TyroCity: Economics 12 Notes

Perfectly inelastic demand

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

If there is no change in quantity demand due to the certain percentage change in price is called perfectly inelastic demand.

In the above fig, when price is OP quantity demand is OQ. When price decreases to Po then demand is constant or same. When the price increases to P1 then the demand is again same. This shows when increases or decreases quantity demand remains same.

Rent

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

Rent
According to tradition, rent arises only from land but according to modern economists, it arises not only from land but arises from all factors of production i.e. labor, capital and organization too. There are 2 concepts of rent. They are

Contract rent:
The contract rent is the amount paid by the user to owner of any factor of production like land per unit of time for the use of the factor of production. It is determined by the user and owner themselves in the contract. It is always positive. During the contact the owner and user may have different terms of contract. The contact rent is usually paid per unit of time and it is revised periodically. For example if a business man takes 2 ropani of land from a farmer paying Rs 50000 per year to build a market center then Rs 50000 is contract rent.

Economic rent:
The difference between total incomes from the use of factor of production hired and contract rent or opportunity cost is called economic rent. It is also defined as excess earning from the use of factor of production over the contract rent.

Mathematically,
Economic rent = total earning- contract rent or opportunity cost
It can be negative, positive or zero
If total earning > contract rent, economic rent is +ve
If total earning < contract rent, economic rent is -ve
If total earning = contract rent, economic rent is 0

Quasi rent: The rent that occurs in the short run and disappears in the long run is called quasi rent. This type of rent arises mainly because of scarcity of the factors of production. The scarcity is caused by loss of skill, knowledge, technology etc.

Ricardian theory of rent
According to David Ricardo, rent is portion of produce of earth paid to the landlord for the use of original and indestructible power of soil. It means the rent is paid by the user to the owner of land. It is paid for the use of fertility of soil. Fertility of soil is naturally determined and not changeable. Rent is directly proportional to fertility of soil. However, the least fertile land used for cultivation has no rent. The land is called marginal land.
Assumptions

Rent arises only from land
Land is used for agricultural (maize) production
Agricultural production starts from the most fertile land and expands to the least fertile land
Supply of land is limited and fixed by nature. It can’t be created and destroyed
Fertility differs from place to place and rent is directly related to fertility

According to David Ricardo, the people firstly choose most fertile land for cultivation. If such type of land is already occupied they expand production to the less fertile land. Rent arises only due to scarcity of land. It can be explained with the help of table and figure as following

Type of land	Harvesting (per acre)	Rent (per acre)
A	100 tons	100-40=60 tons
B	80 toms	80-40=40 tons
C	60 tons	60-40=20 tons
D	40 tons	40-40=0 tons

Let there be an island inhabited with 4 types of land A,B,C and D. the harvesting per acre from the types of land are 100, 80, 60 and 40 tons respectively, if 1st group of people go to the island, they choose type a land. Since the land isn’t occupied by other people they obtain it free of cost. If 2nd group of people go to the land and find type A land already occupied they either choose type B land free of cost of hire the Type A land paying 20 tons per acre rent. If 3rd group of people go to the land and find type A land and type B already occupied they either choose type C land free of cost of hire the Type B land paying 20 tons per acre rent or type A land paying 40 tons per acre rent. If 4th group of people go to the land and find type A land and type B and type C land already occupied they either choose type D land free of cost of hire the Type C land paying 20 tons per acre rent or type B land paying 40 tons per acre rent or type A land paying 60 tons per acre rent. In this way, rent goes on increasing with the expansion of agricultural production from most fertile land top least fertile land.

Criticisms

Land is used for trade, manufacture, recreation, animal husbandry too
Fertility changes from time to time. Fertility can be increased by using fertilizers and irrigation too
Cultivation is not always started from most fertile land. Land is chosen with respect to location, physical facilities and so on
Rent is determined by supple and demand of land too not only by fertility.
Marginal land too has the rent
Rent arises from all factors of production

Barter system

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

It is a primitive type of economic system in which goods and services are exchanged without any common medium of exchange. In the barter system there is no use of money. The goods and goods, gods and services and services and services are exchanges without the use of money. In this type of system there is lack of commercial production accumulation of wealth, store of values and so on. The exchange is possible only if there is double coincidence of wants. The exchange rate is determined by the exchangers, there is no common market place. The nature of economy is subsistent. It generally flourishes among uncivilized and backward communities. It is now used in the modern foreign trade because of having good impact on balance of payment of trading countries.

Features of barter system

Barter system is only possible if there is double coincidence of wants.
There is no use of money. It means there is lack of common medium of exchange
There is absence of common place for exchange
The economy is subsistent in nature. They are not produced to earn money but only to fulfill household needs
There is no store of value of goods and services. Most of the goods are perishable and services are not storable.
There is o production of varieties of goods and services. Production is traditional and there is no diversification in occupation and knowledge too.
There is lack of divisibility of goods
There is lack f deferred payment. During repayment only principle is paid.

Economics XII: Meaning in Factor Prices

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

The factor pricing means the determination of prices of factors of production land, labor, capital and organization. The prices of these factors of production are rent, wage, interest and profit respectively. In the factor pricing, we learn the different theories concerned with the determination of these factor prices.

Difference between fixed and variable cost

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

S.No.	Fixed cost	Variable cost
i.	Those cost which are included on fixed factors of production is called fixed cost.	Those cost which are included on variable factors of production is called variable cost.
ii.	Fixed factors of production are capital equipment, machines, plant, building salary of permanent staff, etc.	Variable factors of production are expenses on raw materials, wages and salary for casual workers, running expenses, etc.
iii.	Fixed costs do not change with the level of output in short run.	Variable cost changes with the changes in output in short run.
iv.	It remains same even at zero level of output.	Variable cost is zero only if there is no production of output.
v.	It remains constant.	It changes at different level of production.

Determinants of demand

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

1. Price : Demand is inversely related to price. If price increases, demand decreases and vice versa. But in case of Giffen goods (goods that are inferior and basic like low quality rice and bread for Nepalese), demand is directly related to price.

2. Price of complementary goods : Demand is inversely related to price of complementary goods. The goods which are consumed together to fulfill a single need like brick and cement, pen and ink are called complementary goods. If price of complementary goods rises demand for the commodity decreases and vice versa.

3. Price of substitutes : Demand is directly related to price of substitutes. The goods among which we choose one to fulfill our need are called substitutes. They are alternative of and competitive to each other like Coke and Pepsi. If prices of substitutes rise, demand increases and vice versa.

4. Income : Demand for normal goods is directly related to income of consumer. If income increases, demand too increases and vice versa. But demand for inferior goods is inversely related to income.

5. Population : Demand is directly related to population and number of consumer. If population increases demand too increases and vice versa.

6. Taste and preferences : If taste and preference of consumer change in favor of goods, demand increases. If it changes against the goods, demand decreases.

7. Tax rates : If government imposes more taxes, the demand decreases and vice versa.

8. Advertisement : Demand is directly related to expenditure and advertisement expenditure. More advertisement for a good brings more demand.

9. Interest rates : Demand is inversely related to interest rate. If interest rate raises people save more, deposit in banks or lend to earn interest. Due to this reason demand decreases and vice versa.

10. Nature of commodity : The demand depends upon the nature of commodities too. The demand for basic goods is relatively inelastic. But demand for luxurious goods is usually elastic.

Supply of capital

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

Supply of capital
It is the amount available for investment. It is called savings. It is the amount left after consumption. It is the monetary value of products left after consumption. It is directly related to interest rate if interest rate is high, the people save more to earn more interest and vice versa.
Symbolically,

In the above table, when interest rate is increased from 4% to 6% and 8% supply of capital ( savings) increases from Rs 6 billions to Rs 8 billions and Rs 10 billions respectively. If we represent savings with respect to interest rate, we obtain an upwardly sloped curve.

The equilibrium interest rate is given by the point of intersection of investment and savings curves. In the above figures, it is given by point E. However, the actual interest rate may be above or below the equilibrium interest rate. If it is above the level of equilibrium, saving exceeds investment. The excess supply of capital brings the interest rate down to equilibrium level. If it is below the level of equilibrium, investment exceeds savings. The excess demand for capital brigs the interest rate up to equilibrium level. It means sooner or later, the actual interest rate comes to the equilibrium level even it is above or below than it at any instant.

Criticisms

Money is not veil and is not just a medium of exchange. It is asset too. More or less money has effect on investment, production, employment level etc.
Money is not demanded or borrowed only for investment but also for speculation and precaution
This theory is based upon diminishing marginal productivity of capital but there may be increase in marginal productivity of capital due to advancement in technology, improvement in human resource etc.
Both demand for capital and supply of capital are not only determined by interest rate but also upon level of income
Supply of capital comes not only from saving but also from dishoarding, depreciation fund etc.
Saving and investment are not independent of each other. They are affected by each other.

The law of maximum satisfaction/ The law of equi-marginal utility/ The law of substitution

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

The law of maximum satisfaction/ The law of equi-marginal utility/ The law of substitution.

This law is developed by H.H Gossen so it is also called the second law of Gossen. We know human wants are unlimited but the resources to fulfill the wants are limited. A rational consumer always tries to maximize his satisfaction by spending his limited money income. Consumer can maximize his satisfaction if he is able to equalize the marginal utility derived from the consumption of different units of several commodities by spending his all limited money income so that this law is known as law of maximum satisfaction or law of equi-marginal utility.

This law is also known as law of substitution because consumer can maximize his/her satisfaction when he/she substitutes the commodities having high marginal utility instead of commodities having the low marginal utility.

Mathematically it is expressed as:

This law is based on the following assumptions:

Consumers should be rational
Price of commodity remains constant
Income of consumers remains constant
Utility can be measured in numbers
Marginal utility of money remains constant

We can describe this theory by the help of given table and figure:

Suppose income of consumer is Rs 50. There are two commodities i.e. x and y for consumption. Price of per unit commodity is Rs 10.

Units	M.U of x	M.U of y
1	12	10
2	10	5
3	8	6
4	6	4
5	4	2
	Total = 40	Total = 30

On the above table by using Rs 50 consumer can consume all five units of x or five units of y or combination of both. When he spends all his income on x he gets 40 as total utility and if he spends all his income on y he gets 30 as total utility. But if he spends his money income on the combination of both i.e. 3 units of x and 2 units of y he gets 48 as total utility which is the maximum satisfaction than any other combination. In this situation utility derived from last units is equal i.e. 8.

The same concept can be explained by given figure:

On the above figure M.U and units of commodity is measured along the y and x-axes. When consumer consumes 3rd coordinate of x he gets AB=M.U and when he consumes second unit of y he gets M.U equal to EF where AB=EF. In these situation consumers gets maximum satisfaction by spending his limited money.

Suppose, consumer consumes FG amount of y commodity at that time he must reduce the consumption of x FG=BC amount. At that time he gets utility area equal to EFGH from y, and he losses the utility area equal to ABCD from x. The area ABCD is greater than the area EFGH. It means consumer losses more and gains less. So, maximum satisfaction is possible only when there is equality of marginal utility from different units of same commodity.

Types of Demand

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

1. Price demand : Demand primarily dependent upon price is called price demand. This demand is sensitive or responsive to the change in price. In case of normal goods, demand increases with fall in price and vice versa. But in case of giffen goods demand increases even there is rise in price.

2. Cross demand : Demand primarily dependent upon prices of related goods is called cross demand. The complementary goods and substitutes are called related goods. In case of complementary goods like pen and ink demand for good is inversely related to the prices of other goods but the case in substituting goods are just opposite. Demand for substituting goods is directly related to prices.

3. Income demand: Demand primarily dependent upon income is called income demand. This demand is sensitive or responsive to the change in income. In case of normal goods, demand increases with rise in income and vice versa. But in case of giffen goods demand decreases when there is increase income.

4. Direct demand : Demand for goods and services made by final consumers to satisfy their wants or needs is called direct demand. For example guest of hotels make the demand for food.

5. Derived demand : Demand for goods and services made according to direct demand is called derived demand. For example demand made by hotels for vegetable, groceries is called derived demand.

6. Joint demand : Demand made for two or more goods and services to satisfy single need or want is called joint demand. For example, tea sugar are demand together to satisfy a single need. The complementary goods are jointly demanded.

7. Composite demand : Demand for a single commodity made in order to use for different purposes is called composite demand. In this case, commodity is one but the number of uses is multiple. For example, the electricity is used for lighting, heating, transportation for the use of different electrical device.

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.

Subsistence theory of wage

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

Subsistence theory of wage

The subsistence theory of wage is also known as “iron law” of wage. It was so named by physiocrats like Lassalle, a German economist and Quesnay, a member of school of economists and developed by David Ricardo. The theory of population, expounded by Malthus was also based on this “iron law”. According to this theory, wages tend to remain at the subsistence level. Wages paid to workers is just sufficient to fulfill their basic needs. Workers don’t have surplus income. If wages rises above this level, this leads to an increase in the population because the increased prosperity of workers will encourage the workers to marry sooner and increase population. This will increase labor supply. The increased competition among workers for employment causes wages to fall again to the subsistence level. Likewise, if the wages fall below the subsistence level, there will be fewer wages and no prosperity. People will have less interest in marriage. Fewer children are born. This will reduce the supply of labor. The competition for employment is reduced and wages tend to rise to the subsistence level. Finally, the wages remain at the subsistence level. The French School of economists, as the physiocrats, looked upon this theory of wages as a natural law. Quesnay had said, “Wages are fixed and reduced to the lowest level by the extreme competition of the workers“.

Criticisms

Ignores the demand side of labor:
This theory is one-sided. It explains the wages from the supply side only. It completely ignored the demand for labor. But if a rise in wages leads to an increase in population, the larger supply of labor may be balanced by an increase in the demand for labor.
No direct relationship between wage level and population:
According to this theory, population increase if the workers are paid above the subsistence level but empirical evidences show the decrease in population or its rater of growth in developed nations even if there is increase in wage level. People spend money on education, family planning, skill development too.
Ignores trade unions:
This theory has ignored trade unions through which the workers make the collective bargaining for their benefits.
Not flexible wage level:
Wages of all workers is at the subsistence level and is not flexible towards up and down. However, wages can differ from occupation to occupation and from place to place.
Exploitative:
There is tendency toward exploitation in this theory. Because, according to the theory wages must be equal to the subsistence level, and-not for comforts and luxuries.

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.