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UNIVERSITY OF MUMBAI

M.Com Semester-1 2018

Economics For Business Decisions Making

Q.1 : Explain the theory of Attributes in details.

Answer.

THE THEORY OF ATTRIBUTES.

Kelvin Lancaster (Consumer Demand: A New Approach, New York, Columbia University Press, 1971)

put forward the characteristic or attributes approach to consumer theory. Kelvin says that consumers demand a

good because of the characteristics, properties and attributes of the good which give rise to utility. For example, a

consumer does not demand eggplant for itself but because egg plants satisfy the demand for calories and proteins.

Calories and proteins contained in a food product are the direct source of utility rather than the product itself.

However, proteins and calories are provided by other vegetables such as spinach and cauliflower also. A

commodity has more than one attribute and any given attribute is present in more than one commodity.

In Panel ‘A’ of Figure 2.4, the X-axis measures the attribute of protein and the Y-axis measures calories.

Let us assume that the consumer’s income is Rs.100 and that Rs.50 worth of Spinach provides the combination of

protein and calories given by point A (A unit of spinach protein is assumed to provide four times calories as much

as a unit of Mustard Green protein because the slope of the Spinach ray is four times larger than the Mustard

Green ray) and Rs.50 worth of Mustard Green gives the combination at point B. The budget line is AB and Area

OAB is called the feasible region and budget line AB is the efficiency frontier. The consumer can purchase any

combination of protein and calories in AOB. In order to maximize utility, the consumer will choose a

combination on budget line AB. If U1 is the indifference curve in the attributes space, the consumer maximizes

utility at point C where indifference curve U1 is tangent to budget line AB. The consumer reaches point C by

obtaining OF attributes by spending Rs.50 on Mustard Green and FC attributes by spending Rs.50 on Spinach.

OF = ½ OB and OG = ½ OA. FC equals OG both in length and direction be noted.

In Panel B, egg-plant, a new commodity is introduced. Egg-plant has half as many calories per unit of

protein as Mustard Green. If Rs.100 worth of egg-plant provides the combination of protein and calories given by

point H, the budget line or efficiency frontier becomes AH. The consumer now maximizes utility at point J where

indifference curve U2 is tangent to budget line AH. The consumer reaches point J by obtaining OK attributes by

spending Rs.50 on egg-plant and KJ = OG attributes by spending the balance Rs.50 on Spinach. The consumer

ignores Mustard greens.

A fall in the price of a commodity is shown by a proportionate outward movement along the attributes

ray of the commodity. An increase in income is shown by a proportionate outward shift of the entire budget line.

A shift in the budget line allows the consumer to reach a higher indifference curve.

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Q.2. Discuss the application of Elasticity of Demand and Supply to Major Economic

Issues.

Answer. A. Price Elasticity of Demand and Supply

1. Price elasticity of demand measures the quantitative response of demand to a change in price. Price elasticity

of demand (ED) is defined as the percentage change in quantity demanded divided by the percentage change

in price. That is,

In this calculation, the sign is taken to be positive, and P and Q are averages of old and new values.

2. We divide price elasticity into three categories:

(a) Demand is elastic when the percentage change in quantity demanded exceeds the percentage change in

price; that is, ED > 1.

(b) Demand is inelastic when the percentage change in quantity demanded is less than the percentage change

in price; here, ED < 1.

(c) When the percentage change in quantity demanded exactly equals the percentage change in price, we

have the borderline case of unit-elastic demand, where ED = 1.

3. Price elasticity is a pure number, involving percentages; it should not be confused with slope of demand

curve.

4. The demand elasticity tells us about the impact of a price change on total revenue. A price reduction

increases total revenue if demand is elastic; a price reduction decreases total revenue if demand is inelastic;

in the unit-elastic case, a price change has no effect on total revenue.

5. Price elasticity of demand tends to be low for necessities like food and shelter and high for luxuries like

snowmobiles and vacation air travel. Other factors affecting price elasticity are the extent to which a good

has ready substitutes and the length of time that consumers have to adjust to price changes.

A. Price Elasticity of Supply

1. Price elasticity of supply measures the percentage change of output supplied by producers when the market

price changes by a given percentage.

In this calculation, the sign is taken to be positive, and P and Q are averages of old and new values.

2. We divide price elasticity of supply into three categories:

(a) Supply is elastic when the percentage change in quantity demanded exceeds the percentage change in

price; that is, Es > 1.

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(b) Supply is inelastic when the percentage change in quantity demanded is less than the percentage change

in price; here, Es < 1.

(c) When the percentage change in quantity supplied exactly equals the percentage change in price, we have

the borderline case of unit-elastic supply, where Es = 1.

C. Applications to Major Economic Issues

(a) One of the most fruitful arenas for application of supply-and-demand analysis is agriculture.

Improvements in agricultural technology mean that supply increases greatly, while demand for food rises

less than proportionately with income. Hence free-market prices for foodstuffs tend to fall. No wonder

governments have adopted a variety of programs, like crop restrictions, to prop up farm incomes.

(b) A commodity tax shifts the supply-and-demand equilibrium. The tax's incidence (or impact on incomes)

will fall more heavily on consumers than on producers to the degree that the demand is inelastic relative to

supply.

(c) Governments occasionally interfere with the workings of competitive markets by setting maximum

ceilings or minimum floors on prices. In such situations, quantity supplied need no longer equal quantity

demanded; ceilings lead to excess demand, while floors lead to excess supply. Sometimes, the interference

may raise the incomes of a particular group, as in the case of farmers or low-skilled workers. Often,

distortions and inefficiencies result.

Paradox of plenty in agriculture implies that a bumper crop reaped by the farmers brings a smaller total

income to them. The fall in the income or revenue of the farmer as a result of the bumper crop is due to the

fact that with greater supply the prices of the crop decline drastically and in the context of inelastic demand

for them, bring about fall in the income of the farmers. Thus, bumper crop, instead of raising their incomes,

reduces them. The reason for this lies in the elasticity of demand for food stuff. The demand for food stuff is

fairly inelastic. An increase in their supply tends to lower their price. The lower price does not increase the

demand for it as per the law of demand or a normal price-demand relationship. Thus large harvest tends to

bring low revenue to the farmers.

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Q.3. Discuss changes in consumer’s equilibrium due to changes in price of a commodity

and derive the consumption curve.

Answer.

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Q.4. Discuss in Details about Price Ceiling and Price Floors.

Answer.

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PRODUCTION ANALYSIS

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Q.5. What is Market Structure? Difference between perfectly and imperfectly competitive

markets.

Answer.

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Q.6. Price and Output Determination under Non-Collusive Oligopoly.

Answer.

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Profit maximization of simple and discriminating monopolist

Monopoly

Introduction:

i. A monopoly is a firm that is the sole seller of a product without close substitutes.

ii. A monopoly firm has market power, the ability to influence the market price of the

product it sells. A competitive firms has no market power.

Why monopoly arises

The main cause of monopolies is barriers to entry- other firms cannot enter the market.

Three sources of barriers to entry:

i. A single firm owns a key resource.

E.g. DeBeers owns most of the world’s diamond mines

ii. The Govt. gives a single frim the exclusive right to produce the good.

E.g., Patents, copyright laws

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