TyroCity: Economics 12 Notes

South Asian free trade agreement

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

The agreement on south Asian free trade area (SAFTA) was signed by all the member states of SAARC during the 12th SAARC summit held in Islamabad on 4-6th January. As a result, SAFTA came into force from 1st January, 2006. SAFTA is a motivation for the commitment to strengthen intra SAARC economic cooperation to maximize the realization of the region’s potential for trade and development for the benefit of their people, in spirit of mutual accommodation, with full respect for the principle of sovereign equality, independence and territorial integrity of all states.

Objectives:

To promote and enhance mutual trade and economic cooperation among contacting states
To eliminate barriers to trade in and to facilitate the cross border movement of goods between the territories of contracting states
To promote conditions of fair competition in the free trade area and ensuring equitable benefits to all contracting states, taking into account their respective levels a pattern if economic development
To create effective mechanism for the implementation and application for joint administration, resolution of disputes
To establish a framework for further regional cooperation to expand and enhance the mutual benefits

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.

Law of Demand

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

The law of demand states that the demand is inversely related to price other things remaining constant (ceteris paribus). It means if price raises demand contracts or decreases and if price diminishes demand expands or increases. The law of demand operates only if factors determining demand other than prices are constant. It means prices of complementary goods, substitutes, income, taste of consumer, population, advertisement etc should be constant.

Law of demand can be explained with the help of demand schedule and demand curve as following

Price( in Rs)	Demand(per week)
10	400
15	300
20	200

Let the initial price Rs 10 per kg and demand be 400 kg per week. If the prices raise to Rs 15 the consumer s reduce their demand. In above table demand is at 300 kg/week when price is Rs 15. If the price further raises to Rs 20 the demand further decreases to 200kg/week. It shows that demand changes inversely to the change in price when other things remain constant. If we represent the table in figure then we obtain a downward sloped demand curve as shown below

In the above figure the demand curve is downward sloped. It shows that demand decreases with rise in price and increases with fall in price.

Assumptions

Price of related goods is constant
Income and taste of consumers are constant
Size of population is constant
There is no change in taxes and advertisement, money supply and government expenditure.

Limitation/ exception to law of demand

Goods of prestige: Demand for goods of prestige like gold, demand may not decrease even there is rise in price. They are purchased and consumed because of their heavy prices.
Goods of hobbies: The law of demand does not hold in case of goods of hobbies like collection, ticket collection, and collection of historical and archaeological materials and so on. The things are collected even paying more and more amount
Goods of addiction: in case of goods and addiction like alcohol, tobacco, drugs etc the demand does not decrease even there is increase in price. Instead of operation of law of demand consumers purchase more units even if there is rise in price.
Giffen goods: Demand for Giffen goods increase even there is rise in price and vice versa. The law of demand isn’t applicable to them. The goods which are both basic and inferior are Giffen goods.
Goods of tradition: The goods consumed according to tradition, culture and religion have usually demand not inversely related to price. For example, during dashain the Nepalese people purchase more goods to celebrate the festival even if prices are increased.
Future expected price: If the consumers expect fall in price in near future, they do not purchase more right now even if there is fall in price currently and vice versa.
Future availability: If the consumers have fear of shortage of commodity in near future, they purchase more and keep the stock even if price has been higher. But if they expect greater availability of goods in the near future, they purchase less quantity even price has been decreased.
Change in taste and preference: If the consumers have the fear of the goods out of fashion in near future, they demand less even if prices are decreased.
Irrationality: Law of demand does not operate in case of irrational consumers. The unscrupulous consumers spend the money not according to satisfaction from the goods.

Why does demand law operate?

Why does demand curve slopes downward?

Why does demand vary inversely with price?

Diminishing marginal utility: According to Gossen, of a consumer goes on consuming more units of same commodity without time gap, marginal utility diminishes. It means 2nd unit gives less utility or satisfaction than 1st unit, 3rd gives less than 2nd and so on. Therefore, the consumer demands more only if prices are reduced.
Real income effect: if price falls real income increases even if the money is constant. Therefore, consumers demand more. If the price rises, real income falls even if money income is constant. Therefore, consumers demand less.
Substitution effect: if a commodity becomes cheaper the commodity is substituted for other substituting goods. If the commodity becomes expensive, it is substituted by other substitutes.
No. of uses: If the price falls, the commodity is used for least important purposes too. That’s why demand increases. If price rises, the commodity is used only for important purposes. That’s why demand decreases.
No. of consumers: If price falls, the consumers who were unable to purchase the commodity because of high price, will also be able to consume the commodity. That’s why demand increases and vice versa.

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.

Capital

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

Capital

It is durable physical assets used in the production. It includes machines, equipment, plants, tools, and so on. Capital is usable many times in production. It has life period. For its contribution in production it is paid interest, it is passive factor of production, it doesn’t yield anything unless it is used with labor. Its supplies are variable. Its use depends upon marginal physical productivity and interest rate, capital is depreciable every year. Depreciation is called capital consumption allowance or obsolete cost.

Capital formation

It is defines as the addition to capital stock used in the production in a fiscal year. The capital stock means the quantity of durable physical assets used in the production available at the beginning of fiscal year. It is the value of machines, equipment, plants, tools, and so on accumulated to the fiscal year. Capital formation is given by the difference between gross investment and depreciation of fiscal year. Depreciation is called capital consumption allowance or obsolete cost. If gross investment is greater than depreciation then there is positive net investment (capital formation) which gives increase in capital stock. If gross investment is less than depreciation then there is negative net investment (capital formation) which gives decrease in capital stock. If gross investment is equal to depreciation then there is no change in net investment (capital formation).

Mathematically,

Capital formation = Gross investment- depreciation

Capital formation depends upon marginal efficiency of capital and interest rate. Capital formation takes place only if marginal efficiency of capital is greater than or equal to interest rate it is less than interest rate the entrepreneurs don’t make investment rather they withdraw the investment.

Sources of capital formation:

If gross investment is greater than depreciation then there is positive net investment (capital formation) which gives increase in capital stock. For increase in capital stock entrepreneurs must have the sufficient investible fund. The investible fund can be generated from different sources like saving, dishoarding, depreciation fund, saving of non-departmental organization, corporate profit, foreign borrowing etc.

Process of capital formation:

1. Financing investment/ collection of investible fund: The investible fund can be generated from different sources like saving, dishoarding, depreciation fund, saving of non-departmental organization, corporate profit, foreign borrowing etc. Among these sources, the most regular and major type of source is saving. The saving of the people and non-departmental organization are encouraged through increase in interest rate, price subsides and so on.

2. Mobilization of fund: The investible funds are mobilized with the help of banks, finance companies, saving and credit cooperatives and so on. The amounts are collected in the form of deposits and through long term credit instruments like bonds, debentures etc. the money collected is lent to entrepreneurs for investment.

3. Investment: The amount collected by banks, finance companies, saving and credit cooperatives and so on in the form of deposits and through long term credit instruments like bonds, debentures etc. are lent to entrepreneurs for investment. Investment brings capital formation but gross investment must be greater than depreciation.

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.

Wage fund theory of wage

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

Wage fund theory of wage
This theory is developed by classical economist named J.S Mill. According to Mill, wage level is determined by wage fund and the number of worker’s employed. To pay the laborer, a wage fund is raised. Once the wage fund id rose, it is kept constant. The wage fund is distributed among the worker’s employed. The workers are assumed to be paid equal amount. It is because the units of labor are homogeneous. If more workers are employed each worker gets fewer amounts and if less number of workers is employed each worker gets more amount of money. The wage level is given by the ratio of wage fund and number of worker’s employed.

Mathematically,

This theory can be explained with the help of table and figure as following:

Wage fund (W.F)	No. of workers (N)	Wage level (W.F/N)
Rs 1,00,00,000	50000	Rs 200
Rs 1,00,00,000	100000	Rs 100
Rs 1,00,00,000	150000	Rs 66.67

In the above table, wage fund raised is Rs 1, 00, 00,000. When the number of workers employed is increased from 50000 to 100000 and 150000 the wage level is decreased from Rs 200 to Rs 100 and Rs 66.67 respectively. It is due to constant wage fund distributed among more workers. If we represent wage level with respect to number of workers employed we obtain a convex curve.

In the above figure, the downward sloped convex curve represents inverse relationship between wage level and no of workers employed.

Assumptions

According to this theory, wage fund is rose before the employment of workers
The workers are paid equally out of the wage fund
The units of labor are homogeneous
The wage level is flexible to the change in number of workers employed
Money is just a medium of exchange

Criticisms

Wage fund is not raised before employing the workers but is rather raised on the basis of worker’s employed
Wage paid to workers differs from place to place, time to time, person to person and organization to organization.
Units of labor are not homogeneous. They differ in skill, knowledge, strength, education, attitude etc.
Wage level is not flexible. Wage level fall is opposed by workers and trade unions
Money is not mere medium of exchange. It has effect on production, investment, employment level etc.

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

Types of money

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

There are different types of money. In the ancient time, the goods of primary importance were used as money in different societies. Money made up of metal, clay, baked leather, hard rocks etc were used but the different types of money can be classified into mainly 4 types. They are

Commodity money The different types of goods durable in nature were commodity money used in ancient times. In the ancient India cow was used as money, in the seashore side fishing hooks and the shells were used as money. Among the hunting commodities, the bows and arrows were used as money. These types of commodity money lacked uniformity and were not usable in all societies. They had more or less importance in different communities. There was difficulty in store measurement of value and transfer from one place to another place.
Metallic money Money made up of metals is called metallic money. It was introduced to overcome the problems in the use of commodity money. The coins were supposed minted in the temple of Goddess Juno. That's why the coins were known as money. There are two types of metallic money. They are:
- Standard metallic money: It is metallic money made up of pure and superior metals like gold and silver. This type of metallic money has the face value just equal to the intrinsic value. The value inscribed in the coins is called face value of money. The value of metal used to mint the coin is called intrinsic value.
- Token money: It is metallic money made up of impure and inferior metals. This type of metallic money has the face value greater than the intrinsic value. Since, the prices of metals change with the time; the standard metallic money is not proper type of money. Moreover, there is need of large quantity of superior and pure metals to mint the large amount of coins. The metallic money is uniform and durable in nature. It is difficult to carry in large amount,. There Is also problem of scarcity of metals to mint the coins.
Paper money It is made up of paper. It is legally tendered. It is issued by monetary authority or central bank of the nation against the reserve of gold. The value of gold kept reserve may be equal to or less than the amount of money issued. It is main type of legally tendered money used in every country. It is lighter less costly to print and safe type of money. But if it is lost, theft or caught fire then owner of the money suffers loss. However, it is easy to carry. There are two types of paper money. They are
- Representative paper money: It is the paper money issued against the reserve of gold equal to the paper money issued. It represents gold kept as security of money issued. It is convertible to gold at any time. It is also called convertible paper money.
- Flat paper money: It is the paper money issued against the reserve of gold of value less than the amount paper money issued. It is not convertible to gold at any time. It is also called non-convertible paper money The face value of paper money is far greater than intrinsic value. Its intrinsic value is infinitely small.
Bank money: It is short term credit instruments issued by banks. They can be cheques, travel cheques, bills of exchange, letter of credit, promissory notes, overdrafts, debit/credit/ATM cards and so on. They are issued for 1 or less than 1 year. They are called liquid assets. They are discounted within one year, before the time of maturation. Most of the bank money are usable only if there are electronic devices.

Others:Besides the 4 types of money there were money made up of baked clay, leather, plastic and so on used in ancient time.

Meaning of international trade

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

International trade is defined as the buying and selling of goods and services between two or more countries. It simply means export and import. In export, there is outflow of goods and services but inflow of money. In import, there is inflow of goods and services but outflow of money. On the basis of export and import, any country may be in surplus or deficit. International trades between countries and across continents have existed for centuries. Traditionally international trade consisted of goods like textile, food items, precious metals and stones, and objects of art and various other items. We have come a long way since the earlier times and International trade today has taken on new dimension. It was a fact earlier that trade between two countries was not limited to economic activity alone but was an extension to political and social ambitions. In this modern time, with the advancement of technology and globalization, it is necessary for all countries to engage in international trade for their survival.

Consumer Surplus

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

Firstly, this theory was developed by French Engineer A.J. Dupit in 1844. Later on it was reformulated by Professor Marshall. This theory is related to the expenditure of daily life. While buying the commodity the consumer always thinks about the utility that he/she can get from the commodity. If consumer can get higher amount of utility in comparison to sacrifice made for the commodity than consumer have surplus. Consumer surplus is the excess amount of utility over sacrifice made for the commodity.

Consumer surplus is the excess amount of price that the consumer is ready to pay over actual price of commodity. Therefore, Consumer surplus = Ready to pay – Actual price of commodity.

We can explain this concept of commodity on the basis of given table:

Units of Commodity	Ready to pay M.U	Actual Price	Consumer Surplus
1	12	4	8
2	10	4	6
3	8	4	4
4	6	4	2
5	4	4	0
	Total = 40	Total = 20	20

On the above table, when consumer purchase first unit of he/she is ready to pay Rs 12 but actual price is Rs 4. So consumer gets surplus. Similarly, the consumer is trady to pay Rs. 10, 8, 6, 4 for 2, 3, 4, and 5th commodity where actual price is Rs 4 and he/she gets 6, 4, 2, and 0 surpluses respectively. Hence, total consumer surplus = T.U – T.E = 40 – 20 = 20.

The same concept can be explained by given figure:

On the above figure, x and y-axis measures unit of commodity and price/M.U respectively. The shaded area is consumer surplus because it is the excess amount of satisfaction over the actual sacrifice made for the commodity.