TyroCity: Economics 12 Notes

Organization

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

The business organization is defined as a firm established and run to earn profit by producing and selling commodities. The main objective of every business organization is to earn profit. To maximize profit, each firm has to fulfill demand for goods or services made by consumers or other firms. For maximum profit, each firm must supply the quantity just equal for demand in the market and there must be maximum difference between revenue and cost of production. There are different types of organizations. There are mainly three types of organization. They are

Sole proprietorship
Partnership
Joint stock

Meaning of Production

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Meaning:
The process of transformation of input into output is known as production. In other words the process of creating utility is known as production.

Production Function:
Production function explains the technological relationship between inputs and outputs. It shows the functional relationship between physical input and output. Or it shows how much physical output can be produced by using the given physical input and given state of technology. Mathematically production function is expressed as
Q = F (L, Ld, C, M, T, N, ……..)
Where,
Q = quantity of output
F = functional relationship
L = labor
Ld = land
C = capital
M = management
T = technology
N = national resources

But generally production function is written as Q = F (L, C)

Production function is divided into two parts:

Short run production function:
Short run is short time period where producer can change the output only by changing labor not capital. So, in short run production function is written as Q = F(L, C)
Where,
Q = output
F = functional relationship
L = labor
C = constant capital
Long run production function:
Long run is the long time period and in the long time period producer can change all input to change the output. So, in long run Q = F ( K, L)
Where,
Q = output
F = functional relationship
K = capital
L = labor

Simple price index number

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Rice index number constructed giving equal weights to all commodities is called simple price index number, in this case, all commodities are given equal importance. The average price is calculated simply dividing the sum of prices by number of commodities.

Mathematically,

simple average price = sum of prices / no. of commodities

After the calculation of average price of base year and current year we change them into their relative values i.e. indices. The rice level of base year is treated as 100 and the price index of current year is calculated using the formula:

Construction of simple price index number can be explained as following:

commodities	Price in 2011	Price in 2012
Rice	Rs 35	Rs 40
Pulses	Rs 30	Rs 95
Clothes	Rs 250	Rs 275
Vegetables	Rs 50	Rs 70
Firewood	Rs 100	Rs 150
Total	Rs515	Rs 630
Average (P/N)	Rs 103	Rs 126
Price index	100	(126/103)*100 = 122.33

In the above table, we have taken only 5 commodities for the sake of simplicity. The sum of the prices of the commodities in the year 2012 is Rs 515 and in the year 2012 is Rs 630. If we divide this sum of prices by number of commodities we obtain the price level of the year RS 103 and Rs 126 respectively. If we change these price levels to price indices using the above formula we obtain 100 and 122.33. It shows there is rise in price level b 22.33 % in the year 2012.

Comparative cost theory of international trade

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

This theory is developed by a classical economist David Ricardo. According to this theory, the international trade between two countries is possible only if each of them has absolute or comparative cost advantage in the production of at least one commodity. This theory is based upon following assumption:

There are only two countries and two commodities
There is no governmental intervention in export and import
Only labor is factor of production. Quantity of labor used gives cost of production
There is perfect mobility of labor within the country but not between the countries
There is no cost of transportation between the countries
The law of constant returns to scale operates in production.
The units of labor are homogeneous
The units of each commodity in both countries are homogeneous

According to comparative cost advantage theory of international trade, each country exports the commodity in which it has cost advantage and imports the commodity in which it has cost disadvantage. This theory can be explained as following:

A. Comparative cost advantage

If a country can produce both commodities with less cost than another country but in different ratio, the country is said to have comparative cost advantage.

Country	Labor required to produce clothe	Labor required to produce shoe
Nepal	10	4
India	20	12
ratio	10/20=0.5	4/12=0.33

In the above table, the cost of production of clothe in Nepal is only 50% of cost of production of clothe in India. In case of shoes, the cost of production is only 1/3rd of cost in India. It shows that Nepal can produce both commodities with fewer cots than India. But in order to take advantage, it produces only shoes land let India produce clothe for it. Nepal produces shoes and exports to India. India produces clothe and exports to Nepal. If they do so, both of them can take benefits.

B. Absolute cost advantage:

If a country can produce a commodity with less cost but has to bear more cost in the production of another commodity than another country then the country is said to have absolute cost advantage. In this case, both of the countries produce and export the commodities in which they have absolute cost advantage.

Country	Labor required to produce clothe	Labor required to produce shoe
Nepal	10	8
India	20	4
ratio	10/20=0.5	8/4=2

In the above table, the cost of production of clothe in Nepal is less than in India. But cost of production of shoes is less in India than in Nepal. In this case, Nepal is said to have absolute cost advantage in production of clothe but absolute cost disadvantage in production of shoes. India is said to have absolute cost advantage in production of shoes but absolute cost disadvantage in production of clothe. Therefore, Nepal produces only clothe and exports to India. India produces only shoes and exports to Nepal. Doing it, both the countries can take benefit.

C. No cost advantage:

If a country can produce both commodities with less cost than another country but in equal ratio, the country is said to have no cost advantage.

Country	Labor required to produce clothe	Labor required to produce shoe
Nepal	10	4
India	20	8
ratio	10/20=0.5	4/8=0.5

In the above table, Nepal is shown able to produce both commodities with less cost than India in equal ratio. It means Nepal has no cost advantage. It is loss to the Nepal to import any commodity form India. That’s why it decides to produce both goods for itself. Therefore, India too produces both goods for itself. Hew is no trade between them.

Criticisms

This theory is not applicable if there are more than two countries and more than two commodities
In every country there is more or less government intervention in international trade
There is cost of transportation from one country to another country
The units of labor are not homogeneous and the workers are paid more or less in different countries
There may be increasing or decreasing returns to scale
Labor is not perfectly mobile within the country too. In the modern era, there is mobility of labor from one country to another
The commodities produced in the different countries differ in quality, taste, size, quantity etc.

Relatively elastic demand

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

If the percentage change in quantity demand is greater than the percentage change in price is known as relatively elastic demand. For example 10% change in demand due to 5% change in demand; we can explain it by following figure

On the above figure, when price is OP then quantity demand for that commodity is OQ. When prices become P1 by increasing by 5% then quantity demand decreases from Q to Q1 by 10% and when price decreases by 5% to Po then quantity demand increases from Q to Qo by 10%.

Malthusian theory of population

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

According to Malthus, population increases at geometric rte whereas means of life increase at arithmetic rate. The geometric growth rate means the progression in the series, 2,4,8,16,32 and so on. It is increase in population at an exponential or increasing rater. The arithmetic growth means the progression like in the series 2,4,6,8,10,12,14 and so on. It means the means of life increases at constant rate. According to Malthus, it is because of operation of law of diminishing return. As population grows faster than means of life, the human beings have to suffer scarcity of means of life. The population becomes too explosively large in comparison to the means of life. Ultimately nature brings natural disaster to control the population. The disasters reduce the population. After disasters, population grows again at geometric rate. It becomes again explosively large and there is deficiency of means of life. After growth of population, the disasters and population growth occur alternatively one after another and recurrently. According to Malthus, population becomes double after 25 years. Human beings can do a little to control the population. He has referred to some measures like

Abstinence from sex
Late marriage
Celibacy

He couldn’t refer family planning and prostitution as the effective measures to control population because these were against the social and religious values in that time. His theory can be explained with the help of table and figure as following:

TIME	POPULATION	MEANS OF LIFE ( IN TONS)
1	2000	2000
2	4000	4000
3	8000	6000
4	16000	8000
5	32000	10000

In the above table population grows in geometric rate from 2000 to 4000, 8000, 16000 and 32000 in 2nd, 3rd, 4th and 5th year respectively. But means of life in increased at arithmetic rate from 2000 tons to 4000, 6000, 8000, 0000 tons respectively. If we represent the population and means of life with respect to time we obtain exponential curve and a straight line upwardly sloped.

In the above figure, the upper curve represents the population. It is exponential in shape. It shows that the population grows geometrically. The lower curve represents means of life. It is liner in shape. It shows that means of life increases arithmetically.

Main propositions of Malthusian theory of population

Population grows in geometric rate like in the series 2,4,8,16,32 and so on. It takes 25 years to double the population. Population growth is a natural phenomenon
Means of life grows in arithmetic rate. The arithmetic growth means the progression like in the series 2,4,6,8,10,12,14 and so on. It means the means of life increases at constant rate. According to Malthus, it is because of operation of law of diminishing return.
There are two types of checks: positive checks: When the population becomes too explosively large in comparison to the means of life, nature brings natural disaster to control the population. The disasters reduce the population. And preventive checks : Abstinence from sex, Late marriage, Celibacy
Positive checks are inevitable.

Criticisms of Malthusian theory

It is pessimistic theory. According to it, natural disasters are inevitable.
Population growth is always not problematic
The population may increase or decrease with time. In many countries it is increased but not in geometric rate. In some countries, population decreases too.
It ignores the change in social, cultural, and political values. It also avoids modern family planning techniques
Technological advancement, exploration of new resources etc can bring increase in return of production too.
The preventive checks are difficult to adopt.

Value of money

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

The value of money is defines as the quantity of goods and services that can be purchased with the amount of money. It is given by the ratio of amount of money and general price level.

Mathematically,
value of money = amount of money / price level

The value of re 1 is the inverse of general price level.

Mathematically,

value of re. 1 = 1 / p

Value of money is inversely related to price level. If price level rises, the value of money decreases and vice versa

If P ↑, value of money ↓
If P ↓, value of money ↑

The relationship between value of money and price level can be explained with the help of table and figure a following

Price level (P)	Value of re. 1 ( 1/P)
Rs 10	0.1
Rs 20	0.05
Rs 30	0.033

In the above table when price level is increased from Rs 10 to Rs 20, 30 value of re 1 is decreased from 0.1 units to 0.05 and 0.033 unit respectively. It shows the inverse relationship between value of money and price level. It we represent the value of money with respect to price level we obtain a monotonically downward sloped curve as shown below:

In the above figure, the convex curve shows the relationship between value of money and price level. It is downward sloped which shoes that value of Rs1 decreases with every increase in price level.

Cross elasticity of demand

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

It refers the percentage change in quantity demand of one commodity i.e. x due to certain change in price of another commodity i.e. y when other things remains the same.

Mathematically,

where,
exy = cross elasticity of demand
∆Qx = change in quantity demand for x commodity
∆Py = change in price of y commodity
Py = initial price of y commodity
Qx = initial quantity demand for x commodity

Perfectly elastic demand

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Due to slight fall or rise in the price of commodity, if quality demand increases or decreases infinitely then it is known as perfectly elastic demand. We can explain it on the following figure:

On the above figure, in initial stage price in OP then quantity is Q. When price slightly increases then demand decreases from Q to Qo. When price decreases then demand increases rapidly from Q to Q1. This shows infinity change.

Concept of capital market

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

The market which deals with medium and long term financial instruments is called capital market. There are long term security transactions in capital market for more than one year to 25. Bonds, shares, debentures, etc are long termed securities. There are also transactions of non-security component for example long term loan provided by banks.

There are two sectors i.e. organized and unorganized. Banks, finance companies, insurance companies, stock exchange centers and center bank are included under the organized sectors as well as traditional money lender, traders, merchants, etc are under unorganized sectors.

According to World Bank, the market in which long term financial instruments such as equities and bonds are raised and traded.

Concept of money market

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Money market refers to the transaction of short term/run credit instrument. These instruments are highly liquid, easily marketable with little chance of loss. The maturity period of these instruments are less than one year. The examples of instruments are treasury bill, bill of exchange, promissory note.

The main function of money market is to make available working capital to the business sector and short term loan to the government.

According to World Bank, a market in which short term securities such as treasury bills, certificates of deposits and commercial bills are traded.

Perfect Competition Market

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Meaning:
The perfect competition is the structure of market in which there are large no. of buyers and sellers. They produce or sell homogenous product. In this market, firm is price taker and market is price maker because price of commodity is determined on the basis of market demand and supply. So, the price of particular commodity remains same everywhere in an economy.

Characteristics / Assumptions of perfect competition market:

Large no. of sellers and buyers:
In this market there is assumed large no. of buiyers and sellers. A buyer and seller in the very small part and seller cannot influence in the market price.

Products homogeneity:
The products produced in the industry are supposed to be homogeneous. Different units of a commodity are similar in content, quality, price, smell, packaging, etc.

Free entry and exit of firm:
There is no barrier on entry of a new firm to the industry and there in no any restriction on exit of firm from the industry.

Profit maximization:
In this market, all firm wants to maximize its profit.

No government regulation:
Government doesn’t influence in this market. There is no licensing system, no tax and subsidy. Government has no role in this type of market.

Perfect mobility of factors of production:
There is assumed that factor of production are free to move from one place to other, one industry to other and one occupation into another.

Perfect knowledge:
It assumes that under perfect competition market buyers and sellers are aware about prevailing market prices. They are also aware of future market condition.

Price and Output determination under perfect competition market:

In the perfect competition market there is large no. of buyers and sellers. Price is determined by market forces and industry. It means market price is determined on the basis of market demand and market supply. The price determined by market/industry is accepted by all the firms. They just adjust their output according to the equilibrium position of firms. The process of price and output determination is explained by the help of given figures.

On the given figure, first of all price and output determination of industry is shown. In the first figure, demand and supply curves are interested at point E. That point determines the equilibrium price of industry i.e. OP and equilibrium price of output of industry i.e. OQ. Suppose, when the price increases from P to P2 then demand is P2K and supply is P2L, it means there is excess supply of goods. So, price tends to decline at OP. On the other hand, when price decreases from P to P1 there is excess demand equal to area MN. It tends to increase price OP so that equilibrium price of market price is OP. The market price is accelerated by all the firms but they are capable to adjust their output according to the equilibrium price of a firm. So, in short run, firm may obtain super normal profit or normal profit or loss.

The firm A, by producing equilibrium output i.e. OQ1 at OP price, the firm has been obtaining super normal profit. Firm B, by producing OQ2 output at OP has been obtaining normal profit. The firm C, by producing OQ3 output at OP price has been obtaining loss. But in the long run, every firm always obtains only the normal profit.