TyroCity: Economics 12 Notes

Uncertainty theory of profit

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

Uncertainty theory of profit
This theory is propounded by Knight. According to this theory, profit is reward for bearing uncertainty. Uncertainty is due to unforeseeable or non insurable risk. According to knight, there are two types of risk. They are foreseeable and unforeseeable. The possible loses due to foreseeable risk is avoidable with insurance. Therefore, the risks are insurable risk but possible loss due to unforeseeable risk is not avoidable with insurance. Therefore, the risks are non foreseeable risk. There are mainly four types of non insurable risk. They are

Risk due to competitors:
Any business firm has the risk due to increase in number of competitors, change in their marketing strategies, improvement in their quality and management, decrease in their cost of production per unit etc. This risk is not avoidable with insurance.
Risk due to change in policy of government:
The government may change its policy related to investment, export, import, taxes, and so on. Due to it, any firm may suffer loss. This risk is not avoidable with insurance.
Risk due to trade cycle:
During recession and depression, most of the business firms suffer loss. This risk is not avoidable with insurance.
Risk due to technological change:
Technology advances with flight of time. If any firm fails to adjust the change in technology, the firm suffers loss. This risk is also not avoidable with insurance.

Criticisms
Not direct relation between profit and uncertainty:
Profit is not directly related to uncertainty. If the business involves high risk, there is more probability of failure and loss rather than profit.
Profit is reward for avoidance of uncertainty:
Profits earned only if uncertainty is successfully avoided using skills, education, knowledge, experiences and so on. It is not earned mere taking uncertainty.
Uncertainty is not factor of production:
According to this theory, uncertainty seems to be the factor of production but factor of production is organization not uncertainty.
Reward for all things performed by organization:
Organization earns profit not only taking uncertainty but for all things it performs. They are innovation, effective combination of inputs, use of skills knowledge etc and bargaining power.

Economics XII: Meaning of Revenue

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

Income earned by the firm or industry by selling the produced output in the market is known as revenue.

According to prof. Dooly, “The revenue of a firm is its sell receipts or money receipts from the sale of products.”

Limitations (Criticisms) of Optimum Theory

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

The Optimum Theory of population has following limitations:

The optimum theory is based on economic consideration only. It has not taken political consideration. There is no wonder that some countries are encouraging population increase basically due to political reason.
The optimum population is an imaginary concept because, less population cannot be increased nor can more population be reduced instantly.
It is difficult to achieve the optimum population.
The optimum population is not a rigid one. It is flexible. The level of optimum population increases with increase in resource and technology. Likewise, it decreases with decrease in resources and technology.

Concepts of Utility

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

Total Utility (T.U): Total utility is the summation of utility derived from the consumption of different unities of same commodity. In other word, it refers to the total sum of marginal utility derived from the consumption of different units of same commodity. Mathematically it is expressed as: T.U = F (Qx) Where, T.U = total utility of x commodity F = fundamental relationship Qx = quantity of x commodity
Average Utility (A.U): Average utility is obtained by dividing the total utility by number of commodities consumed. In other words average utility is the per unit utility. Mathematically, it is expressed as follows: A.Ux = T.Ux / Qx Where, A.Ux = average utility of x commodity T.Ux = total utility of x commodity Qx = quantity of x commodity
Marginal Utility (M.U): The utility derived from the consumption of additional unit of commodity is known as marginal utility. In other words, the change in total utility due to the change in consumption of commodity is known as marginal utility. Mathematically it can be expressed as: M.Ux = ∆T.Ux / ∆Qx Where, M.Ux = marginal utility of x commodity ∆T.Ux = change in total utility of x commodity ∆Qx = change in consumption of x commodity

Positive cross elasticity of substitute goods

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

Cross elasticity of demand is positive because when the price of one commodity i.e. x commodity increases demand for another commodity i.e. y also increases. We can express by the help of given figure.

On the above figure, in initial stage price of x commodity is OP and demand for y commodity is OQ. When price of x is increased from p to P1 then quantity demand for y commodity increases from Q to Q1.

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.

Concepts of short run average cost

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

Concepts of short run average cost:

1. Average fixed cost (AFC):
AFC refers to the fixed cost spend per unit of output produced. It is obtained by dividing total fixed cost by total quantity of output produced.

AFC = TEC / Q

where,
AFC = average fixed cost
TFC = total fixed cost
Q = total quantity of output produced

2. Average variable cost (AVC):
AVC refers to the variable cost spend per unit of output produced. It is obtained by dividing total variable cost by total quantity of output produced.

AVC = TVC / Q

where,
AVC = average variable cost
TVC = total variable cost
Q = quantity of output produced

3. Average total cost (ATC):
It refers to the total cost spend per unit output produced. It is obtained by dividing total cost (TC) by quantity.

ATC = TC / Q

The Law of diminishing marginal utility

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

This law was first developed by H.H Gossen in 1854 AD, which is also the first law of Gassen. This law is based on universal human experience. It explains that for more units of commodity; its M.U derived from each additional unit diminishes in comparison to the previous unit. Hence, the law of diminishing marginal utility implies that consumption of each successive units of a particular commodity gives less and lesser satisfaction to the consumer if a consumer consumes it in a certain time period.

This law is based on the following assumptions:

The consumption is rational
Price of the commodity remains constant
Income of the consumers remains constant
There is no any time gap between the consumption of different units
Size of commodity is suitable.

We can explain this law by the help of given table and figure:

Units of commodity	M.U
1	12
2	10
3	8
4	6
5	4
6	2
7	0
8	-2

On the above table, when the consumer consumes one unit of commodity then marginal utility is 12. When consumption of commodities gradually increases from 1 to 8, the marginal utility decreases from 12 to -2. When consumer consumes 7 units then at that time marginal utility is 0. We can explain the same table by the help of following figure:

On the above graph x and y-axes measures units of commodity and M.U respectively. Marginal utility curve is derived on the basis of above table which is negatively slopped and tends to negative. It indicates when consumer consumes more and more commodity M.U starts to decline and it tends to the negative.

Interest

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

Interest
Interest is the amount addition to principal paid by borrower to lender per unit of time. It is paid by borrower because of different reasons. The reasons are

Inconveniency due to lending: The lender feels inconveniency in lending. The lender will have less amount of money after lending some to the borrower. To compensate the inconveniency, the lender should obtain interest.
Decrease in value of money: The value of money decreases with flight of time. The value of money lent is less during the time of repayment than during the time of lending. For compensating this too, the lender should get interest.
Cost of keeping account: The lender keeps the account of money lent to others bearing some cost. In order to compensate the cost of keeping account to the lender should obtain interest.
Risk in repayment: The lender feels risk in the repayment of loan even the lender will honestly repay the loan in time as per the terms of borrowing and lending. Against this risk in repayment to the lender should obtain interest.
Sharing of benefit from the use of money: Borrower takes benefit from the use of money borrowed. Therefore, the benefits must be shared with lender in the form of interest.

Two concepts of interest
Gross interest:
The additional amount over the principal the borrower pays to the kinder for all the reasons is called gross interest. The gross interest includes the payment to the lender for inconveniency due to lending, decrease in value of money, cost of keeping account, risk in repayment and sharing of benefit from the use of money borrowed. Gross interest is the sum of net interest and interest paid and inconveniency due to lending, decrease in value of money, cost of keeping account and risk in repayment.
Mathematically,
Gross interest = net interest + payment for inconveniency due to lending

payment for decrease in value of money + payment for cost of keeping account + payment for risk in repayment.

Net interest:
It is the addition to principal only for the sharing of benefit from the use of money borrowed. For some economists, it is the payment for decrease in value of money too. It doesn’t include payment for cost of keeping account, inconveniency due to lending and risk in repayment. If we subtract the payment for their reasons from gross interest, we obtain net interest. Therefore, net interest is always less than gross profit.
Mathematically,
Net interest = Gross profit – (payment for inconveniency due to lending

payment for decrease in value of money + payment for cost of keeping account + payment for risk in repayment) Net interest = payment for of benefit from the use of money borrowed. Or, Net interest = payment for of benefit from the use of money borrowed + payment for decrease in value of money.

Classical theory of interest
This theory is propounded by classical economists. It is also called real theory of interest. According to classical theory of interest, interest rate is determined by the real factors like demand for capital and supply of capital. The demand for capital means the investment. It is the demand for capital goods like equipment, plants, machines, tools etc which can be used for production of goods and services. The supply of capital means savings. It is the value of goods and services left after consumption out of the income. The interest rate is determined at the point of equality between investment and saving
Mathematically,
Equilibrium interest is given by
Savings = Investment
This theory is based upon following assumptions

Money is veil and is just a medium of exchange
Money is demanded or borrowed only for investment
There is perfect competition in capital market
Both demand for capital and supply of capital are determined by interest rate.

Interest rate (r)	Demand for capital (I)	Supply of capital (S)
4%	Rs 10 billions	Rs 6 billions
6%	Rs 8 billions	Rs 8 billions
8%	Rs 6 billions	Rs 10 billions

Factors of production

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

The factors used in the production are called factors of production. All of them contribute in the production. For their contribution they are paid remuneration. The factors of production are land, labor, capital and organization. The payments made to the factors of productions are called rent, wage, interest and profits respectively. These payments are called factor incomes. They are made according to their contribution in production.

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.

Demand curve

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

The demand curve can be defined as locus of quantities of a commodity demanded at different possible prices. Each point of demand curve gives a certain quantity demanded at a price. It is derived with the help of a demand schedule. The demand curve is the graphical representation of relationship between demand and price, other things remaining constant.

There are two types of demand curve:

1. Individual demand curve : It is defined as the locus of quantities that a single consumer would purchase at different possible prices. It is downward sloped. It moves from left to right downward. It shows how an individual consumer adjusts his/her demand to the change in price. We can obtain the derivation of individual curve as following:

Let a consumer named “A” wants to purchase the following quantities of a commodity at different possible prices as shown in the table below.

PRICE PER LITER	DEMAND FOR A WEEK
Rs 10	30 liters
Rs 15	20 liters
Rs 20	10 liters

In the above table, the individual demand schedule of consumer A is 30, 20 and 10 liters per week at a price Rs 10, Rs 15, Rs 20 respectively. The table is the list of quantities the consumer A want to purchase at different possible prices. It is called individual demand schedule of consumer A. if we represent the quantities with respect to the pries we obtain downward sloped curve. The curve is individual curve of consumer A.

In the above figure, dd’ is the individual demand curve of consumer A. it is downward sloped. It shows the consumer “A” wants to purchase more quantity at lower price and less quantity at higher price.

2. Market demand curve : It is defined as the locus of quantities that the total consumer would purchase at different possible prices. It is a horizontal summation of individual demand curves. It is obtained representation the market demand with respect to price. The market demand at a certain price is the sum of individual demands. Since, every consumer wants to purchase more quantity at lower price and less quantity at higher price, the market demand too is inversely related to the price. That’s why like individual demand curves, market demand curve too is downward sloped.

we can derive market demand curve with the help of individual demand schedules and individual demand curves as following

Price	Demand A	Demand B	Demand C	Market demand M=A+B+C
Rs 10	5	6	3	14
Rs 15	3	5	2	10
Rs 20	1	4	1	6

In the above table, when price is Rs 10 the consumers A, B and C have demanded 5,6 and 3 units respectively. Here, we have assumed that there are only 3 consumers of the commodity. If we sum up these quantities, we obtain market demand as 14 units at price Rs 10. If price rises to Rs 15, the consumers reduce their demand to 3, 5 and 2 units respectively. If we sum up these quantities, we obtain market demand as 10 units at price Rs 15. Similarly, summing up the quantities 1, 4 and 1 unit at price of Rs 20 that consumers want to purchase, we can obtain the market demand 6 units. If we represent the 14, 10 and 6 units the consumer want to purchase at prices Rs 10, 15 and 20, we obtain market demand curve as shown in the figure.

In the figure above, Dm represents the market demand curve. It is downward sloped. It is obtained by summing up the individual demand curve Da, Db and Dc horizontally.