;..ji'i:
 36

Fig.3.(lil)

L
0

LABOUR‐ DEEPENING TECHNICAL PROGRESS COnStant W

ong a rmius tllrough thC Origin(witい
T∝ hnical progrcss is lめ our― deepcning if,温 ginal
L ratio),the MRSLK incre“ cs.This inlplics thtt the tcchnictt plogress increaSCS the lllal・
Si■ g isoqtlant
il〕

product Of labour iヽ tCr than tho marginal PrOduct Of Capital.The dOWnwards―

b(光 ollles steeper dOng any g市
Cn radius thrOugi tlle origin.ThiS iS ShOwn in ig 3(iv)

:K

o Fig.3 oV)

躙 皿鰈
NEUTRAL‐ TECHN:CAL PROGRESS

鸞脚 1叩
isoCLiNE

LINEAR PROGRAMMiNG
technique for provitling specilic numet'icirl
Linear Progranlmlng ls a recentlY develoPed
 37
solllti()ns ttt solve complex pro,-ri::i.ns involving the optimal use ol'many rcsoLtrces. [t citn be
considered as providing an operati,rnal method for dealin.e with econonric relationships, which
involve discontinuities.
STATEMENT OF THE LINEAR PROGRAMMING PROBLEM
Consider a finn which has a given quantity of three factors of production with which it can
produce two comnodities, x and y. The problem of the llnl is to choose the optimal product mix
which maximise the firm's prolit.
Let the quantities ol'factors of prodr"rction be
L = 400 units of laborrr (hours)
K = 300 units of capital (machine hours)
s = 1000 units clf land (sclr"rare t'eet)

The lirrn can produce either comnroility x ol courntorlity y with thc lirlklwitrg ar,ailahlc pr'occsscs
(itctivitics ) .

Activity Al

Labour' lx=4 ly=1

Capital Kx=1 Ky=1
Land Sx=2 Sy=5
Tlie production of one unit of requires 4 hours of labour, I machine hour ancl 2 square leet ol'
land. Similarly the production of one unit of y requires I hour of labour. I niachine hour an<l 5
square 1'eet ol'land.

The total profit function may be written as z = 2x + I y where z = total prol'it. .

{ = quantity o1'commodity x or level of Actility Al

Y = qlrantity o1'comnrodity y or level ol Activity ,{2
Thc total profit fbnction is called thc ob.jective Iunction.
The lirm, in pr,u'suing thc maximisation of its objective function, has two typcs ol'corlstl'1iuts - teclrnical
(or flnctional) cclnstraints urd non-negativity constraints. Technictrl constraints arc 4x +ly 400

4x+1y S 4(X)

lx + ly< 300
2x + 5y5 1000
The non-negativity constraints are
x>0
Y>0
Thus the linezu'proglamrning problern may be stated as:
Ivlaximise Z = 2x + ly (Obfective tirnction)
Subiect to 4x + ly < 4(X)
I
I x + I y g 400 I technical constraints
J
2x + 5y 5 I(X)O
x>01
I
y > 0 J non-negativity constraints
 38

GRAPHICAL SOLUTION OF THE LINEAR PROGRAMMING PROBLEM

Tlie graphicll solution inr,olves two steps. Firstly, the graphical detertlitlttliiln of tlte rcgiott ol'
l'easrblu. solutions. Secoudll,. the grapliica[ plesetitittion o{'iiic obiective l'rtnctitltt.

(i) Graphical Determination of the Begion of Feasible solution

A softition is calleti 1''easible when it satisf ies all the constraints. The positive quadrant ol the
cg-6rclinate system satisfies non-negativity constraints. Ifl the l'oliowitlg l)gure 2 (r'i) 'AB' is the
boundary set by the factor 'labonr' whose slope is the ratio of the labour inplrts in the prodttctiou ol'
the trvo commoclities X and Y'CD'represents the boundtiry set by the fhctor'capital' and its slope
is the ratio of the capital inputs in the production of the two commodities. 'EF' is the boundary set
by the factor 'land' ancl its slops is the ratio of land inputs in tlie production of the two colrlrodities.

Fig 3.(vi)

The region of l'easible solutions is shown by the area OEGB which ail the i nequality constraiuts
are satisfied.

(il) GRAPHTCAL DETERMINATION OF THE OBJECTIVE FUNCTION

Arnong zrll the feiisible solutions the firm will choosc the one that lltaxin)ises its obicctive
function, that is, the product mix which yields the maximuni profit. The obiective 1'r-rnctiotl tnay be
prcsented graphically by isoplofit lines. We may construct an isopt'otit line by saving the obicctivc
l'unctitln l'or Y.

Profit lLrnction z = 2x + ly =7I*X+nyY

Wherc nx urd 7ry are the unit prof it ol x and y respectivcly.

lZ― π
x x
Y=
πy πy

The slope of isoprol'it line is frx/xr211=2. By assigning various values to the level ol'total
profit (z) we can oompute the whole lamily of isoprofits lines.

sl:pc ttL:妥 準==2=`

Fis 3.(vi)
 39
(ilr) DETERMTNATTON OF THE OpTtMAL SOLUTTON
The optimal solution is fbund by the point of tange,cy of the ffontiu ,crr'r,e
of the regio, asible
solution-s l"o thc highesE possible isoprofit, curue. The optimal solution
depends o, ih. slope ol:thc
isoprofit line.s. il

ht our cxantple thc optintal solurion is point G in Fig. 3 (VIII)

佃 Ｃ
鋤・Ｅ鰤丼
﹁洲］ ヽ

THE SIMPLEX METHOD

Whcn thc Variablc wltosc values tnust be rletcrminerl fi'om the lincar progranrming
method are
tuot'e thiin 1r't'o, the gl'aphical .soluttott is
tJilllcult or impossible because wc lced rnullirJiLncnsional
diagt'alns' Iltcrative nlcthod lirr reaching the optimal mlution is
callc.rl the sirnplex lnethod.
Asstut]c tha( a llrn-i can produce flve conrmoctities (Xl x2,
procluction (Fl . F2, F3)
, ....., X.5) w,ith threc lactor.s ol'

Tlic kttown tnetltorls ol'production ( processes of iictivities) fbr each produc:t

arcr:
Al A2 A3 A4 A5
Aじtivity Activity Activity Activity Activiry.
For Xl For X" For X. For Xo For X″
Fl ll 13
︲   ｋ   ｓ
５

F2 kl
５

k3
F3 ￨[ ￨￨
５

Sl s3

Tllc ullit pl・ olit of thc llvc c0111nlodilics arc

πl,π 2,π 3,π 4,π 5.
Tllc l｀ il‐ 11l wtints to c1100sc thc prodllct inix that lllaxilniscs its total pl・
olll z Lct tis denotc t1lc
]evcls()1:pl()dし lctioll()iltllc llve colllinOditics by thc capital x lcttcl,、
vith appropliatc stibsclipt.VVc
call stttltc thc lillctll p10gral〕 111lillg prOblelll as fol10、
vs:

Milxinlisc:z=π lxl十 π
2X2+π 3X3+π 4ス転十π5X5
SutteCtCd to lFて
1+12X2-13X3+LX+15X5≦ Fl
KlXl+K22ち +K3X3+｀ X4+К
tX5≦ F2
StX l+S2X2+S3X3+S4X4+Sヽ X5≦ F3
Xl≧ ()1,X2≧ 02'X3'≧ ()3'X4≧ °
4'X5≧ ° 5

にぶ :ll■ illl練 l』 概 Itt11等 iit‰ 距

ぶ ‖1『 塩 寝 糧 謂 激鰍 lcLI脚 l肌 II
val・ lablc'Iぃ vill shOw tllc unutiliscd ullits Of tllc cOrrcsponding fど
ctOr()f productiOn.Tllei will bc
 40

21smany slaok valiables tu therc are factors of production. It is assumed that unutilised t'actors have zert)
pr.otitability (neither profit nor loss). With the intloduction of the slack vtuiables the constraints bectlnre'

l,X, + TrXr+ l.X, + LXo + 1.X, + S,= Fl

k,X, + k.X" + k.X, + k.Xo + krX. + Sz = F2
s,X,+ srX, + s.X. + s.Xo + srX, = F3
The fbllowing exiu-nple ilh"rstrirtes the iteration process which is used to lind out the i'casible
strlut irln.

Maximise Z= 3xt + 4x, sub.ject to

x,+x.<6
2xl + 4x2<21
x.>Ox^>0
t- L-

Let X, and Xo be slack variables. Then the problem can be rcwrittcn its:
Maximise Z = 3xl + 4x2 + Ox3 + Ox4 subject to xr+ Xr+X., = 6
2x.,+ 4xr*Xo=)l
X>,0foLi=7,2,3,4
Here we select two slack vzuiables as the initial basic varizrbles. Then the ori-uin, becontcs thc
initialbasic variables. Then the origin becomes the initial btisic leasible solutir:tl (0,0x3, x4). thc
value ol'the ob.jective I'unctiott is Z = 0 .

The hasis wjll be chauge<j at each interactiort, hence thc nutnher to thc lel't rvill also chltnge.

Tabte (1)

Basic variable Pivot Column

x1 x2
１
ヽ Ｌ ｚ

０
・ ０ ・
１   ２
６   ２   ０

I   １
︲

0
  ０
 

４
２
・

Before moving to the next integrat on, we apply the following tcsts based on Linear
Prograrnming theorems.
(I ) all elernents in the Z - l'ow ale greatel' than equal to (>) zct'o, an optintal solttlion hits bccn
U,
obtainecl. Hence ttrt l'tttlher intcl'ttliotts is ttccessary.
(2) Il,elements in Z row <0 (or negative) fbr sorne cohrmn l'urther intct'ittiotts arc rcqttired itnd
sorne ol the elements ol the corresponding vectot's possess positive valucs. [f all tlie elemcnls
in Z row = 0 solutions will be dellnite.
In this example X1 and X2 are negative aud hence fiuther intet'ations are requirecl.

=-':il::if:n::1"',::i*,r, (or vector) witrr the most'ilegati ve ittz- row rrris variabrc,
wlren increased woukl iucrease Z frus.test.:In this exitmple, the lhrgest rtcgative in'Z - t'orv is -J.
Hence x2 is to enter the basis. The vertictrl column containing the eutering varilblcs (x2) is callcd
the pivot column.
 4t
LEAVING BASIS VARIABLES
Those tlie variable which rJecrcases
iurd reaches zero flrst as the entering variable is
For this divide the cotlstant teuu of incrcased.
each constraint equatioir iy ttre couesponding
the entering variable' The basis vzriable coefficient ol
with the smailest ratio is chosen tu the leliving
with the smallest ratio is chosen m the leaving variable.
variable (x4) is called the pivot row. The
at the intersecfion of pivot row and pivot element
corumn is the pivot element (4).
Table (2)

{x3 3t4 1t2

l 0 I -U4l
X2 21/4 1t2 l
I
r o U4
Z 2t -1 I 1) 0 I
Table (2) is prepared by the fbllowing procedures.
I ) the pivot erement (4) so rhar rhe coerricient
or the newry entering
il111#::ri::':ll,;:
2) To obtain the other rows, multiply the
new perlaining to the reaving variable by
the co,espondin_e
i,
coefficient the pivot column and substract
froir ,rru ;;il
tuir. tr I
Here again the coefflcient to Xl negative, "rigiri
so move to the next iteratioil since largest
in z row is -l , rrre newly variable is xfthe;i"d,fuI;; ilb neguive
given is below:
Tabte (3)

xl 3t2 1g2 -u2

x29t20l_1
u2
Z45D0oz
1t2
Srnce no erements^ inz rcw is negative, no further iteration is required.
The elcments i, c pertaining to the basis veuiables give the sorutio,.
Herc,
X, = 312, x.= 912, z = 4512.

THE DUAL PROBLEM AND SHADOW

PRICES
The basic problem whose solution
is attempted by the linear progrtunming
the primal problem'.Each primal problem tochnique is called
corresponds to a dual problem which yields
infbrmation to the decision makei', additional
if the primal problem is maximisation problem; its dual is a
minimisation problem and vice versa.
The shadow prices o.f the factors
of are the input costs or oppoftuniry
'factors fbr the particular 1olygtion costs of the
firm' They are crucial indicators tbr tie expansion of the
which factom bottleneck to.the further
expansion of the rirm. nrey inow
fi,,. They show
with a positive shadow pl.:r- in wtrictr ia.io* w,l appetu
the mor., the shadow prices of the
resources ctin be compared with "piirri-rriru.;;;d.r
thei. market pricer unot rr, ;i;r entreprcneum
profitable to hire trd<Jitiorral units decide whether it is
of these faitors. Trre sharl,w pricei
muclt the protit of the Iirnr will of a factor ,t.nor.., by how
be i,creased ir tne rirm e,rpioys
an additio'al unit or,trri.s tactor.
INPUT.OUTPUTANALYSIS
The input-output developed by : ,.!
Hlrvald's w.assily Leontief is.an application
equilibrium theory' It'is concerned-with of ,general.
an.empirical rtr.ry in@rdependence
sectors of an economy' various "r
sectols are interdepano"oiie"urse
anorg variou.s
depend on inputs furnished by production in a sector must
various ,".ror".
●
 ・
 ,12

orttPitl lltlgct- it
I'put - olltput antrlysis has zr rvide lange of appiications. Give il l; .'uttrtitl
l'tnal

can showthe production lequireme nts 0f virior,, iarturr.

It is rrscd to otrtiiitt ptiliceltorr:s ol dcnratid'
output, employn'rent rutd ilwestment lot'iltegir:n. It is uscii
in ectlnotr-iic tli:"cluptttcttt pl:uillitt;:'
relationships anrJ ol'clt'ccts ('l''"virgc' prtil'it .ttd
stlrdies bf i,terrcgio,r;i';r,t ;;;illationzil dcoriornic
changes on prii:es, of military'nrobilisation and so
on'

In input - output analysis,

-tly a
givett change in rhe outnut oI a scetor t'cquirc' ltttrpottitrttltic
pl'ocesii iltiruts atc
changes in all inputs used ttre ,".tnr. i.e. Ii assu[rcs that iri any prtrductiott
us.cd in f)xed ProPortions.

T+IE INPUT - OUTPUT FRAME WORK

courposci-i of agricLrlttrr0, tltltlLtl'actut'c iittd
Corrsicler the hypothetical tliree - sector econolny
is described hy the itunttai llou' ol ittll''tl and
ser.vice. The interrelationship among the three ,."tori
output in table. ,
,able _ I

InPitt - OutPtrt Fior'i

In<lustiy Industry Purchasing

"I'olltl Cl rttls ()ut
Agriculture Finill Dctuaird Pul
producing

Ｘ
ｌ
Ｃ Ｃ Ｃ
︱︱    う 一
Agriculture XI2

Ｘ
２
x22

    ■フ
Manul'ttgture

３
Ｘ
Service x32

Thc t'iltll denra.ntl sit.)lr li iiti: nlrl r-:lt;tscs fr-r

Tlie column show each seotor as a purchaser ol'uscr.
etrclt sectot'ils; ;r pl(t(JLlocr (\l'ritlpl'i'iut" litc
the final demand sectol' househokJs). The rows show ri
sunr .f purchascs by t rrrcc r nri:r'r'ctii:rlt- s.'i-:1i)r'S
entries in the total gross output colurnn shou, the
trre input - ()Lrtpr,rt rl'anrcu'0r'k uii urrlpiils
iit't:
welr irs trre purchases by tlie final demand sector. In
betwe.-rl i1s totlri gross t)tltptlt iintl ils
irlputed to some inputs. Thus, for each secto', the clillereuce
paymellt lo irouseholds ftrr tltcit'lahrotrl artttcapit]l
total iutermediate purchases shows the sector's
s'r1r)i\' its
fhe input - outpllt tirhle leveals clearly the nlutual inicrdepcndcllcc'ol'l':ti'ir-rLts
rclativc irrpoftalrcc .r' r'i.r,i.us scct()l's i, the
supplicrs c,f inputs and users o[ oLrtpLlts. Aiso, thc
table'
procluction process of a seclor is readily secn frotlt th0

TECHNICAL COEFFICIENTS
arc ohtlinecl by riiVrding itll ctttrics itt cilcir
The technical coellicients in eirch sectol column
vrirue ot the totai gross (),rpr]i. r'irhi,-r 'l sh.r"s
sector column of rable -t by the c.rrespur,Ji*g
to 2tS il sttuctt'tt'irl mttlrir'
technical coefficienls-and such listings arc ref'erled
Table - 2
Structural Mrltrix

Industry lndustry Purchasing

N,Ianu l'itct ttre bcrvlじ じ
Producing Agriculture

il
Agriculture tl,, iI, z ,:

tl,, L\zt ilr,

Mtrnulacture
rl^1l. 11. . il..
Servicc
 43

whtt al=寺

断cI榔 讐駅 ぎ
甜 li量 棚:鍔 w鷺 乱:‖ 淵IWi‖
胤鮮‰硫
∬辮 cdcd to accolllll10datc by llnal dcnland iccluilClllcllts

・ 思
出ム羅ボ‖ は
鳳 2)and sぃ た
。 (Iκ

“
pttil∬ ti離 1)1:W躍 (x3)sc,9r m℃
lサ 1を
1‖
X, = l,X, + ar2 X^+ i,,, x1 * C,
X, = tu, x, + ,\22 X2+ dr..X. * C,
x, = o., X, +
\1X2+ a13X., + C.
Solving these thl.e simuluneous equations
in lluee unknorv.rs, wc ohtain rhc solutions.
 44
Ⅳ10DULE IV

STRUCTURE OF MARKET
JOAN ROBINSON'S IMPERFECT COMPETITION
In the real world fitms were found
tJe enioying internal economies w'rlich was inconrpatible
prot. E.H. cha,rbe.rrn
withthetheoryofpurecompetition.Thereforeanutgentneedwa^sfelttoretornrulatethetlreoryol.
to it near.er to tfe world. This was accompiisrred by
price so as to bring, ltual "The theory of Monopolistic
inoependently and.brougtt oot
and Mrs. Joan Ro-binson who wor.ked Robinson got the
onJlii* Eoonomics *pJrr".t competruon"-respectively' Mrs'
competitiorr,, "r
clues for her theory of inipert'ect
competition ti'om Sratfa'

TlreconceptsofsupplyandderrrandcLlrvesplayarrinrport,antrolcintlre.pricetlreor.y.Under
tlte concept ol'srrpply
itrougtr the .on"ept or demand c.,r'ue re,,ai,s relcvant'
imperr-ect corllpetitiors
.ui". becomes vilgue and itnprecise'
tue jointly detcrmined
imperfbct competition price and quantity Droduced and suppliecl
under
is eu.u'rl t9;11g11ilcost (MC)'
rhe MR
by ttre firm at the tevet at which ,r*gi*iil'Jr.r".irtlY. price - qtrarrtity
competition is ps;,ttran the prlce'.Thus there is no general
under imperfbct, is not detenlined by
since quantity supplied uv u n'* u1o9r imperfect competition
relationship, more
ip y'Ot'imperf'ect competition becomes
price. The irrelevance of price -.uqri, 'l"futioo'f prices, i1 tlie
found that under riit . ,*r" qururtity may uL suppried tit d,fere,t
obvious when it is ate the zlvcragc
prices.In fe flgure 4'1 ARt a,d AR'
MR happens ro b; irr. ,orr. arthese oiii.r*, MR' are their ma.gi'al
.rrrr.r).io' an individuur rtm tiJ ttaR' u"i
.. revenue curves (or dernand
with AR, as the dema,d cutrve and MRt nt the demand
curve turd
revenue curves respectively. producq df supply oQ
,. .MR, as its tu.n. cuire un,te, perf'ect.ir#dd r#*,ritrx pdce QPr and I\4R
onO lvtit' is its corresponding
１

qua,rity of ttre product." Similarly ifiR:;itil;

demancl
"u"t
．

o"upply OQ quantity at QP" price

常

curve, then the iirm will produce

Tlrus,underimperlectcoll]petition,anynumber.ottliff.erentpricesareconrpatiblewit[rtlrc
same MR trnd quantitY suPP1ied'
“のＯ０ ０ＣＯ 。。一α

e outpul o Fig' z

un<iel impcrf'ect competition

involves still ntttrc
The suppty curve of the whole in<lustry
Mr1. Joirn Robinson hirs tretr ro dispose
.f this di1'ficulry and
conceptual difficulties antr problerns. by asstttuing that ( I )
the supply curvc of tne lnou'sir1' under inrperl'ect cotupetition
hirs visualised rilike and (3)'
alike (2) o.*1nJ .urves laceri by individual f irms ale all
cost curves ol all.rms are
Derrr4ndculvesofaltintlividutrlfitnrsnioveinthesanrewaywhentlretotalderrrandcurvcfot.tlre price will rule
witi, ttere assumptions inspite of the impert'ections' tt single
industry increases.
curve'
ffi*irri-rrr.;.rr.ef tbr each positio, of the total domand

,er: (i) It rnay be

Mrs'JolrrrRobinsonhasvisualisedfollowing:trltemative.assumptionsontlrebasisolwlrich
price can be asceftained. According to
strict relationrt ip u.i*.en M.R. and
 45
assumed that any increase in the total demand fbr the product of the industry is equally tlistributed
among all the individual tlrms so that the demand curyes o1'the indivi<lual firms sltilt in the same
ヽ二 、．

way. (ii) As a rcsult of the increase in the total demand curve of the industry, the deinand curves ol
the individual finns are raised veftically, so that a constant amount is added to the price fbr each
output on the demand curves of the individual firms. (iii) As a result of the incrcase in the total .

demand for the industry's product, demand curves of individual firms are shifted to the right so that
a constant amount is added to the output of individual Finns, (iv) As a result of the increase in the
total demand, the demand curves of the individuril firms are raised in such a way that their pr.ice
elasticity remains the sante, but it is not clear from the above assumptions that we reach arny
definite'relationship between price and supply under imperfbct competition.

MONOPOLISTIC COMPETITION
Chamberlin developed his model of monopolistic competition by combining the behavioral
characteristics of perf'ect competition with diff'erentiated products. In monopolistic competitittn.
there is a larye number of firms, none of which is large enough. Entry in to the market is relativclv
easy. Since each firm's product is slightly difl'erentiated f}om those of others, the demrurcl curvc
facing a firm slopes downward to the fight. The demard fbr a monopolistically competitive lirnt's
.
product is elastic, since there al.e many good substitutes.

SHORT RUN EQUTLIBRTUM IN MONOPOLISTIC COMPETITION

The mechanics of analysing the optimal price ard output decision in the shofi run for a
monopolistically competitive firm is identical to that of a pure monopoly model. Given the cost
and revenue curves shown in ligure (4.2) theshort run profii - maximisingoutput.is given by q and
the maximum price of output is PO dollars per unit. Depending on the relative positions of revenue
'ind
cost curves, a monopolistically compeiitiue firm may rrrun u profit, incui a loss oriust break
even. The firm depicted in figure (4.2) is receiving an economic profit.
Y

9/unit Fig 4.2

P。

OOeO
Fig (4.3) Long - run Equilibrium monopolistic - Competition
 46

The long - run eqgiliblir:m position l'or a monopolistic competitor is shown

in ligure (4'3)' In
tangent to his LAC
the long - run equilibriur.u the irionopolistic competitor's AR cttrve must be
mLlsl iirterscct ltis
oulve. When the LAC curve is tangent to his demand (AR) ctlrve, his LMC curve
q0 in either direction
MR curve. Since MR = LMC at the output of q0 any movement away trom
will reduce his profit. Thus tlre monopolistic competitor has no incentive to change his outptlt'
is no incentive for othcr
depicts the situation in which there is zero economic profit, there
,E,
Since
tirms to enter the market. The point 'E' describes the long - run equilibrium'

DUOPOLY MODEL OF COURNOT

This model was advanced by coumot in 1838. It emphasized the interdepen
of firms in att
oligopolistic market. The basic assumptions are ?rs lbllows:
I ) There ar.e two sellers (A antl B) selling a product which is available
tcl them lieely and rn
atlequate quilntities to satisfy all potential dernands'
2) The product is hontogeneolls
3) The demaud curve l'aciug the two sellers is linetu
4) Etrch seller acts on the assurnption that the oLltput of the other, ain l'espects tlf the vitritttts
period, will be kePt constant.
If A is the only seller, he will act a-s a nionopolist and charge a price PM and sell output ON{
and thus maximise his profits.since trt this output his MR will be equal to his MC which is zero'

Dr
＼

＼
＼

＼
、

Here, OM is half of o.D. A',s profit is indicated by the area oMPO, now
B enters the ntarket'
rule, B will set MN
The segment ol the demand curve left fbrB is P.D. Applying the mtrximisation
(i.e.lliMD) units pN prioe. His profits will be MNP's. Meanwhile A will have to lower his price
ro the level of B and A'i profits *ill.ons.quently full to oMSQ' which
will be grcater than than ol B'

The cournot solution may be arrived at A, (Al , A2 may be defined as a locus

of all quantities
given qutrntities off'ered
which A, while seeking to maxinrise profits, offbrs fof sale on the basis of
tbr sale by B. similarly the reaction curve of'B is B,B, This are depicted in fig.
(4.5).

＼
ｂ
︲ Ｂ︲ Ｌ
﹄

-\ ＼
ｂ

at a2 a。 ハ1
 ,17 ,

;\ I depicts A's pt'o[it - ltta>lintising tnonopoly

output on the t]ssumption the B-sel1.s [othinu.
Thi: p,irtt 42 indicatcs the output rvhlch
wiurrr have to produce to inducc
otitptrl: rurd sirtliiarly lir points Bl and l
C,{l = [.[J anrl OA2 = 0B,.
82. since the cruopolists srv sinrilar !in all r.espects.
are u,rrrr'f,r ^,;;ffiJJJt;
Nou';t:istil)lt-'thatAisrvillinglrrol'ltral unitsinrcspouse
hry ol'ltrinSr
toB,ssaleof bl units.Bwillreact
his prol)t - rttitxilttisilu or.rtpr.lt b2. In r.rpu,*.
1o this, A will i,crcase his salc to
ttttits' B r'r'ill t'crcl bv.cducittg his olfi-:rjto a2
b.l, This wril continue until thc poi,. ilt \,vhich
t'eactit'rttci"rl\/cs iutr:rscct. rl'it"'n A's sale the tw.
will be oaiind B's sitle ob. The equilihrium salc
cluptilist is srrLblc. ol,each

BETRAND I\,/lODEL
ln 1883'.losepir Bcrlrzrncr criticised cournot
for his assumption of zsoconiectural vtrdation
rv'ith aspect to qtlatttitl,'' Bertrund's
assumption
p'ice alsrl he assttttlccl tltiit it competrlof,
;; ;,l."o".oni..rurot ,ariation with respect to
u,liilr: iuriving at his own tlecisic.rn on prices,
Itis rit'ai r'villkcep llrs pricc expects that
on the basis of this ancl rbllowi,g the other assu*pr.iors
"u,rrinrt.
cournot, ire provideci iin;rlrcr.naLe ol
ntocle] of duopoly. Thsfigu,; (4.6) explains
Iris model.
Ｙ
︰︲ ︲

Fig(4.6)

12 Pl 人

P百 ce Ofirm A

OA is the lcacti011(t11、 iC of A aJld()B Of B oA indicatesthc p●

cc sct by A to and pl・ ice sct by
B alld()B,Ihc plicc set l)y13 10 any pl・
icc sct byノ ヽ,thc reactiOn curvc Of each duopolist stans li・
tho ol・ igill bccaし !sc,i11 lhis I〕 ()111
10del,thc nlarginal cOsts fOr tlle tv′
O sellers are zcrO and a zcro pricc sct
l)y olie c:olllpcli1 01 、.Otil(i letld lo,l zcl()plice bcing sct by thc Otllcr.
、
Assu11lc that A cntcrs thc lllを
′ llkCt Si13Cc hc is thc sOlc scller.he sets the mol10pol)′ pricc oPI
ヽ、hich wili mと し
、inliヽ c /1ncn
llis I〕 r()11lS｀ 、 B cntcI‐
s thc l〕 lal■ et,hc will rcsp()nd by settillg thc p]・
QQi m ttca、 Ш■ icc
kccp Ю hs monopdy p五 ca Oょ

8ど
/Cl・ (〕
#lぷ lil批 il‖ lれ 鼻 格緊
"OIHw A w■ ,A deddes m
on n・ 。1.A and s0
a picc oP2.BⅢ
1he prOccss continues until pl・
lltttil無 l[11∫ 群 i朋 :
ice for bOtll fall t0
T〕 ]c stllbility()Jc(luilibriunl is c1lsllrcd by thc greacr steephess Of oA as cOnlpared 10 oB.

EDGEWORTH MoDEL .
Tllis is a variani Of thc cOumot sOlution lll・
this mOdじ 1,thё beha宙 Ouralぉ sumptiOn is that thc
rival scllei hOlds tlle plice c()1lStant Tllc QttCl・
assulllptiOi al・ さ:(1)two sellel・
hm電 錮 ∞ ぷ 回 Щ O山 c山 (A&B)scll l
thltthc denlald curve of 珊 A is DI 惣 M中 山 甲 叫 諄 陸 赫 幌 酬 Ⅲ ヽ o
ac叩
黒 器 蹴 認 燎
Ohiё Ctiヽ 'c01｀ ()tlじ h is t()iliaxil■ 4City Oltplt,MP・ ME(4)
lisd his p10its,(5)TllC Pl・ Oduι
tis beins prOducedundercOiditi6ns Of
zcro nlargilltll(り Ost、
.
 48

The logic Ofthe molel iS inOicttDd With the help Ofigure(4.7)

Fis (4.7)

Output

price PM at wlrich MR=MC=)

they coultl set the nonopoly
tf tlre two selleN wherc to combine, be maxintised but the oLrtptlt
of output. with-such u p''itq p'ite' prolits would
and sell N'N units
[51' 1=NF) of each would be unsold'

EXPLANATION OF EDGEWOBTH'S
SOLUTION 'se protits, he
Aentersthemaltetandsincehe.isthesolesellerwhoseekstomaxlml] His
price vrN uni,r, leavi,g NF units output urnsold'
charges the monopoly 1"r,1"ris scene, his iotential market
is EM (ie' ltis
profit i, frrfNifp. when B .;rrr,,t, put
monopoly
NF,oiAi. rt.rrrore atte,llpt to sell a larger oLrt
entird.output + th' ,**rJ *1put
A 1.rnav
since n keeps his price unchanges'
B
by seuing a price **rgi;1v Uetow rh;il;;.tby. so,re of his constomers have
may be able to spll hii entire 'it now observe that
stock'.A witl the
by the rower pri.. *fore A will get a price.ma.gina,y berow
been attracted to B
that"at tliis'prict'lT: only
will the
price of B so as to incretrse nis sates' ii i' po"it'le
abre to sell his entire outpLlt.
B wi, now'eact. This proccss
deserters return, but. A will be prM is rcacrrer. This rir:e is
pl.ioe ol the rivat contrnues until the price
,f untrer cutting the
his entire srlct. But, actually
this pricc is ttttt
common to both u,.,r !u.r, se,er will .ave sold
fof either selle'tcl lowcr the price
Eitttct'
At this poi,t, there is noino.rr.*ent
a stable one,
attempt to remedy the situ^tion. Trrus,
I, this rnrtlel' thcrc is a
se,er may recognise this and
osci-llation of output aid
prices'
tr"iirro"t
recognise rheir muruar
"n^:i;ffiilT'fi:1",?:[:J,XT in which a f,y::T1, who clearrv
of i,terrelationships
produce the lylk th: ild;Fput' There exists a diversity
inrcrdependence 9f
riterature of oligopory co,sists
of various models tlitrt andyse
amoug oligopolistii firms. The ai price leadership; collusion, nr.rker
sharing
ot origopolistic brir.r*r, ,,""*
soure specitic u.rprui,
and price rigiditY.
arc found which iu'e not ptesent in other ntarket
In oligoPoly some sPecial characteristics
forms. TheY are : i,dust'y'
the
*raking of the f'ew fir,rs wrricrr comprise
(l )The i,terdependence in decision
(2)Agreatimportanceofatlvertisingandsellirrgcostsittoligipolistictnarkctconditions.
(3)Tlrepresenceofcorrrpetitiveconditionsinit,carrhardlyhedenied.
(4) lmpofiance of group behaviour and
(5)Theintleternritratenessofthetlemandcut.velacinganoligopolist.

Cotlusive Model ..-.. .- ..^*a1

Inthismodel,considerthecollusionisexplicitaldlflfirmsactastrcartel'Theplice'which
M,R' corresponding to the market demand
is determined by the caftel on the
b*ir;;';;ariv of 1rr9 product, is by other f irnrs'
fbrthe producr of the oligoporist ad
r*;il;ivi.c-ortrre ^c:c:epred
 49
Each tirm will produce artd sell the output at which
the M & R conesponding lo the markcr tJcrnand
tbr the producl equals its indivitlual malginal costs.
since all lirms pr.oduce the siune output, prolits
ue equally divided among them' The problem of sharing prol)ts
ariscs when llrlm herve tJitlbre,r
cost conditions' At any given pfice set by the
cafiel, a tim produce tne same outpr.rt, profits ar.c
equally divided among them. The problem of sharing protits
arises whel firms have dilt'ere,t cost
conditions' At any given price set by the carlel, a firm
with lower costs will mruket a lzugest outpllt
and eam more profits" one approach is to allow
the constituent fir.ms to keep, the profits they
individually make' This would seem to make for a stable
roiriio". The other is that the lower cost
firms should transfer a part of their profits to the higher.o.ri
ti*r. This solutiol is likely 1o bc
unstable since the lowetlcost
firms 1ay pref'er ro ur.i[r,*ov from the carle] trnd operate on their
own and hope to make large pr:ofits. There may also
sonie insiabilitv ln ."t. cosrs since
at the price each firrtt is charging; a single flrm "iiJ.*..,
will view the individual demand curve lhcing ir as
more elastic than the agglegate demand curve.
Such a lirm may tbel that by vr r,-!'!\ur5
braking away fi.m rhe
carte, it can lower prices and incretue it profit its.
consider an altemative niodel in which the collusion is not explicit bur only implicit. The
ntodel is advanced by stackelberg. tt postulates
a leadership - firllowership rclation witlr respect
p.rice' Here thedominant f irrn sets the price, ro
attows the
firni mat*ets thd difterence between the total demand
otheifir;;;...il;iiil;;;;;'rhe <Ionrinanr
lbr the product and lhe ,,,rru,,nt supplied by
the small firms' Assume lhat the prtiduct is
homogenous and prortuction costs may ditlbr m bctr.veen
the tirms. This is illusrrared in figures (4.ga) orJ (+.SUt.

Output
のＣ﹁だ０ミ〓轟い  や

〃轟
芦襟糧 器鮮辮 lm柵 .l滉 Ⅶ
cquating it,IⅥ .R:to its M.c.At this p五
cc,thc sml II鱗 楡 f》
II織 蛯
 50

ol M I M2 units which is niarketed by the dominzrnt

tlrm. The individr-ral demantl
arl excess demand
price set by the clorninant l'irtlt itttd the l'ilnr rvill
curvc l.cing cach fir.rr-r is perleotly elastic i,. the
decidc its outprt by eq,ating tlie M.R. witli its M.c.
rn. virri.ns srnalr lrrnrs are .nrikelr'1ir ha'c
indcntical cosl cottditiotts.
(luestioned in particular, lhe inslitbililt'ariscs
However, the stability ol'such anroclel has heen
ol1 the dominanl Iirm' Thus' wltcrc lhc
p[lcc scl b]'
as the entirc burden of restricting outptlt rests
of rhe smetll tirms there will beett indttcctncnt
thc rlominant flmn exceeds the minimum average costs
firms to enter tlre l'ields. The r:csirlual
ror existing trrms to br.rild more capacity arrJako fb'new
demand, cutve of the dominturt firrn will shift to the
ieft, necessitating the setting '-lp o1'a 11911' protit
maxintisation Price'

PRICE LEADERSHIP
orice. An oligopolish pricing tlccisitrtt
oligopolists are kee.l5r aware of their mutual interdepend
must take into accoLutt likely reactions oI his rivals.
A careless pricing decisitrri t-t'ut)' leacl to cttt
protit. one wtry t. avoitr such p'icc crlrnpctitit,
trirotrt price competition, which lowers everyone's
and estabrish a price acceptable to all oligopoiists
i* trre rua'ket is to .el,v o, the p'ice lcade'ship
prices setby the lcadcr.'there ill'e two ltl.i(]r'
arrangemcnt [n this, lirrns in the martetrotin* the
ancl the birrotletric llrni ttioclcl'
rrariants ol pric:e leadership, the domin:urt lirrls t'uodel

THE DOMINANT FIRM MODEL

I'ollows:
The assunrptions of the dominant l,irrtl model irre as
smail firnts'
(l) The irldustry consists oI one dominilut l'irmand ttrany
sets the market price and allows the srnall lirnrs to sell at this pric:e' Tlte
(2) The domintrnt tirm
dominant lirms market share is given by wlrat is
left'

firrr. s behaves trs if they trre perf'er:t competitors.

They sell t|"rantitic-q at rn'hich thcir
(3) Small
tnarginal costs equal the price set by the dornintult flrm'
the rnarket demancl clrrve, the sr-rpply ctlrves 0l'tlic
sntall
Given the above assllrnptiorls,
graphic ntoclel that produccs a
tirms ancl the MC cul've of the dominant tlr:m. A sitnple (qb)
<leterminate sorutio, ca* be e.siiy constructed.
The dominant firm's qua.tity de,randcd
is given by:
qd = (total qtlantity (quantity suPPlied b1'

clerlancled in the ruarkel ) all snrall l'it'tlts)

Ｐ   Ｄ

'MC
Fig 4.e

/MC
ヽ ′

D'
d1

-{R
O

Price leadership by the dominant firm '

The do,-rinaut fi,,,s demand clrrve, dd 'D' shows the locus

of price quanlity relationsltips
market detnand curve, DD'
obtained by substr.acting hdrizontally the curve fi'om lhe
thc pricc thal is ntost, prolilablc
Wc give an explanation about hor,r,thc clominant lirnr sclects
 5l
to itsell' In ligure (4,9) DDI' dd I , and cul'ves sltow the miu'ket tJeuriurd, thc dourinarlt
finrr,s dcuancl.
tlte sutall lircs cotlbilled )^iilply, rcspectively. The donrinant
tlnn's nralginal rc\rcr.urc cr.rrvc llrrl
correspottds to its denrand curve is tabelled MR. The nrarginal
cost curve sl't5c t6prinant llr.u-r is
labeled MC' Given these MR & MC cllrves the pnrl'it rnaxinrising;
olrt put ancl pricc, thc srprll
f irms are willing to sell S units. The
sum of the qr-rantities soltl by the <lominant artl srnall l'iflrs is
equal io the total quantity demanded in the mar*et (T+s ,nits).

THE BAROMETRTC FIRM MODEL

Anothel lbrltr ol'price lcadership is barornetric price Ieailership.
tn whiclr it llr.Dt irritialcs \cll
ptthlicised cltangcs tltat at'c gcncrall-v lirllowetl
by thiiL l'irms in thc rncrrrstr.-l'. Tlrc pr.ic. lcurlcr ncu.tl
tttll hc thc largest l'inlr' The pl'icc chitttge iinnonncecl
hy thc lcatJer servc ils a bar..urcr-cr.rhirt rullccts
lhe ch:rnging tletnalld a[d sLlpply conrlitions in lhc nrarkel.']'hc
harunrctr.ic pric,: lc,rlr.l.il.cs ri.i
ilct 1o ilnposc its decisiotls,on othcrs. Uttlcss. the pricc
Ieadcrsets the plicc th,t rcllccts thc dc,r;rnrl
and supply conditiotts in the industry, il is not likely
to continue its role as thc ha*Luetric lciulcr.:
Accordin-c to a recent study, pr:ice lcarlership in larye
scalc inclustry hirs clevcloped li.orn thc ciLr.licr.
cxpci'ierrc:e o1'cnt-throual competition:rnd ilccompilnying
violcnt lluctutrtions in pr.icc arrtl eurLrinul;.
Pl'ice leade|ship help avoicl sttch expet'ience
by introrluciig welt-publishc6 systernilric p'ice changcs
that rellect lhe changing market conclitions.

KINKED DEMAND CURVE MODEL

Paul Sweezy's kinkeri detnand cut've moclel attcmpts
to cxplain u,hy lhc pricc stabiliil, .r.
rigidity may exist. Srveczl' wiul1s to exprain wrry price-and
o,tput stii5, u,rrcr.c thcy arc.

In figure (4'10) two demand curves tacrng an oligopolist

are shown. Assume that the curre r)t
matket price is given hy the height of point.
P DDI shows what happens to prise and gutpr,r
the oligopolists pricc is rnatchetJ by ali othe'oligopolists wScn
in trre industry ddi sh,ws rvhar lapper,s
lo price and outpnt when the oligopolists's
1",,'i.Jclianges are not matchetl by other oligop.li:-ts.
'r priccsweezy/s crucial behavioural assumpl.ion is that other oligopolists will march a rcclucli.n
in
in order to protect their niarket sttarc, but will
iguore an increase in pricc. rvhiclr posd.j ,()
tltreat lo llteil markct shares. The denran<J curve
th;r[ re-[]ect this asstruption is girrcrr h1, llrr: lrnkt.rl
.'lcntancl curvc cl PDI in ligurc (4'l l)-
The MR culve di.sconr.inu,us dottcd linc segni::nts;.
tlligttposisL's malginal ctlsti giveir tly:tvtc (:urvL', Ii'rl:*
then thc rrrost pro{itable rlutpr.rr irril cli:ar.lv
o(:c:ul'At Lhe point 0l'the kirik. Sincc the 1lr.ir:e
ii.IR r;[r^,e is clisc:ontinutJus at qo,
optimality in terms of Ir4R = MC. Horvever'. ",..r;;,1;,;';.;;;;;
it is plear: tlrnl;l ; prolit - nraximisi,g ourp*1 is q, .nrl
a,y deviation fi'om q0 reduces prolit. Even thougl,
r,1y ,""Ig.'rrrrs**'i'.rrr iil" oprin-.or oLrtpur
does not change' The best price stiii remaius "orr
at the height of theikink. A substantial chanse
in
demturd ,rav rcsulr o,ly in a piuallel horizonral
output to expurd bur trre price ro rerrrrin rigid
striti in dde;;J;;:ilffi;nil;';i:;l
at trre levei uiir," kink. : :

sweesy's model how the oligopolist's view

rcgarding his conrpetitorx reacticlrrs l.o pr.icc cSarrgcs
might afTect his pricing behavioull.
 う４
くコ
＼
MR｀ 、

g4.11
Fig.(4.11)

υ q。
＼ q
a11(l cttrVe nlodcl
Criticislns:Thcl・ cと llC SCVCral inlpollant critiCisnls agaillst thc kinkcd del■
thC killk
vhy the oli3opOly price sct at thc levcl ol｀
(1)ThC nlo(lcl fails to cXplain、

(2)SwccSyts bcha宙 our温 ぉsump■

on iS Suttect tO qucstion
e me inllexbility of p五 ce
鋤

The ptte五 g● ity Fe■ cted illthe pllbliSheduS愧 ぃ o,t00Ver,xttgc皿

０

d cul17c mOdCl.
SOme W五 ters qllesdon the ompiriCtt relevanOe of SWeezy:kinked,dci祖

BAUMOL'S SALES MAXIMISATION MODEL

business entelpl'ises in the united States'
on the basis of his experience as <;onsultant to cerlain
oligopolistio firms seek to maxiurise salcs
in the late fiftie nuu*oi pot forward a hupothesis that
So long as profits do ttot f[1] below
revenue subject to a minimum protit constiaint. In other words,
firm u'ill try to increase its sales revenue.
some mininium such a
ih figure (4'12)'In the absence of any outptlt
The mtrximisation of the sales model is explained
constraint the maximisatio, of sales revenue
will be achieved at outprt Ms. Thc or-rt at which total
pibfits are nraximised is MP. This is tt outpot at which
MR=YC '|t o1t^nLr.1UP] ]fc slopcs ol'tltc
" protit constraint eil:'l or-9o' t'l: which will
TR and the TC clrrves arc equal. If thele is a :.u:tllrt'
will be oMr' This oLltpLlt is larger lhtrtt thc
maxinrise sales ravenue subiect to the profit.orrrtrui,rt, hence' tltc
suoh as oB would not be opcrartivc' and
one which maximises protit. A protit cnnstraint
would be produced'
,)urpu, OMs, which f:,rlly maximises sales revenue''
Inthemodel,theincreaseinsalesrevenueisobtainedby.reductionintlrepriceoftheprodttct. the
other policy varioabrkes at the disposal o1
The rnoder can be *.oiriro to take into account
oligopolist firm.

MAXIMISATION OF GROWTH - MARRIS

Marrisemphasizedtlrefactthatafirnrseekstomaxinriseitsrateofgrowtlr.salaryand

/
/
/
/
/
 53
pel'quisites of managementma) -r a function of size. Size may enhance a manAgel's ego and
may make hirn f'eel irnportant i1 f^r., ',:citl rnilieu. Thus, the pressures whiclt push managers to
seek to maximise the growth of til,. '"n are not merely economic br.rt psychological and
sooiologic:rl ag well. However, there a,., mits to the management for seeking this ob.iective.
The interest of shareholders have also to r, .. .nsidgred and share prices kept at.reasobly high
levels. There are several reasons for this. Thr rre (1) the managers may own shares and have
an interest in high prices for them. (2) If share prices are high, it may be easier for the firm to
obtain finance from outside for its expansion. If the share prices are unduly depressed, this
may lead to take-over of the firrn and managers may lose not only their autonomy but possibly
even theirjobs.
It is suggested that fbr all these reasons managers attempt to ensule that share prices do not
become unduly depressed.

Malris used a long-run steady-state model in which share pdces equal the prcsent value of a
constant strcam of future dividends. The decision on the rate of dividends is also a decision on the
size of the retained earning available to the firm for its expansion. The rate of dividends influences
the martet price of the shares The dividend policy of the firm is of considerable signilicance in this
model. Thc trade off between the fi'owht of the llrm iurd prices of share sis shows in l'igure (4. l3)

Fig 4.13

Rate of growth firm

Betweeu the points P and O, the growth of the finn is associtrted with higherdividends and
thcrelbre, higher share prices. The intercsts of managers and shareholders coicide. Beyond O,
-srowth is ztssociated with lower dividends zurd lower share prices. Nclw there is a coul1ict
higher
belween the int.erests of the two parties the managers who, prel'er higher growtlt trnd the sharcholders
who pret'er higher dividents and share prices. Management policy will seek to reconcile growth
with share prices, keeping in mind the need to prcvent the takeover the flrm.

MANAqERIAL DISCRETION MODEL OF WILLIAMSON

Williamson iugues that rnanagers have discretion in pursuing policies which maxirnise their'
own utility rather than attempting the maximisation of profits which maximises the utility ol'owner
shareholders. Profit ilcts as a constraint to this managerial behaviour. The shareholders require a
minitnum profit to the paid out in the fbrrn oI dividends. The managerial utility fhnction includes
such vat'iables as salary, security, powel' stiltus, prestige, professional excellence etc, OI'these
variables only salzrry is measurable. The others arc non-pecuniary urd they must be exprcsse<J in
tet'ms of otlter variables which Are measurable. This is attaineil by tlie conoept of expense prel'elence
which is defined as the satisf'action which managers derive fronr certain types of expenditures.
Manager's prestige. Power and stzrtus are reflected in the amount o1''emoluments' they rcccivc i1
tltc forru tll'cxpense Accounts, Iuxiriotrs otfices, company ciu'etc. Also the status arid pou,er.ol'
tltiltta-acrs is associatcd with discrction thcy have in undertaking the invcstnrents bcyond thosc
rgcl.uired fbl' the nonual opcl'atiou of the fll'm.
 54

Thus the utility f'unction of the managers may be written in the lbnn U rri fl (S,IvI, I) Wherc S=
Sttrff expenditue, including managerial salaries il=I1l&nallcrial emoluments I=Discretiollary
investment.
The rnodel will be presented in two stages of sii'iplify the exposition. In the first stage we
assume that there are no mirnagerial emoluments (l,t=O), so that. thc actual prolit is tlie rcpl'oted
prolit fbr tax purposes.
The sirnplilied model rnay be stilted as:

Maximum = f (S,1,,,)

Subiect to where zr2116+T where p = the actual profit,

n = Minimum profit, tmd T = Tix

Since thele are no emoluments, discretionary investment absorbs all the discretionary prollt.

.'.U-1'(S,(n-ftoT))
Assume that there is no lumpsum tax so thirt T = tll (t = marginal Tax rate)

Thus, U=f (Sl (l-t)t-t)

Where (i - t) II - flO - IID is the discretionary prolit.

The graphical presentation ol'the equilibrium of the firm in Williamson's rttodcl reaccluires Ilte
construction ol the indifl'erence cul'ves map of rnanagel's, and the cuLve shou,ing tlie relationship
betwecn tlle two variables, S and ID.
πD

Each inditlet'ence cLlrve shows combinations of S and ID which givc the satne srrtisitctittn to
the nranagers.
The relationship betwcen S iurd IID is detennined by the profit lirnction n - l'(P.S.E)
Where P = Price. S = Stafl expenditure and
E = the condition of the cnvironnr.ent.
At initial stages oI production and up to the level of output where profits retrch their ntitxirnuttt
t1're
level (b) both discretionary plofits and staff expenditures increases. [f production exceeds tltis
level. prolits will starl declining, but staff expenditure continue to increase.
The equilibriurn of this lirm determined by tlie point of tangency ol'the plol'it stafl'curve i.vith
thc hi-shest possible managerial indiff'erlerencc in Williarr-rson's ntodel the stal'l'cxpenditure (-SO)
will bc grcater than tlrat ot'a prolit uraximiser (S1l rnax). Fufther morc, Willizunson's model irnplics
higher output, lower price and lower level of prolit than the profit utaximisation model.
 55
THE BEHAVIOURAL MODEL OF CYERT AND MARCH
The behavioral theories clf the firm stzuted developing in the early l9-50s. The thcciry lrirs been
elaborated by Cyert rurd Miu'ch, with whose narnes it has been connecteci to this day. The simple
model of Cyert and IVIarch illustrates the decision - making process within the modern large
corporation. The model rel'ers to the case of a duopoly. The decisit)u pl'ocess involves the
dctermination of the output which is honrogenous, so that a single price will prel'ail in the nrarket.
Each firttl, in dcciding its output autonratically induces pricc changes in thc miuket. Whcn brrth
l'irms f inally dccide their outpuls, pricc will be determined by the markcl. No chlngcs in inventorie s
arc allowcrd in this rnode l.

THE STEPS MAY BE OUTLINED AS FOLLOWS

(l ) Forecast of competitor's reactions. The fbrecast is basically a straight lorwartl extrapolation ol
the past observed reactions o.l'competitors.
(2) Forecast of flrm's demands - This is bmed on an estimate of the denrand fuuction tloru past
observations.
(3) Estimation of costs:- The cost in the current period is assutned to be the sanle as in the past
peliod.
(4) Specilication ol goals of the llrm:- these are uspiration levcls. In this modcl plol'ir is rlc snly
goal ol'the ljrnr.
(5) Evaluation of resttlts by compiuing them to the goals - Frorn thc inlolntation obtaineti in srcps
l-3 wc obtain a solutiolt.I.e. an estinratc of tire level ol olltpllt, price. cost anrl prol'its. Thcsc
are colrpal'ed to the target levcl of prolits. lf the goals al'e satislled by this solution thc firnr
adopts it. I1'the pl'otit and othergoals arc rlot achievecl, thc lirnr prccccrls to stcp^.
(6) tf goirls are uot attaincd the lirnt re-e.xrur.rincs the estiurrrte ot'its costs:- Rccxauriuati()n starls
witlt costs because this variable is under tlie direct control of the llrnr.
(7) Evaluation of thc new solution by comparing it to goals.
(8) Il tlie goals are riot attained the lirrn re-examines the estimates of its demand.
(9) Evaluation of the new solution by comparing it to goals.
(10)tf goals are not nret the firm read.justs downwards its aspiration levels.
The llrm has rnultiple goals which take the fomr of aspiration levels. The llrrri is a satisl'iccr.
rathcr tltan a tnaximiser. The firm is a satisficer rtither than a maximiser. The
_rroals chau_ee over
tirne depeltding on past attainrltents, tuspirations, demands ol'groups and cxpecl.zrtions. Thc ct-iterion
ol'choice fbr goal - settil)g is that the alternative selectecl.

REFERENCES

(Modules lll and lV)

1) Koustsoyianuis A Modern Micro Economics thc Macmillan press 1994
2) Rebcrt Y Awh: Micro Economics, Theory turd Application
John Wiley and Sons
3) G. C. Dacosta Value and DisLlibution, HIMALAY Delhi 1992
4) Bauural W. J. Economic Theory and Operations Analysis
Prentice Hall Dclhi.
 -56

IVTODULE V

THEORY OF PRICING
A CRITIQUE OF THE NEOCLASSICAL THEORY OF
'*= '''N'
The traditional Neoclassical theory of the firm was accepted by econotnists withor:t criticisrn
till 1939. [t was i1 1939 there arose a mounting dissalisfirction wilh the tladitiotlal theory of the
l,irm. The trssumptions zurd the rnarginaiist behavioral rules were mainly subject to criticrstll. The
impoltturt critics wele fi'orn Erlgland and America.

BASIC ASSUMPTIONS
Tlre Neoclassical theory of the firr is based on certrtin assulllptiolls. They are givctt bclow.

1. The single Owner EntrePreneur

single ownct'enLl'epl'cnetrt'. Thcrc is tto scprtt'rttion
The tr:aditjonrrl thcory ol'the lirm asslllres tr
bctrvecn ownership und miuagement. The owner entrepreneur takcs all thc decisitlns. All tltc
organisational ploblerns zue assumed to be resolved by payments to the lactors employed b)' the
firr-p. The entrepreneur is arlso assumed to have unliniited inlbrmtrtion and unlimited ability to
conlpelre all the possible alternative actions and choose the one thiit maximises hi.s prolit. This
behavior is described by postulating that the entreprenelrr acts with global rationality.
Clearly the above assulnptiolls are unrealistic. In the modern business world the firm is a
complex organisation. Characterised by the diverse of ownership and managcment. This gives
discretion to the managers to pursue goals othel than profit mtrxitnisaliou. lnlot'tnatiotl is tltlt
unlirnited. The managers cannot act with the global rationaiity postulated by thc traditional theory'

2. The Goal of Profit Maximisation

ln traditiorral theory it is assumed that there is only a single goal lor thc l'irtns. i.c. prol'il
ruraxinrisation: - But this is criticised on tlle glound that no l'irnt cau attaitl this gottl bccausc thcv dtr
not lrave the secessary knswledge, intbrmation and ability. Managerial thcorics postttlalc thlrt tltc
tlivorce ol'ownership and l-nanagen-lcllt allows some discrction to the nlarta-scrs itl stlill sctllllg.
T6ey select such goals which maxirnise their own utility I'unction. Salcs tuaxrntisatiott' -uLorvtlt
rnaximisation, sharin-c ol'thc market, invdntory maximisation reputirtioll elc. l11tly be certain ilitus
ol'the flrm according to the new lnallagerial theories.
Some other writers htve suggested that given the uncertainty in the world, the lack of ircctlralte
informatiorl the lirnited, time ain<l limited tibility of the managers to pl'ocess information, and other
constrainls lirms cannot act with the global rationality implied in the traclitional theory of the lirnt.
Ilrleed Llncertlinty nrakes impossible the maximisation of anything. Giverl thcse conditions lirtns
clo not seekminimisatiop ol'prolits, sales, growth or anything else, Instead they e
xhibit a satislicing
behavioq they pursue satislirctory profits, 'satisfzrctory growth' and so on. Firtns act r,vitlr hxlundcd
rationllity. Firprs hlve conslrtrints in pursuing. their goats, set by l'Actors intct'nal tud external to the
Ii rtrt.

3. Apptication of the Marginal Pri4ciple

11 the traditibnal theor.y ol'the lilm it i$,assi.uletl that a llrm nlaxinriscs ils prolit whcn ix
prargilal cost-is equal l9 mirginal rcvelluc (MCI=MR),In cach.pcriocl thc l'it'ttt ttl:txitttiscs in; prol'it
by setting in output,arttt plicc itt tlrb level deljnetltiy'tlie'interiscctiou ol'tltc N/tC antl N'lR c:ttt'ves,
Givcir the temporal intleperrdence of decisions suLh shorr rl]L pr0lit lniyiulisaii0n inrplics krng run
prolit maximisation. ,. .. . , i

. .This behiivioural'n,ie'has'beirr attacked on several groundS. One line of argutnent. is that

although the gozrl of the firm is long run profit maximisation this is ttot necessitrily attained by
 57 1
Cquating thc shOlt l■ ln lllarginal cOst to the sho■
nln mattind“ vcnuc(SRMC=sRMR)Another
linc Oi attack centles。 1l the go」 Of p10■
t maxinlisation as the single goal of the llllln

4.tJncerraゎ ry
ln thc tladitional thcOry Ofthe llrm it wぉ
おsuincd that thc irlln had pc:lbct knOwicdgc。 its
「

ltti ‖
聯蠅 酬 糧
脚i尋 躙 嶽 黒 棚 羅:TttIR肌l棚訛vttdrJ面 “帆ι
dell With this uncclt滅 n,y Thcy assunled lllat tlic
abilitx disuibutiOn Of all possible otltcOnlcs The

l柵淋鮒椰
懺 職 鞍榊 ∬ 榊
郎僻欄聡認 Ы ° 器肝 l出 悶
漱鷺
お
:礎I誤
11∬
I離 :
鼎 躍 ポヽ
服道l席 鷺
C「 .abhy vduぃ ,mch mttj口

#
d by ttc
:::淵 1漱 lυ :円
l淵1輝 齢撫l聯‖輔 i鮮
,cnt value ofthe mture stream Of net proflts ovcr
lg mn OperatiOnal pe● od

aF″ fry Assumprions

ln thc traditiOnal tteOry enty cOn● dcrttiOns

鮮灘挿 油せ[難難籐寒
ミ
ξ:1111[‖ lil』 I![Iil‖littydonotal10W10rentryThCttll10d・ lS
cxtcndcd t()larger nuinbe1 01'sellclsi but the ntinbc:s∝
・ mn bC・
main unchanged in thc llnal!narkcl

駅憮:∬ 出I:1賦 鵬I器 棚腎

w議1棚 ‖
棚格趙 ,lΨ 讐
鶏w∬
acccpt the status quo ol tllc establishcd leadcr POtelld」
cntry and its erに cts oli decis10n llllking
a“ nOt dealt with in tirlditiOnJ theory

a sfar′ c Nafure ・

i鯨l錨‖
f熙構 拝
ド

H9WCVer thc tladiuOnal Jlcory il bぉ だally sta“ c Tllё llllc hoHzon bl thc■ .〕 consstsЮ r
 58
iLs tcnlpoldly "ittdcpendenl. .alld
inrlentitical and independent time periods. Decision arc 1rca1ed
coming of the tradirional tlieory. It is clear rh;( dccisions
fr.obauy this is th" rnort i,opo,t*t'shor1
aflcctcil by llic decisions in pxst
l . i.n pn*ff, independentidecisions taken in;y one pe.io. are This i,tcrtlepcndcnc.' is ignored
periods and will in turn i,fluence the futule decisio,sloafie firm.
prolits arc traxitltised.as tlte lllut
iry ifr. uoOi,io"ul theory, which postulates that the long.tun
1c'erlur- 1o lllc nra'ginal
,rir_i,"ir.i its shorl run prolits in *y on. period, by equati'g ils rnargioirl
co st..

SOURCES OF CRITICISM
lronr va|itnts Patts rl.l Ettrtipu' rnd
Ttle tr.aditional Neoclassrcal theory of the l'rrrl was criticised
thc hehlr,iotrr ol l.il,ttts tn tlrc'
Alrrctica. tn England lhe puhlicurtiorrs ot Ha]l anrl Hitoh concernitrg
rcalworldspttt.t.ed:rseritrttsolarticlesdealirrgwithtlrcwcaknessd.lladillolralllrc(]Iy.[nt!,ic
ol olle allol lrer.
Startcd criticisnl indcpcndcllt
Ulrited Statcs there were mally people to c'itioiselThey
and Friedntiul'
The nrain ct'itics were Lesrcr, Machlup' Oliver Gordon

HALL AND HITCH REPORT (1939)

Hall and Hitch conducted empir.ical study making a covcrage
ol 3l{ lir nrs in Englantl Thc
,tpi"i*"ra taken at landoln and the maitr'points 01'theit repofi are gi\cn hclow:
ol lhc r.'llcliull 'rl llte livals '
L The tirnls do not act to allistically' but they are crrnscious
2'Irrpracticefir.tusdonotat'tempttonaximisepfofitibtttthcyU.ylonrlrkesittislaclorylcVelol.
prolit.
lhe)' scl price ort thc basis 01'avctrtgc
3. The ti rrs do not use margiui ist rule (MC = MR); bur
cost or tull cost.
Gcrrerally the prcocctlprli()n of tlre lirnrs is
pricc and ni)l ()Llllltlt
4.
attd costs'
5. Prices ale lather sticky, dcspite changes in demand
a palticulatplice'
This is due to changes in the elasticity of detnanil ahove

GORDON',S ATTACK ON MARGINALISM (1942)

Gordon,s attack was nainly on the z$sumptions
md postulatiotls ol thc tlitditional theory' His
line ol' attack is summarised as lbilows:
cosl
I . Existencs of too many variahles to inlluence dernand zrnd

behavioul inrippliclblc. [t tttlkcs

2. unoeltainty is an additional rea.son for naking malginalist
anci cost coudiLiotls'
the entreptelleur unablc 10 prcdict the future demand

3,Err-rpiricalevidenccsslrowth2rtthefinrrsuseavelagecosttlltherthalllltrginillcostandnrar.girral
I cvetlue to fix Price

4'ThestudyalsolounrlthattlietinrlskccpgoalsollrClthanpl.tllitlltilritltis:tlittn-
5.Whenevcrther.eisa,Iocal'Plob]emintl-}cfilnlitisnretwithltranitgct.ialsrrJtttitln
6.Gordon,senlpiricalstudyalsoshowsthattherjcmalltlatlrlcostol2rl.illllCalrl]()llrcrtbjcctivcll,
estimated.
Gordonarguesthatallrmcimbeanalysedbypayingattdntionto].lllcel.tililrly'coalttirrttrrl ctc.
.o"fii;;;; goiir, n.,onog".iui problen.rs, piice rigiaity, liniit price, satislicir)g behaviou'
In this approach cost and revenuc
According to him firms ciur use a tlynamic rirtrlt!perjod an.rlysrs.
arc p.sluliitcd, lnd thcn thc
ir,*i"", i" eaoh period withi, ihe horizon of thc entrcpreneu' vnlue of Iuturc nc1 revc*uc p'tllrl
'I'his
anir=pr"n.r, prnaeeds with the maximisatio, ofthe present
plar'rsihlc' is .l litllc tr:e in
.fy".irri. approach to the p,'oblem of un"ertni,ry, alt-hough theoretic.rlly tttctl
;f entrepreneurs. The cnl.l cprclictlf nltlst bc asst t

practicc, because it ilss,mcs given expectatiol$

 -59
to have tlre inlbrmation and ability
to fbrm deflnite expectations about ltture
environment' Given these expeciittions crranges in the economic
the entrepreneur czur proceed with the nraxinrisatio,
discounted values of ltture pti,titobitity of the
strcruns. But expectatio,s are, not expl.ined
and taking them f'or given really in marginalism,
by passed the problern or'un.rrtui,rty insteacl
ol'solving it.
IN DEFENCE OF MARGINALISM
I* spite ol all limitations pointed out
by the..critics the experts on Neoclassical
fbur fines of arguniens in def'ence thc..ry of the
of their traditional rheory. they arc briefly
i:ilJ':* given

1l lt is not tllc l・ ealisll10fattsulllptiOnsbuttherealisll10fpredicti01lsis

2. There are ll10dcnl scientinc nlethOds tO account mは
艤basお 」a曇
thelcriDre Mc and MR cven nOw guide pOlicy nlakes. 巳inal cOst and =11謂
nurginal revenue and

3' The idea of sut'vival'l'the llttest

is valid in indusrry and thererbr.e the
ertr.cprcrleurs, srmehorv
prolit' Even the .on..i, nr:sacriricing, prorir
;1.:lli,l,,:'Jr[il]:'^"''sc ,rtirnarery rcads t.
4' According to Machlup rnatginalist
theory is fairly realistic. Thc contlict
misundersta'<Ii,g of the bttsiness is only with regard to
men about the technical terms used
He again ,u'gues. that therc are psychological in cconomics and Busi,ess.
,.uronri*plaining businessmen,s answers thar
maximisation of protit wzls nol itreit goat.
A businessman being intervielveJ rvishes
as pursuing fair policies; which to appear
do not yield maxirnum (monopoly) protits,
profit' Fut'thermore firms were ali'aid but.just a Iair
to admit rt ui ir,.v *.re charging the monopoly
maximise profit; but they prefbr to price to
state that they set price wyuar
law average cos^ts are taken as basis for r -'v equar to
tu their
urstl average cost, since in
tair prices. 'tveti
Concluding Remarks
I ' The observed 'stickiness' o1' prices
in the lace ol'clranging co,ditions
o1'rhc neocrassicar is not applicabre suggest that ,ral.ginari.sm
ri1 reast in the srr-ortlr.rn.
2" Marginalislit ttces the dilemnra rtl'either
bcins un,calistic or bcing taut.l.rrical
to incorp,atc time ,lrd uucerlirinty ir..ne arenrprs
cl. atrditio.ar gclals.
3' It is not cefltrill that-the pricing practices
repo.ted by trre bus^inessrlen is sru,e
prescribcd in the ntodel ol'marginalism. m thc,,e
these circuntstances it is to be concluclecl that the marginalisr
,rror'utft controver.sy still rc'rains

MARK - UP RULE OF PRICE DETERMINATION

Ma'k-up p'iti1g,l].?dei was developed :
by Hall and Hitch in I939 and turr6er
by PWS Andrews' T' wilso,, Barback ir rvas enriched
uno H n Edwarrls in t 9+0's. Ir{ark-,p
as ilverage cost pl'icillg' cost-plus pr-ici,g is also kn.wn
pricing arr<I full cost prici,g. The
expens, however', ditfer i, respcit moders cleveloped by the trillbrent
of rirethods ,serl in .rii-*,,,i,,g the a'erase
cost.
The general practice ofdetcrminin-u
price underthis m.del is to esti,ratc
cost (AVC) and add to it a f.ir the rr'er.agc, variable
margin Jl profit. The price is deterniincd
Flcrc m is the percentage of plotit as p = AVCI + AVC (r,).
'irhich is e"^rinratcd a.s t rci r"hcr.c c is cquar t. rhc
dcltland' Thc mark-trp percenlage (nr) crasticity o,
is llxecl so as to c0vc[ avcragc lixctl c()sl
lvur'rgc Irxcu
pl'ol)t rnargin (NPM). Thus AVL (ni, c0sr (A
(AFC) antl a nei
= lpg + NpM.
METHODOLOGY
Long
run prolit ntaximisation is the goal
but it is attaine<I not by equating,
ecluating the price with average MC and MR but by
cost in the short run. f)ue ,o ur.Lnrinty
regarcrirrg long run ds.mand
 60
long l'Llll costs' Thercl'ore
schedure is abandoned as a tool of
analysis. uncertai,ty also envel0ps
Andrervs the ave'agc 'ariairlc
srroft mn average cost is tz&en r.or
analysis. For certain expefts like
leplesenting ro*" ,'."'ut t'pn'ity' so small cluttgcs itt tlnlprtt do tlill
c<lst has a saLlccr shape
t:hange average cost or Price'
Untler.ntarkuppricingmorlelpricesareflxedontltebasisol.direct0t)StS()rr,ariablectlsts.
,.Thewiryinwhichbusine-.ssnrendecide*r,,.,p,i..toclrargefortheirproductsa'trdlr,hat()tltputt(l
anarysis of price i,"i output
policy
produce casts doubt * iri. g.*rar appricabffioitronre^ti-onal beha,itrr
revenue and suggest a r-nodb of entrepreneulial
in te,*s of rnarginal .ort o'no marginat 3 ti,enr'cprencurs:
to ignor.. Enipirictrl study of i,r.erviewing
whicrr current .roron i. Jo.trine t iro, fo'rnultrting this ,rodel, l'r"111
33 manutacturing, r retaiters ano
2 nuilo-eils wtr^s made posslbie ro'
arrd (c) n.r,al
(a) average var.iable .* ioir.., cost) ib) average overhead cost
c.stprice includes
crr sirtislirctory margin of profit'

PRICING
RATIONALE OF AVERAGE COST
cost p'icil,g arises trre inherenl p'oblc*rs o1'
The rationtrle or iustification of average
''ornprice a,cl o.tpttl ' TItc ma'ior
onrryri-"rl i,-ttre oete',inatio, o'
rntrrginar cost rurd ,raiginar revenue
problenrs ale given belorv :

rv ill nrake tirc ir'

price abnormzrlly .bovc Ac the potc,tial co*rpcril.r's
(i) rl. the cnu.epreneurs r.ix
cntry.
,rillions ol'ttttils ui nutptll.:'l]d iilso 'tlt'ietics
(ii) protlucirg unit is very large in size producing
a i,rprssible'
a,d marital r'evenue becr',mes practicalrv
11,

of protl,cts Ure.,J..,,totiOn of marginui"ort

than profit maxi,ristrtion;. Theretorc
t'e p.i,ciple .1'
(iii) T'e entrepleneur can htrve motive other
o1'
equatirrg the nrarginal cost and.marginal
,",.nu. has no nruclr valitlity irr tlre detet.trrinatiotr
price aM ou,purlu.re uises the retinal
of average cost pricing.
collusion, (b) considcr.ti.ns o1'*rr.rs'n,
(iv)Fuli cost pricing is the result of.(a) tacit or open
demandandcost,(c)moral.onri"tlorofthefirnrand(d)unccrtaincllectsol'pricervaL'

PRICE OUTPUT WITH FULL COST r ,.,. D

kirrked ilenrttnd crtrl,e of Patrl M.
Srveesy.
with
Hall and Hitch cornbined f.ull cost pricing u'rrich rccnrs as
iJi cost-and a ki,k i, the dema'd curl'c
current price is ti*.0 ,rri the btrsis or
sllown in the diagratn 2'1
ШＯ 一
匡 Ｌ Ｏ Ｚ く 卜の ０ ０

Fig 2.1

OUTPUT
 61
let Lrs suppose MK which is equal to oP.
It willbe noticed that the kink in the denrand curve DD,
is lbrnted at this price oP or MK the
kind in the denrand curye gives explanation lbr the stability .r1
t'igidity o1'price un<Jer oligopoly' Miut+rp price is thus, rigid, checks the potentirrl cntra,ts
tlre diflictrlty of measutjng MC and MR, avoitls
turrl it admits the fiossibilities of motivcs otSer
uaximiszrtirn and collusion among the oli_eopoly rhan p^rl.it
firms.
The origin of kinked clemand curve can
be traced into chamberlin's theory of monopolistic
competition' Later Hall and Hitch used kinked
oligopolies markets. But neither chamberlin
;.;;il;rve ro explain rigidity of prices i,
nor Hall and Hitch useo tnlt?J;,;#;;;;;;]
trs a tool of analysis in rrreir respective
kinked demand curve in his modei of price
rheorems- i ;; p;;i M.-s-r;;; ;;';;ffi; ｀ θ
rigidity in oligopolistic market. rn, logic behind )
the kink in the detnand curve is as fbilowr'
,{n origopoiiti,* believes that if it reduces the
' p[ice of its product the rival firms will
follow uni'n.utrulise the expected gain from price
reductiotl' But if it raises the price the flrm
would either maint:rin. Their prices or ev6,rr
indulge' in price cLrtll]lg, -so that the price-raising
firm stands to lose, at lea.st a part of its
share in ilre market. The oligopoly films
would, therefore, find lno ltit more desirable
desirat to maintairi
tlre prevailing price aud output

COMPARiSON VVITH PuRE COMPET:丁 :ON

Thc price in this rtlotlcl on tlte basis o1'averagc
cost is higher than t6at in thc pur.e
colttpetitio,' llccause ltc.c l.he pricc is bascd on budg-eted
output which is bcl.rv its t-rptimurrr
capacity' Itt case o.l'stl'otlg, potential eutry the price
will tend
towartls conrpetiLive price .

FULL COST pRtCtNG: ANDREW,S VERSTON

Hall and Hitch visttalised a constiurt and flexible
mark-up or: a margin l,or overhetrd c.st
and a normal prof it' But Andrew's version
is characterised by the following f'eatur.cs.
(i) Andrervs discusscs the circumstances in which there
might be sonre llexibility in rhc
customers closer. to prolit maximisation principle.
(ii ) Andrervs does not consider the existence
of kinked demand curvc with nrark - up pricinu.
(iii) Hall a,d Hitch co,sidet'that the avcrage cost
va'ies witrr output and.vera-se cost curve
is 'u'shiipcd' Andt'ews visualise lot a long relevant
ran-se ol'outpnt and ayeragc dir.cct
(t'aliablc-) cost tetttaitls c()ttstar)t and
lherefore the averirge cost clrrve is s,ucer shapcil.
(it')The costtttc nlar-gitl is decided by diviciing
rhc fixccr .sunr ol'nroney (AFC + r,ark-up)
rvith chosen quantiry of goo<is which is agirin
decided by (a) rhe oulpur capaciry, (b) rhr:
plcvious ycal-'s salc and (c) the expected sale.

SUMMARY OF ANDREW'S VERSION

(i) Price, P= AVC + AFC + Margin
(ii) AC is saucer shaped with a long bottorn
(iii)Costing margin does not vary with
output; but it variep when there is a change in
market fbrces to a considerable extent. - the

(iv) A considerable change in the price

of the tactors will bring about zr chance in the plice
of the corln:odity
The ideas given above can bc illtrstrated in
the tig.2.?.
In l'ig' 2'2 ort rcpl'ese nts oLttput, NM is the average
direct cost and I\,lG is lhe a'eragc
lrtdirect c.sl (o,erltead c.st) plus costing margin.
tf:the ;;;;:.;;;;.';o";r"*,ii,,.' ,i.
r'ilngc ol'Itol'izotltal straight line of average
cost the nlar-up price op tloes nor ha'e uny
change hut quantil1. suppliecl rvill bre adjusted
to the <lenrand.
 62

Fig 2.2

ｏ ２ ﹂Ｌ ヽ ″∽ｏ ０

Output

CONDITIONS
MARK.UP PRICING IN CHANGING MARKET
{ and extended by explaining it
with ref'erence to the
Mar.k-up pricing may be turther elaboriated
ii ro tt of'mat*-up pricing model can be
changing market conditions. Butbefole doing ".r;r.r..
summed up trs follows: (tj Under mark-up
pii.ing model the prices are tixed by the llr,rs ort the
p,,ir., ar.e not tirrt t" toit unge aocording
to the changes in dcr,artd ln
basis of lull cost and thes;
by Marshall'
uicts fix-price market a,d notilex-price ma'ket zts described
this respect it is called by the supply
not have to rake ihe prices as determined by
chamberlain iurd Robison. (ii) The flrms do
prices i.e', they Set thcir own priccs'
antl detrrand; but they administer tlreir
respontls to the changed mal'kels sitttittitttls'
Now let us examine how the mark-up price

MARK-UP PRICING AND EXCESS DEMAND

c:urve uttcl QG rcplesents original pticc'
Norv
In Fig,2.3 DD represents the rtriginaldemantl and s. tht:
c'lemand for the comnroclity has increirscd
suppose due to some reason or othei the
. ,rf!;.t.,: -r' , '*' '.d'EIuand curve has been Jift"O tiory-D-D.lo - n'' tf the quantity demancled still remai's OQ the
' '.' t-ll.tlr.E,t in demand the corrt :sponding
. ..',,...: .',. , . .:'. rr r^.---^ L^^.. l-\L
oK and not ('l(
,rrrrl rrnl HIlt tu
QG'i But' Ul change
feslllt Ol
?)S a result
.- .pr1"a *urd nrra. been
level of quantity is also increased at the stmle
ur.iog. cost' Theref'ore the price rvill be Q'T which
is exactly equal to oG, flre or.iginril level of _pric..
ihu, at Q, price which is eqr'ral to oG and Q,T
ourpur is nraintained tu the
quantities OQ and OQ''
,fr.
,,\
.Ir*
Fig 2.3
＼
l\
Ｏｏｔ Ｃ ヽ 一っ。０

co "/
Gi\
- !- \'

N
Output

MARK-UP PRICE AND EXCESS SUPPLY

original price is QG rvhich is
rn ru2,4theoriginal demancl curye is fepresented b{ ?D'The
the demad has come down to D'D' and theretore'
equal to Op. Now due to some reason or othei
the supply is found to be excess. As per the law
of supply or the law of demand the price should
 Fig 2.4

collle down' Btrt rcally rvltztt lrappens is that the quantity

o1'supply is ad.jusretl witho't altccling thc
zlvcrAge cost Ilonr oQ to oQ and the price
remains as e,S *iriri, is eqqaliu qC u, op.
CRITICAL EVALUATLON
(i) Tlre mark-up pricing method appeal's
to be a 'Rule of rrumb, (crurnsy) method which
not seem to conlbrni to llte marginal rule of pricing. croes
But as pointe<i out by MacSlup, it is nor
actuallv incompatibe r'vith the marginal rule or p.iclng.
pricing' it rnay look qtrite similar to the muginal
If we look quite tt e logic of nrark-up
itle. t] ure elasticity of derna,d lbr a product is
grcater' tess matk-up is l'ixed iurrJ it elasticity
is less, greater mark-up is lixetl. TIie, it beconres
same as [4R equal to MC' The relationship
between prl., marginal ,ere,r,",* and marginal co.st
is
c
P=lr4R
' e-l
Bur ar equilibrium MR = MC then e
= fufCfr

At constant cost IvIC = AVC, then p AVC L'

=
e-l
II'we separare by raking LCMI = AVC qI!
P=AVC (l+l)
e-l
But AVC x l/e-1 is nratk up. rherelbre P=AVC
+ Mark-up. suppose price eliuticity of'clerriand
of a product is 5 then the tnalk-up AVC l/e-1 i.e.,
equal ro AVc l/5-5 = I/4. Therefore rhe nrad(-
up li'xed is 25%' o1'AVC' Thetefbre, mark-up plice
is AV o + 2.!%of AVC pr.ice flxed on the basis
o1'Iv{R a,d MC would be consistenr wirh nirit-,,p
prirt,,g e,ri ;;il;; ulsrvr' r'rql
will vary fl0nr rime to tinre with the virriations ir'.ronoor"ir."roirir,rr. ;r;;;il"f,The rnark_up

(iii Duetounceflitintl'businesstnendonorwanrtochangetheor,;r.;r;rjdeaisselr,co,rr.at1iclorl,.
Conclitions tegattling rlcmand st.e,uttr or cun,peiition'teclrnology
etc., iire fasr chiursins.
Bu.sinessrrenwi]lresponcltotlrisclrairging".;;;.;;,..
(iii) Accor'ding to R1'an ptrrl'il ttiitxilttisalion
witl conrc to guidc the
,'' "" i- " " :'''"':n :\' r,kc
hnsincss ro r( rlccisi.ns.
Other obiectives u,ill be only secondary.
r , ,:
(iv) Accordi,g to R.p. Khur price readership
comes contrary t, mark-up
liiicing.
(v) ln co'st plus plicing, hisrorical cost data, rather
than current cost data, ar.e generatty usetl. This
tl1ay ieacl tottnder-pricitl,S ignores the
demand side of the, market and is solely based
on supply
 '64
firms determine their malk-up on the basis
o1'
conditions. This is however not true because tbr
account the eltrsticity aspect o[ the dema,d
what the mar*et can heat, and it doe ,t.t . in o
the product
side ol'the market and is sole ly
(vi) Finally, it is alleged that cost-plus pricing ignores the demand
not true bscause Iirlns dL'termi*e thcir mark-up
basea on suppry conditions. rni, i,, trowiv-er 0l'
on the ba.sis of what the market run rr"*, uno
it doe stake into account ilre eliustic:ity trspcr:t
the demand for the Product'
is acceptable for the very that it rccognises
Han antl Hitch asset that the mark-up prici'g 'etrsorls
and accepts the rteed
the interdependence of the ollgopolisS, it
disliies the pio'p""tt of pt'ice wars
for comnrunitY outlook.

BAIN'S LIMIT PRICING THEORY

in 1949. It wtrs in 1956 he published
J. Bain fbnnulated the Limit-price model in
an article
iBarriers to New Cornpetition" to- exnlt}.n 'why tirr,s over a long period of'
another major work
tt at is, they did not charge the price which would
demand where the elasticity wa.s below uniiv potential
tt rory in this model price is fixed by ttrking
maximise their r.eve,ue. untite the traoitionu'i
entry into consideration.

LIMIT PRICE
the establislred firr-rls in an oligopoly
Limit Price is the critical minimum high price set by Traditio,al theory was
into the industry.
m.rket witrr a view to check the entry of potJntial entrants
in the long run equilibriur-r or trre f i'm and i*dustry'
concerned only with actual entry, which rcsurted and
long_run urirugr cost (pure cor-ripetition)
According to Bain price is set at a level above the
ale two models by Bai, to cxplai,
below the monopori.'pri;i (,hr;; *rrttt vrc=vrR).-ttrere
this'theory.

AssuMPTloNs
,1 There is a determinate long run demand curve f'or the industry's otltptlt, which ris al'f'ected not
market marginal revenue curve rs
UV ,f,, price adjustments oi selers n9r by entry' Hlnce the at diff'ere,t prices
shows the expected sales
determinate. The tong run industry demand curve
nraintained over long Periods'
2,Thereiseffectivecollusionamongtheestablishedoligopolists.3'Thecstablislredtlrmscan
conrputealimitpricebelowwhichentrywillnotocctu..Thelirnitpricedeperrdson(a)the
(b) the martet clasticity ol <lenrarrd, (c) thc shapc
estimation ol'costs ol the potential entrants.
(d) the size of the market and (c) the number o1'
and level of the long run aveBge cost culve,
the tirms in the industrY'
is considerable uncenainty corrcerning thc
4. Above the limit price, entry is attracted antl there
sales of the established fitms'
of their Iong run protits'
5. The established firms seek the maximisation
: f ir i

MODEL I : No COLLUSION WITH NEW ENTRANT

.-""fI;;;;;;a;;il;;, demand is DABDT and the corresponding marginai
revenue.is
it is known both to the
Drbil:L?#Jirnn"r, that the rimit prite PL correctly,calculated and
cttt've Ind
existing firrhs and to the potential entrants, Given PL, only the part AD of the demand
the section of the MR are cefiain tbr the tirms.
The part to the left of A' i'e'' DA is uncetlain
because the behaviour of the entrant is not known.
whether the tirms will charge tl]t f!' tri not
,;;;il; or rt. profitability of alternatives open to them, given their costs. Assume their lodg tur
, cost is LAC. In this case two altematives are
possible eithir to charge the PL and Ieitlise thc
prolit
pLAdpcr with certdnty or to charge the monopoly LAC'=MC' intersecti*g with MR i.c.,
PI\41 .

is equal to MC2' In this case the price that

Assume that the long rr.rn average cost is LAC which
 65
maximises profit PM2. In this case the ceiling set by
the price pL is not operative so it charges
PM2 which maximises profits. In summary, glr"n
that pLis defined the altematir.;;;;;fi"
established firms arc: (a) to charge a price equal
to pL and prevent .;;.t; 6;; ;#;;i;;
below PL and prevent entry (if PM<PL); (c) to cha,ge price
a ubou, pL and take the risk associated
with the ensuing entry and the indetenninate situatio,
tllrut arises in the post entry pedod (if pll <
LAC). The firm will choose the alternative which maximises
profit.

PMI \'..
＼ A
PL

▼、
PM2

PCI
ヽ
Fig 3.1

x[r1 xl- >aua ur Dl

Output

MODEL B: COLLUSION WITH THE NEW ENTRANT

with collusion the whole dcmand curve shifts to the left
by the shar.e which is allocatciJ to thc
new enuant a[ citcrh price' The new DD'curvc
is known with ceftainry at all its points :ls
of the cclllusion' attd stt is thc con'esponding m". 1colrscqucncc
Agiri, the alternative open to thc lirrn are thr.ec:
,
(a) Either charge PI- and exploit AD, without entry
(b) or charge a price above PL and attract entry. The 1irm will eventually
share-of-the mattet' above DD' in a collusive
move to . point on ai
agrcemelt with the new entrant.
(c) or charge the profit maxirnising price if PM<PL
Arnong these alternatives the l.irm will choose
the one that yieltts maximum pr.ofits.

ASSUMPTTONS
The ba.sic assumptions are the fbllowing
(i) The entrants react otr the basis of currcnt price;
they expect the price chargerJ by the estzrblished
０こ” 一いや０う０おい０のＵ日・

, firms to colltinue in the post elttry period.

(iit The establishetj rrrnrs are awirrc of the threat
of potentiar entry; and
Ｙ     Ｄ
い

Fig 3.2
 66
case three maitlr possibilities
(iii) The established finns cur cstimate correctly the lirnit price.rn this
industry profit with'no entr-v resulting
exist and they are : (a) The policy of pricini to maxirnist
(b) When PL<PM, PM bears a lot of risk
is adopted where PL>PM i.e., PL is not Jperative'
because the quantity sold is unceftain and thefefore
PL is operative since new entry is to be
This case rvill occur
pr.rrrr,.o rr pM > pL and if pM is chaiged new enrry will be made.
r.i
if PL < LAC.
of the industry without entry or cxist' The
The first two situations lead to long run equiliblium
would be taking pliice' The lirst tw. situatiotr
third ctrse i*iplies an urstable equilibrium si,rcl e,try
Iead to rong r.un equilibriu,r of tire industr.y without
entry or eirt. Ttre third case inrpries an u,stable
equilibriutn since entry wor-rld be taking place'
The ncw elerne,l tll, Bain's model is the redrawing
ol'the tlarket dentilntj so its to itcctlunt l'or
thc threat of cntry. This r-nodel is not incompatible
with prol'it maximisiltion'

BARRIERS TO NEW COMPETITION

pt1ce set by Oligopolists is below the
In 1949 Bain tr.ied ro explain i1 his article why the actual
rnonopoly price. His u,1r*"r wa^s that it is due to the threat of potential entry' The price above
run profits alid it exists due to the barriers to
competition price is in order to secure maximum long
Bainis ideas ar:e explained under the following heads'
"ntry. two types o1'competition'
(i) concepts of Competition and Entry: Bain distinguishes between potential
and, potentiai competition arising fi'om the
actual co,rpetition betlveen establistred fiims Fel,er w.s the
is attained at P = LAC = LMC'
entry of forms outside the i,dustry. The equilibriim
i.s_one of trre reiisons why thg collusive
first writer to mention that the threat of potentitrl entry
considers entry as thc cstirblishme nt ctf a new
ollogopolist, oo ,oi.t,nrge the monopoly price. Bain
excrudes the 1'olkrwing fi'om thc entry
fir.r which builds or introtjuces new protluctive capacity. He
s,ime oilier tir,r; (b)the expansiott ot the capacity
concept: (a) the take over,t an existing firm by
a firn-r ah'eady established irl atrothet' industry
by an old fir.m an<l (c) cr.oss entl.y, i.e., rhe entiy by
whichatlclstlrept.odttctol.tlrisindtlstrytoitslineol.produc(s.
o1 e ntry whicli he del'ined as
(ii) Barrier.to Entry: Bain introducted the concept of the contlition
trre margin by which tle est$lished fir,rs
ca, raise their price above trre cclmpetitive pricc level
have the following :
persisteirtly witho,t .ttrticting entrY. Sybolically we

tr_PL-PC
PC

Where E - Contlition of entry,

PL = Lirnit Price
PC ComPetitive Price
it is PL = PC (l+E)
to be estabiished' tiepends ou viu'itltts
Tlie lag ol'entry, i.e., the time required lor a new flrm (a)
t.actors which constitute the barriers to entry.
Bain distinguishes the tollowirlg tls the barners
the cstablished fil'rns. (c) Economies 01'
protluct difterentiation, (b) nbsolute cost rxivantiige of
icateirntl(ti)largeinitialcapitaltleeds.

t
LIMITATIONS
defiriition of entry' He
. uurr,, empirical findings have serious limitations due to the-narrow
capacity by existing firms- All
omits corss entry, take-overs, veftical integration and hddition to
pricing behttviol of the firrl' Finally Bain l'ails to
these situtuions have serious irnplictitions fir the
may enhance the likelihood of eritry uncler
see that pr.oduct iirr.r=*i"io, and scale economies
cettaitt conditions.
 6l
In summary, Bain's theory of pricing is basically collusive. T're pdce
set by the flrm with the
lowest cost, and the less efficient firms are price followers.
The leadei, however, does not set price
to maximise his own short run profit as the traditional theory
of the price leader postulates, but
rather does at a price which would prevent entry. The rationale
of this policy is that by preveltipg
entry long run profits are maximised.
Bain's model contains elements of a serious theory to prevent
entry by the new firms.
The exposition is tedious but lacks rigour and it contains
the seminal ideas on the importzurce
ofpotential entry in pricing decisions.

SYLOS LABINI MODEL

Bain's limit pricing rnodel was fufther developed by
P. sylos Labini and it wiu published in
lris famous snrdy oligopoly and rechnical Progreis
in igsl .This new iirnit price rnodel is based
on scale bauiers to entry Economies of large scale production
en-joyed by the existing firms are
strong barriers to protect them from new entrants.
The author highlighted the rleterminants of iirriit
price emd discussed their imprications in homogen.ou,
oi,goporv
ASSUMPTIONS
The rccent development of limit pricing rnodel
of Sylos Labini is baied on the fbllowinq
zusumptiou:
l. The product is homogeneolls and market demand rras unitary erasticity.
2. Cost decrease as ilte size of the plant increases.
3. There is a normal rate of profit in each industry.
4' The price is set by the price leader who is the largest firrn with the lowest
cost.
5. The leader knows the cost structure of all the firms
6. A new firm makes its entry with the smallest plant size.
7 ' The established firms and
the new entrant follow the behavioural rules: (i)
firms believe That entry will be prcvented if The established
the pc. ie., of the entrant; (ii)The new
expect that fhe output ol'the established firms entrants
wiil be the same as the preentry anrl post
entry.
THE MODEL
since this model is based on the scale difference
sylos Labini visualises three sizes of piants:
large' mediutn and small. The empirical
study conducted by the author shows that
firms' their individual capacity, toial volume the number of
of output, shaie of the martet etc. are imporlant part
of the ,rodel and a reaso,able structure is given
in Tabre 4.1

Table 4.l lnitial Mttkct stl■ ldure

, "
Plant size ICapa"y Number of Total Ihitial Market
嚇 dX 鈍四 Rた c Dmmd
siman(xc) 100 …
20 200o 20 40,ooo
Medium(Xnl) 1000 2 2,00o 20 40,Ooo
Largё (測 ) 8,00o 1 8,000 20 l,60,00o

share 20.00 units, 2 firrns 2000 units

ano r rarge fi;il;r ,hires g000 unirs. Suppose th.e average
 68
Thc
costlbrthesmalltirnis isRs.lti.5formeciiumtlrmRs.ltllantll't'rt'thclargcl'irrnitisRslT/-
and thc plicc
outpltt is to slllall is totr
equilibr.ium price at Rs,20/- is not stable; becausc thc ruarket
1'or dil't'crent fit'ttts' ilrc sntallcst l'ittrl
highl scr e,try will take place. The protit rats arc clil'l'ercnt
nrakc the l.wcst tevel oiprolit (8.1 %), rriedium flrms
make modiunr lcvcl ol'prol'it (l l'l'l ) irnd
lar.ge rate ot prolit (17.601,).These ratcs arc higher
thau thc nolnral prol'ir of
tlre large lir.ms make
5To.Tbe excess plolit will atttact new entry'

Table 4.2 C6st stru`ture′ Price′ Profit

Profitlate Unit profit Prlcc Total Revenue

Plant size Average cost

8.1 1.5 20.0 2,()()()

Small irm 18.5
19.5 1,95()
5.4 1.0

0.9 19.4 1,940

5.0

2.() 2()0 2(),0()()

Mcdiulll ill■ 18 11.1

195 19.560
83 1.5

7.8 1.4 19.4 19、 4()()

6.7 1.2 192 19、 2()()

5.0 0.9 189 18,9()()

17.6 3.0 20.0 16(),()()()

Large firm 17
14.7 2.5 19.5 156,000

2.4 19.4 155,20()

14.1

2.2 19.2 153,6()()

12.9
0.85 17.85 142,800
5.0

it did tOtal salcS WOuld risc tO

No ncw large irm wi■ Cntcr illto tllc indllStFy.BccallSe if■
―
,a leVCl 10Wer than thc nlinimtllll acceptable pricc
20,000
′ ノυ ヽ′units
,ヽ and
ul■ ■ιo`ι ■■い the price
し■■Vl′ ^^ν ツ WOuld
… ‐ falltO Rs.12/ .. r^_`1_^`1ヽ ..^′ 、 バ 、1、 :(ヽ 1′ OC til o
ices for thC thl・ CC plttnt sizCs alc
l・
`ヽ
t()any irnl in thc industl・ y.Tilc lllininlulll accCptable pl・
ThCn()nly thcsc Fi「 Ins cと in lllttkC
and 17 95 follを trgc l｀ irllls
1 9.4 for slllall, 18.9 1lor nlcdit11■
rrrinimtrm rate of Profit 5%'.
Eventlreerrtryofilnewmediunrisnotacceptable'Bccauseinsuchcasctheinst'allcdslrlcs
lall to I 8'4 which is uot acccptilble to sntall artcl
would increase to 13,000 utiits and the price would
mcdium size firtns.
tnafket' Their entry would ciltlse salcs to risc to
However, three small size plants can enter the tll' all I'it ms '
exceeds the minimum acce ptiible price
12,300 units a,cl the price to fall to 19.5, which
price to 19'3 a lcvel belo"v the miltimtrtl]
The entry of a lourth small firm would depress ,the
acceptable price of 19'4 of the small firnis'

PRICE DETERMINATION
price leader wl'ro is the largest attd tt.tost ellicicttt
According to sylo's model the price is set by
in trre intr,stry, and sh.trld hc at a
fir,i. The eq'*ibrium price must be .cceptableLy ail the lirms
acceptable pricc covcrs thc T AC ,l'the
plattt attcl
lcvel which woultl pfevent entry. The rrini,-,',u,n The pricc leadcr is
(in Sylo's example it is 5% )'
rhe normal (rrinrroun-,) piolt ,.,ue of t1e industry
assumed to know ttre cost structure of all
plani sizes and the rrrtrmal proljt I'iitc ol' thc indtrstt',v'
ps ice that is acceptahlc by *'cn thc snlallest lit'ttts
Given this inlormation the leaderwill settire
and will deter entrY'
 69
P

Limit Pnce

Ac (Small Plant)

Ac (medium plant)

Ac (Large plant)

Fig 4.3
QuantitY

In fig. 4.3 DD is the rnarket demand curve, PL is the lirnit price fixed by the largest tlrrn. The
linit plice is slightly above the average total cost PS of the snurllest tirtns. In this case the sharc of
the profit of the medillnl and large firms is propottionatcly higher thtin that of the sntall flrnts: Thc
price PL coruesponds to the level output XL=X-XS and the the equilibrium price bccause it satislles
two necessary conditions: (a) it is acceptirble by rill firms, alld (b) it deters entry. II entry occurs thc
total output XL will be incrcascd at the level XL+Xs= X and the pric.e will lall to.iust below thc
nrininrum ncceptablc price ol the entrant, i.e., level ir-rst below P.
As per asslunptiolt il'the ncl Clttl'ant colres to the market hc cau enlcr only 'uvith sntallest and
lcirsl cl'l'icicrrt plunt sizc.
Withthe entry ol'the ncrv conrel'the outputwill.just cxcecdby 100 and bccnc r,r,illdrlvc pricc
dorvn to a lcvcl.iust bclorv AC ol tlic entrant. It should be clear that in Sylo's tuodcl all l'irtns can
eal'n ilhnornial prof its, rvhich rvould inorease with plant size and therc is :rn uppcl'anc1 a lotver liniit
of thc cntry-preventing price : the oquilibriurn price cannot be higher than PL uor lower tlian Ps.
ln Sylos niodel the detenninants ofentry-preventing price are:
(1) The absolute size of the market X
(2) The elasticity of malket X
(3) The technology o1'the industry, which deflnes the available sizes o1'plant
(4) The prices ol lactors ol prodr.rction, which together with tlie technology, dctcrnrines the total
avera_ce cost of thc lirnrs.

DIFFERENTIATED OLIGOPOLY
Alicrgir,,ing adctailcd irccoltn[ o1'the homogencolls oligopoly Sylos-Lubittiextcndcd his analysis
t,r tlrc casc ul dillcrenliatcd oligopoll,. He argucs that when lhe producls arc dill'crentiatcd thc
cntry bal'ncrs will bc stxrugcl than in thc case of the horuogcneous oli-uopoly duc to tnat'kcting
ccctnitnties ol'scale. Thc advcrtisement unit costs and the cosl ol'rtrw rnaterials pcl unit ol'ourlput
are likely to l'all as thc scale of outpllt increases. Hence the overall cost dill'erence betwcen tlte
smaller and larger plants will be greater as compzrred to the homogeneous oligopoly case . Prodnct
di f f'c rentiati on, therefbre, rv ill reinfbrce the scale-btrrrier.

CRITICISM
Syios-Labini's limit pricing model is criticised li'orn two an,qles: (l ) angle o1'asslrmptions ancl
(2) anglc ol' mcthodology.

(1) Unrealistic Assumptions

(a) Constancy of pre-cntrv quantity and post-entry qllantity is unrealistic.
 10
(b) The leader's price fixing policy is debatable. According to tlrr: critics it is irnpossible tor the
largest flrrn to fix the price by lookin-q at the avet'age cost oi rile smallest firm. Even if he looks
at the etverage cost of tlie smallest flrm where .is the :iit;iitlntee to fix tlie price slightly above
his average cost? This is quite doubtf'ul.
(c) The srnallest size of tlie new entrant is not reaU,,:.1.:.

(tl) Sylos-l,abini's behavioru'al rules are alscl debatable,

(ii) Methodological limitations

(a) Sylos-Labini adopted a naive approach based on numerical examples.
(b) The author assurned a very rigiil technology with strong tJiscontinuities. It means that rliff'ercnt
lirms have dilf'erent scale plants hased on dillbrent technologies. This type of convcntional
lnalysis is I'ar I'r'onr reality.
(c) Attother questioltable methodological limitation is that the lirms cll'thc samc size havc similar
costs. In lact fil'ms lnay lesenlble one iurother only artiticially, trecause costs arc likely to
diff'er even if tlie firms operate on similar scale plants. .
(d) Sylos ha.s been criticisetl for dividing tlre firms into three wate riglit compill'tment: small,
medium and large ba.sed on theil sctrle of production and efliciency. This is uurealistic because
small or medium size firms can be more etlcient than the large tirms if they are able to
improve their products. So the fixation of the limit price may not essentially rest with the
largest tirm.
Despite these criticisllls, "Iu geheral Sylos's contribution lies in the s)'stcnlatic rliscussion of
the most impofiant determinauts of the lirnit plice in the case of substantial econornies of scale/"
(Kotltsoyaurnis A.). These lhctors provided the besic matediil ursed by later rvriters in the dcvek)pment
of more general and rigorous morlel in lirnit prrcing.

FRANCO MODIGLIANI MODEL

Modigliani's model o1'lituit pricing is a generalisalion of Sylos l-abini's nrodel by relaxing its
restt'ictive ttssumptions. Dytramic changes in the market are cluly reco-unised tn lhis r-uoclcl.

ASSUMPTIONS
Modigliani retained the a^ssumption of scale - barriers and the behavioural patterx o1 Sylo's
postulate. The assumptions are given below
l. Technology is tlre samc lbr all firrns in thc industr.y
2. There is a minimum optinial plant size (x) to reap the economies of scale anil at this level ol'
produclion the long run average cost (LAC) is shaped.
3. No entry occurs below the minirnur)l optimal pliint size.
4. The product is homogeneolls and the rnarket demantl is known. 5. The largest plant is the
lcadcl'who sets thc pricc.
6. The existing ijnls bclieve that no entry will occur below linrit price and the rr.* .,rr.nr,
believes that the existins lluls will kcep their olltpur constant at thc pre-entry lcvel.
THE MODEL
Witlrout adopting numerical examples the ljmit price (PL) is determined indirectly b1,
deterrnining the total olltplrt which is sold by ail the firms iu the industry. The equilibrium price pL
will be higher tlian the PC==LAC). The established firms will earn abnormal prot)ts due to 1he
scale - balrier rvhich is rellected in the minirnum optimal plant size X.

The main point takeu lor consideration by the finns is the determination of pricc at a level
 71

PL.

Entry Gap

︶∽０ ０ ヽ ＯＯ〓α
(Premium) Fig 5.1
PC=LAC

Entry preventing Region

rvhich will not attract entry. TIle limit price PL>PC. The esttrblished fir'lrs decide lo sell( qlranriry.
XL such that if the entrnnt comes and ofl'ers an additional qlrantity X (the minirr-rr.rlr he can produce
optirnally), the total outpLlt in the market will just exceed the cornpetitive out XC, and the price
would lali.justbelow the Pc= (LAC (Fig.5.1 ). Syrlbolically this behavior muy be srared as follorvs:
The entry pl'eventing oLltpLlt is XL, such that XL + XSXc and the post entry price lalls to P< Pc
(where Pc=LAC).
Given XL. the entr.y pl'even'ting price PL is simultancously tJctcnlrncd 1'r'om the givcn
irtdustry - dctnand curvc. Entry r,vill be prevented as long as X > XL. Il X < XL cutt'\, ()ccllr'.
It lig.
5.1 DD'is thc industty - dcmand culve, X is the minimunr o.ptimal lcvel oJ'oLrtplrt.
XL=Xc - X is the olltput whicli the established lirms should ploducc in ordcr to pi:cvent cntry, ancl
PL is the entry pl'eventing pdce dellned ti'om the demand clrrvc, given XL. Thc scale barriers
●.' 0
cause PL to be highcr than Pc. The dift'erence PL-Pc is the entry gap or prcnrium an<i clefines tlic
amount by which the plice can exceed the LAC withorit attracting entry. The deterntitrants o1'entry
gap and the entry preventing price are:

(i) The absolute market size Xc

(ii) The price elasticity of demand e

(iii) The minimum optimal scaie X

(iv) The prices of lactors of production, which togctllcr vvitll tllc tcchnology dctclininc the LAC,
and the. competitivc price Pc.

The conclusions ol'Modigliani are sruuc as those of Sykrs. They arc: (i) Thcre is a detcrminatc
ciluiiibrium price PL, r,vhich is positively correlated with X anil Pc = (LAC), ancl ncgurively colrelated
with the absolute matet size Xc and the elasticity of demand e ; and (ii) I'hc lirnit pnce will be
higher, tlte larger X, thc higher the Pc, the smaller the. Xc and the snraller lhc pricc elasticiry.
Modigliauri combined the above frictors ingeniously in the following expression:
Y
PL=Pc(l+-::-;
' Xc.e
Where PL = Limit price
Xc = Competitive output
e= Elasticity of demturd
X = The minimunr ol'the optinlutn output
The term )(/Xc conesponds to Bain's conditions to entl.y, E Thc detenllillants of Linlit Pl・ ice
 72
The detel■ Iman“ of lilllit pHce are given by MOdigliani as given below:
(1)The abSolute mttct siК at compctitive p五 ce FelEsentё d by Xc haS a ncgative Кlationship
with limit p五 ce PL.

(il)The p五 ce elasticity of dem臣 ld(e)has a negative relationship with the limit price(PL).

(iii)The minimllm optimal sc4e of the fillll has a posi市 e correl江 10n witll the lilnit pricc PL.

(iV)The p五 ces of the factors of production have correlation with PL.

DYNAM:C CHANGESIN THE MARKET

Modig山 狙 rs lmit pridng modё l cm be ttplied to changi■ g cOndidons hkc incretting costs
and cyclical fluctuations in demand du五 ng times of recession and rccovcry.・

(i)InCrease in C()st:Ifこ os“ change,dl ttrnls ttCば fected ttd hencc thc long lun cost curve
will be raised more or less unifol句 Elly.This deve10pmcnt Will lCad to a rise in the lilnit price.

(11)Cyclical Fluctuation in Delmand:ModigJiani agrees with Sylos's ttain conclllsions

concenling the m激 iヤ ariations in p● Ce and the gross pK)fit ln〔 rk― up OVeFthc vttious phぉ cs ofthe
cyclc. :

(a)PenOd Of Recessio■ :The limit price will shoW a mild tendency tO五 se du五 ng times of
cesSion.Howev∝ the叫 ― up ttay nol五 Se due to the costs Ofidle Cap¨ ty,which wi■ push tlle
■
“1コ ns to give secret p五 ce conceSsions in their e疑 :emeSS tO Securc a lttger share of the smttler
demand.
(b)PeriOdぽ Recovery:There win be atendencyわ r dle price to五 sc,when finll c叩 ¨ity is

Eached.Howeverl狐 ge■ ms may strongly resistthis tendency due to fear'O pOtCnlid entry.Insted
thcy w■ 1“ opt other poLcies suぬ ぉ allowitt abacklog ofdeln翻 l or instituting inbllnd ttionillg
of their deiversides while tt the salne tilne eXpanding capκ ity.Tlle mざ k‐ up will tend to Юtrace the
sliding ptth fonowed in the coniaction,祖 d will stabilisc at its nOrn12■ level,colTesponding to thc
hOrm」 っ五ce line'Of tlle lttge illlls.In generd the m漱 ―
up is not likely to chttge over thc cyclc
appК ciably,but Onc should cxpcci sOme sctttcr ttound this central tcndency:pjccs would tend to
llucttlate only if p五 me costs change,becallsc stlch cllmges wouldセ 鰤 cct皿 1■ l■ls.

CR:T:CiSM
The口 nain sholtcomngs Of Modiglittrs model may be sulrmaised as gi'en below:

(1)TlliS mOdd does五 ot detel■ llille the ind"idud ShTe ofthe ims.

(ii)Typic』 entry by anぃ tめ lishod irln inthe san)orin mOtllerind■ lstryis notttteninto accOlmt.

(五 1)The rationale of tlle p9■ Cy OfiOntry pκ vention is not discussed. t

(iv)Dynamic aspectS a五 sl■ g■ Om growingimttkets are nOt consideFed in this model.

(V)MO亀 革贔i lo6s n111:plli10Ⅲ Ⅲ6in鰤 ёf ims wtth dittrent costs ttd d娩 nt
shttζ leads tO面 皿 d cquilibil・ ium. "liOn “

轟
0設
町ポ椰苛繹叩l尋ギ鎖:躍:耀 織臨 Tlit:常 撚器
PRICING
Pり 日￨:Cl,EcTO甲 ‐ AND l丁 S PROBLEMS
i : !N PUFLIC UTILITIES, i , ,

Public sector enterprises have become a world wide phenoilrenon iu the modern times. State
enterprises have come into existence in all countries, whether capitalistic of socialistic, developed
or underdeveloped. There is hardly any country where the government does not actively participfie
in the establishment arid management of economic and industrial enterprises. The motives behind
 73
schclres of havirg economic. enterydse in
the public sectot.may be lbr saleguarding large socio-
cc,nouric considerations and to meei special iituations.
The iore ot publil .nt, pii-r"r- rroy t.
lbund in ensuring economic .werfare, adiusting
of producti.n of iocial neeos, eliminuring
competition aud monopolies, avoiding
of weatth and income in a tew hands and
maintaining economic justice. "onlentralon

FORMS OF PUBLIC SECTOR ENTERPRISES

A minute observation will attest the view that there
courd be no uniform rule regalding the
fbrm oforganisation in public enterprises.
However, iit as ueen rouna on the analysis ofthe pubric
sector enterprises of va'ious countries that
there are three main types of or.g*ir.ii;,
Deparrmenral form of the managenent, (ii) the til ,t.
Comparf fornr of managenrent, and (iii) the public
Cotporation fbrm of management.
The depatmental fbrm of management is
meant either to provide revenue to the govemment
or to control consumption ol'the public. The
company fbrm of management enjoys flexibility
ioint stock companies. The public iorpor*ion torm'oimunrg.n,rn, of
ti om political inlluence.
,. uutonomous bodies shiekled

CRITERIA OF PRICING POLICY

whcn a public entel prise operates under competilive
conditions no special pr'blcnrs ot pricing
a.ise' The major problems in such a sifuation
ir trrut oi'*"oturning tair co,rpedtion between
public a,d private units. But most ofthe problems
aris" *t putti" enjoy a monopory.,
It should; however' be noted thar-the public "r
utilities are g"rrnuy "*erprises
n,orop,iry I.
tact this is the position in most of_the cases.
Tne oegrce'oiionopoly of course, "i*riri1*"r"p[ry
varies in ditlbrent
cases. The monoporistic element has two
implicatio-ns. rirst, on trre supply side, in the
competing units, it is diflicult, if not impoisible, absence of
to *utr'.ort comparisons. Secondry, on the
demand side, there is scope_for discriminuion
*j
The ntonopolistic element in Indian public "ipfoitutlor.
enterprises is rtifferent lbr diflbrent in<lustries.
(i) There are industries where pr.rblic enterpdses'
enjoy total monopoly, e.g., ereuricity, air cratr
production, state trading , terephone p.oouction,
rt'ute traorng in some commodities.
(ii) hr the second category, trrerc arc industries
where public enterprises enjoy partiar or regionar
nxrnopolies, e. g. road tl.anspolt, electronics,
heavy electr.icals.
( iii) ln the thild category, thele arc industries where
public enterprises lace vcry nornral c.rupctitirur,
either a,10ng themserves or with privale
tbrtiliser.s, steel, nrachiue toors,
antibiotics etc. "o*rprir"r,;.g.
(iv) Lastly there are industries in wlrierr
grlufic glterprises operate under. competitive conrritions
such au soap making, s,It production, ,-f,ip
UuifOtg, .ug.., f,'rr"L _ffri,
is owned mosrly by the srate gor"*-intr. "". ".1"g".y "i,nOr.**
ra ir,ouio'io*.u., u" not"u-tt'rt'in.',r'.ir..
nronopory is generally higher in enterprises or.
o*nea uy it e centrar Govemment than those
owned by the State Covernment.
Broadly speaking, public enterp'ises erjoy
the highest degree of monopoly power because
privare inrercs* are barred f'rom eniering
trrJsi nourti.r
transf'emble. The exarnplas of such industries
irr"i, p.J-*ir'#;;;;;;ii;;"r_
"oa
are proriO"O t y-rif*"y, to a great extent, rhe inemal
airwavs; the elecrricitv boards. the rrttrpu.po."l.dti,;tilrdir*ffi;ffi"r-iiJ.t:
on the whore, the cdteda fbr p.ric.ing poricy art rhe conpetitive and nronopory contritions
lhced by the enterydses togeth,er wiih
*rei-r. iorrns oraorgrii;oo.
PRICING PROCEDURE

, The detenninalion or'lhc price.s of the products of public entelprises depends rargcly on rhe
role:ssigned to such enterpfises in the econbn
c ano ,La:pori"-v ,"i,r, regard to obtaining
resources
 71
have to operate also very importmt in the
from them. The market situation in which they
determination of prices of their products'

躙騨灘鸞彗
よI紺
犠
聯i#書∬雌繊麟捕
t oF thc cOlllnlodity

■■acqu■ c thC pottrtO・ X ttc pHcc lnd° nPut

ty CVCll
n、 alkct
・
SOmetin,cS a publiC SCCtOr tinll lllを
いpdyOrSCnl― m9■ opdypΨ げ
.1.゛
4
お r acぃ mng m。
「
and ix prtes etC thlt StlltthCm bOthキ :
c`oEM卜 MONOpOLIS■ C COND用 ONS
■
o ENTERPRISES UNDER MONOЮ ttS■
I轟 ボTttst:縫 志‖∬
∬品 ‖ I:Л :11じ

:キ
￨llili:‖
派l]}￨￨#‖ :::等 ヽよ
は 1:::胤 I:

costS,Or(b)averagc coStS SOnle othCr suggest

。
palityt pricing alld(C)trair 19turni pricing

c′ ng
ra9 Marg′ nar Cο ,fP″

柵嚇
ふ 鑑胤ぶilttI鵠榊模 畔撤
熱帯鮒職鷺‖
rcsOutcS,tllC Supply of produ∝ Or sel■ 7icc,hO

肥 点
躍棚 ‖ PXl肥 器
J椰燻鎌難椰 榊 1騰lT器 s conlprisc thC grcatcr pa1l o「 S(,Cial costS

rbJ Дverage Cο ,IP′ ′

。Ⅲ9 ′
Cr all tl、 O coStS OF producing
Accordilg to thiS plillCiple priCes should be so dctCrmincd aS tO Coヽ

鳥∬
府肌濫 :胤 ∬
躍ぶ ¶
吼瀾ど :1霧l:1::tWよ 詰
肥ま :‖
． Ｆｉ”〓
‘

l,∬ 1器
 ・ ヽ75 ・ I "

rcJ cos■ pluS Prliclilng .

rJmpo/1 Parliry prlicling

"′

剛胸出I響澪導
器 臨 轟:盤晰 靴 l震∬凛讐ゴ
鷲濡 i黒彙I
 76
til yielcl prol'its or t() stlstilill ltlsscs'
,liil-v be l,t, ()n a no-pr.f it nrl-loss basis, or in stlclt a way' as

{t) Admi nistered Pricing govenrment normally on the basis or cost-plus

a
pdces fixed by the
Adr,i,iste red price.s .re to adn-ri'istered pricc arc stccl'
profit, Some extunplt"oi'"onl1od11es "iuittt
stipulatecl rnargin of public di stributi.u
i-ert,isers. corrrroii,i., ,olJ* ,rr. f air price shops under thc
coar, arurninium and 6

prices'
s.vstem at'e also subject to administered
' sir-uations tt' 1. all
above can be applicable ro a
ior. of thc pri,ciples of pricing discufsed dcpcncling
Dillerent,r.4oo, *oy-ir*. ,o be .clopted tor <titterent cnterpriscs'
kinds of e,terprises. Hence it is ucccssar-v
andihe requirer,ents of the economy.
on t,eir natLlre, stage of development,
lor governn** ,,ii;r"i;ffiil;Jirir., i", ,he price policv to be l'ollorvcd bv the tu'

PTJBLIC UTILITIES puhlic inlcrcst, S() aS t.()

rcl.er to tlrose irrdustries wlriclr htve to be operatctl iri
utilities
hrblic
lveL,aLc by provingrheir services lair.'cl noricriscrimiuir.ry ratcs' Thcy sttppll' gas
ruraxinrise sociar ^t u,dcrt:rtriing, elect.iciry rr.dcrtakirrg'
Nor,rally, tr.r,lspoll
cssentiar comnroditics ru.serviccs. otl'ttcd hy thc strltc arl(l
watcf sLlpply ur,tt'tntti'lls' erc' aLc caucd prrblic t't'ilitit't
,supply collccrns, arc sul-ricct to
governm.niio*,ition, wrrilc thosc ow,eti by pri'atc scctor
ar.e nor.mally free trom trre
taxatiott.
UTILITIES
CHARACTERISTICS OF PUBLIC
Tlreirrrportantclraracteristicsofpublicutilitiesaregivenbelow:
and are given exclusivc rights
to opcritlc ill
level of elficiency
(i) They operate at the higliest
of the s,r,ne ralilitics in thirt arcir,
rcrluce cosr a'id
cefiirin locality so as to avoid ouplication
iurprove the quality of their services'
pl'otect collsLllllcr's
rurd are rcgr'rlated so tIS t0
(ii) They are given monopoly rights by the state
intcrests'
tls also by solnc
.'-"-"+^":'^'71 hrr lre'rvv investment rn pltints an<l equiprlictlts
(iii) They are characterised by hezrvy initial Tlre rcltlt.c. as
plant capacities, wlriclr ctln be tlsed in emergenc.ie' ?' 1, ,".,.0',1..-l'.,0s.
unused arc l]ot l'ully ttscil'
the average aorriar,i, [o l'all so long as the plant capacitics
oLrtpLrt increase,
reasonabre tremand ror thcir
serviccs rlrr,r the clrstolttcrs'
(r,i) public utirities nlust nleet a, trre
lnd courn*r*icatious iu'c sL-l'\'ier''
public ut,ities dear in services ratherthan gooas. Tra*sprlrt 1o tltc
i.i) but the suf,ply of ,.,.1'' goods in regarilctl tts it servicc
Grus, water electricity ,,r. good,
couttriunitY'
said to bc iucrurc
by inrlividutrl oorsurner is also
(vi) Trre demand for the p,bric ut,ity service
inclastic.
(vii)Publicutilityservice.stu.enecessitiesofthecomnrunitytutdalcdenratli]cdcontinurlttsll,
almost round the clock'
(viii)Lastly,theservicesuppliedbytrptrblicutility.isnontratrsl.erablc.ttistlilticultlorthcbuycr
totrirnsf.el.lristlemirndtronronesellertoanothet.'sttppose,iftlreconsrrtrrcrisrrotsatislled
it l.trrttr atlotlrer collipall\,'
between two points, lle cannot btty
wiilr service strpplied by tlre railway can ,ot call in u'othet'
supply in ato*, is unsatisrbctory, thc custorrc's
sirr-rilarly, if the electric
untrtrraki,g to do the iob'
. .,......- rr..,r th,.ir.e r

Itisbecauscottlrcscch2lracteriSticsofpublicurilityprrlilttcts'tha:]l:]]:"nnlyisbcstdtrttclry
ancl cxtettsivtl ctlttipt-tretrt tciluirctl'
lixed ctrpital investrirent
a monopoly. Becausc ol.the large t. opcr.re at thc rnari,*" cc()nontv rrl
pubric utirities rnust enjoy *onopoiial;
*
o,,n entrbre thcni
ihc localities scrvcd bY tltent'
 77
PROBLEMS OF PUBLIC UTILITIES
Tlte committee on public sector underti*ing
have pointed out the lbllor,ving problenrs i,
applying the pricing policl,. rr

(i) Due to lirulty planning thc,scstal-ion pcriocl

oI thc procrucing unirs gcncr.ally gocs
Thcu thc cost of productir)n bL,contcs very 'cr.\,hiulr
high.
(ii) In somc cases pricing policies are not basecl
on rational considerations. Duc to political l.orccs
some are underpriced.
(iii) The social retums to ntost of the pr.oiects
have been low. ,l
(iv) Excessive expenditule on townships,
administrative buildin-ss
utiiities costly. &lrv'|)t rrvrrruo
and guest houses m.ke the public
..
(v) The outpur in nrany cases is row in relation
to trreir instailed capacity.
(vi) There has been ltlw productivity
of labour rmd high absenteeism in these cnterprises.
(vii)lnter - union rivairy, strikes and lock -
outs are seen in these industries.
(r,iii) Suitable managers are noI ahvays
available.
lt may be concluded by saying that no assessment
ol'public sector.'s perlirrmancc and pricing
p,lic1' would bc firi'whictr d.es not ttrkc
into .cc*urt thc technorogical sophisticatio,
ol'thc industr.y within thc public sectol.. antr conrplexit'

OUESTIONS

Essay Type
1' wrat are the basic assumptiotts of the traditional neocliussical theories ol,the
Irrodcrn econornisls r.ciicl lo thent.l firnr'/ Hou.dr.) rlrc

2' critically examine the mark-up rule of price determination.

price will difl'er in changing muket Do you crnsider. rhc nrark-up
conclitjons.?
3' Discttss Bain's lir,it prici,g ,rotlel and bring out how does his rnodel trear
the potenti.ll entry /
4' Exantine sylos-Labirli's linlit pricitrg model. Do you consider this r,odel is
supcr.ior [o Bai,,s

-5. Critically exami,e Fraco Morligliani's nroder or riniit pr.ici,g.

Medium Type
I ' H.w do 1'ou explairr Modi-rrria,i's
tJcterminants of ri,rit price ?
2. what arc thc assu,rprions of sylos-Labini,s moder o1 li,rit pricing.?
3. Hor'v did GorrJon attack trre ,eo-classicar
trreory of trre fir.,r.l
4' How do you explain Bain's concept of
liniit pricing by mnking collus-ion with new entraut.J
Very short type
L What are the fbrms of pubiic sectol.enterprises?
2. .,rWhat do you mean by impofi_parity
pr.icing /
3' Explai, brietly trre lair-ret,,r pricing of
the public ert..prirJr.
<'r-l

4. Wha[ arc the chal.actcristic ol.public

utilities,?
-5. What do you mcan by public utilities./
(i. Exanrinr: lhe problenrs of pr:icing
ol.public utilitie_s,/
 78
芦｀
′
Nl10DULE VI
1 ■

MACRO THEORY OF DISTRIBUT10N

i e"
functional or ftrctorial distriburtion ol'ittctlnte'
ln economic thcory wc ru.e concerned witli I,
as rewards rirr their contriburtion t.
the output' the
distr.ibution of incomc between the factors
lrands of the neoclassical writers, tlre tlreory
of distribution becalne mainly tlrc theory ol.
amrng the
than the disuibution or nationtil inconre
determination of relative fzrctor prices ,.ort."
¨、

aggregatesharesofrents,wagesandprotitsinthesociety'Inotherwords'theneocltrssicalstreated shtrres of
problern. on the other hanrr; how the total
the distribution of income as a rnioroe.*","i"
thevariouscategodesofinconrearedeterminedisthesubjectmattelt]h.'macrotlreoryof below
:. of Incomebistribution. we shail discuss
distribution. This is also czrlled aggr.guiir.Theory
of agglegative shares of income'
various theories which.explain the determination
1'L ' ,-,arr
. 1. RIEARDIAN THEORY OF D]STRIBUTION
InRicardostheorytheeconomyisdividedintotwobroadsectofsagriculturezindindustry.
Brrttheagricultural,,.to,.crccupiesacruciatpltrceintheRicardianmodel,sirrceiiistheforces
workingintheug,i0,tt..,.ntsectortlratdeterminesthedistributivesharesirrtheirrdustt.y:

ASSUMPTIONS
return operates in agriculture'
Firstly, it is zissrtmed that the law of diminishing
theory ol'popr'rlation accot'tlittg to which
thc
Seco,clly Ricarrlo assumes the Malthusian
the minimum subsistence level'
population incretrses il'the wage rate rises above
Tlrirdly,Ricardoregardsprofitsasanecessafyincentiveforcapitalaccunrulzrtionwlriclristlre
key to economic growth'

.―
D
― ヽ

Rent H
Ｅ  ヽ
︶
うＬ ″コ〇 一

ヽ
AP Fig 6.1
Prottt ヽ
・・

ヽ
 

K
 
 
Ｗ
ｏ﹂ぅ︶

一
 
●
、
、
、
一ぅｏ一０＜

ヽ
Wages MP

O LabLulbour

' I " thrce share.s such as tent' wage

Ri"*do discusses the distribfrtion of 'national- outpu! among
the help olmarginal principal the Ricardian
and profit o, u"rri, oi*o ,.purui"'ui11"1qr"s yi,rh
re11in thb national putptrt.and with the sut'plus
thbory explains the deternrination oi it t .ir9'9f
principle.thgtheoryexplainshowtherest'ofthenationaloutpu.tisdivitledbetweenwageiand
the tottrl production qosts will i:ept:esent the
profits. The diffe'en.. tet*rrn tt e iotd proOyl ur9
ointr"irce between rlt *1fY'11p!'oductivity arid
the'
r renr of land. In orher words it is crearthatit,
. average'productivity otlabbur on a given land
willbe.equalto the.rbnt earned fi'om per trnit o1
p-roduct and
. to the differenbe betweerr tlte hveragg
iabohr employed aad the tota! renr,i,iiiui.quur
;. ;;;ri;,gri^t;;,;d"; multiple<t bv the ntmrber oi qnits ot' labour emploled'
 79
Thc differencc betweell tllc mal・ ginal pl・
Oduct and the hvclagc pl・ Odllctis equal to ED which
l・ eprcscnts thc rent carncd On land pcr unit Of labOur enlp10yed.Thc tOtal l・
cnt earned by land is
cqua]tO thc alea BEDC.

4 NOw tlle lclllailling prOduct OMEB is t6 be

sum of wagqs ald prOft KE meastil・ es tllc rate α

蠅∬
ヽ
漁電l駄淵 1北 IT襦 寵燎麗欄服
vagcs and rcnts.
1藷 l‖1:1出 i糀 it出 l

In Ricaldian analysis the nu11lbcr of labOur

thc lllarginal prOductivily curvc licrc thc leOc1 01

は
オ∬:蠍急月
lt躍 鷲
lll讐 ‖
習潔

i爾 鷲蹴灘i蓄職蝋郡 燎
}蜘 ‖懲 棚盤
躍蹴 ∬ 懲胤I器ifll:棚寛
認ittI篭 :器鋼ょ
辮:1嶋 :出 躍=
[ギ l諄 灘構景
鼈I鷺 害 ￨1驚
DEVELOPMENT OF THE ECONOMY ｀

md鷲
ゝ′
脚酬 lTl」淵『
認¶∫
::淵 wi淋 Ⅷ概鮮‖
霊
agc abovc subsistcncc lcvcl.This、 vill incrctsc thc pOpulatioll and thc、
1盤 l器 嵐
ュ11:‖ PI
vage l・ atc cOnlcs 10 scttlc
at subsistcllcc lcvcl.

DECLiN:NG PRODUCT:viTY :
inal products Of lめ our will dttline due tO the

憫 淵 il書辮 脳
…撃血Ю 山
瞥山 deVC・ lCtplllent h鮎 鸞撃
l織鮮 轡iF事
DECLiN:NG PROFIT l l
"山 1締
鮮
離幣源滞蓑 批
難糧職 欝維i椰飾 1姜 T
 80

淵』
出紺濶 癬 淵鳳樹♀
器:獄見 臆1温 服鷲l器樹
鷺
=ド
CR:T:C:SM
fi'om the following stand points'
The Ricttdiam theOw Of diStl・ ibution is cHtiCised

(i) Wrong Predictions

rel.tive rtrbours share in rrrc nari.nal
(a) As against the predictions it has been fbund out that capitalist coLrntrics in spitc
years in the western
income has rcmained constant in the rast 100
production'
of tremendous changes in the method of
also has rcmirined more or less constant'
(b) The declining- rate of profit is not evidenced. It
moving towards stationafy stt[e-'
(c) There is also no sign of capitalist,economies

(ii) Limitations ol Diminishing Returns ol

According to Ricardo technical progress cannot
be so rapid to suspend the operation

diminishing rcturns

(iii) The Assumption of Malthusan Theory of Population

Theincreaseinpopulationwithincreaseinwageisalsoptovedtobeitrcot.rect.Wlratreally
increases while the rate ol
cou-ntries the wage late
happens is quite contrary. In advanced "upi ^fiU
population growth decreases'
InspiteofthelinritationstlrecontributionofsurplusprinciplebyRicarrltlhasproducedlar
reaching eftbcts in economic theory. tt
*u, t*t" u"ti by Mu'" nt stepping stolle l'or burilding the
theory of surPlus value.

MARXIAN THEORY OF DISTRIBUTION

Marxian theory of distribution is essentially
an adaptation of Ricardo's^y'n1us principle'
of dist'ribution is merely an extension of
Marx's
but arrived at differeirt conctusions. His th-e-o-ri i' distributive shares
pmenrof capitarism sir* T lp"gh that changes
;ffiiffi;,;il;
iff* C*.laliy the roonon y,, development in a capitalist country.
COMPONENTS OF NATIONAL INCOME
it ctlnsists
is composed of three eleruents' Firstly'
In Maxian analysis, the total value of output Marx
the production of goods and services.
of the varue or capiiat and raw materials coniumed.in outpttt contains the
as c. Secondly; the total value of
calls it as congtant capital which is expressed in terms
of gooOs and iervices' thtrt is the total wages
value of labour powerused itr ttre proOuction
worters. Marx calls this as variable capital which
is
.f minimum subsistence wages paid to the is created by the
expreqseg as v. rfrirJty, ttre tlotal,vahre
of output contains surpltts value r'r'hich
powe-r and which, as seen abtlve is pockctcd
by
labourers over irnd above the value of their fuUo"r
r"pr*o.J"t s bv pocketed bv the capitarists as protirrbra'd
this is
iil:;:X[ffi;;;;;;;Jir,ir-ir where c sta,ds consr.*r
the iotal output is e[ual ro c + v + s
ffi;q,;,a;;'i"fi M** ito,
capitul,
V stands of variable caPital, and
S stand for surPlus value
:;
BASIC RATIOS
economics to show the rate of exploitation'
There are certain ratio relationships in Marxian
rateofprofitandorganiccompositionofcapital'Theyarcgivenbelow;
 ril
(I ) Ratc ol'exploitatinn = ! '. Prtlflt share
V ". Wage.share

(2) Rate ot'profir = i... -Ptulit' share

=i-
C+v ''"' i;;l ,upirrol
(3) Organic Composition ol'Capital .. Constant capital
= -l
c+v ".. T,tal capital
where S = Surlrus Vuluc
V = Variable capital
r- _ la.---.-,
r_ = Collstant capital
The ratc 01'cxploitattrln s/v l'eprcscnts the r:irr.io
ol'plolit shil'c to thc wagc slrilr.c in thc rrar.ionill
illc'mc' A t'isc itt tltc ritti,Il)eans tlte iucreas.'in
the'aie o1'expatiitti,n a,d |ie,rcc ,ncr.casc i,
sharc'relative to wage shitl'e in the pl.rl.ir
national incourc; a lzrll in tt ir.rtio ,lea,s
in thc prolit share the r.elativc.ccrcasc
antl t'elative' ittcrease in wage sharc in
lhe natio,al inco.-rc.
DECL:N:NG WAGE SHARE

灘 磁瀬簿∫
:綺鷺
‖掘移 漁
I悸鮮罵
=厄
1

capital accumulation helps the capitalist

to a achievc lechnica] pr.o-rr-cs.s. Technic,l
itnd capital accuttrulatit"'' g'ni" in
つ・

,r.o-ur.L,ss
ctrpitalist ccorlonry rry .*in,.ti,rg surplrs
[r.r incrc,si,u
口∩り０崎ミ蟄ヽヽめ卜﹄ＤＯ

tlte sutplus t'alue the capitalists coulpete 'a.rc.

r.vith each rxhc.r'. consecluently, rvith
capitalist econontic systcm, the'elaiive thc dcve l0;rrncnr oi.
share of *ug.... i,, ilr. national inc,,rc
telittive share of prof its will .ise' Thel'elb'c. will lall and tlrc
thc tleveioprrent ol'capitarist cco,o,ry
stetldy worscuitr-s o1'thc livirtg cr-rndiliors in,.r'e.s lhe
or'thc wolkirs ;irr;. rrrjs lras bce.
intlttiscratiott tt1'the proletarial orthe callecl ht, Mal.x ,s thc
Iaw of increasi.giiscry ot.thc
tltis Iarv' tccltltical pl'og'css ancl capitai.ccunrulalir,,.,1,r, wor.ki,s class. Acc.rding til
crttwtlt.l'ltal'i.ttitlitrct'tl)c caiit.,lisr s.cicry,i,r,l .,,,,rc,1,-rcrrl, rlrc
rtrtrst lcu<l t. rhc r.ri i, rhc'clirriv..,r,,l:.',,, ,"rr": ,,,',ilrtl]],,,,,,,,,r
irrrcl l'isc irr hc l.clirtivc sltiir.c ol.prrrl.irs. irc.r)r.
FALLING RATE OF PROFIT
Tltc f)rlling l':ltc ()l'prttl)l rt'as c-xpliri,crl
l-ry 1\,1,r'x u'ith the- hclp .r'tlrc
c,ttrpt;sitiott,l'c.pital' o'ganic c'ntpirsiti,,.l:cirPitrrr r:.rrc.rpt .r.,r.sr,ir.
i., iir.',uti,,.l'cr^.sruur cupirrrr (c)
t, trre
 I!￨1縦 ￨:[Jゴ 櫓
よ
‖誓草
悦I麟 1∫1111榎 111瀧 ili‖ II‖ ド ￨ハ

P= S TttingdlelMweCaleXttld■ ‐
V
I
I

I rvc rvill $ct tht' l'llllt)

Jv扁蝋 n織出lIIギ 翻黒猟」 話謂

i榔 :ぶW鷲 電 T琴 Thcrclbrc \\rc gct thL
rdlttionship as fol10Ws:

P=:(1-て議ヽ戸 )

From the above cqualioll it ltlllows that il the

s/v thc ralirr' o1'cxpkritirtitttl rctttititts c()l)sliirll '
ittctcltscs
thc r.trtc ol.pr.r.il i,viil dcclinc ir'the valucs
0r'c/C+V, i.c.0r-{auic c0rrip0sitiorr ol'cirPitul
increimc, M^r'x als. trrk thc sti,r(lth.t
thc ratc
while holdi,g tliat relirti,e srr^re trl pr.rit rvill
.fhr.rs
as ir rcsurt ol'capital ircr'.ul,liitr.n
irrrd c()rlsurlrcrlt
ol.pr..lit r,vill tlecli'e in thc capitalist ccoriorny *:l'': u].tt
increase in organic composif ion o1'capitai,
ir, *u,t.tn terminology we czlll say tililt 11 ,ll't.
ortplrt,alio l'ises in the p'.ducti,c pruccsscs
view trrat as nrore.upiror is accurnurrated and capittil ol'prol'il
prn,lrcti<'r', tlchnirlures tlrc cmploycd, iltc t rttc
or, in other words, ils rllore capititl int.nriu"
ivith thc assumptiolt lhirt valuc is crcalcd
will fall. Marx could ,n'ir,c .t this conclusion lly sla'ting
to Mat'x collstallt capit:rl (c ) c, rcs ttiit
o,ly by lirbour, *ot by m*chinet1cs. In other *oi l, accortling shat'c.l wilg0s
creittc virlue. Ther.clbrc whcn oo'rposition o1'capit,linc.cases tltc t'clati'c
or_Eruric

dccri,es whicrr reduces the purchasing ion e,

of thc worki^g class. Trris rvill lcircl rtr u,cl':t
rrite of prolit'
ct,nsumption, declinc in price and ttrlling

CRITiCISM
ヽ﹁ ，

Hc had pt'tlvccl to lrc a bacl prophct'

Ⅳlarxian thCOry l〕 tts bccn cl・ itiCiscd On sCVCral groLlndS
true irnd lhc actuttl cvcl)ts ltltvc t'tot
． ．・

his thcOry lltts ll()t COlllC

PlcdictiOn hc llladC On thC bltSiS()1・
ヽ﹁

takcn place in the Mirrxian line'

(i)Marxlradpredictedtlratrelativeslrareol.wagcsinthetlationalittctrttlcrr,tlttldl.allitndthc
All this has rtot c.nle tlltc' Erupiric:rl rcst-itl'cil
econ.mic c.nditions ol,thc workers woulti deteriolate.
income has re*rainetl constanl in [hc *cslcr,
capitalist
has tound thirt share or wirgcs in the nationar srrare 1'r'o* thc
worters have obtained tr rJuc
conntries,instead of 1alling as predicted by Marx. The
nccu*rulal it;rr
erbout by trre tech.ical prog'ess a,d capital
increases in physical productivities brought
in thc capittrlisl cot"tnlrics.
capitalist cotttrtrics as prcdicted
(ii) The lElAtive sharc oI profit also has not cleclined in iulvancctJ ptlrvcl in thc
pr:otil, arrrJ ctlrrcetrtrtrtitln:|
l.ly Marx' on the basis ol tlre ltrlling rate of |u,.1..:silr-u
ecotlonties woultl lta'c pcri.tlic crisis lrnil
hantls ol the f'ew, Marx preclicted that the capitalist
have I'alsitled this glooir)'r 1:,)r..nr, ol'Mi'u'r'
ultimately the system *out,t collapse. Actual cvents
b*t in spite tll'thcsc short rtrtt llttctt"tliti.tls
or,course, there hars traai., rr.r,,l. ayai", in these cconomies ha'c
progress in thc last 100 yca's ()r so. s() th.r thcy
capitalist economies lravc made phenomenzrl
hccotne al'llttcnl cttttntt ics tttlrv'
hc t'citllY tlct'it'ctl
(iii) Scver.al autlrurs havc poinred out thc lau,of l'alling rirtc 0l'ptrrl'it crttttttll
lr.orn the law .l.incrcirsiug trrganic c.urpositio*
ol'capital. whcrt tlrganic t',rrrprrsili., rll'eapital
S ille rcilscs'
is a constant' Btrt C can incl'cltsc tlnly *'1tctl
iucrc:rses thc p'ofit rvill dclrc.r^se o'ly il'S/V
and increase o1'C ctlllllot go to*ucthct''
Thcr.cfore thc assuurpti0n of 0onstancy ol'S/V
labour'therlr'1'tlI r'altte ' Bttt
(iv) La-stly Marxist theor.y of income distribution is biisetl on the
 83
labourthcory o1'valttc is ttot acccptable
rcl the nrodern econ()rnrsts. According
technologl' also cl'eal'e value. The t. ths,r, capitpl,,d
value .Jso tiepenJ, l,rorginal
courntoditl'' The'e1bre i\4rux's thcsis urility or tjemand lirr the
"rl
that varue oi:, .u,r.,,no,ii;;il.,:,ri;iJt#
labour labour tilne t'eqttit'ecl rhe nccpssar.y
to prodL,.a
- it i, quite
r,.-!! obsriletc-an,t h.t itcucptitDlc
\,r,\,\,rLf,L (rru u[,] accept,trlc t. t'e nrutlcr.n
Lcoltol)lisls. ,

Htrrt'evcl'Marxian lltcory o1'tlistribufiorr

lcd t. thc pr1)ccss of i.cr.',rsi,_u,r," i;;;;;ninehaspu*,cr..r.trre
helped the lab.r.c:rs r. ll..rrr rradc
u,ir.s,rri it has
r,l.rour cr..ss.
KALECKI'S THEORY OF DISTBIBUTION
M Kalecki made an iitfempt in his theory
which lrad rnaclc wrong prophecy
wtlgc itttd profil' Accordilt-c ro of decri,ing r:atcs
this theory natiintil l,rro*. rrrrr
atrd wa,ccs a,rl ttrey deperiri ,rrry two co,porlerts, rarnely profits
o, the ,t.sra. on monopory in rtre cc:ollo*y.
PRINCIPLE
Kalecki's tltcory tlf dis^tributio,
is dependc,r on A.p. Lcrrler.'s Micr.cc.,rrnic
ttlon.poly' Sy,rbolicallf it is rcprescnted.as <Jcgr,ce ,r.
e- rn/p; *rr.,:. p srands lru.pricc
c:ost' ltr othet'words p - I)'t sliinds iurd m rbr.rrrar.uirul
lix'p.ofit slurre ar ,,i.rn l.r.r iy KrLlecki
ir.i lris thc.rry or'rlistrib1rti...
ln Kalccki's lb'ntulati.tl ol'lhc
degrec ol 1111111i.,ptrl;'nrargin.lcosl
raw llltlte.ittls pcrrtttit .1'oLllptrl. irrr,,,r.-r.urt ,f l,hrur anrr
Funhlr. in Kalccrk's rrreu,:f-.i,rr (rr,labuur.incrudcs,nrv
tllitttualabtlttt' sittcc hc I)as llcitlcd rv,scs.r.
sala.ics - the rv.ges.t'iritc c,ll.r
thc capit,list class' Thtt5 - u,.r.kcrs rvith rhc incil,res,f
| n, i,r,ii.,,r.l, pe'uniI ot'our.put thc inc..rc .l.lhc c:apita]ist cl,ss
ittcludcs clltl'cpl'cllcul'llrl pl'tll'its
n"tt lrn<l
u'c'he ad iost i.c., irtcrcst dcpr.cci.ti.,
"gg,ag,rtc ,ncr s.,,ric.s.
ASSUMPTIONS
Kalecki ltas madc two ntaior
assutnptiors to explai, his theory
ilssunles that tlie sho,t pc'iod of distribr-rtion. Firstly, hc
rirarginal cost olrrve is equar
manual Iabour and rarv ntiltcriaJs to the shor.t pcri.ri average cost o,
to a cert,rin p..,irt.n,r..io,rii,r*
hc itsstttt-tcs that outpur in the t. practical capacilv. sec.ndl1,,
firms in irr. actual rvorld is below
Thus he asstlmes the cxistcnce lhis rnaxirnurD pr.actical capaciry:
of extcs, capacitv in rrr the sLt'rrullly'
thc lactortnarket and contnro<tiry trrL econorny. lllls ls
Thrs is rjLrc
duc to irnperr.cction
il i,
nrartei
DERIVATION
As wc havc noted earlier Kalecki
slarts from Lc,*er,s ulczlsurc
sin-ulc ljrm. For Lemel. iiegr.ee o1'tlcgrc.c o.l'ntoutrpoly ol. lr
nf,rru,rnf ,,ly
P-rn
[n=-_.-_
p

wlterc f-r-E dsol.gs gl'lrr.,.poly

p = pr.ice

nl = tltru.giltal cost
As pel' itssumption marginal cosl
= average cost. Therefbre in lhc ahove
rb,rfargir,,,r .o,, ;;iTfrffi;,oliiiJ,il,o, lbr.mula w$ can
;T,?-i:ll.r:H;,fi:,::l::a ric-s,ee ,,i,,,,.,,,,p,,ry,r a
singrc
P-''
l,=
o'. P[n = (p-a).............(ii)
(p-a) is the <Jifl'e.cncc bctrveen
the pr.icc o1'the product and
ra\\, utaterials pcr. r-tnit ot. avcr.age cost on lnlrrrtrill ilhtltrt.
oltrput. Thus, tlris dill.erell".'1p_,J
ll nradc up tr]. thc prolit sharc or antj thc
 ti4

ilcorle ol the single ernployer on a single product. Lct x attd l'tlt' tltc tol al pt'tltlttcti0tt
gross capitalist,s
ol'the lirm. 11 we [rultiply hoth sides of the equation lvith x we
get

xp [n (P-a) ..... ... .. ...(iii)

l() uc[ lil' ul()\:'
x (p-a) l.epreseuts the total gross capitalist's income ol'thc cnrploycr'- iltot.elci
\\'c h:t\'r' 1() sLlll I Ltl'r lr -'
capitaliit's income of the economy whcrc thcre are a large number ol' I it'tlts,
1

tlt,-'cclttatitttl rilil
gross capit,rlist incomes of all the firms in the econonry. with such suntttratititt.
can be writtett as:

Σ xp p=Ex(p― a) (iV)

と111 1ll‐ nls ofthC cc()1101〕 ly ltlkcn l()ピ

cthCl.Σ 、P
ΣX(p― a)cquと ヽ
lS thc gl・ ()ss capitalist incolllo o「
´ ″
′
vhich llla、 bc ヽ Vrillげ ll ttヽ F 「 = Σ 、￨) 11
l htis‐
rcprcscnts ttじ grCgate ttirll ovcl・ OF thc econollly、
!icgatc ttil‐ n()vcr T is illa(le tip()1:thc Vitlllc t)1ビ 1い ド｀1ltilitlitを ヽ
l pit)(liitit、
sl、 ()uld bc llotcd that the agじ
ld 11'wc diVidc bOth ditlics oFthc ctluati()ll(lヽ ,

PluS the valllc ofthc law nlatcrials proouCCd ang s。

by the agglcgatc turn over T We get:

Σxp = ΣX(p― a)
T T
But T=Σ xp

Σxpp=Σ xΦ ―→
Σ xp T
If wc divide Σxp by Σxp wc gCtnは cH)dcgrec o「 l110■ opoly which is FCprescnに diド 戸

戸 ΣX(p― a).… ……
(v)
T

¨ 品は y
…
"脚

器:讐 Ⅷ誌器器棚 需∬ l籠 tttW∬ TttiFttIな r「 胤

‖ liFぽ ∬ :1麟

鵬 Wl胤 悧鷲∬ 凛mittili鮒 i出 ‖ 1滞 ょ 糊‖

「 his conclusion stlggcsts t
turn ovCr is constant:′
sI〕 之
lrc did not dcclinc dtic to theil・ ll10nOp()ly()ver thc colollial c(llinil iC)s

LABOUR SHAREIN N.l.AND DEGREE OF MONOPOLY

′ ヽ
vcCn 11lilc1 0〔 lCご lc(〕 t)ll〕 1()1101)い ￨卜 tlll(ll(1い 、til
Kalccki has tlls()1「 ic(lt()shoヽ V thC IClttltionship het、
V lk)1・ tlぅ c loltll Wを lyc sIヽ alC ill th(,cco11011ly lhc1l A‐
shale lll A stを ln(ls l'()1 lhc nlltiollal illc()1llC an(1ヽ .ピ
;(ド ヽ
ヽヽ/、vill l・ cpl・ esent thc」 Oss ctlpitを ｀
「 list inc(〕 lllc()i tllC ecoll()lllV Bti(ヽ ヽ
'c it)ヒ l11(1じ :1111じ l thtll lh、

・)(lCli、 で(lを 1い ()vc

capitalist i nc()inc is cqualt()Σ x(p-O SubStituting A― WRう r、 (pa)i1lC(ltlそ 1l i()1,(、

vc get
、

rlq::l
一
Ｐ  一

=
T
Ｐ

A-W
z_..........(\,I)
'f
 85

Multiplyitrg both sidcs T/W, vv" .tel

Ｔ 一Ｗ
_T (A― W)
PW= T Ｔ 一Ｗ

Ａ 一

Ｗ 一
・ Ｗ
一
Ｐ

戸
+=金
二 1

w=1+P雨
Writing the l・ cccipl・ Ocal()rthc abOve,、 Ⅳe obtain

.\ =満
半 ―・
l+Jn'1-i\\/ """\."/D
W/A, that is wagc/National Inconle repl'esents the lelativc share o1'rvages in natiotrul incutrtd:
Frcru rhe cquiilir-rn (\'ii) it is evideut that the relative shale ol-the wages in national incotrte (W/A)
is inversely lclated r.o clcgrec ol' ruonopoly power [n and T/]V. The otlncludin-u lbntrula cle arlf'
shorvs that thc incrcasc in degrce of Lnonopoly will reduce the relative sltarc ol'r,r,ages: thc lahour's
share will be rcdr,rced not only bectruse ol the rise in the degree ol'monopoly siuce it laises priccs
in t'cliltiotr 1() wilges.
Bi:sides ihc ch;ui_stt in the degrec of monclpclly T/ W can irlso change as a result ol'the chan-qc's
ril tlrc priee o1'hasic ir1u,tilirlcrials in relutiill) to the wagc costs in the ittdustrics. Wlten thc plices til'
iitc busrc litw lrratcrilis chiingc, lhe aggrcgrttc turn ovcr T rvill c:irangc uttd conscrltterrtly TAV rvill
rrlso changc n,hir h, grr,e n tlrc dcglce oI rlouopoly, rvill al'l'ect the shtire ol'wage s in ltatitlnitl incotttc
(\\'/A), 'fhe incrcasc in pricc o1'rirru nraterials and hcnce in TAV will rt--ducc the labour''s sharJc
(\\'A) irritl vicc vcrsa. The advanced capitalisl countries had nxlnopolS' por.r,cr ott the rav, rnatcrials
i,Lrrr;lr.rs.-'d l'r'rin crilorrics u,hich reduccri thc priccs ol'thc basic t'ar.v ntatcriirls u,lticlt hrtrught dotvtt
llrc vlrluc ol'TiW. As ir lcsr.rlt ol'this thc r,vage shirre did not lirll.'fhus Kalccki clcl'ivc ttt,o cttttclLtsiott
Ilt,nr his iurirllsis: (i) A risi: in the dcgrcc ol'rnonopoly causcs a decrcasc in the relativc shurc tll'
nrenual labour W/A; ancl (ii) a decline in the prices ol'rilw nraterials ils it rcsult ol'tnonopctly in tl'ic
l'actor tlarkct causcd a tlccrcasc in thc prices of the demised products (T). Thus thc wit-uc sllal'c w?ts
pushcd up and it rcnlを lillcd collstant in thc tdvallccd capitalist coulltrics.

CONSTANCY OF WAGEノ PROF:T DUR:NG TRADE CYCLES

Enrpirical cvidcncr-s have rcvealed that labour's share in national incortre ltas lcntarined rttolc
i,r lcss coustitlrl in nrau1, ciipitaiist countlies cven during trade- cycles:
(i) Kalecki iir,slrcs thal slump (deplession) the lurn over decrease; but soon ciulels at'c eteatetj
hy tirc pltttluccrs to suvc plolits an tlso there is relucturce on lhe part 0l'cntl'cpl'e ncl,,'s t,.r ntu{c
pricc cuts l'or lcal' ol'intlriciug the cornpetitors to do like wise. With this, the gap hetween the price
lunrl ruarglinal cost jrcl'cas,-: aritl a resull, the degree ol'monopoly incrciises during thc slurrip. Tfc
incrcr-rsc in {lrc tiegrcc ol nronopoly during thc sh-rurp tends to leduce thc sltarc ul'labottr in tllc
liirtiullirl incorirc. But llrc J'all in the priccs o1'rarv materials durin-u thc sluntp lcnds to t:itise it. Tltus
!lic tu,o liu't:cs lvhich tlcti:l'ntiuc llrc shalc ol'labourin national iucuu-tc lvork iu thc opposrte dircctir]n
rrnrl tlrclclbrc c()unler birlancc cach othcr, as a rcsult ol'whiclt labour''s and capitalist slurrcs ln
rratitlual iricottrc rcnt:riu constirnt in tltc slurnp.
(iit In 1hc troonr pcriocl of the busincss cycle when the tra<Je lcvivcs cirrtels are dissolvJd
bccru"rsc cl'inrplovinlr pr()spccts ol'independent tictivity and the enlry of others into the industry.
 86

As a result, coulpetition incrcases during, boom rvhich lecluccs thc dcgrce ol' tttottopoly. Thc
rcduction in the degree ol'lrouon()ly tends to raise the labour's; sirtrc irt nirlinalittcotnc during trortttt
pcriod, but thc risc in thc pl iccs ol'raw uraterials dtrring tht ir,iour tcnd's to rcclucc it. ThLrs iigaitt the
tr.r,'o lilrccs work each ollrer in the boom pcriod aucl as c()nsc(luellce lithottt'ct's lrrid capitalists
sharcs in national inconic rcntain constalll .

CRITICISM
Kalecki's theory ol'clistribution appears lo be an allelnpt to reinstalc Mar.xian tltctttl' ol'
distribution. Kalecki has tried to.iustil'y rvhy the prophecies ol'declining r.vitgc share and I'alling
rate ol'prollt did not occul'in the advanced capitalist countlies. Horvevcr'. Kalccki ntattagcd to do
it r,vith the help of cert"ain the orics which are fnr li'om rcality.
(i) In the f)rst place, Jan pctr has pointcd out thirt Kalccki by attributing prol'its to tltc clcgrce ol'
monopoly alone has ignored other factors in causing profits and al'l'ecting clistribLrtrvc sltitrcs.
(ii) Sccondly, the nrarginal cost cannot be equal to averagc cost in lclual nrukct situation. Tlrc.v
rvill be equal only rvhcn constant lclurns prevail in the markct. Tltus thg thcory ol'dislribution
oi'Kalecki is blsed on im Lrnrcirl assuniption.
liiitThirdly'. Kalccki's thcory ol'distribution irppc?u'sto [riu,e i-r]norcd thc rolc ol'ltadc unions. l{c
lras strcssed only rln the pitrvcr tll'1hc capilalists. As has lrccu curpltusisctl by J. K. Culhruith,
Iabour urrion cxcrciscs a countcrvailing p()wer lo tltr- p()wcr ol'lhc c:lrpitalisls orvtling lhc
nrarrul'acluring intlustrics and tend to l'crlucc thc dcgrcc ol'rnortopolt'irr tlrc cconot'it1'lttttl
conscqucnlly Iaisc thc lab0ur''s sharc itt lhc ttittiunal itictttnc.
(iv) Lastly. Kzrlecki q,1'sn-uly cstahlishcd positive r,:l.rtion betwecn industnitl coucctrlration and tltc
degree o1' nloltopoly. According to flre critics. thc empiricirl cvidcttc'r-'s rvltrt that industrial
concenU'nlion does not incrcirse nronopoly. More, o\/er the propcusill' to ct)lcr into ciitlcls by
oligopolistic linns is not a r:cality espccially to cnter into cartels b), o1,*o,-,n,islic l'il'ttts is ttol a
lcality espccially, durin-s time ol deprcssion, Jrin Pen ilsscrts, "[t .is a chcap illusion to bclievc
that large collcenls lrclp onc another l'urtively. It is easy to describe oli-uopoly ls a ltu,l'it'nts lo
go hand in _elovc r,vith one rulothcr". During tinrcs til'dcpressiou in thc I'irnrs strirgglc tirr'
rlalket u,ithor,rt tmsting ouc anotltcr'.
We conclude that Kirlecki lrirs enrpltasiscd only one lix;tor r,vhiclr ltus a bcurin-lt on itttortic
distlibution. It is cer-tainly 1rue that flrms r,vith a pricc settin-u powel'rvill al'lcct thc distribLrtiott ol'
ir.rcourc. Btrt one should not ignol'c tltc ituportauce o1'othc'r fitctols.

KALDOR'S THEORY OF DISTRIBUTION

Nicholas Kaldor hus rtradc ir gtcat conllibution torvards lhc thLrory tll'ittcottic dislt'ihulittn untl
-l'ltis
it clc:cupies and importirnl posrlion in thc theorics o1'ecortrtntic grorvth. lltctlry is cottsitlclcrlas
very intportant ltecause, accolding to hiur gro\,vth depcnds on distt'ibutioti rtl'incoutc hctn'cclt pt'tri'it
carning class and lvage carning class.

PRINCIPLE
Kaldorusccl-Kcyncsiiurapparatusol'thor"rght,i.e.,Y=W+P(lrrcortrc=Wiigcs+prufits) to
explain the thcory ol'distribution. According to him naliottal irtcorue is dividcd trc{u,ccn wage and
prof it only. Since l(aldor uscd Keynesian appilratlrs lbr his thr:ory ol'tlistributiort he hintscll'cailcd
it as Keyncsian thcory ol'tlistribution. Prol'ils arc deiincd as lhc inconrcs ol'lltc pr'opc11)/ ou,nin-,.:
class and thcrefbre includcd ordinary prol'its, reut aud intercst. Wagcs inclr"rclc n()l orlly lltc rer'r,;.rltl
lirr manual Iabour but salarics as rvell.

ASSUMPTIONS
Kaldor's theor-v ol'distrihution is hased on the lbllowiug assLlnlpli()l)s:
 87
(i) A state ol'lull employnient prevails in the economy turd its iniplication is that total output or
inconrc is given.
(ii) The propensity to silvc by the working class in conslaut ancl very lorv.
(iii) The propsl5ily to save by the prolit earning Glass in large and variahlc.
(ir'; 1'u. wago l'iile (w) should be above a ce(ain mininrurn lcvel, i.c., w > w nrin.
(t') 'fhe pt'of it triargin must also be abovc a ceftain mininlrnt level, i.e.. P/Y > P min.
DERIVAT10N
Supposc W stと inds lk)i the total、 vを tges alld P stand、 lk)rt()tal plollitsと tnd itl1lhcr that S、 v stallds
r()l aggicご と
ltc sttvillgs by thc wage etll・ nlllg ciと 、
ss tuld Sp lk)1・ と
tggl・ cgtttc sttvinピ SI、 ythc pr()1lt carning
class Thcn
Y=恥 /十 P.… .… .… ……(i)
TIre above ecluation is simply an identity which shows that total national incomc (Y) is contposccl
of the suni o[ lggrcgilte wages and aggregate plolits. Now in an equilibrium position the excunl
(intcndcd) s:tvin-rs lt.tust be cqutrl to the intended (ex ante) invcstnrent. Sincc Kaldor deals with an
cquilibriunr state of I'ull cr-nployntcnt we can write: I = S ................. ...(ii)
The total savings in the socicty is the sirur ol aggregirte savings out o1'wagcs and aggrcgate
sin'inss titnr prol)ts. Thcl'clbrel
S=Srv+Sp
Taking thc invcslntcnl as given artd il'we represent avct'age propcnsily t() save o1'the. wagc
lvclitgc propcnsity to suvc ol'the prrll'il canted hy r;p. lhen
cal'ncrs by sr,v anrJ thc

Sw = su,' x \*' itrtci

SP=sPxP
Flonr ccluations (ii) and (iii) il follows that
I=sp.P+sw.W
Ftom ec;uation (i) we know thal W = Y-P
Therelilre, subsritutitrg Y- P 1br W, we get
[ = sD.P + sw (Y-P)
I = sp.P+sw.Y- srv.P
[=(sp-su)P+su,.Y
Dividing both sides bv national inconre (Y) we gct.

IP (sn sw) -- *.sw

-YY
= -
Dividng both sidcs hy (sp-srv) we gct

I _ 1_ P* sw
=sp-s*.
Y sp -sw sp -sw Y sp -sw
Rearranging the abovc equation we get

IlswP
'
Y .sp siv- sp -.sw Y
 ｀ '`「 `:

tt tt

Of
P I I .sw.'
=
-Y sp-sw Y sp-sw
'
Since P stands for prolils sltare iud Y lbr natiollitl ittcotttc
Prollt I I __.y_
Natiorial Income sp - sw Y sP - sw

The above equation shorvs that, given siiving propensitics ol'thc prol'it carning atld witgc ct*rting
class (i.e., sp and sw the rltio o1 prolits to national income (ply) dcpcncls up otl tltc ralio ol'irlve sttllellt
t6 nationll inconre. It is givcn by l/Y). Incrcase in the inveslr)rent ittcottre ratio (l/Y ). that is. I'isc itl
the rate of investmcnt rvill bling arbout au increasc iu shulc ol' pl'ol'its itt ittcotttc, p/1' ancl thc
corresponding decrease in tlie share of wages iu llie incottte , r\'/y.
ln Kaltlor's modcl invcslDtent. or lirtherthe latio of ittvcslt"t.tctlt L() l()tlll ittcotttc, as itt Kc1'csiatl
l5cgry. has becn treatcd as an indcpendcnl variable. that is, it is t'cgatrlccl ils utlr cslloltsive t0 cltatt-scs
i1 the prrlpcnsities l() silvc (sp and srv) lirrlhcr Kaldor''s nrorlcl ol'incotltc tlistrihtrtiolt ltolds gotltl
only il'the saving propensity ol'lhe capitalists. i.c. pnll'it nrargittal ptlpcttsily to sil'c ottl ol'pl'ol'ils
is grcatel than tltc margittal propcnsity to savc tlttt ol'wagLrs.

The important part ol'Kirldor's rnoclel is that shirre prcllit tn the ttaliotlal incotne is a l'rtnc:tiott ttl'
invcslment - income ratio the greater the investrQent irrcome ratio the creatcl' is the share 0[ prolits
in the income and vice vel's1. When, there is a stilte of lull employntent in the ccouotnl,' thc
ipcre ase in the investment outlay ciur bring abouI a new equiiibriurl ',vith highcr lcvcl of investnlcllt
- ilcome ration VY, and investment expenditure and saving - iticomc rclatitln in l'cal tcl'lus docs llol
rise the pricc would rise coutinuously. Thus in the Kalodorian tlteory, slril't in the distrihtrlion ttl'
incrtmc in lavour of the capitalist class in essenti:rl it thcrc is to bc cottliuucd lull crtrployntent
equilihriunr rvitfu the highcr level ol real investment in lhe cconolny.

INCREASE IN TNVESTMENT AND INCREASE IN PROFIT SHARE

Now let us cxanine hor,v the changes in the distribution of income takcs place in f itvttttt' tll' thc
capitalist cllss tluc to lhe increiuse in invcstmcut expcrrditure .'l'his occttrs lltrottglt tllc trc'chanistri
gl't5c clalgcs on thc pricc level. Given lhe levcl ol lirll ctttploytltctlt, \vhcll tltc ittvcsttllcttt
cxpclrJiturc increascs, therc is a rise gcncral pliccs. Nrtr,r,, bccaltsc, tlcc:ttrditlg ttl Kaldor, rvltgcs lag
bchinil pliccs, thc prolit rnargins, ol'the capitalists risc. Ttrus thc risc irl priccs lnd tltc l'ailurc ol thc
lxoney wages to rise at the sanle time, rvill bring aboul itn increase irr thc share of prolits in-thc
national income and corrcsponding deotease in the wage share.

UNIOUENESS OF KALDOR'S FIND!NGS

(i) Accortling to Kaldor suing and investment courbine to dctcrntine distrilruti<tn ol'iucotttc rvhich
in turn tlclerntines thc size ol'nittional incttltre.
(ii) Changes in distribution t'ather that changes in level of incolne provide the itd.jr.rstntent lllechatlislll
hetrvecn saving and invcslutent.

LIMITATIONS
There iu'e solue scriotrs limitations in thc macro theot'y ol'distribtrtittn l'ttruisltcd by Kaldor'.
'lltcy at'e blie t)y stated as given below:

(i) Tlre thcory of distributiou ol'Kaldr)r assunles thal thc nloltc)' wagcs ou-ultt ltl hc llrttre tltittt
socially ac:ceptable ntininrunr Ievcl ol sr.rbsistencc (W>W Mtn) arld it rtee'd tttlt hc alu'a)'s
prirctically tme. The inrplictrlion-ol'this assurnptioll is that the rvrlrket's u,ouid stllll dclllandills
rise in money wa_ces only once this biological subsistettcc is ieached. Since tlrc assul.llption is
not tlue the irnplication need not be vtrlid.
 89
(ii) This theory ignores the relationship between shale of prol'it ancJ substitutability ol'ltrctors. of
production.
(iii)TItc intpitcl ol'tcchnological plogress in inconre distribution is totally ignored in this llrcgry.
(i"') Itt thc phasc ol'techttological pnlgrcss and rising px.lductivity ol'labour Kultkrr's cxpositiorr
wonld nccd to lhe rcvcrscd a grcal cleal.
(v) All reductiotts-in pricc need uot rcduce thc prolit share in inconre (P/Y) sincc, girourcss in
tcchnology nray reducc unit cost. Kaldor ignores this possibility.
It may be concluded by observiug that Kakiro has made an irrpoltant l'indine with respcct to
tltc latio lelationship betwecn investnrent and incolue wlrich <Jeterminc prol'it and \\,age. [l'he liad
explilined thc cornpettsalion pt'inciplc in lnore zrdeqLlirte ntilnner l.he conl.l'ibutiol u,ttr.rltl havc bee n
morc valuable.

PASINETTI'S THEORY OF DISTRIBUTION

Luigi pasinetti is an itupottant contribulnl to the post kcyuesiau economics. His rlost original
contlibtttions stelnllled li.ont Ktrldor's growth ntodel. -He introduced sovernruent expenditure and
laxation to Kaldor s prolit distribution lheory.

DEVIATIONS FROM KALDOR

ln tlte Rcvieu' Of Econtltttic Studics October, 1962 pasinetti shorvccJ tlrat t5c 11lc ol'pr.()l'it in
Kaldor's gl'owth ecluilibriurtt is totally indcpendent ol'lhc saving plopcnsitrcs el't;c q,or.king class
dependrng only on the saving ratc ol'capitalists. But lhm thesc, Pasrnetti has tnadr- sorne dcviarions
and they are givcn belorv:
(i ) Piusianetli's model allowcd the workers to receive inconte more thirn their suhsistence and their.
saving louns a piil't o1'stpply ol'capital.
(ii) ln Kaldor's theoly ol'distribtttion economy is divided into twg classes - lvagc carncrs anr1
capitalists. There are two income categories; wages and plolits. In Pasinettis distr.ibution-
niodel saving by capitalist's (Sp) tmd saving by wage eitnlel.s (sw) arc treated rvithout rJillcr.ence.
(iii) Pasinetti analyscd that jf wotkers are allowed to save they must be allorve<l to orvll
c.pital imd
tlttts, t'c:tP pxrlits ort it. Tltus total profits corrsist ol'two patts; proflf distlibqtcd to capitalist
(Pc) antl'[rrol'its distribured to workers (pw).

CAMBRIDGE THEOREM
Pa.sincttj procccdcd to modity Kaldor''s rlistributr'on rnodcl using thc abgve dcyilligus
i, thc
distributiclu ol'prolits. Thc ntitior anitlytical rcsult that was achicvctl is replcsente<i h1, a r.enrur.karblc
tltcorcttr which Pasirtetti called the "Cntttbritlge Tlreorem". Thc theorclistatcs t51t, on.l.,.,q
r-r.ru
eqtrilibritlm path, with two categories of savem- thc capitalists and workcrs - the r.ate ,1,
-crowlh
plol'ils is deternritted hy tltc ttalural rirte ot gl'owlh dividect try ihe capitalists propc*sity
[o s*\,c
indcpendently of anything also, and, in palticulil independently of technology anrlof
the workers
propensity lo savc.

Gn
r= Where r = rote of prolit
―
Sc
Gn = the natural rate ol'growth
Sc = Saving pxlpcrrsity ol'the capitalist.

lNTRODUCTION OF GOVERNMENT EXPENDITURE

Even tht-rugh many aulhol's tried out various cxtensions ol'Kaldor's distribution
lheory,
surprisingly etiough no one ilaic{ ntuclt allentiorl to the role ol'governt'uent
taxation lnct cxpencliture .
 90

ltwas pasinetti who first thought of introclucitlg government cxpenditut:c itnd taxation
to Kaldor's
prol'it and distributiott tlteol'y. -
ptuinetti adds government-expendil.urc (G) to consumption (c) and iuVeslttteltl ([) to tltc
equation for National lncome (Y),
Y=C+I+G=W+Prv+PC
Right hand side rcpresents incotne disuibution aspect;
W represcnt total wagcs
Pc rcpresent prol'its accruing to cilpitalists, antl

Pw represetlts prol'it accruing to wol'kers

il "T" reptesents total taxation then we ctrn write
Il ST > O tlren it lcads to a
G = (I - ST) T where ST fepresents propoltion ol'taxcs llot spenl.
surplusbudget.OntheotherhandifG>Tiiwillleadtoadeticitbudget.Il,sT=OthenG=Trnd
it leads to a perfectly balanced budget.

IMPACT OF BALANCED BUDGET ON DISTRIBUTION

by taxatiorl ttncJ-str
ln the case of balancecl budget government expcnditure is exactly oovercd
ownership is givcn as:
ST = O. The relevant proportioiraliiy relations between saving and capital

S*_Sc-S
KwKcK
Where,
Kw = crwital owncd l'rY rvtlrkers

Kc = capital owned by capitalists and

(i) I = S and (ii) thc
K = Kw + Kc, i.e., tottrl capital together with other simple relzitions like
The important result that e lilcrges
unifbrmity 01 l:ate of prolit all capitat iirdepentlently of ownership.
is given as:

GN
l-
Sc (l - tP)

where r = Rate of Profit

Gn:= Naiural rate of growth
Sc = Saving propensity of the t:apitalist class

tp = Direct tax 0n Profits

llL't 0l ta.rcs arc tlctcrrlincd
lt shows thatthe rate of prolits aud thus tlre share oi'prol'it"s iu inconlc,
pl'olits to tlic wagcs'
intlcpcn<lently.f taxation. in put it in another way, all taxcs arc shil'tcd li'oru
This is the basic irlea behild Katdor's thcory ol'incoure distributioir. Tlie ctlntributiort ol'Cattrblicl-uc
saving hchaviour'
theory has been to show these results which hold independcntly ol''workcrs'

CASES OF DEFICTT AND SURPLUS BUDGETS , ;i :

The
When ST O govornment systematically spends more (or less) thtin it raise$'tlorl'lttuiatioll'
proportiollality relation is
(') Gn
'= S'C
 91
wl)ctc r = Rarc ol'protit
s'c = c.nitalist's propensity to save conectctt by thc eliccts ul borh
taxirli.rr .rr
prolits and govelnruenl,s delicit spendin_r
Gu = Nltur.irl rate of glowth.
The equilihrium l'atc ol'gtowth-is determined by lhc
uatural r.atc ol
wol"ers savings do uot ltave nay eflcct on the deterrirination -r.rrowth divitlcd by S, C
of the equiii-br.ir.rm r.are und sl",rc ol
profits.
' All thcsc lltii'ke rvatcs, ils a calcgory ol inconre rathcr
vulnclahlc 11.1 11111v 11r t:lxirri,)r), hra irls()
[o uovelltlllellt taxaLioD or dclicit spending
there concsponds au equili[rriunr gr.orvrh path ,u ,rihi.l,
the rutc ol prolits are higher by e.,racrly-thc
or,,orn,,i oil.uues ucl pr(r'irs iis rhe), wcrc (,, rrle
previous equilibr.ium gl.owth path.
To a hi-aher govcrnnlrrlt d('licil spL.tr(ling lhere cor.r.csprrlld5
u'ltlch.botir capitalisls'sa'ing a,d qr)rie's'
I nerv ctluilihriur).1 uro\\th pulh r)ll
siivingr u" f,rl,if,r"rrroycrl. t3Lrr. rvlijlc irr rhe casc or
citpitaJists'slrving lhere is an illcreasc ofprorits rlru
tliirt corrrpcrrs:rte exxcl.lY li)r tlrc (lcsrro),c(i savi gs
xs L() lcitvc pl ol'iLs it's lrel orc in Ihc cit^se srr
0l'wor kcls savirrg dcstrue tion lras n r, c( )rt,pcnsal
$'il1'lcs
ion. i\,1.rcovcr .
{hcnlsclves tttrtsl he ltnvct to colrlpcnsllc
till lirst tltlou.uh il p;rrrial (l!.sllrcrirr},, iln(l st'c(,r(l
lhr.uth1lowel tate o't incotng ren.lerct] recessal y try rtr"l'rciuircnrcnl ()r'
hi,sllcr,'ross 1;r..rirs.
EVALUATION
1'hc validity o I Calt tlrt itluc lhc()t y ol'lhe
lare ol prrrr'iLs secnrs Io go bc),r ),J l hc .,lrs!, o l.
w ith l)ill.rlccd bu(lgcts .rrr l cxicntl t,, th. .urc r:lx,r, i(,rl
ul'n gnieriini",,ii.tt"it *ricthcr lI rrr(rrer\'
iuirnce(l L]
by l]roDcl.r.\.
rrrurrt
nreitns or hy a puhlic <Jebt.
Pasinetti's ntodcl althrtugh an cxtcttsion
and implovenrcrrl ovel clanrhritlrc lhc,rc*
rht^lcscl its tlselirlnoss Iics ntainly its. piece is hr!lrl.1,
i*arr.li,,,,irrrp"iltus. It iuw)r'cs r.ir.,..us ,n;rr1,lit.rrr
l
cxcrcisc invrtlving lot ol hair splitting 'l r* nr iui.r.rt',,nry
wbich to t6c leiirncd ,rca,jc,rieia,sl
Esserrtlally' Pasincrti ttrotlel. is set in
lhc Kcyncsiiin liamc rv,r'k. -I'lrc
pt'tpertsill'ltr sa*e' I S elc scts.tlte ;lu'lrrrcrr..r.s uscti likr.
= aruriysis ri, nrly i,Lrtrc xcyuc"iarr
nl K(yncsiiu) rrrodcl irrc rrpplicahlc t,r r "' ,,t,r,,,sphrr.u. S, t5c lirrirrrrr,rrrs
lltis ntodcl ulsr,
lvhcn a hirl ttcctl htrclgct is plepalctl by
llre rovcrnnlcnt lhc p'olir car.ring cl.rss ir0tl
citt ning ciitss t clttitin Ltn;tl lcc:lcri r..: rr,*:,:
in rlie d istrihutj,,i ,r in.,,,r^-. ivir.u rhc
bLrrlgcr ls cicr i.;r rtrc u,,,, r,,r,I
class is rtt,t'c advcr'.sclv al lccrletl
while thc capitr,li., .i;;;; li;; lirri r advcr.sc
l];utri.whcrr thc.budgr-'t is:;tttplus s lib.,r. t_ln ,t,. ,,,t,,,
hoth rhe copitalis', ,inJ ,ii.'*r,i."r.., h.v0 rirvi)r,hrc
dist l)uttr rn ol irtcoltrc. i, rrr,..
'csulrs
MoDERN THEoRy OF FAcToR pRtCING:
DEBTVED DEMAND AppHoAcH
'rlte tttccltrnisttt ol dctermination 0f lactor
prices does not diller lirndtrncn[ally
plicr:s ol corrlnrrditics. F;lctor pr.iccs iucr'ia,a*ii,"j'iuIr,,,f,.i,, lioru rhiri oi
sttppll'.'Ilrc diltr'tcrre c lics in rltc un.l", tlrc, lirtes ,,1 rlcrrr,rrrtl .,rr,l
delorntinon,t; ,,f ,tia janrnJ,ul.f ,uppfy
In tlrc l9 th ccnrrrr')', c el )n )urists, rrt pr.rrcluclivc rcsr)ur\:.'s.
(
ciassir'ictj ,ir,r,li,,,p1n, i,,i,,i*,, gr.rru
cntteprcnctr'ship Thc p,'ices ol rhesct:,"to,r rlld, rubtrur., t,apilrr ;rrrrr
*crecalteJ;;;,;;_r., I'rsr!:ir arr(l
ilnd cach ttnc was cxaltinctr
by separate hody or.thcory. ' -rEqL' rrirercsl prolil rcsllcclt\'(
and Prolil rcspccrivr,tv

urrlikc rrrc prrrd1lc1s. Iiicturs or'p'oductiorr

do rrol sirr.lsry rilc w.,r (,r'lrrc pe'pJc
lht;, crn be usetl r. pr.otlucc c.,nrr,rr..i.g.,,,,l. rrircctry r rr.r.
lj:.:Il,::,r,J:,J 11..usc
tlurrilr) \!lDts Thcr.clirre. tlcltirrrrl *t,,.t, ,;,ij;i.,:.;;i;;;.;;;r,,,ll;,
lil. laclols oI pn,.tu.t,,,,,t ir-.,,ffcd dutjrcrl tlctrrrrurj
CONCEPTS OF PRODUCTIVITY
At'cracc pllysical pr(xltlclivity is
tltc total plorjucrion rJivirlc.ri h1, rhc rrr.|rihcr
lilut{)l olllploycd. Mlrrgi.rrl pr.ductivity of lirclor i, trr. in",..r*. ol units or.rr
in thc [ot,l oulFrl uiiusc(l l)\.
 q')

quantity of othet l'actors remaiuing conslxnt'

employing an additional unit of the ['actol,
(i)MarginalRevenueProduct(MRP):MRFistheincrementinthetolai"l"tlt:]::l:l
olr .thcr [Lct.r's ,'cr.]lirll)ilrg
die expcnditrfc
ddLrsed by employirlg .r1 additional unit of a factor, oy thc
irneharged. lri utho' i"orrrs N^Rp is the
margi,al physicel prtitlr'rct of thc tactor multi,ii':d
il:' thr: i'i'ltgi'al
rran. it is it',e unp ,vhicir is oflc, tcr,etJ
.rzirginal revenlle,,i...,-rurnp = Mpp *
prothtct or tnetrginirl productivit-v'
to rhe margiual physicar producr ol thc
(ii) varue of Marginar prcduct (vMp) : vMp r.ef'ers r\4[1P x AR' Under
product, i'e" irverage revelltre ; vlr4P =
i'actor multiplied by the price of the a.'-l lirerel'o'e rhc vulr'rc
pri<.:e and margi,trl re venLle are ecir.ral
pi:rl,ect competition 6B = Ir4R and sO
rlttrrarginalpr.otttrct(VMP)andrnarginalrevenueproduct(MRP)areequal'

Fig 6.2(A)
″０っＯ ｏ﹂Ｌ 一

︶０うＯ ｏ﹂Ｌ 一
“ Ｃ一
。﹂。 Σ

。 こ一
０﹂ｏ Ｃ
′

Quanlty of faCtOr
X

Quantity of

m面 山 Nm mmmd
棚 :需 ∬ 嘱 pctitiOn in the prOduct llヽ alkct
監 器

ぞぷ
ksttow iC四
熱 1鮮
電К
∝
舗
e
驚
vclllle墨 雷:羅猟l膜 :li織 lW謂 粗淵ew「 ∬ II‖

be cqllal to VMP undCr inlperfect cOmpctition

lCntal cllangc in thc COSt that｀
(111)Marginal FaCtOr cost(MFC):MFG rctrcstO thc hCrcl■
い
lought about by hiring an adoitiOnd unit Offactor.
IC AtthiS icvCl prt)lit
Firmis eqt五 libriuln in thC prodtiCtlllalkct iS alrivCd atihe when NIR=Ⅳ tlly spcAking
111l attlle factor inali《 〕
t,Gcllclと
is illaxilllised.Now We arc cOnCerned With irllrs cquilibri■ Cd tlt
11larkCt iS arriVCd atヽ ⅣhCn`l giVCn lcvc1 011 0titput iS PI()(lllじ
a llirlllsIS Cquilil)liulll at the lactol・ 7ill bC in Cquilibriunl
ldS a llHnヽ
Vitll given factor priccs.In oJICr wマ
thc nlinimulll COSt pOssiblCヽ
Sin such a、 vay that the lllarginal rate()r technictil Stlbstittlti()1ls
、
vhcll it COlllbilles thc VariOus factol・
ttiO.Syl■ b()lically it iS
hct、 VCen any tWO factorS iS C(lual to thCir price rど

f ttr
MRTSxγ ｀Vh:re PX=P五 CC Or X and Py lS priCC(う
= 下 ,F

veCansaythatairilt::11lFlllli1111111:lilllよ
in tcrl■lS Of lllarsinal productS Of factors、
「hCr9 a lll:
1lsage of fa∝ ors so th江 ｀4Paノ Pa=MPb/Pb=MPC71PC.｀
MP=mJ=inal prOductiVity and P=price.
Butthe abovC Cquihbriul■ l cOndition givcs us the optillltlln factors proportiOns and the ttt)sOllltc
irm.Shoum cl■ lpけ BeCausch懺
a■ outtS Ofthc fた Os WmCh alё 霞 ll‖ :′ 裁 :i[i:11::Ih
Odllct lllalkct anl

Si鱚 貰酬 脳∬
i.c.thc dCgrCC O「 colllpetitiOn that CXiStS ill both pl・

棚 群 蠅 掛ぶ 緊w
留需 器 朧 1警
li‖
i l`: 、:´ .1.、 _、 ,ハ ■ /'i,、 ■ ● ln∩ n∩ rlclv ill lhc fl、 )lo!・ 1111
 produci mar_kct,alld(d)mOpsσ
ny in thc f∝ tOr matttet andふ
OnOp01y in tllc prOduct maよ et.

・゛ 両
μ 山
In Olll・ :lnalysis、 vё assll,1le thit tl〕

導品
e elllrepreneur、 vhO l〕 as 10 1ni■
mbnJ.ic hei∴
1lal.i.e.he tricsIsI」
10 1::ハ
J:晨、
all Cヽ Lla uilit tti thc IIct。
1lsI詰
htth∝
●01llel 0、
11ヒ ctOl卜
1:〕 ,iξ

l is(ぅ :illiγ l
`1、 憾 III:Wil総
ic i、 17ヽ

_
Mpp..、 ′
l:∬
`■ ``、
′ヽ _
:[鋪
FSultil=li・
1ヽ
odudi、
()iI)10(lucli、
°nl lhc゛ 1llPI()yll)Ci1l o
1ll iト
i

｀
;iil :)li:',i:ll:l'll':,,iiff,il: :ill],'lli;iilj:illl':1,:li
1■ ■、 」、
mil酬 Ldtt is c』 d mttLttI「 百
品 1“ ふ I・ 温 1苫ノ7∬よ胤 fWini』 r“ ‖
l[￨‖
:tjj;itiiil,::l:,{*j:;:ri,i;:,';iH;,;
Cmメ Oyme■ofOfa aね
cnlpl()ylllent fac10F u′ ぬ 鮒 山1躍 l191JШ l in山 じ
∝ 。rwhctthettl」
on「 hハ ル、
11ハ 、
、,1.__^、 _J:´ ・
lilξ き:IttI:魚 ireSa.siξ WШ
I■

mtlst
Ш cutル
tt C耐 MFC貴
IFC什 ∩ hr、 、
OmnlヵabOК ァハ上la^… _1___ ・ )d・ NIIRP=MFC and MRP curvc
Iぷ Fぶ 疏 W属 絆
「 討∝ 孟
l轟 TeniIF滝
enl口 Oynlc朧is、
enlp10ynlcnt less
Lsslhヵ 揚謂 端 :さ Ч∬
thann eq面 hb●響
Onllllll、
鳥1:I↓ .・

I∫まi澪ざ
arrrt
￨

(a) Perfect competition in Both Factor and product

Markets
Per.er:t conrpetitiru pr.e'ir,s i, t'e lhct.r.miirtct
u,hen
tit Illclol is lt'ltttt)'tcnr'rrtlS iurd truycls
ale iilerrlical lionr thc scllcl.s poiirt
trl.vicu...
(ii) 1'her"e l-s perl'cct infbrniation
(iii) Ther"e arc a vel.y lar.ge
of buyers and sellcr.s, and
^uniber
(iv) There is lieedorn to have
eritry zind exist
Ll,der perll'ct conlpetitiolt in the
thctoi'nra,ket a Iirm cannot .fl."cct
naryi,g its level of Iirctor employrnent. trre price ol.trrc Iarctor.by
comperirion in rhe;'ac;;; ;arket of rrre la*or firr a srn-ule tirnr T'rrerefbre ,1,, ;;;;i;';;rve
ilill:T_:lict wiu b; p#;;;erasric,. rrrererbre
MFC corncjrtc_s

Ⅲ嵐鳳跳比l蹴 騰群 般 跳蹴 燎馬概器T暮
1171襟 緊
:富∬
￡常ギ
1lh∝ Thswe mttё ぬ
江 灘 淵絲羊 雌
。
「
11larkets a fを tctOr
′
・・ ‐
m“ ∝∞m画 ∞hhト ofprOdtlcl10n will。 fI、 0ぃ ..:′ .^^^―
r prた
卜の ０ ０ Ｃ Ｏ 卜０ く﹂ヽα 匡

AFc=MFC
Ｃ

Fig 6.3
芝

MRP=vMP
QUANT:Tγ oF A FACToR

К
Кm∫ 出l幌 期H罵 Iitlm器
凝
SWd改 J¨ hOw Ⅳ
喫 c
[:ど l↑cw職
7・
卜 の Ｏ Ｏ ｒ Ｏ 卜０ く

MFC=AFc
Ｐ

ヽ
＼       Ｍ
＼     Ｐ

Fig 6.3
▼
＼
＼、
﹂ヽα Ｃ く ヽα ∝ Ｅ

Ａ、． Ｒ
Ｐ
Ｒ

QUANTITY oF A FACToR
 94

・              ハＰ

卜の００ ∝０卜０く些α∝くヽ
M「 C=AFC

・
 
．
ハ﹂︶
Fig 6.4(a)

■∝芝
「ヾ
aUANTITY OF A FACTOR
Ｙ   Ｃ  Ｐ
卜∽００ ＣＯ卜０くしこ匡く、

Fig 6.4(b)
Ｌ∝Σ

o N QUANTITY oF A FAcToR x
.
ARP = AF(l so tltrtt lltc l'il.tns
Thc lolg nrn equilibriut]t, o['tl:e; l'inn will be established rvhcrc
.r.ccarningnntvnur,',.r,,fpt"iii.. TheshortrunequilibriaarcsltowninFig'6'4(A)4,d6'"1'(Bt
prol'its. Abltol'tltltl prol'its is sltori'tt il'
ln thc shor.t nrn t5c [ir,r nray urakc tossus or abnorrDal
(r'4 (B)'
l:ii:.6.4 (A)und thc klss is s-ltowtt in Fig'
artcl Pcrlcct clorttpctitit'tr
(h)pricing ol'Factor.s,in inrpcrlbct Conrpctition at tlrc ploduct N4arket
in thc Fircl()t' Mtrlkct.
it will rtot [x lttrlc tt'
ll'tlrc ljrnr is rvorking under pcrl'ect 0orltpctition in the firclOr'ntarkct
iurlur:rrcc t5c price ol.thc r,u.t,)l. and [,ac[or.r*t ar,rur
lvrlukl bc horiztlutal striri.ulrt liuc.'l'hcrclirrc
Price of ttre tactor' But thc I'irltr itt tltc pt'escllt
the l.irnr will bc in cquilibrium where MRp = MFC = .lllc t,
casc is wor*ing under ,rouop.ly or inrperr'cct
cornpetition on the product ruarliet; it rvill he
so tlreAR curvc will slttpe cltlwtt*'itrds
lttd
cxercise an .inll*ence o'cr the pricc of the ;rodllciantt to VrvlP (t.c.'
(i.e. Mpp x MR) will n.t hc ctluar
MR curve wirl be berow it. conscqucntry ivlRp
MPP x AR)
卜００ ０ α Ｏ 卜０くＬヽ

Fig 6.5
Ｃ
Ｌ∝くヽ
α匡Σ
 95
in Fig.6 5 it will be noticed that MRP(i.e.EN)is less thtm VMP(1.e.,RN).Thel・
ebre thc
ぬct()l gcts,sOllletlling]css tlllln the valuc Of its inarginal prodllct.The equilib五
ulll cl■ lploylllel11 01｀
thc fを tcl()lis ON

(C)MONOPOLY:N THE FACttOR MARKET AND

PERFECT CoMPET:T:ONIN THE COMMoD:TY MARKET
If the lilln is、 vOrkillg tlndcrlllonop01y in tlle factor in2trket it will be able to inlluellce thc pricc
ofthe fど ct01 ancthC lセ tctol cOst curVes will be upwttd risillg curves.The l・
ate,of risc ol・ MFC is
spcediel・ than AFC,In thc pl・ Oduct lllatt if therc is peltct cOlllpetit“ n the MRP colnCides with
VⅣ lP.TIlc c(luilibriutt is cStablished attlle point wheК MRP=MFC.ON quantity ofthe lictOr is
llired at OP I)Hce and at thc factor nlarket thcre will ёxist an abnormal prolit to thё
IPEE'. cxtcnt()1l P

MFC
卜 の ０ ０ に Ｏ 卜 ０ く ﹂ヽα ⊂ くヽα 匡 Σ

P /ノ
Ｐ         Ｃ

/f
/ ´/
ノ Fig 6.6

0 N
QUANTITY OF A FACTOR

(D) MONOPOLY IN THE FACTOR MARKET AND MONOPOLY

IN THE PRODUCT MARKET
ln an isolated tea garden if there is a strnuc trade nn ion tliis type ol' markct
in saitJ t o exist. As
there is monopolv in lhe lactor market the flrm can inlluence
the price ol the lactor: ancl sp lhc
lactor cost curves are upu'ard rising curves. In the product market
the lirm enf oys nronopoly and sp
tire revenue pl'oducl c:Lll'ves are <Jownward sloping. The equilibrium
is esiarrlistrecl .t the point
u'here MFC intersccls rvith MRP. Thelefot'e the equilibrium qur,
ity ol't.he thctor ON is purchasccl
at the OP pticc:. Thtts condition ot equilibriuur is siate<i
as VMp > MRp = I\4FC > AFC. Thc flctor.
is lherel'ore strbject to doublc e.xploitation. The gap EF is rh,-'exploitatigr]
pr-r.urjt,r.l'r.rn, duc to
tttonopoly in the l'aclttt' tttarket: tt is calletJ the monopsonic
expior.atisn and the gap Eu L irr.
ttlonopoll' exploitatiorl pcr Lurit ancl it is called monopolisric
exploitatiel.
卜∽ ０ ０ ∝ ０ 卜 ０ く﹂ ′Ｏ Σ ＞ ′α ∝ Σ

ヽ
     Ｄ ｒ

Fig 6.7
 96
DETERMiNANTS OFTHE DEMAND FORFACIOnS
fi The demand forthe ract(】
s is dctmll■ ed by thc

raJ DemandfOrtteprodrCt i
aplodua.・ ll
F“ tordeianditthederivcddemancdPIV"'Omthedttndlむ
t“ hc郎 l tobrOducし
.a fκ lor,therebre,depends upOn demmdforthelroduё
.

rbJ Prod・ ″ブリ of綺 ●FacFOF LLti宙

・
り Of・ ぶerttt。 .Rodに J前
y ndγ depcnd｀
Demand bra l鷺 tOr dettlふ upon the prod
ι
lpon three elements: .

L蠍艦 欄 」 計∫
脚 ‖1棚 職 I t∬

郡 1織球 翼納 ‖脚
・
rcJ tte price ofOf力 er Facめ rsl
I「 lめ our ttd maё hinCw a“ employmOntinバ Jは11l WheЮ in lllachincッ beCOlncs Clleap lめ Our

will be substituted with nlκ hineけ .

DER:VAT:ON OF DEMAND CURvE FOR A FACTOR UNDER PERFECT COMPET:T10N

Thc dcrivttiOn loracnlan(l cJrve lilor a nctol

‖1榊li轟鼈慰彗 ._
嚇
l〕
:・ icc or thc ihctor.
∝︵
Ｍｂこ﹂山エトＬＯ ＷＯここ

Ｐ Ｐ，■       ｏ

Fig 6.0

ouANTlW OF A.FACTOH

ON unit of the
It the mrrket price o,'ii taotor is Op, then the enrployer''w'il^!lt"t-.:'f.enrploy
thcror and on unirs o[ MRp of rhe tactor is equai to its prici oP.
If thc markct price l'alls ttt
is ctlttitl to new tttarkct
Op. thc anlount dentanded will rise to ON, ttrE, tt r MI1P of tlrc factttr
to a point and thcn slopes dowttwtrds;'
;il oP. iil'MRt surve usually flirst ri"ses trpwaltls 1'lRF crrrve lorttts the
hur it should be noteJirrar outy tire dp*,rward sloppin* Pgr'tion of the
demand curve fbr that factor: .

of an iudustry us tdso
so far we analysed the tlem'and curve of a firrn. Ttrc demaul curve
slopes dowttrwt-S
derive( Qlactly in the same wty. IUdustry's denBnd cu-fvg for the firctor
is done to obtirin
since the MRp cgrves of the constitucni tirrn$ whose lateraf suqnhation'
iudustry's 4emand spwe which slopes d,ownwatds'

FACTORSDETERMINING THE ELASTICITY OF tAeToF DEM&ND

Eltrsticity is the dcgree of correlation that exists between thc
pricc irnd dcnrand or n l'actor'
 .97
or it is the responsiveness of tlie demiurd for a factor when tr change
of its pr.ice occurs. Thc
lollowing factors deterrnine the elasticity of ractor demand.
(a) Declining Mpp
The rate of decline ol marginal physical product is
relevant. It is inve rserly proportion
the elasticity of factor demand.

rbJ Pο ss″ ガ″ry οr Sυ bs″ rtJ′ ′

ο″
The elasticity o1'demantl lor a I'actor depenrls to-a great
extent 0n the eltrsticity.1.
strbstittttion between the l'actor under consitleration
irn<J other factors. If'there trre-mrlre irncl
more substitutes the elasticity
nlrlre crrhct.irrr16o rL^ r r r
^1,.,.ri,-ir-,:- is higher.

f●J Erast′ c′ ty ο′ォ

ヵe Prο d“ ο:
If thc demand fOr a productis highly Olastic then the demand fOr its hctOr is alsO elaltic.

fJJ PrOpο rtiO″ οf a FacrO″

If,paltiCular factOr OfproductiOn acc6untζ
fOr a gretterprOportion say 75 per cent Ofthc
p■ oduct10n COSt thcn any change in the pHOe ofthe factOr will have a substantial cffcct On the
t9td productiOn cOst and hence On tle pFiCe and sales ofthe product.

It may be,cOncluded by saying thatthe demand fOrthe factOrs Of prOduction arises becausc
ofthe demand Or cOnsumptiOn g00ds.As the demand fOr the cOnsunlptiOn goOds and serviccs
incК ases,the demand brね ctOrs which att uSed in theirproductiOn will dsO Increぉ
e.Therebre
the price ofthe factOrs of production is highly assOciated with the price ofthe product c011ling
out of it.

MODEL OUESTIONS

Short Type
l. what are the assumptio,s of Ricardina theory of distrib,tion ?
2. Mention the components of nationar income according to Marx?
r 3' Bring out the plinciple followed by Kalecki is marco theory
of distribution
4' Pinpoint the uniqueness of Kaldor's findings made in the macro theory of distribution.
5. What is 'Cambritlge Theorem, of, pasinetti?
6. Bring out the ........ in the concepts of MRp and VMp
ト ー ●ｑｎ卜ゝヽＪｕ

Medium Type
l.
］
How does Riciirdo explain the declini,g rate of protit.?
 
哩 
，
一    ３．   生   ５． 一６．

，
ｃ    山
ｃ
一

 
︲
ｉ
一
一一
一
一一
一
一

 測
一
一

︲
 
 

ｖ
ａ
 

ｎ
ｃ
モ
 
  
  
 

 
 
 
  
  
  

 
 
 

    呻 
 
  
  
 

 
Ｈ¨
¨¨
¨一
 
  

 
  
  
 
  
 

 
 
  
  
 
  

赫
  
  
 
  
 

一 
 
  
 
  
  

 
  
 
  
  
 

 
 
Ｃ
＾＾
一
・一

 
︶

・
 
 
 

ｕ
︲
 

︲
ｏ
．
︲
  
  
 

職
 
 
  
  
  
 
  
  
  
ｔ
 ︵
・・
・ヽ
 98

Eassy TYPe
Rictirdo'
1. critically examine the macro theory of distribution given by
2. What are the salient features of the macro theory of
distribution put forward by Karl
Marx ?
the macro theory of clistribution
3. Examine the procedure followed by Kalecki to reinstate
of-Marx.
4. what are the contributions of Kaldor towards the theory of distribution'l
given by Pasinetti
5. Make a critical appreciation of the theory, of distribution
in the theory of distribution'
6. Give an account of the derived demand approach
 99
MODULE VH
CAPITAL THEORY CONTROVERSY
INTRODUCTION
Capital thcory grorvs inclcasingly controvenial tLnd it is has tllln,lt
consiclcrable altcntrr)n
liom the economists sincc the lirst decade o1'fte present century. Tlre cr.uciirl questions
llial havc
been keeping the controvelsy alive are : (a what is capital
) / .(b) how is it measureil 1 and (c) hou,
its rate of return should be determined ? In the present aiscussion
the fbcr.ls & ot out attenlion is on
the most popular debate between the lwo Cambddre - Cambridge EDglancl
a[tl Cambridgc
Massirchusetts. Since this debate is ba.setl on the prJblems of icientitlcaiion
of oapital and its
tneasulement it is also lclevallt to note the conceptual debiite
on capital anri the stlgcs thr.ough
which the debate developed into a theoretical con;oversy nearly
eiglit decadcs ago.
1. CONCEPTUAL DEBATE ON CAPITAL
W N Seniol held the view that the tenn capital has been so variously dctiued that it may
bc
doubtlul rvhethel it has any generally received mealing (Outline. p.59).
Tiris confirsion ilrises our
of many probletls in which the chief being the occaslonal wavelin-qs bel\\'cen physical,
clpital
conccpt on thc tlne haud und the monetary concepts on tlre one hand
:urd the ntuneiniy concenls ol
capilal on the other. Evcn tlrrtse attthors who explessed thcmsclvcs
mi)st str.on,clt, in livor.ot phlrsicll
capital conccpt sometimes d'iried into the plesetves of a monet:u.y
one. Rical.do and J.S.i\4i .
a,)ong others occ.sionaly wlote about capital whic.h rcf'e.re<l to rnonct,rl
capital.
Monetary capita.l as sums of moley set apalt rbr tu{her production
tul.ns to be physicar capilal
when they iue converted into lbod, clothing, tools, machine,
raw lratefials e'tc., rvhich arc necesszu.v
to give efl'ect to labour. From these tlie 'claisics' sepalated out
their capital by excluding liI)nr i1,
limt,_ natural agents (though not i mplovenreuts such
as dllins, Ienr:es clc. ) and sccond, all coDsqstors
goods other .than the means of subsisteDce of productive
labour. The identillcalion ol capital .in
physical terms accolllnlod2rles technological changes
when productiviry of capital is mcasirr.ed.
2. THEORETICAL CONTROVERSY

. All capital theories in general, seek to exanine the plinciples and proccdur.cs lhat are lblkrwerl
in thc
.identillcation of capital, its accumulation over time, iis role in produclion llncrion and jrs
rate of Letu:r. The essence of capital theory contloversy, quite
evidenily, Iies in the ract; whether
capital should be leniunerated on thc basis ol its outpuioI in rcrms
ofrhe inpr.rt itsell wiLh r.especr
to its vttrious embodiments' The growlh of controveriy was
in trvo sLa-{e s. lhc ear.lier.oue in the lil.sl
decade of tlre century and the new one quite recently.

EARLIER DEBATE
In the eiuly stage the controversy was between Bohm Bawelt on
the one side and J.B. Crer.k
and Proi'essor Knight on the other side. Bohm Bawert
while tbnnulating his capital-arid intcrest
theories hiid disagreed with atlthe existing theories oftheilkind's.
The argi,n.,ents a,e tl-,e lollr*ing,
i) Capital is not an oliginal source of wealth like labour and
lmd urd so intcr.cst is to be paid l)ot
lbl productivity ol capital alone.
ii) Labour is not d1e only source of value zmrl os he disagrces with the socialist exploitation theory
of capital.
iii) He does not lecogllise capital theory as a piut of value
theory alonc because capital per.fbr.,rs
the functirrn of not crealion of varue but also it serves
the pul.p.se o1'discou.ting tinre.
In the conh.veruy between Bohm Bawerk and J. B. Crerli,
the larter intr.trduced pr.obrcnrs
connectetl with dynamic changes. A stronger attac* was
macre by pror'. Knighr who disa_ui..,i *i,r,
l.he pulpose of Austlirrr thcoly of capital. Trre pur.pose
or,Austrjan rheor.y or capitar \vrs Io sh(,w
 1(X)

rhatcapitaiasadistinctfactorofpr.odttctioncouldbeneasttt.edinlrotlogctrctlrtsLlllils.hothilr I ir
as a.rvholc. Accor',ling to Prr)l Knish
goods and in the economic,system
p,
"o..iii." hcc(,rTIes rr hctc r'( )sc n() Lrs
i."o*a "r,p.*cular.
porrif,la only in i stationary society; but in dynamic societl'capitrl (rl
c.nrrot 5c t,easurctl in lcrtr)s
;G;;rg rise to the conclurionihat th. ,.ot. of reiurn oI capitnl
its productivity but it terms ui.up,tnt intensity and
lhe element o1'r.rnccrtrriuty in\,ol\,cd in it:
acclurulation.

BECENT DEBATE
Tl]e lecent debate is between the two Ciirrrhridgcs
- CarrrbI.itlg.c' Elrgl.rnd and :"ll|].]u'.
,Ma^ssachusetts.Weslrall,lilrconvenience'reltltothclwogroupsaslhcNeil-Kcl,tlcsiltns(s()n]clInl0s
calledtheCanibridgcScrrool)andtheNeo.Classicals(Son-rclillcCallcdNcoC]assiclr]s),\{t.s'
most protrinettt Nco- Kel'ncsionsl' n'ut Stlll:l:,1:t'n
John Robinson. Kaldol and Pasinetti are the
Thc rvrirings .l anothct cconon)ist ol'
Solow ad Meade are tna ,roriproi"inent Neo-Claisicals.
Neo-Keynesians Piero Srirffa are also quite vital
to the dcbates'
authcntic works ol G C Harcourl' and N 'F
The present review is based on the two popular and
Laing.Harcouftobservesthatcapitaltheol.ie.sfelevantatatrrunbe[ol.p()ints]l.tllexirr-trple,thc
courseofcapitalacctrmulationovertimes,bothintheeibsenceiurtltlrept-esenceoIteclrtricalchattgc:
ptogtcss rttlrl
the leliltive contribtttions oltcchnical
the a$empts that have beeumade to estimate
protluctivity; anrl the choicc wliicl] lnusl bc tilrtrlc
capital accumulation to the o*,u[ gio*tr, of
ale lakcn'
*lonlrt urrlou, 2rlternlltive techniques when investment dccisions
The debate is based on the following issues:
(l) whctllcr capital is to be tlcilled l$ a ttttil
(z) urh_.tlr"t rhe enrhodir-d or discrrbodicd tccllnicnl
indepe[dent of distr.iburion ,;; ;;i"., uid
By introducing the concepts *'itl::11,1''l li
changes will I allect this ru,. oi'Lnttnr; ol capital "f
attenpttol3lilteand.o.,u",,."i.,..thei}rgunrentsoftlreNeo-Classicalslnthe|l.cscl)tIc\'ie\\.()]
the controvelsY.

1. CAPITAL AS A UNIT INDEPENDENT

OF DISTRIBUTION AND PRICES

TlreNeo-Keynesiansarecriticalol.-theNeo-Classicallinksbclu,eericquilibr:iunIaCl()fllliL:es
,"A rf,. *"rgi".i products tii*;' This idea is in contbrnity witlr the Clirssicril econourisls
particularlyRicardoarrdMafiwhoarguedthatthetlreolyol.distributiollslrouldheirnalvsi:din ()l,c group ol l hc
theory of value At thc sarllc tillle ol
dif1erefi terms tbm that of ttre Neo-Citissical
between the classcs ol tlre net product c
lln()1 bc
Neo_keynesians argued tllat it,"-Jirttuution in heI 'tielc
understood independently ir.iiiril""a1 narurs of capiralisnr. Jortn Robinson
"rii*
which to meirsulc capitirl rrosc lionr thc rr-[tllllent
tllal htrlh
observes that the searcll for a unil in so tllal lhcir
n,"as.rreo in terms of their own leclinical units
labour and land (hon1og.norri"nuro t e prices
;;;*"1;rJ;,, bt defined rndcpendently ol the equilibriunr l'actor
"uuli
TECHNICAL CHANGE
2. EMBODIED AND DISEMBODIED
Capitzrlgootlsareproducedntealstll.productiorrandthattlle\,altlc()l.itnl,spcciliccirlrlt;r1
This rncilDs tlrar clrangcs irt crtpital g.ods
coods will be af}.e.t"a rrv.rrri!"r-in incorIIc disrribution
(real rarc ot irrcrcsl) as rve ll as h1' c*botlicd t.chnicrtl
il;. ,ril;;;v".t "rs", lnirr. ot'p",rir chungc is rctlrrircd l,r lr,: cr;rrrrirrc.l. c:rtttlrttrlg. cr'"rr"rrrr\lL
change. The tcrr, etrrhodic6 ,a..t,,,.',,i tn Tlt ts l)r'lirl'ls i.l\ I' ir\e in
ia.i', nicnl .',i,''gc i, lilr ProJut li(rlr lutl'. tt'
usedthe principle of ut,,,u '.J t hat ittnovtrt it rtt:
gffectiveness of
",
irlpot, o,rcro lmprovcmenis in thcil quality over tirne. It is slid
$1e
,rewiipes of durable equip[ren1. The stook of cdpital cotnprises
I v.tt ielt'
are usually enbodieo in slock ol'
uititug"t' Hence' capiti'rl.is no lotrger homogencous since tllc
ＦトトＦＦＩ

of capital goods of different wjll be ploductivc tl'rxn

mactrioes of dilftbrent vintagJs. The new machinc
r11o1c
;fit^i;fi;;n thc slnlc lil}l'.] lllc
the new machines embody the latest knorvlcd.{rc. At
the old machines. Because,
;", progress is, said to be disemhodied *'hetr it occttts wilhoul xn)'
il*A;;;, that lechnical
change in the qualitY of inPuts
 101

3. MEASUREMENT OF CAPITAL
T'he Neo-Classical Lrscd aggregAr:r "r'()duction llnction. It is iinearly homogenous production
lirttction in which capital is rnalleable.'i i.lur,.lbre according to therri the marginal product o1'capital
(dy/dk) is equal to the ra[e ol'prolll (r). So the slope of w-r (wage-prolit) curve ilt any point nced
riot be eclual to the ag-ulcgate capital-labour ration. It will by true only when w-r rclation is linear.
Thrs ciur be illustrated with the following diagranr.

Φ“‘ 匡 ΦＯｏ３

Fig 7.1

ttt l)g. 7.1 wuge-prol'it fi'otttier'lirr a technique is represe nted by thc curl,e A B. and the outpnt
pcr wttrker associatcd rvith that tcchnique is represented by OA. Tan Y is thc slcipe o1'tzurgent al P.
'fhe ratio Y-s/r is given by
tanO which is the slope of the line joining the points A and P. Thus for
non-linear rvage-profit li'ontiers tanY and tano are not equal in general, and Prof'essor Samuelson
needs a ltnear relation between prolit and wage to make these two values of capital tbr worker
equal (i.e. tan Y and tan O). Obtaining the equation dy/dk i,0. l' = the malginal product of labour.
This is not tlue when the r,v-r relation is not linear.

4. WICKSELL EFFECT
It is significant to rlote that at the aggregate level it is not col'rect to generalise and say thzu the
rlretl'ginal productttl"Capital' is equal to the rate of inLerest. This inequaiity between the mar_sinal
product of social or aggrcgale capital and the rate of interest wzls pointed out by Wicksell precisely
on the same ground that the Neo-Keynesians in the current capital controversy have been tocusing
ott. Tlte pricc Wicksell ell'cct emphasises variation in the values aggl'egate capital with changes in
Ilte rates ol'iuterest so lhal capital cannot he measured without arguing in a crircle.
Wickscll cilnsidet's lrvo ell'ccts such as price elt'ect and real ctf'ect. Thev are called as'Wicksell
pricc elt'ect' and Wickscll lcal o.tibct'. Thc Wickscll price effbct reltrs to changes in the value of
capitlrl when techniclues do lx)t change. The Wickscll's price eff'ect is zero or ncutral when w-r
rclatiott is linear. Sotuetitrtes the w-r cLlrue may be concave or cotrvex to the origil. Il it is collcrve
to the origitt the value o1'capital increiues with increases in r and-decreases with decreases in r. On
the other hturd, when w-r'cllrve is couvcx to the origin, the value of capital decreases as incr.eases
and increascs as deoreascs.
Wicksell observes changes in tire value of capital as technique changes. This can be illustrated
ri,ilh {he help of the diagram above .

Tlrere al'c two techniques given in tig.1.2. (I) viz. q an<lb techniques. We nore in fig. 7.Z (I)
that as r inct'eases li'ont zcro to rl and beyond, a switch fi'orn the q to the b technique takes place.
As r crosscs rl tltc Valuc 01'capital drops lbrm kl to k2 (11g. II). This means that at the switch point.
A. u'c havc a nc,Qtttive rclation betwecn a change in r ancl a chiurge in k, Due to this, the switchine
is l"crttted lbl'wat'd. This is tn confot'n.tity with tlre Neo-Classicil lesult. Henc-e ir is also t.r,-,-,.i
1lt':;;tive l'ell Wickscll el'l'ect. As r increa,scs beyond rl, since we are llow ()n the b teclniqr.re. thc
valr'te ol capitaJ it.tcreascs (plic,c. etf'ect) until at B if is K^. Br"rt as r ilcreases beyond
r.2, there is tr
switch lj'orrl thc p to thc 6x tcchnique.'Ihc value o1'capital jambs unlo kl, t5e griginal level. Thus;
 102

Φ一
ＯＬ ｏＯＣ＞＞ 一

０ ´ Fig 7.2
ｏ″一

lβ
Ｑ“０ ０ っ一

￨
‘＞

! 11‐
l

卜
=__Kl

' rr (' '

nclre orProlrl
at the switch point B, there is a positive zussociation between changes in r attd chattges in k. At a
higher levei of r we have a corresporldingly higher k, This is termed as bitckwiu:d switching or
capital reversal. This result does not corrcspond with the Neo-Classical conclusiotl.

5. RESWICH!NG
Reswitching is associaled with another phcnomenon which is contritry to the Neo-Classicitl
theory. When there arc hetelogenous capital goorls the term capital ref'ers to some a-sgregales or
index. If we mezrsure capital in values, the prices being used those appropriate to the rAte of intetesl
zrssumed to prevail. this example illustrates 'capital reversal' a sitttzuion where there is a c:hange
tl'om one system to another as the rate of interest faiis, a lower value of capital pel r,volter occurs.
Such a phenomenon is clearly contrary to the Neo-Classical ideas where higher capital-labour
rations were thought to result as the rate of interest f-ell. The case represented in the ligure givcn
below is reproduced with the values of capital per wotter also indicated. Ctrpital-labour rirtions
were thought t9 result as the rate of interest 1'e11. Capital reversal ocolll's ilt point C. This sirnple
cxample illustlirtes another occun'cflce that the Neo-Cltissical theory did not ztllow for. In that
theory it wzis held that 1s tlle rate of interest f'ell, the system of production lunction changed, tlte
change wgulcl he to a s),stem involving higher oLltputs per u,otter. In our example syster)l b ha^s a
lower outpllt pcr workcr cornparecl with q and is utilised itr pret'erence to (l as lhe t'ate of intet'est
lails through (.. lt is possible to <lemonstrate thrrt lower *rtes ol'iuterest can bc iissociatcd wilh
lowel capital-outpLlt t'atios, which is again contrafy to Neo-Classical theory.

Fig 7.3

Profit rate
 103

It'thele is more than one system of production, we rnay deterrnine a wage - plofit cur.r,c lbr.
caclt. Two such systems are presented in the above diagram. The outer envelope ol'these cul.ves
J'r'onr tlrc fitctor - price trontier. In the case represented here it is made up gf the section
ab f1om
cllr'\ie q, bc of curve b, turd cd of cuwe q. tf these ate the only systems of procluction available, thc
il'trlrltcr shows lhe maxitntun r (profit) a"ssociated with minintum wage or the rnnxilr1upr wa,ue
a:;silciateiJ u'ith minimum r. Since the systems of production [epresent stationaly coll]petitive
cqLrilihriUnr thc'operation o1'a given system by capitalists must imply, t6at system maxinrises
prolit. Cotlsequcntlt,, with W in the range bl cl system b would be chosen and outside this ra,_uc
s)'stenl c1 At points b and c botlt systems are equally profitable. Such a point is called a 'srvitch
1-rtrittt'' II'thc wage rates wel'e at c' or b' capitalists would not strictly prelbr to use either.ol. lhc lwo
sv\tcnls rcprcsented
This exatnple indicates immediately that the Neo-Classical conception of capital deepening is
ttoi goitt.u to hold without exception. The diagrarn above exhibits what is callc<l 'reswitching;
or.
ri' rs[]s switchittg'. At very high rates of interest between (c"
ancl r mrximum) techniques q is u.sed.
At llltel'est ratcs below this (between b" and c") techniques b is used. But at even lower interest
ftltcs^ (i ts used. We thus have a situation whete the same system of production is
the most prgl'itablc
at i'Il(x'e than one rate of intercst while another system of production is mclre profitable as the rates
of interost ate betweeu. The classical conceptioll dealt with above irnplicity assumed that this
cottlil nttL occtlr. It wzrs believed that a-s the rate of interest f'ell, production methocls woull changc
lo llrorc round irbout cztpital intensive as less profitable woukl not re-emerge as ntorc prol'itable at
lur cvelt lor,vcr rate of intcrest.

6. SURROGATE PRODUCTION FUNCTION

Satrtuleson using a nrodel with heterogenous capital, tried to validate thc Neo-Classical
pt'opositituts thlouglt conception of the slln'ogate production tirnction. His nioclcl enrpl,ys
thc
1 tril or,;in_u assunlptions :

(it) There are Llvo sectors: Sector I produces capital goods (machines) and sector II produccs
consulrption goods. Joint production is excluded.
(b) Each sector uses capital (n'rachine) es well as labour inputs in the production process.
Capital,
thcrefbre, is non-malleable.
(c) 'fhe prriduc:tion
of capital to labour in both sectors is, equtil:
(d) Thc capital outpllt and labour output ratios in both sectors are the sil]le, so that the technique
oi' production is unifbrm.
(ci l-hc production functious are of the constanl. retllms type.
r.l ) I'erli:cl, contpetitiou prevails.
.\ccording lo this tnodel zr decrease in the rate of protit will lead to the usc of techniques
:rtlPir;yit-tu a higher quantity o1'capital per mau, that is low rtrtes o1 prolit and high !v.ge
l.ates are
Issociaterl u'lth high levels of c:rpital - labour ratio and viceversa. Thus there is n6 resrvitchi,g
ol'
tcchttiqucs. These are the Neo-Clzusical results obtainable 1l'om a variable proportions
,iodel witlt
htrrnogettotts capital. The intrnduction of homogenous capital in a fixed proportion model has
;rpparentlv not nude any differ'ence to the Neo-Cltrssical results.
IIowever it is importall to note the conditions for Samuelson's conclusions and lhe
consequent
vahdutiotl of the Neo-Ciassical rcsults. They are based on his restrictive rusumptions
that the salne
LL'ullnique is uscd in tire nroduction of either a capital or a consumptiou goods
and that the ratio o1'
capilal litbour is independent of the ratio of wage to the rate of prolit. Ther.efbre, fbr
each tcch,iclue,
tVC l.tilvc a Iitlcitr rel:ttions between wage and prolit - irnplying
that the distribution of net ouiprt
lvill ttot affect relative prices or tlle value of capital. In such a siiuation, the value ol capital per
man
is givert b1' the negzrtive slope of tlie w-r f'unction. The Neo-Classical
results are senerally obtained
 t04
with a conventional model in which capital is homogenous or malleable. Strmuelson obtained the
sune rcsults by substituting malleable output for: malleable capital.
It rnay be concluded by saying that the capital theory controversy is very old. It takes ditlerent
tlimensions during diff'erent periods. Even now it remains unsolved. It is not an economic issue as
such; but it is differences exist among the economists capital theory controversy will also coutinue
to exist.

OUESTIONS

Essay Type
Bring out the capital theory controversy between the Neo-Keynesians and thc Nco-Clirssicals.

Medium Type
l. Explain the Wicksell eft'ects on the value of capital.
2. Examine the assumptions :of surrogate production firnction.

Short Type
1. What do you rneall by reswitching technique? What is its implicalion in capital theory
controversy?
2. Examine the embodied and disembodied technical change.
3. Who arc the representatives of Cambridge England and Czrm bridge Massachusetts who led
capital theory controversy ?
 105
MODULE VIII
GENERAL EQUILIBRIUM
An economy consists of various constituent segments which are interconnected and
interdependent. The general equilibriurn approach recognises dependence of constituent parts of
the economic system; it recognise intemelations of economic variables and seeks to answer the
question how all the segments of the economy reach an equilibrium position simultaneously. General
equilibriurn shows, by.using the tools of partial equilibrium analysis how prices and outputs are
simultaneously determined in all segments of the economy. In fact general equilibrium provides a
link between microeconomics and microeconomics.

PARTIAL EOUILIBRIUM AND GENERAL EOUILIBRIUM

Partial equilibrium' in economics means a state of stability of individual segments of the
economy by maximising their respective objective f'unctions. The approach' ignores the
interdependence of the segments of the economy. It isolates one segment of the study fi.om the
chttnges occurdng .outside the area assumed to lemain constant even if incomes change in factor
prices in f actor markets; prices of related goods arc assumed to remain constant even if
they income
change in factor prices in tactor markets; prices of related goods at'e assumed to rcmain constant
even if they change due to change in demand and supply conditions, and the consumel.'s tastes and
perlbmrances are assumed io be given even though they are not.
The general equilibrium refbrs to a state in which all economic units maximise their
respective objective functions and all prices are simultaneously in stability and all markets are
cleared.

GENERAL EOUILIBRIUM APPROACH

General equilibriurn approach explains how equilibrium can be attained simultaneously in the
factor market and commodity market. It also explains that if the equilibrium is attained whether it
is unchemgeable in an intersectional manner. A simple case of: interdependence of mar.kets is
illustrated in fig. 8.1. in a simple model.. Suppose demand for housing incrcases at some point of
time in an economy. House rents go up, increasing the profitability of housing industry, Therefbre
the demand fbr intelmediate goods like steel, cement, bricks and construction tabour incrcases:
The firms producing these intermediate goods increase their demand fbr factor input - land, labour,
capital and organisation - and factor payments increases. Consequently, larger factor incomes-
flow to the households. When household income increases, demtrnd tbr consumer goorts and service
increases and creates another chain of action and rcaction between household and product rnarkets
and factor maltets: The whole economic system functions in a complex rtanner. The complexity

FACTOR SUPPLY

PRODUCT MARKE

Fig 8.1

:NTERDEPENCE OF MARKETS
 ヽ. 106

is fulther increぉ ed due to change ill rclalivc p五 ccs ofproducts and llactors、 vhich cを lヒ lsc,1せ ヽ
:、
Ct〕 li｀ trl卜
1｀

product substitution ttd factor substitution.The vaFiOuS luarkets thus act and l‐ cat;t ill lじ sp● 11ド r it)

changes in thё intё rconnccted lllaよets in innumcrablcヽⅣ五,S.

THE WALRAS:AN EQU:LIBRIUM

Lcon Vvralras, a Frcnch ccononlist,was thc irst to attcnlpt to l・ CC()gnisc を
inti l｀ ()ljllali、 c tilじ

riotls priccs and tluantities in an ccono】 ■

nlutual intcrdepcndcncc of vだ し lic systcln IIc s1loぃ Fcci l11を 11

山ep面 ccsofresourcesarcd10cllylinkCdЮ thcpHccsofoutput,and quan鮨 es ofrc、 ourじ じs supplた d

cannot be dcternlilled v/ithout dctcrlllinillg thc prices of colllll10ditics ヽ

Vcth aslを lll nlo(lcl lctltlilで ド
that all cquatlons lnilst bc solvod Sinlultancou,ly.

Thc behⅣior oferh dcdsion mよ cr in Walrasim systcTll ol｀ generd cquihbHunl is prcscnに d
by a set ofequations,Sincc cach decision nl江 kerftinctionssilllllltancouslyitttwodil'fcrcllt capacitics
―att buyer and scller his bchaviourそ ■cquations consists of tttro stlbscts of Ctlllatiolls.()1lc、 しib、 cl

describes his denland for different colllll10dities(or faCtOrζ );it consists as l■ ally c(ltlを ltion、 セ 111じ
l、

nunlber of conllnoditics multiplied by thc nulllber of firllls supplying thc c()】 ■

l1110(litics 11を tじ 1()「

lllalket is sirlulaly described,in Walrお iglll modcl,by two sctS Of Cquttions― onc cttch On dCl11[い
(1

tti()1ls,tllclじ
and supply sides. In this systclll of deSClibing thC Working of an cconollly throllgh c(lllを
arc as nlany lunkno、 vn'variables to bc dcterllnincd as independcllt ccltlatiOns lillc lllllkl10｀
ハ
/111 を
11C

thc quantities of all colllnlodities and factors purchtscd and sold by cach illdividtlal,と 11ld Plicご s01
all c()illmoditics and ilctors

consLllllCr t W()― c(う nli1lotlity

Wall・2sian sソ stclll Call bc illustlated by considcring a silllplc two―
two l factor modcl of general equilibl・ ium.

Number of equations Number of unknorvns

l. Denland litlnctions Of twO Qumtitts oftw0 300dS

g6ods by two dclllanded by two
consunxls, 2x2二 4 constlmers 2 x2=4

2. Supply f'unctions of two Quantities ol trvo goods

goods bY two limrs 2 x2 =4 suppliedby two lirms 2x2= 4

3. Demand functions of two Quantities of two factors

factors by two firms 2x2= 4 denranded by two tirlns 2 x )- = 4

4. Supply ftinctions of two Quantities of two f itctttrs

factors by two supplicl・ s supplied by two l'irnrs 2 つ

(A&B) 2x2=4

5. Mar*et clearing eqLlations Prices of two

of cotnnro<lities 2 commodities

6. Market clearing equation Price of two

offactors 2 factors 2

Total number of Total nuurbel ol'

equations 20 utrknowns l(l

Assume thattllerc tte only two consumers.A alld B,ollly two()oml■ oo(11lics,X an(l Y all(1

呻 mメ 測 甲 CTI的 血 Ш ∞ m面 鳴 h百 け
Tい …
t劇
∵ 1蜘 ず
 r01
the two tirms. Let us now specify the number of equations an<i of 'unknowns',
iusurnins the existcnce
.fperf'ect competition in both commodity and factor martets.
It is to be noted that the number of equations aurd unknowns are equal. It is a necessary
c.onrlition
fbr the general equilibrium solutiott that the number ol'independent equations must
be the same iLs
the number of unknowns. Another requirement of general equilibrium solution
is that all equations
must be simultaneously solved. The above exarnpie satislies this
condition ol'general equilibriunr
solutiott. The l'ulfillment of this conditiott ltowever cloes not necessarily
ir !u.,et'ol equilibrium solution. -o1,rrrrt.. [he cxistencc of

Let us suppose that zilt ecollollly has n conulodities, h house holds or intliviilLrals
and nr inpLlts.
with thesc details wc can tjcscribe thc corumorjity and input sectors.
THE COMMODITY SECTOR
The de[raud tbr each commodity is expressed by a demand functiou rvhiclr
ilepcnds on prices
ol itll commodities, P7,P2,..... Pn, and onthe level and distribution ol'consumcrincomes
Ml, M2,
""' Mn, which consumers earn by supplying their f'actor services. Thus the tjernand firnction lor.
each commodity may be expressed as:

Q,o = Di (P1 , P2, pn, Ml , M2, .......... Mn)

Where Q,d = Quantity tlemantl by individual i
Pl , P2 etc al'e the prices of commodities
Ml,MZ etc are the income levels of the consltmers.
There are n x h deniand I'unctions in the general system. The supply
of each commodity.is
similariy expressed through supply firnctions. T'he quantity supplied ol'a comuroclity
depends on
tlte prices of allconimodities, P1,P2... Pn anci prices ot all inputs. Vl, V2
... Vu. Thr-rs the supply
function is given as:

Q,'= si (Pl. P2 . Pu, V 1,V2,............. Mn)

Where Q,. = Tlr. Quantity supplied by indivitiual i
PI,PZ etc are the pdces of commodities Vl, Y2 etcare the prices ol ipputs
there are n x f supply f'unotions of n commorlities fbr f li,,s.

TNPUT SECTOR
Resources (or inputs) are owned and supplied by the householtls and
tlemanded flrnts. Let Rki
represent the quantity of resource K owned by an individual i. The
actual quantity supplicd Rk ot'
resoul'ce K will depend upon all input prices and the level and
distrjbution of ownership. Tlms
snpply ftrnction of a resources given as:
Rks = sk ( Vl ,Y2, .....Vn; R*, , Rk2 ....... Rk,,)
Whele R*' = Supply ol'resource K
Y l, V2 etc al'e prices ol' inputs
Rk', Rk2 erc are the quantities or l.esolll.ces
There will be m x h equations
the actual amount dentanded R*'r of each resource will depend on oLltpllt levels, outpgt prices
and input pdces. Thus, :

Rkd = Dk ( Ql, e2, . .. en;p1, pZ, ..,.... pn; Vi, V2, ..... Vn)
' Where R*u = Demand of resource K

Ql, Q2 etc are output levels

 108

Pl, P2 etc are the Prices of outPut

V 1 , V2 etc zlre the Prices of inPuts

There will be n x ln eqllaliolls

model. It may be explessed
Besides, resources constraints should also be incorporated into the
as:

RxD< Rki

R*" = Actual deniand o1'the quantity of resource K

Blqi = Quantity or resource K owned by an individual i
lderities: An important identity which elnerges h'om the circular
tlolvs of iucotlres is tltat
valuesol'alloutpr.rts,i.e.PiQir-nustbeequaltothetotalincomesof ttresociety,ie
Ml +M2 '
N{n.
h

Pi Qi= ....(1)
That is

individr-ral is calculated
Secondly, the total expeuditure equals total incomes. Iucornes ol'each
by multiplying the alnount of resource.
pricc Vr'
K supplied by an individual j, which equals Rkj S, times the resource
m

That is mj = vk R.kj

k=1

Finally, the lundamental identify o1'the economy zrs a whole can thus be exprcssed s:

hm

Σi=1 RQ=Σt=互 〉k= Vk Rs短 …Ⅲ )

t I

Equation (iii) shows that the price of resources are directly linked
to the prices ot or"rtput'
prices a,d qualtities of resources supplietl cannot be determined without detenlining the prices of
must be solved
comrnodities. The Walrasian model, therefore, requires that all equatiotls
simultaneously. A generai equilibriu[l occurs at n + m prices whcn
all tltc cqr'rrtiolls alc
silnultrrncously.

GRAPH!CAL ILLUSTRATION
Assuling a2xZ x 2 model we call show that rrn economy has a tendency tolards general

equilibrium under the following a^ssumptions;

l. Existence ol'perl'ect competition in the commodity and lacttlr tnirrkets'
There are only two comnotiities ( X and Y ) which are substitrttatrlc lo eitclt
olltet'.
2.
Consumers utility functions are given and they maximise theil utility
to ittt:ol-t'tc
3. .-sttt-r.icct

constraint.
 109

4. The re are ouly tu,o lactors ol'production. L and K.

5. Producticln lunctjolt shows tliniinishing marginal rate of technical substituti6n antl decr.easi
rc [Lr l'll s .

6' Filnrs Inaxiulise their profits subiect to resource conslra.int. Witlr these assllprpli()ps t
l'ollrirviltg diagranis iire drAu,n to show equilibriurn in lhc entire ccon()l))y.

(l) FIRM'S AND INDUSTRY,S EOU|L|BRIUM FOR COMMODtTy'X'

Fig. 8.2. A shows that cquilibrium of a single firm and 8.28 shows the ecluilibrium ol'r
industry engaged in the production of the Commorlity X.

Fig 8.2a

Firm lor commodity x

Ｐ   Ｐ
為 ｘ
ｌ
卜 ∽ ０ ０ “ ШＯ 一
匡α

lndustry for commodity x

The equilibrium in the firrn (market) of X commodiry is illustrated in Fig.

8.2A. the initial
demand and supply curves for commodity X ale lepresented by Dxl and
Sxl respectively. The
demand and supply curves interested at point El determining price ollX at Op
xi . At this price,
demand fbr X (i.e' oX) equals its supply. The market fbr conimodity X
being in equilibrilqn, the
one firm industry X would also be in equilibrium. The equilibrium
Fig. 8.28. The firm or industry produces oXl at which-AC MC price
of industi.y x is ittusu.ated i,
= = = rran.
(ii) Firm's and lndustry,s equilibrium for commodity y
The initial equilibriurn positions of commodity market Y and of
industry y have been illustrated
in Fig. 8.3A and 8.38 respecrively.
The commodit.y malket Y is equilibrium at price OPy l at demand Ibr y equals irs supply. 0y l .
 110

Py

Pyr
Fig 8.3 a

Y. Y, Y,

Maket for commodity

PY, = ME1

卜∽００ “ ШＯ一
PY, = MR2
匡α

Fig 8.3B

Industry Y is in equilibrium by producing OYt. At this output AC = MC - price = MR in industry.

Let us now suppose that due to some exogeneous factor consunler's uste challges in favour ol'
commodity X. Aq a result demand curve fbr X, i.e. Dx1 shifts upwards to the position Dx2.
Consequently, price of X rises to Px2. the output of X rises to OX2 and the industry makes an
abrrormal profit of ab per unit'of output. A. cted by the supernormal profits, new fitms enter the
industry and existing one incrcase theii' output As a result dernand for factors incrcases. This causes
a rise in demand for factors increases this are fully employed, question arises whercfbrm the factors
come?. To find an answer to this question, let us examine what is happening in industty Y.

Since we have assuned a shift in consumel''s taste, there being an income: constraint, the
additional demand fbr X comes only from a shift in demand from Y to X. This shift occures
because X and y are substitutes for each other Due to shift in demand tfom Y to X, the initial
demand curve for Y, i.e., Dyl shifts downward to the position of Dy2 and price falls to OY2 iurd
price falls from OP y1 to OPy was showsn in Fig8.3B: =As a result, fhe equilibrium of industry Y
ihifts tiom E1 to E2 and lirms incur a loss of Ce2 per unit as shown in Fig 8'3 B

(iii) Equilibrium for Labour Market for lndustry X

Fig 8.4 a

Labour Market for lndustry X

‐ . , 11
 111

、ユ ー
．
∽ШＯく〓
Fig 8.4 b

Labour Market for lndusti;y

Thc r-l'l'ect ot'increilse in deurand fbr labour is illustrated in Fig.8.4A eurd 8.4 B. Suppose that
the iaLbour martet lirr industry for industry X wan initially in equiiibrium at point El. Due to the
increase in demiurd lbr labour; the demand curve DLl causillg increase in the employment ol'
labour in. Ittdustry- X fi'om OLI to OL2 tutd incrciise in wage rate fbr to industry ii.orn OWl to
Ow2. 'fltc inctea.se in demand lbr labourby an individual firm of the: industry is iliusrrated in Fig.
f{ -l B. It shoivs that the demand curve fbr labour by an individual fi'irn shilts rightward
fiom DLI
lir D[,2. An individua] tl'ini can employ iury number of workers at the ruling wage rate. It is to be
Itolctl tltat thc numhet' ol'llbourers multiplied by lirms give the number of lahoucrs in the industry.
コく 卜 一
α く Ｏ ＬＯ Ｚ 伍 ⊃ 卜 Ш匡

Fig 8.5a

Labour Market for lndustry

R2

Rr
の Ш Ｏ く ≧´

Fio 8.5b

r\r ]\2 r\3

Labour Market for lndustry x

(iv) Equilibrium for

capitat market for lndustry X
The chirnges in tire capital martet ibr industry x is illustrated in Fig 8.5 A and 3.58. Demand
lirr capital inct'eases in this iutlustry, ancl the initial capital demand cur.ve Dkl shifts upwards
to the
position of Dk2 causittg equilibriurn point of capital;rrarket to shilt to E2 and retur.n
on capital to
 112

dse to Ot2by an individual firm increases from Okl to Ok2 (Fig 8.5 B). The total demand.
:

(v) Equilibrium in Labour Market for lndusty Y

The change in Laboul Market in respect of industry Y are illustrated infig. 8-6 and 8.6
B.
Since firms in industry y incur losses (Fig.8.3 80, the demand for labour decrease
and lzrbour

demand curve shifls downwards from its initial position DLI to DL2.
in the industry
Consequently the wage rate decreases from.OWn to OWI employment of labour
decreases it to Lz. rn.-oecreases in demand for labour by an indivirtual flrm of industry Y is
showrr in Fig.8,6 S by a tlownward shift in labour demand curve from DLl to
DL2- Each tjrm
employs less of labour even, though wage rate has gone dowtt from OW1 to 0W2'
Y

w2

wr

Labour Marke! for lndustry Y

Fig 8.6a

Fig 8.6 b

Demand for labour by a firm in industry Y

(vi) Equilibrium in the capital for lndustry Y

sirnilat to tlle
When we turn to the capital rnarkei for industry Y we find here a golgt]ini:
labour market. Demand for capital decreases as shown by the downward shift
of labour demand
retum on capital in the
curye of both individual firms (Fig. 8.7 B) and industry (Fig. 8.7 A) because
industry decreases.
Y

Fl2
コく卜一

Bl
Ｌく０２０Ｚα⊃卜Ш匡

Fig 8.7a

Capital Maket lor lndustry Y

 113

R2

R,

Fig 8.7b

Demand for labour by a firm in industry y

lt may be summed up by saying thart due to the change in consumer's prcf'erence y f:rvour of
commodity caused by an exogenous fact; demanrl fbr commodity has incrcasetl and tbr comnrodity
Y incleased. As a rcsult, price of x incrcases and that of Y decreases. Factor price, renraining thi
same, prtllilability of industry x inct€ases, while that of industry Y decreases. This leads to increase
in dentand fbr f'actors in indusLry X and to dectease in derrand fbr f'actors in inclustry y These
cltanges in denrand lbr firctols have led to disequilibrium in the system since firms in industry X
are earning supemormal protits which is inconsistent with pertbct competition. In a perlbitly
competitive.system, however the disequilibrium is sell corrccting. The above illustration does not
provide a fbrnral ploof fbr the existence of stable general equilibrium solution. tt simply
describes
the tendency towards a genera equilibrium under perfectly competitive conditiols.

EXISTENCE, UNIQUENESS AND STABILITY

The Critics of general equilibrium analysis pose three questions: (i) Does there exist a
.seneral
equilibrium solution? (ii) tf it does, is it unique? (iii) Is the solution stable ?

(i) Existence of General Equitibrium

lf nurnber of equations and the number of unknown are equal sometirnes make one think that
there should exist a general equilibrium solution. But, the equality of number of equations
with
that of unknowns is ncither a sulficient nor a necessary condition fbr the existence of a seneral
cquilibriums solution.
A unique general equilibriurn may exist at zero prices and even at negative prices also. So in
ecluilibrium analysis li'ee goods and nuisance gootls are to be considered. tta.rg.i pointed out
that
′  ∞〓

there is a tendency fbr the li'oo goods to decrcase when economic developr.nt stakes place.
Therefore all kinds of goods shbuld be-included in Walrasian systems aurd Wlarasial-did
not realise
日︹り０崎晏蟄望ヽい卜ヽつ０

it. So his equilibrtum is doubtfirl to exist.

(ll) Uniqueness of General Equitibriun Solution

The uniqueness ol'general equilibrium solution rcquires that, at all partial equilibrium
levels,
demand and supply schedules intemect only at one point giving a positive price.
At any otSer price
higher than the price so determined, supply is greatei than ae*a"d, and at nny lower price
denrands
is greater than supply' But if demand schedule of a commodity is backward
6ending, as in the cme
of inf'erior goods, there will be no unique equilibrium. Instead there will be a multiple
equilibria.
iii) Stability of General Equitibrium is stabte.
Walras also tried to show that general equilibrium is stable. His analysis was
based on the
assulllption that the rate ol'price changes varies directly with the amounf
of excess dentand. Walras
like Marshall treated instability in the context ol nrultiple equilibria the unstable position
ol'
invaliability lkrund between two stable positions. But unstible equilibria i1 Walrtu
arises li.om the
 114

intcrscction of i backward bcnding stlpply culvc of a productive sclwice、 vith it nlolc siCCply lhtlinご

demand CtlⅣ c.This i血 plics tllelosSibilityblltcer五 nly not ulc nさ cessity OF nltllttplc c(luiliblia bccause
lle supply cuⅣ c may ncvcr bcnd back again cven ifthe plices lisc higll

CONTR:BUT:ON OF ARROW AND DEBREU

Wc have scen that tlnequcncies and stttbilityを ue clllcsti(11lablc in ヽVtlllを lsitlll lll()(lCl il thclc is tl
/alitsitul systcill d()csl)()｀ ｀
backwttd belding dcrnalld CulⅣ c.Alli()W ttld E)ebtu havc showntll江 tllcヽ ヽ
CS｀

ld thcrc
a uniquc ano CCOnOl■ licaHy mcani,gilSd帆 ion if rctunls to sCalcヽ conttam or ttnlhlishing出
are no loint prOducts or cxtcmal c∬ ects cithtt in production ol in collstunpti()1l tJndcl rcsutuivc
assunlption uniquc splution is likcly to be obttuncd.

CRITICiSM
Tllc gcnerttcⅢ 五bl・ ium of W山 郎 has sott hni籠 ionsi

{i)Mtty assulllptions at highly“ st五 ctive ttd unК alisuc.

Ⅵ/tllを lS iS doubtlul.
(ii)■ ee対 stence Of cqtliublium as hぉ bccn c]」 IIled by

(ili)TllC_uniqeness ёf gell∝ d equiLb五 um is deb江

あ lc.

(iV)Stability 6f equiliblitlnl isを lso questioned.

CONCLUD:NG REMARKS
Inspt ofthc sholtoⅢ igs,lhe wttrぉ Ln gcnerJ eq面 lib五 ul■ has cc■ 」n ments d itS own Thcy
are givett below i
ur
l Atleast undcr Кs面 ctivc assull■ ptiolls it offcrs an idcだ 11田 ld collll)ICte nlo(lci t)i ccononlic hclltlvi(〕

2. Ullder celt激 n assulliptions the genelial equiliblitllll systelll has a solution

111減 sitllJloll lllls(lCVitlttd ll olll thc
3.Tlle solution a」 its opum4ity hclp one to hlow how ftttlle“
ideal sitlltttion.

4.■lis appЮ ach c“ be helplill in tllc sou10n ofmκ rOccOnolllic controvcrsた s.

y to J10■ 1」 y豆 so∫ valous

ln ine■ 血響 mendolcdthttgcl19・ d eqtlilib五 uihtt a↓ dc applに お刊れ
cconё lllicphcno呼 五 4odcllltllcO五 es oflllollcv,intelllmlonJ tl・ tdじ ;cl■ ployincllt t、 1ld CC()1lolljC 810Wth
とヽ
s is an oulgroヽ Vth
冨e generd eqllilibl■ llnl thcol■ es in a sinlplined ioln:AIso tllc new wcrarc ccOnolllた
of geneF」 equilibrlillm tllco7.

MODEL QUESTION

Short Type
L Wha[ tlcl yotl l]lean by general ecluilibritul'/
2. Mention the contribution mtrde by Alrorv and Dcblew in thc iutalysis ol gcrntrltl ctluilih|itlnt
/

MEDIUM TYPE
t. Bring out the ditTerence between pruriaLl equiiibriuni itltti general equiiibritrrl

2. Givc a b丘 ef account of tire televrurce oI existetlce, uniqueness au.l stahilitl' Wah'asitn gcncrtil
:1
cqtlilibrium
:` :￨￨

Essay type i ,
`￨￨
t. Discuss the general equilibriurn analysis of Leon Wah:as
of
2. Critically examine the inteldependence of lactor nuu'kct ttttd cotluttotiitl' market in the arialysis
general equilibtittm.
 115
Ⅳ10DULE IX

WELFARE ECONOMiCS
Welfau'e econornics is the study of economic wellarc of the rnembers of ii' society as a group.
ln the words of Oskar Lange, "Welfaue economics is consemed with the conditions wl'rich determine
the total economic welfare of a community".

Welfare economics can provide positive basis fbr adopting policies to maximise weltare. It
connects positive economics with nomative economics. Positive economic deals with the actual
situations whercas nornrative econontics deals with the deal situation. It is f}om normative economics
wellarc economic ideas have been developed. Wellare econonrics has to prescribe criteria or norms

Ｊ ﹁
with whiclr one canjudge desirability of certain economic reorganisartion nnd prescr.ibc policies on
that ba-sis. However an impgrlant dill'erence between positive economics autl welllrc economics
rn4y be noted. The propositions and laws derived in positive economics are carpable of being tested
and verified by observations of affects in the real world; on the other hancl they cannot be tested
and verified in welfale econonrics, because we can riotknow whether wellare has actually incrcased
or decrcased. This is because welfare is not an observable guantity like prices or quantities of
goorls. We cannot measure welfare in cardinal terms.

INDIVIDUAL AND SOCIAL WELFARE

Individual welf-are is measured by the arnount of satisfaction that he enioys at a given time. It
is a f'unction of so many economic and non-economic varjables. Accortling to Pigou economic
welfare is a paft of social welfare which could be brought directly or individually into rtlation with
measudng rod or money. Social welfare is sum total of the satisfaction of all the individuals in a
society. [n welfare economics individual weltare is not studied with extra interest.

CRITERIA OF SOCIAL WELFARE

Criteria of social wellare can'be discussed after examining the concepts. According to Prol'.
GratT there are three main concepts of social welfarc and they arc given helorv:

l) Paternalist Concept : This concept describes that views of a paternalist authority or state
and not the individuals in the society, According to this concept the pref'erences of individ-ual
members may be ignored and a common authority like the state ol'dictatoruses its own ideas about
social welfare. Social welfare increases when the paternal authority ol dictator thinks it so.
Economists generally do not accept the paternalist or^dictatorlal concept of'social weltare.
2) Paretian Concept: According to Paretian concept welfare of the society is simply the sum-
total of the welfare of the different individuzrls comprising it. If some persons arc made better ofT
and none worse off social wellare increases and if some arc made worse olT and none better olf and
some one worse off, then according to Paretian concept we cannot know what has happened to the
welfare of the society. The Paretian concept rules out interperconal comparison ol utility of weltare
and rests only-as a generally accepted ethical view and it is goods that if somebody is made better
olf while nobody is worse OfT. In most cases of charges in economic organisation and policy at
least so nre people are ntade worse OlI, the Paretian coucept is of linrited value f or most oI'practical
siLnirLions.

3) Bergsons and Samuelson's Concept: The third concept ot'socinl welfare involves
interpersonal comparison of utility which is to be rna<le by introdu,ing explicit value judgements.
The advocates of this concept are Bergson and Samuelson, Little, Angw zurd' others. They have
described utilily function of various priron, in the society with the help bf social weltare function.
In the tight of values judgements :the corcept of social weltare enable us to judge the welfare
irnplications even when someone is made better ofT and some iu'e r-na,le *o,ls.'ott ou. to the
changes'in the qconomic organisations and policies.
ヽ, こ
 ll6
CRITERIA OF SOCIAL WELFARE
rvc sltitl] now
I-lavi,g introdgcecl the weltiu.e economics and the concept o['ecotrottric rvcllate,
tliscuss the various rvell'are criteria devised by wellare ecoll()lnists'

1) SMITHIAN (GNP) CRITERIA

Oue may horvevcr l'incl
Classical economics did not develop any specific theory of welfarc'
ol' 'uYelfare tnay bc
welfirre propositions in Adam Smith's wealth of Nations. Smith's criteriti
surnmadsedaslbllows. l'hefinalairnofallproductionisconsumptionandincreaseittcotlstttltptitrtt
natioual oLltptlt (or wcaltlt)
results in the level 0f satisfaction. Therelbie, inclease in the level of
thus irllplicitly assuntcd tltai
leads to increase in the level of satisfaction (or welfale). Adam Sn-rith
the level of satisfaction of a society is proportional to the
level o1 its total physrcal oLltpLlt' Adattt
as thc lrlaiu dctert'uinatlt o1'
Smith regarded growth in nzuiontrl ptrysicat product (national wealtli)
welfare.
sr-rhsicliary tltcme 1o Atiartt
Distribution of national wealth (i.e. allocative efl'iciency) rvas only a
ol'the colllpctitivc
S,rith.In respect of resource zrllocation he sholvs thatthe equilibrium pt'ocess
dillercnt indr-tstt'ics: Ft'cr- cotllp'--titiott
rurarket will lead to all optinllun allocrrtion of rcsourccs irmong
pliccs ol crtch
will thus ensltre that right commodities wor-rltJ be produced in right quanlilics. trttd
commodity would be ecltlal ttl its cost,

2) BENTHAM'S CRITERIA
Jeremy Bentham, an English economic argued that welfare is
improved when the grcatcst
well'arc is the sunr ol'tl'tc
good is secured for the grelteit number. Ttre implicit idea is that the tottrl
individuals tr'vo ate bcttcr ol'f
utilities of the individuzrls ol the society. In othei'words, out of three
sutlt ol'ittcrcase in the utilitics
while the third is worse off after the change has taken place, but the
o1 A and B is greater than the decrease in the utility of
C'

3) CARDINALIST CRITERION
rich thc ttlal'ginal trtility ol'
Forthecardinalists welfare istlie sum ol'marginalutility. Forthe
anrl weitltlt will increasc thc lotal
money is less than that tbr the poor. So a retlistribution of incoure
lunction- l'or tnouey' In l'act' hy
.wclfare. But this idezr is based on the assumptiol'l of same utility
rcdistr.ibution of income irnd wealth the etficiency of protluction
will bc dccleascd. Becattsc al
lcast some po6rpeoplc'"vill misuse the income and rvealth tor
unprodltctivc pttt'pose '

pigou adopted a dgal criterion for juciging the improvement in social wcll'arc. His rlital ct'ilct'iott
(or tncome) rvilhot'tt correspotttlittg
.ray be statcd as tin increasc in the val.re of irationiil dividend
increase in the suppl5r ol iactors, and a trans['er of income
Irotn tjch to poor inclicatcs itlct'casc ilt
the national income cor-rld be ittcreascd
social wellare. with iegard to the tirst criterion he fblt that
that redistribution
lrctor supply remaining constant. Regarding thc second criterion; he suggestcd
Thus he proposed his sccond
of ntrtional inco,re .u.rt not lead to decreaie in national tliviriend.
o1'tlte pot-rr r'vithor"rl causing
critedon as any reorganisation of the economy which incrcase the share
rvell'arc'
reductio, in the N.trIis to be rega.ded as an inrprovement in the social

4) PARETO'S OPTIMALITY CRITERION

can be ob.jcctiVcly
Vitredo pareto, an ltalian economist rel'ers to ecououic elliciency thal
least one individual bctter tll'l'and
neasured. Accordilg to this critericln any change thtrt makes at
r1o one wome olf is i1 implovement in socitrl wellare
antl conversely a changc lhill makcs I'Io olle
bctter ofl and at least one worse olf is adecrease in social rvelfar-e.
Ptirclo-tlplitnalitv is a sitttLttiott
onc woISt' ot'l' This is
in which it is iprpossihle to mtrtric any onc better oll wirhout making solllc
also called Paretoelf icie nt.

Limitations
i) It is i,rprtclicable, there is no policy of the Gol,cl'nrncnt ivithcttt gtltlil lrnd had ol' r'at'i(rlts
 117
people and
ii) without interpersctnal coniparison and value.judgment we cannot think ol' rlaximisation ol,
social rvellirre.

s) THE KALDOR-FLICKS COMpENSATTON CR|TER!ON

A chiulgc itt :ttiy sctup in tlrc econotny brings rrbout benel'it 1br sonrcbocly. 'rhcrc ar-c giiiucrs
;urti
at ti.lc same l.ime thete may be sonte losers. The amount ol money that giiineis
arc prepared t' pay is
itssumed to be M- The atnount of money that the losers ready to pay to prcvent
tliat chalge is M. In
llrts case M-M's is the net gain. Il'it is positive it will be an irnprovement it
the social well,arc.
Limitation
If the incorlre distribution is unequal this idea is absuld because MU ol'nloney lnay not bc
cclual. Suppose there is millionaire who is ready to pay Rs.2,000/- for change a,cl thcre is a p.iir
zr
man who is reiidy to pily Rs. I ,000/- tbr preventing that change : Accordin-c
to th is cr.etcrian l\{-Nt,
= I ,(XX)/-' So it adds to social welfhre, but actually it reduces social welllre.
But this criteria at least anticipaLes the interpersopal comparison though
it does not convey tlc
iclea o1' value .judgentents.

6) BERGON-SAMULSO N'S CRITERIO N (SOCIAL WELFARE FUNCTION)

The atterlpts to devisc value-liee well'are criterion do uot yield salisl'actor.y
rcsults irccordin-q
ttl Bergsott and Sallttlson. It is also not possible to evtilr"rate a change which
rrukes s()nlc pel.sops
bctte l' ol'l' and sollle worse ofl without makin-c some implicit
valuc .jud-uenrcnts ab.ut tlrc
deservingness of an individual or group. Recognising the inevitably
or value jiutgerlent, Bergson
suggested that the only rvay out to rcsolve this problemto fbrmulate
a set ol explicit ialue ju6gements
rvhich enable the anzill's1 himself, government authorities, legislator.s
socizrl relorrneLs, or. zrri
irldividual ol' group ol'the society. The explicit value judgements include
ethiczrl, political,
philosophical and religious values.
Burgsot1 suggested that value iudgements may be explicitly fbrmulated
in the lonn o1.a social
wellatre lunction. A welllre fhnctio,r is an indifl'erence nup which
ranks difl'erent corrbinati.ns .l
individual utilities according to a set of explicit valueiudgements about
the distribution of i,co,rc.
lt is analogt)us to the utility tunction ol a consumer: More precisely, a social
welfhre fLnction is an
ol'dinal index of well'are of the society and is the fiurction of the
utility levcls of all indivirJual
tncmbers it r-nay be cxpressed as W = 1'(Ul U2...Un) where W
denotes social wellare anti Ul is
Lttility index o1'the I st individual. Assumirtg a simple economy o1'two per.sor.r.s
A a,rl B the social
,rvcll'are lLnctiou rnay be rvritten as W = 1 (Ua, Ub)

Limitations
First, Bergon's critetiittt requit'es explicit value iudgements. Value
.judger,enis of dill'ere nt
cate_gories of-judges may dift'er,. Economists, valueiurdgment
may ditl,er fi.orn tliose of the legislators
and other. Bergsort docs ttot olfbr a solution to resolve such
difl'erences in value.judgement.
Second, there is no easy method of constructing social welfare
functiorr. Bersson does not courc
out with neccssaly instrucLions fbr drafting wellare.iudgments
which are requireJ in the lbrrnulatiou
ol' rvelfare ltnction. Thus the most imporizrnt problem
of this cretiedon remains unsolved.
ROLE OF VALUEJUDGEMENT tN WELFARE ECONOMTCS
By value judgenient or value we mean the conceptions ol'the people about whtrt is gclort ur
wltat is bad' In other words all ethical judgment sa and statements
which perfbrm recomrnenclatory,
inflrrential and persuasi,e fitncl,ions are value.iudgments.
value .jutlglielts descr.ibe facts in an
elltotive wav and tend to influence people by altemating their
beliel.s or attitutlcs. such statcnlents
this cltangc is dc'sirable ineclualitres of income need be reduced'are
all valLre j,dge,;;;.'-'^"""'
 118

BASES OF VALUE JUDoFMENTS

皿 ∝ ¨ hC」 涵 山 面 ま ∞ 蒟 山 eR袖 山 ky
鳳 潔 サ::器 l胤 :嘲 fif難 富盤 HC札
logic
・ or law.

鷲 椰
cthical tellnlinology,suCh aS inclletse of:'social、
Thus welぬ re eCOnolnist and vJueiudgements cmnot be sep肛
江ed

PROBLEMS OF APPLiCAT:ON

肌葛
mt:¶ rr凛訛瀾:棚 忠誦淵淵lよヽ ギ
棚 :=T器」l濯 品

戦淵器 淵淵肌魚蝋 朧絆1盤獄 盤憮糊庸緞器甘 ま

in盤
脚淵 淵 』 摺淵器 盟肝鯵菖壼
鳳冒聡柵1:ポ ∬ 需1蹂I. :髯
welftte is■ ot ah casy task and COntains
Howevel・ ,when welね rC ecOnOmics has tOjldge thё soCi血
.TmS iS bcCausc the SOdCty or ypup
vtte judgellle■ s lnd intё ipersontt colllp血 sons Of libtジ

憮 撫 構 i轟 ￨∬ 轟 i構 曇 鮒 犠 鮮 榊 ‖ 淵 糞
騨
tic sOciety,becttse va・ lous individuals ch00se dittrently ttd,therebre,therc is no un4niP9VS
fcrcnccs
social choicc.Individllal choice diffCr bccausc various individtlals havc dilTcrcnttastes,prё

i11:‖ ￨::織 f議 ￨::寵 鏃:盤1::11■′よ 出

辮T』1胸 認1滞駐llⅧl鷺 器 ::

wclfarc economics Can not bC purcly o,iccti｀ e or ttec hom vallleiudgcmCnts.

SOC:AL WELFARE FREE FR9M VAIり E JUpGEMENTS

Itis gener』 ybelvedly“ mCmiciansthtt Par∝ O evolved the co“ ept ofsOCid wCrare which

is said to be free froll■ aly v』 ue Judgements,because it iS not based upon any lnter pcrsonal

選
江篤 悧 :淵 鮒κ 磯棚 iξ

躙 1輩酬脚 鳳
器 :Tttt躍1島 =識 lc worse ott the so01温 inCre■ es,th江 1,,if

粽器吻淵1躙 帆
"elね

鮒
櫛絲辮鮮臨猟懺
1織 ∬ぶ濫轟
朧 讐憮 認 識器lttΨ濫出1‖
轟蹴燎群
鷲
手部i鮮露欄 義
ぶ準FIPュ 貰澪
朧∫
econollliSts obieCt tO making interpersond cc
II減 ti薦
since illterperson』 comparison ofutility is bttsed on valllejudgementS.

椰 欄
cblE“ SA十 :￨￨1員 INblPLЁ INPVALUEJI10EMENTS i

・ 器
菫難 難 i棚 :

蹴職胤肥
場 ご:靭1軸蠍機騨灘灘 :鷺
 lll‖ ご
澪品tl卜 露1滞 毬 淵1嵐 ‖
￨‖ :;:ど 総
l111露 :潔 w朧 l:lli跳 器
I漱 : l‖
intlcccptablc valuc judglllさ nt By usingを L`jrit81iOn inv()lving potelltial llloncy colllpcnsati()n,thcタ
set tip a conccalcd interprcsOnal conlparisOn On 4 1■
Oney basisl'.

面‖慇詰器::罵 ‖
I¶ 襴 TFllll甘 胤躍 tよ√
鯖f:￡鳥肌T燎 器
c()inpcnsaJ011.If10scrs arc acthally p。 1■ pcnSated ibr their loss,tllen llo pl・ oblcm arises.It satisics
the Paleto clit91iOn,i.e atleと 、
st One lerson is bcttcr oF and onc pcrson is worsc 01t But if thc
polcnti」 cOnlpe1lsation is llot actually I〕
aid,it wOuld inlplytllttthc prevailing disttibution ofincomc
l■ casures thc l・ elate stl・
cngth ol'1leclillgs ofgaillers and loscls.It飲 )1lows that the individual prefcl・
cllcc
pattcl■ is also knO、 vn.This illeans illter pcl・
sOnal cOn]parison of tltility:But this is an issuc that still
remそ lins LinreSol、 ed.Thc Kaldol・ ― Hicks cliterion,tlleК bre,d6cs nOt provide a tcst i・ ee iOmャ llluc
itidgenlelll.

SOCAIL WELFARE FUNCTIoN AND VALUE」 UDGEMENT

Pl ol.Bci30n lltls pulsucd ll dinbrcnt inc Ofを
りp10achtO wcぬ rc ccononlics i Hc has pmpoun(lcd
the cOnccpt(,l sOcial、 vell■ rc l■ nctiol〕 in whicli ttsct Or valuciudgClllcniS is explicれ y intr(〕 duccd
t11ld with this sOcitll、 vclial・ c l1111(lti011,thc cc01lomiSt call、
ludgc tllc desil・ ability ol'ccl‐ tain ccO■ 01nic

b)`illi』
‖ ゝ
lijII塾驚liIIIIIIIi:1:if』 [1llilttIII[llllili
cannOt bc scpal・ Jcd li・ olll valtlcjudgclllcnts,bcctltise ally statclnent cannot be sepalated fl・
olll ValuC
iudgclllclltS,.1)ecausc any statclllellt about incl・ cascs Or d,creaSes_Or sOcial wel■
trc lunctiOn,alld
h雨 山ЮⅢmm J鋏 山 劇 祀 ヵdttmm雨 nt化
1:il:胤 麗 R'i棚 :I‖ 鳳 賢 l『 RI
鰤 出 器 1諄 鼎 1′ 1龍 l品 l:淵 ,蹴 t劇 ∝ 資 睦 c刺
mmmsど
ircatcd willl suspcciOnH.I″ ikewisc PI()f.BOuldillE wliters,01lc llluSt adnlit that task Of makillE
血 ぬ wm樋

、aluc iudgemcnts cxplicit is very il〕 lpo■

allt lt is Ob宙 Ously prepOsterOus tO stlpposc tllat onё
ciI
SCtllp critclia lk)r iudgcincllls wllich al・ c s01■
chOw inccpcndCnt Or e」 lical norms.
Accol・ ding tO scvclal n10dcln ecOnonlists sucll as Sa11luelsoll,Little and BOulding wclぬ

棚欄 ∫
1)mattlll肥 庶
lc

itt11〕 借:戚
:i:罵 ttI緊
雨
掘榊難鸞選
l朧
黙I蝋‖ ぷ lξ 諸 .wdh℃ 」血輛 Ⅲ /Wdね К∝mo面 ¨

詭棚誂珊罵
d

l猟 瀞i職灘
l樹器轟爵 棚蹴tl譜 1省 10ut湘 ucjlogCmen“ brぬ e
rcason dl誼 ぬ 止
為鷺
wcぬ ke a nЮ l油 r囃 hwき 1ね re a讐 :yIWⅢ
“
d蝋:測 1鱗i鷲悩ittil翼 貯椰 網
deduccs tllc wcl■ 11・
1瀑
●plt)p()ド F it口 1■ OIDl thc g市 cll↓ al口 c judgeinents.
i
γ

CO11lnlentと llld also lllakc rα 」

olllI〕 lcndatiOns ol・
e■ lc
■ 「
icconll■ oldationS inv01、 C｀ alue judg611nents 6ut illey mlllt qolirm tO public opiniOn.
 120

PARETO OPUUALIW
Pareto was the first tof find out an objective tc$ of sccral weltare maxinrum. Parett' t irrirnllity
is a welfare situation li'om which nobody can bc 1p1111. lrede r off without making anybr,ily \vt'ose
off. Pareto deviated tiom traditional appioach to social rr,elflre in two important respecli, I;irst he
reiected the notion of cardinal utility and its additive nllrur. Second he detached welfirrc e('( )nolllics
from the interpersonal comparison of utitities. It is bas,:d r,n tlre ordinal utilities antl also'll eo from
value judgenrents.

PARETO CRITERION
Pareto criterion states that if any rorganisation of economrc rcsources does not harn'irny lrotly
and make someone bctt.:r rrff, it indicates an increase in s,rciul welfare. This can be expl:dned rvith
the help of Edgervorth's box diagram suppose two percons A and B form the society itntl'ctttlsutne
t*o go-odr X and Y. The various levels oi satisfaction by consuming various combinitt iotts of the
two goods have been represented bytheir respective indifference curves. (fig: 3.1 )
E

｀ヽ p/ヽ
＼
:｀ /1「
、 1
〕
、

O.A 'G D

Suppose the initial distributio_n of-good_s gd b:,ween A and B is rcpresenledby the point
I I Both of
f. AccbiOingly A consurnes OAG of X and GK of Y. B consurnes FK of X and KE of Y'
them are replsented by the indifference curves 1a3 and IbI. Any rRovement fiom K
p 'S.through
satisfaction of A without decreasing thc satisfaction
residstribution of two goods incremes the level of
the
of B. Similarly any movement from K to R increases the satisfaction of B without dccrcasing
points
satisfaction of A. The tangency point of various indifference curve.s are the Pareto Optitilum
and teh locus of these points is called the contract curve ccl.
pareto criterion can also be explained with the help of Samuelson'sutility possibility cLlfvc'
Utility possibility curye is the locus of the various combinations of utilities obtained by t[otlt

L__
Q

ヽ 、
 121
persons fi'om the consumption of a particular bundle
of goods. In fig.3 .2 CV is the utility possibility
curve which shows the various levels of utilities ootained
ny two individuals A and B of the socie,v
rcsditing from the redistr'ibution of a fixed bundle of goods
and its consumption uy trr"nr. ;;.;",.r,,1;
to Parcto cdterion, a nlovement t}om to R impliesihat -B
Q the utility or,weliare of increas.r, *rrii[-
that ol'A remains the siune. i.
,

on the other hand, a movement fiom to S implie.s that A has beconie better olt while B hals
Q
become neither better otT nor worse ofr. And a *oue.oent
fi.om e to D u. ony oirru- point on thp
segment between R and S will mean increase in
welfare of both the individuali. . Thus points R, D
and S are preferable to tiom the point of view
Q of social welfare. But it is to be noted that parero
criteiion does not help us in evaluating the changes
in welfarc if the moverrr.ri'l] ;;;T
rcdistribution is from the point o to a point outsidJ,rrr
rcgrnt RS, such as point E on v' the ! cuive
urtv wur vJ
CV, because in this case B has becomi letter off;
Uut A nis ieoome worse olT.
MARGINAL CONDITIONS OF PARETO OPTIMUM
we have seen that Pareto optimum as a position f}om which
it is not possible to ir,provq
welfarc of any one by any reallocation of factors
or of goods without reducing the welfnre oil
someone else' To attain this situration ntaximum
efficiincy must be attaineJ in production,
consumption, distribution and other activities_in
conditions of maximunt welfare. The marginal
the economy.J. R. Hicks catts ttrem il;ffii
conditions of iareto optimality or par.eto ellicie,cy
have been set out by Hicks, Lerner and Lt*ge
iurd not by pareto himself.
The rnarginal conditiorts of maximum welfare
have been derived directly fr.om the tlelinition
of maximum welfa'e. As mentioned above, maximum social welfare
impossible to nrake any better-ofI, by reallocating
is achier#"rJ'1lX
lesources, without making someone else worse-
ofr' Achieving maximum social welt'zue in the sense possible
is only when allocation of productive
factors between the various commodities, allocation
of commodities between ;;#;;i;;
allocation of productive factors between the various;"*ilil;il;;i;;
between consumers, and a[ocation of productive ii commodities
ractorJbei;;;;;il;;*fi;;.tr*,
v u'rvrvrrr rur,s ffiffi;"_;;
Pareto oprimality is therefbre also cailed 'rr
as alrocativ;"fti.;;;;;.

ASSUMPTIONS
Befbre we explain the marginal conrJitions
of welfare maximisation, let us set out the necessary
assumptions which are usually made tbr the fulfillment "-'
of marginal .r,roiir*
Each individual has his own orrlinal utility ltnction and possess a delinite irmount of
product and lirctor.. each

Pi'oduction lirnction of every I'irm attd the

い   ︱  ゛螢﹃ヽ 卜 ご Ｕ

stiite ol'technology is given iuul reprains cousr.ant.

(iii) Goods arE perl''ectly divisible.
(iv) A producer tries to produce a given
output with the least cost combinatio, of 1rctors.
(v) Every individual wunts to maximise his satisfaction.
(vi) Every iridividuar purchases some quantity
of aI goods.
(vii) All factorsof production are perl-ectly mobile.
Given the above assutnptiotts various marginal
conditions (first order conditions) r.equired
the achievement of Pareto optimum of ltn.
maximurll social welfare are explained below.
MARGINAL CONDITIONS
It has been claimecl by several economists
that perfect competion is a1 ideal nrarket
the aftairuIent of Paeto optimality
fb,. which
'ensurcs ol maximum socitrl welfarc as it rurriris air the
conditions requi'ed fb. thc putpot.. The ,rargi,al
ma'ginal conditions fbr the artainment ni:irr.-oprl,,ality
(l) Elliciency in exchunge ol,optimal <listribution o1 goods. are :
 122

(2) Optimal allocation of factots.

(3) Optimum degree of specialisation,
(4) Optimurn factor - protluct relationship,
(5) Optimurn direction or composition of production'
(6) Optimum allocation of factor time aud
them hliefllT onc l-r',' oitc'
(7) Inter - temporal optimum allocation of uroney assets. Let us explain

(1) Efficiency in exchange

of t*rbstitr.rtion betrvee, any,twr) g..rrs
El'liciency in exchangcs clccutls when the rnarginzrl rate
Let A a,ii B be t1c twr) c.'tsttttlors 6r:trvcctt
say X a,d y become aqoit tb,. any'pair of co,sumers.
competitiorl. prices of all go,dr; arc
wh.m two goods X and y are to be distributed under perf'ect
'[t cotlsttmers .l'-v to ntaxiutise t]rcir'
given and same for every oonsumer. is also ri.ssumgcl that
siitisfactionsubiecttotheirbudgetconstraintWithgivenpriceAwillnriixittlisehissatisl.itclitln
*
when MRSA*, = / py.................. (i)

Sirnilarly B will also be trt equilibrium when M

MRSB-y =
* / 0r.................. (ii)
is that prices ol goods ill'c sltlllt t)r'
since the essential condition o1' perfect competition Px
goods / py in cqtratiorl-ll"ttntl (ii) above
uniform for all consllmers, the price ratio.f two
will be the same fol consumers A and B. Therelore it will be MRS'{., =
Ml{So*u

(2) Optimum atloction of factors

This contlition reqttires that for the optin-ral allocatiot-t
ol tactors trtiirginiil ralc ()f 1cr:litlierrl
capital tlt'tst be thc siuuc lor all Prtldttccts'
substitution between ally two ltrctors say labour and
(f l
Synrbolically it is showu that 141158LK = *PK
PL
MRSBIT = (2)
PK
Since under perfect competition prices of
fitctors al'e the same for all the pt'oclucel's" ctclt
lhtrt the MRTS betlveen liibtltll and crlpilitl
it'
protiucer will adi,st the use oifr"t.,r, in such a w.y LK = MRS LK
equal to the same lactol price rtUio. FrOrn
the above equatiott it follo*ws that MRS

(3) OPTIMUM DEGREE OF SPECIALISATION

Pareto optinaiity with regard to the tlegree
of specialisation in prodr-rction bY VaLitrtts ltt'trt
(MRT) betwee' urny two p'.riucts musl he tlit:
requires that the ,rargintrl ratJ o1transfor*rartion r'i,r-rs A,rid B cur:lr
irssri,rc tu'.
same for zrnytwo tirms that proilucc the trvo produc:ts. Let us ol'spe cialisrttiotl'
thc two prodncrs x anrl
y. The pareto optimum with reg:trci to tltc clcgrct-
producing
ol' plodttcts rcqui[es thirt

MRTAxy - MRTB*y
Ｐ 一Ｐ
ｘ
〓
Ｘ

because MRTA
ｙ
Ｐ Ｐ
ｘ 一ｙ
〓

and ⅣIRTBxy

arrd B with their ctlrnrlroditics X iind \''

These are the Sepiuate equilibria of producers A
 123
(4) Optimum factor product re!ationship
Margiual rate ol'translitr.rnation between a Iactor
antj a comrnoditl, implics mirrginal phvsical
product olthc lactol'in lhc proclttclion
ol that commodity. Therelbrc this c.nditi.u requir.es t1,t
MPP of a lacl.or must be tlte sanre for all linns
using the lactor urd producirlg , com-porlity. Jn such
case VN4P will be equal Mpp x px.

lf price of factor = po and price product px

the equation is p. = VMpo=, MppF" px i.c.
= x.
P /P = Mpp|o.....:........
(1) Likewise Po = VMPB Mpp px i.e. po* MppBr..,.....(2)
= oB x =
since under perr'ect cornpetition price of factor pFo
a,d price of pr'<1uct (px) is {he sa,re
tbr all the filrns, it ;rllou,s fr.orn the above equation
(1) and (2) MppFu i... ,ri f*,o, i, the samc
both the fiuls A and B. fir
"
(5) optimum direction (composition)
of production: General economic efficiencv
This condition emphasises how much amounts
of difl'erent goods should o. o;";;d
and
lesoulces fbr which are 10 be allocated.
This reerc to the generat condition tbr optimum
of tesources which has also been called the allocatirDn
cond.itions lor general econ'r,ic ;*.;1i:;,HJ]|[;
MRi
lJlJli::::,,:filT:'ll"1li:."::1',:ii*lTi
consulllcr shOuld be the sallle as tO MRT fOr the :h";
collln10dity bet、1,;;;;,vecna,,vtilesc
――一 ―,一 ′ ヽ rwo .u,n,,,u,ri,i.s ,i:r any
・・ ｀′ し｀'HllllЧ U111じ ヽ lt'1

t、 ′
()cOnll■ odilies

MRTxy: Px
器 = Py

YRsxy=寺 ……………
9)

尉Кmm pelfectCOnlp面 m施 面 ¨ fi滉

i蒻鑑∫肥糧 ::棚織y猟
rcq面 rcdね
rerllll:ed f∩ r 十
1・ ハ n・
the1■ 、 Δ■^^^●
paret0
.・ 1_、 ヽ、
0ptimal
1器
1 cOmpOsi“
^^__ ・・ …
On Or dr:`:∬
驚 選響
I岳 ::i:温lttI
1灘 赫

(6) Optimum altocation of factor,s time

This condition relates to Lhe optjniutn allocation
ol'tl liictor's tirne, particularly huurzru 1abrur
time as belwecn wol'k ltrrllloney iircome
audieisure. According t, this c.n6iti,, i.
labour the MRS betwccti leisure tind cirsc 0l.l.ucrrr
work ,o, i"o,i.v'r;;;;';.,rr be cc*ral r. trrc
l:rbour time and proiittct' Since there N,IRT bcr*,cen
is an incrcase relationship betleen leisurc
one receives lcss money rvhen he gets ancl rnoue y inc.u-rc
morc ieisure.
、≡ 一
⊃ ρｍ  ・  Ｄ
 124
11〕 ation curVCS
1fdifference curVCS arc drawn With n10ney incomc and leisurc and ifthC translk)1・
ll at a poillt(E)、 :hcn
arc drawn、vith labour tinle and thC product bOth ol thClll bccolllC tangclltiを
Ctlllilibriulll is establiShc(1. 、
prescntihg thc ccluality()1・ ⅣIR7・ and ⅣlRS Thusthelc
Both tlle curvcs have cclual slopc at E rё
sh｀ otild be cnough leisurc ibr thc factors

71NTER TEMPORAL ALLOCA丁 :ON OF MON「 Y ASSETS

Ittel蹴 棚評諦器:FⅧ盟電 ユ
鐵TttS∬ 鵠腑鮮 澪Ftti‖ H in・

productivity to thc bOrfOWCr.

器蹴 T蜃 脇
ゞ :器 は
PERFECT COMPETIT:ON AND PARET0 0PTIMALITY

溝置淵
l鶯驚
驀 i雄驚
摘I五鸞‖ l胤

協mt器 器朧 瀾 H器 ‖ lT之 l∬

‖‖器 ‖
I::iiIWIT」 黒乱鷺t韓 [靴

1詰 な
‖ l「 r∬ 淋
獄[:I露罵 1聡 濯 ぎ l」 1111‖

prcvails in thc CConollly.

OPTIMALITY
SECOND ORDER OR TOTAL CONDIT10NS FOR PARETO・

鳥
wclぶ,瞑∬観I:習IIよ lll::1:∬ :鷺II出だ
よ猟償
難::だ flilillilfIItt.iI‖
‖
ミ‖
brdcrconditLolls require,hat an indiffercnce Curv ′
ith
igin.To attain nlaxi11lulllヽ velfare SCCOnd Ordcr conditi01ls tOgCthCrヽ

:tttlltt11朧 :TR温 需llT鳳 mllm∬ 鳳黒

culve tte concave tO thё oI・

譜 ‖
器i∬留∫ :聰 1‐

鮮∬《糧
蹴問:鳳 鳥 i為 11lltl∬ ‖
:ふ 1∬ ‖ ぶ黒11礼 lよ 」
T漱 追
of redistribution Of incolllC and WCalth.

oBSTACLES TO THE ATTAINMENT OF PARET0 0PTIMALITY lC

/cllと ヽ
Cto optinlality and lllaxllllヒ llll SOCitllヽ
Thcre are sol■ lC ObStaCies for tlle attainillCnt Or Pal・
They arc thc fol10Ⅵ /ing:
cI C01■ pCdtion.
(i)ThQ C対 Stencc of monop01y orimperた
{ii)ThC prcscncc of CXtcrnttitiCS,i.C.,extcrnal ccOnOmies and diSeconolllicS in producti()n and
consumptlon.

(iii)The consulllption of publiC goOdS.

(iV)The lack of pcrtCt knOWICdgc.

vih lllatCrial go()dSを 10nC
Above all nlanis desirc is unlinlited:HC Can llcVCr ftilil his dCSirc、
ornltllating tllC conccpt()1
However,Pttct0 1激 d thC buidttiOn of modcrn wclfArc cconOlllicS by l・
sOcial optimum whiCh iS based on tllc concept of ordinal utihty an which is iC6 iolll intcrpcrsOntil
comparisOn of utilities an value judgcmcnt.

NEW WELFARE ECONOMICSi COMPENSAT10N PRINCIPLE

IゴW鍛難1ま 推 l蝋辟椰
I畿 ギ 撚減
‖ :椰事
‖‖ li
 125
otllers wolse off.

ASSUMPTIONS
The colnpensation principlc is hasu,l olr the f'ollowing irssuntptions
(i) The satisl'actiott o1'an indivirlual rs independent of thc others and he is the besr.judgc- of his
u ellitrr'.

(ii) Thcrc cxists uo externalities ol'production trnd consumption

(iii) Thc tastcs of the individuals rernain constant.

. (iv)The ploblern o1'prod'lclion and exchairge can be separated fi'orn the problerl ol'distribution.
(v) Utility ciin be nteasutctl ordinally antl interpersonal c'oruparison ol utilities is rrot possible."
COMPENSATION PRINCIPLE
Kaldor is the first rnan to give a welfirle criterion based on compensating pilyments. This helps
tts to understand and mezlsllre welfare implictrtions of a movement in eithel' direction on the contl'act
curve in tems of Edgewotth's box diagram. If a certain change makes some people better olf ancl
other worse o1, 'then" change will increese social welfare if those who gain coukl cclnrpcnsate the
loscrs and still be better oll'that belbre. Prof. J. R. Hicks supported Kaldor' for ernployinu
conlpellsation principle to' evaluate the change: in social welf'are resr.rltilg fi'om a1y econgmic
rcorganisation that bencl'its, sorne people and liarms the otliers.
llicks has given hrs criterion llom the loser''s point of view, while Kald6r' 11tl lbllulatetj lris
ct'il"crion 1l'oltr gaittet''s point o1'vieu,. Thr:s the two criteria are really, the siule thglr_uh they arc
clotlicd in dill'crent rvot'ds. That is why'they are generally cailed by a sipgle ltallc. "Kald.r.Hrcks
Criterion.
In the diagran siven belotv a graphical illustlation is given to explain the K之 lldor― Hicks
conrpeustrtion criterion.
In the diagrarn DE is the utility possibility curve which l'epl'esents the various coulpensatiorns
of utilities obtained by individuals A and B which are measured on OX axis and OY axis respectively.
Suppose Q is the original level of distribution. As a result of new policy the level of distrit,utloq is
shifted to at which the person B is made bettet off and A is made wol.se off. However, lhe
compensation principle enables us to say whether or not social weltare has increa^sed zus a r.r,,l,iul'
the movement fi'om Q to T.
︱︱︱︱︱︱︱︱︱１１
︱ＩＬ

１１１１１１１１１１トーーＬＩ
ゝ
一一
〓Ｄ∽
¨ｍ

[S∪
ハ
︰

tilly
︱

We have to see whether the indivirlual B who gains with the movenrent fi.on) to T
crolllpensate the individual A who is loser ur<t still be better off tlian befbrc. From
e conrld
tlie figure it is
clear tllat if individual B gives sorlre compensation to A lbr the loss sull'erecl, [he1,
can uro"r,e to t5c
position R at rvhich A is as rvell olf as it was and B is more well off, Therelbre
Q social wellar.e
 126

increi.uses.

Now by whom and how the compensation will be eflectively' done is a difl'erent question.
Here this principle has just cxplained that it has move tl productively more efficient position. I-
the redistribution has moved from l'to G both the indi.,ziduals are better oI'f thzrn they wel'c at the
position Q.

SHIFT IN THE UTILITY POSSLBILITY

Now let us see whru happens to social wellare when t!.le Lltility possibility curve moves oLltwiud
and the 1wo individutrls rnove frotn a point on the utility possibility curve to a point on a highet'
Lttiiity possibility curve. [t can be shown that such a moveilent causes an inrprovemetrt in social
rvclfare. Consider U V is the original utility possibility ourve and Q represents the inilial position.
Noa suppose the utility possibility curve shilis outwzrrd to the new position Ul Vl and the twtl
individuals are placed at R on it. Now the utility of A has increased and that of B has dect'casetl.
But R denotes gretrter social welfare on the basis o,1 Kaldor's criteriou when compared to A be cause
thror:gh mere redistribution of inoome li'oni position R to S cari be ardved at where both individttuls
are better otf when compaled to Q. Theretbre, tuly change in the economy that nrovcs the individuals
li'orn a position on a lower utility possibility curve to a position on a higlrer utility possibility curvc
increases social welfare.
ゝ〓 〓⊃ ∽ ｍ
¨

o A',s Utility v v1 x
SCITOVSKY PARADOX
Scitovsky pointed out an impofiant [uritation ol'Kaldor-Hicks criterion that it might lead to
contradictory iesults. He showed that if in some situation a particular position say B is shown to be
improvement over trnother position say "A" is also shown to be improvement ovel' 'B' on the basis
of lhe same criterion. Since Scitovsky wzrs the first perSon to a point out this paradoxicai result it is
known as Scitovsky Paradox.
This paradox is illustrtrted as given belorv:
 12,7

Lr figtuc JK andCI{ atc the two utiHly possibility curves which intersecr at cach other. Now
Lni initi l p()sitiol) ol'disLribution is at C and iu a result of ucw policy the lcdistlibutiou is at D.
Aecotding Itl Kaldor-Hicks cirtedon it. is an implovenent. ol social welfarc: hccausc by redistribution
it catt bc convetted to thc point F. But a reverse movenlent lio D to C is also ll
itnprovet)tert on
KalJor'-Hocks critclion, i.c., C can be convefled into E by redistribulion. Thus it hecomes
i1l vo,lsistent.

SCITOVSKY'S DOUBLE CR:TER10N

Iu the llcute a movemcnt liom O to G satislles the Kaklor Hicks cdteriou because it is convertiblc
ivi{h It. But a lcverse llom G to O will not incrca.se the social ivell:ue.

メ〓 〓⊃ の ∞

A's Utility
(i) A chargd ittvolvcs tnoventent f'r'om a position on a lower utility possibility cur.ve to a positiul
ol highel uriliry possibiliry curve.
(;i) This happcns only when change brings about increrue in aggregate outpilt l.eal inconre

Tlrcrclble accotditig to the doublc criterion therc shoutd he an increa-se in the production aud
ri b.lter distribution.

AN EVALUAT10N
Tltis plinciplc s'iis rlcr:cloped in 1939 by Kaltior and i[ was supporlcrl hy Hicks in I940. FLu.ther.
ir r'rrs i,prrvcti bv Scir.vsky. The linlitarions of this priuciple arc the lbllowing.
{ i t I)tol' i-itllc has pi)iutcd otll that this is not a wclliue clitcrion at all, because Kaklor. has assumed
weltlte to be :i ltuctittn ol incrcase in ploriuction or eiTiciency inespectivc of the charues in
distlibution
(iir Cr;mpensatitln principle is nol llee tiom value judgments as is claimed by its prolbuntlers.
lr
rnvoives implicit value judgments. The changes whioh enable tlle gainers lo
compensate the
Ioscrs and still be hclter off is irsell a valuc.jr.rdgrnent.
(iii)'i'elllue has dual aspect: absolute and relative. Pcoplc are dissatislled not only becausc
tlley
are poor but mol€ because other peoplc ale vely rich. This idea h;Ls not bcen pr.oper.ly inrlcntitied
iu this cliter ion.
(il ) Accot'ditto to Gortnirn Scitovsky's tiouble critielion can avoid contradiclor.y resrrlts
ouly when
rhc choicc is to be nlade ll onl tlole than two possible positions theu the problelr
ofcolsistelcv
L.:lllll I hC S()lv(.Ll
(\') ll lhe compcnsatictlr is nol Ieally mzde 1he social wclt:rre will dccreasc evcn il'plorJuclion is
iircr cascil.

1r'i) Tltc crlutpensatiur principle does nol lakc into account the cxternal r'I]ecls on
consuurptlo,
anLi pr()dUcl i0n.
 128

SOCIAL WELFARE FUNCT:ON

The concept of Social welfare function was propouded by A.B,rgsoll in his a aniclc“ A
RefOrmulatiOi Of Certain AspeOts of WelfaE Eこ onOmics"in 1938.Later it was supported by
P狐1l Samulsbn.The earlier ttempts had failed to solve the prOblem of ma対 mis江 lon of social
welfare and its measurement.Social welfare mnctiOn is an ordinal illdex of societyts welfare
and is a function of teh utility level of all individuals constituting the sOciety.According to
them W=f(Ul,U2,U3,… .Un)
Where
W repК sents social welぬ К ,

Ul'U2;U3etC:represent the ordinal utility indices of different individuJs.

VALUE JUDGEMENTS
ThesocidwelfaFmnctiOidependsonthevaluejudgementsoftheperSOnOrinsdtu■ on whom
the society hぉ au血 oHsed to do,0・ They are ethical,lolitilC江 ,philoSolhiC滅 ,狙 d religious value,.
The inctase in welfal・ e should not症 iversely affecting these values,Now aises the problem of
inding all au■ ority who lollld giVe pu161y unbaised vttvejudgemellts.BergSOn and samuelson
hⅣe ttSumed a"superman"who pro宙 dё s vttЩ)judgements about changes in sodal welぬ К,In
thc modem tte of democratic govemments people elect their reprcsellt江 市es who cOnstitute th9
色ovemmcnt.The represent血 ves govemnlentゃ rIIledby the m可 OFity ttle fornlulttes v舶 oぃ poucies
onthebasis 6ftheヤ aluejudgelnents mdiis expectedth江 滅lthe policy decisions by the govemnlent
will減 面 at mはillllSing social welitte rallor th2m m枢 1lnising the welfど c of an indi宙 dual or a
paticular section of the society.

Col● ceρ ts Of raFrness al■ frり sm

dД ′
The concept of fairncss rcfers to equitaЫ e distribution of incomc and wealth in an cconollly
without adversely amecung valuejudgements.Itis assumed tllatsuch a himcss in dislibution can
bc ensured only by al:Supelm祖 "whO Can pr額 〕 tise altluism WhiCh nleans sё l■ ess conccri for thc
weraκ Of Others.In the modern tilneS tlle govel■ mcnt 6ftlle elected represtlltativcs is expectOd to
おsumethe lob 6tsuch a.Suremふ 1,cVenthotgh practictty tis a価 luЮ .ProlJ:K.Mellta has
criticisedthe atttuisnl ofthe iSuperman"or institution who iS suppOsedt6 1nよ o狙 unbiased v」
ue
jidgen10nt.Itis impoSsible for a humm being lo get dd 6fp19ゃ ICn∝ 狙d prdudiCes:

SOC:ALINDIFFERENCE CURVES
狙l valueiudgn■ents WhiCh uscl tO dOnstl■ lct
Bergson md Salnuelson expressed the view th江
ttrrel
the socid welfare func■ on muStbe cOnsistenet.Itimphcs dltt ifin a givcn situa● on A is,pК
to B ttd B tO C,tllen A musl be preferК d to C.This is hOtlling but trmsitivity assu,ptiont

Fig 5.1
ゝゲ〓 ″⊃ ０ ｍ
中
 -u I r.r.r.Es,:-_

129
We can explain the social wellare lunction with the help of social indiftbrence curves or
wellare fiontiers. Let us assume that therc are only two pe$o.ns,in the society in which social
weltare f'unction can be l'epresented with the help of social indiflbrence curues. [n tigure 5.1 the
utility ol individuals A and B has been rcprcsented on the horizontal and vertical axes lespectively.
W I , W2, etc. ale the social indifference curues ,representing. successively higher levels of socials
welfare. A social indifference curve is a locus of the various combinations of utilities of A and B
which results in an equal level of social welfue. Any policy change that moves the economy fi'om
Q to T is an improvement. Similarly; a movement from Q to S or from R to S a[so represents an
improvement in social welfare. A movement along the same indifference cllrve represenls no
change in the level of social welfare.

GRAND UTILITY POSSIBILITY FRONTIER

A grand utility possibility fiontier is a locus of the vadous physically attainable utility
combinatiotts of two persons when the factorendowment, state of technology and pref'erence orders
of the individuals arc given.
、”三 ”⊃ の ｍ
・

Every point on the grand possibility curve represents the optimum position with regard to the
allocation of the products alllong the consumers, allocation of factors' imong dif'tbrent pr.oducts j

and the direction of products. Thus every point on the grand utility possibility curve represenrs a
Pal'eto-optimum and'as we nrove fi'om one point to another on it the utility ol'one individual
increases while that o1 the other falls. If we.super impose gland utility possibility curve on the
social indiff'erence curves a unique optirnum position of social wellare is obtained at the point as
e
shown in the tigure 5.2. The point Q represenm the ma.:cimum possible social welfare given the
factor endowments, state of technology and prefbrcnce scales of the individuals. point O is known
as the point of constrained bliss, since given the constraints regarding .factor endowments and
their cument technology, Q is flre highest possible state of social welfare which the society can

FEATURES OF BERGSON-SAMUELSON SOCIAL WELFARE FUNCTION

(i)It is based on explicitly vailue judgemeuts and involves interpersonal compar.isol of utility'
ordinal terms.
(ii) This f'unction is very general. It can accommodate Marshall - Pigou concept according to
which social welf'are is the sum of utilities of vadous individuals cornprising i society.
(iii) It can accommodate any value judgement according to the changed situation.
(iv) Once the value judgement is decided optimality position can be determined
(v) Using this concept along with Pareto-optimality it enables us find out a unique optimum solution
which combines economic efficiency with disuibute justice.
 130
EVALUAT10N
The main aim of welfare econonrics ltas been to i'ind an l.rccptairii
rvliich could memure the changes in social welfare lcsulting flonr ii cliuttgi:
econornic variables. Bergson and Salnuelson cuultl soh,e tltis pt'ottieitr ir_r'
we1farc thnction which is based on explicit value judgen.icnts.

According to Little, Streeton and Baumol it lras a lirrrite.ri 1rt'lr.:lic,rl sigltiiiclnci: Vititr'.:
judgements cannot go hand i-n hand with political and r.:cr)non)ic rcti''iiie '

Professor J.K. Mehta has criticised the social wellare lirnction orr the st olltcl lltat sitpclllirlil ot
authorised lnstitution or tcpresentative governmeflts in ntodet'n iigc ale sttpposcti tri !ilc Lttlhirisc(l
value judgements. But they are not per{ectly selfless. Such scliless sittrtliott is 1iossihl,: otrl-:' itt l
state of windiessness. because wants are the basic eaLrses of varic'rus t1'pcs of scllish rcli\tli\'s.

A highly darnaging drawback of social welfare function ltits bcen pointcd (rLrt ir)'f'. .1 r\t':,r",
who has shown that social welfare function oannot be cousttlcted ort tltc basi:; ol'r';tltic.jttdg.'iricrtlr;
arrived at thtough democratic principle of major:itf iulo in !:r()up dt;cisioti nti.kin5:.
However Prof. Little has stated that the concept o l social rvell'ari: l ttnclion j: it ht'iliirrrt { iltcr i trll it:ti I

concept which completes llre lblrual nlathenladcal s1'stent trj tt,eh';tt'r'ecr)u()lui(;\. irlgln rrilirilriitl,,
analysis does not help us in prclvidin-e a unique solutiott to thc plo[lt)trl ili'it[1.'lilt)isl1..:.r)c]iil
rvellirre. ButBergson-samuels<tn irpplotrch cottld solvc thc prohIuttt rtl l'ttiiltttl: oriI [iri t r,i l';, lt, Irii
o1' maximum social rvelfarc"

SOCIAL WELFARE MAXIMISATION

BATORAPPROACH :

This approach is based on Parcto optimalit), analysis and tltc L:ortccpt () l !lr )L'i;rl ivc ii iii * i It{ i(-'i i( )r1
It pays attention to (i) unique allocation of tactors into inditi'ctcnt proCu,.'ts; tiil Lrl'!i.ltr. (iiill,i.rr ,'l
ttiff'erent ploducts and (iii) unique distribution of prodr.rcts bctrvcett ittr-livttlurLl:, r'.'liii'l: '.'1\sril''
nraximum of social wellale.

ASSUMPTIONS
(i) There are only two firct.ors (k) an<l (I) whiclr are hontogeneous tuitl pi:r'l'ecl1r'iiii'isilrli'.
(ii) Twohomogeneousgoodsaleploducedandproducliottl'tttictiott tcttrtiltsr'i)tlst:lrl1.ir'Lrli;\l;.i rii

returns to scale prevails and thc isoquants are convex 16 1i1s ori;:irr.
(iii)A society htus only tow individuals A and'B rvho havc A uit,cti cottrililtil ordirrrl ptclctcncc
function and it is exhibited by smooth rndiff'crcnce cut'ves.
(iv) There exists a social wellare firnction with value.iudgctn'.:nts.

FACTOR ENDOWMENTS ANE PRODUCTION POSSTBILITY CURVES

Edgeworth'sboxdiagraruisusedasatoololanalysis. lrtthe I'igulc l0,i-arrJ0,11. Ieplcsctit
the amounts of labour and capital available in the economy which arc l'neitstttc6;11;rtlg OX ,nrJ OY
axis respectively in.the box diagram. IF, IIF, III',, I\il- ztttd V,, are succcssii'cJy higl:r'i lsorlttlttlt:;
represenling successively greater output of fbod lbr which Q,. is the origin [f. II. , Tlir.. i\,1r rtrl V,
'arg successfrrlly higher isoquants leprcselltirlg succcssiveiy greater outpllt ri['ciolit l'trr u'l:ii'h (), is
the orlgin. Q, Q2, Q, Qo and Q, arc the tendency points of the iscquanls el:l'o,,tti rintl cioth. 0 L),
is the conttact curve which leplesents the Pirrcto-Optirnai irllocatiott ol.[itclo:'s in iltc pt'rrilttt:l jirlt li
food and cloth.
. By mappin-q the production contract curve li'clni input Spacr't.) oultrilil :rii;r('e \!'ii c.ill r-trrl lllc
production possibility curve wliere the two axes t:epresel)t thc ('utllrti ol t',','l (-i'lln,:rititiii:s - I'oi;.1
and incrcifSeS and ClOth. As we mOve Llpon the c()ntl'tlcl Cinti (),- () thr'{rtili)i-ti rrl i''rlii ilr, I..t:.''.
 131

一ＯｏｏＬ ﹂ｏ﹂ 一
ｏ〓Ｑ“０

Labour lor Food l

︵
０︶〓● 一
０﹄ｏ二“”
五●０ 
。 Food(F)
and c19thdcCκ ases.cOrК sponding10 Q,ぉ g市 c
spre wc plotthe pointin the outputsゎ acc.Likt

槻
Л競霧驚蹴胤:漁、
薦撚鸞榊 櫛 瀞義 驚∬
嶽 鶯 警事
poSibiliり curve inditttes hOw muci・ additiOn:
trmsformed tO f00d productiOFl. 、
PRODuCTIoN POSsIB:L:TY CURVE AND GRAND U■ L:TY POSsiB:L:TY FRONT:ER

箇斐
Y
幣I湘掛lt苺榊榔
丁
〓“２ 〇 一
０ ち Ｑ”ヨ ０

ゝ︶〓 一⊃ ∽
一ｍ

Output/Food

■
 132

rrtility space so as to obtain the utility possibility tiontier. The points R1, R2, R,, R*, R. are taken ttt
rhe utility space and utility possibility fiontier is drawn.
By taking e,, Q2 Q, etc. we can draw different exohange contract clll'ves. Then rve
will get a
number of utility possibility cutves. y
,

メ″〓 一⊃ ∽ ｍ
・

I U ancl Ir utility possibiiity culves on which P2 and R2 tire the relevturt utility
U1 are such
possibiiity poilts which sarisfy thtMRT being equal to SRS. They ioined with VV' "vhich
is tlte
grand utility possibility frontier.

Constrained Bliss
us t0 tind uuique
Social welfare tunction together with grand utility possibility l'rontier enable,s
solution..
Wi, W., Wj and W. trre social welfare fiurction and they have bcctl combitted $'tth the
rW2,

grand itility possibility curri VV, social indifl'erence cllrve wi :.urc1 -urattd utility
possibility curve
possiblc sociitl welf iit'c'
Vv, 0,,. tangential to each other at point Q, which represents the maxitnum
n the t'rrctor endowments, statcof technology and plef'elence or<Jcrs
o1'the individuals. Pornt Q
si'e
,i, W. i, known m the poipt contained bliss. Social welfare represented by Wo and W. are highcr
of
tltr,'k. but it is not iossible to attain them with the given technology arld factor cndowntenls'
Pareto-optimutn points
Thus we can have u uniqo. optimum point from among a ltrrge number of
maximLrlll. Thc point of
on the grand utility poriiUitiiy curve, at which the social weliare is the
goods, unique distribution of goods
constrained bliss represents the unique pattern of prodttction of
production of goods'
between the individual and unique conrbination offactors eniployed to

Fig 5.2
ヽ︶
〓ン⊃ ∽¨
ｍ
 133

ARROW'S CONDITIONS ON SOCIAL CHOICE AND

THE THEORY OF THE SECOND BEST
Bergson and Samuelson made signilicant contribution to welfitre econonrics by introducin9
explicit value.iudgelllents in the lbrm ol'social weitirre function. Bul thcy failed to deal r,i,ith rh.:
questiou trs to ltow to get thesc values. It wiis this problem which was explore d hy An'clu,. Indjvidull ..
ordering of social states will clepend upon his owrl consutrption as rvell us ou the consunlptir)n ()l'
othcrs in the society.

THE PROBLEMS ii
Arrorv starls his iuraiysrs 1l'om the litllowing problcms:
(i) The value -iudgements of a superman or clictator about social weltirre may not bc valid due 1.,,
varicius types of bier^ses in human minrl.
(ii) The problcm of makin-c it social choice based on individual orderings becones dilticult in
lr
detnocratic society in which every individual is li'ee to have his owl individuztl ii'dering of'
vaLious sclcial stzrtes.

CONDITIONS
Now the peftinent questiotl is as to whetherthe social choice can consistently be derivecl h.ortr
individual orderings. Atrow lias laid down five necessary conditiols. In fact these colt1itiols refle<lr
the value iudgements of Arrow.

Condition - 1: Transivity or consistency

Social choices must be consistent or transitive. Transitivity arises when' social ordering h/1^s
the properlies of convexity. [t means that the vadous altematives must be related to one another
tl-v
pref'ele nce or indif'lerence.

Condition - 2: Responsiyeness to individual preferences

The second is the condition of responsiveness to in<lividual pref'erences which implies that tlic
society and its individuals are to be of the same interest. Technically it relers to the point that tllc
social ranking must respond positively to the individual ranking. This means that the social choic[s
must change in the same direction as teh choices o1'the individuzrls constitutilg the society.

︲︲︲︲ＪЧ
]

Condition - 3 : Non lmposition

ｍ
・

The third is the condition ol non-imposition from outside. This sttltes that social choices
not be imposed by anybody liom outside rvithout seeing to the inilividual prelcrenccs.

Condition - 4 : Non Dictatorship

This csndition implies that social choice must not be dicted by a1y one ipdivirluzrl within tire
community. For instance A must not be socially pref'erred to B only because any one individud]in
the society pref'ers A to B irrespective of the preferences are identified on democratic principlNs.

condition - 5 : lndependence of irrevelevant Alternatives

Accortling to tltis, social ranking of any two trlternativr:s is determine exclusively by inciivirt{al
ranking of these trvo alternatives alone and should not be iifl'ected at all by individrial prefbrenclcs
with respect to other alternatives. For example suppose there are three alte;.natives: e,
societyprefersAtoBandBtoC.IfC*.r"rotonleravailable,rhenB,fro"fJioiUl.fi,rr.,f,iir'. i and C ihc
name of C.

GENERAL POSSiB:LiTY ttHFORど M・

￨
ItiSVerydimO11l bmatsoι ialchoices without宙 ohing a lea,t° ne ofthe above condmO卜 s.

t-*-*
 134

So really this is a Geueral irnpossibilit,rr Tlieorem.

(a) Dictatorial or imPosed

Ｊ ｂ
If we excludes the possibility of Interpersonal comparisons of utility then the only method

ｅ
passing from individuJ tastes to social pref'erences which will tie satistactory eurd which
will
defined fbr a wide range of sets of individual orderings are either imposed or dictated'

(b) lnconsistencY
the basis ot
The democratic procedure leads to inconsistent results. The sociitl choices otl
rnajority ruie may be inconsistent even if individual preferences are consistent.
A proof can be given in the fbllowing way:
Ranking of Altematives hy individuals and social qhoice'

Social State
Alternative
x Y Z
つ“

C
X, Y ttndZ ate
In the above table A, B ancl C are three individuarls who constitute the society.
to highest prel'erence, 2 a little
3 social states which are pref'erred by the people diffelently. 3 refer
Iower'and t shows the least pref'erence,
Individual A plel'ers X to Y and Y to Z
Individual B pref'ers Y to Z and Z ttl X
lndividual C prel'ers Zttt X and X to Y
A and B pref'cl Y to X
A and C Pref'cr X to Y and
B and C pref'er Z to X
Tlrtrs the mzriority pr-el'ers X to Y and Y to Z andtherefbre Zto X.But
maiority also prel'ers X
to Z. Thus we see the majority t'ule is inconsistent is social choices.

ARROW'S CONSEOUENCES
(i) the third alternative
Whene ver the two individuals pref'er X to Y thi:n irrespective of the rank of
Z, society will Pref'er X to Y'
individual
(ii) If in a given social cl1oice this will of individual A prevails against the opposition of
or trgrees
B and then the lvill of A will cenainly prevail in case of individual B is independent
rvith A.
(iii)' If individuals A and B hriYe exactly conflicting interests in the choice between tow alternzrtives
' X tin6 y, thel society will be indiftereht between X and Y..It is interestitlg to not that tlic
simple proof ol'general possibility tireorem follows li'on'r the consequence iii.
Th,s sqcial wellirrc l'nnctiitn basecl on all individual prel'erences can not be ctlnsin.rcted'rvitlrottt
violating 1t least one of Arrrxv's seemingly simple anti reasonttble conditiotts.

THEORY OF THE SECOND口 EST

Different ttthorshⅣ 6 discussedthethe6け OfthC second bestin,dittrent contexts.HowcVer,
 ロ

3s
l

t
l

it u'as flt'st gcrter'.ilise d b1' Ri:hard G.Lipsey rud Kelvein Lancaster.Inwelfare economics generaUf
u,e tiiscuss the theory fonnulated by Lipsey and Lancaster. ,,

Basicalll'the t.hcoty of tlte second best is that the fist best solution to welfhre maximisation irs
obt;rinerl u'heu rtll the tnat'siltal ccittditions ot'Pareto optimality tue simultaneously satisfie<1. nut
tt'
an,\' ol'tltc ntarginal conditions is not satisfied somewhere in the econony, the tirst best solutiotr
trilllrlot be ohtrined. And. thr:le irt'e t.eltsorls to believe, that, because of institutional coustraints (lille
Illoll()polii:l; ;ttid olhct'intpcrlec:t.ions, etc.), exterrlaUties-an in<jividualities, one o[ nrore 0f the ljr$l
ordcr conilili,rils rllalrntlt bc srttislied. This rvoukl mean that the lirst solution is unaftainable.
]

Ec0ni-'ntjsis l'0t' lt lottg titnc be[eved tlrat if fbr some reason or other one or niore of the ordJl
cuttditiotts ol Ptreto opl.imalit)'is not ftrlfilled, il is still desifable to satisly the remaining conditiods
to ltille a suluiio:1 as closc as possrble to Pareto optimlln. This belief tbu[d application the
to liel{.
likc ptrlilic llnattce attcl intctuational tlade. But Lipsey and Lancaster suggesied that if one of t{e
Frtt'ttirtti oplit,tunt rottflillon cannot be fuitilled, ttren Lptimum solutionsL U. achieveci
orry (i
(lcpirrlinc Jiorrt all thc other Parclian conditions. It mcans that if any
of the Par.eto opti,lality
cotitiilions is not satislir;d. the irtlempt to leach Pareto optimum - the tist of the secontl tresi, t-ips(y
anti L.altcaster has plovcrl that il the first best solution is not realised, thel there is nothing
i:iroosc bctr,,,eJn the second best or third best itnd so on. - to
l

'I"hc
r:r-rttclt'tsittn is conlrary lo the eiulier be.lief that if the first best is unattairiable, then
,..od,l
l't::rl rttaY b. iil.t2linc(l er.elt il'sonte Piireto optimality conditions are not satisfied,The irlplicatigirs
ol'l.ipse-1' l-ltncaslcr ;u'-[iuuent tol traditional welfare economics are devastating as
their theory
i:llectivcl','t1ttr:stiotts the tiesir:rbilily ol'attainiug Pareto Optirnalitythrough variates policy
lrcasur.[.s
t'rrt Pici:cttteal trasis. Thr.rs the secilud best o1'Lipsey and Lancaster may be soltethin_e whichiis
:.1

Ir-rtirilr, dillbrcnt tl'orn 1bc l'irst hest solution.

l

MODEL OUESTIONS
l

Short type ]

L Vr,'hat is f,areto Optitnality ? ]

2. Bring out rhe irlca rl'crxrrpensatiotrprinciple. ]

3. Whar is rueanl by social u,elttrre l'unction ? l

4. ルIentiOn thc idca coll,cyed by ScitoN7skyts pttadOx.

5. ヽ
Vl〕 at dO yOu tlldcrstand by scitOvskyls doublc c五
terion?
6 ヽ
Vllat i1 11lcant by collstliaillcd bliss in the social welftte?

7 4olた ■ 11lhe c?ncCpl oIBCrgSon―

Sttluclsonゝ socid wellhe.
I CXpl」
8. ヽ
ヽ/hat is`the dLlal Clite1lon of social wclfarc_suggcstcd by PigOu?

91‐ Bring out thc ttCalling of vJuciudgementin wclね rざ ―

econolnics,
‐
rreJtrm fypё _
1, What arc thc ilnpo■ mt critena of soc皿 К?
ケ
..9轟 ilcⅢ l&``r↓ 藁el.ま ILⅢ Ⅲよ
轟 "dぬ
eO:1。 lllis l l・
3.Cin yOudispclllsc■ ■ hv」 iejudgぎ lllc,s in the attainmё nt,。 f socid welf雛 o?
4.恥′
ヽ 1lat aК thc Obstacics tO tlle tttainnlellt,of`Pttet9 opumality?

´
5..Enumcratc the cOndidOns of Al・ row to mtti轟 183。 c血
轟el島 e.
6 Exallllllc the thcOry()1:tllc second bcst. : ・
 , \___

136

Essaytype
1. What is Pareto efficiency'l Elucidate the conditions to attain Pareto optimality.
2. Give a, critical accoLlnt of the compensation pdnciple tbrthe attainment of tnaximutn wcll'are
in the society.
3. What are the impofiant tenets advocated by Bergson and Samuelson to a(tain social wellirre
function?
4. Evaluate the contributions ot Bator to achieve sogial welfare maximisation.

sTUDY MATER:ALS PREPARED BY

1。 Dr. C. T. Paul
St. Thomas Collcge
Thrissur
(Module l, 2 and 5 to 9)

Dr. Ratnaraj
Dr. John Mathai Centre,
Aranattukara
(Moudle 3 and 4)

Ｆ   ＾・
    １

Printed at Calicut University Press