DATE OF EXAM: 15-10-2011

ANSWER KEY MID SEMESTER EXAMINATION, OCTOBER 2011 First Semester ECONOMICS FOR BUSINESS

1. a. Global integration of economies plays a vital role in the economic development of a country. Explain.

Global integration of economies means expansion of economic activities across political boundaries of nation states. It is associated not only with an increasing cross- border movement of goods, services, capital technology information and people but also with an organization of economic activities which straddles national boundaries. This process is driven by the lure of profit and threat of competition in the market. The term Globalization as such denotes integration of national economy with that of the world economy. It is conversion of a national market into international mobility of factors of production. In others words, it may be described as the integration of national economy with that of global economy. An important attribute of Globalization is the increasing degree of openness, which has three dimensions, i.e.; international trade, international investment and international finance. According to World Development Report, Globalization reflects the progressive integration of worlds economies. The manifestation of production includes spatial reorganization of production the interpenetration of industries across borders, the spread of financial markets, and the diffusion of identical consumer goods to distant countries and massive transfer of population across national frontiers. Advantages of Global integration of economies:

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(a) Promise of Increase Productivity And Higher Living Standards: Globalization brings in new opportunities such as access to markets and technology transfer. These opportunities hold out the promise of increased productivity and higher living standards.

(b) Increase In Trade In Goods And Services: There is tremendous growth in trade in goods and services. Trade in goods and services has grown twice as fast as global GDP in the 1990s and the share attributable to developing countries has climbed from 23 to 29 percent. Increased international competition in services will lead to reduction in prices and improvements in quality. This will increase the competitiveness of downstream industries. Both industrial and development economics will gain by opening their markets. (c) Provide New Opportunities For Growth: For developing countries, trade is the primary vehicle for realizing the benefits of Globalization. Imports bring additional competition and variety to domestic markets, which benefit consumers. Exports, on the other hand, enlarge foreign markets and benefit business. Further trade exposes domestic firms to the best practices of foreign firms and encourages greater efficiency. Trade gives forms access to improved capital inputs such as machine tools, which boosts productivity. Trade encourages the redistribution of labor and capital too relatively to more productive sectors. It has contributed to the ongoing shift of some manufacturing and services activities from industrial to developing countries, providing new opportunities for growth. (d) Globalization of Financial Markets: Globalization of finance markets affects development because finance plays an important role in economic growth and industrialization. Financial Globalization affects growth in two ways. First, it increases the global supply of capital. Second, it promotes domestic financial development and hence, improves allocative efficiency, creates new financial instruments, and raises the quality of baking services. (e) Increased Flow Of foreign Market Capital: Globalization leads to increased flo of capital across countries. Flows of foreign capital offer substantial economic gains to all parties. Foreign investors diversify their risks outside their home market and gain access to profitable opportunities throughout the world. Economies receiving inflows raise the level of investment. When there is foreign investment it is generally accompanied by management expertise, training programs and important linkages to suppliers and international markets. (f) Impact on Poverty: The fast growth and overall development resulting from liberalization, increased flow of trade ad capital could have a major impact on poverty. It is likely to reduce the number of people living in absolute poverty.

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(g) Increase The Level Of Interdependence And Competitiveness: Globalization is supposed to accelerate and increase the level of interdependence and competitiveness among nations. It is a change from plan to market. As a consequence, markets for merchandise trade are expanding, more and more service are being traded internationally, and capital is flowing in quicker and increasingly diverse ways across countries and regions. There is increasing integration of countries into World markets for goods, services and capital. In short, Globalization widens and intensifies international linkages in trade and finance. (h) Induce Domestic Firms To Improve Technology: The better technology brought in by the MNCs may induce or provoke the domestic firms to absorb similar technology. This may improve their competitiveness and expansion.

b. The major principles of Business Economics help in decision making. Justify. (10 marks)

Ans: Briefly explain each of the principle: Marginal and Incremental principle, Equimarginal principle, Opportunity cost principle, Principle of time perspective and discounting principle. Use of these principles in decision making is given below:

The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price. A manager can make a rational decision by allocating/hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various uses of resources. According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than its opportunity cost. According to this principle, a manger/decision maker should give due emphasis, both to short-term and long-term impact of his decisions, giving apt significance to the different time periods before reaching any decision. According to this principle, if a decision affects costs and revenues in long-run, all

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those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today.

2. a. (i) Explain why the price in competitive markets settles down at the equilibrium intersection of supply and demand. Explain what happens if the market price starts out too high or too low. What are the equilibrium price and quantity sold if Demand-Supply functions are: Demand: Q=200-2P, Supply: Q=20+4P. (5 marks) Ans: Points to be included in the answer Price in a competitive market or in perfect competition is determined by the invisible hands of market, i.e., the forces of demand and supply. Illustrate market equilibrium. Explain equilibrium quantity and equilibrium price. Explain excess demand and excess supply. Under market equilibrium, quantity demanded equals quantity supplied, so, 2002P=20+4P P=30, Q=140

(ii) Why does the demand curve slopes downward? Illustrate the law of demand with two cases from your own experience. (5 marks) Ans: Explain Income effect, substitution effect and law of diminishing marginal utility. Write any two examples in support of law of demand.

b. A small state university is faced with a critical financial problem. At the present tuition rates, the university is losing Rs. 5 crore per year. The head of the university urges that there should be a 25% increase in tuition fee. Based on the total students enrolled, he projects that this increase would cover the Rs. 5 crore deficit in revenues. Students of economics find a journal article that discusses the price elasticity of demand for college

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education. The author estimates that the elasticity of enrollment at state universities is -1.3 with respect to tuition charges. That is, a 1 % increase in tuition fee would decrease enrollments by 1.3%. (i) What is the nature of Price elasticity of demand for college education in this case? (i) How would the total enrollment be affected, with the proposed hike of tuition fee by 25%. (iii) What is the effect on total revenue, if the price is varied (increased or decreased) for a product/service; demand for the product/service being elastic, inelastic and unitary elastic. (10 marks)

Ans: (i) Here demand for college education is relatively elastic. That is, a 1 % increase in tuition fee would decrease enrollments by 1.3%. When demand is elastic, the quantity effect dominates the price effect; so an increase in the price decreases total revenue.

(i) With the proposed hike of tuition fee by 25%, enrollments will reduce by 25*1.3=32.5% (iii) If demand for a good is elastic (the price elasticity of demand is greater than 1), an increase in price reduces total revenue. In this case, the price effect is weaker than the quantity effect. If demand for a good is inelastic (the price elasticity of demand is less than 1), an increase in price increases total revenue. In this case, the price effect is stronger than the quantity effect. If the demand for the good is unit-elastic (the price elasticity of demand is 1), an increase in price does not change total revenue. In this case the two effects off-set each other.

(a) Distinguish between the law of variable proportion and law of returns to scale. (10 marks)

DATE OF EXAM: 15-10-2011

Ans: Explain law of variable proportion and law of returns to scale with appropriate diagrams. Law of variable proportion is for the short run, law of returns to scale is for the long run. Marginal productivity is never negative in the long run, whereas in the short run, it may become negative.

(b) Write short notes on: (i) Isoqaunt (ii) Economies and Diseconomies of scale (10 marks)

Ans: Explain and illustrate Isoqaunt with its various characteristics and uses. Explain various economies and diseconomies of scale.

3. (a) Oligopolists are more likely to match a price cut than a price increase by a competitor. Why? Illustrate the kinked demand curve model of Oligopoly. (10marks)

Ans: Explain the market structure of Oligopoly, with examples, price war, rigidity of price, cartel etc. Illustrate kinked demand curve.

(b) Explain the various methods of measuring National income.

(10 marks)

Ans: Explain Net output/value added method Expenditure method Factor- Income method

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