Basic Economics

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58636153.doc B.Com-I 1 Mohammad Kashif Hayat

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Q No.1 State and explain the “Law of Diminishing Marginal Utility”
with the help of table and figure (graph) and also explain its
limitations.
A No. 1 The law is defined by the orthodox classical economist. They believed
that utility or intensity of desire goes on diminishing as a consumer consumes
successive units of a commodity. Due to this decreasing trend in units of marginal
utility this law is termed as the law of Diminishing Marginal Utility.
Statement of the law:-
In the words of Alfred Marshall:-
“The additional benefit which a person derives from a given
increase of his stock of a thing diminishes with every
increase in the stock that he already has”.
According to P. A. Samuelson:-
“As the amount consumed of a good increases, the marginal
utility of the good tends to decrease”.
In simple words we can define the law in the following words:-
“If other things remain the same, when a consumer
consumes successive units of a same commodity then
marginal utility starts diminishing”.
Explanation of the statement:-
This law is based on two important facts:
1. Human wants are satiable and thus intensity of such want goes
on diminishing till a point is reached when consumer fully satisfies his desire with
the consumption of successive use of the commodity.
2. Different goods are not perfect substitutes of each other in the
satisfaction of particular wants. Thus the intensity of want diminishes because this
good is not devoted to the satisfaction of other want.
The law of diminishing marginal utility can be defined in the following functional form:
MUx = f (Qx)
This function explains the negative relationship between both of the variable
i.e. Qx# _ MUx ∃
This relationship can be shown in the following table:
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Units
MU TU 20
(q) 18 TU
1 8 8 16
2 6 14 14
12
3 4 18 10
4 2 20 8
5 0 20 6
6 -2 18 4
2
0 q
-2 1 2 3 4 5 6
58636153.doc B.Com-I 2 Mohammad Kashif Hayat MU
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Explanation of the above table and figure:-
In the above table and figure we have explained the working of Law of Diminishing Marginal
Utility (LDMU). When the consumer consumes 1st unit of the commodity then MU (Marginal
Utility) is 8 units as illustrated with point “a” in the figure. On the consumption of 2 nd unit of the
commodity MU decreases to 6 units whereas TU (Total Utility) increases to 14 units. This is
illustrated with point b and b' respectively in the figure. Similarly we have other point c, d, e &
f showing different units of MU against different units consumed of the same commodity.
After joining these points we will get negatively sloped MU Curve indicating the existence of
the Law, whereas for TU we have the point c', d', e' and f' against different units
consumption. Here we observe when MU is decreasing but remain positive while TU is
increasing. When MU is zeroing then TU is maximum and MU become negative while TU
starts decreasing.
Assumption of the law:-

The LDMU holds when the following factors are held constant:
i) Continuous use of the commodity.
The units of the commodity are taken continuously. It means that the commodity
is taken within a certain time.
ii) Reasonable units.
The commodity is taken in suitable and reasonable units. MU of too small units
will increase instead of diminishing.
iii) Fixed income of consumer.
Income of the consumer should not be changed during the study of human
behavior. Increase in income will increase human desires and hence utility.
iv) Unchanged nature of the commodity.
Nature of the commodity should not be changed. Improve in the nature of
commodity will increase MU.
v) Unchanged taste and habits.
Taste and habits of consumer should not be changed. By changing taste or habit
MU may increase.
Limitation of the Law:-

i. Knowledge
The law is not applicable in case of knowledge because the desire of gaining
knowledge increases by reading more and more books.
ii. Ostentation
The law is not applicable is case of ostentations. If a person desires to have more
things of ostentations then his MU will be increased.
iii. Hobbies
In case of hobbies MU increases for greater units of commodity, therefore, the
law is not applicable.
iv. Historical monuments
In case of historical monuments MU increases therefore, the law is not applicable.
v. Drugs

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In case of drugs MU increases on increasing the use of drugs, therefore, the law
is not applicable.
Explain the importance / uses of the “Law of Diminishing Marginal
Utility”.
We have the following uses of Law:-
1. Guidance of the consumer:-

A rational consumer always desires to maximize his utility while his income is
limited. The consumer gets better guidance through this law. A consumer has to
purchase that much units of a commodity for which marginal utility becomes equal
to the price of it i.e.
MUx = Px
2. Calculation of consumer surplus:-

According to the law “consumer surplus is the difference between highest utility
and the actual price which he pays for getting highest utility”.
Therefore, when we are given the values of MU the consumer surplus is the
difference of the units of MU and price of the commodity actually consumer pays
i.e. Consumer Surplus = Marginal Utility – Price
CS = MU – P
P↑ ⇒CS↓
3. Helpful in the law of Equi-Marginal Utility:-

The utility function showing many commodities included in the purchase plan of
the consumer is
U= f ( X1, X2, …….., Xn )
Our consumer is said to be in equilibrium when he consumes that much units of
the commodities when MU of different commodities become equal to each other.
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Q No. 3 State and Explain “Law of Equi-Marginal Utility” with the help
of table and figure and also discus its practical uses.
A No. 3
 Introduction
This law provides guidance to a rational consumer that how he should have to spend
his limited income to attain maximum satisfaction. This law also guides our consumer
that how many units of different commodities a rational consumer should have to
purchase.
 Statement of the law
In the words of Marshall:-
“If a person has a thing which he can put to several uses, he will
distribute it among these uses in such a way that they all have same
marginal utility. If he had a greater marginal utility in one use than in
another, he would gain by taking away some of it from the second use
and applying it to the first”.
Therefore, the law is defining the possible rational attitude of the consumer
against the limited income of the consumer. We can define the law in the following
words.
“If other things remain same a consumer can maximize utility
while spending his limited income over the purchase of different
commodities in such a way that marginal utilities of different
commodities become equal to each other”.
 Explanation of the law

Units (q) MUx MUy
1 12 10
2 10 8
3 8 6
4 6 4
5 4 2
In the above table the LEMU is explained for two commodities “X” and “Y”
when our consumer has limited income of only Rs.5 in his pocket. The LDMU is
applying in case of both “X” and “Y” commodities. Prices of both commodities are
also assumed as Rs. 1 each per unit. Our consumer has a lot of options against the
spending of Rs. 5 as his income. These options are given as under:-
Option # 1 Option # 2
TU = TU5x TU = TU4x + TU1y
= 12+10+8+6+4 = (12+10+8+6) + 10
= 40 = 46
TU = TU3x + TU2y TU = TU2x + TU3y
= (12+10+8) + (10+8) = (12+10) + (10+8+6)
= 48 = 46
TU = TU1x + TU4y TU = TU5y
= 12 + (10+8+6+4) = 10+8+6+4+2
= 40 = 30
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MU3x = MU2y
MUX MUY Line of equi-marginal

14 14 utility
12 12
10 10
8 8
6 6
4 4
2 2
0 0
1 2 3 4 5 1 2 3 4 5
In the above figure the LEMU is illustrated while different units of commodities “X”
and “Y” are measured along horizontal axis and units of MU of both commodities
along the vertical axis. The line of equi-marginal utility brings the consumer
equilibrium at respective points of “ b’ & c " while consumer purchases three units of
commodity “X” and two units of commodity “Y”. When consumer deviates from this
equilibrium as consuming 4 units of “X” commodities and 1 unit of commodity “Y” we
find that consumer has greater loss equivalent the area “a’12b’” compared to the gain
equivalent to the “c34d”. It simply indicates that diversion from equilibrium is harmful
for the consumer.
 Consumer equilibrium
A rational consumer always desires to maximize his utility with in his limited income.
In real life a consumer has to consume many commodities whose prices are different
to each other. In such situation consumer equilibrium is meant. To find out units of
different commodities so that we can maximize his utility within given income.
According to classical economist this can be achieved a point where weighted MU of
different commodities become equal to each other.
U = f (X1, X2, X3, …… Xn)
P1 ≠ P2 ≠ P3 ……… Pn
CE → MU1 / P1 = MU2 / P2 = MU3 / P3 = MUn / Pn
Total: Rs. 16/-

Units MUx MUy MUx/Px MUy/Py
Rs. 2 Rs. 5
1 10 20 5 4
2 8 15 4 3
3 6 10 3 2
4 4 5 2 1
5 2 0 1 0
MU X MU Y
CE → =
PX PY
qx = 3 and qy = 2
E = PxX + PyY
= (2)(3) + (5)(2)
7
= Rs. 16
 Practical uses of LEMU:

It guides the Consumer:-
A consumer always desires to find out units of consume with in his limited income
to get maximum satisfaction. LEMU guides the consumer that he should have to
consume that much units of different commodities where weighted MU of different
commodities become equal to each other.
MU 1 MU 2 MU 3 MU n
MU e = = = = .......... ... =
P1 P2 P3 Pn
It guides the Producer:-
A producer always desires to maximize his profit from his production. For this
purpose he needs to engage that much factor input in such a way that their cost
remains least. LEMU helps the producer for the selection of least cost
combination. This least cost combination can be obtained at that point where
weighted marginal productivities of different factors of production become equal to
each other.
Y = f (L, N, K, E) (Labour, Land, Capital, Organizer)
MPL MPN MPK MPE
PE = = = =
PL PN PK PE
It guides the Finance Minister:-

The job of Finance Minister is to get the revenue for the government so that it can
be spent for the welfare of different sections of the society. If in the society
income in equality prevails while have greater MU of money for the poor and low
MU of money for the rich class. In this regard LEMU helps the Finance Minister
while imposing the tax rate. Finance Minister imposes high rate of tax over the
rich section of the society and low rate of taxes over the poor section of the
society this kind of system is called Progressive Tax System. This helps to reduce
income in equalities in the country.
 Limitations of LEMU:
It cannot be measured:-
Classical economists have assumed utility as measurable concept. According to
Sir John Hicks utility cannot be measured in units because it is related to human
psychology. Therefore, it cannot be measured.
MU of money should be constant:-
The utility analysis is based on the assumption of constant MU of money or value
of money. In practice MU of money can never be assumed constant because
prices do change.
MU cannot be added:-
All classical economists believed that utilities of different commodities are
independent to each other. Hence we cannot add the utility functions of different
commodities.
Too many assumptions:-
It is based on too many assumptions. In real life there are not too many
assumptions.
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Q No. 4 Define Indifference Curve. Explain the main properties of
Indifference Curve?
A No. 4
 Introduction
Indifference curve analysis was presented by sir John Hicks, Hanson and RGD Allen
in their book “Theory of Value and Capital” in 1940s. According to them utility is not a
measurable concept but can only be ranked the choices considering respective
preferences on the graph paper. They develop their theory while assuming:-
 The consumer is a rational person.
 Utility is ordinal concept and can only be reflected and can be shown on the
graph paper.
 Law of Diminishing MRS exists.
U = f(X, Y) and Y↓⇒X↑⇒MRS(Δy ⁄ ∆x) ↓
 Consistency and transitivity of choice exist.
 Concept of Indifference Curve:

Indifference curve is the graph indication of indifferent attitude of the consumer for
different combinations of two close substitutes.
We can understand this concept while assuming two commodities X and Y and
different units of such commodities that the consumer consumes and get same level
of satisfaction.
Level of
X
Y satisfaction
10 2 λ Indifferent behavior
B A 6 5 λ
C 3 9 λ
In the above table we have explained indifferent behavior of the consumer
who is having λ level of satisfaction for different combinations of commodities
X and Y. we can reflect the same on the graph paper.
Y
12
10
0
0 2 4 6 8 10
In the above figure the indifference curve is illustrated for the consuming
different combinations of commodities X and Y. Point “a” in the figure reflect
combination of (2, 10). While point “b” shows combination of (5, 6) and “c” shows
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combination of (9, 3). All these points have the same level of satisfaction. After
joining these points we get negatively sloped indifference curve.
Definition:
The difference curve can be defined in the following words:
“An indifference curve is made after joining different points
having different combinations of two close substitutes while
the consumer remains with same level of satisfaction”.
 Concept of MRS:
The term MRS measures the rate of change in units of one commodity when the
units of other commodities are changed while the consumer remains with the same
level of satisfaction.
For a utility function i.e. U = f (X, Y) MRS is calculated from the following formulas.
i.e.
MRS = ΔY
ΔX ū
(Ratio of change in unites of Y and units of X such that utility remains same)
MRS Level of
Y X
(ΔY/ΔX) satisfaction
ΔY = 4 10 2 -- λ
6 5 4/3 = 1.33 λ
ΔY = 3 3 9 0.75 λ
Graphically MRS can be measured while taking slop of Indifference Curve at
any point where MRS is needed to be computed.
Steep (higher slope)

Slope at “A” = MRSA
Y A
Flat (less slope)
Slope at “B” = MRSB

B
0
Slope of a curve = tangent at the point
Slope at “A” = MRSA Slope at “B” = MRSB
MRSA > MRSB
X
In the above figure we have estimated the value of MRS while taking slope of
indifference curve at any point. We have drawn tangent line at point A and B for
finding the value of MRS. At a point A the tangent line is steep showing greater value
of MRS while at point B the tangent line is flat showing less value of MRS.
 Properties of Indifference Curve:

Keeping In view the nature of indifference curve and MRS we can specify five
important properties of indifference curve i.e.
1- Negative sloping
2- Convex to the origin

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3- They never cross each other
4- Further away from origin shows higher level of satisfaction.
5- They never touch any of the axes.
Now we will discuss these properties one by one.
For a curve we may have four possibilities regarding the slop of a curve i.e. either the
curve may be +ively sloped, zero slope or with infinite slope. If any one of such of
slop confirms the basic idea of indifference curve then we will have such type of
slope for indifference curve other wise we will be -ively sloped.
We have studied earlier that for a desirable indifference curve a consumer should
consume more units of X commodities when he sacrifice some units of commodities
Y to get same level of satisfaction.
1- Negative sloping
Y (i) (ii) (iii)
B>A B>A B>A
y2 B A B y2 B
y1 IC
y1 A
y1 A
x1 x2 X x 1 x 2
X x1 X
0 +ive 0 Zero 0 Infinite
In the above figures we have plotted three possible shapes of indifference curve
with +ive, Zero and infinite slope. All of figures are having preference of the
consumer when he makes from point A to point B. this is totally against the basic
idea of indifference curve and hence the desirable indifference curve can only be
–ively sloped.
2- Convexity:
With –ive sloping indifference curve we have three possible shapes i.e.
i. Convex to the origin
ii. Concave to the origin
iii. Straight line
For finding the desirable shape we should keep in mind that the value of MRS
must be diminishing as we move from left to right downward along the same
indifference curve.
From the above figure it appears that the convex shape of an indifference curve
the required condition of diminishing MRS is fulfill. Hence we conclude here that
convex to the origin is the desirable shape of an indifference curve.
Y (i) (ii) (iii)
Slope at A>Slope at B Slope at A>Slope at B Slope at A=Slope at B
MRSA>MRSB MRSA>MRSB MRSA=MRSB
A A A
B B B
0 X X X
Convex 0 Concave 0 Straight
MRS decreases as we move MRS increases as we move MRS remain same as we move
from left to right along from left to right along from left to right along
the same IC. the same IC. the same IC.

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3- Non-Intersection:
This property means that only one indifference curve passes through a point. If
two indifference curves intersect each other then they will be producing
misleading results. Here in the following we prove this property while taking a
situation when two different indifference curves are intersecting each other.
Y
y1 E
B
y3 IC2
y2 A IC1
X1 X2 X
Level of satisfaction at IC1

Two points “A” and “E” lie on the IC1
Level of satisfaction at A = level of satisfaction at E.
OX2 + OY2 = OX1 + OY1…………. (1)
Level of satisfaction at IC2
Two points “B” and “E” lie on the IC2
Level of satisfaction at B = level of satisfaction at E.
OX2 + OY3 = OX1 + OY1…………. (2)
From equation (1) and (2)
OX2 + OY2 = OX2 + OY3 (OY3>OY2)
But form the figure it appears that OY3 has greater value comparing to OY2. Thus
it means that intersection of two IC2 provide us the wrong information therefore, it
is proved that two or more ICs can never intersect each other.
4- Further away from origin shows higher level of satisfaction.

Higher IC shows higher level of satisfaction; from the basic idea of IC we know
that an IC always shows same level of satisfaction at any point lying over the
curve.
Any point that lies above to the curve will be preferred comparing to the lower one
because higher point lies in the preference reign.
Y
Preference
region
IC2
IC1
X
In the above figure IC1 is the initial IC at which we have located point A the
preference reign at point A is drawn with the help of horizontal and vertical line IC2
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IC passes through the preference reign and hence it is observed that it shows
greater level of satisfaction comparing to IC1 since IC2 is away from origin then IC1
and thus we conclude higher IC shows greater level of satisfaction.
5- They never touch any of the axes.

For the existence of an IC there must be some degree of substitution to exist
between commodities consumed. It means for a desirable IC the value of MRS
should never be zero or infinity. It means IC should not touch either of the axes
because it would not have any substitution over such point any substitution over
such point.
MRS = Infinity
IC1
IC2
MRS = Zero
In the above figure both IC1 and IC2 are not desirable because both are lacking
the degree of substitution at the point where the curves touch the axis. It means
that they never touch the axes.
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Q No. 5 Discuses Consumer Equilibrium using indifference curve
Technique.
A No. 5
 Introduction
By consumer equilibrium we mean to find out units of different commodities that a
consumer should have to consume with in the limited income to get maximum level
of satisfaction. Using IC analyses we can find this equilibrium by using IC map and
budget line representing consumer’s limited income. In the following we briefly
discuss this method while using these concepts one by one.
 Concept of IC
Indifference curve is the graph indication of indifferent attitude of the consumer for
different combinations of two close substitutes.
We can understand this concept while assuming two commodities X and Y and
different units of such commodities that the consumer consumes and get same level
of satisfaction.
Level of
X
Y satisfaction
10 2 λ Indifference curve behavior
B A 6 5 λ
C 3 9 λ
In the above table we have explained indifferent behavior of the consumer

who is having λ level of satisfaction for different combinations of commodities
X and Y. we can reflect the same on the graph paper.
YY
12
10
0
0 2 4 6 8 10
X
IC
In the above figure the indifference curve is illustrated for consuming different
combinations of commodities X and Y. Point “a” in the figure reflect combination of
(2, 10). While point “b” shows combination of (5, 6) and “c” shows combination of (9,
3). All these points have the same level of satisfaction. After joining these points we
get negatively sloped indifference curve.
Definition of IC:
The difference curve can be defined in the following words:

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“An indifference curve is made after joining different points having
different combinations of two close substitutes while the consumer
remains with same level of satisfaction”.
 Concept of budget Line

Budget line is the graphical representation of showing fixed purchasing power of the
consumer in the form of consumer’s money income. It is obvious that the consumer
spends all of his money income over different expenditures i.e.
Income = income expenditure over commodities X & Y
Income = EX + EY
Income = PX.qX + PY.qY
Or
= PX.qX + PY.qY equation of budget
 Graphical explanation of consumer

equilibrium
Let = Rs. 100/-
PX = Rs. 5/-
PY = Rs. 10/-
Income
Y X
Expenditure
10 M-/ PY Rs.100
8 4 Rs.100
Budget line
6 8 Rs.100
4 12 Rs.100
2 16 Rs.100 M / PX
- 20 Rs.100
12
10
0
4 8 12 16 20
From the above table and figures it appears that budget line is made after joining
different points comprising different combination of both commodities X & Y for which
income expenditure remains same. It is noted here that the budget line is negatively
sloped straight line indicating fixed income.
 Conditions of consumers equilibrium

We can find the consumer equilibrium when following conditions are satisfied i.e.
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Necessary Condition:-
MU X PX
=
MU Y PY
MRSXY = MRMSXY
Slope of IC = slop of budget line
It means that both budget line and IC develop a contact to each other in such a way
that the budget line makes a tangent over the IC.
Sufficient Condition:-
The desirable IC should be convex to the origin.
We can show the case of consumer equilibrium while using the conditions of
equilibrium as shown in the following figure.
E
Y1
In the above figure the situation of consumer equilibrium
IC3 is illustrated while the given
income is illustrated with the budget line “AB” andIC map of indifference curves with
IC3>IC2>IC1. At point “E” both the conditions of equilibrium are satisfied and hence
2
IC1
IC2 is highest possible 0level of satisfaction
X1 B attainable X within “AB” given level of
income. Our consumer should have to consume (X1, Y1) combination of both the
commodities and get maximum level of satisfaction.
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Q No. 6 Write short notes on the following?
A No. 6
 PRICE EFFECT: (PE)
Price Effect is the net change in the purchase of a commodity when price of such
commodity is changed while consumer remains in equilibrium. It is quite a fact when
price of a commodity is decreased then consumer finds an increase in his purchasing
power. The difference between units purchased of the commodity whose price is
changed while consumer remains in equilibrium is called the PE.
i.e PX ∃ _ Purchasing power # _ X# & Y# _ U#
PE _ the difference between units purchased
of commodity X while the consumer
remains in equilibrium.
In the above figure consumer’s initial equilibrium is shown at point E1 while

purchasing (X1, Y1) combination of commodities with in the limited income. When
price of commodity X is decreased then the consumer finds the new equilibrium at
point E2 with higher indifference curve IC2 and purchasing X2 units of commodity X.
the difference between X1 and X2 units of commodity X at different price levels and
consumer remains in equilibrium is called PE.
 INCOME EFFECT: (IE)

Income Effect is the change in the units purchased of any commodity when income
of the consumer is changed while consumer remains in equilibrium. We generally
observe that purchasing power of the consumer is increased when income of the
consumer is increased so that consumer will find an increase in his purchase for both
commodities X and Y and finds the equilibrium with higher indifference curve. The
difference between new equilibrium point and the original one is called the IE.
i.e Income# _ Purchasing power # _ X# & Y# _ U#
PE _ the difference between units purchased
of any commodity while the consumer
remains in equilibrium.

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In the above figure IE is reflected while having variation in income of the consumer
and its impact over consumer equilibrium. Consumer is initially in equilibrium at point
E1 while purchasing (X1, Y1) combination of commodities with in his limited income.
Now with the increase in income consumer finds the new equilibrium at point E 2 with
higher indifference curve IC2. Now consumer is consuming X2 & Y2 combination of
commodities X i.e. X1, X2 when income is changed.
If we join both consumer equilibrium points at different income levels then we get
income consumption curve (ICC).
 SUBSTITUTION EFFECT: (SE)

Since both the commodities X and Y are close substitutes to each other. Therefore, if
we desire to find out the degree of substitution between both the commodities then
we have to find the SE. According to Sir John Hicks when price of a commodity
decreases then purchasing power of the consumer increases and he can find the
equilibrium at higher IC. For SE we need to contain the consumer at initial level of
satisfaction by reducing his money income. We reduce money income till the
consumer finds the equilibrium again at initial level of satisfaction. The difference
between the new equilibrium point and the initial one at the same IC is called SE.
i.e. PX∃ _ Purchasing power # _ X# & Y# _ Higher IC
SE _ Reduce money income so that _ the difference between the new and
consumer reaches to the initial initial level of satisfaction is called SE.
level of satisfaction.
In the above figure initial consumer equilibrium point is defined at point E1 on the
budget line A B while purchasing (X1, Y1) combination of commodities with IC IC1. If
price of commodity X falls than there will be increase in real income of the consumer.
For finding the SE we reduce the money income till the consumer equilibrium at point
E2 with the same IC IC1. Therefore, the movement from point E1 to E2 on the same IC
IC1 is called SE.
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Q No. 7 Define the term “Demand” in Economics. State and explain the
Law of Demand in detail with its limitations.
A No. 7
 Concept of Demand
The word demand is used for any desire. In economics demand is related with the
effective desire which is backed by willingness and power to purchase a commodity
in order to obtain it, therefore, demand is related with the following factors:-
• Willingness to purchase
• Sufficient purchasing power
 Law of Demand
The desire of a commodity while having sufficient purchasing power is called
demand. Law of demand explains the effect of change in price over the purchasing
power of the consumer. The inverse relationship between quantity demand and price
is known as law of demand.

We can define the law of demand in the following words:-
“If other things remain the same, when price of a commodity
increases then quantity demand decreases and vice-versa”.
 Explanation of the law of demand

Symbolically the law of demand may be expressed as follows:-
Qd = f (P)
Where Increase in price _ decrease in quality demand P# = Qd∃
Decrease in price _ increase in quality demand P∃ = Qd#
Table
P Qd (KG)
Rs. 5 10
Rs. 10 5
In the above table law of demand is explained, when price of thing is Rs. 5 our
consumer demand 10 Kg of it. When price is increased to Rs. 10 quantity demand
will decrease to 5 Kg. This trend explains the working of the law of demand.
Figure

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Demand curve is made after joining different points comprising different
combinations of price and quantity demand when law of demand holds.
 Assumptions of the law of demand
The law of demand can be proved to be operative when following assumptions are
explained below.
1- Income of the consumer:
Income of the consumer affects the purchasing power of the consumer even though
price of the commodity unchanged. Therefore, we assume that income of the
consumer should remain constant during the discussion.
2- Constant habits and taste of consumer:

Habits and taste are important factors which may negate the operation of the law of
demand. This is because in case of habit and taste price variations do not change
the demand. Hence we assume that taste and habits do not change during the
discussion.
3- Price of substitution:
It is generally observed that price variation of substitute commodities effect the
demand of the related commodity. Therefore, law of demand does not hold for the
related commodity. This is why we assume that price of substitutes should not b
changed during the discussion.
4- Future expectations:
It is assumed that future prospects regarding the price of the commodity and income
of the consumer are not changed. If it changes due to unforeseen events then people
change demand of their product even without having any change in price.
5- Unchanged population and weather conditions:

Change in population of a country greatly effect demand of commodities even price is
not changed. Similarly weather variations also greatly effect demand of related
commodities. Hence we assume that there is no change in population and weather
conditions for the existence of the law.
6- Unchanged stock of wealth:

Stock of wealth determines the purchasing power if people. If stock of wealth
increases then consumer may increase the demand even price is not changed. In
such situation we assume that stock of wealth do not change during the discussion.
 Limitations of the law (Exceptions)

1- Giffen goods:
Giffen goods are associated with the name of Sir Robert Giffen who pointed out
different commodities showing direct relationship between price and quantity
demand.
2- Status symbol commodities:

21
There are certain commodities, which are demanded not because of their intrinsic
worth, but because of their status value, for example luxurious cars are demanded by
the wealth people, even though prices may go up but demands for them will remain
same.
3- Ignorance of the consumer:

Often the consumer is not unduly bothered about the price he is paying. It may be
pay less then this price. But he is not aware of its lower price so he does not go to
another shop. In such case law is not applicable.
4- Expectations of rise and fall in price:

If prices of different commodities are expected to rise or fall in future then in such
case if prices in future are going to rise then the people will rush to purchase more of
the commodity at the present price and vice-versa.
5- Level of price:
Products’ having very low or very high prices have reverse application e.g. salt is
very low priced product and thus people behave opposite to the law of demand. In
such case law is not applicable.
______________________________________________________________

22
Q No. 8 Explain the term “Change in Demand”. What factors are
responsible for the change in demand?
A No. 8
 INTRODUCTION
Quantity demand is the amount of any commodity that the consumer is willing and
able to purchase at a specific time and price level. Demand of any commodity is
affected by many factors such as price of the commodity, price of substitute, income,
taste, habits, fashion etc. therefore, variation in these factors effect the quantity
demand to change. In the following we discuss these kinds of changes one by one.
 CHANGE IN DEMAND
We have two different types of changes in demand and are discussed one by one:-
i. Expansion Vs Contraction in demand:
Expansion in demand:
According to the law of demand when prices of a commodity decreases then it
results the quantity demand to increase this increase in quantity demand is
called expansion in demand. On the graph paper this is reflected with the
movement from left to right downward along the same demand curve i.e. Qd =
f(P)
P∃ _ Qd# (expansion in demand)
P (Rs) Qd (KG)
10 5
5 10
In the above figure the working of the law of demand is explained when price
of the commodity is 10 then the consumer is demanding 5 units of the
commodity as shown with the point “a” in the figure when price decreased to
Rs.5 then the consumer is demanding 10 units of the commodity as shown
with point “b” in the figure. Therefore, as we move from left to right downward
then it is called expansion in demand.
Contraction in demand:
According to the law of demand when prices of a commodity increases then it
results the quantity demand to decrease this decrease in quantity demand is
called contraction in demand. On the graph paper this is reflected with the
movement from right to left upward along the same demand curve i.e.
Qd = f(P)
P# _ Qd∃ (contraction in demand)
P (Rs) Qd (KG)
5 10
10 5
23
In the above figure the working of the law of demand is explained when price
of the commodity is 5 then the consumer is demanding 10 units of the
commodity as shown with the point “b” in the figure when price increased to
Rs.10 then the consumer is demanding 5 units of the commodity as shown
with point “a” in the figure. Therefore, as we move from right to left upward
then it is called contraction in demand.
ii. Rise Vs Fall in demand:

Due to the change in assumptions of the law of demand the entire demand
curve change its position either upward to the right or downward to the left we
call such changes as rise or fall in demand.
If the demand curve changes upward to the right then it is called rise in
demand. However the shift of demand curve to the left is called fall in demand
i.e.
 FACTORS / CAUSES OF CHANGE IN

DEMAND
1- Changes in price of the commodity:
Change in the price of the commodity affects the purchasing power of consumers
and thus the demand of the commodity is changed of by the people.
P∃ _ Purchasing Power# _ qd# (Expansion in demand)
P# _ Purchasing Power∃ _ qd∃ (Contraction in demand)
2- Changes in income:
Change in income affects the purchasing power of consumers and thus the
demand of the commodity is changed of by the people. When income of the

24
consumer will increase the purchasing power will increase and thus he will
purchase more commodities.
Income# _ Purchasing Power# _ qd# (Rise in demand)
Income∃ _ Purchasing Power∃ _ qd∃ (Fall in demand)
3- Change in price of the substitute:

Beef and Mutton are substitutes of each other. When the price of mutton will
increase while price of beef remains constant, demand will fall for mutton and rise
for beef. This will cause demand of beef to increase.
Price of the substitute# _ (Price of related good unchanged) _ qd of related good#
(Rise in demand of related good)
4- Change in population:
There will be a rise in demand for certain commodities such as milk, clothing etc.
due to increase in the number of consumer as the population increases.
Population# _ (Price of good unchanged) _ qd# (Rise in demand)
5- Change in taste and fashion:

If a certain good is out of style the demand for it will decrease, even though its
price is constant we can sees that when the new competitive products are
available. For the same price as the old products the demand will increase.
Taste and habits (improve) _ qd# (Rise in demand)
Fashion (improve) _ qd# (Rise in demand)
6- Discovery of new substitute:

When a new substitute of a commodity emerges in the market, it attracts the
people and there is a desire to buy the new product and thus the consumer will
shift to the new commodity and demand of old commodity will decrease, although
the price is almost the same.
New product _ qd# (Rise in demand)
7- Change in Govt. policy:

Govt. policy affects the demand of individuals while imposing the direct and
indirect taxes, the demand will decrease if taxes will increase, while the prices are
constant.
Taxes# _ qd∃ (fall in demand)
Taxes∃ _ qd# (rise in demand)
 REASONS FOR NEGATIVE SLOPING OF

DEMAND CURVE
Demand curve is negatively sloped due to the following reasons:-
1. Real income effect:
Still to type
_________________________________________________________________
25

26
Q No. 9 Define the term “Elasticity of Demand” and discuss different
methods of measuring elasticity of demand.
A No. 9
 Introduction
According to the law of demand change in price brings an inverse change in quantity
demand (Qd) but it does not tell us that to what extant quantity demand will have a
change to some change in price of the commodity. In this way law of demand is a
qualitative concept because it tells us only direction of charge. How ever elasticity of
demand is quantitative concept which exactly tells us the degree of flexibility in
quantity demand to some change in price of the commodity.
Qd = f (P)
P# _ Qd∃ (Law of Demand)
(Elasticity of demand) P# (10%) _ Qd∃ (10%) or ∃ (less than 10%) or ∃ (more than
10%)
 Definition
The term elasticity refers to the degree of flexibility.
In the words of Prof. Alfred Marshall:-
“The elasticity of the demand in a market is great or small
according as the amount demanded increases much or little
for a given fall in price and diminishes much or little for a
given rise in price”.
According to Prof. Cairn Cross:-
“The elasticity of demand for a commodity is the rate at which
quantity bought changes as the price changes”.
From the above definitions it is clear that elasticity of demand measures the degree
of flexibility demand for any change in price of the commodity. We can define this
concept as given in the following words:-
Elasticity of demand measures proportionate change in quantity demand to the
proportionate change in price of the commodity.
Proportion ate change in quantity demand
Ed =
Proportion ate change in price
 Degree of elasticity of demand

1- Relative elastic demand :- (E d > 1)
Qd shows greater response to any change in price of the commodity.
P∃ (10%) _ Qd# (more than 10%)
58636153.doc B.Com-I 26 QdKashif Hayat

Mohammad
27
2- Relative inelastic demand :- (E d < 1)
Qd shows less response to any change in price of the commodity.
P∃ (10%) _ Qd# (less than 10%)
P
Qd
3- Unitary elastic demand :- (E d = 1)
Qd shows same response to any change in price of the commodity.
P∃ (10%) _ Qd# (10%)
P
Qd
4- Perfectly inelastic demand :- (E d = 0)
Qd shows no response to any change in price of the commodity.
P∃ (10%) _ Qd# (No change)
P
Qd
5- Perfectly elastic demand :- (E d = ∞)
Qd shows infinite change while price is not changed.
P∃ (not changed) _ Qd# (infinite change)
P
Qd
28
 Methods of measuring elasticity of

demand
1- Flux or percentage method
According to flux, elasticity of demand measures percentage change in Q d to the
percentage change in price of the commodity.
i.e.
Percentage change in quantity demand
Percentage change in price
Q − Q1
Qd = 2 ×100
Percentage change in Q1
P2 − P1
P= ×100
Percentage change in P1
For example:-
P Qd
Rs.10 20
Rs.15 10
10 − 20
Qd = ×100
Percentage change in 20
= -50%
15 −10
P= ×100
= 50%
− 50%
Ed = = −1
50%
|Ed| = 1 (unitary elastic)
2- Total outlay method

The term total outlay refers to the total amount in cash that a consumer spends
over the purchase of a commodity. It means we can find out total outlay by
multiplying price of the commodity with units demanded.
i.e. TO = Price x quantity demand
TO = P.q = f (P)
It means we can observe elasticity of demand from the relationship between

variation in price of the commodity and variation in total outlay.
i.e. if P∃ _ Qd# _ TO# (Ed > 1)
P∃ _ Qd# _ TO (same) (Ed = 1)
P∃ _ Qd# _ TO∃ (Ed < 1)
(Ed > 1) (Ed = 1) (Ed < 1)

29
3- Formula method
 Point elasticity of demand (important)
If we get a very small change in price of the commodity which results very small
change in quantity demand and on the graph paper two different points appear in
such a way that it appears almost a single point. Therefore, elasticity of demand
between such points is called point elasticity of demand.
Formula:-
∆Qd P
Ed = .
∆P Q
e.g.
P Qd
Rs.10 20
Rs.10.25 19.75
ΔQd = 19.75 - 20 = -0.25
ΔP = 10.25 - 10 = +0.25
P = 10, Q = 20
− 0.25 10 1
Ed = × = − = −0.5
0.25 20 2
|Ed| = 0.5 < 1 (Inelastic)
 Arc elasticity of demand

If we have very prominent change in price of the commodity which results
prominent change in quantity demand and on the graph paper we get two
different points in such a way that an arc can be drawn through them. The
elasticity of demand between such points is called an arc elasticity of demand.
q − q1 P2 + P1
Ed = 2 .
P2 − P1 q2 + q1
e.g.
P Qd
Rs.10= P1 20= q1
Rs.15= P2 10= q2
10 − 20 15 +10
Ed = .
15 −10 10 + 20
−10 25 5
Ed = . = − = −1.67
5 30 3
|Ed| = 1.67 > 1 (Elastic)

30
4- Graphic method
Graphically we may be given two types of demand and price relationships. These
are:-
• Linear or straight line demand curve
We can trace out the elasticity of demand on each of the graph while using point
elasticity method. In case of linear demand curve we first have to locate the point
along the demand curve where elasticity of demand is needed to estimate.
We compute elasticity of demand at such point by dividing the lower distance of
the point with the upper distance along the same demand curve as shown in the
figure. P
∞
A
Let “C” is in the middle Ed = 1
CB
Ed at “C” = =1 C Ed < 1
CA
E
Ed = 0
0 Qd
B
EB 0
Ed at “E” = <1 Ed at “B” = =0
EA BA
FB AB
Ed at “F” = >1 Ed at “A” = =
FA 0 ∞
0 ≤ Ed ≤ ∞
• Nonlinear or curve demand curve
In case of curvilinear demand and price relationship we first locate the point at
which elasticity of demand is needed to estimate. Then we draw tangent line over
such point and then extend the tangent line till it meets with both of the axes.
Then we use the same method as used in linear demand curve.
P D
B
A
D
0 Qd
C
AC
Ed at “A” =
AB
_________________________________________________________________
MRS = Infinity
31
Q No. 10 Explain determinants / Factors of Elasticity of demand (Ed).
A No. 10
By determinants of elasticity of demand we mean the factors due to which Ed
(elasticity of demand) varies in different ranges. Followings are the important
determinants:-
1) Level of Income :
For high income earners, the increase in price of the commodity will not mater so
much, so minor change will occur in demand, therefore the Ed will be inelastic. On the
other hand for the poor or low income earners, due to the increase in price of the
commodity, the demand would greatly change so the Ed will be elastic.
High income earners _ Ed < 1
Low income earners _ Ed > 1
2) Availability of substitute :
If a commodity has close substitute at reasonable price, so due to the increase in
price of the commodity the demand would be change greatly, so the Ed will be elastic.
On the other hand if a commodity has not any substitute, then the people are bound
to buy that one to fulfill their necessity, so the demand will change to little extent, so
the Ed will be inelastic.
In case of available substitute _ Ed > 1
In case of non-availability of substitute _ Ed < 1
3) Nature of commodity :
Commodities are classified as necessities and luxuries. In case of necessities due to
the increase in price, there will be small change in demand because people are
bound to buy them man can not live without them e.g. salt, wheat, sugar, so Ed for
necessities will be inelastic. On the other hand in case of luxuries due to the increase
in price of the commodity, there will be great change in demand because lot of
people will find that out of their range, so Ed will be elastic.
Necessities _ Ed < 1
Comforts or luxury _ Ed > 1
4) Habitual necessities :
The Ed for those commodities which are a part of consumer’s habit will be inelastic
because due to the increase in price of that commodities there will be minor change
in demand because the consumer is bound to buy them, he can not leave them (if he
will leave them then it means that it will not his habit in the future), e.g. collection of
stamps. The consumer will decrease his expenditure over the purchase of other
commodities to buy habitual commodities.
Habitual _ Ed < 1
5) Possibility of postponing a commodity :

Those commodities whose purchase can be postpone then due to the rise in price
the demand will greatly change, therefore the Ed will be elastic. For example if prices

32
of woolen clothes will increase then the middle class people will use their old woolen
clothes and postpone the purchase of new clothes.
Possibility of postpone _ Ed > 1
6) Share of commodity in total expenditure :

Those commodities whose share is lesser in the total expenditure then Ed will be
inelastic e.g. matchbox. On the other hand those commodities whose share is
greater in the total expenditure then Ed will be elastic.
Greater share _ Ed > 1
Lesser share _ Ed < 1
7) Joint demand :
Different commodities are jointly demanded, Ed is inelastic for them e.g. petrol of car
because petrol is the necessity of car and people are bound to buy petrol, without
petrol they cannot use car, if price of petrol will rise then there will be small change in
demand.
Joint demand _ Ed < 1
8) Price level :
Ed will be inelastic for those commodities whose prices are very low or very high
because very low level or very high level price does not affect the demand greatly
e.g. price of match.
Joint demand _ Ed < 1
___________________________________________________________________

33
Q No. 11 Define the term “Supply” state and explain law of supply with the
help of table and figure?
A No. 11
• INTRODUCTION
The term supply is related with the behavior of a producer who always desires to
maximize his profit. This is why producer relates supply of the commodity with the
price of such commodity and other factors that may affect his profit i.e.
QS = f (price, cost of production, price of raw material, technology, Govt. policy…)
• NATURE OF SUPPLY
The term supply refers to the amount of the commodity which a producer is willing to
sell in the market at a certain price level and at certain time.
Supply
Price Time
(Daily, weakly, fortnightly, monthly…)
Production
Supply at the acceptable price Stock

Reserve Price: Minimum price at which the producer is willing to sell the products but below this all
these products become stock.
• LAW OF SUPPLY
Law of supply explains direct relationship between quantity supply and price of the
commodity at which the producer is willing to sell his products in the market.
Producer considers increasing price for having greater profit and therefore, he will
increase QS of the same commodity and vice-versa. However we can define the law
of supply in the following words.
• STATEMENT OF THE LAW

“If other things remaining the same, when price of a
commodity increases then its quantity supply (QS) also
increases and vise-versa”.
i.e. QS = f (P)
P# _ QS#
P∃ _ QS∃ (Price and QS are moving in the same direction)
• EXPLANATION OF THE LAW

From the above statement of the law we perceive the idea that both QS and Price of
the commodity are directly related to each other. We can understand the working of
the law through the following table and figure.
20
P QS 15 b
Rs.10 50
Price
10 a
Rs.15 100
5
58636153.doc B.Com-I 33 0 Mohammad Kashif Hayat Qs

0 50 100 150
34
In the above table and figure we have plotted the supply curve while having the
mutual relationship between prices of the commodity along with Qs of the commodity.
When price of the commodity was Rs.10 then the producer supplies 50 units of the
commodity as shown with point “a” in the figure. When price increases to Rs.15/unit
then Qs also increases to 100 units as shown with point “b” in the figure. After joining
points “a” and “b” in the figure, we will get positively sloped “SS” supply curve.
Supply curve is made after joining different points having different combinations of
price and Qs for which law of supply exists.
• ASSUMPTIONS OF THE LAW

The existence of the “law of supply” is attached with the following assumptions.
1- Price of the raw material:-

It is assumed that price of the raw material used in the production process do not
change. This is because any change in price of raw material would affect the
profit margin of the producer to change.
2- Cost of production:-
It is assumed that the entire cost of production for producing the commodity is not
changed during the discussion. This is because any change in it would affect the
profit margin and thus supply will be disturbed.
3- State of technology:-
It is assumed that the technique of production is not changed during the
discussion this because any improvement in technology may increase the supply
even at the same price.
4- Govt. policies:-
It is assumed that the Govt. policies regarding taxation and subsidy (some relief
from the actual amount) should not be changed during the discussion.
5- Law and order situation:-

It is assumed that law and order situation in the country is not changed during the
study of the situation.
_________________________________________________________________

35
Q No. 12 Discuss about the changes in Supply, also discuss main causes of
change in supply.
A No. 12
• Introduction
Changes in quantity supply due to either change price of the commodity or change in
other factors is called change in supply. It can be classified as:-
• Expansion Vs Contraction in Supply

Expansion in supply:-
According to the law of supply we know that when price of the commodity increases
then quantity supply will be increased or have expansion if other factors are not
changed.
QS = f (P)
P# _ QS# (Expansion)
15
For Example:-
10 b
Price
P Qs
Rs.5 20 5 a
Rs.10 40
0 Qs
0 20 40 60
In the above figure the working of the law of supply is explained when price of the
commodity is Rs.5 then the producer/supplier is supplying 20 units of the commodity
as shown with the point “a” in the figure when price increased to Rs.10 then the
producer is supplying 40 units of that commodity as shown with point “b” in the figure.
Therefore, as we move from left to right upward then it is called expansion in supply.
Contraction in supply:-
According to the law of supply we know that when price of the commodity decreases
then quantity supply will also be decreased or have contraction if other factors are
constant.
QS = f (P)
P∃ _ QS∃ (Contraction) 15
For Example:- 10 a
Price
P Qs 5 b
Rs.10 40
Rs.5 20 0 Qs
0 20 40 60
In the above figure the working of the law of supply is explained when price of the
commodity is Rs.10 then the producer/supplier is supplying 40 units of the
commodity as shown with the point “a” in the figure when price decreased to Rs.5
then the producer is supplying 20 units of that commodity as shown with point “b” in
36
the figure. Therefore, as we move from right to left downward then it is called
contraction in supply.

37
• Rise Vs Fall in Supply

Due to the change in assumptions of the law of supply the entire supply curve
change its position either downward to the right or upward to the left we call such
changes as rise or fall in supply.
If the supply curve changes downward to the right then it is called rise in supply.
However the shift of supply curve to the left is called fall in supply i.e.
• Factors / Causes of change in supply

1- Changes in price of the commodity:
Change in the price is the major factor of change in supply. When the price of the
commodity will increase then the producer will be having more profit then before
and thus he will increase his supply of commodity. We can say that due to
increase in price the Qs will also increase and vice-versa.
P# _ Qs# (Expansion in supply)
P∃ _ Qs∃ (Contraction in supply)
2- Change in cost of production:

Change in cost of production is also one of the major factors in the change of
supply. If net invested expenditure on the production of required commodity will
increase then sourly the ratio of profit will decrease and therefore, producer will
decrease his supply of commodity so it will be fall in supply, similarly if cost of
production will decrease then the producer will have greater profit so it will be rise
in supply.
Cost of production# _ Qs∃ (Fall in supply)
Cost of production∃ _ Qs# (Rise in supply)
3- Change in price of raw material:

If price of raw material will increase then sourly the ratio of profit will decrease so
it will be fall in supply, similarly if cost of production will decrease then the
producer will have greater profit and therefore, he will increase his quantity supply
so it will be rise in supply.
Price of raw material# _ Qs∃ (Fall in supply)
Price of raw material∃ _ Qs# (Rise in supply)
_________________________________________________________________

38
Q No. 13 Discuss the nature of Elasticity of Supply along with its
determinants.
A No. 13
 INTRODUCTION
According to the Law of Supply change in price brings a direct change in quantity
supply (Qs) but it does not tell us that to what extant quantity supply will have a
change to some change in price of the commodity. In this way law of supply is a
qualitative concept because it tells us only direction of charge. However elasticity of
supply is quantitative concept which exactly tells us the degree of flexibility in quantity
supply to some change in price of the commodity.
Qs = f(P)
P# _ Qd# (Law of Supply)
(Elasticity of supply) P# (10%) _ Qd# (10%) or # (less than 10%) or # (more than
10%)
 DEFINITION
The term elasticity refers to the degree of flexibility. Elasticity of supply measures the
degree of flexibility supply for any change in price of the commodity. We can define
this concept as given in the following words:-
“Elasticity of supply measures proportionate change in quantity
supply to the proportionate change in price of the commodity”.
Proportionate change in quantity supply

Proportionate change in price
Q − Q1 ∆Q S
QS = 2 × 100 = × 100
Percentage change in Q1 Q
P2 − P1 ∆P
P= × 100 = × 100
Percentage change in P1 P
∆ QS
× 100 ∆ Q
Q S P
ES = = .
∆ P × 100 ∆P Q
P
We may have the range of Es between zero and infinity i.e. 0 ≤ Es ≤ ∞
For example:-
P QS
Rs.1 20
0
Rs.1 30
5
30 − 20
QS = ×100 = 50%
15 −10
P= ×100 = 50%

39
50%
ES = =1
50%
ES = 1 (unitary elastic)
 DEGREE OF ELASTICITY OF
SUPPLY
1- Relatively elastic supply:- (E S > 1)
Qs shows greater response to any change in price of the commodity.
P∃ (10%) _ QS∃ (more than 10%)
P
S
(SPSC)
S
QS
2- Relative inelastic supply:- (E S < 1)
QS shows less response to any change in price of the commodity.
P∃ (10%) _ QS∃ (less than 10%)
P
S
(LPSC)
S QS
3- Unitary elastic supply:- (E S = 1)
QS shows same response to any change in price of the commodity.
P∃ (10%) _ QS∃ (10%)
P
S
Q
4- Perfectly inelastic supply:- S (E S = 0)
QS shows no response to any change in price of the commodity.
P∃ (10%) _ QS (No change) P

40
S (MPSC)
S
QS
5- Perfectly elastic supply :- (E S = ∞)
QS shows infinite change while price is not changed.
P (not changed) _ QS∃ (infinite change)
P
S S
QS
 Determinants / Factors of Elasticity
of supply ( ES )
1. The intensity of use of the fixed factor :
The producer can increase his production if the firm is under utilized or working
below the full capacity so he can increase the supply by increasing his production,
therefore, supply curve will be elastic because. Whereas if the firm is over utilized or
working at full capacity he can not increase his working capacity and that’s why he
can not increase his supply, therefore, the supply curve will be inelastic.
If the factor is under utilized (less) _ ES > 1
If the factor is over utilized (fully) _ ES < 1
2. The availability of other factors :

Availability of other factors such as cash, labor, capital, raw material plays an
important role over the supply curve. If the producer wants to increase supply by
increasing his production and he wants to utilize other factors and that are easily
available, he can do this and the supply curve in this case will be elastic. On the
other hand if producer wants to utilize other factors and these are not easily available
then the supply curve will be inelastic.
If other factors are further easily available _ ES > 1
If other factors are not further easily available _ ES < 1
3. The time factor :

Time factor is also one of the important factors in the elasticity of supply. In short
period it is difficult to enhance his business, so the supply curve will be inelastic. If
there is long period to enhance the business, so the supply curve will be elastic. On
the other hand if there is market period the supply curve will be perfectly inelastic.
Short period _ ES < 1
Long period _ ES > 1
41
Market period _ ES = 0
4. Nature of the commodity :
Perishable goods such as vegetables which can not be stored, supply will not change
and thus it will be inelastic. Otherwise if the nature of thing is durable the producer
can store his goods if price will decrease and therefore the supply curve will be
elastic. Perishable goods _ ES < 1
Durable goods _ ES > 1
___________________________________________________________________
Production
The production refers to a process when we engage different factors of production
such as land, labour, caporal and entrepreneur to get some units of output i.e.
Inputs (Land, labour, capital, intervener) _ process _ output
Production functions
Production functions define technical relationship between units of output and units of
the factor inputs in the production process. i.e.
Output = f (Land, labour, capital, entrepreneur)
or Y = f (L, N, K, E)
The classical economists have always considered a short period production function
where labour was considered as the only variable input while other factors were held
constant. Y = f (L)
Labour:-
The physical and mental activity that is performed by human beings for the sack of
getting reward is called labour. The reward paid to the labour is called wages.
Land:-
All of the God gifted elements to human beings are classified as land. However the
lord-land get reward while using the productive activities of the land called rent.
Capital:-
The physical and non-physical present assets which can be used to generate more
output or income is called capital. e.g. roads, Buildings, machines, lower services,
doctor services. The reward paid to the capital owner for the use of productivity of
capital is called interest.
Entrepreneur:-
The person who decides and organizes entire production and takes risks is called
entrepreneur. The reward charged against taking risk is called profit.
Concept of production function:-
For short-period production function we have following important concepts to study.
1. Total product: (TP)
TP
The total amount of the commodity

40 which is produced by the labour units engaged in
the production process is called
35 total product (TP). i.e. TP = P1, P2, P3, ….., Pn
Total product has the characteristic
30 that it is increasing but at a diminishing rate.
Labour TP 25
0 - 20
1 4 15
10
58636153.doc B.Com-I 5 41 Mohammad Kashif Hayat
0 L
0 1 2 3 4 5 6 7 8
42
2 9
3 15
4 22
5 28
6 33
7 37
2. Average Product: (AP)

The term average is used as per unit. Average product (AP) is defined as total
product (TP) per labour units engaged in the production process. We simply calculate
value of AP by dividing units of total product (TP) by the labour units (L) engaged in
TP
the production process i.e. AP =
L
The values of AP have the characteristic that they are rising and after reaching to
some maximum start declining.
3. Marginal Product: (MP)
The term marginal refer to the rate of change unit. Marginal product (MP) is the rate
of change in units of total product (TP) when there is some change in units of
labour (L). It can also be defined as the productivity of last labour unit engaged in the
production process i.e.
∆TP
MP =
∆L
Or MP4 = TP4 – TP3 ( MPn = TPn – TPn-1 )
TP
40 TP
35
30
25
20
Labour Total Average Marginal
Product Product Product 15
(L)
(TP) AP = TP/L (MP) 10
1 4 4.0 -
5
2 9 4.5 5
0 L
3 15 5.0 6
4 20 5.0 5 0 1 2 3 4 5 6 7 8
5 24 4.8 4
6 26 4.3 2
7
TP/MP
7 26 3.7 0 MP
8 624 3.0 -2 4. Marginal Revenue Product:
5 (MRP)
MRP is defined as the rate of change in the total revenue product when there AP
is
4
some change in labour units engaged in the production process i.e.
3 ∆TRP
MRP =
2 ∆L
1 MRP = MP ×P { TRP = TP x P }
0 L
-1 0 1 2 3 4 5 6 7 8 9
-2
43
Q No. 14 State and explain “Law of Increasing Returns” with the help of
table and figure also explain practical importance of the law.
A No. 14
 Introduction
The Law of Increasing Returns discusses the direct relationship between successive
labour units engaged in the production process and MP. This law explains that
efficiency of every new labour unit is increasing due to the application of modern
means of production. In the early stage of production process both MP and MRP will
be increasing till maximum efficiency is achieved.

In the word of Alfred Marshall:
“An increase of labour and capital leads generally to improve
organization, which increases the efficiency of labour and
capital”.
We can also explain the law in the following words:

“If other factors except labour are held constant, when
successive labour units are engaged in the production
process then MP and MRP will be increasing”.
 Explanation
From the above definitions it appears that MP is having a functional relationship with
the labour units engaged in the production process i.e.
MP = f (L)
L# _ MP# _ MRP# (Law of Increasing Returns)
Where MRP = MP x P
We can explain this law with the following table and figure:-
MP/MRP
MRP
60
L MP P MRP 55
(Rs) 50
45
1 5 2 10 40
2 10 2 20 35
3 15 2 30 30 MP
25
4 20 2 40
20
5 25 2 50 15
6 30 2 60 10
58636153.doc B.Com-I 5 43 Mohammad Kashif Hayat
0
1 2 3 4 5 6
44
L
In the above figure we have explained the working of the LIR against different labour
units engaged in the production process. When second labour unit is engaged the
MP was “10” as shown with point “b” in the figure while MRP is “20” as shown with
point “b’ ” in the figure. For third labour unit MP rises to “15” and MRP rises to “30”
units showing the increasing trend. This increasing trend continues for successive
labour units engaged in the production process. In the figure the increasing trend of
both MP and MRP indicates the existence of the law. Both graphs of MP and MRP
are positively sloped from left to right.
 Other name of the law:

Law of Increasing Returns is also known as law of Decreasing Cost. This can be
observed from the following important equation:-
W MP/MC
i.e. MC= 26 MP
MP
24
L# _ MP# (Law of Increasing Returns) 22
L# _ MC∃ (Law of Decreasing Cost) 20
18
16
L MP W MC 14
1 5 Rs.60 12 12
10
2 10 Rs.60 6 8
3 15 Rs.60 4 6
4 20 Rs.60 3 4 MC
2
5 25 Rs.60 2.4 0
1 2 3 4 5
 Assumptions
The LIR is applicable when the following assumptions do persist in the economy.
1- Technology:
It is assumed that state of technology is not changed during the production process.
If technology changes then their might is some change in production efficiencies of
labour units engaged in the production process.
2- Homogeneous labour units:

It is assumed that all labour units are homogenous with respect to their productive
efficiency. This is because any change in them would seas the working of the law.
3- Perfect competition:
It is assumed that conditions of perfect competition exist both in product and factor
market.
4- Elastic supply of inputs:

45
It is assumed that the supply of factors if production is freely elastic during the
production process.
 Practical application of the law:

 The law of Increasing Returns is always applied in any production setup
where to available factors are not fully utilized. However economists believed that
this law is applied in the production setups where capital or manmade resources
are mostly used. Hence manufacturing industries confirm the application of this
law. This is because continuous improvement in the technique of production
improves the efficiency of all the factors used in the production process. This
situation persists till the maximum capacity of the plant is utilized.
 In agriculture sector this law may be applicable when improvement
means of cultivations are used in the economy that increases the fertility of the
soil and better crop management.

46
Q State and explain “Law of Constant Returns” with the help of table
and figure also explain practical importance of the law.
 Introduction
The Law of Constant Returns discusses the constant behavior of MP when
successive labour units are engaged in the production process. It means that total
output will be increasing at a constant rate.
This law can be explained in the following words:
“If other factors except labour are held constant, when a
producer engages successive labour units in the production
process then both MP and MRP will remain constant”.
 Explanation
From the above definition it appears that MP is a constant function of the labour units
engaged in the production process.
i.e. MP ≠ f (L)
L↑ → MP (Constant) → MRP (Constant)
Where MRP = MP x P
MP/MRP
25
L MP P MRP
(Rs) 20 MRP
1 10 2 20 15
2 10 2 20
3 10 2 20 10 MP
4 10 2 20 5
5 10 2 20
0
1 2 3 4 5
In the above figure we have explained the working of the LCR against different
labour units engaged in the production process. Here we observed that values of
both MP and MRP are constant to “10” and “20” respectively for different labour units
engaged in the production process. This constant trend continues for successive
labour units engaged in the production process. In the figure the constant trend of
both MP and MRP indicates the existence of the law. The graph of both MP and
MRP are having zero slope and parallel to labour axis.
 Assumptions
The LCR is applicable when the following assumptions do persist in the economy.
1- Technology:
2- Homogeneous labour units:
47
market.
4- Supply of inputs:
It is assumed that the all the desired factor inputs have unitary elastic supply. It
means that factors are equally available as compared to their demand.
The law of Constant Returns is applied in those production setups where both
capital and nature play their role side by side. This is why small scale cottage
industries and extracting units are the examples where MP remains constant for
every new labour unit engaged in the production process.
Law of Constant Returns is also known as Law of Constant Cost. This can be
W
i.e. MC= Law of Constant Const
MP
L# _ MP (Constant) _ MC (Constant)
Law of Constant Returns
L MP W MC MP/MC 15
1 10 Rs.60 6
2 10 Rs.60 6 10
3 10 Rs.60 6
4 10 Rs.60 6 5
5 10 Rs.60 6
0
1 2 3 4 5

_________________________________________________________________

48
State and explain “Law of Diminishing Returns” with the help of
table and graph also explain practical importance of the law.
 Introduction
The Law of Diminishing Returns was presented by the classical economists who
believed that in the production process every next labour unit produces diminishing
contribution in the producing output. It means Total output is increasing but at the
diminishing rate and MP for successive labour units go on diminishing. This
diminishing trend is generally known as the LDR.
 Statement Of The Law
In the words of Alfred Marshall:
“An increase in labour and capital applied in cultivation of land
causes in general a less then proportionate in the amount of
product raised, unless it happened to coincide with an
improvement in the arts of agriculture”.
We can also explain the law in the following words:
“If other factors except labour are held constant, when we
engage successive labour units in the production process
then MP and MRP will be diminishing”.
 Explanation
From the above definitions it appears that MP is having a functional relationship with
the labour units engaged in the production process i.e.
MP = f (L)
L → MP↓ → MRP↓ (Law of Diminishing Returns)
Where MRP = MP x P
MP/MRP
14
L MP P MRP 12
Rs.2 10
1 5 2 10
8
2 7 2 14
3 6 2 12 6
4 5 2 10 4 MRP
5 4 2 8
2 MP
6 2 2 4
0
1 2 3 4 5 6
L
In the above table and figure we have explained the working of the LDR
against different labour units engaged in the production process. When second
labour unit is engaged the MP was “7” as shown with point “b” in the figure while
MRP is “14” as shown with point “b’ ” in the figure. For third labour units MP declines
to “6” and MRP declines to “12” units showing the diminishing trend. This diminishing
trend continues for successive labour units engaged in the production process. In the
figure the declining trend of both MP and MRP indicated the existence of the law.
49
 Assumptions:
The LDR is applicable when the following assumptions do persist in the economy.
1- Technology:
2- Homogeneous labour efficiency:
market.
4- Maximum level of production:
It is assumed that production has gone to its maximum level.
Law of Diminishing Returns is also known as law of Increasing Cost. This can be
W MP/MC
i.e. MC= 26 MC
MP
24
L → MP↓ (Law of Diminishing Returns) 22
L → MC↑ (Law of Increasing Cost) 20
18
16
L MP W MC 14
1 10 Rs.50 5 12
2 8 Rs.50 6.25 10
8
3 6 Rs.50 8.3 6
4 4 Rs.50 12.5 4
5 2 Rs.50 25 2 MP
0
1 2 3 4 5

 In the period of Alfred Marshall there was not too much awareness of
industries so according to the definition of the A. Marshal it is applicable in the
agriculture sector because of two factors i.e.
1) Constant fertility of the soil and fixed amount of soil. When we engage
successive labour units on a piece of land then the Marginal Productivity of
labour starts diminishing because it exhausts the productivity of land to
some extant. Alfred Marshall defines the law is of universal application in
every production set-up.
1. According to the modern economists, LDR is applicable in industrial sector
because of the fact that different inputs used in the production process are
not perfect substitutes to each other. Similarly managerial inefficiencies,
labour union activities, improper combination of inputs etc. are the
important ones that confirm the application of this law.

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1

58636153.doc B.Com-I 1 Mohammad Kashif Hayat

Assumption of the law:-

Limitation of the Law:-

58636153.doc B.Com-I 3 Mohammad Kashif Hayat

We have the following uses of Law:-

1. Guidance of the consumer:-

2. Calculation of consumer surplus:-

3. Helpful in the law of Equi-Marginal Utility:-

58636153.doc B.Com-I 4 Mohammad Kashif Hayat

 Explanation of the law

MUX MUY Line of equi-marginal

Total: Rs. 16/-

 Practical uses of LEMU:

It guides the Finance Minister:-

58636153.doc B.Com-I 8 Mohammad Kashif Hayat

 Concept of Indifference Curve:

Steep (higher slope)

Slope at “B” = MRSB

 Properties of Indifference Curve:

58636153.doc B.Com-I 10 Mohammad Kashif Hayat

58636153.doc B.Com-I 11 Mohammad Kashif Hayat

Level of satisfaction at IC1

4- Further away from origin shows higher level of satisfaction.

5- They never touch any of the axes.

58636153.doc B.Com-I 13 Mohammad Kashif Hayat

In the above table we have explained indifferent behavior of the consumer

58636153.doc B.Com-I 14 Mohammad Kashif Hayat

 Concept of budget Line

 Graphical explanation of consumer

 Conditions of consumers equilibrium

58636153.doc B.Com-I 16 Mohammad Kashif Hayat

In the above figure consumer’s initial equilibrium is shown at point E1 while

 INCOME EFFECT: (IE)

58636153.doc B.Com-I 17 Mohammad Kashif Hayat

 SUBSTITUTION EFFECT: (SE)

58636153.doc B.Com-I 18 Mohammad Kashif Hayat

 Statement of the law

 Explanation of the law of demand

58636153.doc B.Com-I 19 Mohammad Kashif Hayat

2- Constant habits and taste of consumer:

5- Unchanged population and weather conditions:

6- Unchanged stock of wealth:

 Limitations of the law (Exceptions)

2- Status symbol commodities:

3- Ignorance of the consumer:

4- Expectations of rise and fall in price:

58636153.doc B.Com-I 21 Mohammad Kashif Hayat

ii. Rise Vs Fall in demand:

 FACTORS / CAUSES OF CHANGE IN

58636153.doc B.Com-I 23 Mohammad Kashif Hayat

3- Change in price of the substitute:

5- Change in taste and fashion:

6- Discovery of new substitute:

7- Change in Govt. policy:

 REASONS FOR NEGATIVE SLOPING OF

58636153.doc B.Com-I 25 Mohammad Kashif Hayat

 Degree of elasticity of demand

58636153.doc B.Com-I 26 QdKashif Hayat

 Methods of measuring elasticity of

2- Total outlay method

It means we can observe elasticity of demand from the relationship between

(Ed > 1) (Ed = 1) (Ed < 1)