PYQS

QUES 1) A) Explain the effect of an imposition of a tax on manufacturers of drugs using

demand-supply diagram on the price and quantity traded of the illegal drugs market.

Ans: When a tax is imposed on manufacturers of illegal drugs, it essentially increases the cost
of production for these manufacturers. This increase in cost will shift the supply curve of
illegal drugs to the left.

Here's how this shift affects the market:

 Reduced Supply: As the cost of production rises, manufacturers will be less willing
to supply the same quantity of drugs at the original price. This leads to a decrease in
the overall supply of illegal drugs in the market.
 Increased Price: With a reduced supply and relatively unchanged demand, the price
of illegal drugs will tend to increase. This higher price makes the drugs less affordable
for consumers.
 Decreased Quantity Traded: The combination of higher prices and reduced supply
will result in a decrease in the quantity of illegal drugs traded in the market.

Key Points to Consider:

 Demand Elasticity: The impact of the tax will depend on the price elasticity of
demand for illegal drugs. If demand is relatively inelastic (meaning consumers are not
very responsive to price changes), the price increase will be significant, but the
quantity traded may not decrease substantially. Conversely, if demand is elastic, the
price increase will be smaller, but the quantity traded will decrease more significantly.
  Black Market Dynamics: The illegal drug market is inherently complex and operates
outside of traditional economic frameworks. Factors such as smuggling, black market
pricing, and varying levels of enforcement can significantly influence the actual
impact of a tax.
 Unintended Consequences: While a tax may reduce the supply and consumption of
illegal drugs, it could also have unintended consequences. For example, it could lead
to an increase in the production and sale of synthetic drugs, which may be even more
dangerous. Additionally, it could empower criminal organizations involved in drug
trafficking.

Conclusion:

In theory, a tax on manufacturers of illegal drugs can lead to higher prices, reduced supply,
and decreased quantity traded. However, the actual impact will depend on various factors,
including the specific drug, the level of the tax, the elasticity of demand, and the dynamics of
the black market. It's crucial to consider these factors and potential unintended consequences
when evaluating the effectiveness of such a policy.

b) Explain why the Production Possibility Curve (PPC) is bowed outward (concave to the
origin). What will be the shape of the PPC if the opportunity cost of Good Y in terms of
Good X is constant?

PPC is concave to the origin because of increasing Marginal opportunity cost. This is because
in order to increase the production of one good by 1 unit more and more units of the other
good have to be sacrified since the resources are limited and are not equally efficient in the
production of both the goods.

The slope of PPC depends upon marginal opportunity cost. a constant

opportunity cost indicates that given resources are equally suited for the
production of two goods. So when opportunity cost is constant, PPC curve is a
straight line.

QUES2) (A) Does a price ceiling fixed by the government always change the
market outcome? Give reasons for your answer.

A price ceiling set by the government does not always change the market outcome. Whether
or not a price ceiling has an effect on the market depends on whether it is set above or below
the equilibrium price (the price where supply equals demand).

Case 1: Price Ceiling Above Equilibrium Price

 If the price ceiling is set above the equilibrium price, the market outcome will not
change.
 In this scenario, the market price is already lower than the ceiling, so producers and
consumers will continue to transact at the equilibrium price.
 The price ceiling is irrelevant because it doesn't constrain the price in the market.
Case 2: Price Ceiling Below Equilibrium Price

 If the price ceiling is set below the equilibrium price, the market outcome will
change.
 A price ceiling below equilibrium creates a shortage because at the lower price, the
quantity demanded exceeds the quantity supplied.
 Consumers want to buy more at the lower price, but producers are less willing to
supply the good at this price.
 This leads to a persistent shortage of the good or service in the market, and may also
result in other effects such as black markets or rationing.

Key Points:

 No Change in Outcome: If the price ceiling is above the equilibrium price, the
market can continue functioning normally.
 Market Disruption: If the price ceiling is below the equilibrium price, it distorts the
market, creating a shortage and possibly leading to inefficiencies or unintended
consequences.

Thus, a price ceiling only changes the market outcome if it is set below the equilibrium
price.

B) Consider the following demand and supply equations, where Q_{s} is the quantity
supplied, Q_{D} is the quantity demanded and P is the price of the commodity:

Q_{s} = 2P - 100 Q_{D} = 200 - P

(i) Solve for the equilibrium quantity and price.

(ii) Suppose a tax of Rs. 15 per unit is imposed on buyers, making the new demand curve
as: Q_{D} = 200 - (P + 15) Calculate the tax revenue earned by the government.
QUES3) A) Calculate cross price elasticity of demand between the following pairs of goods
and examine how the goods are related in each case, when the price of Gel pen changes from
Rs. 5 to Rs. 2:
(i) Gel pen and Ball point pen
(ii) Gel pen and Refill Ink

Cross-price elasticity of demand = % change in quantity demanded of Good B

% change in price of Good A
B) It is observed that at the existing equilibrium demand is highly inelastic while the supply
is highly elastic. If the buyers have to pay a tax of Rs. T for each unit they buy, who will bear
the higher burden of tax: buyer or seller? Explain why.

In this scenario, where demand is highly inelastic and supply is highly elastic, we need to
understand how the tax burden will be shared between buyers and sellers. To do this, let's
explore the concepts of tax incidence and how the elasticity of demand and supply affect
who bears the tax burden.

1. Elasticity of Demand and Supply:

Inelastic Demand: When demand is highly inelastic, it means that the quantity demanded
does not respond much to changes in price. In other words, consumers are less sensitive to
price changes, and they will continue to buy nearly the same quantity even if the price rises
due to the tax.
Elastic Supply: When supply is highly elastic, it means that the quantity supplied responds
significantly to changes in price. Sellers are willing to increase the quantity they sell if they
can get a higher price, and they will reduce supply if the price they receive falls due to the
tax.

2. Tax Incidence:
Tax incidence refers to the distribution of the burden of the tax between buyers and sellers.
The relative elasticity of demand and supply determines how the tax burden is shared:
If demand is inelastic, buyers will bear a larger share of the tax burden because they are less
responsive to price changes.
If supply is elastic, sellers will bear a smaller share of the tax burden because they can adjust
their supply more easily in response to changes in price, so they are less willing to absorb the
tax.

3. Who Bears the Higher Tax Burden?

Inelastic Demand: Since consumers are not very responsive to price changes, they are
willing to pay the higher price even when a tax is imposed. This means that buyers will
absorb a larger share of the tax burden.
Elastic Supply: Since producers are highly responsive to price changes, they can adjust their
production or reduce the quantity they supply if the price they receive falls due to the tax.
Therefore, sellers will absorb a smaller share of the tax burden.

4. Conclusion:
The buyer will bear the higher burden of the tax in this situation because:
Demand is inelastic: Consumers are not sensitive to price increases, so they continue
purchasing the product even when the price rises due to the tax.
Supply is elastic: Sellers can adjust the quantity they supply based on price changes, and
they will be less willing to absorb the full tax.
In short, buyers will bear a larger share of the tax burden because they are less sensitive
to price changes, and sellers, due to their more elastic supply curve, will adjust their behavior
to minimize their share of the burden.
QUES4) (a) Consider a consumer consuming two goods X and Y, where X is an inferior
good for him. Suppose the price of Good X rises. What would be the effect of this change on
the consumption of Good Y. Illustrate with the help of diagram(s).

Understanding the Impact of an Inferior Good Price Rise on Consumption of Another Good
Let's analyze how a price increase of an inferior good (Good X) affects the consumption of
another good (Good Y). We'll use a diagram to illustrate this.
Inferior Good: An inferior good is one whose demand decreases as consumer income
increases. In other words, consumers tend to buy less of it when they become richer.
Price Rise of Inferior Good (X)
When the price of Good X rises, it becomes relatively more expensive compared to Good Y.
This has two main effects on consumption:
1. Substitution Effect: As Good X becomes more expensive, consumers will tend to
substitute it with Good Y, which is now relatively cheaper. This leads to an increase
in the consumption of Good Y.
2. Income Effect: Since Good X is an inferior good, a price rise effectively reduces the
consumer's purchasing power. This is because the consumer now has to spend more
on Good X if they want to maintain the same consumption level. As a result, the
consumer feels poorer, and since Good Y is likely a normal good (demand increases
with income), the consumption of Good Y will increase.
Diagrammatic Representation:

In the diagram:
 The original budget constraint is BC1.
 The price increase of Good X shifts the budget constraint inward to BC2, pivoting
around the Y-axis.
 The initial optimal consumption bundle is at point A.
 After the price increase, the new optimal consumption bundle is at point B.
As you can see, the consumption of Good Y increases from Y1 to Y2 due to both the
substitution and income effects.
In Summary:
When the price of an inferior good rises, the consumption of another good (especially a
normal good) tends to increase due to both the substitution effect and the income effect.

(b) Explain what would be the shape of the indifference curves when marginal rate of
substitution between two goods is zero.

When the marginal rate of substitution (MRS) between two goods is zero, the indifference
curve takes on a specific shape. The MRS measures the rate at which a consumer is willing to
give up some amount of one good in exchange for an additional unit of another good while
remaining indifferent (equally satisfied).
When the MRS is zero, it means that the consumer is not willing to give up any amount of
one good for more of the other, indicating that the two goods are perfect substitutes for each
other. In this case, the indifference curve will be a straight line, showing that the consumer is
equally satisfied with any combination of the two goods along that line.
This implies that the consumer is willing to trade the goods at a constant rate, regardless of
the quantity of each good. Therefore, the shape of the indifference curve when the MRS is
zero is a straight line.

QUES5) a) Using indifference curves analysis, explain the labour-leisure choice of an

individual when the wages change, and the resulting shape of the labour supply curve. (8)

(b) A consumer spends his entire income on buttermilk and biscuits. Can both be inferior
goods at the same time? Explain.

If both buttermilk and biscuits were inferior goods:

 As the consumer's income increases:

o Demand for buttermilk would decrease.
o Demand for biscuits would also decrease.

 This would mean the consumer would be spending less on both goods as their income
rises.
 Contradiction: This contradicts the assumption that the consumer spends their entire
income on these goods. If they are spending less on both, they would have unspent
income, which violates the budget constraint.

Therefore, it is not possible for both buttermilk and biscuits to be inferior goods for a
consumer if they spend their entire income on these two goods.

Possible Scenarios:

 One good could be inferior, and the other could be normal or superior.
 Both goods could be normal goods.

In conclusion, the concept of inferior goods is incompatible with the assumption of spending
all income on two goods when both are inferior.

QUES 6) Naveen, a college student has Rs. 600 a week to spend. Whenever he goes to watch
a movie, he always buys two burgers. The price of the burger is Rs. 50 and the price of a
movie ticket is Rs 100. Answer the following questionS

(A)Draw Naveen's budget constraint.

The budget constraint equation is:

 50B+100M=600
 

(b) Find the rate at which burger can be traded for a Movie ticket?

he slope of the budget line is the ratio of the prices of the two goods:

Slope of Budget Line=−50/100 = -1/2

This means that for every additional movie ticket Naveen buys, he must give up 2 burgers.
Conversely, for every additional burger he buys, he must give up half a movie ticket.

Thus, the rate at which burgers can be traded for a movie ticket is 2 burgers per movie
ticket.

(c) Draw few indifference curves for Naveen showing his preferences over burger and movie

Indifference curves represent combinations of goods that give the consumer the same level of
satisfaction. In this case, Naveen has a preference for both burgers and movies, but since he
always buys two burgers for every movie, we can assume that his preferences are somewhat
fixed.

Since he consumes 2 burgers per movie, an indifference curve for him would typically show
a fixed proportion between the two goods. The curve will be L-shaped, with a kink where
the ratio is exactly 2 burgers per 1 movie ticket.

For example:

 1 movie ticket + 2 burgers

 2 movie tickets + 4 burgers
 3 movie tickets + 6 burgers

This means Naveen derives the same satisfaction from consuming (2,1), (4,2), and (6,3)
(where the first number refers to the number of burgers and the second to the number of
movie tickets).

(d) Find the equilibrium consumption of burger and movie for Naveen, when he spends his
entire income.
(e) Now suppose, he gets a scholarship of Rs. 200. How would Naveen's consumption of
burgers and movies change, when he spends his entire income?

(f) Continuing with Part (d), now suppose the price of burger falls to Rs. 20. How would
Naveen's consumption of burgers and movies change? Will he be spending his entire income?
QUES 10) Under what conditions will a firm shut down temporarily? Explain.

A firm will shut down temporarily when:

 Price (P) < Average Variable Cost (AVC): The firm cannot cover its variable costs
of production, leading to greater losses from producing than from shutting down.
 In the case where the price is greater than AVC but less than Average Total Cost
(ATC), the firm might continue producing to cover some of its fixed costs, but will
still incur a loss. In the long run, it may shut down if the price remains below the
ATC.
 Anticipation of recovery: The firm expects that prices will rise in the future, so a
temporary shutdown will help minimize losses until the market conditions improve.
In short, the temporary shutdown decision hinges on whether the firm can cover its variable
costs. If not, it is more economical to cease production temporarily and avoid incurring
further losses.

QUES11) Explain why in the short run equilibrium of the perfectly competitive firm price is
equal to marginal cost, while in the long run equilibrium price is equal to marginal cost as
well as average cost.

Certainly, let's break down why in a perfectly competitive market:

1. Short-Run Equilibrium: Price = Marginal Cost
Profit Maximization: In the short run, a perfectly competitive firm
maximizes profit by producing where marginal revenue (MR) equals
marginal cost (MC).
Price Taker: In perfect competition, firms are price takers. They have no
control over the market price and must accept the prevailing market price
for their output.
1

Marginal Revenue and Price: Since each additional unit sold fetches the
same price, marginal revenue for a perfectly competitive firm is equal to
the market price (MR = P).
Therefore, in the short run equilibrium:
P = MR = MC
Firms will continue to produce as long as the price is greater than or equal
to their average variable cost (AVC) to minimize losses.
2. Long-Run Equilibrium: Price = Marginal Cost = Average Cost
Entry and Exit: In the long run, new firms can enter the market if existing
firms are making economic profits (profit above and beyond the
opportunity cost of capital). Conversely, firms will exit the market if they
are incurring economic losses.
Zero Economic Profit: In long-run equilibrium, economic profits are zero.
This means that firms are earning just enough revenue to cover all their
costs, including the opportunity cost of capital.
Average Cost: Zero economic profit implies that price equals average total
cost (P = ATC).
Relationship to Marginal Cost: Since profit is maximized where MR = MC,
and in perfect competition, P = MR, it follows that in long-run equilibrium:
P = MR = MC = ATC
In summary:
In the short run, firms maximize profit by producing where price equals
marginal cost.
In the long run, entry and exit of firms drive economic profits to zero,
leading to a situation where price equals marginal cost and average total
cost.
Let me know if you'd like to delve deeper into any specific aspect of this!

QUES12) Why do the average and marginal revenue curves for a firm in a
competitive market horizontal?
 In a perfectly competitive market, firms are price takers, meaning they cannot influence
the market price. The price is determined by the overall market supply and demand, and
individual firms must accept that price.

 AR is equal to the price because, for every unit sold, the firm receives the same price,
and therefore, the revenue per unit is constant.

 MR is equal to the price because the firm’s decision to produce an additional unit does
not affect the market price. Since every additional unit is sold at the same price, the marginal
revenue from selling one more unit is equal to the price.

 As a result, both AR and MR are horizontal at the market price. This means that the
revenue per unit (AR) and the additional revenue from one more unit (MR) do not change as
output increases.

QUES 13) Why do firms enter an industry when they know that in the long run economic
profit will be zero?

1)Short-Run Profit Incentive: Firms enter because, in the short run, the potential for positive
economic profits exists. They may expect prices to remain high for some time or believe they
can take advantage of current market conditions, such as temporary shifts in demand or
reductions in costs due to technological improvements or economies of scale.

2)Long-Run Equilibrium: Firms enter knowing that in the long run, when the market reaches
equilibrium, profits will be driven down to zero. However, during the transitional period, they
can still capture economic profits. Once the market reaches long-run equilibrium, firms are
making normal profits (just enough to cover all costs, including opportunity costs).

3)Expectation of Future Growth: Even though economic profits in the long run are zero,
firms may expect future opportunities or benefits that can arise from their presence in the
market.

4)Experience and Efficiency: Firms entering early may expect to become more efficient over
time, reducing costs and improving their market position.
Brand Loyalty or Network Effects: In some industries, early entry may lead to brand
recognition, customer loyalty, or network effects that provide a competitive edge over time,
even if economic profits are zero in the long run.