Assignment One

Answer the following Descrip ve Category ques ons in about 500 words each. Each ques on
carries 20 marks. Word limit does not apply in case of numerical ques ons 2×20 = 40

Q- How is Monopoly different from that under Perfect Compe on? Explain the long run
equilibrium under Monopoly.

Ans : Differences between Monopoly and Perfect Compe on:

1. Number of Firms:

o Monopoly has a single firm domina ng the market, while perfect compe on has
many firms.

2. Market Power:

o A monopolist is a price maker, se ng prices above marginal cost, whereas firms in

perfect compe on are price takers, accep ng the market price.

3. Barriers to Entry:

o Monopoly has high barriers to entry, preven ng compe on, while perfect
compe on has no barriers, allowing free entry and exit.

4. Product Differen a on:

o A monopolist sells a unique product with no close subs tutes, while firms in perfect
compe on sell iden cal products.

5. Demand Curve:

o A monopolist faces a downward-sloping demand curve, while firms in perfect

compe on face a perfectly elas c demand curve.

Long-Run Equilibrium under Monopoly:

In the long run, a monopolist can sustain economic profits due to high barriers to entry. The
equilibrium is achieved where:

1. Profit Maximiza on: The monopolist produces at the output level where Marginal Revenue
(MR) = Marginal Cost (MC).

2. Price Se ng: The price is set on the demand curve at this output level, which is higher than
the marginal cost.

3. Economic Profits: Unlike perfect compe on, the monopolist earns posi ve economic
profits in the long run, as no new firms can enter to compete.

4. Inefficiency: The monopolist produces less output and charges a higher price than in perfect
compe on, leading to alloca ve inefficiency (P > MC) and produc ve inefficiency (not
producing at minimum ATC).
Q-2 Give reasons for diminishing returns to scale accruing to a firm in the long run.

Ans- Reasons for Diminishing Returns to Scale in the Long Run

Diminishing returns to scale occur when a firm increases all inputs propor onately but experiences a
less than propor onate increase in output. This phenomenon is observed in the long run and can be
a ributed to the following reasons, as explained in the IGNOU BECC-101 (Introductory
Microeconomics) book:

1. Managerial Inefficiencies:
As a firm expands, managing large-scale opera ons becomes complex. Coordina on among
departments, communica on gaps, and decision-making delays lead to inefficiencies,
reducing produc vity.

2. Limited Resources:
Certain inputs, such as skilled labor or raw materials, may become scarce as the firm grows.
This scarcity limits the firm's ability to maintain propor onal output growth.

3. Overu liza on of Fixed Factors:

Even in the long run, some factors (e.g., land, specialized machinery) remain rela vely fixed.
Overu liza on of these factors leads to conges on and inefficiency, reducing output returns.

4. Diseconomies of Scale:
Large-scale produc on o en leads to diseconomies of scale, such as higher administra ve
costs, bureaucra c delays, and increased wastage. These factors counteract the benefits of
scaling up.

5. Technological Constraints:
Technology may not always scale propor onately with input increases. For instance, doubling
machinery may not double output due to technical limita ons or inefficiencies in produc on
processes.

6. Market Constraints:
As the firm grows, it may face difficul es in sourcing inputs or distribu ng output efficiently,
especially if market condi ons (e.g., transporta on, supply chains) do not scale
propor onately.

In conclusion, diminishing returns to scale arise due to managerial challenges, resource limita ons,
overu liza on of fixed factors, diseconomies of scale, technological constraints, and market
inefficiencies. These factors hinder the firm's ability to maintain propor onal output growth as it
expands in the long run.
Q- In a duopolist market two firms can produce at a constant average and marginal cost of AC = MC =
2. They face the market demand curve P = 14 – Q, where Q = Q1 + Q2, here Q1 is the output of Firm
1, Q2 is the output of Firm 2. In the Cournot’s model:

(i) Find the ac on-reac on func ons of the two firms.

(ii) What are the profits of the two firms.

(iii) Calculate the profit maximizing levels of output (Q1 and Q2) and price.

Ans- In a duopoly market with two firms producing at a constant average and marginal cost
of AC=MC=2AC=MC=2, and facing the market demand curve P=14−QP=14−Q, where Q=Q1+Q2Q=Q1
+Q2, we can analyze the Cournot equilibrium as follows:

(i) Ac on-Reac on Func ons of the Two Firms

In Cournot's model, each firm chooses its output (Q1Q1 or Q2Q2) to maximize its profit, taking the
other firm's output as given. The profit func ons for the two firms are:

To find the reac on func ons, we take the first-order condi ons (FOCs) for profit maximiza on:

For Firm 1:

For Firm 2:
(ii) Profits of the Two Firms

To find the profits, we first solve for the equilibrium outputs (Q1Q1 and Q2Q2) by subs tu ng the
reac on func ons into each other:

From Firm 1's reac on func on:

Q- The Paul Sweezy’s kinked demand curve model shows price rigidity under Oligopoly. Explain how.

Ans- Paul Sweezy’s Kinked Demand Curve Model and Price Rigidity in Oligopoly

The kinked demand curve model, proposed by Paul Sweezy, explains price rigidity in oligopolis c
markets. Oligopoly is characterized by a few interdependent firms, where each firm’s decisions affect
others. Sweezy’s model is based on the following key assump ons and reasoning, as explained in
the IGNOU BECC-101 (Introductory Microeconomics) book:

1. Kinked Demand Curve:

o The demand curve faced by an oligopolis c firm has a kink at the prevailing price.

o If the firm raises its price, compe tors do not follow, making the demand
curve elas c above the kink (firm loses significant market share).

o If the firm lowers its price, compe tors match the price cut, making the demand
curve inelas c below the kink (firm gains li le market share).

2. Marginal Revenue (MR) Discon nuity:

o The kink in the demand curve creates a discon nuity (gap) in the MR curve.

o At the kink, the MR curve has a ver cal break, meaning small changes in marginal
cost (MC) do not affect the profit-maximizing output or price.

3. Price Rigidity:

o Firms maximize profit where MR = MC.

o Due to the MR gap, even if MC shi s (due to cost changes), the firm has no incen ve
to change its price as long as MC remains within the gap.

o This leads to price rigidity, as firms avoid price changes to prevent losing market
share or triggering price wars.

4. Interdependence:

o Firms an cipate compe tors’ reac ons, making them reluctant to alter prices.

In conclusion, Sweezy’s model highlights how the kinked demand curve and MR discon nuity lead
to stable prices in oligopoly, even when costs or demand condi ons change.

Reference: IGNOU BECC-101, Block 5, Unit 3: Market Structures.

Assignment Two
Answer the following Middle Category ques ons in about 250 words each. Each ques on carries
10 marks. Word limit does not apply in applica on part of the ques on. 3x10=30

Q-1 (a)What is economic rent? Discuss the Ricardian theory of economic rent.

(b)The demand for factors is called derived demand . Explain

Ans - (a) Economic Rent and Ricardian Theory of Economic Rent

Economic Rent refers to the payment made to a factor of produc on (e.g., land, labor, or capital)
over and above its opportunity cost. It is the surplus earned by a factor due to its scarcity or unique
produc vity. For example, a highly skilled worker earning more than the minimum wage required to
keep them in their job is receiving economic rent.

Ricardian Theory of Economic Rent:

David Ricardo, a classical economist, explained economic rent in the context of land. According to
him:

1. Land Differen als: Land varies in fer lity and loca on. Some lands are more fer le or be er
located, making them more produc ve.

2. Surplus from Superior Land: Farmers first cul vate the most fer le land. As demand for
agricultural products increases, less fer le land is brought into cul va on.

3. Economic Rent as Surplus: The surplus earned from superior land (due to higher
produc vity) over the cost of cul va ng the least fer le land (marginal land) is
called economic rent.

4. No Rent on Marginal Land: The least fer le land earns no rent, as it only covers the cost of
produc on.

Ricardo’s theory highlights that economic rent arises due to the scarcity and differen al
produc vity of factors of produc on.

(b) Derived Demand for Factors

The demand for factors of produc on (land, labor, capital) is called derived demand because it
depends on the demand for the final goods and services they produce. For example:

1. Labor Demand: A factory hires workers not because it values labor itself, but because labor is
needed to produce goods that consumers demand.

2. Capital Demand: Machines are demanded because they help produce goods that are sold in
the market.

3. Land Demand: Land is demanded for agriculture or construc on based on the demand for
food or housing.
In essence, the demand for factors is derived from the demand for the final products they help
create. If consumer demand for a product falls, the demand for the factors used to produce it will
also decline.

Reference: IGNOU BECC-101, Block 6, Unit 2: Factor Pricing.

(250 words)

Q-2 Why do you find varia ons in the wage-rates across different professions? Give reasons as to
why a professor is paid higher salary than a school teacher?

Ans- Reasons for Varia ons in Wage Rates Across Professions

Wage rates vary across professions due to differences in skill requirements, demand-supply
dynamics, and job characteris cs. Here are the key reasons:

1. Skill and Educa on:

Professions requiring higher educa on, specialized training, or advanced skills (e.g., doctors,
engineers, professors) command higher wages. For example, a professor typically holds a
Ph.D. and has exper se in a specialized field, whereas a school teacher may only need a
bachelor’s degree.

2. Demand and Supply:

Wages are influenced by the demand for and supply of labor. Professions with a shortage of
skilled workers (e.g., IT professionals) pay higher wages, while those with an oversupply of
labor (e.g., clerical jobs) pay less.

3. Produc vity and Contribu on:

Professions that contribute significantly to an organiza on’s or society’s produc vity (e.g.,
professors contribu ng to research and educa on) are paid more than those with limited
impact.

4. Job Complexity and Responsibility:

Jobs involving higher responsibility, decision-making, or complexity (e.g., professors
designing curricula and conduc ng research) are compensated more than rou ne or less
complex jobs (e.g., school teachers following set syllabi).

5. Market Forces:
Professions in high-demand sectors (e.g., technology, healthcare) o en pay more due to
compe ve market forces, while others (e.g., teaching) may have lower wage growth.

6. Social and Economic Value:

Professions perceived to have higher social or economic value (e.g., professors shaping
future genera ons) may a ract higher salaries compared to those with less perceived value.

Why a Professor is Paid More Than a School Teacher

1. Higher Qualifica ons: Professors typically hold advanced degrees (Ph.D.), while school
teachers may only need a bachelor’s degree.

2. Specialized Exper se: Professors have specialized knowledge and contribute to research,
which adds value to academia.
 3. Greater Responsibility: Professors design curricula, mentor students, and conduct research,
whereas school teachers follow established curricula.

4. Market Demand: Universi es compete for highly qualified professors, driving up wages,
while school teaching has a larger labor supply.

In conclusion, wage varia ons reflect differences in skills, responsibili es, and market dynamics.

(250 words)

Q- What are externali es? Explain with diagram why is the op mal output not reached under
nega ve externality.

Ans - Externali es

Externali es are the unintended side effects of an economic ac vity on par es not directly involved
in the ac vity. They can be posi ve (beneficial) or nega ve (harmful).

Nega ve externality occurs when the produc on or consump on of a good imposes costs on third
par es, leading to overproduc on or overconsump on. This can be illustrated with a diagram:

In the diagram, the supply curve (S) represents the private cost of produc on, while the demand
curve (D) represents the private benefit of consump on. The intersec on of S and D determines the
market equilibrium output (Q*) and price.

However, when considering the nega ve externality, the social cost (including the external cost) is
higher than the private cost. This leads to overproduc on, as the market equilibrium occurs at a
higher output level (Qe) than the socially op mal level (Q*). This is because the nega ve externality
is not reflected in the market price, causing producers to produce more than is socially desirable.
As a result, the op mal output is not reached under nega ve externality, leading to a welfare loss for
society. This situa on calls for government interven on, such as taxes or regula ons, to internalize
the external cost and bring produc on and consump on to the socially op mal level.

Assignment Three
Answer the following Short Category ques ons in about 100 words each. Each ques on carries 6
marks. Word limit does not apply in applica on part of the ques on. 5x6=30

Q- What do you understand by the term “Excess Capacity”?

Ans - Excess Capacity refers to a situation where a firm produces at a level below its
minimum efficient scale (MES), resulting in underutilization of resources. In monopolistic
competition, firms operate with excess capacity in the long run due to product differentiation
and downward-sloping demand curves. They produce less than the output at which average
costs are minimized, leading to inefficiency. This occurs because firms face a trade-off
between producing at optimal scale and maintaining product variety.

Q- What is an Income consump on curve? Draw the Income consump on curve for an inferior good.

Ans- The Income Consumption Curve (ICC) shows the combination of goods a consumer
chooses at different income levels, holding prices constant. It traces the optimal
consumption bundles as income changes. For an inferior good, the ICC slopes backward
because, as income rises, the consumer buys less of the inferior good and more of the
normal good. For example, if cheap noodles are an inferior good, the consumer may switch
to better alternatives as income increases.

Q- . What are the policy instruments available for government interven on to regulate inefficient
market situa ons?

Ans- The government uses various policy instruments to regulate inefficient market
situations, such as:

1. Taxes and Subsidies: Correct externalities (e.g., carbon tax for pollution,
subsidies for education).
2. Regulations: Impose rules to control harmful activities (e.g., emission
standards).
3. Price Controls: Set price ceilings or floors to address inequities (e.g.,
minimum wage).
4. Public Provision: Supply public goods (e.g., national defense, healthcare).
5. Tradable Permits: Allow trading of pollution rights to achieve efficiency.

These tools help address market failures like externalities, public goods, and
monopolies.

Q- What is the concept of efficiency in economics? How is the efficient alloca on of resources done
among firms?
Ans- In economics, efficiency refers to the optimal allocation of resources to
maximize societal welfare. It occurs when resources are allocated in a way that no
one can be made better off without making someone else worse off (Pareto
efficiency). Efficient allocation among firms is achieved when:

1. Marginal Cost (MC) = Price (P): Firms produce at the level where the cost of
producing one more unit equals the price consumers are willing to pay.
2. Equal Marginal Products: Resources are allocated so that the marginal
product of each input is equal across firms, ensuring no reallocation can
increase total output.

Q- Elucidate the features exis ng under Oligopolis c market structure.

Ans- An oligopolistic market is characterized by:

1. Few Sellers: A small number of firms dominate the market.

2. Interdependence: Firms are mutually dependent; actions of one affect others.
3. Barriers to Entry: High entry barriers (e.g., patents, economies of scale)
restrict new firms.
4. Non-Price Competition: Firms compete through advertising, branding, and
innovation rather than price.
5. Price Rigidity: Prices tend to remain stable due to fear of price wars
(explained by the kinked demand curve).
6. Collusion: Firms may collude to set prices or output, forming cartels.