Question

QUESTION 3

3.1 What does normal profit mean? Explain the difference between normal profit and economic profit.

3.2 Explain the relationship between average product and marginal product.

3.3 In economics we consider both explicit costs and implicit costs. Differentiate between implicit and explicit

costs.

QUESTION 4

An economist needs a deep understanding of price elasticity concepts and their applicability in today’s economy.

4.1 Define price elasticity of demand and how it is measured.

4.2 Explain the FIVE (5) categories of price elasticity of demand.

4.3 Explain the relationship between the total revenue from the sales of a product and the price elasticity of

the demand for the product. SS

QUESTION 5

5.1 List FIVE (5) requirements for perfect competition to exist.

5.2 Explain why any firm maximises profit, or minimises losses, when marginal cost is equal to marginal

revenue.

5.3 Explain the shape of the marginal revenue curve facing (a) a perfectly competitive firm and (b) a

monopolistic firm.

QUESTION 6

6.1 Briefly discuss the main components of total spending in the economy.

6.2 Identify the THREE (3) main withdrawals (or leakages) from the circular flow of income and spending in

an open economy.

6.3 Explain with examples, the following:

6.3.1 Constant returns to scale.

6.3.2 Increasing returns to scale.

6.3.3 Decreasing returns to scale.

Answer 1

3)3.1. Normal profit is the minimum profit required for a business to remain in the industry. It occurs when economic profit is zero. When total revenue – total cost (implicit cost +explicit cost =0, the normal profit arise. If the difference between the total revenue and total cost (Implicit cost + explicit cost) is greater than zero the economic profit arise.

3.2. The movement of average product depends upon the movement in marginal product. When marginal product is higher than the average product, the average product is rising. When the marginal product is lower than the average product, the average product falling. When marginal product equals the average product, the average product is maximum.

3.3. Explicit cost is costs in terms of money expenditure. It is the cost on factors or services hired or purchased which involves a money payment. Explicit costs are the opportunity cost of self-owned factors or services in which there is no money payment. Its value is imputed. For calculating economic profit, both implicit and explicit costs are taken. For calculating accounting profit only explicit costs are considered.

4) 4.1. Price elasticity of demand is the degree of responsiveness in demand to a given change in price. It shows at what extent the demand decrease with a rise in price and increase with a fall in price. The price elasticity of demand is measured by dividing the percentage change in quantity demanded by the percentage change in price. PED= %change in QD/Percentage change in price.

4.2. Price elasticity of demand can be classified into elastic demand, inelastic demand unitary elastic demand, perfectly inelastic demand and perfectly elastic demand. If the percentage change in demand is greater than the percentage change in price the demand is said to be elastic. The elasticity coefficient is greater than 1. If the percentage change in demand is less than the percentage change in price the demand is said to be inelastic. The elasticity coefficient in this case will be less than 1. If the percentage change in demand is equal to percentage change in price the demand is unitary elastic and the elasticity coefficient will be equal to 1. If the percentage change in demand is infinite the demand is perfectly elastic. The elasticity coefficient will be equal to ∞. If the change in price does not produce any change in demand the demand is perfectly inelastic. The elasticity coefficient will be equal to 0.

4.3. In case of elastic demand total revenue increase with fall in price and decrease with rise in price.

When the demand is inelastic, a rise in price increases the total revenue but a fall in price cause revenue loss.

When the demand is unitary elastic total revenue remain the same with fall or rise in price.

5)5.1. A market is said to be perfectly competitive if it satisfy the following conditions. 1. Large number of small buyers and sellers, 2. Homogenous product, 3. Perfect knowledge about the market, 4. Freedom of entry and exit and 5. Absence of transport cost.

5.2. The profit maximizing condition of a firm is when the marginal revenue is equal to marginal cost. When the marginal revenue is greater than the marginal cost the firm gets higher profit. Thus to maximize profit the firm expand output until MC=MR. On the other if the marginal revenue is less than the marginal cost the firm will reduce the output till MC=MR in order to minimize loss.

5.3. Under perfect competition the firms are the price takers. The products are homogenous and perfect output. All units can be sold at a single price. Thus the MR curve faced by a firm under this market is a horizontal straight line.

But under monopolistic competition a firm must reduce the price in order to increase the sales. The product differentiation enables the firms to increase the sales by lowering the price. Thus MR curve faced by a firm in this market is downward sloping.

6).6.1. The main components of total spending in an economy are consumption, investment, government purchase and net export.

6.2. The main withdrawals or leakages from circular flow in an open economy are 1. Savings, 2. Taxes and 3. Import. Saving is the income not spends on consumption or investment. Taxes are revenue collected by the government from individuals and firms. Import is the income spent by the domestic citizens on foreign goods.

6.3.1. When the output increases in the same proportion to the increase in input, this is constant returns. 30% increase in input leads to 30% increase in output.

6.3.2. When output increase more than proportionately to the increase in input, it is increasing returns. 30% increase in input leads to 50% increase in output

6.3.3. When output increase less than proportionately to the increase in input, it is decreasing returns. 30% increase in input results in 20% increase in output.