1

58636153.doc

B.Com-I

Mohammad Kashif Hayat

Q No.1

State and explain the Law of Diminishing Marginal Utility with the help of table and figure graph! and al"o explain it" li#itation".

$ No. 1

The law is defined by the orthodox classical economist. They believed that tility or intensity of desire !oes on diminishin! as a cons mer cons mes s ccessive nits of a commodity. " e to this decreasin! trend in nits of mar!inal tility this law is termed as the law of "iminishin! #ar!inal $tility.

State#ent of the law%In the words of %lfred #arshall&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. %ccordin! to '. %. (am elson&As the amo nt cons med of a good increases! the marginal tility of the good tends to decrease. In sim)le words we can define the law in the followin! words&"f other things remain the same! when a cons mer cons mes s ccessive nits of a same commodity then marginal tility starts diminishing.

&xplanation of the "tate#ent%This law is based on two im)ortant facts& 1. * man wants are satiable and th s intensity of s ch want !oes on diminishin! till a )oint is reached when cons mer f lly satisfies his desire with the cons m)tion of s ccessive se of the commodity. +. "ifferent !oods are not )erfect s bstit tes of each other in the satisfaction of )artic lar wants. Th s the intensity of want diminishes beca se this !ood is not devoted to the satisfaction of other want. The law of diminishin! mar!inal tility can be defined in the followin! f nctional form& #$x , f -.x/ This f nction ex)lains the ne!ative relationshi) between both of the variable i.e. .x# _ #$x This relationshi) can be shown in the followin! table& 'nit" (! 1 + 3 0 5 6
58636153.doc
22 20 18 16 14 12 10 8 6 4 2 0 -2

)' 8 6 0 + 1 -+
B.Com-I

*' 8 10 18 +1 +1 18

*'

( +
1 2

Mohammad Kashif Hayat

)'

3 #$planation of the above table and fig re%&

In the above table and fi! re we have ex)lained the wor2in! of 3aw of "iminishin! #ar!inal $tility -3"#$/. 4hen the cons mer cons mes 1st nit of the commodity then #$ -#ar!inal $tility/ is 8 nits as ill strated with )oint 5a6 in the fi! re. 7n the cons m)tion of + nd nit of the commodity #$ decreases to 6 nits whereas T$ -Total $tility/ increases to 10 nits. This is ill strated with )oint b and b' res)ectively in the fi! re. (imilarly we have other )oint c8 d8 e 9 f showin! different nits of #$ a!ainst different nits cons med of the same commodity. %fter :oinin! these )oints we will !et ne!atively slo)ed #$ C rve indicatin! the existence of the 3aw8 whereas for T$ we have the )oint c'8 d'8 e' and f' a!ainst different nits cons m)tion. *ere we observe when #$ is decreasin! b t remain )ositive while T$ is increasin!. 4hen #$ is ;eroin! then T$ is maxim m and #$ become ne!ative while T$ starts decreasin!.

$""u#ption of the law%The 3"#$ holds when the followin! factors are held constant& i! +ontinuou" u"e of the ,o##odit-. The nits of the commodity are ta2en contin o sly. It means that the commodity is ta2en within a certain time. .ea"onable unit". The commodity is ta2en in s itable and reasonable nits. #$ of too small nits will increase instead of diminishin!. /ixed in,o#e of ,on"u#er. Income of the cons mer sho ld not be chan!ed d rin! the st dy of h man behavior. Increase in income will increase h man desires and hence tility. 'n,hanged nature of the ,o##odit-. <at re of the commodity sho ld not be chan!ed. Im)rove in the nat re of commodity will increase #$. 'n,hanged ta"te and habit". Taste and habits of cons mer sho ld not be chan!ed. By chan!in! taste or habit #$ may increase.

ii!

iii!

i0!

0!

1i#itation of the 1aw%i. 2nowledge The law is not a))licable in case of 2nowled!e beca se the desire of !ainin! 2nowled!e increases by readin! more and more boo2s. ii. 3"tentation The law is not a))licable is case of ostentations. If a )erson desires to have more thin!s of ostentations then his #$ will be increased. iii. 4obbie" In case of hobbies #$ increases for !reater nits of commodity8 therefore8 the law is not a))licable. i0. 4i"tori,al #onu#ent" In case of historical mon ments #$ increases therefore8 the law is not a))licable. 0.
58636153.doc

5rug"
B.Com-I

Mohammad Kashif Hayat

0 In case of dr !s #$ increases on increasin! the se of dr !s8 therefore8 the law is not a))licable.

&xplain the i#portan,e 6 u"e" of the Law of Diminishing Marginal Utility.

4e have the followin! ses of 3aw&1. Guidance of the consumer%% rational cons mer always desires to maximi;e his

tility while his income is

limited. The cons mer !ets better ! idance thro !h this law. % cons mer has to ) rchase that m ch nits of a commodity for which mar!inal tility becomes e= al to the )rice of it i.e. #$x , 'x +. Calculation of consumer surplus%%ccordin! to the law consumer surplus is the difference between highest utility and the actual price which he pays for getting highest utility. Therefore8 when we are !iven the val es of #$ the cons mer s r)l s is the difference of the nits of #$ and )rice of the commodity act ally cons mer )ays i.e. Cons mer ( r)l s , #ar!inal $tility > 'rice C( , #$ > ' '? C( 3. Helpful in the law of Equi-Marginal Utility%The tility f nction showin! many commodities incl ded in the ) rchase )lan of the cons mer is $, f - @18 @+8 AA..8 @n / 7 r cons mer is said to be in e= ilibri m when he cons mes that m ch nits of the commodities when #$ of different commodities become e= al to each other. BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

58636153.doc

B.Com-I

Mohammad Kashif Hayat

Q No. 3 $ No. 3

State and &xplain Law of #' i&Marginal Utility with the help of table and fig re and also disc s its practical ses. Introduction

This law )rovides ! idance to a rational cons mer that how he sho ld have to s)end his limited income to attain maxim m satisfaction. This law also ! ides o r cons mer that how many nits of different commodities a rational cons mer sho ld have to ) rchase.

In the words of #arshall&-

Statement of the law

"f a person has a thing which he can p t to several ses! he will distrib te it among these ses in s ch a way that they all have same marginal tility. "f he had a greater marginal tility in one se than in another! he wo ld gain by taking away some of it from the second se and applying it to the first.

Therefore8 the law is definin! the )ossible rational attit de of the cons mer a!ainst the limited income of the cons mer. 4e can define the law in the followin! words. "f other things remain same a cons mer can ma$imi(e tility while spending his limited income over the p rchase of different commodities in s ch a way that marginal tilities of different commodities become e' al to each other.

E planation of the law

'nit" (! 1 + 3 0 5 )'x 1+ 11 8 6 0 )'11 8 6 0 +

In the above table the 3C#$ is ex)lained for two commodities 5@6 and 5D6 when o r cons mer has limited income of only Es.5 in his )oc2et. The 3"#$ is a))lyin! in case of both 5@6 and 5D6 commodities. 'rices of both commodities are also ass med as Es. 1 each )er nit. 7 r cons mer has a lot of o)tions a!ainst the s)endin! of Es. 5 as his income. These o)tions are !iven as nder&!ption " # T$ , T$5x , 1+F11F8F6F0 , 01 !ption " % T$ , T$3x F T$+y , -1+F11F8/ F -11F8/ , 08 !ption " ' T$ , T$1x F T$0y , 1+ F -11F8F6F0/ , 01
58636153.doc B.Com-I

!ption " $ T$ , T$0x F T$1y , -1+F11F8F6/ F 11 , 06 !ption " & T$ , T$+x F T$3y , -1+F11/ F -11F8F6/ , 06 !ption " ( T$ , T$5y , 11F8F6F0F+ , 31

Mohammad Kashif Hayat

6 MU% ) MU$y
)'8
14 12 10 8 6 4 2 0 1 2 3 4 5

)'9
14 12 10 8 6 4 2 0 1 2 3

3ine of e= i-mar!inal tility

In the above fi! re the 3C#$ is ill strated while different nits of commodities 5@6 and 5D6 are meas red alon! hori;ontal axis and nits of #$ of both commodities alon! the vertical axis. The line of e= i-mar!inal tility brin!s the cons mer e= ilibri m at res)ective )oints of 5 bG 9 c H while cons mer ) rchases three nits of commodity 5@6 and two nits of commodity 5D6. 4hen cons mer deviates from this e= ilibri m as cons min! 0 nits of 5@6 commodities and 1 nit of commodity 5D6 we find that cons mer has !reater loss e= ivalent the area 5aG1+bG6 com)ared to the !ain e= ivalent to the 5c30d6. It sim)ly indicates that diversion from e= ilibri m is harmf l for the cons mer.

Consumer equili*rium

% rational cons mer always desires to maximi;e his tility with in his limited income. In real life a cons mer has to cons me many commodities whose )rices are different to each other. In s ch sit ation cons mer e= ilibri m is meant. To find o t nits of different commodities so that we can maximi;e his tility within !iven income. %ccordin! to classical economist this can be achieved a )oint where wei!hted #$ of different commodities become e= al to each other. $ , f -@18 @+8 @38 AA @n/ '1 I '+ I '3 AAA 'n CC J #$1 K '1 , #$+ K '+ , #$3 K '3 , #$n K 'n *otal% .". 166'nit" 1 + 3 0 5 MU X MU Y = CC J PX PY =x , 3 and =y , + C , 'x@ F 'yD , -+/-3/ F -5/-+/
58636153.doc B.Com-I

)'x Es. + 11 8 6 0 +

)'Es. 5 +1 15 11 5 1

)'x67x )'-675 0 3 + 1 0 3 + 1 1

Mohammad Kashif Hayat

O , Es. 16

+ractical uses of ,EMU-

:t guide" the +on"u#er%% cons mer always desires to find o t nits of cons me with in his limited income to !et maxim m satisfaction. 3C#$ ! ides the cons mer that he sho ld have to cons me that m ch nits of different commodities where wei!hted #$ of different commodities become e= al to each other. MU 1 MU 2 MU 3 MU n MU e = = = = .......... ... = P P2 P3 Pn 1 :t guide" the 7rodu,er%% )rod cer always desires to maximi;e his )rofit from his )rod ction. Lor this ) r)ose he needs to en!a!e that m ch factor in) t in s ch a way that their cost remains least. 3C#$ hel)s the )rod cer for the selection of least cost combination. This least cost combination can be obtained at that )oint where wei!hted mar!inal )rod ctivities of different factors of )rod ction become e= al to each other. D , f -38 <8 M8 C/ -3abo r8 3and8 Ca)ital8 7r!ani;er/ MPL MPN MPK MPE PE = = = = PL PN PK PE :t guide" the /inan,e )ini"ter%The :ob of Linance #inister is to !et the reven e for the !overnment so that it can be s)ent for the welfare of different sections of the society. If in the society income in e= ality )revails while have !reater #$ of money for the )oor and low #$ of money for the rich class. In this re!ard 3C#$ hel)s the Linance #inister while im)osin! the tax rate. Linance #inister im)oses hi!h rate of tax over the rich section of the society and low rate of taxes over the )oor section of the society this 2ind of system is called Progressive Tax System. This hel)s to red ce income in e= alities in the co ntry.

,imitations of ,EMU-

:t ,annot be #ea"ured%Classical economists have ass med tility as meas rable conce)t. %ccordin! to (ir Nohn *ic2s tility cannot be meas red in nits beca se it is related to h man )sycholo!y. Therefore8 it cannot be meas red. )' of #one- "hould be ,on"tant%The tility analysis is based on the ass m)tion of constant #$ of money or val e of money. In )ractice #$ of money can never be ass med constant beca se )rices do chan!e. )' ,annot be added%%ll classical economists believed that tilities of different commodities are inde)endent to each other. *ence we cannot add the tility f nctions of different commodities. *oo #an- a""u#ption"%It is based on too many ass m)tions. In real life there are not too many ass m)tions.
58636153.doc B.Com-I

Mohammad Kashif Hayat

8 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

58636153.doc

B.Com-I

Mohammad Kashif Hayat

Q No. 4 $ No. 4

5efine :ndifferen,e +ur0e. &xplain the #ain propertie" of :ndifferen,e +ur0e; Introduction

Indifference c rve analysis was )resented by sir Nohn *ic2s8 *anson and EP" %llen in their boo2 5Theory of Qal e and Ca)ital6 in 1R01s. %ccordin! to them tility is not a meas rable conce)t b t can only be ran2ed the choices considerin! res)ective )references on the !ra)h )a)er. They develo) their theory while ass min!& The cons mer is a rational )erson. $tility is ordinal conce)t and can only be reflected and can be shown on the !ra)h )a)er. 3aw of "iminishin! #E( exists. $ , f-@8 D/ and D @ #E(-y Sx/ Consistency and transitivity of choice exist.

Concept of Indifference Cur.e-

Indifference c rve is the !ra)h indication of indifferent attit de of the cons mer for different combinations of two close s bstit tes. 4e can nderstand this conce)t while ass min! two commodities @ and D and different nits of s ch commodities that the cons mer cons mes and !et same level of satisfaction. 1e0el of 8 9 "ati"fa,tion 11 + T Indifferent behavior 6 5 T 3 R T In the above table we have ex)lained indifferent behavior of the cons mer who is havin! T level of satisfaction for different combinations of commodities @ and D. we can reflect the same on the !ra)h )a)er. 9
12 10 8 6 4 2 0 0 2 4 6 8 10

B % C

8 In the above fi! re the indifference c rve is ill strated for the cons min! different combinations of commodities @ and D. 'oint 5a6 in the fi! re reflect combination of -+8 11/. 4hile )oint 5b6 shows combination of -58 6/ and 5c6 shows
58636153.doc B.Com-I

Mohammad Kashif Hayat

11 combination of -R8 3/. %ll these )oints have the same level of satisfaction. %fter :oinin! these )oints we !et ne!atively slo)ed indifference c rve. 5efinition% The difference c rve can be defined in the followin! words& =$n indifferen,e ,ur0e i" #ade after >oining different point" ha0ing different ,o#bination" of two ,lo"e "ub"titute" while the ,on"u#er re#ain" with "a#e le0el of "ati"fa,tion?.

Concept of M0S-

The term #E( meas res the rate of chan!e in nits of one commodity when the nits of other commodities are chan!ed while the cons mer remains with the same level of satisfaction. Lor a tility f nction i.e. $ , f -@8 D/ #E( is calc lated from the followin! form las. i.e.
#E( , D

-Eatio of chan!e in nites of D and nits of @ s ch that tility remains same/

/9 < 4 /9 < 3

).S 1e0el of /91/23 "ati"fa,tion 11 + -T 6 5 0K3 , 1.33 T 3 R 1.O5 T Pra)hically #E( can be meas red while ta2in! slo) of Indifference C rve at any )oint where #E( is needed to be com) ted. 9 8
(tee) -hi!her slo)e/ (lo)e at 5%6 , #E(%

Llat -less slo)e/

(lo)e at 5B6 , #E(B

1 (lo)e of a c rve , tan!ent at the )oint (lo)e at 5%6 , #E(% (lo)e at 5B6 , #E(B #E(% V #E(B @ In the above fi! re we have estimated the val e of #E( while ta2in! slo)e of indifference c rve at any )oint. 4e have drawn tan!ent line at )oint % and B for findin! the val e of #E(. %t a )oint % the tan!ent line is stee) showin! !reater val e of #E( while at )oint B the tan!ent line is flat showin! less val e of #E(.

1+58636153.doc B.Com-I

+roperties of Indifference Cur.e<e!ative slo)in! Convex to the ori!in

Mee)in! In view the nat re of indifference c rve and #E( we can s)ecify five im)ortant )ro)erties of indifference c rve i.e.

11

Mohammad Kashif Hayat

11
305They never cross each other L rther away from ori!in shows hi!her level of satisfaction. They never to ch any of the axes.

<ow we will disc ss these )ro)erties one by one. Lor a c rve we may have fo r )ossibilities re!ardin! the slo) of a c rve i.e. either the c rve may be Fively slo)ed8 ;ero slo)e or with infinite slo)e. If any one of s ch of slo) confirms the basic idea of indifference c rve then we will have s ch ty)e of slo)e for indifference c rve other wise we will be -ively slo)ed. 4e have st died earlier that for a desirable indifference c rve a cons mer sho ld cons me more nits of @ commodities when he sacrifice some nits of commodities D to !et same level of satisfaction. 1Negati0e "loping -i/ -ii/ -iii/ D BV% BV% BV%
y+ y1 % B % B

y1 x1

IC

y+

y1 % x+ x x x1 @ @ 1 + @ 1 1 1 Five Wero Infinite In the above fi! res we have )lotted three )ossible sha)es of indifference c rve with Five8 Wero and infinite slo)e. %ll of fi! res are havin! )reference of the cons mer when he ma2es from )oint % to )oint B. this is totally a!ainst the basic idea of indifference c rve and hence the desirable indifference c rve can only be >ively slo)ed. 2+on0exit-% 4ith >ive slo)in! indifference c rve we have three )ossible sha)es i.e. i. Convex to the origin ii. Concave to the origin iii. Straight line Lor findin! the desirable sha)e we sho ld 2ee) in mind that the val e of #E( m st be diminishin! as we move from left to ri!ht downward alon! the same indifference c rve. Lrom the above fi! re it a))ears that the convex sha)e of an indifference c rve the re= ired condition of diminishin! #E( is f lfill. *ence we concl de here that convex to the ori!in is the desirable sha)e of an indifference c rve.

-i/
(lo)e at %V(lo)e at B

-ii/
(lo)e at %V(lo)e at B

-iii/
(lo)e at %,(lo)e at B

#E(%V#E(B
% B

#E(%V#E(B
% B

#E(%,#E(B
% B

Convex

Concave

(trai!ht

#E( decreases as we move from left to ri!ht alon! the same IC.

#E( increases as we move from left to ri!ht alon! the same IC.

#E( remain same as we move from left to ri!ht alon! the same IC.

58636153.doc

B.Com-I

11

Mohammad Kashif Hayat

1+ 3Non-:nter"e,tion% This )ro)erty means that only one indifference c rve )asses thro !h a )oint. If two indifference c rves intersect each other then they will be )rod cin! misleadin! res lts. *ere in the followin! we )rove this )ro)erty while ta2in! a sit ation when two different indifference c rves are intersectin! each other. D

y1 y3 y+

C
B %

IC+ IC1 @

@1

@+

,e.el of satisfaction at IC# Two )oints 5%6 and 5C6 lie on the IC1 3evel of satisfaction at % , level of satisfaction at C. 7@+ F 7D+ , 7@1 F 7D1AAAA. -1/ ,e.el of satisfaction at IC$ Two )oints 5B6 and 5C6 lie on the IC+ 3evel of satisfaction at B , level of satisfaction at C. 7@+ F 7D3 , 7@1 F 7D1AAAA. -+/ Lrom e= ation -1/ and -+/ 7@+ F 7D+ , 7@+ F 7D3 -7D3V7D+/ B t form the fi! re it a))ears that 7D3 has !reater val e com)arin! to 7D+. Th s it means that intersection of two IC+ )rovide s the wron! information therefore8 it is )roved that two or more ICs can never intersect each other. 4/urther awa- fro# origin "how" higher le0el of "ati"fa,tion. *i!her IC shows hi!her level of satisfactionX from the basic idea of IC we 2now that an IC always shows same level of satisfaction at any )oint lyin! over the c rve. %ny )oint that lies above to the c rve will be )referred com)arin! to the lower one beca se hi!her )oint lies in the )reference rei!n. D 'reference re!ion IC1 IC+ @

In the above fi! re IC1 is the initial IC at which we have located )oint % the )reference rei!n at )oint % is drawn with the hel) of hori;ontal and vertical line IC+
58636153.doc B.Com-I

1+

Mohammad Kashif Hayat

13 IC )asses thro !h the )reference rei!n and hence it is observed that it shows !reater level of satisfaction com)arin! to IC1 since IC+ is away from ori!in then IC1 and th s we concl de hi!her IC shows !reater level of satisfaction. 5*he- ne0er tou,h an- of the axe". Lor the existence of an IC there m st be some de!ree of s bstit tion to exist between commodities cons med. It means for a desirable IC the val e of #E( sho ld never be ;ero or infinity. It means IC sho ld not to ch either of the axes beca se it wo ld not have any s bstit tion over s ch )oint any s bstit tion over s ch )oint. #E( , Infinity IC1

IC+ #E( , Wero

1 In the above fi! re both IC1 and IC+ are not desirable beca se both are lac2in! the de!ree of s bstit tion at the )oint where the c rves to ch the axis. It means that they never to ch the axes. BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

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B.Com-I

13

Mohammad Kashif Hayat

10

Q No. 5 $ No. 5

5i",u"e" +on"u#er &(uilibriu# u"ing indifferen,e ,ur0e *e,hni(ue. Introduction

By cons mer e= ilibri m we mean to find o t nits of different commodities that a cons mer sho ld have to cons me with in the limited income to !et maxim m level of satisfaction. $sin! IC analyses we can find this e= ilibri m by sin! IC ma) and b d!et line re)resentin! cons merGs limited income. In the followin! we briefly disc ss this method while sin! these conce)ts one by one.

Concept of IC

B % C

Indifference c rve is the !ra)h indication of indifferent attit de of the cons mer for different combinations of two close s bstit tes. 4e can nderstand this conce)t while ass min! two commodities @ and D and different nits of s ch commodities that the cons mer cons mes and !et same level of satisfaction. 1e0el of 8 9 "ati"fa,tion 11 + T Indifference c rve behavior 6 5 T 3 R T In the above table we have ex)lained indifferent behavior of the cons mer who is havin! T level of satisfaction for different combinations of commodities @ and D. we can reflect the same on the !ra)h )a)er. 99
12 10 8 6 4 2 0 0 2 4 6 8 10

8 :+ 8

In the above fi! re the indifference c rve is ill strated for cons min! different combinations of commodities @ and D. 'oint 5a6 in the fi! re reflect combination of -+8 11/. 4hile )oint 5b6 shows combination of -58 6/ and 5c6 shows combination of -R8 3/. %ll these )oints have the same level of satisfaction. %fter :oinin! these )oints we !et ne!atively slo)ed indifference c rve. 5efinition of :+% The difference c rve can be defined in the followin! words&
58636153.doc B.Com-I

10

Mohammad Kashif Hayat

15
=$n indifferen,e ,ur0e i" #ade after >oining different point" ha0ing different ,o#bination" of two ,lo"e "ub"titute" while the ,on"u#er re#ain" with "a#e le0el of "ati"fa,tion?.

Concept of *udget ,ine

B d!et line is the !ra)hical re)resentation of showin! fixed ) rchasin! )ower of the cons mer in the form of cons merGs money income. It is obvio s that the cons mer s)ends all of his money income over different ex)endit res i.e. Income , income ex)endit re over commodities @ 9 D Income , C@ F CD Income , '@.=@ F 'D.=D 7r , '@.=@ F 'D.=D e= ation of b d!et

equili*rium
3et , Es. 111K'@ , Es. 5K'D , Es. 11K9 11 8 6 0 + 12 10 8 6 4 2 0 4 8

Graphical

e planation

of

consumer

8 #-K 'D 0 8 1+ 16 +1

:n,o#e &xpenditure Es.111 Es.111 B d!et line Es.111 Es.111 Es.111 Es.111

# K '@

12

16

20

Lrom the above table and fi! res it a))ears that b d!et line is made after :oinin! different )oints com)risin! different combination of both commodities @ 9 D for which income ex)endit re remains same. It is noted here that the b d!et line is ne!atively slo)ed strai!ht line indicatin! fixed income.

Conditions of consumers equili*rium

4e can find the cons mer e= ilibri m when followin! conditions are satisfied i.e. 58636153.doc B.Com-I Mohammad Kashif Hayat 15

16 )ecessary *ondition%& MU X PX , MU Y P Y #E(@D , #E#(@D (lo)e of IC , slo) of b d!et line It means that both b d!et line and IC develo) a contact to each other in s ch a way that the b d!et line ma2es a tan!ent over the IC. + fficient *ondition%& The desirable IC sho ld be convex to the ori!in. 4e can show the case of cons mer e= ilibri m while e= ilibri m as shown in the followin! fi! re. sin! the conditions of

D
% C

In the above fi! re the sit ation of cons mer e= ilibri IC3 m is ill strated while the !iven income is ill strated with the b d!et line 5%B6 and ma) of indifference c rves with IC+ IC IC3VIC+VIC1. %t )oint 5C6 both the conditions of e= 1 ilibri m are satisfied and hence @ within 5%B6 !iven level of @1 B attainable IC+ is hi!hest )ossible 1 level of satisfaction income. 7 r cons mer sho ld have to cons me -@18 D1/ combination of both the commodities and !et maxim m level of satisfaction.

D1

@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@

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B.Com-I

16

Mohammad Kashif Hayat

1O

Q No. 6 $ No. 6

Arite "hort note" on the following; +0ICE E44EC56+E3

'rice Cffect is the net chan!e in the ) rchase of a commodity when )rice of s ch commodity is chan!ed while cons mer remains in e= ilibri m. It is = ite a fact when )rice of a commodity is decreased then cons mer finds an increase in his ) rchasin! )ower. The difference between nits ) rchased of the commodity whose )rice is chan!ed while cons mer remains in e= ilibri m is called the 'C. i.e '@ _ ' rchasin! )ower # _ @# 9 D# _ $# 'C _ the difference between nits ) rchased of commodity @ while the cons mer remains in e= ilibri m.

In the above fi! re cons merGs initial e= ilibri m is shown at )oint C1 while ) rchasin! -@18 D1/ combination of commodities with in the limited income. 4hen )rice of commodity @ is decreased then the cons mer finds the new e= ilibri m at )oint C+ with hi!her indifference c rve IC+ and ) rchasin! @+ nits of commodity @. the difference between @1 and @+ nits of commodity @ at different )rice levels and cons mer remains in e= ilibri m is called 'C.

I7C!ME E44EC5- 6IE3

Income Cffect is the chan!e in the nits ) rchased of any commodity when income of the cons mer is chan!ed while cons mer remains in e= ilibri m. 4e !enerally observe that ) rchasin! )ower of the cons mer is increased when income of the cons mer is increased so that cons mer will find an increase in his ) rchase for both commodities @ and D and finds the e= ilibri m with hi!her indifference c rve. The difference between new e= ilibri m )oint and the ori!inal one is called the IC. i.e Income# _ ' rchasin! )ower # _ @# 9 D# _ $# 'C _ the difference between nits ) rchased of any commodity while the cons mer remains in e= ilibri m.

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18 In the above fi! re IC is reflected while havin! variation in income of the cons mer and its im)act over cons mer e= ilibri m. Cons mer is initially in e= ilibri m at )oint C1 while ) rchasin! -@18 D1/ combination of commodities with in his limited income. <ow with the increase in income cons mer finds the new e= ilibri m at )oint C + with hi!her indifference c rve IC+. <ow cons mer is cons min! @+ 9 D+ combination of commodities @ i.e. @18 @+ when income is chan!ed. If we :oin both cons mer e= ilibri m )oints at different income levels then we !et income cons m)tion c rve -ICC/.

SU8S5I5U5I!7 E44EC5-

6SE3

(ince both the commodities @ and D are close s bstit tes to each other. Therefore8 if we desire to find o t the de!ree of s bstit tion between both the commodities then we have to find the (C. %ccordin! to Sir John ic!s when )rice of a commodity decreases then ) rchasin! )ower of the cons mer increases and he can find the e= ilibri m at hi!her IC. Lor (C we need to contain the cons mer at initial level of satisfaction by red cin! his money income. 4e red ce money income till the cons mer finds the e= ilibri m a!ain at initial level of satisfaction. The difference between the new e= ilibri m )oint and the initial one at the same IC is called (C. i.e. '@ _ ' rchasin! )ower # _ @# 9 D# _ *i!her IC (C _ Eed ce money income so that cons mer reaches to the initial level of satisfaction. _ the difference between the new and initial level of satisfaction is called (C.

In the above fi! re initial cons mer e= ilibri m )oint is defined at )oint C1 on the b d!et line % B while ) rchasin! -@18 D1/ combination of commodities with IC IC1. If )rice of commodity @ falls than there will be increase in real income of the cons mer. Lor findin! the (C we red ce the money income till the cons mer e= ilibri m at )oint C+ with the same IC IC1. Therefore8 the movement from )oint C1 to C+ on the same IC IC1 is called (C. BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

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1R

Q No. B $ No. B

5efine the ter# =5e#and? in &,ono#i,". State and explain the 1aw of 5e#and in detail with it" li#itation".

Concept of 9emand

The word demand is sed for any desire. In economics demand is related with the effective desire which is bac2ed by willin!ness and )ower to ) rchase a commodity in order to obtain it8 therefore8 demand is related with the followin! factors& 4illin!ness to ) rchase ( fficient ) rchasin! )ower

,aw of 9emand

The desire of a commodity while having sufficient purchasing power is called demand. 3aw of demand ex)lains the effect of chan!e in )rice over the ) rchasin! )ower of the cons mer. The inverse relationshi) between = antity demand and )rice is 2nown as law of demand.

Statement of the law

"f other things remain the same! when price of a commodity increases then ' antity demand decreases and vice&versa.

"e can define the law of demand in the following words#$

E planation of the law of demand

'# , .d ' , .d#

(ymbolically the law of demand may be ex)ressed as follows&.d , f -'/ 4here Increase in )rice _ decrease in = ality demand "ecrease in )rice _ increase in = ality demand

Table
7 Qd 2C! Es. 5 11 Es. 11 5 In the above table law of demand is ex)lained8 when )rice of thin! is Es. 5 o r cons mer demand 11 M! of it. 4hen )rice is increased to Es. 11 = antity demand will decrease to 5 M!. This trend ex)lains the wor2in! of the law of demand.

Figure

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"emand c rve is made after :oinin! different )oints com)risin! different combinations of )rice and = antity demand when law of demand holds. :ssumptions of the law of demand
The law of demand can be )roved to be o)erative when followin! ass m)tions are ex)lained below. 1Income of the consumer: Income of the cons mer affects the ) rchasin! )ower of the cons mer even tho !h )rice of the commodity nchan!ed. Therefore8 we ass me that income of the cons mer sho ld remain constant d rin! the disc ssion. 2Constant habits and taste of consumer: *abits and taste are im)ortant factors which may ne!ate the o)eration of the law of demand. This is beca se in case of habit and taste )rice variations do not chan!e the demand. *ence we ass me that taste and habits do not chan!e d rin! the disc ssion. 3Price of substitution: It is !enerally observed that )rice variation of s bstit te commodities effect the demand of the related commodity. Therefore8 law of demand does not hold for the related commodity. This is why we ass me that )rice of s bstit tes sho ld not b chan!ed d rin! the disc ssion. 4Future expectations: It is ass med that f t re )ros)ects re!ardin! the )rice of the commodity and income of the cons mer are not chan!ed. If it chan!es d e to nforeseen events then )eo)le chan!e demand of their )rod ct even witho t havin! any chan!e in )rice. 5Unchanged popu ation and !eather conditions: Chan!e in )o) lation of a co ntry !reatly effect demand of commodities even )rice is not chan!ed. (imilarly weather variations also !reatly effect demand of related commodities. *ence we ass me that there is no chan!e in )o) lation and weather conditions for the existence of the law. "Unchanged stoc# of !ea th: (toc2 of wealth determines the ) rchasin! )ower if )eo)le. If stoc2 of wealth increases then cons mer may increase the demand even )rice is not chan!ed. In s ch sit ation we ass me that stoc2 of wealth do not chan!e d rin! the disc ssion.

,imitations of the law 6E ceptions3

1$iffen goods: Piffen !oods are associated with the name of Sir %obert &iffen who )ointed o t different commodities showin! direct relationshi) between )rice and = antity demand. 258636153.doc B.Com-I

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Mohammad Kashif Hayat

+1 There are certain commodities8 which are demanded not beca se of their intrinsic worth8 b t beca se of their stat s val e8 for exam)le l x rio s cars are demanded by the wealth )eo)le8 even tho !h )rices may !o ) b t demands for them will remain same. 3Ignorance of the consumer: 7ften the cons mer is not nd ly bothered abo t the )rice he is )ayin!. It may be )ay less then this )rice. B t he is not aware of its lower )rice so he does not !o to another sho). In s ch case law is not a))licable. 4'xpectations of rise and fa in price: If )rices of different commodities are ex)ected to rise or fall in f t re then in s ch case if )rices in f t re are !oin! to rise then the )eo)le will r sh to ) rchase more of the commodity at the )resent )rice and vice-versa. 5(e)e of price: 'rod ctsG havin! very low or very hi!h )rices have reverse a))lication e.!. salt is very low )riced )rod ct and th s )eo)le behave o))osite to the law of demand. In s ch case law is not a))licable.

______________________________________________________________

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Q No. 8 $ No. 8

&xplain the ter# =+hange in 5e#and?. Ahat fa,tor" are re"pon"ible for the ,hange in de#and;

I750!9UC5I!7

. antity demand is the amo nt of any commodity that the cons mer is willin! and able to ) rchase at a s)ecific time and )rice level. "emand of any commodity is affected by many factors s ch as )rice of the commodity8 )rice of s bstit te8 income8 taste8 habits8 fashion etc. therefore8 variation in these factors effect the = antity demand to chan!e. In the followin! we disc ss these 2inds of chan!es one by one.

i.

CH:7GE I7 9EM:79 Expansion Vs Contraction in demand:

4e have two different ty)es of chan!es in demand and are disc ssed one by one&'xpansion in demand# %ccordin! to the law of demand when )rices of a commodity decreases then it res lts the = antity demand to increase this increase in = antity demand is called ex)ansion in demand. 7n the !ra)h )a)er this is reflected with the movement from left to ri!ht downward alon! the same demand c rve i.e. .d , f-'/ ' _ .d# -ex)ansion in demand/ 7 ."! 11 5 Qd

2C!

5 11

In the above fi! re the wor2in! of the law of demand is ex)lained when )rice of the commodity is 11 then the cons mer is demandin! 5 nits of the commodity as shown with the )oint 5a6 in the fi! re when )rice decreased to Es.5 then the cons mer is demandin! 11 nits of the commodity as shown with )oint 5b6 in the fi! re. Therefore8 as we move from left to ri!ht downward then it is called ex)ansion in demand. Contraction in demand# %ccordin! to the law of demand when )rices of a commodity increases then it res lts the = antity demand to decrease this decrease in = antity demand is called contraction in demand. 7n the !ra)h )a)er this is reflected with the movement from ri!ht to left )ward alon! the same demand c rve i.e. .d , f-'/ '# _ .d -contraction in demand/ 7 Qd 2C! 11 5 ++
Mohammad Kashif Hayat

."!

5 11
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In the above fi! re the wor2in! of the law of demand is ex)lained when )rice of the commodity is 5 then the cons mer is demandin! 11 nits of the commodity as shown with the )oint 5b6 in the fi! re when )rice increased to Es.11 then the cons mer is demandin! 5 nits of the commodity as shown with )oint 5a6 in the fi! re. Therefore8 as we move from ri!ht to left )ward then it is called contraction in demand.

ii.

Rise Vs Fall in demand:

" e to the chan!e in ass m)tions of the law of demand the entire demand c rve chan!e its )osition either )ward to the ri!ht or downward to the left we call s ch chan!es as rise or fall in demand. If the demand c rve chan!es )ward to the ri!ht then it is called rise in demand. *owever the shift of demand c rve to the left is called fall in demand i.e.

9EM:79

4:C5!0S 1 C:USES !4 CH:7GE I7

1Changes in price of the commodity: Chan!e in the )rice of the commodity affects the ) rchasin! )ower of cons mers and th s the demand of the commodity is chan!ed of by the )eo)le. ' _ ' rchasin! 'ower# _ =d# -Cx)ansion in demand/ '# _ ' rchasin! 'ower _ =d -Contraction in demand/ 2Changes in income: Chan!e in income affects the ) rchasin! )ower of cons mers and th s the demand of the commodity is chan!ed of by the )eo)le. 4hen income of the
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Mohammad Kashif Hayat

+0 cons mer will increase the ) rchasin! )ower will increase and th s he will ) rchase more commodities. Income# _ ' rchasin! 'ower# _ =d# -Eise in demand/ Income _ ' rchasin! 'ower _ =d -Lall in demand/ 3Change in price of the substitute: Beef and # tton are s bstit tes of each other. 4hen the )rice of m tton will increase while )rice of beef remains constant8 demand will fall for m tton and rise for beef. This will ca se demand of beef to increase. 'rice of the s bstit te# _ -'rice of related !ood nchan!ed/ _ =d of related !ood# -Eise in demand of related !ood/ 4Change in population: There will be a rise in demand for certain commodities s ch as mil28 clothin! etc. d e to increase in the n mber of cons mer as the )o) lation increases. 'o) lation# _ -'rice of !ood nchan!ed/ _ =d# -Eise in demand/ 5Change in taste and fashion: If a certain !ood is o t of style the demand for it will decrease8 even tho !h its )rice is constant we can sees that when the new com)etitive )rod cts are available. Lor the same )rice as the old )rod cts the demand will increase. Taste and habits -im)rove/ _ =d# -Eise in demand/ Lashion -im)rove/ _ =d# -Eise in demand/ 6Discovery of ne substitute: 4hen a new s bstit te of a commodity emer!es in the mar2et8 it attracts the )eo)le and there is a desire to b y the new )rod ct and th s the cons mer will shift to the new commodity and demand of old commodity will decrease8 altho !h the )rice is almost the same. <ew )rod ct _ =d# -Eise in demand/ !Change in "ovt# policy: Povt. )olicy affects the demand of individ als while im)osin! the direct and indirect taxes8 the demand will decrease if taxes will increase8 while the )rices are constant. Taxes# _ =d -fall in demand/ Taxes _ =d# -rise in demand/

9EM:79 CU0;E

0E:S!7S 4!0 7EG:5I;E S,!+I7G !4

"emand c rve is ne!atively slo)ed d e to the followin! reasons&1# $eal income effect:

Still to t-pe
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB
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+5

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Q No. D $ No. D

5efine the ter# =&la"ti,it- of 5e#and? and di",u"" different #ethod" of #ea"uring ela"ti,it- of de#and.

%ntroduction
%ccordin! to the law of demand chan!e in )rice brin!s an inverse chan!e in = antity demand -.d/ b t it does not tell s that to what extant = antity demand will have a chan!e to some chan!e in )rice of the commodity. In this way law of demand is a = alitative conce)t beca se it tells s only direction of char!e. *ow ever elasticity of demand is = antitative conce)t which exactly tells s the de!ree of flexibility in = antity demand to some chan!e in )rice of the commodity. .d , f -'/ '# _ .d -3aw of "emand/ -Clasticity of demand/ '# -11Y/ _ .d -11Y/ or -less than 11Y/ or -more than
11Y/

Definition
The term elasticity refers to the de!ree of flexibility. In the words of Prof. (lfred )arshall#$ The elasticity of the demand in a market is great or small according as the amo nt demanded increases m ch or little for a given fall in price and diminishes m ch or little for a given rise in price. %ccordin! to Prof. Cairn Cross#$ The elasticity of demand for a commodity is the rate at which ' antity bo ght changes as the price changes?. Lrom the above definitions it is clear that elasticity of demand meas res the de!ree of flexibility demand for any chan!e in )rice of the commodity. 4e can define this conce)t as !iven in the followin! words&Clasticity of demand meas res )ro)ortionate chan!e in = antity demand to the )ro)ortionate chan!e in )rice of the commodity.
Ed = Proportion ate change in quantity demand Proportion ate change in price

Degree of elasticity of demand

1$elative elastic demand :&' d ( 1) .d shows !reater res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .d# -more than 11Y/ '

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+O 2$elative inelastic demand :- &' d * 1) .d shows less res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .d# -less than 11Y/ '

3+nitary elastic demand :&' d , 1) .d shows same res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .d# -11Y/ '

.d

.d 4-erfectly inelastic demand :- &' d , .) .d shows no res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .d# -<o chan!e/ '

5-erfectly elastic demand :.d shows infinite chan!e while )rice is not chan!ed. ' -not chan!ed/ _ .d# -infinite chan!e/ '

.d

&' d , )

.d
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1-

/ethods of measuring demand Flux or percentage method

elasticity

of

%ccordin! to fl x8 elasticity of demand meas res )ercenta!e chan!e in . d to the )ercenta!e chan!e in )rice of the commodity. i.e. 'ercenta!e chan!e in = antity demand 'ercenta!e chan!e in )rice Q Q1 Qd = 2 100 Q 1 'ercenta!e chan!e in
P=

'ercenta!e chan!e in Lor exam)le&7 Es.11 Es.15 Qd +1 11

P2 P 1 100 P 1

'ercenta!e chan!e in , -51Y 'ercenta!e chan!e in , 51Y

Ed = 50% = 1 50%

Qd =

10 20 100 20

P=

15 10 100 10

ZCdZ , 1 - nitary elastic/

2-

Total outlay method

The term total o tlay refers to the total amo nt in cash that a cons mer s)ends over the ) rchase of a commodity. It means we can find o t total o tlay by m lti)lyin! )rice of the commodity with nits demanded. i.e. T7 , 'rice x = antity demand T7 , '.= , f -'/ It means we can observe elasticity of demand from the relationshi) between variation in )rice of the commodity and variation in total o tlay. i.e. if ' _ .d# _ T7# -Cd V 1/ ' _ .d# _ T7 -same/ -Cd , 1/ ' _ .d# _ T7 -Cd [ 1/

-Cd V 1/
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-Cd [ 1/
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3-

If we !et a very small chan!e in )rice of the commodity which res lts very small chan!e in = antity demand and on the !ra)h )a)er two different )oints a))ear in s ch a way that it a))ears almost a sin!le )oint. Therefore8 elasticity of demand between s ch )oints is called )oint elasticity of demand.

Formula method Point e asticit& of demand (important)

Lorm la&Ed =

Qd P . P Q

e.!. 7 Es.11 Es.11.+5 , 1R.O5 - +1 , -1.+5 , 11.+5 - 11 , F1.+5 Qd +1 1R.O5

.d '

' , 118 . , +1 0.25 10 1 Ed = , = 0.5 0.25 20 2

ZCdZ , 1.5 [ 1 -Inelastic/

*rc e asticit& of demand

If we have very )rominent chan!e in )rice of the commodity which res lts )rominent chan!e in = antity demand and on the !ra)h )a)er we !et two different )oints in s ch a way that an arc can be drawn thro !h them. The elasticity of demand between s ch )oints is called an arc elasticity of demand. q q1 P2 + P 1 Ed = 2 . P2 P 1 q2 + q1 e.!. 7 Qd Es.11, '1 +1, =1 Es.15, '+ 11, =+
10 20 15 +10 . 15 10 10 + 20 10 25 5 Ed = . = = 1.67 5 30 3 Ed =

ZCdZ , 1.6O V 1 -Clastic/

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4-

Graphic method

Pra)hically we may be !iven two ty)es of demand and )rice relationshi)s. These are&-

Linear or straight line demand curve

4e can trace o t the elasticity of demand on each of the !ra)h while sin! )oint elasticity method. In case of linear demand c rve we first have to locate the )oint alon! the demand c rve where elasticity of demand is needed to estimate. 4e com) te elasticity of demand at s ch )oint by dividin! the lower distance of the )oint with the ))er distance alon! the same demand c rve as shown in the fi! re. ' % 3et 5C6 is in the middle
Ed at C = CB =1 CA

Cd , 1 C C 1 B
Ed at =

Cd [ 1 Cd , 1 .d

EB <1 EA FB Ed at ! = >1 FA Ed at E =

1 Cd

0 =0 BA AB Ed at " = = 0

Nonlinear or curve demand curve

In case of c rvilinear demand and )rice relationshi) we first locate the )oint at which elasticity of demand is needed to estimate. Then we draw tan!ent line over s ch )oint and then extend the tan!ent line till it meets with both of the axes. Then we se the same method as sed in linear demand c rve. ' " B % " 1
AC Ed at " = AB

.d C

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#E( , Infinity

31

Q No. 10 $ No. 10

&xplain deter#inant" 6 /a,tor" of &la"ti,it- of de#and &d!.

By determinants of elasticity of demand we mean the factors d e to which Cd -elasticity of demand/ varies in different ran!es. Lollowin!s are the im)ortant determinants&1/ 0evel of %ncome : Lor hi!h income earners8 the increase in )rice of the commodity will not mater so m ch8 so minor chan!e will occ r in demand8 therefore the Cd will be inelastic. 7n the other hand for the )oor or low income earners8 d e to the increase in )rice of the commodity8 the demand wo ld !reatly chan!e so the Cd will be elastic. *i!h income earners _ Cd [ 1 3ow income earners _ Cd V 1 +/ 1vailability of substitute : If a commodity has close s bstit te at reasonable )rice8 so d e to the increase in )rice of the commodity the demand wo ld be chan!e !reatly8 so the Cd will be elastic. 7n the other hand if a commodity has not any s bstit te8 then the )eo)le are bo nd to b y that one to f lfill their necessity8 so the demand will chan!e to little extent8 so the Cd will be inelastic. In case of available s bstit te _ Cd V 1 In case of non-availability of s bstit te _ Cd [ 1 3/ 2ature of commodity : Commodities are classified as necessities and l x ries. In case of necessities d e to the increase in )rice8 there will be small chan!e in demand beca se )eo)le are bo nd to b y them man can not live witho t them e.!. salt8 wheat8 s !ar8 so Cd for necessities will be inelastic. 7n the other hand in case of l x ries d e to the increase in )rice of the commodity8 there will be !reat chan!e in demand beca se lot of )eo)le will find that o t of their ran!e8 so Cd will be elastic. <ecessities _ Cd [ 1 Comforts or l x ry _ Cd V 1 0/ 3abitual necessities : The Cd for those commodities which are a )art of cons merGs habit will be inelastic beca se d e to the increase in )rice of that commodities there will be minor chan!e in demand beca se the cons mer is bo nd to b y them8 he can not leave them -if he will leave them then it means that it will not his habit in the f t re/8 e.!. collection of stam)s. The cons mer will decrease his ex)endit re over the ) rchase of other commodities to b y habit al commodities. *abit al _ Cd [ 1 5/ -ossibility of postponing a commodity : Those commodities whose ) rchase can be )ost)one then d e to the rise in )rice the demand will !reatly chan!e8 therefore the Cd will be elastic. Lor exam)le if )rices
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3+ of woolen clothes will increase then the middle class )eo)le will se their old woolen clothes and )ost)one the ) rchase of new clothes. 'ossibility of )ost)one _ Cd V 1 6/ 4hare of commodity in total e5penditure : Those commodities whose share is lesser in the total ex)endit re then Cd will be inelastic e.!. matchbox. 7n the other hand those commodities whose share is !reater in the total ex)endit re then Cd will be elastic. Preater share _ Cd V 1 3esser share _ Cd [ 1 O/ 6oint demand : "ifferent commodities are :ointly demanded8 Cd is inelastic for them e.!. )etrol of car beca se )etrol is the necessity of car and )eo)le are bo nd to b y )etrol8 witho t )etrol they cannot se car8 if )rice of )etrol will rise then there will be small chan!e in demand. Noint demand _ Cd [ 1 8/ -rice level : Cd will be inelastic for those commodities whose )rices are very low or very hi!h beca se very low level or very hi!h level )rice does not affect the demand !reatly e.!. )rice of match. Noint demand _ Cd [ 1 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

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Q No. 11 $ No. 11

5efine the ter# =Suppl-? "tate and explain law of "uppl- with the help of table and figure;

The term s ))ly is related with the behavior of a )rod cer who always desires to maximi;e his )rofit. This is why )rod cer relates s ))ly of the commodity with the )rice of s ch commodity and other factors that may affect his )rofit i.e. .( , f -)rice8 cost of )rod ction8 )rice of raw material8 technolo!y8 Povt. )olicyA/

INTRODUCTION

The term s ))ly refers to the amo nt of the commodity which a )rod cer is willin! to sell in the mar2et at a certain )rice level and at certain time. Supply 'rice Production ( ))ly at the acce)table )rice (toc2 Time
-"aily8 wea2ly8 fortni!htly8 monthlyA/

NATURE OF SUPPLY

.e"er0e 7ri,e& #inim m )rice at which the )rod cer is willin! to sell the )rod cts b t below this all these )rod cts become stoc2.

3aw of s ))ly ex)lains direct relationshi) between = antity s ))ly and )rice of the commodity at which the )rod cer is willin! to sell his )rod cts in the mar2et. 'rod cer considers increasin! )rice for havin! !reater )rofit and therefore8 he will increase .( of the same commodity and vice-versa. *owever we can define the law of s ))ly in the followin! words.

LAW OF SUPPLY

STATEMENT OF THE LAW

i.e.

"f other things remaining the same! when price of a commodity increases then its ' antity s pply ,-+. also increases and vise&versa. .( , f -'/ '# _ .(# ' _ .( -'rice and .( are movin! in the same direction/

Lrom the above statement of the law we )erceive the idea that both .( and 'rice of the commodity are directly related to each other. 4e can nderstand the wor2in! of the law thro !h the followin! table and fi! re.
20 15 7ri,e 10 5 a

EXPLANATION OF THE LAW

7 Es.11 Es.15
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50 100 150

30

In the above table and fi! re we have )lotted the s ))ly c rve while havin! the m t al relationshi) between )rices of the commodity alon! with .s of the commodity. 4hen )rice of the commodity was Es.11 then the )rod cer s ))lies 51 nits of the commodity as shown with )oint 5a6 in the fi! re. 4hen )rice increases to Es.15K nit then .s also increases to 111 nits as shown with )oint 5b6 in the fi! re. %fter :oinin! )oints 5a6 and 5b6 in the fi! re8 we will !et )ositively slo)ed 5((6 s ))ly c rve. ( ))ly c rve is made after :oinin! different )oints havin! different combinations of )rice and .s for which law of s ))ly exists.

The existence of the 5law of s ))ly6 is attached with the followin! ass m)tions. 1Price of the ra! materia :It is ass med that )rice of the raw material sed in the )rod ction )rocess do not chan!e. This is beca se any chan!e in )rice of raw material wo ld affect the )rofit mar!in of the )rod cer to chan!e. 2Cost of production:It is ass med that the entire cost of )rod ction for )rod cin! the commodity is not chan!ed d rin! the disc ssion. This is beca se any chan!e in it wo ld affect the )rofit mar!in and th s s ))ly will be dist rbed. 3%tate of techno og&:It is ass med that the techni= e of )rod ction is not chan!ed d rin! the disc ssion this beca se any im)rovement in technolo!y may increase the s ))ly even at the same )rice. 4$o)t+ po icies:It is ass med that the Povt. )olicies re!ardin! taxation and s bsidy -some relief from the act al amo nt/ sho ld not be chan!ed d rin! the disc ssion. 5(a! and order situation:It is ass med that law and order sit ation in the co ntry is not chan!ed d rin! the st dy of the sit ation. BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

ASSUMPTIONS OF THE LAW

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35

Q No. 12 $ No. 12

5i",u"" about the ,hange" in Suppl-E al"o di",u"" #ain ,au"e" of ,hange in "uppl-.

Chan!es in = antity s ))ly d e to either chan!e )rice of the commodity or chan!e in other factors is called chan!e in s ))ly. It can be classified as&-

Introduction

'5pansion in supply:%ccordin! to the law of s ))ly we 2now that when )rice of the commodity increases then = antity s ))ly will be increased or have ex)ansion if other factors are not chan!ed. .( , f -'/ '# _ .(# -Cx)ansion/
15

E pansion ;s Contraction in Supply

Lor Cxam)le&10 b a

7 Es.5 Es.11

Q" +1 01

7ri,e

5 0 0 20

40

Q" 60

In the above fi! re the wor2in! of the law of s ))ly is ex)lained when )rice of the commodity is Es.5 then the )rod cerKs ))lier is s ))lyin! +1 nits of the commodity as shown with the )oint 5a6 in the fi! re when )rice increased to Es.11 then the )rod cer is s ))lyin! 01 nits of that commodity as shown with )oint 5b6 in the fi! re. Therefore8 as we move from left to ri!ht )ward then it is called ex)ansion in s ))ly. Contraction in supply:%ccordin! to the law of s ))ly we 2now that when )rice of the commodity decreases then = antity s ))ly will also be decreased or have contraction if other factors are constant. .( , f -'/ 15 ' _ .( -Contraction/
7ri,e

Lor Cxam)le&7 Es.11 Es.5 Q" 01 +1

10 5 0 0 20 40 b

Q" 60

In the above fi! re the wor2in! of the law of s ))ly is ex)lained when )rice of the commodity is Es.11 then the )rod cerKs ))lier is s ))lyin! 01 nits of the commodity as shown with the )oint 5a6 in the fi! re when )rice decreased to Es.5 then the )rod cer is s ))lyin! +1 nits of that commodity as shown with )oint 5b6 in
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Mohammad Kashif Hayat

36 the fi! re. Therefore8 as we move from ri!ht to left downward then it is called contraction in s ))ly.

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Mohammad Kashif Hayat

3O " e to the chan!e in ass m)tions of the law of s ))ly the entire s ))ly c rve chan!e its )osition either downward to the ri!ht or )ward to the left we call s ch chan!es as rise or fall in s ))ly. If the s ))ly c rve chan!es downward to the ri!ht then it is called rise in s ))ly. *owever the shift of s ))ly c rve to the left is called fall in s ))ly i.e.

0ise ;s 4all in Supply

4actors 1 Causes of change in supply

1Changes in price of the commodity: Chan!e in the )rice is the ma:or factor of chan!e in s ))ly. 4hen the )rice of the commodity will increase then the )rod cer will be havin! more )rofit then before and th s he will increase his s ))ly of commodity. 4e can say that d e to increase in )rice the .s will also increase and vice-versa. '# _ .s# -Cx)ansion in s ))ly/ ' _ .s -Contraction in s ))ly/ 2Change in cost of production: Chan!e in cost of )rod ction is also one of the ma:or factors in the chan!e of s ))ly. If net invested ex)endit re on the )rod ction of re= ired commodity will increase then so rly the ratio of )rofit will decrease and therefore8 )rod cer will decrease his s ))ly of commodity so it will be fall in s ))ly8 similarly if cost of )rod ction will decrease then the )rod cer will have !reater )rofit so it will be rise in s ))ly. Cost of )rod ction# _ .s -Lall in s ))ly/ Cost of )rod ction _ .s# -Eise in s ))ly/ 3Change in price of ra material: If )rice of raw material will increase then so rly the ratio of )rofit will decrease so it will be fall in s ))ly8 similarly if cost of )rod ction will decrease then the )rod cer will have !reater )rofit and therefore8 he will increase his = antity s ))ly so it will be rise in s ))ly. 'rice of raw material# _ .s -Lall in s ))ly/ 'rice of raw material _ .s# -Eise in s ))ly/ BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

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38

Q No. 13 $ No. 13

5i",u"" the nature of &la"ti,it- of Suppl- along with it" deter#inant".

%27$8D+C7%82
%ccordin! to the 3aw of ( ))ly chan!e in )rice brin!s a direct chan!e in = antity s ))ly -.s/ b t it does not tell s that to what extant = antity s ))ly will have a chan!e to some chan!e in )rice of the commodity. In this way law of s ))ly is a = alitative conce)t beca se it tells s only direction of char!e. *owever elasticity of s ))ly is = antitative conce)t which exactly tells s the de!ree of flexibility in = antity s ))ly to some chan!e in )rice of the commodity. .s , f-'/ '# _ .d# -3aw of ( ))ly/ -Clasticity of s ))ly/ '# -11Y/ _ .d# -11Y/ or # -less than 11Y/ or # -more than
11Y/

D'9%2%7%82
The term elasticity refers to the de!ree of flexibility. Clasticity of s ))ly meas res the de!ree of flexibility s ))ly for any chan!e in )rice of the commodity. 4e can define this conce)t as !iven in the followin! words&#lasticity of s pply meas res proportionate change in ' antity s pply to the proportionate change in price of the commodity. 'ro)ortionate chan!e in = antity s ))ly 'ro)ortionate chan!e in )rice Q S Q Q1 QS = 2 100 = 100 Q1 Q 'ercenta!e chan!e in
P=

'ercenta!e chan!e in

P2 P1 P 100 = 100 P1 P

100 Q S P ES = = . P 100 P Q P Q
4e may have the ran!e of Cs between ;ero and infinity i.e. 0 < &" < Lor exam)le&7 Es.1 1 Es.1 5 QS +1 31
QS =

QS

30 20 100 = 50% 20 'ercenta!e chan!e in 15 10 P= 100 = 50% 10 'ercenta!e chan!e in

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Mohammad Kashif Hayat

3R
ES = 50% =1 50%

C( , 1 - nitary elastic/

D'"$'' 4+--0:

89

'0147%C%7:

89

1$elatively elastic supply:&' 4 ( 1) .s shows !reater res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .( -more than 11Y/ ' ( (
-('(C/

2$elative inelastic supply:&' 4 * 1) .( shows less res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .( -less than 11Y/ ' (

.(

-3'(C/

.( ( 3+nitary elastic supply:- &' 4 , 1) .( shows same res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .( -11Y/ ' (

. 4-erfectly inelastic supply:- ( &' 4 , .) .( shows no res)onse to any chan!e in )rice of the commodity. ' -11Y/ _ .( -<o chan!e/ '
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01

( -#'(C/ ( 5-erfectly elastic supply :.( shows infinite chan!e while )rice is not chan!ed. ' -not chan!ed/ _ .( -infinite chan!e/ ' ( (

.( &' 4 , )

.(

Determinants ; 9actors of 'lasticity of supply & '4 )

1. 7he intensity of use of the fi5ed factor : The )rod cer can increase his )rod ction if the firm is nder tili;ed or wor2in! below the f ll ca)acity so he can increase the s ))ly by increasin! his )rod ction8 therefore8 s ))ly c rve will be elastic beca se. 4hereas if the firm is over tili;ed or wor2in! at f ll ca)acity he can not increase his wor2in! ca)acity and thatGs why he can not increase his s ))ly8 therefore8 the s ))ly c rve will be inelastic. If the factor is nder tili;ed -less/ _ C( V 1 If the factor is over tili;ed -f lly/ _ C( [ 1 2. 7he availability of other factors : %vailability of other factors s ch as cash* labor* capital* raw material )lays an im)ortant role over the s ))ly c rve. If the )rod cer wants to increase s ))ly by increasin! his )rod ction and he wants to tili;e other factors and that are easily available8 he can do this and the s ))ly c rve in this case will be elastic. 7n the other hand if )rod cer wants to tili;e other factors and these are not easily available then the s ))ly c rve will be inelastic. If other factors are f rther easily available _ C( V 1 If other factors are not f rther easily available _ C( [ 1 3. 7he time factor : Time factor is also one of the im)ortant factors in the elasticity of s ))ly. In short )eriod it is diffic lt to enhance his b siness8 so the s ))ly c rve will be inelastic. If there is lon! )eriod to enhance the b siness8 so the s ))ly c rve will be elastic. 7n the other hand if there is mar2et )eriod the s ))ly c rve will be )erfectly inelastic. (hort )eriod _ C( [ 1 3on! )eriod _ C( V 1
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Mohammad Kashif Hayat

01 #ar2et )eriod _ C( , 1 4. 2ature of the commodity : 'erishable !oods s ch as ve!etables which can not be stored8 s ))ly will not chan!e and th s it will be inelastic. 7therwise if the nat re of thin! is d rable the )rod cer can store his !oods if )rice will decrease and therefore the s ))ly c rve will be elastic. 'erishable !oods _ C( [ 1 " rable !oods _ C( V 1 BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB +roduction The )rod ction refers to a )rocess when we en!a!e different factors of )rod ction s ch as land8 labo r8 ca)oral and entre)rene r to !et some nits of o t) t i.e. In) ts -3and8 labo r8 ca)ital8 intervener/ _ )rocess _ o t) t +roduction functions 'rod ction f nctions define technical relationshi) between nits of o t) t and nits of the factor in) ts in the )rod ction )rocess. i.e. 7 t) t , f -3and8 labo r8 ca)ital8 entre)rene r/ or D , f -38 <8 M8 C/ The classical economists have always considered a short )eriod )rod ction f nction where labo r was considered as the only variable in) t while other factors were held constant. D , f -3/ (abour:The )hysical and mental activity that is )erformed by h man bein!s for the sac2 of !ettin! reward is called labo r. The reward )aid to the labo r is called wages. (and:%ll of the Pod !ifted elements to h man bein!s are classified as land. *owever the lord-land !et reward while sin! the )rod ctive activities of the land called rent. Capita :The )hysical and non-)hysical )resent assets which can be sed to !enerate more o t) t or income is called ca)ital. e.!. roads8 B ildin!s8 machines8 lower services8 doctor services. The reward )aid to the ca)ital owner for the se of )rod ctivity of ca)ital is called interest. 'ntrepreneur:The )erson who decides and or!ani;es entire )rod ction and ta2es ris2s is called entre)rene r. The reward char!ed a!ainst ta2in! ris2 is called profit. Concept of production function:Lor short-)eriod )rod ction f nction we have followin! im)ortant conce)ts to st dy. 1. 5otal product- 65+3 The total amo nt of the commodity which is )rod ced by the labo r nits en!a!ed in 40 the )rod ction )rocess is called i.e. T' , '18 '+8 '38 A..8 'n 35 total )rod ct -T'/. Total )rod ct has the characteristic that it is increasin! b t at a diminishin! rate. 30 25 1abour *7 20 1 15 1 0
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Mohammad Kashif Hayat

1 5 6 B 8

0+ + 3 0 5 6 O R 15 ++ +8 33 3O :.erage +roduct- 6:+3 sed as )er nit. %vera!e )rod ct -%'/ is defined as total nits en!a!ed in the )rod ction )rocess. 4e sim)ly calc late nits of total )rod ct -T'/ by the labo r nits -3/ en!a!ed in
AP = TP L

2. The term avera!e is )rod ct -T'/ )er labo r val e of %' by dividin!

the )rod ction )rocess i.e.

The val es of %' have the characteristic that they are risin! and after reachin! to some maxim m start declinin!. 3. Marginal +roduct- 6M+3 The term mar!inal refer to the rate of chan!e nit. #ar!inal )rod ct -#'/ is the rate of chan!e in nits of total )rod ct -T'/ when there is some chan!e in nits of labo r -3/. It can also be defined as the )rod ctivity of last labo r nit en!a!ed in the )rod ction )rocess i.e.
MP =

7r

#'0 , T'0 > T'3 40 35 30 25 *7

TP L

- #'n , T'n > T'n-1 / *7

1abour 1!

*otal 7rodu,t *7!

$0erage 7rodu,t $7 < *761

)arginal 7rodu,t )7!

0 0.1 5 R 0.5 5 1 0 15 5.1 6 0 1 2 3 4 5 6 B 8 +1 5.1 5 +0 0.8 0 +6 0.3 + B +6 3.O 1 6+0 4. Marginal 0e.enue +roduct3.1 -+ 6M0+3 5 #E' is defined as the rate of chan!e in the total reven e )rod ct when there $7 is 4 some chan!e in labo r nits en!a!ed in the )rod ction )rocess i.e. 3 TRP MRP = 2 L \ TE' , T' x ' ] MRP = MP P 1 0 1 58636153.doc B.Com-I Mohammad Kashif Hayat 0+ -1 0 1 2 3 4 5 6 B 8 D -2
*76)7

1 + 3 0 5 6 O 8

20 15 10

)7

03

Q No. 14 $ No. 14

State and explain =1aw of :n,rea"ing .eturn"? with the help of table and figure al"o explain pra,ti,al i#portan,e of the law.

Introduction
The 3aw of Increasin! Eet rns disc sses the direct relationshi) between s ccessive labo r nits en!a!ed in the )rod ction )rocess and #'. This law ex)lains that efficiency of every new labo r nit is increasin! d e to the a))lication of modern means of )rod ction. In the early sta!e of )rod ction )rocess both #' and #E' will be increasin! till maxim m efficiency is achieved.

Statement of the law

In the word of %lfred #arshall& =$n in,rea"e of labour and ,apital lead" generall- to i#pro0e organiFationE whi,h in,rea"e" the effi,ien,- of labour and ,apital?. 4e can also ex)lain the law in the followin! words& =:f other fa,tor" ex,ept labour are held ,on"tantE when "u,,e""i0e labour unit" are engaged in the produ,tion pro,e"" then )7 and ).7 will be in,rea"ing?.

E planation
Lrom the above definitions it a))ears that #' is havin! a f nctional relationshi) with the labo r nits en!a!ed in the )rod ction )rocess i.e. #' , f -3/ 3# _ #'# _ #E'# -3aw of Increasin! Eet rns/
4here #E' , #' x '

4e can ex)lain this law with the followin! table and fi! re&)76).7

1 1 + 3 0 5 6

)7 5 11 15 +1 +5 31

7
."!

).7 11 +1 31 01 51 61

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+ + + + + +

60 55 50 45 40 35 30 25 20 15 10 5 0

).7

)7

03
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Mohammad Kashif Hayat

3 4 5 6

00

1
In the above fi! re we have ex)lained the wor2in! of the 3IE a!ainst different labo r nits en!a!ed in the )rod ction )rocess. 4hen second labo r nit is en!a!ed the #' was 5116 as shown with )oint 5b6 in the fi! re while #E' is 5+16 as shown with )oint 5bG 6 in the fi! re. Lor third labo r nit #' rises to 5156 and #E' rises to 5316 nits showin! the increasin! trend. This increasin! trend contin es for s ccessive labo r nits en!a!ed in the )rod ction )rocess. In the fi! re the increasin! trend of both #' and #E' indicates the existence of the law. Both !ra)hs of #' and #E' are )ositively slo)ed from left to ri!ht.

!ther name of the law3aw of Increasin! Eet rns is also 2nown as law of "ecreasin! Cost. This can be observed from the followin! im)ortant e= ation&i.e. #C,
W M P
)76)+
26 24 Eet rns/ 22 20 Cost/ 18 16 14 12 10 8 6 4 2 0 1 2 3 4

)7

3# _ #'# -3aw of Increasin! 3# _ #C -3aw of "ecreasin! 1 1 + 3 0 5 )7 5 11 15 +1 +5 A Es.61 Es.61 Es.61 Es.61 Es.61 )+ 1+ 6 0 3 +.0

)+
5

:ssumptions
The 3IE is a))licable when the followin! ass m)tions do )ersist in the economy. 1,echno og&: It is ass med that state of technolo!y is not chan!ed d rin! the )rod ction )rocess. If technolo!y chan!es then their mi!ht is some chan!e in )rod ction efficiencies of labo r nits en!a!ed in the )rod ction )rocess. 2-omogeneous abour units: It is ass med that all labo r nits are homo!eno s with res)ect to their )rod ctive efficiency. This is beca se any chan!e in them wo ld seas the wor2in! of the law. 3Perfect competition: It is ass med that conditions of )erfect com)etition exist both in )rod ct and factor mar2et. 458636153.doc B.Com-I

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Mohammad Kashif Hayat

05 It is ass med that the s ))ly of factors if )rod ction is freely elastic d rin! the )rod ction )rocess.

+ractical application of the law The law of Increasin! Eet rns is always a))lied in any )rod ction set ) where to available factors are not f lly tili;ed. *owever economists believed that this law is a))lied in the )rod ction set )s where ca)ital or manmade reso rces are mostly sed. *ence man fact rin! ind stries confirm the a))lication of this law. This is beca se contin o s im)rovement in the techni= e of )rod ction im)roves the efficiency of all the factors sed in the )rod ction )rocess. This sit ation )ersists till the maxim m ca)acity of the )lant is tili;ed. In a!ric lt re sector this law may be a))licable when im)rovement means of c ltivations are sed in the economy that increases the fertility of the soil and better cro) mana!ement.

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06

State and explain =1aw of +on"tant .eturn"? with the help of table and figure al"o explain pra,ti,al i#portan,e of the law. Introduction

The 3aw of Constant Eet rns disc sses the constant behavior of #' when s ccessive labo r nits are en!a!ed in the )rod ction )rocess. It means that total o t) t will be increasin! at a constant rate.

Statement of the law

This law can be ex)lained in the followin! words& =:f other fa,tor" ex,ept labour are held ,on"tantE when a produ,er engage" "u,,e""i0e labour unit" in the produ,tion pro,e"" then both )7 and ).7 will re#ain ,on"tant?.

E planation
Lrom the above definition it a))ears that #' is a constant f nction of the labo r nits en!a!ed in the )rod ction )rocess. i.e. #' f -3/ 3 #' -Constant/ #E' -Constant/
4here #E' , #' x '

4e can ex)lain this law with the followin! table and fi! re&)76).7
25

1 1 + 3 0 5

)7 11 11 11 11 11

7
."!

).7 +1 +1 +1 +1 +1

20 15 10 5 0 1 2 3 4

).7

+ + + + +

)7

In the above fi! re we have ex)lained the wor2in! of the 3CE a!ainst different labo r nits en!a!ed in the )rod ction )rocess. *ere we observed that val es of both #' and #E' are constant to 5116 and 5+16 res)ectively for different labo r nits en!a!ed in the )rod ction )rocess. This constant trend contin es for s ccessive labo r nits en!a!ed in the )rod ction )rocess. In the fi! re the constant trend of both #' and #E' indicates the existence of the law. The !ra)h of both #' and #E' are havin! ;ero slo)e and )arallel to labo r axis.

:ssumptions
The 3CE is a))licable when the followin! ass m)tions do )ersist in the economy. 1,echno og&: It is ass med that state of technolo!y is not chan!ed d rin! the )rod ction )rocess. If technolo!y chan!es then their mi!ht is some chan!e in )rod ction efficiencies of labo r nits en!a!ed in the )rod ction )rocess. 2-omogeneous abour units: It is ass med that all labo r nits are homo!eno s with res)ect to their )rod ctive efficiency. This is beca se any chan!e in them wo ld seas the wor2in! of the law. 58636153.doc B.Com-I Mohammad Kashif Hayat 06

0O 3Perfect competition: It is ass med that conditions of )erfect com)etition exist both in )rod ct and factor mar2et. 4%upp & of inputs: It is ass med that the all the desired factor in) ts have nitary elastic s ))ly. It means that factors are e= ally available as com)ared to their demand.

Practical application of the law:

The law of Constant Eet rns is a))lied in those )rod ction set )s where both ca)ital and nat re )lay their role side by side. This is why small scale cotta!e ind stries and extractin! nits are the exam)les where #' remains constant for every new labo r nit en!a!ed in the )rod ction )rocess.

!ther name of the law3aw of Constant Eet rns is also 2nown as 3aw of Constant Cost. This can be observed from the followin! im)ortant e= ation&i.e. #C,
W M P
3aw of Constant Const

3# _ #' -Constant/ _ #C -Constant/

3aw of Constant Eet rns

1 1 + 3 0 5

)7 11 11 11 11 11

A Es.61 Es.61 Es.61 Es.61 Es.61

)+ 6 6 6 6 6

)76)+ 15
10

0 1 2 3 4 5

BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

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08

State and explain =1aw of 5i#ini"hing .eturn"? with the help of table and graph al"o explain pra,ti,al i#portan,e of the law.
:ntrodu,tion The 3aw of "iminishin! Eet rns was )resented by the classical economists who believed that in the )rod ction )rocess every next labo r nit )rod ces diminishin! contrib tion in the )rod cin! o t) t. It means Total o t) t is increasin! b t at the diminishin! rate and #' for s ccessive labo r nits !o on diminishin!. This diminishin! trend is !enerally 2nown as the 3"E. State#ent 3f *he 1aw In the words of %lfred #arshall& =$n in,rea"e in labour and ,apital applied in ,ulti0ation of land ,au"e" in general a le"" then proportionate in the a#ount of produ,t rai"edE unle"" it happened to ,oin,ide with an i#pro0e#ent in the art" of agri,ulture?. 4e can also ex)lain the law in the followin! words& =:f other fa,tor" ex,ept labour are held ,on"tantE when we engage "u,,e""i0e labour unit" in the produ,tion pro,e"" then )7 and ).7 will be di#ini"hing?. &xplanation Lrom the above definitions it a))ears that #' is havin! a f nctional relationshi) with the labo r nits en!a!ed in the )rod ction )rocess i.e. #' , f -3/ 3 J #'^ J #E'^ -3aw of "iminishin! Eet rns/ 4here #E' , #' x ' 4e can ex)lain this law with the followin! table and fi! re&14

)76).7

1 1 + 3 0 5 6

)7 5 O 6 5 0 +

7 .".2 + + + + + +

).7 11 10 1+ 11 8 0

12 10 8 6 4 2 0 1 2 3 4 5 6

).7 )7

In the above table and fi! re we have ex)lained the wor2in! of the 3"E a!ainst different labo r nits en!a!ed in the )rod ction )rocess. 4hen second labo r nit is en!a!ed the #' was 5O6 as shown with )oint 5b6 in the fi! re while #E' is 5106 as shown with )oint 5bG 6 in the fi! re. Lor third labo r nits #' declines to 566 and #E' declines to 51+6 nits showin! the diminishin! trend. This diminishin! trend contin es for s ccessive labo r nits en!a!ed in the )rod ction )rocess. In the fi! re the declinin! trend of both #' and #E' indicated the existence of the law.
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0R

$""u#ption"%
The 3"E is a))licable when the followin! ass m)tions do )ersist in the economy. 1*e,hnolog-% It is ass med that state of technolo!y is not chan!ed d rin! the )rod ction )rocess. If technolo!y chan!es then their mi!ht is some chan!e in )rod ction efficiencies of labo r nits en!a!ed in the )rod ction )rocess. 24o#ogeneou" labour effi,ien,-% It is ass med that all labo r nits are homo!eno s with res)ect to their )rod ctive efficiency. This is beca se any chan!e in them wo ld seas the wor2in! of the law. 37erfe,t ,o#petition% It is ass med that conditions of )erfect com)etition exist both in )rod ct and factor mar2et. 4)axi#u# le0el of produ,tion% It is ass med that )rod ction has !one to its maxim m level.

W M P

3ther na#e of the law%

)76)+
26 24 22 20 18 16 14 12 10 8 6 4 2 0 1 2 3 4

3aw of "iminishin! Eet rns is also 2nown as law of Increasin! Cost. This can be observed from the followin! im)ortant e= ation&i.e. #C, )+ 3 J #'^ -3aw of "iminishin! Eet rns/ 3 J #C? -3aw of Increasin! Cost/ 1 1 + 3 0 5 )7 11 8 6 0 + A Es.51 Es.51 Es.51 Es.51 Es.51 )+ 5 6.+5 8.3 1+.5 +5

)7
5

7ra,ti,al appli,ation of the law%

In the )eriod of (lfred )arshall there was not too m ch awareness of ind stries so accordin! to the definition of the (. )arshal it is a))licable in the a!ric lt re sector beca se of two factors i.e. 1/ Constant fertility of the soil and fixed amo nt of soil. 4hen we en!a!e s ccessive labo r nits on a )iece of land then the #ar!inal 'rod ctivity of labo r starts diminishin! beca se it exha sts the )rod ctivity of land to some extant. %lfred #arshall defines the law is of niversal a))lication in every )rod ction set- ). 1. %ccordin! to the modern economists8 3"E is a))licable in ind strial sector beca se of the fact that different in) ts sed in the )rod ction )rocess are not )erfect s bstit tes to each other. (imilarly mana!erial inefficiencies8 labo r nion activities8 im)ro)er combination of in) ts etc. are the im)ortant ones that confirm the a))lication of this law. 58636153.doc B.Com-I Mohammad Kashif Hayat 0R